Opinion
NO. CY-02-3076-EFS
March 22, 2004
ORDER AFFIRMING IN PART AND REVERSING IN PART THE BANKRUPTCY COURT'S ORDER, REMANDING, AND CLOSING FILE
U.S. Bank appeals from the Bankruptcy Court's Findings of Facts and Conclusions of Law. (Ct. Rec. 2.) The underlying action was brought by Cenex to retrieve crop proceed checks received by U.S. Bank. The Bankruptcy Court held that Cenex was entitled to recover the Stefflers' 1998 crop proceeds since Cenex had a senior crop lien and perfected security interest. After review of the memoranda and certificate of record and consideration of the arguments of the parties, the Court hereby AFFIRMS IN PART AND REVERSES IN PART the Order of the Bankruptcy Court.
I. JURISDICTION AND STANDARD OF REVIEW
This Court has jurisdiction to hear this appeal from a final order of the bankruptcy court pursuant to 28 U.S.C. § 158. The bankruptcy court's conclusions of law are subject to de novo review, while its findings of fact are reviewed under the clearly erroneous standard. F.R.Bankr.P. 8013; In re Eastman, 188 B.R. 621, 624 (B.A.P. 9th Cir. 1995). A finding of fact is clearly erroneous when the reviewing court, after consideration of the entire record, is left with the firm conviction that a mistake has been made. United States v. Gypsum Co., 333 U.S. 364, 395 (1948). The burden of establishing that a finding of fact is clearly erroneous is upon the appellant. In re Drehsen, 190 B.R. 441, 442 (M.D. Fla. 1995). De novo review applies to a grant of summary judgment, and the evidence must be analyzed in a light most favorable to the party against whom judgment was entered. In re De Laurentiis Entm't Group, Inc., 963 F.2d 1269, 1271-72 (9th Cir. 1992).
II. FACTS AND PROCEDURAL HISTORY
This is a complicated bankruptcy matter involving both secured interests and negotiable instruments. The Bankruptcy Court did an excellent job of developing the. record. On appeal, much of the evidence is uncontroverted; parties stipulated to many of the facts in the Pretrial Order and U.S. Bank only challenges three of the Bankruptcy Court's Findings of Fact. Accordingly, the following are uncontroverted facts.
Debtors, Dennis K. Steffler and Diana Steffler, were residents of Grant County, Washington. The Stefflers farmed row crops and obtained financing for the farming operation from U.S. Bank since at least 1993. In 1997, U.S. Bank provided the farming business with an operating loan. U.S. Bank knew the farming operation suffered large losses in 1997 and that the 1997 operating loan could not be repaid when it came due in March of 1998; when the 1997 operating loan came due it had an unpaid balance of more than $1, 480,000. U.S. Bank also knew that Mr. Steffler had taken money from the 1997 operating loan for the purpose of making an unauthorized purchase of a new home.
From March 1998 through July 1998, U.S. Bank had a number of discussions with Mr. Steffler about the financing for the farming operation. During this time, U.S. Bank was aware that Cenex, a cooperative association which sells fertilizer and crop protection products, was selling such "crop inputs" to the Stefflers. In fact, Cenex had filed a crop lien on April 24, 1998, against the 1998 crops listed thereon and their proceeds, U.C.C.-4 Lien Statement, file no. 98-114-0155. On July 20, 1998, Mr. Steffler signed a security agreement in favor of Cenex, and Cenex filed a U.C.C.-l Financing Statement listing Mr. Steffler as Debtor on July 23, 1998, file No. 98-204-0379.
Although U.S. Bank had concerns about the losses suffered by the farming operation in 1997, as well as the Stefflers' inability to pay the 1997 operation loan when it came due in March of 1998, it continued to advance money to the Stefflers from March 1998 through July 1998 totaling more than $938,000. In addition, even though U.S. Bank's financing statement had been filed before Cenex filed its crop lien, U.S. Bank did not document or keep track of its 1998 advances to Mr. Steffler in such a way as to enable it to trace its advances to 1998 crop inputs.
From May 1998 through July 1998, U.S. Bank and Cenex had a number of discussions concerning Staffler's 1998 farm operations. U.S. Bank learned that the farming operation had a carryover debt from 1996 and 1997 with Cenex in the approximate sum of one million dollars. During these discussions, U.S. Bank provided Cenex with a portion of the farming operation's budget identifying 1998 revenue projections; however, U.S. Bank did not provide Cenex with that portion of the budget identifying 1998 expenses. The 1998 budget, prepared by U.S. Bank, identified $420,000 of short-term debt as revenue but did not include any payment of that debt in the projected expenses. The Bank also prepared a financial statement for the farming operation which intentionally omitted carryover debt owed by the Stefflers to Cenex of more than one million dollars.
U.S. Bank made three loans to the Stefflers on July 30, 1998: (1) a $170,000 loan that was payable in full on or before October 26, 1998, (2) a $250,000 loan that was payable in full on or before December 15, 1998, and (3) a 1998 operating line of credit in the maximum sum of $2,500,000 that was payable in full on or before December 15, 1998. On July 30, 1998, U.S. Bank realized that the farm operation's budget did not support payment of the 1998 loans when they were scheduled to become due and payable, and knew that Cenex had provided the farm operation with almost all of the inputs needed to grow the 1998 crops. These loan documents and a letter sent to the Stefflers, dated July 28, 1998, require that requests for advances exceeding $20,000 be submitted in writing together with supporting invoices; this requirement was not enforced by U.S. Bank. Accordingly, the advances from this operating line to purchase inputs used to produce 1998 crops were not traceable to specific crop inputs. However, the bank was familiar with the amount of money the farming operation needed in order to pay for 1998 crop inputs and knew that the 1998 farming expenses, exclusive of harvest costs, were incurred before July 30, 1998.
