The Rights of a Prepetition Lien Holder Against Postpetition Proceeds from a Sale of Real Property

Gabriel Eckstein

St. John’s University School of Law

American Bankruptcy Institute Law Review Staff

            An unpaid secured lender with a prepetition mortgage does not have a right to receive payment of proceeds from a postpetition sale of real property. In evaluating the Texas Business & Commerce Code and title 11 of the United States Code (the “Bankruptcy Code”), the United States Bankruptcy Court for the Southern District of Texas, in In Re Burts Construction, Inc., held that a secured creditor has the right to receive monetary payment for property sales based on its lien on “accounts.” The Bankruptcy Court further held the secured creditor's prepetition lien on accounts did not extend to proceeds from court-approved postpetition sale of real property.

In 2017, Allegiance Bank loaned Burts Construction, Inc. (the “Debtor”) $1.5 million.  The loan was secured by a lien on “all assets of the debtor, including all accounts.”[1] In May of 2020, Allegiance filed a UCC-1 Financing Statement with the Texas Secretary of State to perfect its lien on the debtor’s assets.[2] In 2022, the Debtor commenced a chapter 11 bankruptcy case.[3] As part of the Bankruptcy Court’s first day orders, the Bankruptcy Court allowed an agreed cash collateral order stating Allegiance was entitled to protection in the form of replacement liens and a super priority administrative claim equal to any diminution in the value of its cash collateral.[4] Later in 2022, the Bankruptcy Court authorized the Debtor to sell real property free and clear of all liens against debtor.[5] After selling the real property, the Debtor wanted to use the proceeds to pay off Allegiance’s claim.[6] Both the Debtor and Allegiance claimed the sale proceeds are subject to Allegiance’s prepetition lien because the sale of the house created an “account” as defined under Texas Business & Commerce Code § 9.[7] Ag Pay, an unsecured creditor, argued that article 9 applies only to personal property and not real property.[8]

            Section 9 of the Texas Business & Commerce Code defines an “account” to include “right to payment of a monetary obligation . . . for property that has been sold, leased, licensed, assigned, or otherwise disposed of.”[9] The Court determined Section 9-109(d)(11) prohibits Allegiance's Article 9 liens from extending to the sale proceeds.[10] Allegiance’s lien did not create an interest in the property itself, rather it just created a right to receive money payments for property sales based on its lien on “accounts.”[11]

The Bankruptcy Court found that Section 522(a) of the Bankruptcy Code, not Article 9 of the UCC, prohibits a secured lender from receiving monetary payments, based on a lien resulting from a security agreement with the debtor, from “property acquired by the estate” after the bankruptcy petition date.[12] The court distinguished the current case from Nittolo and applied Section 552(a) of the Bankruptcy Code.[13] The Nittolo Court held that the revised, expanded definition of “account” under New York's Article 9 (which contains identical language to Texas's revised Article 9), included the right to payment of proceeds from the sale of real property. [14] However, this case differs from Nittolo based on the timing of the sale of the property, noting that case involved a prepetition sale, and this case involves a postpetition one.[15] The court then turned its analysis to Section 552(a) of the Bankruptcy Code. Section 552(a) states that postpetition “property acquired by the estate” after the bankruptcy petition date is “not subject to any lien resulting from any security agreement entered into by the debtor” before the petition date.[16] The Bankruptcy Code should be read plainly and it’s interpretation should “begin, and if possible, end with the language of the statute.”[17] In this case, the sale is considered “property acquired by the estate” and therefore prevents Allegiance’s prepetition lien on accounts to extend to the sale proceeds.[18]

Accordingly, the Bankruptcy Court held the secured creditor was not entitled to proceeds. Exceptions under Section 552(b) do not apply because the court-approved real estate deal permitting the sale occurred postpetition and the sale proceeds were acquired by the estate postpetition. Therefore, the Debtor’s motion to pay Allegiance Bank with the sale proceeds was denied. The Debtor will need to find other ways to fulfill their obligations to creditor Allegiance Bank.