Qmect, Inc. v. Burlingame Capital Partners II et al

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K
UNITED STATES BANKRUPTCY COURT
NORTHERN DISTRICT OF CALIFORNIA
In re 	No. 04-41044 TK
Chapter 7
QMECT, INC.,
Debtor.
___________________________/
QMECT, INC., 	A.P. No. 04-4171 AT
Plaintiff,
vs.
BURLINGAME CAPITAL PARTNERS,
II, L.P.; ELECTROCHEM FUNDING,
LLC,
Defendants.
___________________________/
MEMORANDUM OF DECISION
Defendant Burlingame Capital Partners, II, L.P. (“Burlingame”)
asks 	the 	Court 	to 	reconsider 	its 	memorandum 	decision 	(the
“Memorandum”) 	denying 	Burlingame’s 	motion 	for 	summary 	judgment 	in
this preference action. 	In this adversary proceeding, Plaintiff John
T. 	Kendall, 	chapter 	7 	trustee, 	(the 	“Trustee”) 	seeks 	to 	avoid 	as
preferential 	the 	security 	interests 	in 	inventory 	and 	accounts
Signed: December 11, 2007
________________________________________
LESLIE TCHAIKOVSKY
U.S. Bankruptcy Judge
________________________________________
Entered on Docket
December 11, 2007
GLORIA L. FRANKLIN, CLERK
U.S BANKRUPTCY COURT
NORTHERN DISTRICT OF CALIFORNIA
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1In its original decision, the Court referred to new inventory
being “generated.” 	This verb was misleading. 	The Debtor provided
a service; while it may have acquired inventory, it did not
“generate” inventory.
2
receivable 	and 	their 	proceeds 	acquired 	by 	Burlingame 	during 	the
preference 	period 	to 	the 	extent 	of 	Burlingame’s 	“improvement 	of
position.” 	See 11 U.S.C. § 547(c)(5). 	Burlingame contends that the
Court made clear error, justifying reconsideration, when it concluded
that these transfers gave Burlingame more than it would have received
in 	a 	liquidation; 	see 	11 	U.S.C. 	§ 	547(b)(5); 	and 	that 	its 	secured
position 	“improved” 	during 	the 	preference 	period; 	see 	11 	U.S.C. 	§
547(c)(5). 	Each of these arguments will be addressed below.
SUMMARY OF UNDISPUTED FACTS
The 	Debtor 	filed 	a 	chapter 	11 	bankruptcy 	petition 	on 	February
27, 2004. 	Prior to the filing and during the chapter 11 phase of the
case, before the case was converted to chapter 7, the Debtor operated
an 	electroplating 	business. 	Customers 	of 	the 	Debtor 	would 	supply
objects 	to 	the 	Debtor 	which 	the 	Debtor, 	using 	chemicals, 	would
electroplate and return to their owners. 	These operations generated
accounts 	receivable. 	Although 	not 	held 	for 	sale, 	the 	chemicals
qualified 	as 	the 	Debtor’s 	inventory. 1 	See 	Cal. 	Comm. 	Code 	§
9102(48)(D) (“materials used or consumed in a business”).
At the beginning of the preference period–-on December 27, 2003-
-the Debtor had two secured creditors. 	The senior secured creditor
was 	Comerica 	Bank 	(“Comerica”). 	The 	junior 	secured 	creditor 	was
Burlingame. 	Both Comerica and Burlingame had security interests in
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2Shortly before the Debtor’s bankruptcy petition was filed,
Burlingame purchased Comerica’s secured claim. 	Shortly after the
petition was filed, the principals of Burlingame formed defendant
Electrochem Funding LLC (“Electrochem”), and the secured claim
acquired from Comerica was transferred to Electrochem.
3The Trustee’s opposition to the motion incorporates the
Declaration of Marc Lumer (the “Lumer Declaration”), the Debtor’s
accountant during the chapter 11, filed in support of his
opposition to Burlingame’s previous motion for summary judgment.
The Lumer Declaration states that the increase in the value of the
accounts receivable and inventory was $156,939.
