Title: Allis-Chalmers Cred. Corp. v. Cheney Investment, Inc.

State: kansas

Issuer: Kansas Supreme Court

Document:

227 Kan. 4 (1980)
605 P.2d 525
ALLIS-CHALMERS CREDIT CORPORATION, Appellant,
v.
CHENEY INVESTMENT, INC., Appellee.
No. 49,924

Supreme Court of Kansas.
Opinion filed January 19, 1980.
Larry B. Spikes, of Martin, Pringle, Schell, and Fair, of Wichita, argued the cause and was on the brief for the appellant.
Keith D. Richey, of Rumsey and Richey, of Wichita, argued the cause and was on the brief for the appellee.
The opinion of the court was delivered by
PRAGER, J.:
This is a dispute between two secured creditors over the priority of their security interests in an Allis-Chalmers combine. The facts in the case are undisputed and are covered generally by a stipulation of fact filed by the parties in district court. The factual circumstances giving rise to the controversy are set out in chronological order as follows: On November 16, 1970, Lloyd Catlin executed a retail installment contract to Ochs, Inc., a dealer for Allis-Chalmers Corporation, to cover the purchase price of an Allis-Chalmers combine identified as G-7754. This contract was in a total amount of $10,149.44 including the financing charge. There was no provision in the contract for future advances. In the course of the opinion, this will be referred to as contract #1. This contract was assigned to plaintiff-appellant, Allis-Chalmers Credit Corporation, who financed the transaction. On November 27, 1970, a financing statement covering combine G-7754 was filed by Allis-Chalmers with the register of deeds of Barber County, Kansas.
On December 19, 1970, Cheney Investment Company, Inc., the defendant-appellee, made a cash advance to Lloyd Catlin, taking *5 a security interest (chattel mortgage) in combine G-7754. On December 24, 1970, Cheney Investment filed a financing statement covering combine G-7754 with the Barber County register of deeds. In the course of the opinion, we will refer to the security interest of Cheney Investment as the chattel mortgage. On September 17, 1971, Catlin purchased a new Allis-Chalmers combine G-17992 from Highway Garage and Implement Company, another dealer of Allis-Chalmers. The retail installment contract which created the security interest included both the new combine, G-17992, and the used combine, G-7754. This contract will be referred to in the opinion as contract #2. Contract #2 provided that contract #1 was cancelled and the notation "Payoff ACCC-Wichita $4,542.00" was written on its first page. The balance owing under contract #1 was included in the purchase price stated in contract #2. There was no other reference to the prior security agreement or financing statement. On September 29, 1971, Allis-Chalmers Credit Corporation, as assignee of contract #2 from Highway Garage and Implement Company, filed a financing statement covering both the new combine G-17992 and the used combine G-7754. On February 16, 1972, Allis-Chalmers notified Cheney Investment of its claim to a senior security interest on combine G-7754, as Cheney had taken possession of that combine when Catlin defaulted on his loan payments to Cheney Investment.
On May 30, 1972, Allis-Chalmers and Cheney Investment executed a letter agreement to allow combine G-7754 to be returned to Catlin, the debtor, with each party to notify the other if Catlin defaulted on either financing agreement. On September 11, 1973, after several revisions and amendments to contract #2, Catlin sold combine G-17992 and paid Allis-Chalmers $11,641.12, leaving an unpaid balance of $8,300. A new payment schedule was prepared for the balance owing plus a new finance charge. Thereafter, Catlin defaulted on his payments, both to Allis-Chalmers and to Cheney Investment. On March 1, 1974, Cheney Investment sold combine G-7754 at a chattel mortgage sale, having taken possession shortly after Catlin defaulted on the Allis-Chalmers obligation. Allis-Chalmers participated in the sale but was not the purchaser. The sale proceeds totaled $8,560. Subtracting the amount then owing to Cheney Investment and costs, there remained $2,111.80 to satisfy the security interest of Allis-Chalmers.
*6 Following the above events, the plaintiff, Allis-Chalmers, brought this action against Cheney Investment for conversion of combine G-7754, claiming a senior and prior security interest. At that time, Catlin's indebtedness to Allis-Chalmers was in the amount of $8,650 plus interest. In its answer, Cheney Investment claimed a first and prior lien against the combine in the amount of $6,093.79 plus interest. All of the above facts were stipulated by the parties. In addition to the stipulation, the case was submitted on the deposition of Richard F. Ellis, vice-president of Allis-Chalmers. In his deposition, Ellis testified that contract #1 between Ochs, Inc., and Lloyd Catlin was paid off and cancelled at the time contract #2 was executed and the balance owing on contract #1 was carried forward and became a part of the consideration for contract #2. He agreed that contract #2 was a new and separate contract.
