Melon Produce, Inc., In re

• Decision Date: 02 June 1992
• Docket Number: No. 91-2250,91-2250
• Parties: , Bankr. L. Rep. P 74,967, 19 UCC Rep.Serv.2d 300 In re MELON PRODUCE, INC., Debtor. Joseph BRAUNSTEIN, Trustee, Plaintiff, Appellee, v. Peter KARGER, Defendant, Appellant. . Heard
• Court: U.S. Court of Appeals — First Circuit

Page 71

976 F.2d 71

23 Bankr.Ct.Dec. 825, Bankr. L. Rep. P 74,967,

19 UCC Rep.Serv.2d 300

In re MELON PRODUCE, INC., Debtor Joseph BRAUNSTEIN, Trustee, Plaintiff, Appellee, v. Peter KARGER, Defendant, Appellant.

No. 91-2250.

United States Court of Appeals First Circuit.

Heard June 2, 1992.

Decided Sept. 29, 1992.

Charles W. Morse, Jr. with whom Alan M. Spiro and Friedman & Atherton, Boston, Mass., were on brief, for defendant, appellant.

John J. Kuzinevich with whom Isaac H. Peres and Riemer & Braunstein, Boston, Mass., were on brief, for plaintiff, appellee.

Before BREYER, Chief Judge, LAY, ^* Senior Circuit Judge, and O'SCANNLAIN, ^** Circuit Judge.

BREYER, Chief Judge.

This appeal raises a technical question about bankruptcy preferences. Suppose a Creditor has a security agreement that covers "rights to money" and contains an "after-acquired property" clause. Suppose at a later time, within the preference period, the Debtor sells other property to third parties, accepts checks from those parties as payment, and immediately endorses those checks over to the Creditor. Does the Creditor have a perfected security interest in those checks or in the "rights to money" that they represent, thereby permitting the Creditor to lawfully receive payments which would otherwise constitute an unlawful "preference?" The district court thought the answer to this question was "no," and it therefore held that the Creditor had received an unlawful preference. We affirm the district court's judgment.

I Background

The appellant, Peter Karger, says that, in 1984, he wanted to lend about $600,000 to a company called A. Pellegrino & Sons, then in Chapter 11 bankruptcy proceedings. In order to obtain security for his loan, and with the approval of the bankruptcy court, Karger had Pellegrino transfer two valuable assets--some leases on bays at the New England Produce Center and some stock in that Center--to a new corporation (called Melon Produce), which Karger owned. Melon Produce then guaranteed repayment to Karger of the $600,000 loan. And, just to be certain that Melon could pay if necessary, Karger was to obtain a security interest in Melon's assets.

If Karger has accurately described what was supposed to happen, then, when the parties drafted the relevant legal documents, something must have gone wrong. The security agreement that Karger executed (with appropriate U.C.C. filings) in August 1984 did not mention Melon's two main assets--the leases and the stock. It did mention, however, various other Melon assets, including "instruments" and all "rights ... to the payment of money." It also specified that Karger would receive a security interest in all such assets "hereinafter acquired."

Apparently, Pellegrino did not repay the loan, for the parties agree that three years later Melon owed Karger about $500,000. In early 1987, Melon sold its leases and stock to third party buyers for $430,000. At the closing, on February 27, 1987, Melon transferred the leases and stock to the buyers; the buyers gave Melon's clerk checks totalling $430,000; the clerk endorsed the checks to Karger in partial satisfaction of Melon's debt; and Karger (through an agent) took the checks and deposited them in his account.

Within a year Melon, too, was bankrupt. Melon's bankruptcy trustee, noting that Karger was an "insider" and that the February 27, 1987 transfer took place within the year preceding bankruptcy, claimed that the transfer was an unlawful "preference," which Karger must return to the bankruptcy estate. 11 U.S.C. § 547(b). As we have said, the district court found that the transfer constituted a preference, 122 B.R. 641, and Karger now appeals.

II Analysis

A "preference" is a transfer of a debtor's assets, during a specified pre-bankruptcy period, that unjustifiably favors the transferee over other creditors. See 4 Collier on Bankruptcy § 547.01 at 547-14 (15th ed. 1992) ("A preference is an infraction of the rule of equal distribution among all creditors."). The preference section of the Bankruptcy Code permits the bankruptcy trustee to "avoid any transfer of property" made (1) to an "insider" creditor; (2) on account of "an antecedent debt;" (3) while the debtor was insolvent; (4) within one year before the filing of the bankruptcy petition; (5) that enables the creditor to receive more than he would have received in liquidation in the absence of the transfer. 11 U.S.C. § 547(b). We assume that the transfers to Karger satisfy the first three criteria (insider, antecedent debt, and insolvency). And, February 1987 was within one year of Melon's bankruptcy filing. But what about the final requirement? Did the transfer of the $430,000 unjustifiably favor Karger by giving him more than he would have received in liquidation?

