The Ninth Circuit Bankruptcy Appellate Panel has held that a finance company did not have a perfected security interest in equipment lease payment pools assigned to it because neither the assignee, nor the assignor with which it had contracted, filed the appropriate UCC financing statements.  

The court also held that the assignee’s possession of surety bonds guaranteeing the lease payment streams in the event of default did not suffice to perfect its security interests. In re Commercial Money Ctr., Inc. (Federal Deposit Insurance Corp. v. Kipperman), 392 B.R. 814 (9th Cir. BAP Aug. 4, 2008).  

As a result, the Ninth Circuit BAP upheld a ruling allowing a bankruptcy trustee to avoid the assignee’s security interest in the lease payments and surety bonds. The case highlights the importance of ensuring that a party that contracts to file UCC financing statements following the assignment of equipment lease payment streams, follows through.  

Assignment Agreement

Commercial Money Center Inc. (CMC) purchased equipment and leased it to consumer end-users with subprime credit. CMC then grouped these leases together into lease pools and assigned the lease payments,—but not the leases themselves—to third-party investors. To enhance the marketability of the lease pools, CMC obtained surety bonds guaranteeing the lease payments, and assigned its rights under the bonds to investors.  

NetBank, FSB was one such investor, paying some $47 million for seven lease pools. The parties signed a Sale and Servicing Agreement under which CMC assigned to NetBank its rights to and interests in the lease payments and its rights under the surety bonds. As security for the lease payments, CMC granted NetBank a security interest in assets that included the leases themselves, the leased equipment, insurance policies and all items contained in the lease files, and other documents relating to the leases.  

CMC represented to NetBank that it would take all necessary actions to ensure NetBank maintained a first priority perfected lien or ownership interest in the leases and transferred assets, including filing UCC financing statements. However, CMC did not file such financing statements, nor did NetBank.  

CMC served as sub-servicer of the leases, acting as NetBank’s agent, and retained possession of the lease files. NetBank obtained physical possession of the surety bonds. CMC failed to distribute payments owed to NetBank, and NetBank demanded compensation from the guarantor of the surety bonds, Royal Indemnity Company, for the defaulted payments. Royal complied and took action against CMC. CMC ultimately resigned as sub-servicer, was ordered to turn over its lease files to Royal, and filed a voluntary chapter 11 petition.  

Adversary Proceeding

More than a year after the petition date, the bankruptcy trustee commenced an adversary proceeding against NetBank. The bankruptcy court granted summary judgment in favor of the trustee, avoiding NetBank’s security interest in rights to future payments due under the leases, and in contract rights under the surety bonds.  

The Federal Deposit Insurance Corporation (FDIC), in its role as receiver for NetBank, appealed, and the case eventually reached the Ninth Circuit BAP. Though a number of issues were in dispute in the original case, the issue that survived on appeal was whether NetBank perfected its security interests in the lease payments and the surety bonds, so as to withstand the trustee’s avoidance powers.  

The FDIC argued that NetBank perfected its security interest in the lease payments by constructive possession of the leases through its third-party agent, Royal. But the Ninth Circuit BAP did not agree.  

“Within the Ninth Circuit, the agent must have actual possession of the collateral in order for the secured party to have a perfected security interest,” the court stated [italics in original]. “The leases were not physically transferred to Royal outside the preference period.”  

Sophisticated Creditor

The court similarly rejected the argument that CMC held the leases in “constructive trust” for Royal, noting that NetBank should have acted to ensure its interests were secured. “It is inappropriate to impose a constructive trust where a commercially sophisticated creditor did not take reasonable steps to ensure that its security interests were perfected,” the court stated.  

“NetBank was a sophisticated commercial entity that should have acted further to protect its security interests.… The FDIC has not shown that NetBank was prevented from verifying whether CMC filed financing statements or from taking possession of the leases itself.”  

The Ninth Circuit BAP also rejected the FDIC’s argument that its interests were secured by possession of the surety bonds. The FDIC had objected to a ruling by the bankruptcy court that the surety bonds were supporting obligations rather than instruments under the UCC.  

Though the surety bonds were assignable, they did not represent “absolute rights ‘to the payment of a monetary obligation,’” the Ninth Circuit BAP determined, citing precedent. Further, an underwriting executive at Royal indicated that the surety bonds constituted supporting obligations rather than instruments, the court noted. In a deposition, she testified that she had written a “Request for Confirmation” letter “to confirm the arrangement [she] believed was in place,” stated the court.“By their terms, the surety bonds fundamentally are not instruments. They are supporting obligations provided for security purposes,” the court concluded. “The surety bonds guarantee lease payments up to a maximum amount in the event of default, but they do not stand independent of the underlying leases as monetary payment obligations.”  

The case reinforces the importance of ensuring that a party that contracts to file UCC financing statements does, in fact, file those statements.