Hyper Technical Error In Debtor’s Name Dooms Creditor’s UCC Financing Statement/Lien

Lesson.  If the debtor is an individual, use the spelling of the name as listed on his or her Indiana driver’s license when filing the UCC financing statement.    

Case citeIn re: Nay, 563 B.R. 535 (S.D. Ind. 2017) (pdf).

Legal issue.  Whether a creditor’s inadvertent omission of the letter “t” from the debtor’s middle name invalidated its UCC financing statement.

Vital facts.  In 2014, Plaintiff Mainsource held a blanket security interest in Debtor’s personal property.  In 2015, Leaf loaned money to Debtor to purchase two Dump Wagons (equipment) and filed UCC financing statements with the Indiana Secretary of State to perfect liens on the Wagons.  The UCCs identified the Debtor’s name as “Ronald Mark Nay.”  The Debtor’s name listed on his most recent Indiana driver’s license, however, was “Ronald Markt Nay.”    

Procedural history.   Nay arises out of an adversary proceeding, Mainsource Bank v. Leaf Capital, a lien priority dispute.  The U.S. Bankruptcy Court for the Southern District of Indiana ruled on a motion for judgment on the pleadings filed by Plaintiff Mainsource seeking to invalidate Leaf’s competing security interest.    

Key rules

Ind. Code 26-1-9.1-503(a), a lengthy statutory provision, outlines when a financing statement “sufficiently provides the name of the debtor.”

Ind. Code 26-1-9.1-506 deals with the effect of errors or omissions in financing statements.  The key concept is whether the mistake was “seriously misleading.” 

Much of the Nay opinion involved an analysis of Ind. Code 26-1-9.1-506(c), which is a safe harbor provision that allows creditors to overcome “seriously misleading” mistakes if the subject financing statement “was otherwise discoverable by searching under the Debtor’s correct name using the standard search logic promulgated by the Indiana Secretary of State.”      

Holding.  Judge Basil H. Lorch III granted the pending motion and found that Plaintiff Mainsource was entitled to judgment as a matter of law.  Leaf’s security interest was unperfected.  Mainsource held the first priority security interest in the Dump Wagons.

Policy/rationale

The difference between “Mark” and “Markt”, especially in a middle name, would not seem to be a “seriously misleading” error.  However, under Section 503(a), if the debtor has a driver’s license, a financing statement must provide “the name of the individual which is indicated on the driver’s license.”  By definition, therefore, Leaf’s misspelling was seriously misleading.

The Court addressed whether the financing statement was nevertheless discoverable using “standard search logic.”  Maybe it was.  But, in the end, and even after noting that the result seemed “harsh,” the Court still felt compelled to strictly adhere to the operative statutory language requiring the name of the Debtor to be the name set out on his Indiana driver’s license.    

Related posts.     

What Is A “Purchase Money Security Interest”?

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I often represent parties in commercial loan enforcement cases and lien priority disputes.  If you need assistance with a similar matter, please call me at 317-639-6151 or email me at john.waller@woodenlawyers.com. You also can follow me on Twitter @JohnDWaller or on LinkedIn, or you can subscribe to posts via RSS or email as noted to your left.


UCC Security Interest Lesson: Nemo Dat Quot Non Habet

The title of this short post is a common law maxim that “no one can give what he does not have.”  The maxim was at the heart of the Northern District of Indiana’s opinion in Infinaquest v. Directbuy, 2014 U.S. Dist. LEXIS 61739 (N.D. Ind. 2014) (.pdf) related to an alleged UCC security interest.

Money flowInfinaquest was a dispute between parties owed money under contracts they had with a debtor company.  One of the creditors claimed to have a security interest in the debtor’s receivables (the “Lender”).  The opposing side (actually, two creditors, one of which was a franchisor) held contractual set-off rights to the debtor’s receivables (collectively, the “Franchisors”).  Based on the agreements between the parties, the Franchisors routinely swept the debtors accounts and collected their payments, with the debtor then receiving the net.  In short, the debtor got its money after the Franchisors got theirs. 

Problem.  In Infinaquest, the debtor defaulted, but the Franchisors were able to grab $400,000 before the Lender, which claimed the 400k was the Lender’s, not the Franchisors’.  The legal issue was whether the Lender took its alleged security interest subject to the Franchisor’s contractual set-off rights.  The case and the resulting opinion of the Court is fairly complicated.  Certain provisions of the UCC are sliced and diced, including the definitions of “account debtor” and “assignee.”  Please read the opinion for a deeper analysis. 

Argument.  The Franchisors contended that the debtor “could only assign an interest in what it actually possessed,” and the debtor did not own the receivables outright.  Since the debtor’s rights to the money were subject to the Franchisors’ rights, any alleged security interest in the debtor’s receivables was subject to the set-off rights of the Franchisors.  “In other words, it was not possible for [the debtor] to give away what it did not have.”  Nemo dat quot non habet

Subject to.  The Court agreed with the Franchisors.  The debtor’s interest in its account was subject to the Franchisors’ contractual set off.  The outcome also was consistent with the UCC, Ind. Code Sec. 26-1-9.1-203(b)(2):  “a security interest is enforceable against the debtor and third parties with respect to the collateral only if … the debtor has rights in the collateral or the power to transfer rights in the collateral to a secured party.”  The lesson is that one cannot grant a security interest in property it does not own or control.

The Court granted summary judgment to the Franchisors, who were defendants in the suit brought by the Lender.  The Lender based its cause of action on theories of conversion and tortious interference with a contract, both of which failed as a matter of law.  The $400,000 in question belonged to the Franchisors, who exercised control over it pursuant to their contractual set-off rights.  The Franchisors were justified in taking the debtor’s money from the debtor’s accounts, to the detriment of the Lender.       


What Is A Fixture?

Enforcing commercial loan defaults sometimes involves the foreclosure on, or repossession of, loan collateral called a “fixture,” which is a hybrid of real and personal property.  Given their nature, fixtures can be the subject of disputes between mortgagees and other creditors who argue about who has priority over the fixture or whether there is a security interest in the fixture to begin with.    

