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Court Of Appeals upholds Avoidance Of Preferential Transfer Based Upon Kentucky Supreme Court's Explanation Of Kentucky Law

The United States Court of Appeals for the Sixth Circuit Court recently affirmed a Bankruptcy Appellate Panel that held that a bank which loaned an individual the funds to buy a motor vehicle could not overcome the avoidance of its lien as a preferential transfer after the person filed for bankruptcy. The Court so found because the lien at issue was not perfected under Kentucky law within the time frame necessary to be considered an exception to the avoidance of preferential transfers under the Bankruptcy Code.

In In re Johnson, 611 F.3d 313, 314 (6th Cir. 2010), the Court of Appeals considered a situation where the trustee (the “Trustee”) for the bankruptcy of Michael Johnson attempted to avoid the lien filed by Branch Banking & Trust Company (“BB&T”) on Mr. Johnson’s newly purchased truck. BB&T loaned Mr. Johnson the money to purchase the truck on February 8, 2005. Id. at 314. The company that sold Mr. Johnson the truck mailed the title lien statement, application for certificate of title and the fees for same to the Letcher County Kentucky’s County Clerk’s office. Id. The company did this through certified mail, return receipt requested. Id. The Clerk’s office received the documents on February 22, 2005 but did not indicate the documents had been received by stamping them until March 7, 2005. Id. In addition, the Clerk did not upload BB&T’s lien for recordation until March 7, 2005. Id. Subsequently, the Kentucky Transportation Cabinet issued the certificate of title noting BB&T’s lien of March 7, 2005. Id.

On May 11, 2005, Mr. Johnson filed a petition for bankruptcy under Chapter 7. Id. The Trustee subsequently moved to avoid the lien filed by BB&T under 11 U.S.C. § 547(b). Id. The Trustee did so on the grounds that the lien was a preferential transfer that did not fall within any exceptions under the Bankruptcy Code. Id. The trustee and BB&T filed cross motions for summary judgment and the bankruptcy court granted summary judgment to BB&T. Id. Although the Trustee moved to alter or amend the judgment, the attempts were denied and the Trustee then appealed to the Bankruptcy Appellate Panel (“BAP”). Id.

The BAP disagreed with the bankruptcy judge’s determination that BB&T’s lien was perfected on February 22, 2005 when the Clerk received the documents from the company. Id. at 314–15. The BAP determined that perfection was not made until March 7, 2005. Id. The seeming innocuous difference in the dates of perfection was critical to determine whether BB&T fit into an exception in the Bankruptcy Code that allows creditors to not have their liens avoided as preferential transfers if the creditor was the organization that provided the financing for the purchase of the item at issue. To not have the lien avoided, the creditor’s lien must be perfected within 20 days. 11 U.S.C. § 547(c)(3). In In re Johnson, the time of the receipt of the documents by the Clerk fell within the twenty days, but the time of noting the interest on the title did not.

When applying the exception (known as the “enabling loan exception”), bankruptcy courts look to state law to determine when the perfection of the lien occurred. See In re Johnson, 611 F.3d at 315. Mr. Johnson’s case was complicated by the fact that both BB&T and the Trustee had provisions of Kentucky law that seemed to support their respective positions.

Kentucky Revised Statute § 186A.195(5) indicates that a lien on a motor vehicle may be perfected once it is received by the county clerk, along with the necessary fees. Kentucky Revised Statute §186A.190 states that a lien on a motor vehicle is perfected once it is so noted on the title. Because of the seeming divergence between the statutes, the Sixth Circuit Court of Appeals verified the question to the Kentucky Supreme Court. In re Johnson, 611 F.3d at 315.

Upon its review of the two seeming divergent statutes, the Kentucky Supreme Court determined that the controlling statute was K.R.S. § 186A.190, meaning that perfection does not occur until noted on the title itself. Id. at 315. The Kentucky Supreme Court noted that K.R.S. § 186A.195(5) was to apply to priority between the creditors themselves. Id. As a result, the Trustee was able to avoid BB&T’s lien because the timing of the perfection of BB&T’s lien fell outside of the time allowed for the “enabling loan exception”. Id. at 316.

One of the lessons for lending institutions is to make sure that the paperwork for perfecting automobile liens in Kentucky is transmitted with enough time to be perfected within the 20 day timeframe.

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William T. Repasky practices with the Litigation Department at Frost Brown Todd. He focuses on lending and commercial services; banking litigation and financial institutions.