Maryland Bankruptcy Court Rules Security Interest Priority Freezes During Bankruptcy Proceedings

The Bankruptcy Court for the District of Maryland recently ruled that a secured creditor still retains its priority over junior creditors if its UCC financing statement lapsed during a bankruptcy case.  The case, Firstrust Bank v. Industrial Bank[1] resolves a conflict between federal bankruptcy law and UCC state law. The “freeze rule” maintains the status of the financing priority of the secured creditors throughout a bankruptcy case.

Essex Construction, LLC filed for bankruptcy and on the date of filing bankruptcy (the petition date), two banks held perfected security interests in the debtor’s assets: Firstrust Bank and Industrial Bank. The latter held the senior interest by recording its UCC-1 financing statement in 2012, while Firstrust filed in 2014. The debtor filed for bankruptcy in 2016, and a year later, Industrial’s financing statement lapsed while the bankruptcy was continuing.

The banks disagreed on the effect of the post-petition lapse. Firstrust argued that state law—Article 9 of the UCC—mandates that it should jump Industrial in priority and that a bankruptcy proceeding should not change this result under state law.  Industrial asserted that the freeze rule in federal bankruptcy law, rendered the post-petition lapse inapplicable for determining priority.

In bankruptcy, the freeze rule freezes the priority of a security interest as of the petition date, which will remain the priority throughout the bankruptcy case. This principle has been recognized by the U.S. Supreme Court since at least 1931: “valid liens existing at the time of the commencement of a bankruptcy proceeding are preserved.” Isaacs v. Hobbs Tie & Timber Co., 282 U.S. 734, 738 (1931).

The Court in Firstrust Bank v. Industrial Bank agreed that the freeze rule-maintained Industrial’s priority—a result that the drafters of the UCC affirmed in their comments to Article 9. A senior secured creditor in bankruptcy need not file a continuation statement to maintain its priority.

A creditors’ rights, obligations, and potential liabilities under the Bankruptcy Code can be hard to navigate. If you need assistance understanding how to safely proceed in Bankruptcy Court, contact the experienced litigation attorneys at Goosmann Law in our Sioux City, Sioux Falls, and Omaha offices.

[1]Firstrust Bank v. Indus. Bank (In re Essex Constr., LLC), 591 B.R. 630 (Bankr. D. Md. 2018).