Opinion ID: 2364401
Heading Depth: 1
Heading Rank: 3

Heading: The Bank's Rights to the CD Under Article 9 Were Superior to Read & Lundy's Writ of Attachment Because the Bank Possessed a Prior Perfected Security Interest

Text: We hold that the bank's rights to apply the CD to the balance due on the defaulted loan were superior to Read & Lundy's writ of attachment because it was a secured creditor with a prior perfected security interest in this collateral. In the world of debtors and creditors, first in time is often first in right. Here, the bank was first in time when it perfected its security interest in the pledged CD by taking possession of this instrument before Read & Lundy served its writ of attachment on the bank. [5] Initially, we note that U.C.C. Article 9, as it stood before its 2001 revision, governed Brier's pledge of his CD. See G.L. 1956 § 6A-9-102(2) (This chapter applies to security interests created by contract, including pledge   .). All statutory citations to the U.C.C. in this decision, therefore, are to the version of Article 9 that preceded the 2001 revisions (1992 Reenactment), unless otherwise noted. But regardless of which version of the code we apply, we conclude that the bank held a prior perfected security interest in the Brier CD. See Ben Carpenter, Security Interests in Deposit Accounts and Certificates of Deposit Under Revised UCC Article 9, 55 Consumer Fin. L.Q. Rep. 133, 136 (2001) (hereinafter, Carpenter) (collateral classification of nontransferable CDs are the same under both versions of Article 9). Article 9 of the code, as adopted by § 6A-9-305, codifies the common law of pledge, setting forth the general rule that a secured party obtains a perfected security interest when that party takes possession of the collateral securing a loan. Section 6A-9-305 plainly states that [a] security interest in    instruments    may be perfected by the secured party's taking possession of the collateral. Thus, if Brier's CD qualified as an instrument as that term is used in Article 9, then the bank held a perfected security interest when it took possession of the CD. But if the CD constituted some other type of collateral, then the bank would hold only an unperfected security interest because it failed to file a financing statement, pursuant to § 6A-9-302(1). Our first task, therefore, is to determine the collateral classification of this CD. Under Article 9, the CD is either a deposit account, a general intangible, or an instrument. If the CD was a deposit account, then Article 9 would not apply to this transaction. See § 6A-9-104(m) (This chapter does not apply    [t]o a transfer of an interest in any deposit account   .). Instead, the common law governing pledges would determine the rights of the bank. See Duncan Box & Lumber Co. v. Applied Energies, Inc., 165 W.Va. 473, 270 S.E.2d 140, 143 (1980). But if the CD qualified as an Article 9 instrument, then the bank, under Article 9, perfected its security interest when it took possession of the CD. See § 6A-9-305. And if the CD was a general intangible, as Read & Lundy argues, then the bank could perfect its security interest only by filing a financing statement  an act that the bank concedes it did not perform. See § 6A-9-302(1). Under the plain language of Article 9, it is readily apparent that the CD was not a deposit account. Section 6A-9-105(1)(e) defines a [d]eposit account as a demand, time, savings, passbook, or like account maintained with a bank, savings and loan association, credit union, or like organization, other than an account evidenced by a certificate of deposit.  (Emphasis added.) Because the definition of a deposit account expressly excludes CDs, the CD at issue here was either a general intangible or an instrument. Section 6A-9-106 defines a [g]eneral intangible[] as any personal property (including things in action) other than goods, accounts, chattel paper, documents, instruments, and money. According to the Official Comment, this category is a `catchall' intended to bring under Article 9 `miscellaneous types of contractual rights and other personal property which are used or may become customarily used as commercial security.' Evan H. Krinick, Most Courts Classify Nonnegotiable Certificates of Deposit That Also State They Are Nontransferable as Instruments; Thus, Lenders May Perfect Their Liens on Such Collateral by Possession, 117 Banking L.J. 347, 347-48 (2000) (hereinafter, Krinick). The comment lists goodwill, literary rights, trademarks, copyrights, and patents as examples of general intangibles. Id. at 348, 270 S.E.2d 140. Because this is a catch-all category, Brier's CD cannot qualify as a general intangible if it constitutes an instrument. An Article 9 instrument is a negotiable instrument    or a certificated security    or any other writing which evidences a right to the payment of money and is not itself a security agreement or lease and is of a type which is in ordinary course of business transferred by delivery with any necessary indorsement or assignment.  