UNITED STATES BANKRUPTCY COURT
EASTERN DISTRICT OF KENTUCKY
BOB'S SALADS, INC.
DEBTOR CASE NO. 89-00151
This matter is before the Court on a Motion for Determination of Priority filed by Bruce and Ruth Henderson ("the Hendersons") and Chapland, Inc., creditors of the debtor. Responses have been filed by Equal Opportunity Finance, Inc. ("EOF") another creditor of the debtor. This Court has jurisdiction of this matter pursuant to 28 U.S.C.'1334(b); it is a core proceeding pursuant to 28 U.S.C. '157(b)(2)(K).
The issue of priority as between these two creditors has previously been brought before this Court. After a hearing conducted on October 17, 1989, the Court entered an Order on May 9, 1990 in conformity with a Memorandum Opinion of the same date. The Court found therein that on February 12, 1982, the debtor issued to the Hendersons its note for $210,000.00. The debtor was to buy stock back from the Hendersons and then transfer it to JBS Investment. In conjunction therewith, the debtor executed a security agreement in rolling stock consisting of several vehicles. A financing statement was filed on February 16, 1982 (file number 35275), which stated that it covered all machinery, equipment, furniture and fixtures, and all inventory of the debtor and proceeds of collateral. It did not mention vehicles. The Court pointed out the obvious inconsistency between the security agreement and the financing statement.
On August 7, 1984, the debtor executed a security agreement to EOF conveying a security interest in all accounts, contract rights, equipment, machinery, motor vehicles, inventory and fixtures to secure the payment of obligations of the debtor's parent corporation, JBS Investment, in the principal sum of $50,000.00. The security agreement contained no recitation of any consideration flowing to the debtor. The debtor and EOF executed a financing statement covering the same collateral, excluding motor vehicles, and the same was filed (file number 51225) on August 8, 1984. EOF filed a continuation statement on March 16, 1989.
On August 17, 1984, the Hendersons executed a waiver and release in favor of the debtor, consenting to the debtor's granting a security interest in its assets to EOF. The waiver recited that the debtor agreed and acknowledged that the Hendersons' security interest was superior in priority to that to be granted to EOF. The waiver also recited that the debtor and the Hendersons had entered into two separate security agreements on February 12, 1982. Contemporaneously with the execution of the waiver and release, the debtor also executed a combined financing statement and security agreement conveying to the Hendersons a security interest in "all machinery, equipment, furniture and fixtures". No financing statement was filed regarding this security interest.
The Hendersons filed financing statements covering specific items of property on August 24, 1984 (file numbers 51543, 51544, 51545, and 51546). On August 18, 1987, Bruce Henderson filed a continuation statement with respect to the financing statement covering all machinery, equipment, furniture and fixtures, and all inventory of the debtor and proceeds of collateral (file number 35275), previously filed of record on February 16, 1982. The Court pointed out that the continuation statement was filed six months after the expiration of the five-year period for filing such statement.
The debtor filed its Chapter 11 petition in this Court on July 6, 1989, and on August 9, 1989, the Hendersons filed continuation statements with respect to the financing statements filed on August 24, 1987 (file numbers 51543 through 51546). As part of its May 9, 1990 Order, the Court converted the case to a Chapter 7 proceeding. In consideration of its findings, the Court came to the conclusion that EOF's security interest was prior in time to the Hendersons' security interest in the machinery, equipment, furniture and fixtures of the debtor. The Court stated that its determination was made without prejudice to the right of the trustee to preserve the Hendersons' lien ahead of EOF's for the benefit of the estate pursuant to 11 U.S.C.'551 and to contest the validity of EOF's security interest on the basis of failure of consideration or any other basis.
The Motion for Determination of Priority that is presently before this Court was filed on August 21, 1990. The Hendersons had previously filed into evidence the "missing" security agreement which had been executed on February 12, 1982. Their Motion requested the Court to "preserve the security interest of the Movants ahead of the security interest of EOF in accordance with 11 U.S.C., Section 551 so that they will have the first and prior lien on the machinery, equipment, furniture and fixtures of the Debtor, Bob's Salads, Inc." This language suggests that the Hendersons
expect their security interest to be preserved pursuant to 11 U.S.C.'551 for their benefit.
