Opinion ID: 3016918
Heading Depth: 1
Heading Rank: 3

Heading: The UCC Provisions

Text: This case turns primarily on the provisions of the Arizona UCC that govern a creditor’s rights to the proceeds of his collateral.5 The default rule is that a security interest in property includes an interest in the proceeds of that property. Ariz. Rev. Stat. § 47-9203(C) (1999) (“Unless otherwise agreed a security agreement gives the secured party the rights to proceeds provided by § 47-9306.”). The parties here did not opt out of this default; rather, they explicitly granted FINOVA a security interest in proceeds in the mortgage. The Trustee argues, however, that this security interest does not give FINOVA a right to the disputed insurance money, because that money is not “proceeds” properly understood, and because awarding it to FINOVA would constitute 5 In July 2001, Arizona adopted a revised UCC Article 9. See 1999 Ariz. Sess. Laws ch. 203. The pre-revision Arizona UCC was in place at all relevant times during this controversy; we will refer mainly to that Code, and will do so in the present tense. 6 a double recovery forbidden by the UCC. We consider each of these contentions in turn.
Our starting point is perforce UCC § 9-306, which defines the term “proceeds” and governs a secured creditor’s rights to the proceeds of his collateral. The relevant parts of this section are set forth in the margin. 6 The definition of “proceeds” is found in 6 Section 9-306, as numbered in the Arizona statute, reads: § 47-9306. “Proceeds”; secured party’s rights on disposition of collateral A. “Proceeds” includes whatever is received upon the sale, exchange, collection or other disposition of collateral or proceeds. Insurance payable by reason of loss or damage to the collateral is proceeds, except to the extent that it is payable to a person other than a party to the security agreement. Any payments or distributions made with respect to investment property collateral are proceeds. Money, checks, deposit accounts and the like are “cash proceeds”. All other proceeds are “non-cash proceeds”. B. Except where this chapter otherwise provides, a security interest continues in collateral notwithstanding sale, exchange or other disposition thereof unless the disposition was authorized by the secured party in the security agreement or otherwise, and also continues in any identifiable proceeds including collections received by the debtor. C. The security interest in proceeds is a continuously perfected security interest if the interest in the original collateral was perfected but it ceases to be a perfected security interest and becomes unperfected ten days after receipt of the proceeds by the debtor unless: ... 2. A filed financing statement covers the original collateral and the proceeds are identifiable cash proceeds; ... 7 subsection (a), the first sentence of which defines the term to include “whatever is received upon the sale, exchange, collection or other disposition of collateral or proceeds.” Ariz. Rev. Stat. § 47-9306(A). The following sentence reads: “Insurance payable by reason of loss or damage to the collateral is proceeds, except to the extent that it is payable to a person other than a party to the security agreement.” Id. The plain language of § 9-306(a) leaves no doubt that the insurance money at issue here constitutes proceeds of the engine, because it was “[i]nsurance payable by reason of loss or damage to the collateral.” FINOVA, by perfecting its security interest in the engine, was entitled to look to those proceeds as collateral under § 9-306(b). Under 11 U.S.C. § 552(b), prepetition security interests that apply to proceeds of collateral also apply to proceeds of such collateral acquired after the bankruptcy petition. It is undisputed that FINOVA had perfected its security interest in the engine prior to Tower’s bankruptcy. FINOVA’s interest in those proceeds was therefore also perfected, because Tower had not received them prior to entering bankruptcy. See Ariz. Rev. Stat. § 47-9306(D)(2) & (3). The Trustee argues that the first sentence of § 9-306(a), which requires a “sale, exchange, collection or other disposition” of property, limits the definition of “proceeds” to encompass only the results of a “transforming event.” Under this view, a creditor D. In the event of insolvency proceedings instituted by or against a debtor, a secured party with a perfected security interest in proceeds has a perfected security interest only in the following proceeds: ... 