Posts in UCC/Security Interests

April 16, 2013
Innocent Purchaser Of Motorcycle Loses To Secured Party In Replevin Action

The vernacular of “foreclosure” typically relates to real estate, while “replevin” normally pertains to personal property.  For more, click on my prior post What Is Replevin?  In Dawson v. Fifth Third Bank, 965 N.E.2d 730 (Ind. Ct. App. 2012), the Indiana Court of Appeals teaches us that security interests in personal property generally will not be extinguished even if the ownership of that loan collateral changes. 

Situation.  In Dawson, Buyer purchased a motorcycle from Seller, who had given Buyer a certificate of title showing the motorcycle was free of any lienholders.  Buyer later learned that Seller fraudulently obtained the title and that the current certificate of title listed Bank as a lienholder.  Which party - Buyer or Bank - was entitled to possession of the motorcycle free and clear of all liens?

Replevin 101.  Replevin is a statutory remedy allowing one to recover possession of property “wrongfully held or detained” by another.  Ind. Code § 32-35-2 is the Indiana statute.  The elements of a replevin action require the plaintiff to prove (a) its title or right to possession, (b) that the property is unlawfully detained and (c) that the defendant wrongfully holds possession.  In the secured lending context, Indiana law is clear that, upon default, a creditor has the right to take possession of the collateral securing its claim and in accordance with the agreement with the defaulting party.

Competing rights.  Bank held a security interest in the motorcycle based upon Seller’s promissory note and security agreement.  The most current certificate of title on file with the Bureau of Motor Vehicles reflected Bank’s security interest.  Bank had never released its lien.  In what proved to be a fatal error, Buyer purchased the motorcycle without checking with the BMV to verify that the certificate of title supplied by Seller was the most recent one.  Since Seller was in default under the security agreement based upon non-payment, Bank, as the secured party, had the right to take possession of the motorcycle.  Ind. Code § 26-1-9.1-609(a).  Buyer did not dispute Bank’s rights.  Rather, Buyer contended that its purchase, and thus ownership, of the motorcycle precluded Bank from arguing that Buyer wrongfully held possession of the motorcycle – one of the elements of an Indiana replevin claim.  Bank, while not contesting ownership, asserted that such ownership was subject to Bank’s lien. 

Ownership immaterial.  A security agreement is effective against purchasers of collateral.  Ind. Code § 26-1-201-9.1.  Third-party purchasers are therefore at risk if they buy encumbered personal property from a seller/debtor in default.  Although Buyer had an interest in the motorcycle as its purchaser, the interest was not superior to Bank’s perfected security interest.  The Court affirmed the trial court’s summary judgment for Bank accordingly. 

Perfection.  Footnote 4 of the Dawson opinion contains lots of information related to certificates of title and the issue of perfecting Bank’s security interest.  Bank’s perfection was a non-issue, but the Court’s remarks are informative.

Equitable estoppel.  The Court in Dawson devoted a portion of its opinion to Buyer’s claim for equitable estoppel.  The discussion focused on certificates of title and which party was in the best position to protect itself based upon the public records.  The opinion is helpful for those who deal with motor vehicle transactions.  In the end, Bank was not responsible for Seller’s loss. 

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Posted at 12:18 PM in Replevin , UCC/Security Interests  |  Permalink

July 01, 2011
Indiana Supreme Court Clarifies Indiana Law In Distinguishing A True Lease From A Sale Subject To A Security Interest

Today’s post supplements my February 11, 2011 post regarding Gibraltar Financial v. Prestige Equipment punch press case.  On June 21, 2011 (.pdf), the Indiana Supreme Court reversed the Court of Appeals’ decision that was the topic of my prior article.  At issue is the sometimes difficult question of whether a transaction constituted a lease or a sale subject to a security interest. 

UCC, generally.  Although the case involved Colorado law, the operative statutes are similar, if not identical, to those in Indiana.  The first is the UCC’s definition of a lease at Ind. Code § 26-1-2.1-103(j).  The “key thing to note” with regard to the definition is that lease and security interest-based transactions “are mutually exclusive.”  The second and more central statute is I.C. § 26-1-201(37), which sets forth rules for distinguishing the two transactions.  The provision is complex.  The Gibraltar opinion helps parties and their lawyers navigate through that statute.  (Colorado’s version is Colo.Rev.Stat. § 4-1-203.)

Security interest per se.  The Court first concluded that one component of Section 201(37) is to create a two-pronged “bright-line test” to decide the issue of whether the transaction has created a security interest.  If the facts meet the test, “no further inquiry is required.” 

    Prong 1.  The first prong is satisfied “if the consideration that the lessee is to pay the lessor for the right to possession and use of the goods is an obligation for the term of the lease and is not subject to termination by the lessee.”  The Court in Gibraltar concluded that the lease was not subject to termination.  Thus the first prong of the bright-line test was met.