3
virtually 	all 	of 	the 	Debtor’s 	assets, 	which 	included 	accounts
receivable and inventory. 2
At 	all 	times 	during 	the 	preference 	period, 	Burlingame 	was
undersecured: i.e, the value of its collateral, taking into account
the 	amount 	of 	the 	senior 	secured 	debt, 	was 	less 	than 	the 	amount 	of
Burlingame’s debt. 	During the preference period, some, if not all,
of 	the 	accounts 	receivable 	in 	which 	Burlingame 	held 	a 	security
interest 	at 	the 	beginning 	of 	the 	preference 	period 	generated 	cash
proceeds. 	These proceeds were then spent in the continued operation
of the business, and new accounts receivable were generated.
Pursuant to the after-acquired property clause in Burlingame’s
security 	agreement, 	Burlingame 	automatically 	acquired 	liens 	in 	the
new accounts receivable generated during the preference period. 	On
the petition date, the value of Burlingame’s security interest in the
Debtor’s 	accounts 	receivable 	and 	inventory 	then 	in 	existence 	was
greater 	than 	the 	value 	of 	its 	security 	interest 	in 	the 	accounts
receivable 	and 	inventory 	in 	existence 	at 	the 	beginning 	of 	the
preference period. 3 	On the petition date, the Debtor was subject to
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4Schedule E of the Debtor’s Schedules of Assets and
Liabilities, which is attached to the Lumer Declaration, lists
$83,433 in unpaid priority wage claims. 	As applicable to the
Debtor’s case, priority wage claims must have arisen during the 90
days preceding the filing of the petition. 	See 11 U.S.C.
§ 507(a)(4)(A) (formerly 11 U.S.C. § 507(a)(4)(A)). 	See Pub. L.
No. 109-8, §§ 212, 1401, 119 Stat. 23, 51, 214.
4
unpaid 	employee 	wage 	claims 	for 	services 	provided 	during 	the
preference 	period 	and 	may 	also 	have 	been 	subject 	to 	unpaid 	vendor
claims for goods provided during the preference period. 4
APPLICABLE LAW
A. 	MOTION FOR SUMMARY JUDGMENT
Rule 56 of the Federal Rules of Civil Procedure, made applicable
to 	this 	adversary 	proceeding 	by 	Rule 	7056 	of 	the 	Federal 	Rules 	of
Bankruptcy 	Procedure, 	provides 	that 	summary 	judgment 	should 	be
granted 	if 	there 	are 	no 	genuine 	issues 	of 	material 	fact 	and 	the
moving 	party 	is 	entitled 	to 	judgment 	as 	a 	matter 	of 	law. 	Fed. 	R.
Civ. P. 56(c). 	The moving party bears the burden of establishing the
absence 	of 	a 	genuine 	issue 	of 	material 	fact. 	Celotex 	Corp. 	v.
Catrett, 477 U.S. 317, 322-23 (1986). 	That burden may be met either
by 	producing 	evidence 	sufficient 	to 	entitle 	the 	moving 	party 	to
judgment 	in 	its 	favor 	or 	by 	raising 	a 	point 	of 	law 	with 	the 	same
effect based on the undisputed facts.
If 	the 	moving 	party 	meets 	its 	initial 	burden 	by 	producing
evidence, 	the 	party 	opposing 	the 	motion 	must 	come 	forward 	with
specific facts establishing a genuine factual issue and may not rely
on mere allegations or denials. 	Anderson v. Liberty Lobby, Inc., 477
U.S. 	242, 	250 	(1986). 	The 	trial 	judge 	must 	accept 	as 	true 	all
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evidence offered by the party opposing the motion and must draw all
legitimate 	inferences 	in 	its 	favor. 	Windon 	Third 	Oil 	and 	Gas
Drilling P’ship v. Federal Deposit Ins. Corp., 805 F.2d 342, 346 (10 th
Cir. 	1986), 	cert. 	denied 	480 	U.S. 	947 	(1987). 	Where 	the 	moving
party’s 	contention 	is 	that 	the 	plaintiff’s 	claim 	must 	fail 	as 	a
matter of law, based on undisputed facts, the motion may be decided
without 	any 	additional 	evidence. 	See 	Thrifty 	Oil 	Co. 	v. 	Bank 	of
American 	Nat’l 	Trust 	& 	Sav. 	Ass’n, 	322 	F.3d 	1039, 	1046 	(9 th 	Cir.
2003).
The plaintiff has the burden of proof with respect to the main
elements of a preference claim. 	11 U.S.C. § 547(g). 	The defendant
has 	the 	burden 	of 	proof 	with 	respect 	to 	any 	affirmative 	defense
asserted to a preference claim. 	Id.