In July of 1998, U.S. Bank and Cenex reached an agreement. As part of this agreement, Cenex would not immediately attempt to collect payment of its carryover debt from the Stefflers and Cenex would indorse checks representing 1998 crop proceeds so that those checks could be deposited in the Stefflers' checking account.
The Stefflers did not pay the $170,000 when it came due on October 26, 1998. Cenex was not informed of this default by either U.S. Bank or the Stefflers. On this same date, U.S. Bank knew that the Stefflers would be unable to pay the 1998 loans when the same were scheduled to come due. On December 15, 1998, the Stefflers did not pay the $250,000 loan or the 1998 operating loan; again, neither U.S. Bank nor the Stefflers informed Cenex of the default on these loans.
An employee of a Seattle branch of U.S. Bank inadvertently filed a termination statement of its perfection of the security interest in the farming operation's collateral on October 16, 1998. After the termination statement, U.S. Bank continued to claim a perfected security interest in the 1998 crops in correspondence mailed to Cenex on December 22, 1998, and in telephonic communications between Cenex and U.S. Bank during February of 1999. In correspondence to the Stefflers dated January 15, 1999, U.S. Bank acknowledged the potential for a dispute with Cenex regarding competing claims to the 1998 crop proceeds.
Mr. Steffler was previously married to the late Kathy Steffler. In 1993, Mr. Steffler and Kathy Steffler borrowed money from U.S. Bank for the farming operation; U.S. Bank perfected its security interest by filing a U.C.C.-l financing statement on March 8, 1993, with Washington State, file No. 93-067-0949. After Kathy's death, Mr. Steffler remarried, and on March 21, 1997, Mr. Steffler and Diana Steffler entered into an Agricultural Security Agreement with U.S. Bank. In connection with this agreement, an Amendment to the prior U.C.C.-l financing statement changed debtor number two from Kathy Steffler to Diana Steffler. This document was filed on March 31, 1997, file No. 97-090-0507. As a result of this amendment, U.S. Bank mistakenly filed a U.C.C.-3 Change Statement with the termination box checked, which stated: "Secured Party(ies) no longer claim a security interest under the financing statement bearing file number shown in box 5."
Mr. Steffler received checks representing proceeds of 1998 crops. The following checks included the Steffler(s) and U.S. Bank as payees, were deposited in the Stefflers' personal checking account at U.S. Bank, and in turn Mr. Steffler made a check payable to U.S. Bank on the Stefflers' personal check: (1) Check No. 124615, dated 10/10/98, $26,034.83, issued by Basic American/Sunspiced, and (2) Check No. 021080, dated 11/13/98, $93, 439.02, issued by Washington Potato.
U.S. Bank contends that these two checks should not be part of the present lawsuit between itself and Cenex, and were inappropriately allowed in by the Bankruptcy Judge by granting Cenex's motion to amend pleadings.
The following checks named Cenex, U.S. Bank, and the Steffler(s) as payees, were deposited into the Stefflers' personal checking account, and in turn Mr. Steffler made a check payable to U.S. Bank on the Stefflers' personal checks: (1) Check No. 195360, dated 10/23/98, $54, 346.87, issued by Cenex Supply Marketing, (2) Check No. 02031, dated 11/17/98, $91, 417.25, Issued by Basic American/Sunspiced, (3) Check No. 1922261, dated 11/20/98, $25, 493.54, issued by Cenex Harvest States, (4) Check No. 2610, dated 12/05/98, $336, 401.06, issued by Columbia River Sugar Co., and (5) Check No. 2611, dated 12/05/98, $50,695.65, issued by Columbia River Sugar.
The following checks included Cenex, U.S. Bank, and the Steffler(s) as payees, and were delivered directly to U.S. Bank, without running through the Stefflers' personal account: (1) Check No. 7944, dated 12/29/98, $88, 903, issued by Maizena, Inc., (2) Check No. 02362, dated 01/14/99, $26,034.83, issued by Basic American/Sunspiced, and (3) Check No. 002541, dated 02/12/99, $94, 999.66, issued by Basic American/Sunspiced.
In February of 1999, U.S. Bank informed Cenex that it would no longer continue to provide financing for the farming operation and that it would not release 1998 crop proceeds or advance money from the operation loan in order for the Stefflers to pay Cenex for its 1998 crop inputs. Also, in February of 1999, U.S. Bank continued to represent that its financing statement was senior and superior to the Cenex crop lien and financing statement.
In late February 1999, Cenex obtained a lien search and discovered the existence of U.S. Bank's termination statement. On March 5, 1999, Cenex informed U.S. Bank of the results of the lien search and demanded payment of all 1998 crop proceeds. Following this demand, the following 1998 check proceed checks were indorsed by Mr. Steffler and U.S. Bank and were delivered directly to Cenex: (1) Check No. 22253, dated 03/31/99, $46,719.51, issued by Washington Potato a/k/a Oregon Potato, and (2) Check No. 195901, dated 05/05/99, $90, 356.37, issued by Cenex Harvest States. The following check was tendered to the court, pursuant to the parties' agreement: Check No. 8147, dated 05/28/99, $88, 902.90, issued by Maizena, Inc.
Based on the above thirteen checks, U.S. Bank received 1998 crop proceeds totaling $887,765.71 and Cenex received 1998 crop proceeds totaling $137,075.88.
III. ISSUES ON APPEAL
On appeal, U.S. Bank argues the following findings of fact are clearly erroneous:
1. The Bankruptcy Court's finding that U.S. Bank knew on July 30, 1998, that Steffler had not paid for his 1998 crop inputs to Cenex. (Finding of Fact 24.)
2. The Bankruptcy Court's finding that Mr. Steffler's crop proceeds were going to be a source of repayment for Cenex. (Finding of Fact 25.)
3. The Bankruptcy Court's finding that U.S. Bank and Cenex did not make any agreement regarding the priority of payment from Steffler's 1998 crop proceeds. (Finding of Fact 26; related to Conclusion of Law 10.)
