In re Main Street Business Funding, LLC, No. 23-2430 (3d Cir. Sept. 5, 2024) (Ambro, J.), the Third Circuit confirmed that an all-assets lien that extends to after-acquired property does not extend to a borrower’s commercial tort claims unless described with sufficient particularity under the Uniform Commercial Code (“UCC”). The court also confirmed that commercial tort claims can constitute proceeds of collateral, but that the commercial tort claims here did not constitute proceeds of the loan at issue in the case. 

Background

In Main Street, the lender and borrower entered into a security agreement that granted the lender an all-assets lien in the borrower’s “tangible and intangible personal property . . . ., whether now owned or hereafter acquired . . . ., together with all proceeds thereof . . . .”

Later that year, the borrower filed a suit against a former consultant, alleging that the consultant borrowed money in the borrower’s name without authorization and then embezzled the funds (the “Commercial Tort Litigation”).

Creditors of the borrower, including the lender, filed an involuntary Chapter 7 case against the borrower. Post-petition, the bankruptcy court approved a settlement of the Commercial Tort Litigation and the secured lender filed a motion requesting that the settlement funds be transferred to him as his collateral. The bankruptcy court denied the motion and the district court and Third Circuit affirmed.

Summary of the Law

Article 9 of UCC governs the enforceability of security interests in personal property. 

Section 9-102(13) of the UCC defines a “Commercial tort claim” to mean a “claim arising in tort with respect to which . . . (A) the claimant is an organization; or (B) the claimant is an individual and the claim: (i) arose in the course of the claimant's business or profession; and (ii) does not include damages arising out of personal injury to or the death of an individual.” 

Under Section 9-203(b)(2) and (b)(3)(i) of the UCC, to lien specific property, the debtor must have rights in that property and the security agreement must sufficiently describe it. 

Under Section 9-108(e) of the UCC, a commercial tort claim cannot be described by the type of collateral, but rather, must be described the specific claim with sufficient particularity.

The Bankruptcy Court Found that the Lien Did Not Extend 
to the Commercial Tort Claim Because the Claim Was Not Described “At All”

Pennsylvania law governed the security agreement and the bankruptcy court applied Pennsylvania’s “gist of the action” doctrine, “to determine whether a lawsuit is grounded in tort or contract.” In doing so, the bankruptcy court found that the embezzlement claims within the Commercial Tort Litigation constituted commercial tort claims under the UCC

And because the security agreement “did not describe the underlying claim at all,” the bankruptcy court concluded that the security agreement did not encumber the Commercial Tort Litigation. The Third Circuit found that it was “no doubt understandable” that the security agreement did not describe the commercial tort claims “because the [Commercial Tort] Litigation did not exist at the signing of that agreement.” 

The Secured Lender’s “Novel” “Gist of the Settlement” Argument 

On appeal to the Third Circuit, the lender principally argued that the stolen funds at the heart of the Commercial Tort Litigation constituted the proceeds of his collateral. The Third Circuit rejected this argument because (i) a debtor can only pledge property if the debtor has rights in the collateral; and (ii) the debtor did not have rights in the cash which was stolen prior to entering into the security agreement. 

The Third Circuit distinguished another precedent, which stood for the proposition that “a security interest in collateral also encumbers commercial tort claims that are its proceeds.” In other words, a security interest extends to a commercial tort claim if those claims constitute proceeds of the collateral. 

The Third Circuit found that this Commercial Tort Litigation could not be proceeds of collateral under the security agreement because the commercial tort claims “emanate[d]” from funds that were not subject to the lender’s security interest. Thus, the Commercial Tort Litigation could not “qualify as proceeds of a non-existing security interest.”

Takeaways

Main Street reconfirms that a security agreement must sufficiently describe commercial tort claims to make these claims collateral under a security agreement. The case also reconfirms that a commercial tort claim does not become encumbered under an after-acquired property clause in a security agreement. Nevertheless, commercial tort claims can be encumbered if they constitute proceeds of collateral. Lenders seeking to encumber tort claims as proceeds must draft their security agreements carefully to ensure that proceeds include commercial tort claims.