Winthrop J. Allegaert, as Trustee in Bankruptcy of Dupont Walston, Inc., Cross-Appellant v. Chemical Bank, Cross-Appellee

Citations: 657 F.2d 495; 1980 U.S. App. LEXIS 14761; 6 Bankr. Ct. Dec. (CRR) 1247Docket: 348

Court: Court of Appeals for the Second Circuit; August 19, 1980; Federal Appellate Court

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Chemical Bank appeals a judgment from the United States District Court for the Eastern District of New York that granted summary judgment to the trustee in bankruptcy of duPontWalston, Inc. on two counts of voidable preferences under the Bankruptcy Act. The district court determined that one payment was made within four months of bankruptcy, and that there were no material factual disputes regarding the elements necessary to establish a voidable preference. However, on appeal, the Circuit Court reversed the district court’s decision concerning the first payment, establishing it occurred more than four months before the bankruptcy. The court remanded the matter regarding the second payment due to existing material factual disputes. Chemical Bank's motion to transfer was dismissed as moot, but it was granted leave to renew motions to add counterclaims and to implead third parties.

The case involves complex agreements between two broker-dealers, Walston Company, Inc. and duPont Glore Forgan, Inc., and two banks, Security National Bank (subsequently Chemical Bank) and the Bank of America. The dispute originated in November 1972 when Chemical Bank lent Walston $5 million under a subordinated loan agreement. Following this, in February 1973, Walston entered a similar agreement with the Bank of America for $2.5 million. Amid financial troubles in the brokerage sector, the Perot Interests sought to merge Walston and DGF, proposing a significant cash transfer from Walston to DGF, which required consent from both banks, who demanded additional protections in return.

Walston agreed to split an $8.6 million DGF debenture into two parts: a $5,733,333 debenture for Chemical Bank and a $2,866,667 debenture for Bank of America (BOA), which was approved by Walston's Board on July 1, 1973, and formalized on July 2, 1973. Chemical Bank and Walston entered into a Pledge Agreement (PA) that granted Chemical Bank an immediate security interest in the debenture as collateral for Walston's indebtedness. The PA specified that Walston had limited rights to receive payments unless there was a default. The loan agreement with Chemical Bank was amended to align with the PA. A similar Pledge Agreement was executed with BOA for its debenture, and both banks took possession of their respective debentures.

In January 1974, DGF made $3.5 million in prepayments to Walston, reducing the collateral value for Chemical Bank's loan significantly. Following Chemical Bank's legal action for recovery of the prepayment, a settlement was reached on March 26, 1974, with DGF paying Chemical Bank $2,233,333, while BOA received full payment on its debenture. BOA subsequently endorsed a check for $366,666 to Chemical Bank, reflecting the difference between its debenture and the loan amount. These payments were intended to reduce Walston's Senior Subordinated Note.

Walston filed for Chapter XI bankruptcy on March 27, 1974, and was declared bankrupt on May 30, 1974. The trustee in bankruptcy filed a complaint in October 1974, alleging that the payments to Chemical Bank and BOA were recoverable as voidable preferences and fraudulent transfers. After motions for summary judgment were filed by the trustee and Chemical Bank, the district court ruled on July 12, 1978, in favor of the trustee, determining that the payments constituted voidable preferences under the Bankruptcy Act.

Chemical Bank's security interest in the DGF Debenture, valued at $5,733,333, attached on March 26, 1974, when the bank received collateral proceeds, contrary to the July 2, 1973 date stated in the Purchase Agreement (PA). The district court interpreted the PA in conjunction with the Subordination Loan Agreement (SLA) and its amendment, indicating the parties intended a deferred attachment. The court ruled that both the $2,233,333 and $366,666 payments were voidable preferences, as no material factual disputes existed regarding the necessary elements for such a claim.

Chemical Bank contends that the court erred in granting summary judgment, arguing that the transfer was perfected on July 2, 1973, and that genuine issues of material fact regarding voidable preferences were present. Additionally, Chemical Bank appeals the denial of its motions to transfer, implead third parties, and counterclaim. The plaintiff trustee supports the district court's interpretation, asserting that the DGF Debenture does not qualify as a 'security' or 'instrument' under the New York Uniform Commercial Code (NYUCC) and maintains that the subordination provisions of the SLA are still applicable. The trustee also argues for interest on the judgment from the date of the preferential transfer rather than the action's commencement date.

To establish a voidable preference, a plaintiff must meet seven specific elements under the Bankruptcy Act, including the transfer of property to a creditor for an antecedent debt while the debtor is insolvent and within four months of bankruptcy. Elements (1) and (5) must be assessed together with the provision that a transfer is considered made when it is perfected to the extent that no subsequent lien could take precedence over the transferee's rights.

