Court Opinion

ID: 9528237
Source: CourtListenerOpinion
Date Created: 2023-08-07 03:38:39.008764+00
Date Added: 2024-06-11T13:26:36.697623
License: Public Domain

Prager, J.,
dissenting.
I respectfully dissent from the majority opinion’s conclusion that the bank should be allowed to defeat the finance company’s secured interest in the proceeds from the sale of collateral. The majority discusses the interrelationship between the bank’s right of setoff and the creditor’s security interest, but fails to define the status of that relationship under Kansas law today. Instead, the majority simply concludes that the debit occurred in the ordinary course of business and without notice of conflicting claims. I cannot agree.
Assuming the finance company’s security interest is properly perfected, the bank is entitled to the funds only if it is able to establish that its statutory right of setoff under K.S.A. 9-1206 is superior to the perfected security interest under Article 9 of the Uniform Commercial Code, or that the bank received the money in the ordinary course of business under K.S.A. 1980 Supp. 84-1-201(9).
The majority recognizes that other jurisdictions have reached *552conflicting conclusions as to the relative priority between bank setoffs and perfected security interests. The majority opinion notes the two prevailing theories: (1) The “legal rule” which prohibits a bank from exercising its right of setoff only when it has knowledge of a third party’s interest in the funds in the debtor’s account, and (2) the “equitable rule” which prohibits a bank from applying funds to a depositor’s antecedent debt, despite lack of knowledge of any conflicting claims to the funds, if the bank has not changed its position or has no superior equities. Early Kansas cases held that actual knowledge by the bank of a third party’s claim to funds in the debtor’s account precluded setoff. See, e.g., Gunn v. Bank, 97 Kan. 404, 155 Pac. 796 (1916); Tough v. Bank, 89 Kan. 583, 132 Pac. 174 (1913); Kimmel v. Bean, 68 Kan. 598, 75 Pac. 1118 (1904). In Williams v. Hanston State Bank, 140 Kan. 260, 36 P.2d 84 (1934), the bank was precluded from applying funds deposited in its debtor’s account to that debt, where it was charged with knowledge of a third party’s interest in those funds. Plaintiffs had purchased land from the debtor-depositor, and the transfer of ownership was published in the local newspaper. The land was subject to oil leases, and rentals had been routinely deposited in debtor’s account. After the sale and publication, the oil company, through error, made a deposit for rentals to the debtor’s account, which should have been paid to the purchaser. The bank thereafter applied the funds to a debt owed to them by the debtor. The court denied the bank authority to apply the funds to the antecedent debt, citing 13 A.L.R. 334:
“Where the bank, although having no actual notice of the character of funds deposited with it, has knowledge of circumstances such as are regarded as sufficient to necessitate inquiry upon its part, the general rule is that the bank cannot, as against the true owner, set off such funds against the individual indebtedness of the depositor to the bank.” 140 Kan. 266.
Just as publication imparts constructive notice (see, e.g., K.S.A. 60-307), the filing of Article 9 financing statements constitutes notice to the entire world of the secured party’s interest in collateral. Allis-Chalmers Cred. Corp. v. Cheney Investment, Inc., 227 Kan. 4, 10, 605 P.2d 525 (1980). The purpose of UCC filing requirements for the perfection of security interests, then, is to give notice of the secured party’s interest to all third parties dealing with the subject matter of the security interest. Once the *553security interest is perfected by filing, a bank would be charged with notice, and thus, its right of setoff would be properly subordinated to the security interest.
Under Kansas law, the finance company had an interest in the funds deposited in the home company’s account. The interest of a secured creditor in the proceeds from the sale of the collateral is provided for in K.S.A. 1980 Supp. 84-9-306(2). The UCC has two other provisions which support the subordination of a statutory right of setoff to an Article 9 perfected security interest in the proceeds of the collateral. K.S.A. 1980 Supp. 84-9-104(1) excludes from the article “any right of setoff.” K.S.A. 84-9-310 gives priority to mechanics’ liens for work or services necessary for the preservation of the collateral. See, Kansas Comment to 84-9-310. K.S.A. 84-9-201 establishes the validity of a security interest against third parties, unless the Code provides otherwise. There is nothing in Article 9 to suggest a perfected security interest is subordinate to a right of setoff. Had the legislature intended to subordinate the security interest to setoffs, it could have so provided in a manner similar to the 84-9-310 priority given to mechanics’ liens.
