United States Court of Appeals
For the First Circuit
No. 06-1982
IN RE: CHRISTINE H. LAZARUS,
Debtor.
__________
JOSEPH B. COLLINS, TRUSTEE IN BANKRUPTCY OF CHRISTINE H. LAZARUS,
Appellant,
v.
GREATER ATLANTIC MORTGAGE CORPORATION and
MORTGAGE ELECTRONIC REGISTRATION SYSTEMS, INC.,
Appellees.
APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MASSACHUSETTS
[Hon. Michael A. Ponsor, U.S. District Judge]
Before
Boudin, Chief Judge,
Torruella and Lynch, Circuit Judges.
Steven A. Munson with whom Hendel & Collins, P.C. was on brief
for appellant.
Jennifer Rood with whom Bernstein Shur was on brief for
appellees.
January 9, 2007
BOUDIN, Chief Judge. On August 17, 2001, Christine
Lazarus and her sister purchased real property in Springfield,
Massachusetts--Lazarus' residence--as joint tenants, taking out a
loan secured by a mortgage from Washington Mutual. In a
refinancing on June 22, 2004, both sisters executed a promissory
note, and a mortgage on the property to secure the note, in favor
of Greater Atlantic Mortgage Corporation ("GAMC").1
On July 1, 2004, GAMC paid the funds generated by the
note, in the amount of just over $96,000, to Washington Mutual to
discharge the latter's loan to the sisters and terminate the
latter's mortgage interest. The new mortgage was recorded on July
15, 2004, in the county registry of deeds. The discharge of the
Washington Mutual mortgage was recorded on August 3, 2004. On
September 29, 2004, Lazarus filed for chapter 7 bankruptcy.
In January 2005, the trustee in the Lazarus bankruptcy
case sought to avoid the GAMC mortgage on the ground that it
constituted a preferential transfer of Lazarus' property made
within the 90-day period preceding the filing of the bankruptcy
petition. Under section 547(b) of the Bankruptcy Code, 11 U.S.C.
§ 547(b) (2000):
[T]he trustee may avoid any transfer of
an interest of the debtor in property–-
1
GAMC was represented in the papers by its agent, Mortgage
Electronic Registration Systems, Inc. ("MERS"), but it simplifies
the discussion to treat GAMC as the affected party.
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(1) to or for the benefit of a
creditor;
(2) for or on account of an antecedent
debt owed by the debtor before such transfer
was made;
(3) made while the debtor was
insolvent;
(4)
made--
(A) on or within 90 days before
the date of the filing of the petition; or
(B) . . .
(5) that enables such creditor to
receive more than such creditor would receive
if--
(A) the case were a case under
Chapter 7 of this title;
(B) the transfer had not been
made; and
(C) such creditor received
payment of such debt to the extent provided by
the provisions of this title.
On cross motions for summary judgment, the bankruptcy
judge declined to set aside the mortgage. In re Lazarus, 334 B.R.
542, 553-54 (Bankr. D. Mass. 2005). The judge said that no
creditor could have been prejudiced by GAMC's delay in perfecting
its mortgage because Washington Mutual left its mortgage "on the
books" until after GAMC had recorded its mortgage; thus, the
property never appeared to be unencumbered. The district court
affirmed with a short opinion adopting the reasoning of the
bankruptcy judge.
On this appeal, the trustee claims that the mortgage
should have been set aside, making the secured property or at least
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Lazarus' interest in it–-other than any exempted interest-
–available to all creditors. The issues, matters of law that we
review de novo, In re DN Assocs., 3 F.3d 512, 515 (1st Cir. 1993),
are two: whether there was a preferential transfer under section
547(b) and, if so, whether it was rescued from avoidance by section
547(c), which provides exceptions to section 547(b).
The dispute as to section 547(b) is narrowed by agreement
that the allegedly preferential transfer was of "an interest in
property" (the new mortgage); that it was "to or for the benefit of
a creditor" (GAMC); that the Lazarus note was an "antecedent debt";
that the transfer was made while Lazarus was "insolvent"; and that
it was made within 90 days of Lazarus' later bankruptcy filing.
Further, unless avoided, the mortgage would give GAMC "more than it
would receive" as a general creditor.