A security interest in the $5,733,333 DGF Debenture was established between Chemical Bank and Walston through a pledge agreement (PA) perfected on July 2, 1973. This perfection renders the subsequent $2,233,333 transfer from DGF to Chemical Bank occurring more than four months prior to Walston's bankruptcy non-voidable, leading to the failure of the plaintiff's preference claim. Chemical Bank asserts that the PA created a valid security interest under the New York Uniform Commercial Code (NYUCC), which requires that a debtor signs a security agreement describing the collateral, that the interest attaches, and that it is perfected. The PA meets these criteria as it sufficiently identifies the DGF Debenture as collateral, confirms the agreement to attach the interest, demonstrates that value was given, and acknowledges Walston's rights in the collateral. The trustee's claim that attachment was intended to be postponed until an event of default lacks merit, as the NYUCC stipulates that postponement requires an explicit agreement, which is not present in this case. Thus, the court must determine the validity and perfection of the security interest based on the established facts.

A security interest is expected to attach immediately upon extending credit, requiring explicit terms to ensure this attachment occurs upon meeting three specific prerequisites. The district court's interpretation of the relevant documents led to the rejection of the plaintiff trustee's arguments. The court recognized an ambiguity in the contractual language, concluding that the parties intended to delay the attachment of the security interest until an event of default occurred. While Paragraph 1 of the Pledge Agreement (PA) indicates an intent to create an immediate security interest, Paragraph 2 suggests otherwise, stating that the borrower can receive payments unless a default occurs. In this context, the district court referenced two relevant Third Circuit cases for guidance: *In re Dolly Madison Industries, Inc.*, where attachment was explicitly postponed by the parties, and *In the Matter of Copeland*, which indicated an immediate attachment without such explicit conditions. The district court determined that the language of the PA was ambiguous, lying between the two cases, as it did not express a clear postponement of attachment like *Dolly Madison* but allowed the bank to exercise secured party rights only after a continuing default.

The district court addressed an ambiguity in the contractual language by referencing an amendment to the Service Level Agreement (SLA), which added a new Paragraph 8 stating that the Borrower and Bank had entered into a Pledge Agreement (PA) that should be construed consistently with Paragraph 3 of the SLA. Paragraph 3 subordinates the Senior Subordinated Note and waives the Bank's right to banker's lien security. However, the district court incorrectly interpreted the PA in line with the SLA's subordination clause rather than the amended provisions, resulting in a backward analysis of the documents. This approach contradicts standard practices, which dictate that later amendments should clarify earlier documents, not vice versa. Additionally, the court improperly relied on extrinsic evidence beyond the documents' text, which is irrelevant in summary judgment contexts, referencing cases that affirm this principle.

Moreover, the district court mischaracterized the case's position relative to precedents. In Dolly Madison, a security interest only attached upon default due to a specific clause, while in Copeland, the silence regarding attachment timing was crucial. In contrast, Paragraph 1 of the PA explicitly grants an immediate security interest to Chemical Bank, with Paragraph 2 outlining the rights concerning proceeds before and after default. There is no clause postponing the attachment of the security interest, making the circumstances of the PA distinct from both Dolly Madison and Copeland, affirming that Chemical Bank's security interest attaches immediately.

The Pledge Agreement (PA) and the Security Loan Agreement (SLA) establish that the parties intended an immediate attachment of the security interest, as clearly articulated in Paragraph 1 of the PA. This provision states that the Borrower pledges Senior Subordinated Debentures to the Bank, granting the Bank a security interest. According to New York UCC Section 9-204(1), for a security interest to be considered deferred, there must be explicit language indicating such intent, which is absent in the PA. While Paragraph 3 of the SLA limits the Bank's rights regarding security and priority over other creditors, it was amended on July 2, 1973, to align with the PA, introducing a new Paragraph 8 to ensure consistency between the two agreements. This modification was necessary to avoid rendering the PA meaningless, as it would contradict the very nature of an immediately attaching security interest.

Paragraph 2 of the PA, referenced by the district court, pertains solely to the distribution of proceeds from the collateral and does not affect the establishment of the security interest itself. Therefore, the documentation and applicable law indicate that the parties successfully created an immediately attaching security interest.

For the security interest to be valid against the debtor and third parties, perfection is required, which can be achieved through a financing statement or possession of the collateral. Possession is necessary for perfection in this case, as defined by Section 9-305 of the NYUCC, which specifies that a security interest in instruments can only be perfected through possession. The DGF Debenture qualifies as an "instrument" under NYUCC definitions, as it is a written document evidencing a right to payment and transferable through delivery with necessary endorsements.

