GREED IS A TERRIBLE THING

I have a distaste for lender against lender litigation.  That goes for any financial institution for that matter.  Perhaps it comes from the doctrine of not airing one’s dirty laundry.  I am reminded of this from a decision that came down this Monday (March 2, 2020, for those reading this in reprint) by the US District Court for the S.D. Indiana.  No one gains from these types of lawsuits. 

If the following story bores you (and it should not) please do read the penultimate statement at the end.

BMO Harris Bank was financing a construction project for its customer, North & Maple LLC, with Midwest Form Constructors, LLC as the general contractor.  Throughout most of the project BMO Harris funded advances to Midwest’s account at Salin Bank and Trust Company to be used for the completion of the construction project.  At some point North & Maple notified BMO Harris to no longer send loan advances to Midwest but instead, to send them to Atlas Funds Control, LLC, the agent for Midwest’s bonding company.

However, when BMO Harris received instructions to transfer funds to Atlas, BMO mistakenly wired the funds to Midwest’s account at Salin.  Salin accepted the wire transfer and credited the funds to Midwest’s bank account and then withdrew most of it as a setoff to credit an outstanding loan made by Salin to Midwest. 

BMO promptly issued a recall request advising Salin of the mistake and demanding that the wire be returned.  Salin did not and instead, completed the setoff transaction.  Salin did this even though it had full knowledge that Midwest was having financial problems.  BMO claimed that Salin knew, or should have known, that the transfer was mistakenly sent to Salin.

BMO Harris brought an action against Salin for unjust enrichment, conversion and replevin.  Salin moved for judgment dismissing the action relying on Article 4A of the Indiana Uniform Commercial Code (yes, the UCC has more than Article 9), arguing that was the exclusive source of rights for financial institutions participating in the federal wire transfer system.  The court began with an examination of the Article 4A definition of a fund transfer:

 [T]he series of transactions, beginning with the originator’s [North & Maple] payment order, made for the purpose of making payment to the beneficiary [Midwest] of the order. The term includes any payment order issued by the originator’s bank [BMO Harris] … intended to carry out the originator’s payment order. A funds transfer is completed by acceptance by the beneficiary’s bank [Salin] of a payment order for the benefit of the beneficiary of the originator’s [North & Maple] payment order.


Keep in mind that North & Maple’s payment order was for the funds to go to Atlas – not Midwest.  The Court went on to consider Section 211 of Article 4, which provides:

(a) A communication of the sender [also North & Maple] of a payment order canceling or amending the order may be transmitted to the receiving bank [Salin] orally, electronically, or in writing[.]

(b) Subject to subsection (a), a communication by the sender [North & Maple or BMO standing in its shoes] canceling or amending a payment order is effective to cancel or amend the order if notice of the communication is received at a time and in a manner affording the receiving bank a reasonable opportunity to act on the communication before the bank accepts the payment order.

(c) After a payment order has been accepted, cancellation or amendment of the order is not effective unless the receiving bank [Salin] agrees or a funds-transfer system rule allows cancellation or amendment without agreement of the bank.

The Court then turned to case law from other districts, focusing on a New York case:

“[P]arties whose conflict arises out of a funds transfer should look first and foremost to Article 4A for guidance in bringing and resolving their claims[.]” …. If a situation is unequivocally covered by particular provisions in Article 4A, then it is beyond debate that Article 4A governs exclusively. …. However, courts should not interpret this directive to mean that Article 4A has “completely eclipsed” the applicability of common law in the area of funds transfers. …. (Article 4A “does not establish a legislative intent to preclude any and all funds transfer actions not based on Article 4A”); ….(holding that Article 4A did not preempt common law claim when the UCC was “silent” as to the factual scenario alleged);. Rather, preemption likely does not foreclose common law claims related to funds transfers when the disputed “conduct or factual scenario is not addressed squarely by the provisions of [Article 4A].”

The Court went on to conclude:

Article 4A does not squarely address BMO’s allegations and thus does not preempt the common law claims presented.

