Preferences: Judgment Creditors May Find Themselves Exposed Given the Nature of Judgment Liens

Karim v. Bayview Loan Servicing, LLC (In re Karim), 582 B.R. 193 (Bankr. N.D. Ill. 2018) –

Chapter 11 debtors sought to avoid prepetition transfers to a judgment creditor as preferences. The debtors received a check in connection with the sale of real estate. The judgment creditor asserted a statutory lien and then obtained a state court order requiring the debtors to turn over the check to the creditor.

Specifically, the creditor obtained a state court judgment in the amount of ~$220,000 and served a citation to discover assets on the debtors. Several months later the debtors sold some real estate and received a check for ~$45,000 for their share of the sale proceeds. The record did not include any information regarding a purchase agreement. Rather it simply showed that the sale occurred, and the debtors received a check. A little over a month later the judgment creditor obtained a state court order for turnover of the check. The debtors promptly complied. About a month after that the debtors filed bankruptcy.

Under applicable state law “service of a citation to discover assets creates a ‘lien’ binding the ‘nonexempt personal property’ of the judgment debtor.” The court noted that a tangible check (as opposed to the intangible rights it represents) is nonexempt personal property. The debtors sought to avoid the citation lien on the check as a preference.

Under section 547 of the Bankruptcy Code the elements of a preference are a transfer to or for the benefit of a creditor on account of an antecedent debt while the debtor was insolvent made within 90 days prior to bankruptcy that enables the creditor to obtain more than it would in a chapter 7 case. The only dispute was when the transfer occurred – before or during the 90 day preference period. So, the critical question was when did the citation lien attach to the check.

As a preliminary matter, the issue of whether and when a transfer occurred is a question of federal law as defined in the Bankruptcy Code. Under section 101(54) a “transfer” includes creation of a lien and other means of voluntarily or involuntarily parting with an interest in property. However, generally bankruptcy courts look to state law to define property interests and when a transfer event occurs.

Under the court’s analysis of section 547, a transfer takes place on the latest of four dates:

  • The date it is effective between the parties if it is perfected within 30 days.
  • If not perfected within 30 days, on the date of perfection.
  • If not perfected prior to bankruptcy or within 30 days of effectiveness between the parties, then the date immediately before the petition is filed.
  • But in no case is the transfer made “until the debtor has acquired rights in the property transferred.”

The debtors contended that the transfer occurred on the date they received the check (within the preference period), while the judgment creditor argued that it occurred on the date the citation was served (outside the preference period).

Under state law service of the citation created a general lien in favor of the judgment creditor on the debtor’s personal property, and the statute permitted the lien to attach to after acquired property. However, the basic principle was that there is a lien on after acquired property only after the debtor acquires an interest in the property. In this case that meant there was no lien until the debtors acquired the check.

To avoid this issue the judgment creditor argued that there was a lien on the debtors’ “expectancy” of receiving the check. The court rejected this argument saying that no authority was offered for the proposition that the “mere possibility or expectation of receiving property (the proceeds) from the sale of one’s assets in the future is itself present ‘nonexempt personal property’ capable of being bound by the citation lien.”

The court conceded that cases cited by the creditor supported the propositions that a lien can attach to a debtor’s choses in action or other intangible property and to the proceeds of such property; and if the citation was served on a third party, it could lien funds owed to the debtor by those third parties. However, there was no evidence of any chose in action or other intangible property, nor was there evidence of service on a third party.

Consequently, the court determined that the lien attached when the debtors first acquired the check – which was within the 90 day preference period. Accordingly, the lien would be avoided as a preference.

The court went on to address the turnover of the check. Since the lien on the check was avoided, the judgment creditor’s claim to the check was unsecured. As a result, turnover of the check gave the creditor more than it would have received in a chapter 7 bankruptcy. So, the transfer of the check would also be avoided as a preference.

A key point is that under the state statute the citation lien did not extend to real property, only personal property. Otherwise, the lien would have attached to the real property when the citation was served (outside the preference period), and that lien would have extended to the check as proceeds. The result would have been no preference.

The result also might have been different if there was evidence of a purchase agreement. It might have been argued that (1) the debtors’ interest in the purchase agreement was subject to the lien, and (2) the check was proceeds of the purchase agreement. Given the timing described in the opinion it is likely that the debtors’ interest in the purchase agreement arose prior to the 90 day preference period so that the creation of the lien would not have been a preference.

Vicki R Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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