Garrett B. Hannegan
James C. Tucker
Morgan & Pottinger, P.S.C.
New Albany, IndianaAttorneys for Appellee
Tucker and Tucker
Garrett B. Hannegan
James C. Tucker
HCC CREDIT CORPORATION,
f/k/a HESSTON CREDIT CORP.,
Appellant (Plaintiff below),
SPRINGS VALLEY BANK & TRUST,
Appellee (Defendant below).
) Supreme Court No.
) Court of Appeals No.
Lindsey Tractor Sales, Inc., sold 14 tractors to a customer and used the $199,122 proceeds to pay off the debt it owed Springs Valley Bank & Trust. Yet HCC Credit Corporation had financed Lindsey's purchase of the tractors and held a valid and perfected security interest in both the tractors and the proceeds from their sale. Because we hold that the payment to the bank was not in the
ordinary course of the operation of Lindsey's business,
HCC is entitled to recover the $199,122.
Lindsey Tractor Sales, Inc., purchased wholesale farm equipment from Hesston Corporation
for resale in Lindsey's French Lick farm machinery sales and service business. At the times relevant
to this case, HCC Credit Corporation provided financing for the purchases.
Written contracts governed the relationship between Hesston and HCC and Lindsey,
including a security agreement. In the security agreement, Lindsey granted HCC a security interest
in all the equipment it purchased from Hesston and in the proceeds from the sale of the equipment.
Lindsey also agreed to pay HCC immediately for equipment sold from the proceeds of the sale.
However, at no time did Hesston or HCC require Lindsey to deposit or segregate proceeds from the
sale of Hesston products in a separate account.
The parties agree and the trial court found that the security agreement was binding and
enforceable against Lindsey, that Lindsey understood the purpose and effect of the security agreement (including the requirement of paying for equipment immediately when sold), and that HCC had
a valid and perfected security interest in the equipment and proceeds from the sale thereof.
In 1991, the Indiana State Department of Transportation agreed to purchase from Lindsey 14 Hesston tractors. Lindsey acquired the tractors from Hesston on credit provided by, and subject
to the security agreement in favor of, HCC. Lindsey received payment from the State on August 15,
1991, and deposited the proceeds of $199,122 in the company's checking account at Springs Valley
Bank & Trust. At the time of the deposit, Lindsey had $22,870 in other monies on deposit in the
account. On the next day, August 16, 1991, Lindsey wrote a check on this account payable to the
bank for $212,104.75.
Lindsey's payment to the bank of the proceeds from the sale of the tractors was applied to
pay debts owed by Lindsey to the bank. These debts were evidenced by four promissory notes dated
January 23, 1987, November 19, 1990, February 7, 1991, and February 13, 1991. All four represented previously refinanced debts and t
hree of them were not yet due when they were paid on
August 16. The bank and Lindsey did not discuss paying off the four notes with Lindsey prior to
their payment, nor did the bank seize the account to pay the notes. More specifically, Lindsey did
not tell anyone associated with the bank that $199,122 of the $212,104.75 used to pay off the notes
was from the sale of Hesston products. On the other hand,
during the previous eight years Lindsey
had borrowed funds or refinanced debts in excess of 100 times with the bank. The average debt
balance outstanding during that period was between $100,000 and $200,000. After the notes were
paid with the proceeds from the sale of the tractors, Lindsey owed the bank between $2,000 and
Lindsey filed a bankruptcy liquidation proceeding in December of 1991, and dissolved shortly
Under both the terms of the security agreement between the parties and the provisions of
Article 9 of the Uniform Commercial Code as adopted by our legislature, HCC had a valid and
perfected security interest in the $199,122 proceeds from the sale of the tractors. See Ind.Code §
26-1-9-306(2) (a security interest continues . . . in any identifiable proceeds including collections
received by the debtor). If this were the end of the matter, there is no question but that HCC would
be entitled to the money: U.C.C. Article 9 gives the secured party, upon a debtor's default priority
over 'anyone, anywhere, anyhow' except as otherwise provided by the remaining [U.C.C.] priority
rules. Citizens Nat'l Bank of Whitley County v. Mid-States Dev. Co., 177 Ind.App. 548, 557, 380
N.E.2d 1243,1248 (1978) (citing Ind.Code § 26-1-9-201; other citations omitted).