UCC.  Indiana’s Uniform Commercial Code, which deals with, among other things, secured transactions (in Article 9.1), talks in detail about fixtures.  Curiously, the UCC does not provide a practical definition of a fixture.  I.C. § 26-1-9.1-102(41) says that a fixture means “goods that have become so related to particular real property that an interest in them arises under real property law.”  Not helpful.

Common law definition.  Indiana case law defines fixtures, and the best discussion comes from the Indiana Supreme Court in Gill v. Evansville Sheet Metal Works, 970 N.E.2d 633 (Ind. 2012).  Citing to older Indiana cases, the Court stated:

A fixture is a former chattel or piece of personal property that has become a part of real estate by reason of attachment thereto.  . . .  As a general matter, personal property becomes a fixture if the following are established:  (1) either actual or constructive annexation of the article to the real property; (2) adaptation of the article to the use of the real property in general or to the part of the real property to which the article is connected; and (3) an intent by the annexing party to make the article a permanent accession to the real property.

In an earlier case, Ind. Dep’t of Natural Res. v. Lick Fork Marina, 820 N.E.2d 152 (Ind. Ct. App. 2005), the Court of Appeals referred to Black’s Law Dictionary, noting that a fixture is “personal property that is attached to land or a building and that is regarded as an irremovable part of the real property.” 

A transformed good.  Here are some examples of fixtures:  underground storage tanks, landscaping, furnaces, sprinkler systems and water softeners.  One specific illustration comes from Conseco Finance v. Old National Bank, 754 N.E.2d 997 (Ind. Ct. App. 2001) dealing with security interests in manufactured homes:

When purchased from a retail establishment, the manufactured home is a “good,” and clearly moveable; but once placed on real estate, attached to a foundation, and connected to utilities, it becomes a fixture.

A fixture starts out as personal property but converts into a fixture when it becomes attached to the real estate.  This is one of the reasons why there can be questions surrounding whether a mortgage, as opposed to a UCC financing statement, creates a lien on a fixture. 

Generalities.  A creditor that obtains a security interest in a fixture should be mindful of competing claims from other secured creditors, such as asset-based lenders, which finance with goods and personal property, and mortgagees, which loan on real estate.  (A creditor can obtain a purchase money security interest in a fixture.)  To perfect a security interest in fixtures, we recommend filing two financing statements:  (i) one with the Secretary of State of the state in which the party assigning a security interest has been organized, and (ii) a “fixture filing” with the pertinent county recorder’s office.  Although a mortgage can double as a fixture filing if it includes the statutory elements of a fixture filing, lender’s counsel usually file a UCC financing statement too.  Here is a short list of the more important provisions of Indiana’s UCC, Article 9.1, that deal with fixtures:

• Priority:  I.C. § 26-1-9.1-334

• Perfecting, generally:  I.C. § 26-1-9.1-310 and 301(3)(a)

• Perfection, where:  I.C. § 9-1-9.1-501

• Enforcement:  I.C. § 9-1-9.1-604

For more on security interests and related issues, click on the UCC/Security Interests category that is along the right side of my home page.  For more on how to finance based on fixtures or enforce loans with fixtures as collateral, please contact me.  Thanks to my colleague Sierra Bunnell for her input into this post.


TIMBER! Creditor’s Alleged Security Interest Falls

In Re: Cruse, 2013 Bankr. LEXIS 360 (S.D. Ind. 2013) (.pdf) is about UCC secured transactions generally, and security interests in timber specifically.  The Court’s opinion is helpful to asset-based lenders and their counsel in Indiana. 

The debt.  In Cruse, a Chapter 13 bankruptcy case, the Debtor was in the business of buying and harvesting timber (living trees) and reselling the timber after it was cut.  The Debtor and the Creditor entered into a contract that allowed the Debtor to harvest timber on the Creditor’s land in exchange for payment, including a percentage of the sales.  Following the filing of the Debtor’s bankruptcy, the unpaid Creditor filed a proof of claim

The objection.  The Debtor did not object to the amount of the Creditor’s claim but rather its alleged secured status.  The Creditor contended that the Debtor’s property (the timber) was subject to the Creditor’s security interest.  The Debtor responded that the Creditor’s proof of claim contained no documentation to support a lien or a security interest. 

The law.  The issue in Cruse was whether the Creditor had a perfected security interest in the timber, which is considered personal property (not real property in this context).  The Court identified the applicable legal rules:

  • Article 9.1 of the Uniform Commercial Code governs the creation and perfection of liens in personal property.
  • Under I.C. § 26-1-9.1-102(44) , both “standing timber that is to be cut and removed under a conveyance or contract for sale” and timber already harvested are classified as “goods.”
  • Both “attachment” and “perfection” of a security interest are needed to enforce a security interest in goods against the debtor (and third parties). 
  • “Attachment” pertains to the creation of the security interest as between the secured party (creditor) and the debtor and requires the debtor to have rights in the collateral he intends to pledge to the secured party.
  • “Attachment” involves the execution of a written security agreement between the debtor and the secured party that describes the collateral (unless the secured party is in possession of the collateral).
  • “Perfection” is an additional step that makes the security interest effective against third parties.
  • A security interest in “timber to be cut” is perfected by filing a financing statement with the office designated for the recording of a mortgage on the related real property, which in Indiana is the county recorder’s office.  I.C. § 26-1-9.1-501(a)(1)(B); I.C. § 32-21-4-1(a)(1).
  • A security interest in timber already cut is perfected by filing a financing statement with the secretary of state’s office.  I.C. § 26-1-9.1-501(a)(2).

The result.  In Cruse, the Creditor provided no evidence of a written security agreement.  Even so, the creation and attachment elements were immaterial because there was “nothing in the record that suggest[ed] [the security interest] was perfected.”  The Creditor offered no evidence of any filing in the county recorder’s office or in the secretary of state’s office.  The Court sustained the Debtor’s objection to the Creditor’s secured claim and rendered the claim unsecured.

The Creditor could have created and perfected an enforceable lien on the Debtor’s timber, but the absence of a written security agreement and appropriate governmental filings was fatal in Cruse.


Successor Bank Has Standing to Enforce

Throughout the recent economic downturn and wave of foreclosure cases, “lack of standing” has been the most common, but not necessarily the most successful, defense asserted by borrowers in mortgage foreclosure cases.  The theory came into vogue with the 2007 Boyko opinion, about which I wrote six years agoPichon v. American Heritage, 2013 Ind. App. LEXIS 10 (Ind. App. 2013) succinctly rejects the defense based upon the given facts.

