The Eleventh Circuit recently affirmed the avoidance of nearly $2 million in postpetition payments made by debtor Delco Oil, Inc. (the “Debtor”) to its petroleum supplier Marathon Petroleum Company, LLC (“Marathon”).[1] The Eleventh Circuit held that funds received by Marathon from the Debtor constituted cash collateral that the Debtor had spent without the permission of either its secured lender, CapitalSource Finance (“CapitalSource”), or the bankruptcy court and, therefore, could be avoided under sections 549(a) and 363(c)(2) of the Bankruptcy Code. This decision is a reminder to any vendor who deals with a debtor-in-possession that the vendor should confirm the debtor is authorized to use cash collateral before it engages in postpetition business with a debtor.
The Debtor was a distributor of motor fuel and other petroleum products. In 2003, the Debtor entered into a sales agreement with Marathon under which the Debtor began purchasing petroleum products from Marathon. Several years later, in April 2006, the Debtor entered into a financing agreement with CapitalSource pursuant to which the Debtor granted CapitalSource a security interest in all of the Debtor’s personal property, including inventory, accounts receivable, and cash deposit accounts.
On October 17, 2006 (the “Petition Date”), approximately six months after it granted CapitalSource a blanket security interest in all of its personal property, the Debtor filed a voluntary petition for relief under chapter 11 of the Bankruptcy Code. On the Petition Date, the Debtor filed an emergency motion requesting authorization to use cash collateral to continue its operations. CapitalSource objected to the Debtor’s use of its cash collateral. On October 18, 2009, the bankruptcy court allowed the Debtor to continue operating as a debtor-in-possession, but did not rule on the cash collateral motion.
Between October 17, 2006 and November 6, 2006, the Debtor used more than $1.9 million in cash to pay Marathon for petroleum products pursuant to the parties’ sales agreement (the “Postpetition Payments”). On November 6, 2006, the bankruptcy court denied the Debtor’s request to use cash collateral.
The Debtor voluntarily converted its case to a case under chapter 7 in December 2006. The chapter 7 trustee (the “Trustee”) brought suit against Marathon to avoid the Postpetition Payments under sections 549(a) and 363(c)(2) of the Bankruptcy Code. The bankruptcy court granted summary judgment in favor of the Trustee. The district court affirmed the bankruptcy court’s decision granting summary judgment, and Marathon appealed to the Eleventh Circuit Court of Appeals.
The Eleventh Circuit affirmed the lower courts’ orders avoiding the Postpetition Payments. In affirming summary judgment, the Eleventh Circuit rejected each of the arguments Marathon raised in its defense against the avoidance action.
The Court began by rejecting Marathon’s argument that the Postpetition Payments were not actually cash collateral because CapitalSource lost its security interest in the funds when the funds were transferred to Marathon. In support of its position, Marathon cited Fla. Stat. § 679.332(2), which states that “[a] transferee of funds from a deposit account takes the funds free of a security interest in the deposit account unless the transferee acts in collusion with the debtor in violating the rights of the secured party.”[2]
The Eleventh Circuit held that while the Debtor’s transfer of the Postpetition Payments did strip CapitalSource of its security interest in the funds under Fla. Stat. § 679.332(2), that fact had no bearing on the analysis in the case. The Trustee’s right to avoid the Postpetition Payments did not stem from the fact that CapitalSource held a security interest in the transferred funds, but the fact that the Debtor had transferred the funds without the permission of the bankruptcy court or CapitalSource in violation of section 363(c) of the Bankruptcy Code. Whether the Debtor lawfully transferred the Postpetition Payments had to be determined the moment before the funds were transferred, not after the transfer was complete. The Court stated that to hold otherwise would “render section 363(c) virtually meaningless.” If CapitalSource held a valid security interest in the Postpetition Payments before they were transferred to Marathon, the Debtor was in violation of section 363(c) of the Bankruptcy Code and the transfers should be avoided.
The Court went on to reject Marathon’s argument that CapitalSource did not perfect its security interest in the Debtor’s deposit account, and thus the Postpetition Payments, because CapitalSource did not file a deposit account control agreement. More specifically, Marathon argued that a genuine issue of material fact existed as to whether the Postpetition Payments were identifiable proceeds of CapitalSource’s secured collateral. The Court held that under Fla. Stat. § 679.3151(1)(b) and (3), CapitalSource’s security interest attached to the identifiable proceeds of its collateral, and its interest in the proceeds was perfected if the interest in the original collateral was also perfected.[3] CapitalSource held a perfected security interest in all of the funds in the deposit account because CapitalSource held a perfected security interest in all of the Debtor’s personal property (including any inventory or account receivable proceeds that were deposited into the deposit account). Because the Postpetition Payments came from the deposit account, the Postpetition Payments constituted identifiable proceeds of CapitalSource’s collateral.
Finally, the Court rejected Marathon’s argument that, as a matter of policy, innocent vendors who deal with a debtor-in-possession should have a defense against avoidance when the parties make equivalent exchanges of value in the ordinary course of business. The Court reviewed the plain language of sections 363(c)(1) and 363(c)(2) of the Bankruptcy Code and determined that Congress intentionally placed a limitation on the use of cash collateral in the ordinary course of business. The Court also noted that the avoidance provisions of sections 549(a) and 550(a) of the Bankruptcy Code did not include a defense based on the mental culpability of the transferee. The Court declined to create such an exception and upheld the avoidance of the Postpetition Payments.
This decision places a burden on vendors dealing with debtors-in-possession. Under this decision, a vendor bears the responsibility for confirming not only that postpetition cash payments made by a debtor are made with the permission of either the bankruptcy court or the debtor’s secured creditors, but also that the debtor is abiding by any budgetary or other limitations put in place by the court or the secured lender. A vendor’s lack of knowledge about whether a debtor is authorized to use cash collateral, even in the ordinary course of business, may not protect the vendor from avoidance actions seeking recovery of those payments. In order to protect itself from any potential avoidance actions, a vendor should confirm that a cash collateral order is in place, and that the debtor is abiding by its terms, before the vendor does business with a debtor-in-possession.
For more information on the material presented in this alert, please contact Eric R. Goodman ( or 216.861.7418), Alexis C. Osburn ( or 216.861.7873) or your regular Baker Hostetler contact. We hope you find this information helpful.
[1] See Marathon Petroleum Co., LLC v. Cohen (In re Delco Oil, Inc.), 599 F.3d 1255 (11th Cir. 2010).
[2] Fla. Stat. § 679.332(2) (2010).
[3] Fla. Stat. § 679.3151(1)(b) & (3).
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