On April 28, the US Bankruptcy Court for ND Oklahoma in Kirtley v. Mabrey Bank (In re Rudick)[1] ruled that an entity other than the debtor may grant a lien on the debtor’s property, affirming the legal standard that the consent of the true owner is sufficient to give a debtor rights in the collateral to grant a security interest in that property . As a result, the bankruptcy court also held that the bank’s security, perfected before the debtor’s bankruptcy, was enforceable and took priority over the trustee’s rights to the property.

One of the three key elements of Article 9 of the Uniform Commercial Code (UCC) for seizure of a lien on personal property is that the debtor granting the lien has “rights in the security”.[2] The concept of “rights in the collateral” is distinct from that of “title” to the assets; a debtor can grant a lien under less than the entire bundle of rights that includes title. Under the UCC, a debtor’s “limited rights in collateral, other than full title, are sufficient for a security interest to be seized”. The bankruptcy court of In re Rudick tackled this problem.

Background

In In re Rudick, individual Michael Rudick has filed a voluntary petition for relief under Chapter 7 of the US Bankruptcy Code. Rudick’s petition included, among other things, certain personal property consisting of vehicles, tractors, boats and trailers (collectively, the Property). Prior to the date of the Petition, Rudick had a banking relationship with Mabrey Bank (Bank) and had entered into several personal loans with the Bank. Rudick also owned an Oklahoma limited liability company known as Cornerstone Concrete and Excavation LLC (Cornerstone). Cornerstone was a separate legal entity from Rudick. Prior to the date of the petition, Cornerstone had entered into a commercial loan transaction with the Bank, whereby it purported to grant a security interest in the property to the Bank to secure Cornerstone’s loan from the Bank. The Bank has filed liens on the property. Rudick executed the relevant bank loan documents on behalf of Cornerstone in his capacity as President of Cornerstone.

Analysis

The issue is whether Cornerstone’s grant of a security interest in the property was attached to the date of the petition and was enforceable, which would violate the trustee in bankruptcy’s rights in the property following the Chapter 7 filing. The trustee in bankruptcy claimed that Cornerstone could not grant a security interest in the property because it did not own the property. The Bank did not dispute that Cornerstone did not own the property, but argued that ownership did not affect Cornerstone’s ability to grant enforceable security.

Bankruptcy court noted seizure of security is governed by Oklahoma Commercial Code Section 1-9-203[3], which adopts UCC Rule 9-203. Under Oklahoma UCC Rule 9-203, a security interest attaches to the warranty when:

• The debtor has signed a guarantee contract describing the guarantee.

• The value has been given.

• The debtor has rights in the collateral or the power to transfer rights in the collateral to a secured creditor.

Only the third point was in issue — whether Cornerstone had rights in the Property or the power to transfer rights in the Property to the Bank. The bankruptcy court determined that Cornerstone had rights to the property based on Rudick’s consent to grant those rights to Cornerstone. The bankruptcy court upheld a previous decision that “an owner’s permission to use collateral creates rights in the debtor sufficient to give rise to enforceable security”, and that consent may be implied depending on facts and circumstances.

Result

The bankruptcy court found that Rudick’s signature on behalf of Cornerstone was evidence that Rudick had been informed and knew of Cornerstone’s grant to the Bank and that Rudick had consented to the grant. Further, the Bank could rely on Rudick’s statement that Cornerstone had the authority to pledge the property as security for the loan. As such, Cornerstone had rights in the property, and the property was subject to a valid security interest in favor of the bank at the time Rudick filed for bankruptcy.

The bankruptcy court found an opposite circumstance with a contrary decision. In this case, a person taking out a personal loan and signing the corresponding loan documents in his own name could not pledge rights to property belonging to a company that the same person owned. The individual’s signature alone does not prove any consent of the company to pledge company property or that the individual otherwise has any rights to company property. Lenders should take note of the divergent results.

Importance

It is essential that a lender understands who owns the collateral, especially if it is important to the underwriting and credit profile of a loan. In In re Rudick, the Bank had the advantage of the law favoring its position, but the prudent approach would have been to have Rudick directly engage the rights in the Property in a personal and non-representative capacity. Notwithstanding the ultimately favorable outcome, properly documenting this transaction would have saved the Bank the time and cost of litigation with the trustee in bankruptcy.

Lenders are advised to consult their legal advisor whenever issues relating to seizure or perfection of liens are involved. This may be “other property”, but legal counsel can help a lender determine the suitability of such property as collateral.

[1] Kirtley v. Mabrey Bank (In re Rudick), No. 20-11918-M (Bankr. ND Okla. April 28, 2022).

[2] § 9-203. Seizure and enforceability of security; Product ; support bonds; Formal Requirements., UCC Text § 9-203.

[3] Ok so. Stat. tit. 12A, § 1-9-203.