Section 551 provides that "[a]ny transfer avoided under section 522, 544, 545, 547, 548, 549, or 724(a) of this title, or any lien void under section 506(d) of this title, is preserved for the benefit of the estate but only with respect to property of the estate." (Emphasis supplied) Clearly, therefore, any transfer that the trustee may avoid pursuant to the enumerated sections is preserved for the benefit of the estate, and not for the benefit of any creditor. In order to determine if the Hendersons' security interest may be preserved for the benefit of the estate, it is necessary to analyze the trustee's position pursuant to'544.
11 U.S.C.'544(a), the "strong arm statute", puts the trustee in the position of a judgment lien creditor on the date of the filing of the bankruptcy petition. If the Hendersons' lien was unperfected on that date the trustee may avoid it. An unperfected security interest is subordinate to the rights of a lien creditor. KRS 355.9-301(1)(b). A lien creditor includes a trustee in bankruptcy. KRS 355.9-301(3). In order for the Hendersons' security interest to be perfected a financing statement must have been filed. KRS 335.9-302.
According to the record in this case, a security agreement which encumbered all machinery, equipment, furniture and fixtures, inventory and proceeds of collateral of the debtor was executed on February 12, 1982. A financing statement with respect thereto was filed on February 16, 1982. A continuation statement with respect to this financing statement was not filed until August 18, 1987. KRS 355.9-403(2) provides that a filed financing statement is effective for a period of five years from the date of filing. The effectiveness of the filed financing statement lapses on the expiration of the five year period, unless a continuation statement is filed prior to the lapse. If a lapse occurs, the security interest becomes unperfected and subject to defeat. Leibson and Nowka's The Uniform Commercial Code of Kentucky, at'8.3(E), p. 745, quotes from Official Comment 3 to section 9-403:
Under the fourth sentence of subsection (2) the security interest becomes unperfected when filing lapses. Thereafter, the interest of the secured party is subject to defeat by those persons who take priority over an unperfected security interest (see Section 9-301), and under Section 9-312(5) the holder of a perfected conflicting security interest is such a person even though before lapse the conflicting interest was junior.
The Hendersons' security interest in the debtor's machinery, equipment, furniture and fixtures, inventory and proceeds of collateral became unperfected on February 17, 1987. The 1983 Kentucky Commentary to this section states that after a security interest becomes unperfected because a filing has lapsed, the interest of the secured party is subject to defeat by those persons who take priority over an unperfected security interest. See KRS 355.9-301 referred to hereinabove.
In addition, the Hendersons' filing of a continuation statement after lapse did not have the effect of reperfecting their security interest from the time of filing. The language of KRS 355.9-403(3) precludes such a result as it requires that the continuation statement must "state that the original statement is still effective." Upon a lapse, the original financing statement is not "still effective", and the security interest cannot be reperfected by filing a continuation statement thereafter. Leibson and Nowka, at'8.3(E), page 748. The Hendersons' security interest was therefore subject to defeat by the trustee as of the date of filing of the bankruptcy petition.
However, the Hendersons' security interest was subject to defeat by EOF on February 17, 1987. At that time EOF had a perfected security interest in the debtor's accounts, contract rights, equipment, machinery, motor vehicles, inventory, and fixtures by virtue of the security agreement executed on August 7, 1984 and a financing statement filed on August 8, 1984. As referred to hereinabove, KRS 355.9-312(5)(a) provides that conflicting security interests rank according to priority in time of filing or perfection. On February 17, 1987 the security interest of EOF was perfected; that of the Hendersons was not. Therefore, even though EOF's interest was junior before the lapse, its interest was elevated to a superior status once lapse occurred.
In addition, the superior status of EOF's interest is not affected by the fact that it had knowledge of the Hendersons' security interest when it executed its security agreement with the debtor. In Hutchison v. C.I.T. Corporation, 576 F.Supp. 1 (W.D.Ky. 1982), aff'd. 726 F.2d 300 (6th Cir. 1982), the court held that a recorded security interest was superior to an unrecorded security interest in the same collateral, even though the holder of the recorded security interest had notice of the secured party's unrecorded security interest, pursuant to KRS 355.9-312(5)(a)(b).
Putting the trustee in the place of the Hendersons renders his status as a lienholder inferior to that of EOF. Preservation alone does not enhance the status of the trustee's lien. Connelly v. Marine Midland Bank, N.A., 61 B.R. 748 (W.D.N.Y. 1986). A bankruptcy trustee who avoids and then preserves the lien of a creditor cannot acquire greater rights in the property than those to which he succeeded. In re Appalachian Energy Industries, Inc., 25 B.R. 515 (Bkrtcy.M.D.Tenn. 1982). For the lien preserved by the trustee for the benefit of the estate to have priority over that of EOF, the trustee would have to have been able to avoid a security interest of the Hendersons continuously perfected through the filing of the Chapter 11 petition under some other provision of the Bankruptcy Code or state law. The Court's Order of May 9, 1990 addresses the right of the trustee to "contest the validity of the security interest of Equal Opportunity Finance, Inc. on the grounds of failure of consideration or on any other grounds."
