USCA1 Opinion
September 29, 1992
UNITED STATES COURT OF APPEALS
FOR THE FIRST CIRCUIT
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No. 91-2250
IN RE: MELON PRODUCE, INC.,
Debtor,
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JOSEPH BRAUNSTEIN, TRUSTEE,
Plaintiff, Appellee,
v.
PETER KARGER,
Defendant, Appellant.
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APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MASSACHUSETTS
[Hon. Edward F. Harrington, U.S. District Judge]
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Before
Breyer, Chief Judge,
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Lay,* Senior Circuit Judge,
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and O'Scannlain,** Circuit Judge.
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Charles W. Morse, Jr. with whom Alan M. Spiro and Friedman &
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Atherton were on brief for appellant.
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John J. Kuzinevich with whom Isaac H. Peres and Riemer &
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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
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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
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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
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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
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Bankruptcy 547.01 at 547-14 (15th ed. 1992) ("A preference
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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
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Bankruptcy 547.08 at 547-43 (15th ed. 1992); see also 11
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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
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the creation or perfection takes place during the preference
period (and the other criteria are satisfied). See In re
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Taco Ed's, 63 Bankr. 913, 925 (N.D. Ohio 1986) and cases
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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
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(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
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the time of filing of the U.C.C. financing statement. Mass.
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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
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interest does not relate back to 1984, however, for
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Bankruptcy Code preference purposes.
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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
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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
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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
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Bankruptcy 547.13 at 547-59-61 (15th ed. 1992) (explaining
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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.
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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
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Law 288 (2d ed. 1982) (noting uncertainty as to whether
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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
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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);
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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
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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
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purposes of determining bankruptcy preferences, the transfer
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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.
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Pa. 1987) (proof of claim is competent evidence when offered
against a debtor); In re Trans Air, 103 Bankr. 322, 325
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(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
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(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
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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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