Delaware Truck Sales, Inc. v. Wilson

The opinion of the Court was delivered by

HANDLER, J.

This ease presents issues of commercial law arising from the secured indebtedness of a business corporation and attempts by two creditors to satisfy their respective obligations out of the same collateral security. The controversy arose after the debt- or defaulted on both obligations. The debtor surrendered to the .second or junior creditor its accounts receivable, which the junior creditor then collected. The senior creditor, a bank, which had obtained a default judgment against the debtor, made a claim against the junior creditor, contending that it had a first priority lien on the accounts receivable. The junior creditor paid the bank a sum approximating the bank’s judgment against the debtor in exchange for the bank’s judgment together with the underlying debt and all its security. The junior creditor thereafter instituted this action to foreclose on the residential mortgage that the personal guarantors had given to the bank to secure the underlying debt. However, the debtor and guarantors claimed that the debt to the bank had been satisfied when the junior creditor collected the accounts receivable and paid them over to the bank.

The Chancery Division granted the junior creditor’s motion for summary judgment. The Appellate Division reversed in an unreported opinion. This Court granted certification. 126 N.J. 340, 598 A.2d 897 (1991).

I

On August 20, 1984, Delaware Repair Service, Inc. (Delaware Repair) entered into a financial agreement with Royal Bank of *23Pennsylvania (Royal Bank or bank). Royal Bank loaned $75,-000 to Delaware Repair evidenced by a demand promissory note. Delaware Repair also secured the loan. It executed a financing statement covering all of its “inventory, equipment, fixtures, machinery, appliances, tools, furniture and furnishings, leasehold interests, accounts receivable, now and hereafter acquired.” Royal Bank filed that financing statement with the Camden County Clerk on September 19, 1984, and with the Secretary of State on September 25, 1984. As further security for the loan to Delaware Repair, defendants, Edward Wilson, a principal of Delaware Repair, and his wife, Joan Wilson, personally guaranteed the loan, which in turn was secured by a mortgage on their residence.

Plaintiff, Delaware Truck Service, Inc. (Delaware Truck), a corporation engaged in the cargo-container-repair business, sold its assets to Delaware Repair. According to the sales contract, dated September 6, 1984, the assets transferred included: “the machinery and equipment of the Seller as set forth on Exhibit ‘A’ hereto the business and goodwill of the Seller and including all customer records and files presently in the hands of Seller.” Delaware Repair agreed to pay Delaware Truck a total of $300,000, $30,000 in cash, plus a promissory note for $270,000 payable in sixty equal monthly installments. Defendant Edward Wilson and George Fandrick, both former employees of Delaware Truck, personally guaranteed payment on the note. The agreement provided that Delaware Repair would execute “financing statements” that would create a lien in favor of plaintiff covering all assets sold, plus a “secondary lien” on Delaware Repair’s accounts receivable, “subject only to a prior lien in favor of Purchaser’s institutional lender.” Delaware Truck filed a financing statement covering Delaware Repair’s “inventory, equipment, fixtures, machinery, appliances, tools, furniture and furnishings, now and hereafter acquired” with the Secretary of State on August 29, 1984 (which predated the signing of the sales agreement), and with the Camden County Clerk on September 13, 1984. It filed a separate financing *24statement on October 4, 1984, covering Delaware Repair’s accounts receivable.

Delaware Repair eventually defaulted on its payments to Delaware Truck and Royal Bank. On May 27, 1988, Delaware Repair entered into an agreement with Delaware Truck whereby Delaware Repair acknowledged its inability to pay the $166,935.58 it owed plaintiff and surrendered to plaintiff all of the assets in which plaintiff held a security interest. According to the “Surrender Agreement,” those assets included “inventory, equipment, fixtures, machinery, appliances, tools, furniture and furnishings, now and hereafter acquired,” as well as its accounts receivable. The agreement also noted that the accounts receivable were “probably” subject to a “secondary lien * * * in favor of Royal Bank of Pennsylvania * * In the months following the surrender of assets, plaintiff collected $98,600 from Delaware Repair’s accounts receivable, and applied that money to Delaware Repair’s debt.

