Indiana Commercial Foreclosure Law

“Lease” Lien Vs. Possessory Lien

This is Part II of my discussion of Gangloff Industries v. Generic Financing, 2009 Ind. App. LEXIS 897 (Ind. Ct. App. 2009) (.pdf).  Click here for last week’s post.  Having concluded that Generic had a security interest in the semi-truck, the Indiana Court of Appeals turned to whether Gangloff had a possessory lien and, if so, whether Generic’s security interest had priority over Gangloff’s lien.  Asset-based lenders who find themselves in a dispute with a mechanic or storage facility over the rights to possession of loan collateral should find this post informative.  

Possessory lien.  The Court first explained that Gangloff did in fact have a possessory lien.  In Indiana’s “Scrapping Motor Vehicles” statute, specifically I.C. § 9-22-5-15(a) and (b), a “possessory lien” is granted to an entity that “performs labor, furnishes material or storage, or does repair work on a . . . semi-trailer . . . at the request of the person who owns the vehicle” or that provides towing services on the vehicle “for reasonable value of the charges for such labor, materials, storage, repairs or towing.”  In Indiana, this possessory lien “is perfected by retention of possession of the vehicle by the person asserting the lien.”  Gangloff had a possessory lien because it fronted the semi-truck’s repairs, towing expenses and storage fees for which Bougher did not pay.  Gangloff perfected its lien because it retained possession of the semi-truck (until the trial court ordered Gangloff to relinquish possession to Generic). 

Priority dispute.  Indiana’s portion of the UCC dealing with secured transactions, at I.C. § 26-1-9.1-333(a), generally defines a possessory lien as:

an interest, other than a security interest or an agricultural lien:  (1) that secured payment or performance of an obligation for services or materials furnished with respect to goods by a person in the ordinary course of the person’s business; (2) that is created by statute or rule of law in favor of the person; and (3) whose effectiveness depends on the person’s possession of the goods.

The Court acknowledged that the UCC recognized Gangloff’s statutory, possessory lien.  Pursuant to Section 333(b), the possessory lien “has priority over a security interest . . . unless the lien is created by a statute that expressly provides otherwise.”  Since I.C. § 9-22-5-15 is silent as to the priority of competing liens, Gangloff’s possessory lien took priority over Generic’s security interest.  As such, the Court of Appeals reversed the trial court’s judgment awarding damages and attorney’s fees in favor of Generic and remanded the case for further proceedings. 

The risks/rewards of possession.  The trial court originally held that Gangloff owed Generic excess repossession expenses, lost lease income, witness travel expenses and attorney’s fees.  The trial court seemingly based its conclusion upon Gangloff’s wrongful possession of the semi-truck.  The reversal and remand by the Court of Appeals signaled, however, that it was Gangloff who should recover damages, consistent with its lawful, perfected possessory lien.  It appears that, before Generic can act upon its security interest in the semi-truck, Generic must satisfy Gangloff’s possessory lien.  But ironing out the wrinkles going forward may be complicated due to the trial court’s initial, erroneous order of possession.  Perhaps the alleged damages incurred by the respective parties will be offset against one another in order to arrive at a conclusion as to who owes money to whom. 

One of many lessons from Gangloff is that, if you’re a possessory lien holder and if you feel strongly about the validity of your lien, you should stand firm and  not surrender the collateral until your lien is satisfied.  On the other hand, possessory lien holders can be exposed to liability to a secured lender if the lien is flawed or it wrongfully retains control over the collateral.  These cases can be tricky and expensive, as documented in the Gangloff litigation. 

Indiana Court Of Appeals Tackles True Lease Vs. Secured Loan Question

When commercial asset-based lenders and their collection counsel are confronted with defaults under agreements labeled a “lease,” such as an equipment lease, often there is a question of whether the transaction was a true lease as opposed to a secured loan.  A detailed discussion of the differences between the two transactions goes beyond the scope of this post, but generally the nature of the underlying transaction will affect, among other things, the remedies available to the lender/lessor upon a default.  My focus here simply is to outline how Indiana courts might evaluate whether the underlying deal is a lease or a secured loan in the first place.  The recent Indiana Court of Appeals opinion in Gangloff Industries v. Generic Financing, 2009 Ind. App. LEXIS 897 (Ind. Ct. App. 2009) (.pdf) is informative.

The circumstances.  Generic Financing entered into a “Lease Agreement” with Robert Bougher concerning a semi-truck.  The Court outlined portions of the agreement on pages 2-4 of the opinion.  Bougher’s wife and Gangloff entered into a separate “Owner Operator Service Contract” by which the wife agreed to operate the semi-truck and to haul goods for Gangloff.  A couple years later, the semi-truck broke down and required $6,000 in repairs.  Gangloff paid for the repairs.  Bougher was to re-pay Gangloff, but Bougher died before he could do so.  Gangloff took possession of the semi-truck pending the wife’s payment of recovery and storage expenses. 

