An Equitable Tightrope: Blackjewel’s Balancing Act On After-Acquired Property In Bankruptcy – Insolvency/Bankruptcy/Re-structuring

An Equitable Tightrope: Blackjewel’s Balancing Act On After-Acquired Property In Bankruptcy – Insolvency/Bankruptcy/Re-structuring


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It is well recognized that, in keeping with the “fresh
start” or “rehabilitative” policy, the Connecticut bankruptcy
Code invalidates after-acquired property clauses in prepetition
security agreements, but also includes an exception to the general
rule for prepetition liens on the proceeds, products, offspring, or
profits of prepetition collateral. Less well understood is that
there is an “exception to the exception” if a bankruptcy
court determines that the “equities of the case” suggest
that property acquired by the estate should be free of such

This exception was recently addressed by the U.S. District Court
for the Southern District of West Virginia. In United Bank v.
Blackjewel, L.L.C. (In re Blackjewel, L.L.C.)
, 2021 WL 2667511
(S.D. W. Va. June 29, 2021), appeal filed, No. 21-1831
(4th Cir. July 30, 2021), the court affirmed a bankruptcy court
order denying an undersecured lender’s motion seeking as a form
of “adequate protection” the payment of asset sale
proceeds allegedly subject to its prepetition security interest in
receivables. According to the district court, the Connecticut bankruptcy court
did not abuse its discretion in finding that it would be
inequitable for the lender’s liens to attach to the proceeds of
a postpetition sale because “allowing [the lender] to receive
the proceeds of unencumbered estate assets would be inequitable to
the unsecured creditors.”

Invalidation of Certain After-Acquired Property Clauses in

Section 552(a) of the Bankruptcy Code states that “[e]xcept
as provided in subsection (b) of this section, property acquired by
the estate or by the debtor after the commencement of the case is
not subject to any lien resulting from any security agreement
entered into by the debtor before the commencement of the
case.” This provision reflects the principle that “the
debtor’s fresh start should entitle the debtor to use
after-acquired property, so long as it is not property of the
estate under section 541(a)(6) [defining as “estate
property” the proceeds, product, offspring, rents, or profits
of or from estate property], free and clear of a prebankruptcy
lien.” Collier on Bankruptcy (“Collier”) ¶
552.01 (16th ed. 2021).

Section 552(b)(1), however, includes a limited “savings
clause” for certain security interests. That section provides,
with limited exceptions not relevant here:

 [I]f the debtor and an entity
entered into a security agreement before the commencement of the
case and if the security interest created by such security
agreement extends to property of the debtor acquired before the
commencement of the case and to proceeds, products, offspring, or
profits of such property, then such security interest extends to
such proceeds, products, offspring, or profits acquired by the
estate after the commencement of the case to the extent provided by
such security agreement and by applicable nonbankruptcy law, except
to any extent that the court, after notice and a hearing and based
on the equities of the case, orders otherwise.

11 U.S.C. § 522(b)(1). A separate savings clause for
pledged real property rents and related fees is covered by section

Thus, the savings clause for liens on postpetition proceeds,
products, or profits of (or rents from) property pledged
prepetition is itself subject to an exception “to the extent
that the court, after notice and a hearing and based [on] the
equities of the case, orders otherwise.” In re Las Vegas
Monorail, Co.
, 429 B.R. 317, 344 (Bankr. D. Nev. 2010). This
“exception to the exception” authorizes a bankruptcy
court to utilize its discretion when deciding whether to allow a
prepetition lien to survive postpetition. See United Va. Bank
v. Slab Fork Coal Co.
, 784 F.2d 1188, 1191 (4th Cir. 1986);
Gray v. Bank of Early, 2018 WL 9415069, *6 (M.D. Ga. Sept.
20, 2018).

Courts have typically applied the “equities of the
case” exception in cases where a secured creditor would
receive a windfall because, for example, the value of the
creditor’s collateral is increased by an expenditure of estate
funds that would otherwise be distributed to unsecured creditors in
the case. Id. (citing cases and noting that five courts of
appeals have embraced this interpretation of section
552(b)(1)’s purpose and application); accord In re
Transcare Corp.
, 2020 WL 8021060, *41 (Bankr. S.D.N.Y. July 6,
2020) (“The ‘equities of the case’ exception is a
means of allocating the value of post-petition collateral proceeds
between the secured creditor and the estate.”); see
Collier at ¶ 552.02[4].

The legislative history of section 552(b) indicates that the
exception is intended to cover situations such as when raw
materials are converted into inventory, or inventory into accounts
at the expense of the bankruptcy estate, therefore depleting
available funds for general unsecured creditors. See H.
Rep. No. 95–595, at 376–77 (1977). In enacting it,
lawmakers strove to strike an appropriate balance between the
rights of secured creditors and the rehabilitative purposes of the
Bankruptcy Code. See Slab Fork, 784 F.2d at 1191.

