II. TRUSTEE'S AVOIDING POWERS
A. "Strong Arm" Powers of the Trustee - § 544(a)
Pursuant to Section 544(a), a trustee has the power to avoid certain transfers and obligations of the debtor that could be avoided by a creditor of the debtor, irrespective of whether such a creditor exists. This is known as the "strong arm" power of the trustee and elevates the trustee to the status of a "hypothetical lien creditor." A Chapter 11 debtor in possession may exercise the strong-arm powers conferred under Section 544. See BFC Chems., Inc. v. Smith-Douglass, Inc., 46 B.R. 1009, 1017 (E.D.N.C. 1985). Section 544(a), in conjunction with N.C. Gen. Stat. § 25-9-317, enables the trustee, as a lien creditor, to subordinate the rights of any unperfected security interest or any rights that could be defeated by a judicial lien creditor, a creditor with an unsatisfied execution or a bona fide purchaser of real property.
With respect to personal property, N.C. Gen. Stat. § 25-9-317 reflects the correlation between state law priority rules and Section 544(a) of the Bankruptcy Code. Under N.C. Gen. Stat. § 25-9-317(a)(2), an unperfected security interest is subordinate to the rights of a person who becomes a "lien creditor" before the security interest is perfected. "Lien creditor" is defined in N.C. Gen. Stat. § 25-9-102(a)(52) to include a trustee in bankruptcy. The defects that may cause a security interest to remain unperfected or to be deemed unperfected include, among others:
(1) failure to file in the correct office;
(2) failure to determine proper ownership of the collateral;
(3) failure to set forth the debtor's correct name;
(4) failure to adequately identify the collateral;
(5) failure to properly authenticate the financing statement;
(6) failure to tender the correct fee, resulting in delayed filing intercepted by a bankruptcy petition; and
(7) failure to file a timely continuation statement.
If the security interest of a creditor is unperfected on the petition date, then the judicial lien creditor status of the trustee under Section 544(a)(1) (or the creditor status of the trustee under Section 544(a)(2)) will enable the trustee to avoid the security interest and take the property into the debtor's estate.
The introductory clause to Section 544(a) indicates that the exercise of the strong arm powers can be carried out without regard to any knowledge of the trustee or any creditor. 11 U.S.C. § 544(a). It should be noted that this clause refers to actual knowledge of the trustee or other estate representative. This clause does not pertain to constructive or inquiry notice of an interest under state law which may be imputed to an estate representative. Under these circumstances, the imputed knowledge could defeat the avoidance powers. See In re Rose, 2009 WL 2226658 (Bankr. E.D.N.C. July 20, 2007), aff'd, 2010 WL 9904855 (E.D.N.C. Feb. 9, 2010), aff'd, 418 F. App'x 244 (4th Cir. 2011) (holding that the trustee could not use strong arm powers to avoid a mortgage despite discrepancy in lot number as party searching title would have found the document).
1. Judicial Lien Creditor
Pursuant to Section 544(a)(1), the trustee acts a hypothetical lien creditor and has the powers of a judicial lien creditor as of the date of the bankruptcy filing. A judicial lien creditor is one who extends credit to the debtor, as of the time of the filing of the case, and who obtains a judicial lien on all the property of the debtor. When the trustee steps into the shoes of the judicial lien creditor, he or she can avoid any transaction or claim, such as an unperfected security interest, which could be avoided by a judicial lien creditor. If an unperfected security interest is avoided by the trustee, the creditor loses its lien and is reduced to the status of a general unsecured creditor.
The extent of the trustee's rights as a judicial lien creditor is determined under applicable non-bankruptcy law. Examples of where a trustee will be looking to determine if the lien is properly perfected generally will be the failure to properly file the Uniform Commercial Code financing statement, a lapse of the financing statement, or a mistake in the description or other necessary language contained in the financing statement. Unrecorded or defective deeds of trust will also be subject to defeat by the trustee's hypothetical lien creditor's status. This portion of the strong arm statute will create very favorable results for the trustee/debtor and more painful results for the presumed secured creditor. See PTM Technologies, Inc., Adv. Proceeding No. 10-06023 (Bankr. M.D.N.C. July 1, 2011), wherein a secured creditor with a $5,000,000 claim misspelled the debtor's name on its financing statement by indicating "PTM Tecnologies, Inc." (omitting the "h" in "Technologies"). Using Section 544(a), the Court found that the safe harbor statute (N.C. Gen. Stat. § 25-9-506(b)) did not apply and the misspelling was seriously misleading and therefore unperfected their $5,000,000 claim in the bankruptcy case. William L. Stocks, Judge (Opinion entered 7/1/2011).
