William E. Boyd
James E. Rogers College of Law
University of Arizona
Wells Fargo Bank Minnesota, National Association v. B.C.B.U, 143 Cal. App. 4th 493 (Cal. App. 2006)
CANINE Chapters 4 (Scope of Article 9) and 37 (Foreclosure as to Intangibiles)
Lease versus security interest; waiver of defense clause; finance lease and hell or high water clause 1-201(b)(37); 1-203; 9-403; Article 2A, 2A-407)
This case offers an opportunity to explore some possible overlap between Article 9 (dealing with secured transactions) and Article 2A (dealing with leases). In the case the ostensible lessee of medical equipment, who had signed a document stating that the equipment had been received when the equipment actually had not and never was delivered, was sued for non-payment by a bank to which the purported lease had been assigned. The lessee asserted non-delivery as a defense and the bank claimed that the defense was not available because the lease document contained a waiver of defense clause enforceable by the bank under new section 9-403. The lessee argued that Article 2A, section 2A-407, rather than new section 9-403 governed and that the former applies to deny to a lessee the defense of non-delivery only where the leased goods have been accepted. The trial court held in favor of the bank and the court of appeals affirmed on the ground that new section 9-403 and not Article 2A, section 2A-407 controlled.
According to the court under new section 9-403 a waiver of defense clause is enforceable when the assignee satisfies the requirements necessary to qualify as a holder in due course of a negotiable instrument under Article 3 and where these requirements have been met only so-called real defenses, such as infancy and illegality, that are available against a holder in due course under Article 3, section 3-305, may be asserted against the assignee. To this extent appellate courts application of new section 9-403 is informative but unremarkable. However, the courts explanation of why new section 9-403 rather than Article 2A, section 2A-407, governed and why this determination dictated a result in favor of the bank is less than clear.
Article 2A, section 2A-407, gives to the lessor in a finance lease transaction the benefits of a hell or high water clause, i.e., denies to a lessee defenses such as failure of consideration, after the leased goods have been accepted. The lessee argued that because the goods had never been accepted the defense of non-delivery was available. The court of appeals responded that
Section 10407 [Californias version of Article 2A, section 2A-407] governs relations between parties to a finance lease prior to acceptance of the goods. But once the lessee accepts the goods, or, as here, the lessee executes documents that on their face say he has accepted the goods, his rights against some-but not all-assignees are governed by section 9403. It is only the assignee who, in effect, qualifies as a holder in due course who enjoys the benefits of section 9403. Those who do not have recourse only to section 10407 [2A-407]. In other words, once there is an assignment to one who qualifies for holder in due course status under section 9403, that section imposes additional rules beyond those of section 10407 [2A-407].
In other words, for the court of appeals, new section 9-403 governs when the assignee satisfies the requirements of holding in due course that are pre-conditions to the enforceability of a waiver of defense clause under new section 9-403 and where the assignee does not satisfy the requirements the assignee may look to Article 2A, 2A-407. Under such a reading of new section 9-403 and Article 2A, section 2A-407, the status of the assignee with regard to having met the requirements of holding in due course or not determines which section applies.
Such an analysis manages to confuse and otherwise obscure what should be controlling, namely, whether the transaction involves a true lease as to which Article 2A and section 2A-407 may apply or a security interest subject to Article 9 and section 9-403. Article 2A, section 2A-407 applies to finance leases, but only a lease may be a finance lease.
At one point the court appears to appreciate what is actually at stake. Thus, it observes:
This case involves not the creation of a finance lease, or a dispute between lessor and lessee. Rather, it involves a security transaction, where an account has been sold to a third party and the dispute is between the account debtor and the assignee. Section 9403 specifically covers this situation, and it also covers the situation where other law prohibits the enforceability of a waiver of defenses clause. That is not to say section 9403 controls as the more specific statute, only that the general canons cited do not provide any useful guidance, let alone compel the conclusion argued for by B.C.B.U [the ostensible lessee].
But, the court never really comes to grips with the tough question of whether the transaction in the case was a true lease or a security interest. As discussed in Chapter 4 (Scope of Article 9), courts have long struggled with distinguishing a true lease from a security interest and continuing efforts to assist courts and parties to make the distinction, such as moving out of Article 1, section 1-201(b)(37) (defining security interest) and into Article 1, section 1-203, the factors that distinguish a lease from a security interest, have not eliminated the difficulty.
The transaction in the case involved what has come to be referred to as securitization, an arrangement by which leases are assigned to a trustee to secure notes evidencing loans, and does not have the appearance of a finance lease in which a buyer orders equipment and then identifies a party who will take an assignment of the purchase order and lease the equipment to the buyer, and to this extent the transaction may well have been a security interest rather than a lease. However, as noted, the court does not engage in the systematic inquiry that is necessary to make the required determination.
With regard to the ultimate determination, it is worth noting that the lease document contained a declaration that it was a finance lease governed by Article 2A, section 2A-407 (and this declaration may have contributed to the courts difficulty in framing the critical issue), but labels and form do not govern over substance.
The court does acknowledge the importance of waiver of defense clauses and their enforceability under new section 9-403 to the viability of securitization arrangements as follows:
Sound policy also supports our understanding that section 9403 must govern the instant dispute between an assignee with holder in due course status and an account debtor (lessee). Securitization is the modern version of the historical practice of financing by factoring, in which a factor bought a creditor's accounts by paying a percentage of the face value and receiving an assignment of the accounts. (See generally, 4 J. White and R. Summers, Uniform Commercial Code (5th ed.2002), § 30-7, pp. 45-46.) Enforcing a waiver of defenses, save for those that would be good against a holder in due course of a negotiable instrument, promotes the transfer of accounts by allowing a purchaser to rely on the face of the documents. Thus, the lessee, like the maker of a negotiable instrument, bears the risk of putting into the stream of commerce documents that appear regular on their face but have underlying flaws.
The decision in the case, of course, stresses the risk associated with signing a document stating that goods have been received when they have not and makes the point that the entire controversy could have been avoided if the ostensible lessee had refused to do so.
Sunflower Bank, N.A. v. Kindsvater, 144 p.3d 81 (Kan. App. 2006)
CANINE Chapters 8 (The Specifics of Enforcement A Security Agreement Authenticated by the Debtor or Its Equivalent), 14 (The Nitty Gritty of Filing), 23 (Continuing Perfection The Need to Reperfect (or Refile)) and 28 (Secured Party Versus Secured Party)
Release of lien and rescission of security agreement versus termination of a financing statement; first to file priority; secured versus unsecured; 9-201; 9-203, 9-322(a); 9-513; 9-515
In this case Sunflower Bank, who held a security interest in debtors personal property and who had duly filed a UCC 1 covering the collateral, executed a release of lien to permit the debtor to refinance with Farmers Bank (who in turn refinanced with PCA) and to pay off an operating loan owed to Sunflower. Sunflower agreed to file a termination of the financing statement, but never did so and, in fact, filed continuation statements. Sunflower later foreclosed real estate mortgages on the debtors property and sought a determination that its security interest in the debtors personal property was prior to that of PCA and to recover the proceeds of collateral sold by PCA. The lower court held that PCA had priority and the court of appeals affirmed.
According to the court of appeals, as a result of the release of lien Sunflower Bank did not have an enforceable security interest in the personal property in dispute and there was no security interest to be perfected by the financing statement filed by Sunflower Bank and the fact that this financing statement had not lapsed or been terminated was immaterial.
Although the facts are less than clear, if the court of appeals was saying that the security agreement authenticated in favor of Sunflower Bank by the debtor had effectively been rescinded by the release of lien agreement then its decision is correct. As explained in CANINE Chapter 8 (The Specifics of Enforceability The Need for an Authenticated Security Agreement or Its Equivalent) in the absence of an authenticated security agreement a security interest is not enforceable and does not attach and any credit not within the scope of an enforceable security interest is unsecured. If Sunflower Bank was an unsecured creditor then Farmers Bank and, as explained in CANINE Chapter 25 (The How and Why of Priority), its successor PCA would have priority under new section 9-201.
However, that Farmers Bank and its successor PCA prevailed on the specific facts of the case is not to say that it is unimportant that the financing statement filed by Sunflower Bank that had not lapsed or been terminated and actually had been continued so that it remained effective as to collateral covered by the financing statement. As explained in Chapter 14 (The Nitty Gritty of Filing) and Chapter 23 (Continuing Perfection The Need to Reperfect (or to Refile)) of the CANINE text a financing statement is effective until it lapses under new section 9-515 or is terminated under new section 9-513. As further explained in Chapter 28 (Secured Party Versus Secured Party), so long as a financing statement continues to be effective it poses a risk to any later filing secured party.
Thus, if in the Sunflower case Sunflower Bank and the debtor entered into a new security agreement and Sunflower Bank extended credit secured by an interest in collateral that was the subject of the agreement between the debtor and Farmers Bank and PCA as its successor, Sunflower Bank would have priority under the first to file rule of new section 9-322(a).
The message to a refinancing creditor is make sure the financing statement filed by the creditor whose secured debt is being paid off is properly terminated under new section 9-513.
See also Lewiston State Bank v. Greenline Equipment, L.L.C., 147 P.3d 951 (Utah App. 2006) in this Commentary (wherein the court holds that a creditor who pays off a purchase money obligation can succeed to the PMSI priority only if a purchase money obligation remains)
IIG Capital, LLC v. Archipelago, L.L.C., 829 N.Y.S. 2d 10 (N.Y. App. Div. 2007)
CANINE Chapters 4 (Scope of Article 9) and 37 (Foreclosure as to Intangibles)
When notification of an assignment prevents payment to an assignor from discharging a debt; account debtors right to request proof of an assignment; assignment versus security interest insofar as right to collect is concerned; sales and outright assignments of accounts versus assignments of accounts for security; sale of accounts as being within the scope of Article 9; notification versus non-notification financing; the need for a default as to a security interest in accounts; 9-109(a)(3); 9-406; 9-607
In this case the court held that the account debtor had been sufficiently notified of an assignment of accounts that the account debtors payments to the debtor/assignor under new section 9-406(a) did not discharge the obligation owed to the assignee on the assigned accounts. The assignee had sent a letter notifying the defendant of the assignment, to which were attached invoices evidencing the assignments. The assignee had FedEx receipts to support its claim and these were enough to overcome the account debtors assertion that it had not received notification of the assignment. The account debtor might have demanded further proof of the assignment under new section 9-406(c) but it had not done so.
The court did not discuss the requirement in new section 9-406(a) that the notification be authenticated by the assignor or assignee. New section 9-102(a)(7) defines authentication to mean to sign or to execute or otherwise adopt a symbol, or encrypt or similarly process a record in whole or in part, with the present intent of the authenticating person to identify the person and adopt or accept a record. Presumably, the assignees letter was signed and, therefore, authenticated, but some attention to the requirement was in order. In any event, an assignee should be aware of the requirement and make sure it is satisfied. Where the communications are in electronic form the latter part of the definition of authentication is applicable. The meaning of authentication in the context of authenticating a security agreement is considered in CANINE Chapter 8 (The Specifics of Enforceability The Need for an Authenticated Security Agreement or Its Equivalent).
As the court notes, under new section 9-406(c), if so requested by an account debtor an assignee must seasonably furnish reasonable proof that an assignment has been made and if the assignee fails to comply with such a request the account debtor may discharge the obligation by paying the debtor/assignor. As discussed in Official Comment 4 to new section 9-406 an account debtor who has received notification of an assignment and has requested reasonable proof of the assignment may discharge its obligation by paying the assignor at the time when payment is due (or even earlier if reasonably necessary to avoid risk of default) but payment to the debtor/assignor substantially in advance of the time that the payment is due will not discharge the obligation unless the assignee has failed to seasonably provide requested proof of the assignment.
There was in the case an issue of exactly which accounts had been assigned and that question could not be disposed of on summary judgment. The notification referenced a factoring agreement and an attached schedule of assigned accounts but the schedule was not in fact attached. The assignee sought to get around the difficulty with respect to the factoring agreement by relying on a security interest in the accounts. As the points out, where a security interest as opposed to an outright assignment is involved a creditor may demand that an account debtor pay it rather than the assignee only in the event of a default on the part of the debtor/assignor or if the debtor/assignor and assignee have so agreed. New section 9-607 so provides.
This point implicates the difference between assignments of accounts for security and outright assignments (sales) of accounts and notification versus non-notification financing. As explained in CANINE Chapter 37 (Foreclosure as to Intangibles), distinguishing between an outright assignment (sale) and an assignment for security can be difficult. However, as further explained in CANINE Chapter 4 (Scope of Article 9) under new section 9-109(a)(3) sales (outright assignments) of accounts are within the scope of Article 9 and subject to the rules governing security interests in accounts.
As pointed out in Chapter 37, notification financing means that the debtor/assignor and assignee have agreed that the assignee will take over collection of the accounts and the account debtors will be so notified whereas as to non-notification financing the debtor/assignor continues to collect the accounts unless and until there is a default (such as under new section 9-607 will permit the assignee to notify the account debtor to cease paying the debtor and pay the assignee instead).
Retenbach Constructors, Inc. v. CM Partnership, 639 S.E.2d 16 (N.C. App. 2007)
CANINE Chapters 23 (Continuing Perfection The Need to Reperfect (or Refile)) and 24 (Continuing Perfection Changes as to the Use of Collateral or the Location of the Collateral or the Debtor; Security Interests in Proceeds)
Assigning a bare financing statement (separate from the secured debt); assignment of a security interest separately from the secured debt; subordination; first to file priority based on a financing statement that has not lapsed or been terminated; 9-322(a); 9-339; 9-509; 9-511; 9-513; 9-514; 9-515
In this case two creditors, LSB and CM claimed security interests in the same accounts receivables as collateral by virtue of assignments of accounts. The facts are complicated. In 1999 LSB loaned money to Forsyth Drywall, secured by Forsyth Drywall's inventory, accounts, equipment, and other collateral. LSB then filed a financing statement [covering this collateral]. In 2001 UC also took a security interest in Forsyth Drywall's accounts receivable. UC requested a first lien position as a condition of the loan to Forsyth Drywall and in the fall of 2001 LSB filed an amendment to its financing statement, purporting to make a partial assignment to UC of its security interest in certain of Forsyth Drywall's accounts receivables. Thereafter, UC advanced Forsyth Drywall money in exchange for he interest in Forsyth Drywall's accounts receivable.
In June of 2002, CM took a security interest in Forsyth Drywalls accounts, including the accounts claimed by LSB and UC, and advanced money to Forsyth Drywall, which Forsyth Drywall used to repay the debt it owed to UC. However, CM did not file a financing statement until January of 2003. In the interim, in June of 2002, LSB made a second loan to Forsyth Drywall and the debts owed by Forsyth Drywall to LSB were consolidated. The second loan also was secured by an interest in Forsyth Drywall's accounts, including the accounts claimed both by LSB and UC. LSB relied for perfection of its security interest in this collateral on the financing statement filed in 1999 (before UC or CM entered the picture). In February 2003 UC executed a reassignment of the first lien position to LSB.
The trial court granted LSB's motion for summary judgment, from which order CM appeals.
The court engages in some bothersome discussion of relative priorities of buyers of accounts receivables, but correctly determines that apart from the matter of the amendment to its 1999 financing statement purporting to make a partial assignment its security interest, LSB clearly has priority over CM under the first to file rule of new section 9-322(a). LSB was the first to file insofar as it filed in 1999 and CM did not file until 2003. The court properly notes that the first to file rule would give LSB priority even if its security interest had been the subject of a new security agreement authenticated when LSB made its second loan in 2002. As explained in CANINE Chapter 23 (Continuing Perfection The Need to Reperfect (or to Refile)) and Chapter 28 (Secured Party Versus Secured Party) a financing statement need not be tied to a particular debt or security agreement or security interest to confer priority under the first to file rule. It is only necessary that the financing statement cover the collateral at issue.
The more interesting question addressed by the court is whether the amendment to the 1999 financing statement purporting to assign the security interest operated to alter the result required by the first to file rule applied in the absence of this amendment.
CM argued that the amendment to the 1999 financing statement had the effect of transferring the security interest in the accounts at issue to UC or had otherwise left LSB without a security interest in the accounts. The courts response to CMs argument is questionable in a number of respects. Thus, the court insists, arguably unnecessarily, that a security interest does not exist and cannot be assigned separately from the debt it secures. To support its conclusion the court relies on cases involving secured promissory notes. As explained in Chapter 20 (Perfection of Security Interests in Fixtures and Other Real Estate Related Collateral) to perfect a security interest in the mortgagees interest in a note secured by a real estate mortgage (or the beneficiarys interest in a note secured by a deed of trust) it is necessary to perfect a security interest in the note as the real estate security follows the debt.
However, it can happen that there is no debt to assign. If a debtor authenticates a security agreement in described collateral but no debt has been incurred as of the time of the execution of the security agreement (such as may well be the case) there is nothing to prevent the secured party from assigning the security agreement to another creditor who then extends credit, at which point the security interest attaches to the collateral described in the security agreement.
The court also, again arguably unnecessarily, improperly asserts that a financing statement has no legal significance independently of a security agreement. As discussed above, the court correctly noted earlier in its opinion that under the first to file rule of new section 9-322(a) LSB could have priority over CM by virtue of its 1999 financing statement even if the security agreement creating the security interest in the accounts at issue was executed at the time of the second loan in 2002.
However, the court then concludes that there was no security agreement-related documentation by which LSB had assigned its security interest to UC and so the 1999 financing statement continued to be effective and the effect of the amendment was to exchange [the parties] relative priority positions with respect to the accounts receivables.
The courts conclusion that an assignment of a security interest cannot be accomplished by an amendment to a financing statement seems right. As discussed in CANINE Chapter 13 (Perfection by Filing) and Chapter 14 (The Nitty Gritty of Filing), financing statements do not define or establish security interests. They only give notice that there may be a security interest in indicated collateral. Stated somewhat differently, as noted in CANINE Chapter 8 (The Specifics of Enforceability An Authenticated Security Agreement or Its Equivalent) security agreements are contracts governed by the law of contracts. Assignments of security agreements and the security interests they may render enforceable likewise also are creatures of contract. Financing statements, on the other hand, are Article 9 devices for giving public notice.