The litigation.  While Gangloff had the semi-truck in storage, Generic filed a lawsuit.  There were multiple causes of action and legal theories asserted between Gangloff and Generic concerning who was entitled to possession of the semi-truck and who owed damages to whom.  In order to resolve the damages and possession issues, the Court of Appeals had to address the question of whether the “Lease Agreement” between Generic and Bougher was a true lease or a security interest (a loan secured by the semi-truck).   

The test.  The Court initially turned to Indiana’s UCC, specifically Ind. Code § 26-1-1-201(37), which defines a security interest as “an interest in personal property or fixtures which secures payment or performance of an obligation.”  The Court next noted that “the primary issue to be decided in determining whether a lease is ‘intended as security’ is whether it is in effect a conditional sale in which the ‘lessor’ retains an interest in the ‘leased’ goods as security for the purchase price.”  The UCC refuses to recognize form over substance, which is why Indiana’s UCC includes a lease intended as security in the statutory definition of security interest. 

The Court in Gangloff explained that I.C. § 26-1-1-201(37) “unequivocally” states that a lease will be deemed a security interest if:

(1) the consideration the lessee is to pay the lessor is an obligation for the term of the lease and the lessee may not terminate the obligation; and
(2) one of four enumerated conditions [a-d outlined in the statutory  subsection] apply.

Here is a .pdf of the portion of the statute quoted by the Court, including subsections (a)-(d).  In Gangloff, the “only potentially relevant condition” was subsection (d), which involves the lessee’s option to become the owner of the goods for no additional consideration or for nominal additional consideration upon compliance with the lease. 

The application of the test.  The Generic/Bougher agreement obligated Bougher to pay Generic monthly installments totaling $43,051.95 over a period of thirty-eight months.  This consideration was loosely based upon the price of the semi-truck plus interest.  Furthermore, Generic alone had the option to terminate the “Lease” before the fixed term.  As such, the written agreement met part (1) of the statutory test. 

Regarding part (2), specifically subsection (d) under the statute, the Court cited case law for the following proposition:

The courts are clear upon one thing, which is that where the terms of the lease and option purchase are such that the only sensible course of action for the lessee at the end of the term is to exercise the option to purchase and become the owner of the goods, then the lease is one intended to create a security interest.

Bougher had the option to purchase the semi-truck for $3,190.00, which was 10% of the financed amount.  Had Bougher fully complied with the agreement for three years use of the semi-truck, he would have paid, including the down payment, a total of $45,762.00.  The Court held that subsection (d) was satisfied because “the only sensible course of action would have been to exercise the option and purchase the truck for a fraction of the total rent price.”  Thus, the “Lease Agreement” created a security interest rather than a true lease.   

The consequences.  The Court’s conclusion that the Generic/Bougher “lease” created a security interest (like a loan secured by the semi-truck) clarified all sorts of issues regarding the relative rights of the parties.  Next week’s follow-up post will address the second part of the Gangloff opinion concerning a lien priority dispute between Gangloff and Generic.  The objective of today’s post was to highlight the importance of recognizing that not all “lease” agreements will be treated as leases.

Indiana UCC Internet Sale and Deficiency Judgment Upheld

If you are chasing a deficiency owed under a personal guaranty, and if the guarantor is contesting collection efforts based upon either a failure to conduct a UCC sale in a commercially reasonable fashion and/or a failure to provide adequate notice of the sale, then the Indiana Court of Appeals’ recent decision in Moore v. Wells Fargo Construction, 2009 Ind. App. LEXIS 732 (.pdf) may help tackle the issue.  In Moore, the Court affirmed the trial court’s judgment against a personal guarantor and ruled favorably for the creditor/secured lender on the UCC-related issues. 

Backdrop.  In 2000, a mining corporation received financing for an excavator through plaintiff lender for about $550,000.  In return for the financing, the principals of the mining corporation, including defendant Moore, personally guaranteed the indebtedness.  The written guaranty included the following waiver language:

Each of us waives . . . the failure to notify any of us of the disposition of any property securing the obligations of [mining corporation] the commercial reasonableness of such disposition or the impairment, however caused, of the value of such property. . . .

Mining corporation defaulted on the loan in 2003, and lender took possession of the excavator.  The lender ultimately disposed of the excavator through a sale, which left a balance (deficiency) of about $250,000.  The lawsuit surrounded the lender’s collection of the deficiency from Moore.  The parties tried the case to the judge, who ruled in favor of the lender.  The guarantor appealed.