The district court held in favor of defendant Cheney Investment, reasoning that contract #2 cancelled the prior contract #1 and was thus an entirely new and separate agreement which created an entirely new and distinct security interest. In its memorandum decision, the trial court emphasized that contract #1 was one involving only the sale of combine G-7754 and, since it contained no provision covering future advances or sales, it was a distinct and separate transaction from contract #2. The trial court then concluded that the advances made under contract #2, dated September 17, 1971, did not relate back and were not covered by the financing statement filed by Allis-Chalmers on November 27, 1970. Thus, it concluded that the intervening security interest of Cheney Investment, created by its chattel mortgage on December 19, 1970, and perfected by the filing of its financing statement on December 24, 1970, was a security interest, senior and prior to the security interest of Allis-Chalmers created by contract #2 in September of 1971. The trial court entered judgment in favor of defendant Cheney Investment, and Allis-Chalmers has appealed to this court.
The question of priority presented in this case is one of first impression in this state under the Kansas Uniform Commercial Code, K.S.A. 84-1-101 et seq. The subject of secured transactions is covered in Article 9 of the code (84-9-101 through 84-9-508). The question of priorities between conflicting security interests is *7 controlled by K.S.A. 84-9-312(5)(a). However, that section interrelates with and must be read with other sections of Article 9 in order to be properly understood. At the outset, we should consider some of these provisions of the code before turning to a resolution of the issue presented. K.S.A. 84-9-303 requires both "attachment" and "perfection" for a security interest to come into existence. Attachment occurs when a creditor extends value and enters into an agreement for the debtor to give a security interest to the creditor in some property of the debtor (84-9-204[1]). Perfection is accomplished (with exceptions not here pertinent) upon the filing of a financing statement (84-9-302). It is immaterial which of these steps occurs first. It is provided in 84-9-402 that a "financing statement may be filed before a security agreement is made or a security interest otherwise attaches." The UCC comment to 84-9-303 states:
In this case, both of the parties have perfected their respective security interests. Simply stated, the issue to be determined is which of their security interests is entitled to priority over the other. Section 84-9-312(5)(a) governs the priority as between conflicting security interests. Prior to 1975, K.S.A. 84-9-312 provided in part as follows:
At this point, we should examine K.S.A. 84-9-402. Subsection (1) sets out the simple formal requisites of a financing statement under this article:
(1) Signatures of the debtor and secured party;
(2) addresses of both parties; and
(3) a description of the collateral by type or item.
It is important to note that the security agreement itself is not filed of record. As pointed out in the official UCC comment to *8 84-9-402, this section adopts a system of "notice filing." The notice itself indicates merely that the secured party may have a security interest in the collateral described. The burden is placed upon other persons to make further inquiry from the parties concerned in order to obtain a disclosure of the complete state of affairs. The code philosophy is that a simple, filed notice that the secured party and debtor may be financing with respect to collateral described in the financing statement should be a "red flag" warning to third parties not to proceed with any financing on the same collateral of the debtor until investigation is made to see that the road ahead has been cleared. See In re Rivet, 299 F. Supp. 374, 379 (E.D. Mich. 1969), citing Professor Roy L. Steinheimer, Jr., of the University of Michigan Law School, in a commentary on 9-402 in 23 M.C.L.A. 467. In his article, Professor Steinheimer suggests that if there is a prior filing, the second lender should do one of the following things:
The controversy arose in this case, as it has in other cases, because K.S.A. 84-9-312(5)(a), as originally adopted, did not have clear and specific language governing the right of a lender to include later advances made in subsequent transactions under the financing statement filed at the time of the original transaction. It should be noted that K.S.A. 84-9-204(5) provided that "[o]bligations covered by a security agreement may include future advances or other value whether or not the advances or value are given pursuant to commitment."