B. 	MOTION FOR RECONSIDERATION
Motions 	for 	reconsideration, 	if 	filed 	within 	ten 	days 	of 	the
entry 	of 	the 	order 	or 	judgment, 	are 	considered 	under 	the 	standards
applicable to motions to alter or amend judgments. 	See Fed. R. Civ.
P. 	59(e); 	Fed. 	R. 	Bankr. 	P. 	9023 	(making 	Rule 	59 	applicable 	to
bankruptcy cases). 	Such motions may be granted on four grounds: 	(1)
the judgment is based upon manifest errors of law or fact; (2) there
is newly discovered or previously unavailable evidence; (3) amendment
is 	necessary 	to 	prevent 	manifest 	injustice; 	or 	(4) 	there 	is
intervening change in the controlling law. 	McDowell v. Calderon, 197
F.3d 1253, 1255 (9 th Cir. 1999), cert. denied, 529 U.S. 1082 (2000);
In 	re 	Arden 	Properties, 	Inc., 	248 	B.R. 	164, 	168 	(Bankr. 	D. 	Ariz.
2000). 	Whether 	to 	grant 	or 	deny 	such 	a 	motion 	is 	entrusted 	to 	the
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sound judgment of the trial court. 	Burlingame does not present any
newly 	discovered 	or 	previously 	unavailable 	evidence 	nor 	does 	it
contend 	that 	there 	has 	been 	an 	intervening 	change 	in 	the 	law.
Rather, Burlingame contends that, in denying its motion for summary
judgment, the Court made manifest errors of law and that amendment is
necessary to prevent a manifest injustice from occurring.
DISCUSSION
Burlingame based its motion for summary judgment on two grounds.
First, it contended that, as a matter of law, under the facts recited
above, the Trustee could not establish that the transfers of security
interests 	in 	the 	accounts 	receivable 	and 	inventory 	acquired 	during
the 	preference 	period 	permitted 	Burlingame 	to 	receive 	more 	than 	it
would have received in a chapter 7 liquidation had the transfers not
occurred. 	11 U.S.C. § 547(b)(5). 	Second, Burlingame contended that,
even 	if 	the 	Trustee 	could 	establish 	this 	element 	of 	a 	preference
claim, it would be entitled to a complete defense under 11 U.S.C.
§ 	547(c)(5). 	The 	motion 	for 	reconsideration 	reiterates 	these 	two
contentions. 	The Court will address each argument in turn.
A. 	FIFTH ELEMENT OF A PREFERENCE CLAIM
As 	relevant 	to 	this 	proceeding, 	11 	U.S.C. 	§ 	547(b) 	provides
that, 	“[e]xcept 	as 	provided 	in 	subsection 	(c)..., 	the 	trustee 	may
avoid any transfer of an interest of the debtor in property–
(1) to or for the benefit of a creditor;
(2) for or on account of an antecedent debt owed by the debtor
before such transfer was made;
(3) made while the debtor was insolvent;
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5For this purpose, it must be assumed that the liquidation
occurred on the date the bankruptcy petition was actually filed,
not on the date of the transfer. 	Castletons, 990 F.2d at 554
(citing Palmer Clay Prods. Co. v. Brown, 297 U.S. 227, 229 (1936)).
7
(4) made–
(A) on or within 90 days before the date of the filing of
the petition;...
(5) 	that 	enables 	such 	creditor 	to 	receive 	more 	than 	such
creditor would receive if–
(A) the case were a case under chapter 7 of this title;
(B) the transfer had not been made; and
(C) 	such 	creditor 	received 	payment 	of 	such 	debt 	to 	the
extent provided by the provisions of this title.
11 	U.S.C. 	§ 	547(b). 	Each 	of 	the 	elements 	recited 	above 	must 	be
established for the trustee to prove a claim to avoid a preferential
transfer 	by 	the 	debtor. 	Section 	547(e)(3) 	provides 	that, 	for
purposes of section 547, “a transfer is not made until the debtor has
acquired rights in the property transferred.” 	11 U.S.C. § 547(e)(3).