Section 6A-9-105(1)(i). (Emphasis added.) Here, neither party contends that the CD qualified as an Article 3 negotiable instrument or an Article 8 certificated security. Therefore, the bank possessed a prior perfected security interest in the CD only if the CD was a writing of a type that could be transferred by delivery with any necessary endorsement or assignment in the ordinary course of business. Read & Lundy argues that Brier's CD cannot constitute an instrument because it bore a legend on its face describing it as nontransferable. Citing In re Cambridge Biotech Corp., 178 B.R. 34 (Bankr. D.Mass.1995), Read & Lundy contends that this legend was dispositive on the issue of transferability. As such, this CD was a general intangible, it maintains, and therefore, the bank's failure to file a financing statement caused it to be an unperfected secured creditor. We disagree with this contention because In re Cambridge Biotech Corp. represents the minority view on this issue and its reasoning is against the weight of authority. See generally Krinick, at 351 (discussing In re Cambridge Biotech Corp. under Minority View heading). Instead, the majority of courts have held that CDs stamped nontransferable are nonetheless instruments for Article 9 purposes. [6] See § 6A-9-105(1)(i) (defining term instrument). Courts adopting the prevailing view hold that a CD bearing a nontransferable legend is an instrument under the U.C.C. because it still qualifies as a writing which evidences a right to the payment of money and is not itself a security agreement or lease and is of a type which is in ordinary course of business transferred by delivery with any necessary indorsement or assignment. In re Omega Environmental Inc. v. Valley Bank, NA, 219 F.3d 984, 986 (9th Cir.2000) (per curiam) (citing Va.Code § 8.9-105(1)(i)). The majority of courts so hold even though the CD in question bears a nontransferable legend  because such CDs still are, as a matter of law, writings of a type that are transferred by delivery in the ordinary course of business with any necessary endorsement. Thus, as a matter of law, [t]here is no basis in UCC § 9-105(1)(i) for allowing the legend on a writing to control its transferability. In re Latin Investment Corp. v. Capital Bank, N.A., 156 B.R. 102, 106 (Bankr.D.C. 1993). In so ruling, most courts defer to the `realities of the marketplace' rather than `narrowly looking to the form of the writing.' In re Omega Environmental Inc., 219 F.3d at 987. Almost every court to face the issue has rejected the argument that the language on the certificate is controlling, i.e., if a certificate of deposit bears the legend `nontransferable' it cannot be `in the ordinary course of business transferred.' Id. Instead, recognizing that the business world regularly transfers writings bearing the legend `nontransferable,' the court should give that practice legal effect unless doing so is inconsistent with the U.C.C.' In re Latin Investment Corp., 156 B.R. at 106. We are persuaded to adopt this prevailing view, not merely because a majority of courts that have struggled with this issue have so concluded, but also because it is in concert with one of the underlying purposes of the U.C.C.: namely, to effectuate customary business practices, not thwart them. See G.L.1956 § 6A-1-102(2)(b) & cmt. See also In re Latin Investment Corp., 156 B.R. at 106. We note that the case principally relied on by Read & Lundy, In re Cambridge Biotech Corp., is often criticized because that court made no attempt to effectuate the usual business practices that apply to the transferability of CDs. E.g., In re Omega Environmental, Inc., 219 F.3d at 988 n. 8. Instead, the bankruptcy judge in that case simply said, I do not agree that the `realities of business practice' need to be consulted. In re Cambridge Biotech Corp., 178 B.R. at 38. In addition, other cases adopting the minority position are similarly unconvincing because they assume that a CD bearing a nontransferable legend means that it is a writing of a type that is automatically nontransferable, regardless of the actual business practice that prevails in this area. See Prudential-Bache Securities, Inc. v. Bartow County Bank, 187 Ga.App. 530, 370 S.E.2d 751, 752 (1988) (concluding, without analysis, that `nontransferable' facial language precluded CD from qualifying as an `instrument' under Article 9); Bank IV Topeka, N.A. v. Topeka Bank & Trust Co., 15 Kan.App.2d 341, 807 P.2d 686, 691 (1991) (same). Instead, we recognize that banks, which are subject to various state and federal regulatory requirements, often stamp their CDs as nontransferable for reasons wholly unrelated