GAMC purports to dispute this last proposition by saying
that it would not have made the loan without the mortgage and so no
general creditor was made worse off by the refinancing. This is a
different issue–-a claim of no prejudice–-to which we will return.
But the fact remains that recognizing the mortgage would give GAMC
"more than it would receive" without it, which is why it is
fighting to retain the mortgage.
GAMC's concession that the note was for an antecedent
debt requires somewhat more explanation. Although the note and
mortgage were executed and apparently delivered to GAMC on the same
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day, section 547(e) provides that for real property (with an
exception not here relevant), a "transfer is made" when it occurs
only if the transfer is perfected within 10 days of the actual
transfer; otherwise it is deemed made only "at the time such
transfer is perfected." 11 U.S.C. § 547(e)(2)(A), (B).2
Perfection, in this case, required the filing of the
mortgage with the local registry of deeds. Because this filing
occurred 14 days after the initial transfer of funds, section
547(e) requires that the transfer be deemed to have occurred on the
date of perfection. The mortgage, therefore, secured a debt
antecedent to the transfer rather than simultaneous with it. GAMC
does not dispute this reading of the statute.
What GAMC does seriously dispute is that the transferred
property interest was that "of the debtor." This might seem an odd
position–-after all, Lazarus did grant a mortgage interest in favor
of GAMC in property she co-owned. However, GAMC relies on the so-
called "earmarking doctrine" in contending that the transfer ought
to be viewed in substance as a transfer of the mortgage from
Washington Mutual to GAMC.
Where funds received by the debtor are "earmarked" for
another, courts have sometimes held that the funds are not "really"
2
After the events in this case, the time period was extended
by Congress to 30 days, but the amendment has no effect on this
case. Bankruptcy Abuse Prevention and Consumer Protection Act of
2005, Pub. L. No. 109-8, § 403 (codified at 11 U.S.C. § 547(e)(2)).
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the debtor's property so that the retransfer to the final recipient
is not a preference under section 547(b). E.g., In re Superior
Stamp & Coin Co., 223 F.3d 1004, 1010 (9th Cir. 2000). In the
classic case, one who has guaranteed a debt of the debtor gives the
debtor the funds to pay off the creditor and the debtor does so but
then goes bankrupt shortly thereafter.
Under the earmarking approach, courts view the funds as
transferred by the guarantor to the creditor through, but not by,
the debtor. If the earmarked funds were treated as those of the
debtor, the guarantor's payment could often be recaptured from the
original creditor as an avoidable preference and the guarantor
would then have to pay twice. Further, the earmarking approach
leaves the estate no worse off than it would have been if the
guarantor had advanced nothing to the debtor but paid off the debt
directly.
Most circuits who have spoken have extended this
earmarking concept to situations where a new creditor--not a
guarantor--advances funds to the debtor to pay off debts to other
creditors, substituting itself for the old creditor.3 In the
3
E.g., In re Superior Stamp & Coin Co., 223 F.3d at 1010;
Coral Petroleum, Inc. v. Banque Paribas-London, 797 F.2d 1351, 1356
(5th Cir. 1986). Other circuits have recognized the doctrine.
E.g., In re Kumar Bavishi & Assocs., 906 F.2d 942, 944 (3d Cir.
1990); In re Montgomery, 983 F.2d 1389, 1395 (6th Cir. 1993); In re
Kelton Motors, Inc., 97 F.3d 22, 27 (2d Cir. 1996); In re Bohlen
Enters. Ltd., 859 F.2d 561, 566 (8th Cir. 1988) (recognizing, but
expressing doubts). The decisions require that the new creditor
have an agreement with the debtor to pay off a particular creditor.
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substitute creditor case, as with the guarantor example, the
earmarking doctrine relies on a conceptual view that the payment
passing through the debtor's hands is not his and that he is merely
a kind of bailee.
The bankruptcy judge in this case extended the earmarking
approach to the case before us, concluding that there was
effectively a transfer of a security interest from Washington
Mutual to GAMC without disadvantaging the estate. In re Lazarus,
334 B.R. at 553-54. But use of the earmarking doctrine in this
case is not conceptually similar to the guarantor or new creditor
cases where it could plausibly be argued that there was merely an
arrangement between third parties with no property transfer by the
debtor.
