Opinion ID: 445533
Heading Depth: 1
Heading Rank: 1

Heading: Rights to the collateral.

Text: 8 Except where the code provides otherwise, a security interest continues in collateral notwithstanding sale, exchange or other disposition thereof unless the disposition was authorized by the secured party.... Sec. 9306(2). Where the collateral consists of goods, such as the refining lots in this case, the code makes two exceptions to this general rule: (1) a buyer in ordinary course of business takes the collateral free of all security interests created by the seller of the goods, even perfected ones, Sec. 9307(1); and (2) a buyer not in ordinary course of business takes the collateral with rights superior to unperfected security interests in the collateral if he meets the requirements of Sec. 9301(1)(c). See U.C.C. Sec. 9-306 official comment 3 (1977). 9 Because there is no evidence that the bank or the Small Business Administration authorized the sale of the refining lots outside the ordinary course of business, Handy & Harman must fit within one of these exceptions in order to take the collateral free of the government's security interest. 10 The security agreement between Coronado and the bank authorized Coronado to sell the Inventory in the ordinary course of business. This authorization applies to the refining lots. They were inventory as defined both in the security agreement and in the code. See Sec. 9109(4). 2 Because the security agreement uses the code terms ordinary course of business, we conclude that the security agreement's authorization to sell the collateral has the same effect as Sec. 9307(1), permitting a buyer in ordinary course of business to take the collateral free of all security interests created by the seller. Therefore we do not separately consider whether the sale to Handy & Harman complies with the authorization in the security agreement, but turn directly to the question whether it falls within Sec. 9307(1). 11
12 Contrary to the district court's conclusion, Handy & Harman does not qualify for status as a buyer in ordinary course of business and thus cannot take the collateral free of the government's security interest under Sec. 9307(1). 13 Section 1201(9) defines buyer in ordinary course of business. Most important for this case is its proviso that  '[b]uying' may be ... on secured or unsecured credit ... but does not include a transfer ... in total or partial satisfaction of a money debt. By barring a purchaser who takes goods in satisfaction of a debt from ordinary course status, the code requires that a buyer in ordinary course of business give new value for the goods. J. White & R. Summers, Handbook of the Law under the Uniform Commercial Code Sec. 25-13 (2d ed. 1980); Skilton, Buyer in Ordinary Course of Business under Article 9 of the Uniform Commercial Code (and Related Matters), 1974 Wis.L.Rev. 1, 30 n. 75. 3 14 The new value requirement is central to the functioning of the code's system of inventory financing. Inventory is valuable to a merchant only if he can sell it to his customers. If the merchant's inventory financer could foreclose the security interest in the goods after they had been sold, prospective customers would be reluctant to buy the merchandise. Recognizing this, Sec. 9307(1) facilitates sales of inventory by providing that the ordinary buyer of inventory 4 takes the goods free of any security interest, even if he knows that they are subject to a security interest, so long as he does not have actual knowledge that the sale violates the terms of a security agreement. See Sec. 9307(1) and U.C.C. Sec. 9-307 official comment 2 (1977). 15 At the same time, the rule of Sec. 9307(1) is carefully limited to avoid unduly endangering the position of the inventory financer. By incorporating the definition of buyer in ordinary course of business, Sec. 9307(1) permits a buyer of inventory to take the inventory free of a security interest only if he gives some new value in exchange for the inventory. The inventory financer is protected because his security interest in the inventory will attach to the new value, which constitutes proceeds of the inventory. See Sec. 9306(2). If the rule were otherwise, and a transferee of inventory who received the goods in satisfaction of a pre-existing debt were permitted to keep them free of security interests, the effect would be to enable an unsecured creditor--the transferee--to bootstrap himself into priority over the secured creditor who looks to the inventory for security. The new value requirement should be strictly construed to preclude the frustration of the code's priority provisions. 16 This case illustrates the problem created when Handy & Harman decided to treat its promise to pay Coronado for the refining lots as subject to a set off against the debt Coronado already owed to Handy & Harman. While the set off was legal, it was inconsistent with the new value requirement. We conclude that Handy & Harman may not claim the status of a buyer in ordinary course of business. Handy & Harman's exercise of the offset created the very problem that the new value requirement was designed to prevent. Because of the offset, Coronado received no money to which the government's security interest could attach. The government is left in exactly the same position that it would occupy if Handy & Harman had never promised to pay Coronado and had taken the collateral in partial satisfaction of Coronado's debt in the first place. 