The Bankruptcy Appellate Panel ("BAP") for the Eighth Circuit recently held that a secured creditor obtained a valid lien on collateral because technical defects in the bill of sale did not invalidate a transfer of title to the collateral, and rejected the argument that the secured creditor should have inspected the bill of sale before advancing funds.
A copy of the opinion is available at: Link to Opinion
This was a dispute over the validity and priority of interest in collateral in goods. The seller ("Seller") sold the collateral to a broker ("Debtor") that delivered the collateral to another company for care and maintenance ("Care Company"). The Care Company financed Debtor's purchase of cattle through a line of credit it had with a lender ("Lender") and asserted a lien against the collateral.
But, Seller only received partial payment for the collateral because Debtor's checks failed to clear. Seller then exercised his right to reclaim the collateral under the Uniform Commercial Code ("UCC") for nonpayment. The problem for the Seller was that the holder of a valid security interest takes priority over a reclaiming unsecured creditor.
Care Company argued that its security interest attached to the collateral the moment that Debtor became the owner of the collateral, even if Debtor's title was voidable due to Seller's later assertion of reclamation rights. Thus, Care Company argued that its interest in the collateral took priority over Seller's.
Seller alternatively argued that: (1) Care Company's lien was not valid because title to the collateral did not properly transfer from Seller to Debtor due to defects in the bill of sale, and (2) even if title were transferred, Care Company did not exercise good faith as required to perfect a valid lien under the UCC.
Debtor filed a Chapter 11 bankruptcy case and the collateral was sold. The proceeds were held pending the outcome of the litigation. The Bankruptcy Court concluded on cross motions for summary judgment that Care Company's lien and, in turn Lender's lien, were both valid and that Care Company and Lender were entitled to the proceeds of the sale of the collateral. Seller appealed.
The first issue before the BAP was whether Seller transferred title to Debtor to allow Care Company's lien to attach to the collateral.
The collateral consisted of cattle, and Seller surrendered possession of the cattle to Debtor in Colorado. Section 35-54-101 of the Colorado Revised Statues, commonly referred to as the "livestock bill of sale law," required a bill of sale between the buyer and sell of livestock. A livestock bill of sale required, among other things, a bill of sale signed by both the seller and buyer, giving the post-office address of each, in the presence of a witness who also signed his name and address. Colo. Rev. Stat. § 35-54-103.
In this case, the bill of sale was signed by Seller and a witness, but it was not signed by Debtor, and none of the parties' post office addresses were given. Thus, Seller argued that title to the collateral was never transferred from Seller to Debtor, because the bill of sale was not in strict compliance with Colorado's livestock bill of sale requirements. And, because Seller did not transfer ownership of the cattle to Debtor, Seller argued that Debtor could not have granted Care Company a security interest in the collateral. The BAP disagreed.
In a case involve similar facts, the Colorado appellate court held that title to cattle only passes if the transfer of possession is accompanied by a bill of sale in compliance with the livestock statutes. Cugnini v. Reynolds Cattle Co., 648 P.2d 159 (Colo. App. 1981) ("Cugnini I"), aff'd 687 P.2d 962 (Colo. 1984) ("Cugnini II"). However, in an attempt to harmonize the livestock bill of sale laws with the UCC, the Colorado appellate court in Cugnini I reversed the trial court and held that if neither party can claim valid title under the livestock bill of sale laws, the court may resort to the UCC to resolve the dispute. Id., at 164. Thus, the court in Cugnini I concluded that because the buyer took physical delivery of the cattle, and the seller transferred all of their rights to buyer, the buyer had acquired title under the UCC and was therefore entitled to the proceeds of the sale. Id.
In Cugnini II, the Colorado Supreme Court affirmed the appellate court, and held that "noncompliance with the livestock bill of sale requirement [did] not necessarily prevent transfer of title." Cugnini II, 687 P.2d at 965. In other words, transfer of title was not dependent on compliance with the livestock statutes. Because the livestock bill of sale statutes did not necessarily determine when valid title to cattle passes, the Colorado Supreme Court ruled that courts must look to other sources of the law, such as the UCC, to determine possession of valid title. Id
Relying on Cugnini, the BAP found that if Seller had valid title (which Seller insisted that it did), it could pass valid title to Debtor (who could then grant a lien to Care Company) without fully complying with the livestock bill of sale laws, if the UCC requirements for attachment were met.
