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Wacky Warehouse Lien Scam

posted by Adam Levitin

The US Trustee's office just prevailed in a sanctions case against a law firm with a most creative fee scam.  To oversimplify (and leave out certain other issues of bad behavior), the law firm steered debtors who owned cars in which they had zero equity into an arrangement in which the debtor's car would be towed for an (unpaid) fee by an affiliated firm and then stored in Indiana. The existing auto lender would never be notified of any of this. The affiliate would then assert a warehouseman's lien for the unpaid fee and foreclose on the car, and use the sale proceeds to pay back the fee and pay the debtor's bankruptcy filing fee to the law firm, with the auto lender getting nothing. 

Now you might be wondering how this is possibly an acceptable foreclosure sale distribution. The problem, it seems, is not that the warehouseman's lien primed the auto lender's lien. It turns out that the choice of Indiana might not be coincidental. UCC 9-333 says that a possessory lien has priority over other security interests unless "the lien is created by a statute that expressly provides otherwise."  The UCC has a warehouseman's lien provision, UCC 7-209, but that provision expressly states that the warehouseman's possessory lien is normally subordinate to existing liens. So if the lien were under UCC 7-209, then existing auto lender's lien would ride through the foreclosure and the existing auto lender would still be able to foreclose on the car (if it could locate it).

But Indiana has another warehouseman's lien statute (actually two of them, at least):  one for warehousemen, and one for the towing and storage of motor vehicles. I assume the latter is the applicable statute as it is more specific, but it doesn't really matter as neither of them provides that the lien is subordinate to an existing security interest.  (The same would be true if there were a common law lien.)  So I think the effect of the foreclosure sale was to wipe out the auto lender's subordinate lien.  

The matter doesn't end there, however.  Even though the junior lien gets wiped out in the foreclosure sale, it should still be entitled to share in the distribution if there are more funds than necessary to repay the senior (warehouseman's) lien. Or at least I think, as that's the way it works everywhere, but I haven't been able to find the relevant Indiana foreclosure sale distribution statute. In other words, the problem isn't so much that the scam stripped the existing auto lender of its lien (although there are certainly some equitable argument to be made there), but that the excess funds from the foreclosure sale went to pay the law firm for the bankruptcy fees, rather than to the auto lender. 

All told, it's a scam that only a secured credit nerd could love. Makes me think that some lawyers were paying very close attention in their secured credit class, but missed the ethics discussion. 


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