However, that did not end the case: it only denied the motion to dismiss.  BMO Harris still needs to prove its case – especially that Salin knew of Midwest’s financial distress and that BMO would no longer be sending wires to Midwest. 

Perhaps reasonable minds will prevail and the banks will recognize their risks and reach a settlement.

BMO erred and Salin took advantage of it.  There was a time when financial institutions would not seize upon an opportunity like this.  Disputes such as these reflect poorly on the industry and only help to fuel borrowers’ claims against lenders.

Here comes the penultimate statement.

How could they have avoided airing their dirty laundry?  Arbitration. With arbitration the same result could have come about but without the notoriety of having the decision made public.  Yes, one of the major benefits of arbitrating disputes is that the process may remain confidential.  Had these parties submitted their dispute to arbitration those of you thinking “How dumb” or “How greedy” would never have known of this. 

You will be reading more on these pages about using arbitration in commercial finance disputes.  Its time has come.

BMO Harris Bank N.A. v Salin Bank and Trust Company, 2020 WL 998657, (SD Indiana, March 2, 2020)

PACA BITES AGAIN

There is always room for another PACA story.  Perhaps had Produce Pay, Inc. read this blog it would be in a better position today.  Instead…., well read on.

Produce Pay billed itself as a  “multi-service finance company” that could provide “access to cash flow…the day after you ship your produce to the U.S.”.  Spiech Farms, LLC is a grower and processor of blueberries, asparagus, and grapes.  Spiech fell on hard times in early 2017 when frost destroyed a significant portion of its blueberry crop. In an attempt to shore up its financial state, Spiech entered into a “Distribution Agreement” with Produce Pay.

The Distribution Agreement provided that Spiech would notify PP that it had a pallet of produce for sale by registering that pallet on Produce Pay’s software platform. Produce Pay would then purchase the pallet of produce from Spiech for half the market price. In connection with that purchase, Spiech would assign “all right, title and interest” in the produce to PP, but Spiech would keep the produce in its possession.

 Spiech would then sell, or attempt to sell, that produce to a grocery store or other customer. Whether Spiech sold the produce or not, it was obligated to repay the money it received from Produce Pay, plus a commission, within 30 days after receipt. After 30 days, the commission rate increased. After 60 days, Spiech had to “repurchase” the produce from Produce Pay by repaying the purchase price to Produce Pay, plus a commission.  Although the agreement claimed the transaction to be a purchase of the produce, In effect, the agreement, provided for short-term loans from Produce Pay as a partial advance on payments that Spiech expected to receive from its existing customers. Also by listing its produce on Produce Pay’s software platform, Spiech could potentially reach new customers. If Spiech sold the produce to a customer introduced by Produce Pay, then Produce Pay would receive a higher commission.

As you must have anticipated, Spiech filed for bankruptcy protection.

Produce Pay asserted a $1 million PACA claim against the bankruptcy estate to recover the unpaid cash advances that Produce Pay made to Spiech. The bankruptcy court held an evidentiary hearing and denied Produce Pay’s claim.  Produce Pay appealed to the United States District Court for the Western District of Michigan.

Readers of WCS will recall our two-part blog published in March of 2018, which addressed a decision of the Ninth Circuit Court of Appeals in which the Ninth Circuit reversed its long standing policy of not exercising a “true sale” analysis in situations concerning factoring of PACA receivables.  In doing so the Ninth Circuit joined the Second, Fourth and Fifth
Circuits, holding:

…. a PACA trustee’s true sale of accounts receivable for a commercially reasonable discount from the accounts’ face value is not a dissipation of trust assets and, therefore, is not a breach of the PACA trustee’s duties. … (“The assets of the trust would thus have been converted into cash and the receivables would no longer have been trust assets.”… “[A] ‘bonafide purchaser’ of trust assets receives the assets free of claims by trust beneficiaries” and noting that the determinative issue on appeal is whether the “factoring agreement” was a loan secured by accounts receivable or a true sale of accounts receivable); … (“[N]othing in PACA or the regulations prohibits PACA trustees from attempting to turn receivables into cash by factoring. To the contrary a commercially reasonable sale of accounts for fair value is entirely consistent with the trustee’s primary duty.”)…

Produce Pay apparently believed that by purchasing produce with full recourse it would obtain the benefits of a PACA trustee.  Instead, it paid a high tuition for its lesson.

