Compliance Bulletin

Court Decision Raises Stakes For Secured Creditors
June 8, 2009

This Legal Bulletin was prepared for CBA by Peter Munoz [1] of the law firm of Reed Smith. Peter is a member of CBA’s Legal Affairs Committee.

The recent court decision in Franke v. BAM Building Company, 172 Cal. App. 4th 224; 91 Cal. Rptr. 3d 212 (2d Dist. March 17, 2009) highlights the risk that a levying creditor faces when levying on assets that are encumbered by a prior lien. In brief, the decision holds that a levying creditor who supplies a bond as an undertaking in connection with a levy on an asset is liable for all damages incurred by the secured creditor even in excess of the amount of the bond and in excess of the amount of the levying creditor’s claim. The decision could also raise the risks to a secured creditor whose lien is not properly perfected and who challenges the lien of the levying creditor.

Background

BAM Building (“BAM”) was a creditor to C.W and Marlene Wilburn (the “Wilburns”). The Wilburns, through a compromise, had an unsecured claim against a company that was in bankruptcy (“Bankruptcy Claim”). Nicholas Franke (“Franke”) had been the attorney for the Wilburns and claimed that he had been given a lien on the Bankruptcy Claim to secure his fees.

BAM sought to attach any distribution which would be paid on the Bankruptcy Claim and obtained a writ of execution against the Wilburns in the Municipal Court for any distribution paid on the Bankruptcy Claim (“Wilburn Distribution”). The writ of execution was served on the Bankruptcy Trustee (“Trustee”).

To protect his lien, Franke the attorney filed a third-party claim asserting a senior lien on the Wilburn Distribution. In reply pursuant to CCP 720.260, BAM filed an undertaking in the sum of $2,500 to indemnify Franke against any losses he might incur by reason of the enforcement. Franke offered his own undertaking in the same sum to indemnify BAM under CCP 720.630.

Franke disputed the priority in which the Trustee intended to make the distribution and moved in the Municipal Court for an order recognizing his senior claim to the Wilburn Distribution and to require BAM to indemnify Frank for any losses incurred.

After several rulings among the Municipal Court, Bankruptcy Court, and the Bankruptcy Appellate Panel over the relative priority as between BAM the levying creditor and Franke the secured creditor, the Bankruptcy Court ruled in favor of Franke and ordered that the Trustee pay to Franke the full amount of the Wilburn Distribution. Franke then filed a separate action in the Municipal Court against BAM under CCP 996.430(a) to collect his losses incurred as a result of BAM’s enforcement actions.

The Municipal Court ruled in favor of Franke and awarded him all the losses he requested: (i) attorneys fees incurred in the Bankruptcy Court; (ii) the reduction in the Wilburn Distribution which was attributable to the legal fees incurred by the Trustee in handling BAM’s claim to the Wilburn Distribution; (iii) compensation for the delay in receiving his distribution; (iv) pre-judgment interest incurred from the date of the undertaking; and (v) attorneys fees incurred by Franke in the Municipal Court action on the undertaking. In the aggregate, these amounts far exceeded the amount of BAM’s undertaking.

BAM appealed on a number of grounds including (i) that the losses should have been capped at the amount of the undertaking; (ii) that Franke’s lien was invalid, and since BAM did not receive the distribution from the Bankruptcy Court there could not have been an improper levy; (iii) Franke was not entitled to be awarded his losses since he failed to pursue his original claim in the Municipal Court; and (iv) Franke’s losses should be limited to the fees incurred in the Municipal Court.

Appellate Decision

The Appellate Court upheld the damages except for the award of attorneys fees incurred in the Municipal Court action. The Appellate Court ruled:

  • The losses were not capped at the amount of the $2,500 bond issued under CCP 720.260. It includes all losses incurred by Franke except as otherwise expressly provided by statute.
  • Franke incurred losses as a result of BAM’s efforts to levy execution regardless of the fact that BAM did not receive all of the amounts owed on the Wilburn Distribution from the Trustee.
  • Franke’s failure to obtain a determination liability on the undertaking in the Municipal Court did not discharge the surety; Franke could file a separate action for BAM’s liability on the undertaking.
  • Four of the five of Franke’s monetary claims were affirmed, all except the attorneys fees in the action on the undertaking since the undertaking did not expressly provide for recovery of attorneys fees.

Conclusions

The Franke decision has a significant impact on any dispute between a secured creditor and a levying creditor. First and most important, it emphasizes that the levying creditor, by providing the undertaking, becomes liable for all losses incurred by the secured creditor. Many attorneys who practice in this area mistakenly believe that the losses are capped at the amount of the undertaking.

Second, the decision makes it clear that the losses that can be recovered from the levying creditor can exceed the amount in dispute and the amount of the levying creditor’s claim.

Third the recoverable losses can include attorneys fees in a related action and, if the undertaking so provides, can include attorneys fees in the underlying action on the bond. The recoverable losses can also include the time-value of money, interest on any liquidated sum and all other reasonably calculated losses.

The possibility of such significant losses will act as a deterrent against any levying creditor who seeks to levy on a secured creditor’s collateral assets unless the levying creditor is certain of the priority of its levying lien.

On the other hand, the same law that applies to a levying creditor who submits an undertaking will apply just as well to a secured creditor who submits an undertaking when it asserts a third party claim to its collateral (to prevent it from being levied upon). If for any reason the secured party’s claim is defeated, the levying creditor will be entitled to recover all losses the levying creditor incurs in connection with the secured creditor’s assertion of the third party claim.

In short, the Franke decision “raises the stakes” for both the levying creditor and the secured creditor in a dispute over the attachment on the collateral.

  1. Mr. Munoz may be reached at (415) 543-8700.

The information contained in this CBA Regulatory Compliance Bulletin is not intended to constitute, and should not be received as, legal advice. Please consult with your counsel for more detailed information applicable to your institution.

© This CBA Regulatory Compliance Bulletin is copyrighted by the California Bankers Association, and may not be reproduced or distributed without the prior written consent of CBA.

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