U.S. v. Handy and Harman

• Decision Date: 28 December 1984
• Docket Number: No. 83-5697,83-5697
• Citation: 750 F.2d 777,39 UCC Rep. Serv. 1553
• Parties: 39 UCC Rep.Serv. 1553 UNITED STATES of America, Plaintiff-Appellee, v. HANDY AND HARMAN, a New York corporation, Defendant-Appellant.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 777

750 F.2d 777

39 UCC Rep.Serv. 1553

UNITED STATES of America, Plaintiff-Appellee, v. HANDY AND HARMAN, a New York corporation, Defendant-Appellant.

No. 83-5697.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted Feb. 9, 1984.

Decided Dec. 28, 1984.

George H. Wu., Asst. U.S. Atty., Los Angeles, Cal., for plaintiff-appellee.

Martin S. Zohn, Pacht, Ross, Warne, Bernhard & Sears, Inc., Los Angeles, Cal., for defendant-appellant.

Appeal from the United States District Court for the Central District of California.

Before BROWNING, Chief Judge, and GOODWIN and KENNEDY, Circuit Judges.

GOODWIN, Circuit Judge.

Handy & Harman appeals from a judgment for the United States for the value of certain metal that Handy & Harman had purchased and in which the Small Business Administration had a security interest perfected in one state but not in the state where collection was attempted.

In 1978, Coronado Trading Co., a New Mexico-based manufacturer of jewelry, borrowed $200,000 from Albuquerque National Bank. The loan was guaranteed by the Small Business Administration. To secure the loan, Coronado gave the bank a security interest in its inventory and accounts receivable. The bank perfected the security interest by filing a financing statement with the appropriate office in New Mexico.

Coronado had a continuing trade relationship with Handy & Harman, a dealer in precious metals. From time to time Coronado purchased gold and silver from Handy & Harman. Coronado also regularly sent scraps of precious metals and crucibles left over from jewelry making, collectively known as "refining lots," to Handy & Harman's refining facilities in California. Handy & Harman's practice was to refine and assay this material, and determine the value of the metal. Coronado could then choose to receive the value of the metal, less charges for refining and assay, in a variety of ways. Coronado could direct Handy & Harman to (1) consign to Coronado's account metals with a value equivalent to that of the refining lot; (2) credit Coronado's account with the dollar amount of the refining lot; or (3) remit the value of the lot directly to Coronado by check.

By June of 1980, Coronado had defaulted on its bank loan, and the bank assigned the loan and security interest to the SBA. After the default but prior to any litigation, Coronado sent several refining lots to Handy & Harman and requested payment by check for the value of the lots after refining. At that time Coronado owed Handy & Harman roughly $30,000 for previous purchases of metal. In July 1980, the Small Business Administration notified Handy & Harman by telephone and in writing that it had a security interest in Coronado's inventory and demanded return of the scraps or of the refined metal.

In November 1980, Handy & Harman informed Coronado that it had credited the value of the June refining lots against Coronado's debt to Handy & Harman. Because the value of Coronado's refining lots was less than the amount of Coronado's debt, Handy & Harman remitted nothing to Coronado or to the government for the refining lots. The government sued Handy & Harman for the return of the metal or its value and prevailed in the district court.

Handy & Harman's appeal presents a conflict between the holder of a security interest in collateral, the United States, and a purchaser of that collateral, Handy & Harman. The parties agree that California's version of the Uniform Commercial Code governs this case. See Cal.Com.Code Secs. 1105, 9103(1)(b) (West Supp.1984). ¹ As a general rule, when collateral subject to a security interest is sold, the security interest continues in both the collateral and in the proceeds generated by the sale. Sec. 9306(2). We must determine the rights of the parties to both the collateral itself and to the proceeds of the collateral.

I. Rights to the collateral.

Except where the code provides otherwise, "a security interest continues in collateral notwithstanding sale, exchange or other disposition thereof unless the disposition was authorized by the secured party...." Sec. 9306(2). Where the collateral consists of goods, such as the refining lots in this case, the code makes two exceptions to this general rule: (1) a buyer in ordinary course of business takes the collateral free of all security interests created by the seller of the goods, even perfected ones, Sec. 9307(1); and (2) a buyer not in ordinary course of business takes the collateral with rights superior to unperfected security interests in the collateral if he meets the requirements of Sec. 9301(1)(c). See U.C.C. Sec. 9-306 official comment 3 (1977).

