An Equitable Tightrope: Blackjewel's Balancing Act on After-Acquired Property in Bankruptcy

It is well recognized that, in keeping with the "fresh start" or "rehabilitative" policy, the Bankruptcy Code invalidates after-acquired property clauses in prepetition security agreements, but also includes an exception to the general rule for prepetition liens on the proceeds, products, offspring, or profits of prepetition collateral. Less well understood is that there is an "exception to the exception" if a bankruptcy court determines that the "equities of the case" suggest that property acquired by the estate should be free of such liens.

This exception was recently addressed by the U.S. District Court for the Southern District of West Virginia. In United Bank v. Blackjewel, L.L.C. (In re Blackjewel, L.L.C.), 2021 WL 2667511 (S.D. W. Va. June 29, 2021), appeal filed, No. 21-1831 (4th Cir. July 30, 2021), the court affirmed a bankruptcy court order denying an undersecured lender's motion seeking as a form of "adequate protection" the payment of asset sale proceeds allegedly subject to its prepetition security interest in receivables. According to the district court, the bankruptcy court did not abuse its discretion in finding that it would be inequitable for the lender's liens to attach to the proceeds of a postpetition sale because "allowing [the lender] to receive the proceeds of unencumbered estate assets would be inequitable to the unsecured creditors."

Invalidation of Certain After-Acquired Property Clauses in Bankruptcy

Section 552(a) of the Bankruptcy Code states that "[e]xcept as provided in subsection (b) of this section, property acquired by the estate or by the debtor after the commencement of the case is not subject to any lien resulting from any security agreement entered into by the debtor before the commencement of the case." This provision reflects the principle that "the debtor's fresh start should entitle the debtor to use after-acquired property, so long as it is not property of the estate under section 541(a)(6) [defining as "estate property" the proceeds, product, offspring, rents, or profits of or from estate property], free and clear of a prebankruptcy lien." Collier on Bankruptcy ("Collier") ¶ 552.01 (16th ed. 2021).

Section 552(b)(1), however, includes a limited "savings clause" for certain security interests. That section provides, with limited exceptions not relevant here:

 [I]f the debtor and an entity entered into a security agreement before the commencement of the case and if the security interest created by such security agreement extends to property of the debtor acquired before the commencement of the case and to proceeds, products, offspring, or profits of such property, then such security interest extends to such proceeds, products, offspring, or profits acquired by the estate after the commencement of the case to the extent provided by such security agreement and by applicable nonbankruptcy law, except to any extent that the court, after notice and a hearing and based on the equities of the case, orders otherwise.

11 U.S.C. § 522(b)(1). A separate savings clause for pledged real property rents and related fees is covered by section 552(b)(2).

Thus, the savings clause for liens on postpetition proceeds, products, or profits of (or rents from) property pledged prepetition is itself subject to an exception "to the extent that the court, after notice and a hearing and based [on] the equities of the case, orders otherwise." In re Las Vegas Monorail, Co., 429 B.R. 317, 344 (Bankr. D. Nev. 2010). This "exception to the exception" authorizes a bankruptcy court to utilize its discretion when deciding whether to allow a prepetition lien to survive postpetition. See United Va. Bank v. Slab Fork Coal Co., 784 F.2d 1188, 1191 (4th Cir. 1986); Gray v. Bank of Early, 2018 WL 9415069, *6 (M.D. Ga. Sept. 20, 2018).

Courts have typically applied the "equities of the case" exception in cases where a secured creditor would receive a windfall because, for example, the value of the creditor's collateral is increased by an expenditure of estate funds that would otherwise be distributed to unsecured creditors in the case. Id. (citing cases and noting that five courts of appeals have embraced this interpretation of section 552(b)(1)'s purpose and application); accord In re Transcare Corp., 2020 WL 8021060, *41 (Bankr. S.D.N.Y. July 6, 2020) ("The 'equities of the case' exception is a means of allocating the value of post-petition collateral proceeds between the secured creditor and the estate."); see generally Collier at ¶ 552.02[4].

The legislative history of section 552(b) indicates that the exception is intended to cover situations such as when raw materials are converted into inventory, or inventory into accounts at the expense of the bankruptcy estate, therefore depleting available funds for general unsecured creditors. See H. Rep. No. 95–595, at 376–77 (1977). In enacting it, lawmakers strove to strike an appropriate balance between the rights of secured creditors and the rehabilitative purposes of the Bankruptcy Code. See Slab Fork, 784 F.2d at 1191.

