The trustee takes subject to all liens, except judicial liens acquired within four months prior to the filing of the petition in bankruptcy, and except liens constituting preferences within such four months.
(1) In general.
It is not the intention of the bankruptcy to take from a lien creditor his advantage. A trustee takes subject to all valid liens that general creditors or subsequent lien creditors would have to recognize if there were no bankruptcy proceedings, with two general exceptions; first: judicial liens acquired within four months immediately prior to the filing of the petition are dissolved; and secondly, liens acquired within such four months' period to secure existing debts, are dissolved as constituting preferences.
Let us consider in more detail.
136. Dushane v. Beall, 161 U. S. 513.
137. In re Geo. F. Scruggs, (D. C. Ala.) 31 A. B. R. 94.
138. Watson v. Merrill, (C. C. A.) 136 Fed. 359.
(2) Liens secured through judicial proceedings within four months.
If a lien is acquired by obtaining a judgment or making an attachment or other judicial process, within four months immediately prior to the filing of the petition, it is dissolved by the bankruptcy proceeding. That is, the judgment or attaching creditor becomes in the bankruptcy court merely a general creditor, with no advantage over other general creditors by reason of his lien. The reason for this provision in the law is very obvious. A main intention of the bankruptcy law is to secure a division of a bankrupt's estate equally among general creditors. If a general creditor merely by being more diligent in getting a judgment or levying an attachment, could thereby fix a lien on the insolvent estate he would frequently take everything, leaving the other general creditors with no remedy. Therefore, the law wisely provides that the lien of a judicial proceeding given by state law is dissolved by the bankruptcy proceeding, if it was obtained within the preceding four months, that period being taken as the limit of the present time in the bankrupt's life.
"Had Congress enacted other than it did in these plain words, or had courts by construction, given any supposed limitation to those plain words, and thereby had intra four months liens been allowed to take away the assets which passed to the bankruptcy court by the filing of the petition in bankruptcy, the power of the court to administer bankrupt estates would have been absolutely defeated."140 In this latter case it was held that the dischargeability of the debt under the bankruptcy proceedings was immaterial to the question whether the lien was dissolved.
139. Metcalf v. Barker, 187 U. S. 165.
140. Wagner v. Mt. Carmel Iron Works, (C. C. A. 3rd Cir.) 270 Fed. 80.
(3) Judicial liens secured prior to four months.
If the lien of an attachment, judgment or other judicial process, was acquired more than four months ago when the petition is filed, it will not be affected by the bankruptcy proceeding and the creditor will have the advantage of his lien over general creditors and over subsequent lien holders. This is for the reason that it is considered far enough back not to have been acquired as any unjust advantage over the bankrupt's present general creditors.
Thus in the case of Metcalf v. Barker, the court said: "In our opinion the conclusion to be drawn from this language (of the statute, section 67f, Bankr. Act 1898) is that it is the lien created by a levy, or a judgment, or an attachment, or otherwise, that is invalidated, and that where the lien is obtained more than four months prior to the filing of the petition, it is not only not to be deemed to be null and void on its adjudication, but its validity is recognized. When it is obtained within the four months the property is discharged therefrom, but not otherwise."
(4) Liens arising out of contract at inception of indebtedness.
Such liens are good and will prevail against the trustee no matter when acquired. Thus D borrows money from C and to secure him gives him a mortgage on his real estate, or pledges with him personal property, or gives him a chattel mortgage which C properly records. This lien will stand even if the lien holder understood at the time that the debtor was insolvent. As was stated n an early case141 "An insolvent person may properly make efforts to extricate himself from his embarrassment, and therefore he may borrow money and give at the time security therefor, provided always the transaction be free from fraud in fact, and upon the Bankrupt Act."
In such cases, there is no depletion of the estate. In return for the lien the bankrupt receives assets. This is a principle we all proceed upon and it is a necessary rule of action, for if the creditor feared he could not assert his security, he would lend no money except to those in unquestionably solvent circumstances.
Such liens, however, will not be good against the trustee, where when the bankruptcy proceedings were begun, they would not have been good against creditors, because not properly recorded, or possession taken under them.142
(5) Liens arising out of contract after inception of indebtedness.
Liens so acquired by a creditor who knows or has reasonable cause to believe that a preference is intended would be good only in case they were acquired more than four months prior to the filing of the petition, because otherwise they would be preferences.143
(6) Liens given by law not arising out of contract or judicial proceedings.
Liens that are allowed by the local law as good against general creditors, are not dissolved in the event of
141. Daily v. Inst, 1 Dill. 144, Fed. Cas. 3571.
142. In re Buchner, (D. C. 111.) 202 Fed. 979.
143. Stedman v. Bank, 117 Fed. 937 (holding that a chattel mortgage given in part to secure a past, and in part to secure a present indebtedness, is voidable pro tanto only.) bankruptcy, but by permission of the act are allowed to stand.
Such are liens of bailee's, mechanic's liens, etc. The fact that they must (for instance, mechanic's liens) be enforced in judicial proceedings, does not make them judicial liens and they are not to be so classed.
Thus A delivers lumber to B to be used by B in building a house on B's property. The local statute gives to a person who furnishes material for the improvement of real estate a lien called a mechanic's lien. This lien is good in bankruptcy.144
(7) Equitable liens.
In a proper case where it is equitable to fasten a lien upon a debtor's property in favor of a creditor who, although having no legal lien, has a claim that ought to be fastened upon some particular property of the bankrupt, a court of bankruptcy as a court of equity will allow and enforce such lien.145
(8) Right of court to order property sold free of liens not voidable.
The bankruptcy court has the implied power to sell property which is subject to liens sold free of the liens, the proceeds to be held subject to the lien. Such a sale operates as a foreclosure and gives the purchaser good title free of the lien.146
144. In re Bennett, (C. C. A. 6th Cir.) 153 Fed. 673. In re Laird, (C. C. A. 6th Cir.) 109 Fed, 550 (statutory labor lien) ; Henderson v. Mayer, 225 U. S. 631.
145. In re Plantations Co., (D. C. Pa.) 270 Fed. 273; Boise v. Talcott, (C. C. A. 2nd Cir.) 264 Fed. 60.
146. Gantt v. Jones, (C. C. A. 4th Cir.) 272 Fed. 117.
(9) Preservation of voidable liens for benefit of estate.
If a lien is of the kind dissolved by the bankruptcy proceedings (liens operating as preference, liens secured by judicial process within four months period) the court may order it to be preserved for the benefit of the estate.147 For instance, suppose Debtor gives a chattel mortgage to M to secure a present loan, but M does not record it. J then gets a judgment against Debtor. Afterwards M records the chattel mortgage, and Debtor then goes into bankruptcy, all happening within four months. The bankruptcy deprives J of his judgment lien, but it will be preserved for the benefit of the estate, to prevent M's lien from being good.
147. Bankr. Act, 1898, SEC. 67 (3) ; In re Martin, 236 U. S. 288.