However, it is not clear that concluding that the security interest created by the initial security agreement authenticated by Forsyth Drywall had not been assigned was necessary to a determination that LSBs 1999 financing statement gave LSB priority under the first to file rule of new section 9-322(a). The 1999 financing statement was effective in the absence of lapse or termination, irrespective of any particular security agreement or debt obligation. When LSB entered into the security agreement in 2002 a debt secured by the accounts in dispute arose and the security interest associated with this debt had priority because the financing statement filed in 1999 covering the accounts in dispute continued to be effective and gave LSB priority under the first to file rule of new section 9-322(a). To this extent, contrary to the courts insistence a financing statement does have a life of its own.
If there had been an assignment of the security interest created in 1999 the debt remaining unpaid at the time of the assignment could become unsecured and would remain unsecured unless the new security agreement brought the unpaid debt within its scope. The consolidation of the unpaid debt with the second loan served the purpose of securing not only the second loan but also the unpaid debt.
The dispute in Retenbach offers an opportunity to discuss how assignments of security interests and financing statements should be made. As to assignments of security interests, because security interests are creatures of contract, an assignment of a security interest should be done through an authenticated agreement clearly identifying the interest to be assigned, the scope of the assignment and whether the assignment is intended to be permanent or temporary. As Retenbach illustrates it is not a good idea to even attempt to assign a security interest using an amendment to a financing statement and an amendment to a financing statement likely will be ineffective to accomplish an assignment of a security interest.
Although it is not technically necessary, where it is contemplated that the assignee will effectively displace the assignor as the secured party of record, the party who under new section 9-511 has the ability to authorize amendments to a financing statement and to whom inquiries about a security interest are to be directed, an amendment to the financing statement making the assignee the secured party of record likely will be desirable. Such an amendment is expressly provided for in new section 9-514. Such an amendment also would be in order where there is no assignment of a security interest but rather an assignment of a financing statement alone, something the court in Retenbach had trouble understanding is possible.
The court in Retenbach dismissed the possibility that the amendment could be a subordination agreement as no party made such a claim. A subordination agreement is one by which a party with priority agrees to subordinate its priority to another party to the agreement. New section 9-339 provides, probably unnecessarily, that nothing in Article 9 precludes a subordination agreement. The Official Comment to section 9-339 observes that only a person entitled to priority can effectively subordinate its position and no persons rights can be adversely affected by an agreement to which the person is not a party. It is a good idea to keep in mind the possibility of subordination as a way of dealing with an outstanding interest that has priority.
Feliciana Bank & Trust v. Manuel & Sessions, L.L.C., 943 So.2d 736 (Miss.App. 2006)
CANINE Chapters 5, 8, 20, 27 and 32
Whether a holder of a deed of trust on land has a security interest in standing timber and whether any security interest extends to timber that is cut and sold and the proceeds thereof; priority as between holder of deed of trust and person taking an interest in timber to be cut or that has been cut; Article 2, section 2-107; 9-102(a)(44); 9-102(a)(41); 9-108; 9-301(3)(B) [comment 5c to 9-301]; 9-203(b)(3)(A); 9-334; 9-501(a)(1)(A)
In this case the owner of land on which there was standing timber created a deed of trust in favor of Feliciana Bank. The deed of trust was duly recorded in the real estate records. Later the landowner contracted to have the timber cut and removed. The timber was cut and removed and sold to a mill. The holder of the deed of trust sued for waste. It was held that the holder of the deed of trust had a security interest in the trees, that the interest survived the contract to cut and remove the timber and that cutting and removing the timber supported an action for waste.
The court struggles with the effect of Article 2, section 2-107(2) and new section 9-102(a)(44), under which timber subject to a contract to cut and remove the timber constitutes goods. It concludes that the UCC leaves intact prior state law, according to which a conveyance of real estate conveys timber standing on the real estate unless the timber has been excluded from the conveyance, and that under that law the holder of the recorded deed of trust had a claim to the timber that protected it against later conveyances of the timber itself.
The Feliciana case offers an interesting example of the collision between real property law and personal property law not unlike that arising with respect to fixtures and growing crops. Consequently, the case presents an opportunity to consider how disputes between real estate parties and parties asserting security interests in timber to be cut should be resolved. That is, if the defendants in the case were asserting Article 9 security interests in the timber how they would have fared against the holder of the deed of trust.
The Article 9 drafters have made repeated attempts to deal with conflicts between real estate parties and parties asserting security interests in fixtures under Article 9. New section 9-334 sets forth an elaborate priority scheme for dealing with such conflicts. As for growing crops, new section 9-334(i) provides quite simply that perfected security interests in growing crops have priority over a conflicting interest of an owner or encumbrancer of the real estate so long as the debtor has an interest of record or is in possession of the real estate.
Common to the rules applicable to conflicts involving fixtures and growing crops is the assumption that real estate parties have interests in such property despite the fact that fixtures and growing crops constitute goods and Article 9 parties have interests in fixtures and growing crops even though real estate parties have rights in such property. On the basis of this assumption, Article 9 views conflicts involving fixtures and growing crops between real estate parties and Article 9 parties as priority disputes and Article 9 sets forth rules for determining which claimant has priority under what conditions.
Article 9 does not set out rules expressly addressing disputes involving timber to be cut between real estate parties and Article 9 parties (parties claiming interests in the timber as goods). However, new Article 9, section 9-203(b), provides that where a security interest in timber to cut depends for its enforceability on an authenticated security agreement there must be a description of the real estate concerned in the agreement. Moreover, under new section 9-301(3)(3) the law of the jurisdiction where the real estate is located governs perfection and non-perfection of a security interest in timber to be cut and under new section 9-501(1)(A) a financing statement covering timber to be cut must be filed in the real estate records and under new section 9-502(b) to be sufficient must indicate that it covers the timber to cut, that it is to be filed in the real estate records, provide a description of the real estate to which the timber to be cut is related and, if the debtor does not have an interest of record in the real estate, provide the name of a record owner. These sections together make clear that an security interest in timber to be cut is governed by Article 9 and spell out the steps necessary to making an interest in the timber enforceable and to perfecting the interest.
The question of whether a particular real estate party has an interest in timber to be cut that is subject to an Article 9 security interest, as in Feliciana, is governed by local real estate law and a determination of how that law has been impacted by the adoption of Article 2, section 2-107 and Article 9, section 9-102(a)(44). According to the court in Feliciana, under the local law a conveyance of real estate conveys an interest in timber unless the timber has been excluded and the deed of trust was sufficient to convey the rights in timber given by the local law. It may be that the law of other jurisdictions will be similar but it will be necessary to consult that law to be sure. Further according to the court in Feliciana, the adoption of Article 2, section 9-107, and new Article 9, section 9-102(a)(44) did not alter the local law insofar as a conveyance of real estate operated to convey rights in timber. This conclusion seems reasonable but, once again, local law must be consulted to be sure.
Alternatively, a real estate party may choose to take a security interest in the timber directly and describe the timber appropriately.
Assuming that under applicable law a conveyance of real estate conveys an interest in timber and that the adoption of Article 2, section 2-107, and new Article 9, section 9-102(a)(44) have not altered the law to this extent, as stated by the court in Feliciana, the question is one of priority. As noted, by contrast to disputes involving fixtures and growing crops, new Article 9 does not provide priority rules that expressly address a conflict between a real estate party and an Article 9 party.
Fashioning a system of rules that adequately treats conflicts between security interests in timber to be cut and real estate interests obviously is an undertaking that goes beyond the scope of these materials. However, some of the ingredients of such a system are already in place in new Article 9. Thus, a major concern that real estate interests are recorded in a different recording system than are Article 9 security interests is responded to with the device of a fixture filing, a specialized Article 9 filing that must be filed where a real estate interest is recorded. As noted above, under new Article 9 perfection of a security interest in timber to be cut requires a specialized filing in the real estate records in the jurisdiction where the real estate is located.
These requirements would support rules that conferred priority on the basis of who filed or who perfected first, a familiar priority concept throughout the law. For example, suppose that the facts of Feliciana were that a security interest in timber to be cut and removed arose after the deed of trust was executed and recorded. If the Article 9 creditor did as new section 9-501(a)(1)(A) required and filed in the real estate records the creditor should as well search those records for potential competing interests, including mortgages and deeds of trust on the real estate and should be aware of the deed of trust. Consequently, it would seem fair to subordinate the security interest to the deed of trust interest (and fairer yet if the Article 9 party filed in and searched only the Article 9 system).
However, new section 9-502(c) appears to qualify such a result insofar as it provides that a record of a mortgage or deed of trust is effective as to timber to be cut only if the record indicates that it covers timber to be cut. This section seems to be saying that even an Article 9 party who searches and files in the real estate records will not be put on notice of a deed of trust interest in timber to be cut unless the deed of trust recording refers to timber to be cut. In any event, as to the hypothetical dispute, the deed of trust holder would have priority only where the deed of trust recording refers to timber to be cut (and otherwise satisfies new section 9-502(c)). Conversely, where the deed of trust recording does not refer to the timber to be cut and the Article 9 security interest is filed in the real estate records the security interest would have priority under the first to file or perfect rule.
It may also be asked what should happen when the deed of trust is executed after the contract to cut and remove timber is made. It might be argued under some variation of nemo dat doctrine that a deed of trust cannot reach what has been contracted away. The court in Feliciana alluded to this possibility but seemed more inclined to view the dispute as one of priority. A priority analysis seems even more clearly suited to a case where a security interest in timber to be cut is created before a deed of trust on the real estate is executed.
Thus, according to the rules discussed above, if the security interest has been filed in the real estate records as required by new sections 9-301(3), 9-501(a)(1)(A) and 9-502(b) then the filing is effective and under a first to file or perfect rule should have priority. On the other hand, if the security interest was not filed properly then the deed of trust party should not be deemed to be on notice of the interest and should deed of trust party should prevail, at least if the deed of trust recording satisfies new section 9-502(c) by referring to timber to be cut. Of course, if neither the security interest nor the deed of trust interest has been properly recorded then, arguably, the priority should be given to the interest that attached first along the lines of the rule provided for in new section 9-322(a)(3).
Under the foregoing analysis real estate interests in timber to be cut are brought within Article 9 insofar as there is a question of the priority of such an interest that conflicts with an Article 9 security interest in the timber. That being the case it would seem to behoove a party who takes a deed of trust on real estate on which timber is standing to expressly claim an interest in timber to be cut in the deed of trust and not just the recording. At this point the deed of trust holder has effectively become an Article 9 secured party and the rules for dealing with the whole range of priorities, including buyers of timber to be cut, will apply.
Thus, in the ultimately controlling paragraph of the courts opinion the court states:
We conclude that the proper analysis is not one of cancellation but of priority. Historically, a deed of trust granted a security interest in all property that was part of the realty. Under the UCC, though, if a typical deed of trust is executed after a contract for the cutting of the timber has been executed but before the actual harvesting of the trees, the deed of trust will either not apply to the timber at all because the timber is now personalty, or else the deed of trust will be subordinate to a prior UCC filing. Conversely, if the deed of trust predates any contract to cut the timber, the security interest vests in timber and cannot be divested simply by a contract for sale. Again, the matter is one of priority. A related statute makes clear that security interests in crops and fixtures filed under real property law remain valid encumbrances, but that competing security interests created under Article 9 of the UCC create issues of priority. [9-334] Similarly, the previously quoted section on sales relating to timber recognizes the continuing effect of real property rules when it states that timber sales under the UCC are subject to any third party rights provided by the law relating to realty records.... [2-107(3)]
Consumer Portfolio Services, Inc. v. Rouse, 638 S.E.2d 442 (Ga. App. 2006)
CANINE Chapters 33 (A Secured Partys Options on Default) 35 (Disposing of Collateral to Satisfy a Secured Debt) and 38 (Remedies for a Secured Partys Failure to Comply with Article 9)
Failure to strictly comply with the notice requirements of a special statute governing deficiencies in connection with a repossession of a vehicle results in the denial of a deficiency even though failure to satisfy the notification requirements of Article 9 might not have this effect; waiver of the terms of a security agreement; 9-611, 9-611; 9-613; 9-614; 9-615
This case involved a special state statute dealing with repossession and sale of vehicles. Under the statute the creditor was required to send a notice to the debtor stating that the creditor could seek a deficiency and that the debtor had a right of redemption and a right to demand a public sale. Under the statute the debtor was required to send the demand by registered or certified mail. The debtor sent notice via fax instead. The court held that notice via fax did not satisfy the express statutory mandate to send the notice by registered or certified mail
However, in communications with the debtor the creditor had invited phone calls and provided a fax number. The court held that the creditor had thereby waived the requirement of notice by registered or certified mail.
Moreover, the statute required that notice of the right to demand a pubic sale, etc. had to be sent to the address in the security agreement and the creditor had sent the notice to a post office box address given by the debtor in an extension agreement. Failure to strictly comply with this statutory requirement resulted in the denial of a deficiency. The court referred to a decision under which failure to strictly comply with the requirements of former section 9-504 did not result in an absolute bar to a deficiency but failure to strictly comply with the special statute had this consequence.
D.A.N. Joint Venture, III v. Clark, 218 S.W.3d 455 (Mo. App. 2006)
CANINE Chapters 35 (Disposing of Collateral to Satisfy a Secured Debt), 38 (Remedies for a Secured Partys Failure to Comply with Article 9)
No statute of limitations in Article 9; Article 2, section 2-725 four-year statute of limitations applies to an action for a deficiency in connection with a secured sale rather than the statute of limitation applicable to breaches of contract generally; Article 2, section 2-725; Article 2, section 2-102; statute of limitations applicable to secured loans; when statute of limitations begins to run
The court in this case affirms a trial court decision applying the four-year statute of limitation contained in Article 2, section 2-725, to a deficiency action brought by the assignee of a contract for the sale of a used automobile secured by an interest in the automobile. It did so on the ground that the deficiency action arises out of a sale of goods within the scope of Article 2. In so doing the court rejected the assignees argument that a ten-year general statute of limitations governing actions for the payment of money grounded upon a writing should apply.
The court notes that Article 9 contains no statute of limitations but that the overwhelming majority of courts in other jurisdictions have applied the four-year limitations period, citing Marchitelli, Annotation, Causes of action governed by limitations period in UCC Section 2-725, 49 A.L.R.5th (collecting cases) and Daimler Chrysler Services North America, L.L.C. v. Ouimette, 830 A.2d 38, 42 (2003) (collecting cases).
The court rejects the finance companys argument that the application of Article 2, section 2-735, to the transaction is barred by Article 2, section 2-102, governing the scope of Article 2 and providing that:
Unless the context otherwise requires, this Article applies to transactions in goods; it does not apply to any transaction which although in the form of an unconditional contract to sell or present sale is intended to operate only as a security transaction nor does this Article impair or repeal any statute regulating sales to consumers, farmers or other special classes of buyers.
According to the court, relying on an Official Comment to section 2-102, the language only as a security transaction means contracts that are the in the form of a sale but that are in substance a secured loan.
The court then examines the nature of a deficiency action. It concludes that a deficiency action is based upon the personal liability of the debtor stemming from a breach of the sales contract and that the secured aspect of the transaction ended when the vehicle was repossessed and sold and its value applied to the balance owing on the contract.
The court alludes to the situation where the transaction is a loan from the outset, namely, where a creditor lends money to the debtor to purchase a vehicle and takes a security interest in the vehicle. However, the court it insists that the finance companys claim arose out of the sales contract and came into existence after the sale by virtue of an assignment of the sales contract thereby leaving open the question remains as to which statute of limitations would apply to a case where the plaintiff lent the money to purchase the vehicle.
That a different statute of limitations could apply to a lender whose rights arise by assignment of a sales contract than to a lender who provided the funds to purchase the subject of the sales contract seems odd. But, the difference between assignees and lenders is important elsewhere, for example, as to the application of A.R.S. § 44-5501, which as discussed in CANINE Chapters 34 (Getting Possession of the Collateral) and 38 (Remedies for a Secured Partys Failure to Comply with Article 9), forces a creditor in certain consumer cases to choose between repossession and recovering a deficiency.
Where a statute of limitations is interposed as a defense there is the question of when the wrong on which the action is based arose. The court notes that the deficiency claim arose, at the latest, when the debtor was notified that the debtor was in default.
In re Millivision, Inc., 474 F.3d 4 (1st Cir. 2007)
CANINE Chapters 13 (Overview of Perfection by Filing), 14 (The Nitty Gritty of Filing), 26 (Secured Party Versus Lien Creditor; Future Advances; Bankruptcy), 28 (Secured Party Versus Secured Party) and 30 (Secured Party Versus Trustee in Bankruptcy)
Generally applicable law as used in BRA § 546(b) refers to non-bankruptcy law; commencement of an involuntary case within BRA § 544(a) means the date the petition is filed and not when the order for relief is granted; filing a financing statement after a bankruptcy case is commenced violates the automatic stay; exception for purchase money security interests; filing a financing statement before a security agreement is authenticated; BRA §§ 362(a); 362(b)(3); 544(a); 546(b); 547; 549; new Article 9 sections 9-317(e), 9-502(d) and 9-509(b)
In this case the First Circuit Court of Appeals affirmed lower court decisions sustaining the avoidance of a security interest under BRA § 544(a) of a security interest not perfected on the date an involuntary bankruptcy was commenced..
The facts were that the creditor made a $500,000 secured loan on December 11, an involuntary bankruptcy was filed against the debtor the next day and the creditor filed a financing statement perfecting its security interest on December 16th. The security interest was avoided by the trustee under BRA § 544(a) and the trustees action was upheld by the bankruptcy court and the bankruptcy court of appeals.
