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Impact of Chapter 11 Bankruptcy on Liens

In the Chapter 11 bankruptcy case of Acceptance Loan Company, Inc. v. S. White Transportation, Inc., the Fifth Circuit recently held that a secured creditor’s lien remained in place after the confirmation of the debtor’s plan, despite the fact that the secured creditor received bankruptcy notices and took no action to protect its interest until after the plan was confirmed.

Generally under the Bankruptcy Code, after the confirmation of a Chapter 11 plan, any property “dealt with” by the plan is free of liens, unless the liens are preserved by the plan. Courts have previously clarified that in order for a lien to be voided, the secured creditor must have “participated” in the bankruptcy case. Many courts have indicated that simply receiving notice of a plan and having the opportunity to object is sufficient participation to void a secured creditor’s lien. Thus, a bank with a lien is generally advised to actively participate in the bankruptcy case by, for example, filing a proof of claim, voting on plan confirmation, and taking other appropriate actions.

Conversely, the Fifth Circuit determined that the mere receipt of notices was insufficient to constitute participation. The Fifth Circuit’s decision essentially allowed the secured creditor to ignore a Chapter 11 case with no repercussions. While this holding raises hope for those banks that inadvertently miss deadlines or otherwise fail to take appropriate action, it also raises concerns for those banks that do actively participate in the bankruptcy process. The holding raises the possibility that liens purportedly voided under a plan might later be deemed valid, which in turn causes uncertainty for all parties.

Though it is unclear whether the Fifth Circuit’s approach will be widely followed, the case serves as an important reminder that a Chapter 11 bankruptcy can significantly impact the rights of secured parties, including banks. Banks should take this opportunity to reevaluate internal procedures for responding to the receipt of a bankruptcy notice. Because no two debtors or bankruptcy cases are identical, we recommend seeking legal advice each time a notice is received.