Creditor’s OMEGA Mistake Started with Collateral Description

Creditor’s OMEGA Mistake Started with the Collateral Description in Its UCC Filing

In Omega Optical, Inc. 476 B.R. 157 (Bankr. E.D.Pa. 2012) (“Omega”) Omega filed bankruptcy and listed Sovereign Bank (“Sovereign”) as a secured creditor within the filing. Indeed, Sovereign was a secured party, as they had filed a UCC Financing Statement. Unfortunately for Sovereign, they made a few mistakes… a few costly mistakes.

Oh the Collateral Description

In the filing, Sovereign described the collateral as “all assets.” As you know, a vague collateral description can be fatal. Article 9 does allow a creditor to list collateral as “all assets” on the actual financing statement, but the creditor must provide a more thorough collateral description within the Security Agreement.

In this case, however, the Bankruptcy Judge, Bruce Fox, deemed the collateral description of “all assets” as it appeared on the financing statement to be:

“…super-generic and not sufficient to effectively perfect a lien on any collateral. In addition, the description of the collateral is limited to the collateral that existing [sic] at the time the lien was filed, and does not extend to any collateral acquired after the lien was filed. Therefore, Sovereign Bank’s lien is not properly perfected.”

Reclassified aka Demoted

Because the UCC was not properly perfected, Omega’s proposed reorganization plan demoted Sovereign’s claim to that of an unsecured creditor. Once demoted to unsecured, Sovereign’s UCC was terminated and all security (or potential security) forfeited. The court subsequently held a plan confirmation hearing and Sovereign did not object to the plan – the very plan which indicated they were unsecured. They, Sovereign, even filed an unsecured proof of claim.

Did Sovereign not realize it had been bumped from secured to unsecured? Why wouldn’t they object to a plan that could cost them a significant amount of money?

Yes, Sovereign “knew” it had been bumped, meaning, Sovereign did not object to the plan, which for all intents and purposes indicates that they knew they were considered unsecured.

“I object” came, but it came too late.

A few months after the plan confirmation, Sovereign filed a motion requesting to amend their proof of claim, stating that their lack of objection to the plan and that asserting an unsecured proof of claim was an “obvious oversight.”

As an aside, Section 506(d)(2) of the Bankruptcy Code does state that failing to provide a proof of claim does not, by itself, void the lien:

“Sections 501 and 1111 of the Code govern the filing of proofs of claims. In a Chapter 11 proceeding, only creditors whose claims are listed by the debtor as “disputed, contingent, or unliquidated” are required to file proofs of claim. Bankruptcy Rule 3003(c)(2) directs that a creditor so listed must file, and that one who fails to do so will not be treated as a creditor “with respect to such claim for the purposes of voting and distribution.” This rule does not, however, extinguish a creditor’s lien as a penalty for failure to file a proof of claim. In fact, the legislative history of § 501(a) indicates that it is “permissive only, and that no creditor is required to file a proof of claim.”… However, “the filing of a proof of claim is a prerequisite to the allowance of unsecured claims, including the unsecured portion of a secured claim, and priority claims.” Furthermore, “[f]iling a proof of claim may be unnecessary… in situations in which the creditor is secured and has not asserted a claim against the estate, and no determination under section 506(d) has been requested.”

So, if Sovereign’s only error was thatthey “forgot” to file a proof of claim or “accidentally” filed the wrong proof of claim, their lien likely would not have been vacated. But, because Sovereign’s UCC was deemed unperfected AND they neglected to file the proper proof of claim, 506(d)(2) can’t “save” them.

Four Parts

According to the bankruptcy judge, when determining whether or not a lien is extinguished by the confirmation process, there is a “four part test”:

“Four conditions must therefore be met for a lien to be voided under section 1141(c): (1) the plan must be confirmed; (2) the property that is subject to the lien must be dealt with by the plan; (3) the lien holder must participate in the reorganization; and (4) the plan must not preserve the lien.”

Unfortunately for Sovereign, they got 4 out of 4 on this test:

  • The plan was confirmed
  • The property (collateral) was dealt with by the plan
  • Sovereign participated when they submitted the unsecured proof of claim
  • The plan considered Sovereign unsecured, which means the lien was not preserved

Lessons Learned

  • Properly identify the collateral in the UCC filing (quite frankly, much of this could have been avoided, if the collateral description was sufficient enough to keep the UCC in play).
  • File the proper forms & pay attention (nothing worse than being the only kid who didn’t do their homework and getting called out on it later).

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