Maryland Legal Alert for Financial Services

In This Issue:

LENDERS' LIEN HELD TO HAVE PRIORITY IN CONSIGNED GOODS

TEMPORARY ADMINISTRATIVE FREEZE ON CHAPTER 7 DEBTOR'S ACCOUNT DOES NOT VIOLATE AUTOMATIC STAY

THERE APPEARS TO BE INCREASING REGULATORY FOCUS ON THIRD-PARTY RELATIONSHIPS

Lenders' Lien Held to Have Priority in Consigned Goods

In retail bankruptcy cases, disputes occasionally arise between a secured lender and a seller of goods on consignment as to which party has a superior interest in the goods.  In a recent decision, the United States Bankruptcy Court for the District of Delaware discussed the priority issue in great depth and ruled in favor of the lenders in the case. 

A sporting goods and apparel company filed its Chapter 11 case on March 2, 2016. Earlier, in 2006, a group of lenders extended financing to the company and was granted a second lien in inventory that was perfected by the filing of a financing statement. This second lien became a first lien after the first lienholder was paid in full during the company’s bankruptcy proceeding. 

In 2011, a sporting goods manufacturer agreed to sell its goods to the company on consignment. Under the consignment agreement, the manufacturer was entitled to receive 45% of the retail selling price on each sale. The manufacturer did not file a financing statement covering its goods until January 25, 2016. It sent notice of the filing to the predecessor administrative agent for the lending group but did not notify the current agent even though a search of the financing statement records would have disclosed the name and address of the current agent. During the bankruptcy case the Court permitted the company to pay the manufacturer as goods were sold subject to the right of the lenders to seek disgorgement from the manufacturer if the lenders' lien was subsequently held to have priority.

Both the lenders and the manufacturer moved for summary judgment on the lien priority issue. The lenders prevailed in the case as the Court analyzed whether the Uniform Commercial Code filing requirements applied to the arrangement between the company and the manufacturer. Ultimately, the Court decided that the manufacturer did not effectively provide notice of its financing statement to the lenders' administrative agent. Click here for further details on this case and contact Lawrence D. Coppel to discuss.

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Temporary Administrative Freeze on Chapter 7 Debtor's Account Does Not Violate Automatic Stay

A recent decision from the United States District Court for the Southern District of New York offers useful insight for depository institutions seeking to comply with the Bankruptcy Code (Code) when an individual account holder files a Chapter 7 bankruptcy petition. The case concerns a national bank’s internal policy under which the bank places a temporary freeze on Chapter 7 debtors’ accounts on the date of filing if the accounts have an aggregate value exceeding $5,000.00. After the bank freezes the debtors’ accounts, the bank immediately notifies the Chapter 7 trustee of the freeze and requests the trustee’s direction regarding the disposition of the frozen funds. The Court analyzed tension between two sections of the Code to determine if the bank’s freeze in the case violated an automatic stay put in place by a trustee. Ultimately, the Court determined that the bank’s freeze did not violate the automatic stay because the bank did not exert control over the funds during the stay. The Court also determined that the bank was allowed to protect itself by temporarily holding the funds until it received instructions from the trustee. Click here to read about the distinguishing facts of the case and contact Bryan Mull for more details.

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There Appears to Be Increasing Regulatory Focus on Third-Party Relationships

Third-party relationships have been a hot topic for many years for financial institutions, and federal regulators appear to be scrutinizing the potential risks these relationships pose to financial institutions. The Office of the Comptroller of the Currency (OCC) issued third-party risk management guidance in 2013 and frequently asked questions to supplement that guidance in 2017. In April of 2019, the Federal Deposit Insurance Corporation (FDIC) issued a Financial Institution Letter providing examination observations concerning gaps in financial institutions’ contracts with third-party technology service providers. The FDIC guidance concluded that some financial institution “contracts with technology service providers lack sufficient detail regarding contract parties’ respective rights and responsibilities for business continuity and incident response.” The National Credit Union Administration (NCUA) issued specific guidance concerning evaluating and monitoring third-party relationships (particularly where vendors are given access to nonpublic personal information) in a supervisory letter. In a changing world in which businesses rely more and more on cloud-based applications and digitized data, the concerns surrounding vendor relationships are more significant than ever. Please contact Andy Bulgin for further details about this topic.

Contact Andy Bulgin