Hoch v. Ellis

627 P.2d 1060, 31 U.C.C. Rep. Serv. (West) 760, 1981 Alas. LEXIS 486

• Court: Alaska Supreme Court
• Decided: May 8, 1981
• Docket: 4475
• Status: Published

Opinions

OPINION

RABINOWITZ, Chief Justice.

Charles Ellis and his wife Evalyn, as shareholders in B & E Enterprises, Inc., owned the Norge Village Happy Hour Cleaners, a laundromat and dry cleaning operation in Fairbanks. The business operated out of a building owned by Bud Mey-eres. In 1967, the business was sold to the 3-H Corporation, an Alaska corporation. 3-H was a family operation with the majority of the stock owned by Edward A. Hoch.¹ The sale of the business was for $154,500. 3-H put up $12,000 as down payment and earnest money. A promissory note for the remaining $142,500 was executed along with a security agreement covering this entire amount. The promissory note was signed both by Edward A. Hoch as president of 3-H Corporation and by each of the three Hochs, individually. The collateral for the security agreement was:

[a]ll of the cleaning, laundry and related equipment, fixtures and furniture, and any replacements thereof, now owned or hereafter acquired for use in [the laundromat and dry cleaning operation] ....

Upon assuming the business, 3-H had initial success in running the laundromat.

In December 1970, 3-H Corporation opened another laundry facility, Suds Laundry and Dry Cleaners, in another section of Fairbanks. Business, however, deteriorated to the extent that 3-H Corporation, in 1971, filed a Chapter XI proceeding in federal court. Edward A. Hoch (henceforth Hoch) testified that it was starting the second laundry operation that drove the 3-H Corporation under financially. For a period of thirteen months, Hoch continued to operate both facilities as a debtor in possession. The business was finally adjudicated bankrupt on October 13, 1972.

During the period of the Chapter XI proceedings, 3-H made only one payment on the promissory note. Appellees instituted suit on August 15, 1972, on the sum still owing on the promissory note, $70,915.86 plus interest.² As part of the sale of the business, Ellis had also transferred to 3-H the right to lease the premises of the laundromat at a rental of $1200 per month. Payments on the lease had been kept current through the bankruptcy adjudication proceedings except for the last few monthly payments. After bankruptcy adjudication in October 1972, Ellis was uncertain as to the disposition of the secured property. During the winter of 1972-73, Ellis was living with his family in Phoenix, Arizona, and attempting to clarify the situation by phone. During one of these calls, Ellis offered the landlord of the building, Bud Meyeres, the collateral in part payment of the past due rent. This offer was rejected. Ellis and his wife then came to Fairbanks to try to settle the matter. Ellis never testified as to exactly how long he was in Fairbanks, but it appears to have been, at most, a week or two. They arrived at the end of March. On March 28, Ellis filed an application for reclamation, seeking to reclaim the collateral on the security agreement since it failed to cover the amount secured. Ellis testified that he had not sought reclamation earlier because he had not previously known what to do and had not sublet the building during this period, because he concluded that no one would rent it filled with laundry equipment in a state of disrepair. On April 2, 1973, the trustee in bankruptcy turned the collateral over to Ellis.

At that point, Ellis began making inquiries regarding potential purchasers. Through a series of phone calls, Florian Maldonado was located. Maldonado purchased the equipment for $10,000 cash, and subsequently invested an additional $38,000 in refurbishing the business. Maldonado also sublet from Ellis the building housing the laundry. However, the lease was for $1500 per month, $300 more than the rate at which 3-H Corporation had leased the building from Ellis ($1200 per month was also the rent in the original lease between Ellis and Meyeres).

Suit proceeded on the original promissory note, and after a non-jury trial the superior court ruled:

The Ellises are entitled to a judgment against both Defendants, jointly and severally for all amounts unpaid on the Promissory Note, after having been given credit for the amount obtained at the sale and the amount obtained in the companion California litigation, interest thereon as appropriate, costs and attorney’s fees.³

The paramount issue on this appeal is whether the superior court erred in deducting, from the amount found due from Hoch to Ellis on the promissory note, only $10,000 for the collateral. More specifically, the question is whether there was sufficient evidence advanced by the Ellises to support the superior court’s conclusion that the laundry equipment collateral was worth only $10,000, the price for which it was sold, rather than the more than $70,000 remaining to be paid on the promissory note.

