United States v. Handy and Harman, a New York Corporation

Citations: 750 F.2d 777; 39 U.C.C. Rep. Serv. (West) 1553; 1984 U.S. App. LEXIS 15573Docket: 83-5697

Court: Court of Appeals for the Ninth Circuit; December 28, 1984; Federal Appellate Court

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Handy and Harman is appealing a judgment favoring the United States regarding a security interest in certain metals purchased by Handy and Harman from Coronado Trading Co. In 1978, Coronado borrowed $200,000 from Albuquerque National Bank with a Small Business Administration (SBA) guarantee, securing the loan with a security interest in its inventory and accounts receivable, which was perfected in New Mexico. Coronado regularly purchased precious metals from Handy and Harman and sent refining lots to their facilities in California for processing. 

After defaulting on the loan in June 1980, Coronado requested payment by check for the value of additional refining lots sent to Handy and Harman, despite owing approximately $30,000 for previous purchases. The SBA informed Handy and Harman of its security interest in Coronado's inventory and requested the return of the scraps or refined metal. Handy and Harman subsequently credited the value of the June refining lots against Coronado’s debt, choosing not to remit any funds to Coronado or the government due to the value being less than the outstanding debt.

The government sued Handy and Harman for the return or value of the metals, winning in district court. The appeal highlights a legal conflict between the SBA's security interest and Handy and Harman’s claims as a purchaser. The case is governed by California's Uniform Commercial Code, which maintains that a security interest persists in both the collateral and any proceeds from its sale, necessitating a determination of the parties' rights to the collateral and its proceeds.

A security interest in collateral persists despite sale or other disposition unless authorized by the secured party, as outlined in Sec. 9306(2). Two exceptions apply when the collateral consists of goods: (1) a buyer in the ordinary course of business acquires the goods free of all security interests from the seller, even if perfected (Sec. 9307(1)), and (2) a buyer not in the ordinary course may take the goods free from unperfected security interests if they meet specific criteria (Sec. 9301(1)(c)). In this case, Handy and Harman must demonstrate eligibility for one of these exceptions to claim the collateral free from the government’s security interest, as there is no evidence of authorization for the sale outside the ordinary course of business.

The security agreement between Coronado and the bank allowed Coronado to sell inventory in the ordinary course of business, categorizing the refining lots as "inventory." This authorization aligns with Sec. 9307(1), permitting a buyer in ordinary course to take goods free from the seller's security interests. However, the analysis does not hinge on the security agreement's authorization but rather on whether Handy and Harman qualify as buyers in ordinary course.

Handy and Harman do not meet the criteria to be considered buyers in the ordinary course of business under Sec. 1201(9), particularly because the code stipulates that buying may occur on credit but excludes transfers made to satisfy a debt. This requirement for "new value" reinforces the inventory financing system, allowing merchants to sell inventory without the risk of foreclosure on security interests after sale. Consequently, buyers can take goods free of security interests unless they have actual knowledge of violations of the security agreement.

Section 9307(1) protects inventory financiers by allowing buyers to take inventory free of security interests only if they provide new value in exchange. This prevents unsecured creditors from gaining priority over secured creditors. The case involving Handy and Harman shows the complications arising when they used a set-off against a pre-existing debt owed to them by Coronado. This set-off violated the new value requirement, meaning Handy and Harman could not claim the status of a buyer in ordinary course of business, as they did not provide new funds for the inventory. Their offset meant that Coronado received no funds for which the government’s security interest could attach, leaving the government in its original position as if no transaction had taken place.

The ruling specifies that a buyer on credit cannot qualify for ordinary course status if they offset their payment promise with an existing debt at the time of purchase. However, the court does not rule out other defenses, like breach of warranty, that may not disqualify a buyer from ordinary course status. This holding aligns with California law, specifically regarding the automatic offset of cross-demands under Cal. Civ.Proc.Code Sec. 431.70, which suggests that Handy and Harman's transaction was essentially a settlement of the existing debt at the time of the collateral purchase.

Consequently, Handy and Harman, while not qualifying as a buyer in ordinary course and thus unable to take the collateral free of a perfected security interest, may still have priority over unperfected security interests under Sec. 9301(1)(c).

Section 9301(1)(c) establishes that an unperfected security interest in goods is subordinate to the rights of a "buyer not in ordinary course of business," provided the buyer gives value and receives the collateral without knowledge of the security interest and before it is perfected. In this case, the government's security interest is deemed unperfected against Handy and Harman, as the government failed to refile its financing statement in California within four months after the collateral's arrival, as required by Section 9103(1)(d)(i). Handy and Harman is recognized as a purchaser despite not giving new value to Coronado, thus the government's security interest is unperfected against them.

The government contends that its notification to Handy and Harman of the security interest within the four-month period should maintain perfection, citing legal scholars who argue that asserting a security interest before the deadline negates the need for refiling. However, the reasoning behind this perspective does not align with the specifics of the case, as the government merely notified Handy and Harman and did not take legal action to recover the collateral until after the four-month period had expired. 

The court emphasizes that merely providing notice of a security interest privately does not satisfy the requirements of Section 9103(1)(d)(i) to maintain perfection, which necessitates public filing. The public filing of a financing statement ensures clear evidence of timing, reducing disputes regarding compliance with the four-month re-filing requirement. In contrast, private notice introduces uncertainty regarding receipt and acknowledgment within the purchasing organization, undermining the intention to minimize litigation.