The creditor appealed, arguing that BRA § 546(b), providing that the avoidance power of the trustee is subject to any generally applicable law that gives to the creditor the benefit of any relation back period and that BRA §§ 547(c) and (e) and 549 are such generally applicable law. The creditor further argued that an involuntary bankruptcy is commenced in an involuntary bankruptcy on the date an order for relief is granted (which was after the financing statement was filed) and not when the bankruptcy petition is filed and that the effect of the avoidance is to give unsecured creditors a windfall that is contrary to the equitable nature of a bankruptcy proceeding.
The BRA § 546(b) argument was rejected on the ground that BRA §§ 547(c) and (e) are not generally applicable law within the meaning of BRA section § 546(b), agreeing with the conclusion of other courts and commentators that the phrase refers to applicable non-bankruptcy law. The court of appeals might have added, as was noted by the bankruptcy court, that BRA §§ 547 (c) and (e) (dealing with avoidable preferences) and BRA § 549 (dealing with the avoidance of post-petition transfers) were not implicated by the trustees action. CANINE Chapter 26 (Secured Party Versus Lien Creditor; Future Advances; Bankruptcy) explores an appropriate use of BRA § 546(b) save a purchase-money security interest the filing as to which was made after bankruptcy was filed but within the twenty-day period provided in new Article 9 section 9-317(e). In particular, it should be noted that the creditors security interest in the Millivision case secured an operating loan and was not a purchase money security interest eligible for new Article 9 section 9-317(e) and BRA § 546(b) protection.
The court of appeals also rejected the creditors argument that the bankruptcy case was commenced on the date the order for relief was granted because BRA § 303(b) expressly provides that an involuntary case against a person is commenced by the filing with the bankruptcy court of a petition under Chapter 7 or 11 [of the bankruptcy statute]. As is discussed at length in CANINE Chapter 26 (Secured Party Versus Lien Creditor; Future Advances; Bankruptcy), whether or not a security interest will survive an avoidance challenge is often seen as the acid test of whether an attorney has done his or her job in putting together a secured transaction.
For completeness, it should be noted that the creditor technically had violated the automatic stay in BRA § 362(a) barring actions to improve a creditors position, including perfecting a security interest, after a bankruptcy case has been commenced. As the creditor correctly argued, and as is discussed in CANINE Chapter 26 (Secured Party Versus Lien Creditor; Future Advances; Bankruptcy), had BRA § 546(b) been applicable to the case the post-petition action would have been excepted from the stay under BRA § 362(b).
In response to the creditors claim that the avoidance conferred a windfall on unsecured creditors and was contrary to the equitable nature of bankruptcy the court notes that the creditor could have prevented the avoidance simply by filing a financing statement prior to making the loan. Given that the creditor filed five days after the loan was closed, hardly an untoward delay, the decision may seem a bit harsh. On the other hand, the debtor clearly was in financial difficulty and, as explained in CANINE Chapter 13 (Overview of Perfection by Filing) and Chapter 28 (Secured Party Versus Secured Party), it is good practice to file as early as possible and new Article 9 section 9-502(d) permits the filing of a financing statement before a security agreement is made or a security interest attaches. As noted in CANINE Chapter 13 (Overview of Perfection by Filing) and Chapter 14 (The Nitty Gritty of Filing), however, a creditor must get special authorization to file a financing statement before a security agreement is authenticated and the creditor cannot rely on new section 9-509(b) under which authentication of a security agreement authorizes the filing of an initial financing statement and amendments covering collateral described in the security agreement and proceeds.
Coffey v. Singer Asset Finance Co., L.L.C., 2007 WL 258962 (Tex. App. 2007)
CANINE Chapters 4 (Scope of Article 9), 5 (Classification of Collateral), 10 (The Need for Value and Debtors Rights in the Collateral); 33 (A Secured Partys Options on Default) and 37 (Foreclosure as to Intangibles)
A security interest in structured settlement rights is enforceable and is not an assignment or commutation barred by an annuity contract or special statute; waiver of anti-assignment provision prohibiting transfers for security; tort claims and settlements; classification and scope of Article 9; new sections 1-201(b)(37); 9-102(a)(42); 9-109; 9-401; 9-408
In this case the debtors secured loans by granting the lenders security interests in structured-settlement rights arising out of the settlement of personal injury claims and funded by annuity contracts issued by insurance companies. The debtors sought a declaratory judgment that the interests created by the debtors were unenforceable because they were prohibited by anti-assignment clauses in the annuity contracts and by an insurance statute rendering assignments and commutations in violation of the clauses void and against public policy. The debtors also relied on an provision in the annuity contracts prohibiting transfers of the benefits for security purposes.
The court held that the pledges were enforceable because they were not assignments within the meaning of the statute and rather were security interests expressly permitted by a section of the insurance statute providing that the prohibition on which the debtors relied did not apply to (2) a debt of the insured or beneficiary secured by a pledge of the policy or its proceeds. In so holding the court rejected the debtors argument that the distinction between security interests and assignments and commutations is only one of semantics on the ground that in common usage an assignment divests the assignor of all rights in the thing assigned whereas a security interest only creates a lien to secure payment of a debt. The court noted that the loan documents use the language pledge and collaterally assign and the latter means to assign for security. It added that the documents provide for termination of the transfer when the loan debts are paid.
As to commutation, the court concluded that a commutation is an exchange or replacement and the lump sum payments do not result in a commutation because there was no replacement.
As for the anti-assignment clauses prohibiting assignments and encumbrances, the debtors waived these clauses. In so holding, the court relied on a Texas case in which an outright assignment of structured settlement payments in return for a lump sum payment in violation of an anti-assignment clause in the settlement agreement was deemed effective because the debtor had voluntarily agreed to an express waiver of the anti-assignment provision in the contract transferring the interest in the settlement payments.
Some of the loan documents signed by the debtors contained the following:
Any and all restrictions on the ability to pledge the Collateral were included in the Release and/or Annuity solely at Borrower's request and for Borrower's benefit and not for the benefit or protection of any other person. Any such restriction was included by Borrower as a precautionary measure in order to assure the Borrower of certain favorable tax treatment under Internal Revenue Code (the Code) Section 104(a)(2). Whether or not such precautionary measure was necessary, Borrower now decides to forego said favorable treatment. Borrower acknowledges that all income realized by Borrower after closing upon any investment or use of the Loan Amount (unless exempt under a separate Code provision (e.g. interest earned on municipal bonds)) may be taxable to Borrower under the Code and that this transaction may result in an increase in the amount of income taxes paid by Borrower to the Internal Revenue Service. For the benefit of Lender, Lender's Assignee and/or their successors and assigns, the Annuity Owner and on behalf of Borrower and Borrower's estate, heirs, beneficiaries, executors, administrators, and legal representatives, Borrower hereby WAIVES AND RELEASES all rights of Borrower in, to, or under, such restrictions on the ability to pledge, if any.
As to those loans where there was no express waiver in the documents the debtors are estopped to assert the anti-waiver clause. This is what the court said.
Douglas did not expressly renounce the anti-assignment provision in her settlement agreement when she executed the loan documents with Settlement Capital. However, she voluntarily signed the loan agreements and accepted the lump sum payment Settlement Capital offered in exchange for a security interest in those payments three times. Appellees argue Douglas is estopped from asserting the anti-assignment provision. We agree.
In Johnson, we discussed the doctrine of estoppel by contract and how a party may be estopped where his conduct induced action in reliance upon it, and that it would operate as a fraud upon the assured to allow the party to disavow their conduct. [Citation omitted.] We said the doctrine of estoppel by contract is another way of saying a party is bound by the terms of his contract unless it is void, annulled, or set aside in some way.
[Citation omitted.]
The court also rejected the debtors argument that the pledges violated public policy. In so doing it asserts that in the Texas case referred to above the court examined the IRC, Texas decisions, decisions from other federal and state courts, decisions involving the Texas Structured Settlements statute (that requires court approval of a structured settlement) and similar statutes and decisions in other states and rejected the public policy argument.
Madisonville State Bank v. Canterbury, Stuber, Elder, Gooch & Surratt, P.C., 209 S.W.3d 254 (Tex. App. 2006)
CANINE Chapters 5 (Classification of Collateral), 9 (The Specifics of Enforceability After-acquired Collateral; Future Advances; Transferred Collateral and Proceeds; and the New Debtor Problem), 29 (Secured Party Versus Secured Party (continued)
Payments from a deposit account not subject to a security interest are not within the scope of new section 9-332 protecting a payee of a check drawn on a deposit account subject to a security interest; when new section 9-332 does apply; new 9-315(a)(2); 9-332
In this case a bank lent 8.0 million to debtor (a line of credit) and took a security interest in debtors accounts, inventory, chattel, documents and equipment. Subsequently, the debtor paid a law firm $59,000 plus using checks drawn on another bank. The bank sued the law firm for conversion alleging that the payments were not authorized. The law firm asserted new section 9-332 as a defense. The bank asserted that new section 9-332 does not apply because bank did not have a security interest in the deposit account and rather had a security interest in accounts, inventory, etc. and seeks summary judgment. The trial court granted summary judgment in favor of the firm.
The court of appeals reversed on the ground that new section 9-332 does not apply to checks drawn and paid on the deposit account held by the debtor at another bank not subject to the banks security interest. The court referred to the text of new section 9-332 and an example in Official Comment 2 to this section as follows:
(b) A transferee of funds from a deposit account takes the funds free of a security interest in the deposit account unless the transferee acts in collusion with the debtor in violating the rights of a secured party.
***
Example 1: Debtor maintains a deposit account with Bank A. The deposit account is subject to a perfected security interest in favor of Lender. Debtor draws a check on the account, payable to Payee. Inasmuch as the check is not the proceeds of the deposit account (it is an order to pay funds from the deposit account), Lender's security interest in the deposit account does not give rise to a security interest in the check. Payee deposits the check into its own deposit account, and Bank A pays it. Unless Payee acted in collusion with Debtor in violating Lender's rights, Payee takes the funds (the credits running in favor of Payee) free of Lender's security interest. This is true regardless of whether Payee is a holder in due course of the check and even if Payee gave no value for the check.
The court of appeals then concluded that because the firm did not offer any evidence that it had control of the bank account it could not have a perfected security interest within the meaning of new section 9-332.
The court seems to have reached the correct result because new section 9-332 does not apply to a deposit account that is not subject to a security interest that the payee is trying to avoid. In essence the banks claim has nothing to do with its security interest. Rather, it was asserting the unauthorized use of the proceeds of a line of credit.
If line of credit proceeds had been deposited into the bank account and if the bank had a security interest in the bank account and if the bank was asserting an unauthorized use of the bank account collateral then new section 9-332 could apply. Similarly, if the line of credit proceeds had been used to acquire inventory that was sold and if the proceeds of the sale had been deposited into the bank account and if the bank could establish an interest in the bank account as proceeds under new section 9-315 (see CANINE Chapter 9 (The Specifics of Enforceability - After-acquired Collateral, Future Advances, Transferred Collateral and Proceeds, and the New Debtor Problem)) then new section 9-332 could apply to protect the firm as to checks drawn on the bank account. But, in neither instance would it matter whether the banks security interest in the bank account had been perfected by control. And, the courts discussion of control and perfection of the bank account at issue and the need for the law firm to offer proof of control is off the mark and adds nothing to the decision.
Vars v. Citrin, 470 F.3d 413 (1st Cir. 2006)
Chapter 4 (Scope of Article 9), 10 (The Need for Value and Debtors Rights in the Collateral); 5 (Classification of Collateral), 12 (Perfection Generally)
State law permits a security interest in a liquor license and the security interest is protected by due process but there is no due process violation where a liquor license is properly terminated because of a debtors financial and tax difficulties; Article 1, section 1-201(b)(37); new section 9-109; 9-102(a)(42)
This case involves a 42 U.S.C. § 1983 action the exact nature of which is unclear. However, the subject of the action was a liquor license. The plaintiffs sold a tavern business and took a security interest in the assets of the business, including a liquor license. The buyer/debtor encountered tax problems and its corporation charter was suspended. A further consequence of the difficulties was that the liquor license was not renewed.
Rhode Island courts have recognized that a liquor license, though not property in the traditional sense, is valuable and the holder of such a license enjoys some protection. The liquor business, however, is subject to the police power that permits the government to restrict the sale of a liquor license or prohibit it entirely. Rhode Island law limits the term of the liquor license to one year. The plaintiffs interest, moreover, was derivative of that of the buyers who held the license.
In affirming in affirming a lower court decision against the plaintiffs, the court of appeals held that while the plaintiffs had a protectable interest during the pendency of the 2001 revocation process, they had none when the City Council reduced the number of liquor licenses. At the time of the Council meeting, almost two months after the license had expired and with no application for renewal having been filed, the plaintiffs were without a right or interest on which to base a due process claim.
The case is interesting insofar as the court acknowledges that a highly regulated liquor license that is subject to termination by a regulatory agency may be collateral under Article 9 and that there is due process protection of a security interest in a liquor license.
Stockman Bank of Montana v. AGSCO, Inc., 727 N.W.2d 742 (N.D. 2007)
Chapters 4 (Scope of Article 9), 5 (Classification of Collateral), 9 (The Specifics of Enforceability After-acquired Collateral, Future Advances, Transferred Collateral and Proceeds, and the New Debtor Problem), 12 (Perfection Generally), 13 (Overview of Perfection by Filing), 31 (Secured Party Versus Statutory Liens Including Agricultural Liens and Federal Tax Liens; Banks Right of Set Off)
Priority of agricultural supplier lien over security interest; agricultural liens; proceeds; new 9-102(a)(5); 9-109; 9-310(a); 9-315(a)(2); 9-322(a); 9-322(g); 9-501(2)
In this case a bank with a security interest in crops and the proceeds thereof sued for a determination that its security interest had priority over a seed supplier who claimed an agricultural lien on the crops and proceeds. The trial court concluded that the seed supplier did not have an enforceable lien and the supplier was not entitled to any crop proceeds.
The agricultural supplier lien statute entitled any person who furnished seeds used in the production of crops to an agricultural suppliers lien on the crops, that a properly filed lien was effective from the date the seeds were furnished and the agricultural lien had priority over all other liens except an agricultural processors lien.
The bank conceded that the seed supplier had properly filed the statement required by the statute but argued that the supplier had not provided the agricultural producer a statement advising the producer that a lien would be filed if the amount owed for the seeds was not paid. The trial court applied a strict compliance test and concluded that under that test the seed supplier was not eligible for an agricultural suppliers lien. The court of appeals reversed holding that a substantial compliance test should govern and that because the agricultural producer had actual notice there was substantial compliance with the statute and the seed supplier, therefore, qualified for the lien and had priority over the bank.
By focusing on the question of which test of compliance governed the court of appeals overlooked a number of important issues. To begin with there is no discussion of that important fact that agricultural liens, as defined in new section 9-102(a)(5) to mean essentially a lien by statute on farm products, are within the scope of Article 9, that under new section 9-310(a) an Article 9 financing statement must be filed to perfect an agricultural lien or that under new section 9-501(a)(2), except in the case of as-extracted collateral and timber to be cut and a financing statement filed as a fixture filing, the filing must be made centrally, typically meaning the secretary of states office. See CANINE Chapter 4 (Scope of Article 9) and Chapter 13 (Overview of Perfection by Filing). The adoption of new Article 9 means that state legislatures must examine statutes creating liens that may qualify as agricultural liens under Article 9. To the extent that a state legislature has not considered the matter and clarified the procedure for perfecting a lien that qualifies as an agricultural lien it will be up to the courts to reconcile new Article 9 with a statute creating such a lien. This did not happen in the Stockman Bank case.
Likewise, there was no attention to the fact that the new Article 9 priority rules must be considered in connection with disputes between secured parties and holders of agricultural liens. Thus, as discussed in CANINE Chapter 31 (Secured Party Versus Statutory Liens Including Agricultural Liens and Federal Tax Liens; Banks Right of Set Off), under new section 9-322(g) a perfected agricultural lien has priority over a conflicting security interest if the statute creating the agricultural lien so provides. The statute in the Stockman Bank case conferred priority on the agricultural suppliers lien but, as noted, it is not clear that the seed suppliers lien was perfected within the meaning of new section 9-322(g).
Lastly, as explained in CANINE Chapter 9 (The Specifics of Enforceability After-acquired Collateral, Future Advances, Transferred Collateral and Proceeds, and the New Debtor Problem) the new Article 9 rules governing the enforceability and perfection of security interests in proceeds do not apply to agricultural liens and an agricultural lien extends to proceeds only to the extent that the statute creating the lien so provides. The dispute in Stockman Bank involved proceeds of crops produced with the seeds supplied by the seed supplier, but there is no indication that the statute creating the suppliers lien applied to proceeds, either by the terms of the statute or by court decision.
In short, the more interesting and more important issues regarding agricultural liens were simply not addressed by the court in Stockman Bank.
Keybank National Association v. DPR Construction, Inc., 149 P.3d 233 (Or. App. 2006)
Chapter 35 (Disposing of Collateral to Satisfy a Secured Debt), 37 (Foreclosure as to Intangibles)
Where an account debtor has no place of business or has designated a specific place to receive notification until notification in proper form is received at the designated place payments to the assignor/debtor will discharge the debt owed by the account debtor; new 9-406; former Article 1, section 1-201(a)(26); Article 1, section 1-202 (replacing Article 1, section 1-201(a)(26))
Under new section 9-406(a) an account debtors obligation is discharged by payments to an assignor/debtor prior to the time the account debtor receives a notification in proper form instructing the account debtor to pay the assignee and not the debtor. The contract between the debtor and the account debtor obligated the assignor/debtor to send invoices and other notices to the account debtor to a specific building at a particular location, namely, 2501 NW 229th Ave., RS3-309, Hillsboro, OR 97124. It was held that notification was not received until it was received at the specific building and that payments made to the debtor prior to that time discharged the account debtors obligation within the meaning of new section 9-406(a).
According to the court, the question was when the account debtor received notification of the assignment at the place held out by the person as that phrase is used in Article 1, section 1-201(a)(26)(b) (now Article 1, section 1-202(e)) providing that a person receives notice or notification when: . . . (b) it is duly delivered at the place of business through which the contract was made or at any other place held out by the person as the place for receipt of such communications. In the courts judgment, the notification was received when it was received at the specific building (RS3-309) and not at the street address.
