Court Opinion

ID: 9746952
Source: CourtListenerOpinion
Date Created: 2023-08-27 14:46:48.614273+00
Date Added: 2024-06-11T07:25:18.706594
License: Public Domain

POLLOCK, J.,
concurring.
I concur in the judgment of remand, and write separately with the hope of providing further guidance to the trial court. *35My concern is that without further explanation, the court might misconstrue the rights and duties of the parties and reach a result that is both contrary to law and inequitable. That possibility involves more than theoretical nuances. At stake is the home of defendants Edward L. Wilson and Joan Wilson, his wife (the Wilsons).
This appeal arises from the motion of plaintiff, Delaware Truck Sales, Inc. (Delaware Truck), for summary judgment to foreclose a mortgage given by the Wilsons to secure their guaranty of a promissory note executed by Mr. Wilson’s corporation, Delaware Repair Services, Inc. (Delaware Repair), in favor of Royal Bank of Pennsylvania (Royal Bank or bank). Although the record is sparse, the following facts emerge. Edward Wilson formerly worked for Delaware Truck, which was in the business of repairing cargo containers. Together with another former employee, he incorporated Delaware Repair to purchase the assets of Delaware Truck. Mr. Wilson arranged on August 20, 1984, with Royal Bank for a $75,000 line of credit evidenced by a promissory note signed by Delaware Repair. To secure the loan, Delaware Repair executed a financing statement covering various assets, including inventory and accounts receivable. Royal Bank filed the financing statement with the Camden County Clerk on September 19, 1984, and with the Secretary of State on September 25, 1984. As further security, the Wilsons executed a personal guaranty, secured by the subject mortgage on their residence, which Mrs. Wilson had inherited from her mother.
In the interim, on September 6,1984, Delaware Repair signed a contract to purchase the assets of Delaware Truck. The purchase price of $300,000 was paid by a $270,000 promissory note and a $30,000 cash payment. Mr. Wilson and the co-employee guaranteed payment of the note. Mrs. Wilson, however, assumed no personal liability to Delaware Truck. Nor did the Wilsons execute a mortgage on their home in favor of Delaware Truck. The agreement contemplated that Delaware Repair would execute “financing statements” that would in-*36elude a “secondary lien” on Delaware Repair’s accounts receivable, “subject only to a prior lien in favor of Purchaser’s institutional lender.” On October 4, 1984, fifteen days after Royal Bank had filed financing statements covering Delaware Repair’s receivables, Delaware Truck filed a financing statement covering those receivables. Thus, as the majority finds, “Royal Bank’s priority interest in the accounts receivable of Delaware Repair was superior to the security interest of plaintiff.” Ante at 28, 618 A.2d at 307. That finding, in my opinion, governs the rights and duties of the parties and controls the outcome of this case.
Like the Appellate Division and the majority, I believe that Royal Bank had a senior lien on non-inventory-generated accounts receivable. I disagree, however, with the majority’s statement that Delaware Truck “arguably was * * * entitled to collect any inventory-generated accounts receivable and apply the proceeds in satisfaction of the debt owed [to it] by Delaware Repair.” Ante at 31, 618 A.2d at 309. I do not dwell on this disagreement because, as the Appellate Division found, the inventory “sounds like a minor incidental part of the business and its proceeds.” Thus, even if Delaware Truck had a valid lien on proceeds traceable to inventory, it was obligated to surrender the bulk of the proceeds to Royal Bank because the bank’s lien covered most, if not all, of the proceeds.
Delaware Repair defaulted on its payments to Delaware Truck and Royal Bank. On May 27, 1988, Delaware Repair signed a “Surrender Agreement” with Delaware Truck, in which Delaware Repair acknowledged that it owed $166,935.58, and surrendered to Delaware Truck all assets in which Delaware Truck held a security interest, including inventory and accounts receivable of $140,000. Without notifying Royal Bank, Delaware Truck collected $98,600 on those receivables. Notwithstanding Royal Bank’s prior security interest, Delaware Truck applied the proceeds to reduce the debt secured by its subordinate security interest in the accounts receivable.
*37In December 1988, Royal Bank obtained a default judgment against Delaware Repair and the Wilsons for $62,000 — $36,600 less than the amount recovered by Delaware Truck on Delaware Repair’s receivables. If Delaware Truck had honored Royal Bank’s senior security interest, the Wilsons’ debt to the bank would have been satisfied and Royal Bank would have cancelled both their guaranty and their mortgage, with the result that it would not have obtained its judgment against them.
