From time to time a lender may find itself holding funds that are not its property and to which multiple parties claim an interest. The lender does not want to be accused of exercising control over those funds (conversion), but does not want to take the risk of delivering the funds to the wrong person and remaining at risk of having to pay the “wronged” party. That is the purpose of an interpleader action – to implead (deposit the funds into court for a determination of who is entitled to them. Interpleaders may be used to dispose of funds (defensive) or to recover funds. For example, imagine you have placed account debtors on notice and the “bad guy” borrower is disputing your entitlement to the funds and pressuring the account debtor to pay him. You can bring the interpleader action to force the account debtor to deposit the funds in court.

An interesting interpleader case recently came down from the California Court of Appeal involving proceeds from the award winning Broadway musical, Million Dollar Quartet (MDQ). The question in this interpleader action was which adverse claimant was entitled to the impleaded funds: a judgment creditor with a properly recorded judgment lien, or an assignee who did not file a financing statement with respect to distributions irrevocably assigned to it by the judgment debtor before the judgment lien was recorded.

The appellate court determined that the answer depended on whether under California’s Uniform Commercial Code the assignment created a security interest that had to be perfected (but was not) by the filing of a financing statement. The court then determined that the trial court was correct in holding that although the assignment created a security interest, the judgment creditor was entitled to the impleaded funds because its recorded judgment lien had priority over the unperfected security interest.

The interpleader action followed a prior action brought by Cleopatra Records as an investor in the development of the MDQ musical which prior action ultimately resulted in a judgment in favor of Cleopatra. Prior to the entry of the judgment, the author of the musical (one of the judgment debtors) assigned part of his interest in future distributions from the production of the musical to the law firm that represented the defendants in the lawsuit. The trial court in the interpleader action ruled that the assignment constituted a “security interest” that was subject to (UCC) perfection by the filing of a financing statement inasmuch as the transaction did not involve real property and because the assignment was of a percentage of the interest in future distributions that would revert to the debtor once the debt to the law firm was paid.

The law firm argued that the transfer was an absolute assignment. However the court dismissed that claim because the assignment reverted back once the firm’s fees had been paid and because the assignment was not for the full amount of the asset.

The appellate court held that because the law firm did not file a financing statement, Cleopatra’s judgment lien had “priority in time of filing or perfection”of the unperfected assignment to the law firm.

Two worthwhile takeaways from this case:

  1. Although there are other legal theories the law firm might have pursued the lesson from this case is clear: When in doubt file. A prophylactic filing could have saved this law firm the trouble and aggravation it put itself through.
  2. When holding funds in which you do not have an interest and which are subject to multiple claims, implead the funds by bringing an interpleader action. The court awarded MDQ its attorneys fees and costs, which the court directed were to be deducted from the impleaded funds. Thus, there was no loss for doing the right thing and at the same time demonstrated MDQ’s clean hands in not retaining possession of the funds.

MDQ, LLC et al. v Gilbert, Kelly, Crowley & Jennett LLP, Court of Appeal, Second District, Division 8, California. 2019 WL 948726.

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