California Appeals Court OKs Subordination of Priority Liens If Fiduciary Engages in Inequitable ConductLast month, a California appeals court ruled that priority liens could be subordinated if a fiduciary engages in inequitable conduct toward a person to whom a fiduciary duty is owed.

The case — Feresi v. The Livery, LLC — establishes and reiterates that, in California, the usual system of setting priorities for liens can be modified where a lien in superior position was ultimately determined to be procured improperly.

During their marriage, James Mesa and Renee Feresi purchased a 25 percent interest in The Livery, LLC. Mark Hartley, who served as the LLC’s president and managing member, was an investor in the LLC via a family trust. When Mesa and Feresi were subsequently divorced, Mesa pledged his 12.5 percent share in the LLC to Feresi to secure his financial obligations to her as a result of the divorce settlement. Feresi did not file a UCC-1 financing statement to perfect her security interests, but did notify the LLC of the arrangement and the LLC’s records were then amended and Feresi identified as a member of the LLC on the LLC’s tax returns.

When Mesa fell behind in his financial obligations to Feresi, Hartley provided him with a short-term loan and secured that loan with the same LLC membership share that had been pledged to Feresi. Feresi then filed a quiet title action to compel Mesa to transfer his membership share in the LLC to her.

Aware that Feresi had not filed a UCC-1 financing statement, Hartley filed one to reflect his loan to Mesa. After a family court ordered Mesa to transfer his share in the LLC to Feresi, Hartley filed notice that he would sell Mesa’s share to satisfy the loan debt.

After Feresi filed suit for declaratory and injunctive relief, a trial court found that Hartley had breached his fiduciary duty to Feresi and that action invalidated the security interest between Mesa and Hartley.

On appeal, the Second Appellate District affirmed the trial court’s ruling, finding that “if a fiduciary engages in inequitable conduct with respect to a person to whom a fiduciary duty is owed, then its claim, lien or security interest may be wholly or partially subordinated.”

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