Because there is no evidence that the bank or the Small Business Administration authorized the sale of the refining lots outside the ordinary course of business, Handy & Harman must fit within one of these exceptions in order to take the collateral free of the government's security interest.

The security agreement between Coronado and the bank authorized Coronado to "sell the Inventory in the ordinary course of business." This authorization applies to the refining lots. They were "inventory" as defined both in the security agreement and in the code. See Sec. 9109(4). ² Because the security agreement uses the code terms "ordinary course of business," we conclude that the security agreement's authorization to sell the collateral has the same effect as Sec. 9307(1), permitting a buyer in ordinary course of business to take the collateral free of all security interests created by the seller. Therefore we do not separately consider whether the sale to Handy & Harman complies with the authorization in the security agreement, but turn directly to the question whether it falls within Sec. 9307(1).

A. Buyer in ordinary course of business.

Contrary to the district court's conclusion, Handy & Harman does not qualify for status as a buyer in ordinary course of business and thus cannot take the collateral free of the government's security interest under Sec. 9307(1).

Section 1201(9) defines "buyer in ordinary course of business." Most important for this case is its proviso that " '[b]uying' may be ... on secured or unsecured credit ... but does not include a transfer ... in total or partial satisfaction of a money debt." By barring a purchaser who takes goods in satisfaction of a debt from ordinary course status, the code requires that a buyer in ordinary course of business give new value for the goods. J. White & R. Summers, Handbook of the Law under the Uniform Commercial Code Sec. 25-13 (2d ed. 1980); Skilton, Buyer in Ordinary Course of Business under Article 9 of the Uniform Commercial Code (and Related Matters), 1974 Wis.L.Rev. 1, 30 n. 75. ³

The new value requirement is central to the functioning of the code's system of inventory financing. Inventory is valuable to a merchant only if he can sell it to his customers. If the merchant's inventory financer could foreclose the security interest in the goods after they had been sold, prospective customers would be reluctant to buy the merchandise. Recognizing this Sec. 9307(1) facilitates sales of inventory by providing that the ordinary buyer of inventory ⁴ takes the goods free of any security interest, even if he knows that they are subject to a security interest, so long as he does not have actual knowledge that the sale violates the terms of a security agreement. See Sec. 9307(1) and U.C.C. Sec. 9-307 official comment 2 (1977).

At the same time, the rule of Sec. 9307(1) is carefully limited to avoid unduly endangering the position of the inventory financer. By incorporating the definition of buyer in ordinary course of business, Sec. 9307(1) permits a buyer of inventory to take the inventory free of a security interest only if he gives some new value in exchange for the inventory. The inventory financer is protected because his security interest in the inventory will attach to the new value, which constitutes "proceeds" of the inventory. See Sec. 9306(2). If the rule were otherwise, and a transferee of inventory who received the goods in satisfaction of a pre-existing debt were permitted to keep them free of security interests, the effect would be to enable an unsecured creditor--the transferee--to bootstrap himself into priority over the secured creditor who looks to the inventory for security. The new value requirement should be strictly construed to preclude the frustration of the code's priority provisions.

This case illustrates the problem created when Handy & Harman decided to treat its promise to pay Coronado for the refining lots as subject to a set off against the debt Coronado already owed to Handy & Harman. While the set off was legal, it was inconsistent with the new value requirement. We conclude that Handy & Harman may not claim the status of a buyer in ordinary course of business. Handy & Harman's exercise of the offset created the very problem that the new value requirement was designed to prevent. Because of the offset, Coronado received no money to which the government's security interest could attach. The government is left in exactly the same position that it would occupy if Handy & Harman had never promised to pay Coronado and had taken the collateral in partial satisfaction of Coronado's debt in the first place.

We hold only that a buyer of goods on credit cannot qualify for ordinary course status under Sec. 1201(9) if he subsequently offsets his promise to pay with a debt that was in existence at the time he bought the goods. We do not hold that all defenses to, or offsets of, a buyer's promise to pay will disqualify the buyer from status as one in ordinary course of business. It may be, for example, that a buyer of goods on credit could assert a breach of warranty defense to his promise to pay without losing his status as a buyer in ordinary course. We do not decide that question, but note only that such a defense would not have the effect of offsetting the...