On learning that Delaware Truck had applied the proceeds to reduce the amount owed on its note rather than that of Royal Bank, the bank threatened to sue Delaware Truck. The two creditors settled their dispute, apparently without the knowledge or consent of the Wilsons.
Under the settlement, Delaware Truck paid Royal Bank $59,-500, only $2,500 less than the amount of the bank’s judgment against defendants. The record does not indicate whether the $59,500 derived from the $98,600 that Delaware Truck had misappropriated from the proceeds of Delaware Repair’s receivables. If so, that would compound the wrongfulness of Delaware Truck’s misuse of the proceeds. In exchange for the $59,500, Royal Bank assigned its judgment to Delaware Truck, together with the Wilsons’ personal guaranty secured by the mortgage on their home. Royal Bank signed a subordination agreement prepared by Delaware Truck’s attorney, in which Royal Bank acknowledged that “every security interest held by Royal Bank in each and every asset of Delaware Repair Services, Inc. is subordinate to the security interest of Delaware Truck.”
To the extent that the agreement indicates that Royal Bank’s security interest in Delaware Repair’s accounts receivable was subordinate to that of Delaware Truck, the agreement, as the majority implicitly recognizes, is incorrect. If the purpose of the provision was to reflect Royal Bank’s intent to subordinate its security interest, that provision should not bind the Wilsons. *38Under the agreement, Royal Bank’s loan was satisfied; the bank would not care if its security interest was subordinate to that of Delaware Truck. The two creditors could not bargain away the debtors’ expectation that the bank loan, which was secured by the subject mortgage, would be satisfied from the proceeds of accounts receivable in favor of their obligation to Delaware Truck.
The majority correctly concludes that notwithstanding the “intentions of the parties, we cannot discount the force of the Appellate Division’s conclusion that [Delaware Truck] was acting as a constructive trustee on Royal Bank’s behalf.” Ante at 30, 618 A.2d at 308. In support of that conclusion, the majority relies on the silence of the record concerning the knowledge or expectations of the two creditors. Also relevant, as the majority acknowledges, ante at 31, 618 A.2d at 308-09, are the guarantors’ expectations. If the Wilsons had agreed with Royal Bank that the bank enjoyed a senior security interest in the proceeds, the two creditors by themselves could not defeat that expectation.
A fair reading of the record suggests that by applying the proceeds of the receivables to its own claim, Delaware Truck deprived Royal Bank of money to which it was entitled, forced the bank to threaten suit, and then resolved the dispute by paying the bank virtually all the money due on the bank’s loan. Thus, Delaware Truck enhanced its position, first by paying itself $98,600 due Royal Bank and later by taking an assignment of the subject mortgage. If Delaware Truck had paid the bank $62,000 from the proceeds of the receivables, the bank’s loan would have been satisfied and Royal Bank would have cancelled the mortgage. By misappropriating the proceeds of the receivables, Delaware Truck prevented the payment of Royal Bank’s loan and facilitated the assignment of the subject mortgage, all to its benefit and the Wilsons’ detriment. Having brought the bank to the bargaining table by not honoring the bank’s senior security interest in the receivables, Delaware Truck improved its position to the prejudice of the Wilsons. *39Until it acquired Mrs. Wilson’s guaranty and the subject mortgage, Delaware Truck had no claim against her or her family home. If it had paid Royal Bank from the proceeds of the receivables, Delaware Truck never would have acquired the mortgage from the bank. Only by misusing the proceeds was Delaware Truck able to acquire the mortgage that it now seeks to foreclose.
In April 1989, Delaware Truck sued Delaware Repair and the Wilsons on both the note signed by Delaware Repair in favor of Delaware Truck and on Royal Bank’s judgment. That action apparently drove Edward Wilson into bankruptcy and induced Delaware Truck to bring the present action to foreclose on the Wilsons’ home.
Throughout these proceedings, the cornerstone of Delaware Truck’s position has been its claim that it was entitled to the proceeds of the accounts receivable because its security interest was senior to that of Royal Bank. The trial court accepted that claim, but both the Appellate Division and this Court have correctly rejected it.
The trial court also adopted Delaware Truck’s alternative argument that through the subordination agreement and assignments from Royal Bank, Delaware Truck had obtained a senior security interest in the receivables. In adopting that argument, the court relied on the Wilsons’ guaranty, which stated that it could be enforced “without first resorting to any security or other property or invoking other available rights or remedy.”
