Maryland Legal Alert for Financial Services

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Maryland Legal Alert - October 2019

IN THIS ISSUE:

SMALL BUSINESS REORGANIZATION ACT OF 2019 BALANCES THE INTERESTS OF DEBTORS AND CREDITORS

CHANGES TO MARYLAND MORTGAGE LENDER REGULATION

LOANS SECURED BY BITCOIN

PROPOSED GARNISHMENT RULE CHANGES AUTHORIZE GARNISHEES TO TERMINATE STAGNANT GARNISHMENTS

THIRD CIRCUIT RULES THAT A TAX SALE MAY BE AVOIDED AS A PREFERENCE

Small Business Reorganization Act of 2019 Balances the Interests of Debtors and Creditors

On August 23, 2019, the President signed into law the Small Business Reorganization Act of 2019 (“SBRA”). The SBRA, which becomes effective on February 19, 2020, adds new Subchapter V to Chapter 11 of the Bankruptcy Code.  The SBRA will apply to a “small business debtor,” which is defined as an individual, corporation, partnership and limited liability company that has no more than $2,725,000 of non-contingent liquidated secured and unsecured debt of which at least 50% arose from commercial or business activities.  A small business debtor must elect to proceed under Subchapter V when it files its Chapter 11 case. Upon filing, the court will appoint a Subchapter V trustee to oversee the case in manner similar to a Chapter 13 trustee.

The SBRA requires that a small business debtor proceeding under Subchapter V must file its plan within 90 days after starting its case. In exchange for this accelerated timeframe, a small business debtor’s plan will not need to comply with the “absolute priority rule,” which requires that if equity holders in a debtor wish to retain their equity interests under a plan of reorganization, unsecured creditors must be paid in full or the equity holders must make a meaningful financial contribution to the plan from personal or nondebtor assets. Instead, a small business debtor must distribute all of its “projected distributable income” over a three to five year period. 

Click here to learn more about the SBRA and its implications, including its amendments to the preference claim section of the Bankruptcy Code.

Practice Pointer: While the enactment of the SBRA will make it more difficult for unsecured creditors to block the confirmation of a small business debtor’s plan under Subchapter V, the appointment of a trustee and the expedited time frame for the filing of a Chapter 11 plan should benefit creditors.  Many of the small business cases that are being filed today are by debtors that lack sufficient capital and/or are poorly managed. Subchapter V will not help a business that cannot survive under any circumstance. The requirements imposed by the SBRA should result in a more expeditious resolution of the Chapter 11 case than exists today.  

Contact Lawrence Coppel | lcoppel@gfrlaw.com | 410-576-4238

Changes to Maryland Mortgage Lender Regulation

On September 13, 2019, the Commissioner of Financial Regulation adopted amendments to regulations that apply to licensed Maryland “mortgage lenders.” These changes were first proposed on March 1, 2019 and, as adopted by the Commissioner, become effective on October 4, 2019. Please see our special Legal Alert concerning these changes. 

Practice Pointer: The new regulations apply to licensed “mortgage lenders” (as defined in Md. Code Ann., Fin. Inst. 11-501). Maryland-chartered banks and out-of-state banks that maintain a deposit-taking branch in Maryland are not subject to the new regulations. Out-of-state banks with no deposit-taking branches in Maryland that engage in mortgage lending should carefully review the new regulations.

Contact Andy Bulgin | abulgin@gfrlaw.com | 410-576-4280
Contact Christopher Rahl | crahl@gfrlaw.com | 410-576-4222

Loans Secured by Bitcoin

As the interest in cryptocurrency continues to increase, our financial institution clients have been asking about making loans secured by Bitcoin.  Clients periodically ask if and how a loan can be properly secured where a cryptocurrency asset like Bitcoin is the collateral.  

Lenders often wrestle with just what Bitcoin is and whether they need to focus on Article 8 or Article 9 under the Uniform Commercial Code (UCC).  Under Article 9, Bitcoin likely falls into the “general intangible” definition, but treating Bitcoin as a general intangible is a risky proposition for a lender.  That is, the filing of a financing statement (the means of perfecting a security interest in a general intangible) will not prevent those holding the digital keys to specific Bitcoin from transferring that Bitcoin to others.  Bitcoin can fit the definition of “investment property” under UCC Article 8, which includes a “securities account”. Under UCC Article 8, a “securities account” is an account where a “financial asset” is or can be credited and “financial asset” in turn, includes property that is held by a securities intermediary for another in a securities account (so long as the parties have agreed to treat the underlying asset as a “financial asset” under UCC Article 8). 

One viable structure under the UCC to make a loan secured by Bitcoin is to require the borrower to establish a digital wallet with a third party wallet provider who will agree to hold the Bitcoin under a control agreement with the lender. The third party wallet provider would issue three digital keys (one held by each party to the control agreement) to the digital wallet, and Bitcoin in the digital wallet would only be subject to transfer from the digital wallet if two of the three keys were used. The control agreement between the borrower, lender, and third party wallet provider would set forth the circumstances under which the borrower is permitted to access the Bitcoin and what events constitute a default entitling the lender to use its digital key (along with the digital key held by the wallet provider) to effect a sale or transfer of the underlying Bitcoin. 

Click here to learn more about the unique challenges in using Bitcoin as collateral. 

