FYI: 6th Cir Holds "Proceeds" in UCC Article 9 Financing Statement Did Not Include Accounts Receivable

The U.S. Court of Appeals for the Sixth Circuit, in what it characterized as an issue of first impression under Tennessee law, concluded that the term "proceeds," as used financing statements used to perfect UCC Article 9 security interests, does not include the debtor's accounts receivable. 

 

A copy of the opinion is available at:  http://www.ca6.uscourts.gov/opinions.pdf/13a0326p-06.pdf

 

At issue was the specific language used in the financing statements of secured creditors.  Beginning in late 2004, the plaintiff entered into a series of secured transactions with the debtors for the sale or lease of certain tractors and trailers.  The parties executed security agreements that gave the plaintiff a security interest in the debtors' tractors and/or trailers, accounts, and in the proceeds from the agreed-upon collateral. 

 

The plaintiff filed financing statements in connection with the security agreements, and the financing statements identified the collateral as the specified tractors and/or trailers and "all proceeds thereof, including rental and/or lease receipts."  The plaintiff's financing statements did not include the term "accounts" or "accounts receivable." 

 

Around the same time that the plaintiff entered into the secured transactions with the debtors – but after the plaintiff filed its financing statements – the defendants also entered into secured transactions with the same debtors.  The defendants filed their financing statements, which specifically stated that the defendants had a security interest in "all accounts receivable now outstanding and hereafter arising." 

 

In 2009 the debtors defaulted.  While the plaintiff took possession the collateral securing the agreements, the defendants took possession of the debtors' accounts receivable.  The plaintiff brought suit, asserting that it possessed a perfected security interest – and thus had first priority – in the debtors' accounts receivable.  The plaintiff argued that the term "and all proceeds thereof" in its financing statements included the accounts receivable.  The district court granted the defendants' motion for summary judgment, finding that the plaintiff's financing statements were not sufficient to put defendants on notice that plaintiff claimed a security interest in the accounts receivable, and holding as a matter of law that the term "proceeds," as used in a financing statement, does not include a debtor's accounts receivable.

 

On appeal, the Sixth Circuit focused on the specific language of the financing statements at issue and analyzed the term "proceeds" under Tennessee's Commercial Code.  The court acknowledged that the plaintiff took the proper steps necessary for its security interest to attach to debtors' accounts.  The issue, clarified the court, was whether the plaintiff properly perfected its security interest in the debtors' accounts. 

 

Like the Uniform Commercial Code, Tennessee's Commercial Code required the secured creditor to file a financing statement that describes the collateral covered by the financing statement in order to perfect the security interest.  The Court stated that although "minor mistakes" on financing statements are not fatal, the financing statements are required to be sufficiently accurate such that third parties are put on notice. 

 

In determining that the plaintiff's financing statements were not sufficient to put the defendants on notice that plaintiff had a security interest in the debtors accounts receivable, the Sixth Circuit was critical of the language the plaintiff chose to include (and not include) in the financing statements.  The "financing statements identified specific pieces of equipment and several types of collateral. . . However, the description of collateral in plaintiff's financing statement did not list 'account' or 'accounts receivable.' Pursuant to the maxim, expressio unius est exclusio alterius, (the mention of one subject in a statute means the exclusion of other subjects that are not mentioned), the limiting language of plaintiff's financing statements identified only items that were subject to the security interest."  Without the term "account" or "accounts receivable," the Sixth Circuit held, the defendants had no reason to know or expect that plaintiff claimed a security interest in them.

 

Next, the Sixth Circuit analyzed whether accounts or accounts receivable constituted "proceeds" under Tennessee's Commercial Code.  The plaintiff attempted to argue that the phrase "all proceeds thereof" in its financing statements encompassed the debtors' accounts receivable.  The Court, relying on the statutory construction of "proceeds" under the Commercial Code, disagreed.  Although the Sixth Circuit acknowledged that the term "proceeds" under Chapter 9 of the Tennessee Commercial Code was broadly defined, the Court held that to include "accounts" and "accounts receivable" in that definition would render the term "accounts" – which was separately defined under the Commercial Code – meaningless: "we decline to expand the definition of the general term, 'proceeds,' in such a way that it would subsume the specific term, 'accounts.'" 