As noted above, in its motion for summary judgment, Burlingame
contended 	that 	the 	Trustee 	would 	be 	unable, 	as 	a 	matter 	of 	law, 	to
establish 	the 	fifth 	element 	of 	a 	preference 	claim: 	i.e., 	that 	the
transfers of security interests in the accounts receivable generated
and inventory acquired during the preference period permitted it to
receive more than if the transfers had not been made and the assets
of the debtor had been liquidated in accordance with bankruptcy law. 5
In 	support 	of 	its 	position, 	Burlingame 	relied 	on 	In 	re 	Castletons,
Inc., 	990 	F.2d 	551 	(10 th 	Cir. 	1993). 	In 	Castletons, 	the 	trustee
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sought 	to 	avoid 	as 	preferential 	transfers 	of 	security 	interests 	in
accounts receivable and inventory. 	The claims were dismissed after
a 	trial 	on 	merits. 	The 	district 	court 	affirmed 	as 	did 	the 	Tenth
Circuit Court of Appeals. 	990 F.2d at 553-60.
Like 	Burlingame, 	the 	secured 	creditor 	in 	Castletons 	had 	a
security interest in virtually all of the debtor’s assets, including
accounts 	receivable 	and 	inventory--that 	is, 	a 	“blanket 	lien.” 	The
security interest was duly perfected before the commencement of the
preference period. 	The Castletons court concluded that, under these
circumstances, it was impossible for the trustee to prove the fifth
element of a preference claim. 	It reasoned as follows:
Wile 	the 	identity 	of 	individual 	items 	of
collateral 	changed 	because 	of 	sales 	and
subsequent 	acquisitions 	of 	new 	collateral, 	the
overall 	nature 	of...[the 	secured 	creditor’s]
security interest remained the same. 	Thus, even
though trustee is semantically correct when she
says...[the 	secured 	creditor] 	acquired 	“new”
collateral 	during 	the 	preference 	period, 	the
collateral 	was 	new 	only 	to 	the 	extent 	of 	its
description. 	In 	fact, 	the 	so-called 	new
collateral merely evolved from “old” collateral.
Therefore, 	the 	extent 	of...[the 	secured
creditor’s] 	covered 	position 	remained 	the 	same
throughout the preference period.
Id. at 556.
Thus, although the Castletons court acknowledged the existence
of 11 U.S.C. § 547(e)(3), it failed to apply the statute as written.
The Castletons court reasoned that, because the “new” collateral was
the 	“proceeds” 	of 	the 	secured 	creditor’s 	“old” 	collateral, 	it 	was
essentially 	the 	“same” 	collateral, 	and 	no 	new 	transfers 	occurred
during the preference period. 	However, this was not the case. 	The
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difference 	between 	the 	“old” 	accounts 	receivable 	and 	inventory 	and
the “new” accounts receivable and inventory was not purely semantic;
it 	was 	literal. 	The 	Castletons 	court 	created 	a 	legal 	fiction 	that
the old and new assets were the same assets to prevent what it viewed
as an unfair result.
George 	Santayana 	wrote 	that: 	“Those 	who 	cannot 	study 	history,
are 	doomed 	to 	repeat 	it.” 	The 	Castletons 	court 	may 	not 	have 	been
made aware of a similar legal fiction created by some courts prior to
the 	enactment 	of 	the 	Bankruptcy 	Code. 	To 	prevent 	the 	avoidance 	of
transfers of security interests in accounts receivable and inventory
under 	similar 	circumstances, 	these 	courts 	created 	a 	legal 	fiction
that the relevant transfer occurred when the security agreement was
created 	and 	perfected. 	Assuming 	this 	occurred 	prior 	to 	the
commencement of the preference period, this pre-Bankruptcy Code legal
fiction protected the transfers of security interests in the accounts
receivable and inventory acquired by the debtor during the preference
period 	from 	avoidance 	as 	preferential 	transfers. 	See 	DuBay 	v.
Williams, 417 F.2d 1277, 1287-88 (9 th Cir. 1969); Grain Merchants of
Ind., Inc. v. Union Bank & Savings Co., 408 F.2d 209, 212 (7 th Cir.
1969).
When 	the 	Bankruptcy 	Code 	was 	enacted, 	both 	this 	legal 	fiction
and the equitable need for it were eliminated. 	See S. Rep. No.
95-989, at 89 (stating that § 547(e)(3) was enacted to overrule DuBay
and 	Grain 	Merchants); 	see 	also 	11 	U.S.C. 	§ 	547(c)(5)(creating 	a
defense 	for 	such 	transfers 	to 	the 	extent 	the 	creditor’s 	overall
secured 	position 	was 	not 	“improved” 	as 	a 	result 	of 	the 	transfers).