17 We hold only that a buyer of goods on credit cannot qualify for ordinary course status under Sec. 1201(9) if he subsequently offsets his promise to pay with a debt that was in existence at the time he bought the goods. We do not hold that all defenses to, or offsets of, a buyer's promise to pay will disqualify the buyer from status as one in ordinary course of business. It may be, for example, that a buyer of goods on credit could assert a breach of warranty defense to his promise to pay without losing his status as a buyer in ordinary course. We do not decide that question, but note only that such a defense would not have the effect of offsetting the promise to pay with a debt that was in existence at the time the goods were bought. 18 Our holding is consistent with California law outside the California Commercial Code. As Handy & Harman itself points out, Cal.Civ.Proc.Code Sec. 431.70 (West Supp.1984) permits offset of cross-demands for money as a defense to an action brought on one of the demands. Case law construing former Cal.Civ.Proc.Code Sec. 440, to which Sec. 431.70 is a successor, see Cal.Civ.Proc.Code Sec. 431.70 legislative comment (West 1973), holds that cross-demands are deemed paid at the moment that they coexist. Singer Co. v. County of Kings, 46 Cal.App.3d 852, 869, 121 Cal.Rptr. 398, 409 (1975); Hauger v. Gates, 42 Cal.2d 752, 755, 269 P.2d 609, 611 (1954); Note, Automatic Extinction of Cross-Demands: Compensatio from Rome to California, 53 Calif.L.Rev. 224, 264 (1965). Assuming that Sec. 431.70 applies to this case, Handy & Harman's promise to pay would have been deemed offset with the debt Coronado owed Handy & Harman at the moment that Handy & Harman bought the collateral. The purchase of the collateral thus would have been in satisfaction of that pre-existing debt from the outset. 19
20 Although Handy & Harman does not qualify as a buyer in ordinary course of business and thus cannot take the collateral free of a perfected security interest, it may qualify for the priority over unperfected security interests that Sec. 9301(1)(c) accords a buyer not in ordinary course of business. 21 Section 9301(1)(c) subordinates an unperfected security interest in goods to the rights of a buyer not in ordinary course of business to the extent that he gives value and receives delivery of the collateral without knowledge of the security interest and before it is perfected. Section 9301(1)(c) applies here because the code deems the government's security interest in the collateral to be unperfected as against Handy & Harman. 22 The government's security interest in the collateral was perfected in New Mexico by filing a financing statement with the appropriate office in that state. Section 9103(1)(d)(i) required the government to refile its statement in California within four months of the arrival of the collateral in that state to maintain its perfection. 5 The government did not refile. In the absence of a refiling within four months of the removal of collateral to California, a security interest in the collateral is deemed to have been unperfected as against a person who became a purchaser after removal. Sec. 9103(1)(d)(i). Handy & Harman qualifies as a purchaser of the collateral even though it did not give new value to Coronado. See Secs. 1201(32) and (33). Because Handy & Harman was a purchaser after removal, Sec. 9103(1)(d)(i) provides that the government's security interest is unperfected as against Handy & Harman. 23 The government urges us to ignore the plain language of Sec. 9103(1)(d)(i) and to hold that because the government notified Handy & Harman of its security interest within Sec. 9103's four-month grace period the security interest continued to be perfected notwithstanding the government's failure to refile in California. In support of its position the government cites Professors White and Summers, who believe that 24 As long as the out-of-state secured party asserts his security interest before the four-month period expires, he should not have to refile in order to win. In this setting it makes sense to freeze the relative priorities inside the four month period because that is when the conflict quickens. Thereafter, all that remains are settlement negotiations or trial. A refiling would add nothing.... Finally, the secured party should win against a nonordinary-course buyer if he asserted his rights within the four-month period. 25 J. White & R. Summers, supra, Sec. 23-18 at 974 (footnotes omitted). 