Retroactive Lien Priority Meets the Automatic Stay

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Dec/Jan 2001

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We began writing this column to report on cutting-edge developments in bankruptcy
law. We are always on the lookout for interesting cases of first impression,
especially at the circuit court level. When the U.S. Court of Appeals for the
First Circuit noted in <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re 229 Main Street Limited Partnership, 262 F.3d
1 (1st Cir. 2001)</a>, that the interplay between a state environmental superlien
statute and the automatic stay was "heretofore untouched by any appellate court," we
could hardly contain our excitement. Because 229 Main Street deals with the
intersection of federal and state law, it is one of those cases defining the margins
of bankruptcy law.

The debtor in 229 Main Street owned a shopping plaza in Natick, Mass., where one
tenant operates a dry cleaning business. Releases of hazardous chemicals used in the
dry cleaning process contaminated the property. The Massachusetts Department of
Environmental Protection (the Commonwealth) determined that the contamination posed a
threat to the town's drinking water. To avert the threat, the Commonwealth expended
funds on emergency cleanup activities. It then sought reimbursement from the debtor for
those expenses, as well as assurances with respect to anticipated future expenditures.
The Commonwealth also advised the debtor of its intention to record a lien against
the property to secure present and future cleanup costs under the Massachusetts
environmental superlien statute.

The debtor denied responsibility for the contamination and contested the Commonwealth's
action by demanding an administrative hearing. Before the hearing was concluded,
however, the debtor filed its chapter 11 case. The debtor acknowledged that the
principal reason for filing was to avoid perfection of the Commonwealth's lien under
the environmental superlien statute.

The hearing officer ruled that the Commonwealth's post-petition effort to perfect
the environmental superlien fell within an exception to the automatic stay and refused
the debtor's request to adjourn the administrative proceeding. The debtor then asked
the bankruptcy court to hold the Commonwealth in contempt for violating the automatic
stay because of its continued prosecution of the administrative proceeding. The
bankruptcy court refused. The debtor appealed, and the district court affirmed that
the automatic stay did not preclude the Commonwealth's continuation of administrative
proceedings in order to perfect its environmental super-lien. The debtor then appealed
to the First Circuit.

The court viewed this case as being "at a crossroads formed by the intersection of
federal and state law." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… F.3d at 2</a>. As such, it had to reconcile two
sections of the Bankruptcy Code, §§362(b)(3) and 546(b) (1)(A),
which set forth an exception to the automatic stay, and the Massachusetts environmental
superlien statute, <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…. Gen. Laws Ch. 21E, §13</a>, which was designed to
assure the prompt and efficient cleanup of hazardous materials. (The Massachusetts
statute provides that once the Commonwealth expends money cleaning up polluted
property, it may place a lien on the property with priority over any prior recorded
encumbrance.)

The question before the court was whether the environmental superlien statute fits
within the exception to the automatic stay described in §§362(b)(3) and
546(b) of the Bankruptcy Code. The debtor argued that the environmental superlien
statute falls outside of the narrow exception and is subject to the automatic stay.
The Commonwealth maintained that it comes within that safe harbor and, as such, is
excepted from the automatic stay.

The court began with an analysis of §362(b)(3). It determined that
eligibility for the exception to the automatic stay depends on the existence of three
elements: (1) an "act to perfect," (2) an "interest in property" and (3) the
circumstances under which the perfection-authorizing statute fits within
§546(b)(1)(A).

The threshold question considered was whether the Commonwealth had a pre-petition
"interest in property." The debtor argued that the Commonwealth did not have an
"interest in property" at the time its bankruptcy case was filed because that
requirement could only be satisfied by the existence of a pre-petition lien. Since
there was no such lien of record at the time of the filing, the Commonwealth had
no interest. The court rejected that argument, concluding that the term "interest in
property" is not synonymous with term "lien." Using the traditional tools of statutory
construction, the court decided that the term "interest in property" as used in
§362(b)(3) is broader than the term "lien." The court went on to review the
facts of the Commonwealth's effort to prosecute its rights under the environmental
superlien statute and its pursuit of the lien through the administrative proceeding and
concluded that the amalgam of such actions was sufficient to satisfy the
"interest-in-property" requirement.

