Someone who finances prosecution of a personal injury claim in New York has nothing more than an unsecured claim if the debtor who holds the claim files bankruptcy before settlement or entry of judgment on the claim, according to Bankruptcy Judge Elizabeth S. Stong of Brooklyn, N.Y.
The debtor was injured before bankruptcy. Also before bankruptcy, the debtor signed a litigation finance agreement under which he received $20,000. He would be liable to return the $20,000 plus interest only if he settled or won the suit, and then only from the winnings.
In New York, personal injury claims cannot be sold or assigned. However, New York permits assignment of proceeds from a personal injury claim.
That’s what happened. The litigation finance agreement gave the lender an assignment of proceeds of the claim to secure the debt. The finance agreement also granted the lender a security interest in the proceeds of the claim.
The debtor said in the litigation finance agreement that he did not intend to file bankruptcy at any time in the future. If there were a bankruptcy, the debtor agreed to schedule the litigation proceeds as having been assigned to the lender and not to show the agreement as giving rise to a debt owing to the lender.
By the time of bankruptcy, the lender’s claim was almost $50,000, because interest on the claim was slightly above 50% per annum.
After the debtor filed a chapter 7 petition, the trustee retained special counsel, who promptly secured a $75,000 settlement. Judge Stong approved the settlement and payment of special counsel’s $25,000 fee.
The lender had filed a secured claim for about $50,000 and claimed the remainder of the settlement.
Combining his personal injury exemption under Section 522(d)(11)(D) with his wildcard exemption under Section 522(d)(5), the debtor claimed exemptions totaling some $39,000, to be taken from the net settlement proceeds.
The lender objected to the debtor’s exemption claim, contending that the assignment prevented the proceeds from becoming part of the estate, and if the proceeds were estate property, the lender claimed an equitable lien on the proceeds.
The debtor, of course, contended that the assignment of the proceeds was ineffective after bankruptcy.
What’s paid first: the lender’s claim or the debtor’s exemption?
Judge Stong ruled in favor of the debtor in her May 6 opinion, concluding that the lender had neither an enforceable assignment of proceeds as of the filing date nor an equitable lien or constructive trust.
Judge Stong said there was no question about the validity of the debtor’s claimed exemptions. The question was whether the lender’s rights took the proceeds out of the estate and out of the hands of the debtor. In other words, did the claim and proceeds become estate property under Section 541?
Judge Stong concluded that the debtor at least had an equitable interest in the claim and potential proceeds on the filing date. However, the absence of a judgment or settlement on the filing date was pivotal.
As another bankruptcy judge in Brooklyn had held 10 years earlier, the assignment of future proceeds would come into effect on settlement or entry of judgment and would not relate back to the date of the assignment. That is to say, there was no prebankruptcy assignment of proceeds because none existed until after bankruptcy.
There being no assignment on the filing date and no relation back, the automatic stay in Section 362(a)(4) and the limitation on the postpetition effect of a security interest in Section 552(a) together preclude enforcement of the lien on proceeds that could only arise after filing.
Without a lien, could the lender nonetheless claim the proceeds via an equitable lien or constructive trust?
Among the criteria recognized in the Second Circuit for creation of a constructive trust, the most important is the prevention of unjust enrichment. In turn, unjust enrichment requires some prepetition unjust conduct, Judge Stong said.
There being no unjust conduct, Judge Stong ruled there was no equitable lien or constructive trust.
Judge Stong relegated the lender to the status of an unsecured creditor.
Someone who finances prosecution of a personal injury claim in New York has nothing more than an unsecured claim if the debtor who holds the claim files bankruptcy before settlement or entry of judgment on the claim, according to Bankruptcy Judge Elizabeth S. Stong of Brooklyn, N.Y.
The debtor was injured before bankruptcy. Also before bankruptcy, the debtor signed a litigation finance agreement under which he received $20,000. He would be liable to return the $20,000 plus interest only if he settled or won the suit, and then only from the winnings.
In New York, personal injury claims cannot be sold or assigned. However, New York permits assignment of proceeds from a personal injury claim.
That’s what happened. The litigation finance agreement gave the lender an assignment of proceeds of the claim to secure the debt. The finance agreement also granted the lender a security interest in the proceeds of the claim.
The debtor said in the litigation finance agreement that he did not intend to file bankruptcy at any time in the future. If there were a bankruptcy, the debtor agreed to schedule the litigation proceeds as having been assigned to the lender and not to show the agreement as giving rise to a debt owing to the lender.