The issue as to the priority of the security interest of a lender, who made advances after the filing of the original financing statement, over the security interest of an intervening creditor came before a Rhode Island superior court in Coin-O-Matic Service Co. v. Rhode Island Hospital Trust Co., 3 U.C.C. Rptr. Serv. 1112 (R.I. Super. Ct. 1966). The district court in the present case relied upon Coin-O-Matic in holding that the security interest of Cheney Investment was prior to the security interest of Allis-Chalmers. In Coin-O-Matic, the debtor gave a security interest in an automobile to the seller, who assigned the debt to *9 Rhode Island Hospital Trust Company which filed a financing statement. One year later, the debtor gave Coin-O-Matic a security interest. It filed a financing statement. The following month, Rhode Island Hospital Trust Company loaned the debtor an additional sum of money, one-third of which was used to pay off the first note to Rhode Island Hospital Trust Company. The first note was cancelled, a new security agreement executed, and a new financing statement filed. When the debtor went into bankruptcy, both Coin-O-Matic Service Company and Rhode Island Hospital Trust Company claimed a prior security interest in the automobile. Rhode Island Hospital Trust Company argued that the first financing statement was sufficient to protect the second contract, as it effectively put the whole world on notice that the collateral was subject to present and future security interests in favor of the filing party. This argument was rejected by the Rhode Island superior court. The Coin-O-Matic court first recognized that giving the first-to-file priority in all subsequent transactions placed the lender in an unusually strong position. The court reasoned that, under such a holding, the debtor would be precluded from obtaining a second loan, even to pay off the first, because subsequent lenders would be reluctant to lend money based on the collateral already mortgaged, as their security interest would always be subject to preemption by a subsequent security agreement in favor of the first creditor. The court stated that to construe the UCC to give the first lender an interest in collateral for future advances, absent future advance provisions in the security agreement, would render information obtained under 9-204 irrelevant. The court noted that the first creditor could easily protect future advances by including a future advance provision as authorized by 9-204(5).
The ultimate conclusion in Coin-O-Matic was that a reasonable interpretation of 9-312(5)(a) should be that a "single financing statement in connection with a security agreement when no provision is made for future advances is not an umbrella for future advances based upon new security agreements, notwithstanding the fact that involved is the same collateral." (3 U.C.C. Rptr. Serv. at 11201.) This portion of the decision in Coin-O-Matic caused controversy and widespread criticism of the rule announced therein.
The holding in Coin-O-Matic, requiring a future advance *10 clause in the original security instrument in order for future advances to have 9-312 priority, has been rejected by the vast majority of the jurisdictions in subsequent cases. In rejecting Coin-O-Matic, those courts generally stress the "notice" or "red flag" function of the code and hold that a financing statement on file is notice to the entire world of present or future security interests in the collateral. Cases taking this approach which are contrary to the rule of Coin-O-Matic are the following: In re Rivet, 299 F. Supp. 374; First Nat. Bank & T. Co. of Vinita, Okl. v. Atlas Credit Corp., 417 F.2d 1081 (10th Cir.1969); James Talcott, Inc. v. Franklin National Bank, 292 Minn. 277, 194 N.W.2d 775 (1972); In re Wilson, 13 U.C.C. Rptr. Serv. 1195 (E.D. Tenn. 1973); In re Gilchrist Company, 403 F. Supp. 197 (E.D. Pa. 1975); Index Store Fixture Co. v. Farmers' Trust Co., 536 S.W.2d 902 (Mo. App. 1976); Thorp Finance v. Ken Hodgins, 73 Mich. App. 428, 251 N.W.2d 614 (1977); Matter of Gruder, 89 Misc.2d 477, 392 N.Y.S.2d 203 (1977); Genn v. CIT Corp., 40 Md. App. 516, 392 A.2d 1135 (1978); Chrysler Credit Corp. v. Community Banking Co., 35 Conn. Supp. 73, 395 A.2d 727 (1978).
The rationale found in James Talcott, Inc. v. Franklin National Bank, 292 Minn. at 290-292, well illustrates the approach taken by those courts which have rejected the rule adopted in Coin-O-Matic:
Matter of Gruder, 89 Misc.2d at 481, reached the same result, quoting White & Summers, U.C.C. HB, § 25-4 at p. 908, as follows:
The only case supporting Coin-O-Matic called to our attention is Texas Kenworth v. First Nat. Bank of Bethany, 564 P.2d 222 (Okla. 1977). We have concluded that the district court in this case was not justified in relying upon the decision in Coin-O-Matic. The rule of Coin-O-Matic was immediately rejected by the UCC permanent editorial board. It conceded that under the 1962 code, as originally adopted, the position of an intervening creditor in reference to a subsequent advance by an earlier secured party was debatable. In order to clarify the matter, the editorial board suggested an amendment to 9-312 by the addition of a new subsection (7) which was subsequently adopted in various states. Subsection (7) was adopted by the Kansas legislature by amendment of K.S.A. 84-9-312 in 1975, effective January 1, 1976. The new subsection (7) may be found at K.S.A. 1979 Supp. 84-9-312(7) and is as follows:
The issue has clearly been laid to rest in Kansas by the adoption of the new subsection (7) of K.S.A. 1979 Supp. 84-9-312 by the Kansas legislature in 1975. We note the official UCC comment to *12 that section which is printed in the 1979 Supp. at p. 64, and which states as follows:
Comment (7) is followed by example 5, which sets forth a hypothetical factual situation involving a question of priority which essentially presents the same issue to be decided in this case. It states:
Also note should be taken of the official UCC comment to K.S.A. 1978 Supp. 84-9-402, which states on p. 75 of the 1979 Supp. as follows:
It is clear that subsection (7) was adopted by the Kansas legislature to make it clear that K.S.A. 84-9-312(5)(a) should be applied to future advances made by the first creditor, whether such advances are "committed" or "noncommitted" thus making it immaterial whether or not there was a future advance provision in *13 the original security agreement. We regard this amendment as a clarification of the original intent of the legislature when it adopted the Uniform Commercial Code in 1965.