The provision interpreted by the court now appears in Article 1, section 1-202(e). That section provides:
(e) Subject to subsection (f), a person receives a notice or notification when:
(1) it comes to that persons attention; or
(2) it is duly delivered in a form reasonable under the circumstances at the place of business through which the contract was made or at another location held out by that person as the place for receipt of such communications.
The language of the Article 1, section 1-202(e) is substantively the same as former Article 1, section 1-201(a)(26), except that the subsection is expressly subject to Article 1, section 1-202(f). Subsection (f) provides:
(f) Notice, knowledge, or a notice or notification received by an organization is effective for a particular
transaction from the time it is brought to the attention of the individual conducting the transaction and, in any event, from the time it would have been brought to the individuals attention if the organization had exercised due diligence. An organization exercises due diligence if it maintains reasonable routines for communicating significant information to the person conducting the transaction and there is reasonable compliance with the routines. Due diligence does not require an individual acting for the organization to communicate information unless the communication is part of the individuals regular duties or the individual has reason to know of the transaction and that the transaction would be materially affected by the information.
It is not apparent that this change in the law would produce a different outcome in the case. Official Comment 3 to Article 1, section 1-202, states that subsection (f) makes clear that notice, knowledge, or a notification, although received, for instance, by a clerk in Department A of an organization, is effective for a transaction conducted in Department B only from the time when it was or should have been communicated to the individual conducting the transaction. Thus, subsection (f) is aimed at organizations with multiple departments and it provides that when notification is received by a department that reasonably should have sent it on to another department then notification may be deemed to have been received when it is received by the department that should have sent it on.
The Keybank case involved the situation where the account debtor was doing business at a location belonging to and managed by another business and unless there was proof that the account debtor had arranged with that other business to bring notifications received by it to the attention of the account debtor subsection (f) should not apply.
The message to the assignee is that it should use care to see that notification is sent to the specific address provided for in the contract between the account debtor and the debtor. Moreover, an assignee would be well-advised not to hope that subsection (f) of Article 1, section 1-202, will work to save it from an error of its own making. Lastly, of course, the assignee should send notification in a manner that allows the assignee to establish a record of notification having been sent and received.
Davenport v. Bates, 2006 WL 367875 (Tenn. App. 2006)
Chapters 33 (A Secured Partys Options on Default), 34 (Getting Possession of the Collateral), 35 (Disposing of Collateral to Satisfy a Secured Debt), 38 (Remedies for a Secured Partys Failure to Comply with Article 9)
This case involved the repossession and resale of two vehicles, a Corvette and a truck, each of which the debtor admitted was used in the debtors landscaping business, actions for a deficiencies in connection with each sale, and a counterclaim for wrongful repossession. The case raised a number of important issues.
In response to the action for a deficiency as to the contract for the sale of the Corvette the buyer counterclaimed for wrongful possession. As stressed in CANINE Chapter 33 (A Secured Partys Options on Default), an essential pre-condition of self-help foreclosure, including repossession of the collateral, is that there has been a default. Relying on a real estate mortgage case and an article by Professor Lloyd (Wrongful Repossession in Tennessee, 65 Tenn. L. Rev. 761 (1998), the court sustained a jury finding that the seller had waived any default associated with paying late as to the sale of the Corvette by a three-year course of conduct of accepting late payments without advising the buyer that future late payments would not be accepted.
The contract contained a general anti-waiver clause to the effect that the failure of the secured party to exercise its remedies on one default would not waive its ability to exercise its rights as to subsequent defaults. The court refused to allow this clause to operate to prevent the waiver. In so doing, the court distinguished general anti-waiver clauses from those requiring that any waiver be in writing (no oral modification clauses). It concluded that although clauses requiring that waivers be in writing are made effective by a state statute, general anti-waiver clauses have been denied effect on the ground of estoppel or that they are against public policy.
The court noted that, as was stressed in CANINE Chapter 33 (A Secured Partys Options on Default), a secured party who has engaged in conduct that could lead to a waiver may reinstate the default obligation by notifying the debtor that strict adherence to the terms of the contract would be demanded in the future, but that the seller in Davenport had not so notified the buyer.
There also was evidence that the sellers response to the late payment that lead to the repossession may have been prompted by the sellers dissatisfaction with landscaping work done by the debtor for the seller.
A second issue in the case was whether the seller had sent the reasonable notification of the disposition of the vehicles required by new section 9-611. The court of appeals, noting that notification has as its purpose to allow a debtor to take appropriate action to protect its interest in collateral, upheld a jury finding that the requirement had not been satisfied. The seller testified that it had a policy to send a notice letter to a customer ten days prior to the sale of their repossessed vehicles and that he sent the appropriate letters to the buyer but that the letters had been returned because the buyer would not accept his mail. However, the seller offered no evidence to support this testimony and, in particular, the seller failed to produce copies of the letters. According to the court, in the absence of such evidence a jury could choose to believe the buyers testimony that no letters were ever sent.
The seller asserted that he had been instructed to communicate only with the buyers attorney and that the attorney refused to accept letters notifying the buyer of a disposition. It seems the jury disregarded this assertion, but the assertion poses the interesting question of what legal effect should be given to such actions by a debtor and a debtors attorney. A debtor should not be able to defeat a secured partys effort to comply with the reasonable notification requirement by refusing to accept letters containing the notification. Indeed, as explained in CANINE Chapter 35 (Disposing of Collateral to Satisfy a Secured Debt), new section 9-611 requires only that reasonable notification be sent and not that it be received. On the other hand, consistently with attorney/client obligations, where a secured party has been advised that the debtor is represented by an attorney the secured party should address all communications, including those aimed at complying with the demands of Article 9 in connection with a disposition of collateral, to the debtors attorney and communications addressed to the debtors attorney surely would constitute notice as defined in Article 1, section 1-202(d) (formerly Article 1-201(26)).
The interesting twist presented by the Davenport case is that the debtor was insisting that there had been no default as to the Corvette and that the secured party had no right to repossess or resell that vehicle. In a sense the letters were of no legal effect and the debtor had no obligation to accept them. Of course, even if this is so, that it was so depended upon whether the debtor was able to make its case that there was no default. Consequently, the debtor and the debtors attorney would be well advised to accept the letters and act accordingly pending a disposition of the wrongful repossession claim.
There were a range of issues regarding the sellers right to a deficiency and the calculation of any such deficiency and the buyers right to a surplus, statutory or actual damages, and how any surplus or damages should be measured. The courts discussion of these issues is confusing at best. New section 9-625(c)(2) provides that where a secured party fails to comply with Article 9 in disposing of consumer goods the debtor is entitled to recover in any event an amount not less than the credit service charge plus 10 percent of the principal amount of the obligation or the time-price differential plus 10 percent of the cash price. As is explained in CANINE Chapter 38 (Remedies for a Secured Partys Failure to Comply with Article 9), statutory damages are made available because of the particular difficulty of proving actual damages in a consumer goods situation. The court points out that credit service charge and time-price differential are not defined and then, relying on Zinnecker, The Default Provisions of Revised Article 9 of the Uniform Commercial Code: Part II, 54 Bus. Law. 1737, 1804 (1999), concludes that time price differential is the difference the credit price and the cash price of goods and pertains to sales of goods as distinguished from loans.
However, the discussion of the proper measure of damages under new section 9-625(c)(2) turns out to be dictum because such damages are available only as to consumer goods and the court reverses the trial courts decision that the Corvette constituted consumer goods. Consumer goods is defined in new section 9-102(a)(23) to mean goods that are used or bought for use primarily for personal, family, or household purposes. Noting that there is some uncertainty in the case law, the court of appeals concludes that classification of collateral is a question of law and the decision of the trial court on the matter was to be reviewed de novo. The court then reviews the testimony and decides that the Corvette was used primarily in the buyers landscaping business and, consequently, did not constitute consumer goods. In so doing the court rejects the buyers argument that the Corvette was a collectors item that was inherently for personal use.
As noted in CANINE Chapter 5 (Classification of Collateral), where goods are used both for personal, family and household purposes and for business purposes a determination must be made as to which use is the dominant or primary use and the courts decision that the Corvette was used primarily in the debtors business seems right. As also noted in CANINE Chapter 5, under new section 9-102(a)(23), the test is whether the goods are used or bought for use primarily for personal, family or household purposes. It can happen that goods are bought for consumer purposes but then used primarily in business. As further noted in CANINE Chapter 5, in such a case how the goods would be classified at the time the security interest attaches should govern. However, there was no evidence in the case that the buyer bought the Corvette for personal, family or household purposes and then used it in his landscaping business.
As for the wrongful repossession, the court concludes that damages should be measured by the difference between the fair market value of the Corvette and the balance of indebtedness still owing rather than the amount received at the disposition less the balance owing. The court does not indicate the nature of a wrongful repossession action. It could be an action rooted in contract and Article 9 or an action sounding in tort. The court does say that the measure chosen gives the buyer the benefit of the bargain thereby suggesting the action is one for breach of contract. As explained in CANINE Chapter 38 (Remedies for a Secured Partys Failure to Comply with Article 9), Article 9 permits an action for conversion where the secured party has repossessed in the absence of a default. That a debtor may sue in tort is important because damages could include punitive damages. It appears that the buyers attorney did not attempt to recover punitive damages, but this possibility should always be kept in mind.
The courts treatment of the deficiency and surplus issues is even less satisfying. Although not clear from the opinion the court appears to conclude that the proper measure of a surplus or a deficiency, depending on the numbers, is the difference between the balances owing on the secured obligations and the prices of the vehicles obtained on resale. As discussed in CANINE Chapter 35 (Disposing of the Collateral to Satisfy a Secured Debt), in the usual case, this would be the appropriate measure under new section 9-615(d) providing for recovery of a surplus by a debtor or a recovery of a deficiency by a secured party. However, as also explained in CANINE Chapter 35, and more fully in CANINE Chapter 38 (Remedies for a Secured Partys Failure to Comply with Article 9), where the question of the secured partys compliance with Article 9 is placed in issue and the secured party fails to prove compliance a different calculation is required.
Specifically, under new section 9-626(a)(3) a deficiency in other than a consumer transaction is to be measured by the difference between the secured obligation and the amount of proceeds that would have been realized if the secured party had complied with Article 9 and under new section 9-6262(a)(4) this amount is presumed to be equal to the secured obligation. As explained in CANINE Chapter 38 (Remedies for a Secured Partys Failure to Comply with Article 9) this measure of a deficiency where the secured party has failed to comply with Article 9 is known as the rebuttable presumption approach. The collateral is presumed to be worth the amount the debtor owes. The presumption is rebuttable in that the secured party may attempt to show that a different amount would have been obtained even if the secured party had complied with Article 9.
The court in Davenport makes no reference to new section 9-626. There is an odd footnote in which the court states that the buyer was not asserting that the disposition was not made in a commercially reasonable manner and that if the disposition had not been made in a commercially reasonable manner then the damages would be the excess of the fair market value at the time of the repossession over the greater of the disposition sale price of the collateral or the indebtedness due on the collateral. [Emphasis in the original] This confusing formulation does not appear to be consistent with that required by new sections 9-626(a)(3) and (a)(4). More importantly, the court seems to be suggesting that only where the secured party has failed to dispose of collateral in a commercially reasonable manner does a different measure of damages apply. Under new section 9-626(a) the calculation explained above is applicable for any failure of the secured party to comply with Article 9, including a failure to send reasonable notification.
Compounding the confusion as to how a deficiency should be measured is that the court discusses a special measure of damages only as to the Corvette and assumes that the usual measure of damages should apply as to the truck. But, there was a failure to send reasonable notification as to both the Corvette and the truck and that failure should have led to a special measure of damages for any deficiency as to the truck as well as the Corvette.
For completeness, it is worth noting that if the court had concluded that the Corvette was a consumer good then there would have been a consumer transaction as defined in new section 9-102(a)(26). In that event the rebuttable presumption approach to determining a deficiency provided for in new sections 9-626(a)(3) and (a)(4) would not apply. As explained in CANINE Chapter 38 (Remedies for a Secured Partys Failure to Comply with Article 9) under new section 9-626(b) a court is supposed to fashion the rules for calculating deficiencies in consumer transactions and in doing so the court is not supposed to draw any inferences from the measure of damages required for non-consumer transaction cases. As further explained in CANINE Chapter 38 (Remedies for a Secured Partys Failure to Comply with Article 9) it remains to be seen what courts in particular states will do in consumer transactions where the secured party has failed to comply with Article 9, but that courts would use a measure less favorable to debtors than that applicable in non-consumer transactions seems unlikely.
Alete, Inc. v. GEC Engineering, Inc., 726 N.W.2d 520 (Minn. App. 2007)
Chapters 8 (The Specifics of Enforceability A Security Agreement Authenticated by the Debtor or Its Equivalent), 13 (Overview of Perfection by Filing)
A financing statement cannot be used to broaden the scope of a security interest evidenced by an unambiguous description in a security agreement; composite document doctrine; descriptions employing the address where collateral is located; inquiry notice; new 9-108, 9-203(b)(3); 9-502;
In this case a Minnesota lender lent to a Missouri debtor with the expectation that the debtor would move its operations from Missouri to Minnesota. The debtor authenticated a security agreement describing the collateral as [a]ll equipment and inventory located at Borrower's facility at 510 W. 3rd Avenue North, Aurora, Minnesota. The lender then filed in Minnesota a financing statement listing equipment and inventory located at that Minnesota site. Subsequently, it became clear that the debtor was not going to move its operations from Missouri to Minnesota and the lender filed a financing statement in Missouri. The financing statement filed in Missouri contained the following language:
This financing statement covers the following types or items of property....
A. All equipment and inventory located at Borrower's facility located at 116 Holloway Road, Ballwin, MO[.]
A dispute arose between a purchaser of the item of equipment and the lender. The court properly concluded that the unambiguous description in the security agreement limited the security interest to equipment located in Minnesota and that the financing statement filed in Missouri, and which referred to equipment located in Missouri, could not be used to broaden the scope of the security interest.
As explained in CANINE Chapter 8 (The Specifics of Enforceability A Security Agreement Authenticated by the Debtor or Its Equivalent), a security agreement serves two related purposes. The first is to allow a court to conclude that the debtor has created a security interest in favor of the creditor. The second is to evidence through an adequate description exactly what property is within the scope of the security interest. The documents in Aleto satisfied the first purpose but not the second. As the court notes, it is not only the interests of the debtor but also those of third parties that are at stake and, therefore, a court must be able to objectively determine that a security interest was created in the property claimed by the creditor.
As for whether the financing statement could be used to broaden the security interest evidenced by the unambiguous description of collateral in the security agreement, as explained in CANINE Chapter 13 (Overview of Filing), a financing statement is intended to give constructive notice that a security interest may have been created in property indicated in the financing statement. As the court noted in Aleto, a financing statement does not contain any language indicating that the debtor is granting a security interest to the creditor, but rather that a security interest may have been created in generally described property and it is incumbent on third parties to determine exactly what property, if any, is subject to an enforceable security interest.
The court in Aleto indicated that, as noted in CANINE Chapter 8 (The Specifics of Enforceability A Security Agreement Authenticated by the Debtor or Its Equivalent), parol evidence is admissible to embellish the description of a security agreement but concluded that other than the financing statement, appellant offers only obscure references to the engine in various items of correspondence as evidence of such an amendment . . . that are oblique at best and require considerable interpolation and we are aware of no court that has held that a standard financing statement, standing alone or with only parol evidence, is sufficient as a matter of law to create a security interest in collateral, or to amend an unambiguous security agreement.
The attempt by the lender to use of the financing statement expand the security interest to reach the equipment in dispute implicates what, as explained in CANINE Chapter 8 (The Specifics of Enforceability A Security Agreement Authenticated by the Debtor or Its Equivalent), has been referred to as the composite documents doctrine, according to which multiple documents that contain a sufficient internal link or nexus may be read together in determining the scope of a security interest (and even to compensate for the absence of a formal document labeled as a security agreement). In this regard the court decided that the financing statement relied on by the lender had no reference to the described property as collateral.
It is worth noting that in an important sense the lenders difficulties are traceable to the fact that the item of equipment it sought to claim had been described in the security agreement using a specific address where the equipment was located. As discussed in CANINE Chapter 8 (The Specifics of Enforceability A Security Agreement Authenticated by the Debtor or Its Equivalent), describing property by referring to its location is a time-honored practice, but as this case demonstrates a secured party must be careful in so describing property. Had the security agreement described the equipment using the address where the equipment was located in Missouri rather than where it was supposed to end up in Minnesota the security interest would have been enforceable. Better yet, where it is contemplated that collateral may be moved from one state to another it would be preferable to describe the property by item or type or some other language permitted by new section 9-108 governing descriptions of collateral otherwise than by using an address where it is or would be located.
In re Borden, 361 B.R. 489 (B.A.P. 8th Cir. 2007)
Chapters 4 (Scope of Article 9) and 31 (Secured Party Versus Statutory Liens Including Agricultural Liens and Federal Tax Liens; Banks Right of Set-Off)
The priority conferred by new section 9-333 of a statutory lien for providing materials and services to goods over a security interest arising before the materials or services were provided is not lost where the debtor temporarily regains possession of the goods without the consent of the lien holder; new 9-109(d)(2); 9-201; 9-333
This case involves a priority dispute between the holder of an artisans lien on farm equipment for repairs to the equipment not paid for by the debtor and a secured party with a security interest in the debtors equipment. New section 9-333 confers priority on holders of possessory liens created by statute except where the statute expressly subordinates the lien. The party claiming the artisans lien qualified for the new section 9-333 priority except for the fact that the debtor had regained possession without the lien holders consent and then returned the equipment. The court of appeals concluded that the artisans lien was not lost where the debtor had regained possession without the consent of the lien holder. In the course of its lengthy opinion the court provides a useful discussion of the nature of artisan liens and especially the purpose of the possession requirement and how it should factor into priority disputes.