2. In identifiable cash proceeds in the form of money which is neither commingled with other money nor deposited in a deposit account prior to the insolvency proceedings; 3. In identifiable cash proceeds in the form of checks and the like which are not deposited in a deposit account prior to the insolvency proceedings; . . . . Ariz. Rev. Stat. § 47-9306 (1999). 8 can obtain the proceeds only as a substitute for the original collateral, not as an addition to it. But this interpretation is contradicted by the clear language of the second sentence (“Insurance payable by reason of loss or damage to the collateral is proceeds . . .”), and we have found no case that supports it.7 7 The Trustee cites a number of cases that contain general statements that insurance is proceeds where the collateral is completely lost. But these cases do not support the inverse proposition that insurance is not proceeds where the collateral survives in some form. See Miller v. Norwest Bank Minn., N.A. (In re Inv. & Tax Servs., Inc.), 148 B.R. 571, 573 (Bankr. D. Minn. 1992) (“Where the creditor requires the debtor to insure the collateral and the collateral is subsequently destroyed, the insurance proceeds are in essence proceeds from the disposition of the collateral.”); Stodd v. Reynard (In re Shooting Star Enters., Inc.), 76 B.R. 154, 156 (B.A.P. 9th Cir. 1987) (“Although it is well recognized that the term ‘proceeds’ is to be given a broad and flexible interpretation, it is also recognized that ‘[p]roceeds constitute whatever is substituted for the original collateral.’”) (quoting In re Judkins, 41 B.R. 369, 372 (Bankr. M.D. Tenn. 1984)); Ford Motor Credit Co. v. Stevens (In re Stevens), 130 F.3d 1027, 1030 (11th Cir. 1997) (“In the context of the insurance policy on the truck, therefore, the proceeds act as a substitute for the insured collateral.”). Similarly, the Trustee cites an academic article for the proposition that “[i]f one attempted to hypothesize the ex ante bargain of the reasonable debtor and secured party, one would expect them to understand that insurance monies would stand in the stead of damaged collateral.” R. Wilson Freyermuth, Rethinking Proceeds: The History, Misinterpretation and Revision of U.C.C. Section 9-306, 69 Tul. L. Rev. 645, 658 (1995). This article does not support the Trustee’s position. First of all, Professor Freyermuth, like the cases discussed in the previous paragraph, merely argues that proceeds should include (at a minimum) “substitutes” for damaged collateral, not that they should include only such substitutes. In fact, he argues for a liberalized definition of proceeds, one that would include lease payments, id. at 65967, and cash dividends on stock, id. at 668-72, neither of which are substitutes for the underlying collateral. Furthermore, Freyermuth relies on the hypothetical ex ante bargain between debor and creditor, while in this case we can examine the actual ex ante bargain, which granted FINOVA an absolute right of approval over the insurance proceeds, see infra Part IV.A, and a mortgagee payee interest in those proceeds, see infra Part IV.B. Together, these agreements constitute strong evidence 9 We are also confident that the Arizona courts would reject the Trustee’s view. The Arizona Court of Appeals has read the second sentence of § 9-306(a) independently of the first and held that “the meaning of [the second sentence of § 47-9306(A)] is clear on its face,” and that “the ‘right to payment’ under an insurance policy constitutes ‘proceeds’ subject to Article 9 of the UCC.” Valley Nat’l Bank of Ariz. v. Cotton Growers Hail Ins., Inc., 747 P.2d 1225, 1231 (Ariz. Ct. App. 1987). We note too that Airwork Corp. v. Markair Express, Inc. (In re Markair, Inc.), 172 B.R. 638 (B.A.P. 9th Cir. 1994), a (non-Arizona) Ninth Circuit Bankruptcy Appellate Panel case, assumed, though it did not directly hold, that a secured creditor could be entitled to keep both a repaired aircraft engine and the insurance proceeds thereof. We therefore are not convinced that § 9-306(a) limits the definition of “proceeds” to encompass only those proceeds that entirely replace collateral. Instead, it is quite clear that the insurance money at issue here constitutes “proceeds” under the UCC’s definition.