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The legal fiction applied by the Castletons court is simply the DuBay
and 	Grain 	Merchants 	legal 	fiction 	under 	another 	name. 	Given 	the
legislative history recited above, employing such a legal fiction is
both inappropriate and unnecessary.
In the Memorandum, the Court did not focus on this legal fiction
but rather took issue with the Castletons court’s definition of the
term 	“proceeds.” 	In 	its 	motion 	for 	reconsideration, 	Burlingame
contends that the Court committed clear error in its construction of
the term “proceeds.” 	It also contends that the Court’s construction
of 	the 	term 	is 	inconsistent 	with 	its 	construction 	of 	the 	term 	in
connection 	with 	Burlingame’s 	motion 	for 	relief 	from 	stay. 	The
Court’s decision in that contested matter has since been affirmed by
the 	United 	States 	District 	Court 	for 	the 	Northern 	District 	of
California. 	See 	In 	re 	Qmect, 	Inc., 	373 	B.R. 	682 	(N.D. 	Cal. 	2007).
Burlingame 	contends 	that 	the 	Court 	is 	bound 	by 	principles 	of
collateral 	estoppel 	and 	law 	of 	the 	case 	to 	abide 	by 	its 	prior
definition of “proceeds.”
The 	Court 	continues 	to 	believe 	that, 	given 	the 	nature 	of
Burlingame’s 	business, 	the 	proceeds 	of 	Burlingame’s 	security
interest 	did 	not 	include 	new 	accounts 	receivable 	although 	the
“floating 	lien” 	contained 	in 	its 	security 	agreement 	did 	cause 	its
security 	interest 	to 	attach 	to 	them. 	However, 	even 	if 	the 	Court’s
narrow 	reading 	of 	the 	term 	“proceeds” 	is 	incorrect, 	the 	result 	is
still 	the 	same. 	The 	transfer 	of 	a 	security 	interest 	in 	an 	account
receivable 	created 	during 	the 	preference 	period 	is 	subject 	to
avoidance as a preference even if the account receivable in question
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6Section 547(c)(5) provides statutory evidence for this
proposition. 	Section 547(c)(5) provides a defense to avoidance as
a preference for transfers of security interests in accounts
receivable and inventory “or the proceeds of either” occurring
during the preference period to the extent the secured creditor’s
secured position has not been “improved.” 	See 11 U.S.C.
§ 547(c)(5). 	If transfers in “proceeds” are not subject to
preference attack, this phrase would be unnecessary.
7Because the Court’s ruling on this issue no longer turns on
the definition of “proceeds,” several of the cases cited by
Burlingame are no longer relevant and will not be discussed. 	See
e.g. In re Filtercorp, Inc., 163 F.3d 570 (9 th Cir. 1998); In re
Bumper Sales, Inc., 907 F.2d 1430 (4 th Cir. 1990).
11
is the “proceeds” of inventory in existence prior to the beginning of
the preference period. 6 	Without the legal fiction that a different
asset 	is 	really 	not 	a 	different 	asset, 	but 	merely 	a 	change 	in
description, the result is a potentially avoidable transfer. 7
Castletons is a Tenth Circuit decision and thus not binding on
this Court. 	However, Burlingame contends that the rationale employed
by the Castletons court was adopted by the Ninth Circuit in Smith’s
Home 	Furnishings, 	Inc., 	265 	F.3d 	959 	(9 th 	Cir. 	2000) 	and 	must
therefore be followed by this Court. 	The problem with this argument
is 	that 	there 	is 	a 	substantial 	difference 	between 	this 	case 	and
Smith’s, 	both 	with 	respect 	to 	the 	nature 	of 	the 	claim 	and 	the
underlying facts.
In 	Smith’s, 	the 	trustee 	sought 	to 	avoid 	payments 	made 	to 	a
secured 	creditor 	during 	the 	preference 	period, 	not 	transfers 	of
security 	interests. 	Second, 	the 	trustee 	failed 	to 	prove 	that 	the
secured 	creditor 	was 	not 	at 	all 	times 	fully 	secured. 	The
significance of the latter difference is that, even if the challenged
payments 	had 	not 	been 	made, 	the 	fully 	secured 	creditor 	would 	still
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8The Smith’s court did mention in this context that all
payments to the creditor came from its collateral. 	Smith’s 225
F.3d at 965. 	However, as discussed above, since the creditor was
fully secured and would have been paid in full in a liquidation
even if it had received no payments, the payments could not have
been avoided regardless of their source. 	Thus, the Court views
this reference as dicta.