Karger must concede that in February 1987 he received $430,000 that would otherwise have gone to Melon. But, Karger makes an argument that we simplify, place within the relevant legal context, and paraphrase as follows: 'The funds that Karger received amounted to no more than he would have received anyway in liquidation, in the absence of the transfer. In a Chapter 7 liquidation, a secured creditor normally receives the value of the property in which he holds perfected security interests (at least where no other creditor enjoys a higher priority). 4 Collier on Bankruptcy § 547.08 at 547-43 (15th ed. 1992); see also 11 U.S.C. § 544 (trustee in bankruptcy has status of lien creditor under state law); Mass.Gen.L. ch. 106, § 9-301(1)(b), (3) (lien creditor receives priority over secured creditor only if such creditor's interest is unperfected). And (says Karger), Karger was a secured creditor with perfected security interests, both in Melon's "instruments," (namely, the buyers' checks that Melon endorsed to Karger) and in "rights to money" (namely, Melon's rights to payment for the leases and stock that Melon sold). Thus, (concludes Karger) the February 1987 transfer did not give Karger more than that to which he would anyway (in liquidation) have been entitled.'

We cannot accept this argument, for we do not agree that Karger held a perfected security interest, either in "instruments" or in "rights to money" that would entitle him to obtain the $430,000 ahead of other creditors in liquidation. That is because the creation of a perfected security interest in property is itself a preference when the creation or perfection takes place during the preference period (and the other criteria are satisfied). See In re Taco Ed's, 63 B.R. 913, 925 (N.D.Ohio 1986) and cases cited therein; 11 U.S.C. § 101 (defining "transfer" broadly to include "retention of title as a security interest"); 4 Collier on Bankruptcy § 547.03 at 547-18 (15th ed. 1992) ("transfer" encompasses any transfer of an interest in property). Although Karger received perfected security interests in the checks and rights to money, those interests were transferred in February 1987, during the preference period, and not before.

Karger's basic strategy is the following: (1) He claims that he obtained a security interest (a) in Melon's rights to money from the buyers of its leases and stock and (b) in the checks that the buyers gave Melon. He notes that Melon's right to money arose out of its sales contract and existed despite the receipt of the checks, until the checks were honored. Cf. Barnhill v. Johnson, --- U.S. ----, 112 S.Ct. 1386, 118 L.Ed.2d 39 (1992) (transfer of assets takes place when creditor's bank receives funds and credits his account, not when check is initially received). (2) He points to his security agreement's coverage of "instruments" and "rights to money," to its "after-acquired property" clause, and to the Uniform Commercial Code provision that creates a perfected security interest in collateral covered by that clause dating from the time of filing of the U.C.C. financing statement. Mass.Gen.L. ch. 106, § 9-204(1) ("A security agreement may provide that any or all obligations covered by the security agreement are to be secured by after-acquired collateral...."); Mass.Gen.L. ch. 106, §§ 9-302, 9-304 (setting out U.C.C. filing requirements). (3) He concedes some difficulty in applying this provision to his security interest in the checks in light of other U.C.C. provisions that normally date perfection of security interests in instruments from the time of physical possession. Mass.Gen.L. ch. 106, § 9-304(1). But, he says, the "relation back" applies, at least, to his security interest in the "rights to money." And, (4) it means that the bankruptcy trustee must consider the "transfers" to him of the perfected security interests (at least in the "rights to money") to have taken place in 1984, well before the preference period began to run. Hence, (5) the February 1987 actual transfer of funds (presumably from the buyers' bank accounts to Karger's bank account) gave him nothing beyond that to which he was entitled (by a pre-1987 perfected security interest) in its absence.

This result makes one hesitate. Can a creditor (say, a creditor without fraudulent intent who is, like Karger, able to control a debtor corporation), up to the very moment of bankruptcy, simply exchange the corporation's unsecured assets for assets covered by a previously executed security agreement's after-acquired property clause and thereby obtain those assets ahead of unsecured creditors? The answer to this question, in general, is "no." The fatal flaw in Karger's argument is that a perfected security interest in Melon's after-acquired "rights to money" may relate back to his 1984 U.C.C. (security agreement) filing for U.C.C. security interest priority purposes. The interest does not relate back to 1984, however, for Bankruptcy Code preference purposes.

In order to obtain the "relation back" that he needs, Karger would have to argue successfully that his security interest in "rights to money" fits within the special exception for "receivables" (and "inventory")...