The court next turned to the "act-to-perfect" requirement. The debtor argued that
since §362(b)(3) only exempts acts to perfect, any act that simultaneously
creates and perfects (which was what the Massachusetts environmental superlien statute
provides) cannot qualify for the exception to the automatic stay. After reviewing
applicable case law, the court also rejected this argument. It held that the plain
language of §362(b)(3) appeared to cover the simultaneous creation and perfection
of the lien based on a pre-petition "interest in property." Since, in the court's
view, "an act that both creates and perfects in one fell swoop is an act to
perfect," <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… F.3d at 7</a>, the simultaneous creation and perfection of the
environmental superlien comes within the exception to the automatic stay so long as
the creditor held a valid pre-petition "interest in the property."

Last, the court analyzed whether the Massachusetts environmental superlien statute
met the criteria of §546(b)(1)(A). It determined that three elements of
§546(b)(1)(A) must coalesce: (1) the creditor must act pursuant to a
law of general applicability; (2) the law must allow the creditor to perfect an
interest in the property; and (3) self-perfection must be effective against
previously acquired rights in the property. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… F.3rd at 8</a>. The court had
little difficulty satisfying the first element because, for a law to be "generally
applicable," it must apply to cases both within and outside of bankruptcy. The
court concluded (and the debtor conceded) that the Massachusetts environmental
superlien statute satisfies that definition.

The debtor argued, however, that the environmental superlien statute did not satisfy
the second and third elements of §546(b)(1)(A) because the Commonwealth had
no pre-petition interest in the property; that perfection (here, the act of
recording) is a prerequisite to establishing priority, but no act of recording ever
occurred; and that only state statutes that contain explicit "relation back" language
can satisfy §546(b). The court was unconvinced by each of these arguments,
especially by the assertion that a state statute must explicitly provide that perfection
relate back to a pre-petition date in order to fit within the safe harbor of
§546(b)(1)(A). It held that there is no requirement that the generally
applicable law referenced in §546(b) contain an explicit "relation-back" mechanism.

The court concluded its analysis by determining that the Massachusetts environmental
superlien statute satisfied the second and third elements of §546(b)(1)(A)
because it allowed the Commonwealth to perfect its interest in property by recording,
registering or filing that interest, and that such perfection is effective against
entities that already had acquired rights in the property. Concluding that the
Massachusetts environmental superlien statute satisfied the combined requirements of
§§362(b)(3) and 546(b)(1)(A) and, accordingly, fell within the exception
to the automatic stay, the court upheld the decisions of the district court and
bankruptcy court.

Does 229 Main Street have wider implications than just the facts of the case?
It does in at least two foreseeable ways: It may influence filing strategies, as
well as bankruptcy case dynamics. Although the result of 229 Main Street is not
terribly surprising (it was certainly anticipated by Collier; see 5 Collier on
Bankruptcy, 15 ed. rev., ?546.03[5]), it confirms that this creditor's
remedy is alive and well outside of the more familiar application by taxing
authorities.

In 229 Main Street, the debtor apparently assumed that it would be able to cut
off the Commonwealth's retroactive lien rights by simply filing before the lien was
actually recorded. The timing of its filing appeared to be premised on this
(erroneous) assumption. Because the timing of filing may not necessarily cut off
certain creditors' retroactive lien rights, this case suggests that debtors rethink the
wisdom of delaying filing until just before an actual lien attaches. Debtors may now
be forced to file even earlier to pre-empt the amalgam of a creditor's actions from
ripening into an "interest in property," notwithstanding that an actual lien has not
yet attached.

229 Main Street may also affect the dynamics of the bankruptcy case itself. It
is clear that certain creditors' post-petition activities can retroactively affect lien
priorities and, accordingly, profoundly re-order the relative rights of other creditors.
As a result, fully secured pre-petition lienholders may be rendered undersecured or,
even worse, unsecured, with the attendant changes in their set of rights and
expectations. This possibility will require greater diligence by both debtors and
creditors who can no longer assume that the relative rights of secured creditors are
fixed on the date of filing. Debtors will have to consider whether potential
retroactive lien creditors will change the dynamics of the bankruptcy case and, if so,
how they will have to be dealt with during the case and under a plan. Secured
creditors, especially those holding senior mortgages on environmentally distressed
property, must now monitor their borrowers more closely to protect against (or at
least factor in) the possibility of involuntary subordination. After 229 Main
Street, the automatic stay's breathing spell became somewhat more airless.

Journal Authors

Leonard P. Goldberger

Journal Date

Saturday, December 1, 2001 - 12:00

Bankruptcy Rule

2001