Guided by the legislative history, some courts have examined
three factors when determining whether the equities of the case
exception should apply: “the amount of time and estate funds
expended on the collateral, the position of the secured party, and
the rehabilitative nature of the bankruptcy case.” In re
Laurel Hill Paper Co.
, 393 B.R. 89, 93 (Bankr. M.D.N.C. 2008).
Other courts have “conducted a balancing of equities to
determine whether a security interest in post-petition proceeds
should be reduced.” Gray, 2018 WL 9415069, at *9
(citing and discussing cases).


In July 2017, coal mining company Blackjewel L.L.C.
(“Blackjewel”) became a co-obligor on a loan made to a
Blackjewel affiliate by United Bank (“lender”) under a
2012 loan and security agreement. The lender’s collateral
originally included the affiliate’s “accounts, receivables
and inventory,” but was amended in 2013 to grant the lender a
security interest in the affiliate’s property, “whether
now owned or hereafter acquired,” including, among other
things, all accounts and receivables, all “rights, agreements,
and property securing or relating to payment of the
[r]eceivables,” all “[p]roceeds and products of all of
the foregoing in any form, … and all increases and profits
received from all of the foregoing.” The lender renewed its
financing statements covering this collateral (owned by both the
affiliate and Blackjewel) after Blackjewel became a co-obligor on
the loan.

Also in July 2017, Riverstone Credit Partners
(“Riverstone”) agreed to loan Blackjewel $34 million in
exchange for a security interest in substantially all of
Blackjewel’s assets, including coal mined from Wyoming.

In 2018, Blackjewel entered into a coal supply agreement
(“BJMS coal agreement”) with Blackjewel Marketing and
Sales LP (“BJMS”), whereby Blackjewel agreed to sell all
coal produced from its Wyoming mines to BJMS.

As of June 2019, there were no outstanding amounts owed by BJMS
to Blackjewel under the BJMS coal agreement (or a previous
agreement with BJMS’s predecessor-in-interest), meaning that
Blackjewel had no corresponding accounts receivable.

Blackjewel and certain affiliates (collectively,
“debtors”) filed for chapter 11 protection in July 2019
in the Southern District of West Virginia.

In August 2019, the federal government halted the transport of
certain coal shipments from the debtors’ properties in Kentucky
and Virginia, alleging that the debtors failed to pay prepetition
employee wages and that the coal shipments were therefore “hot
goods” under applicable federal law.

The lender filed claims in the chapter 11 cases asserting that
it was owed approximately $7 million.

In October 2019, the debtors moved for authorization to sell
substantially all of their Wyoming mining assets. In connection
with the proposed sale, the debtors sought court approval of
several settlement agreements, including: (i) an agreement with
BJMS providing that BJMS would pay the debtors for coal mined
postpetition and the parties would exchange mutual releases; (ii)
an agreement with the federal government settling the hot goods
dispute under which the debtors would use a portion of the BJMS
settlement proceeds to pay the outstanding wage claims of
employees; and (iii) an agreement with Riverstone under which the
debtors would pay Riverstone $32 million in exchange for a release
of its liens.

The bankruptcy court approved the sale and the related
settlement agreements on October 4, 2019.

In accordance with the BJMS settlement, BJMS then paid the
debtors $8,513,496, consisting of: (i) $3,038,496 for postpetition
accounts receivable generated between September 27, 2019, and the
effective date of the sale; and (ii) $5,475,000 for accounts
receivable generated between the bankruptcy petition date and
September 26, 2019. Thereafter, the debtors used approximately $6.3
million of the settlement proceeds to pay employee wages, leaving
approximately $2.1 million in “residual proceeds” from
the BJMS settlement.

After the sale, the lender, asserting that its claim was
undersecured and that its security interest attached to both
prepetition and postpetition accounts receivable, filed a motion
seeking payment of the residual proceeds as a form of
“adequate protection.” The debtors objected. They argued
that the lender’s lien did not encumber the residual proceeds
for the following reasons: (i) the BJMS settlement proceeds could
not be proceeds of the debtors’ prepetition accounts receivable
because, as of the petition date, there were no amounts owed by
BJMS to the debtors; (ii) even if the BJMS settlement proceeds were
proceeds of the debtors’ postpetition accounts receivable, the
lender did not have a lien on such proceeds because section 552(a)
severed the lien on the debtors’ accounts receivable as of the
petition date; (iii) section 552(b)(1) did not apply because
postpetition accounts receivable are not proceeds of prepetition
accounts receivable; and (iv) even if the lender’s lien
technically extended to the BJMS settlement proceeds, the court, in
its discretion and pursuant to section 552(b)(1), should determine
that the equities of the case precluded the lender’s lien from
attaching to the residual proceeds.

The bankruptcy court denied the lender’s adequate protection
motion, finding that the lender failed to perfect its alleged
security interest under applicable law in the BJMS coal agreement.
It also found that, unlike Riverstone, the lender never had a lien
(perfected or otherwise) on coal (mined or unmined) from
Blackjewel’s Wyoming mines.