As explained in Chapter 4 (Scope of Article 9) and Chapter 31 (Secured Party Versus Statutory Liens Including Agricultural Liens and Federal Tax Liens; Banks Right of Set-Off), liens by law are outside the scope of new Article 9 except that section 9-333 applies with respect to priority of such a lien. Consequently, state law governs the existence of any lien such as that for providing materials and services to goods. If a lien qualifies as a possessory lien, defined by new section 9-333(a) as an interest that (1) secures payment for services or materials furnished with respect to the goods by a person in the ordinary course of the persons business, (2) is created by statute or rule of law in favor of the person and (3) whose effectiveness depends on the persons possession of the goods, then the lien has priority under new section 9-333(b) over a security interest in the goods unless the lien is created by statute and the statute expressly subordinates the lien.
In Borden, a person who had provided materials and services to farm equipment subject to an Article 9 security interest claimed a lien under a Nebraska statute on that equipment. The statute did not expressly subordinate the lien to the security interest so the question was whether the lien was a possessory lien within new section 9-333(a) that had priority over the security interest under new section 9-333(b). The persons claim satisfied the requirements of the Nebraska statute and was a possessory lien under new section 9-333(a) except for the fact that for reasons that are not apparent the debtor had regained possession of the farm equipment without the consent of the person claiming the lien and then returned the equipment to the possession of that person.
The court reviews decisions from other jurisdictions, noting that in some states the lien is lost while the property is out of the artisans possession but revived when the artisan regains possession, that the lien could be subordinated to a bona fide purchaser who purchased or a creditor who levied on the property while it was in possession of the owner/debtor and that in some states if the artisan did not take action to recover possession that might be construed as conditional consent to the debtors temporary use of the property but that such conditional consent to a prior non-consensual taking would not defeat the lien. The court then concludes that the person making the repairs in Borden had not consented to the loss of possession and that its lien was prior to the security interest.
The court observes that the possession requirement is intended to provide inquiry notice to third parties who, given the absence of any registry scheme for an artisans liens, would be at risk against a secret lien. However, the security interest in the Borden case, as would be true in most cases, arose before the services supporting the repair lien were given. Consequently, notice or the lack thereof is not enough to explain a decision in favor of the person providing the services. Rather, as the court notes, artisans who provide labor and materials add to the value of the goods whereas the credit supporting a security interest is extended on the basis of the value of the property at the time of the security interest arises and to give the security interest priority would be unfair.
The lower court was troubled by a perceived lack of certainty that would result if an artisan were permitted to retain a lien without maintaining possession of the property. That same concern led to a dissent in the court of appeals. For the appeals court, however, while certainty is a valid goal in statutory interpretation, it should not come at the expense of the purpose behind the statute to protect the rights of an artisan whose services have enhanced the value of the property and whose claim is in dispute only through no fault of the artisan.
In re Commercial Money Center, Inc., 350 B.R. 465 (B.A.P. 9th Cir. 2006)
Chapters 4 (Scope of Article 9), 5 (Classification of Collateral), 15 (Perfection by Possession (including Documents of Title)), 18 (Perfection By Doing Nothing Automatic Perfection), 26 (Secured Party Versus Lien Creditor; Future Advances; Bankruptcy), 30 (Secured Party Versus Trustee in Bankruptcy)
New 9-309(3); 9-330
This complicated case involves the securitization industry. The debtor leased equipment to lessees with sub-prime credit and then packaged groups of leases together and assigned its contractual rights to future lease payments to various lenders. To enhance the marketability of these payment streams the debtor obtained surety bonds guaranteeing the payments and assigned its rights under the surety bonds to the lenders. As security for the lenders receipt of the lease and surety bond payments the debtor granted the lenders security interests in the underlying equipment leases. The transactions were structured so that the payment streams and the interests in the underlying leases were separated into two interests, i.e. so that the payment streams were stripped from the underlying equipment leases.
When the debtor defaulted and filed bankruptcy the trustee in bankruptcy sought to avoid what the trustee asserted to be security interests in the payment streams, essentially under BRA § 544(a) according to which a trustee may avoid a security interest that is not perfected on the date of bankruptcy. The court of appeals agreed with the lenders that the underlying leases constituted chattel paper but the payment streams stripped from the leases were payment intangibles interests in which could be on perfected on attachment under new section 9-309(3), that is, perfected automatically without filing a financing statement or other such action. However, automatic perfection under new section 9-309(3) applies only where the transfer of the payment intangible is by a sale and is not a transfer for security. The court of appeals agreed with the bankruptcy court that the transfers of the payment streams were for security and were not sales and the interests could not be perfected automatically under new section 9-309(3). It then held that the security interests in the payment intangibles had not been perfected by filing or by constructive possession and were avoidable under BRA § 544(a) as not being perfected on the date of bankruptcy.
[Explore the analysis of each question classification and security interest versus sale and also the matter of perfection by filing or constructive possession (how that could be)]
on and the alleged need of participants in that industry to be able to strip paymentsThe principal issue in this case appears to be one of first impression for us or any court of appeals. We are told that the multi-billion dollar securitization industry depends on being able to fractionalize financial assets, and specifically on stripping payment streams from underlying transactions such as the equipment leases in this case. The issue is whether those payment streams are chattel paper or payment intangibles. On cross-motions for partial summary judgment the bankruptcy court held that the payment streams are chattel paper. We disagree. The underlying equipment leases are chattel paper but the payment streams stripped from the leases are payment intangibles.
This means that the assignment of the payment streams could be automatically perfected under Revised Uniform Commercial Code (UCC) Article 9, Section 9-309(3), but only if the assignment is a sale. We agree with the bankruptcy court that the transactions in this case are loans, not sales, so there is no automatic perfection. However, there are unresolved factual and legal issues as to whether perfection was accomplished by taking possession of the underlying leases through a third party agent.
* * *
Commercial Money Center, Inc. (Debtor) leased equipment to lessees with sub-prime credit. It packaged groups of leases together and assigned its contractual rights to future lease payments to entities such as Net.Bank, Inc., FSB (NetBank). To enhance the marketability of these payment streams Debtor obtained surety bonds guaranteeing the payments and it assigned its rights under the surety bonds to NetBank. As security for NetBank's receipt of the lease payments and any surety bond payments, Debtor granted NetBank a security interest in the underlying leases and other property. In other words, Debtor assigned NetBank both an interest in the payment streams and an interest in the underlying leases, but it separated the two interests.
A representative SSA (Sale and Servicing Agreement) in the excerpts of record states in one part (§ 2.1(c)) that Debtor and NetBank intend a sale, not a loan:
(c) The execution and delivery of this Agreement shall constitute an acknowledgment by each of [Debtor as] Seller and [NetBank as] Purchaser that they intend that each assignment and transfer herein contemplated constitute a sale and assignment outright, and not for security, of the [Transferred Assets, defined in Section 2.1(a) to include the payment streams due or on deposit, the surety bonds, and proceeds of those things], conveying good title thereto free and clear of any Liens, from [Debtor] to [NetBank], and that all such property shall not be part of the estate of [Debtor] in the event of bankruptcy .... In the event that such conveyance is determined to be made as security for a loan made by [NetBank] to [Debtor], [Debtor] hereby grants to [NetBank] a first priority security interest in all of [Debtor's] right, title and interest in and to the [Transferred Assets] .... [Emphasis added.]
On the other hand, Section 2.10 of the SSA characterizes the transaction as a loan, not a sale, for tax purposes:
SECTION 2.10 Income Tax Characterization. This Agreement has been structured with the intention that the [amounts payable to NetBank] will qualify under applicable federal, state, local and foreign tax law as indebtedness of [Debtor] secured by the Leases and other assets described in Section 2.1. The parties hereto agree to treat and to take no action inconsistent with the treatment of [such amounts] as such indebtedness for purposes of federal, state, local and foreign income or franchise taxes and any other tax imposed on or measured by income. [Emphasis added.]
Other provisions of the SSA also use both sale and loan terminology.
Other details of the arrangement disclose its complexity.
Trustee's Complaint seeks declaratory relief and avoidance of NetBank's interests under a combination of the UCC and the Bankruptcy Code. Trustee claims that NetBank has not satisfied the requirements for perfection of its interests in the payment streams and therefore its interests are avoidable using his strongarm powers. See 11 U.S.C. § 544, 550 and 551. The Complaint also seeks a judgment avoiding as a preference any perfection of NetBank's interests in the Transferred Assets that might have occurred within 90 days of the Petition Date. See 11 U.S.C. § 547 (as enacted prior to any amendments by The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Pub. L. 109-8, 119 Stat. 23, because this case was filed before its effective date). This preference claim anticipates NetBank's assertion that it obtained actual or constructive possession of the leases through the Royal Possession Order, which was issued within the 90 day preference period. See 11 U.S.C. § 547(b)(4)(A).
NetBank's Answer alleges (1) that Royal had actual and constructive possession before and after the [Royal Possession Order] which led to [NetBank] being perfected with respect to [the Transferred Assets], (2) more generally, that agents and/or bailees always had possession of the items in which [NetBank] is secured, (3) that while [NetBank] did not file a UCC-1 [financing statement] ... to the extent required, [Debtor and/or Surety] were legally responsible for such filings, and (4) that any transfers that might otherwise be avoidable as preferences were protected by the ordinary course of business defense of 11 U.S.C. § 547(c)(2). The Answer asserts numerous other affirmative defenses including equitable estoppel because Debtor and/or Surety were responsible for, among other things, transferring the sold assets, and perfecting and protecting [NetBank's] secured rights and interests under the [SSAs] and under the surety bonds.
After a hearing on December 20, 2004, the bankruptcy court issued a memorandum decision that Trustee is entitled to judgment on each of the claims described above. [Citation omitted.] It ruled that the payment streams constitute chattel paper and therefore NetBank was required to perfect its interests under the rules applicable to chattel paper. In the alternative, the bankruptcy court ruled that, even if the payment streams are not chattel paper, NetBank cannot benefit from the automatic perfection rule applicable to sales of payment intangibles (Rev. UCC § 9-309(3)) because the transactions at issue were loans rather than sales. The bankruptcy court's decision states, It is undisputed that NetBank did not perfect its interests in the payment streams either by filing financing statements or by taking possession of the underlying leases.
The parties agree that Nevada's version of Revised UCC Article 9 states the applicable law of perfection. There are no material differences between the Nevada version and the uniform versions of the relevant provisions.
Most perfection is not automatic. One exception is a sale of payment intangibles (referred to as a security interest), which is perfected automatically: The following security interests are perfected when they attach: ... 3. a sale of a payment intangible[.] [9-309(3)]
The UCC distinguishes between the monetary obligation evidenced by chattel paper and the chattel paper itself:
1. In this article:
* * * * * *
(k) Chattel paper means a record or records that evidence both a monetary obligation and a security interest in or a lease of specific goods .... As used in this paragraph, monetary obligation means a monetary obligation secured by *476 the goods or owed under a lease of the goods .... [Emphasis added.] [9-102(a)(11)]
This language on its face defines chattel paper to mean the records that evidence certain things, including monetary obligations. Payment streams stripped from the underlying leases are not records that evidence monetary obligations-they are monetary obligations. Therefore, we agree with NetBank that the payment streams are not chattel paper.
If they are not chattel paper, what are they? Most monetary obligations are accounts but the definition of account excludes rights to payment evidenced by chattel paper. Therefore the monetary obligations in this case fall within the payment intangible subset of the catch-all definition of general intangibles. See [9-102(a)(2)] (Account means a right to payment of a monetary obligation ... for property that has been or is to be ... leased ... [but the term] does not include rights to payment evidenced by chattel paper ...); 104.9102(1)(pp) (General intangible means any personal property other than accounts, chattel paper, and various other specified types of property, and specifically includes payment intangibles); FN 7 104.9102(1)(iii) (redesignated as (hhh) by S.B. 201) (Payment intangible means a general intangible under which the account debtor's principal obligation is a monetary obligation). See generally In re Wiersma, 324 B.R. 92, 106-07 (B.A.P. 9th Cir. 2005) (discussing why definition of payment intangible includes assignment of payment right under settlement agreement).
FN 7. We recognize that the definition of general intangibles excludes chattel paper, but because the monetary obligations are not chattel paper they are not excluded from the definition of general intangibles.
As stated by one publication, the carved-out payment streams seem to fit the definition of payment intangible like a glove. Barkley Clark and Barbara Clark, The Law of Secured Transactions Under the UCC, ¶ 10.08[8][D]. That publication specifically disagrees with the bankruptcy court's decision in this case that the payment streams are chattel paper.
Our analysis might stop here. As the bankruptcy court noted, the plain language of the statute is usually conclusive. * * * Nevertheless, the bankruptcy court interpreted the plain words of the statute in a manner with which we do not agree:
The definition [of chattel paper] states three requirements before collateral is characterized as chattel paper: 1) a record; 2) that evidences both a monetary obligation; and 3) a security in or a lease of specific goods. A monetary obligation is defined as a monetary obligation secured by the goods or owed under a lease of the goods. The parties do not dispute that all three elements for chattel paper are met with respect to the underlying equipment leases, but NetBank seeks to characterize the monetary obligation owed under the lease as a payment intangible. This proposition does not follow from the plain language of the statutory definition of chattel paper and such a reading would essentially delete the monetary obligation requirement from the definition. See Singer, Sutherland Statutes and Statutory Construction, § 47.79 (6th ed. 2000) (A canon of statutory construction is that a definition which declares what a term means excludes any meaning that is not stated). The court finds that the monetary obligation (i.e., the payment streams) constitute chattel paper. [Emphasis added.]
We do not understand how NetBank's reading would essentially delete the monetary obligation requirement from the definition of chattel paper. That requirement simply describes the type of records involved-they must be records that evidence a monetary obligation, among other characteristics. [9-102(a)(11)]. The leases do that, so they are chattel paper, but the payment streams do not. As stated above, they are not records that evidence monetary obligations, they are the monetary obligations.
The bankruptcy court's memorandum decision also comments, in a footnote, that The Court views NetBank's argument that [Debtor] transferred only the payment streams, and not the underlying leases, immaterial to the legal issue involved. We disagree, for the reasons just stated.
As an alternative basis for its ruling, the bankruptcy court considered the policies behind the statute. We agree with the bankruptcy court that the UCC aims to provide certainty in financial transactions and some means for third parties to discover competing interests in property, at least when that property is collateral or some types of purchased property. We are not persuaded that the plain meaning of the statute conflicts with such policies, or alternatively that it is our role to rewrite the statute if there is any such conflict.
The principal decision cited by the bankruptcy court involved an assignee (Jefferson) that had been assigned only the payment streams and not the underlying equipment leases. In re Commercial Management Services, Inc., 127 B.R. 296 (Bankr. D. Mass. 1991). A critical difference is that Jefferson had also taken possession of the leases. Id. at 299. Here the possession of the leases is a disputed issue.
The Chapter 7 trustee in that case argued that the payment streams were general intangibles and that Jefferson had not perfected its interest in those payment streams because it had not filed any financing statements. The Commercial Management court rejected this argument, holding that Jefferson perfected its security interest [in the payment streams] by possession of the leases. Id. at 305. The Commercial Management court acknowledged that the UCC does not specifically provide for this result:
The [UCC] does not specifically provide that the transfer of chattel paper transfers the obligation it represents; nor does it specifically provide that perfection of a security interest in the written paper, for example, by possession, perfects a security interest in those obligations. It merely provides in Section 9-305 that [a] security interest in chattel paper may be perfected by the secured party's taking possession of the collateral.
Commercial Management, 127 B.R. at 302 ( quoting Boss, Lease Chattel Paper: Unitary Treatment of a Special Kind of Commercial Specialty, 1983 Duke L.J. 69, 92 (1983) (footnotes omitted)).
Nevertheless,
[t]aking possession of the collateral, the chattel paper itself, would be meaningless unless the paper represented the underlying rights which were transferred by a transfer of the paper. Therefore, the necessary implication of [former UCC Section 9-305 [permitting perfection by possession] is that delivery of chattel paper operates to transfer the claim that the paper represents ....
Commercial Management, 127 B.R. at 302 ( quoting Boss, Lease Chattel Paper: Unitary Treatment of a Special Kind of Commercial Specialty, 1983 Duke L.J. at 92-93 (1983) (footnotes omitted)).
Commercial Management is not binding precedent but we assume for purposes of this discussion that it is correct.FN 8 Nevertheless, it is distinguishable. As NetBank's attorney argued before the bankruptcy court:
FN 8.See generally Rev. UCC § 9-109 Official Comment 5 (stating that a sale of chattel paper includes a sale of a right in the receivable); Rev. UCC § 9-313 Official Comment 2 (implying that delivery of a writing, such as tangible chattel paper, operates to transfer the right to payment);
Commercial Management, 127 B.R. at 303-304 (quoting authority that the advantages of chattel paper would be lost if possession of the records does not perfect an interest in the payment streams, and such perfection prevents a dishonest pledgor from misleading a potential subsequent lender into believing that [the pledgor] is free to pledge that same property again ...) (citations and footnotes omitted).
Certainly if you sell a piece of chattel paper, it does come with all the rights that are thereunder. But the flip side of that is not true. If you buy some of the pieces under the chattel paper [i.e. the payment streams], it doesn't mean that you're getting the chattel paper as well.
Transcript Dec. 20, 2004, p. 50:13-17.
In other words, delivery of the chattel paper may operate[ ] to transfer a perfected interest in the associated payment streams, as Commercial Management holds, but that does not mean that payment streams are chattel paper. When stripped from the chattel paper they are payment intangibles.
Trustee argues that the automatic perfection of payment intangibles in Revised UCC § 9-309(3) was only intended to address loan participations, not the payment streams in this case. We are not persuaded. Nothing in the statute limits its application to loan participations. See [9-309(3)] (stating simply, The following security interests are perfected when they attach: ... (3) a sale of a payment intangible, without mentioning loan participations). The official comments imply that a participation is just one type of interest that a party can assign in the monetary obligation. See Rev. UCC § 9-109, Official Comment 5 (a sale of chattel paper or certain other things, such as an account, includes a sale of a right in the receivable, such as a sale of a participation interest) (emphasis added).
