Diamond National Corporation v. Lee

• Decision Date: 05 August 1964
• Docket Number: No. 18846.,18846.
• Citation: Diamond National Corporation v. Lee, 333 F.2d 517 (9th Cir. 1964)
• Parties: DIAMOND NATIONAL CORPORATION, Appellant, v. Dale LEE, Trustee in Bankruptcy, et al., Appellees.
• Court: U.S. Court of Appeals — Ninth Circuit

333 F.2d 517 (1964)

DIAMOND NATIONAL CORPORATION, Appellant, v.Dale LEE, Trustee in Bankruptcy, et al., Appellees.

No. 18846.

United States Court of Appeals Ninth Circuit.

June 18, 1964.

Rehearings Denied August 5, 1964.

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Sidney E. Smith, Scott W. Reed, Coeur d'Alene, Idaho, for appellant and cross-appelleeDiamond National Corp.

Bliss O. Bignall, Jr., Coeur d'Alene, Idaho, Richards, Haga & Eberle, Boise, Idaho, for appellee and cross-appellantDale Lee, Trustee in Bankruptcy.

Dale Clemons, Clemons, Skiles & Green, Boise, Idaho, for appelleeA. Morrison Lumber Co., Inc.

Ted Eberle, Richards, Haga & Eberle, Boise, Idaho, for appelleeDouglas-Guardian Warehouse Corp.

Stephen Bistline, Sandpoint, Idaho, for appelleesPost Falls Lumber Co., Inc., Ed Olson and State of Idaho.

Riner E. Deglow, Spokane, Wash., Glenn Bandelin, Bandelin & Cogswell, Sandpoint, Idaho, for appellees Smith, Neu, and Linscott.

Before HAMLEY and MERRILL, Circuit Judges, and KILKENNY, District Judge.

KILKENNY, District Judge:

Presented for decision on this appeal and cross-appeal is the correctness of the District Court's judgment denying petitions for review of certain orders of a referee in bankruptcy and adopting, as those of the court, the findings and conclusions made and entered by the referee.The facts are not in serious dispute.For a number of years the appellant, Diamond National Corporation,¹ transacted business with the bankrupt, R. J. Spring Lumber Company, Inc., a corporation, engaged in the logging and sawmill business near Sandpoint, in the State of Idaho.In the summer of 1960 the indebtedness of the bankrupt to Diamond reached a figure of approximately $200,000.00, at which time the bankrupt executed and delivered to Diamond a certain promissory note in said sum and a real and chattel mortgage to secure the same.In excess of $150,000.00 remains owing on the note.The mortgage was recorded on August 12, 1960.The validity of the recording as a chattel mortgage is in dispute.

The mortgage covered, among other things, certain machinery, furniture and fixtures and

"All logs and lumber now on hand or hereafter acquired, situated on the above described premises."

The "above described premises", being the real property leased by the bankrupt and used by it for the milling and storage of logs and lumber.

An involuntary petition in bankruptcy was filed against the bankrupt in October, 1961.During the pendency of those proceedings and on the 23rd day of January, 1962, a receiver was appointed who immediately took possession of and sold the logs, lumber, machinery, furniture and equipment then on the premises, the proceeds of the sales of which are here in controversy.Adjudication in bankruptcy was made on February 16, 1962.

During the course of its operations, and after recording of the mortgage, the bankrupt found it necessary to arrange for additional financing.This was secured through what is known, in the industry, as a field warehousing arrangement with Douglas-Guardian Warehouse Corporation.²Under this arrangement certain designated parcels or piles of lumber on the premises were designated as in the possession of Douglas and thereafter it would issue negotiable warehouse receipts to A. Morrison Lumber Company,³ which company would thereupon loan money, on said receipts, to the bankrupt.Diamond attempted to move into possession of the property in September 1961.

Due to the fact that certain items of the property were subject to the claims of different creditors, the proceeds of the sales were established in three separate funds, as follows:

(1) The lumber warehoused to Douglas and, on which Morrison had made advances.Sales price, $30,000.00.

(2) The logs and lumber on bankrupt\'s premises, not subject to the warehouse receipts mentioned in number one.Sales price, $50,000.00.

(3) Machinery, furniture, equipment and fixtures on premises.Sales price, $22,000.00.

VALIDITY OF DIAMOND'S MORTGAGE

The solution to many of the problems presented by the appeal and the cross-appeals of a number of the appellees, depends upon the validity or invalidity of Diamond's mortgage.Consequently, our first assignment is to consider the nature, effect and duration of the lien, if any, created by such mortgage.The referee found that the mortgage was valid, even as to the shifting stock of logs and lumber, but that Diamond waived its lien in favor of Douglas and that the liens of other creditors were superior in right to that of Diamond on such property.

The validity of the mortgage is attacked by the trustee in bankruptcy and other appellees in the following areas:

(A) Diamond\'s failure to enforce the sales and accounting provisions of the chattel mortgage on shifting stock of logs and lumber.

