Secured Transactions - To Participate Or Not To Participate: A Secured Party's Question

Keywords: secured transactions, secured lenders, bankruptcy, secured claims, secured creditor.

Economic downturns often oblige secured lenders to become involved actively in the bankruptcy of their borrowers and in related disputes concerning the propriety of the lenders' secured claims and the treatment of those claims in the borrowers' reorganization or liquidation. Thus, many insolvency and workout topics have appeared in this space since the Great Recession began more than four years ago.

Today, however, we consider what might happen to a secured claimif the creditor fails, or elects not, to participate in its debtor's bankruptcy case.We are prompted to do so by a recentMississippi federal district court decision, Acceptance Loan v. S.White Transportation (In re S. White Transportation),1 which held that a secured creditor who did not file a proof of claimor otherwise appear in a debtor's bankruptcy case did not lose its lien after confirmation of the debtor's plan of reorganization.

Background

It is a longstanding general principle of bankruptcy law that liens pass through bankruptcy unaffected.2 An exception to this rule is U.S. Bankruptcy Code §1141(c),3 which provides that, under certain circumstances, "property dealt with by [a Chapter 11] plan is free and clear of all [liens.]" In applying §1141(c), the U.S. Court of Appeals for the Fifth Circuit, in In re Ahern Enterprises,4 ruled that a lien would be discharged under a Chapter 11 plan if four conditions were met. First, the plan must be confirmed. Second, the property subject to the lien must be dealt with by the plan. Third, the lienholder must have participated in the debtor's reorganization. Finally, the plan must not explicitly preserve the lien. The condition at issue in S. White Transportation, and of most interest to secured creditors, was the requirement that a secured creditor "participate" in the debtor's reorganization.

Although other courts have generally adopted Ahern's four-part test, there has been little analysis of what constitutes "participation" for the purposes of §1141(c). In Ahern itself, an undersecured creditor did not file a proof of claim regarding its secured claim or otherwise involve itself in its capacity as a secured creditor. It was deemed nevertheless to have participated in the case because it had filed, in its capacity as an unsecured creditor, a proof of claim for the deficiency portion of its claim. The court also concluded that the debtor's plan of reorganization gave the creditor sufficient notice of the treatment of the creditor's collateral for the purposes of §1141(c). Thus, because due process was satisfied and because the creditor had participated by filing a proof of claim, albeit solely in its capacity as an unsecured creditor, the creditor's lien was extinguished under §1141(c).5 In an earlier case, In re Penrod,6 the Seventh Circuit held that a secured creditor participated in a bankruptcy proceeding solely by filing a proof of claim. Penrod appeared to set a standard that a secured party's filing of a proof of claim is sufficient participation to permit its lien to be extinguished. At least one bankruptcy court decision, however, rejected the notion that even the affirmative act of filing a proof of claim is necessary to constitute the required level of participation. The court in In re Regional Building Systems7 held that nothing in §1141(c) mandates that a proof of claim be filed for a lien to be stripped. Rather, according to the court, §1141(c) dictates only that the secured creditor receive notice of the case and the terms of any proposed plan.

It...