In December 1988, Royal Bank sued Delaware Repair and the guarantors on the unpaid promissory note and obtained a default judgment against Delaware Repair and the guarantors in the full amount of $62,000. The record does not indicate that any of the defendants interposed any defenses. Thereafter, Royal Bank, apparently having learned that Delaware Truck had obtained and collected the debtor’s accounts receivable, sought to recover from Delaware Truck the amounts thus realized. In April 1989, Royal Bank entered into a settlement agreement with Delaware Truck. Delaware Truck paid $59,500 in exchange for an assignment of Royal Bank’s judgment against Delaware Repair and the guarantors, its security interests in Delaware Repair’s assets, and the Wilsons’ personal guaranty secured by the mortgage on the Wilson home. Royal Bank also entered into a subordination agreement with plaintiff whereby Royal Bank acknowledged that “every security interest held by Royal Bank in each and every asset of Delaware Repair Services, Inc. is subordinate to the security interest of Delaware Truck.”

*25In April 1989, Delaware Truck filed suit against Delaware Repair, Edward and Joan Wilson, and George Fandrick seeking to collect on the note made by Delaware Repair in favor of plaintiff, as well as on Royal Bank’s judgment.1 It sued to enforce both the note and personal guaranties. In July 1989, defendant Edward Wilson filed for personal bankruptcy. Plaintiff then filed a motion in bankruptcy court seeking to modify the automatic stay so that it could foreclose the mortgage on the Wilsons’ residence, which constituted security for the Wilsons’ personal guaranty. The bankruptcy court granted the motion, and plaintiff, as assignee of Royal Bank, filed the complaint in this action seeking to foreclose on the Wilsons’ residence.

The trial court granted plaintiff’s motion for summary judgment. Defendants argued that because Royal Bank had the first lien on accounts receivable, plaintiff should have applied the proceeds from the accounts receivable to satisfy the mortgage obligation in favor of Royal Bank. The trial court rejected defendants’ arguments on two grounds. First, the trial court found that plaintiff had a senior security interest in the accounts receivable because plaintiff had filed a financing statement before Royal Bank. Second, even if plaintiff’s security interest was junior to Royal Bank’s, the trial court found that plaintiff had obtained the senior security interest through the assignment and subordination agreements. The trial court relied on the language of the guaranty made by the Wilsons to Royal Bank, which stated that the guaranty may be enforced “without first resorting to any security or other property or invoking other available rights or remedy.”

*26The Appellate Division reversed, concluding that plaintiff could not foreclose on the mortgage. The Appellate Division found that Royal Bank was first to file a financing statement covering accounts receivable and therefore had priority over plaintiffs security interest in Delaware Repair’s accounts receivable. The Appellate Division, however, further determined that because the moneys collected by plaintiff from Delaware Repair’s accounts receivable should have been applied to Royal Bank’s debt, the latter’s debt had been satisfied and extinguished with the payment to Royal Bank.

II

Plaintiff first argues that it had priority with respect to Delaware Repair’s accounts receivable, and therefore its realization of the proceeds from the accounts receivable prior to the assignment of Royal Bank’s interests against Delaware Repair could not satisfy Delaware Repair’s debt to Royal Bank.

Both creditors, Delaware Truck and Royal Bank, had perfected their respective security interests in Delaware Repair’s assets through the execution of financing statements describing the collateral. N.J.S.A. 12A:9-302 and 303. Delaware Repair executed a UCC-1 financing statement in favor of Royal Bank on its demand promissory note covering accounts receivable. Delaware Repair gave plaintiff a financing statement on the debtor’s promissory note which created a lien on all or most of its assets, including accounts receivable. Consequently, each secured creditor had a perfected security interest in the same collateral.

N.J.S.A. 12A:9-312 addresses the priority of creditors with respect to collateral. When no special priority rules are in effect, N.J.S.A. 12A:9-312(5)(a) governs the determination of priority between parties with a security interest in the same collateral:

*27In all cases not governed by other rules in this section * * * priority between conflicting security interests in the same collateral shall be determined according to the following rules:
(a) Conflicting security interests rank according to priority in time of filing or perfection * * *.

Thus, priority to collateral and its proceeds depends on when the parties filed financing statements covering the claimed collateral.

On August 29, 1984, Delaware Truck filed a financing statement covering the debtor’s assets with the Secretary of State. That financing statement did not mention Delaware Repair’s accounts receivable. However, the sales agreement between these parties, dated September 6, 1984, stated that the lien in favor of plaintiff was only “secondary” with respect to the accounts receivable. Although the agreement by its date was executed after the filing of the financing statement, that the basic understanding embodied therein preceded the filing of Delaware Truck’s first financial statement is inferable from its reference to accounts receivable. On September 25, 1984, Royal Bank filed a financing statement that specifically covered the debtor’s accounts receivable. Thereafter, on October 4, 1984, plaintiff filed an additional financing statement covering the debtor’s accounts receivable.

