In K & L Trailer Leasing, Inc. v. Fellhoelter, 2012 Bankr. LEXIS 1370, 630 B.R. 81, 2021 WL 201 3008 (E.D. Tenn. May 19, 2021) the overpowering impact of a UCC filing was vividly demonstrated when it enabled a bank to assert a priority secured position in collateral that had been illegally transferred to a third party.
The case factsThe case arose as a contest between Greenville Federal Bank (“GFB”) on the one hand, and (i) the Trustee in Bankruptcy (“TIB”) for K & L Trailer Leasing, Inc. (Leasing”)and (ii) Leasing’s shareholders, the Fellhoelters, on the other hand. Sequentially, the dispute arose as follows.
On October 1, 2010 GFB made a $2.5m loan to K & L Sales and Leasing, Inc. (“Sales”) not to be confused with Leasing despite the similarity of names. GFB was granted a security interest in all of Sales’ assets. The security interest was perfected by the filing of a UCC-1 financing statement with the Tennessee Secretary of State; it was continued in effect by the filing of a UC -3 continuation statement on October 1, 2015.
Sales was engaged in the sale of used trailers. The trailers were its inventory.
The only filing necessary for perfection of the bank’s security interest was the state filing.
Kris Fellhoelter was the only shareholder of Sales and also owned 50% of the shares of Leasing. His parents owned the other 50%.
Business transactions between Sales and Leasing generally involved Leasing purchasing or leasing trailers from Sales followed by Leasing entering into leases with third parties.
In May of 2020 Sales transferred trailers that were subject to GFB’s security interest to Leasing at a rate twenty times greater than the historical average monthly rate. More than $2m in value changed hands. The volume of transfers in June 2020 also greatly exceeded the historical average monthly rate. It all came to an end in June 2020 when both Sales and Leasing filed petitions for relief under the Bankruptcy Code. Proceedings in the cases showed no payment was made for the last-minute transfers.
GFB’s position was that the unfunded transfers from Sales to Leasing were not transfers to a buyer in the ordinary course of business (which would have negated the bank’s security interest). GFB claimed it was due all of the proceeds from the sale or leasing of the trailers subject to its security interest.
GFB was challenged by the TIB for Leasing who contended that the bank’s security interest lapsed when Sales made the transfers to Leasing because Sales was in a different line of business than Leasing. The TIB claimed that his powers of avoidance under Section 544 of the Bankruptcy Code permitted him to overcome the bank’s security interest.
How did the court rule?The court ruled in favor of GFB, rejecting the Trustee’s position. It cited prior rulings that diminution of retailer’s inventory via “sham” sales does not defeat a lender’s secured position against transferred inventory. When a “sham” sale takes place there really is no buyer, let along a buyer in the ordinary course of business.
As to the TIB’s assertion of his “strong-arm” powers under Section 544 of the Bankruptcy Code, the court said that since there were no buyers in the ordinary course of business, “GFB’s perfected security interest in the trailers continued in the hands of Leasing and nothing about Section 544(a)(1) or(2) allows the Trustee to overcome GFB’s prior perfected security interest”.
What’s the point?
Cases such as this emphasize the extraordinary value of a UCC filing effected through the expertise of a leading service provider.
This piece is authored by Michael Weissman, Of Counsel at Levin Ginsburg
Michael L. Weissman is an attorney in Chicago who has served as Executive Vice President and General Counsel of a banking group, as an adjunct professor at a law school, as a FINRA arbitrator, as an educational trainer in the United States and overseas, as chairman of a leading legal educational organization in Illinois, and as an expert witness in commercial lending cases. Weissman is a winner of the 2018 Addis Hull Award of the Illinois Institute for Continuing Legal Education for speaking, writing, and governance. He serves as a consultant to Wolters Kluwer Lien Solutions and The Risk Management Association.