repairs were completed and until Stylemaster specifically “accepted” the molds from their
manufacturer.’ See T.R. 1/21/03, p. 55, Testimony of Raymond Wenk (“Debugging isn’t complete until
the product is accepted by the customer and saying the mold is in good condition and I will pay all
balances owed on it.”). Because Matrix presumably did not complete the debugging by the time that
Stylemaster filed for bankruptcy, Matrix asserted at trial that Stylemaster never accepted the molds, and
thus that the molds were still owned by Cost Reductions. If Stylemaster did not own the molds, Matrix
concluded, it did not have the power to grant the Bank a lien on those molds.
The Bankruptcy Court disagreed with Matrix’s position and concluded that Stylemaster did own

the molds, stating that:

The acceptance that Matrix refers to appears to be nothing more than an

industry practice that determines when the cost of repair and debugging

ofa new mold shifts from the seller to the buyer. There is no evidence

that it means anything else. Stylemaster appears to have had complete

control over the molds in question, deciding where they should be

shipped and how they would be used in production. There is no

evidence that Stylemaster was prohibited from using the molds as

collateral or that Cost Reductions had any input with regard to the

disposition of the molds, other than approval of repair cost that it was

required to pay during the debugging phase. Thus, Stylemaster

exercised ownership rights in the collateral.
Inre S.M. Acquisition Co., 296 B.R. 452, 464 (Bankr. N.D. Il]. 2003). Although the Bankruptcy Court’s
rationale is sound, it does not provide us with enough information to assess, on appeal, whether the court

was legally justified in its conclusion that Stylemaster exercised sufficient ownership rights to give alien

on the property in question.

‘Again, the argument that Cost Reductions owned the molds because they were responsible for
debugging costs is completely at odds with Matrix’s other contention that Stylemaster owes Matrix
money for repairing and debugging costs. However, this is an issue which we will address at a later date,
once the Bankruptcy Court has issued further findings.

4


its facility. In fact, Stylemaster warranted that all of its property was housed at four locations, none of
which was Matrix’s facility. When Stylemaster and the Bank revised the loan agreement in 1997,
Stylemaster again failed to list Matrix’s facility as a place where collateral was kept. Given this
evidence which suggests that the Bank did not know about the molds, it is unlikely that the Bank could
persuade the Bankruptcy Court that it believed that Stylemaster owned the molds. Thus, the estoppel
portion of the Midwest Decks test probably will not apply in this case.
CONCLUSION

For the foregoing reasons, we remand this case to the Bankruptcy Court for further evidentiary
proceedings, if necessary, and for a more specific statement of its reasons for concluding that
Stylemaster had sufficient rights in the molds to convey a security interest in them to the Bank. The
remand is limited to this purpose. Once the Bankruptcy Court has issued an opinion, we will set a
briefing schedule should one of the parties indicate that it wishes to appeal the Bankruptcy Court’s

findings on remand. Once the issue is fully briefed on appeal, we will consider it along with the

remainder of the issues presented by the parties on appeal. Itjs so ordered.

MARVIN EMASPEN
United States District rudge 4

Dated yf: h oo Y


The Bankruptcy Court correctly observed that neither the Illinois statute nor the Uniform
Commercial Code (which also uses the phrase) defines the Phrase “rights in the collateral,” but that
several courts have interpreted its meaning. Jnre S.M. Acquisition Co., 296 B.R. 452, 464 (Bankr. N.D.
Ill. 2003). The phrase “rights in the collateral” is not Synonymous with ownership or title because one
may have a valid security interest in Property that is not owned by the grantor of the interest. See Guzell
v. Hiller, 233 F.3d 518, 521 (7th Cir. 2000). Rather, cases interpreting earlier versions of the Ilinois
Code (which also uses the phrase) have named three ways in which rights in the collateral may be
obtained: 1) the debtor may have possession and title to the goods; 2) the true owner consents to the
debtor’s use of the collateral as security; or 3) the true owner is estopped from denying a security
interest. Midwest Decks, Inc. v. Butler & Baretz Acquisitions, Inc., 649 N.E.2d 511 (Ill. App. Ct. 1 995).
The Bankruptcy Court Properly cited this authority, and then went on to conclude that Stylemaster
exercised ownership rights in the collateral because it had “complete control” over the molds. However,
none of the criterion articulated in Midwest Decks Suggests that having “complete control” over an item

of property alone is sufficient to Satisfy the “rights in the collateral” requirement?

