After a secured creditor refused to terminate a UCC‑1 financing statement and filed a UCC‑3 continuation statement instead, individual Chapter 7 debtors sued the creditor alleging violations of their discharge injunction.
The debtors owned an insurance agency. As part of a loan transaction the debtors granted the lender a lien on “[a]ll accounts receivable and all business assets, either now owned or hereafter acquired by debtor, wherever located, together with any replacements thereof and additions and accessions thereto and all products and proceeds of the foregoing.”
The lender received a distribution of ~$325 on its ~$50,000 claim in the bankruptcy case, and the debtors received a discharge order. After the discharge, the debtors asked the lender to remove its UCC filing since the underlying obligation had been discharged. The lender’s response was that the UCC would “only be withdrawn after Plaintiff surrendered the full amount demanded by [lender].” It also subsequently filed a continuation statement so that the UCC would not expire. In response the debtors sought a court order requiring the lender to remove its UCC and seeking punitive damages together with legal fees based on violation of the discharge injunction.
Section 524(a) of the Bankruptcy Code provides that a discharge “operates as an injunction against the commencement or continuation of an action, the employment of process, or an act, to collect, recover or offset any such debt [discharged under Section 727] as a personal liability of the debtor, whether or not discharge of such debt is waived.”
To prevail, the debtors had to establish that the lender violated “a definite and specific order of the court” with knowledge of the order. Binding precedent established that this required actual as opposed to constructive knowledge. The court noted that the purpose of a discharge injunction is to promote the “fresh start policy” by protecting debtors against prepetition debts. However, it addresses only an action against the debtor in personam, and does not preclude an in rem action against the collateral.
The court went on to note that ordinarily prepetition liens pass through bankruptcy unaffected unless they have been disallowed or avoided in the bankruptcy. In particular, liens are not affected by the in personam discharge of the debt. Thus, the lender may look to its collateral for satisfaction of its prepetition debt, even though it could not sue the debtors personally. In this case the renewal of the UCC lien was an in rem action, and thus did not violate the discharge injunction.
There was a further argument relating to collateral covered by the “after-acquired” clause. Under Section 552(b) of the Bankruptcy Code, a prepetition security interest extends to property acquired by a debtor prepetition, as well as the products and proceeds of such property, but does not extend to property acquired after the bankruptcy petition was filed. However, to prevail the debtors had to show more than simply that the UCC was extended and that the security agreement included an after-acquired property clause. Rather they had to show that there was an effort to collect the debt personally, an attempt to liquidate post-petition collateral, or an effort to improperly “coerce” or “harass” the debtors.
With respect to the demand for payment as a condition for releasing the lien, “A secured creditor’s demand for payment as a condition of satisfying a valid lien on property is not an act to collect a debt ‘as a personal liability of the debtor’ prohibited by §524(a)(2).”
That left the question of whether there was an attempt to coerce or harass the debtors. The court was able to postulate circumstances in which the refusal to release a lien could be a subterfuge, and noted that action taken for purposes of coercion could be a basis for holding a creditor in contempt. For example, if the collateral did not have any value, so that there was no legitimate economic reason to retain the lien.
However, it was up to the debtors to show that there was no legitimate economic reason to maintain the lien – which they did not do. Consequently, the bankruptcy court concluded that the lender had not violated the discharge injunction.
It is always wise to remember that just because a bankruptcy case appears to be over does not mean that there are no remaining restrictions on exercise of a lender’s rights and remedies.
Vicki R. Harding, Esq.