Orix Credit Alliance, Inc. v. Sovran Bank, N.A.

4 F.3d 1262, 1993 WL 326710

• Court: Court of Appeals for the Fourth Circuit
• Decided: August 30, 1993
• Docket: No. 92-2386
• Status: Published

Opinions

HAMILTON, Circuit Judge:

Orix Credit Alliance, Inc. (Orix) appeals the district court’s grant of summary judgment in favor of Sovran Bank (Sovran) awarding Sovran a priority claim to the proceeds arising from the sale of a Crane on which Orix maintained a security interest lien. Finding no error, we affirm.

I

This controversy involves a dispute over the right to proceeds from the sale of a debtor’s collateral. In September 1988, Orix and its debtor, AE. Finley and Associates (Finley), entered into an agreement under which Orix agreed to finance, from time to time, Finley’s acquisition of large industrial equipment and machinery which Finley would then either rent or resell. On September 30,1988, Finley executed Orix’s standard security agreement which granted Orix a security interest in all equipment financed by Orix.

On July 16, 1990, pursuant to their arrangement, Orix financed Finley’s purchase of an American Crawler Crane (the Crane). Finley executed and delivered to Orix a promissory note in the amount of $305,000 and Orix filed a financing statement for the Crane with the appropriate Virginia officials. At the same time, Orix wrote a letter to Finley’s lender, Sovran, which stated:

We (Orix) have acquired one or more security interests (sic) in the goods described below: [the Crane].

We would appreciate it greatly if you would acknowledge that our interest in the goods described above is, and will be, prior to any interest of your company in such goods. Please confirm by signing in the place provided below and returning the original of this letter to us.

Joint Appendix (J.A) at 786. On July 16, 1990, a loan officer at Sovran, Elspeth McClelland, executed this subordination agreement, expressly acknowledging that Orix had a superior security interest in the Crane.

Finley maintained both a lending and depository relationship with Sovran. Specifically, Sovran provided Finley with a revolving line of credit and three bank accounts. The first account was a “cash collateral account,” which was maintained by Sovran to receive all incoming payments from Finley’s customers. Finley did not have direct access to or use of the funds in the cash collateral account. Each banking day, on a regular and routine basis, the deposits to the cash collateral account from the previous day were removed and applied to the outstanding balance of Finley’s line of credit with Sovran. The second account was the “controlled disbursement account” on which Finley wrote checks. Under normal operating procedures, when the checks written on this account were presented to Sovran for payment, Sovran would notify Finley and, after Finley requested an advance under its line of credit, Sovran would then deposit sufficient funds from the line of credit into this account to pay the checks.¹ Sovran and Finley implemented this arrangement at the inception of their relationship in December 1988, and the established procedures remained unchanged.

In 1991, Finley’s financial situation worsened. Thus, when Finley’s line of credit formally expired in July 1991, Finley was unable to pay the outstanding balance due Sovran. Consequently, on September 4, 1991, Sovran formally declared default on Finley’s line of credit. In an attempt to cure its financial situation, Finley decided to sell some of the equipment which it currently leased. Pursuant to this decision, Finley arranged to sell the Crane to Signet Leasing and Finance Corporation (Signet). Orix authorized this sale on the condition that Finley would first use the proceeds to pay the remaining debt owed to Orix on this Crane. Orix took no other precautionary measures to ensure payment by Finley even though, as the secured party, it was in a position to do so.

On September 20, 1991, Finley informed Sovran that Signet would be wiring $565,000 into Finley’s cash collateral account and requested Sovran to notify Finley when the wire transfer arrived. After receiving the wire transfer on that day, Sovran provided Finley with the requisite notice and, on the next banking day, routinely transferred the funds to reduce Finley’s line of credit bal-anee.² On September 23, 1991 — the first banking day after the wire transfer — Finley wrote a cheek on its controlled disbursement account to Orix for $257,648, the balance of the debt owed Orix on the Crane.

On September 30, 1991, this check was presented to Sovran for payment. On that day, Sovran advised Finley that a total of $288,388 had been presented for payment on the controlled disbursement account. As was customary, Finley then requested Sov-ran to advance that amount under the line of credit in order to cover these checks. In response, Sovran refused to advance the requested amount because it exceeded the remaining availability under Finley’s line of credit.³ Sovran further advised Finley that the applicable banking laws only required payment of approximately $6,000 in cheeks presented that day. Finley thus reduced its requested advance to $6,000. On the next day, October 1, 1991, Finley’s check to Orix was again presented to Sovran for payment. Because the amount of the Orix check again exceeded Finley’s availability under its line of credit, Sovran dishonored the check.

