Citizens Bank and Trust Co. v. Security First Insurance Holdings (In re Brooke Capital Corporation), 588 Fed. Appx. 834 (10th Cir. 2014).
In December 2007, Brooke Capital Corporation (“BCC”) obtained a $12.38 million loan (the “BCA Loan”) from Brooke Capital Advisors (“BCA”), an affiliate of BCC, and a $9 million loan (“Citizens Loan”) from Citizens Bank & Trust Company (“Citizens Bank”). BCC granted BCA a security interest in all of BCC’s “right, title, and interest” in the stock of First Life America Corporation (“FLAC”), a BCC subsidiary. The Citizens Loan was secured by stock in other BCC affiliates, but not in FLAC.
In March 2008, BCA sold fractional interests called “participations” in the BCA Loan to three parties (collectively, the “Participants”) through three separate but nearly identical agreements (“Participation Agreements”). When these Participation Agreements were entered into, each Participant owed an outstanding debt to another BCC affiliate, Aleritas Capital Corporation (“Aleritas”). In connection with each of the Participation Agreements, Aleritas had promised that if BCC or BCA defaulted, the participation amount would be applied to the principal and interest on each respective Participant’s outstanding loan with Aleritas. The Participation Agreements also contained express language purporting to assign BCA’s security interest in the FLAC stock to the Participants by stating: “[a] security interest in the [p]roperty is assigned and sold to [Participant].”
Shortly after executing these two loans transactions, BCC began having financial difficulties. Citizens Bank, BCA and BCC began “workout” discussions on the Citizens Loan. The parties eventually entered into a “Payment Agreement” under which BCA and BCC promised to Citizens Bank that proceeds from a proposed sale of FLAC would be applied to the Citizens Loan after Citizen Bank released its original collateral, even though the Citizens Loan was not originally secured by any interest in FLAC. Citizens Bank and BCA placed the FLAC stock in escrow so that Citizens Bank could perfect the its security interest in the same by control.
By September 2008, BCC filed for bankruptcy. Under the bankruptcy proceedings, the FLAC stock was sold for $2.5 million. Citizens Bank filed a declaratory judgement action in the bankruptcy court to determine priority rights to the FLAC sale proceeds. The primary issue here was whether Citizens Bank had a superior claim in the FLAC stock to that of the Participants.
Under the three Participation Agreements, BCA would make payments to the Participants on a pro-rata basis as BCC made payments on the underlying loan. More importantly, however, the Participation Agreements also required BCA to repurchase the Participants’ interests by a date certain, which ultimately led to a recharacterization by the bankruptcy court of each Participation Agreement as a disguised loan rather than a true participation. The Tenth Circuit upheld this recharacterization, noting that where a participant may receive repayment other than from the underlying borrower (in this case, a repurchase of the participation interests by BCA), courts will generally recharacterize participation interests as loans. Accordingly, the Participants were now creditors of BCA and needed to take additional steps in order to be to perfected in collateral, even though each Participation Agreement contained language of assignment in transferring BCA’s perfected security interest.
This recharacterization from a true participation into a loan ultimately affected how the Tenth Circuit interpreted the assignment provision in the Participation Agreements, as well as how it applied the relevant UCC perfection rules. The court began by noting that upon recharacterization of the transaction, a court must look beyond the language of the relevant agreements in order to determine the true nature of the interests granted. While there was express language of assignment in the Participation Agreements, the true nature of the underlying interests was that each Participant had a loan to BCA and that BCA had a loan to BCC (i.e., separate and distinct loan transactions). As a result, the Participants could not claim automatic perfection under UCC 9-310(c) vis-à-vis the assignment language the Participation Agreements. UCC 9-310(c) provides for automatic perfection where a secured party, like BCA, assigns a perfected security interest. Since UCC 9-310(c) was unavailable to the Participants, they must perfect any security interest by filing a financing statement.
The Tenth Circuit found that the Participants held security interests in a payment intangible of BCA (i.e., BCA’s right to receive payments from BCC under the BCA Loan) and a general intangible of BCA (i.e., BCA’s security interest in the FLAC stock). However, the Participants did not hold a direct security interest in BCC’s ownership of the FLAC stock. Because UCC 9-310(c) was unavailable and the Participants failed to file financing statements, the court concluded that the Participants only held unperfected security interests, which were lower in priority to Citizens Bank’s perfected security interest in the FLAC stock.
