American Pouch Foods, Inc., In re

• Citation: 769 F.2d 1190
• Decision Date: 30 July 1985
• Docket Number: No. 83-2530,83-2530
• Parties: 33 Cont.Cas.Fed. (CCH) 73,772, 41 UCC Rep.Serv. 972 In re AMERICAN POUCH FOODS, INC., Debtor-Appellant.
• Court: United States Courts of Appeals. United States Court of Appeals (7th Circuit)

Page 1190

769 F.2d 1190

33 Cont.Cas.Fed. (CCH) 73,772, 41 UCC Rep.Serv. 972

In re AMERICAN POUCH FOODS, INC., Debtor-Appellant.

No. 83-2530.

United States Court of Appeals Seventh Circuit.

Argued Sept. 13, 1984.

Decided July 30, 1985.

Richard J. Mason, Levit, Miller & Mason, Chicago, Ill., for appellant.

Kenneth Oestreicher, U.S. Justice Dept., Civil Div., Washington, D.C., for appellee.

Before FLAUM, Circuit Judge, and SWYGERT and FAIRCHILD, Senior Circuit Judges.

FAIRCHILD, Senior Circuit Judge.

In a reorganization proceeding under Chapter 11 of the Bankruptcy Code the district court decided, in response to a complaint by the United States, that the United States held absolute title (and right to possession) to certain goods in the possession of the Debtor, American Pouch Foods, Inc. (Pouch). The court abstained from hearing Pouch's counterclaim. In Re American Pouch Foods, Inc., 30 B.R. 1015 (D.C.N.D.Ill.1983). Pouch appeals. We affirm.

In January 1979, Pouch entered into a procurement contract with the United States Defense Logistics Agency (Government). The contract called for Pouch to produce combat rations, known as "Meals, Ready to Eat" (Food Pouches), for use by branches of the Armed Services. The contract gave Pouch the right to progress payments upon request, not more often than bi-weekly. The payments were limited to 90% of Pouch's cost incurred to the date of payment. The so-called title vesting clause of the progress payment part of the contract provided that title to all parts, materials, inventories, work in process and various other categories immediately vested in the Government. ¹ Other provisions gave the Government the right to terminate for default (or for convenience of the Government) and to require delivery to it of completed supplies and manufacturing materials. The contract also provided that if, after notice of termination for default, it was determined that Pouch was not in default or that default was excusable, the rights and obligations of the parties would be the same as if the notice of termination had been for convenience of the Government.

After making approximately $13 million in progress payments the Government terminated the contract for default. The Government claimed that Pouch had not complied with required production schedules. On November 10, 1980, three days after the contract was terminated, Pouch filed a petition for reorganization under Chapter 11 of the Bankruptcy Code, 11 U.S.C. Sec. 101 et seq. The Government claimed ownership and possession of all the property allocable to the contract in Pouch's possession or stored at warehouse facilities on its behalf. On December 5, 1980 the Government filed an adversary complaint in bankruptcy court to obtain possession.

Pouch filed an answer principally alleging wrongful termination of the contract and that the Government's title was a security interest not perfected as required by law and subordinate to the rights of the debtor and creditors. Pouch filed a counterclaim seeking damages arising from wrongful termination of the contract.

On February 9, 1981, the bankruptcy court held that, as a matter of law, the Government had absolute title to the property in question and was entitled to repossess it.

While the appeals were pending the bankruptcy court held that it had jurisdiction to hear Pouch's counterclaim even though the Armed Services Board of Contract Appeals had concurrent jurisdiction over the claim.

After the district court decided that questions of fact must be determined and remanded to the bankruptcy court, the Government filed a motion for reconsideration. In 1983, before that motion was decided, Pouch filed a motion in the district court to withdraw from the bankruptcy court the reference of the Government's adversary proceeding. That motion was granted.

Upon reconsideration the district court held that, as a matter of law, the Government had absolute title to all of the property covered by the title vesting clause. In Re American Pouch Foods, Inc., 30 B.R. at 1023. The court also noted that if the Government only took a lien on the allocable property, to secure its progress payments, the lien would be paramount to any other liens. Id. The court decided to abstain from hearing Pouch's counterclaim because the issue was better brought before the Armed Services Board of Contract Appeals. Id. at 1024.

I

Pouch is a debtor in possession in a reorganization proceeding and as such claims, under 11 U.S.C. Sec. 544(a)(1), the rights and powers of a creditor with a judicial lien. Pouch argues that the title vesting clause in the contract only gave the Government a security interest (lien) in the contract property and that Pouch's hypothetical lien has priority because the Government's lien was not perfected in compliance with the Illinois Commercial Code.