The trial court found that plaintiff had priority over the accounts receivable interests of Royal Bank. The Appellate Division disagreed. It gave considerable weight to the September 6, 1984 agreement between plaintiff and Delaware Repair, which acknowledged that plaintiff’s security interest in the accounts receivable was subject to Royal Bank’s prior lien. Plaintiff concededly had filed its financing statement with the appropriate offices, respectively, on August 29 and September 13, 1984. However, that financing statement did not specify accounts receivable among the covered assets. On the other hand, Royal Bank, before the end of September 1984, filed a financing statement that expressly and specifically covered accounts receivable. Only thereafter, on October 4, 1984 did *28plaintiff file a second financing statement that specifically referred to accounts receivable. By that time, Royal Bank held a priority-lien position with respect to the accounts receivable.

Plaintiff alleges, however, that because it was first to file a financing statement with respect to “inventory,” Royal Bank does not have priority over any inventory-generated accounts receivable. See discussion, infra, at 30-31, 618 A.2d at 308-309. Barring this claim, we are thus satisfied that the Appellate Division correctly concluded that Royal Bank’s priority interest in the accounts receivable of Delaware Repair was superior to the security interest of plaintiff.

Ill

After Delaware Repair’s defaults, the creditors independently proceeded against the debtor to obtain satisfaction of their respective debts. Delaware Repair turned over all of its assets to Delaware Truck through a surrender agreement, which included its accounts receivable and inventory. Plaintiff realized $98,000 from the proceeds of the accounts receivable. Royal Bank separately obtained a default judgment against Delaware Repair. Royal Bank then made a claim against Delaware Truck, presumably when it learned that Delaware Truck had obtained the accounts receivable and had proceeded to collect them. Royal Bank and Delaware Truck entered into an assignment and subordination agreement whereby Delaware Truck paid Royal Bank $59,500 and Royal Bank assigned to plaintiff its $62,000 default judgment against Delaware Repair, together with the personal guaranties and its secured collateral.

The lower courts held diametrically opposing views of the legal consequences of those transactions. As earlier mentioned, the trial court found that Delaware Truck had properly obtained the senior security interest in defendant’s assets because it had filed a financing statement before Royal Bank, and had later received an assignment of Royal Bank’s interest. The Appellate Division, however, found that Royal Bank was the *29first to file a financing statement with specific reference to the accounts receivable, and determined that Royal Bank had the senior security interest in the accounts receivable. We conclude that the evidence of record, consisting only of that produced to support plaintiffs motion for summary judgment, is not sufficient as a matter of law to sustain a judgment for Delaware Truck, the moving party, as found by the trial court, or for defendants, the debtor, Delaware Repair, and the individual guarantors, as determined by the Appellate Division.

According to the Appellate Division, Delaware Truck, as the junior creditor, when it came into possession of the accounts receivable by way of the surrender by Delaware Repair, held those receivables only as a trustee or agent on behalf of Royal Bank because the latter had a senior security interest in the receivables. Hence, plaintiff’s collection of Delaware Repair’s accounts receivable was deemed to be on behalf of Royal Bank, and its subsequent payment of the proceeds from the receivables to the bank satisfied and extinguished Delaware Repair’s debt to Royal Bank. With the disappearance of the debt, the security for the debt likewise evanesced.

It is readily inferable that both Delaware Truck and Royal Bank, in the settlement between them, did not intend to satisfy and thereby discharge the underlying obligations of defendants to Royal Bank. Ordinarily, the intention of the parties determines whether a transfer of money by a third person to a creditor constitutes a discharge or purchase of an underlying debt or note. See Bills and Notes, 10 C.J.S. 451 (“Whether a payment by a stranger was intended in fact to be a payment or a purchase is to be gathered from their acts and declarations and the surrounding circumstances. * * * [I]t is the agreement between the third person [purchaser] and the holder that controls.”); see also Mt. Holly State Bank v. Washington Hotel, 220 N.J.Super. 506, 510, 532 A.2d 1125 (App.Div.1987) (recognizing whether giving of note extinguishes old debt depends on intention of the parties); Payment, 60 *30Am Jur 2d § 82 (“where a third person pays an obligation of another under agreement with the creditor that it is not to operate as an extinguishment of the debt, it will not have that effect”). This rule may apply to transactions between junior and senior creditors. E.g., Ottenheimer Publishers v. Regal Publishers, 626 S.W.2d 276 (Tenn.Ct.App.1981) (junior secured creditor did not intend to satisfy underlying debt owed to senior creditor when junior creditor collected debtor’s accounts receivable after debtor’s insolvency; therefore an assignment to junior creditor of senior’s rights against debtor on payment of collected proceeds to senior creditor was not enforceable).