The Appellate Division, however, concluded that because Delaware Repair should have applied the proceeds to Royal Bank’s debt, that debt should be deemed satisfied. It relied on N.J.S.A. 12A:9-312(5), which grants priority to the first creditor to perfect a security interest by filing. The court reasoned that Delaware Truck should have honored Royal Bank’s senior security interest and paid the amount needed to satisfy the Wilsons’ debt to the bank. Like the bank, the Wilsons had a right to *40expect that Delaware Truck would pay the bank before paying itself. Only by violating its duty under the Uniform Commercial Code was Delaware Truck able to bring the bank to the bargaining table and obtain the bank’s consent to the agreement. From Royal Bank’s perspective, once its loan was satisfied, it had no financial interest in the legal relationship between Delaware Truck and the Wilsons. Neither Delaware Truck nor Royal Bank inquired whether their agreement defeated the Wilsons’ expectations.
The majority finds “readily inferable that both Delaware Truck and Royal Bank, in the settlement between them, did not intend to satisfy and thereby discharge the underlying obligations of defendants to Royal Bank.” Ante at 29, 618 A.2d at 308. The record may support, but hardly compels such a finding. Hence, I would not leap to the conclusion that “from the face of the documents evidencing the transaction, it appears that Delaware Truck and Royal Bank mutually intended to transfer, not extinguish, Delaware Repair’s underlying debt to Royal Bank.” Id. at 30, 618 A.2d at 308. My difference with the majority ordinarily might not amount to anything more than a quibble. Here, the difference requires further explanation.
I agree with the Appellate Division that the Wilsons’ debt to Delaware Truck was extinguished as a matter of law. The majority, however, goes no further than to concede that “the Appellate Division may have been correct in concluding that the debt was extinguished as a matter of law.” Id. at 30, 618 A. 2d at 308. That equivocation reflects a misperception of the relationship between the Wilsons and Royal Bank and of that between Royal Bank and Delaware Truck. The misperception causes the majority’s “hesitancy * * * in affirming [the judgment of the Appellate Division] based on the absence in the record of evidence relating to the circumstances surrounding Royal Bank’s claim against Delaware Truck and the settlement of that claim.” Ibid.
*41More important than the relationship between Royal Bank and Delaware Truck, I believe, is that between the bank and the Wilsons. Like the bank, the Wilsons, as guarantors of Delaware Repair’s debt to Royal Bank, had the right to expect that Delaware Truck would respect the seniority of the bank’s security interest. Delaware Truck and Royal Bank could not deprive the Wilsons of that right without the Wilsons’ consent. See Ottenheimer Publishers v. Regal Publishers, 626 S.W.2d 276, 280 (Tenn.App.1981) (stating that debtor “does at least have the right to have the collateral disposed of in a manner which will satisfy the debt for which it was offered as security”). Hence, I disagree with the majority’s suggestion that the Wilsons’ expectations may be relevant because “the status of Delaware Truck in collecting the accounts receivable is determinative of its right as assignee to enforce Royal Bank’s remedies against the debtors-guarantors * * Ante at 31-32, 618 A.2d at 309. The Wilsons’ expectations are relevant not because Delaware Truck’s status is determinative, but because their expectations limit the extent to which Royal Bank and Delaware Truck may deal with the proceeds of Delaware Repair’s receivables.
Similar reasoning leads me to conclude that the majority has unduly emphasized the position taken by the Wilsons in the action by Royal Bank. The Wilsons’ rights should be determined by their original agreement with the bank, rather than by their position in subsequent litigation. Any failure of the Wilsons to contest vigorously Royal Bank’s claim need not reflect their belief that “Delaware Truck could reduce its own larger claim against defendants without first satisfying the underlying debt of Royal Bank.” Ante at 32, 618 A.2d at 309.
I also believe that the majority misperceives the significance of the Wilsons’ guaranty. By its terms, the guaranty was absolute, unconditional, and assignable. Under the circumstances of this case, however, Delaware Truck should not be allowed to avail itself of the guaranty or of its self-serving *42agreement with Royal Bank, an agreement that apparently was drafted by Delaware Truck’s attorney without the knowledge or consent of the Wilsons. The reason is that the guaranty is subject to the Wilsons’ expectation that Delaware Truck would pay Royal Bank from the proceeds of the receivables. Thus, the point is not that “Royal Bank might have had an obligation under the personal guaranties to proceed against the real-estate mortgage in order to enable plaintiff to achieve a recovery out of the accounts receivable.” Ante at 33, 618 A.2d at 310. Rather, the point is that Delaware Truck and Royal Bank’s agreement alone could not deprive the Wilsons of their rights, notwithstanding the terms of the guaranty. A contrary result could lead to a circuity of action: the Wilsons could recover from Royal Bank for its failure to apply the proceeds to the loan secured by their guaranty, and the bank could then recover from Delaware Truck for the misapplication of the proceeds.
