Post Bankruptcy Settlement Proceeds Constitute "Proceeds" of Bank's Prepetition Real Property Collateral

In a significant ruling, the Ninth Circuit Bankruptcy Appellate Panel has clarified that when a bank’s prepetition deed of trust expressly encompasses the right to payment of settlement proceeds for any reduction in the value of the debtor’s real property, the bank’s lien attaches to those proceeds following a bankruptcy filing. This is an important decision, as the court determined that the bank’s lien extended to the postpetition settlement proceeds as “proceeds” of the bank’s real property collateral, thereby providing the bank with its bargained-for protection.

In In re Endresen, the debtors purchased ten investment properties in Portland, Oregon. To purchase the properties, the debtors obtained loans from multiple banks, and secured the loans with deeds of trusts recorded against each of the properties. The deeds of trusts contained terms defining “Miscellaneous Proceeds” to include, without limitation, an award of damages for damage to or destruction of the real property and also provided that all proceeds be assigned and paid to the banks. 

About ten years later, the debtors filed for Chapter 7 bankruptcy and received their discharge. Thereafter, the debtors were added as co-plaintiffs in construction defect litigation pending against the builder of the properties. The bankruptcy court reopened the debtors’ chapter 7 case and their claims were subsequently settled for over $300,000. The chapter 7 trustee argued that the bankruptcy estate had a superior interest in the settlement proceeds due to the general rule that property acquired postpetition by the debtor or the bankruptcy estate is not subject to any lien resulting from a prepetition security agreement. 

The court rejected the trustee’s argument. Relying in part on the above definition of “Miscellaneous Proceeds” in the banks’ deeds of trust, the court determined that if a prepetition security interest encumbers collateral and its proceeds, any proceeds of that prepetition collateral remain subject to the security interest even if those proceeds are received postpetition. 

This is case is very helpful given the surprising lack of prior authority on this issue. Notably, the Bankruptcy Code does not define the term “proceeds”. Thus, in the loan origination phase, banks would be wise to define the term “proceeds” in their security instruments as broadly—and specifically—as possible. Please contact us if you have questions or need assistance with the enforcement of liens on postpetition proceeds of prepetition real property collateral.

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