But in promulgating the 1972 version of Article 9 of the Uniform Commercial Code, the National Conference of Commissioners on Uniform State Laws (NCCUSL) appended the following
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 the ordinary course. The law of
fraudulent conveyances would no doubt in appropriate cases support recovery of
proceeds by a secured party from the transferee out of ordinary course or otherwise
in collusion with the debtor to defraud the secured party.
U.C.C. § 9-306 cmt. 2(c) (1972), 3 U.L.A. 441 (1981) (emphasis supplied). We will refer to this
official comment in this opinion as Comment 2(c).
Although our legislature has never adopted the NCCUSL comments as authoritative,See footnote 1 there seems to be general agreement that, at least to some extent, Comment 2(c) is an exception to the Indiana U.C.C.'s general priority rules.See footnote 2 The bank argues that in this case, the proceeds were paid out of Lindsey's checking account in the operation of Lindsey's business and that the payment was made in the ordinary course without any collusion with the debtor. As such, the bank contends, Comment 2(c) operates to provide that the bank received the $199,122 free of any claim which HCC
had in it as proceeds.See footnote
The trial court and Court of Appeals adopted this rationale. HCC now seeks
transfer, arguing that its perfected security interest entitles it to the proceeds.
At a certain level of abstraction, this case requires us to assess the relative rights of a secured
creditor to the proceeds of its collateral and of a third party to whom the debtor transfers those
proceeds. Sound commercial policy considerations can be marshaled in support of both the rights
of the secured party and the rights of the transferee.
Commercial policy considerations supporting the rights of a secured party are well set forth well by Judge Garrard in Citizens National Bank.See footnote 4 In that case, the debtor sold collateral in which a party held a valid and perfected security interest. When the debtor deposited the proceeds in the debtor's bank account, the bank exercised a contractual right of set-off. In weighing the bank's right
to set-off against the secured party's interest in the proceeds, the court found that a
should be able to rely on its compliance with the U.C.C.'s requirements for perfection and its search
of the public recording system as against the unrecorded interest of the setting-off bank. 177
Ind.App. at 559, 380 N.E.2d at 1249.
Were this otherwise, Judge Garrard wrote, a secured party
with an interest in proceeds could not rely on recording. Id. Instead, he reasoned, the secured
party would be required to take additional steps to insure full protection such as requiring special
accounts or inquiring into loan transactions which are not a matter of public record. 177 Ind.App.
at 559, 380 N.E.2d at 1250.
Putting such a duty on a secured party, as well as permitting a bank
to prevail if that duty is not met, undercuts significant values of certainty, efficiency and reliance
which are at the heart of the [U.C.C.'s] emphasis on public filing. Id.
The court also noted that while it might be a safe practice for a secured party to require that
proceeds be payable to it before future advances to the debtor
are made, it is purposefully not
required by the [U.C.C.] for the maintenance of a proceeds security interest since it tends to curtail
commercial practice and business operation. Id. In holding for the secured party, Judge Garrard
concluded that if U.C.C. Article 9 is to be a comprehensive system for the perfection of security
interests in personal property we see no reason for requiring special standards, with their increased
costs, that must be met if a secured party is to prevail over a bank's right of set-off. The [U.C.C.'s]
priority rules are sufficient. Id.
In Citizens National Bank, the conflicting interests were between the creditor's perfected security interest and the bank's right to set-off. In the case before us, the conflicting interests are
between HCC's perfected security interest and the bank's asserted right as ordinary course transferee.See footnote
As such, the result in Citizens National Bank does not dictate the result here. But Citizens
helps us understand the policy interests that favor enforcing HCC's perfected security
interest _ that requiring secured parties to take steps beyond those specified in Article 9 to protect
their interests undercuts significant values of certainty, efficiency and tends to curtail commercial
practice and business operation.
Just as Judge Garrard gives sound policy reasons in Citizens National Bank for enforcing perfected security interests, there are sound policy reasons for allowing third party transferees to retain proceeds of another's collateral. When he was a judge of the United States Court of Appeals for the First Circuit, Justice Breyer had occasion to address this subject: If . . . courts too readily impose liability upon those who receive funds from the debtor's ordinary bank account _ if, for example, they define 'ordinary course' of business too narrowly _ then ordinary suppliers, sellers of gas, electricity, tables, chairs, etc., might find themselves called upon to return ordinary payments . . . to a debtor's secured creditor, say a financier of inventory. Harley-Davidson Motor Co., Inc. v. Bank of New England-Old Colony, N.A., 897 F.2d 611, 622 (1st Cir. 1990) (internal citation omitted).