U.S. Bank presents the following legal issues:
1. Whether U.S. Bank is entitled to retain the funds representing the crop proceeds checks as it is a holder in due course. (Conclusion of Law 7.)
2. Whether U.S. Bank is entitled to retain the 1998 crop proceeds because Cenex waived its rights in the crop proceeds checks. (Conclusion of Law 9.)
3. Whether U.S. Bank is entitled to retain the proceeds from certain crop proceeds checks having received them in the ordinary course of business. (Conclusion of Law 8.)
4. Whether Cenex did not agree to subordinate its crop lien in favor of U.S. Bank. (Conclusion of Law 10; connected to Finding of Fact 26.)
5. Whether U.S. Bank is entitled to the 1998 crop proceeds to the extent they represent repayment of the bank's 1998 inputs. (Conclusion of Law 4.)
6. Whether Bankruptcy Court erred in allowing Cenex to amend its Complaint to include two additional claims for conversion regarding checks numbered 124615 and 021080 and whether those clams should have been allowed to relate back to avoid the bar of the statute of limitations. (Conclusions of Law 15 16.)
7. Whether the Bankruptcy Court erred by concluding that U.S. Bank breached a contract with Cenex when that was never a claim asserted by Cenex. (Conclusion of Law 5.)
8. Whether U.S. Bank is entitled to an equitable reinstatement of its security interest. (Conclusion of Law 11.)
9. Whether the Bankruptcy Court committed reversible error by incorporating sua sponte its oral ruling into the written Findings of Fact and Conclusions of Law over the objection of U.S. Bank.
IV. DISCUSSION
A. Findings of Fact1. Finding of Fact No. 24
The Bankruptcy Court found:
When Bank made its loans to Steffler on July 30, 1998, Bank knew that Steffler had not paid Cenex for 1998 crop inputs by virtue of the Cenex crop lien filed on April 24, 1998, and by virtue of communications with Cenex occurring before July 30, 1998.
(Finding of Fact No. 24.) U.S. Bank contends this finding is clearly erroneous since the mere filing of a crop lien does not create knowledge that the 1998 Cenex crop inputs have not been paid and there is no evidence that U.S. Bank knew that Steffler owed Cenex for its 1998 inputs on or before July 30, 1998, especially since the crop lien states that payment is due on "12-31-98." U.S. Bank points to the testimony claiming that Mr. Steffler told U.S. Bank that Cenex was paid current on the 1998 inputs, the Stefflers' draws matched the budgeted expenditures for crop inputs, and no one from Cenex informed U.S. Bank that Mr. Steffler owed Cenex over a half-million dollars for 1998 inputs.
Cenex argues that the evidence confirms that at the time the Bank made its loans to the Stefflers on July 30, 1998, the Bank knew that the Stefflers were not paying Cenex for 1998 inputs. Cenex points to the testimony of Mr. Davies, the Cenex manager, who stated that when he met with U.S. Bank loan officers, Mr. Weimer and Mr. Merell, in May of 1998 he informed them that Cenex had not received any payment for 1998 inputs. Cenex argues that Mr. Davies' testimony was supported by Mr. Weimer and Mr. Merrell's testimony. In addition, Cenex points to the existence of the Cenex crop lien highlighting that the Bankruptcy Court remarked that it would be inconsistent for Cenex to file a crop lien in April of 1998 and then fail to mention concerns about payment of Steffler's 1998 account in subsequent conversations with U.S. Bank.
U.S. Bank replies that the testimony may reflect that sometime in May Cenex told U.S. Bank that Cenex had unpaid inputs but no testimony reflects that U.S. Bank knew two months later that Cenex's 1998 inputs continued to be unpaid. U.S. Bank highlights that on June 2, 1998, Mr. Steffler took a $75,000 advance and signed a financial statement showing no debt to Cenex and he told U.S. Bank that the 1998 Cenex inputs had been paid current. The evidence shows that Mr. Steffler withdrew $493,000 between mid-March of 1998 and mid-June of 1998. U.S. Bank contends that it is reasonable to assume he used this to pay Cenex for the inputs incurred in 1998 since the farm budget allocated approximately $683,000 for seed, fertilizer and chemicals.
The Court concludes that the Bankruptcy Court's decision was not clearly erroneous. U.S. Bank had no reason to believe the Stefflers paid off the Cenex 1998 crop inputs as compared to the 1996/1997 carryover debt. U.S. Bank representatives testified that Mr. Steffler advised him that he was paid current. However, this Court defers to the Bankruptcy Court's credibility determinations. Although this Court may reach a different determination, it cannot say that the Bankruptcy Court's finding that on July 30, 1998, U.S. Bank knew the Stefflers had not paid Cenex for its 1998 inputs was clearly erroneous.
2. Finding of Fact No. 25:
The Bankruptcy Court entered the following factual finding:
In July of 1998 Bank and Cenex reached an agreement that (1) Cenex would not immediately attempt to collect payment of its carryover debt from Steffler; (2) Cenex would be paid for 1998 inputs with money from 1998 crop proceeds and from Steffler's 1998 operation loan; and, (3) Cenex would endorse checks representing 1998 crop proceeds so that those checks could be deposited in Steffler's checking account.
(Finding of Fact 25 (emphasis added).) U.S. Bank contends that the Bankruptcy Court's finding that the Stefflers' crop proceeds were going to be a source of repayment for Cenex was clearly erroneous. U.S. Bank argues that if Cenex actually believed that it was to be repaid out of the Stefflers' 1998 crop proceeds, then Cenex would have retained the crop proceeds checks. Further, U.S. Bank argues that by indorsing the 1998 crop proceed checks and tendering them without a restrictive indorsement, to Mr. Steffler, Cenex evidenced that it knew it was not entitled to those checks. Cenex argues Mr. Davies' testimony supports the Bankruptcy Court's finding.