26 We are not persuaded that Professors White and Summers are speaking to the situation presented by our case. Their reference to settlement negotiations or trial suggests that they may have in mind a situation where the secured party asserts its security interest by filing suit within the four-month period. In our case the government's only action within the four-month period was to notify Handy & Harman, by telephone and letter, of its security interest and to demand return of the collateral. The government did not file this action to recover the collateral until after the four-month period had expired. 27 A secured party's giving notice of its security interest to an intervening purchaser within four months of removal of the collateral to a new state is not sufficient to override the plain language of Sec. 9103(1)(d)(i) and maintain perfection. Notice of a security interest, given privately by a secured party to a purchaser after collateral has been moved from one state to another, is not a satisfactory substitute for public filing of a financing statement, the action that Sec. 9103(1)(d)(i) contemplates in most instances. See Sec. 9302 (filing of financing statement required to perfect most security interests). The financing statement obviates problems of proof. When a financing statement is filed, a public officer records the date and time of filing so there can be no dispute over whether the refiling took place within four months after removal of the collateral. Private notice, on the other hand, raises evidentiary questions and subjective responses. For example, who in the organization, if anyone, actually received the notice? One purpose of filing is to reduce litigation. 28 Moreover, a financing statement gives notice to all the world, while private notice, as in this case, may be limited to only one purchaser of the collateral. If notice to less than all the world is sufficient to maintain perfection as against those who receive the notice, circular priorities become a possibility. For example, assume that ordinary goods subject to A's perfected out-of-state security interest are brought into California. Assume that B takes a security interest in the collateral within four months of its arrival and perfects by filing in California. A does not refile in California, but within the four-month period privately notifies B of his security interest. If the government's position is adopted, A is superior to B. Now assume that C also takes a security interest in the collateral and perfects by filing after B. A does not notify C of his security interest and, as already mentioned, does not refile within the four-month period. Under the first-to-file-or-perfect rule of Sec. 9312(5), B is superior to C. But because A neither notified C of A's security interest nor refiled, C is superior to A. In sum: A is superior to B, who is superior to C, who is superior to A. Circular priorities can be resolved, but interpretations of the code that would give rise to them should be avoided. Because the government's position could give rise to circular priorities, we conclude that it is not a reasonable interpretation of the code. The government's security interest remained unperfected as against Handy & Harman. 29 We now must consider whether Handy & Harman meets the other requirements of Sec. 9301(1)(c). Handy & Harman must be a buyer of the collateral, and must give[ ] value and receive[ ] delivery of the collateral without knowledge of the security interest and before it is perfected. 30 Handy & Harman is a buyer of the collateral. The code does not define the term buyer, and buying is defined only in the context of a buyer in ordinary course of business. Sec. 1201(9). The code does define the term sale, however, as the passing of title from the seller to the buyer for a price. Sec. 2106(1). Handy & Harman's purchase of the collateral qualifies as a sale--title passed and the parties agreed on a price for the goods--and thus Handy & Harman, as one receiving goods by sale, must be a buyer. 31 The government never reperfected its security interest in the collateral, so Handy & Harman meets the requirement of taking the collateral before the security interest was perfected. Handy & Harman also received delivery of the collateral and gave value for it because sections 1201(44)(c) and (d) define value as accepting delivery under a pre-existing contract for purchase, or any consideration sufficient to support a simple contract. 32 However, the record does not show whether Handy & Harman gave value and took delivery without knowledge of the government's security interest. U.C.C. Sec. 9-301 official comment 4 (1977) makes clear that the requirement that a buyer be without knowledge of the security interest applies both to giving value and to taking delivery. The district court found that Handy & Harman bought the collateral without knowledge that the sale was in violation of the government's security agreement, but this is a different question from whether Handy & Harman knew of the security interest. We must remand the case for findings on this point. 33 Because Handy & Harman may be able on remand to show that Sec. 9301(1)(c) entitled Handy & Harman to priority over the government's unperfected security interest in the collateral, we next consider the rights of the parties to the proceeds of the collateral if the collateral is no longer in existence. 34