We acknowledge that there is significant intuitive appeal to the notion that a creditor should not be able to recover both his collateral and the proceeds thereof. Such a situation bears a resemblance to a double recovery. The UCC provides that “The secured party may claim both proceeds and collateral, but may of course have only one satisfaction.” Ariz. Rev. Stat. § 47-9306 cmt. 3 (1999).8 Thus, while we have decided that the insurance money that the expectations of the parties favor allowing FINOVA to recover. 8 The revised UCC moves this limitation to one recovery from the official comments to the statutory text, and changes its wording significantly. See Ariz. Rev. Stat. § 47-9102(64) (2004) (“Proceeds . . . means . . . (e) to the extent of the value of collateral and to the extent payable to the debtor or the secured party, insurance payable by reason of the loss or noncomformity of, defects or infringement of rights in, or damage to the collateral.” (emphasis added)). This provision was not, of course, in effect at the times relevant to the current dispute; hence we need not explore its meaning. 10 constitutes “proceeds,” we must conduct a further inquiry before deciding conclusively that FINOVA is entitled to recover it. FINOVA has a claim to any proceeds of its collateral under UCC § 9-306 and 11 U.S.C. § 552(b), but that claim may be superseded by the UCC’s limitation to “one satisfaction.” We examine that limitation below, both in the general case and as applied to crosscollateralized creditors. We also draw an analogy to the case in which the collateral is sold, rather than damaged, and use the courts’ treatment of sale proceeds to inform our treatment of insurance proceeds.
It is perfectly evident that the creditor’s recovery is limited by the amount of its debt: a creditor who lends $100 secured by an engine with a fair market value of $100 cannot recover both the engine (at its full value) and any insurance proceeds on it. This is the minimum meaning of Comment 3. It is equally clear that the creditor’s security interest is limited by the amount of its collateral: a creditor who lends $200 secured only by an engine with a value of $100 is secured only for $100; the remaining $100 of its debt will be only an unsecured claim in bankruptcy. See 11 U.S.C. § 506(a). The difficult case is where the value of the original collateral plus proceeds exceeds the value of the original collateral, but is less than the amount of the debt. In that case, may the creditor recover the collateral and proceeds (limited only by the amount of its debt), or is it limited to the value of its original collateral? This is a vexing question, and one that does not seem to have been directly decided.9 On the one hand, the debtor might 9 Several courts have decided a related but not identical issue. This line of cases involves a confirmed Chapter 11 or 13 plan which includes a cram-down of a secured creditor’s claim on an asset of the estate (often a motor vehicle); after the asset is destroyed, the creditor demands the insurance proceeds to the extent of its original claim rather than its claim as modified by the plan. In these cases, the courts reject the creditor’s attempt to get an additional satisfaction of its debt, stating that the creditor’s “interest in the insurance proceeds flowing from the destruction of the secured collateral is only as great as its interest in the 11 argue that the creditor’s security interest is limited to the value of the collateral, not of the claim. Giving the insurance payment to the creditor would arguably create a larger security interest than the creditor bargained for, and thus lead to a windfall. On the other hand, the plain language of the UCC gives the creditor a security interest in proceeds of the collateral. The creditor’s “windfall” is no different from a situation in which the collateral’s market value increases: the creditor simply gets the benefit of all increases in value of the collateral—whether those increases come by appreciation or by insurance payments—up to the total value of the claim. Because FINOVA’s cross-collateralization, and other facts specific to the case at bar, are enough for FINOVA to recover, we need not decide this question in the general case.10
