June 27, 2008

Sixth Circuit Holds that the Earmarking Doctrine Does Not Provide a Refuge from Preference Exposure for Late-Perfecting Secured Creditors

In a decision issued on June 26, 2008, the Sixth Circuit Court of Appeals held that the earmarking doctrine does not provide a refuge for late-perfecting secured creditors and thus does not shield the creditor from preference exposure in a subsequently filed bankruptcy case.  Lee v. Shapiro.  

In the case, debtor David Scott Lee refinanced a residential mortgage loan with Chase Manhattan Mortgage Corporation approximately six months before he filed a voluntary Chapter 7 bankruptcy petition.  Chase was both the holder of the original mortgage and the refinanced mortgage. Seventy-seven days before Lee filed his bankruptcy case, and seventy-two days after Chase had distributed the funds that were used to discharge the original mortgage, a new mortgage on his residential real estate was recorded in favor of Chase to secure Lee’s obligation to repay the new loan. At issue in the appeal was whether the secured creditor's new mortgage lien may be avoided as a preferential transfer under 11 U.S.C. § 547.  In addition to rejecting Chase's defense based on the earmarking doctrine, the court also rejected the contention that perfection of its mortgage during the 90-day preference period did not result in diminution of debtor's bankruptcy estate.

This E-alert was prepared by Justin W. Ristau. Please contact any member of the Bricker & Eckler Creditor Rights & Bankruptcy group for more information.