On October 2, 1991, Finley’s loan officer at Sovran, McClelland, sent a memorandum to her superiors discussing the Finley line of credit. The memo indicated that, after the $2,000,000 line of credit expired in July 1991, Sovran’s credit committee had approved an extension of this line of credit until October 31, 1991.⁴ Despite this authorization, the memo indicated that McClelland had verbally informed Finley that Sovran would reduce the line to $1,600,000 through October 1, 1991, and, on that date, reduce the line an additional $200,000 to $1,400,000 until October 31, 1991.⁵ The memo also suggested that, in order to avoid “arbitrarily cutting the line” and to protect the bank, Sovran should send written notice to Finley advising of these reductions. J.A. at 404. Finally, the memo indicated that, on October 1, 1991, Sovran “returned ... a large check to [Orix] that was being used to pay off some equipment that was sold.” Id. The memo identified two reasons for returning this check:

(1) The line [of credit] balance would have been $1,595,000 and this would have been $195,000 over the agreed amount; and

(2) The collateral sheet showed that there was not the collateral availability. The availability was $1,574,000.

Id.6 The same day, Sovran had Finley sign a letter formally acknowledging Sovran’s reduction in the line of credit to $1,400,000, effective as of October 1, 1991. J.A. at 409-10.

After Sovran dishonored the check to Orix, Orix filed suit against Sovran in the United States District Court for the District of Maryland. After the completion of discovery, the parties filed cross motions for summary judgment. Orix essentially argued that, because the funds in Finley’s cash collateral account on September 20, 1991 constituted identifiable proceeds from the sale of Orix’s collateral, under Virginia’s Uniform Commercial Code (Va.U.C.C.) § 8.9-306(2) Orbe had a continuing security interest in those funds. Thus, Orix claimed Sovran had no right to use the Signet-remitted funds to reduce Finley’s line of credit balance with Sovran.

The district court rejected Orix’s argument and granted Sovran’s motion for summary judgment. The district court reasoned that the transfer of the funds in question occurred in Finley’s ordinary course of business and, therefore, Va.U.C.C. § 8.9-306 as qualified by Comment 2(c) to that section, extinguished Orix’s security interest in those proceeds.

Orix now appeals to this court.

II

In its appeal, Orix first contends that the use of funds from Finley’s cash collateral account to reduce Finley’s line of credit with Sovran cannot be considered a transaction in the ordinary course of Finley’s business if Sovran knew another creditor had a security interest in those proceeds.⁷ Orix reasons that Comment 2(c) to Va.U.C.C. § 8.9-306 only protects a transferee who has no knowledge of a prior security interest in the proceeds received. We disagree.

Section 8.9-306(2) of the Va.U.C.C. gives a secured creditor a continuing security interest in “any identifiable proceeds [from the sale of collateral] including collections received by the debtor.” However, this security interest in proceeds is not absolute. Comment 2(c) to this provision states, in relevant part:

Where cash proceeds are covered into the debtor’s checking account and paid out in the operation of the debtor’s business, recipients of the funds of course take free of any claim which the secured party may have in them as proceeds. What has been said relates to payments and transfers in ordinary course.

Although we found no Virginia authority directly on point, courts have uniformly recognized that a transferee’s knowledge of a prior security interest in proceeds does not, by itself, suggest that the transfer of those proceeds occurred outside the ordinary course of the debtor’s business. The case relied on by the district court, In re Halmar Distributor’s, Inc., 116 B.R. 328 (Bankr.D.Mass.1990), rev’d on other grounds 968 F.2d 121 (1st Cir.1992), provides a good example.

In Halmar, a supplier sold inventory to a debtor on credit and took a purchase money security interest in that inventory and any resulting proceeds. The debtor also maintained a banking relationship similar to the arrangement Finley had with Sovran. Specifically, the debtor had a revolving line of credit and a lockbox account with its bank. Under the lockbox arrangement, the debtor’s customers mailed all payments to that account and the bank automatically applied those receipts to reduce the debtor’s line of credit. As a consequence of this arrangement, the bank often used proceeds from the supplier’s collateral to reduce the line of credit even though the bank knew the supplier had a security interest in those proceeds.