The District Court affirmed the bankruptcy court’s denial of  Produce Pay’s PACA claim, stating:

The bankruptcy court properly determined that Spiech did not transfer its receivables, or any other interest protected by a PACA trust, to [Produce Pay]..

The District Court went on to say:

…when making this determination, the bankruptcy court employed a “transfer-of-risk” test that has been used in circumstances that are different from the instant case. In the cases cited by the bankruptcy court, courts applied this test to determine whether the buyer of agricultural commodities breached its duties as a PACA trustee when entering into what was either a lending arrangement or a sale of the buyer’s rights in its own receivables. [citations omitted] But there is no reason why the same test should not apply to the agreement between Spiech and [Produce Pay]. Indeed, the UCC recognizes that it is not unusual for a commercial agreement to “blur” the distinction between a transaction “in which a receivable secures and an obligation” and one in which “the receivable has been sold outright.” [citation omitted] This is one of those agreements. Although the circumstances of the aforementioned cases were different, the transfer-of-risk test performs the same basic function in those cases as it does in this one; it helps the court distinguish the true nature of the parties’ agreement. It was not improper for the bankruptcy court to employ a widely-used test to ascertain whether the distribution agreement assigned Spiech’s rights in its receivables.

Although not specifically stating it, both courts utilized a “true sale” test.  Simply, Spiech sold its produce or its receivables, Produce Pay retained full recourse to Spiech, denying it the protection of a “true sale.”

Had Produce Pay followed this blog [OK, the facts in this case preceded the March, 2018 blog] it would have been $1mm richer.

The takeaway for lenders and factors following this blog is to exercise caution when dealing with collateral that is protected by PACA. When PACA bites, it takes  a pound of flesh with it.

In re: Spieth Farms, LLC, Debtor, Produce Pay, Inc v Spiech Farms, LLC. (United States District Court, W.D. Michigan, December 17, 2019)

COLLATERAL DESCRIPTION BY REFERENCE

The UCC has two standards for collateral description. Section 9-108 provides that the security agreement’s “description of personal … property is sufficient, whether or not it is specific, if it reasonably identifies what is described.”  It goes on to give examples (not requirements) of reasonable identification.  However, it specifically prohibits super-generic description:

A description of collateral as ‘all the debtor’s assets’ or ‘all the debtor’s personal property’ or using words of similar import does not reasonably identify the collateral.

On the other hand, the UCC permits super generic descriptions of collateral on the financing statement.  Section 9-504 provides: 

A financing statement sufficiently indicates the collateral that it covers if the financing statement provides: (1) a description of the collateral pursuant to Section 9-108; or (2) an indication that the financing statement covers all assets or all personal property.

So the standard for a security agreement is specific while the standard for a financing statement is generic.  What if the financing statement merely provides that the collateral is what is described in the security agreement without anything further?

No problem when you get a UCC search which shows a prior lien on “all assets”.  How about if the UCC search only states that the secured party is secured in the collateral described in the security agreement?  What do you do?  Do you rely on the security agreement your prospective borrower hands over to you?  What if it had been amended to add more collateral?  And what if your intended borrower does not want you to approach the existing lender. 

Now comes a decision from the United States Court of Appeals for the Seventh Circuit (Chicago – a significant commercial center).  Yes, the situation in this decision is different from what I described above but the issue is not.  The Court indicated that the issue was

a matter of first impression for our court: Whether Illinois’s version of Article 9 of the Uniform Commercial Code requires a financing statement to contain within its four corners a specific description of secured collateral, or if incorporating a description by reference to an unattached security agreement sufficiently “indicates” the collateral.

