Bankruptcy Preference Risks to Secured Lenders Using Blocked Accounts: Why You Shouldn’t Sleep Comfortably at Night

The Secured Lender

When negotiating and drafting payoff letters, outgoing lenders should be wary of the risks of potential preference liability to a bankruptcy trustee with certain clawback rights for payments previously made. This event may result in an outgoing lender holding an unsecured claim against the borrower despite having previously been secured.

A payoff letter typically sets forth the total amount owed, along with the certain obligations of the outgoing lender following payment in full. These actions often include executing lien terminations and releases and filing UCC-3 termination statements. Payoff letters also usually contain survival provisions and releases by the borrower. Survival provisions ensure that certain loan obligations survive the payoff and remain enforceable. Common examples include indemnification obligations and provisions relating to the revival and reinstatement of obligations and liens. These are particularly important in scenarios where a payment made by an account debtor is later challenged as void, voidable, or otherwise subject to recovery under applicable bankruptcy laws. Such survival provisions often state that any previously released or terminated liens shall be reinstated and enforceable.

Preference risk in payoff transactions is a nuanced and often underappreciated issue for Outgoing Lenders. While standard payoff procedures—receipt of funds, release of liens, and termination of control agreements—may appear routine, failure to properly address these items may leave the Outgoing Lender with significant exposure.

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