Secured Creditors as Garnishees
When CPLR section 5222(b)'s fourth sentence refers to transferring the debtor's "property," it is using the crude totemistic notion of property, not the sophisticated Hohfeldian usage that philosophy prefers. Property is a thing, such as a lawn mower or a caveman's shillelagh. Property is not the debtor's interest in a thing, as the eggheads insist.
This causes headaches for senior secured creditors with perfected security interests in collateral they have repossessed. This is because the creditor in possession is, basically, a bailee--a person in rightful possession of property of another. (315) A foreclosure sale under Article 9 constitutes the transfer of the debtor's property interest to a buyer. (316) Any such transfer violates the restraining notice served upon the foreclosing secured party. (317) This is so whether the debtor equity is valuable or not. (318)
This is certainly odd. On the one hand, a senior secured party can prevent the sheriff from selling collateral at an execution sale; the sheriff is even guilty of conversion if the sheriff continues an execution sale over the protest of the secured party. (319) Yet an unsecured creditor with no lien at all can stop the senior secured party from foreclosing, simply by serving a restraining notice. (320) To proceed, the secured party needs to procure a court order permitting the alienation of the debtor's property. (321) According to CPLR section 5222(b) (fourth sentence), alienation of the judgment debtor's property interest is forbidden "except upon direction of the sheriff or pursuant to an order of the court." (322)
Could a secured creditor consult a sheriff and obtain immunity from the restraining notice? It is may seem strange that the sheriff has authority to negate the effect of the restraining notice, but, in the context of a garnishee who is a senior secured party, the matter makes sense. If the sheriff perceives that the garnishee has a perfected security interest to which any possible judicial lien is junior, the sheriff can say so and permit the foreclosure sale to proceed. Where the security interest is senior, the secured party's possessory right is better than any possessory right of the sheriff pursuant to judicial process. The sheriff should be competent to vacate the restraining notice if it serves no purpose in preserving the status quo in anticipation of a later execution sale. It may be observed, that, historically, sheriffs were presiding judges. (323) So this part of section 5222(b) restores to the shrievalty some fragment of its medieval glory.
If the sheriff is unwilling to authorize the foreclosure sale, then a secured party must proceed under CPLR section 5240, which invites the court "at any time, on... the motion of any interested person,... [to] make an order denying, limiting, conditioning, regulating, extending or modifying the use of any enforcement procedure." (324)
In CIMC Raffles Offshore (Singapore) Ltd. v. Schahin Holding S.A., (325) the court implied that restraining notices are completely ineffective against senior secured parties, where there is no valuable debtor equity in the collateral. (326) In CIMC, an account debtor (327) paid funds to a collateral agent for senior secured parties. (328) The collateral agent was served with a restraining notice. (329) The collateral agent froze all the collateral accounts and, as a result, the routine payment of senior debt service was halted. (330) The senior lenders moved that the restraining notice be vacated so that the senior payment could go forward. (331) Appropriately, the court gave that relief, but on grounds far too broad for the problem at hand.
The restraining notices were effective in the first instance only against property "which could be assigned or transferred" by the judgment debtor. (332) According to the CIMC court, the debtor could not assign or transfer its interest in the collateral accounts, as these were encumbered by senior security interests. (333)
This misconceives the matter. It is true that a debtor cannot convey its equity interest free and clear of the senior security interests. (334) But it could convey its equity interest in the accounts subject to the security interest. (335) Accordingly the debtor always has property which could be "assigned or transferred" within the meaning of CPLR section 5201(b).
Under old Article 9 this was clear. Old section 9-311 provided: "The debtor's rights in collateral may be voluntarily or involuntarily transferred ... notwithstanding a provision in the security agreement prohibiting any transfer or making the transfer constitute a default." (336) This clear statement of the principle has now been muddied. Under new section 9-401, "whether a debtor's rights in collateral may be voluntarily or involuntarily transferred is governed by law other than this article." (337) So in modern times, one must consult, not the UCC, but New York common law (badly atrophied since the UCC went effective) as to whether debtor equity in bank accounts could be transferred.
There is no reason to think why not. Bank accounts are commercial property and are, in general, alienable. (338) Granted, the transfer is subject to the rights of the senior secured parties. (339) But it cannot generally be said that encumbered bank accounts are property which a debtor cannot assign or transfer, within the meaning of CPLR section 5201(b).
