Braunstein v. Karger

Opinion

USCA1 Opinion

September 29, 1992
                            UNITED STATES COURT OF APPEALS
                                FOR THE FIRST CIRCUIT

                                 ____________________

        No. 91-2250

                             IN RE:  MELON PRODUCE, INC.,

                                       Debtor,
                                      __________

JOSEPH BRAUNSTEIN, TRUSTEE,

                                 Plaintiff, Appellee,

                                          v.

                                    PETER KARGER,

                                Defendant, Appellant.
                                 ____________________

                     APPEAL FROM THE UNITED STATES DISTRICT COURT

                          FOR THE DISTRICT OF MASSACHUSETTS

                   [Hon. Edward F. Harrington, U.S. District Judge]
                                               ___________________
                                 ____________________

                                        Before

                                 Breyer, Chief Judge,
                                         ___________
                             Lay,* Senior Circuit Judge,
                                   ____________________
                          and O'Scannlain,** Circuit Judge.
                                             _____________
                                 ____________________

            Charles  W.  Morse, Jr.  with whom  Alan M.  Spiro and  Friedman &
            _______________________             ______________      __________
        Atherton were on brief for appellant.
        ________
            John  J.  Kuzinevich  with  whom  Isaac  H.  Peres  and  Riemer  &
            ____________________              ________________       _________
        Braunstein were on brief for appellee.
        __________
                                 ____________________

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____________________

        _____________________

        *  Of the Eighth Circuit, sitting by designation.
        ** Of the Ninth Circuit, sitting by designation.

BREYER,   Chief  Judge.    This  appeal  raises  a
                                 ____________

             technical question  about bankruptcy preferences.  Suppose a

             Creditor  has a  security agreement  that covers  "rights to

             money"  and  contains an  "after-acquired  property" clause.

             Suppose at a  later time, within the  preference period, the

             Debtor sells other property to third parties, accepts checks

             from  those parties  as  payment, and  immediately  endorses

             those checks over to the Creditor.  Does the Creditor have a

             perfected  security  interest  in  those checks  or  in  the

             "rights to  money" that  they represent,  thereby permitting

             the  Creditor  to  receive payments  which  would  otherwise

             constitute  an  unlawful "preference?"   The  district court

             thought  the  answer  to  this  question  was  "no,"  and it

             affirmed a  bankruptcy court decision that  the Creditor had

             received  an unlawful  preference.   We affirm  the district

             court's judgment.

                                          I

                                      Background
                                      __________

                       The appellant, Peter  Karger, says that, in  1984,

             he  wanted to  lend about  $600,000 to  a company  called A.

             Pellegrino   &  Sons,   then   in  Chapter   11   bankruptcy

             proceedings.   In order to obtain security for his loan, and

             with  the  approval  of  the bankruptcy  court,  Karger  had

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Pellegrino transfer  two valuable  assets -- some  leases on

             bays at the  New England  Produce Center and  some stock  in

             that Center -- to a  new corporation (called Melon Produce),

             which Karger owned.  Melon Produce then guaranteed repayment

             to  Karger of the  $600,000 loan.   And, just to  be certain

             that  Melon could pay if  necessary, Karger was  to obtain a

             security interest in Melon's assets.

                       If  Karger  has  accurately  described   what  was

             supposed  to  happen, then,  when  the  parties drafted  the

             relevant legal  documents, something  must have  gone wrong.

             The   security   agreement   that   Karger   executed  (with

             appropriate U.C.C.  filings) in August 1984  did not mention

             Melon's two main assets -- the leases and the stock.  It did

             mention,  however,  various  other  Melon  assets, including

             "instruments"  and all  "rights  . .  .  to the  payment  of

             money."    It also  specified  that Karger  would  receive a

             security interest in all such assets "hereinafter acquired."

