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MONTH-IN-BRIEF (Mar 2020)

Bankruptcy Law

Release Of Liens Supported Contemporaneous Exchange Defense

By Michael Enright

Secured lenders in workout scenarios often are faced with the problem of a junior secured creditor or lienholder who is “out of the money” but holds a position that would otherwise prevent a consensual resolution. Motivated by the desire to avoid a liquidation that may yield a lower recovery than a workout, the senior creditor could decide to take a partial recovery and leave something for the junior creditor, to facilitate the release of the junior liens and achieve an exit.  If the junior creditor is the beneficiary of such a deal, and waives its security interests in exchange for a partial payment in the workout, can it subsequently shelter that payment from a bankruptcy trustee on the basis that the waiver of its security interest was a contemporaneous exchange for new value under Section 547(c)(1) of the Bankruptcy Code, and therefore not recoverable as a preference?  The court in Lauter v. Wells Fargo Bank, N.A. (In re Gas-Mart USA, Inc.), Case No 19-6013 (B.A.P. 8th Cir. March 19, 2020) ruled in favor of the junior secured creditor, upholding the bankruptcy court’s determination that the junior secured creditor’s waiver in such a situation did comprise new value. Despite the trustee’s advocacy that the court should consider the reality that the collateral was insufficient to provide for a recovery to the junior secured creditor, such that its lien waiver should not be attributed any value, the court saw the “reality of the situation” differently, and expressly held that “[w]hen, as in this case, a senior secured lender voluntarily releases its liens for less than full payment and a junior secured creditor releases its liens, the requirement for providing new value under §547(c)(1) by the junior creditor is satisfied.” Junior secured creditors will find some comfort in this decision when they contemplate releasing their liens in exchange for payment in a workout where the senior secured creditor is willing to take less than payment in full to get the deal done. 

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