 

In further support of its limited interpretation of the term "proceeds," the Sixth Circuit relied on the Commentary to the UCC where the drafters explained that "proceeds" does not refer to "income generated from the debtor's own use and possession of goods" or to situations where there was "no disposition of the goods by the security lease."  PEB Commentary No. 8 § 9-306(1).  The Sixth Circuit agreed with the district court that in order for rights to "arise out of collateral," they must have been obtained as a result of some loss or dispossession of the party's interest in that collateral, not simply the use.  Finally, the Court reviewed other courts' interpretation of the UCC and concluded that those cases support the position that revenues earned through the use of collateral are not proceeds. 

 

Accordingly, the Sixth Circuit affirmed the district court's findings that the financing statements did not sufficiently put defendants on notice, and that the term "proceeds" in a financing statement does not include the accounts receivable of the debtor.  Because the plaintiff's security interest in debtors' accounts was not perfected, plaintiff's security interest was subordinate to defendants' perfected security interest.

 

 

 

 

 

Ralph T. Wutscher
McGinnis Wutscher Beiramee LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct: (312) 551-9320
Fax: (312) 284-4751
Mobile: (312) 493-0874
Email: RWutscher@mwbllp.com

 

Admitted to practice law in Illinois

 

 

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FYI: 9th Cir Rules Plaintiff Must Introduce Evidence to Meet CAFA's "Local Controversy" Exception, Inferences as to Citizenship Insufficient

The U.S. Court of Appeals for the Ninth Circuit recently held that the plaintiff bears the burden of proving the "local controversy" exception under the federal Class Action Fairness Act (CAFA).  The Court's ruling establishes that plaintiffs in a putative class action are no longer allowed to rely on inferences regarding the citizenship of the class members to establish the exception.

 

A copy of the opinion is available at:

http://cdn.ca9.uscourts.gov/datastore/opinions/2013/12/02/13-56699.pdf

 

A consumer brought a putative class action in San Diego County Superior Court against an auto finance company and a local automobile dealership, alleging violations of various provisions of California state consumer law related to automobile finance contract disclosures.  Capital One removed the matter to the U.S. District Court for the Southern District of California under the Class Action Fairness Act ("CAFA"), 28 U.S.C. §§ 1332(d) and 1453(d). 

 

As you may recall, under CAFA, the federal diversity jurisdiction requirements are broadened such that complete diversity is no longer required but only minimal diversity, see 28 U.S.C. §1332(d)(2), and the amount in controversy is satisfied if the aggregation of the class members' claims satisfies the minimum amount of $5 million.  28 U.S.C. § 1332(d)(6). 

 

There are, however, exceptions to the CAFA.  One such exception is what is commonly referred to as the "local controversy" exception, 28 U.S.C. § 1332(d)(4)(A).  Under that exception, a district court shall decline to exercise jurisdiction over a class action if four specific requirements are satisfied: (1) greater than two-thirds of the members of the proposed class are citizens of the state in which the action was originally filed, (2) at least one defendant is one from whom significant relief is sought, whose alleged conduct forms a significant basis of the claims asserted and is a citizen of the state in which the action was originally filed, (3) principal injuries allegedly caused by the defendants were incurred in the state in which the action was originally filed, and (4) during the three year period preceding the filing of the action no other class action has been filed asserting the same or similar allegations against any of the defendants.  The burden of establishing the applicability of an exception to CAFA jurisdiction rests with the party seeking to remand the matter to state court. 

 

In the lower court, the plaintiff argued that his proposed class definitions, which essentially defined the class as all persons who purchased and registered cars in California, was sufficient to establish the local controversy exception applied.  The auto finance company disagreed and argued that the plaintiff was required to introduce evidence, and not rely on assumptions or inferences, to establish that two-thirds of the proposed class members were citizens of California.  The district court agreed with plaintiff and remanded the case to state court.  The auto finance company appealed. 