Royal Bank recognized that its primary obligor was Delaware Truck. On discovering that Delaware Repair had misapplied the accounts receivable, the bank did not seek to foreclose on the Wilsons’ home, but threatened to sue Delaware Truck. Had the Wilsons paid Royal Bank under their guaranty of Delaware Repair’s loan, they would have been subrogated to the bank’s rights against Delaware Truck for misappropriation of the proceeds of the receivables. See Langeveld v. L.R.Z.H. Corp., 74 N.J. 45, 51, 376 A.2d 931 (1977) (“Upon paying the debt, the surety is, as a matter of law, subrogated to all the creditor’s, rights against the principal debtor and is entitled to all benefits derivable from any security of the principal debtor that may be in the creditor’s hands.”); see also Ottenheimer Publishers, supra, 626 S.W.2d at 281 (“Generally, a surety or guarantor, by payment of the debt of his principal * * * acquires an immediate right to be subrogated * * * to all rights, remedies and securities which were available to the creditor * * *.”). In effect, the parties would have landed in their present position with the Wilsons entitled to credit against Delaware Truck for the misuse of the proceeds of Delaware *43Repair’s receivables. Thus, I believe the majority goes too far in stating that “it seems clear that defendants’ claim that the personal guaranties were discharged because the collateral held by Royal Bank had been impaired through its liquidation is not sustainable.” Ante at 34, 618 A.2d at 310. For, as we have held, “The rule forbidding impairment of collateral has as its chief aim the protection of [the] potential benefits made available through subrogation.” Langeveld, supra, 74 N.J. at 51, 376 A.2d 931.
The majority should not rely on the possibility that Royal Bank may have had an equitable obligation to marshall its assets in favor of Delaware Truck. As previously indicated, the critical relationship is not that between Royal Bank and Delaware Truck, except insofar as N.J.S.A. 12A:9-312(5) obligates Delaware Truck to honor the bank’s senior security interest. The focus should be on the relationship between Delaware Truck and the Wilsons.
N.J.S.A. 12A:9-504 generally authorizes creditors to dispose of collateral to satisfy a defaulted loan. An earlier section, N.J.S.A. 12A:9-306(2), provides that a security interest continues in the proceeds from the disposition of collateral. No one disputes that the security interest of a creditor continues in the proceeds from the collection of accounts receivable. N.J.S.A. 12A:9-306, comments 2 & 3; 9 Ronald A. Anderson, U.C.C. § 9-306:11, at 142 (1985); 9 William D. Hawkland, Uniform Commercial Code Series § 9-306:03 (1986). The priority of a creditor with a perfected security interest in the receivables continues in the proceeds. 3 Theodore Eisenberg, Debtor-Creditor Law 1115.05[B], at 15-85 (1989). A creditor with a security interest in accounts receivable need not take possession of the receivables to perfect its lien. Id. at 15-89. A secured creditor who disposes of proceeds in violation of article 9 “is liable to the debtor and other secured parties for any loss caused by his failure to comply.” Id. ¶ 15.09[H], at 15-149.
*44I do not read Professors White and Summers’s text to the contrary. In their text, they state that they do not believe that a senior secured party “may seek to assert a prior claim to the proceeds of the sale conducted by the junior secured party.” 2 James J. White & Robert S. Summers, U.C.C. § 27-9, at 593 (3d ed. 1988). That statement appears in a discussion of the relative rights of creditors in the context of a foreclosure sale of collateral under section 9-504(4) of the Uniform Commercial Code, adopted in New Jersey as N.J.S.A. 12A:9-504(4). Their criticism is that if the senior creditor “wants such priority, he should have to run the foreclosure sale. And if he does not, his interest is protected anyway.” 2 White & Summers, supra, § 27-9, at 593. Taken in context, that statement should not apply to the collection of accounts receivable by a junior creditor in possession.