collateral itself.” Ford Motor Corp. v. Stevens (In re Stevens), 130 F.3d 1027, 1030 (11th Cir. 1997); accord Ford Motor Corp. v. Feher, 202 B.R. 966 (Bankr. S.D. Ill. 1996); In re Arkell, 165 B.R. 432 (Bankr. M.D. Tenn.); see also In re Jones, No. 99-43196, 2004 WL 2191692 (Bankr. S.D. Ga. June 4, 2004). These cases are easily distinguishable: in the Stevens line, the creditor’s secured claim had already been modified, and it was asking for insurance proceeds that exceeded the value of its allowed claim under the plan. The Stevens creditor was asking for more than “one satisfaction” of its secured debt, as modified by the debtor’s court-approved plan. Tower, on the other hand, is in Chapter 7, and no plan has been approved that could modify FINOVA’s secured claim. Moreover, unlike in Stevens, the engine at issue here was not being used by the estate under a cram-down; rather, it had already been returned to FINOVA as part of Tower’s liquidation. 10 We note that the revised UCC might allow the creditor to recover only the original value of his collateral; the revised Code now defines “proceeds” to include insurance only “to the extent of the value of collateral.” Ariz. Rev. Stat. § 47-9102(64) (2004). While this language is not perfectly clear, it would seem to limit recovery to the value of the original collateral; insurance payments beyond that value would, it seems, not constitute “proceeds.” But, of course, the revised UCC was not in effect at any time relevant to this case, and we have already concluded that the insurance money did constitute “proceeds” under the old UCC, see supra Part III.A. 12 FINOVA’s loans to Tower were cross-collateralized; that is, under the May 6, 1996, agreements between Tower and FINOVA, numerous Tower assets became collateral for numerous loans by FINOVA. In FINOVA’s submission, Tower owed FINOVA some $56 million when it filed for bankruptcy, and returned collateral worth $36 million, leaving some $20 million still due. Much of FINOVA’s collateral was apparently damaged or impaired due to Tower’s negligence. The result of this cross-collateralization is that the original value of FINOVA’s collateral was not merely the original value of the aircraft engine at issue in this case. Instead, FINOVA had numerous pieces of collateral collectively worth millions of dollars. Much of this collateral was impaired or damaged at some point between the time Tower entered the financing agreements and the time the disputed insurance proceeds were paid. This fact is important because it eliminates any concern we might have about giving FINOVA a windfall by allowing it to recover those proceeds. As we note above, there may be some reason to think that the UCC’s limitation to “one satisfaction” limits secured creditors to the original value of their collateral, although we will ultimately conclude, based on an analogy to sale proceeds, that the better view is to allow creditors to recover up to the value of their debt, see infra Part III.B.3. But even if we were to limit FINOVA to the original value of its collateral, the fact of cross-collateralization means that it will certainly recover less than the original value of all of its collateral. The effect of the cross-collateralization clauses was to make some large quantity of Tower’s assets collateral for all $56 million of its debt to FINOVA.11 If the only impairment to FINOVA’s collateral were the damage to the engine, and if that damage were fully repaired, then the insurance proceeds would increase the value of the collateral, and create a difficult case, see supra Part III.B.2. But in fact collateral worth millions of dollars was destroyed. Thus it is misleading to state that Tower returned the 11 The record does not reflect the exact value of the assets involved in the cross-collateralization agreements. In any case, it would seem to be significantly greater than the $36 million worth of collateral that was ultimately returned to FINOVA. At all events, our analysis does not depend on the exact figure. 13 collateral at issue here in fully repaired condition. The specific aircraft engine was returned fully repaired, but much other collateral was destroyed, damaged, or subject to liens, and all of this collateral secured the same loans. We therefore should not view the insurance proceeds on one particular engine as increasing the value of that specific piece of collateral, and thus creating a windfall; rather, we should view it as only partially compensating for the destruction of several other pieces of collateral. On that view, awarding those proceeds to FINOVA does not create more than one satisfaction, as the overall value of the collateral is still significantly impaired. The cross-collateralization clauses, and the fact that FINOVA’s other collateral was impaired, leave us satisfied that awarding the insurance proceeds to FINOVA would not create a windfall or a double satisfaction. Even if it recovers both the engine and the insurance proceeds, FINOVA will still recover less than its entire debt, and also less than the original value of its collateral. In such circumstances, a double recovery is impossible.