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have been paid in full. 	The payments challenged as preferential did
not give the creditor more because the creditor could never receive
more than full payment of its debt. 8 	The Court does not read Smith’s
as adopting the Castletons court’s legal fiction that a new asset is
simply an old asset with a new description.
In sum, the Court continues to conclude that the Burlingame is
not 	entitled 	to 	summary 	judgment 	on 	the 	fifth 	element 	of 	the
preference claim. 	However, the motion for reconsideration is granted
to 	the 	extent 	that 	the 	Court’s 	rationale 	for 	this 	conclusion 	has
“evolved.”
B. 	“IMPROVEMENT IN POSITION” DEFENSE
Burlingame’s second ground for its motion for summary judgment
was 	that, 	even 	if 	the 	transfers 	did 	constitute 	preferences, 	it 	is
entitled to a complete defense to their avoidance under 11 U.S.C. §
547(c)(5). 	In 	the 	Memorandum, 	the 	Court 	held 	that 	Burlingame 	was
only 	entitled 	to 	a 	limited 	defense. 	In 	its 	motion 	for
reconsideration, Burlingame contends that the Court committed clear
error in reaching this conclusion as well.
Section 	547(c)(5) 	provides 	that 	the 	trustee 	may 	not 	avoid 	a
transfer under § 547(b):
(5) that creates a perfected security interest
in inventory or a receivable or the proceeds of
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either, except to the extent that the aggregate
of 	all 	transfers 	to 	the 	transferee 	caused 	a
reduction, 	as 	of 	the 	date 	of 	the 	filing 	of 	the
petition and to the prejudice of other creditors
holding unsecured claims, of any amount by which
the 	debt 	secured 	by 	such 	security 	interest
exceeded the value of all security interests for
such debt...[at the beginning of the applicable
preference period].
11 U.S.C. § 547(c)(5). 	This defense is generally referred to as the
“improvement 	in 	position” 	defense. 	Thus, 	the 	value 	of 	an
undersecured creditor’s collateral in relationship to its debt on the
petition 	date 	is 	compared 	with 	the 	value 	of 	its 	collateral 	in
relationship to its debt at the beginning of the preference period.
The transfers during the preference period are only avoidable to the
extent that its undersecured position on the earlier date is greater
than its undersecured position on the later date.
The 	Trustee 	presented 	evidence 	that 	the 	value 	of 	the 	Debtor’s
accounts 	receivable 	and 	inventory 	increased 	by 	$156,939 	during 	the
preference period. 	Burlingame presented no evidence to the contrary.
Nevertheless, Burlingame contended that it was entitled to a complete
defense 	because 	the 	Trustee 	would 	be 	unable 	to 	prove 	that 	the
preferential transfers prejudiced unsecured creditors. 	See 11 U.S.C.
§ 	547(c)(5). 	Again, 	for 	this 	contention, 	Burlingame 	relied 	on
Castletons and its “blanket lien” theory.
The 	Castletons 	court 	held 	that, 	for 	unsecured 	creditors 	to 	be
prejudiced 	by 	the 	“improvement 	in 	position” 	of 	a 	creditor 	with 	a
floating lien in accounts receivable and inventory, there had to be
other 	unencumbered 	assets. 	Because 	the 	secured 	creditor 	held 	a
blanket 	lien 	and 	was 	undersecured, 	both 	at 	the 	beginning 	of 	the
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preference 	period 	and 	on 	the 	petition 	date, 	in 	either 	instance,
unsecured 	creditors 	would 	have 	received 	nothing. 	Therefore, 	the
transfers did not prejudice them.
In the Memorandum, in rejecting this rationale, the Court noted
that 	the 	rationale 	only 	made 	sense 	if 	one 	accepted 	the 	Castletons
court’s construction of the term “proceeds.” 	Otherwise, absent the
preferential 	transfers, 	all 	of 	the 	new 	accounts 	receivable 	and
inventory 	would 	have 	been 	unencumbered. 	Failing 	to 	avoid 	the
transfers 	would 	prejudice 	unsecured 	creditors 	by 	depriving 	them 	of
recourse to these new assets.