After reviewing the entire record, the Court finds the Bankruptcy Court's finding clearly erroneous. The testimony shows that U.S. Bank and Cenex representatives understood that Cenex would be paid from the operating line of credit. The operating line of credit would be "funded" with the 1998 crop proceed checks. The testimony shows that Cenex understood that the Stefflers would either write Cenex a check on their personal account or ask U.S. Bank for an advancement on the operating loan. After the 1998 crop proceeds were received, Mr. Steffler deposited the indorsed checks into his personal account. Mr. Steffler chose not to provide funds to Cenex. After reviewing the record, the Court is firmly convinced that the factual finding that "Cenex would be paid for 1998 inputs with money from 1998 crop proceeds" is clearly erroneous and therefore as to Finding of Fact 25 the Court finds: Cenex would be paid for 1998 inputs with money from Stefflers' 1998 operating loan.
3. Finding of Fact No. 26
Finding of Fact No. 26 entered by the Bankruptcy Court was, "Bank and Cenex did not make any agreement regarding the priority of payment from Steffler's 1998 crop proceeds." U.S. Bank argues that the Bankruptcy Court erred in finding that U.S. Bank and Cenex did not make any agreement regarding the priority of payment from the Stefflers' 1998 crop proceeds and its conclusion that Cenex did not agree to subordinate its crop lien in favor of U.S. Bank. Cenex responds that the record confirms that priority of the interests was not an element of the agreement which the parties negotiated in May or June of 1998 as is evidenced by Mr. Weimer's and Mr. Merrell's testimony.
R.C.W. § 62A.9-316 supports U.S. Bank's proposition that the U.C.C. anticipates and accommodates subordination agreements. See also Williams v. First Nat'l Bank Trust, 482 P.2d 595, 597 (Okla. 1971); In re Mihalko, 87 B.R. 357, 365 (E.D. Pa. 1988). R.C.W. § 62A.1-201(3) defines "agreement" as "the bargain of the parties in fact as found in their language or by implication from other circumstances including course of dealing or usage of trade or course of performance. . . ."
R.C.W. § 62A.9-316 provides, "This Article does not preclude subordination by agreement by a person entitled to priority."
The Court agrees with the Bankruptcy Judge's factual finding that the parties' agreement did not include subordination of Cenex's security interest or crop lien to U.S. Bank's security interest. During the parties' negotiations, the parties understood that U.S. Bank had the prior security interest. Accordingly, there was no reason for Cenex to subordinate its security interest or crop lien because they were already junior to U.S. Bank's interest. Accordingly, the Court agrees with the Bankruptcy Court's finding.
U.S. Bank did not challenge the following legal conclusions of the Bankruptcy Court:
(1) The Bank's perfected security interest in Stefflers' 1998 crops and 1998 crop proceeds became unperfected when U.S. Bank filed its termination statement on October 16, 1998.
(2) When U.S. Bank refiled its financing statement on March 22, 1999, its then perfected security interest in Stefflers' 1998 crop and 1998 crop proceeds was junior and inferior to financing statement.
1. Conclusion of Law No. 7
The Bankruptcy Court held the "Bank cannot make any claim to crop proceeds as a holder in due course," (Conclusion of Law No. 7). In response to Cenex's conversion action, U.S. Bank contends that is entitled to retain the funds representing the crop proceeds checks because it is a holder in' due course ("HIDC"), by definition or by virtue of a transfer of HIDC status from Cenex.
A secured party may bring a conversion action to recover proceeds wrongfully paid to a third party. J.I. Case Credit Corp. v. First Nat'l Bank, 991 F.2d 1272 (7th Cir. 1993). The general rule is a person taking an instrument, is subject to a claim of a property or possessory right in the instrument or its proceeds, including a claim to rescind a negotiation and to recover the instrument or its proceeds. R.C.W. § 62A.3-306. However, a person having rights of an HIDC takes free of the claim to the instrument. Id.; Wesche v. Martin, 64 Wash. App. 1, 8 (1992). Whether a party is an HIDC is a factual question. Merrick v. Peterson, 25 Wash. App. 248 (1980).
Article 9 provides, "[n]othing in this Article limits the rights of a holder in due course of a negotiable instrument . . . [these] holders . . . take priority over an earlier security interest, even perfected, to the extent provided in Articles 3. . . . R.C.W. § 62A.9-309.
(a) Payee
Cenex's main argument is that a payee, which U.S. Bank was, cannot be an HIDC, citing to Comment 4 to R.C.W. 62A.3-302 and Comment 2 to R.C.W. § 62A.3-305. Comment 2 to R.C.W. § 62A.3-305 provides,
In most cases the holder in due course will be an immediate or remote transferee of the payee of the instrument. In most cases the holder in due course doctrine is irrelevant if defenses are being asserted against the payee of the instrument, but in a small number of those cases the payee of the instrument may be a holder in due course.
The Bank understands the interaction of 3-302(2) and 3-305 as follows: payees may be holders in due course, but like any other holder in due course, the respective rights are still subject to the defenses of § 3-305. The Court agrees with U.S. Bank's analysis. U.S. Bank is a payee, who can also be an HIDC. U.S. Bank did not deal directly with the maker of the instruments. It was named as a payee simply because it had a security interest in the 1998 crop proceeds. Accordingly, the Court finds that this case is one of "a small number of those cases [where] the payee of an instrument may be a holder in due course." See R.C.W. § 62A.3-305 Crat. 2.