We start with the applicable provisions of the U.C.C. Former AS 45.05.788(c) [U.C.C. § 9-504(3)] provided, in relevant part, that “every aspect of the disposition including the method, manner, time, place, and terms must be commercially reasonable,” and that (with exceptions not relevant here) “reasonable notification of the time and place of a public sale or reasonable notification of the time after which a private sale or other intended disposition is to be made shall be sent by the secured party to the debtor.”⁴

Appellants argue that the sale was deficient in both these respects, i. e., that notification of the sale was not given to them, and that the manner of the sale was not “commercially reasonable.”

If the sale was deficient in either respect, then a burden is placed upon appellees to rebut the presumption that the fair market value of the collateral was at least equal to the amount of the outstanding debt. If they fail to meet this burden, then the presumption leads to the conclusion that the entire debt is discharged:

The fair and reasonable value of the collateral at the time of repossession should be offset against the balance due on the security agreement. Where the collateral has been sold in a sale that does not comply with the provisions of the UCC, there is a rebuttable presumption that the fair and reasonable value of the collateral is at least equal to the amount of the outstanding debt.

Kobuk Engineering & Contracting Services, Inc. v. Superior Tank & Construction Co-Alaska, Inc., 568 P.2d 1007, 1013 (Alaska 1977). In Kobuk, we applied this rule to a sale which did not meet the “commercially reasonable” requirement. In Weaver v. O’Meara Motor Co., 452 P.2d 87 (Alaska 1969), we applied this same rebuttable presumption rule to a sale which failed to comply with the notice requirements.

Addressing the notice issue first, we note the superior court concluded that the sale violated the notice provision of the statute. This finding was amply supported by the evidence. That being the case, our ruling in Weaver controls this matter: “Where noncompliance with the notice of sale provision of AS 45.05.788(c) [currently AS 45.09.504(c)] has been shown, the burden of proving that the market value of the collateral was received at the sale is upon the secured party.” Id. at 91-92.

Appellants also argue that the sale was not commercially reasonable. We need not address that argument, in light of our agreement with the superior court’s conclusion that the notice provisions were violated. Were we to find that the sale was commercially unreasonable, then, under Ko-buk, a rebuttable presumption would attach that the fair and reasonable value of the collateral was at least equal to the amount of the outstanding debt. This is the practical equivalent to the burden imposed by Weaver. If the appellees carry their burden of proof under Weaver, they have rebutted any presumption which would attach under Kobuk were we to find that the sale was not commercially reasonable.

Thus, it is clear that the issue is whether the appellees met their burden of proving that the market value of the collateral was received, in order to rebut the presumption that the collateral at the time of sale was worth at least the amount of the unpaid debt. Initially, we must determine what standard of proof must be met. In Kobuk, we specifically stated that the burden is on the secured party to prove by “convincing” evidence the value of the collateral. 568 P.2d at 1014. Here the superior court was uncertain as to the appropriate burden of proof,⁵ but specifically found the evidence clear and convincing.⁶ Given Alaska’s position of not totally depriving the secured party of compensation when there is noncompliance with U.C.C. requirements, we think that the more exacting standard of clear and convincing evidence ⁷ is appropriate.

Having established the standard, we turn to the facts. In Kobuk, we noted two ways in which the applicable presumption may be rebutted:

In order to overcome that presumption, the secured party has the burden of either (1) obtaining a fair and reasonable appraisal at or near the time of repossession, or (2) producing convincing evidence of the value of the collateral. In order to meet the latter burden the secured creditor is required to bring forward proof of the condition of the collateral and the usual price of items of like condition.⁸

568 P.2d at 1013-14.

As to the appraisal leg of this test, the superior court was faced with a variety of appraisals submitted by Hoch in his attempt to persuade the court that the sale was commercially unreasonable. The superior court found these too speculative and unreliable to consider, so we will disregard them.⁹

As to the fair market value of the collateral, the superior court placed considerable weight on the testimony of Maldonado, who purchased the equipment.¹⁰ Maldonado stated that his purchase was a gamble. He stated that he paid $10,000, which he thought was a reasonable price.¹¹ His testimony as to the cost and effort it took to get the equipment working clearly showed that the equipment was in a poor state of repair.¹² It took $38,000 and an undetermined amount of labor to get the business operational. His testimony, in large part, substantiated a finding that the three estimates proffered by Hoch did not take into account the severe dilapidation of the equipment. While the equipment may have been worth $40,000 or more in good condition or easily repairable condition, its actual state was such that $40,000 may have been unreasonably high. As to the accompanying fixtures, the expense of having to install a new boiler and make the accompanying fixture replacements served to discredit the high values placed on the fixtures by Hoch, Stansberry, and Craft.