*The facts of this case are not neatly analogous to those of. ‘Midwest Decks and thus the law
announced in Midwest Decks is not easy to apply. In both Midwest Decks and the subsequent cases that
have applied its legal standard, the Parties to the case had competing ownership claims to the collateral in
question. Here, Cost Reductions is not a Party, nor does it claim that it owned the molds. Rather, it is
Matrix that claims that Cost Reductions owned the molds, This puts us in a rather unique position for

which the Midwest Decks test is not a neat fit. It is therefore understandable that Judge Schmetterer

three methods enumerated for establishing rights in the collateral Constitutes is an exhaustive list.
Indeed, other states have devised other tests in attempting to define “rights in the collateral,” See, e.g.,
Hong Kong and Shanghai Banking Corp. v. HFH USA Corp., 805 F. Supp. 133 (W.D. N.Y. 1992)
(applying New York law). However, we have been unable to find any authority in Illinois other than the
test announced in Midwest Decks from which we could infer that complete control of the collateral is
sufficient to constitute rights in the collateral. For this reason, although we are willing to entertain
Suggestions by the Bankruptcy Court that we should look to other interpretations of that Phrase that have
been used outside this jurisdiction, we may do so only if the standard used by the Bankruptcy Court is
well-articulated and the factual record is developed sufficiently to support the use of, such a standard,

6

ee esre*«,_*«~,c....___——-


(ALYS!

We have two concerns with the Bankruptcy Court’s finding that Stylemaster had authority to
grant a security interest in the molds. Our first has to do with the applicable burden of proof. It is well-
established that “{t]he burden of proving that an item of property is subject to a security interest is on
the party asserting the interest.” In re Standard Foundry Prods., Inc., 206 B.R. 475, 478 (Bankr. N.D.
Ill. 1997). It was therefore the Bank’s burden to prove that Stylemaster owned the molds at the time it
allegedly conferred a security interest in them to the Bank. We do not believe that the Bankruptcy
Court’s opinion places sufficient emphasis on this burden with regard to the question of who owned the
molds. For example, it emphasized that “[t]here is no evidence that Stylemaster was prohibited from
using the molds as collateral or that Cost Reductions had any input with regard to the disposition of the
molds...” In re S.M. Acquisition Co., 296 B.R. 452, 464 (Bankr. N.D. Ill. 2003). Citing simply to the
absence of evidence regarding ownership does not indicate that the Bank fulfilled its burden of showing
that it owned the collateral. One of the decisions for our decision to remand, therefore, is for a more
complete explanation of how the Bank fulfilled its burden of proof with regard to the issue of ownership.

Our second concern with the Bankruptcy Court’s finding is that, although it correctly cited the
appropriate statutory law, it did not explain how it applied that law to the facts of the present case or how
the evidence produced at trial supported its finding. Illinois law provides that a security interest is only
enforceable against the debtor and third parties with respect to an item of collateral if: 1) value has been
given for the collateral; 2) “the debtor has rights in the collateral or the power to transfer rights in the
collateral to a secured party”; and 3) one of several specifically enumerated conditions have been met.
810 II). Comp. Stat. 5/9-203. The issue we address here is whether Stylemaster had “rights in the

collateral”such that it could transfer a security interest in that collateral to the Bank.


The second and third categories listed in Midwest Decks test apply only where the debtor lacks
title to and possession of the collateral, for both of those categories refer to the “true owner” of the
collateral as being someone other than the debtor. In this case, if the Bankruptcy Court were to find that
Stylemaster lacked title to and possession of the goods, the “true owner” would be Cost Reductions (the
seller of the molds).

