Bank of Kansas v. Hutchinson Health Services, Inc.

• Decision Date: 21 April 1989
• Docket Number: No. 62727,62727
• Citation: 13 Kan.App.2d 421,773 P.2d 660,9 U.C.C. Rep. Serv.2d 307
• Parties: , 9 UCC Rep.Serv.2d 307 BANK OF KANSAS, Appellee, v. HUTCHINSON HEALTH SERVICES, INC., a Kansas corporation, and State of Kansas Department of Social and Rehabilitation Services, Defendants, and Central State Bank, Trustee, Intervenor, and State Department of Human Resources of Kansas, Appellant.
• Court: Kansas Court of Appeals

Page 660

773 P.2d 660

13 Kan.App.2d 421, 9 UCC Rep.Serv.2d 307

BANK OF KANSAS, Appellee, v. HUTCHINSON HEALTH SERVICES, INC., a Kansas corporation, and State of Kansas Department of Social and Rehabilitation Services, Defendants and Central State Bank, Trustee, Intervenor and State Department of Human Resources of Kansas, Appellant.

No. 62727.

Court of Appeals of Kansas.

April 21, 1989.

Review Granted June 6, 1989.

Syllabus by the Court

1. The priority as between a right of setoff and a perfected security interest is governed by Article 9 of the Uniform Commercial Code.

2. The act allowing setoff against debtors of the State (K.S.A. 75-6201 et seq.) specifies the priority to be given to multiple claims by state agencies when the offset amount is not sufficient to satisfy every claim presented. K.S.A. 75-6211. It does not address the priority of a secured creditor's claim to the same funds.

3. The Kansas Employment Security Law (K.S.A. 44-701 et seq.) does not give the Department of Human Resources a "super-priority" for delinquent unemployment contributions over other creditors.

4. When an account receivable has been assigned as security and is perfected, the assignee takes free of all claims, other than those arising on the contract, which accrue after the account debtor is notified of the assignment. K.S.A. 84-9-318(1)(b).

5. An assignee "notifies" an account debtor of an assignment by taking such steps as may reasonably be required to inform the account debtor "in ordinary course whether or not" the account debtor actually comes to know of it. K.S.A.1988 Supp. 84-1-201(26). Notification not "in ordinary course" will be considered sufficient if it ensures that the account debtor receives actual notice of the assignment.

6. In the absence of an express statutory definition to the contrary, a claim for delinquent unemployment contributions "accrues" when the obligations are due and payable.

H. Dean Cotton, Topeka, for appellant.

David E. Roberts of Dennis O. Smith, Chartered, Hutchinson, for appellee.

Before RULON, P.J., and REES and DAVIS, JJ.

DAVIS, Judge:

This appeal involves conflicting claims by the Bank of Kansas (Bank) and the State of Kansas to Medicaid reimbursement funds owed by the Kansas Department of Social and Rehabilitation Services (SRS) to Hutchinson Health Services, Inc., (HHS) a nursing home operator. The Bank holds a perfected security interest in HHS' accounts receivable, which include the Medicaid reimbursement funds, based on three loans it made to HHS, which loans are in default. The State of Kansas through the Department of Human Resources (DHR) claims the right of setoff for delinquent unemployment contributions owed by HHS. The trial court held that the Bank's perfected security interest prevailed over the State's right of setoff. We affirm in part, reverse in part, and remand for further proceedings.

The resolution of this case requires us to answer two questions: (1) Whether the priority rules of Article 9 of the Uniform Commercial Code (UCC) apply to a priority battle between a creditor's right of setoff and another creditor's perfected security interest in the debtor's accounts receivable; and (2) if so, what specific rules apply and with what result?

The facts are not in dispute. The Bank made three separate loans to HHS totaling $281,384.58. These loans were secured by a perfected security interest in HHS' accounts receivable, which include Medicaid reimbursement funds.

HHS defaulted. The Bank filed suit on November 16, 1984, and on November 19, 1984, filed an amended petition against HHS and SRS, seeking judgment against HHS on the promissory notes for $186,141.51 plus interest and seeking orders requiring the SRS to pay all of HHS' Medicaid reimbursement accounts to the Bank. DHR intervened in the suit, alleging that HHS owed $14,916.42 in delinquent unemployment contributions and that the State of Kansas was entitled to offset this amount against the Medicaid reimbursement funds owed by SRS to HHS.

On March 15, 1985, the Bank and the DHR entered into an agreed order recognizing that the State of Kansas had acquired by setoff $14,916.42 from the Medicaid reimbursement funds owed to HHS. Both parties agreed that the question of priority to these funds would be reserved for a later determination. The Bank was granted judgment against HHS for $197,812.42 plus interest. The Medicaid reimbursement funds were then paid into court by SRS and distributed to the Bank in partial satisfaction of its judgment. The trial court held that the Bank's perfected security interest in the Medicaid reimbursement funds had priority over DHR's right of setoff and granted judgment for the Bank for the $14,916.42 plus interest.

