TIMBER! Creditor’s Alleged Security Interest Falls

In Re: Cruse, 2013 Bankr. LEXIS 360 (S.D. Ind. 2013) (.pdf) is about UCC secured transactions generally, and security interests in timber specifically.  The Court’s opinion is helpful to asset-based lenders and their counsel in Indiana. 

The debt.  In Cruse, a Chapter 13 bankruptcy case, the Debtor was in the business of buying and harvesting timber (living trees) and reselling the timber after it was cut.  The Debtor and the Creditor entered into a contract that allowed the Debtor to harvest timber on the Creditor’s land in exchange for payment, including a percentage of the sales.  Following the filing of the Debtor’s bankruptcy, the unpaid Creditor filed a proof of claim. 

The objection.  The Debtor did not object to the amount of the Creditor’s claim but rather its alleged secured status.  The Creditor contended that the Debtor’s property (the timber) was subject to the Creditor’s security interest.  The Debtor responded that the Creditor’s proof of claim contained no documentation to support a lien or a security interest. 

The law.  The issue in Cruse was whether the Creditor had a perfected security interest in the timber, which is considered personal property (not real property in this context).  The Court identified the applicable legal rules:

• Article 9.1 of the Uniform Commercial Code governs the creation and perfection of liens in personal property.
• Under I.C. § 26-1-9.1-102(44) , both “standing timber that is to be cut and removed under a conveyance or contract for sale” and timber already harvested are classified as “goods.”
• Both “attachment” and “perfection” of a security interest are needed to enforce a security interest in goods against the debtor (and third parties). 
• “Attachment” pertains to the creation of the security interest as between the secured party (creditor) and the debtor and requires the debtor to have rights in the collateral he intends to pledge to the secured party.
• “Attachment” involves the execution of a written security agreement between the debtor and the secured party that describes the collateral (unless the secured party is in possession of the collateral).
• “Perfection” is an additional step that makes the security interest effective against third parties.
• A security interest in “timber to be cut” is perfected by filing a financing statement with the office designated for the recording of a mortgage on the related real property, which in Indiana is the county recorder’s office.  I.C. § 26-1-9.1-501(a)(1)(B); I.C. § 32-21-4-1(a)(1).
• A security interest in timber already cut is perfected by filing a financing statement with the secretary of state’s office.  I.C. § 26-1-9.1-501(a)(2).

The result.  In Cruse, the Creditor provided no evidence of a written security agreement.  Even so, the creation and attachment elements were immaterial because there was “nothing in the record that suggest[ed] [the security interest] was perfected.”  The Creditor offered no evidence of any filing in the county recorder’s office or in the secretary of state’s office.  The Court sustained the Debtor’s objection to the Creditor’s secured claim and rendered the claim unsecured.

The Creditor could have created and perfected an enforceable lien on the Debtor’s timber, but the absence of a written security agreement and appropriate governmental filings was fatal in Cruse.