The Ninth Circuit’s recently re-issued decision in the case In re Taylor (USAA Federal Savings Bank v. Thacker), Dkt. No. 08-60033, filed March 22, 2010 (Taylor), addresses the remedies available when a secured creditor’s lien is declared to be avoidable by the bankruptcy estate under the trustee’s avoiding powers. The case illustrates that the determination that the transfer of the security interest should be avoided is only the first step in granting relief to the estate, and formulating the proper remedy for the estate is more complicated than it would appear both practically and legally.

Facts of the Case
The debtors obtained a loan of $18,020 from USAA Federal Savings Bank to finance most of the purchase price of a car in Idaho. Under Idaho law, the bank was required to file the necessary forms and affidavits to perfect its purchase money lien on the vehicle within 30 days of the date the debtors took delivery of the vehicle. The bank filed its application for certificate of title with the Idaho Transportation Department 16 days following the delivery of the vehicle to the debtors. Idaho state law also required an affidavit of inspection signed by an officer of the Idaho Transportation Department to be completed, which was not signed and submitted to the Idaho Transportation Department until 21 days following the date the debtors obtained delivery of the vehicle. Idaho state law has a grace period for completion and filing of all required documents to perfect the lien.

Within 30 days after purchasing the vehicle (and eight days after the bank perfected its security interest in the vehicle under Idaho law), on September 28, 2005, the debtors filed a joint voluntary petition for relief under Chapter 7 of the Bankruptcy Code. Seventeen months later, the Chapter 7 trustee filed suit against the bank, seeking to avoid the transfer of the security interest in the vehicle as a preference.

Ground for Avoidance of Security Interest
A transfer made to or for the benefit of a creditor, within 90 days of the date of a debtor’s bankruptcy, for or on account of an antecedent debt, which enables a creditor to receive more than it would have received if the transfer had not occurred, constitutes a preference that is avoidable by a trustee for the benefit of the bankruptcy estate. Section 547(c) sets forth a series of exception to the trustee’s right to avoid a preference. One exceptions set forth in §547(c)(3) provides that the transfer is not avoidable if the transfer is a grant of a purchase money security interest that is perfected on or before 20 days after the debtor receives possession of the property. The exception has since been amended to extend the time deadline for perfection to 30 days.

The court in Taylor rejected the bank’s contention that the state law grace period applied to allow the perfection to relate back, properly holding that the Bankruptcy Code’s time deadline for perfection in order for the preference exception to apply governed and trumped any longer state law period for the purpose of determining if the transfer could be avoided. The court therefore concluded the transfer was a voidable preference not subject to the exception of §547(c)(3).

The Key Issue:
The Remedy for the Estate Based on Avoidance of the Transfer
The bankruptcy court ruled that the transfer of the security interest in the vehicle to the bank should be avoided. Bankruptcy Code §550 provides that when a transfer has been avoided, the court may either award the estate a.) the actual property transferred (in this case, the security interest) or b.) the “value” of the property transferred. The bankruptcy court found the trustee should be awarded the “value” of the property transferred, and the court entered a monetary judgment in favor of the trustee in the amount of $18,020, the amount of the original vehicle loan, plus interest.

The effect of the judgment was that the bank would be able to retain its lien on the vehicle but would have to pay the estate $18,020 plus interest as the value of the security interest as of the date of when the lien was transferred to the bank to secure the loan. The bank had asserted the proper remedy was simply to avoid the security interest in the vehicle for the benefit of the estate. However, the bankruptcy court ruled that such a remedy would not return the bankruptcy estate to the position it was in when the transfer was made since the value of the security interest had declined as the value of the vehicle decreased and as a result of the monthly payments made by the debtors.

The Ninth Circuit held that the bankruptcy court abused its discretion in ruling the trustee was entitled to a monetary award in the amount of the original loan amount based on the avoided transfer. The court held that the determination that the perfection of security interest was a transfer that could be avoided only authorized the court to avoid the security interest, not the underlying loan.

The court recognized that under §550, the bankruptcy court could award the “value” of the property transferred, rather than the property itself, in granting a remedy for the preference avoidance. However, the court held that the bankruptcy court abused its discretion in determining that the “value” of that security interest was the amount of the original loan. The Ninth Circuit held there was no evidence in the record to support the bankruptcy court’s conclusion the security interest was worth $18,020, the original loan amount, when the security interest was granted since the vehicle’s value likely started depreciated as soon as it was purchased and delivered. The Ninth Circuit therefore ruled, since there was no evidence in the record from which to determine the “value” of the security interest, the proper remedy was for the bankruptcy court to simply return the security interest itself to the estate.

The Ninth Circuit also held the monthly payments made to the bank on account of the car loan had to be considered in the relief granted to the trustee and remanded the action to the bankruptcy court for further proceedings. The court instructed that if payments were made by the estate either post-bankruptcy or within the 90 days preceding the bankruptcy filing, then those payments would have to be returned to the estate.

Issues of Note
Despite the court’s concern that the estate recover payments made from estate assets in order to held make the estate whole, in fact, it seems unlikely the bankruptcy estate in a Chapter 7 proceeding would have made any payments on the car loan. Since postpetition earnings of individuals in Chapter 7 are not property of the estate, it seems unlikely that there would be any basis for the estate to recover such payments.

The decision does not state whether the debtors had reaffirmed the car loan but does state they continued to have possession of the car at least until shortly before judgment was rendered. Since the 2005 enactment of BAPCPA, in order for the debtors to retain the vehicle post-bankruptcy after filing a Chapter 7 petition, they would have had to either redeem the vehicle or reaffirm the debt in order to retain the car. See In the Matter of Dumont (Dumont v. Ford Motor Credit Co.), 581 F.3d 1104 (9th Cir. 2009). Therefore, it seems likely they reaffirmed the debt, and were continuing to make payments on the vehicle from their postpetition earnings.

The reaffirmation of the debt may explain in part why the bank apparently did not seek a determination that the debt was non-dischargeable (reaffirmation would have the effect of making the debt non-dischargeable). The fact that the debtors filed a Chapter 7 liquidation within 30 days of acquiring, and being qualified to purchase, suggests that the loan may have been obtained under false pretenses or fraud (promise made without intent to perform) or based on a materially false financial statement, which could have made the debt non-dischargeable.

Although not discussed in the opinion, if the bank could continue to collect the balance of the car loan despite having its security interest avoided because the debtors had reaffirmed the debt, that fact may have been considered by the bankruptcy court in trying to make the estate whole by providing for a monetary judgment in the amount of the original vehicle loan rather than simply preserving and transferring the security interest in the vehicle to the estate.

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Lesley Anne Hawes, a partner in the Los Angeles office of McKenna Long & Aldridge, LLP, specializes in the representation of secured and unsecured creditors in bankruptcy proceedings and in the representation of federal equity receivers appointed in civil enforcement actions by federal agencies such as the Federal Trade Commission and Securities and Exchange Commission. Hawes is a regular contributor to the Monitor and other legal journals, and she has lectured for the National Business Institute and other organizations. She graduated Order of the Coif from University of Southern California law school and earned her undergraduate degree in political science magna cum laude from the University of Southern California.