In In re Tuscany Energy,[1] the U.S. Bankruptcy Court for the Southern District of Florida recently addressed the issue of whether a pre-petition retainer paid to a debtor’s attorney from an account encumbered by a security interest remains subject to the creditor’s lien. Corporate debtors must be represented by counsel in bankruptcy, and attorneys typically require a retainer. Because many debtors have creditors with blanket liens encumbering all assets, this situation arises frequently. The bankruptcy court noted that few reported cases involve a secured creditor claiming a continuing security interest in a retainer because, under the U.C.C., the secured creditor retains no interest at all in funds paid to debtor’s counsel as a pre-petition retainer, except in extremely unusual circumstances.[2]
Facts
Prior to filing its chapter 11 petition, Tuscany Energy paid a retainer to its bankruptcy counsel from a deposit account with SunTrust Bank. About nine months later, the court approved compensation for debtor’s counsel and granted permission to apply the retainer to approved fees over the objection of Armstrong Bank, which asserted a security interest in the deposit account held at SunTrust Bank. The court ruled that upon payment of the retainer to debtor’s counsel, Armstrong had no interest whatsoever in the funds.[3]
Armstrong then filed an adversary complaint seeking an order (1) directing counsel to return the retainer funds to the estate, (2) ruling that the unearned portion of the retainer as of the petition date was cash collateral, and (3) determining that Armstrong had a first-priority lien on those funds, or alternatively, (4) that any claim of the debtor’s counsel to the funds be equitably subordinated to Armstrong’s claim.[4] The defendants filed a motion to dismiss, but because they did not assert issue preclusion, the court did not consider its prior interim ruling allowing compensation.
Instead, the court dismissed the complaint because, based on Armstrong’s own allegations, it did not have a perfected security interest in the funds used to pay the retainer on the petition date, and debtor’s counsel did. The court also held that Armstrong’s allegations did not state a claim for relief because when the retainer was paid to debtor’s counsel, Armstrong lost any and all interest it held in the funds under Florida’s version of the UCC.
Discussion
Armstrong alleged that its security interest was perfected because it filed UCC financing statements, but a security interest in a deposit account may only be perfected by control over the account.[5] To maintain control, a secured creditor must be the depository bank or the depository bank’s customer, or there must be a control agreement. The deposit account at issue was not held at Armstrong, and the bank did not allege that it was the depository bank’s customer or that there was a control agreement. As a result, Armstrong’s security interest was unperfected on the petition date.
On the other hand, debtor’s counsel had an enforceable security interest in the retainer by virtue of its engagement agreement and had perfected its lien by possession of the funds.[6] If Armstrong had a security interest on the retainer, it was junior to the lien held by debtor’s counsel.
More importantly, even if Armstrong had properly perfected its security interest, when the retainer was paid to debtor’s counsel, the bank lost any interest it had in the funds. UCC § 9-332 provides that “a transferee of funds from a deposit account takes the funds free of a security interest in the deposit account unless the transferee acts in collusion with the debtor in violating the rights of the secured party.” For Armstrong to maintain its interest in the funds, debtor’s counsel must have acted in collusion with the debtor in violating the rights of the bank.
The bankruptcy court looked to the official comment to UCC § 9-332 to determine what constitutes “collusion.” The official comment to § 9-332 draws a parallel to §§ 8-115 and 8-503(e), which explain that collusion involves being complicit in a wrongdoing, and is explicitly compared to aiding and abetting or an intentional tort. In order to collude, the recipient of a transfer must have “affirmatively engaged in wrongful conduct.”[7] “Mere knowledge of the rights of the others and that the transferor’s act is wrongful is not sufficient to support a claim of collusion.”[8] Armstrong’s allegations did not support a finding that debtor’s counsel colluded with the debtor to violate the rights of the bank, especially in light of the fact that the bank’s unperfected security interest was avoidable under § 544, therefore the funds could have been used by the debtor to pay administrative expenses, including approved fees of debtor’s counsel.[9]
The bankruptcy court further held that Armstrong’s claims for conversion, tortious interference and unjust enrichment did not support a claim for relief and reasoned that these claims should also be dismissed for another independent reason.[10] Because UCC § 9-332 provides a high bar to a secured creditor’s pursuit of a transferee from a deposit account, “pursuit on an alternative claim requiring lesser proof would significantly undermine the collusion standard required under the statute.”[11] Article 9 of the UCC impliedly prohibits alternative claims against a transferee or competing secured creditor.
Finally, the bankruptcy court ruled that because Armstrong had no security interest in the retainer, and it did not allege inequitable conduct, debtor’s counsel’s lien on the retainer could not be equitably subordinated.
Conclusion
The In re Tuscany decision clearly articulates why pre-petition retainers paid to debtor’s counsel from an encumbered deposit account are not typically subject to a secured creditor’s lien, even if such lien is properly perfected. The attorney’s mere knowledge that the retainer is paid from an encumbered account while the debtor is in default is not sufficient to establish “collusion.” The funds will remain subject to a pre-petition lien only in extremely unusual circumstances where the debtor’s counsel affirmatively engages in wrongful conduct similar to aiding and abetting or an intentional tort. The UCC’s high bar for recovery from a transferee of a deposit account operates as an implied prohibition of alternative claims for recovery from a transferee.
Author Information
Jeffrey Coe is an attorney with Mesch Clark Rothschild, PC in Tucson, Ariz. He represents chapter 11 debtors and specializes in restructuring and bankruptcy litigation.
[1] Armstrong Bank v. Shraiberg, Landau & Page P.A. and Tuscany Energy LLC (In re Tuscany Energy), Case No. 16-10398-EPK, Adv. No. 17-01380-EPK (Bankr. S.D. Fla. Jan. 25, 2015).
[2] Id. at 3.
[3] Id. at 6; see also In re Tuscany Energy, 561 B.R. 910 (Bankr. S.D. Fla. 2016).
[4] Id. at 2.
[5] U.C.C. § 9-312.
[6] U.C.C. §§ 9-312 and 9-313.
[7] U.C.C. § 8-503(3), cmt. 3.
[8] In re Tuscany Energy at 10 (citing U.C.C. § 8-115 cmt. 5).
[9] Id. at 11.
[10] Id. at 13.
[11] Id. at 14.