As 	with 	the 	previous 	issue, 	the 	Court 	now 	concludes 	that 	the
critical 	error 	in 	the 	Castletons 	court’s 	rationale 	is 	not 	its
construction of the term “proceeds.” 	Rather, its critical error is
its apparent assumption that the transfer of a security interest in
an 	asset 	created 	or 	acquired 	during 	the 	preference 	period 	is 	not
avoidable when the asset so created or acquired is the “proceeds” of
an asset encumbered by the same security interest in existence prior
to 	the 	commencement 	of 	the 	preference 	period. 	As 	discussed 	above,
that assumption is incorrect.
However, in its reply to the Trustee’s opposition to its motion
for 	reconsideration, 	Burlingame 	raised 	a 	new 	argument 	for 	its
contention 	that 	it 	has 	a 	complete 	defense 	under 	11 	U.S.C. 	§
547(c)(5). 	In its reply and at the hearing on the motion, Burlingame
argued 	that 	its 	“position” 	had 	not 	“improved” 	because 	its 	debt 	had
increased 	during 	the 	preference 	period, 	due 	to 	the 	accrual 	of
interest 	and 	late 	fees, 	even 	more 	than 	the 	value 	of 	its 	collateral
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9Burlingame correctly noted that the amount of the increase
was the subject of a final judgment in a related adversary
proceeding.
10The Trustee did cite language from two respected legal
treatises that referred to changes in the debt due to “advances” in
their discussion of the “improvement in position” defense.
However, nothing in the citations directly addressed the issue
presented here.
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had increased. 9 	Because the Trustee had not had a fair opportunity
to address this argument, the Court permitted the parties to submit
post-hearing briefs.
In 	his 	post-hearing 	brief, 	the 	Trustee 	asserted 	that, 	for
purposes 	of 	determining 	a 	secured 	creditor’s 	“improvement 	in
position” pursuant to 11 U.S.C. § 547(c)(5), the only changes in the
“debt” during the preference that should be considered were increases
due 	to 	additional 	“advances” 	or 	decreases 	pursuant 	to 	additional
“payments.” 	Increases 	in 	the 	debt 	other 	than 	additional 	advances
should not be considered. 	The Trustee conceded that he had found no
express support for this proposition in legal treatises or case law. 10
He based his assertion primarily on policy grounds.
The Trustee noted that, if the transfers attacked as preferences
had 	been 	payments 	rather 	than 	transfers 	of 	security 	interests 	and
Burlingame were asserting a “new value” defense pursuant to 11 U.S.C.
§ 547(c)(3), increases due to interest, late charges, and attorneys’
fees 	would 	not 	qualify 	as 	“new 	value.” 	See 	11 	U.S.C. 	§
547(a)(2)(defining “new value” as “money or money’s worth in goods,
services, or new credit”). 	He also observed that 11 U.S.C. § 506(b)
excludes 	post-petition 	interest 	and 	attorneys’ 	fees 	from 	an
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11The Trustee also argued that the litigation in this
adversary proceeding had not been conducted “fair and square.” 	He
noted that, as trustees frequently are, he was at a disadvantage by
not having been involved in the underlying case and the various
adversary proceedings from their onset. 	He contended that this
made the late assertion of the argument concerning the increase in
debt particularly unfair. 	However, the Trustee failed to request
additional time to brief this late raised issue. 	Had he asked for
it, the Court would have provided the Trustee with any reasonable
amount of time required to compensate for this disadvantage.