to their actual transferability in the commercial marketplace. Thus, [m]ost institutions include a `nontransferable' legend on their certificates of deposit to avoid classifying the time deposits as transaction accounts under Federal Reserve Board Regulation D, which are subject to different reserve and reporting requirements. Carpenter, at 136 n. 29 (citing 12 C.F.R. § 20.4.2(f)). This is not to say that, in this case, the bank actually labeled the CD as nontransferable for reasons relating to such reserve and reporting requirements. But it does show that a nontransferable legend, by its very terms, does not necessarily preclude a depositor from transferring the CD to third parties in the ordinary course of business. Read & Lundy next argues that even if we adopt the majority view, the bank did not present sufficient evidence to establish that CDs, such as this one, that the bank stamped as nontransferable were nonetheless transferred and transferable in the ordinary course of business. We disagree because [t]he question of whether a particular document qualifies as an instrument under the U.C.C. is a question of law. In re Coral Petroleum, Inc., 50 B.R. 830, 837, 838 (Bankr.S.D.Tex.1985) (holding that nonnegotiable note qualified as an Article 9 instrument despite the limits on its transferability). The test for transferability is what professionals ordinarily would do to transfer an interest in the claim evidenced by the writing in question. Only if they would deliver the writing (with any necessary indorsement or assignment) will the writing be an [A]rticle 9 instrument. Steven L. Harris, Non-Negotiable Certificates of Deposit: An Article 9 Problem, 29 U.C.L.A. L.Rev. 330, 372 (1981) (hereinafter, Harris). The rationale behind this rule is that [i]f professionals who deal with a writing attach importance to possession of the writing, then the law likewise should attach significance to possession. Id. This test comports with the underlying purpose of the U.C.C.: namely, to effectuate existing business practices. Thus, if this CD was pledgeable at common law, it should remain so under Article 9. See id. at 373. [7] Here, the bank obviously attached significance to possession of the CD because it incorporated the holder's possession and endorsement of the CD as a precondition to payment. Aside from bearing the nontransferable legend, the CD also stated on its face that It Will Pay To the Order of Michael Brier    On Return Of This Certificate Properly Endorsed.  (Emphasis added.) By incorporating possession and endorsement of the CD as a precondition to payment, the bank implicitly acknowledged that the CD was indeed transferable. See First National Bank in Grand Prairie v. Lone Star Life Insurance Co., 524 S.W.2d 525, 530 (Tex.Civ. App.1975). Otherwise, why would the bank have required Brier to return and endorse the CD upon seeking payment? Such presentation is necessary for the bank's protection because lack of possession would indicate that the named owner of the certificate of deposit may have transferred it to a third party. Id. Clearly, the principal reason the bank required Brier's possession of the CD as a precondition to payment was to protect itself from claims asserted by potential third-party transferees of the CD. But [n]o such protection would be necessary if the certificate were not    transferable. Id. For this reason, we hold, the bank, by expressly incorporating the holder's possession and endorsement as a precondition to payment, implicitly recognized that Brier's CD was indeed of a type that was transferable in the ordinary course of business, notwithstanding the nontransferable legend. See General Electric Co. v. M & C Manufacturing, Inc., 283 Ark. 110, 671 S.W.2d 189, 190 (1984) (holding as matter of law that nontransferable CDs were Article 9 instruments); Citizens National Bank of Orlando v. Bornstein, 374 So.2d 6, 10 (Fla.1979) (holding, as matter of law, that CDs containing restrictions on transfers were nonetheless Article 9 instruments). Therefore, because the CD was an instrument that was transferable in the ordinary course of business, we hold that the bank had a perfected security interest in the CD. For this reason, the bank's perfected security interest in Brier's CD took priority over Read & Lundy's later-served writ of attachment. As a secured creditor with a prior perfected security interest in the CD, the bank possessed superior rights to any subsequent lien creditors, including Read & Lundy. Although not expressly stated, the code clearly implies that a secured party with a perfected security interest is entitled to priority over a creditor who has obtained a later lien on the collateral by attachment, garnishment, levy, or the like. See James J. Wright & Robert S. Summers, 4 Uniform Commercial Code § 33-2 at 278 (5th ed.2002) (commenting that