Prince Lobel Wins Appeal Affirming Availability of Escrow Arrangements for Secured Creditors

In the Press · August 20, 2014

Prince Lobel attorneys Thomas M. ElcockKristin M. Knuuttila and Thomas R. Sutcliffe representing BHC Interim Funding II, LP and BHC Interim Funding III, LP (“BHC”) recently won an appeal before the Massachusetts Appeals Court in an important case involving questions of first impression under Article 9 of the Uniform Commercial Code.  BHC had intervened in a Superior Court case and sought to enforce its prior perfected security interest in funds that a judgment creditor, William Zimmerling, was trying to claim.  The Superior Court judge entered a preliminary injunction placing the disputed funds in escrow pending resolution of the competing claims.  Zimmerling, however, argued that once the funds were placed in escrow, BHC’s prior security interest was extinguished under M.G.L. c. 106, § 9-332(b).  Section 9-332(b) states that “[a] transferee of funds from a deposit account takes the funds free of a security interest in the deposit account.”  Zimmerling reasoned that, when the funds were placed into escrow, they were “transferred” either to the escrow agent (by virtue of the agent having physical control over the funds) or to Zimmerling (by virtue of his having received an equitable interest in the funds).  The Superior Court disagreed and ruled in favor of BHC.  Zimmerling appealed.

Prior to this dispute, no Massachusetts appellate court had opined on the meaning of the word “transfer” under Section 9-332(b).  Furthermore, case law in other jurisdictions was scant, and some of what did exist supported Zimmerling’s position.  The Appeals Court, however, relying heavily on arguments that Prince Lobel had made, concluded that neither the text of Section 9-332(b), nor the policy rationale behind that provision, supported a reading that would extinguish a creditor’s interest in funds simply because those funds were placed in escrow.  The Court determined that Zimmerling was not himself a “transferee.”  As the Court explained (and as Prince Lobel argued in the Superior Court and on appeal), the plain language of Section 9-332(b) applies only to a transfer “of funds” – i.e., the actual receipt of the funds themselves, not just a mere equitable interest.  The Court rejected Zimmerling’s claim that the escrow agent was a transferee because (as Prince Lobel had also argued), the escrow agent simply held the funds as a fiduciary and therefore did not have legal title.  The Court further determined that case law to the contrary in other jurisdictions was unpersuasive.

The Court further observed, as had Prince Lobel both in its briefing and at oral argument, that there were strong policy reasons for not allowing the placement of funds into escrow accounts to affect prior security interests. The purpose of Section 9-332(b) is to ensure the liquidity of funds and the finality of transactions in which funds are exchanged. But as the Court also recognized, “[b]y definition, a court-ordered escrow account is the antithesis of finality”; such escrow accounts, rather, are intended to freeze money pending resolution of the parties’ claims.  Therefore, the Court concluded, Zimmerling’s argument, when “[t]aken to its logical conclusion, . . . would render inoperable the use of escrow agreements in commercial transactions involving secured parties,” a result that would impede the U.C.C.’s goal of  “‘permit[ting] the continued expansion of commercial practices through custom, usage, and agreement of the parties.'” (quoting M.G.L. c. 106, § 1-103(a)(2)).

The Court’s decision applied a pragmatic analysis that accommodates both the importance of ensuring the liquidity of funds and the reality of commercial transactions involving escrow accounts – particularly where a court orders money placed into escrow.  Whether other jurisdictions will follow Massachusetts’s lead remains to be seen.

A copy of the Appeals Court’s decision can be found here.

For further information please contact Thomas M. Elcock at 617 456 8155, telcock@PrinceLobel.com, Kristin M. Knuuttila at 617 456 8170, kknuuttila@PrinceLobel.com, or Thomas R. Sutcliffe at 617 456 8054, tsutcliffe@PrinceLobel.com, the authors of this alert and counsel for BHC.