This decision was not about a dispute between lenders as to whom held a valid interest.  It was an action by a Chapter 7 trustee against First Midwest Bank (FMB).  FMB made a loan to 180 Equipment LLC.  The security agreement contained 26 categories of collateral (e.g. accounts, goods, etc).  Instead of using the “all asset” description in the financing statement, FMB, instead, described the collateral as

[a]ll Collateral described in First Amended and Restated Security Agreement dated March 9, 2015, between Debtor and Secured Party.

When FMB brought an action against the trustee to recover almost $8 million that it claimed to be the proceeds of collateral in which it held a properly perfected and senior interest, the trustee asserted a counterclaim under §544(a) of the Bankruptcy Code, that, as a statutory lienholder, the trustee’s lien was superior to the interest of FMB because FMB did not properly perfect its interest due to its failure to provide a sufficient collateral description.  The Bankruptcy Court ruled in favor of the Trustee and the appeal was certified directly to the Seventh Circuit.[1]

The appeals court stated:

A court must view the statute as a whole, construing words and phrases in light of other relevant statutory provisions and not in isolation. Each word, clause, and sentence of a statute must be given a reasonable meaning, if possible, and should not be rendered superfluous.

The Court looked at Section 9-502, which requires that a financing statement:

(1) provide the name of the debtor; (2) provide the name of the secured party or its representative; and (3) indicate the collateral covered by the financing statement.

The Court went on:

A financing statement that substantially satisfies these requirements is effective, even if it has minor errors or omissions that are not “seriously misleading.” ….. But if a financing statement fails these basic requirements, the lender’s interests are subject to avoidance under §544(a) of the Bankruptcy Code.

It recited Official Comment 2 of Section 9-102, as follows:

This section adopts the system of “notice filing”. What is required to be filed is not, as under pre-UCC chattel mortgage and conditional sales acts, the security agreement itself, but only a simple record providing a limited amount of information (financing statement)…. The notice itself indicates merely that a person may have a security interest in the collateral indicated. Further inquiry from the parties concerned will be necessary to disclose the complete state of affairs.

The Court held that the financing statement is an abbreviation of the security agreement and concluded:

The approach … to financing statements supports the conclusion that incorporation by reference is permissible in Illinois as “any other method” under § 9-108, so long as the identity of the collateral is objectively determinable. That requirement is met here by the security agreement’s detailed list of the collateral.

* * *

The plain and ordinary meaning of Illinois’s revised version of the UCC allows a financing statement to indicate collateral by reference to the description in the underlying security agreement.

Reversed.  Success to FMB.  But what can we take away from this?

First, of course, FMB could have avoided a ton of aggravation (and legal costs) if it merely described its collateral as “all assets” on the financing statement – or even “all assets other than…” assuming its list of 26 was not intended to be all inclusive.

The more significant issue, referring back to the situation described above, is that lenders must exercise caution when intending to lend against collateral that is represented not to be part of a prior lender’s collateral package.  In such a case, and when the prior lender’s financing statement does not clearly enumerate the collateral description (as the Seventh Circuit stated), “Further inquiry from the parties concerned will be necessary to disclose the complete state of affairs.”

In other words, if the proposed borrower does not want you to communicate with the prior lender as to the nature of the collateral – and you cannot enter into a reasonable intercreditor agreement, are you that hungry to do the deal?

All of this said, I have found that financing statements filed by equipment leasing companies to give notice of their interest in their leased equipment may describe collateral by reference to the lease agreement.  In examining these leases I have, on occasion, found broad granting clauses securing the lessee’s obligations.  Without that review lenders would have found themselves subordinate to the prior filed lessor.

You may detect my distaste for descriptions of collateral by reference but, at least in the Seventh Circuit, it is sufficient and we must be guided accordingly.

In re 180 Equipment LLC, 938 F3d 886 (7th Cir, 2019)


[1] This is a process employed when the parties agree that an appeal to the District Court would be futile.

