What Happens When a Secured Creditor Files a Late Claim in an Equity Receivership?

Pitting a receivership court’s inherent equitable powers against pre-existing property rights can lead to some pretty interesting questions.  In SEC v. Wells Fargo Bank, N.A., 848 F.3d 1339, 1343-44 (11th Cir. 2017), the Eleventh Circuit recently examined whether a district court’s inherent authority to establish a claims submission process allowed the court to extinguish a security interest in real property based solely upon an untimely proof of claim.  Much to the relief of secured creditors, the Eleventh Circuit held that the district court erred, as a matter of law, by extinguishing the creditor’s pre-existing property rights under those circumstances.

Introduction

Equity vests a district court with “‘broad powers and wide discretion to determine relief in an equity receivership.’” Wells Fargo, 848 F.3d at 1343-44 (quoting SEC v. Elliot, 953 F.2d 1560, 1566 (11th Cir. 1992)).  These powers include:  (i) establishing procedures for the submission of claims to a receiver, and (ii) setting a claims bar date. Id. at 1344 (citing SEC v. Tipco, Inc., 554 F.2d 710, 711 (5th Cir. 1977)).

The Facts

In the Wells Fargo case, the SEC sought, and obtained, the appointment of a receiver over several entities that perpetrated a failed Ponzi scheme.  Although not a named party to the receivership action, Well Fargo Bank, N.A. (Wells Fargo) held security interests in three properties taken over by the receiver.

After appointing the receiver, the district court entered an order: (i) establishing procedures for submitting claims to the receiver, (ii) setting a deadline for claims submissions, and (iii) barring any claims submitted after the deadline.  In compliance with this order, the receiver mailed a claims packet to Wells Fargo.  Wells Fargo responded, but only identified one of its three secured loans in the claims form.

Approximately a year and a half after the claims deadline expired, Wells Fargo filed a motion arguing either that it did not need to file a proof of claim to preserve its security interests, or alternatively, for leave to file a late proof of claim.  The district court ruled against Wells Fargo, concluding that Wells Fargo failed to preserve its security interests because it failed to comply with the court orders establishing the claims procedure.  Wells Fargo appealed, and the Eleventh Circuit reversed.

Legal Analysis

The Eleventh Circuit began its analysis from the dual premises that “‘security interests in property are determined by state law’” and that “‘a receiver appointed by a federal court takes property subject to all liens, priorities, or privileges existing or accruing under the laws of the state[.]” Wells Fargo, 848 F.3d at 1344 (quoting Burtner v. United States, 440 U.S. 48, 55 (1979) and Marshall v. New York, 254 U.S. 380, 385 (1920)).  From there, the Eleventh Circuit turned to bankruptcy law, which it described as “both analogous and instructive here.” Id.

In bankruptcy, “a secured creditor’s lien remains intact through the bankruptcy, regardless of whether the creditor files a proof of claim.” Id. at 1344 (citing In re Bateman, 331 F.3d 821, 827 (11th Cir. 2003)).  This is true because, “[g]enerally speaking, no other creditor except the lienholder is entitled to any part of the proceeds of property covered by a lien until the lienor is first paid.” Id. at 1345 (quoting Ralph Ewing Clark, A Treatise on the Law and Practice of Receivers, § 646 (3d ed. 1959)).

Thus, the Eleventh Circuit concluded that although a secured creditor may submit a proof of claim (which, in turn, submits the secured creditor to the jurisdiction of the receivership court) to preserve its ability to recover any unsecured portion of its debt from general receivership assets, it need not do so to preserve its right to collect, first, from its collateral.  Specifically, the Eleventh Circuit held that “a federal district court cannot order a secured creditor to either file a proof of claim and submit its claim for determination by the receivership court, or lose its secured state-law property right that existed prior to the receivership.” Id. at 1345.

Take Away Points

If, and how, the broad powers of receivership courts can affect third-parties’ interests often raise difficult questions. The Wells Fargo case answers one of those questions, by holding that secured creditors’ pre-existing security interests should survive a receivership regardless of any court-established claims submission process.

If you are interested in learning more about the compelling area of receivership law, please check out our Receivership Law Handbook.