Guided by the legislative history, some courts have examined three factors when determining whether the equities of the case exception should apply: "the amount of time and estate funds expended on the collateral, the position of the secured party, and the rehabilitative nature of the bankruptcy case." In re Laurel Hill Paper Co., 393 B.R. 89, 93 (Bankr. M.D.N.C. 2008). Other courts have "conducted a balancing of equities to determine whether a security interest in post-petition proceeds should be reduced." Gray, 2018 WL 9415069, at *9 (citing and discussing cases).


In July 2017, coal mining company Blackjewel L.L.C. ("Blackjewel") became a co-obligor on a loan made to a Blackjewel affiliate by United Bank ("lender") under a 2012 loan and security agreement. The lender's collateral originally included the affiliate's "accounts, receivables and inventory," but was amended in 2013 to grant the lender a security interest in the affiliate's property, "whether now owned or hereafter acquired," including, among other things, all accounts and receivables, all "rights, agreements, and property securing or relating to payment of the [r]eceivables," all "[p]roceeds and products of all of the foregoing in any form, … and all increases and profits received from all of the foregoing." The lender renewed its financing statements covering this collateral (owned by both the affiliate and Blackjewel) after Blackjewel became a co-obligor on the loan.

Also in July 2017, Riverstone Credit Partners ("Riverstone") agreed to loan Blackjewel $34 million in exchange for a security interest in substantially all of Blackjewel's assets, including coal mined from Wyoming.

In 2018, Blackjewel entered into a coal supply agreement ("BJMS coal agreement") with Blackjewel Marketing and Sales LP ("BJMS"), whereby Blackjewel agreed to sell all coal produced from its Wyoming mines to BJMS.

As of June 2019, there were no outstanding amounts owed by BJMS to Blackjewel under the BJMS coal agreement (or a previous agreement with BJMS's predecessor-in-interest), meaning that Blackjewel had no corresponding accounts receivable.

Blackjewel and certain affiliates (collectively, "debtors") filed for chapter 11 protection in July 2019 in the Southern District of West Virginia.

In August 2019, the federal government halted the transport of certain coal shipments from the debtors' properties in Kentucky and Virginia, alleging that the debtors failed to pay prepetition employee wages and that the coal shipments were therefore "hot goods" under applicable federal law.

The lender filed claims in the chapter 11 cases asserting that it was owed approximately $7 million. 

In October 2019, the debtors moved for authorization to sell substantially all of their Wyoming mining assets. In connection with the proposed sale, the debtors sought court approval of several settlement agreements, including: (i) an agreement with BJMS providing that BJMS would pay the debtors for coal mined postpetition and the parties would exchange mutual releases; (ii) an agreement with the federal government settling the hot goods dispute under which the debtors would use a portion of the BJMS settlement proceeds to pay the outstanding wage claims of employees; and (iii) an agreement with Riverstone under which the debtors would pay Riverstone $32 million in exchange for a release of its liens.

The bankruptcy court approved the sale and the related settlement agreements on October 4, 2019.

In accordance with the BJMS settlement, BJMS then paid the debtors $8,513,496, consisting of: (i) $3,038,496 for postpetition accounts receivable generated between September 27, 2019, and the effective date of the sale; and (ii) $5,475,000 for accounts receivable generated between the bankruptcy petition date and September 26, 2019. Thereafter, the debtors used approximately $6.3 million of the settlement proceeds to pay employee wages, leaving approximately $2.1 million in "residual proceeds" from the BJMS settlement.

After the sale, the lender, asserting that its claim was undersecured and that its security interest attached to both prepetition and postpetition accounts receivable, filed a motion seeking payment of the residual proceeds as a form of "adequate protection." The debtors objected. They argued that the lender's lien did not encumber the residual proceeds for the following reasons: (i) the BJMS settlement proceeds could not be proceeds of the debtors' prepetition accounts receivable because, as of the petition date, there were no amounts owed by BJMS to the debtors; (ii) even if the BJMS settlement proceeds were proceeds of the debtors' postpetition accounts receivable, the lender did not have a lien on such proceeds because section 552(a) severed the lien on the debtors' accounts receivable as of the petition date; (iii) section 552(b)(1) did not apply because postpetition accounts receivable are not proceeds of prepetition accounts receivable; and (iv) even if the lender's lien technically extended to the BJMS settlement proceeds, the court, in its discretion and pursuant to section 552(b)(1), should determine that the equities of the case precluded the lender's lien from attaching to the residual proceeds.

The bankruptcy court denied the lender's adequate protection motion, finding that the lender failed to perfect its alleged security interest under applicable law in the BJMS coal agreement. It also found that, unlike Riverstone, the lender never had a lien (perfected or otherwise) on coal (mined or unmined) from Blackjewel's Wyoming mines.

