Opinion ID: 901757
Heading Depth: 1
Heading Rank: 5

Heading: When is a Seller Regarded to Have Created a Security Interest?

Text: [¶ 30.] This Court has not interpreted the created by the seller limitation in a similar d.b.a. situation. The Minnesota Supreme Court interpreted the limitation in a fronting situation, where a farmer used separate and distinct real persons  his hired help and his children  to sell farm products subject to a security interest the farmer had created. Hufnagle, 720 N.W.2d at 584. The Minnesota Supreme Court concluded that the term seller should mean the same thing for the notice exception and for the created by the seller limitation. Therefore, it held that because the fronting children and hired help did not create the security interest, the buyer took subject to the security interest. Id. at 586. [¶ 31.] The fronting situation in Hufnagle, however, is distinguishable from the d.b.a. situation for two reasons. First, the summary judgment record submitted in Hufnagle did not fully explain the circumstance under which the [fronting parties] became involved with the sales to [the buyer]. Id. at 584. The Minnesota court acknowledged that it did not know the actual relationship between the owner and fronting parties, and the court assumed three potential scenarios. The fronting party was: (1) an agent selling on behalf of the owner as an undisclosed principal; (2) a commission merchant or selling agent; or (3) the owner of the farm product who was selling on his/her own behalf. Id. Although the court ultimately concluded that these three types of fronting persons could not be sellers of the debtor's property and simultaneous creators of the debtor's security interest, the Hufnagle court conceded its conclusion was based on the factual scenarios possible on this record .... Id. Hufnagle did not, however, consider the fourth factual scenario that is before this Court, i.e., debtors who created the security interest, and conducted their business under their d.b.a. business name. [¶ 32.] Unlike Hufnagle, Berwalds created the security interest, but did not transfer the collateral to a distinct, real person for a later sale. They utilized their d.b.a. to sell the cattle themselves. Therefore, for purposes of the created by the seller limitation, Berwalds cannot be separated from the acts of their d.b.a. C & M Dairy. See Jaffe v. Nocera, 493 A.2d 1003, 1008 (D.C.Ct.App.1985), providing, `[t]he ordinary sense of the word's X, d/b/a Y, Inc. should `convey the message' that X remains personally liable for this entity's (Y's) obligations. (quoting S. Ins. Co. v. Consumer Ins. Agency, Inc., 442 F.Supp. 30, 31 (E.D.La.1977)). This is far different than Hufnagle where separate and distinct sellers sold the collateral without having any business relationship or interest in the debtor's business. [14] Hufnagle specifically noted that collateral was sold in the names of third persons not involved with the debt to [seller]. Hufnagle, 720 N.W.2d at 580. [¶ 33.] Hufnagle is further distinguished because it appeared to involve collusion on the part of the buyer. Fin Ag, Inc. v. Hufnagle, Inc., 700 N.W.2d 510, 518 (Minn.Ct.App.2005). Although the Minnesota Supreme Court did not specifically rely on this fact, it did not reject the Minnesota Court of Appeal's analysis noting the extensive previous sales relationship between the owner of the cattle and the buyer, and the familial and employment relationships of the supposed sellers to the actual owner. Id. One such relationship involved sales by and proceeds checks payable to the owner's children, one of whom was only five years old at the time of sale. Id. Thus, Hufnagle involved a buyer that apparently knew of the lien and appeared to be a participant in the scheme to defraud the creditor. In this case, Fin-Ag concedes there was no collusion, and Cimpl's neither knew of the lien nor was a participant in the scheme to defraud Fin-Ag. [¶ 34.] More fundamentally, however, we disagree with Hufnagle's created by the seller legal analysis for two reasons. First, as previously noted, Hufnagle did not have an adequate factual record on summary judgment, see supra ¶ 31 citing Hufnagle, 720 N.W.2d at 584, and the court therefore assumed the fronting situation involved one of three scenarios. The only scenario that could be applicable here is the Hufnagle example of a sale by an undisclosed principal. In its analysis of this scenario, however, the Minnesota court incorrectly assumed that one who deals with the agent of an undisclosed principal has knowledge of the undisclosed principal's identity and, therefore, notice of an EFS under the undisclosed principal's name. The entire Hufnagle analysis is premised on this incorrect assumption: If we view [the owner of the collateral] as the seller, assuming that the [fronting party] sold the collateral as agents for [the owner] as an undisclosed principal, the exception in section 1631(e) for [notice of] a security interest as to which notice has been given would apply because [the buyer] received notice of [the lender's] interest against [the owner], and [the buyer] did not secure a waiver of the interest from [the lender]. 