Priority Lienholder does not Waive Senior Security Interest by Failing to Exercise Remedies Prior to Junior Judgment Creditor Exercising Foreclosure Rights
Article courtesy of Andrew Thomison (of Baker Botts)
In Legacy Bank v. Fab Tech Drilling Equipment, Inc., 566 S.W.3d 922 (Tex. App. 2018), the Texas Court of Appeals (the “Court“), in an issue of first impression in Texas, considered whether the holder of a prior perfected security interest waived its priority right to collateral by failing to declare a default or otherwise take an affirmative action to foreclose on collateral prior to a judgment lien creditor exercising foreclosure rights on the same collateral through garnishment.
In October of 2011, the debtor, Canyon Drilling Company (“Canyon”) executed a promissory note in favor of Legacy Bank (“Legacy”). The note was secured by, among other things, Canyon’s accounts receivable, and Legacy’s security interest was perfected through the filing of a UCC-1. The terms of Canyon’s note provided that Legacy was entitled to “delay or forego enforcing any of its rights or remedies under the Note without losing them”. Canyon and Legacy also executed a lockbox agreement, and Legacy began receiving payments on Canyon’s invoices directly to the lockbox.
In December of 2012, Fab Tech Drilling Equipment, Inc. and Impulse Electric, Ltd. (“Appellees”) obtained a default judgment for unpaid services against Canyon for $1.7 million. Appellees sought to enforce on the judgment by obtaining a writ of garnishment against certain of Canyon’s accounts receivable. Legacy filed a plea of intervention, asserting that it held a properly perfected security interest in such accounts receivable that was superior to Appellees’ judgment lien. The disputed funds were deposited into the registry of the court shortly thereafter. Legacy provided a notice of default against Canyon, but continued to advance funds to Canyon for a period of time before ultimately exercising its foreclosure rights after the note became due in April 2014.
In October 2016, in a trial by jury, the jury determined that Legacy waived its right to recover over the Appellees, and therefore the disputed funds were awarded to the Appellees. Legacy appealed. On appeal, the Court determined that there was no evidence that Legacy waived its security interest by implication, because there was no evidence that Legacy took any action inconsistent with its security documentation, and therefore, there was no evidence supporting the jury’s determination.
In applying principles of garnishment law to the circumstances, the Court noted that Appellees would step into the shoes of Canyon with respect to the disputed funds by virtue of the garnishment, but would acquire no greater rights than Canyon would be able to assert or enforce against Legacy with respect to the continued existence of Legacy’s security interest. Therefore, the UCC would afford Legacy the opportunity to trace and recapture its prior perfected security interest in the garnished funds even though Legacy had not exercised those rights prior to the garnishment. The Court concluded by reversing the trial court’s judgment awarding the disputed funds to the Appellees and awarded the disputed funds to Legacy instead.
