Judge Romero Explains Why Lenders Can’t Claw Back Retainers Paid by Debtors

Have you ever wondered why a secured lender cannot claw back a retainer paid to a debtor’s law firm, even if the law firm knew the retainer was paid, perhaps improperly, from an account in which the lender had a perfected security interest?

In a masterful opinion, Bankruptcy Judge Michael E. Romero of Denver explained the ins and outs of the Uniform Commercial Code in meticulous detail. The bottom line is this: The law firm’s retainer is sacrosanct unless the firm was in “collusion” with the debtor.

UCC buffs should read the June 22 opinion in full text. Suffice it to say that Judge Romero’s 46-page, single-spaced opinion allows debtor’s counsel to keep a retainer unless the lawyer was deep in the woods helping the debtor violate the lender’s security interest.

The Retainer Was Proceeds of Collateral

The facts were necessarily complicated but came down to this: The debtor’s secured lender had a perfected security interest in the bank account from which the debtor paid retainers to three law firms. Naturally, the law firms had possessory security interests in the retainers under the retainer agreements coupled with Colorado law.

Arguably, the debtor violated the lender’s security interest in paying the retainers. The chapter 7 trustee sued the law firms for receipt of preferences and fraudulent transfers of the lender’s collateral. The question came down to this: Did the lender’s security interests attach to the firms’ retainer accounts?

The answer was “no.” Arriving at the answer required Judge Romeo to analyze dozens of UCC provisions.

The Lawyers Win Absent ‘Collusion’

Jumping almost to the conclusion, Judge Romero ruled that the retainers in the hands of the law firms were not “accounts” over which the lenders would have had security interests. From the debtor’s perspective, the retainers became general intangibles in the form of choses in action, giving the debtor the right to return the retainers if they were unused. The choses in action were general intangibles as to which the lender had a lien.

But that’s not the end of the story. The lender may have had a right to glom the retainers if the lawyers were required to pay them back to the debtor, but did the lender’s security interest extend to the retainers themselves after the retainers were being held by the firm?

Judge Romero found the answer in UCC 9-332(a), which provides that a “transferee of money takes the money free of a security interest unless the transferee acts in collusion with the debtor in violating the rights of the secured party.” [Emphasis added.] In the case at hand, the lender never had a security interest in “money,” so the outcome did not turn on conflicting security interests.

Expanding on Section 9-332, Judge Romero decided that “the Law Firms had a possessory security interest in the funds in [their retainer] account, as to which the Lenders never had a security interest. Simply put, in the absence of collusion, the Lenders never had a property right in the funds transferred to the Law Firms.”

“In the absence of collusion,” Judge Romero said, the “Law Firms, like any other commercial vendor, are entitled to the benefit of the policy underlying [UCC § 9-332], which is to place a premium on the finality of commercial transactions by protecting completed transactions from being placed in jeopardy, thereby moving forward the wheels of commerce.”

What Is ‘Collusion’?

Although victory for the law firms was almost within reach, Judge Romero could not grant them summary judgment because the record was not complete regarding “collusion.” He went on to lay out the law firms’ burdens in showing lack of collusion.

Judge Romero cited a case where the law firm knew the debtor was in default and that a bank had a lien on all assets. The court ruled that knowledge of the lien in itself did not amount to collusion.

To show collusion, the recipient must be a “bad actor” who is “complicit in wrongdoing.” Judge Romero cited caselaw where collusion is “explicitly” compared to aiding and abetting an intentional tort. In other words, mere knowledge of the rights of others does not amount to collusion.