In In re BDC Group, Inc., No. 23-00484, 2024 Bankr. LEXIS 2105 (Bankr. N.D. Iowa), the Iowa bankruptcy court held that a pre-petition lien in “general intangibles” does not give a secured creditor a lien in avoidance actions arising under Chapter 5 of the Bankruptcy Code, such as preference and fraudulent transfer causes of action. 

Background

Pre-petition, the debtor executed multiple security agreements in favor of the secured creditor, granting a lien on the debtor’s “general intangibles.” After the debtor filed for bankruptcy, the secured creditor timely filed a proof of claim and filed a motion to recognize its security interests in the debtor’s Chapter 5 avoidance actions and proceeds based on the debtor’s pledge of its general intangibles.

The official committee of unsecured creditors objected and argued that there was no legal basis for the secured creditor’s security interests to reach the Chapter 5 claims because the claims only came into being upon the commencement of the bankruptcy case. Following the conversion of the bankruptcy case from Chapter 11 to Chapter 7, the Chapter 7 trustee adopted the position of the committee. 

The bankruptcy court granted summary judgment in favor of the Chapter 7 trustee, holding that, as a matter of law, the secured creditor’s lien on general intangibles did not extend to the Chapter 5 claims.

Avoidance Actions Are Considered After-Acquired Property 
That Are Not Subject to Pre-Petition Liens

The bankruptcy court first recognized well-established case law holding that Chapter 5 claims are “after acquired property.” 

Section 552 of the Bankruptcy Code draws a distinction between “after acquired property” (which is not subject to a pre-petition lien) and “proceeds” of pre-petition property (which are subject to the pre-petition lien). 

Under Section 552(a) of the Bankruptcy Code, “property acquired by the estate or by the debtor after the commencement of the case”—i.e., “after-acquired property”—is “not subject to any lien resulting from any security agreement entered into by the debtor before the commencement of the case.” However, under Section 552(b), a security interest may extend to proceeds of the property acquired by a debtor post-petition. 

The bankruptcy court cited multiple sources, finding that avoidance actions constitute after-acquired property, to which pre-petition liens do not attach: 

• “Avoidance actions, including those arising under state law, can only be brought by the trustee after the petition is filed under the trustee’s section 5[4]4(b) rights. These claims, therefore, arise post-petition and must be considered after-acquired property belonging to the estate.”
• “Because the Debtor does not own the right to pursue a fraudulent transfer action in bankruptcy (since that action belongs to the trustee post-petition under section 544(b)), the Debtor could not have encumbered or assigned that right prepetition.” 
• “Once a bankruptcy case commences, . . . all recoveries under the avoiding powers are property of the estate, administered almost exclusively by the trustee for the benefit of the estate as a whole rather than for any creditor individually, it is difficult to see how such recoveries can be other than ‘after-acquired property’ within the meaning of section 552(a) . . .” 

A Debtor’s Inchoate Interest in Avoidance Actions 
Does Not Permit a Lien to Attach to These Claims

The bankruptcy then rejected the secured creditor’s argument that the Eighth Circuit’s recent decision in Pitman Farms v. ARKK Food Co. (In re Simply Essentials), 78 F.4th 1006 (8th Cir. 2023) somehow overruled prior established case law. 

The bankruptcy court summarized Simply Essentials as holding that a debtor “has an inchoate interest in . . . avoidance actions prior to the commencement of the bankruptcy proceedings” because a debtor has the right to file for bankruptcy and only the debtor in possession or trustee may file the avoidance actions to recover property for the benefit of the estate. 

The secured creditor argued that this “inchoate interest” permitted its pre-petition lien to attach to the post-petition avoidance action claims. The bankruptcy court dismissed this argument as the secured creditor “read[ing] far too much” into Simply Essentials and concluded that “[n]owhere does Simply Essentials say Debtor’s pre-petition inchoate right extends to or matures into the Debtor’s right to recovery of the value of avoidance.”

Thus, the bankruptcy court explained that Simply Essentials limited a debtor’s rights in avoidance actions “to the act of filing the bankruptcy” and after the debtor files, that inchoate right “is limited to the remote right to participate in a distribution if enough recovery is made that all creditors are paid in full.” However, these bundle of rights did translate to a debtor having the right to recovery on the avoidance actions.    

The bankruptcy court further buttressed its conclusion by observing “if bankruptcy was never filed,” the secured creditor would have collected “nothing” on the avoidance actions because “[t]he inchoate property rights Debtor had pre-petition never encompassed—nor could they ever encompass—any collectible value outside bankruptcy.”

Additionally, the bankruptcy court observed that the secured creditor’s position “would entirely undermine” Simply Essentials’ holding that “avoidance actions are property of the estate that the trustee can sell ‘for the benefit of the estate’” (emphasis added). Treating avoidance actions “as a single creditor's collateral” would preclude selling avoidance actions for the benefit of the estate “because a pre-petition creditor could lock them up for its sole benefit.” 

Conclusion

In re BDC Group, Inc. affirms established precedent that the grant of a lien in general intangibles does not create a valid lien on post-petition avoidance actions. Further developments in the law, and perhaps a different set of facts, will determine if secured creditors are able to successfully draft workarounds to this outcome.