720 N.W.2d at 586 (citing 7 USC § 1631(e)(3)). As is readily apparent, this analysis assumes that in this scenario the buyer would have EFS notice of the lender's security interest because the buyer would have notice of the agent's undisclosed principal's name. However, by definition, one cannot have notice of the principal's name for purposes of notice when the agency relationship involves an undisclosed principal. The dissent makes the same mistake. See infra ¶ 61. [¶ 35.] We also disagree with Hufnagle because its created by the seller analysis is premised on the observation that legislative intent does not support the notion that a seller could be considered differently, depending on the context in which it is used. See Hufnagle, 720 N.W.2d at 588-89. In our view, Hufnagle overlooked two instructive statements of Congressional intent. In the first, dealing with the reason for preempting all provisions of state law that prevented buyers in the ordinary course from taking free of agricultural lenders' security interests, Congress noted that innocent buyers of farm products should not ... become unwilling loan guarantors, in essence assuming the credit supervision responsibilities that rightly belong with the lender who is making the profit off the loan to begin with. [Especially where a]t the same time, farm product buyers have no control over the lender's practice, and receive no compensation in the form of interest to cover the risk exposure and jeopardy unknowingly and unwillingly assumed. H.R. Rep. No. 99-271(I) at 109, U.S.Code Cong. & Admin.News 1985 at 1210. And in the second, with respect to notice, Congress specifically intended to preempt state laws that require buyers to check public records, obtain no-lien certificates from the farm products sellers, or otherwise seek out the lender and account to that lender for the sale proceeds. Id. at 110, U.S.Code Cong. & Admin.News 1985 at 1211. [¶ 36.] In light of this express intent, for purposes of the notice exception, it is unreasonable to conclude that Congress intended to require a buyer like Cimpl's to determine the legal status of C & M Dairy or be subjected to constructive notice that Berwalds were legally the sellers. Cimpl's simply had no duty, other than to check the master list, to determine whether C & M Dairy was a seller on Fin-Ag's EFS. Likewise, with respect to the created by the seller limitation, we believe it is unreasonable to conclude Congress intended that buyers, acting in the ordinary course of business, would not be protected by the FSA from debtors who created a security interest in collateral and subsequently utilized their business d.b.a. in selling the collateral. [¶ 37.] In addition to instructive Congressional intent, Hufnagle also failed to consider several cases that have considered the created by the seller limitation in factual contexts more akin to the d.b.a. seller in our case. Although these courts interpreted UCC § 9-307 (now UCC § 9-320), the cases are applicable because when the FSA was enacted, it adopted the UCC created by the seller language. Hufnagle, 720 N.W.2d at 585. Furthermore, FSA implementing regulations specifically recognize that court decisions involving UCC terms within the farm products exception in Section 9-307(1), which are not defined in the FSA, are applicable in interpreting the FSA. 9 CFR § 205.211 (2006). [¶ 38.] In one case that Hufnagle considered but rejected, the Eighth Circuit Court of Appeals concluded that a farmer, who sold farm products to an elevator that he also owned, was the seller who created the security interest even though the elevator was the immediate seller to the ultimate purchaser. First Bank of N.D. (N.A.)