When the debtor encountered financial difficulties and did not repay the supplier, the supplier filed suit against the bank. The supplier claimed that, because the supplier had a continuing security interest in the proceeds, the bank had no right to use those proceeds to reduce the outstanding balance on the debtor’s line of credit with the bank. The bankruptcy court rejected this claim, reasoning in part that “the transfer of proceeds in the ordinary course of business ... [should have] the same consequences as ordinary course transfers of [the] original collateral.” Id. at 333. Under § 9-307(1) of the Uniform Commercial Code (U.C.C.), a purchaser of goods in the ordinary course of business takes those goods free of any security interest created by his seller, “even though the buyer knows of [the security interest].” Id. Thus, the bankruptcy court concluded that “a transfer [of proceeds] in the ordinary course of a debtor’s business terminates a security interest [in those proceeds]” regardless of the transferee’s knowledge. Id.

We believe Virginia law would apply the rationale of the Halmar court to the present case. As the First Circuit has noted:

[W]e can imagine good commercial reasons for not imposing, even upon sophisticated suppliers or secondary lenders, who are aware that inventory financers often take senior secured interests in “all inventory plus proceeds,” the complicated burden of contacting these financers to secure permission to take payment from a [debtor’s] ordinary commingled bank account.

Harley-Davidson Motor Co. v. Bank of New England, 897 F.2d 611, 622 (1st Cir.1990) (emphasis in original). Thus, we hold that a transferee’s knowledge of a prior security interest in proceeds does not, by itself, indicate that the transfer of these proceeds occurred outside the ordinary course of the debtor’s business. Consequently, Sovran’s knowledge of Orix’s prior security interest in the proceeds in question does not require a conclusion that Sovran’s use of those proceeds to reduce Finley’s line of credit occurred outside the ordinary course of Finley’s business.

Ill

Orix next contends that Sovran’s use of the proceeds in question does not qualify as a transaction in the ordinary course of Finley’s business because those proceeds were not “paid out in the operation of the debtor’s business.” Va.U.C.C. § 8.9-306, Comment 2(c) (emphasis added). We disagree.

To support its argument, Orix relies on Barber-Greene Co. v. National Bank of Minneapolis, 816 F.2d 1267 (8th Cir.1987). In Barber-Greene, a supplier sold machinery on credit to a debtor, taking a security interest in that machinery. The debtor also maintained a banking relationship which included a revolving credit facility, a “collateral account” and a “general operating account.” Pursuant to their agreement, the proceeds from the sale of the debtor’s inventory were deposited in the collateral account. “The bank [then] periodically, and at its discretion, transferred funds from the collateral account” to reduce the debtor’s loan balance. Id. at 1269 (emphasis added). Upon the debtor’s request for credit, the bank would advance funds from the revolving loan and credit the debtor’s general operating account.

When the debtor’s financial situation deteriorated, the bank applied funds from all of the debtor’s accounts to reduce the loan balance. Because the debtor did not pay the supplier, the supplier filed suit against the bank. The supplier claimed that it had a security interest in the proceeds superior to the bank’s. In response, the bank argued that the transfers occurred in the ordinary course of the debtor’s business and, therefore, Comment 2(c) to Va.U.C.C. § 8.9-306 extinguished the supplier’s security interest in those proceeds.

The Eighth Circuit rejected the bank’s argument, concluding that “[t]he proceeds were not paid out by [the debtor] in the ordinary course of its business.” Id. at 1273. The court reasoned:

Comment [2(c)] presupposes an account over which the debtor voluntarily makes deposits, and from which the debtor voluntarily makes payments to third parties who take in good faith. [The debtor in the present case] had no control over the collateral account. The bank had sole control. [The debtor] had no choice but to deposit the proceeds from the sale of all inventory into the collateral account. [The debtor] was never faced with decisions as to when and to whom payments from the account should be made, because [the debt- or] had no control over the proceeds once they were deposited in the collateral account.

Id. at 1272. In addition, the Barber-Greene court noted that Comment 2(c) to U.C.C. § 9-306 was not intended to protect banks which knowingly attempt to place themselves in a stronger position than that of creditors holding a superior claim as to those proceeds. Id.

