Beware Attorney Charging Liens On California Real Property – Law360
Law360, New York (March 23, 2015, 8:28 PM ET) — California fee contracts between an attorney and client often include provisions that provide the attorney with a “charging lien”, i.e., a lien upon property owned by the client to insure the payment of fees. Charging liens are valid provisions of a fee contract in California, and such “secret” liens take effect and are perfected upon execution of the contract creating the lien. See Carroll v. Interstate Brands Corp., 99 Cal. App. 4th 1168, 1175 (2002). Although charging liens are “perfected” under state law upon execution of the contract, after filing a notice of charging lien — and especially if the attorney asserts the lien against the client’s real property — attorneys should file and record the notice in the county in which the property is located, although such recordation is not required to perfect the lien. In the context of a bankruptcy case, which this article will examine, a Chapter 7 trustee plays a prominent role in the ultimate treatment of the lien with respect to property of the bankruptcy estate. Indeed, a Chapter 7 trustee can sell free and clear of secret liens on real property under 11 USC § 544.
Particularly in the Chapter 7 bankruptcy context where a Chapter 7 trustee takes all property of the estate as a bona fide purchaser for value under Section 544 of the Bankruptcy Code, attorneys holding charging liens should take care to adequately record their charging liens against real property to insure that the lien will not be avoided by the Chapter 7 trustee. Indeed, the secured status of the attorney’s asserted charging lien must be considered in light of the trustee’s strong-arm powers in addition to state law considerations.
There are several laws that assist a trustee when dealing with charging liens. First, Section 544 of the Bankruptcy Code, the trustee’s “strong-arm” powers, authorizes the trustee to avoid such secret liens on real property as follows:
The trustee shall have … the rights and powers of, or may avoid any transfer of property of the debtor … that is voidable by-
(3) a bona fide purchaser of real property, other than fixtures, from the debtor, against whom applicable law permits such transfer to be perfected, that obtains the status of a bona fide purchaser and has perfected such transfer at the time of the commencement of the case, whether or not such a purchaser exists. 11 U.S.C. § 544(a)(3)
This section allows the trustee to challenge prepetition transfers and to avoid claims that are unperfected against real property pursuant to state law: “The purpose of the strong arm clause is to cut off unperfected security interests, secret liens and undisclosed prepetition claims against the debtor’s property as of the commencement of the case.” In re Canney, 284 F.3d 362, 374 (2d Cir. 2002) (emphasis added); In re Commercial Money Ctr. Inc., 350 B.R. 465, 474 (9th Cir. BAP 2006) (“Trustee’s strongarm powers generally enable him to avoid a pre-petition unperfected transfer by Debtor of an interest in its property”).
Furthermore, as a “hypothetical” creditor and bona fide purchaser, the trustee is not required to show an actual prepetition transfer by the debtor. Indeed, Section 544(a)(3) applies even when there has been no transfer of real estate but where there exists any asserted but unrecorded interests in real property. In In re Roman Catholic Archbishop of Portland in Oregon, 335 B.R. 868, 877 (Bankr. D. Or. 2005); see also In re Kasparek, 426 B.R. 332, 344 (10th Cir. BAP 2010) (“The rights and powers of a bona fide purchaser include the right to obtain title to property free of certain unrecorded interests; the exercise of that right does not necessarily require the avoidance of a transfer.”).
The trustee’s right to avoid a charging lien with respect to the property is governed by California law. See Kipperman v. Sutherland (In re Bush), 356 B.R. 28, 37 (Bankr. S.D. Cal. 2006) (citing Placer Savings & Loan Association v. Walsh (In re Marino), 813 F.2d 1562, 1565 (9th Cir. 1987)). The California Civil Code permits a judicial lien creditor and/or bona fide purchaser to avoid an unperfected security interest in real property as follows:
Every conveyance of real property … is void as against any subsequent purchaser or mortgagee of the same property … whose conveyance is first duly recorded, and as against any judgment affecting the title, unless the conveyance shall have been duly recorded prior to the record of notice of action. Cal. Civ. Code § 1214.
Despite the fact that California law provides that charging liens are perfected upon execution of the fee contract, the trustee may avoid a charging lien as against real property under this standard.
For example, in the case of In re Bush, supra, the Bankruptcy Court for the Southern District of California considered the enforceability of an attorney charging lien similar to the one asserted in this case. Indeed, in Bush, the attorney and client (the debtor) entered into a prepetition retainer agreement, whereby the debtor agreed to the granting of a charging lien to the attorney, by which the attorney could recover money and property due to, or received by the debtor as a result of assets awarded to the debtor in a dissolution proceeding. 356 B.R. at 30. Thereafter, the family court judge signed a Stipulation Re: Fees, in which the debtor agreed that his portion of owed attorneys’ fees could be paid from his share of escrow proceeds from the sale of community real property. Id. at 31.
Thereafter, the debtor filed a voluntary Chapter 7 petition, and sought to sell the real property and collect his homestead exemption. Id. The attorney filed a proof of claim in the bankruptcy case, asserting that, pursuant to the charging lien, she had a secured claim entitled to satisfaction from escrow by proceeds from the sale of the real property. Id.
The bankruptcy court held that, although attorney charging liens are “valid and perfected upon execution of the contract creating the lien,” when considered in light of a bankruptcy trustee’s avoidance powers, the charging lien was avoidable. 356 B.R. at 34-35, 37-38. Indeed, the court explained that, “Considered under [Civil Code § 1214] alone, a judicial lien creditor and bona fide purchaser would be able to avoid debtor’s transfer of the security interest in the real property to [attorney].” Id. at 38. Thus, the court found that the trustee, by virtue of his status as a hypothetical lien creditor and bona fide purchaser, “could not be charged with constructive notice of [attorney’s] Stipulation [Re: Fees] which was not recorded as of the petition date.” Id.
Thus, attorneys who seek to collect from their clients by asserting charging liens against real property owned by those clients should carefully consider the impact of the client’s potential future bankruptcy filing, and should duly record notices of charging liens against such real property to insure that the lien does not become an unsecured claim — as opposed to one secured by the real property — in the client’s bankruptcy case.
—By Jessica Bagdanov, Brutzkus Gubner
Jessica Bagdanov is an associate in Brutzkus Gubner’s Los Angeles office.
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