Chapter 12 Liens

• Jurisdiction: United States

Chapter 12 Liens

§ 12.1 ~ Introduction: Your Mother Didn't Raise You to Be an Unsecured creditor

Bankruptcy distributes property when there is not enough to go around. The residual class in priority — the one for which the money runs out — shares whatever is left pro rata. But nobody wants to be in the residual class. They want to go to the front of the queue, where they will get paid first before questions of insufficiency arise.

Broadly speaking, there are two ways to get to the head of the queue. One is to have a priority recognized by the bankruptcy statute. The other is to enjoy some sort of prior right under non-bankruptcy law that will be respected in bankruptcy.¹ In this chapter, we deal with prior rights created independently of bankruptcy law but that are respected in bankruptcy. For convenience, and at the risk of oversimplification, we call these non-bankruptcy rights "liens."

A "lien" is not easy to define. Outside of bankruptcy, there is nothing like unanimity on what it means to have a lien — to say nothing of how you get one, or keep one. The Bankruptcy Code offers some help here. It defines a lien as a "charge against or interest in property to secure payment of a debt or performance of an obligation."² For our purposes, we might put the point a little differently: We can say that a lien is a present, nonpossesso-ry property interest in collateral that, upon the happening of certain events such as default on a loan, may be seized and sold to satisfy the debtor's obligation. Because the lien is a property right, it puts the creditor at the head of the queue. But there is a corollary advantage: If the creditor truly has a lien, and if the bankruptcy process does nothing to "deal with" the lien, then the lien "rides through"; in other words, it remains as an encumbrance on the property after the bankruptcy is completed.³

Taking that point of departure, it is useful to recognize three kinds of liens:

- "Consensual" liens. These are liens that arise via an agreement between the debtor and a creditor. The category includes, for example, mortgages on real estate and personal property security interests. The Code uses the term "security interest," which it defines as a "lien created by agreement."⁴
- "Judicial" liens. These are liens that arise out of the judicial process. The Code defines a judicial lien as a "lien obtained by judgment, levy, sequestration, or other legal or equitable process or proceeding."⁵
- And finally, what we might call "status" liens. These liens arise in favor of creditors in a certain class as a result of their status, such as mechanic's liens, attorney's liens on papers, and so forth. The Code does not use the term "status lien." It does, however, include the term "statutory lien," which it defines as a "lien arising solely by force of a statute on specified circumstances or conditions, or lien of distress for rent, whether or not statutory...."⁶ A statutory lien is not necessarily a lien created by statute. This is clumsy, but the point is probably clear enough.

We address each class of lien separately below. Before we get down to specifics, we offer (in §§ 12.2 and 12.3) some general comments.

§ 12.2 ~ general comment: property and contract

The first point to remember about lien law is that it subsists on the borderland between property and contract. So-called consensual liens arise, by definition, via an agreement between debtor and creditor. Status-based liens usually have a contractual basis as well; a mechanic will not get a mechanic's lien unless he makes some kind of deal with the customer. Even judicial liens are frequently contractual in provenance in the sense that the judiciary intervenes when a deal goes bad.

But all these relationships are noncontractual — call them property-based or perhaps proprietary — in the sense that they purport to bind people who had nothing to do with any underlying contract, and indeed, may never have even known about it. We respect these lien rights in bankruptcy (insofar as we do respect them) because we respect non-bankruptcy property rights, and we recognize the lien right as a species of property.

This perspective helps to explain one of the oddities of draftsmanship in the Bankruptcy Code. The point of all this theoretical background is to establish that lien rights by definition (often) come first in bankruptcy — ahead of unsecured claims, even ahead of the so-called bankruptcy priorities. That is axiomatic. The oddity is that nowhere in the Bankruptcy Code is there any hint of a declaration of this axiomatic rule: Lien rights do not just go at the head of the list; they are so far at the head of the list that they are not on the list at all.

Taken in context, this point is perhaps not as bizarre as it sounds. The law assumes certain first principles. Nowhere in the law of divorce, for example, does it specify that you have to be married in order to get a divorce; it is just taken for granted.