Harley-Davidson makes a strong statement of the policy interests supporting the bank's claim
to the $199,122. But it is interesting to note that despite Judge Breyer's conception of the commercial utility of a fairly broad meaning for ordinary course, his court was unwilling to find that the
transferee bank in the Harley-Davidson case was entitled to summary judgment.
Judge Garrard's opinion in Citizen's National Bank and Judge Breyer's in Harley-Davidson
each illustrates the way the U.C.C. streamlines legal impediments to commerce: reducing the burden
on perfected secured parties in the former and reducing the burden on ordinary course payees in the
latter. But the drafters of the U.C.C. recognized that these two efforts could come into conflict as
they do in this case. Comment 2(c) is meant to resolve that conflict.
Comment 2(c) is not a statute and is not written in the form of a statute; it does not set forth a tightly-worded rule, followed by equally tightly-worded elements necessary to establish its application. Rather, it is a narrative collection of three sentences from which we conclude that a recipient of a payment made in the ordinary course by a debtor takes that payment free and clear of any claim that a secured party may have in the payment as proceeds. The Comment also tells us that the payment (1) will be in the ordinary course if it was made in the operation of the debtor's business but (2) will not be in the ordinary course if there was collusion with the debtor to defraud the secured party. We do not take these two factors to be the equivalent of statutory elements but rather descriptive of two parameters for determining ordinary course. That is, whether a payment was made in the ordinary course will be a function of (1) the extent to which the payment was made in the routine operation of the debtor's business and (2) the extent to which the recipient was aware that it was acting to the prejudice of the secured party.See footnote 7
in this or related bankruptcy contexts.
As to the awareness of prejudice parameter, it is hard to imagine the recipient of the monthly utility or rent payment having any knowledge that it was being paid with proceeds.See footnote 14 At the other end of the spectrum is actual fraud in which debtor and recipient have colluded against the secured party.See footnote 15 Between these poles will fall payments where the recipient knows that a security interest exists but does not know that the payment is being made in violation of that interest; payments where the recipient had sufficient notice to put a reasonable recipient, exercising prudent business practices, on notice that something was awry; and payments where the recipient has information causing it to suspect strongly that a payment violates a secured party's interest, yet takes deliberate steps to avoid discovering more.See footnote 16
We reaffirm that a security interest continues in any identifiable proceeds of collateral including collections received by the debtor. Ind.Code §§ 26-1-9-201 & 306(2). We also reaffirm that Comment 2(c) is the law of Indiana: a recipient of a payment made in the ordinary course by a debtor takes that payment free and clear of any claim that a secured party may have in the payment as proceeds.See footnote 18 And we hold that whether a transfer of proceeds is in the ordinary course requires an assessment of both (1) the extent to which the payment was made in the routine operation of the debtor's business and (2) the extent to which the recipient was aware that it was acting to the prejudice of the secured party. Because we agree that imposing liability too readily on payees . . . could impede the free flow of goods and services essential to business, J.I. Case, 991 F.2d at 1277, we further hold that the transfer will be free of any claim that a secured party may have in it as
proceeds unless the payment would constitute a windfall to the recipient
. A windfall occurs in this
context when the recipient has no reasonable expectation of being paid ahead of a secured creditor
because of the extent to which the payment was made outside the routine operation of the debtor's
business, because of the extent to which the recipient was aware that it was acting to the prejudice
of the secured party, or because of both of these factors in combination.
While the determination of ordinary course is a question of law, sometimes an evaluation
of the extent to which the payment was routine or the extent of the recipient's knowledge will
require factual analysis. In such a situation, summary judgment would be inappropriate.See footnote
Before applying these principles to the case before us, it is important to discuss
Credit Corp. v. First National Bank of Madison County,
991 F.2d 1272 (7th Cir. 1993)
of the United States Court of Appeals for the Seventh Circuit applying Indiana law to a substantially
identical problem. (J.I. Case served as the principal authority for the Court of Appeals in this case.)
As in the case before us, the debtor in J.I. Case deposited proceeds from the sale of secured agricultural equipment in his business checking account where it was commingled with funds from
The debtor then used the commingled funds to pay creditors other than the secured
creditor, including his bank lender. After careful analysis of whether these payments were payments
and transfers in ordinary course within the meaning of Comment 2(c), the court concluded:
[U]nder Comment 2(c), a payment is within the ordinary course if it was made in the
operation of the debtor's business and if the payee did not know and was not reckless
about whether the payment violated a third party's security interest.
