Telemart Enterprises, Inc., Matter of

• Decision Date: 17 September 1975
• Docket Number: No. 73-2694,73-2694
• Citation: 524 F.2d 761
• Parties: 17 UCC Rep.Serv. 881 In the Matter of TELEMART ENTERPRISES, INC., Bankrupt. ALFRED M. LEWIS, INC., Petitioner-Appellant, v. Lawrence HOLZMAN, Trustee, Appellee.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 761

524 F.2d 761

17 UCC Rep.Serv. 881

In the Matter of TELEMART ENTERPRISES, INC., Bankrupt.

ALFRED M. LEWIS, INC., Petitioner-Appellant, v. Lawrence HOLZMAN, Trustee, Appellee.

No. 73-2694.

United States Court of Appeals, Ninth Circuit.

Sept. 17, 1975.

Order Nov. 6, 1975.

Norman R. Allenby (argued), San Diego, Cal., for petitioner-appellant.

David A. Block (argued), San Diego, Cal., for appellee.

OPINION

Before CHAMBERS, CHOY and GOODWIN, Circuit Judges.

CHOY, Circuit Judge:

Telemart Enterprises, Inc., is a California corporation formed to engage in the sale and delivery of retail merchandise primarily grocery goods in response to telephone orders. Telemart opened for business on September 13, 1970, experienced immediate operational difficulties, and petitioned for a Chapter XI arrangement on September 29.

Alfred M. Lewis, Inc. (Lewis), sold frozen foods and groceries worth $61,587.43 on credit to Telemart. Lewis had delivered this merchandise throughout the period from August 27 to September 25. On September 30, having learned of Telemart's Chapter XI petition, Lewis demanded return of the delivered goods pursuant to section 2-702(2) of the Uniform Commercial Code (Calif.Comm.Code § 2702(2)). The referee in bankruptcy denied Lewis' petition for reclamation on the ground that Lewis had failed to prove that Telemart was insolvent at any time before September 29. The district court affirmed without opinion. Lewis appeals, claiming not only errors in the referee's findings, but violations of his procedural rights before the bankruptcy court. We reverse and remand for a new hearing.

Statutory Lien

The trustee asserts at the outset that UCC § 2-702(2) ¹ is invalid against him because it is statutory lien which first becomes effective upon the insolvency of the debtor. Bankruptcy Act § 67c(1)(A), 11 U.S.C. § 107c(1)(A). ² His argument that the right to reclaim has the same effect as a lien has found increasing support recently from courts and commentators. In re Good Deal Supermarkets, Inc., 384 F.Supp. 887 (D.N.J.1974); In re Federal's, Inc., 12 UCC Rep.Serv. 1142 (E.D.Mich.1973); Countryman, Buyers and Sellers of Goods in Bankruptcy, 1 New Mexico L.Rev. 435 (1971). ³ We believe, however, that to so hold would violate Congress' intent in enacting section 67c.

One principal goal of the Bankruptcy Act is to distribute the bankrupt's assets equitably among all of his creditors. ⁴ At the same time, Congress has maintained a general policy of recognizing property interests established by state law. Thus, section 70a vests the trustee only "with the title of the bankrupt as of the date of the filing of the petition . . . ." 11 U.S.C. § 110a. The trustee is subject to the same defenses as the bankrupt from whom he derives his title. See Bank of Marin v. England, 385 U.S. 99, 101, 87 S.Ct. 274, 17 L.Ed.2d 197 (1966); Donaldson v. Farwell, 93 U.S. 631, 23 L.Ed. 993 (1876). These two policies are inherently contradictory, and much of the history of the Act chronicles successive attempts by Congress to strike a proper balance between the interests involved. See Marsh, Triumph or Tragedy? The Bankruptcy Act Amendments of 1966, 42 Wash.L.Rev. 681, 732-33 (1967).

The Act's handling of statutory liens has been one focal point of this conflict. The Act frustrates a debtor's attempt to prefer some creditors over others by invalidating transfers on account of antecedent debts made while insolvent and within four months of the date of bankruptcy. Section 60, 11 U.S.C. § 96. A lien, of course, is an interest in property. Before 1938, however, section 60 did not conflict with a state's power to define property interests by creating liens. The courts consistently held that liens created by state statute were immune from invalidation under section 60 as it then read. See In re San Joaquin Valley Packing Co., 295 F. 311, 313-14 (9th Cir. 1924); 3 Collier, Bankruptcy P 60.12 (14th ed. 1975). The Chandler Act of 1938 amended section 60, however (ch. 575, § 1, 52 Stat. 840, 869-71), and expanded the definition of a "transfer" to include creation of a lien. Bankruptcy Act § 1(30), 11 U.S.C. § 1(30). To insure that statutory as opposed to consensual liens would remain valid, even though created within four months of bankruptcy and while the debtor was insolvent, they were expressly excepted from the expanded sweep of section 60. Bankruptcy Act § 67b, 11 U.S.C. § 107b. Congress thus deferred to policy decisions by the states to favor certain classes of creditors by creating property interests in their behalf. Comment, Liens and Fraudulent Transfers Under the Chandler Act, 87 U.Pa.L.Rev. 317, 321-22 (1939); Comment, Statutory Liens Under Section 67c of the Bankruptcy Act, 62 Yale L.J. 1131, 1136 (1953).