As for the second category of Midwest Decks, it provides that a person may give a security
interest in goods where the “true owner” consents to the use of those goods as collateral. There is
nothing in the Bankruptcy Court’s findings of fact or opinion which would indicate that Cost Reductions
consented to the use of the molds as collateral for Stylemaster’s loan from the Bank. Likewise, the third
category of Midwest Decks states that a person may give a security interest in collateral where the “true
owner” is estopped from asserting that it owned the goods. Again, we lack sufficient evidence to assess
whether Cost Reductions should be estopped from asserting that it owned the molds. Moreover, to
succeed on an estoppel theory, the court must find that “(t]he party asserting the estoppel . . . actually
relied on the words or conduct and may not have had knowledge of (or convenient access to) facts
contrary to those on which he relied.” In re Pubs, Inc., 618 F.2d 432, 438 (7th Cir. 1980). Here,
although the Bankruptcy Court never addressed the specific question of whether the Bank relied on
representations made by Cost Reductions about ownership of the molds, it did make affirmative findings
which suggest that the Bank never even knew that the molds existed. For example, during loan
negotiations between Stylemaster and the Bank, the Bank was not informed that Matrix was one of

Stylemaster’s molders. Similarly, it was not informed that Matrix held some of Stylemaster’s molds at

133 (W.D. N.Y. 1992) (finding that constructive possession plus title is sufficient to confer “rights in the
collateral” where delivery of the collateral is to someone other than the debtor). The Bankruptcy Court
made evident its belief that Stylemaster had complete control over the molds and we see no reason to
disturb that factual finding. We therefore conclude that, for the purposes of the Midwest Decks test,
Sytlemaster had “possession” of the molds.


4

i
a, Minute Order Form (06/97)

United States District Court, Northern District of Hlinois

Nai if Assigned Jud { Sitting Judge if Other
vor Magistrate Judge Marvin Aspen than Assigned Judge
CASE NUMBER 03 C 7072 DATE 4/28/2004
CASE Matrix IV, Inc. Vs. American National Bank & Trust Co.
TITLE
{In the following box (a) indicate the party filing the motion, e.g., plaintiff, defendant, 3rd party plaintiff, and (b) state briefly the nature
MOTION: of the motion being presented.]
DOCKET ENTRY:

a)

o Filed motion of [ use listing in “Motion” box above.]

(2) o Brief in support of motion due
(3) Oo Answer brief to motion due . Reply to answer brief due.
(4) oO Ruling/Hearing on set for at :
(5) B Status hearing set for 6/24/2004 at 10:30 A.M..
(6) Oo Pretrial conference[held/continued to} (set for/re-set for] on set for at .
(7) QO Trial[set for/re-set for] on at
(8) Oo [Bench/Jury trial] [Hearing] held/continued to at
(9) im This case is dismissed [with/without] prejudice and without costs[by/agreement/pursuant to}
QFRCP4(m) ClLocal Rule 41.1 CFRCP41(a)(1) O FRCP41(a)(2).
ao) [Other docket entry] Enter Memorandum Opinion and Order: We remand this case to the
Bankruptcy Court for further evidentiary proceedings. Once the Bankruptcy Court has issued an opinion,
we will set a briefing schedule should one of the parties indicate that it wishes to appeal the Bankruptcy
Court’s findings on remand. Once the issue is fully briefed on appeal, we will consider it along with the
remainder of the issues presented by the parties on appeal. The in court hearing set for 4/29/04 is stricken.
a1) @ (For further detail see order attached to the original minute order.]
No notices required, advised in open court. Document
; Number
‘No notices required. number of notices
wv | Notices mailed by judge’s staff.
Notified counsel by telephone. APR 29 7