(b) By Definition
Section 62A.3-302(a) sets out the requirements for an HIDC:
(1) The instrument when issued or negotiated to the holder does not bear such apparent evidence of forgery or alteration or is not otherwise so irregular or incomplete as to call into question its authenticity; and (2) The holder took the instrument (i) for value, (ii) in good faith, (iii) without notice that the instrument is overdue or has been dishonored or that there is an uncured default with respect to payment of another instrument issued as part of the same series, (iv) without notice that the instrument contains an unauthorized signature or has been altered, (v) without notice of any claim to the instrument described in R.C.W. 62A.3-306, and (vi) without notice that any part has a defense or claim in recoupment described in R.C.W. § 62A.3-305(a).
R.C.W. § 62A.3-302(a); Cent. Wash. Bank v. Mendelson-Zeller, 113 Wn.2d 346, 353 (1989). There appears to be no dispute that the checks were authentic and complete, U.S. Bank is a holder, U.S. Bank took the checks for value, the instrument was not overdue or dishonored, and the signatures were authorized. The only requirements that are challenged are whether U.S. Bank took the checks in good faith and without notice of any claims against them.
U.S. Bank contends that it acted in good faith since it acquired the checks in an ordinary deposit transaction. Cenex argues that U.S. Bank did not take in good faith because U.S. Bank knew that the Stefflers were in trouble on the bank loans.
Good faith is defined as "honesty in fact in the conduct or transaction concerned." R.C.W. § 62A.1-201 (19). The good faith test is a subjective test; there is no reasonable care standard included in the good faith requirement. Merrick v. Peterson, 25 Ash. App. 248 (1980); Von Gohren v. Pac. Nat. Bank of Wash., 8 Wash. App. 245 (1973).
Cenex cites to Financial Management Services, Inc. v. Familian Corp., 905 P.2d 506, 512 (Ariz.App. Div. 1 1995). In Familian Corp., a senior secured creditor sued a junior secured creditor to recover proceeds collected by the junior creditor from a common debtor's accounts receivable. The court held that the junior creditor took the proceeds clear of the senior creditor's security interest because the junior creditor was an HIDC of the joint checks issued by customers of the debtor. In so holding, the court reasoned that the junior creditor acted in good faith, even though it knew of the senior interest, because it did not know that receiving such payments violated the financing arrangement between the debtor and senior secured creditor. The court noted that the filing of a financing statement does not charge the junior creditor with knowledge that it or the debtor acted wrongfully by performing their joint check agreement. Yet, "[h]ad [the junior creditor] believed that [the debtor] was on the verge of bankruptcy or unable to pay [the senior creditor], [the junior creditor's] actions may have constituted bad faith. The record is clear, however that [the junior creditor] believed that [the debtor's] business was strong and that [the junior creditor] knew that [the debtor] had made a large payment to [the senior creditor]." See also N. Cent. Kan. Prod. Credit Assn, v. Boese, 19 UCC Rep. Serv. 179, 185 (D. Kansas 1976) (finding junior creditor acted in good faith and observed reasonable commercial practice even though it did not conduct a search for security interests).
The Court agrees with the rule that knowledge that a senior party filed a financing statement or lien is insufficient by itself to defeat good faith. However, even though the Court concludes that U.S. Bank did not have notice of a claim on the instrument, the Court determines that U.S. Bank did not act in good faith since it knew the Stefflers had been unable to pay the 1997 operating loan when it came due and also that the Stefflers defaulted on the loan due on October 26, 1998, and then later the loans due in December 1998. Accordingly, U.S. Bank had reason to believe that the Stefflers' financial condition was precarious.
(c) Transfer of HIDC status
In the alternative, U.S. Bank suggests that it is a holder in due course by virtue of a transfer of HIDC status from Cenex via the eight checks indorsed by Cenex and then deposited into Stefflers' personal account. An instrument is transferred when it is "delivered by a person other than its issuer for the purpose of giving to the person receiving delivery the right to enforce the instrument." R.C.W. § 62A.3-203(a). A transfer,
vests in the transferee any right of the transferor to enforce the instrument, including any rights as a holder in due course, but the transferee cannot acquire rights of a holder in due course by a transfer, directly or indirectly from a holder in due course if the transferee engaged in fraud or illegality affecting the instrument.Id. § 62A, 3-203(b).
The Court concludes U.S. Bank cannot obtain holder in due course by virtue of a transfer of HIDC status because the Court finds that Cenex was not an HIDC. Cenex could not take in good faith because it too knew that Stefflers' farming operation was not financially successful. The farming operation still owed Cenex for 1996-97 crop inputs. Under the agreement, Cenex did believe that it would be paid for the 1998 crop inputs through the operating loan. However, the 1996-97 crop inputs were still unpaid.
For the above reasons, the Court finds that U.S. Bank is not an HIDC of the 1998 crop proceed checks either by definition or by virtue of a transfer of HIDC status.
2. Conclusion of Law No. 9
The Bankruptcy Court concluded:
Since Cenex endorsed checks representing payment of crop proceeds pursuant to its understanding with Bank, its endorsement of those checks did not constitute any waiver of its right to payment from the crop proceeds.
(Conclusion of Law No. 9). U.S. Bank contends that is entitled to retain the 1998 crop proceeds because Cenex waived its rights in eight of the crop proceeds checks by indorsing each of the checks in question and tendering them to Mr. Steffler, without a restrictive indorsement as provided under R.C.W. § 62A.3-206(c). Cenex responds the Bankruptcy Court's conclusion of law is supported by the Bankruptcy Court's Finding of Fact No. 25 finding that U.S. Bank and Cenex agreed that Cenex would be paid for 1998 inputs with money from 1998 crop proceeds and from the Stefflers' 1998 operating loan. Further, Cenex argues that it was simply performing its agreement with U.S. Bank to indorse checks and that Cenex would be paid for 1998 inputs from crop proceeds as well as from money in Stefflers' operating loan.