RECOVERING ON COLLATERAL – AND ITS HIDDEN COSTS

Asset based lenders lend against the value of their collateral – at least they are supposed to.  Thus, when making a loan the lender needs to consider what it will cost to recover on its collateral in order to set a reasonable advance rate.  Each type of collateral has its own issues in recovering.  Account debtors protest in paying someone other than the debtor.  Landlords deny access to inventory and equipment until the rent is paid. Even then, equipment has additional issues.  For example, we once represented a lender who wanted to take back a huge printing press that required the removal of exterior wall to a building.  We succeeded in obtaining a court order authorizing the demolition and replacement of the wall but the cost and time affected the lender’s recovery on its collateral.

Rolling stock has its own types of issues.  The 1984 film Repo Man made the repossession of rolling stock entertaining but it is far from fun – even when you have a set of keys. 

UCC 9-609 of the UCC provides:

SECURED PARTY’S RIGHT TO TAKE POSSESSION AFTER DEFAULT.

(a) Possession; rendering equipment unusable; disposition on debtor’s premises.  After default, a secured party: (1) may take possession of the collateral; and (2) without removal, may render equipment unusable and dispose of collateral on a debtor’s premises under Section 9-610.

(b) Judicial and non-judicial process.  A secured party may proceed under subsection (a): (1) pursuant to judicial process; or (2) without judicial process, if it proceeds without breach of the peace. (emphasis added).

(c) Assembly of collateral. If so agreed, and in any event after default, a secured party may require the debtor to assemble the collateral and make it available to the secured party at a place to be designated by the secured party which is reasonably convenient to both parties.

A recent decision from the United States District Court for the District of Maryland highlights how easy it is for a debtor to make out a claim for breach of the peace in a non-judicial repossession of collateral.  The plaintiffs (the debtor) purchased a dump truck financed by the lender and a dispute arose concerning payments.  When the lender’s “repo man” showed up with a tow truck, the debtor protested loudly and called the police who directed the debtor to allow the repossession.  The debtor then brought an action against the lender claiming that the repossession was in violation of UCC § 9-609 because it involved a breach of the peace.

The Court held:

Plaintiff alleges that he “objected loudly” to the repossession and claimed that Defendant “did not have the right” to repossess the truck…. Plaintiff further alleges that this disagreement “intensified” to the point that the police were called. …… Therefore, Plaintiff plausibly alleges that Defendant violated § 9-609(b).

The lender’s motion to dismiss the action was denied and even if the lender will ultimately recover its collateral, the cost to do so has gone through the roof.

The Maryland case addressed complications from recovering collateral without judicial process.  A few weeks earlier the United States District Court for the District of New Mexico addressed a judicial process to recover collateral – commonly referred to as replevin.  That case was brought ex parte – meaning that the debtor did not appear in the case.  Even so, a court will review the facts and determine whether the lender is entitled to repossess its collateral even upon the debtor’s default in responding to the claim.

Replevin was an original common-law remedy, however most states have since authorized a suit for replevin by statute. The New Mexico statute provides:

Any person having a right to the immediate possession of any goods or chattels, wrongfully taken or wrongfully detained, may bring an action of replevin for the recovery thereof and for damages sustained by reason of the unjust caption or detention thereof…  A replevin suit has two possible components: physical recovery of the collateral, and pursuit of damages for wrongful taking… . In order to obtain a pre-judgment writ of replevin, an affidavit must be filed [according to the statute] “stating: A. that the plaintiff is lawfully entitled to the possession of the property mentioned in the complaint; B. that the same was wrongfully taken or wrongfully detained by the defendant; C. that the plaintiff has reason to believe that the defendant may conceal, dispose of, or waste the property or the revenues therefrom or remove the property from the jurisdiction, during the pendency of the action; D. that the right of action accrued within one year; and E. specific facts, from which it clearly appears that the above allegations are justified”

The magistrate judge hearing the dispute broke out and applied the facts to each of the required elements that needed to be proven and went on to recommend to the District Court that it:

authorize the issuance of a writ of replevin for recovery of the collateral described in the complaint and supporting documents

But that successful ruling was not the end of the story.  Inasmuch as replevin is an equitable remedy, it typically comes with the requirement for the posting of a bond – just in case the debtor ultimately appeals and disproves what the court had granted.  In this case, the bond was to be in an amount “double the value of the collateral as described in the complaint and supporting documents”

These costs are often anticipated and even mitigated by obtaining landlord waivers.  The loan agreement should include a provision where the borrower grants the lender and its agents a license to enter the debtor’s premises (even to break locks) to repossess the collateral, which entry is specifically agreed not to be a breach of the peace.