Pouch relies on United States v. Kimbell Foods, Inc., 440 U.S. 715, 99 S.Ct. 1448, 59 L.Ed.2d 711 (1979). There the Supreme Court was confronted with the issue of "whether contractual liens arising from certain federal loan programs take precedence over private liens, in the absence of a federal statute setting priorities." 440 U.S. at 718, 99 S.Ct. at 1453 (footnote omitted). The loan programs involved were those of the Small Business Administration and Farmers Home Administration. The Court found it clear that priority of liens stemming from federal lending programs must be determined with reference to federal law. 440 U.S. at 726, 99 S.Ct. at 1457. After analysis of the character and purposes of the lending programs, the Court found it prudent in determining priority "to adopt the ready made body of state law as the federal rule of decision until Congress strikes a different accommodation." 440 U.S. at 740, 99 S.Ct. at 1464 (footnote omitted).

Pouch first contends that the title vesting clause in the Pouch contract creates only a security interest in the Government such as was clearly the case in Kimbell Foods and secondly that the principles applied in Kimbell Foods require application of the Illinois Commercial Code to determine priority here. It would follow that Pouch's statutory lien as debtor in possession would be superior to the lien of the Government.

We first consider whether the Government has title such that there is no question of priority of liens. The clear and precise language of the contract between Pouch and the Government granted the Government title. Pouch argues that, notwithstanding the language of the contract, given the intent of the parties, the many incidents and risks of ownership retained by Pouch under the contract, and modern theory in the law of secured transactions, the title vesting clause should not be interpreted literally as grant of title to the Government.

We acknowledge, generally, that contract language which purports to place title to goods in a party not in possession of them may well create only a security interest in that party. See, e.g., Commercial Code provisions, Ill.Rev.Stat. ch. 26, Secs. 1-201(37) (Supp.1985), 9-102 and 9-202 (1974). The terms of this contract left Pouch with many of the incidents and risks of ownership.

Thus there would be considerable reason to treat provisions like these, if found in a private contract, as creating a security interest. On the other hand, this is a contract for the procurement of materials for national defense, with its terms spelled out in the regulations of the Defense Department, 32 C.F.R. Sec. 163.79, and a history suggesting a substantial reason for very literal interpretation of the title vesting language.

Since 1823 there has been a federal statute prohibiting advances of public money and payment on contracts in excess of the value of service rendered or goods delivered previously to payment. 3 Stat. 723, Rev.Stat. Sec. 3648 (1873), 31 U.S.C. Sec. 529 (1981), 31 U.S.C. Sec. 3324 (1983). Apparently there grew up a concept of purchase of unfinished goods in return for progress payments (often, in earlier years, referred to as "partial payments"), and doctrine that this statute is not violated by payment previous to delivery if title to the portion paid for has vested in the Government at the time of payment, or if the articles are then impressed with a valid lien in favor of the Government.

Although the practice has been severely criticized, e.g., McClelland, The Illegality of Progress Payments as a Means of Financing Government Contractors, 33 Notre Dame Law. 380 (1958), the theory had been supported by a 1941 ruling of the Comptroller General, 20 Comp.Gen. 917, 918 (1941), quoted in McClelland, op. cit. p. 389, and by opinions of the Attorney General, cited in Whelan, Government Supply Contracts: Progress Payments Based on Costs; The New Defense Regulations, 26 Fordham Law Rev. 224, 232 (1957).

In 1911 a statute expressly authorized the Navy to make progress payments (referred to as partial payments) in return for a lien, paramount to all other liens. 37 Stat. 32, 10 U.S.C. Sec. 7521.

The First War Powers Act, 55 Stat. 839, Sec. 201, December 8, 1941, authorized advance and progress payments on war effort contracts.

Statutory authority for advance payments (but not progress payments) was conferred by Sec. 5 of the Armed Services Procurement Act of 1947, 62 Stat. 21, February 19, 1948. Section 5(b) required adequate security and provided that the contract may include a lien, paramount to all other liens. ²

In 1952 Defense Contract Financing Regulations were issued. 32 C.F.R. Part 82, 17 Fed.Reg. 3581, April 23, 1952. There were references to progress payments as one method of financing, along with advance payments and guaranteed loans. An earlier form of regulations required the vesting of title when progress (partial) payments were made. City of Detroit v. Murray Corp., 355 U.S. 489, 517-18 n. 4, 78 S.Ct. 458, 465-66 n. 4, 2 L.Ed.2d 441 (1958) (Whittaker, J., dissenting).

On December 17, 1956, revised Defense Contract Financing...