                       Apparently, Pellegrino did not repay the loan, for

             the parties agree that  three years later Melon  owed Karger

             about $500,000.    In early 1987, Melon sold  its leases and

             stock to third party  buyers for $430,000.  At  the closing,

             on February 27, 1987, Melon transferred the leases and stock

             to  the  buyers;  the   buyers  gave  Melon's  clerk  checks

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totalling $430,000; the clerk  endorsed the checks to Karger

             in partial satisfaction of Melon's debt; and Karger (through

             an agent) took the checks and deposited them in his account.

Within a  year Melon, too, was  bankrupt.  Melon's

             bankruptcy trustee, noting that  Karger was an "insider" and

             that the February  27, 1987 transfer  took place within  the

             year preceding bankruptcy, claimed  that the transfer was an

             unlawful  "preference," which  Karger  must  return  to  the

             bankruptcy  estate.  11 U.S.C.    547(b).  As  we have said,

             the bankruptcy  court found that the  transfer constituted a

             preference;  the  district court  affirmed;  and  Karger now

             appeals.

                                          II

                                       Analysis
                                       ________

                       A "preference" is a transfer of a debtor's assets,

             during a specified pre-bankruptcy period, that unjustifiably

             favors the transferee over other creditors. See 4 Collier on
                                                         ___   __________

             Bankruptcy   547.01 at 547-14 (15th ed. 1992) ("A preference
             __________

             is an infraction of the rule of equal distribution among all

             creditors.").  The preference section of the Bankruptcy Code

             permits  the bankruptcy  trustee to  "avoid any  transfer of

             property" made (1) to an  "insider" creditor; (2) on account

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of "an antecedent debt;" (3) while the debtor was insolvent;

             (4)  within one  year before  the  filing of  the bankruptcy

             petition; (5) that enables the creditor to receive more than

             he  would have received in liquidation in the absence of the

             transfer. 11 U.S.C.   547(b).   We assume that the transfers

             to  Karger  satisfy  the  first  three   criteria  (insider,

             antecedent debt,  and insolvency).   And, February  1987 was

             within one  year  of Melon's  bankruptcy filing.   But  what

             about  the  final  requirement?   Did  the  transfer  of the

             $430,000 unjustifiably favor Karger  by giving him more than

             he would have received in liquidation?

                       Karger  must  concede  that  in February  1987  he

             received $430,000  that would otherwise have  gone to Melon.

             But, Karger makes an argument that we simplify, place within

             the  relevant  legal context,  and  paraphrase, as  follows:

             'The  funds that Karger received amounted to no more than he

             would have received anyway in liquidation, in the absence of

             the  transfer.   In  a  Chapter  7  liquidation,  a  secured

             creditor  normally receives  the  value of  the property  in

             which he holds perfected  security interests (at least where

             no other creditor enjoys  a higher priority).  4  Collier on
                                                               __________

             Bankruptcy   547.08  at 547-43 (15th ed. 1992);  see also 11
             __________                                       ___ ____

             U.S.C.    544  (trustee in  bankruptcy  has  status of  lien

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creditor  under  state law);  Mass.  Gen. L.  ch.  106,   9-

             301(1)(b), (3) (lien creditor receives priority over secured

             creditor only  if such creditor's interest  is unperfected).

             And  (says  Karger),  Karger  was a  secured  creditor  with

             perfected security interests, both in Melon's "instruments,"

             (namely, the  buyers' checks that Melon  endorsed to Karger)

             and in "rights to money," (namely, Melon's rights to payment

             for the leases and stock that Melon sold).  Thus, (concludes

             Karger) the  February 1987 transfer did not give Karger more

             than that to  which he  would anyway  (in liquidation)  have

             been entitled.'

                       We  cannot accept  this  argument, for  we do  not

             agree that Karger held a perfected security interest, either

             in "instruments" or in "rights  to money" that would entitle

             him  to obtain  the  $430,000 ahead  of  other creditors  in

             liquidation.  That  is because the  creation of a  perfected

             security interest  in property  is itself a  preference when
                                                ______

             the creation or perfection takes place during the preference

             period  (and the other criteria  are satisfied).   See In re
                                                                ___ _____

             Taco Ed's, 63  Bankr. 913,  925 (N.D. Ohio  1986) and  cases
             _________

             cited therein; 11 U.S.C.   101 (defining "transfer"  broadly

             to include  "retention of title as a  security interest"); 4

             Collier on  Bankruptcy    547.03 at  547-18 (15th  ed. 1992)
             ______________________

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("transfer" encompasses  any  transfer  of  an  interest  in

             property).    Although  Karger  received  perfected security

             interests in the checks and rights to money, those interests

             were  transferred in  February 1987,  during the  preference

             period, and not before.

