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In re Bucala: SDNY Bankruptcy Court Finds Creditor to be Secured Even Without a Formal Security Agreement
Practical Law Legal Update 4-517-7341 (Approx. 4 pages)
In re Bucala: SDNY Bankruptcy Court Finds Creditor to be Secured Even Without a Formal Security Agreement
by PLC Finance
| Published on 02 Feb 2012 • New York |
The US Bankruptcy Court for the Southern District of New York granted a creditor's motion for summary judgment affirming that it was a secured creditor though there was no formal security agreement, the documents creating the security agreement were flawed and its security interest was not perfected.
On January 30, 2012, the US Bankruptcy Court for the Southern District of New York issued a decision finding that the plaintiff was a secured creditor because a security agreement had been formed under New York law. The court reached this decision even though there was no formal security agreement, the relevant documents were flawed and the plaintiff never perfected its security interest. Ultimore, Inc. v. James and Doreen Bucala (In re: Bucala) re-emphasizes that courts may liberally construe the New York UCC (NY UCC) to promote its underlying purposes and policies.
Background
The defendant debtors purchased a manufactured home from the plaintiff under a contract of sale. Under the contract, the plaintiff was to hold a promissory note for the remainder of the purchase price. The promissory note provided that a motor vehicle lien may be filed against the title of the home and that the plaintiff could repossess the home in the event of the debtors' default under the promissory note. The debtors then entered into a contract to sell the home to a third party on April 15, 2011 and filed Chapter 7 on July 11, 2011. In August 2011 they sold the home.
On August 13, 2011 the Chapter 7 trustee filed a report of no distribution and the debtors then amended their schedules to change the plaintiff from a secured creditor to an unsecured creditor. The plaintiff brought a summary judgment motion seeking a declaratory judgment that it was a secured creditor with a security interest in the home because a security agreement had been formed under New York law.
Outcome
The court looked at the NY UCC definitions of secured party and security agreement and the requirements for a security interest. NY UCC Section 9-203(b)(3)(A) states that a security interest attaches to collateral and is enforceable if the debtor authenticates a security agreement that provides a description of the collateral. The court granted the plaintiff's motion for summary judgment, finding that it was a secured creditor because an enforceable security agreement existed under the NY UCC.
Authentication Requirement Satisfied
"Authenticating" includes signing or executing a record with the present intent of the authenticating person to identify the person and adopt or accept a record (NY UCC § 9-102(a)(7)). The court held that because NY UCC Section 9-203 does not require both parties to sign a security agreement for it to be enforceable, the authentication requirement had been satisfied because the defendant debtors had signed both the contract and the promissory note.
Collateral Description Sufficient
The court reasoned further that a security agreement's description of the collateral is sufficient if it reasonably identifies what is described (NY UCC § 9-108(a)). In this case, the description of the home (which was the collateral) in the promissory note differed from the description in the contract (for example, the year noted). However, the court stated that it "may look to multiple documents to determine whether a valid and enforceable security agreement exists." The court found that when reading the contract and the promissory note together, it is obvious that the two documents describe the same collateral, even though they were not identical.
The court stated that for the plaintiff to be denied its secured status because of a typographical error in the collateral description "would represent a warrantless reliance on formalism and would violate the general rule that the UCC be 'liberally construed and applied to promote its underlying purposes and policies'" (see In re Numeric Corp., 485 F.2d 1328 (1st Cir. 1973)). The description provided made it possible to identify the collateral, so the court found the description was sufficient.
Valid Security Agreement Created
The defendant debtors argued that the use of the phrase "lien may be filed" in a section of the promissory note labelled "Additional Promises and Agreements of the Borrower" did not demonstrate the intent to grant a present security interest in the collateral because of the use of the word "may." The court disagreed, noting that NY UCC Section 9-102(a)(7) only requires evidence of a present intent to create a security agreement.
In addition, a security agreement does not need to be labelled, nor does it need to be a formal and separately signed document. Therefore, based on reading the promissory note in full and because the promissory note elsewhere referred to the plaintiff as a secured creditor, the court decided the "present intent" requirement had been met and a security agreement had been created.
Failure to Perfect Not Determinative
The court also determined that the plaintiff held a purchase-money security interest (PMSI) in the home and the plaintiff's failure to perfect its PMSI in the home did not affect its status as a secured creditor (NY UCC §§ 9-102(a)(54(A)) and 9-103(b)(1)). The defendants had argued that because the plaintiff never perfected the motor vehicle lien, it never had a security interest. The NY UCC does not require a security interest to be perfected and failure to do so does not invalidate the security agreement.
The debtors argued finally that the Chapter 7 trustee could void an unperfected security interest under section 544 of the Bankruptcy Code, and in effect did so by filing a report of no distribution. However, the court held that the report of no distribution was simply an asset report reflecting that the trustee believed there were no assets available to distribute. The court said the report had no effect on whether the plaintiff was secured.
Practical Implications
Ultimore, Inc. v. Bucala (In re: Bucala) re-emphasizes that the NY UCC can be liberally construed by courts to promote its underlying purposes and policies. The case also illustrates that, under the NY UCC:
- A formally labeled separate document may not be required to create a valid security agreement.
- Typographical errors will not necessarily invalidate a security agreement if the collateral description provided when the relevant documents are read together makes it possible to identify the collateral.
In practice, it is preferable to have a separate document clearly labeled as a security agreement to avoid any misunderstandings. In addition, counsel should always be careful to avoid typographical errors. For more on UCC security interests and security agreements, see Practice Notes, Security Agreement: Overview and UCC Creation, Perfection and Priority of Security Interests.