Trustee argues that our interpretation of the statute will lead to endless debates over whether particular assignments are actually sales or secured loans. Again, we are not persuaded. Many transactions fall clearly on one side or the other of the sale versus loan dichotomy. When the answer is not clear the UCC contemplates that courts will need to decide the issue. See, e.g., Rev. UCC § 9-109, Official Comment 5 ([N]either this Article nor the definition of security interest in [Rev. UCC] Section 1-201 provides rules for distinguishing sales transactions from those that create a security interest ....). If such decisions are too burdensome on the commercial markets or on litigants then the remedy is with the legislature and not the courts. See generally Roger Falke, 116 Nev. At 588, 3 P.3d at 664 (Where the language of a statute is plain and unambiguous ... there is no room for construction, and the courts are not permitted to search for its meaning beyond the statute itself) (citation omitted).
Trustee also argues that if Revised UCC Article 9 permits purchases of payment streams to be automatically perfected, as we have held, then this permits secret interests and will wreak havoc on the financing markets. According to Trustee, there is no way for a hypothetical financier to protect itself against the possibility that an entity such as Debtor will transfer interests in the same payment streams more than once. NetBank responds that payment stripping is a bedrock principle of the securitization industry and that Trustee's concerns are misplaced.
NetBank argues persuasively that, if the hypothetical financier is the first to perfect, then generally it will be first in priority. See [9-322(a)(1).FN 9 For these purposes it does not matter if the transaction was a sale or a secured loan because the UCC covers both, as we have discussed. Nor does it matter if the financier's interest is in the payment streams alone or in the underlying chattel paper leases, because a perfected interest in chattel paper includes the associated payment streams, at least if the reasoning in Commercial Management applies. Commercial Management, 127 B.R. 296
FN 9. 1. Except as otherwise provided in this section, ... (a) Conflicting perfected security interests and agricultural liens rank according to priority in time of filing or perfection. [9-322(a)(1)].
A more difficult example is if the financier purchased an interest in the chattel paper leases after Debtor had already sold the payment streams to someone else. The financier might have no way to know of that prior security interest. FN 10 The holder of that secret interest might not have filed any financing statements, or taken possession of the leases, or given any other notice because, under our holding, its interest would be automatically perfected under Revised UCC § 9-309(3).
FN 10. As noted at the start of this discussion, the term security interest includes sales, not just collateral for loans.
NetBank argues that the financier could protect itself by taking possession of the leases, which allegedly would give it priority over the secret interest under the special rule of Revised UCC §9-330(b). That rule is codified in [the Nevada version]
104.9330. Priority of purchaser of chattel paper or instrument.
* * * * * *
2. A purchaser [i.e., financier] has priority over a security interest [i.e. the secret interest] in the chattel paper which is claimed other than merely as proceeds of inventory subject to a security interest if the purchaser [financier] gives new value and takes possession of the chattel paper under NRS 104.9105 in good faith, in the ordinary course of [the financier's] business, and without knowledge that the purchase violates the *480 rights of the secured party [i.e., the holder of the prior but secret interest].
Nev. Rev. Stat. § 104.9330(2). FN 11
FN 11. In the above hypothetical the chattel paper leases are sold to the financier, rather than assigned as security for a loan, but NetBank's argument is not limited to sales because the term purchaser includes not only a buyer but also a secured lender. See Nev. Rev. Stat. § 104.1201(2)(cc) ( Purchase means taking by sale, lease, discount, negotiation, mortgage, pledge, lien, security interest, issue or reissue, gift or any other voluntary transaction creating an interest in property.) (emphasis added) and (dd) ( Purchaser means a person that takes by purchase.).
We note that this special priority rule only applies by its terms to an interest in the chattel paper. We have just held that the payment streams stripped from the leases are not chattel paper, so arguably this special priority rule is inapplicable, although Trustee has not argued the point. On the other hand, from the financier's point of view the assignment of an interest in chattel paper includes the associated payment streams, under the reasoning in Commercial Management. Therefore, for purposes of competing priorities under Revised UCC Section 9-330(b), the secret interest may be an interest in the financier's chattel paper. We explicitly decline to resolve this ambiguity in Revised UCC Section 9-330(b), because neither that statute nor the hypothetical situations posed by the parties are before us on this appeal. It is sufficient for our purposes that the plain meaning of the chattel paper definition in Nevada Revised Statutes § 104.9102(1)(k) does not lead to a result that is demonstrably counter to the legislative intent Roger Falk e, 116 Nev. at 588, 3 P.3d at 664; Ron Pairs Enters., 489 U.S. at 240-42, 109 S. Ct. 1026. If it turns out that the plain meaning of the chattel paper definition could cause problems under statutory provisions that are not at issue on this appeal, such as Revised UCC Section 9-330(b), then the answer lies either in the courts' interpretation of those provisions to harmonize the statute or in legislative amendment to the statute, not in disregarding the plain meaning of unambiguous provisions.
For all of these reasons we must apply the plain meaning of the statute: the payment streams separated from the underlying leases do not fall within the definition of chattel paper. Nev. Rev. Stat. § 104.9102(1)(k). Rather, these monetary obligations fall within the payment intangible subset of the catch-all definition of general intangibles. See Nev. Rev. Stat. § 104.9102(1)(b) (Account) (UCC § 9-102(a)(2)); § 104.9102(1)(pp) ( General intangible) (UCC § 9-102(a)(42)); and § 104.9102(1)(iii) (redesignated as (hhh) by S.B. 201) (Payment intangible) (UCC § 9-102(a)(61)).FN12
FN 12. Both NetBank and Trustee submitted declarations of expert witnesses, which the bankruptcy court excluded. The declarants-Professor Steven L. Harris for Trustee and Professor Charles W. Mooney, Jr. for NetBank-were the two reporters for the Permanent Editorial Board who worked on the revisions that became Revised UCC Article 9. NetBank argues that the bankruptcy court improperly struck this evidence to the extent it constituted factual testimony from a key participant in the drafting of Revised Article 9 to clarify any ambiguity in the statute, citing In re Boogie Enterprises, Inc., 866 F.2d 1172, 1174 (9th Cir. 1989) (citing treatise by Professor Gilmore, who helped draft Article 9 of the UCC); Ritzau v. Warm Springs West, 589 F.2d 1370, 1376 n. 4 (9th Cir. 1979) (citing article by principal draftsman of uniform code). Trustee argues, among other things, that [m]aterial not available to the lawmakers is not considered, in the normal course, to be legislative history. Gustafson v. Alloyd Co., 513 U.S. 561, 579 (1995). We need not decide this issue because if there was any error in excluding the Professors' declarations it was harmless: we have reviewed the declarations and they do not change our conclusions.
Because the payment streams are payment intangibles, NetBank's interest in them would be automatically perfected upon attachment under Nev. Rev. Stat. § 104.9309(3) if its transactions with Debtor were sales rather than loans. We now turn to that issue.
B. Debtor's transactions with NetBank were loans, not sales
As noted above, the UCC leaves to the courts the decision whether a transaction is a loan or a sale. See Rev. UCC § 9-109, Official Comment 5. Although Nevada law governs, neither party has argued that there is anything distinctive about Nevada's approach to the issue and both parties treat decisions from other states as relevant.
NetBank argues that Trustee bears the burden of proving that the transactions were loans rather than sales, citing In re Pillowtex, 349 F.3d 711 (3d Cir. 2003) (transaction was secured financing rather than true lease). Pillowtex held that the party seeking to re-characterize the transaction bears the burden of proof (349 F.3d at 716-17 & n. 6) and in this case it is debatable who that is, because contractual language supports both parties. The SSAs state on the one hand that the parties intend the transactions to be sales (§ 2.1(c)) and on the other hand that the transactions are intended to be indebtedness for tax purposes (§ 2.10). Nevertheless, we assume without deciding that Trustee bears the burden of proof.
NetBank also argues that there is nothing impermissible about intending different treatments for different purposes.
[F]or bankruptcy and financial purposes, the parties will often structure the transaction as a sale. However, for tax purposes, a lessor will often try to structure a transaction as a secured loan to avoid paying tax which would be incurred by the immediate recognition of significant amounts of rental income unless a lessor can achieve a specific tax benefit from accelerating taxable income, such as utilizing an expiring net operating loss.
Stuart M. Litwin and William A. Levy, Securitization of Equipment and Auto Leases, reprinted in New Developments in Securitization 2002, § 30:3.15 (Practicing Law Inst. # A0-00E0).
NetBank's concern is misplaced. We do not read the bankruptcy court's decision as in any way criticizing the parties' attempt to characterize the same transaction in different ways for different purposes. Labels can make a difference, but in this case the labels are conflicting so they carry little weight. Labels also cannot change the true nature of the underlying transactions. [Citation omitted.]
Whether a transaction is a sale or a loan is based on the intentions of the parties as determined from all the facts and circumstances surrounding the transactions at issue. Golden Plan, 829 F.2d at 709. NetBank argues that the bankruptcy court erred by excluding the declarations of its own executives and Debtor's former executives regarding their understanding of the transactions. The bankruptcy court stated, in a tentative ruling which it later reaffirmed:
I'm looking at the [SSA] and ... it does appear to the Court that [the] agreement is unambiguous. I can't see the need for parol evidence. The bank has provided [various] declarations .... And in looking at ... the appropriate case law ... the Ninth Circuit Woodson case and the Golden Plan case, the most applicable to this matter, I just don't see the need for any parol evidence....
... [W]e're dealing with sophisticated parties. If the parties and their attorneys can't memorialize their understanding of the agreement, then I don't know who can.
[NetBank] cites some cases in support of its position; Golden Plan is one. There are a couple more cases.... [T]hose cases basically dealt with fraud issues, Ponzi schemes, hundreds if not thousands of investors getting prospectuses, getting told something by a sales person over the phone or in writing, and that's why the court let that testimony in, and that's completely different from what we have in this case.
Transcript Dec. 20, 2004, pp. 5:4-6:13.
We have already noted that the SSAs contain contradictory terminology, so we cannot agree with the bankruptcy court that the documents are unambiguous. Nevertheless, the declarations were properly excluded under the parol evidence rule.
We interpret Golden Plan to mean that testimony should be admitted or excluded consistent with the ordinary rules regarding parol evidence. Golden Plan, 829 F.2d 705. The SSAs include an integration clause. SSA § 10.1. Therefore, parol evidence is admissible to resolve ambiguities but not to vary or contradict the terms of a written agreement. [Citation omitted.]
We must read the executives' declarations in the light most favorable to NetBank, as the non-moving party. [Citation omitted.] Nevertheless, we conclude that they either contradict the documents or add nothing to the documents and the undisputed facts.
The declaration of NetBank's senior lending officer, for example, states that if NetBank had viewed the transactions as loans then it would have insisted on promissory notes, extensive foreclosure rights, and personal guarantees from Debtor's principals. First, there is no dispute about what protections NetBank did or did not obtain. No declarations are needed on that issue. Second, from the face of the documents the parties obviously were aware that payment streams might later be determined to be made as security for a loan by [NetBank] to [Debtor]. SSA § 2.1(c). The parties even granted NetBank a first priority security interest in contemplation of that possibility. SSA §§ 2.1(c), 10.8. Therefore, the declaration was properly excluded. [Citation omitted.]
Turning to the documents, NetBank points out that in Golden Plan the Ninth Circuit reversed a finding that the transactions at issue were loans rather than sales, and did so despite the fact that the debtor or its agent retained physical possession of the property being sold and had a similar servicer advance provision. Golden Plan, 829 F.2d at 709-711. NetBank also notes that the courts do not give controlling weight to any one factor and not all factors need to point in the same direction. [Citation omitted.]
NetBank cites numerous alleged characteristics of sales in the documents:
* sale terminology in the SSAs and other documents and the lack of typical loan provisions (presumably meaning guarantees, extensive foreclosure rights, and similar provisions);
* Debtor's assignment of the payment streams to NetBank without recourse (SSA § 2.1);
* the fact that Debtor was permitted but not required to make Servicer Advances (SSA § 4.6);
* NetBank's ability to assign its rights in certain circumstances (SSA § 2.9) which it characterizes as treating the payment streams as its own property; FN 13
FN 13. The SSA provides that NetBank may assign or transfer the Transferred Assets and related security interests ... in whole but not in part to another financial institution, and if NetBank assigns a part interest then the conveyance shall be exclusively between the [NetBank] and such assignees or transferees, and other parties [to the SSA] shall not in any respect be obligated to, nor shall they be required to deal or communicate with, such assignees or transferees. SSA § 2.9.
In our view this provision is entirely consistent with NetBank's role as a lender. It can sell participations in the loan, but unless it sells the entire loan the borrower (Debtor) and Sureties are entitled to deal solely with NetBank.
* Debtor's lack of such rights (SSA § 6.4(c));
* NetBank's purported inability to accelerate payments under the SSAs, and Debtor's purported lack of rights to repurchase or receive a reconveyance of the payment streams (SSA § 2.6); FN 14
FN 14. In fact, as NetBank concedes, upon a breach of warranty Debtor is obligated to repurchase the payment streams. See SSA § 2.6.
* the fact that the interest rate is fixed, which NetBank characterizes as evidence that the Interest Rate is simply a mechanism to compute the present discounted value of the Transferred Property (SSA § 1.1); and
* that Debtor allegedly retained no residual interest in the payment streams upon their sale to NetBank.
On this last point NetBank argues that the reconveyance of the Transferred Assets at the end of the SSAs' 60-month Collection Period (SSA § 2.8) would not actually convey any payment streams because those payment streams will be exhausted when NetBank is paid the full Original Principal Amount plus all Interest amounts. Trustee acknowledges that typically there were 62 payments under each lease and the lessee made two payments to Debtor upon signing the lease so there were 60 remaining payments. The exception, NetBank concedes, is that if Debtor made an optional Servicer Advance because a lessee failed to make a lease payment (SSA § 4.6) then Debtor would retain any lease payments that it received after termination of the SSAs along with any late fees. According to NetBank, these latter circumstances do not evidence that Debtor retained any interest in the payment streams. Trustee posits a situation in which the last 10 of 60 lease payments were not paid by the lessee and were advanced by Debtor to illustrate that Debtor could receive a substantial residual interest upon termination of the SSA.
Despite NetBank's arguments, the transactions bear far more hallmarks of a loan than a sale. Each month Debtor as Sub-Servicer is required to pay NetBank a minimum fixed amount ($258,270.47 in the sample SSA) plus any additional interest and principal amounts owing to NetBank, regardless of what is or is not paid by the lessees. See SSA §§ 1.1, 3.7, 4.7(a). Debtor's assignment of the Transferred Assets to NetBank is non-recourse but just like many non-recourse loans it is secured by Debtor's property, including the underlying leases and equipment. See SSA § 2.1(b). Debtor as Sub-Servicer bears all costs of collection from lessees (SSA § 3.1), NetBank pays no fees for this expense or any other costs of servicing the leases (SSA § 5.1), and if there is a shortfall at the end of the 60-month Collection Period then Debtor as Sub-Servicer is required to make up the shortfall and pay ongoing interest until all principal is repaid in full (SSA § 2.8). At that point any residual value in the Transferred Assets is returned to Debtor with no possibility of NetBank receiving more than repayment of the principal and interest ( id.) whereas Debtor can retain any subsequent payments and late fees paid by the lessees. SSA § 4.6. In other words, NetBank (1) has none of the potential benefits of ownership and (2) is contractually allocated none of the risk of loss.
These are strong indicia of a loan rather than a sale. The absence of risk seems to result in a finding of a debtor-creditor relationship in most cases. Woodson, 813 F.2d at 271. See also Lendvest, 119 B.R. at 200 (transaction was loan where documents placed risk of loss on debtor and not investors); In re S.O.A.W. Enterprises, Inc., 32 B.R. 279, 282 (Bkcy W.D. Tex. 1983) (transactions were disguised loans rather than sales where investor ran no real risk), cited with approval in Golden Plan, 829 F.2d at 709-10, In re Evergreen Valley Resort, Inc., 23 B.R. 659, 661 (Bkcy D. Maine 1982) (a security interest is indicated if the assignee must account to the assignor for any surplus received from the assignment over the amount of the debt rather than retaining such surplus as one of the benefits of ownership) (citation omitted). Compare Golden Plan, 829 F.2d at 709 (assumption of risk [by investors] strongly suggests that [they] were not in a creditor-debtor relationship with [the debtor]).
NetBank argues that it now has a real risk of loss, as evidenced by the bankruptcy court's Judgment. NetBank misstates the issue. In determining whether parties intended a sale or a loan the issue is how risks are contractually allocated when the transactions were entered into. In this case the risk was allocated to Debtor. The fact that Debtor later became insolvent is irrelevant. In Woodson the debtor had not paid its investors and was in bankruptcy but the contractual risk was allocated to the debtor. Primarily for that reason the transaction was determined to be a loan rather than a sale. Woodson, 813 F.2d at 270-72.
NetBank argues that the issue on this appeal is not whether [Debtor] was relieved of the risks of owning the Leases but whether [Debtor] continued at risk with regard to NetBank. (Emphasis added.) This is too narrow a reading of the transactions and of Woodson and the other cases cited above. For purposes of determining whether a transaction is a sale or a loan, one useful factor is who is economically at risk. Under the transaction terms described above, it is Debtor, not NetBank, which is contractually allocated the risk of loss if, for example, a larger number of lessees default than expected.
NetBank notes that the debtor in Woodson guaranteed a rate of return and monthly payments and purchased an insurance policy insuring those guarantees. Woodson, 813 F.2d 266. NetBank argues that these elements are not present in this case because (a) Debtor transferred the payment streams to NetBank without recourse or guarantees; (b) Surety guarantees performance by the lessees, not by Debtor; and (c) NetBank is not a party to any private arrangements between Debtor and Surety for indemnity and allegedly there is no evidence that NetBank was aware of the indemnity agreements when the SSAs were signed.
