Opinion
Case No. 09-38388-svk.
November 16, 2010
MEMORANDUM DECISION ON MOTION TO AVOID LIEN ON EXEMPT PROPERTY
Bankruptcy Code § 522(f) allows a debtor to avoid a nonpossessory lien on exempt tools of the trade. The Debtors here seek to avoid such a lien, but the secured creditor has objected, pointing out that it has possession of the property, after a pre-petition replevin. The issue is whether the creditor's possession converts a nonpossessory lien into a nonavoidable possessory interest.
The parties stipulated to the following facts: On February 21, 2007, James J. Mahoney and Sandra M. Mahoney (the "Debtors") entered into a secured credit transaction with CoVantage Credit Union (the "Credit Union"). The Credit Union loaned the Debtors $50,000 secured by the Debtors' pre-existing personal property including a Mack dump truck, custom equipment trailer, skid load trailer, Case backhoe, and a bulldozer (the "collateral"). Under the Security Agreement, the Credit Union had the right to take possession of the collateral after default, without notice or a hearing. However, when the Debtors defaulted, the Credit Union sought and obtained a replevin judgment in Shawano County Circuit Court on November 12, 2009. The Credit Union then repossessed the collateral on December 24, 2009. A week later, the Debtors filed their Chapter 7 bankruptcy petition.
Although the Stipulation of Facts gives the original loan amount as $80,000, the Debtors' attorney represented that the amount was actually $50,000.
Apparently George Bailey was not the loan officer in charge that day. See It's a Wonderful Life (Liberty Films 1946).
Although the Credit Union remains in possession of the collateral, the Debtors have claimed it exempt as tools of the trade, and filed a Motion to avoid the Credit Union's security interest under Bankruptcy Code § 522(f)(1)(B)(ii). That section provides that the debtor may avoid a nonpossessory, nonpurchase-money security interest to the extent the lien impairs the debtor's exemption in implements or tools of the trade. While the Credit Union does not dispute that the collateral qualifies as tools of the Debtors' trade, or that the security interest is nonpurchase-money, the Credit Union argues that either the replevin judgment or the Security Agreement provision concerning repossession after default gives the Credit Union a possessory security interest in the collateral. In response, the Debtors assert that the original security interest was nonpossessory, and the Credit Union's subsequent replevin judgment cannot transform an avoidable security interest into a nonavoidable security interest. Although an early case from the Western District of Wisconsin Bankruptcy Court held to the contrary, the majority of the courts to have considered this issue side with the Debtors.
To determine whether a security interest is possessory or nonpossessory, the critical question is how the lien attached and became enforceable against the debtor. In re Vann, 177 B.R. 704, 709 (D. Kan. 1995). In order to create a possessory security interest, the agreement between the parties must contemplate that the secured party will possess the collateral, and, pursuant to the agreement, the secured party must possess the collateral. In re Schultz, 101 B.R. 68, 71 (Bankr. N.D. Iowa 1989). In this case, the security agreement provided that the Debtors would maintain possession of the collateral until default; thus the Debtors granted the Credit Union only a nonpossessory security interest in the collateral. And the Credit Union's security interest did not transform into a possessory security interest when it took actual possession of the Debtors' tools of the trade, because the Credit Union was taking possession of its collateral after default. The majority rule is that a security interest does not become possessory, and therefore nonavoidable, when the creditor takes possession of the collateral following default. See, e.g., In re Vann, 177 B.R. at 709; In re White, 203 B.R. 613 (Bankr. N.D. Tex. 1996); In re Kinnemore, 181 B.R. 516 (Bankr. D. Idaho 1995); In re Schultz, 101 B.R. 68. Contra In re Shepler, 78 B.R. 217 (Bankr. W.D. Wis. 1987) (citing In re Sanders, 61 B.R. 381 (Bankr. D. Kan. 1986)).
The Credit Union cites the Western District decision in Shepler, but later courts have disagreed with the underlying rationale of that case, and, the District Court in Kansas expressly rejected Sanders, the Kansas Bankruptcy Court case on which Shepler heavily relied. In re Vann, 177 B.R. at 709. Moreover, the case is factually distinguishable, in that the secured creditor in Shepler failed to properly perfect its lien by filing its financing statement in the correct recording office, and the creditor's subsequent replevin judgment and repossession of the collateral was the first time the creditor's security interest attached. 78 B.R. at 219. In this case, the Credit Union's nonpossessory security interest was properly perfected and attached long before the repossession of the collateral. However, even if the Shepler creditor's security interest had been validly perfected from the beginning, this Court considers the analysis of cases like Vann more compelling on the issue at bar. The nature of the security interest as possessory or nonpossessory should be determined from the parties' initial agreement as to whether the debtor or the creditor is entitled to possession of the collateral, and not from the creditor's later exercise of its remedy on default.
The Credit Union also claims that the language of the Security Agreement giving the Credit Union the right to take possession of the collateral on default evidences the parties' agreement to create a possessory security interest. This argument must fail. Allowing a creditor to take possession of collateral after default is not only common practice, but immaterial to the determination of whether the creditor's interest is possessory. Under the Credit Union's theory, virtually every security interest would be possessory, since virtually every security agreement contemplates that the creditor will be entitled to repossess its collateral after default. See In re Kinnemore, 181 B.R. at 519-20 (recognizing that almost all security agreements grant the secured party the right to take possession of collateral upon default to enforce the lien).
Accordingly, this Court concludes that the Credit Union holds a nonpossessory, nonpurchase-money security interest in the collateral, and the Debtors are entitled to avoid the Credit Union's lien under § 522(f)(1)(B)(ii). An Order will be entered granting the Debtors' Motion to Avoid Lien and to Compel Turnover.
Dated: November 16, 2010