Practice Pointer: As Bitcoin and other cryptocurrencies grow more prevalent, lenders should acquaint themselves with how these assets function and how they fit within existing legal frameworks. A lender seeking to use Bitcoin as collateral should consider employing a control agreement/digital wallet strategy to ensure that the asset does not dissipate without its knowledge. In any event, because of the volatility of Bitcoin, lenders should only consider virtual currency for significantly lower LTV loans and smaller loan sizes. 

Contact Christopher Rahl | crahl@gfrlaw.com | 410-576-4222

Proposed Garnishment Rule Changes Authorize Garnishees to Terminate Stagnant Garnishments

Under existing Maryland garnishment rules, after a depository institution is served with a writ of garnishment, the garnishee must maintain a hold on the judgment debtor’s accounts until further order of court. Typically, when a garnishee is holding funds of the judgment debtor, the garnishment is resolved in one of two ways: (i) the judgment creditor seeks disbursement of the garnished funds, or (ii) the judgment debtor seeks release of the account from garnishment. Often, however, neither party takes action to resolve the garnishment, leaving the garnishee depository institution stuck holding accounts indefinitely.

Recently, the Standing Committee on Rules of Practice and Procedure (the “Committee”) issued a Notice of Proposed Rule Changes in which the Committee proposed amendments to the garnishment rules to help garnishees address the problem of stagnant garnishments. The Committee proposed identical amendments to Maryland Rules 2-645 (covering Circuit Court garnishments) and 3-645 (covering District Court garnishments), which provide that if a garnishee files an answer and no further filings are made in response within 120 days, the garnishee may serve a notice of intent to terminate the garnishment. The notice provides parties 30 days to object to the termination of the garnishment, failing which the garnishee may file a termination of garnishment, which releases the garnishee from any further obligation to hold the judgment debtor’s funds.

Practice Pointer: These proposed rule changes should bring much needed clarity and finality to the garnishment process for garnishees. Instead of suffering through indefinite account holds, garnishees may seek termination of the writ, which should either prompt the parties to act or relieve the garnishee from the burden of continued compliance with the writ. Interested parties have until October 15, 2019 to submit comment on the proposed rule changes. We anticipate that the Court of Appeals will consider the proposed rule changes in mid-November and we will continue to monitor the status of these rule changes.

Contact Bryan Mull | bmull@gfrlaw.com | 410-576-4227

Third Circuit Rules That a Tax Sale May Be Avoided as a Preference

A recent decision from the United States Court of Appeals for the Third Circuit will likely rekindle the discussion of whether a transfer of property resulting from a tax sale or foreclosure sale may be avoided in bankruptcy. The court held that a Chapter 13 debtor may avoid a transfer of the debtor’s property to a tax sale purchaser made during the 90 day period before bankruptcy as a preferential transfer. The property, which was valued at $335,000, was transferred to the holder of a $45,000 tax lien, who had moved to foreclose the debtor’s right of redemption under New Jersey law.  

Generally, under Section 547(b) of the Bankruptcy Code, a transfer of a debtor’s property to a non-insider creditor within 90 days before the debtor’s bankruptcy filing may be avoided as a preference if the transfer was (i) made on account of an antecedent debt, (ii) while the debtor was insolvent, and (iii) the effect of the transfer was to give the creditor more than the creditor would have received, before any transfer, in a Chapter 7 case pending at that time.  The Third Circuit held that the tax lienholder received an avoidable preference because the tax lienholder received property worth $345,000 to satisfy a $45,000 debt, which was substantially more than what the creditor would have received in a Chapter 7 bankruptcy case.

The tax lienholder argued that the preference claim was barred under a 1994 Supreme Court case,  BFP v. Resolution Trust Corp., 511 U.S. 531 (1994), which held that a transfer of property from a properly conducted foreclosure sale could not be avoided as a fraudulent transfer under Section 548 of the Bankruptcy Code. The Third Circuit disagreed, observing that BFP addressed a different issue, namely, whether property sold at a properly conducted foreclosure sale could be avoided as a fraudulent transfer.  Whereas the Supreme Court in BFP focused on the “reasonably equivalent value” element of the claim, in a preference action, a trustee (or Chapter 13 debtor) need only show that a creditor received more on its claim than would have been the case in a Chapter 7 case. The Third Circuit also noted that the Supreme Court limited its decision in BFP to only cover foreclosures of real property and that “considerations bearing upon other foreclosures and forced sales (to satisfy tax liens, for example) may be different.” 

Click here to learn more about the case and its implications.

Practice Pointer: Before this decision, lower courts were divided on the issue of whether a transfer of property resulting from a tax or foreclosure sale could be avoided as a preference.  Courts that refused to allow the claim did so on the authority of BFP.  Although the Third Circuit’s decision dealt with a transfer of property arising from foreclosure of a tax lien, where such sales rarely result in a purchase approximating much more that the tax due, lenders should evaluate their bidding strategy at a foreclosure sale because a credit bid of an amount that is less than the actual debt could expose the lender to a preference claim.  However, as a practical matter, because most bankruptcy filings occur before a foreclosure sale takes place, we do not expect that there will be a flood of preference claims against lenders or even tax sale lienholders if the Third Circuit’s decision is followed in Maryland and other jurisdictions.

Contact Lawrence Coppel | lcoppel@gfrlaw.com | 410-576-4238