The DGF Debenture qualifies as an Article 9 instrument under NYUCC 8-102's definition of 'security.' It meets the criteria of being issued in bearer or registered form, recognized as a medium for investment, part of a class or series, and evidencing an interest in property or obligations of the issuer. The Plaintiff acknowledges that the first element is satisfied. The second element is confirmed as subordinated debentures of brokerage houses are commonly recognized as investment media. The third element is also met, as two DGF Debentures were issued, fulfilling the class or series requirement. The fourth element's satisfaction is considered self-evident.

Chemical Bank took possession of the DGF Debenture in July 1973, which was recognized by the district court, thereby perfecting its security interest at that time. According to Section 60(a) of the Bankruptcy Act, a transfer is voidable if it occurs within four months prior to bankruptcy. However, since Chemical Bank's interest was perfected more than four months before Walston's bankruptcy filing, the transfer is not considered preferential. Consequently, the plaintiff trustee has not proven the elements of a voidable preference, and Chemical Bank is entitled to summary judgment on Count One.

The plaintiff trustee contends that payments received by Chemical Bank on the DGF Debentures violate the subordination provisions of the Subordination Loan Agreement (SLA). The trustee asserts that the SLA's Paragraphs 3.1 and 6.4 establish that Chemical Bank's loan is subordinate to senior claims, preventing Chemical Bank from having collateral. However, the document clarifies that the parties amended the SLA's subordination and no-security provisions through a Pledge Agreement (PA), which created a valid security interest under the New York Uniform Commercial Code (NYUCC). Section 9-201 of the NYUCC indicates that a security interest is effective against creditors and supersedes any subordination agreement. The commentary emphasizes that the security agreement dictates the rights between the lender and borrower and binds third parties, with the security interest taking precedence over the subordination agreement. The $2,233,333 payment to Chemical Bank, made under the PA, is thus not subject to the SLA's subordination provisions. Additionally, since the security interest was perfected in July 1973, prior to Walston's bankruptcy filing, the payment cannot be considered a voidable preference, leading to a summary judgment in favor of Chemical Bank on Count One. The excerpt also addresses BOA's endorsement of a DGF check to Chemical Bank, noting Walston's earlier subordinated loan agreement with BOA and a similar Pledge Agreement that granted BOA a security interest in a DGF Debenture.

In March 1974, following the settlement of a lawsuit between Chemical Bank and Walston, BOA received full payment on a $2,866,667 DGF Debenture, despite having only loaned Walston $2.5 million. This resulted in an overpayment to BOA of $366,667, which Walston instructed BOA to endorse to Chemical Bank. It was understood that this amount would reduce Walston's Senior Subordinated Note. The district court ruled that the endorsement constituted a voidable preference due to findings regarding Walston's insolvency and the ownership of the funds. However, the appellate court reversed this ruling, identifying material questions of fact regarding the ownership of the transferred property, specifically whether the $366,667 could be considered Walston's property given that the DGF check was made out to BOA. 

Additionally, it was noted that under the terms of the applicable agreement, Walston was not entitled to payments after an event of default, which may have occurred as early as January 1974. The court highlighted the need for further factual determinations regarding Walston's default and insolvency status. Furthermore, there were uncertainties about whether the $366,667 was part of funds allegedly converted by Walston, suggesting that if those funds were traced back to converted property, they could not be classified as a voidable preference. Overall, the court determined that these complex factual issues warranted a trial rather than summary judgment.

The payment in question lacks clarity regarding whether it was made to settle Walston's prior debt or to benefit BOA or DGF. This payment arose from a settlement in Chemical Bank's lawsuit against Walston, DGF, and the Perot Interests, where Chemical Bank alleged multiple claims: Walston's default under the SLA with a $5 million recovery sought; DGF's $3.5 million prepayment to Walston during default, which Chemical Bank argued was a conversion of funds; and claims of misrepresentation by the Perot Interests that induced Chemical Bank's consent to a Realignment. Chemical Bank also asserted that $40 million transferred from Walston to DGF constituted fraudulent conveyances and sought a receiver for both entities and an injunction against further transfers. DGF, Walston, and the Perot Interests had strong incentives to avoid the litigation since any relief granted could severely impact their interests. Upon receiving $2.6 million from DGF and BOA, Chemical Bank released all defendants and dismissed its lawsuit with prejudice. This situation raises a genuine issue of material fact regarding the nature of the $366,667 payment, leading to the reversal of the district court’s summary judgment for the plaintiff trustee on Count Thirteen and remanding for further proceedings. The previous ruling that Counts Fourteen to Eighteen of the plaintiff's complaint are moot is subject to reevaluation. Furthermore, the settlement in the Allegaert v. Perot case has altered circumstances, allowing Chemical Bank to renew its motions to add counterclaims and implead third parties. The plaintiff trustee's appeal concerning the interest judgment date is dismissed as moot, while Chemical Bank's motion to file a supplemental brief is denied.