The eight checks at issue are: (1) Check No. 195360, dated 10/23/98, $54, 346.87, issued by Cenex Supply Marketing, (2) Check No. 02031, dated 11/17/98, $91, 417.25, issued by Basic American/Sunspiced, (3) Check No. 1922261, dated 11/20/98, $25, 493.54, issued by Cenex Harvest States, (4) Check No. 2610, dated 12/05/98, $336, 401.06, issued by Columbia River Sugar Co., (5) Check No. 2611, dated 12/05/98, $50,695.65, issued by Columbia River Sugar, (6) Check No. 7944, dated 12/29/98, $88, 903, issued by Maizena, Inc., (7) Check No. 02362, dated 01/14/99, $26,034.83, issued by Basic American/Sunspiced, and (8) Check No. 002541, dated 02/12/99, $94, 999.66, issued by Basic American/Sunspiced.
"[W]aiver is the intentional and voluntary relinquishment of a known right, or such conduct as warrants an inference of the relinquishment of such right." Estate of Lindsay v. Lindsa, 91 Wash. App. 944, 950 (1998) (citation omitted)). The knowledge of the right can be either actual or constructive. Constantino v. Mareschi, 9 Wn.2d 638, 652-53 (1941). Waiver occurs when the party voluntary acts, implying a choice, to dispense of a right or forego an advantage. Estate of Lindsay, 91 Wash. App, at 951.
In Anon, Inc. v. Farmers Production Credit Association of Scottsburg, 35 U.C.C. Rep. Serv. 1383, 1388 (Ind.App. 1983), the Indiana state court determined that a secured creditor waived its security interest in hogs when it allowed the debtor to sell the hogs upon condition that debtor promptly remit proceeds of sale to secured creditor, in contradiction to the contract requirement that debtor obtain prior written consent for such sales from secured creditor.
The Court finds the Indiana state court's analysis helpful in analyzing whether a secured party takes an intentional act that is inconsistent with a right, thereby waiving that right. Here, the Bankruptcy Court appeared to charge U.S. Bank with the knowledge that it terminated its perfected security interest on October 16, 1998, but the Bankruptcy Court apparently did not charge Cenex with the knowledge that it possessed a senior security interest. Under Article 9, the Court finds that both U.S. Bank and Cenex are to be charged with the knowledge of U.S. Bank's termination statement, and corresponding effect. Therefore, Cenex is imputed with knowing that U.S. Bank did not have a perfected security interest; rather, Cenex had priority to the 1998 crop proceeds. R.C.W. § 62A-9-312. By intentionally indorsing the checks, and then providing the indorsed checks to Mr. Steffler or U.S. Bank, Cenex waived its ability to assert its senior interest. Accordingly, U.S. Bank did not convert these eights checks from Cenex.
The Court acknowledges that the indorsement of the checks was part of the parties' agreement; however, the Bankruptcy Court determined that this agreement did not affect the parties' priority, a finding which Cenex did not appeal. Yet, the filing of the termination agreement did alter the parties' priorities. Both parties are charged with the knowledge of this change in status. Accordingly, when Cenex indorsed these checks they engaged in an intentional act which was directly adverse to its senior security interest. Cenex contends that the parties' agreed that Cenex would be paid from either the crop proceed checks directly or the operating loan, and therefore, allowing these checks to be paid to U.S. Bank first was not in contravention to its senior interest. However, the Court concludes otherwise. The Court finds Cenex's indorsement and then transfer to either Mr. Steffler or U.S. Bank to be an intentional relinquishment of their senior security interest. Therefore, U.S. Bank is entitled to these eight crop proceed checks.
3. Conclusion of Law No. 8
The Bankruptcy Court entered the following legal conclusion: "Bank cannot make any claim to. crop proceeds as payment received in the ordinary course of business." (Conclusion of Law No. 8.)
U.S. Bank argues that it is entitled to retain the proceeds from seven crop proceeds checks since it received them in the ordinary course of business pointing to the "otherwise provided language" in R.C.W. 62A.9-306. Cenex argues that these payments were not in the ordinary course since U.S. Bank knew or was reckless about knowing whether the payment violated Cenex's security interest.
The following checks at issue are those that were deposited in the Stefflers' personal checking account at U.S. Bank, and in turn Mr. Steffler made a check payable to U.S. Bank on the Stefflers' personal checking account: (1) Check No. 124615, dated 10/10/98, $26,034.83, issued by Basic American/Sunspiced, (2) Check No. 021080, dated 11/13/98, $93, 439.02, issued by Washington Potato, (3) Check No. 195360, dated 10/23/98, $54, 346.87, issued by Cenex Supply Marketing, (4) Check No. 02031, dated 11/17/98, $91, 417.25, issued by Basic American/Sunspiced, (5) Check No. 1922261, dated 11/20/98, $25, 493.54, issued by Cenex Harvest States, (6) Check No. 2610, dated 12/05/98, $336, 401.06, issued by Columbia River Sugar Co., and (7) Check No. 2611, dated 12/05/98, $50,695.65, issued by Columbia River Sugar.
Section 62A.9-306 provided that a properly perfected security interest extends to the identifiable cash proceeds of a sale of collateral subject to that security interest. Also, the holder of the security interest is entitled to recover cash proceeds from unauthorized subsequent transferees. Yet, Official Comment 2(c) to § 62A.9-306 provided:
Where cash proceeds are covered into the debtor's checking account and paid out in the operation of the debtor's business, recipients of the funds of course take free of any claim which the secured party may have had in them as proceeds. What has been said relates to payments and transfers in ordinary course. The law of fraudulent conveyances would no doubt in appropriate cases support recovery of proceeds by a secured party from a transferee out of ordinary course or otherwise in collusion with the debtor to defraud the secured party.
R.C.W. § 62A.9-306 Cmt. 2(c) (emphasis added). The dictionary defines "collusion" as "an agreement to defraud another or obtain something forbidden by law." Black's Law Dict. (7th Ed. 1999).