-Jamestown v. Pillsbury Co., 801 F.2d 1036, 1038-40 (8th Cir.1986). In considering the limitation, the court treated the security interest as being created by the elevator because the farmer, who actually created the security interest, was the owner of both the farming operation and the elevator. Id. at 1039-40. The Eighth Circuit Court of Appeals did so even where, unlike this case, the grain elevator was legitimately incorporated as a separate entity. Id. at n. 4. The court reasoned, `the relationship between the former owner [of the collateral] and the [immediate] seller may be such that the security interest created by the former owner may be regarded as having been created by the seller....' Id. (quoting 9 Anderson on the Uniform Commercial Code § 9-307:8, at 194-95 (3d ed. 1981)) (alteration in original). [¶ 39.] Both Iowa and Oklahoma have also declined to strictly construe the created by the seller limitation where the creator of the prior lien and the immediate seller are separate but closely related entities, or the seller has been `instrumental in creating the encumbrance and conflict.' C & J Leasing II Ltd. P'ship v. Swanson, 439 N.W.2d 210, 213 (Iowa 1989) (quoting Adams v. City Nat. Bank & Trust Co., 565 P.2d 26, 31 (Okla.1977) (per curiam)) (citing G.M.A.C. v. Keil, 176 N.W.2d 837, 841 (Iowa 1970))). Unlike Hufnagle, the Iowa Supreme Court reasoned that the buyer was entitled to prevail over the remote lienholder because, the legislature did not intend [the created by the seller language] to give `preference [in cases where] a lien's... creator was not as shown on the records, but [was involved with] another party under a confidential transaction of which the ultimate purchaser had no knowledge.' Id. (quoting G.M.A.C., 176 N.W.2d at 841; Adams, 565 P.2d at 31). The Iowa Supreme Court explained: where a[n owner] who is not a secured party has been instrumental in creating an encumbrance and the resulting priority conflict for an innocent buyer in ordinary course, courts must apply broadly the `by [the] seller' language [ ] to effectuate the statute's protective purposes. Id. at 214. [¶ 40.] The Oklahoma Supreme Court reached the same conclusion. It explained the situation in which the created by the seller limitation was actually intended by citing the most widely cited decision involving a security interest not `created by his seller.' Adams, 565 P.2d at 30 (citing National Shawmut Bank of Boston v. Jones, 108 N.H. 386, 236 A.2d 484 (N.H. 1967)). The Oklahoma court explained that the intended application only involves a security interest not created by the seller or by the seller's related party, but by an entirely separate third person who completed a bona fide sale of the collateral to the immediate seller. Id. [15] [¶ 41.] Finally, like the Iowa and Oklahoma Supreme Courts, an Arizona court of appeals concluded that the protection [for buyers] in the ordinary course under section 9-307(1) may potentially extend to a buyer from a seller who acquired the collateral from a related entity that is liable as debtor under a security agreement. Deutsche Credit Corp. v. Case Power & Equip. Co., 179 Ariz. 155, 876 P.2d 1190, 1197 (Ct.App.1994). Although Deutsche did not ultimately extend buyer in the ordinary course protection, it recognized that an invocation of the `alter ego' or `piercing the corporate veil' doctrine may be utilized to disregard separate corporate existence, so the owners could be viewed as both the creators of the security interest and the sellers of the collateral. Id. The Arizona court noted, the corporate fiction will be disregarded when the corporation is the alter ego or business conduit of a person, and when to observe the corporation would work an injustice. Id. [¶ 42.] Ultimately, the created by the seller limitation was generally designed to insure compliance by a retailer under an agreement with his inventory financer not to sell without financer's permission. Adams, 565 P.2d at 30. However, [i]t is illogical to believe when the codal redactors drafted this limitation they anticipated a buyer would not be protected from misrepresentation by [a creator of a security interest] who had manipulated [the collateral] for his own benefit. Id. On the contrary, [n]othing in the comments to Article 9 require the `created by his seller' limitation to be an insurmountable barrier to good faith acquisition of pre-encumbered property from [a seller] who himself was instrumental in creating the encumbrance and conflict. Id. at 31. [¶ 43.] Cimpl's case is even more persuasive than the foregoing authorities because, unlike those cases, Berwalds and C & M Dairy were not separate corporations. C & M Dairy was the d.b.a. for Calvin and Michael Berwald, and C & M Dairy was the name under which Berwalds conducted their cattle business. Legally, C & M Dairy was the Berwalds. Therefore, we need not pierce a corporate veil to conclude that C & M Dairy was the alter ego of Berwalds. Because C & M Dairy was the alter ego of the Berwalds, and because Berwalds created the security interest, C & M Dairy must be regarded as the seller who created the security interest. [¶ 44.] We recognize that the Minnesota Supreme Court disagreed with the Eighth Circuit Court of Appeals analysis in First Bank of N.D. (N.A.)