In Grogan, the debtors planted and harvested Christmas trees. The bankruptcy court was called upon to determine whether the debtors could exercise their “strong arm” powers under Section 544(a) of the Bankruptcy Code to trump the liens of two of their lenders on the Christmas trees.
Both lenders had loans secured by a combined mortgage and security agreement. Both mortgages were recorded and both lenders filed UCC financing statements. Grogan turned on (1) the relative priority of a real estate mortgage and a judgment lien with the priority of a UCC Article 9 security interest, and (2) the sufficiency of a collateral description for purposes of a UCC Article 9 security agreement.
As discussed in prior blog posts (including Bye Bye Mortgage), Section 544(a) of the Bankruptcy Code gives a trustee or debtor the ability to assert the rights and powers of, and to avoid transfers that are voidable by, a hypothetical bona fide purchaser of real estate.
An alternate provision in Section 544(a) allows a trustee or debtor to also assert the rights of a hypothetical creditor that extends credit at the commencement of the case and at the same time obtains a judicial lien (which may be on real or personal property). Section 101 of the Bankruptcy Code defines judicial lien as a “lien obtained by judgment, levy, sequestration, or other legal or equitable process or proceeding.” The rights derived from holding a judicial lien, like the rights of a bona fide purchaser of real property, are generally determined by applying state law.
Under Oregon law, entry of a judgment automatically gives rise to a lien on real property, but does not create a lien on personal property until the sheriff actually levies on the property pursuant to a writ of execution. The sheriff may levy by either seizing the property or by attaching a notice to it. When a sheriff levies on personal property, the judgment creditor obtains an interest that is the same as a secured creditor perfected under the Uniform Commercial Code.
In Grogan, the lenders first argued that the Christmas trees were not personal property, and consequently their liens were perfected by the recorded mortgages and were senior to the rights of a hypothetical judgment lien creditor. The court disagreed, finding that the Christmas trees were “crops,” which are “goods,” and more specifically “farm products.”
The lenders also argued that a sheriff could not levy on growing crops so that there could not be any judicial lien on the crops if they were personal property. However, the court noted that the sheriff could either post notices or seize the crops (i.e. by harvesting).
Once it was established that the Christmas trees were crops under UCC Article 9, the debtors could assert the rights of a hypothetical judgment lien creditor with a lien equivalent to an Article 9 security interest to trump the mortgage liens, since under UCC Section 9-334 a perfected security interest in crops has priority over a conflicting interest of a mortgagee or owner of the real property.
So, the lenders could prevail only if their UCC security interests were senior. On this issue, it was clear that adequate financing statements had been filed prior to the bankruptcy (and thus would give priority over the judgment lien creditor’s interest). The key question was whether the security agreements adequately described the Christmas trees as collateral.
Although a financing statement may contain a very general description (such as “all assets”), a security agreement must “reasonably identify” the collateral. UCC Section 9-108 provides that a description such as “all the debtor’s assets” or “all the debtor’s personal property” is insufficient, while a specific listing or references to UCC categories of collateral will generally be sufficient.
The first lender’s security agreement collateral description included: “All of the trees, bushes, vines and other permanent plantings now or hereafter located on the real property (the ‘plantings’).” The debtors argued that the word “permanent” modified trees, and consequently the Christmas trees were not included in the collateral since they were not permanent (i.e. it was contemplated the trees would be harvested). They conceded that the parties intended to grant a security interest in the Christmas trees, but contended that the security agreement was defective as written.
In response, the court gave a discourse on proper contract interpretation. After touching on various topics such as the “doctrine of the last antecedent,” the raging debate about “omitting the serial (aka ‘Harvard’ or ‘Oxford’) comma before the conjunction joining the last item,” and various uses of the phrase “permanent crops” to distinguish permanent crops from “annual crops,” the court came back to the conclusion that “context is key,” and a third party would be put on notice to inquire about the scope of collateral such that the description in the security agreement was sufficient to include the Christmas trees.
The second lender’s security agreement was even clearer in that it specifically referenced Christmas trees as part of the collateral.
Consequently, the court held that the security agreements reasonably identified the Christmas trees as collateral under the UCC, and the loans were secured by properly perfected unavoidable security interests in the Christmas trees and proceeds.
This case highlights two areas to watch in evaluating potential lien avoidance issues: (1) it is important to consider the rights of a hypothetical judicial lien creditor as well as a hypothetical bona fide purchaser, even in a real estate context, and (2) when dealing with the UCC, it is important to pay particular attention to the description of collateral in the security agreement.