Merritt Dredging Co., Inc., In re

• Decision Date: 12 February 1988
• Docket Number: No. 87-2065,87-2065
• Citation: 839 F.2d 203
• Parties: , 5 UCC Rep.Serv.2d 900 In re MERRITT DREDGING COMPANY, INC., Debtor. COMPLIANCE MARINE, INC., Plaintiff--Appellant, v. Kevin CAMPBELL, Trustee--Appellee.
• Court: U.S. Court of Appeals — Fourth Circuit

Page 203

839 F.2d 203

1988 A.M.C. 2339, 5 UCC Rep.Serv.2d 900

In re MERRITT DREDGING COMPANY, INC., Debtor COMPLIANCE MARINE, INC., Plaintiff--Appellant, v. Kevin CAMPBELL, Trustee--Appellee.

No. 87-2065.

United States Court of Appeals Fourth Circuit.

Argued Nov. 5, 1987.

Decided Feb. 12, 1988.

Frederick Albert Gertz (Gertz, Kastanes & Moore, Columbia, S.C., on brief), for plaintiff-appellant.

Kenneth Arthur Campbell, Jr. (Bell, Campbell, Chard & McNeill, Mount Pleasant, S.C., on brief), for trustee-appellee.

Before RUSSELL, WILKINSON, and WILKINS, Circuit Judges.

WILKINSON, Circuit Judge:

In 1983, Merritt Dredging Company entered into an agreement with Compliance Marine, Inc. for the use of a barge. When Merritt filed for bankruptcy in 1984, a trustee took possession of all of Merritt's personal property, including the barge. Compliance sought to recover the barge or the proceeds from its sale, but the bankruptcy court found Compliance's interest in the barge to be subordinate to that of the trustee. The district court affirmed the bankruptcy court's decision, and Compliance appeals. We affirm.

I.

Compliance is a Louisiana corporation with its principal place of business in Louisiana. Merritt is a South Carolina corporation with its principal place of business in that state. In the spring of 1983, Merritt sought from Compliance a barge for use at a project in Mississippi. Compliance prepared and executed a "charter party," which it mailed to Merritt in Charleston, South Carolina. Merritt made certain changes to the charter party, executed it, and returned it to Compliance, asking Compliance to accept the changes by initialing. Compliance did so and delivered the barge to Merritt in Louisiana.

The final agreement between the parties called for Merritt to hire the barge for three months at the rate of $2,500 per month. It also gave Merritt the "right and option" to renew the agreement at the same rate on a month-by-month basis after the initial three-month period. The charter party was written on a standard form contract, to which the parties added a clause which stated, "[i]f barge is purchased within the term of this Charter Party Agreement, 100% of Charter Hire shall apply to the purchase price of $30,000." The agreement also required Merritt to insure the barge at its expense. Merritt purchased insurance on the barge which contained navigational limits confining the use of the barge to Louisiana, Mississippi, and Texas. The charter party required Merritt to abide by the provisions of the insurance policy. Unlike our dissenting brother, however, we do not read the agreement itself to impose any navigational limits.

Merritt exercised its option to renew after the initial three-month period, and made payments under the charter party for five months, through October, 1983. In March, 1984, Merritt filed a voluntary petition for reorganization under Chapter 11 of the Bankruptcy Code. The proceeding was converted in September, 1984 to a Chapter 7 proceeding, and a trustee was appointed. The trustee took possession of all of Merritt's personal property, including the barge, which was then located in Charleston, South Carolina.

The trustee moved to sell the barge for $20,000 in October, 1984, and Compliance objected to the sale. When the parties agreed that Compliance's interest in the barge would be transferred to the proceeds of the sale, the barge was sold. After the sale, Compliance moved for payment of its claim, and the trustee objected to the claim. The bankruptcy court sustained the trustee's objection and denied Compliance's motion for payment, holding that Compliance's interest in the barge was subordinate to that of the trustee. The district court affirmed, and Compliance brought this appeal.

Here, as below, the contentions center chiefly on the question of choice of law. The trustee asserts that Merritt's interest in the barge is governed by South Carolina law. Under South Carolina law, the trustee argues, the charter party represents a security agreement, and Compliance's failure to perfect its interest in the barge by filing rendered its interest subordinate to that of the trustee. Compliance argues that Louisiana's law, which does not recognize conditional sales, governs the determination of the interests conveyed by the charter party. Compliance contends that under Louisiana law the charter party represents a lease which conveyed no ownership interest to Merritt, and that the barge is therefore not part of the debtor's estate.

II.

A.

