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Sachs v. Jefferson Loan Company

A-2897-09T3 (N.J. Super. App. Div. 2010) (Unpublished)

LOAN; LIENS; BANK ACCOUNTS — When a bank is both the secured lender and holds a security interest in its borrower’s bank account at that same bank, it may, to the possible detriment of inferior secured creditors, allow the borrower to withdraw money from that account solely for the purpose of preserving the collateral and to realize on the value of additional collateral, such as to collect outstanding accounts receivable that would, if successful, enlarge the total amount of money available to pay all secured creditors.

A company was in the business of making auto and other consumer loans. It financed its operations by issuing debentures to investors, and also by way of a secured bank line of credit. The debentures were bonds backed only by the company’s general credit and its financial reputation. They were not backed by a lien on the company’s asserts. A creditor holding five debentures sought to recover its investment after the company notified him that it was ceasing its operations and would be liquidated. At the time, the company owed its secured bank lender millions of dollars on the line of credit. It negotiated an agreement with its bank to allow its debenture holders to share equally in the company’s revenues once the bank was paid $3.5 million on its secured debt. Even though the company was no longer engaged in new business, it continued to collect revenues from loans and from other debts owed to it by third parties.

The debenture holder pursued two avenues of potential recovery – a levy upon proceeds held by a law firm retained to collect sums owed to the company by third parties, and a levy on the company’s bank account which had been established with the same secured creditor. The bank had filed a UCC-1 financing statement to perfect its secured interest. The lower court vacated the debenture holder’s levy on the proceeds held by the law firm and denied turnover of those funds. It concluded that the money held by the law firm was subject to the UCC-1 filed by the bank, as a secured creditor, and that the bank held a superior interest to the creditor’s judgment lien.

After this unsuccessful attempt, the debenture holder tried to obtain recovery from funds in the company’s bank account at the secured creditor’s bank, and alternatively sought an order directing the bank to turn over those funds and to direct the company to make monthly installment payments until the creditor’s judgment was satisfied. The debenture holder did not file or serve any pleading against the bank naming it as a party and did not assert any specific claims or allegations against the bank. It conducted limited discovery concerning the account, and found that the bank had let the company pay more than $100,000 out of the account to various parties. The debenture holder argued that the bank waived its asserted priority position as a secured creditor by allowing these withdrawals. The company presented a certification from its bank stating that the bank had only allowed the company to use the account to pay expenses associated with the collection of accounts where the proceeds collected served to reduce the amount owed to the bank. The certification did not explain how the disbursements in question satisfied this condition as legitimate expenses associated with the collection of accounts.

The lower court denied relief to the debenture holder, again simply asserting that the bank held a superior creditor interest. It understood the concerns raised by the debenture holder about the bank allowing the debtor to draw from its deposit account, but found it significant that the debenture holder did not name the bank as a party or bring specific claims against the bank. The debenture holder appealed. At the time of appeal, the debtor still owed the bank five million dollars, and the bank’s recovery apparently had not yet reached the negotiated threshold for the equal sharing of revenues with the debenture holders.

In the appeal, the Appellate Division remanded the matter for further proceedings, finding that the bank’s superior position as a secured creditor to that of the debenture holder arose in a special context, one under which the debtor maintained a deposit account at the bank that was also its secured creditor. According to the Court, a bank is authorized to allow a depositor, against whose accounts it has a secured interest as a creditor, to use the funds on deposit for reasonable business purposes in order to preserve the collateral of the debtor, but the Court found the lower court did not make any specific findings concerning the propriety of these specific disbursements or whether they were made appropriately to preserve the collateral so that the debtor could continue to recover additional revenues and wind up its affairs. In its remand, the Court also agreed with the lower court’s suggestion that the debenture holder file an appropriate pleading to make the bank a party if the debenture holder intended to persist in making specific allegations about the mishandling of funds. Lastly, the Court directed the lower court to use its discretion to permit further discovery that might be warranted concerning the debtor’s bank account.

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