## Facts

- Kors, Inc., a Vermont plastics manufacturer, obtained layered financing involving (1) a working-capital loan from SBIC secured by Kors’s accounts, inventory, and machinery/equipment (including equipment leased from RIDC), and (2) a separate equipment-financing transaction in which the Bank loaned funds to RIDC and Kors for the purchase of Rextrusion machinery.
- SBIC properly perfected its security interest by filing financing statements signed by Kors and RIDC.
- The Bank’s security agreement covered the Rextrusion machinery and related collateral (including proceeds) and acknowledged SBIC’s security interest as subordinate with respect to that machinery.
- SBIC and RIDC entered a subordination agreement to induce the Bank’s loan, subordinating their interests to the Bank’s interest in the Rextrusion equipment collateral.
- The Bank filed financing statements naming and signed only by RIDC, not Kors; the Bank’s security interest was later held unperfected under applicable filing requirements.
- Kors filed for bankruptcy (eventually Chapter 7), and the trustee sold the machinery/equipment for about $1.1 million.
- The trustee avoided the Bank’s unperfected security interest under 11 U.S.C. § 544 and asserted that the avoided lien, preserved under § 551, also carried the Bank’s priority benefit under the subordination agreement, allowing the estate to take ahead of SBIC.
- The district court held that the trustee could not capture the benefit of the subordination agreement for the estate and ordered distribution consistent with the agreement.

## Issues

1. Whether a trustee who avoids an unperfected security interest under 11 U.S.C. § 544 and preserves it under § 551 may assert all associated priority advantages, including benefits created by a creditor subordination agreement.
2. Whether §§ 544 and 551 permit a trustee to displace or re-order distributions mandated by a contractual subordination agreement among creditors.

## Decision

- The Second Circuit affirmed the district court.
- The trustee could avoid the Bank’s unperfected lien under § 544, and the avoided lien was preserved for the estate under § 551.
- Preservation did not allow the trustee to seize or rewrite the distribution priorities established by the creditors’ subordination agreement.
- The collateral sale proceeds were required to be distributed according to the subordination agreement’s terms.

## Legal Principles

- Under 11 U.S.C. § 544, a trustee may avoid a security interest that is unperfected and thus ineffective against a hypothetical lien creditor under applicable nonbankruptcy law.
- Under 11 U.S.C. § 551, an avoided lien is preserved for the benefit of the estate to prevent junior interests from improving their position due to avoidance.
- Preservation under § 551 does not enlarge the avoided lienholder’s rights; the estate takes the avoided lien subject to the same contractual and legal limits that burdened it.
- Contractual subordination agreements are generally enforceable in bankruptcy according to their terms; avoidance and preservation powers do not, without an independent basis, authorize reallocating the benefit of subordination to the estate.

## Conclusion

The trustee could avoid and preserve the Bank’s unperfected lien, but §§ 544 and 551 did not permit the trustee to appropriate the Bank’s contract-based priority under a subordination agreement; distributions from the collateral proceeds had to follow the creditors’ subordination arrangement.


In re Kors, Inc., 819 F.2d 19 (2d Cir. 1987)