Before addressing the questions raised by this appeal, we note that this court has resolved a priority battle between Bank of Kansas and Central State Bank in this same case involving different funds. Bank of Kansas v. Hutchinson Health Services, Inc., 12 Kan.App.2d 87, 735 P.2d 256, rev. denied 241 Kan. 838 (1987). Central State Bank offset the funds in HHS' checking account against debts HHS owed to it, but the Bank of Kansas claimed that it was entitled to the funds because they were identifiable proceeds of HHS' accounts receivable, in which the Bank of Kansas held a perfected security interest. We held that while a bank or other creditor seeking to exercise a right of setoff need not comply with the requirements of Article 9, "the priority as between a right of setoff and a perfected security interest is governed by Article 9." 12 Kan.App.2d at 93, 735 P.2d 256.

(1) Do the priority rules of Article 9 of the Uniform Commercial Code apply to a priority battle between a creditor's right of setoff and another creditor's perfected security interest in the debtor's accounts receivable?

While our previous decision provides a direct answer to our first question, DHR argues that we should limit this holding to priority battles between banks and other financial institutions. Although the previous appeal involved a priority battle between two banks, our holding applies to any priority battle involving a right of setoff and a perfected security interest. We again hold that "the priority as between a right of setoff and a perfected security interest is governed by Article 9." 12 Kan.App.2d at 93, 735 P.2d 256.

Both parties advance arguments as to why the above rule should not apply in this case. DHR argues that the priority rules of Article 9 need not be applied to resolve this appeal because it, as an agency of the State, is entitled to "super-priority" under Kansas statutes allowing setoff against debtors of the State (K.S.A. 75-6201 et seq.) and the Kansas Employment Security Law (K.S.A. 44-701 et seq.). We disagree.

The setoff act specifies the priority to be given to multiple claims by state agencies when the setoff amount is not sufficient to satisfy every claim presented. K.S.A. 75-6211. It does not address the priority of a secured creditor's claim to the same funds.

The Kansas Employment Security Law requires employers to contribute an amount based on their employees' wages to the Employment Security Fund. K.S.A.1988 Supp. 44-710. If an employer fails to DHR relies on K.S.A. 44-717(c), which provides:

                pay, the Secretary of Human Resources may bring a civil action against him to collect the amount owed.  K.S.A. 44-717(b).  The secretary may also file a lien against "all property and rights to property, whether real or personal, belonging to such employer or person."   Such a lien is subject, however, to prior filed liens.  K.S.A. 44-717(e)
                

"In the event of any distribution of employer's assets pursuant to an order of any court under the laws of this state, including but not limited to any probate proceeding, interpleader, receivership, assignment for benefit of creditors, adjudicated insolvency, composition or similar proceedings, contributions or payments in lieu of contributions then or thereafter due shall be paid in full from the moneys which shall first come into the estate, prior to all other claims, except [certain] claims for wages."

The words "but not limited to" and the references to probate proceedings and interpleader actions were added by amendment in 1983. L.1983, ch. 169, § 8.

In John Deere Co. v. Butler County Implement, Inc., 232 Kan. 273, 655 P.2d 124 (1982), the Supreme Court held that K.S.A. 44-717(c) did not apply to interpleader actions since an interpleader action was not of the same general class as a proceeding winding up the affairs of a business. 232 Kan. at 277, 655 P.2d 124. This holding has been overruled by the amendment discussed above.

The Supreme Court, however, also addressed DHR's argument that 44-717(c) afforded it a preemptive priority over secured creditors, even though 44-717(e), dealing with liens, would afford DHR's lien priority over subsequently filed liens only. 232 Kan. at 277, 655 P.2d 124. In the words of the court:

"The contention of Human Resources that K.S.A. 44-717(c) afforded it a preemptive priority over even secured creditors without regard to any time sequence is quite inconsistent with K.S.A. 44-717(e) which requires Human Resources to comply with rather complex procedures before it may assert a lien that only takes priority as to subsequently perfected liens." 232 Kan. at 278, 655 P.2d 124.

We conclude that K.S.A. 44-717(c) does not give the State of Kansas a super-priority.

The Bank also argues that we need not apply the priority rules of Article 9 to resolve this appeal. It contends that the State's setoff is invalid because DHR allegedly failed to comply with the requirements of the setoff act. This argument fails for two reasons. First, we think that the Bank implicitly recognized that DHR had complied with the requirements of the setoff act when it stipulated that DHR had acquired the Medicaid reimbursement funds by setoff and that the issue in the case was the proper...