The First Circuit reached the same result in a similar case, New Hampshire Business Development Corp. v. F.R. Lepage Bakery, 832 F.2d 7 (1987). There, New Hampshire Business Development Corp. (NHBDC) had a $50,000 senior security interest in accounts receivable of one Cross. F.R. Lepage Bakery (Lepage) held a junior security interest in the same receivables. Lepage collected the proceeds of the receivables. The issue was whether Lepage was obliged to account to NHBDC to the extent of its $50,000 security interest. The court ruled that
[t]he rights of the secured parties in the collateral after a debtor’s default are the essence of a security transaction. It is the relationship between a senior secured creditor and a junior secured creditor that defines their obligations. Although not extensive, the case law indicates that it is the obligation of the junior creditor to account for and pay over to the senior creditor the sums collected.
[Id. at 10 (citations omitted).]
I agree.
The court also found that
[t]he relationship of the parties and the circumstances of the case also give rise to the remedial device of a constructive trust. The junior creditor (Lepage) holds the right to payment from the common debtor (Cross) as a constructive *45trustee for the senior creditor (NHBDC) after the default of the common debtor.
[M at 11 (citations omitted).]
That case involved the imposition of a constructive trust on a junior creditor in favor of a senior creditor. The present matter concerns the relationship between a misappropriating junior creditor and the debtor and the debtor’s guarantors, but the distinction should not make any difference.
“[A] constructive trust, unlike an express trust, is a remedial and not a substantive institution.” Austin W. Scott, Constructive Trusts, 71 L. Q.Rev. 39, 41 (1955) (citing Roscoe Pound, The Progress of the Law — Equity, 33 Harv.L.Rev. 420, 421 (1920)). In Beatty v. Guggenheim Exploration Co., 225 N.Y. 380, 122 N.E. 378, 380 (1919), Judge Cardozo defined a constructive trust as “the formula through which the conscience of equity finds expression. When property has been acquired in such circumstances that the holder of the legal title may not in good conscience retain the beneficial interest, equity converts him into a trustee.” See also Restatement of the Law of Restitution § 160 (1937); 5 Austin W. Scott & William F. Fratcher, The Law of Trusts § 452, at 304 (4th ed. 1989) (“A constructive trust arises where a person who holds title to property is subject to an equitable duty to convey it to another on the ground that he would be unjustly enriched if he were permitted to retain it.”); 4A Richard R. Powell, The Law of Real Property § 594, at 48-3 to -4 (same); 4 John N. Pomeroy, Equity Jurisprudence § 1044, at 93 (1941) (“They arise when the legal title to property is sustained by a person in violation, express or implied, of some duty owed to the one who is equitably entitled, and when the property thus obtained is held in hostility to his beneficial rights of ownership.”); accord D’Ippolito v. Castoro, 51 N.J. 584, 588-89, 242 A.2d 617 (1968); Stewart v. Harris Structural Steel Co., Inc., 198 N.J.Super. 255, 265-66, 486 A.2d 1265 (App.Div.1984); Massa v. Laing, 160 N.J.Super. 443, 446, 390 A.2d 624 (App.Div.1977), aff'd o.b., 77 N.J. 227, 390 A. 2d 547 (1978); Callahan v. Callahan, 142 N.J.Super. 325, *46329, 361 A.2d 561 (App.Div.1976); Hirsch v. Travelers Ins. Co., 134 N.J.Super. 466, 470, 341 A.2d 691 (App.Div.1975).
By not turning over the proceeds to Royal Bank, Delaware Truck unjustly enriched itself and became a constructive trustee for the benefit of the Wilsons. See 5 Scott & Fratcher, supra, § 462.2, at 313-14 (stating that unjust enrichment may arise out of wrongful acquisition or retention of property). The subordination agreement between Delaware Truck and Royal Bank is irrelevant; the constructive trust arises to prevent the unjust enrichment of Delaware Truck at the expense of the Wilsons. See id. § 462, at 311. Royal Bank was entitled to an equitable lien on the proceeds. 4 Scott & Fratcher, supra, § 291.4, at 82; id. § 508.2, at 569.
On remand, I believe the trial court should focus on the Wilsons’ right to expect Delaware Trust to turn over the proceeds to Royal Bank for application against Delaware Repair’s $75,000 bank loan, which was secured by the subject mortgage.
POLLOCK and STEIN, JJ., concurring in the result.
For reversal and remandment — Chief Justice WILENTZ, and CLIFFORD, HANDLER, POLLOCK, O’HERN, GARIBALDI and STEIN — 7.
For affirmance — None.