This appears especially accurate at the time and place in question. The local economic market at the time of sale is a recognized factor in determining the value of the collateral.¹³ Although neither of the other two Fairbanks laundry operators were informed of the sale, one directly stated he had been in no position to bid on it. During the spring of 1973, Fairbanks was in a severe economic slump prior to the start of the pipeline and buyers were difficult to find. We would conclude that the superior court was correct in its finding that the fair market value of the collateral at the time of sale was the $10,000 the Ellises received, except for one disturbing aspect of the transaction.

Hoch further asserts that the increase in the rent pertaining to the sublease of the building resulted in a “secret profit” obtained by the Ellises in their sale to Maldonado, which should have been reflected in the deficiency judgment. This court dealt with an analogous problem in Kobuk, in which we found potential self-dealing when the secured creditor purchased the collateral for a fraction of the secured debt and resold it for two and one-half times that amount six weeks later.¹⁴ We noted:

Where by failing to give such notice as would guarantee competitive bidding the secured party insures an opportunity for self-dealing, we will scrutinize the sale closely.¹⁵

The problem was that the secured debtor could thus obtain a double recovery — once from the second sale of the collateral to the third party, and once from the deficiency judgment, which would be reduced only by the artificially deflated amount realized from the original sale.

In this case, although the sale of the collateral was to an independent third party, we are again faced with a situation in which the secured creditor could have artificially deflated the formal sale price for the collateral by offering it as part of a package deal, along with an inflated price for the leasehold. Concomitant with the sale was a sublease to Maldonado at a rental that was $300 per month more than had previously been paid by the Hochs.

As in Kobuk, the Ellises could in effect recover twice for some portion of their debt: once from the increase in rent obtained from Maldonado in return for the artificially deflated price of the collateral, and again from the deficiency judgment against the Hochs, which would only be offset by that artificially deflated price. As Hoch noted, “[s]ince the sublease had a remaining term of 13 years 8 months, the Ellis[es] stood to gain a total profit of $49,200 ($300 X 164 months).”

Ellis, in response, argues that the leasehold was not part of the security interest arrangements, and notes that former AS 45.05.696(10) [currently AS 45.09.104(10)] excludes leaseholds from the application of U.C.C. security provisions. However, we think Hoch is correct in arguing that this is irrelevant to a determination of whether the arrangement manages by an adjustment of the two amounts to provide for a hidden profit not properly reflected in the deficiency judgment.

The original lease from Meyeres to Ellis was executed in 1966 for $1,200 per month, and the sublease between Ellis and Maldonado, in 1973, for $300 more per month, may not have been unreasonable, given continually rising property values. However, if there was such a poor business climate that it affected the sale of laundry equipment and furnishings, as Ellis argues, it would most likely have also affected the value of a lease of premises designed for use as a laundry.

Regrettably, the court made no specific findings on this issue. No evidence was advanced at trial by either party to suggest what the reasonable rental value of this building was in 1973. Nevertheless, we think that this factual situation presents a strong likelihood that such manipulation occurred. Given that the Ellises had the burden of overcoming, by clear and convincing evidence, the presumption that the value of the repossessed collateral was equal to the debt it secured, and given that situations, such as this one, which present opportunities for “double recovery” must be closely scrutinized, we think that a substantial profit received from such apparent manipulation of the terms of the sale must be, under the circumstances presented here, offset against any deficiency judgment obtained. Since no notice was given to the debtor, and since no evidence was presented by the secured creditor explaining the increased rental on valid grounds, the increased rentals obtained will be offset against the deficiency resulting from the sale. Thus, in the case at bar, the deficiency judgment must be reduced by the present value of the $49,200 that is receivable by the Ellises over the remaining term of the lease.

REVERSED and REMANDED.

BURKE, J., dissents.

1 . Edward A. Hoch testified that he owned over fifty percent of the stock; his father, Edward H. Hoch, owned ten percent and his uncle, Walter G. Hoch, owned one-thir/i of the stock.

2 . The suit was brought by Charles and Evalyn Ellis to whom the promissory note had been assigned by B & E Enterprises in 1969. The complaint stated that the last payment had been made in October 1971 and $70,915.86 was owing, plus interest from October 1971. The suit was originally brought against Edward H. Hoch, Edward A. Hoch, and Walter G. Hoch and not against 3-H Corporation. Walter G. Hoch was dropped from the suit, though, because of a separate action brought against him in California that resulted in a settlement agreement.

3 . For an explanation of the California litigation, see note 2, supra.

