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ABI Bankruptcy Reform

By Randall Klein and Prisca Kim
April 02, 2015

When Congress enacted the 1978 Bankruptcy Code, two competing groups of lawyers and academics squared off: those who favored restructuring opportunities for debtors by restricting the scope of secured lender rights and remedies; and those who favored the expansion and protection of commercial lending laws. ( See Kronman, The Treatment of Security Interests in After-Acquired Property Under the Proposed Bankruptcy Act, 124 U. Pa. L. Rev . 110-111 (1975)). Under state law, a broad security interest could give a secured creditor a lien on all future, after-acquired collateral. But the tension focused on whether to allow a secured creditor to improve its position with new property acquired after the bankruptcy case. The result was the broad mandate of Section 552 of the Bankruptcy Code: A prepetition lender with a lien on an asset enjoys a post-petition lien on the proceeds of that asset.

This rule fit well with the asset-based lending practices in 1978. For example, a prepetition lender's lien on a book publisher's inventory prepetition would continue post-petition with respect to accounts generated from the sale of such inventory and the eventual cash payment when received by the debtor. If that cash was then used to purchase all of the raw materials for the production of new books, the lender's lien would attach to those new books and all of the resulting accounts and cash. However, if that cash was used to purchase only half of the raw materials and the other half was purchased with post-petition trade credit, the proceeds of the finished goods would be allocated based on the “equities” of the case. Thus, because asset-based lending was the predominant form of secured lending in 1978, the Bankruptcy Code requirement for an equitable sharing of proceeds between secured and unsecured components was relatively uncontroversial.

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