In re Kristie Edna Bumstead

• Court: District Court, W.D. Washington
• Decided: May 9, 2025
• Docket: 3:24-cv-05341
• Status: Unknown

Opinion

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3 4 5 6 7 UNITED STATES DISTRICT COURT WESTERN DISTRICT OF WASHINGTON 8 AT TACOMA 9 In re: CASE NO. 24-CV-5341-BHS 10 Kristie Edna Bumstead, U.S.B.C. NO. 24-40245 11 Debtor. ORDER 12 LPL Financial LLC, 13 Appellant, 14 v. 15 Kristie Edna Bumstead, 16 Appellee. 17

18 This MATTER is before the Court on Appellant LPL Financial LLC’s appeal, 19 Dkt. 10, of the bankruptcy court’s Order, Dkt. 1 at 12, ruling that LPL does not have a 20 security interest in post-bankruptcy petition payments owed to debtor Kristie Bumstead. 21 22 1 I. BACKGROUND 2 Matthew Bumstead is Kristie Bumstead’s spouse.1 Dkt. 11 at 40. He is a licensed

3 investment advisor and was previously employed at LPL as an independent securities 4 broker. Id. at 44–45. 5 In 2019, Bumstead borrowed $2.35 million from LPL to build a securities practice 6 on LPL’s platform. Id. at 10. The term note required him to “transfer to LPL any and all 7 securities or investment advisory accounts [he] maintain[ed] at other securities or 8 investment advisory firms within thirty (30) days of execution.” Id. at 11. He provided as

9 collateral his “right, title or interest in . . . all non-qualified brokerage and investment 10 advisory accounts maintained at LPL,” “all Accounts,” and their “Proceeds and 11 products.” Id. at 11. LPL perfected its security interest with the Washington State 12 Department of Licensing in “all of [Bumstead’s] rights, title and interest to all [his] assets 13 . . ., whether now owned or hereinafter acquired, wherever located, and all proceeds . . .

14 thereof.” Id. at 291–94. 15 In 2022, LPL terminated Bumstead and he defaulted on the loan, with 16 approximately $2.34 million in principal outstanding. Dkt. 10 at 7; Dkt. 12 at 10. LPL 17 initiated Financial Industry Regulatory Authority (FINRA) arbitration against Bumstead 18

19 20 1 While Kristie Bumstead is the debtor for purposes of the bankruptcy petition, the bankruptcy estate comprises “[a]ll interests of the debtor and the debtor’s spouse in community 21 property.” 11 U.S.C. § 541(a)(2); In re Homan, 112 B.R. 356, 359 (9th Cir. 1989). Because Matthew Bumstead’s investment advisory assets are at issue here, the Court will refer to him as 22 “Bumstead” in this Order. 1 to recover its money. Dkt. 10 at 7. Kristie Bumstead filed for Chapter 11 bankruptcy,2 2 and the FINRA arbitration was indefinitely stayed. Dkt. 11 at 110.

3 Meanwhile, in 2023, Bumstead began working as an independent contractor at 4 another financial services firm, SB Advisory, where he remains employed. Id. at 92, 101, 5 262. Most of his clients followed him from LPL to the new firm. Id. at 52. Only 5 of his 6 current 203 managed accounts are associated with new clients. Id. at 75, 78. Bumstead 7 charges his clients a 1.1% fee. Id. at 54–55. A third-party financial custodian holds the 8 client funds and distributes the fees to SB Advisory. Id. at 67–68. SB Advisory keeps a

9 portion as payment for its trading platform software, and the rest is Bumstead’s 10 compensation. Id. at 54–55. 11 When Kristie filed for bankruptcy, the Bumsteads had a balance of $1,230.61 12 across all their bank accounts and Bumstead was owed $7,226.18 in SB Advisory client 13 fees. Id. at 53, 231. Accordingly, LPL had a secured lien on $8,456.79 in cash. Id. at 55.

14 LPL argued in the bankruptcy court that it was also entitled to “ongoing advisory 15 fees generated from Mr. Bumstead’s prepetition investment advisory agreements” with 16 SB Advisory clients because they were “proceeds of LPL’s collateral.” Dkt. 11 at 21. The 17 court disagreed, ruling that the “fact that Bumstead signs the investment advisory 18 agreement does not make it an account which the LPL security agreement applies to.”