Rather, in refinancing there are multiple transactions,
including a new loan to the debtor, a mortgage back from the debtor
to the new lender, a pre-arranged use of the proceeds of the loan
to pay off the old loan and the release of the old mortgage. Thus,
new proceeds are generated, nominally for the benefit of the
debtor, and the debtor, by making a new mortgage, transfers a
property interest to the new lender.4
2 Collier on Bankruptcy ¶ 547.03, at 547-24 (15th ed. 2006).
4
In this case, the trustee is not seeking to recover for the
estate loan proceeds paid on the debtor's behalf by the new lender
to the original lender--which would confront a number of obstacles-
-but only to address the grant of the new mortgage by the debtor to
the new lender.
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Thus, in this case, Lazarus made a new mortgage in favor
of GAMC, probably on different terms than the original (or there
would have been no benefit to refinancing). Then, when GAMC paid
off Washington Mutual's loan, the latter released its own mortgage.
This did not transfer the old mortgage to GAMC; it merely meant
that GAMC's mortgage was now first in line rather than a
subordinate mortgage. The debtor did not act merely as a bailee
with the mortgage passing through her hands from Washington Mutual
to GAMC.
Thus, the earmarking concept does not provide GAMC an
escape from the plain language of section 547(b) in the case of a
belatedly-perfected transfer of a security interest. Although one
circuit supports the bankruptcy judge's use of the earmarking
doctrine in a like case, In re Heitkamp, 137 F.3d 1087, 1089 (8th
Cir. 1998); see also In re Lee, 339 B.R. 165, 170 (E.D. Mich.
2006), this approach has been justly opposed on the ground that it
amounts to ignoring the statutory language.5 To avoid the
statutory language, GAMC resorts to the underlying policy arguments
ably argued by GAMC's counsel.
GAMC's first point in response is that although formally
the mortgage was given for an antecedent debt, the preexisting
5
E.g., In re Messamore, 250 B.R. 913, 917 (Bankr. S.D. Ill.
2000); In re Shreves, 272 B.R. 614, 625 (Bankr. N.D. W. Va. 2001);
In re Schmiel, 319 B.R. 520, 528 (Bankr. E.D. Mich. 2005). See
generally Rogers, Applicability of the Earmarking Defense to a
Preference Action, 25 Am. Bankr. Inst. J. 20 (May 2006).
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creditors would be in about the same position if no refinancing had
occurred. Nor is there any indication that any new creditor lent
money, during the refinancing, believing that the Washington Mutual
mortgage had been released; indeed, as the bankruptcy judge noted,
the old mortgage was discharged but the discharge was itself not
timely recorded.
Conversely, if the transaction is deemed an avoidable
preference, GAMC will still hold the unpaid note but GAMC seemingly
will lose its status as a secured creditor of Lazarus vis à vis the
other creditors. This may, or may not, be as bad as a guarantor
having to pay twice; but it is certainly a penalty. But the
penalty is not without a general benefit–-pour encourager les
autres–-and is easily avoided by recording within 10 days as the
statute directed.
Probably other creditors were not prejudiced in this
instance; but the formal requirements of section 547 were designed
to work mechanically, avoiding the necessity of demonstrating
prejudice. The Code lays down formal requirements with substantive
consequences. The litigation in this case is one of the costs of
ignoring the statute; the costs would be greatly multiplied if in
each instance inquiry had to be made as to whether or not prejudice
had occurred.
The avoidable preference provision first appeared in the
1898 Code, framed in general terms. A preference was created when
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an insolvent debtor made a transfer within four months of filing
that enabled a creditor to obtain more than the other creditors in
his class. Act of July 1, 1898, ch. 541, § 60, 30 Stat. 544, 562.
Then, after an abortive experiment in 1903, Act of Feb. 5, 1903,
ch. 487, § 13, 32 Stat. 797, 799-800, Congress in 1910 introduced
into the section what was effectively a recording requirement for
mortgages, albeit without a grace period. Act of June 25, 1910,
ch. 412, § 11, 36 Stat. 840, 842.