This deference to state-created liens led to abuses. The Chandler Act abolished state statutory priorities among unsecured creditors at the same time that it recognized state liens. In section 64 of the Bankruptcy Act, it established five classes of general creditors entitled to successive priority in the distribution of the bankrupt's general assets. Creditors' groups quickly exerted pressure on state legislatures to preserve their favored position by upgrading their state priorities to the status of liens, thus perpetuating the conflict between state and federal priorities which the Chandler Act had been expected to end. Section 67c, as amended in 1966, is an attempt to minimize state conflicts with federal priorities by invalidating as against the trustee some of the more obviously spurious liens, those which function more as priorities in bankruptcy than as property interests. See Sen.Rep.No.1159, 89th Cong., 2d Sess., 1966 U.S.Code Cong. & Ad.News 2456, 2461.

Section 67c is thus a remedial trimming-back of the special exemption conferred on statutory liens by section 67b. It was not intended to serve as a new tool by which the trustee could cut down provisions of state law obviously not entitled to the benefits of section 67b. As discussed below, under section 2-702(2) receipt of goods on credit while insolvent is deemed a fraud on the creditor rendering the sale voidable. The sale thus is defective from its inception. Clearly no new security has been given for an antecedent debt; the "lien," if it is conceived as such, attached at the instant the debt was created. Because no transfer is made on account of an antecedent debt, section 60 could never be applicable. Section 2-702(2) clearly, therefore, was not an attempt to escape the effect of section 60 by creating a spurious statutory lien, and enactment of section 2-702(2) did not present the abuse which section 67c was designed to combat. Accordingly, we would not be justified in using section 67c to strike down UCC § 2-702(2).

Disguised State Priority

The trustee suggests that even if section 2-702(2) is not a statutory lien, it is the result nonetheless of an analogous attempt by the state to give sellers of goods a priority in bankruptcy. Even if not invalid under section 67c, therefore, we should strike it down as in conflict with the policy against recognition of state priorities and with the federal scheme of priorities established by section 64 of the Act. We disagree.

Although the Act pursues a basic policy of deference to state definitions of property, giving the trustee only those interests in property possessed by the bankrupt under state law, this policy is an "interstitial" rule to be observed only when a more express provision of the Act does not command otherwise. Bank of Marin, 385 U.S. at 105, 87 S.Ct. 274 (Harlan, J., dissenting). The trustee's power under section 60 to avoid certain preferential transfers is but one instance in which he is armed with greater powers over property than was the bankrupt. We have held that a state-created property interest which functions in practice as a state priority is similarly ineffective against the trustee. Elliott v. Bumb, 356 F.2d 749 (9th Cir. 1966).

In Elliott, a California statute provided that a licensed issuer of money orders held the proceeds of the sale in trust for the benefit of the purchaser; furthermore, if the issuer commingled the proceeds with his own assets, all his assets were impressed with a trust in the amount of the proceeds. We held that identifiable funds were properly held in trust. We invalidated application of the statute to commingled funds, however. By relieving the purchaser of his normal obligation to trace the proceeds of the sale, the law in effect gave the purchaser a priority over other general creditors in the unsecured portion of the bankrupt's estate. ⁵

The distinction drawn in Elliott is instructive. Under state law, the issuer of the money order accepted payment only in the capacity of a trustee; he never held absolute ownership of the funds. We respected the state's definition of the issuer's relationship to those paid-in funds. On the other hand, we disregarded the state's attempt to impose a "trust" on funds whose ownership had vested previously in the issuer. Regardless of the state's terminology, the effect of the statute was to give one class of creditors purchasers of money orders priority in the distribution of the bankrupt issuer's general assets.

The difficulty in applying this distinction to section 2-702(2) results from the UCC's policy against defining rights and duties between parties in terms of "title." The Code does provide that in situations not covered by the Code in which title is material, title shall be deemed to pass upon physical delivery of the goods. UCC § 2-401(2). A reservation of title by the seller is to be regarded as reservation of a security interest. UCC § 2-401(1). Hence, title to the goods in question did pass from Lewis to Telemart.

The Code nowhere discusses the concept of a voidable transfer of title. The right of a seller under section 2-702(2) to reclaim goods and be restored to his pre-sale status is, however,...