                       Karger's  basic strategy is  the following: (1) He

             claims  that he obtained a  security interest (a) in Melon's

             rights  to money from the buyers of its leases and stock and

             (b) in the checks that the buyers gave Melon.  He notes that

             Melon's right to money  arose out of its sales  contract and

             existed  despite the receipt of the checks, until the checks

             were  honored.   Cf. Barnhill  v. Johnson,  112 S.  Ct. 1386
                              __  ________     _______

             (1992) (transfer of assets  takes place when creditor's bank

             receives funds  and credits his  account, not when  check is

             initially  received).    (2)   He  points  to  his  security

             agreement's coverage of "instruments" and "rights to money,"

             to its "after-acquired property"  clause, and to the Uniform

             Commercial Code provision that  creates a perfected security

             interest in  collateral covered  by that clause  dating from
                                                                     ____

             the time of filing of the U.C.C. financing statement.  Mass.
             ____________________________________________________

             Gen.  L.  ch. 106,    9-204(1)  ("A  security agreement  may

             provide that any or all obligations covered by the  security

             agreement are to be secured by after-acquired collateral . .

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. ."); Mass. Gen. L. ch.  106,     9-302, 9-304 (setting out

             U.C.C.  filing   requirements).     (3)  He  concedes   some

             difficulty  in  applying  this  provision  to  his  security

             interest in  the checks in light of  other U.C.C. provisions

             that  normally  date  perfection  of security  interests  in

             instruments from the time of physical possession. Mass. Gen.

             L.  ch. 106,   9-304(1).   But, he says, the "relation-back"

             applies, at least, to his  security interest in the  "rights

             to money."    And, (4) it means that  the bankruptcy trustee

             must  consider  the  "transfers"  to him  of  the  perfected

             security  interests (at least  in the "rights  to money") to

             have taken place in 1984,  well before the preference period

             began  to run.  Hence, (5) the February 1987 actual transfer

             of  funds  (presumably from  the  buyers'  bank accounts  to

             Karger's bank account) gave him nothing beyond that to which

             he was entitled (by  a pre-1987 perfected security interest)

             in its absence.

                       This result  makes one  hesitate.  Can  a creditor

             (say,  a creditor  without  fraudulent intent  who is,  like

             Karger, able  to control  a debtor corporation),  up to  the

             very moment of bankruptcy, simply exchange the corporation's

             unsecured assets for assets covered by a previously executed

             security  agreement's  after-acquired  property  clause  and

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thereby  obtain those  assets ahead of  unsecured creditors?

             The answer to this question, in general, is "no."  The fatal

             flaw  in  Karger's argument  is  that  a perfected  security

             interest in  Melon's after-acquired  "rights to money"   may

             relate back  to his 1984 U.C.C.  (security agreement) filing

             for  U.C.C.  security  interest  priority  purposes.     The
             ___________________________________________________

             interest  does  not  relate   back  to  1984,  however,  for
                             ___                                      ___

             Bankruptcy Code preference purposes.  
             ___________________________________

                       In  order to  obtain the  "relation back"  that he

             needs,  Karger would  have  to argue  successfully that  his

             secured  interest  in  "rights  to money"  fits  within  the

             special exception for "receivables" (and "inventory") in the

             Bankruptcy Code's preference section. 11 U.S.C.   547(c)(5).