-Jamestown, and was unwilling to consider a seller in two different ways. Hufnagle did so, however, relying on the premise that there was no significant indication that this was the legislature's intent. Hufnagle, 720 N.W.2d at 588-89. This rationale overlooked compelling expressions of congressional intent. See supra ¶ 35. The Hufnagle analysis also failed to consider the two different contexts and purposes for which the term seller is used in the FSA. With respect to the notice exception, Congress clearly required the lender's strict compliance with the identification of the seller on the EFS, and South Dakota has implemented rules that require secured parties to list a d.b.a. as a separate debtor. With respect to the created by the seller limitation, Hufnagle overlooked important cases that have identified legislative intent that this type of limitation was not intended to protect the secured party when related parties create the encumbrance and sell the collateral. [¶ 45.] The dissent follows the same path emphasizing that [w]e certainly should not interpret seller two different ways, when many commentators have criticized the limitation `created by the seller,' in the context of 9-307 [now 9-320 and the FSA], yet the clause has never been amended or eliminated since the UCC was rewritten in 1957. Infra ¶ 65 (citing Hufnagle, 720 N.W.2d at 585) (citing William H. Lawrence, The Created by His Seller Limitation of Section 9-309(1) of the UCC: A Provision in Need of an Articulated Policy, 60 Ind. L.J. 73, 73-74 (1984-85); Richard H. Nowka, Section 9-302(a) of Reviewed Article 9 and The Buyer in the Ordinary Course of Pre-Encumbered Goods: Something Old and Something New, 38 Brandeis L.J. 9, 23-24 (1999-2000)). The dissent fails to recognize, however, that these commentators would not support the dissent's literal application of the created by the seller provision. On the contrary, Professor Lawrence criticizes opinions like the dissent, which apply the created by the buyer's seller provision in a mechanical fashion without any attempt to address the policy considerations. Lawrence, supra, 73. He cautions that [b]y [such] mechanical jurisprudence ... courts may satisfy their task of implementation... but they must look beyond the mere words to the context of their adoption in order to construe the statute in ways that will achieve its legislative purpose. Id. at 75-76. He points out that the purpose of the limitation is twofold. The first is to protect buyers in the ordinary course who are involved in apparent authority sales established by: entrustment of the collateral to debtors; inventory financing; and by placing the debtor in possession of goods when the debtor is in the business of selling goods of the same kind. Id. at 81-82. When some or all of these factors are present, the secured party is deemed to have vested the debtor with indicia of apparent authority protecting the buyer from the security interest. Id. The second purpose arises from agency law: protection is afforded a buyer under principles of entrustment of possession of the collateral and under the principle that a buyer who reasonably believes that the seller is the owner should be protected, even if the owner is an undisclosed principal. Id. at 85-86. Finally, Professor Lawrence points out that as between an innocent buyer and an innocent secured party, the laws' allocation of risk identifies the secured party as the party most responsible for loss. Id. at 95-96. Although relying on Professor Lawrence, the dissent fails to apply his analysis supporting protection of the buyer in this case. (Professor Nowka sets forth analogous purposes for the provision; Nowka, supra, 23-24) [¶ 46.] Ultimately, we agree with the Eighth Circuit Court of Appeals, and the Iowa, Arizona, and Oklahoma state courts. These courts either:(1) hold that the created by the seller limitation does not apply; or (2) treat the immediate seller as the entity that created the security interest when the immediate seller and the remote grantor of the security interest are closely related and the remote grantor was instrumental in creating the conflict. [¶ 47.] For the foregoing reasons we conclude that, as the alter ego of Berwalds, C & M Dairy should be regarded as the seller who created the security interest within the meaning of 7 USC § 1631(d). And, because C & M Dairy was the only seller identified at sale, but was not identified on the master list, Cimpl's did not have written notice of the security interest under 7 USC § 1631(e)(3). Consequently, Cimpl's was entitled to FSA protection. Accordingly, Cimpl's took the cattle sold by C & M Dairy free of Fin-Ag's security interest, and Cimpl's cannot be liable for conversion. Because we dispose of Fin-Ag's appeal on the FSA, we do not reach the parties' other issues.