Opinion ID: 373418
Heading Depth: 1
Heading Rank: 3

Heading: Buyer In Ordinary Course

Text: 28 Under § 9-307(1), a buyer in ordinary course takes free of any secured interest of a creditor. Section 9-307(1) contains a cross-reference to § 1-201(9), which defines buyer in ordinary course as follows: 29 Buyer in ordinary course of business means a person who in good faith and without knowledge that the sale to him is in violation of the ownership rights or security interest of a third party in the goods buys in ordinary course from a person in the business of selling goods of that kind . . . . 30 UCC § 1-201(9). This case presents us with the interpretation of two phrases in this definition: good faith and buys in ordinary course. 31 At the outset, we note that these two phrases overlap to some extent. For example, if the sale was a sham to avoid the seller's obligation to his creditor, then it probably would not satisfy either of these two elements of the buyer in ordinary course requirement. Nevertheless, we feel that the two concepts must be kept analytically distinct, and we now consider each in turn.
32 There is a split among states as to whether good faith as it applies to a buyer in ordinary course under § 9-307(1) is to be tested by a subjective or objective standard. Those courts picking a subjective standard have relied on § 1-201(19), which defines good faith as honesty in fact. Those courts picking an objective standard have relied on § 2-103(1)(b), which states:  'Good faith' in the case of a merchant means honesty in fact and the observance of reasonable commercial standards of fair dealing in the trade. See generally Sherrock v. Commercial Credit Corp., Del., 290 A.2d 648 (1972). See also Tumber v. Automation Design & Mfg. Corp., 130 N.J.Super. 5, 324 A.2d 602 (L.Div. 1974) (discussing good faith of buyer in ordinary course under § 2-403, which deals with entrusting goods to merchant). 33 Although the parties have cited no New Jersey case directly addressing the question of what good faith means in the context of § 9-307(1) and we have found none, we feel the standard for good faith under § 9-307(1) is a subjective one. Section 9-307(1) cross-references to § 1-201(9), which includes good faith as part of the definition of buyer in ordinary course. The definition in § 1-201(9) also refers to knowledge of the violation of a security agreement, which is some evidence that the drafters contemplated a subjective standard for § 9-307. Moreover, § 9-307(1) itself says that the buyer takes free of the security interest even if (he) knows of its existence, which buttresses this conclusion. 34 In addition, the definitions in § 1-201 apply throughout the code (s)ubject to additional definitions contained in the subsequent Articles or unless the context otherwise requires. The very absence in article 9 of an additional definition, in contrast to article 2, is indicative of an intent that the article 1 definition control. As to the context, the cross-reference in § 9-307(1) to the article 1 definition of buyer in ordinary course seems to contemplate general use of the article 1 definitions. In short, we feel it inappropriate to import the article 2 definition into article 9 without more explicit statutory authority. 35 The district court here held that the plaintiff's conduct did not satisfy a subjective standard of good faith. The court noted the following factors as determinative: the amount purchased was far greater than any single purchase the plaintiff had ever made, the plaintiff's acquisition department never consulted its sales people about resale possibilities, the sale was made at a time when the demand for sand was low (making resale less likely), and the plaintiff tried to terminate the contract after it decided not to buy Hollander. The court found that all this amounted to a predominant purpose of keeping Hollander viable pending the purchase decision, making the plaintiff in subjective bad faith. 36 It is important to note how the general definition of good faith operates in the context of article 9. Section 9-307(1) itself states that the buyer in ordinary course takes free of a security interest even if he knows of its existence. Section 1-201(9) says the buyer must be without knowledge that the sale to him is in violation of . . . the security interest of a third party. The comment explains how these two sections relate in the context of the good faith requirement: the buyer takes free if he merely knows there is a security interest which covers the goods but takes subject if he knows, in addition, that the sale is in violation of some term in the security agreement not waived by the words or conduct of the secured party. UCC § 9-307, comment 2. 3 37 In addition, the use of the work know in both § 1-201(9) and § 9-307(1) is significant. The Code carefully distinguishes notice and knowledge, defining the latter as knowledge in fact and not constructive notice. See UCC § 1-201(25); Federal Insurance Co. v. Pipeco Steel Corp., 125 N.J.Super. 563, 312 A.2d 510 (App.Div. 1973). Even assuming constructive notice of the existence of a security interest because of the filing of the financing statement, See note 3 Supra, the Code seems to contemplate that only actual knowledge as to whether the sale violates the security agreement constitutes bad faith. 38 Thus the crux of the good faith inquiry under § 9-307(1) is the buyer's state of mind with respect to the security agreement between his seller and the seller's creditor. Here, the intent found by the district court tells us nothing about the plaintiff's state of mind as to whether the sale violated the Hollander-defendant security agreement. All that the evidence shows, and all that the district court found, was that the plaintiff wanted to keep Hollander viable pending a purchase decision. We have not been pointed to any evidence whatsoever that the plaintiff in fact knew the terms of the security agreement or anything else that would tend to show knowledge that the sale violated the security agreement. 39 It is true that if a buyer wants to keep a seller viable, it may be inferred that the buyer probably knows that the seller is having trouble with creditors. Yet that only shows that the buyer knows that creditors exist; it says nothing about whether the buyer knows the creditors are secured or unsecured or whether the buyer knows the sale violates any security agreement. In short, mere intent to keep Hollander viable pending a purchase decision, without more, does not satisfy the standard relating to good faith in article 1 as it applies to article 9. 40 Moreover, even assuming that the plaintiff knew of the terms of the security agreement, there is only one provision in it that seems relevant here. The security agreement states: As to Collateral which is inventory, sand, gravel or other minerals heretofore or hereafter extracted from the Sand Plant, (Hollander) may, until notice from the Bank, sell, lease or otherwise dispose of it in the ordinary course of business and collect the cash or non-cash proceeds thereof. 41 Thus assuming that the plaintiff knew of this provision, the relevant question is whether the plaintiff knew the sale was one not in ordinary course. This depends on whether in fact the sale was not in ordinary course, a question to which we turn in the next section. Although good faith and buying in ordinary course are analytically distinct, in this case the answer to one is determined in part by the answer to the other. Because the district court did not consider the question in this manner, we reverse and remand.