Thus, from the face of the documents evidencing the transaction, it appears that Delaware Truck and Royal Bank mutually intended to transfer, not extinguish, Delaware Repair’s underlying debt to Royal Bank. However, regardless of that intent, the Appellate Division may have been correct in concluding that the debt was extinguished as a matter of law. As stated earlier, Royal Bank had priority security interest in Delaware Repair’s accounts receivable. That priority interest endured even after plaintiff liquidated the receivables and realized their proceeds. N.J.S.A. 12A:9-306(2) (stating that priority of a creditor holding a perfected security interest continues in proceeds from disposition of collateral); see discussion, supra, at 27-28, 618 A.2d at 307. Consequently, in the absence of countervailing considerations, Royal Bank had a right to require plaintiff to disgorge the proceeds of the accounts receivable to the extent of its priority lien interest. New Hampshire Business Dev. Corp. v. F.R. Lepage Bakery Inc., 832 F.2d 7 (1st Cir.1987). Therefore, despite the contrary intentions of the parties, we cannot discount the force of the Appellate Division’s conclusion that plaintiff was acting as a constructive trustee on Royal Bank’s behalf.

The hesitancy that we have in affirming that determination is based on the absence in the record of evidence relating to the circumstances surrounding Royal Bank’s claim against Dela*31ware Truck and the settlement of that claim. The record does not sufficiently indicate whether Royal Bank knew, expected, or reasonably anticipated that the accounts receivable would be turned over to Delaware Truck and whether the collections of those receivables would be applied first to Delaware Repair’s debt of Delaware Truck. Conversely, the record is silent with respect to Delaware Truck’s knowledge or expectations in obtaining the accounts receivable and ignoring Royal Bank’s priority when it collected the proceeds of those receivables. The record does not inform us whether Delaware Truck had any claim of right to the accounts receivable sufficient to justify its collection and application of some portion of their proceeds to its debt, or whether it had any valid defenses by way of bar or set-off to Royal Bank’s later demand that the collected moneys be paid over.

For example, plaintiff alleges that not all of the moneys collected by it on accounts receivable were in fact moneys subject to the superior claim of Royal Bank. The record indicates that plaintiff was first to file a financing statement with respect to “inventory.” When a secured party has a security interest in the debtor’s inventory that is covered by a properly-filed financing statement, and the debtor sells the inventory on • open account creating accounts receivable, the creditor automatically retains a perfected security interest in those accounts receivable. N.J.S.A. 12A:9-306(3). See 2 James J. White & Robert S. Summers, Uniform Commercial Code, 346 (3d ed. 1988). Plaintiff arguably was therefore entitled to collect any inventory-generated accounts receivable and apply the proceeds in satisfaction of the debt owed by Delaware Repair. N.J.S.A. 12A:9-504(1)(b) and N.J.S.A. 12A:9-502.

Because the status of Delaware Truck in collecting the accounts receivable is determinative of its right as assignee to enforce Royal Bank’s remedies against the debtors-guarantors, the intentions and expectations of the latter in surrendering the accounts receivable to Delaware Truck may also be relevant. *32As noted, Royal Bank sued to recover the loan guaranteed by defendants approximately six months after defendants had surrendered the accounts receivable to Delaware Truck and, presumably, after Delaware Truck had begun to collect the receivables. Delaware Repair and the individual guarantors defaulted in that suit. However, the record is silent with respect to whether defendants took the position, as they do now, that Royal Bank’s debt had already been satisfied via the surrender of accounts receivable to, and their collection by, Delaware Truck. The defendants’ apparent failure to raise that defense, or to claim any set-offs, or to seek to implead Delaware Truck as the holder, constructive trustee, or agent of a fund owed Royal Bank, bear on whether defendants believed Delaware Truck could reduce its own larger claim against defendants without first satisfying the underlying debt of Royal Bank.