Finally, the court concluded that the equities of the case did not favor the lender. First, it explained, the coal sold by the debtors to BJMS postpetition was not encumbered by the lender's liens, and, even if the coal was later converted to create encumbered "proceeds" of the BJMS coal agreement, allowing any prepetition security interest to attach to such postpetition proceeds would constitute a windfall to the lender at the expense of the estate and unsecured creditors.

Second, the court wrote, even if the lender had perfected its interest, "it would be inequitable for any liens to attach to the postpetition proceeds … because those proceeds arose out of the unencumbered inventory of the estate, [and] allowing [the lender] to receive the proceeds of unencumbered estate assets would be inequitable to the unsecured creditors."

The lender appealed to the district court.

The District Court's Ruling

On appeal, the district court framed the issue before it as "whether the bankruptcy court abused its discretion by relying on a clearly erroneous factual finding to rule that even if [the lender] had perfected its valid security interest, the equities of the case nonetheless prevent that interest from attaching." Blackjewel, 2021 WL 2667511, at *4.

The lender argued on appeal that the bankruptcy court's equities of the case holding was an abuse of discretion because the decision was based on the "erroneous factual finding" that the Wyoming coal was unencumbered, albeit not by the lender's security interest, but by Riverstone's lien. According to the lender, because the coal was subject to Riverstone's lien, "depriving [the lender] of its security interest does not protect the unsecured creditors in this case," but instead "creates a windfall for unsecured creditors where none should exist."

The debtors countered that the case was a "textbook" equities of the case situation. They argued that:

(i)  It was undisputed that, when the debtors filed for bankruptcy, no accounts receivable remained outstanding on the coal supply contracts in which the lender asserted a security interest;

(ii) After the petition date, the debtors took several steps to increase the value of the lender's collateral, including obtaining postpetition financing, resolving disputes with their employees, business partners, and the federal government, and resuming limited mining operations in Wyoming;

(iii) Through these efforts, the debtors converted "raw materials" (unextracted coal) into "inventory," and "inventory into accounts";

(iv) The residual proceeds represented the remainder of the debtor's postpetition coal sales in Wyoming, after the debtors, BJMS, and Riverstone settled and mutually released all claims against each other, and therefore, the proceeds were unencumbered assets of the estate;

(v) Even if the coal was encumbered by Riverstone's lien, the lender failed to explain why a lien held (and released) by a different secured party would affect the bankruptcy court's conclusion that it was "inequitable" for the lender to receive the postpetition residual proceeds; and

(vi) Allowing the lender to receive the proceeds of sales generated solely by the postpetition efforts of the debtors "would create a windfall to the bank at the expense of the estate and unsecured creditors," who owned the coal at issue and were directly responsible for any increase in value realized through the postpetition sales.

Id. at *6.

U.S. District Judge Robert C. Chambers rejected the lender's argument that depriving it of its security interest would create an unearned windfall for unsecured creditors. He noted that the lender's contention hinged on the bankruptcy court's decision in Laurel Hill, where the court found that "payments at the expense of secured creditors rather than at the expense of the estate, do not support an equities of the case award to the unsecured creditors."

According to Judge Chambers, Laurel Hill is distinguishable. In that case, he explained, the assets in question were encumbered by the very creditors who sought payment pursuant to their security interest, leading the court to conclude that the equities of the case exception could not be applied to deprive the secured creditors access to the sale proceeds, because "[t]he costs of the alleged enhancement thus were paid from encumbered funds and not from unencumbered funds of the estate." By contrast, Judge Chambers noted, in this case, estate assets sold to create the BJMS settlement proceeds were encumbered by a different creditor (Riverstone) that released its lien and never claimed any right to the residual proceeds. Id. at *7.

In addition, Judge Chambers explained, even if the lender had a security interest in the proceeds generated by the BJMS coal agreement, it did not have a security interest in Blackjewel's coal, which it converted into inventory and then into accounts, and, in doing so, depleted estate assets that would otherwise be available to pay unsecured creditors. Moreover, although those assets may have been encumbered by a different secured creditor at the time they were converted into inventory, they were released from that encumbrance when the BJMS settlement became effective.

The district court accordingly ruled that the bankruptcy court did not abuse its discretion in concluding that it would be inequitable for the lender alone to reap the benefits of the residual proceeds from the BJMS settlement.


Blackjewel does not break any new ground on section 552 and the "equities of the case" exception. Even so, the ruling is a reminder to secured creditors that a bankruptcy court has broad discretion to disallow liens on postpetition proceeds, products, offspring, or profits based on the equities of the case. It also reinforces the importance of careful drafting of security agreements and financing statements to identify collateral clearly.

The lender appealed the district court's ruling to the U.S. Court of Appeals for the Fourth Circuit, which will have another opportunity to weigh in on the equities of the case exception in section 552(b).

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