## Facts

- John W. Chung executed a promissory note secured by a deed of trust on real property (the Chung note and deed of trust).
- A&W Properties (A&W) acquired the Chung note and the deed of trust securing it (the Chung security).
- On July 1, 1981, A&W issued its own promissory note to Executive Growth Investments, Inc. (EGI) (the A&W note).
- To secure the A&W note, A&W purported to transfer to EGI a 34.83% interest in the Chung note and deed of trust; the assignment of the deed of trust was recorded in August 1981, and the Chung note was placed with EGI.
- In September 1981, EGI split its interest associated with the A&W note and the Chung security into 10 “shares” and sold those shares to individual investors, including Evelyn Feldman.
- Feldman paid $10,000 for an 8.2% interest and received documents titled “Assignment of Collateral Security Note,” “CLTRLNOTE,” and a “Disclosure of Material Facts and Risk Factors.”
- The transaction documents described Feldman as an “investor,” described her funds as “principal,” allowed EGI to substitute collateral other than the A&W note for EGI’s obligations, and gave Feldman recourse against EGI for any payment shortfalls by A&W.
- EGI retained possession/control of the A&W note and the related collateral documents; investors did not receive possession of the note, and no investor received payments.
- EGI filed Chapter 11 on March 18, 1982; the case converted to Chapter 7 on June 25, 1982, and Martin A. Rechnitzer was appointed trustee.
- The trustee, with court approval, sold the A&W note and the Chung security and held the proceeds pending determination of competing claims.
- The trustee brought an adversary proceeding against Feldman (and other investors) to avoid their claimed interests under 11 U.S.C. § 544(a); the matter was decided on cross-motions for summary judgment, with Feldman the remaining active defendant.

## Issues

1. Whether, as of the petition date, Feldman held an interest in the A&W note (and related sale proceeds) that was perfected and enforceable against the bankruptcy trustee’s hypothetical lien-creditor (and related strong-arm) status under 11 U.S.C. § 544(a) and applicable California law.
2. Whether the trustee’s court-ordered sale of the A&W note and Chung security prevented the trustee from using § 544(a) to avoid Feldman’s claimed fractional interest.

## Decision

- The court granted the trustee’s motion for summary judgment and denied Feldman’s motion.
- The court held that the trustee could use § 544(a) to avoid Feldman’s claimed fractional interest because her interest was not perfected as against a hypothetical lien creditor as of the petition date.
- The court rejected Feldman’s argument that the trustee “affirmed” her rights by selling the Chung security, explaining that the dispute concerned ownership and priority in the A&W note and the proceeds attributable to it, not the continued validity of the underlying Chung security itself.

## Legal Principles

- Under 11 U.S.C. § 544(a), the trustee has, as of the petition date and without regard to actual knowledge, the rights and powers of a hypothetical judicial lien creditor (and other hypothetical parties specified in the statute) to determine priority under nonbankruptcy law.
- If a claimant’s interest in the debtor’s property would be subordinate to a hypothetical lien creditor under applicable state law because the interest is unperfected or not properly structured, the trustee may avoid that interest for the benefit of the estate.
- For interests in promissory notes and related collateral, state-law perfection and notice rules (including rules tied to possession/control and recording where applicable) govern whether the interest is effective against third parties such as lien creditors.
- Where the debtor retains possession and control of the note and the transaction documents show an “investor” relationship with recourse against the debtor and collateral-substitution rights, a court may treat the claimant’s rights as at most an unperfected, equitable claim that does not defeat the trustee’s § 544(a) priority.

## Conclusion

In *In re Executive Growth Investments, Inc.*, the bankruptcy court held that the Chapter 7 trustee could avoid an investor’s claimed fractional interest in a promissory note under § 544(a) because, under California law, the investor did not hold a perfected interest enforceable against a hypothetical lien creditor as of the petition date; the trustee’s authorized sale of the note and collateral did not bar the trustee from asserting the estate’s superior rights to the proceeds.


In re Executive Growth Investments, Inc., 40 B.R. 417 (1984)