The determination of property rights in the assets of a bankrupt's estate is generally a matter of state law. Butner v. United States, 440 U.S. 48, 54, 99 S.Ct. 914, 917-18, 59 L.Ed.2d 136 (1979). Because the property right at issue in this case grows out of a transaction having significant contacts to two states, we must first decide whether the law of South Carolina or that of Louisiana determines the extent of Merritt's interest in the barge. We conclude that South Carolina law is applicable.

In Klaxon Co. v. Stentor Electric Manufacturing Co., 313 U.S. 487, 496, 61 S.Ct. 1020, 1021-22, 85 L.Ed. 1477 (1941), the Supreme Court held that a federal court sitting in diversity must apply the choice of law rules of the state in which it sits. The Klaxon rule rested on the rationale that a federal court, in determining state law issues which arise in federal court only by the accident of diversity, must apply state law, including state conflict of law rules, to those issues. Id.; Erie Railroad Co. v. Tompkins, 304 U.S. 64, 58 S.Ct. 817, 82 L.Ed. 1188 (1938). That same principle applies where a federal court addresses state law claims under its pendent jurisdiction. Colgate Palmolive Co. v. S/S Dart Canada, 724 F.2d 313, 316 (2d Cir.1983), cert. denied, 466 U.S. 963, 104 S.Ct. 2181, 80 L.Ed.2d 562 (1984); System Operations, Inc. v. Scientific Games Development Corp., 555 F.2d 1131, 1136 (3d Cir.1977).

The question of what choice of law rules should be applied by a bankruptcy court presents another wrinkle. Although bankruptcy cases involve federal statutes and federal questions, a bankruptcy court may, as here, face situations in which the applicable federal law incorporates matters which are the subject of state law. It is clear that a federal court in such cases must apply state law to the underlying substantive state law questions. Whether a court in such a situation must apply the conflicts rule of the forum state in determining which state's law to apply or may choose the applicable state law as a matter of independent federal judgment, however, has remained an open question. See 1A Moore's Federal Practice p 0.325 (2d ed. 1985). We believe, however, that in the absence of a compelling federal interest which dictates otherwise, the Klaxon rule should prevail where a federal bankruptcy court seeks to determine the extent of a debtor's property interest.

The argument for applying the Klaxon rule to state law questions arising in bankruptcy cases is compelling. A uniform rule under which federal bankruptcy courts apply their forum states' choice of law principles will enhance predictability in an area where predictability is critical. Most important, such a rule would accord with the model established by Erie and Klaxon. Both those cases make clear that federal law may not be applied to questions which arise in federal court but whose determination is not a matter of federal law: "[e]xcept in matters governed by the Federal Constitution or by Acts of Congress, the law to be applied in any case is the law of the State." Erie, 304 U.S. at 78, 58 S.Ct. at 822. Such is the case with questions regarding the extent of a bankruptcy debtor's property interests. "Property interests are created and defined by state law. Unless some federal interest requires a different result, there is no reason why such interests should be analyzed differently simply because an interested party is involved in a bankruptcy proceeding." Butner, 440 U.S. at 55, 99 S.Ct. at 918. It would be anomalous to have the same property interest governed by the laws of one state in federal diversity proceedings and by the laws of another state where a federal court is sitting in bankruptcy. Because no overwhelming federal policy requires us to formulate a choice of law rule as a matter of independent federal judgment, we adopt the choice of law rule of the forum state, South Carolina.

B.

South Carolina has adopted the Uniform Commercial Code, including its choice of law provision, Sec. 1-105. That statute provides, in relevant part:

[W]hen a transaction bears a reasonable relation to this State and also to another state or nation the parties may agree that the law either of this State or of such other state or nation shall govern their rights and duties. Failing such agreement this act applies to transactions bearing an appropriate relation to this State.

S.C. Code Ann. Sec. 36-1-105(1) (Law.Co-op.1976). Under Sec. 36-1-105, South Carolina law will be applied in determining the extent of the property interest in the barge conveyed to Merritt by the charter party if the charter party bears an "appropriate relation" to that state. ¹

The term "appropriate relation" is not defined in Sec. 36-1-105, and South Carolina's courts have not interpreted it. The UCC's Official Comments provide little guidance, stating only that "the question what relation is 'appropriate' is left to judicial decision," and that, in defining the term, courts are "not strictly bound by [choice of law] precedents established in other contexts [because the UCC] is in large part a reformulation and restatement of the law merchant and of the understanding of a business community which transcends state and even national boundaries." U.C.C. Sec. 1-105 official comment 3 (1978).

The majority of courts, however, has defined "appropriate relation" in accord with the dominant trend in modern conflict of laws analysis, under...