Details.  Pichon is a very involved appellate opinion following a trial that dealt with at least nine separate issues, one of which was whether the plaintiff had standing to enforce a $650,000 promissory note.  The plaintiff, American Heritage Banco, Inc. (AHB), was the successor-in-interest to First National Bank of Fremont (FNBF).  AHB had acquired FNBF following a merger.  The note in question was payable to FNBF.  The defendant borrower alleged that AHB was not the real party in interest.  The trial court concluded that AHB had standing to enforce the note because it occupied the status of “holder” of the note.

Standing-related statutes.  The Indiana Court of Appeals agreed with the trial court.  There were two Indiana statutes relevant to the Pichon opinion.  First, I.C. § 26-1-3.1-301 states that a “person entitled to enforce instrument” means the “holder” of the instrument.  Second, I.C. § 26-1-1-201(20) defines “holder,” which includes one in possession of a negotiable instrument (a) if that instrument is payable to an identified person and (b) if the identified person is in possession. 

Ruling.  For purposes of the trial, the parties stipulated that FNBF was merged into AHB.  Pursuant to that merger, AHB was the successor to FNBF.  In Pichon, the subject note expressly stated that it was payable to FNBF or “its successors and assigns,” and AHB had possession of the note.  As such, the Court of Appeals affirmed the trial court’s conclusion that AHB had standing to enforce the note.

Related posts.  Here are links to some other posts that relate to the standing defense: 

Happy Holidays everyone.


Proving You’re The Holder Of The Note

An assignee of a loan (purchaser of a promissory note and mortgage) must establish in any foreclosure action its status as the current holder (owner).  In a foreclosure action, a defendant borrower or guarantor sometimes will defend the case by asserting that the plaintiff assignee lacks standing to enforce the loan.  Collins v. HSBC Bank, 2012 Ind. App. LEXIS 452 (Ind. Ct. App. 2012) provides a road map for plaintiff assignees to defeat such arguments and to obtain summary judgment.

Set up.  In 2004, the borrower in Collins executed and delivered to his original lender a promissory note evidencing a loan for the purchase of real estate.  To secure repayment of the note, borrower executed a mortgage.  The original lender later sold/assigned the loan.  In 2007, borrower stopped making payments, at which time the plaintiff in Collins, as holder (owner) of the note at the time, filed a foreclosure complaint and obtained summary judgment in its favor.  Defendant borrower appealed the trial court’s grant of summary judgment.  The issue in Collins was whether the trial court erred in not concluding that there was a factual question regarding plaintiff’s status as the holder/owner of the promissory note.

Evidence.  The promissory note attached to the plaintiff’s complaint was not endorsed from the original lender to the plaintiff.  In connection with its summary judgment motion, the plaintiff tendered an affidavit, with a copy of the note, but failed to attach an endorsement, allonge or assignment.  However, the plaintiff later submitted an affidavit that attached a copy of the original note, which included an endorsement by the original lender to the plaintiff lender.  In addition, at the summary judgment hearing the plaintiff produced the original promissory note.  (Production of the original loan docs is not required to succeed on summary judgment, but in my view is the ultimate trump card to any standing defense.) 

Law.  Borrower maintained that, among other things, plaintiff’s complaint and first affidavit required the trial court to deny summary judgment and to weigh the evidence at trial as to whether the plaintiff was the owner of the note.  But the record on appeal disclosed that the plaintiff presented the original note, with borrower’s inked signature, together with the endorsement from the original lender to the plaintiff.  According to the Indiana Court of Appeals, that was enough to establish plaintiff’s right to enforce.  See, Ind. Code §§ 26-1-3.1-204(c) and 301(1), and 1- 201(20)(A).  The Court in Collins affirmed the trial court’s summary judgment accordingly: 

The evidence shows not only that [plaintiff] is in possession of the original note but also that the original note was endorsed to [plaintiff].  There exists no better evidence to establish that [plaintiff] is the present holder of the note entitled to enforce the note under Indiana law.

The Collins opinion is good law for assignees attempting to enforce their loans.  The case also highlights the importance for prospective assignees to obtain, in the loan purchase transaction, the original loan documents and assignments.  While that’s not always possible, presentation of the original note and mortgage can be definitive proof that you’re the holder/owner of the loan.


Innocent Purchaser Of Motorcycle Loses To Secured Party In Replevin Action

The vernacular of “foreclosure” typically relates to real estate, while “replevin” normally pertains to personal property.  For more, click on my prior post What Is Replevin?  In Dawson v. Fifth Third Bank, 965 N.E.2d 730 (Ind. Ct. App. 2012), the Indiana Court of Appeals teaches us that security interests in personal property generally will not be extinguished even if the ownership of that loan collateral changes. 

Situation.  In Dawson, Buyer purchased a motorcycle from Seller, who had given Buyer a certificate of title showing the motorcycle was free of any lienholders.  Buyer later learned that Seller fraudulently obtained the title and that the current certificate of title listed Bank as a lienholder.  Which party - Buyer or Bank - was entitled to possession of the motorcycle free and clear of all liens?

Replevin 101.  Replevin is a statutory remedy allowing one to recover possession of property “wrongfully held or detained” by another.  Ind. Code § 32-35-2 is the Indiana statute.  The elements of a replevin action require the plaintiff to prove (a) its title or right to possession, (b) that the property is unlawfully detained and (c) that the defendant wrongfully holds possession.  In the secured lending context, Indiana law is clear that, upon default, a creditor has the right to take possession of the collateral securing its claim and in accordance with the agreement with the defaulting party.

Competing rights.  Bank held a security interest in the motorcycle based upon Seller’s promissory note and security agreement.  The most current certificate of title on file with the Bureau of Motor Vehicles reflected Bank’s security interest.  Bank had never released its lien.  In what proved to be a fatal error, Buyer purchased the motorcycle without checking with the BMV to verify that the certificate of title supplied by Seller was the most recent one.  Since Seller was in default under the security agreement based upon non-payment, Bank, as the secured party, had the right to take possession of the motorcycle.  Ind. Code § 26-1-9.1-609(a).  Buyer did not dispute Bank’s rights.  Rather, Buyer contended that its purchase, and thus ownership, of the motorcycle precluded Bank from arguing that Buyer wrongfully held possession of the motorcycle – one of the elements of an Indiana replevin claim.  Bank, while not contesting ownership, asserted that such ownership was subject to Bank’s lien. 

