Bankruptcy/Debtor-Creditor Rights Blog

CHECK YOUR COLLATERAL: NON-POSSESSORY, NON-PURCHASE MONEY SECURITY INTERESTS MAY BE AVOIDED IN BANKRUPTCY

Posted May 18, 2010

Author: Chris A. McNulty

Creditors that have taken collateral that the borrower already owned may want to check their loan documents and see whether the collateral is being used as a “tool of the trade.”  If it is, the creditor may be in an unfortunate position should the borrower file bankruptcy, according to a recent opinion handed down by Judge Ben T. Barry, United States Bankruptcy Judge for the Western District of Arkansas.  Pursuant to 11 U.S.C. § 522(f)(1)(B)(ii), an individual debtor may claim exemptions in certain “tools of the trade” if they are “reasonably necessary to the debtor’s trade or business” and avoid a creditor’s lien to the extent the lien impairs the exemptions. 
 In In re Osborn, Case No. 3:09-bk-73333 (Bankr. W.D. Ark. Oct. 5, 2009), the debtor, a fishing guide who spent from three to seven days a week guiding on the river, filed a Motion to Avoid Nonpossessory Nonpurchase-Money Security Interest (“Motion to Avoid). At the same time the creditor bank filed a Motion for Relief from the Stay and for Abandonment of Property (“Motion for Relief”).  At the hearing, the debtor and the bank stipulated to certain facts: (1) the bank had a valid, perfected security interest in a Nissan Frontier, a Honda ATV, a fishing boat and trailer, a Mercury motor, and a Kubota tractor (collectively, the “collateral”); (2) the bank’s interest was a non-possessory, non-purchase-money security interest; (3) the Bank’s interest had a value of $44,310.60; and (4) if the court found that the collateral were tools of the trade, the debtor had an exemption of $12,105.00 pursuant to 11 U.S.C. §§ 522(d)(5) and (d)(6). 
 Based on testimony of the debtor, the court deemed the Nissan Frontier, the boat, the trailer, and the motor (“exempted collateral”) to be reasonably necessary to the debtor’s business.  The court found that the debtor did not need the Kubota tractor or the ATV for his business and therefore were not tools of his trade.  Thus, the debtor could avoid the bank’s interest in the Nissan, boat, motor, and trailer to the extent the lien impaired the tools of the trade exemptions. The court then heard testimony from the debtor and the bank’s employees as to the fair market value of the exempted collateral, which the court found to be $16,560.00.
 The court then had to determine whether the bank’s lien actually impaired the debtor’s allowed exemptions.  11 U.S.C. § 522(f)(2) gives the formula for determining whether a lien impairs an exemption:
 
a lien shall be considered to impair an exemption to the extent that the sum of (i) the lien; (ii) all other liens on the property; and (iii) the amount of the exemption that the debtor could claim if there were no liens on the property; exceeds the value that the debtor’s interest in the property would have in the absence of any liens. 
11 U.S.C. § 522(f)(2).  The bank’s lien was stipulated to be $44,310.60.  There were no other liens on the property.  The parties also stipulated that the debtor was entitled to an exemption of $12,105.  From this total––$56,415.60—the court subtracted the fair market value of the property if no liens existed––$16,560.00—to calculate how much of the bank’s lien could be avoided: $39,855.60.  Now the bank’s remaining lien on the property was just $4455 ($44,310.60–$39,855.60).

 The bank was saved, however, by their Motion for Relief because the debtor failed to correctly file a statement of intention indicating what he planned to do with the property pursuant to 11 U.S.C. § 362(h)(1).  The debtor filed the requisite statement of intention indicating that he wanted to redeem the property.  Tools of the trade, however, cannot be redeemed—only “tangible personal property intended primarily for personal, family, or household use” can be.  11 U.S.C. § 722.  The court found that although the bank was not entitled to relief from the stay for lack of equity because the debtor now had approximately $12,000 worth of equity in the exempted collateral, it was entitled to relief from the stay for cause because the debtor had failed to abide by 11 U.S.C. § 362(h)(1). 
 Banks should be aware of any loans on their books such as the one to this fishing guide.  Although this situation will mostly like arise with smaller loans to individuals who run their business as a sole proprietor, such as a fishing guide, duck hunting guide, or landscaper, for example, a bank can save itself a lot of money and grief by documenting exactly what collateral is going to be included in the loan and more specifically, whether each piece of collateral is a tool of that borrower’s particular trade. Banks may also consider adding conspicuous waiver language in which a borrower waives its tools of the trade exemptions in bankruptcy, just as many banks currently do with homestead exemptions.  Most states allow homestead waiver exemptions and most likely would do the same with tools of the trade waivers, if challenged.

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