Trustee objects that NetBank has raised this last issue for the first time on this appeal and that it is therefore procedurally improper. We agree. NetBank has not pointed us to any portion of the excerpts of record in which it raised this issue.[Citations omitted.] [Footnote omitted.]
Alternatively, we reject NetBank's argument because it reverses the burden of proof. As a matter of law a surety would normally have a right of indemnity from one such as Debtor. See generally Black & Decker (U.S.), Inc. v. Essex Group, Inc., 775 P.2d 698, 699 (1989) (When one party is subject to liability, which, as between that party and another, the other should bear, the first party is entitled to full indemnity) (citation omitted). Therefore, absent evidence to the contrary, the transaction between NetBank and Debtor placed the ultimate risk of loss on Debtor. We asked NetBank's counsel about this at oral argument and he pointed us to no contrary evidence or special rule of law applicable to this case.
Alternatively, even if NetBank could show that it was ignorant of Debtor's specific contractual and legal obligations to indemnify Surety, the other transaction terms leave no doubt who has the ultimate risk of loss. Under the SSAs Debtor as Sub-Servicer assumes all responsibility, as agent for and on behalf of the Servicer, to perform the duties of the Servicer hereunder. SSA § 3.7. As set forth above, those duties include paying NetBank all principal and interest regardless of what is or is not paid by the lessees, or for that matter what is or is not paid by Surety under its surety bonds. Debtor must continue to do these things as long as it remains the Sub-Servicer while absorbing all costs and receiving no compensation. NetBank offers no reason why Debtor would agree to these terms unless Debtor was the ultimate obligor rather than Surety. Nor has NetBank explained why the SSAs would include the option of Servicer Advances-which presumably are useless to Surety because it would have to advance the same funds under its surety bonds-unless Debtor was ultimately responsible for all payments. Debtor's assets, including the underlying leases, are pledged to NetBank to secure the obligations under the SSAs. Therefore, even if NetBank was unaware of Debtor's obligation to indemnify Surety, the SSAs leave no doubt that the ultimate risk was on Debtor.
We agree with the bankruptcy court that the transactions were loans, not sales. Therefore, NetBank does not satisfy one of the criteria under Nev. Rev. Stat. § 104.9309(3) (The following security interests are perfected when they attach: ... (3) a sale of a payment intangible[.]) (emphasis added). NetBank's interest was not automatically perfected.
* * *
On the issue of financing statements, Trustee has met his burden. Trustee's Complaint alleges that the requisite financing statements were not filed. NetBank's Answer admits that it did not file them. NetBank cannot create a genuine issue of material fact by suggesting the possibility, unsupported by any evidence, that somebody else might have filed them. [Citation omitted.] NetBank's opening brief on this appeal concedes that if the transaction is characterized as a loan by NetBank to [Debtor] secured by chattel paper or payment intangibles [then] NetBank's security interest would be perfected only if NetBank can establish that it took possession of the Leases. (Emphasis added.)
NetBank's Answer suggests that it had actual or constructive possession. Its reply brief on this appeal concedes that NetBank itself never took possession of the Leases but NetBank argues that it had possession of the leases either through a third party agent or through Debtor as Sub-Servicer.
Debtor cannot be NetBank's agent. As a matter of law, an assignee cannot leave the debtor in possession of the collateral and then claim to have possession through the debtor as its agent. See Nev. Rev. Stat. § 104.9313(3) and (8) (referring to possession by person other than debtor) and Rev. UCC § 9-313, Official Comment 3 (The debtor cannot qualify as an agent for the secured party for purposes of the secured party's taking possession.). NetBank argues that we should disregard this limitation in the statute because Debtor was acting as Surety's agent not NetBank's agent. The only decision it cites involved creditors who had taken possession of the promissory notes at issue shortly after the transaction closed, and later commenced foreclosure proceedings by transferring those notes to the party they knew as their trustee and fiduciary who turned out to be the debtor's subsidiary, not the debtor. In re Bruce Farley Corp., 26 B.R. 164 (S.D. Cal. 1981). The collateral was not left in the control of the debtor. Id. at 165. The Farley court held that [t]he debtor's lack of possession coupled with actual possession by the creditor, the creditor's agent or the bailee serves to provide notice to prospective third party creditors that the debtor no longer has unfettered use of his collateral. Id. (quoting Heinicke Instruments Co. v. Republic Corp., 543 F.2d 700, 702 (9th Cir. 1976) (emphasis altered). NetBank does not explain how possession by Debtor in this case would provide similar notice to third party creditors, assuming without deciding that Farley was correctly decided. But cf.Heinicke, 543 F.2d at 702 (The notice function of U.C.C. § 9-305 would be defeated if the debtor, or a person under the debtor's control, were left in possession of the collateral) (emphasis added).
The remaining issues are whether NetBank had possession of the leases through a third party agent and whether NetBank thereby perfected its interest in the payment streams. See Commercial Management, 127 B.R. 296. NetBank claims that Debtor's books and records are unclear about who had possession prior to the Petition Date (Transcript, Dec. 20, 2004, p. 56:3-17) and that Royal or Amwest may have held the leases as its agent.
Trustee responds that the issue of possession was not disputed before the bankruptcy court. The bankruptcy court agreed, stating [i]t is undisputed that NetBank did not perfect by either method [filing or taking possession]. (Emphasis added.) Based on the excerpts of record before us, we disagree.
One way in which NetBank disputed the issue of possession was by moving to strike Trustee's stated understanding that Debtor had physical possession of the leases as contemplated by SSA § 2.2(b). The bankruptcy court granted NetBank's motion to strike this statement, both orally at the hearing on December 20, 2004, and in a written order on February 25, 2005. See Transcript, Dec. 20, 2004, pp. 7:1-17, 53:21-57:6. The parties also argued before the bankruptcy court regarding the effect of the Royal Possession Order and the Royal TRO.
Trustee points to the Royal Possession Order as evidence that Royal first obtained possession on or after the date of that order, but as NetBank points out that order deals with documents and records not previously made available to the Sureties. That phrase supports NetBank's assertion that the Sureties may have had possession before the date of that order.
NetBank also points out that, prior to the Royal Possession Order, the Royal TRO ordered Debtor to make available to Royal all books, records, and accounts related to the Royal bonded leases within two days of receipt of that order. The Royal TRO is dated February 1, 2002, several weeks outside of the 90-day preference period asserted in Trustee's Complaint. See 11 U.S.C. § 547(b)(4)(A).
Trustee claims that the Royal TRO only directed Debtor to give Royal access to the leases, and that Debtor was not ordered to turn over the leases until the Royal Possession Order was issued. Trustee also claims that even if Royal had possession of the leases Royal never executed SSAs with NetBank and Royal only took over Amwest's role as Surety and not as Servicer. Based on these alleged facts, Trustee concludes that Royal could not have been NetBank's agent and therefore NetBank could not have had possession of the leases through Royal. See Transcript, Dec. 20, 2004, p. 85:8-17.
Trustee's arguments only further establish that there are genuine issues of material fact as to who had possession, when, and in what capacity. This precludes summary judgment. [Citation omitted.]
V. CONCLUSION
NetBank entered into transactions with Debtor that were intentionally structured to have characteristics of both a loan and a sale. It relied on Debtor and others to file UCC-1 financing statements, or otherwise assure that its interests in the payment streams from Debtor's leases were perfected, if they were not automatically perfected.
We hold, contrary to the bankruptcy court, that the payment streams are payment intangibles under Revised UCC Article 9 and therefore could have been automatically perfected if the payment streams had been sold to NetBank. We agree with the bankruptcy court, however, that the transactions between NetBank and Debtor are not sales but are secured, non-recourse loans instead. Therefore, NetBank's interests were not automatically perfected. There remain genuine issues of fact and law as to whether NetBank's interests were perfected by possession through an agent such as Royal or Amwest. Trustee did not meet his burden on the factual issue by submitting uncontested evidence regarding who held the leases at the relevant times, nor did Trustee establish entitlement to a judgment as a matter of law by establishing that, contrary to Commercial Management, possession of the leases could not perfect an interest in the payment streams. These unresolved issues preclude summary judgment for Trustee.
Accordingly, we AFFIRM IN PART, REVERSE IN PART, AND REMAND.
Kentucky Highlands Investment Corp. v. Bank of Corbin, 217 S.W.3d 851 (Tex. App. 2006)
Kentucky Highlands was the primary lender to Tri-County Manufacturing and Assembly Incorporated (Tri-County Manufacturing) and its affiliates, including Tritech Electronics, LLC (Tritech). Various loans extended to these debtors by Kentucky Highlands totaled more than five million dollars. Kentucky Highlands contended that the loans were secured by a properly perfected security interest in all of the debtors' personal property and an assignment of the debtors' customer accounts receivable.
Tritech maintained a commercial deposit account with the Bank of Corbin. The Bank obtained a security interest in the deposits held at the Bank pursuant to a loan agreement dated April 6, 2001, between Tritech and the Bank, and it held a well-established right of set-off against the account.
Customer payments generally were not deposited into Tritech's account. Instead, provisions of its loan agreements with Kentucky Highlands required Tritech to direct customers to remit their payments directly to Kentucky Highlands. The Tritech deposit account was funded primarily by transfers from an account held by Tri-County Manufacturing. Tri-County Manufacturing funded those advances on a line of credit provided by Kentucky Highlands. Kentucky Highlands was aware of Tritech's account with the Bank of Corbin. Pursuant to the provisions of KRS FN2 355.9-104(1), it could have taken steps to protect itself by taking control of the account. But it made no attempts to do so.
FN2. Kentucky Revised Statutes 355.9-104 provides as follows:
(1) A secured party has control of a deposit account if:
(a) The secured party is the bank with which the deposit account is maintained;
(b) The debtor, secured party, and bank have agreed in an authenticated record that the bank will comply with instructions originated by the secured party directing disposition of the funds in the deposit account without further consent by the debtor; or
(c) The secured party becomes the bank's customer with respect to the deposit account.
(Emphasis added).
In March or April of 2002, the relationship between Kentucky Highlands and its debtors began to deteriorate. An audit conducted by Kentucky Highlands in mid-July 2002 indicated that its debtors had overstated available accounts receivable and inventory by nearly 1.5 million dollars. In a meeting held on July 24, 2002, the debtors were instructed by Kentucky Highlands not to collect any accounts receivable. By July 26, 2002, at the latest, Kentucky Highlands believed that its debtor's president was engaged in illegal activity. (Deposition of Ray Moncrief, Chief Executive Officer of Kentucky Highlands, at 85.) Nevertheless, Kentucky Highlands did not invoke or initiate any judicial process to assert control over Tritech's accounts receivable.
Kentucky Highlands alleged that from approximately July 2, 2002, and continuing through approximately August 2, 2002, Tritech began depositing customer payments totaling nearly $400,000.00 into its own account at the Bank. Kentucky Highlands claimed that the Bank was paying overdrafts on the account during this period of time. Kentucky Highlands alleged that the Bank applied the funds deposited by Tritech to its overdrafts and to its other credit accounts held by the Bank-despite the Bank's knowledge that Kentucky Highlands held a properly perfected security interest in all of the debtors' accounts receivable.
On February 19, 2004, Kentucky Highlands filed a complaint against the Bank, alleging that Tritech had breached several of its agreements with Kentucky Highlands. Kentucky Highlands claimed that by depositing customer payments directly into its account with the Bank, Tritech converted funds belonging to Kentucky Highlands. Kentucky Highlands also alleged that the Bank knew-or should have known-that Tritech's deposits amounted to a conversion of its funds. Kentucky Highlands claimed that the Bank had colluded with its debtors to divert the proceeds of the collateral assigned to Kentucky Highlands. Kentucky Highlands charged that the Bank had aided and abetted Tritech in this conversion of funds belonging to Kentucky Highlands. (Complaint at 3.) Kentucky Highlands sought recovery of the customer payments deposited into the subject account.
In its answer, the Bank denied the allegations. The Bank claimed that it had a superior right of set-off against the disputed funds under the provisions of Kentucky's commercial code (as amended) and that it had no duty to monitor deposits being made into the subject account or to scrutinize the status of the collateral claimed by Kentucky Highlands. Invoking the provisions of Kentucky's commercial code, the Bank filed a comprehensive motion for summary judgment.
In its response to the Bank's motion for summary judgment, Kentucky Highlands argued strenuously and persuasively that the decision of the Kentucky Supreme Court in General Motors Acceptance Corporation v. Lincoln National Bank, 18 S.W.3d 337 (Ky. 2000) (GMAC), controlled the dispute and that GMAC had not been superseded by subsequent amendments to the commercial code. It also argued that it had offered sufficient evidence of collusion among the parties and related entities to preclude summary judgment on that separate count in the Complaint.
The trial court granted the Bank's motion for summary judgment on November 24, 2004. It ruled that the 2001 amendments to Kentucky's commercial code governed the action and that under these statutory provisions, Kentucky Highlands had no viable claims against the Bank. The court reasoned that the Bank's security interest in the deposit account had priority over the security interest held by Kentucky Highlands and that the Bank had a right of set-off against all of the funds deposited into Tritech's account that was superior to any right possessed by Kentucky Highlands. In addition, the court rejected the contention of Kentucky Highlands that the Bank had a duty to monitor Tritech's account in an effort to determine if its deposits might be proceeds of accounts receivable claimed by another secured creditor (namely, Kentucky Highlands). This appeal followed.
* * *
The trial court granted the Bank's motion for summary judgment on November 24, 2004. It ruled that the 2001 amendments to Kentucky's commercial code governed the action and that under these statutory provisions, Kentucky Highlands had no viable claims against the Bank. The court reasoned that the Bank's security interest in the deposit account had priority over the security interest held by Kentucky Highlands and that the Bank had a right of set-off against all of the funds deposited into Tritech's account that was superior to any right possessed by Kentucky Highlands. In addition, the court rejected the contention of Kentucky Highlands that the Bank had a duty to monitor Tritech's account in an effort to determine if its deposits might be proceeds of accounts receivable claimed by another secured creditor (namely, Kentucky Highlands). This appeal followed.
* * *
The parties agree that the issues before us are governed by the provisions of Revised Article 9 of the Uniform Commercial Code (the UCC) as adopted by Kentucky and which became effective on July 1, 2001. Kentucky Highlands contends that the decision of the Supreme Court of Kentucky in GMAC, supra, a case factually similar to the one before us, remained intact and unaffected precedentially-even after the General Assembly adopted revisions to Kentucky's commercial code in the wake of GMAC. Conversely, the Bank argues that the revisions to Article 9 rendered the decision in GMAC meaningless with respect to this case.
In GMAC, the Supreme Court of Kentucky was asked to decide whether a deposit bank could apply the cash proceeds of a creditor's collateral to cover its depositor's overdrafts. Id. Relying on a decision rendered by the Supreme Court of Iowa in 1989, our Court concluded that the secured creditor had priority over the interest of the deposit bank in the account by virtue of its security agreement with the depositor, metaphorically holding that the bank could not bypass or leapfrog the secured creditor by reimbursing itself for overdrafts taken from deposits which were derived from identifiable cash proceeds of the secured creditor's collateral. Id.
Kentucky Highlands argues that the decision could hardly be more clear, or more clearly applicable to the case presented ... against the Bank. Brief at 4. Applying the reasoning of GMAC to the facts of the case before us, Kentucky Highlands essentially contends that the Bank of Corbin could not reimburse itself for Tritech's overdrafts from an account into which customer payments had been deposited-payments (or collateral) that belonged to (and should have been paid directly to) Kentucky Highlands under its loan agreements with Tritech.
The Bank contends that the drafters of the UCC (and Kentucky legislators adopting and incorporating its provisions in our statutes) clearly intended to reverse the prevailing trend in existing law. That is, their adoption of the revisions to Article 9 was directly aimed at undoing the effects of the Supreme Court's decision in GMAC. According to the Bank, [t]he drafters of Revised Article 9 and the legislature determined that the interests of depository banks, the free flow of commerce and the checking system are superior to the interest of secured creditors in funds deposited into accounts at depository banks.
Appellee's Brief at 1. Consequently, the Bank argues that a new presumption of priority has been conferred upon depository banks and that secured creditors are required to take specific steps to preserve their interest in funds held by a bank.
We agree with the Bank's argument. By enacting the revisions, the drafters of Revised Article 9 and the legislature of Kentucky have clearly and deliberately shielded depository banks from claims and priority disputes with secured creditors.
Addressing the priority of conflicting security interests in a deposit account, KRS 355.9-327 provides as follows:
(1) A security interest held by a secured party having control of the deposit account under KRS 355.9-104 has priority over a conflicting security interest held by a secured party that does not have control.
(2) Except as otherwise provided in subsections (3) and (4) of this section, security interests perfected by control under KRS 355.9-314 rank according to priority in time of obtaining control.
(3) Except as otherwise provided in subsection (4) of this subsection, a security interest held by the bank with which the deposit account is maintained has priority over a conflicting security interest held by another secured party.
(4) A security interest perfected by control under KRS 355.9-104(1) has priority over a security interest held by the bank with which the deposit account is maintained. (Emphasis added.)
The official commentary to the UCC explains the bank's super-priority status as follows:
Under paragraph (3), the security interest of the bank with which the deposit account is maintained normally takes priority over all other conflicting security interests in the deposit account, regardless of whether the deposit account constitutes the competing party's original collateral or its proceeds. A rule of this kind enables banks to extend credit to their depositors without the need to examine either the public record or their own records to determine whether another party might have a security interest in the deposit account.
* * * *
A secured party who claims the deposit account as proceeds of other collateral can reduce the risk of becoming junior by obtaining the debtor's agreement to deposit proceeds into a specific cash-collateral account and obtaining the agreement of that bank to subordinate all its claims to those of the secured party. But if the debtor violates its agreement and deposits funds into a deposit account other than the cash-collateral account, the secured party risks being subordinated.
(Emphasis added). [KRS 355.1-110 permits the use of the official comments in the construction and application of Chapter 355.]