Ownership immaterial.  A security agreement is effective against purchasers of collateral.  Ind. Code § 26-1-201-9.1.  Third-party purchasers are therefore at risk if they buy encumbered personal property from a seller/debtor in default.  Although Buyer had an interest in the motorcycle as its purchaser, the interest was not superior to Bank’s perfected security interest.  The Court affirmed the trial court’s summary judgment for Bank accordingly. 

Perfection.  Footnote 4 of the Dawson opinion contains lots of information related to certificates of title and the issue of perfecting Bank’s security interest.  Bank’s perfection was a non-issue, but the Court’s remarks are informative.

Equitable estoppel.  The Court in Dawson devoted a portion of its opinion to Buyer’s claim for equitable estoppel.  The discussion focused on certificates of title and which party was in the best position to protect itself based upon the public records.  The opinion is helpful for those who deal with motor vehicle transactions.  In the end, Bank was not responsible for Seller’s loss. 

 


Indiana Supreme Court Clarifies Indiana Law In Distinguishing A True Lease From A Sale Subject To A Security Interest

Today’s post supplements my February 11, 2011 post regarding Gibraltar Financial v. Prestige Equipment punch press case.  On June 21, 2011 (.pdf), the Indiana Supreme Court reversed the Court of Appeals’ decision that was the topic of my prior article.  At issue is the sometimes difficult question of whether a transaction constituted a lease or a sale subject to a security interest. 

UCC, generally.  Although the case involved Colorado law, the operative statutes are similar, if not identical, to those in Indiana.  The first is the UCC’s definition of a lease at Ind. Code § 26-1-2.1-103(j).  The “key thing to note” with regard to the definition is that lease and security interest-based transactions “are mutually exclusive.”  The second and more central statute is I.C. § 26-1-201(37), which sets forth rules for distinguishing the two transactions.  The provision is complex.  The Gibraltar opinion helps parties and their lawyers navigate through that statute.  (Colorado’s version is Colo.Rev.Stat. § 4-1-203.)

Security interest per se.  The Court first concluded that one component of Section 201(37) is to create a two-pronged “bright-line test” to decide the issue of whether the transaction has created a security interest.  If the facts meet the test, “no further inquiry is required.” 

    Prong 1.  The first prong is satisfied “if the consideration that the lessee is to pay the lessor for the right to possession and use of the goods is an obligation for the term of the lease and is not subject to termination by the lessee.”  The Court in Gibraltar concluded that the lease was not subject to termination.  Thus the first prong of the bright-line test was met.

    Prong 2.  The second prong is satisfied if one or more of four “Residual Value Factors” identified in the statute are found to exist.  In Gibraltar, only one of the four factors were potentially at issue:  whether the lease provided the lessee with an option to become the owner of the goods for no additional consideration or for nominal additional consideration upon compliance with the lease.  The Court (and the Court of Appeals) wrote at length about two different tests applicable to this prong:  the “Fair Market Value Test or Standard” and the “Option Price/Performance Cost Test.”  (Review the opinion for details.)  The Court held that prong 2 was not satisfied under either test, essentially because “compliance with the Lease required [lessee] to pay more than nominal consideration to become the owner of the press.” 

Because prong 2 of the bright-line test was not met, there was no security interest per se created by the lease.

Fall back.  If the transaction does not pass the two-pronged bright-line test, Indiana courts must turn to a consideration of “the economic reality of the transaction in order to determine . . . whether the transaction is more fairly recognized as a lease or as a secured financing agreement.”  The Court discussed the pertinent statutory provisions and described their complexity, as well as courts’ struggles with interpreting them.  The Court’s solution was to articulate the following rule:  the question is whether the economic realities of the transaction dictate that it is a lease, and the focus in answering the question should be on the operative “economic factors” that drove the transaction.  The Court’s opinion identified some of the factors to be considered, none of which alone controls.  Indeed there were factors supporting both sides in Gibraltar.  The bottom line is that a resolution of this issue is highly dependent upon the facts. 

No summary judgment.  The Gibraltar decision involved an appeal of the trial court’s summary judgment ruling, which was affirmed by the Court of Appeals.  Here’s how the Indiana Supreme Court left the case: 

the defendants had the burden of establishing the absence of any genuine issue of material fact as to the economic realities of the transaction dictating that it was a lease as a matter of law.  To do so required evidence of the expectations of [lessee] and [lessor] at the time the transaction was entered into as to such factors as the value of the punch press on the EBO and lease expiration dates, the discount rate, and whether the “only economically sensible course” for [lessee] would have been to exercise the EBO. 

The Court saw “no way of resolving this case without this evidence” and thus reversed the case.   

Gibraltar serves as a reminder that not all “lease” agreements will be treated as leases.  Lenders should be attentive to these rules and to structure their transactions accordingly, depending upon whether they desire the transactions to be true leases versus a secured loans.  This dense body of law plays an important role when asset-based lenders and their collection counsel are confronted with defaults on these transactions.  The nature of the underlying transaction will control the remedies available to the lender/lessor, as well as who owns the asset. 


Prejudgment Possession (Replevin) of Equipment Permitted Under Indiana Law

This post falls in line with those of January 31, 2009, December 7, 2010, and January 6, 2011 regarding Indiana’s remedy of replevin, including the right to prejudgment possession of personal property loan collateral.  The Indiana Court of Appeals’ decision in Deere v. New Holland, 2010 Ind. App. LEXIS 1899 (Ind. Ct. App. 2010) (click and save for .pdf) supports the proposition that prejudgment repossession is available in Indiana.  The Court also held that the creditor’s lien survived the debtor’s transfer of the property.

What happened.  The creditor in Deere held a perfected security interest in farm equipment.  The original debtor traded the equipment to another business, which relied upon statements of third parties that the creditor’s lien had been satisfied.  The successor business – the defendant in the suit – did not contact the creditor to verify whether the liens had been released.  There was a default under the applicable security agreement, and the amount due under the agreement was accelerated as a result.  As is often the case, the agreement provided the creditor with the right to recover the equipment upon the default.  The case surrounded the defendant’s (the subsequent owner of the equipment) objection to the creditor’s effort to repossess.

