It is well recognized that, in keeping with the "fresh start" or "rehabilitative" policy, the Bankruptcy Code invalidates after-acquired property clauses in prepetition security agreements, but also includes an exception to the general rule for prepetition liens on the proceeds, products, offspring, or profits of prepetition collateral. Less well understood is that there is an "exception to the exception" if a bankruptcy court determines that the "equities of the case" suggest that property acquired by the estate should be free of such liens.
This exception was recently addressed by the U.S. District Court for the Southern District of West Virginia. In United Bank v. Blackjewel, L.L.C. (In re Blackjewel, L.L.C.), 2021 WL 2667511 (S.D. W. Va. June 29, 2021), appeal filed, No. 21-1831 (4th Cir. July 30, 2021), the court affirmed a bankruptcy court order denying an undersecured lender's motion seeking as a form of "adequate protection" the payment of asset sale proceeds allegedly subject to its prepetition security interest in receivables. According to the district court, the bankruptcy court did not abuse its discretion in finding that it would be inequitable for the lender's liens to attach to the proceeds of a postpetition sale because "allowing [the lender] to receive the proceeds of unencumbered estate assets would be inequitable to the unsecured creditors."
Invalidation of Certain After-Acquired Property Clauses in Bankruptcy
Section 552(a) of the Bankruptcy Code states that "[e]xcept as provided in subsection (b) of this section, property acquired by the estate or by the debtor after the commencement of the case is not subject to any lien resulting from any security agreement entered into by the debtor before the commencement of the case." This provision reflects the principle that "the debtor's fresh start should entitle the debtor to use after-acquired property, so long as it is not property of the estate under section 541(a)(6) [defining as "estate property" the proceeds, product, offspring, rents, or profits of or from estate property], free and clear of a prebankruptcy lien." Collier on Bankruptcy ("Collier") ' 552.01 (16th ed. 2021).
Section 552(b)(1), however, includes a limited "savings clause" for certain security interests. That section provides, with limited exceptions not relevant here:
[I]f the debtor and an entity entered into a security agreement before the commencement of the case and if the security interest created by such security agreement extends to property of the debtor acquired before the commencement of the case and to proceeds, products, offspring, or profits of such property, then such security interest extends to such proceeds, products, offspring, or profits acquired by the estate after the commencement of the case to the extent provided by such security agreement and by applicable nonbankruptcy law, except to any extent that the court, after notice and a hearing and based on the equities of the case, orders otherwise.
11 U.S.C. ' 522(b)(1). A separate savings clause for pledged real property rents and related fees is covered by section 552(b)(2).
Thus, the savings clause for liens on postpetition proceeds, products, or profits of (or rents from) property pledged prepetition is itself subject to an exception "to the extent that the court, after notice and a hearing and based [on] the equities of the case, orders otherwise." In re Las Vegas Monorail, Co., 429 B.R. 317, 344 (Bankr. D. Nev. 2010). This "exception to the exception" authorizes a...