(B) Diamond\'s failure to take possession of the property on default in payment.

(C) Diamond\'s failure to properly record the chattel mortgage.

SHIFTING STOCK

(A) All parties recognize that the logs and lumber in question constitute what is known in law as a shifting stock of merchandise and that the particular logs and lumber on the premises were acquired by the mortgagor after the execution and delivery of the mortgage.

The law of the State of Idaho is controlling on extent of the lien, and the validity of the mortgage.McKenzie v. Irving Trust Co., 323 U.S. 365, 370, 65 S.Ct. 405, 89 L.Ed. 305;In re Simpson, 31 F.2d 317(D.C.Idaho1929)aff'd.Patnott v. Simpson & Co., 35 F.2d 840(9th Cir.1929);Eberly v. Dudley, 314 F.2d 8, 12(9th Cir.1962).Proper provisions in a mortgage creating a lien on after acquired property are recognized, as valid, by the statutory and decisional law of the State of Idaho.Section 45-107, Idaho Code.Poage v. Co-Operative Publishing Co., 57 Idaho 561, 66 P.2d 1119, 110 A.L.R. 1322;Hudson v. Kootenai Fox Farms Co., 47 Idaho 58, 272 P. 704.However, after acquired property clauses, such as here in question, are invalid insofar as applied to a shifting stock of merchandise.In re Marsh(D.C.Idaho1931)53 F.2d 400;Ryan v. Rogers, 14 Idaho 309, 94 P. 427;Lewiston National Bank v. Martin, 2 Idaho 734, 23 P. 920, unless the mortgage contains a proper accounting provision, In re Marsh, supra;Ryan v. Rogers, supra.The trustee in bankruptcy stands in the same position as an attaching or execution creditor under the law of Idaho.Kettenbach v. Walker, et al., 32 Idaho 544, 186 P. 912.

Where the mortgagor, with the knowledge and consent of the mortgagee, remains in possession of the chattels, and with the knowledge and consent of the mortgagee sells and disposes of the mortgaged property, without applying the proceeds of the sale to the reduction of the mortgage debt, such action will invalidate and void the mortgage.Ryan v. Rogers, supra, 14 Idaho 309, 94 P. p. 428.Diamond concedes the above, but counters with the argument that the mortgage in question contains an accounting and liquidation provision⁴ which, the Idaho courts recognize as valid.Lewiston National Bank v. Martin, supra.However, failure to comply with the terms and conditions of the accounting provision will invalidate the mortgage.Lewiston National Bank v. Martin, supra;Ryan v. Rogers, supra.

The undisputed testimony is that the accounting arrangement as outlined in the mortgage was abandoned by the parties shortly after its execution.At that time the parties substituted, for said accounting provisions, an agreement whereby the mortgagor would pay to Diamond an arbitrary figure of $2.00 per thousand on any and all lumber which was sold.This arrangement was later confirmed by letters.Typical of these letters, over the signature of Diamond, is the one shown in the footnote.⁵Attached to the letters was a release, signed by the bankrupt, directing Morrison Lumber Company, among other things, to release and pay directly to Diamond $2.00 per thousand on all lumber sold and delivered by the bankrupt.Conceded, is the fact that the parties never attempted to place of record the new or substitute agreement.The only accounting ever made by Spring to Diamond after that time was on the basis of the $2.00 per thousand required by the substitute agreement.There was no accounting of "the entire proceeds of sales and collections made by the mortgagor in said business, less the reasonable and proper amount necessary to defray the expense of operating said business" as required in the mortgage.The referee found that this arrangement amounted to a waiver by Diamond of its lien or right to the proceeds of the lumber sales or advances made by Douglas.The court did not make a specific finding on whether the new or substitute arrangement destroyed the lien of Diamond's mortgage on the after acquired shifting stock of logs and lumber.The record supports the referee's finding that Diamond was aware of Spring's default in payment on the mortgage after November, 1960, and from March, 1961, was fully aware of the insolvent condition of Spring, but took no action to take possession until mid-September, 1961.Diamond took no inventories of the lumber, nor did it check the books of the lumber company except on an occasion about March 23, 1961, and again on September 5, 1961.

As we view it, the Idaho law, in the protection of creditors, requires a provision with reference to sales and accounting, to be incorporated on a shifting stock of goods.Here a provision was so incorporated.That provision was ignored and another provision substituted.The latter provision was never incorporated in the mortgage, nor did Diamond attempt to place the same of record.The validity of Diamond's mortgage on the shifting stock of merchandise, depended on the provision in the mortgage with reference to accounting.Since the parties chose to ignore such provision, the mortgage on the shifting stock of merchandise is void.

Cauthorn v. Burley State Bank, 26 Idaho 532, 144 P. 1108, cited by Diamond, only...