2. Unsatisfied Execution Creditor
Pursuant to Section 544(a)(2), the trustee steps into the shoes of an unsatisfied execution creditor that extends credit to the debtor as of the time of the filing of the case and obtains an execution against the debtor that is returned unsatisfied. If a claim is not good as against this creditor, it is not good as against the trustee. Most competing liens and security interests will lose as against the status of the trustee in this category unless the lien is perfected. One of the goals of this portion of the strong arm powers is to permit the trustee to obtain the benefits of equitable remedies available under state law. Examples include obtaining the ability for discovery of assets or marshaling which might not be available to judicial lien creditors. See H.R. Rep. No. 89-686 (1965); S. Rep. No. 89-1159 (1966), reprinted in 1966 U.S.C.C.A.N. 2032. However, it should be remembered that the trustee cannot assert the status of a hypothetical tax lien creditor using this strong arm power. See Schlossberg v. Barney, 380 F.3d 174 (4th Cir. 2004).
3. Bona Fide Purchaser of Real Estate
In the case of a transfer of real property, the trustee is afforded the status of a bona fide purchaser of the subject real property (hereinafter "BFP") at the time of commencement of the case. If a hypothetical BFP of the subject real property would have rights superior to the rights of the debtor's transferee, the trustee can avoid the transfer to the transferee. 11 U.S.C. § 544(a)(3). However, Section 544(a)(3) specifically limits the avoidance abilities of the trustee to circumstances of a BFP of real property and does not include fixtures. See In re Story, No. 16-40102 (Bankr. W.D.N.C. 2016), J. Craig Whitley, Judge (unpublished decision 9/21/2016). The trustee, as BFP, can avoid the security interest of a secured creditor with an unrecorded or improperly recorded deed of trust on the debtor's real estate. If the deed of trust is recorded, then the secured creditor's interest is preserved in the subject real property unless the trustee's other avoidance powers prevail. Any liens on real estate that would not be valid as against a BFP will not survive against the trustee. Typical examples of liens that may be avoided under Section 544(a)(3) are unrecorded deeds, unrecorded deeds of trust, unrecorded leases in excess of three years and materialmen's liens where notices were not filed within the required time or where suit was not instituted within the required time after notice. Consistent with the other avoiding powers, the issue as to whether the transfered lien or interest in question is valid as against the trustee standing in the hypothetical status as a bona fide purchaser is going to be dependent upon the substantive law of the state governing the property in question. See Miller v. LaSalle Bank, N.A., 595 F.3d 782 (7th Cir. 2010). The trustee's action pursuant to Section 544(a)(3) may be subject to various state law defenses, including the doctrine of equitable lien and/or equitable subrogation. See Am. Gen. Fin. Serv., Inc. v. Barnes, 623 S.E.2d 617, 619-20 (N.C. App. 2006); First Union Nat'l Bank v. Lindley Lab., 510 S.E.2d 187, 188 (N.C. App. 1999). See also In re Hayes Iron & Metal, Inc., No. 13-1057 (Bankr. M.D.N.C. May 23, 2014); Rhodes v. Fla. Metal Trading, Inc., Adv. Proceeding No. 13-2058, May 23, 2014, William L. Stocks, Judge (unpublished).
These strong-arm powers mean that if a transfer is not good as against a judicial lien creditor, a BFP of real property, or a creditor with an unsatisfied writ of execution, then the transfer is avoidable by the trustee.
B. Successor to Actual Creditors - § 544(b)
Section 544(b)(1) provides that the trustee may avoid any transfer of an interest of the debtor or any obligation incurred by the debtor that is avoidable under state law by an actual creditor holding an unsecured claim that is allowable under Section 502. In other words, the trustee succeeds to the rights of an existing unsecured creditor and may avoid the entire interest of another creditor that could be defeated by the unsecured creditor under state law. Furthermore, since Section 544(b) deals only with an actual unsecured creditor, the adversary proceeding complaint alleging this section must allege that an actual creditor with an unsecured claim would have standing to avoid the transfer under non-bankruptcy law does in fact exist. See In re Imageset, Inc., 299 B.R. 709, 715 (Bankr. D. Me. 2003) (holding that the trustee must demonstrate the existence of an actual unsecured creditor who could avoid the transfer). The principal uses of Section 544(b) are to vest in the trustee the avoidance rights of an unsecured creditor to set aside a transfer in violation of the state bulk sales statute or the state fraudulent conveyance law.
It is important to note that the rights asserted...