Repossession rules.  The Court in Deere reiterated that, upon a default, creditors have the right to take possession of the collateral securing their claim.  See Indiana Code § 26-1-9.1-601(a) and 609(a)(1).  Significant to Deere, “a security agreement is effective against purchasers of the collateral.”  I.C. § 26-1-9.1-201(a).  Depending upon the circumstances, repossession can occur through self-help or, as in Deere, a suit for replevin.  An Indiana replevin action is a “speedy statutory remedy designed to allow one to recover possession of property wrongfully held or detained as well as any damages incidental to detention.”  A plaintiff/creditor must prove:  (1) it has the right to possession, (2) that the property is unlawfully detained, and (3) that the defendant wrongfully holds possession.  The Court concluded, based upon undisputed facts, that the creditor was entitled to possession, use and disposition of the equipment pending final adjudication of the claims of the parties.

Notice of lien.  The real meaty issue in Deere related to the defendant’s belief, based upon representations made by third parties, that the creditor’s liens had been satisfied.  Indeed proof showed that such representations occurred.  Nevertheless, the evidence was undisputed that the defendant had actual notice that the prior lien existed at a point in time, and the defendant never contacted the creditor to confirm the alleged satisfaction of the lien. 

BFP defense?  The court translated the defendant’s argument as “raising an affirmative defense that it was a bona fide purchaser because it relied in good faith on the information it gleaned from [third parties].”  I have written about the bona fide purchaser defense on a handful of occasions, including on October 4, 2009 when I discussed how actual knowledge defeats Indiana’s bona fide purchaser doctrine.  This knowledge was fatal in the Deere case.  The defendant had actual notice of the perfected security interest in the equipment.  Any reliance on statements by third parties with respect to the satisfaction of liens “simply was not reasonable”: 

As a general rule, we find that it is unreasonable to rely on the statements of third parties – or the [original] debtor – about the current status of security interests.

The lesson for parties acquiring equipment that may be subject to a security interest is to conduct an independent investigation into the status of any liens.  Relying on written or oral representations by the seller will not protect parties from a creditor’s action to foreclose the lien.  From the creditors’ perspective, in cases of clear defaults, Indiana law generally allows repossession (and liquidation) of personal property loan collateral before the entry of judgment.


Bankruptcy Proofs Of Claim And Standing/Loan Assignment Issues

Secured lenders faced with loans in default may find themselves entangled in a borrower’s or guarantor’s bankruptcy case and thus forced to file a proof of claim (POC).  In my April 27, 2007 post, I wrote about POCs, including when a creditor should file one.  In the Matter of Larkin, 2010 Bankr. LEXIS 3609 (N.D. Ind. 2010) (click and save for .pdf), Judge Dees provides a thorough opinion surrounding the sufficiency of the documentation needed to support a POC, which opinion also touches upon the “standing” issue that has been prevalent in mortgage foreclosure law for the past three or four years.

POC general rules.  The main POC rule is located at Federal Rule of Bankruptcy Procedure 3001.  A POC, if executed and filed in accordance with the Rules, “shall constitute prima facie evidence of the validity and amount of the claim.”  Fed. R. Bankr. P. 3001(f).  If the claim is based on a writing, the original or a duplicate of the written document must be filed with the proof of claim.  F.R.B.P. 3001(c).  If the creditor asserts a security interest in the debtor’s property, the POC “shall be accompanied by evidence that the security interest has been perfected.”  F.R.B.P. 3001(d).  The POC is deemed allowed, unless a party in interest objects. 

Entire document.  In the Larkin matter, the debtor’s first objection surrounded the mortgagee creditor’s attachment of only certain pages of the underlying loan documents.  The issue was whether this “substantially” complied with Rules 3001(c) and (d).  The Court held that the attachment requirement in Rule 3001(c) mandates specific, not substantial, compliance and, as such, the Court initially ruled that the POC was not valid.  (After a continuance of the hearing on the objection, the creditor corrected the problem by attaching a complete set of documents.  You always should do the same.)

Mortgage assignment.  The creditor in Larkin was an assignee of the loan.  The mortgage assignment had not been recorded.  Indiana’s recording statutes regarding assignments of mortgages “are designed to protect third party purchasers and mortgagees, not mortgagors.”  The recording of an assignment of mortgage “is not necessary to the validity of the mortgage, but is simply a protection to a good-faith purchaser of the mortgage itself . . ..”  Since the debtor was a mortgagor, not a subsequent purchaser, the debtor could not challenge the validity of her properly-recorded mortgage for failure to record a subsequent assignment.  (We would advise recording all mortgage assignments as soon as possible, but the act of recording does not affect the enforceability of the mortgage as between the mortgagor and the mortgagee’s assignee.) 

Post-petition assignment.  The debtor also contended that, because the mortgage assignment was post-petition, it was ineffective because it violated the automatic stay.  Not so, said the Court.  Bankruptcy law provides that “once the original grant by the mortgagor to the mortgagee has been perfected, the later assignment of that mortgage does not involve a transfer of property of the debtor . . . and cannot constitute a violation of the automatic stay.”  Larkin supports the notion that post-petition loan assignments are appropriate. 

Note assignment.  The debtor also attacked the validity of the transfer of the promissory note from the original holder to the current creditor.  This is the “real party in interest” and “standing” defense advanced by debtors over the last few years.  (See my November 15, 2007 post.)  The Larkin opinion provides a solid summary of the law applicable to the assignment of promissory notes via endorsement or allonge.  Endorsement is defined by Black’s Law Dictionary as “the placing of a signature, sometimes with an additional notation, on the back of a negotiable instrument to transfer or guarantee the instrument or to acknowledge the payment.”  “Allonge” is a “French term used in legal contexts for a paper that is annexed to a note.”  In Indiana, an endorsement “on an allonge is valid even though there is sufficient space on the instrument for an indorsement.”  I.C. § 26-1-3.1-204(a).  The Court in Larkin concluded that the subject allonge that was affixed to the debtor’s note (and included with the POC) was a part of the note, and thus constituted a valid endorsement.