             That   exception  recognizes   that  a   company's  specific

             receivables   (and  inventory)  tend  to  turn  over,  often

             quickly, as  the company collects the  receivables due (say,

             from the sale of goods) in one year and (through more sales)

             generates more receivables due the next year.  The exception

             essentially permits a creditor  with, say, a "floating lien"

             on the "receivables" of such a company to maintain that lien

             as  the  specific  accounts  receivable are  paid  off,  and

             replaced by new ones, without fear that a future  bankruptcy

             trustee  will  mount a  preference  attack  on new  accounts

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receivable  arising  during the  "preference"  period.   The

             exception   protects   new   receivables   from   preference

             challenges, however, only insofar as they substitute for old
                                                       __________

             ones.  Insofar  as the grant of  a security interest in  the

             new  collateral  (receivables or  inventory that  comes into

             existence  during   the  preference  period)   improves  the
                                                            ________

             creditor's  position  (compared  to  his  position  at   the

             beginning of  the preference period), the  grant of security

             constitutes a  preference to the extent  of the improvement.

             11  U.S.C.     547(c)(5).    See  generally   4  Collier  on
                                          ___  _________      ___________

             Bankruptcy   547.13 at 547-59-61 (15th ed. 1992) (explaining
             __________

             the "improvement in position" test).  

                       The "rights to money" arising from Melon's sale of

             its  leases and stock fall  within the literal  scope of the

             Bankruptcy  Code's  definition  of  "receivable,"  namely  a

             "right to payment, whether or not such right has been earned

             by performance." 11 U.S.C.   547(a)(3).  Nonetheless, Karger

             cannot take advantage of this exception because he fails the

             "improvement in position" test.  Karger began the preference

             period with his $500,000 debt totally unsecured.  He himself

             argues  that he ended the period with $430,000 in "rights to

             money" securing  that same debt.   Consequently, he improved

             his position vis-a-vis other  creditors by that same amount.

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Thus,  the special  exception for "receivables"  cannot help

             him.   

                       There is another reason  why the exception may not

             help him.   To  apply  the Bankruptcy  Code's definition  of

             "receivable"  literally,  to  cover  Melon's  rights,  would

             extend the special exception  for "receivables"  well beyond

             the kind of receivables that  tend to turn over, in a  flow,

             as a firm collects  old accounts and generates new  ones  --

             the kind of "accounts receivable" to which the U.C.C. refers

             through its related definition of "account."  See Mass. Gen.
                                                           ___

             L. ch. 106,   9-106  (defining "account" more restrictively,

             as "any  right to payment  for goods  sold or leased  or for

             services rendered which is not evidenced by an instrument or

             chattel  paper,  whether  or  not  it  has  been  earned  by

             performance").   And,  we  are uncertain  just  how far  the

             Bankruptcy  Code definition  of  "receivable"  is  meant  to

             extend the scope of  the "receivables" preference exception.

             We  have not  found authority  for the proposition  that the

             exception extends to a single right  to payment arising from

             a major corporate  change outside of the ordinary  course of

             business -- such as a debtor's sale of all its major assets,

             as occurred here.  The definition of "receivable" under  the

             Bankruptcy Code  is not settled  law.  Cf.  Vern Countryman,
                                                    __

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Andrew  L. Kaufman,  & Zipporah Batshaw  Wiseman, Commercial
                                                               __________

             Law  288 (2d  ed. 1982)  (noting  uncertainty as  to whether
             ___

               547(a)(3)'s  definition  of "receivable"  includes chattel

             paper and  instruments).   The  issue has  not been  argued.

             Given  the fact  that, even  if the  "receivables" exception

             applied, Karger  would  fail the  "improvement in  position"

             test  to the extent of his entire security interest, we need

             not answer  the  question of  how  far the  Bankruptcy  Code

             definition   of  "receivable"   departs   from  the   U.C.C.

             definition of "account."  And, we state expressly that we do

             not do so.

                       Since Melon's "rights to money" do not fall within

             the  special "receivables" exception,  they come  within the

             scope of a more  general "preference" provision that states,

             "a transfer is not made until the debtor has acquired rights
                                               ______

             in  the   property  transferred."    11  U.S.C.    547(e)(3)

             (applicable   to  all   after-acquired  property   with  the

             exception of  inventory and receivables, which  are governed

             by   547(c)(5)).  The  object of this statutory  language is

             to  "prevent[]  after-acquired  property  from  being deemed

             perfected at  the date of the  original security agreement."

