Prioritizing Creditors: The Doctrine of Equitable Marshaling

Prioritizing Creditors: The Doctrine of Equitable Marshaling


Under Article 9 (Secured Transactions) of the Uniform Commercial Code, the default rule for priority among secured creditors is the first-to-file-or-perfect. U.C.C. § 9-322 (a)(1) (Official Text 2009). In other words, the secured party that first files a financing statement in the public records or otherwise perfects has priority over a later secured party. This priority rule, of course, encourages secured creditors to file their financing statements as quickly as possible, thereby giving notice to the world of their security interests. In a recent bankruptcy case, a secured party that failed to file its financing statement in a timely manner was forced to resort to the doctrine of equitable marshaling to shore up its position. Illini Bank v. Clark (In re Snyder), 2010 Bankr. LEXIS 2626 (Bankr. C.D. Ill. Aug. 25, 2010). Although the court's application of equitable marshaling allowed the secured party to recover something from its collateral, a prompt filing would have given it the undisputed senior position.

In Snyder, the debtors, a married couple operating a family farm, had three secured creditors: Tri Ag, Ag-Land, and Illini Bank. In 2002 the debtors borrowed $129,544 from Tri Ag on an unsecured basis. On February 10, 2006, the husband debtor alone executed a security agreement granting Tri Ag a security interest in all crops grown on certain land farmed by the debtors. Tri Ag, however, did not file a financing statement perfecting its security interest until April 7, 2006. In re Snyder, 2010 Bank. LEXIS 2626, at *3-4. Earlier on February 27, 2006, a second lender, Ag-Land, had filed a financing statement covering the debtors' crops and equipment and naming both Ray and Gloria Snyder as the debtors. Ag-Land advanced $250,000 to the debtors between 2006 and 2009 and had the both debtors sign various security agreements and promissory notes. 2010 Bankr. LEXIS 2626, at *4-5. Finally, in 2007, the debtors borrowed close to $700,000 from a third lender, Illini Bank, secured by a security interest in the debtors' crops, machinery and equipment, and other items. Illini Bank filed a financing statement naming both debtors with the Illinois Secretary of State. 2010 Bankr. LEXIS 2626, at *5.

On April 15, 2009, the debtors filed a Chapter 12 petition in bankruptcy and three months later filed a Chapter 12 Plan of Reorganization under which they proposed to pay Illini all of the crop proceeds from 2008 and 2009. In re Snyder, 2010 Bank. LEXIS 2626, at *3, 7. Illini Bank had acquired the first priority position by buying Ag-Land's claim on June 17, 2009. 2010 Bankr. LEXIS 2626, at *6. Tri Ag, the chronologically second secured party, filed a motion for summary judgment, arguing that the court should apply the doctrine of equitable marshaling to force Illini Bank to seek recovery of its loans first from the debtors' equipment, in which Tri Ag had no security interest, before resorting to the crop proceeds, in which both Illini Bank and Tri Ag held security interests. 2010 Bankr. LEXIS 2626, at *1, 7-8.

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