42 In part, § 1-201(9) defines a buyer in ordinary course as one who (1) buys in ordinary course . . . (2) from a person in the business of selling goods of that kind. The second clause clearly requires an inquiry into the seller's status. The question here is whether the first clause requires an inquiry into the nature of the transaction or the buyer's status. The defendant argues that the plaintiff's intent to keep Hollander viable and the characteristics of the transaction transform the plaintiff into a financier or creditor of Hollander and thus not a buyer in ordinary course. 43 As an initial matter, it is unfortunate that the Code defines buyer in ordinary course in part by using the exact words to be defined. By saying that a buyer in ordinary course is one who buys in ordinary course, the phrase seems redundant and thus meaningless. Instead of asking whether a buyer in ordinary course must buy in ordinary course, it seems to clarify the issue to ask whether a buyer under § 1-201(9) must buy in ordinary course. 44 No New Jersey case directly addresses the meaning of the phrase buys in ordinary course. Cunningham v. Camelot Motors, Inc., 138 N.J.Super. 489, 351 A.2d 402 (Ch.Div. 1975), listed a four part test for determining whether a buyer satisfies the test of § 1-201(9): good faith, no knowledge a security interest is violated, seller in the business of selling this type of goods, and payment in present value. Although the court did not say whether the buyer also must buy in ordinary course and held that all four elements were satisfied, it seems that the precise question of whether the phrase buys in ordinary course has independent meaning was not presented directly. This is so probably because the buyer was a consumer who bought a car, the prototypical buyer in ordinary course. Thus we have little case law guidance as to how New Jersey would treat the present issue. 45 We feel that the phrase buys in ordinary course requires some inquiry into the nature of the transaction. The words cannot refer to the seller's status, for they then would be redundant of the phrase in the business of selling goods of that kind. We invoke the doctrine of construction that every phrase in a statute should be given meaning if possible. We believe that New Jersey courts faced with this question would not read out these words in § 1-201(9). 46 It remains to be answered exactly what meaning should be given the phrase buys in ordinary course. Some of the normal situations where courts have found that a party did not buy in ordinary course do not seem to be present here. See, e. g., Morey Machinery Co. v. Great Western Industrial Machinery Co., 507 F.2d 987 (5th Cir. 1975) (close relation of the buyer and seller raising a danger that the sale was effected to protect the collateral from the seller's creditor); Ray v. City Bank & Trust Co., 358 F.Supp. 630 (S.D.Ohio 1973) (sale was partial satisfaction of prior debt owed by seller to buyer). See generally Independent News Co. v. Williams, 293 F.2d 510 (3d Cir. 1961). 47 The facts noted by the district court as detailed in the previous section do pose one problem, however. It found that the plaintiff purchased an unusual amount for the plaintiff at a time of slow market demand. Given Hollander's financial position, there thus was a danger that it would dissipate the large influx of cash, either by using it to pay unsecured creditors or by other means, leaving the defendant without collateral to secure its loan. 48 This presents a very close question. The activities falling inside or outside the ordinary course test lie along a spectrum. At one end, the grocery retailer who buys a single shipment of canned goods buys in ordinary course. At the other end, the person who buys the business with all its inventory does not buy the inventory in ordinary course. What we have here is a situation somewhere between the two. While it might be possible to come up with a judicially formed test that addresses the question, we think that article 6 of the UCC provides a possible framework for analysis. 49 Under article 6, a bulk sale of inventory of a debtor triggers certain rights in the creditor such as notice from the buyer and a chance to step in and protect its interest. See UCC §§ 6-104 to -105. One of the problems sought to be corrected was dissipation of the proceeds of the sale by the debtor to the detriment of the creditor. Id. § 6-101, comments 2, 4. Although the comment only mentions the debtor who runs away with the proceeds, we feel that the present situation is sufficiently analogous to warrant use of article 6. Where the Code addresses itself to the same type of problem as that here, we think it better to rely on those provisions rather than trying to formulate a rule ourselves. Moreover, this reasoning is consistent with the goal of the UCC, which is to read the Code as an integrated whole and a comprehensive attempt to deal with problems from a variety of perspectives. 50 The facts here require a remand for the district court to consider the question in the first instance. For example, the district court must first decide if this was a bulk sale under article 6. See UCC § 6-102(1) (sale of a major part of the inventory); New Jersey Study Committee Comment to N.J.Stat.Ann. § 12A:6-102, comment 2. This in part will involve the question of what time frame to use in deciding what proportion of Hollander's inventory was sold (E. g., monthly or yearly inventory). Next, the district court must determine if the plaintiff and Hollander complied with article 6. Finally, the court should consider whether the buyer can prevail on any other ground against the creditor under article 6 and whether that ground applies to article 9. 51 In short, we believe that a bulk sale within article 6 would not be a purchase in ordinary course under § 1-201(9) and § 9-307(1). Accordingly, we reverse and remand to the district court for further proceedings on this question and any other theory that may be applicable.