Memorandum of Decision Re: Security Interest as Preference

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Decisions
IN THE UNITED STATES BANKRUPTCY COURT FOR THE NORTHERN DISTRICT OF CALIFORNIA
In re ARNOWITZ STUDIOS, INC.,                                                 No. 95-11492      Debtor. ___________________________/ ARNOWITZ STUDIOS, INC.,      Plaintiff,    v.                                                                                           A.P. No. 95-1189 SILICON VALLEY BANK,      Defendant. ______________________________/
Memorandum of Decision
     Plaintiff and debtor in possession Arnowitz Studios, Inc., filed its Chapter 11 petition on June 16, 1995. At the time it filed its petition, its principal asset was license fee income from computer software it had created. The issue in this adversary proceeding is whether the security interest of defendant Silicon Valley Bank in those license fees is avoidable as a preference.      On September 15, 1994, Arnowitz agreed in writing to give the Bank a security interest in the license fees to secure a $175,000.00 line of credit. At the same time, Arnowitz executed a Negative Pledge Agreement whereby it promised not to sell or encumber its intellectual property.      On November 4, 1994, the Bank filed a UCC-1 financing statement. However, the financing statement did not describe the Bank's security interest, but only the Negative Pledge Agreement. It read as follows:          Debtor has agreed with Secured Party that Debtor          will not pledge any of its intellectual property to a third party.          The purpose of this UCC Financing Statement is to notify all searching parties          of Debtor's Negative Pledge Agreement with Secured          Party.      On March 20, 1995, the Bank filed a new UCC-1 correctly identifying its security interest. However, Arnowitz filed its Chapter 11 petition within 90 days thereafter. Assuming Arnowitz was insolvent on March 20, 1995, avoidance of the Bank's lien as a preference depends on when its security interested was perfected on that date or by the November 4 filing.      Section 547(e)(2)(B) of the Bankruptcy Code provides that a transfer of an interest in personal property is made when the transfer is perfected. Section 547(e)(1)(B) provides that a transfer of personal property is perfected when a creditor cannot obtain a judicial lien superior to the transferee. If the November 4 UCC-1 perfected the Bank's security interest, then there was no preference. If the security interest was not perfected until March 20, then there was a preference.       A purely negative covenant against encumbrances does not create a legal or equitable lien. Kuppenheimer & Co. v. Morin, 78 F.2d 261, 263 (8th Cir.1935) cert. den. 296 U.S. 615 (1936). Section 9311 of the California Commercial Code provides that a judicial lien is valid notwithstanding a prior covenant not to encumber. Furthermore, "it seems clear that buyers, transferees and creditors will take free of the prohibitory covenant even if they have knowledge of it." Gilmore, Security Interests in Personal Property, p. 1018 (1965). Moreover, Commercial Code section 9402 provides that a financing statement must contain a statement describing the collateral. The November 4 statement does not describe any collateral. It only describes what is not collateral.      Since knowledge of a negative pledge agreement does not defeat the rights of a subsequent creditor, such a creditor would have no obligation to make further inquiry after seeing the Bank's November 4 financing statement. The November 4 filing did not in itself describe any collateral. It therefore did not serve to perfect the Bank's security interest. That interest was not perfected until March 20, well within the preference period.      For the foregoing reasons, judgment will be entered avoiding the Bank's security interest and preserving it for the benefit of the estate. However, enforcement of the judgment will be stayed as ordered at trial in order to give the Bank further opportunity to investigate the debtor's solvency and seek a new trial as to that issue if post-trial discovery establishes that Arnowitz was solvent.1      This memorandum constitutes the court's findings and conclusions pursuant to FRCP 52(a) and FRBP 7052. Counsel for Arnowitz shall submit an appropriate form of judgment forthwith which counsel for the Bank has approved as conforming to this decision.
Dated:                                                                                                                 _______________________                                                                                                                                 Alan Jaroslovsky                                                                                                                              U.S. Bankruptcy Judge
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     1. While the evidence at trial established that Arnowitz was not as insolvent as it claimed, it appeared nonetheless that it was insolvent on March 20. However, the court leaves the door open for the Bank to seek a new trial as to this issue, since trial was expedited to accommodate the debtor's pending plan and the Bank had limited opportunity to conduct disc