We think the rationale employed by the Barber-Greene court does not apply to the present case. In Halmar, a case which closely resembles the instant matter, the court concluded that the proceeds were “paid out” in the ordinary course of the debtor’s business. In reaching this conclusion, the court distinguished Barber-Greene on the basis that:

[T]he cash transfers to the bank in [Barber-Greene ], far from being in the ordinary course, were precipitated by the debt- or’s deteriorating financial condition. The bank set off all of the debtor’s deposit accounts, not just the collateral account, in payment of its indebtedness. It did so because of the debtor’s defaults. Nor was there any of the consent and acquiescence which is present here_ The [Barber-Greene ] court was presented with conduct amounting to foreclosure, and the decision should be read in that light.

Raimar, 116 B.R. at 334.

We think this distinction applies with equal force to the present case. Unlike the bank’s discretionary transfer of funds in Barber-Greene, Sovran routinely withdrew the previous day’s deposits to Finley’s cash collateral account on the next banking day and applied this amount against the outstanding balance due on Finley’s line of credit with Sovran. Moreover, the system facilitating the transfer of these funds to Sovran remained unchanged from the inception of Sovran and Finley’s relationship in 1988. In contrast, the bank in Barber-Greene began offsetting all of the debtor’s accounts at the onset of its debtor’s financial troubles. Because Sovran merely followed preexisting and long-established procedures, the concerns expressed by the Barber-Greene court relating to a bank’s knowing attempt to gain a stronger position as to proceeds do not exist in the present case. Instead, under such circumstances we think the proceeds in question were “paid out in the operation of the debtor’s business” as contemplated by Comment 2(c) to Va.U.C.C. § 8.9-306.⁸

IV

As a final argument, Orix contends that the district court erred in awarding summary judgment in favor of Sovran because the evidence before the district court created a genuine issue of material fact as to whether Sovran’s use of the proceeds in question occurred in the ordinary course of Finley’s business. Orbe relies on two eviden-tiary facts to support this argument. We think neither evidentiary fact created a triable issue and discuss our reasons with respect to each fact separately.

A

Orix first contends Finley’s deteriorating financial condition and Sovran’s subsequent declaration of default on Finley’s line of credit on September 4,1991, suggests that, at the time Sovran used the proceeds in question, there was no business as usual between Sov-ran and Finley. Thus, Orix concludes that the district court should conduct a full trial before determining whether the transaction in question occurred in the ordinary course of Finley’s business. We disagree.

Comment 2(c) to Va.U.C.C. § 8.9-306 states that, in order for a transferee of proceeds to take free of any security interest in those proceeds, the proceeds must be “paid out in the operation of the debtor’s business.” (Emphasis added). Thus, determining whether the transfer of proceeds occurred in the ordinary course of business requires us to focus on Finley’s rather than Sovran’s business. Despite Finley’s financial troubles, we think the payments to Sovran clearly occurred within the ordinary course of Finley’s business.

As previously discussed, Sovran and Finley, at the inception of their relationship in 1988, voluntarily established the procedures through which Sovran applied the proceeds in question. In addition, Sovran routinely and daily withdrew these funds automatically, without the exercise of any discretion by either party. Because this system existed before the onslaught of Finley’s financial woes, and neither Finley’s subsequent financial troubles nor Sovran’s declaration of default altered this procedure, we think neither of these facts suggest that the transaction in question occurred outside the ordinary course of Finley’s business. Thus, we believe the facts relied on by Orix did not create a triable issue.

B

Orix also argues that Sovran’s “retroactive” reduction of Finley’s line of credit on October 2, 1991, from $1,600,000 to $1,400,-000, and the subsequent dishonoring of Finley’s check to Orix also suggest Sovran did not take the proceeds in the ordinary course of Finley’s business.⁹ Orix reasons that this “retroactive” reduction in Finley’s line of credit reflects a deliberate attempt to avoid paying Orix. Orix adds “[i]f Sovran truly would have been operating in the ordinary course of business, it would have honored Finley’s check to Orix based on the sufficient [collateral] availability that existed on the [two] days the check was presented for payment.” Brief of Appellant at 21. Thus, Orix concludes that a trial is necessary to determine whether the transaction in question occurred in the ordinary course of Finley’s business. We disagree.