the Code, by negative implication states that a perfected secured creditor trumps a later lien creditor). The only time a lien creditor takes priority over a secured creditor is when the lien attaches before the secured creditor can perfect its security interest in the collateral. See § 6A-9-301(1)(b) (subordinating an unperfected security interest to the rights of a party who becomes a lien creditor before the secured party can perfect). Here, the bank perfected its interest in the CD when it took possession of the CD in June 1996. [8] Read & Lundy, however, did not obtain a writ of attachment until September 1996, and the writ did not become effective until January 1997. Thus, at the earliest, Read & Lundy obtained a writ of attachment some three months after the bank perfected its security interest in Brier's CD. Because the bank unmistakably perfected its security interest before the Superior Court issued the writ of attachment, let alone before it became effective, the bank's right to apply the CD to the defaulted loan trumps Read & Lundy's later-served writ of attachment. We also note that the bank possessed superior rights to the CD because it had the common-law right to set off the CD against the balance due on the defaulted CSI loan. A bank can exercise its common-law right of setoff when: (1) there is mutuality of obligation between the bank and its customer; (2) the funds against which a setoff is exercised belong to the customer; (3) the money to be set off has been deposited into a general  as opposed to a special, reserve, or trust  account; and (4) the debt owed by the customer to the bank is mature. E.g., Firstar Eagan Bank, N.A. v. Marquette Bank Minneapolis, N.A., 466 N.W.2d 8, 12 (Minn.Ct.App.1991). Here, there was mutuality of obligation because the bank owed Brier the money attributable to the CD and Brier had guaranteed the CSI loan personally  a loan that was in default when the bank set off the CD against the balance due on the loan. See In re Foutz, 271 F.Supp. 847, 849-50 (W.D.Va.1967) (holding that bank had right to set off funds in a customer's account against debt that the bank customer had incurred as a surety or guarantor). In addition, Brier indisputably owned the CD, and the money was not in a special or reserve account. Finally, the debt was mature because CSI's repeated late payments and other failures to comply with the loan terms constituted defaults under the applicable loan documents, thereby entitling the bank to deem the entire debt due. See Frierson v. United Farm Agency, Inc., 868 F.2d 302, 304 (8th Cir.1989) (holding that [f]or setoff purposes    a debt [is] due when the bank has the power to deem the debt due, not when the bank actually exercises that power). Although Read & Lundy served the bank with the writ of garnishment before the bank began making collection calls on the CSI loan, the bank properly exercised its common-law right to setoff. Although a bank does not have to exercise its rights of setoff when garnishment or attachment proceedings begin, see General Electric Credit Corp. v. Tarr, 457 F.Supp. 935, 937 (W.D.Pa.1978), it may lose the right to do so if it fails to act before such proceedings are completed. Baltimore and Associates, Inc. v. Municipal Escrow and Title Co., 625 F.Supp. 1271, 1273 (D.D.C.1985). Here, the Superior Court issued a writ of attachment in January 1997. Thereafter, the bank applied the CD to the CSI loan in January 1999. As explained previously, this writ of attachment did not mature into a right of garnishment until September 2001  more than two years after the bank exercised its right of setoff. Therefore, although the bank applied the CD to the loan balance after Read & Lundy first caused it to be served with the writ of attachment, the bank plainly exercised its setoff rights before this writ matured into a right of garnishment. This result comports with the fact that a majority of courts have held that a garnishee-bank may exercise its right of setoff against indebtedness which matures after the garnishment writ is served. Carpenters Southern California Administrative Corp. v. Manufacturers National Bank of Detroit, 910 F.2d 1339, 1341 (6th Cir.1990) (collecting cases). These courts recognize that a garnishing creditor, such as Read & Lundy, has no greater rights in the assets of a bank's customer than the bank's customer has in those assets. A garnishing creditor steps into the shoes of the bank's customer and it is subject to any claim of the garnishee bank to which the bank's customer also is subject. Id. Thus, courts reason, if they allowed a subsequent garnishing creditor to prevail over a bank's right to setoff against its customer, they would afford this creditor greater rights than the bank's customer possesses in such assets that it has placed in the bank's control. See id. at 1341-42.