Basically, the CIMC court theorized that if the debtor cannot convey free and clear of perfected security interest, it cannot convey at all. (340) On this view, "debtor equity" is inalienable property not susceptible to any levy. (341) If the court's theory were taken to its limit, restraining notices could not be effective to restrain secured parties, even as to collateral as to which the debtor has a valuable equity. Where a valuable equity exists, the debtor still cannot convey free and clear of the senior perfected security interest. On CIMCs reasoning, that makes the debtor's property inalienable.
As we have seen, the CPLR's theory of property is that property is a thing--such as a lawn mower. It is not a debtor's interest in a thing. Either the restraining notice applies to the lawn mower or it doesn't. Whether the debtor's interest in the lawn mower is valuable (that is, it is held in esteem by hypothetical buyers in the market) has no bearing on the application of restraining notice. It applies to the lawn mower, not to the debtor's interest in the lawn mower. Like it or not, the restraining notice applies to all collateral, or to none at all, in which case a secured party could dispose of valuable debtor equity.
Significantly, the security agreement in CIMC provided that one of the judgment debtors could have a distribution from the encumbered account to cover operating expenses. (342) The restraining notice was deemed effective to prevent the collateral agent from distributing to the judgment debtor. This is inconsistent with the view that the bank account was inalienable by the debtor. If indeed the judgment debtor had no property interest at all in the account, then the withdrawal of expense reimbursements should not have been a transfer of debtor property. In truth, however, the debtor was receiving encumbered dollars in which the debtor had a preexisting valueless equity. This transfer was a violation of the restraining notice. As indeed was any payment of cash collateral to a senior secured party. Such payments extinguish the debtor's technical equity in the encumbered dollars. Any transfer of debtor property (regardless of value) violates the restraining notice.
What the court should have said is that the restraining notice was completely effective against the collateral agent, but that the court had discretion to permit payments to the senior secured parties, (343) where the dollars paid were encumbered dollars which the judgment creditor could not use to satisfy a judgment.
Normatively, should senior secured parties be free and clear of the restraining notice? The matter is not simple. Where there is no debtor equity, the restraining notice has no point, as a subsequent levy by the sheriff will not produce value for the creditor. But where a valuable equity does exist, the restraining notice serves the purpose of slowing down the foreclosure sale until the objecting creditor can establish a junior lien, which the senior secured party must respect. (344) Writing a statute that differentiates in advance between valueless and valuable assets poses a profound challenge. In light of that, perhaps the CPLR is wise to make the senior secured party, in all cases, to seek a vacation of the restraining notice from the courts.
Purchasers of Restrained Personal Property
Suppose a garnishee served with a restraining notice is the bailee of debtor property. A debtor can always sell free and clear of the restraining notice because restraining notices do not create liens. (345) Yet, according to CPLR section 5222(b)'s fourth sentence, the garnishee is not to "suffer" a transfer of the thing in which the debtor has a property interest. (346)
Suppose, for example, that on a Monday a bailee holding the debtor's lawn mower has been served with a restraining notice. Suppose the debtor sells her bailor's interest in the mower to X, a purchaser. If the debtor has not been served with a restraining notice, the debtor does not act wrongly in selling the mower to X. X then shows up and demands the mower. Does the garnishee violate the restraining notice by surrendering the mower to X?
CPLR section 5222(b) is ambiguous on this score. We know that the restraining notice was effective on Monday because the debtor then held debtor property--that is, the mower. Accordingly, the garnishee is "forbidden to ... suffer any sale ... [of] such property." (347) The word "suffer" arguably could be read to mean that the garnishee must not recognize X's ownership rights.
|Author:||Carlson, David Gray|
|Position:||I. Restraining Notices F. Property 2. Secured Creditors as Garnishees through I. Paying Debts v. Setting off Debts, p. 1529-1561 - New York - Chief judge Lawrence H. Cooke Eighth Annual State Constitutional Commentary Symposium|
To continue readingFREE SIGN UP
COPYRIGHT TV Trade Media, Inc.
COPYRIGHT GALE, Cengage Learning. All rights reserved.
COPYRIGHT GALE, Cengage Learning. All rights reserved.