Other jurisdictions have also concluded that a bank’s right of set off is subordinate to a perfected security interest. In Nat. Acceptance Co. of America v. Va. Capital Bank, 498 F. Supp. 1078 (E.D. Va. 1980), the court discussed the 9-104(i) exclusion of setoffs from Article 9, and concluded that the statute clarified the status of a bank with a right of setoff as that of a general creditor, rather than a secured creditor with priority under Article 9. In Citizens Nat. Bank v. Mid-States Dev. Co., _ Ind. App. _, 380 N.E.2d 1243 (1978), the court relied on UCC § 9-201 which gives priority to a secured party over anyone, unless such priority is set forth elsewhere in the Code. Subordination of the bank’s right of setoff to perfected security interests is thus supported in Kansas law, as well as other jurisdictions considering the interrelationship of setoff rights with UCC Article 9 perfected security interests.
As noted previously, a bank’s authority to set off funds in a depositor’s account against an antecedent debt is authorized in K.S.A. 9-1206. The right of setoff, however, requires mutuality of obligations between the bank and the depositor. Docking v. Commercial National Bank, 118 Kan. 566, 568, 235 Pac. 1044 *554(1925); 10 Am. Jur. 2d, Banks § 666, p. 635. Without determining priority between setoffs and security interests, it is clear that, in the present case, the bank could not have exercised its right of setoff against the home company account, as the debt was owed by the trailer company, and there was therefore no mutuality of obligations.
The majority also concludes that the debit was not really a setoff, but a transfer in the ordinary course of the bank’s business, particularly since the majority found no indication of the bank’s knowledge of any third-party interest to the funds. It is difficult to distinguish this transfer from a setoff. Gary Heideman, president of both the trailer and home companies, testified that he did not remember authorizing the transfer. He did admit, however, that he had the authority to make the transfer and did not object to it after receiving notice of the debit. Joe Beckham, a bank employee, testified that Heideman had previously sold secured collateral in violation of security agreements, and that the bank had told him that the next time collateral was sold in violation of those agreements, the bank would “press charges.” Steven Beurge, a bank vice-president, testified that he talked with Heideman on the phone on August 13, 1974, when the bank’s collateral was discovered missing from the trailer company’s lot. Heideman was informed that the trailer company had to pay the remaining balance on the loan secured by the trailers that day. According to Beurge, at that time Heideman authorized the debit from the home company’s account. The debit clearly constituted a withdrawal of funds to be applied to an antecedent debt owed to the bank. The only elements distinguishing this transaction from a setoff are the lack of mutuality of obligations and the bank’s assertion that Heideman authorized the debit.
It is equally difficult to understand, both under the law and the circumstances of this particular case, how the debit could be considered as being within the ordinary course of the bank’s business. The continuation of the security interest in proceeds after the sale of collateral is authorized in K.S.A. 84-9-306(2). The majority opinion cites the Official UCC Comment (2) (c) that a security interest in cash proceeds deposited in an account remains perfected until transferred in the ordinary course of business.
Other jurisdictions have relied upon this comment to find the *555bank’s conduct in applying a depositor’s funds to an antecedent debt prohibited as outside the ordinary course of business. For example, in Brown & Williamson T. Corp. v. First Nat. Bk. of Blue Island, 504 F.2d 998 (7th Cir. 1974), the bank’s conduct was found not to be within the ordinary course of business so as to defeat the creditor’s perfected security interest in proceeds where the creditor presented its draft upon the account, the bank falsely represented to the creditor that there were insufficient funds in the account to cover the draft, and the bank then procured a debit memorandum in its favor from the debtor-depositor. In Universal C.I.T. Credit Corp. v. Farmers Bank of Portageville, 358 F. Supp. 317 (E.D. Mo. 1973), the debtor authorized the bank’s debit in payment of an antecedent debt for the stated purpose of defeating the creditor’s security interest. Additionally, the transfer was made after business hours. Under those circumstances, the bank’s conduct was “clearly outside the ordinary course of business,” and did not defeat the perfected security interest. In Anderson, Clayton & Co. v. First Am Bank, 614 P.2d 1091, 1094 (Okla. 1980), the court interpreted the UCC Official Comment to § 9-306 to mean that “a security interest in proceeds remaining in a bank account continues until the funds are actually transferred in the ordinary course of business.” The Oklahoma court found no precise definition of “ordinary course of business,” but borrowed from UCC § 1-201(9) to find requirements of good faith and honesty without knowledge of preexisting claims. The bank was precluded from asserting its right of setoff where it was charged with knowledge of the preexisting security interest.