On the basis of the reasoning set forth above, we hold that the security interest of Allis-Chalmers in combine G-7754 is prior and superior to the security interest of the defendant, Cheney Investment, Inc. Under the undisputed facts, the proceeds from the sale of the Allis-Chalmers combine G-7754 totaled $8,650. At the time the suit was filed, Catlin's indebtedness to Allis-Chalmers was in the total amount of $8,650 plus interest. Since the security interest of Allis-Chalmers equals or exceeds the amount of the net proceeds received from the sale of the combine, after expenses of sale, Allis-Chalmers is entitled to apply the net proceeds to its debt.
The judgment of the district court is reversed and the case is remanded to the district court with directions to enter judgment in favor of the plaintiff Allis-Chalmers, awarding it the net proceeds from the sale of combine G-7754, after deducting the expenses of sale, together with interest as allowed by law and for the costs of the action.
HOLMES, J., dissenting.
I must respectfully dissent. In my opinion the trial court reached the right conclusion in this case and I would adopt the rule and reasoning set forth by the Rhode Island Superior Court in Coin-O-Matic Service Co. v. Rhode Island Hospital Trust Co., 3 U.C.C. Rptr. Serv. 1112 (R.I. Super. Ct. 1966), cited and discussed in the majority opinion. The facts are adequately set forth by the majority and need not be repeated.
As noted by the majority, a basic theory behind the UCC is one of notice filing and that a notice when filed becomes a red flag to be heeded by all. However, the same applies to the filing made by defendant Cheney Investment, Inc. Their filing is also a red flag to all who might thereafter undertake dealings with the original debtor, Catlin. In the instant case it appears clear that the initial contract and obligation underlying the first filing by Allis-Chalmers was paid and satisfied at the time the second contract was entered into and a second financing statement filed. To say that, lacking a future advance clause as contemplated by the code, life could be breathed back into the first filing when the underlying *14 obligation upon which it was based has been satisfied is difficult to accept.
The majority chooses to follow the majority rule that no future advance clause was necessary in the initial security instrument but concedes that the meaning of the statute (84-9-312[5]), upon which this conclusion rests, was debatable. The UCC permanent editorial board recognized the deficiency and recommended the addition of 9-312(7) to the code. Kansas adopted this new provision, to cover situations like the one before this court, in 1975. However, this case must be determined under the "debatable" meaning of the code prior to that amendment.
Plaintiff could have protected its future advances and its second contract by the notice filed under the first contract, if it had desired to do so, by complying with former 84-9-204(5) and including an after-acquired property and future advance clause in the original security agreement. The official UCC comment to 84-9-204(5) states in part:
The majority concludes that 84-9-312(7) was passed by the legislature in 1975 "as a clarification of the original intent of the legislature" and that 84-9-312(5) really applied to future advances all along even though there was no compliance with 84-9-204(5). Such a conclusion may not be justified. The general rule is set forth in Curless v. Board of County Commissioners, 197 Kan. 580, 587, 419 P.2d 876 (1966), where this court stated:
*15 In Coin-O-Matic, the court, after quoting section 9-312(5)(a), states at 1115-1120:
....
"Section 6A-9-204, subsection (5) provides:
*16 ....
In the instant case the parties appear to have considered the original transaction as a single transaction. No provision was made in the security agreement for future advances or after-acquired collateral. At the time of the second transaction a new combine was purchased, a new contract prepared, the old contract was paid off and cancelled. The case falls squarely within the rationale and holding of Coin-O-Matic and the opinion in that case is, in my opinion, a correct application of the UCC provisions as they existed prior to the 1975 amendment to the statute.
I would affirm the trial court with the proviso that any funds collected by Cheney Investment, Inc., in excess of the indebtedness due it together with appropriate costs, storage and other items properly included, be paid to plaintiff to apply on its claim against Catlin and the security.
SCHROEDER, C.J. and HERD, J., join the foregoing dissenting opinion.