In Wheeling & Lake Erie Railway Co. v. Keach (In re Montreal, Maine & Atlantic Railway, Ltd), __F3d__, 2015 WL 4934212 (1st Cir. August 19, 2015), a case of first impression at the appellate level, the US Court of Appeals for the First Circuit, applying Maine law, held that a lender’s financing statement covering “ inventory, accounts and payment intangibles (as those terms are defined in the Uniform Commercial Code)”, together with proceeds including insurance proceeds, did not perfect a security interest in the borrower’s recovery of $3.8 million under a business interruption insurance policy. The court’s ruling was based on the fact that UCC Article 9, in Maine, excludes from its scope the granting of a lien on an insurance policy except for a lien on healthcare insurance receivables. As a result of the ruling, the borrower’s bankruptcy trustee was permitted to retain the full amount of the recovery free and clear of Wheeling’s lien.
For reasons unknown, Wheeling did not argue that the borrower’s right to payment was a proceed of an account or payment intangible. Support for this argument is found in an unpublished decision, MNC Commercial Corp. v. Rouse, 1992 WL 674733 (W.D. Mo. December 15, 1992), where the district court held that, under Missouri law, a recovery under a business interruption insurance policy was a “proceed” of the lender’s collateral because the lender held a perfected lien in the debtor’s income (i.e. its accounts, general intangibles). As a result, the court ruled that the lien could be perfected by the filing of a financing statement under Article 9. However, Wheeling argued that the policy was its primary collateral, as opposed to a proceed of accounts and intangibles.
Left open by the First Circuit was the issue of what steps must be taken to perfect a security interest in a payment right under an insurance policy which is not a health care insurance policy. The court stated that since there was no applicable statute, Maine’s common law would apply. Although declining to answer the question definitively, the court ruled that the lender’s mere filing of a financing statement describing its collateral as accounts and payment intangibles was insufficient, and that Maine’s highest court would require “some additional step, designed to furnish fair notice to other creditors…” Id. at *9. The court noted that under pre-UCC law, a creditor could perfect its lien in a chattel mortgage by possession but went on to acknowledge that where a payment right is involved, possession is an impractical manner of perfection. Id. at *8. In a footnote to its opinion, the court also noted that the lender could have informed the insurer of the lender’s interest and taken a direct assignment, or require the debtor to name it as a loss payee under the policy. Id. at *9 n.6.
The Wheeling decision has created uncertainty as to how to perfect a lien in a payment right under an insurance policy. Most jurisdictions, including Maryland (Md. Ann. Code, Com. Law § 9-109(d)(8)), exclude a security interest in an insurance policy from Article 9 (except for a lien on healthcare insurance receivables). Except for a provision in the Insurance Article governing liens in insurance premium financing contracts (Ins. § 23-310), there is no Maryland statute concerning the perfection of a lien in an insurance policy, or payment right thereunder, and no dispositive case law. In the case of casualty insurance, the practice of lenders is for the lender to require the borrower to have the lender named as a loss payee, and to have the declarations page note the lender’s interest. In the case of life insurance (including key man insurance), lenders usually take an assignment of the policy and record the assignment with the insurance carrier. Whether these steps are sufficient for perfection purposes is unclear as a result of the Wheeling decision since such actions do not provide “fair notice to other creditors”. As a result, notwithstanding the exclusion of most insurance policies from the scope of Article 9, a lender should consider filing a financing statement that specifically refers to the policy or payment right to which the lien will attach in order to provide “fair notice to other creditors."