The Court finds helpful the Seventh Circuit's discussion and analysis in J.I. Case Credit Corp, v. First National Bank, 991 F.2d 1272 (7th Cir. 1993), of previous cases, including Linn Co-op Oil Co. v. Norwest Bank Marion, 444 N.W.2d 497 (Iowa 1989), and Harley-Davidson Motor Co. v. Bank of New England-Old Colony, N.A., 897 F.2d 611 (1st Cir. 1990). The Court agrees with the Seventh Circuit's ruling that "a payment is within the ordinary course if it was made in the operation of the debtor's business and if the payee did not know and was not reckless about whether the payment violated a third party's security interest." See ITT Commercial Fin. Corp. v. Bank of the West, 166 F.3d 295, 305 (5th Cir. 1999) (adopting the Seventh Circuit's rule). The Seventh Circuit noted that "[a] person can know that a security interest exists but not know that a payment is being made in violation of that interest." Id. at 1278.
The Fourth Circuit follows this same rule, stating in Orix Credit Alliance, Inc. v. Soveran Bank N.A., 4 F.3d 1262 (4th Cir. 1993), "a transferee's knowledge of a prior security interest in proceeds does not, by itself, indicate that the transfer of these proceeds occurred outside the ordinary course of the debtor's business." Rather, the court is to analyze the particular arrangement or course of dealing between the parties to determine whether the receipt of proceeds was consistent with such and in the ordinary course. Id.
Cenex is correct that neither Washington courts nor the Ninth Circuit have yet adopted Comment 2(c) as legal precedent. Yet, the Court concludes the Washington legislature's intent can be inferred from the 2001 revisions to Article 9. R.C.W. 62A.9A-332 now provides:
Transfer of money; transfer of funds from deposit account, (a) Transferor of money. A transferee of money takes the money free of a security interest unless the transferee acts in collusion with the debtor in violating the rights of the secured party. (b) Transferee of funds from deposit account. A transferee takes the funds free of a security interest in the deposit account unless the transferee acts in collusion with the debtor in violating the rights of the secured party.
These revisions changed primarily the general layout of Article 9, and the U.C.C. Comments provide "the Comments to former Article 9 will remain of substantial historical value and interest. They also remain useful in understanding the background and general conceptual approach of this Article." U.C.C. Cmt 1. (Source). Accordingly, the Court adopts the rule that one who takes a check in the ordinary course of business takes fee of a security interest if the payee did not know and was not reckless about whether the payment violated a third party's security interest.
Here, U.S. Bank and the Stefflers had a business relationship since 1993. The Stefflers had a personal checking account and an operating line of credit with U.S. Bank during this period. Per the advise of his accountant, Mr. Steffler would deposit a crop proceeds check into his personal account. To pay off his operating line of credit, he would then write a check on his personal checking account to U.S. Bank. The process of depositing the crop proceeds to the Stefflers' account and then writing a check from the account to U.S. Bank to apply against the Stefflers' loans with U.S. Bank was the routine manner in which financing and repayment between the Stefflers and U.S. Bank had been handled for at least five years prior the 1998 crop year. Accordingly, when Mr. Steffler deposited the seven 1998 crop proceed checks into his personal account in the fall/winter of 1998 and then wrote a check to U.S. Bank towards his operating line of credit, this was done in the ordinary course of the debtor's business. U.S. Bank officials took no unusual steps to exact early payment or otherwise enforce U.S. Bank's security interest. Further, there is no evidence that U.S. Bank and Mr. Steffler colluded. When these seven checks were received, neither U.S. Bank representatives nor Mr. Steffler were actually aware of the termination agreement. Accordingly, they could not, and did not, reach an "agreement" to defraud Cenex. For the above reasons, U.S. Bank is entitled to the seven 1998 crop proceed checks which were received in the ordinary course of business.
The Court notes it previously concluded that U.S. Bank was entitled to five of these 1998 crop proceed checks because Cenex waived its senior interest.
4. Conclusion of Law No. 10
The Bankruptcy Court determined: "Cenex did not make any agreement to subordinate its crop lien and its perfected security interest in favor of Bank." (Conclusion of Law No. 10.) As discussed above in connection with Finding of Fact 26, the Court agrees with this determination,
5. Conclusion of Law No. 6
The Bankruptcy Court entered the following conclusion:
The Cenex crop lien filed on April 24, 1998, and the Cenex financing statement filed on July 23, 1998, created valid and enforceable rights in and to the 1998 crop proceeds that were senior and superior to any competing claims by Bank.
(Conclusion of Law No. 6.) U.S. Bank contends it is entitled to the 1998 crop proceeds to the extent they represent repayment of the bank's 1998 inputs. Cenex argues U.S. Bank no longer had a perfected security interest in the Stefflers' 1998 crops as a result of the termination statement. Further, Cenex argues that there is a distinction between a security interest in proceeds and a security interest in instruments, and U.S. Bank cannot trace the proceeds. R.C.W. § 62A.9-312(2).
The general rule is "conflicting liens and security interests [of crops and their proceeds] shall rank in accordance with the time of filing." R.C.W. § 60.11.050(1). However, "liens and security interests which are incurred to produce the crop take priority over liens and security interests which were not incurred to produce the crop." Food Servs. of Am. v. Royal Heights, 123 Wn.2d 779, 793 (1994); R.C.W. § 60.11.050(3).
The Court determines that after October 16, 1998, Cenex had the senior security interest. U.S. Bank may have perfected its security interest in the crop proceeds upon possessing the checks; however, this perfected security interest was junior to Cenex's security interest. Accordingly, Cenex has priority for the 1998 crop proceeds received. However, the Court concludes that U.S. Bank has priority, due to its financing statement filed in 1999 for the 1998 crop proceeds, over Cenex's claims payment for 1996/1997 crop inputs.