An additional circumstance that bears on the understanding and expectation of defendants with respect to whether the disposition of the accounts receivable served to extinguish Royal Bank’s debt is the nature and purpose of the guaranty defendants gave Royal Bank and the understanding of defendants in providing that guaranty. The guaranty on its face gives broad rights to Royal Bank. It states that it is “a continuing, absolute and unconditional guaranty” and may be enforced “without first resorting to any security or other property or invoking other available rights or remedies.” Thus, under the guaranty Royal Bank had virtually uncontrolled discretion to deal with the collateral, including the right to assign it. See Lenape State Bank v. Winslow Corp., 216 N.J.Super. 115, 127-28, 523 A.2d 223 (App.Div.1985) (unconditional guaranty grants lender full power, in its uncontrolled discretion and without notice to debtor, to deal in any manner with debtor’s liabilities and collateral). Arguably, those rights included the right to foreclose on the guarantors’ mortgage and forego its other security interests. N.J.S.A. 12A:9-501(4); see also Lenape State Bank, supra, 216 N.J.Super. at 130, 523 *33A.2d 223 (secured party can either proceed against personal property under U.C.C. and real property pursuant to New Jersey real-property law or proceed against both real and personal property under New Jersey real-property law). Thus, on Delaware Repair’s default, Royal Bank was free to seek recourse directly against the guarantors and to enforce any of its security interests to satisfy its debt. Id. at 126, 523 A.2d 223 (unconditional guaranty permits creditor to move against guarantor without first acting against either collateral or principal debtor).

Moreover, under the doctrine of marshalling assets in an action against defendants, Royal Bank might have had an obligation under the personal guaranties to proceed against the real-estate mortgage in order to enable plaintiff to achieve a recovery out of the accounts receivable. See Meyer v. United States, 375 US. 233, 84 S.Ct. 318, 11 L.Ed.2d 293 (1963) (recognizing that court may compel senior creditor who can elect to satisfy claim from one of two available funds belonging to debtor to resort first to the fund unavailable to junior creditor). Hence, in the context of this case, it would also be relevant to determine whether the guarantors, the Wilsons, when signing the guaranty and mortgage, knew or should have known that the bank could, in effect, forego its priority in the receivables, or, indeed, whether in the face of the Wilsons’ imminent or actual bankruptcy, the bank would be required or expected to defer to Delaware Truck as the junior creditor with respect to the accounts receivable. Despite the broad range of remedial rights under the guaranty, the record is devoid of any evidence that would tend to show that Royal Bank reasonably would have pursued any particular remedy under the guaranty to the exclusion of another, or whether in its settlement with Delaware Truck it intended to select among the remedies provided by the guaranty.

Finally, it seems clear that defendants’ claim that the personal guaranties were discharged because the collateral held *34by Royal Bank had been impaired through its liquidation is not sustainable. Guarantors may waive their rights to claim impairment of collateral as a defense in the guaranty agreement. Such a waiver, however, must be unequivocal before it will effectively preclude a guarantor from asserting the defense. Langeveld, v. L.R.Z.H. Corporation, 74 N.J. 45, 376 A.2d 931 (1977).

These several considerations appear material to whether plaintiff, Delaware Truck, improperly enhanced its position by paying itself $98,000 due Royal Bank and later by taking an assignment of the subject mortgage; and whether Royal Bank, though well within its rights to assign its default judgment and security interests, including defendants’ personal guaranty secured by their residential mortgage, merely received a sum that was equivalent to the amount of the bank’s judgment against defendants. Additional evidence should inform the determination of whether plaintiff and Royal Bank entered into a valid settlement permitting plaintiff to foreclose on defendants’ residence.

Ill

We do not purport to resolve any of the factual issues that appear germane to proper determination of the claims in this case, or to intimate the weight, if any, to be ascribed to any facts that are found. While we cannot on this record indicate that any particular determination of these issues would dictate a resolution in favor of either party, the relevance of these issues forestalls a motion for summary judgment based on the current record.

In conclusion, we reverse the judgment of the Appellate Division, and remand this matter to the trial court for further proceedings consistent with this opinion.

Timothy Realty Corporation, the owner of the property on which Delaware Repair’s operations were being conducted, was also a plaintiff. The debtor apparently had defaulted on its rental obligations to Timothy Realty in 1985. The record does not disclose the dispositions relating to this plaintiff or defendant George Fandrick.