In 1938, through the Chandler Act, Congress introduced a
more detailed definition of preference, Act of June 22, 1938, ch.
575, § 60, 52 Stat. 840, 869, and in 1950, a 21-day grace period
for perfection was added.6 Act of Mar. 18, 1950, ch. 70, § 1, 64
Stat. 24, 26. The legislative history reveals that this last was
designed to create "an appropriately rigid time limitation." H.R.
Rep. No. 81-1293 (1949). Then, in 1978, the then-new Bankruptcy
Code reduced the time limit for perfection to 10 days, as it
remained during the transactions in this case. Bankruptcy Reform
Act of 1978, Pub. L. No. 109-279, § 547(e)(2).
It is one thing to impose a gloss on the statute, such as
the earmarking doctrine, that achieves formal compliance with the
6
The grace period was added in response to concerns (well-
founded or not) that courts would strictly interpret the concept of
"antecedent debt" without consideration of the necessary lag
between transfer and recording. Morris, Bankruptcy Law Reform:
Preferences, Secret Liens and Floating Liens, 54 Minn. L. Rev. 737,
750-51 (1970)
-10-
statute to rescue a transaction where no prejudice occurred. It is
another to make lack of prejudice itself a substitute for formal
compliance. The history of section 547 just recounted is of
amendments that try to make the statute self-executing to avoid
uncertainty and litigation costs; we will not undo that effort.
GAMC suggests an alternative route to the bankruptcy
judge's outcome. Section 547(b) is itself subject to exceptions
set forth in section 547(c). In particular, section 547(c)(1)
excludes an otherwise avoidable transfer
to the extent that such transfer was—-
(A) intended by the debtor and the creditor to
or for whose benefit such transfer was made to
be a contemporaneous exchange for new value
given to the debtor; and
(B) in fact a substantially contemporaneous
exchange.
The first of these two requirements is arguably
satisfied. The transfer being attacked--Lazarus' grant of a
mortgage to GAMC–-was intended to be a contemporaneous exchange for
new value given to the debtor, namely, the loan to Lazarus from
GAMC used to pay off Lazarus' debt to Washington Mutual. The
question, then, is whether under subsection (B) the exchange was in
fact "substantially contemporaneous."
Because of the failure to perfect within 10 days, we must
(under section 547(e)(2)(B)) treat the property transfer as
occurring on recordation on July 15, 2004; because the debt arose
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earlier–-either on June 22 (when the note was signed) or July 1
(when the funds were disbursed)--it is antecedent but by only two
or three weeks. GAMC says that this is contemporaneous enough; the
trustee, that the 10-day period specified in section 547(e)(2)
should control.
GAMC's plight, although of its own making, invites some
sympathy, especially because there probably was no prejudice to
creditors. At first blush the phrasing of section 547(c)(1)--the
contemporaneous requirement--looks as if it affords us flexibility.
However, the seeming flexibility is deceptive. We conclude that to
expand the 10-day limitation would defy the governing canon of
construction and specifically undercut Congress' purpose.
Section 547(c)(1) was aimed, as its legislative history
shows, at a generic problem: those on the verge of bankruptcy
still need to buy things (e.g., groceries or household items) and
the fact that checks are used (with a brief gap between purchase
and payment) ought not render the payment avoidable as one made for
an antecedent debt. H.R. Rep. No. 95-595, at 373 (1977).
By contrast, section 547(e)'s 10-day limit is directed
specifically to mortgages and applies even if the loan and mortgage
are exchanged simultaneously. Congress' concern, therefore, was
not with whether the exchange was simultaneous or nearly so, but
with getting the mortgage recorded within a reasonably brief and
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predefined period. The aim was to combat secret liens and protect
those who might lend in ignorance of the mortgage.
The House Report on the 1910 amendment, which introduced
the modern perfection requirement, explained: "[A]s to other
creditors and the rest of the outer world, the 'transfer' is . . .
not a complete 'transfer' . . . at all until recording . . . .