In this vein, someone researching the discussion of secured creditors' (lien) rights in the legislative history of the Bankruptcy Act of 1898, the predecessor of our modern law, would find nothing at all. Can we, therefore, infer that the law did not respect lien rights? We can infer nothing of the sort. Indeed, if you had asked an 1898 drafter why he didn't mention lien rights, he probably would have explained that lien rights, by their proprietary nature, were not part of the bankruptcy process at all, so the Act's way to "speak" on the subject was to remain silent.

"Not part of the bankruptcy process at all": This is not even remotely true today. Secured creditors in bankruptcy get beaten around the head and shoulders all the time, and they do some beating on others, as well. But the basic principle persists.

§ 12.3 ~ general comment: property and remedy

One more point on this first principle: To assert a "lien right" under non-bankruptcy law is to make not just one, but either or both of two different claims. It is first a claim of priority in the sense set forth above. But to say "I have a lien" under non-bankruptcy law is often also to say that "I have a right to special collection remedies that are cheaper and more convenient than remedies available to those who do not hold liens."

As a practical matter, these claims are often both true together: Lien law does in fact award to the favored creditor both priority rights and special remedies. But it is worth noting for a moment that there is no necessity that this be so. Rather, linking priority and remedy probably arises through a venerable error about the nature of "property." In an earlier day, we supposed that property was unitary, and if you were proprietary in one respect (priority), then it followed that you were proprietary in another (remedy).

If we were writing on a clean slate, it is unlikely that we would take the same view today. We live in an age where we recognize that "property" is not an indivisible primary unit, but rather the center of a force field of positive and negative signs that you can slice and dice into a thousand separate pieces. But the law has great respect for tradition, and we stick to the old ways. For our purposes, it may be useful to just note that most often it is the priority issues, and not the remedy problems, that exercise the analytical powers of the court.

§ 12.4 ~ Consensual Lien

The most common lien problem in bankruptcy probably is the conflict over the priority of a creditor whose lien is consensual. The typical "family business" debtor is likely to owe:

- money to the bank on a term loan secured by real estate;
- a "working-capital loan" secured by inventory and receivables; and
- any number of "purchase money" loans secured by individual items of personal property.

All of these fall under the rubric of consensual liens, and in all cases, the creditor will be seeking to assert his lien rights to get paid first out of the finite pool of assets, at least to the extent of the value of its collateral.

§ 12.5 ~ personal property

Almost all consensual liens in personal property will be governed by Article 9 of the Uniform Commercial Code (UCC), which is the law — though with many non-uniform variations — in every state in the U.S.⁷

The linchpin of UCC Article 9 is § 9-317(a)(2).⁸ It provides (inter alia) that an unperfected security interest is subordinate to the rights of a lien creditor. This lien creditor rule at the state law level dovetails nicely with the trustee's lien creditor power under Bankruptcy Code § 544(a)(1); we develop the point at more length below.

Article 9 also sets forth traffic rules for a number of other priority disputes — such as priority among competing secured creditors. These rules are important enough in themselves, but they really do not have a lot to do with bankruptcy. Indeed, where the fight is solely between two secured creditors and does not affect the estate or other creditors, there may be no bankruptcy court jurisdiction.⁹ Having said that, there are plenty of lien priority and similar battles fought between secured creditors in bankruptcy court, such as where lien priorities affect plan confirmation, use of cash collateral, adequate protection, post-petition financing, etc.

In the latest revision of Article 9, the drafters extended its coverage beyond mere "consensual liens." The current version provides that Article 9 also covers priority issues in "agricultural liens" — property interests in farm products, created by statute.¹⁰ Of course, we can imagine a world in which a single priority statute governs all statutory liens. This is not one of them; the reason for covering agricultural liens but not, for example, mechanic's liens probably has far more to do with history and entrenched social patterns than it does to any abstract principle.

Article 9 also involves priority disputes in a few cases where there is no "lien" at all but rather an absolute transfer of ownership rights. This category...