KRS 355.9-340 establishes similar priority rules with respect to the depository bank's right of set-off against funds in a customer account that might be subject to a claim by a secured creditor. KRS 355.9-340 provides as follows:
(1) Except as otherwise provided in subsection (3) of this section, a bank with which a deposit account is maintained may exercise any right of recoupment or set-off against a secured party that holds a security interest in the deposit account.
(2) Except as otherwise provided in subsection (3) of this section, the application of this article to a security interest in a deposit account does not affect a right of recoupment or set-off of the secured party as to a deposit account maintained with the secured party.
(3) The exercise by a bank of a set-off against a deposit account is ineffective against a secured party that holds a security interest in the deposit account which is perfected by control under KRS 355.9-104(c), if the set-off is based on a claim against the debtor.
KRS 355.9-104 places a bank's right of set-off ahead of the security interest of a secured party in the deposit account. Under this provision, a secured party's interest in the account will be subordinate until and unless the security interest in the deposit account is perfected by control under KRS 355.9-104(c).
Kentucky Highlands contends that the priority rules established by KRS 355.9-340 do not apply where a secured party claims a security interest in the cash proceeds deposited into the commercial account rather than a security interest in the deposit account itself. We disagree. That construction would fail to distinguish between a creditor who neglected to protect its interests and a conscientious secured party that took the necessary steps to establish its priority. The revisions to Article 9 recognize that very distinction. The result urged by Kentucky Highlands conflicts with the clear intention of revised Article 9: to provide a comprehensive and predictable framework by which parties may avoid priority disputes and to protect the interests of depository banks.
Under the revised portions of the UCC, depository banks receive an automatic perfected interest in the accounts of their customers. Kentucky Highlands was aware of its debtors' deposit account with the Bank of Corbin and yet acquiesced in its use without taking any action to assert priority as to proceeds to which it claimed entitlement. Kentucky Highlands was on notice that the Bank could assert a claim against the deposit accounts at any time. Although Kentucky Highlands was in a position to protect its priority through a variety of means, it nonetheless risked becoming subordinate by doing nothing. It is true that the Bank might have protected itself by simply refusing to honor its customer's overdrafts. However, the revised statute required Kentucky Highlands as a secured creditor to monitor its debtor's business and to police its own collateral-not to shift such duties onto the Bank. A depository bank no longer bears the burden to ascertain the source of funds deposited into its customers' accounts and to determine whether there is a creditor who may have a lien on those funds before a bank can assert its rights as a secured creditor-namely, its rights to set-off against the account.
We conclude that the provisions of KRS 355.9-340 directly govern this priority dispute. A depository bank may properly exercise its right of set-off against a secured party who seeks to assert an interest in a commercial deposit account-regardless of whether the secured party claims a security interest in the deposit account as original collateral or as its proceeds. The trial court did not err by granting summary judgment to the Bank on this issue.
Next, Kentucky Highlands contends that the trial court erred by granting summary judgment to the Bank because it had offered sufficient evidence of collusion between the Bank and Tritech to deprive Kentucky Highlands of the value of its collateral. In support of its argument, Kentucky Highlands relies on the following provisions of KRS 355.9-332:
(1) A transferee of money takes the money free of a security interest unless the transferee acts in collusion with the debtor in violating the rights of the secured party.
(2) A transferee of funds from a deposit account takes the funds free of a security interest in the deposit account unless the transferee acts in collusion with the debtor in violating the rights of the secured party.
The Official Comment explains as follows:
[T]his section does not cover the case ... in which a bank debits an encumbered account and credits another account it maintains for the debtor.
A transfer of funds from a deposit account, to which subsection (b) applies, normally will be made by check, by funds transfer, or by debiting the debtor's deposit account and crediting another depositor's account....
We are not persuaded that KRS 355.9-332 is applicable to this case. By its terms, the statute is intended to provide broad protection for transferees of funds from a deposit account representing the proceeds of a secured creditor's collateral. More significantly, we are not persuaded that these provisions pertain to priority conflicts between a depository bank and a secured creditor concerning funds in the deposit account. A depository bank is not a transferee as described by the language of the statute.
Finally, we note that the provisions of KRS 355.9-341 set forth the rights and duties of a bank with respect to deposit accounts as follows:
Except as otherwise provided in KRS 355.9-340(3) [where the secured party has become the bank's customer under 9-104(1)(c) ], and unless the bank otherwise agrees in an authenticated record, a bank's rights and duties with respect to a deposit account maintained with the bank are not terminated, suspended, or modified by
(1) The creation, attachment, or perfection of a security interest in the deposit account;
(2) The bank's knowledge of the security interest; or
(3) The bank's receipt of instructions from the secured party.
Again, the Official Comment provides a helpful explanation:
This section is designed to prevent security interests in deposit accounts from impeding the free flow of funds through the payment system. Subject to two exceptions it leaves the bank's rights and duties with respect to the deposit account and the funds on deposit unaffected by the creation or perfection of a security interest or by the bank's knowledge of the security interest. In addition, the section permits the bank to ignore the instruction of the secured party unless it had agreed to honor them or unless other law provides to the contrary. A secured party who wishes to deprive the debtor of access to funds on deposit or to appropriate those funds for itself needs to obtain the agreement of the bank, utilize the judicial process, or comply with procedures set forth in other law....
(Emphasis added).
The Bank was statutorily authorized to ignore even direct instructions from Kentucky Highlands with respect to its conduct toward the deposit account. Kentucky Highlands failed to avail itself of direct agreement with the Bank or to become the Bank's customer as provided by statute in order to protect its interests. The Bank was entitled to judgment as a matter of law with respect to this issue, and the trial court did not err by granting the summary judgment.
The judgment of the Whitley Circuit Court is affirmed.
Lewiston State Bank v. Greenline Equipment, L.L.C., 147 P.3d 951 (Utah App. 2006)
On March 5, 1998, Pali Brothers Farms (Pali Brothers) purchased two combines from Case Equipment. Pali Brothers financed its purchase under an agreement with New Holland Credit Company (New Holland) whereby New Holland obtained a PMSI in the combines. New Holland filed and perfected a financing statement on March 5, 1998.
¶ 3 On February 22, 2000, Pali Brothers executed a promissory note, borrowing $300,750 from the Bank. Pali Brothers granted the Bank a security interest in all present and incoming equipment. The Bank filed and perfected a financing statement on February 25, 2000. On February 26, 2001, Pali Brothers executed a second promissory note, payable to the Bank, this time borrowing $275,687.50 and granting the Bank a security interest in all farm equipment. The Bank filed and perfected a financing statement on May 8, 2001.
Subsequently, Pali Brothers defaulted on its payments to New Holland. On January 14, 2002, Greenline paid Pali Brothers's outstanding debt to New Holland in the amount of $67,654.79. In exchange, Greenline requested and received a lien release from New Holland on the two combines.
On February 20, 2002, Eli and Bart Pali executed a variable rate loan contract and security agreement with John Deere & Company (John Deere), which financed Eli and Bart Pali's purchase of the two combines from Greenline. FN 1 Eli and Bart Pali agreed to pay John Deere an origination charge of $150 and a finance charge of $10,626.43, as well as $67,654.79 for the two combines. Repayment was deferred for one year. On March 6, 2002, John Deere filed and perfected a financing statement, designating the two combines as security for the loan.
FN 1. Both brothers individually, rather than Pali Brothers Farms, were designated as and signed as buyers on the loan and security agreement.
Greenline contacted the Bank on March 25, 2002, to request subordination of the Bank's interest in the combines. The Bank did not agree to subordination. Pali Brothers defaulted on their payments to the Bank, and Eli and Bart Pali, as individuals, defaulted on their payments to John Deere. Thereafter, John Deere took possession of the two combines. Upon receiving a demand letter from the Bank that asserted its priority secured position in the equipment, John Deere assigned its interest in the equipment to Greenline. Greenline then sold the combines without notifying the Bank. On October 15, 2003, the Bank filed a complaint for disgorgement of the collateral or its proceeds, plus interest, costs, and attorney fees.
The parties filed cross-motions for summary judgment. The trial court denied Greenline's motion and granted the Bank's motion, ruling that Greenline's security interest in the combines was junior to the Bank's security interest as a matter of law. The court awarded damages to the Bank for $78,000 with ten percent per annum interest pursuant to [Citations omitted.] Additionally, the court denied the Bank's motion for summary judgment regarding attorney fees.
I. Purchase-Money Security Interest [Footnote omitted.]
Greenline argues that it retained New Holland's original PMSI in the two combines after Pali Brothers refinanced its purchase-money obligation. Greenline relies, in part, on Utah Code section 70A-9a-103(6)(c), which states, In a transaction other than a consumer-goods transaction, a purchase-money security interest does not lose its status as such, even if the purchase-money obligation has been renewed, refinanced, consolidated, or restructured. Utah Code section 70A-9a-103(6)(c) (2001). Greenline maintains that Pali Brothers refinanced its obligation as established by the following circumstances: FN3
FN 3. Greenline devotes a significant portion of its brief to arguing that the legislative intent underlying section 70A-9a-103(6)(c) was to ensure that purchase-money status survives refinancing under the dual status rule, rather than be transformed into non-preferred debt under the transformation rule. U.C.C. § 9-103 cmt. 7(a); see also Utah Code Ann. § 70A-9a-103(6)(c) (2001). However, the Bank does not, nor do we, dispute this claim, and our analysis assumes validity of the dual status rule. See U.C.C. § 9-103 cmt. 7(a) (stating that the dual status rule is explicitly provided for in Uniform Commercial Code (U.C.C.) section 9-103(e) and [f]or non-consumer-goods transactions, this Article rejects the transformation rule).
To avoid default upon New Holland's purchase-money security interest, on February 20, 2002 the Pali Brothers as debtors negotiated a refinance of the outstanding balance of the original purchase-money debt, $67,654.79, with ... John Deere on behalf of Defendant Greenline. According to the terms of their refinance agreement, [Greenline] agreed to pay the outstanding balance owed to New Holland on the combines of $67,654.79, then refinance the same equipment for the same outstanding balance with the Pali Brothers.
Greenline asserts that in return for the refinance, Pali Brothers agreed to give Greenline a [PMSI] in the combines in connection with this purchase and re[sale]. And because it purportedly retained the original PMSI in the collateral, Greenline concludes that it had priority over the Bank's security interest. FN4 We disagree with Greenline's interpretation of these circumstances and conclude that the status of the original PMSI did not survive under section 70A-9a-103(6)(c) because Greenline, as a new creditor, satisfied and terminated the original purchase-money obligation, thereby extinguishing the PMSI. It was only after a span of time that Greenline extended new credit to Eli and Bart Pali in return for a security interest in the same collateral.
FN 4. The parties do not dispute the trial court's determination that New Holland had priority over the Bank's security interest under Utah's version of Article 9 of the U.C.C. See Utah Code Ann. §§ 70A-9a-101 to -709 (2001). In particular, Utah Code section 70A-9a-324 provides that a perfected purchase-money security interest ... has priority over a conflicting security interest in the same goods. Id. § 70A-9a-324(1) (2001). In addition, [i]f more than one security interest qualifies for priority in the same collateral, id. § 70A-9a-324(7), then pursuant to Utah Code section 70A-9a-322, [c]onflicting perfected security interests ... rank according to priority in time of filing or perfection, see Id. § 70A-9a-322(a)(1) (2001)..
[R]efinanced is not defined in Utah's Article 9. Utah Code section 70A-9a-103. FN 5 When interpreting a statute, we give effect to the legislative intent, as evidenced by the [statute's] plain language, in light of the purpose the statute was meant to achieve. [Citation omitted.] And we interpret a statute's plain language in harmony with other statutes in the same chapter and related chapters. Id. (citation omitted). A well-settled principle of statutory construction is to rely on the plain meaning of a word or phrase unless it is ambiguous, see id. at ¶ 15, in which case we look to legislative history and other policy considerations for guidance, id. at ¶ 17 (quotations and citation omitted).
FN 5. U.C.C. section 9-103(f) an identical counterpart to Utah Code section 70A-9a-103(6)(c), likewise does not define refinance. See U.C.C. § 9-103(f)(3) (2005); U.C.C. § 9-103 cmt. 7(b).
Because the statute does not define refinance FN6 and its application appears to depend on the actual facts of a transaction, we turn first to the goals and purposes of Article 9. The policies underlying Article 9 support our conclusion that the status of an original PMSI does not survive when a new creditor satisfies and terminates the original purchase-money obligation and subsequently extends new credit to the debtor for a security interest in the same collateral. Such a transaction contravenes [a] fundamental purpose of Article 9, [which] is to give notice to third persons and simplify the filing process. [Citation omitted.] In other words, the purpose of Article 9 is to create commercial certainty and predictability by allowing [creditors] to rely on the specific perfection and priority rules that govern collateral. [Citation omitted.]
FN 6. Refinancing is defined in Black's Law Dictionary 1285 (7th ed.1999), as [a]n exchange of an old debt for a new debt, as by negotiating a different interest rate or term by repaying the existing loan with money acquired from a new loan. We believe this definition is inadequate to establish a plain meaning for our purposes, as it does not address several relevant factors, such as the identity of the second loan creditor or the significance of secured transactions.
In this case, the Bank received a security interest, junior to New Holland's PMSI, on February 22, 2000, and again on May 8, 2001. On January 14, 2002, in exchange for satisfying Pali Brothers's debt, Greenline requested and received from New Holland a lien release on the two combines, which thereby extinguished New Holland's PMSI. At this point, the Bank's perfected security interest became superior to any security interests perfected after May 8, 2001. See Utah Code Ann. §§ 70A-9a-324(7), -322(1)(a). Over one month later, on February 20, Eli and Bart Pali granted John Deere a security interest in the combines. Therefore, the Bank's perfected security interest had priority over John Deere's later-acquired security interest. See id. §§ 70A-9a-324(7), -322(1)(a). If we held, instead, that John Deere retained New Holland's PMSI, then the Bank, when it executed its promissory notes and perfected its security interest, could not assume that it had priority once New Holland's PMSI was extinguished. Further, the state would have no recorded prior liens after New Holland's lien release. In addition, during the gap between January 14 and February 20, 2002, any potential creditors would have no notice of Greenline's PMSI and would enter into secured loan agreements under the false assumption of having a priority position.
Case law in other jurisdictions FN7 further supports our conclusion that under section 70A-9a-103 and U.C.C. section 9-103 a PMSI does not ordinarily survive when a new creditor pays off a debtor's obligation to a prior PMSI lender. See, e.g., In re Moody, 97 B.R. 605, 607 (Bkcy D. Kan. 1989) (holding that the status of a PMSI held by retailer was lost when the debtor refinanced her obligation with a third-party creditor); In re Richardson, 47 B.R. 113, 118 (Bkcy W.D. Wis. 1985) ([W]here a third party ... advances money to the debtor which is applied to the balance of the original note, the original lender is paid off and completely drops from the picture.... [T]he PMSI is extinguished.).
FN 7. Because the Uniform Commercial Code is national in character, case law interpreting it is also national. Consequently, where Utah's version of the U.C.C. is uniform, we rely on case law from other jurisdictions to interpret the Code. [Citation omitted.]
By contrast, our review of case law indicates that a PMSI may survive refinancing in only two circumstances: (1) when an original creditor, or (2) a creditor's assignee, refinances a debtor's obligation incurred to purchase the secured collateral. [Citations omitted.]
Turning to the official comment after section 9-103 FN 8, we glean a similar understanding of the term refinance.
FN 8. Although the Utah legislature has not adopted the official comments to the U.C.C., they are nonetheless persuasive authority. [Citations omitted.]
Whether [a refinance] encompass[es] a particular transaction depends upon whether, under the particular facts, the purchase-money character of the security interest fairly can be said to survive. [The term refinanced] contemplates that an identifiable portion of the purchase-money obligation could be traced to the new obligation resulting from [the] ... refinancing.
U.C.C. § 9-103 cmt. 7(b).
In the present matter, contrary to Greenline's description of events, two distinct transactions occurred after New Holland's loan and security agreement with Pali Brothers. The first transaction occurred on January 14, 2002, when Greenline paid off Pali Brothers's outstanding debt to New Holland for the two combines. As a result of satisfying Pali Brothers's debt, New Holland gave Greenline a lien release on the two combines. Greenline's payment satisfied and terminated Pali Brothers's purchase-money obligation and thereby extinguished New Holland's priority PMSI. New Holland then dropped from the picture. New Holland did not assign its PMSI to Greenline when it exchanged the lien release for payment on the obligation.
The second transaction occurred over a month later when Eli and Bart Pali purchased the two combines from Greenline with financing from John Deere. John Deere and/or Greenline were both new creditors in this transaction because neither was involved in the security agreement between New Holland and Pali Brothers. There were two distinct transactions interrupted by a span of time when the only financing statements on file with the state were those of the Bank. Furthermore, as the trial court noted, there is nothing in the documents representing the transaction between Eli and Bart Pali on one hand, and John Deere and Greenline, on the other, reflecting an intent to continue the effectiveness of New Holland's PMSI. Indeed, the identity of the borrower changes from Pali Brothers, the company, to the Pali brothers, the individuals. Consequently, Pali Brothers did not refinance its purchase-money obligation to New Holland with John Deere or Greenline, as contemplated under section 70A-9a-103(6)(c). See Utah Code Ann. § 70A-9a-103(6)(c). On the contrary, New Holland's PMSI ended and over a month intervened before John Deere entered into a new security agreement with Eli and Bart Pali. Eli and Bart Pali merely obtained a new loan for a similar amount, secured by the same collateral.
* * *
Conclusion
We acknowledge the policy considerations underlying Article 9 to promote notice and predictability in commercial transactions. A PMSI is extinguished upon satisfaction and termination of the purchase-money obligation, and the status of the original PMSI is not preserved unless the subsequent refinance is by the original creditor or its assignee, and even then, only to the extent all or part of the original purchase-money obligation remains owing. We note, however, that there may be other requirements, not relevant to this case. Accordingly, we affirm the trial court's grant of summary judgment to the Bank and the trial court's denial of Greenline's motion for summary judgment. We also affirm the trial court's denial of the Bank's motion for summary judgment regarding attorney fees and costs.