 

On appeal, the Ninth Circuit first held that plaintiff bore the burden of establishing the "local controversy" exception to CAFA, and that the issue of citizenship was set as of the date the case became removable.  As to the citizenship of the class members, plaintiff again argued that his proposed class definitions likely consisted of more than two-thirds of California citizens.  The Ninth Circuit agreed that it was likely that the two-thirds requirement would be satisfied, but that plaintiff needed to introduce facts to establish it as fact. 

 

The Ninth Circuit held that when the facts are in dispute, CAFA requires district courts to make factual findings before the matter will be remanded.  "The statute does not say that remand can be based simply on a plaintiff's allegations, when they are challenged by the defendant. . . We conclude that there must ordinarily be at least some facts in evidence from which the district court may make findings regarding class members' citizenship for purposes of CAFA's local controversy exception."  The Ninth Circuit relied on In re Sprint Nextel Corp., 593 F.3d 669 (7th Cir. 2010) to support its ruling. 

 

Although the Ninth Circuit conceded that plaintiff's proposed class definitions would likely satisfy the two-thirds requirement, it went on to hold that "likely," with no facts in support, was not sufficient.  "As the Seventh Circuit (in Sprint) noted, such freewheeling discretion amounts to no more than guesswork.  Sensible guesswork, based on a sense of how the world works, but guesswork nonetheless." 

 

The Ninth Circuit then identified examples of how plaintiff's proposed class definitions may not encompass only citizens of California, such as automobiles purchased by members of the military, out-of-state students, owners of second homes and other temporary residents who are citizens of other states or not a U.S. citizen.  Another factor giving the Ninth Circuit pause was that the proposed class potentially included individuals who had purchased the vehicle more than five years prior to when the date became removable and those individuals may no longer have been citizens of California. 

 

The Ninth Circuit acknowledged that its ruling would result in "some degree of inefficiency by requiring evidentiary proof of propositions that appear likely on their face."  Cognizant of the inefficiency that would result, the Ninth Circuit cautioned that "any such inefficiency is largely of the parties' own making."  The Court then stated that both parties could have avoided such inefficiency had they selected different strategies.  For the plaintiff, he could have expressly limited the class by defining it to consist of only California citizens or he could have opted to not seek remand and proceeded in federal court.  Similarly, the auto finance company could have allowed the matter to proceed in state court initially or after the district court ordered it remanded. 

 

The Court next addressed auto finance company's argument that the matter should be remanded to the district court with instructions to deny plaintiff's motion to remand.  The auto finance company argued that plaintiff should not have "another bite of the apple" because of the inefficiency and delay that would result from the district court making factual findings.  The Ninth Circuit disagreed, and stated "that inefficiency and delay is at least equally attributable to [the auto finance company] for insisting that plaintiff affirmatively prove with evidence a proposition that seems likely to be true."

 

Finally, as an evidentiary matter, the Ninth Circuit acknowledged that there may be practical obstacles in establishing citizenship for the necessary two-thirds of the class, and ruled that the plaintiff may rely on "the presumption of continuing domicile" to establish citizenship, "which provides that, once established, a person's state of domicile continues unless rebutted with sufficient evidence of change."  The Court observed that the plaintiff's burden of proof should not be exceptionally difficult to bear.

 

Accordingly, the Ninth Circuit vacated the district court's remand order, and remanded the matter to the district court with the instructions to allow the plaintiff the opportunity to renew his motion to remand and present evidence to establish the two-thirds requirement of the exception. 

 

 

 

Ralph T. Wutscher
McGinnis Wutscher Beiramee LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct: (312) 551-9320
Fax: (312) 284-4751
Mobile: (312) 493-0874
Email: RWutscher@mwbllp.com

 

Admitted to practice law in Illinois

 

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Our updates are available on the internet, in searchable format, at:
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