A financing statement serves as public notice, whereas private notice is limited to specific purchasers, potentially leading to circular priority issues. In a hypothetical scenario, A has a perfected security interest in collateral that is later brought into California. B perfects a security interest within four months without knowledge of A’s interest, which A privately notifies. Subsequently, C also takes a security interest after B but without A's notification. According to the first-to-file-or-perfect rule, B has priority over C, but C ultimately has priority over A due to A's failure to notify C or refile, resulting in a circular priority situation. This highlights that the government's interpretation, which could create such circular priorities, is unreasonable.

Handy and Harman qualifies as a "buyer" under the UCC, having given value and received delivery of the collateral without knowledge of the government's unperfected security interest. However, it remains unclear whether Handy and Harman was unaware of the security interest. The case is to be remanded for clarification on this point. 

Additionally, Handy and Harman’s promise to pay for the collateral constitutes proceeds, classified as an account under the UCC. The government retains a security interest in these proceeds due to its security agreement and relevant UCC provisions.

Handy and Harman argues that under Section 9318(1), it can offset a $30,000 debt owed by Coronado against the government's claim. Section 9318(1) states that unless there is an enforceable agreement preventing the assertion of defenses or claims, the rights of an assignee are limited by the terms of the contract between the account debtor and the assignor, as well as any defense or claim of the account debtor that accrues before notification of the assignment. Handy and Harman is identified as the account debtor, with the government acting as the assignee due to a security agreement and Section 9306. 

The excerpt references case law indicating that a secured party has an automatic right to proceeds unless otherwise agreed, and that accounts generated from the sale of inventory are treated under Section 9-318 as original collateral. It asserts that an offset qualifies as a valid "defense or claim" under Section 9318(1), countering the government's argument that its status as a secured lender prevents Handy and Harman from asserting the offset.

Typically, an inventory financer secures a loan with a security interest in inventory and proceeds from its sale. If the debtor becomes insolvent, the financer can take possession of the collateral and collect on accounts. Even if the inventory has been sold, the secured party retains rights against purchasers for repossession or conversion as long as the security interest remains. Additionally, the inventory financer can pursue a contractual claim against buyers who have not fully paid their accounts, independent of any conversion claims. However, the financer can only receive one satisfaction for claims arising from these actions.

Section 9318 provides a defense only in cases based on the assignment of an account and does not apply to suits for repossession or conversion, as those actions rely on the secured party's superior property interest in the inventory itself. While the security interest remains intact, the inventory financer is protected from Sec. 9318(1) offsets since conversion actions are available. If the security interest is severed (e.g., by a buyer in ordinary course), the financer may have to pursue an action on the account, at which point Sec. 9318(1) could limit recovery due to the account debtor's offsets. Without an enforceable security interest, the typical priority rules favoring secured parties do not apply, as established in relevant case law. 

The case at hand hinges on whether the government's security interest has been cut off under Sec. 9301(1)(c). An inventory financer can choose to pursue either a conversion action, avoiding Sec. 9318 defenses, or an action on the account as an assignee, which subjects them to those defenses. Both the inventory financer and the account debtor have legitimate interests that require protection. The Oregon Supreme Court highlighted the need for a balance that allows some setoffs to prevent undue prejudice against the account debtor while ensuring the assignment remains a viable security measure. Additionally, the code penalizes secured lenders who neglect to oversee their debtor's activities, suggesting that they should also assume risks related to the failure of their security interest, potentially allowing unsecured creditors to claim offsets stemming from the debtor's conduct.

The government’s cited cases, Associates Discount Corp. and Citizens National Bank, are deemed irrelevant as they pertain to offsets against cash proceeds in deposit accounts, which do not qualify as "accounts" under the applicable code sections. The court in Iowa Beef incorrectly ruled against allowing an offset concerning a security interest in an account, as it solely referenced the aforementioned cases. The analysis should have focused on whether the account debtor was a buyer in the ordinary course, thus taking the collateral free of any security interest. 

The ruling concludes that Handy and Harman can offset the debt owed to them by Coronado against the account in which the government holds an unperfected security interest. The district court's judgment is vacated and the case is remanded to determine if Handy and Harman took delivery of the collateral without knowledge of the government's interest. If they did so without knowledge, their interest will prevail; if they had knowledge, the judgment will favor the government. Additionally, while the refining lots are agreed to be inventory, the classification of crucibles may vary, yet the commingling of materials results in a security interest over the entire mass. 

The California Commercial Code clarifies that a buyer in the ordinary course does not need to provide new value for the transaction to be valid, although this interpretation may conflict with other legal precedents. The commentary provided by West Publishing is not authoritative in California law and thus does not bind the court's decision.

Under U.C.C. Secs. 1-201(9) and 9-307(1), only buyers of inventory can acquire goods free of security interests, which applies to purchases from sellers engaged in selling goods. Goods held for sale by such sellers qualify as inventory, unless they are farm products in the possession of a farming debtor. U.C.C. Sec. 9-307(1) does not allow buyers of farm products to take them free of security interests, whereas California’s Commercial Code Sec. 9307(1) permits buyers in ordinary course to acquire both inventory and farm products free of such interests. Additionally, Sec. 9103(1)(d)(i) states that if collateral is brought into California while under a perfected security interest from another jurisdiction, that interest remains perfected unless the required filing action is not taken within four months. In this instance, the government failed to perfect its security interest within that timeframe after the collateral's arrival in California.