The “ordinary course” transfers described in Comment 2(c) to Va.U.C.C. § 8.9-306 “ha[ve] a fairly broad meaning” and exclude only that conduct which “in the commercial context, is rather clearly improper.” Harley-Davidson, 897 F.2d at 622. In the present case, the uncontradicted evidence in the record indicates that Sovran and Finley verbally agreed to the reductions in the line of credit on September 11, 1991. J.A. at 439. Because the parties agreed to these reductions before Sovran knew of Finley’s check to Orix — Finley did not even write this check until September 20, 1991 — we think the evidence in the record does not support a conclusion that Sovran deliberately implemented a “retroactive” reduction in Finley’s line of credit merely to avoid paying Orix. Thus, Sovran’s reduction in the line of credit was not “clearly improper” and did not occur outside the ordinary course of Finley's business.¹⁰

V

For the reasons stated herein, the judgment of the district court is affirmed. AFFIRMED.

1 . The third account was a payroll account which is not relevant to this appeal.

2 . This wire transfer included proceeds arising from Signet's purchase of the Crane and other equipment from Finley.

3 . Had Sovran advanced the funds requested on September 30, 1991, Finley’s indebtedness to Sovran would have totalled $1,602,206 or $2,206 in excess of the $1,600,000 total credit available. J.A. at 279.

4 . At her deposition, McClelland testified that there was only an internal authorization by Sov-ran’s credit committee to extend the line until October 31, 1991. Sovran did not communicate this extension to Finley. J.A. at 329.

5 .Finley and Sovran apparently reached an oral agreement on these reductions at a meeting held on September 11, 1991. J.A. at 439.

6 . Notably, on October 1, 1991 the Orix check only exceeded the available line of credit because Sovran reduced the amount of credit from $1,600,000 to $1,400,000 on that day. Under the $1,600,000 line of credit in effect until September 30, 1991, the Orix check would not have exceeded the available credit.

7 . The parties dispute whether Sovran actually knew that the September 20, 1991, wire transfer contained proceeds from the sale of collateral in which Orix had a security interest. For purposes of reviewing the district court's summary judgment, however, we must view the facts in the light most favorable to Orix. Thus, we will assume Sovran had such knowledge.

8 . We think these facts also distinguish the instant matter from other cases relied on by Orix. See, e.g., National Acceptance Co. of America v. Virginia Capital Bank, 498 F.Supp. 1078, 1083 (E.D.Va.1980); In re Northwest Liquor Industries, Inc., 107 B.R. 616 (Bankr.W.D.Wi.1988); Dominion Bank of Richmond v. Plaza One Associates, 15 U.C.C. Reporting Service 2d 1349, 1991 WL 296735 (E.D.Va.1991); Linn Cooperative Oil Co. v. Norwest Bank Marion, 444 N.W.2d 497 (Iowa 1989); Citizens National Bank of Whitley County v. Midstates Development Company, Inc., 177 Ind.App. 548, 380 N.E.2d 1243 (1978). In all of these cases, the courts determined that the respective suppliers had a superior interest in proceeds which the banks had used to reduce the debtors’ debt with the bank. However, none of these cases involved an arrangement whereby, from the inception of the bank's relationship with its debtor, the bank automatically withdrew funds from the debtor's account.

In fact, the disputed transactions in most of these cases involved a bank's right to set-off. Such transactions rarely occur within the ordinary course of business. See, e.g., Franklin v. First National Bank of Morrill, 848 P.2d 775, 781 (Wy.1993) ("This definition [of ordinary course of business] expressly excludes set-offs of preexisting debt.”); Tuloka Affiliates v. SEC State Bank, 229 Kan. 544, 627 P.2d 816, 820 (1981) (The seizure of funds through the right of set-off presents a unique situation_").

9 . Orix argues that Sovran “retroactively” reduced Finley's line of credit because Sovran did not write its memorandum discussing the proposed reduction, or solicit Finley’s written acknowledgment of this reduction until the next day, October 2, 1991.

10 . Moreover, because Finley’s requested advances on September 30 and October 1, 1991 exceeded the remaining available credit under Finley’s line of credit with Sovran, we do not think the mere existence of sufficient "collateral availability” on these two days indicates that Sovran wrongfully dishonored the check to Orix.