While there is no indication in the present case of either the debtor’s or bank’s intent to circumvent a valid security interest, the circumstances of the debit are sufficiently irregular to make the bank’s conduct “outside the ordinary course of business.” First, the debit was made from the account of one company to satisfy the debt of another. This should have alerted the bank that perhaps the debtor was, in fact, “robbing Peter to pay Paul.” Ordinarily, a bank may comply with a verbal direction from a depositor for the dispersal of funds without liability to the bank. See, Mathey v. Central National Bank of Junction City, 179 Kan. 291, 294, 293 P.2d 1012 (1956) (depositor’s verbal instruction to the bank justifies the bank in acting accordingly); Tough v. Bank, 89 Kan. 583 (depositor’s verbal authorization to apply funds in *556account to debt owed to the bank served the same purpose as a check); 10 Am. Jur. 2d, Banks § 496, p. 465. A bank should not, however, be able to apply funds in contradiction of a third party’s interest, particularly where the dispersal is in favor of the bank. A prudent banker, under these circumstances, should have required some written authorization, since the withdrawal was from an account other than that of the debtor, and because the withdrawal was in favor of the bank.
In National Accept. Co. of America v. Virginia, 491 F. Supp. 1269 (E.D. Va. 1980), the bank was precluded from applying a depositor’s funds to an antecedent debt as constituting conduct outside the ordinary course of business, even though there was no indication of intent to defraud the secured creditor, knowledge of the secured creditor’s interest, or other bad faith. The bank had exercised its right of setoff against the debtor’s bank accounts, taking funds which were proceeds subject to the creditor’s security interest. The court found UCC § 1-201(9) to be applicable. That statute is identical to the Kansas counterpart, K.S.A. 1980 Supp. 84-1-201(9), and states:
“ ‘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 but does not include a pawnbroker. . . . ‘Buying’ may be for cash or by exchange of other property or on secured or unsecured credit and includes receiving goods or documents of title under a preexisting contract for sale but does not include a transfer in bulk or as security [for] or in total or partial satisfaction of a money debt.”
The court held that the bank’s exercise of its right of setoff was not in the ordinary course of business, because the debtor was not in the business of selling funds in its accounts, and because it took the proceeds in satisfaction of an antecedent indebtedness.
The majority opinion also attempts to justify its conclusion by shifting to the secured creditor the burden of policing collateral and proceeds. Pre-Code law placed on the interest holder the duty of looking after its collateral and of seeing that the proceeds from the sale of that collateral were properly applied. See, e.g., Farmers State Bank v. Bank of Inman, 123 Kan. 238, 242, 254 Pac. 1038 (1927). Enactment of the UCC, however, relieves the secured creditor of this burden, as evidenced by K.S.A. 1980 Supp. 84-9-306(2), which provides for the continuation of the security interest in the proceeds after sale, and K.S.A. 1980 Supp. 84-9-*557205, which validates the security interest in collateral in the possession and control of the debtor. See National Accept. Co. of America v. Virginia, 491 F. Supp. at 1274. The majority’s chastisement of the finance company’s lack of diligence in policing the collateral is therefore misplaced, especially since it is noted in the same opinion that it would be “wholly illogical” to allow the debtor to defeat a perfected security interest by depositing the proceeds in a different account.
I would hold that a bank’s application of funds in a debtor’s account to an antecedent debt should not be considered a transaction in the ordinary course of the bank’s business so as to defeat a perfected security interest. The fact that the funds were wrongfully deposited in a different account, and that-the president of both companies allegedly approved the withdrawal and application should not change the result. Accordingly, I dissent from the majority opinion that, under the totality of the circumstances, the bank was entitled to apply the secured proceeds to the trailer company’s antecedent indebtedness to the bank, thereby defeating the finance company’s security interest.
Miller and Herd, JJ., join the foregoing dissenting opinion.