Chemical Bank perfected a valid security interest in the DGF Debenture on July 2, 1973. The payment of $2,233,333 from DGF to Chemical Bank on March 26, 1974, was not deemed a voidable preference. Consequently, the district court's summary judgment in favor of the plaintiff trustee on Count One is reversed, and Chemical Bank is granted summary judgment on that count. There are genuine issues of material fact regarding whether the endorsement of a $366,667 check from DGF to BOA to Chemical Bank constitutes a voidable preference, leading to the reversal of the district court's summary judgment on Count Thirteen and a remand for further proceedings. On remand, Chemical Bank may renew motions to add counterclaims and implead third parties. Chemical Bank's motion to transfer is dismissed as moot, along with the plaintiff trustee's motion regarding the interest judgment date. Additionally, Chemical Bank's request to submit a supplemental brief or to remove parts of the plaintiff trustee's reply brief is denied. 

The legal framework governing the Note stipulates that it is a Senior Subordinated Note, ranking above other subordinated debts of the borrower, except for claims from commercial banks. In the event of the borrower's insolvency, the holder of the Note cannot participate in asset distribution until all Senior Claims are satisfied, with adequate provisions deemed sufficient for this purpose.

In the event of Insolvency Proceedings involving the BORROWER, any distribution of assets or payments related to the Subordinated Instalment will be made pro rata to holders of Senior Claims until they have received full payment or adequate provision for such payment. The holder of the Note will be subrogated to the rights of these Senior Claims for any amounts paid. If the holder of the Note receives a payment on the Subordinated Instalment prior to maturity and the BORROWER's Aggregate Indebtedness exceeds 1,200% of its Net Capital, or falls below the minimum required by the Exchange’s Rules, such payment will be rescinded and must be repaid to the BORROWER, remaining subject to subordination provisions. Any action to recover these payments must be initiated within two years of the payment date. The term "Insolvency of BORROWER" refers to the definition in section 1(19) of the Bankruptcy Act, while "Senior Claim" pertains to claims arising before the maturity of the Subordinated Instalment, excluding claims subordinated to others. The provisions outlined serve to define the rights of the Note holder in relation to Senior Claims but do not diminish the BORROWER's unconditional obligation to pay the Note holder. Furthermore, the BANK, as the holder of the Note, agrees not to assert any security interests or liens on the BORROWER's property and waives any right of set-off for payment of the Note. Any prior agreements between the BORROWER and the BANK will be amended to align with these stipulations.

Upon the occurrence of an Event of Default, the Note and all related payments, including accrued interest, will become immediately due and payable without the need for presentment or notice, which the BORROWER waives. However, payments remain subordinated as outlined in Paragraph 3.1. A liquidation, as referenced in Paragraph 6.1, will be considered to have begun on the date the Event of Default occurs. The BORROWER has pledged a Senior Subordinated Debenture from duPont Glore Forgan Incorporated, amounting to $5,733,333, as collateral for the Note and other obligations under the Loan Agreement. Until an Event of Default occurs, the BORROWER can receive payments on this Debenture. If an Event of Default continues, payments will be redirected to the BANK, which will apply any cash held to cover its costs and the indebtedness represented by the Note, as per the Uniform Commercial Code. A Pledge Agreement effective July 2, 1973, formalizes this arrangement regarding the Debenture, with provisions in Paragraph 3 to be interpreted consistently with the Pledge Agreement. Prepayments have received approval from the New York Stock Exchange.

Negotiations resulted in the execution of a Participation Agreement (PA) and an Amendment to the Subordination Loan Agreement (SLA), intended to ensure Chemical Bank received consideration for its consent to a Realignment. The plaintiff trustee argues this effort was futile, suggesting Chemical Bank's consent could only have merit if there were no senior claims, which would necessitate Walston being solvent while ceasing operations. The intention was clear that Chemical Bank should gain something in exchange for its consent, as a security interest is ineffective if the debtor is financially troubled. Chemical Bank contends that subordination provisions in the SLA were only activated upon insolvency, making its subordination inchoate and allowing for the possibility of security on Walston's debt. Although the court does not take a position on the implications of the subordination clause, it emphasizes that the security interest holds primacy. The district court determined Walston was insolvent on March 26, 1974, based on its Chapter XI petition schedules, but Chemical Bank questions the accuracy of this determination and notes the lack of evidence regarding Walston's insolvency in January 1974. The court acknowledges that there are unresolved factual issues regarding the timing and extent of Walston's default and insolvency that must be addressed on remand.