POCs filed by our firm, whether secured or unsecured, that are based upon written documents include a complete copy of the underlying loan documents and any assignment papers.  It is also our practice to prepare and attach an “Attachment to Proof of Claim” that gives a brief description of the nature of the claim and references the attachments.  The Attachment would spell out, among other things, the factual and documentary basis that the creditor is the holder of the note and mortgage, and has the present ability to enforce the subject loan. 


Set-Off Versus Garnishment: Rights To And Priorities In Deposit Accounts

Fifth Third Bank v. Peoples National Bank, 210 Ind. App. LEXIS 952 (Ind. Ct. App. 2010) (.pdf) outlines a plethora of legal principles related to judgment enforcement generally and garnishment proceedings specifically.  The opinion analyzes a priority dispute between one lender, which had a judgment lien in a checking account, and a second lender, which had a security interest in the same account.

The parties and the account.  An accounting firm, OMS, opened a checking account with Fifth Third.  Fifth Third also loaned OMS approximately $1.5MM, secured in part by the same account.  Years later, Peoples obtained a judgment against OMS in the amount of $64,000.  About the same time, OMS defaulted on the Fifth Third loan.  Fifth Third did not initially freeze the OMS checking account.  Meanwhile, Peoples initiated proceedings supplemental against OMS and named Fifth Third as a garnishee defendant.  Although Fifth Third did not at first disclose to Peoples that OMS had the account, it subsequently identified the account and froze it.  In a separate suit, Fifth Third soon thereafter got its own judgment against OMS.

Competing interests.  The Court in Fifth Third noted that, under Indiana law, a judgment creditor (here, Peoples) acquires an equitable lien “on funds owed by a third party [here, Fifth Third] to the judgment debtor [here, OMS] from the time the third party receives service of process in proceedings supplemental.”  The third party (here, Fifth Third) may be “liable for paying out funds in a manner inconsistent with the judgment creditor’s lien.”  On the other hand, Indiana recognizes a right of depositary bank (here, Fifth Third) to set-off any amounts owed to it with funds from its “indebted depositors’ [here, OMS’s] account after receipt of notice of garnishment proceedings.”  The pivotal rule proved to be:  a garnishing creditor (here, Peoples) “has no greater rights in the judgment debtor’s [here, OMS’s] assets than the judgment debtor does.” 

General rule of priority.  In Fifth Third, the “first in time is first in right” rule applied.  Fifth Third, a secured creditor with a perfected prior security interest in the deposit account, had rights that were superior to Peoples, a subsequent judgment (unsecured) creditor.  At the time of the loan default, OMS owed Fifth Third in excess of $470,000, which was the account balance at the time in question.  Once OMS defaulted, Indiana law entitled Fifth Third to exercise the remedy of self-help in order to apply the balance of the deposit account to the indebtedness owed under the security agreement.

Compelled to set-off?  Peoples asserted various equitable arguments against Fifth Third’s position.  Peoples contended that, by not immediately exercising the right to set-off, Fifth Third lost its superior priority status and should have been foreclosed from attempting to belatedly enforce its right to the account.  Under the UCC, a secured party holding a perfected security interest in a deposit account “may set-off or apply the balance of the deposit account to the loan obligation secured by the deposit account.”  Again, Peoples, the garnishing creditor, had no greater rights in OMS’s assets than did OMS.  OMS owed Fifth Third in excess of $1MM.  The OMS deposit account contained only $470,000.  As such, OMS’s rights in the deposit account “were extremely subject to” Fifth Third’s security interest.  According to Fifth Third, a failure to exercise set-off will not result in a subordination of those rights to the rights of a garnishing creditor.

Compelled to freeze?  Peoples also claimed that Fifth Third lost its superior priority status when Fifth Third continued to honor checks drawn on the deposit account after the OMS loan default.  Fifth Third’s security interest was automatically perfected by its “control” over the account.  Ind. Code § 26-1-9.1-104 provides that the requisite “control” over the account exists even if the debtor retains the right to direct the disposition of the funds in the account.  Fifth Third’s decision to allow OMS to reach the funds was not inconsistent with the required “control” for purposes of automatic perfection.  Banks have “the latitude to allow their indebted depositors to have reasonable access to funds, which may enable them to continue to operate and generate revenue that may be applied to their existing indebtedness.”  Under circumstances like those in Fifth Third, the failure to freeze an account that is subject to set-off will not permit a garnishing creditor to assume senior status.

 


"Lease" Held To Be A Lease, Not Seller Financing

This follows-up my 11-5-09 post Indiana Court of Appeals Tackles True Lease Vs. Secured Loan Question.  Last year, the Court of Appeals addressed the same issue in a different context in Gibralter Financial v. Prestige Equipment, 2010 Ind. App. LEXIS 626 (Ind. Ct. App. 2010) (.pdf).  If you're an asset-based lender struggling with understanding your rights under a written agreement named a "lease," which may have been intended to be a secured loan, Gibralter is a nice Indiana opinion that outlines some of the key issues for consideration. 

Big picture.  The dispute in Gibralter boiled down to whether the subject transaction was a financed sale or a lease.  At stake was ownership of a quarter million dollar punch press.  If the Court deemed the transaction to be a lease, as opposed to a sale, then the lessor/alleged seller retained ownership of the punch press. 

Legal test.  The case actually involved Colorado law, but it appears Indiana's UCC provisions are similar to Colorado's, so the legal analysis essentially is the same.  The key statute is Ind. Code 26-1-1-210(37), including specifically subsection (b).  These cases involve a two-pronged test:

  1. whether the right to possession and use is subject to termination by the lessee;
  2. whether the lessee had an option to become the owner for "nominal additional consideration" once the lease was paid.