991 F.2d at 1279. The court held that the payments were made in the ordinary course of business
and the secured party was not entitled to recover them
because both (1) the bank did not know that
the debtor's payments violated the secured party's security interest (although the bank did know
about the secured party's security interest) and (2) the bank did not receive payments from the
debtor in reckless disregard of the fact that those payments violated the secured party's security
interest. Id.; accord, ITT Commercial Fin. Corp. v. Bank of the West, 166 F.3d 295, 307 (5th Cir.
Without expressing any view as to the outcome of J.I. Case, it is clear that the Seventh
Circuit's approach focussed exclusively on the awareness of prejudice parameter. As discussed
supra in footnote 16, we generally agree with this analysis. But the court did not independently
examine the extent to which the debtor's payment to the bank was made in the routine operation of
the debtor's business. For this reason, we decline to follow J.I. Case.
We hold that Lindsey's payment of $199,122 to the bank here was not a payment in the
ordinary course of the operation of Lindsey's business.
There is no disagreement as to the following
facts. See Record at 19-20; 374; 418. The bank was aware that HCC had a valid and perfected
security interest in Lindsey's tractor inventory. The bank took this into account in making its
decision to extend credit to Lindsey and did not take a security interest in any of the collateral
covered by HCC's security agreement.
During the eight years prior to the payment at issue here,
Lindsey had borrowed funds or refinanced debt in excess of 100 times with the bank and the average
debt balance owed was between $100,000 and $200,000. Two of the notes Lindsey paid off
represented a refinancing of approximately $225,000 in continuing debt carried by the bank. After
the notes were paid off, Lindsey was in the unprecedented position of owing the bank only between
$2,000 and $15,000. The bank's senior loan officer agreed with HCC's counsel that the $199,122
payment was extraordinary and constituted the largest ever made on any debt Lindsey owed the
bank. The officer also said, Anytime a significant loan balance is paid off you have to look at it as
something that would not be a normal trade transaction, like paying interest or something like that.
The payment to the bank constituted the proceeds of collateral in which HCC had a valid and perfected security interest. The payment was used to liquidate a substantial secured debt which, for the most part, was not due. It was an extremely large payment, the likes of which Lindsey had never made before . And although the bank was not advised that the source of the payment it received constituted the proceeds of HCC's collateral, the bank knew of HCC's perfected security interest.
As such, it had
extended credit to Lindsey with the express understanding that HCC stood in a
superior position to be repaid, at least in certain circumstances. We conclude that the payment was
not in the ordinary course of Lindsey's business. For the bank to prevail would result in a windfall
_ a windfall because the bank had no reasonable expectation that Lindsey could or would liquidate
its debt due the bank in advance of paying HCC for the tractors financed _ at the expense of HCC
which had taken all measures required by the U.C.C. to protect its interest. As a result, the exception to the Indiana U.C.C.'s priority rules provided by Comment 2(c) does not apply and
the bank, is entitled to the $199,122.
Having previously granted transfer, thereby vacating the decision of the Court of Appeals, we
now reverse the judgment of the trial court and remand this matter to the trial court with directions
that summary judgment be entered for HCC and for any further proceedings that may be required.
SHEPARD, C.J., and DICKSON, SELBY, and BOEHM, JJ., concur.
context of buying which is not always applicable in Comment 2(c) disputes (including this one). See ITT Commercial Fin. Corp. v. Bank of the West, 166 F.3d 295, 306 (5th Cir. 1999); Merchants Nat'l Bank & Trust Co. v. United States, 202 Ct. Cl. 343 n.3 (1973). We also note that § 1-201(9) contains a knowledge requirement on the part of the buyer which differs from that which we find required by Comment 2(c). Accord, J.I. Case Credit Corp. v. First National Bank of Madison County, 991 F.2d 1272, 1278 (7th Cir. 1993); contra, Bank of Oklahoma, N.A. v. Islands Marina, Ltd., 918 F.2d 1476, 1481 (10th Cir. 1990); Farmers & Merchants Nat'l Bank v. Sooner Coop., Inc., 766 P.2d 325, 330 (Okl. 1988).
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