    Prong 2.  The second prong is satisfied if one or more of four “Residual Value Factors” identified in the statute are found to exist.  In Gibraltar, only one of the four factors were potentially at issue:  whether the lease provided the lessee with an option to become the owner of the goods for no additional consideration or for nominal additional consideration upon compliance with the lease.  The Court (and the Court of Appeals) wrote at length about two different tests applicable to this prong:  the “Fair Market Value Test or Standard” and the “Option Price/Performance Cost Test.”  (Review the opinion for details.)  The Court held that prong 2 was not satisfied under either test, essentially because “compliance with the Lease required [lessee] to pay more than nominal consideration to become the owner of the press.” 

Because prong 2 of the bright-line test was not met, there was no security interest per se created by the lease.

Fall back.  If the transaction does not pass the two-pronged bright-line test, Indiana courts must turn to a consideration of “the economic reality of the transaction in order to determine . . . whether the transaction is more fairly recognized as a lease or as a secured financing agreement.”  The Court discussed the pertinent statutory provisions and described their complexity, as well as courts’ struggles with interpreting them.  The Court’s solution was to articulate the following rule:  the question is whether the economic realities of the transaction dictate that it is a lease, and the focus in answering the question should be on the operative “economic factors” that drove the transaction.  The Court’s opinion identified some of the factors to be considered, none of which alone controls.  Indeed there were factors supporting both sides in Gibraltar.  The bottom line is that a resolution of this issue is highly dependent upon the facts. 

No summary judgment.  The Gibraltar decision involved an appeal of the trial court’s summary judgment ruling, which was affirmed by the Court of Appeals.  Here’s how the Indiana Supreme Court left the case: 

the defendants had the burden of establishing the absence of any genuine issue of material fact as to the economic realities of the transaction dictating that it was a lease as a matter of law.  To do so required evidence of the expectations of [lessee] and [lessor] at the time the transaction was entered into as to such factors as the value of the punch press on the EBO and lease expiration dates, the discount rate, and whether the “only economically sensible course” for [lessee] would have been to exercise the EBO. 

The Court saw “no way of resolving this case without this evidence” and thus reversed the case.   

Gibraltar serves as a reminder that not all “lease” agreements will be treated as leases.  Lenders should be attentive to these rules and to structure their transactions accordingly, depending upon whether they desire the transactions to be true leases versus a secured loans.  This dense body of law plays an important role when asset-based lenders and their collection counsel are confronted with defaults on these transactions.  The nature of the underlying transaction will control the remedies available to the lender/lessor, as well as who owns the asset. 

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Posted at 03:06 PM in UCC/Security Interests  |  Permalink

June 06, 2011
Prejudgment Possession (Replevin) of Equipment Permitted Under Indiana Law

This post falls in line with those of January 31, 2009, December 7, 2010, and January 6, 2011 regarding Indiana’s remedy of replevin, including the right to prejudgment possession of personal property loan collateral.  The Indiana Court of Appeals’ decision in Deere v. New Holland, 2010 Ind. App. LEXIS 1899 (Ind. Ct. App. 2010) (click and save for .pdf) supports the proposition that prejudgment repossession is available in Indiana.  The Court also held that the creditor’s lien survived the debtor’s transfer of the property.

What happened.  The creditor in Deere held a perfected security interest in farm equipment.  The original debtor traded the equipment to another business, which relied upon statements of third parties that the creditor’s lien had been satisfied.  The successor business – the defendant in the suit – did not contact the creditor to verify whether the liens had been released.  There was a default under the applicable security agreement, and the amount due under the agreement was accelerated as a result.  As is often the case, the agreement provided the creditor with the right to recover the equipment upon the default.  The case surrounded the defendant’s (the subsequent owner of the equipment) objection to the creditor’s effort to repossess.

Repossession rules.  The Court in Deere reiterated that, upon a default, creditors have the right to take possession of the collateral securing their claim.  See Indiana Code § 26-1-9.1-601(a) and 609(a)(1).  Significant to Deere, “a security agreement is effective against purchasers of the collateral.”  I.C. § 26-1-9.1-201(a).  Depending upon the circumstances, repossession can occur through self-help or, as in Deere, a suit for replevin.  An Indiana replevin action is a “speedy statutory remedy designed to allow one to recover possession of property wrongfully held or detained as well as any damages incidental to detention.”  A plaintiff/creditor must prove:  (1) it has the right to possession, (2) that the property is unlawfully detained, and (3) that the defendant wrongfully holds possession.  The Court concluded, based upon undisputed facts, that the creditor was entitled to possession, use and disposition of the equipment pending final adjudication of the claims of the parties.

Notice of lien.  The real meaty issue in Deere related to the defendant’s belief, based upon representations made by third parties, that the creditor’s liens had been satisfied.  Indeed proof showed that such representations occurred.  Nevertheless, the evidence was undisputed that the defendant had actual notice that the prior lien existed at a point in time, and the defendant never contacted the creditor to confirm the alleged satisfaction of the lien. 

BFP defense?  The court translated the defendant’s argument as “raising an affirmative defense that it was a bona fide purchaser because it relied in good faith on the information it gleaned from [third parties].”  I have written about the bona fide purchaser defense on a handful of occasions, including on October 4, 2009 when I discussed how actual knowledge defeats Indiana’s bona fide purchaser doctrine.  This knowledge was fatal in the Deere case.  The defendant had actual notice of the perfected security interest in the equipment.  Any reliance on statements by third parties with respect to the satisfaction of liens “simply was not reasonable”: 

As a general rule, we find that it is unreasonable to rely on the statements of third parties – or the [original] debtor – about the current status of security interests.