Commercial reasonableness of sale.  Moore’s first contention on appeal was that the sale of the excavator was not conducted in a commercially reasonable fashion, as required by Indiana Code § 26-1-9.1-1-610(b).  The lender, in response, pointed to the above-quoted waiver language in the guaranty.  Without ever addressing whether the sale actually met the commercially reasonable standard, the Court concluded:

We agree with Moore that § 26-1-9.1-610 requires sales such as the instant one to be commercially reasonable.  But the plain language of the Guaranty shows that Moore intended to waive any claim regarding the commercial reasonableness of the sale of the Excavator.  Thus, under the Guaranty, Moore has waived that claim.

In this case, the written instrument trumped the statutory requirement. 

Notice of sale.  Moore’s second contention on appeal was that the lender failed to provide the appropriate notice.  The Court’s analysis concerned I.C. §§ 26-1-9.1-611 and 613, which govern the notification required before a secured creditor may sell certain loan collateral.  In Moore, the lender sold the excavator through an internet auction website, and Moore’s legal attacks focused on notice technicalities about the “location for the sale.”  Indeed, the operative statutes require that notices state the “time and place of a public disposition.”  The lender’s notification identified its intent to sell the excavator in a public auction over the internet, which notice listed the date and web address for the auction and the physical address of the auction company.  While the Court conceded that “an internet auction has no physical location and is not a situs in the traditional sense,” the notice in question “adequately apprised Moore where the auction would be held, allowing him to monitor or even participate in the auction.”  The Court concluded that the lender satisfied the location requirements of I.C. § 26-1-9.1-613(1)(E). 

The Moore case reminds us that clear and unambiguous waiver language in written contracts (in this case, a guaranty) can help control the outcome a secured lender seeks.  Moore offers nothing terribly new in that regard.  Moore is, however, fairly unique in its analysis of the notice issues surrounding internet-based disposition of the loan collateral.  The Indiana Court of Appeals took what appears to be a practical and appropriate approach to applying Indiana’s UCC to the realities of today’s world.

What Is A “Purchase Money Security Interest”?

Asset-based lenders with deals in Indiana need to be familiar with Indiana’s definition and application of a “purchase money security interest”.  Fortunately, a recent case from the U. S. Bankruptcy Court for the Southern District of Indiana, In Re:  Myers, 2008 Bankr. LEXIS 2172 (Myers.pdf), helps answer the question of what is a purchase money security interest.

Definition.  The Bankruptcy Code does not define “purchase money security interest”.  The Myers Court thus looked to state law “to fill the void,” including Indiana’s version of the UCC.  Specifically, Ind. Code § 26-1-9.1-103 outlines in detail the definition.  A purchase money security interest “in goods” is defined in section (b):

A security interest in goods is a purchase-money security interest:
(1)  to the extent that the goods are purchase-money collateral with respect to that security interest;
(2) if the security interest is in inventory that is or was purchase-money collateral, also to the extent that the security interest secures a purchase-money obligation incurred with respect to other inventory in which the secured party holds or held a purchase-money security interest; and
(3) also to the extent that the security interest secures a purchase-money obligation incurred with respect to software in which the secured party hold or held a purchase-money security interest.

According to I.C. § 26-1-9.1-103(a), “purchase money collateral” means “goods or software that secures a purchase money obligation incurred with respect to that collateral.”  That statute also provides the definition of “purchase money obligation”, which means “an obligation of an obligor incurred as all or part of the price of the collateral or for value given to enable the debtor to acquire rights in, or the use of the collateral if the value is in fact so used.”  The Court summed things up:

Thus, if the debt created by the money loaned or the credit extended was (1) incurred as all or part of the price of the collateral or (2) for value given by the creditor to the debtor to enable the debtor to acquire rights in or the use of the collateral, the debt so incurred is a “purchase money obligation”; the collateral which was purchased by the debtor and in which the creditor takes a security interest is “purchase money collateral”; and the security interest obtained in the collateral by the creditor is a “purchase money security interest”.

PMSI in action.  The Myers case addressed to what extent a lender had a purchase money security interest in a vehicle.  As part of the subject transaction, negative equity in the debtor’s trade-in was rolled into the loan, so the loan amount far exceeded the price of the vehicle.  (“Negative equity” meant the difference between the value of the trade-in and the amount still owed on it.)  The issue in Myers surrounded whether the creditor’s purchase money security interest extended to the negative equity portion of the loan, which begged the question of whether the negative equity loan was a “purchase money obligation”.  To qualify, the loan must have been either “(1) incurred as all or part of the price of the vehicle or (2) was value given by [creditor] to enable the debtor to acquire rights in [ownership] or the use of the vehicle.” 