             4  Collier on Bankruptcy   547.19 at 547-85 (15th ed. 1992);
                _____________________

             In re Northwest Electric  Co., 84 Bankr. 400, 403  (W.D. Pa.
             _____________________________

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1988); In  re R & T  Roofing Structures, 42 Bankr.  908, 912
                    ________________________________

             n.11  (D. Nev. 1984).    Thus,  Massachusetts commercial law

             might give  Karger priority over  a similar creditor  with a

             later-filed  security  interest.     But,  regardless,   for
                                                                      ___

             purposes of determining bankruptcy preferences, the transfer
             ______________________________________________

             of the  perfected security interest  to Karger did  not take

             place  before Melon  acquired  the "property"  in  question.

             Melon's rights to money arose  (and it obtained the  checks)

             in February  1987.   Hence, any perfected  security interest

             that  Karger  obtained  in   that  property  amounted  to  a

             "transfer"  to him of that interest in February 1987, during

             the preference period, not in 1984.

                        The upshot of this analysis is that the transfers

             of security interests were voidable preferences.  Therefore,

             Karger  was an unsecured creditor of Melon.  As an unsecured

             creditor, Karger would not have received in liquidation what

             he  received  through  the  February  1987  money  transfer.

             Hence,  the  February 1987  transfer  of  $430,000 from  the

             buyers  to  Karger  was,   like  the  transfer  of  security

             interests, a voidable preference. 

                                         III

                                   Summary Judgment
                                   ________________

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Karger also  disputes a  matter that until  now we

             have  assumed in favor of  the trustee, namely,  that at the

             time of transfer  (February 1987) Melon was  insolvent.  The

             trustee  moved for summary judgment on this point.  In doing

             so,  he noted that Melon owed Karger $500,000 and he pointed

             to other proofs of  claim amounting to about $342,000.   The

             trustee  also  stated  that  Melon had  assets  worth  about

             $430,000.   Cf., e.g., In  re Lewis, 80  Bankr. 39, 40 (E.D.
                         ___  ____  ____________

             Pa. 1987) (proof of claim is competent evidence when offered

             against  a debtor);  In re  Trans Air,  103 Bankr.  322, 325
                                  ________________

             (S.D. Fla. 1985) (court  adjudicating a preference challenge

             can take notice  of debtor's schedule of  debts to determine

             insolvency issue); In  re F.H.L., Inc.,  91 Bankr. 288,  295
                                ___________________

             (D.N.J. 1988) (same).

                       Fed. R. Civ. P.  56 (made applicable by Bankruptcy

             Rule 7056) requires  a party opposing  a motion for  summary

             judgment to "set forth specific facts showing  that there is

             a genuine issue for trial."  Fed R. Civ. P. 56(e).  The only

             specific  fact  that  Karger   set  forth  consists  of  his

             statement  in  an affidavit  that  Melon  had owned  various

             pieces  of  furniture,  equipment,  and  other  items   that

             Karger's brother, who  operated Melon, stole.   We can  read

             the  affidavit as pointing to a Melon asset that the trustee

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did  not take into account,  namely, a claim  that Melon may

             have  against  Karger's  brother  for the  value  of  stolen

             furniture and equipment.  But, we cannot read that affidavit

             as setting  forth specific facts indicating  that this asset

             is worth a  significant amount of money.   Consequently, the

             court correctly concluded that Karger had failed to  raise a

             "genuine" issue of "material" fact in respect to insolvency.

One  final  point:    appellant  argues  that  the

             judgment was not sufficiently  "final" to permit the appeal.

             See 28 U.S.C.   1291.  The record reveals, however, that the
             ___

             district  court,  on  December  13, 1991,  entered  a  final

             judgment appealable under Fed. R. Civ. P. 54(b), along  with

             the  statement of reasons that the rule requires.  Any claim

             of non-appealability is without merit.

The judgment of the district court is

                       Affirmed.    
                       ________

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