19 Dkt. 7-1 at 54. It concluded the client fees were not proceeds of funds owed to Bumstead 20

2 Bumstead provides financial services through Clarity Capital Management, a sole 21 proprietorship he co-owns with Kristie. Dkt. 7-1 at 27. Kristie filed for Chapter 11 bankruptcy because they both qualify as a “small business debtor” under 11 U.S.C. § 1182(1). Dkt. 11 at 22 124. 1 pre-petition under the Bankruptcy Code, 11 U.S.C. § 552(b). Id. at 54–55. The 2 Bankruptcy court held the total collateral was only $8,456.79, which LPL collected. Id. at

3 55. 4 LPL appealed to this Court. Dkt. 1. It maintains that it has a security interest in 5 advisory fees generated from agreements executed before Kristie filed for bankruptcy. 6 Dkt. 10 at 11. Bumstead responds that the SB Advisory client accounts are not LPL’s 7 collateral to begin with. Dkt. 12 at 12–13. 8 II. DISCUSSION

9 On appeal, a bankruptcy court’s factual findings are reviewed for clear error, and 10 legal conclusions and mixed questions of law and fact are reviewed de novo. Banks v. 11 Gill Distribution Centers, Inc., 263 F.3d 862, 867 (9th Cir. 2001). 12 A. Under 11 U.S.C. § 552(b)(1), a creditor’s security interest may extend to post- petition proceeds in some instances. 13 The Bankruptcy Code provides that generally, a bankruptcy filing cuts off security 14 interests in property acquired by a debtor’s estate after “the commencement of the case.” 15 11 U.S.C. § 552(a). However, if a security agreement extends to property of the debtor 16 acquired pre-bankruptcy and “to proceeds . . . of such property,” then the security interest 17 extends to those proceeds even if they are received after the bankruptcy petition’s filing. 18 11 U.S.C. § 552(b); In re Skagit Pacific Corp., 316 B.R. 330, 335 (9th Cir. BAP 2004). 19 This means “a creditor’s security interest only encompasses the cash collected on existing 20 pre-petition accounts.” Id. at 336. “Proceeds of post-petition accounts receivable do not 21 fall within the § 552(b) proceeds exception.” Id. 22 1 The purpose of § 552 is to “allow a debtor to gather into the estate as much money 2 as possible to satisfy the claims of all creditors.” In re Bering Trader, 944 F.2d 500, 502

3 (9th Cir. 1991). § 552(b) is a “narrow exception to the general rule of 552(a)” and 4 “balances . . . freeing the debtor of pre-petition obligations with a secured creditor’s 5 rights to maintain a bargained-for interest in certain items of collateral.” Id. 6 Washington’s Uniform Commercial Code (UCC)3 defines an “account” as “a right 7 to payment of a monetary obligation, whether or not earned by performance . . . for 8 services rendered or to be rendered.” RCW 62A.9A-102(a)(2)(A). Proceeds” means

9 property “acquired upon the sale . . . or other disposition of collateral,” “collected on, or 10 distributed on account of, collateral,” or “rights arising out of collateral,” among others. 11 RCW 62A.9A-102(a)(64)(A)-(C). 12 The Washington UCC conforms with § 552(b), providing that “notwithstanding 13 sale . . . or other disposition” of collateral, a creditor’s security interest continues in the

14 collateral and “any identifiable proceeds.” RCW 62A.9A-315(a). “Proceeds that are 15 commingled with other property are identifiable proceeds . . . to the extent that the 16 secured party identifies the proceeds by a method of tracing, including application of 17 equitable principles, that is permitted under law.” RCW 62A.9A-315(b)(2). The creditor 18 must “provide documentation of its identifiable or traced proceeds” using an approved

20 3 State law governs the “nature and extent of security interests.” Bering Trader, 944 F.2d at 502. See Jipping v. First Nat’l Bank, 568 B.R. 321, 324 n.22 (D. Alaska 2017) (citing Butner v. United States, 440 U.S. 48, 55 (1979)) (state law governs interpretation of a security 21 agreement to determine scope of a claimed security interest); In re Days Cal. Riverside Ltd. P’ship, 27 F.3d 374, 375–76 (9th Cir. 1994) (state law determines what constitutes proceeds 22 from property secured before bankruptcy). 1 tracing methodology. Skagit, 316 B.R. at 338. The “self-serving testimony of a creditor is 2 inadequate.” Id. at 339.

3 In Skagit, the Ninth Circuit Bankruptcy Appellate Panel (BAP) confirmed that any 4 claimed security interest in a post-bankruptcy petition account receivable must be 5 “properly traced to . . . pre-petition collateral.” Id. at 336–37. Skagit concerned 6 commingled proceeds from the sale of pre-petition collateral with a post-petition account 7 receivable created for a contract project that the debtor completed after filing for 8 bankruptcy. Id. at 333, 340. The BAP held that revenue generated after filing for

9 bankruptcy “solely as a result of a debtor’s labor is not subject to a creditor’s pre-petition 10 interest,” and any “interest in, or connection to the right in the account receivable” 11 needed to be traced back to the pre-petition collateral. Id. at 336. Because the creditor had 12 failed to adequately identify the commingled proceeds “by a method of tracing permitted 13 under law,” the BAP rejected the claimed security interest in the post-petition account

14 receivable. Id. at 340 (citing RCW 62A.9A-315(b)(2)). 15 More recently, in a different context, the BAP held that § 552(b)(1) applied to 16 post-petition settlement proceeds. In re Endresen, 548 B.R. 258, 273–74 (9th Cir. BAP 17 2016). The debtors obtained a loan to purchase several rowhomes, granting the lender a 18 security interest in all “miscellaneous proceeds” from “compensation, settlement, or