The Hendersons have argued that pursuant to KRS 355.9-204(1) [now 355.9-203(1)], EOF's security interest did not attach because value was not given and the debtor did not obtain rights in the collateral. The Hendersons point out that the Court, in its May 9, 1990, Memorandum Opinion noted that the security agreement executed by EOF and Bob's Salads recited no consideration flowing to Bob's Salads. However, as EOF has pointed out, the Uniform Commercial Code does not require that the benefit flow to the party granting the security interest. This section focuses on the giving of value by the secured party. Value is defined in KRS 355.1-201(44)(d) as "consideration sufficient to support a simple contract."
Kentucky courts have held that in order to find that there was valid consideration for a contract there must be a benefit to the promisor or a detriment to the promisee. More v. Carnes, 309 Ky. 41, 214 S.W.2d 984; Robbins v. Robbins, 246 Ky. 411, 55 S.W.2d 31. See also In re Terminal Moving & Storage Co., Inc., 631 F.2d 547 (8th Cir. 1980), in which the court held that a security interest attached when the secured party extended credit in exchange for the pledge of assets. As consideration might be a benefit accruing to a party or a detriment suffered by a party, the extension of credit was a legal detriment to the secured party/promisee, and constituted sufficient consideration to support a simple contract. In the same manner, EOF's security interest attached because it gave value and is therefore not invalid for failure of consideration.
The Hendersons further contend that EOF's security interest must be found invalid because the debtor did not have rights in the collateral at the time the agreement was executed. They base this contention on the fact that the February 12, 1982 security agreements provided that Bob's Salads could not further encumber the collateral without the prior consent of the Hendersons. Bob's Salads entered into the security agreement with EOF on August 7, 1984, and the Hendersons' waiver and release was not obtained until August 17, 1984, ten days later. However, this Court agrees with EOF that the "rights in collateral" contemplated by this section are in the nature of title or ownership rights, not any contractual arrangement the debtor may have entered into to refrain from further encumbering the collateral. It is the opinion of this Court, therefore, that EOF's security interest did attach on August 8, 1984.
To further challenge the validity of EOF's security interest, the Hendersons argue that the security agreement between Bob's Salads and EOF is not enforceable because it did not conform to the requirements of KRS 355.9-203(1) (the version in force in 1984) because it was not entered into by the "debtor". They contend that by the definition of "debtor" contained in KRS 355.9-105, the agreement must be executed by the person who owes payment or other performance of the obligation secured. However, the full definition of "debtor" in that section includes the following language:
Where the debtor and the owner of the collateral are not the same person, the term 'debtor' means the owner of the collateral in any provision of the Article dealing with collateral, the obligor in any provision dealing with obligation, and may include both when the context so requires.
Since, as EOF points out, KRS 355.9-203 deals with the enforceability of interests granted in collateral, it deals with collateral. Therefore, pursuant to KRS 355.9-203(1)(b), the "debtor" who must execute the security agreement is the owner of the collateral, in this case Bob's Salads.
Finally, the Hendersons maintain that the validity of EOF's security interest must fail because the waiver and release was obtained fraudulently. The claim of fraud is based on the fact that Bob's Salads and EOF had already executed a security agreement on August 7, 1984, ten days before the Hendersons executed the waiver and release. This claim has no merit. The Hendersons suffered no detriment by their execution of the waiver and release. It acknowledged the superiority and priority of their lien. Their position was protected, and would have continued to be protected if they had not allowed their security interest to lapse.
In consideration of all of the foregoing, it is therefore the opinion of this Court that the trustee may preserve the lien of the Hendersons for the benefit of the estate pursuant to 11 U.S.C.'551. However, the validity of EOF's security interest not having been successfully challenged, the trustee may not defeat it. Judgment will be entered in accordance with this Opinion, setting out the specific interests at issue herein.
By the Court -
Robert B. Conley, Esq.
W. Thornton Scott, Esq.
David P. Chinn,Esq.
Donald L. Frailie, II, Esq., Trustee