After looking at a number of technical, legal bases, the Court concluded:

For the Debtor here to acquire ownership rights in the Vehicle, she needed financing and, under this transaction, she could not get financing without including her trade in . . ..  For her to include the trade in, she had to pay off the debt owed on it, and for her to pay the debt owed on the [trade in], she had to borrow enough funds to cover the trade in debt as well as the price of the Vehicle.  . . .  [T]his Court finds that it is difficult to see how the funds used to pay the negative equity here could not be viewed as an expense incurred in connection with acquiring rights in the Vehicle, and moreover believes the negative equity financing here is “precisely the type” of such expense.

Because the creditor’s purchase money security interest covered the money used to finance the negative equity, the court held the entire loan to be secured. 

Even though the Myers decision involved a consumer transaction, the case could apply to Indiana commercial transactions.  At a minimum, the opinion helps illustrate what a purchase money security interest is.

THE VALIDITY OF SECURITY INTERESTS IN MEDICARE RECEIVABLES

Lock Realty Corp. v. U.S. Health LP, which was the backdrop of my December 14, 2006 post, continues to be a lawyer’s dream in terms of complexity and challenges.  The case also continues to be educational for creditors that need to protect their rights in deals gone bad.  The lawsuit, which is pending in the Northern District of Indiana under case number 3:06-cv-487, involves six different law firms, as well as the U.S. Attorney’s Office, and nine parties.  The February 27, 2007 opinion from Judge Robert L. Miller, Jr. addresses a priority dispute over accounts receivable, specifically Medicare receivables. 

The parties.  In this piece of the case, secured creditors National City Bank (“Nat City”) and Health Care Services (“HCS”) battled judgment creditor Lock Realty.  The secured creditors sought an order directing AdminiStar Federal, the entity responsible for processing the Medicare claims of Americare (a nursing home business), to pay them funds that represent their secured interests in the A/R of Americare.  Lock at 1-2.  HCS provided housekeeping services for Americare nursing homes and, in lieu of immediate payment, took a secured interest in Americare’s A/R.  Nat City took an interest in Americare’s A/R to secure payment under a loan agreement with an affiliate of Americare.  In November of 2005, before Lock Realty became a judgment creditor, Nat City and HCS perfected their security interests through the filing of appropriate financing statements with the Indiana Secretary of State.

Priority.  A prior perfected security interest is superior to a judgment lien.  See,  Ind. Code 26-1-9.1-317 and 322 HCS and Nat City filed appropriate financing statements with the Secretary of State.  They perfected their security interests in Americare’s A/R before Lock Realty became a judgment creditor.  As such, HCA and Nat City had superior claims to the funds.  Id. at. 5.

Validity:  the anti-assignment statute.  The more meaty issue related to the validity of the security interests in the first place.  Lock Realty argued that the funds at issue were Medicare payments and that the federal “anti-assignment” statute rendered the interests in the A/R unenforceable.  The opinion gets into an involved and technical discussion of the anti-assignment statute, 42 U.S.C. 1395g(c).  Generally, the statute prohibits Medicare funds from being paid directly to someone other than the provider.  The statute does not, however, prohibit someone other than the provider from receiving the funds if they first flow through the provider.  Id. at 3.  As a fundamental proposition, therefore, lenders can secure loans by Medicare receivables.  Id. at 4.  In Lock, neither secured party had a right to file a claim for direct payment of Medicare funds.  The rights flowed through the medical provider.   “[N]either [HCS nor Nat City] could receive Medicare funds pursuant to their arrangement without subsequent judicial enforcement of the security agreement.”  Id. at 9. 

Lien enforcement.  Whether and how the subject security interests could be enforced was a critical question in Lock.  Judge Miller held that, although federal law preempts non-judicial enforcement of the such security interests under the UCC, HCS and Nat City ultimately could receive direct payment by court order.  The financing arrangements of HCS and Nat City were valid and in accord with the anti-assignment statute.  Judge Miller merely enforced the security agreements.  His court-ordered assignment, which directed payment from AdminiStar to the secured parties, did not violate the anti-assignment statute.  Id. at 9-10.

Cliff notes.  Judge Miller’s February 27 opinion teaches us that (1) a prior security interest is superior to a judgment lien, (2) a lender can take a valid security interest in the Medicare A/R of a medical provider and (3) the enforcement of the security interest – the right to directly receive the money – requires a court order.

If you’re a commercial lending institution with loans secured by governmental Medicare payments, you or your lawyer should study Judge Miller’s opinion further.  Also, stay tuned for additional court commentary that may arise out of this fairly complex lawsuit.  Lenders who deal with nursing home borrowers and related entities will continue to learn from the issues being litigated in Lock.