Conversion of Personal Property Collateral

Written By: Eric D. Dean

It is quite common in business related loans for the borrower to grant the lender a security interest in the borrower’s business assets including such things as inventory, equipment, accounts and receivables, as collateral for the loan.

Often, after the loan is made, when the borrower is facing financial difficulties, it will concoct a scheme, perhaps involving others, to sell and liquidate inventory, equipment and other assets and discount its receivables, so that it can garner cash before the lender can seize the loan collateral.

It is important to note that, as a matter of law, the proceeds of the sale of loan collateral are also loan collateral. Therefore, if the lender can locate these proceeds it can do so by obtaining appropriate court orders, perhaps on an emergency basis, obtaining an order requiring an accounting and turning over the liquidation proceeds.

Where collateral has been dissipated or diverted by the borrower, a claim for damages may also be available. The claim would generally be framed as a claim for accounting and conversion. The money claims generally would be for an award, based on the value of the lender’s missing collateral, plus interest and at least against the borrower, for attorney’s fees. This claim is called a “conversion claim”.

It is important to note that “intent” is not a required element of a conversion claim. The simple act of the wrongful taking of property in which the lender has a security interest is the seminal fact in establishing a conversion claim. It is also material that even without knowledge of the lender’s security interest, any person or entity that assists the borrower in the conversion of the lender’s collateral, or who took possession of the personal property collateral, can also be found liable for the conversion.  If an intent or conspiracy to deprive the lender of its collateral can be established, it will open the door for a punitive damage claim against the perpetrators who knowingly and intentionally participated in the conversion.

While the determination of whether to pursue a damage claim for missing personal property collateral is an economic one, it is important for the lender to maintain awareness that the possibility of the claim exists. This recognition may not only present the source of a recovery in a court action (or arbitration if an arbitration provision is incorporated into the loan documents) but also may present the basis for an adversary complaint in bankruptcy challenging discharability or leverage in settlement negotiations.