If the answer to question 1 is "yes," then the analysis ends because the subject document will be considered a lease.  If the answer is "no," then question 2 must also be answered.  If the answer to question 2 is "yes," then the document/transaction will be considered a security agreement/sale.  On the other hand, if the answer to question 2 is "no," then the document will be considered a lease

Test results.  Reading a legal test is one thing, but understanding it is another.  Illustrations help, which is why I always attach .pdf's of the legal opinions to my posts.  Gibralter explains in detail why the lessor (alleged seller) prevailed on its contention that this was a lease transaction.  As to question 1, the Court stated that, for a lease to be terminable, "the lessee must have the right to cease payments and walk away from the lease without further future financial responsibility to the lessor."  In Gibralter, no such right existed, so the Court turned to question 2.  The Court's discussion of question 2 was quite involved and dealt with an examination of such things as the lessee's costs and payments, as well as the value of the punch press.  There are a couple of sub-tests that deal with this issue, including the "FMV Standard" and the "Option Price/Performance Cost Test."  Read the decision for more.  In the end, the Court concluded that, given all the facts and circumstances, "Key retained a meaningful residuary interest and that the Lease was merely a lease." 

In the final analysis, the Court held that Key (the lessor/ alleged seller) was the owner of the punch press.  Any lenders reading this post should remain mindful of these tests and to structure their transactions accordingly, depending upon whether they intend for them to be a true lease versus a secured loan.    

Note:  The Indiana Supreme Court has reversed the Court of Appeals, as outlined in my July 1, 2011 post


Statutory Disposition of Foreclosure Sale Proceeds

When foreclosing on a borrower’s loan collateral, it’s no secret that banks and commercial lending institutions ultimately are seeking money.  Normally, they hope to dispose of the collateral and, ideally, become whole from the proceeds of the sale.  A senior lien holder will obtain most, but not all, of any such proceeds.  In Indiana, statutes govern specifically who gets the cash.

Mortgages.  Ind. Code § 32-30-10 outlines the procedures for mortgage foreclosure actions.  The distribution of proceeds from a judicial sale are statutorily mandated.  First Federal Savings Bank v. Hartley, 799 N.E.2d 36, 40 (Ind. Ct. App. 2003).  According to I.C. § 32-30-10-14, which should be used as a template when preparing the section of any proposed foreclosure decree/order dealing with the disposition of sheriff’s sale proceeds, the money must be applied as follows:

1.  Sale expenses.  The first payout is to the civil sheriff for its fees and notice/advertising costs.  A sheriff’s sale in Indiana costs a few hundred dollars.  Under certain circumstances, Indiana law allows a mortgage foreclosure sale to be conducted by a private auctioneer, and the fees of the auctioneer would be a part of this payout.

2.  Senior mortgage debt.  The payment of the outstanding principal, interest and costs to the senior lien holder comes second.  This almost always will be the full, accelerated debt as articulated in the judgment.  (2010 statutory revisions did away with post-sale payment of taxes.  If the senior mortgagee prepaid any delinquent real estate taxes, its counsel should attempt to build those losses into the judgment.) 

3.  Junior liens.  Any payments of amounts owed to any junior lien holders are next, in accordance with their legal priority and as articulated in the court's decree.

4.  Surplus to mortgagor.  Lastly, if any sale proceeds remain, that "surplus must be paid to the clerk of the court to be transferred, as the court directs, to the mortgage debtor, mortgage debtor's heirs, or other persons assigned by the mortgage debtor." 

Security Interests.  The disposition of collateral under Indiana’s UCC, Article 9.1 (Secured Transactions), is slightly different and will depend upon the nature of the collateral.  Article 9.1 should be reviewed in detail for each specific case and the particular collateral in question, because there are many different rules that could apply.  With certain collateral (accounts receivable, for instance), disposition by sale normally will not occur.  On the other hand, sales of tangible personal property collateral, like inventory or equipment, are common.  I.C. § 26-1-9.1-610 speaks to disposing of collateral after default.  Unlike with mortgages, in Indiana a judicial sale of personal property collateral is not required.  Lenders may choose to conduct the sale privately, although it may make sense to group the personal property with any real estate that is being sold at a sheriff’s sale.  I.C. § 26-1-9.1-615 governs how to apply the proceeds: 

1.  Sale Expenses.  First, proceeds are applied to the reasonable expenses of retaking, holding, preparing for disposition and reasonable attorney’s fees and expenses incurred by the secured party.  This would include payment of the sheriff’s fees if the civil sheriff is conducting the sale, or to private auctioneers upon a private sale.

2.  The Debt.  Second, payment goes to the satisfaction of the obligation secured by the security interest.

3.  Junior Liens.  The third payment, if any, would be for the satisfaction of the obligation secured by any subordinate security interest.

4.  Debtor.  Finally, any remaining proceeds go to the debtor.

So, if and to the extent there are cash proceeds from an Indiana foreclosure sale of loan collateral, the debt of the plaintiff lender will not be satisfied until after the sale-related expenses are reimbursed.  Also, lenders should not receive a windfall from a sale because the borrower generally receives any surplus, but that normally is a very remote possibility.    

(This revises/updates my 1-9-07 post.)


Creditor May Repossess Collateral And Sue For Full Debt Simultaneously, And Generally Is Not Compelled To Accept Short Sale

If you work for a commercial lending institution and have ever wondered (1) whether you must accept a short sale of non-real estate collateral and/or (2) whether you first must obtain a  judgment before repossessing that collateral, then SFG v. N59CC, 2010 U.S. Dist. LEXIS 20931 (N.D. Ind. 2010) (.pdf) will be of benefit to you. 

Enforcement measures.  SFG involved the standard parties to a commercial loan enforcement action:  a lender (the plaintiff), and a borrower and guarantors (the defendants).  The loan was for $1,020,000, and the collateral was an aircraft.  Upon the loan default, the lender filed a lawsuit based upon the promissory note and security agreement.  While the suit was pending (before judgment), the lender repossessed the aircraft.  Later, the lender filed a motion for summary judgment seeking the entire amount of the debt.  The SFG opinion dealt with the borrower/guarantors’ objection to the motion.

Parallel tracks fine.  The UCC, which governed the lender’s remedies, did not require the lender to choose between two remedies of money judgment and repossession.  The lender was “well within its authority to pursue a judgment against [borrower and guarantors] for the default while simultaneously repossessing the aircraft.”  Ind. Code § 26-1-9.1-601 states that, after a debtor defaults, a secured party may “reduce a claim to judgment, foreclose, or otherwise enforce the claim.”  The secured party’s rights are “cumulative and may be exercised simultaneously.”  (But be sure to check your security agreement for self-help and repossession rights and/or limitations.) 

