It’s rare to see a judge make a mistake so big that the legislature feels compelled to correct it before the ink has had time to dry on the opinion. But a judge in the bankruptcy court for the Western District of Texas did just that, causing the Texas Legislature to act quickly and decisively to overturn the decision by statute. In late June of this year, Texas enacted Senate Bill 1592 with immediate effect, specifically to correct the error made last November by the judge in interpreting the Texas Motor Vehicle Certificate of Title Statute in the case In re Clark Contracting Services ( 399 B.R. 789, 2008 Bankr. LEXIS 3991 (Bkrtcy. W.D. Tex. Nov. 28, 2008)).
So why did the Legislature feel the need to act with such lightning speed? The judge’s mistaken interpretation of Texas certificate of title law threatened to further limit the availability of vehicle financing in an already tight credit market by depriving vehicle financiers of an important source of funds - asset securitizations. Apparently, the Texas Legislature didn’t think Texas could afford to wait to see if the decision was reversed on appeal.
The situation in the Clark case seemed straightforward. Clark Contracting Services, a construction company, bought six big specialized trucks that happened to need certificates of title under the Texas titling law. CIT Equipment Financing financed Clark’s purchase of the trucks, with the trucks serving as collateral subject to security interest in favor of CIT. CIT appeared as lienholder on the six certificates of title.
About a year later, Wells Fargo Equipment Finance bought the financing contracts from CIT. As part of the deal, Wells Fargo took assignment of CIT’s security interest in the trucks, but did not re-title the vehicles to replace CIT as the noted lienholder on the certificates of title. About a year after that, Clark filed a Chapter 11 bankruptcy.
In the bankruptcy, Clark asked the court to void Wells Fargo’s security interest in the trucks. Clark argued that the Texas titling law required Wells Fargo to re-title the vehicles to show Wells Fargo as the secured party on the title in order for the security interest to remain perfected after the assignment. The bankruptcy judge agreed with Clark, leaving Wells Fargo with no collateral and an unsecured claim in the bankruptcy proceeding.
The judge’s interpretation of Texas certificate of title law on this point exposed the holders of millions of ordinary Texas motor vehicle financing contracts to the risk of having the security interest in the vehicle voided if the customers who owed the money under the contracts filed for bankruptcy protection. Many sales finance companies and banks bundle up the financing contracts they buy from dealers and sell the bundles to a securitization trust. The trust sells securities to investors that represent ownership of a piece of the payment streams due under the bundles of contracts the trust bought. This process, known as “securitization,” is a critically important source for the funds finance companies and banks need to buy more financing contracts from dealers.
As part of the process, the securitization trust takes an assignment of the security interest in the vehicles that serve as collateral for the individual financing contracts in the bundles. In Texas and elsewhere, it is common practice not to re-title the vehicles to show the securitization trust as a new secured party on the title. First, it would be enormously expensive to retitle thousands of vehicles as part of the process. Second, listing the securitization trust on the title would likely confuse the customers who owe the money under these contracts because the finance company or bank usually continues to service the contracts in its own name after they are securitized.
Until the Clark case, nobody other than a few self-interested debtor’s attorneys and bankruptcy trustees interpreted Texas law to require the securitization trust to re-title, and there were rock-solid reasons for interpreting it that way. The Texas Certificate of Title statute stated that a secured party “may” record the assignment, but was silent on what, if any, consequences attached to the failure to do so. The Official Comments to Uniform Commercial Code Section 9-310 provide that when a state certificate of title statute is silent on whether the assignment of security interest must be recorded to continue perfection, a creditor should follow the rule in Section 9-310 for assignments of security interests perfected by filing a financing statement. That section indicates that there is no need to record the assignment. UCC Permanent Editorial Board Commentary 12 thoroughly and exhaustively explains why this is the proper outcome given the relationship between the UCC and the certificate of title laws. The Commentary makes clear that UCC Article 9 only defers to the certificate of title laws to the extent these laws speak specifically to the requirements for continued perfection after security interest is initially perfected by notation on the certificate of title. Otherwise the Article 9 perfection rules govern certificates of title. Unfortunately, the judge in Clark thought he saw a specific requirement in the Texas Certificate of Title statute to re-title after assignment where none existed.
Fortunately, the bankruptcy judge’s interpretation of Texas law was so clearly wrong, the Texas Legislature quickly acted to correct the mistake by enacting Senate Bill 1592. The bill provides that a lienholder may assign a recorded lien without making any filing or giving any notice to the debtor. It further provides that the assigned lien remains valid and perfected and retains its priority. An assignee may, “but need not to retain the validity, perfection, and priority of the lien assigned,” apply for the assignee to be named as the lienholder.” In an apparent effort by the Legislature to ensure the public knows the judge in Clark got it wrong, the Legislature included Section 7 of the bill, which states:
This Act is intended to clarify that under existing law, an assignment of a recorded security interest may be recorded on the title, but does not have to be recorded on the title, to retain the validity, perfection, and priority of the security interest securing the obligation assigned to the assignee.
The bill also adds language to the title statutes governing boats and manufactured homes to accomplish the same purpose.
We understand that Wells Fargo still plans to appeal the Clark decision. Getting the decision overturned would help guard against judges in other states making the same mistake when interpreting certificate of title statutes similar to Texas. However, industry can rest assured that the Texas issue is dead. Wouldn’t it be nice if all bad bankruptcy court decisions had such a happy ending?
Thomas J. Buiteweg is a partner in the Michigan office of Hudson Cook, LLP. Basis Points readers can reach Tom at 734-222-6025 or by email at tbuiteweg@hudco.com.