[This is] the bottom principle of the right to legislate against
secret liens." H.R. Rep. No. 61-511, at 8 (1910). See generally
Morris, Bankruptcy Law Reform: Preferences, Secret Liens and
Floating Liens, 54 Minn. L. Rev. 737 (1970).7
True, the later 10-day grace period was an arbitrary
compromise--mechanical deadlines almost always are--and can result
in losing security even where no one was prejudiced. But such
deadlines have the benefit of being specific and avoiding
litigation about actual prejudice. This was the approach Congress
chose. To enlarge the 10-day deadline for secured interests is to
undo Congress' choice.
The cases on this precise issue are few and are divided.
One circuit has flatly rejected the attempt to use section
7
In 1973, the Commission assisting Congress in drafting what
would become the 1978 Code, noted that "[o]ne of the essential
features of any bankruptcy law is the inclusion of provisions
designed to invalidate secret transfers." Transmitting a Report of
the Commission on the Bankruptcy Laws of the United States, at 18
(Sept. 6, 1973). See also Weisberg, Commercial Morality, the
Merchant Character, and the History of the Voidable Preference, 39
Stan. L. Rev. 3 (1986).
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547(c)(1) to extend the 10-day period, while another has allowed
such an extension, supported by a summary affirmance in another
circuit of such an extension by a bankruptcy appellate panel where
the delay in perfection was satisfactorily explained.8 But nothing
in the latter two cases does anything to answer our concern that
this is simply an end run around the 10-day limit and so a
disregard of Congress' specific intent.
In statutory construction, the more specific treatment
prevails over the general. United States v. Lara, 181 F.3d 183,
198 (1st Cir. 1999); Diaz v. Cobb, 435 F. Supp. 2d 1206, 1213 n.7
(S.D. Fla. 2006) (lex specialis derogat lex generalis). No direct
conflict is required: the rationale against applying a general
provision in this circumstance is to protect against "undermin[ing]
limitations created by a more specific provision." Varity Corp. v.
Howe, 516 U.S. 489, 511 (1996).
8
Compare In re Arnett, 731 F.2d 358, 364 (6th Cir. 1984), with
In re Dorholt Inc., 224 F.3d 871, 874 (8th Cir. 2000), and In re
Marino, 193 B.R. 907, 915 (B.A.P. 9th Cir. 1996), aff'd, 117 F.3d
1425 (9th Cir. 1997). Yet another circuit decided a similar issue
in the state insurance context (relying on interpretations of the
federal bankruptcy code), Pine Top Ins. Co. v. Bank of Am. Nat'l
Trust and Sav. Ass'n, 969 F.2d 321 (7th Cir. 1992), and its holding
has been expanded by other courts to federal bankruptcy. See In re
McLaughlin, 183 B.R. 171, 175 (Bankr. W.D. Wis. 1995). But see In
re Messamore, 250 B.R. at 920 & n.11 (noting that Pine Top might
not be controlling, but finding a failure to meet even this
flexible standard). In the context of section 547(c)(3), other
circuits have held that section 547(c)(1) cannot be used to give
more flexibility to the limitation given in section 547(c)(3).
See, e.g., In re Davis, 734 F.2d 604, 606-07 (11th Cir. 1984).
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Our case illustrates this warning. Congress has been
laboring for many years to devise and refine a specific, largely
mechanical test to govern security interests in the context of
antecedent debt. The contemporaneousness test was added late in
the day to address a much broader generic problem--ordinary
exchange of goods for check or credit payment--where recording and
other perfection devices do not exist. The test was assuredly not
meant to override the specific 10-day requirement.
The judgment must be vacated and the case remanded for
further proceedings. The parties apparently disagree about the
consequences of triggering section 547(b); but those issues have
not been briefed to this court and must be litigated at the trial
level in the first instance.9 Each side will bear its own costs on
this appeal.
It is so ordered.
9
Seemingly two issues remain to be litigated. 11 U.S.C. §
550(a) states that "to the extent that a transfer is avoided under
section . . . 547 . . ., the trustee may recover, for the benefit
of the estate, the property transferred, or, if the court so
orders, the value of such property." In the bankruptcy court, the
trustee argued for the value of the mortgage to return to the
estate and GAMC argued for the mortgage itself to become property
of the estate. The second issue is that of the debtor's non-debtor
co-mortgagor and the effect her interest has on the avoidance of
the transfer.
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