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undersecured 	creditor’s 	secured 	claim. 	He 	acknowledged 	that 	in 	a
contested 	matter 	in 	the 	underlying 	case, 	the 	Court 	has 	concluded
that, 	notwithstanding 	11 	U.S.C. 	§ 	506(b), 	Burlingame’s 	unsecured
claim 	may 	include 	its 	post-petition 	attorneys’ 	fees. 	However, 	he
correctly 	noted 	that 	this 	opinion 	was 	the 	subject 	of 	substantial
controversy. 	Finally, 	he 	contended 	that 	the 	factual 	issue 	of 	the
amount 	of 	the 	increase 	of 	Burlingame’s 	debt 	during 	the 	preference
period 	was 	not 	actually 	litigated 	in 	the 	related 	adversary
proceeding. 	Therefore, the Trustee argued the Court’s determination
of 	the 	amount 	of 	Burlingame’s 	debt 	should 	not 	bind 	the 	Trustee 	in
this adversary proceeding. 11
Burlingame 	responded 	to 	each 	of 	these 	arguments. 	First, 	it
noted that statutory construction must begin with the language of the
statute, not with policy. 	When the language of the statute is clear,
policy 	need 	not 	and 	should 	not 	be 	consulted. 	Burlingame 	correctly
noted 	that 	11 	U.S.C. 	§ 	547(c)(5) 	refers 	only 	to 	“debt,” 	not 	to
“advances” or “new value.” 	Second, unless otherwise indicated, the
definition of terms used in the Bankruptcy Code are governed by state
law. 	Under 	state 	law, 	the 	additional 	interest, 	late 	fees, 	and
attorneys’ fees incurred during the preference period would clearly
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be 	considered 	part 	of 	the 	“debt.” 	Moreover, 	11 	U.S.C. 	§ 	506(b)
excludes 	only 	“post-petition” 	interest 	and 	attorneys’ 	fees 	from 	an
undersecured creditor’s secured debt.
Finally, 	Burlingame 	took 	issue 	with 	the 	Trustee’s 	contention
that the amount of its debt was not actually litigated in the related
adversary 	proceeding. 	To 	the 	contrary, 	it 	contended, 	this 	and 	all
other matters were fiercely litigated. 	Even though the other party
to the litigation was the Debtor, not the Trustee, the ultimate party
in interest was the bankruptcy estate. 	Therefore, the Trustee should
be bound by the determination in that proceeding.
The 	Court 	finds 	the 	arguments 	made 	and 	authority 	cited 	by
Burlingame 	more 	persuasive 	than 	those 	advanced 	by 	the 	Trustee.
Section 547(c)(5) refers to “debt.” 	“Debt” is defined as “liability
on a claim.” 	See 11 U.S.C. § 101(12). 	“Claim” is defined extremely
broadly and would certainly include pre-petition interest, late fees,
and attorneys’ fees. 	See 11 U.S.C. § 101(5).
Section 	506(b), 	which 	excludes 	post-petition 	interest 	and
attorneys’ 	fees 	from 	an 	undersecured 	creditor’s 	secured 	claim, 	has
no 	bearing 	on 	the 	amount 	of 	the 	secured 	creditor’s 	debt, 	either 	as
of 	the 	petition 	date 	or 	90 	days 	before 	that 	date. 	Finally, 	the
determination of Burlingame’s debt was actually litigated. 	Because
the 	Court 	found 	that 	the 	form 	of 	Burlingame’s 	proof 	of 	claim 	was
inadequate to shift the burden of production to the Debtor and at the
insistence 	of 	the 	Debtor, 	Burlingame 	was 	required 	to 	prove 	each
element of its claim in excruciating detail.
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CONCLUSION
For 	the 	reasons 	stated 	above, 	Burlingame’s 	motion 	for
reconsideration 	will 	be 	granted. 	The 	Court 	reaffirms 	its 	original
decision 	that 	the 	Trustee 	is 	able 	to 	establish 	all 	the 	elements 	of
a 	preferential 	transfer 	claim, 	including 	11 	U.S.C. 	§ 	547(b)(5),
although 	the 	reasons 	for 	its 	decision 	have 	altered 	somewhat.
However, 	the 	Trustee 	does 	not 	contend 	that 	value 	of 	Burlingame’s
collateral increased during the preference period by more $157,000.
The 	Court 	has 	already 	determined 	the 	amount 	of 	Burlingame’s 	debt
increased 	during 	the 	same 	period 	by 	at 	least 	$165,184. 	Therefore,
the 	Court 	finds 	that 	Burlingame 	is 	entitled 	to 	a 	complete 	defense
under 	11 	U.S.C. 	§ 	547(c)(5). 	Thus, 	the 	Court 	will 	grant 	summary
judgment 	in 	favor 	of 	Burlingame. 	Burlingame 	is 	directed 	to 	submit
a proposed order and judgment in accordance with this decision.
END OF DOCUMENT
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COURT SERVICE LIST
William W. Huckins
Allen, Matkins, Leck, Gamble, Mallory et al.
3 Embarcadero Center 12th Fl.
San Francisco, CA 94111
Reidun Stromsheim
Law Offices of Stromsheim and Assoc.
201 California St. #350
San Francisco, CA 94111
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