The lesson for parties acquiring equipment that may be subject to a security interest is to conduct an independent investigation into the status of any liens.  Relying on written or oral representations by the seller will not protect parties from a creditor’s action to foreclose the lien.  From the creditors’ perspective, in cases of clear defaults, Indiana law generally allows repossession (and liquidation) of personal property loan collateral before the entry of judgment.

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Posted at 09:54 AM in Replevin , UCC/Security Interests  |  Permalink

May 28, 2011
Bankruptcy Proofs Of Claim And Standing/Loan Assignment Issues

Secured lenders faced with loans in default may find themselves entangled in a borrower’s or guarantor’s bankruptcy case and thus forced to file a proof of claim (POC).  In my April 27, 2007 post, I wrote about POCs, including when a creditor should file one.  In the Matter of Larkin, 2010 Bankr. LEXIS 3609 (N.D. Ind. 2010) (click and save for .pdf), Judge Dees provides a thorough opinion surrounding the sufficiency of the documentation needed to support a POC, which opinion also touches upon the “standing” issue that has been prevalent in mortgage foreclosure law for the past three or four years.

POC general rules.  The main POC rule is located at Federal Rule of Bankruptcy Procedure 3001.  A POC, if executed and filed in accordance with the Rules, “shall constitute prima facie evidence of the validity and amount of the claim.”  Fed. R. Bankr. P. 3001(f).  If the claim is based on a writing, the original or a duplicate of the written document must be filed with the proof of claim.  F.R.B.P. 3001(c).  If the creditor asserts a security interest in the debtor’s property, the POC “shall be accompanied by evidence that the security interest has been perfected.”  F.R.B.P. 3001(d).  The POC is deemed allowed, unless a party in interest objects. 

Entire document.  In the Larkin matter, the debtor’s first objection surrounded the mortgagee creditor’s attachment of only certain pages of the underlying loan documents.  The issue was whether this “substantially” complied with Rules 3001(c) and (d).  The Court held that the attachment requirement in Rule 3001(c) mandates specific, not substantial, compliance and, as such, the Court initially ruled that the POC was not valid.  (After a continuance of the hearing on the objection, the creditor corrected the problem by attaching a complete set of documents.  You always should do the same.)

Mortgage assignment.  The creditor in Larkin was an assignee of the loan.  The mortgage assignment had not been recorded.  Indiana’s recording statutes regarding assignments of mortgages “are designed to protect third party purchasers and mortgagees, not mortgagors.”  The recording of an assignment of mortgage “is not necessary to the validity of the mortgage, but is simply a protection to a good-faith purchaser of the mortgage itself . . ..”  Since the debtor was a mortgagor, not a subsequent purchaser, the debtor could not challenge the validity of her properly-recorded mortgage for failure to record a subsequent assignment.  (We would advise recording all mortgage assignments as soon as possible, but the act of recording does not affect the enforceability of the mortgage as between the mortgagor and the mortgagee’s assignee.) 

Post-petition assignment.  The debtor also contended that, because the mortgage assignment was post-petition, it was ineffective because it violated the automatic stay.  Not so, said the Court.  Bankruptcy law provides that “once the original grant by the mortgagor to the mortgagee has been perfected, the later assignment of that mortgage does not involve a transfer of property of the debtor . . . and cannot constitute a violation of the automatic stay.”  Larkin supports the notion that post-petition loan assignments are appropriate. 

Note assignment.  The debtor also attacked the validity of the transfer of the promissory note from the original holder to the current creditor.  This is the “real party in interest” and “standing” defense advanced by debtors over the last few years.  (See my November 15, 2007 post.)  The Larkin opinion provides a solid summary of the law applicable to the assignment of promissory notes via endorsement or allonge.  Endorsement is defined by Black’s Law Dictionary as “the placing of a signature, sometimes with an additional notation, on the back of a negotiable instrument to transfer or guarantee the instrument or to acknowledge the payment.”  “Allonge” is a “French term used in legal contexts for a paper that is annexed to a note.”  In Indiana, an endorsement “on an allonge is valid even though there is sufficient space on the instrument for an indorsement.”  I.C. § 26-1-3.1-204(a).  The Court in Larkin concluded that the subject allonge that was affixed to the debtor’s note (and included with the POC) was a part of the note, and thus constituted a valid endorsement.

POCs filed by our firm, whether secured or unsecured, that are based upon written documents include a complete copy of the underlying loan documents and any assignment papers.  It is also our practice to prepare and attach an “Attachment to Proof of Claim” that gives a brief description of the nature of the claim and references the attachments.  The Attachment would spell out, among other things, the factual and documentary basis that the creditor is the holder of the note and mortgage, and has the present ability to enforce the subject loan. 

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Posted at 09:19 AM in Bankruptcy Issues , UCC/Security Interests  |  Permalink