Why don’t lenders claim to have security interests in counsels’ retainers, and why don’t they object to the payment of fees without adequate protection for use of their collateral?
Except in “extremely unusual circumstances,” Bankruptcy Judge Erik P. Kimball of West Palm Beach, Fla., explained why the “secured creditor retains no interest at all in funds paid to the debtor’s counsel as a pre-petition retainer.” He also explained why a professional has a security interest in a retainer ahead of everyone else.
Judge Kimball’s case was typical of most chapter 11s. The primary secured lender had a lien on all of the debtor’s property, including deposit accounts. Before filing, the debtor paid a retainer to counsel. The retainer came from a bank account over which the lender did not have control.
When counsel filed an interim fee application, the lender did not object to the reasonableness of the fees but did claim that its lien covered the retainer. The lender contended that the firm could not draw the retainer unless the debtor provided adequate protection for the use of its collateral.
In his Dec. 30 opinion, Judge Kimball explained why the lender was wrong on every count. He observed that there are few decisions dealing with lenders who object to payment of fees by contending that a retainer, as property of the debtor, represents collateral that cannot be used without the provision of adequate protection.
The unfettered ability to draw down retainers largely stems from Section 9-332 of the Uniform Commercial Code. That section says that the transferee of money from a deposit account takes free of any security interest “unless the transferee acts in collusion with the debtor in violating the rights of the secured party.”
In the instant case, the lender did not claim there was collusion in payment of the retainer before bankruptcy. Consequently, Judge Kimball said the law firm took the retainer free of the lender’s lien. Although the retainer remained property of the debtor, the firm had a perfected, possessory security interest in the retainer under UCC § 9-203.
Even if there were no Section 9-332, Judge Kimball said the money paid for the retainer was not the lender’s collateral because the lender had not perfected a lien in the debtor’s bank account by obtaining control over the account as required by UCC § 9-104.
Even if the lender somehow had a continuing security interest in the retainer, the result would be the same, Judge Kimball said, because the firm had a valid lien. Since the lender’s security interest in the bank account was unperfected, its interest would be junior to the firm’s.
The lender relied on a bankruptcy court decision from another state where the court required the debtor to provide adequate protection for using a retainer to pay fees. Judge Kimball said that case was inapposite because the court did not explain why the retainer represented cash collateral. Evidently, the parties in that case agreed that the retainer was cash collateral.