Docketing to mail notices. , |
Mail AO 450 form “dt rs. —_

Copy to judge/magistrate judge. “ay

arz204

=> dave mailed notice
courtroom Lot —

GL deputy’s . ow
initials

Date/time received in ;
central Clerk’s Office mating deputy ital

2



Applying Midwest Decks to this case, we are without sufficient evidence to conclude as to
whether Stylemaster had adequate “rights in the collateral” to transfer a security interest in the molds
to the Bank, We address each of the three methods announced in Midwest Decks of determining “rights
in the collateral” in turn. First, title and possession of an item of collateral are sufficient to constitute
“rights in the collateral.” Our first question is thus whether Stylemaster had title to and possession of
the molds, After examining the Bankruptcy Court’s findings of fact as well as the record on appeal, we
find that we are without guidance as to whether Stylemaster had title to the molds at the time it gave the
Bank its security interest. For example, we do not know if there was a sale agreement between
Stylemaster and Cost Reductions which specified when title would pass from one party to the other. See,
e.g., 810 Il. Comp. Stat. 5/2-401(1) (“title to goods passes from the seller to the buyer in any manner
and on any conditions explicitly agreed on by the parties.”). We do not know whether, according to the
parties’ agreement, the molds could have been rejected by Stylemaster even if they conformed to
specifications agreed to by the parties (a so-called “sale on approval”). See, e.g., 810 Ill. Comp. Stat.
5/2-326(2) (providing that “[g]oods held on approval are not subject to the claims of the buyer’s
creditors until acceptance.”). The Bankruptcy Court’s opinion is devoid of any mention of the issue of
title. We thus find that we do not have enough information to assess whether the Bankruptcy Court
believed that Stylemaster had title to the goods at the time it entered into the security agreement with

the Bank.®

We believe that the record is not sufficiently developed on this point for us to do so.

SAs Matrix points out in its brief, the Midwest Decks test requires both title and possession. It is
undisputed that Stylemaster did not have physical possession of the molds (they were in Matrix’s hands).
However, possession is not simply physical. Blacks Law Dictionary defines possession as “[hJaving
control over a thing with the intent to have and to exercise such contro} . . . [a} person who, although not
in actual possession, knowingly has both the power and the intention at a given time to exercise dominion
or control over a thing, either directly or,through another person or persons.” Black’s Law Dictionary
1163 (6th ed.1990); see also Hong Kong and Shanghai Banking Corp. v. HFH USA Corp., 805 F. Supp.

7


Bank and Stylemaster in which Stylemaster granted the Bank a first priority lien on all of its property
(including the molds). The Bank brought this Adversary proceeding before the Bankruptcy Court
seeking a declaratory judgment that the Bank is entitled to the molds that are currently being held by
Matrix.

Matrix presents several counter-arguments. For the purposes of this opinion, Matrix’s important
argument is that Stylemaster did not have the authority to give the Bank a lien on some of the molds
because Stylemaster lacked sufficient possessory interest to give anyone a security interest in those
molds.

The molds in question were ordered by Stylemaster in 1998 and shipped directly from the seller,
a company called Cost Reductions, to Matrix’s manufacturing plant. Matrix had to “debug” the molds
before they could be put into production by setting them up, testing them, and repairing them. Based
on the testimony of several witnesses, the Bankruptcy Court found that it was industry practice for the
seller (not the buyer) of a new mold to pay for any repair or debugging cost incurred before the mold
could be used in production. Accordingly, the Bankruptcy Court determined that Cost Reductions, not
Stylemaster, had to pay for the cost of debugging and repair. At trial, Matrix cited to this industry

standard as evidence that Stylemaster did not actually obtain title or control over the molds until the

>Matrix’s central argument on appeal, which we refrain from addressing in this opinion, is that it
has a first priority tool and die lien on the molds which trumps the lien asserted by the Bank. As
Bankruptcy Judge Schmetterer astutely pointed out in his opinion, this argument stands in direct
contradiction to Matrix’s other argument (addressed here) that Stylemaster did not have the authority to
give anyone a lien on certain molds because it did not own them. If, in fact, Stylemaster did not own or
have control over the molds, then neither Matrix nor the Bank could have obtained a lien on those molds
for money owed to them by Stylemaster. Thus, if upon remand Judge Schmetterer decides that
Stylemaster did not have rights over the molds in question, then those molds would simply be removed
from consideration in the present action. Given this potential result, it is curious that Matrix would argue
with such vigor that Stylemaster lacked authority to grant a lien on the molds. Matrix is, however, the
master of its own case, and we will therefore address all of the arguments it has raised, whether we
believe them to be wise or not.