The lesson is that it costs – and sometimes dearly – to recover on collateral and that cost needs to be factored into the amount a lender is advancing based upon the value of the collateral.  As we say time and time again: plan your divorce before you get married -be sure your loan agreements adequately provide for your recovery in the event things do not go as hoped when you made the loan.

Darren Trucking Company v. PACCAR Financial Corp., USDC Maryland, August 20, 2019, 2019 WL 3945103

Commercial Credit Group Inc. v. Protégé Excavation, Inc. USDC New Mexico, August 5, 2019 2019 WL 3973848.

MITIGATING THE COSTS IN RECOVERING ON DEFAULTED LOANS

Lawyers who represent lenders in recovering on defaulted loans are consistently confronted with the lender’s quest to recover the maximum amount at the lowest cost.  Not an unreasonable request.  However, too often the lender’s own form of agreement does not provide assistance in keeping down the costs.

In preparing this article I chose to go beyond the four corners of the judge’s decision and took advantage of electronic filing of documents (PACER) so I could see the promissory note at issue.  I was looking, in particular, to see whether a certain typical clause was included in the form but could not find it.

This case was brought against an individual to recover on two promissory notes.  Simple.

The Court ruled:

at oral argument…. the Defendant conceded that he owed the Plaintiff monies under the two Promissory Notes and that he was in default, as well. The Defendant challenged, however, the amount which Plaintiff claims to be due and owing. The Defendant consented to the entry of summary judgment as to liability but reserved the right to contest the amount of the debt at a hearing on damages. Accordingly, the Motion for Summary Judgment is GRANTED as to liability only.

The Defendant retains the right to challenge the Plaintiff’s proof as to the amount of the judgment sought and to present evidence regarding the same. A hearing to determine the Plaintiff’s damages (the amount of the judgment) shall be held….

Translated?  The bank is granted summary judgment on liability only but still needs to prove the amount owed at a separate evidentiary hearing. 

Could this “extra trial” have been avoided?

It appears (from the decision) that at the hearing on the motion for summary judgment the pro se defendant made a “bald protest” as to the amount claimed by the bank.  For whatever reason, the judge considered that sufficient to put the bank to its burden of proof on the amount owing.

Lenders typically include a clause providing that it will send monthly statements of account which statement shall be deemed to be true and correct unless timely objected to.  Thus, the statement will be deemed to be an account as stated and primary evidence in a contest as to the amount owed. 

A typical clause might read as follows:

Account Stated.  Lender’s books and records showing the account between Lender and Borrower shall be admissible as evidence in any action or proceeding, shall be binding upon the Borrower for the purpose of establishing the items therein set forth and shall constitute prima facie proof thereof.  Lender’s monthly statements setting forth the transactions hereunder rendered to Borrower whether by electronic means or otherwise shall, to the extent to which no written objection is made within thirty (30) days after the end of the month following the month of the statement, be binding upon Borrower and constitute an account stated between Lender and  Borrower and be binding upon Borrower.

A clause such as this shifts the burden of proof on the amount due to the borrower and away from the lender.  Had this clause been included in the note, the bald allegation of a dispute as to the amount would not have prevented the granting of a judgment in an amount certain and would have avoided the necessity of additional proceedings, which likely will include discovery and court appearances, all of which run up the cost of litigation.

Lending money is easy.  Getting it back is not.  That is why we fill up so many pages of a loan agreement.  Plan your divorce before you get married.

TD Bank, N.A. v. Michael C. Culver, 2019 WL 2579232