19 proceeds . . . for damage” to the property.” Id. at 261. After filing for bankruptcy, the 20 debtors pursued civil litigation against the builder of the rowhomes for significant 21 construction defects and ultimately settled. Id. at 262. The BAP concluded the settlement 22 amount were “proceeds” of the lender’s real property collateral under § 552(b)(1). Id. at 1 270. Even though the settlement amount was received post-petition, it was a “substitute 2 for [the] realty collateral,” “paid for the purpose of repairing damage to the real property

3 collateral,” the proceeds of which were covered by the security agreement. Id. at 273–74. 4 The lender therefore had an extended security interest in the settlement proceeds. Id. 5 B. LPL has not adequately traced Bumstead’s client fees back to its original collateral. 6 LPL contends the SB Advisory client fees are proceeds because “they are derived 7 from and arise out of” its pre-petition security interest in Bumstead’s accounts. Dkt. 10 at 8 18–19. It argues the security agreement encumbers “the right to commissions or fees 9 from broker and investment advisory accounts serviced by Mr. Bumstead, whether or not 10 such accounts are held at LPL, because those fees are directly and indisputably traceable 11 to the original collateral.” Id. (citing U.C.C. § 9-102, cmt. 13d (Am. L. Inst. & Unif. L. 12 Comm’n 2022)). 13 Bumstead responds that the SB Advisory client accounts are not Bumstead’s 14 accounts and therefore not LPL’s collateral. Dkt. 12 at 12. He argues that even if the 15 accounts were LPL’s collateral, it cannot enforce its security interest because he does not 16 have “rights in the collateral” until he “provides his investment advisory services to the 17 clients.” Id. (citing RCW 62A.9A-203(b)(2)). He further contends the fees are his post- 18 petition wages generated solely from his labor and thus exempt from § 552(b). Id. at 15– 19 16. 20 The security agreement between Bumstead and LPL listed Bumstead’s 21 “investment advisory accounts maintained at LPL,” all his “Accounts,” and their 22 1 proceeds as collateral. Dkt. 11 at 11. LPL’s security interest in Bumstead’s LPL advisory 2 accounts ended when Bumstead stopped working there. By encumbering Bumstead’s

3 “accounts” generally, the agreement gave LPL a security interest in Bumstead’s rights to 4 monetary payment for any rendered services. See RCW 62A.9A-102(a)(2)(A). But that 5 security interest was cut off as soon as Kristie filed for bankruptcy. Skagit, 316 B.R. at 6 336. 7 The post-petition client fees are not a “substitute” for the underlying collateral— 8 Bumstead’s accounts—as was the case in Endresen. Rather, the fees owed to Bumstead

9 are much more like the Skagit debtor’s post-petition account receivable. Bumstead earns 10 the client fees as the result of his own labor, and it is of no consequence that the labor is 11 produced as an independent contractor rather than as an employee.4 To the extent that 12 LPL has any interest in those fees because LPL clients followed Bumstead to SB 13 Advisory, they are now commingled with Bumstead’s post-petition earnings. LPL must

14 therefore prove, by an approved tracing method, that “the money currently in 15 [Bumstead’s] account corresponds to its collateral.” Skagit, 316 B.R. at 338. LPL has not 16 done so. It merely points to Official UCC § 9-102, comment 13d to argue that the fees 17 being first paid to SB Advisory does not invalidate its security interest. Dkt. 10 at 22–23. 18

19 20 4 The debtor provides a persuasive policy argument that if money earned by the debtor were proceeds—not wages for labor—and therefore recoverable by the creditor, the debtor 21 would have no incentive to work resulting in a nonviable Chapter 11 plan. See RCW 62A.9A- 109(d)(3) (Washington’s UCC does not apply to “[a]n assignment of a claim for wages, salary, 22 or other compensation of an employee.”). 1 Comment 13d indeed states there is “no requirement that property be ‘received’ by 2 the debtor for the property to qualify as proceeds.” U.C.C. § 9-102, cmt. 13d (Am. L.

3 Inst. & Unif. L. Comm’n 2022). But it also requires the “property be traceable, directly or 4 indirectly, to the original collateral.” Id. It does not obviate state law’s requirement that 5 the creditor use methods approved by law to trace identifiable, commingled proceeds 6 back to collateral. The mere assertion that the client fees are “directly and indisputably 7 traceable to the original collateral” is not enough. Dkt. 10 at 19. 8 The bankruptcy court did not err in concluding that LPL’s security interest does

9 not extend to post-petition client fees owed to Bumstead. The bankruptcy court’s decision 10 is AFFIRMED. 11 IT IS SO ORDERED. 12 Dated this 9th day of May, 2025. 13 A

14 15 BENJAMIN H. SETTLE United States District Judge 16 17 18 19 20 21 22