Stylemaster owned! some of the property at issue in this case. Because we believe this question is
central to resolution of the entire dispute (at least with regard to the particular property in question), we
refrain from ruling on the remainder of the issues raised by Matrix in its appeal until after the
Bankruptcy Court has conducted these further proceedings. We also dismiss as moot Matrix’s Motion
to Supplement the Record on Appeal, as the proffered documents are relevant to the question of who
owned the molds.”
BACKGROUND

The following facts are taken from the Bankruptcy Court’s findings of fact and conclusions of
Jaw. See Stylemaster, 296 B.R. at 456-58. Stylemaster is a company that purchases and sells storage
containers that are manufactured using plastic injection molds. The Bank is a creditor of Stylemaster.
At the time it filed the present action, Stylemaster owed the Bank over nine million dollars. Matrix, a
vendor that manufactured plastic storage containers for Stylemaster using plastic injection molds, is also
one of Stylemaster’s creditors. Stylemaster currently owes Matrix over six million dollars.

Stylemaster voluntarily filed for bankruptcy protection in 2002. The present dispute centers
around efforts made by the Bank and Matrix to recoup some of the money owed to them by Stylemaster.
The Bank argues that it is entitled to a first-priority lien on all of Stylemaster’s property, including sixty-
two plastic injection molds that were purchased by Stylemaster but that are currently held by Matrix.

The Bank claims that this lien stems from certain loan and security agreements entered into between the

"For the purposes of this opinion, we use the term “own” in a particular sense. Rather than
associating ownership with title, as is traditionally the case, see Black’s Law Dictionary 1105 (6th ed.
1990) (defining “own” as having “legal title”), we use the term specifically to mean “rights in the
collateral or the power to transfer rights in the collateral to a secured party,” which is the standard set
forth in Illinois law for assessing whether a party has the right to give another party a security interest in
goods. See 810 Ili. Comp. Stat. 5/9-203.

Thus, the Bankruptcy Court may itself decide whether or not to allow the proffered documents
into evidence on remand.


UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF {LLINOIS
EASTERN DIVISION

In re:

S.M. ACQUISITION CO., d/b/a
STYLEMASTER, INC.,

Debtor.

MATRIX IV, INC., No. 03 CV 7072
Appellant,

v.

AMERICAN NATIONAL BANK AND
TRUST COMPANY OF CHICAGO,

Appellee.

eS SS SSeS ee

MEMORANDUM OPINION & ORDER

MARVIN E. ASPEN, District Judge:

S.M. Acquision Co., d/b/a Stylemaster, Inc. (“Stylemaster”) filed a petition for bankruptcy relief
under Chapter 11. American National Bank and Trust Company of Chicago (the “Bank”) brought a
related adversary proceeding against Matrix IV, Inc. (“Matrix”) in which the Bank sought a declaration
that its lien on certain Stylemaster property was superior to the lien asserted by Matrix. After a bench
trial, the United States Bankruptcy Court for the Northern District of Illinois issued its findings of fact
and conclusions of law and entered judgment in the Bank’s favor. See In re S.M. Acquisition Co., 296
B.R, 452 (Bankr. N.D. III. 2003). Matrix now appeals the judgment, as well as the Bankruptcy Court’s
earlier decision to strike one of Matrix’s affirmative defenses. For the reasons set forth below, we

remand the action to the Bankruptcy Court for further proceedings on the specific issue of whether

DOCKETED

APR 29 2004