While few cases directly address the issue of whether a creditor can recover both repaired collateral and the insurance proceeds for damage to that collateral, several courts have examined the situation in which creditors claim both collateral and the sale proceeds of that collateral. Because sale and insurance proceeds are governed by the same UCC provisions, see Ariz. Rev. Stat. § 47-9306(A), these cases provide a helpful analogy to the present case, and inform our understanding of the meaning of “one satisfaction” under § 9-306. To clarify our discussion, we use a hypothetical case. A creditor lends a debtor $100, secured by an engine initially worth $100. The engine’s value then depreciates to $50, and the debtor secretly sells it to a third party for $50. The hypothetical relies on the assumption that the third-party buyer is not a bona fide purchaser or buyer in ordinary course, and has no right to retain the engine. We also assume that the sale price is § 9-306 “proceeds,” and that the creditor’s security interest in it is perfected under § 9- 306(c) & (d). If the debtor then enters Chapter 7 bankruptcy and cannot pay its unsecured debts, may the creditor then claim the $50 14 proceeds from the debtor and proceed against the third party on its perfected security interest in the engine? The language of § 9-306(b) seems clear enough: the creditor’s security interest “continues in collateral notwithstanding sale . . . unless the disposition was authorized by the secured party . . . and also continues in any identifiable proceeds including collections received by the debtor.” Ariz. Rev. Stat. § 47-9306(B). The creditor can thus look to both the sale proceeds and the engine itself (in the third party’s hands). Here again, the creditor “may claim both proceeds and collateral, but may of course have only one satisfaction.” Ariz. Rev. Stat. § 47-9306 cmt 3. The crucial question, in this hypothetical as in the case at bar, is what constitutes a “satisfaction.” Does this comment mean that the creditor may claim both proceeds and collateral, but only receive one of them? Or does it mean that the creditor may receive both proceeds and collateral, so long as its total recovery is less than the value of its debt? In our view, it is clear that the creditor may receive both proceeds and collateral, and is limited only to the amount of its debt, not the value of the underlying property. See, e.g., Taylor Rental Corp. v. J.I. Case Co., 749 F.2d 1526, 1529 (5th Cir. 1985) (interpreting identical Florida UCC provision and stating that “[a] creditor may pursue several remedies until the debt is satisfied”); Standard Dyeing & Finishing Co. v. Arma Textile Printers Corp., 85 Civ. 5399, 1991 WL 49782,  (S.D.N.Y. Mar.25, 1991) (“‘When an unauthorized disposition of collateral has occurred, a secured party has numerous cumulative remedies at its disposal; it is not forced to elect a single remedy. . . . [A] creditor may pursue several remedies until the debt is satisfied.’”) (citation and emphasis omitted); Fleet Capital Corp. v. Yamaha Motor Corp., U.S.A., 2002 WL 31174470,  (S.D.N.Y. 2002); cf. Frantz v. First Nat. Bank & Trust Co. of Wyoming, 687 P.2d 1159, 1162 (Wyo. 1984) (“Although [a creditor] is entitled to only one satisfaction for the underlying debt, he may seek it in different ways.” (emphasis added)). These cases demonstrate that our hypothetical creditor could recover both collateral and proceeds up to the amount of his debt, and present a clear analogy to the case at bar. In our hypothetical case, the creditor is undersecured because of depreciation in the value of the engine; here, the creditor is undersecured because of 15 loss of other collateral specifically covered by crosscollateralization clauses. As discussed above, see supra Part III.A.2, the cross-collateralization clauses allow FINOVA to treat all of its collateral, and the proceeds thereof, as collateral for all of its debts. Thus, by virtue of the loss of its other collateral, FINOVA is in essentially the same situation as our hypothetical creditor whose single piece of collateral has depreciated, and can recover from both the collateral and the proceeds. 12 The Trustee disagrees with this result, citing a Bankruptcy Court case that holds that a secured claim is limited to the sale price of the collateral where it was sold pursuant to a Chapter 11 plan. See In re Broomall Printing Corp., 131 B.R. 32, 36 (Bankr. D. Md. 1991); cf. United Fruit & Produce Co. v. Absolute Exterminating (In re United Fruit & Produce), 242 B.R. 295, 306 (Bankr. W.D. Pa. 1999). We do not think that Broomall is applicable here. Tower is not in Chapter 11, and far from getting court or creditor approval for the “disposition” of the collateral, Tower repaired it without getting FINOVA’s contractually required permission. We note that § 9-306(b) grants a creditor a continuing interest in both collateral and proceeds unless the creditor authorized the transfer, Ariz. Rev. Stat. § 47-9306(B); the fact of authorization in Broomall distinguishes it from the present case. We thus conclude that, under the Arizona UCC as it was in effect at the time relevant to this case, FINOVA was entitled to recover both its collateral and the insurance proceeds from that collateral.