Introduction

A recent ruling of the Seventh Circuit Court of Appeals resulted in an otherwise secured lender’s claim being rendered unsecured because the lender ignored warning signs casting doubt on the debtor’s right to pledge the collateral. In Grede v. Bank of New York Mellon Corp. (In re Sentinel Management Group, Inc.), 2016 U.S. App. LEXIS 284, the debtor was a cash management company. It invested its customers money and held the purchased securities for its customers’ accounts. The debtor also traded on its own account, and borrowed money to do so.

For the past several years, creditors in the Ninth Circuit were confounded by an interpretation of the bankruptcy code that permitted individual chapter 11 debtors to retain a significant portion of their assets without creditor consent.  The problem was particularly vexing in the context of high net worth individuals, some of whom held multiple ownership interests in entities that held valuable assets or generated significant income.  That loophole was finally closed on January 28, 2016 when the Ninth Circuit Court of Appeals determined that the “absolute priority rule” applies i