6. Amendment of the Complaint
U.S. Bank argues the Bankruptcy Court erred in allowing Cenex to amend its Complaint to include two additional claims for conversion regarding checks numbered 124615 and 021080. If this amendment was in error, U.S. Bank states that these two claims would be barred by the statute of limitations since Cenex failed to foreclose on its crop lien within the statutory period. R.C.W. § 60.11.130; Pearle v. Greenlee, 76 Wash. App. 338, 340 (1994). Cenex argues the Bankruptcy Court properly allowed Cenex to amend its complaint under Federal Rule of Evidence 15(a) so as to confirm that it was requesting foreclosure of a crop lien as well as foreclosure of its perfected security interest.
The Court finds that the Bankruptcy Court did not error in granting Cenex leave to amend, thereby adding or clarifying that the two checks are part of the dispute. The Bankruptcy Court adequately balanced the factors involved and gave U.S. Bank sufficient time to show prejudice. 7. Conclusion of Law No. 5
The Bankruptcy Court concluded:
Bank breached its promise and agreement with Cenex that Cenex would be paid for 1998 inputs with money from 1998 crop proceeds and from Steffler's 1998 operating loan.
(Conclusion of Law 5.)
U.S. Bank argues this conclusion was reached in error because a breach of contract claim was never asserted by Cenex. Further, U.S. Bank points out that there is no evidence in the record that U.S. Bank promised to pay Cenex, but rather, Mr. Davis' testimony shows that he expected payments to come from Mr. Steffler. Cenex contends that the Bankruptcy Court properly determined that a contract existed between U.S. Bank and Cenex after reviewing the arguments and testimony presented by Cenex.
After review of the findings of fact, the Court finds the Bankruptcy Judge's conclusion was in error. Even if such a claim was raised by Cenex, the parties' agreement did not guarantee that U.S. Bank would pay Cenex. There was no testimony presented that Cenex expected to be paid in a manner differently than it had in the past, i.e. Mr. Steffler would pay Cenex. There was no testimony that U.S. Bank would directly pay Cenex. The evidence showed the parties understood that Mr. Steffler had a line of credit at U.S. Bank and that he could use this line of credit to seek advancements to pay Cenex. Mr. Steffler chose not to; U.S. Bank cannot be said to be in breach of an agreement due to Mr. Steffler's decision. Accordingly, Conclusion of Law No. 5 is clearly erroneous. ///
8. Conclusion of Law No. 11
After review of the evidence, the Bankruptcy Court concluded,
Bank is. not entitled to equitable reinstatement of the financing statement that was terminated when it erroneously filed its termination statement on October 16, 1998.
(Conclusion of Law No. 11.) U.S. Bank argues that it is entitled to an equitable reinstatement of its security interest and that the mistaken filing of the termination statement should not result in a windfall to Cenex. Cenex argues that U.S. Bank is not entitled to equitable relief since it inadvertently filed a termination statement.
The Court agrees with the Bankruptcy Court's conclusion. The case law is clear that if a third-party's, i.e. Cenex's, rights are affected by the termination agreement that equitable reinstatement of the perfected security interest is inappropriate. U.S. Bank v. Oliverio, 109 Wash. App. 68 (2001); In re Burkard, 6 UCC Rep. Serv. 244 (Bankr. S.D. Ohio 1969).
9. Incorporation of Findings and Conclusions
The Court determines that the Bankruptcy Court did not err by incorporating the oral factual findings and conclusions into the written Findings of Fact and Conclusions of Law.
V. CONCLUSION
After reviewing the record, arguments, and relevant statutes and case law, the Court determines Cenex and U.S. Bank are entitled to the 1998 crop proceed checks as follows:
(1) Cenex:
(2) U.S. Bank:
(a) Check No. 22253, dated 03/31/99, $46,719.51, issued by Washington Potato a/k/a Oregon Potato
(b) Check No. 195901, dated 05/05/99, $90, 356.37, issued by Cenex Harvest States
(c) Check No. 8147, dated 05/28/99, $88, 902.90, issued by Maizena, Inc.
(a) Check No. 124615, dated 10/10/98, $26,034.83, issued by Basic American/Sunspiced (ordinary course of business)
(b) Check No. 021080, dated 11/13/98, $93, 439.02, issued by Washington Potato (ordinary course of business)
(c) Check No. 195360, dated 10/23/98, $54, 346.87, issued by Cenex Supply Marketing (ordinary course of business; waiver)
(d) Check No. 02031, dated 11/17/98, $91, 417.25, issued by Basic American/Sunspiced (ordinary course of business; waiver)
(e) Check No. 1922261, dated 11/20/98, $25, 493.54, issued by Cenex Harvest States (ordinary course of business; waiver)
(f) Check No. 2610, dated 12/05/98, $336, 401.06, issued by Columbia River Sugar Co. (ordinary course of business; waiver)
(g) Check No. 2611, dated 12/05/98, $50,695.65, issued by Columbia River Sugar (ordinary course of business; waiver)
(h) Check No. 7944, dated 12/29/98, $88, 903, issued by Maizena, Inc. (waiver)
(i) Check No. 02362, dated 01/14/99, $26,034.83, issued by Basic American/Sunspiced (waiver)
(j) Check No. 002541, dated 02/12/99, $94, 999.66, issued by Basic American/Sunspiced.
IT IS HEREBY ORDERED that the Findings and Fact and Conclusions of Law entered by the Bankruptcy Court for the Eastern District of Washington, are AFFIRMED IN PART AND REVERSED IN PART. U.S. Bank's appeal is REMANDED to the Bankruptcy Court for immediate implementation of this Order.
The District Court Executive is directed to enter this Order, provide copies to all counsel, provide a certified copy of this Order to the Clerk of the United States Bankruptcy Court for the Eastern District of Washington, Case No. 00-06907-R51 before the Honorable John A. Rossmeissl, deny all pending motions as moot, and close the file.
IT IS SO ORDERED. The District Court Executive is hereby directed to enter this Order and to furnish copies to all counsel.