4 . Subsection (c) reads:

Disposition of the collateral may be by public or private proceedings and may be made by way of one or more contracts. Sale or other disposition may be as a unit or in parcels and at any time and place and on any terms, but every aspect of the disposition including the method, manner, time, place, and terms must be commercially reasonable. Unless collateral is perishable or threatens to decline speedily in value or is of a type customarily sold on a recognized market, reasonable notification of the time and place of a public sale or reasonable notification of the time after which a private sale or intended disposition is to be made shall be sent by the secured party to the debtor, and, except in the case of consumer goods, to any other person who has a security interest in the collateral and who has duly filed a financing statement indexed in the name of the debtor in the state or who is known by the secured party to have a security interest in the collateral. The secured party may buy at a public sale, and, if the collateral is of a type customarily sold in a recognized market or is of a type whiqh is the subject of widely distributed standard price quotations, he may buy at private sale.

This section has been renumbered as AS 45.09.-504(c).

5 . At trial, there was confusion as to what standard of proof “convincing” was intended to establish. Hoch argued that this court’s use of “convincing” created a standard of clear and convincing evidence.

6 . The superior court thereafter noted:

I don’t think that’s the test. I think that this is a civil case like all other civil cases and the test is by a preponderance of the evidence and clearly that burden has been met.

Since the superior court found that the higher burden of clear and convincing evidence was met, there is no possibility of error through failure to apply the correct burden of proof.

7 . McCormick notes that this standard is applied in “miscellaneous types of claims and defenses, varying from state to state, where there is thought to be a special danger, or where the court considers that the particular type of claim should be disfavored on policy grounds.” C. McCormick, Law of Evidence § 340, at 797-98 (2d ed. 1972). The danger of deception is, we think, well illustrated by the facts in Kobuk and in this case; and the policy we are trying to forward is one of compliance with the statutory procedures of the U.C.C.

8 .For another discussion of the kinds of evidence that may be used to establish the adequacy or insufficiency of the resale price, see J. White & R. Summers, Uniform Commercial Code § 26-11 at 989-90 (1972).

9 . Most of the appraisals were submitted by Hoch, and they valued the equipment at an amount considerably higher than the amount owed. As such, they avail the Ellises nothing. One contemporaneous assessment by Jim Moran in November 1972 estimated a value of $3,810; the superior court, however, found that this did not “rise to the level of an appraisal.”

10 . The superior court’s finding of fact no. 6 states: “The testimony of FLORIAN MALDONADO is the most credible.” The court had clarified at trial that it was not judging credibility as to who was lying or telling the truth but who had the best opportunity to see and report on the equipment.

11 . Maldonado stated he did not think he would have paid $20,000 for the equipment, and he did not not know if he would have paid $15,-000.

12 . Specifically, Maldonado testified as to the following items of equipment:

a. All 20-20 # washers were operational after repair of ‘[njumerous motors, pumps, timers, door switches, glass doors.’

b. Only three of eight-8 # dry cleaners were repairable.

c. All 12-50 # dryers were repairable. ‘[M]ost of the coils in the dryers were frozen and busted.’

d. The 20/40 # dry cleaner was not repairable after $1,200 of contracted repair work (unpaid) and was abandoned.

e. The high pressure oil boiler required a McDonald valve (costing approximately $150) to make it operational.

f. Of four extractors, continued use was made of only one.

g. The steam press, the ironamatic press and air vacuum unit form finisher were operational.

h. Only one of two 30 # washers was repairable after replacing bearings, seals, etc.

i. The electric mangle was junked.

j. The six Speed Queen washers were replaced.

k. The low pressure boiler was replaced. The old boiler had to be cut and taken out. The new one required a separate boiler room extension and additional steam lines plumbing.

All this took about five or six weeks to get the business operational. During this time, Maldonado worked 16 to 18 hours a day, and his wife, children and friends worked cleaning up the place. A total of $38,000 was spent getting the place operational, which only included a fraction of the labor.

13 .See Hall v. Owen County State Bank, 370 N.E.2d 918, 929 (Ind.App.1977) (“[Ejven though a low sale price itself is insufficient to overturn a sale, closer scrutiny will generally be given sales in which there is a substantial difference between the sale price and the fair value to determine whether there were legitimate causes for the low price such as a depressed or non-existent market, or whether the low price was caused by the secured party’s failure to proceed in a commercially reasonable manner”). See also Commercial Credit Corp. v. Wollgast, 11 Wash.App. 117, 521 P.2d 1191, 1195 (1974).

14 . Kobuk Eng’r & Contracting Serv., Inc. v. Superior Tank & Constr. Co-Alaska, Inc., 568 P.2d 1007, 1009-10 (Alaska 1978).

15 . Id. at 1011.