Double recovery?  Theoretically, the pursuit of multiple remedies could give rise to the recovery of more than the original debt.  However, SFG reminds us that the “check on a plaintiff’s right to pursue multiple remedies . . . is the requirement that a plaintiff proceed in a commercially reasonable manner and apply the proceeds of the disposition to the amount owed by the defendant.”  See I.C. § 26-1-9.1-608 through 610.  This means, among other things, that the lender in SFG must later account to the defendants for any proceeds of the sale of the aircraft. 

Short sale lost.  While the motion for summary judgment was pending, a “short sale” offer for the aircraft surfaced that would have netted $570,000 to the lender.  The defendants conceded that the aircraft was worth more but were inclined to move forward anyway, assuming the lender committed to structure a settlement for the payment of the remaining balance (the deficiency).  For a variety of reasons, the lender allegedly failed to “seal the deal,” so the sale never occurred.  The defendants claimed that, to their detriment, the lender failed to act in a commercially reasonably manner.  The defendants contended that any judgment amount should therefore be reduced by $570,000.

Commercially reasonable?  Judge Simon devoted a substantial portion of his opinion to a discussion of whether the contemplated short sale was “commercially reasonable” or whether the lender’s alleged failure to agree to the short sale was “commercially reasonable.”  In the end, Judge Simon overruled the defendants’ objection to the motion for summary judgment on the grounds that issues of commercial reasonableness were not ripe for adjudication. 

If [lender] fails to conduct its sale of the plane in a commercially reasonable manner, [borrower or guarantors] may then bring an action to recoup any loss.  In the meantime, because [borrower and guarantors] concede liability and the amount of damages under the agreements, summary judgment in this action is proper. 

Short sale not mandated.  The defendants’ only chance of making any hay out of the lost short sale in SFG will be if, post-judgment, the lender fails to liquidate the aircraft for more than $570,000.00.  Conceivably, the defendants in SFG could then pursue a claim against the lender to recover the difference - by establishing that the lender failed to act in a commercially reasonable manner for not accepting the prior short sale.  Even then, however, there would be a multitude of factors that will go into the validity of such a claim, including an examination of the proposed short sale terms and conditions as compared to those of the subsequent liquidation sale.  Under the circumstances in SFG, the creditor was not initially compelled to accept the short sale. 


Negative Equity/PMSI - Split Of Authority In The Seventh Circuit

On August 29, 2008, I addressed the question of "What is a 'purchase money security interest?'"  The case giving rise to my discussion was In Re: Myers, 2008 Bankr. LEXIS 2172, and the circumstances surrounded a bankruptcy case and whether a creditor's purchase money security interest (PMSI) extended to the negative equity part of a loan to purchase a vehicle.  Although the primary purpose of my post was to define and illustrate a PMSI, I necessarily had to point out that Myers concluded that the entire loan was secured -- the creditor's PMSI covered the money used to finance the negative equity. 

The purpose of today's post simply is to provide a footnote that bankruptcy courts within Indiana's circuit (the Seventh Circuit) are split on the negative equity issue.  Although representative of the minority view, In Re: White, 2009 Bankr. LEXIS 3156 (.pdf) is a strong opinion from Judge Lorch that negative equity "is merely the debtor's antecedent debt which is assumed by the [creditor]."  Thus it "does not fit within the definition of a PMSI...." 

The Myers and White opinons offer differing views on the negative equity question, but both are helpful in understanding the nature of a PMSI and a secured lender's rights in such a lien.   

 


Indiana Court Touches Upon Factoring Agreements

The U. S. District Court for the Northern District of Indiana recently addressed some procedural issues associated with the enforcement of a factoring and security agreement.  Here is a .pdf of JD Factors v. Freightco, 2009 U.S. Dist. LEXIS 72636 (N.D. Ind. 2009).  There are a handful of things to take away from JD Factors.

1.  The business of factoring is a kind of financing characterized by “the buying of accounts receivable at a discount.”  In JD Factors, JD and Brankle entered into a factoring and security agreement whereby JD agreed to buy Brankle’s accounts receivable under an agreed-upon discount formula.  Under the agreement, JD advanced money to Brankle in exchange for an assignment of all rights, payments and proceeds in Brankle’s accounts.  Account debtors then paid JD directly.  The factoring and security agreement granted JD a first priority security interest in Brankle’s assets, including the accounts receivable.

2.  Generally, factoring agreements can involve a security interest being granted in an account.  As such, Indiana’s version of the UCC can govern the relationship.  Ind. Code § 26-1-9.1-109(a) states that Article 9 will apply to a transaction intended to create a security interest in accounts and to any sale of accounts.

3.  I.C. § 26-1-9.1-607 states:  “If so agreed, and in any event after default, a secured party . . . may enforce the obligations of an account debtor . . . and exercise the rights of the debtor with respect to the obligation of the account debtor . . . . to make payment or otherwise render performance to the debtor . . ..”  Under the UCC, therefore, JD (as a secured party) was entitled to enforce collection of defendant Freightco’s (the account debtor’s) debt.

4.  The Court rejected the proposition that the secured party/factoring relationship was akin to that of principal and agent.  Again, Article 9 of the UCC, not principal/agency law, applied.  “Here, [plaintiff/JD] is not acting as a mere collection agent for Brankle; rather, the two entities are parties to a sophisticated lending relationship.”  Only JD, not Brankle, possessed the authority to seek collection of the receivable.  “[JD] is a secured party possessing a right to be enforced, and Section 607 of the Indiana UCC provides the statutory authority for its enforcement of the [debt/account receivable].” 

The JD Factors opinion arose out of a technical dispute surrounding “diversity of citizenship” and whether the case could be in federal court, as opposed to state court.  For any lawyers reading this post, the Court concluded that “[JD] as a secured party possesses a right subject to enforcement in this action and thus is a ‘real party in interest’.  Consequently, diversity of citizenship exists between plaintiff [JD], a company of California citizenship, and defendant Freightco [account debtor], a company of Indiana citizenship . . ..”  Freightco asserted that the Indiana citizenship of Brankle should destroy diversity so as to force the case to be heard in the Indiana state courts.  The Court denied Freightco’s motion to dismiss. 


“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.  SeeInd. 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 providerId. 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.