Finally, the court concluded that the equities of the case did
not favor the lender. First, it explained, the coal sold by the
debtors to BJMS postpetition was not encumbered by the lender’s
liens, and, even if the coal was later converted to create
encumbered “proceeds” of the BJMS coal agreement,
allowing any prepetition security interest to attach to such
postpetition proceeds would constitute a windfall to the lender at
the expense of the estate and unsecured creditors.

Second, the court wrote, even if the lender had perfected its
interest, “it would be inequitable for any liens to attach to
the postpetition proceeds … because those proceeds arose out of
the unencumbered inventory of the estate, [and] allowing [the
lender] to receive the proceeds of unencumbered estate assets would
be inequitable to the unsecured creditors.”

The lender appealed to the district court.

The District Court’s Ruling

On appeal, the district court framed the issue before it as
“whether the bankruptcy court abused its discretion by relying
on a clearly erroneous factual finding to rule that even if [the
lender] had perfected its valid security interest, the equities of
the case nonetheless prevent that interest from attaching.”
Blackjewel, 2021 WL 2667511, at *4.

The lender argued on appeal that the bankruptcy court’s
equities of the case holding was an abuse of discretion because the
decision was based on the “erroneous factual finding”
that the Wyoming coal was unencumbered, albeit not by the
lender’s security interest, but by Riverstone’s lien.
According to the lender, because the coal was subject to
Riverstone’s lien, “depriving [the lender] of its security
interest does not protect the unsecured creditors in this
case,” but instead “creates a windfall for unsecured
creditors where none should exist.”

The debtors countered that the case was a “textbook”
equities of the case situation. They argued that:

(i)  It was undisputed that, when the debtors filed for
bankruptcy, no accounts receivable remained outstanding on the coal
supply contracts in which the lender asserted a security

(ii) After the petition date, the debtors took several steps to
increase the value of the lender’s collateral, including
obtaining postpetition financing, resolving disputes with their
employees, business partners, and the federal government, and
resuming limited mining operations in Wyoming;

(iii) Through these efforts, the debtors converted “raw
materials” (unextracted coal) into “inventory,” and
“inventory into accounts”;

(iv) The residual proceeds represented the remainder of the
debtor’s postpetition coal sales in Wyoming, after the debtors,
BJMS, and Riverstone settled and mutually released all claims
against each other, and therefore, the proceeds were unencumbered
assets of the estate;

(v) Even if the coal was encumbered by Riverstone’s lien,
the lender failed to explain why a lien held (and released) by a
different secured party would affect the bankruptcy court’s
conclusion that it was “inequitable” for the lender to
receive the postpetition residual proceeds; and

(vi) Allowing the lender to receive the proceeds of sales
generated solely by the postpetition efforts of the debtors
“would create a windfall to the bank at the expense of the
estate and unsecured creditors,” who owned the coal at issue
and were directly responsible for any increase in value realized
through the postpetition sales.

Id. at *6.

U.S. District Judge Robert C. Chambers rejected the lender’s
argument that depriving it of its security interest would create an
unearned windfall for unsecured creditors. He noted that the
lender’s contention hinged on the bankruptcy court’s
decision in Laurel Hill, where the court found that
“payments at the expense of secured creditors rather than at
the expense of the estate, do not support an equities of the case
award to the unsecured creditors.”

According to Judge Chambers, Laurel Hill is
distinguishable. In that case, he explained, the assets in question
were encumbered by the very creditors who sought payment pursuant
to their security interest, leading the court to conclude that the
equities of the case exception could not be applied to deprive the
secured creditors access to the sale proceeds, because “[t]he
costs of the alleged enhancement thus were paid from encumbered
funds and not from unencumbered funds of the estate.” By
contrast, Judge Chambers noted, in this case, estate assets sold to
create the BJMS settlement proceeds were encumbered by a different
creditor (Riverstone) that released its lien and never claimed any
right to the residual proceeds. Id. at *7.

In addition, Judge Chambers explained, even if the lender had a
security interest in the proceeds generated by the BJMS coal
agreement, it did not have a security interest in Blackjewel’s
coal, which it converted into inventory and then into accounts,
and, in doing so, depleted estate assets that would otherwise be
available to pay unsecured creditors. Moreover, although those
assets may have been encumbered by a different secured creditor at
the time they were converted into inventory, they were released
from that encumbrance when the BJMS settlement became

The district court accordingly ruled that the bankruptcy court
did not abuse its discretion in concluding that it would be
inequitable for the lender alone to reap the benefits of the
residual proceeds from the BJMS settlement.


Blackjewel does not break any new ground on section 552
and the “equities of the case” exception. Even so, the
ruling is a reminder to secured creditors that a bankruptcy court
has broad discretion to disallow liens on postpetition proceeds,
products, offspring, or profits based on the equities of the case.
It also reinforces the importance of careful drafting of security
agreements and financing statements to identify collateral

The lender appealed the district court’s ruling to the U.S.
Court of Appeals for the Fourth Circuit, which will have another
opportunity to weigh in on the equities of the case exception in
section 552(b).

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.


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