As you may recall, Section 2-401 of the UCC provides, in relevant part: (1) "title to goods passes from the seller to the buyer in any manner and on any conditions explicitly agreed on by the parties," and (2) "[u]nless otherwise explicitly agreed title passes to the buyer at the time and place at which the seller completes performance with reference to the physical delivery of the goods, despite any reservation of a security interest and even though a document of title is to be delivered at a different time or place…"
Here, it was undisputed that (i) Seller surrendered possession of the cattle to Debtor in Colorado, (ii) Seller signed a bill of sale transferring title to Debtor, and (iii) the contract between Seller and Debtor contained no reservation of title or security interest.
Therefore, pursuant to Section 2-401, the BAP held that title passed from Seller to Debtor at the moment the collateral was transferred.
Next, the BAP turned to Care Company's security interest in the cattle.
Section 2-403 of the UCC provides, in relevant part: "[a] person with voidable title has power to transfer a good title to a good faith purchase for value … [if] the delivery was in exchange for a check which is later dishonored, or the delivery was procedure through fraud." Neb. Rev. Stat. U.C.C. § 2-403(1)(b), (d).
Under Section 2-403, the BAP determined that Debtor received title (albeit voidable title) from Seller at the time of transfer, and Debtor also received the power to transfer good title to a good faith purchaser for value.
On the question of whether Care Company was a good faith purchaser, Seller argued that the Bankruptcy Court used the wrong standard. Specifically, Seller asserted that the Bankruptcy Court should have found Debtor was a "merchant" under the UCC and applied the UCC's higher standard of good faith for such merchants.
As you may recall, a "merchant" is defined in Article 2 of the UCC as "a person who deals in goods of the kind…" Neb. Rev. Stat. U.C.C. § 2-104(1). Livestock are "goods" under the UCC. Cugnini I, 648 P.2d at 163. "'Good faith' in the case of a merchant means honesty and the observance of reasonable commercial standards of fair dealing in the trade.'" Neb. Rev. Stat. U.C.C. § 2-103(1)(b).
Seller argued that Care Company failed to observe reasonable commercial standards in releasing the funds to Debtor without first ascertaining that Debtor owned the cattle. More specifically, Seller argued that based on the summary judgment record, the Bankruptcy Court erroneously found that (i) cattlemen generally consider the bill of sale in this case to be valid documentation of ownership, and (ii) Care Company had seen the defective bill of sale prior to releasing the funds to Debtor.
The BAP rejected Seller's argument for two main reasons. First, Care Company introduced affidavits from a number of individuals in the cattle and feedlot business who testified that the bill of sale at issue would be considered to be a valid bill of sale if it had been presented to them. And, Seller did not submit any affidavit to dispute Care Company's evidence as to the documentation that cattlemen routinely require to transfer ownership.
In fact, according to the BAP, the statements in the affidavit were supported by both law and common sense. The technical defects in the bill of sale – itself governed by Nebraska law -- did not affect the transfer of title because Seller owned the cattle and could therefore transfer title to Debtor under "any manner and on any condition explicitly agreed on by the parties." Neb. Rev. Stat. U.C.C. § 2-401(1). Thus, when Seller gave a bill of sale signed by him, and witnessed by a state inspector, transferring ownership of the cattle to Debtor, along with possession of the cattle, cattlemen and their lenders would reasonably conclude that he had transferred ownership of such cattle to Debtor.
Second, the BAP rejected Seller's argument that Care Company should have inspected the bill of sale before advancing funds to Debtor. In Cugnini II, the Colorado Supreme Court held that title could be transferred before or after payment. Cugnini II, 687 P.2d at 967 ("Some purchasers refuse to pay for cattle until after the brand certificates is received; however, others, on occasion will pay for cattle before the delivery of a brand inspection certificate and rely on getting it later.")
Relying on Cugnini II, the BAP held that it was immaterial whether Care Company wired the funds before or after seeing the bill of sale because it did not affect the outcome of this case. In other words, whether Care Company saw the bill of sale before releasing the funds would only matter if Seller did not pass title to Debtor. Here, because Seller transferred title to Debtor, and due to Care Company's line of credit arrangement with Debtor, the collateral became subject to Care Company's lien the moment Debtor became their owner.
In sum, the BAP concluded that "[t]he purpose of Article 2 of the UCC is to facilitate the free flow of commerce. That purpose would not be served if lenders were obligated to ascertain that their borrowers have ownership and possession of collateral before funds are lent."
Accordingly, the BAP affirmed the Bankruptcy Court's orders holding that Care Company's lien was superior to Seller's rights as an unpaid seller.
Ralph T. Wutscher
Maurice Wutscher LLP
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