In Feresi v. Livery, 2014 LEXIS 1138 (Cal.App. 2d Dist. Dec. 15, 2014), a California court held that equitable principles control over the Uniform Commercial Code’s priority scheme when a creditor breaches its fiduciary duty owed to another creditor.

Mesa and Faresi were husband and wife, respectively.  Feresi obtained a stake in a limited liability company — half of the 25% she owned with Mesa — pursuant to a judgment dissolving the marriage.  The husband granted the wife a lien against his 12.5% interest to secure other obligations related to the divorce.  However, he did not perfect the lien by filing a UCC Financing Statement.  The wife promptly notified the company’s manager of her own 12.5% ownership stake and her lien against her former husband’s 12.5% interest.

Thereafter, the manager made a loan to the husband and took a security interest in his 12.5% interest.  The husband defaulted on his obligations to his former wife, who attempted to foreclose her lien.  When the manager learned of the foreclosure attempt, he filed a UCC Financing Statement to perfect his lien.

The wife’s foreclosure was successful.  The husband later defaulted on his indebtedness to the manager.  The manager claimed a senior lien and attempted to foreclose his lien against the portion of the company now owned by the wife.  Specifically, the manager argued that the wife’s lien was unperfected.

Although the court acknowledged that the manager’s lien was senior to earlier unperfected liens, the UCC provides that that the code is supplemented by principles of law and equity.  Moreover, the court found that the manager owed fiduciary duties to the company’s members (including the wife), and perfecting his lien ahead of the wife without her knowledge breached his fiduciary duties.  Accordingly, the court ruled that the wife holds her membership interest free and clear of the manager’s lien.

This result cuts against the strict, predictable order of priorities under the UCC, and it is sure to cause commercial lawyers significant heartburn.  It is important to note that pursuant to Bankruptcy Code Section 544, an unperfected lien is avoidable regardless of the debtor’s actual knowledge of other liens.

This article was first published on the California Bankruptcy Blog at http://calbk.blogspot.com/2015/01/ucc-lien-priorities-altered-when-one.html

About the author:

Reno F.R. Fernandez III is a partner with Macdonald Fernandez LLP, a bankruptcy, turnaround and insolvency litigation firm with offices in San Francisco and Modesto, California.  Mr. Fernandez is also the chair of BASF’s Commercial Law & Bankruptcy Section. Follow him on Twitter at @CalBKAttorneys