In re WL Holmes LLC, ___ Fed. Appx. ___, 2013 WL 4019397 (3rd Cir 2013)
WL Holmes filed for chapter 11 bankruptcy protection in February 2009, and the case was converted to chapter 7. Wachovia filed an action in the bankruptcy court seeking a declaration that it had a valid and perfected security interest in JLH’s deposit account, and WL Holmes’ chapter 7 trustee sought to invalidate Wachovia’s security interest on the grounds that WL Holmes was unable to pledge as collateral a deposit account that was actually owned by JLH.
On summary judgment, the bankruptcy court ruled that Wachovia had a validly perfected security interest on the grounds that WL Holmes had “use and control” of the JLH account, and, alternatively, that JLH consented to the use of its account as collateral. On appeal, the District Court reversed on the “use and control” issue, but upheld Wachovia’s security interest on the grounds of JLH’s knowledge and consent. The rulings were further appealed to the Third Circuit.
The Third Circuit analyzed the validity of the security interest under the California UCC. Under UCC section 9203(a), a security interest in a deposit account is enforceable when: (1) value has been given, (2) the debtor has rights in the collateral or the power to transfer rights to a secured party, and (3) the secured party has control over the deposit account. The critical issue in this case was the second element: whether WL Holmes had sufficient rights to pledge the deposit account of its subsidiary, JLH.
The Third Circuit ruled that the deposit account could be pledged so long as it was done with the knowledge and consent of the subsidiary. Mr. Stelmar negotiated the loan and executed the pledge as CFO of WL Holmes. At the time of execution, Mr. Stelmar was also serving as president of the account owner, JLH, and had broad powers to make decisions for JLH, including the power to pledge JLH’s assets as collateral. Because Mr. Stelmar had personal knowledge of the pledge (and in fact, negotiated the pledge), his knowledge as JLH’s president could be imputed to JLH regardless of whether Mr. Stelmar signed the agreement in the name of JLH. The Third Circuit ruled that JLH knew of the pledge through Mr. Stelmar, and JLH’s knowledge manifested its consent to the pledge. Accordingly, the Third Circuit ruled that Wachovia’s security interest in the deposit accounts was properly perfected. The Third Circuit declined to rule on the issue of “use and control.”
When perfecting security interests, the details matter, including the legal capacity of the signatories of a pledge to actually pledge the collateral. Creditors should carefully analyze what title a pledgor has in the collateral being pledged, and if title is held by another entity – even a wholly owned subsidiary – creditors should be sure to obtain the express written consent of the owner of the collateral. While consent may be implied under the facts and circumstances, as it was in this case, it is better to not leave the issue to chance.