Executive Financial Services, Inc. v. Pagel, s. 58045

• Decision Date: 21 February 1986
• Docket Number: Nos. 58045,58046,s. 58045
• Citation: 715 P.2d 381,238 Kan. 809
• Parties: , 59 A.L.R.4th 553, 42 UCC Rep.Serv. 1185 EXECUTIVE FINANCIAL SERVICES, INC., Appellant, v. Donald H. PAGEL, Henry D. Pagel, d/b/a Pagel and Sons, a partnership; the John Deere Company; Gene R. Mohr, James B. Loyd, d/b/a Mohr-Loyd Leasing; and Dennison State Bank, Appellees. EXECUTIVE FINANCIAL SERVICES, INC., Appellant, v. Paul S. MORSE, Ted R. Morse, and Fred S. Morse, d/b/a Riverview Farms; Marvin Allen, Jr.; James B. Loyd and Gene R. Mohr, d/b/a Mohr-Loyd Leasing; First National Bank of Olathe; and Northeast Kansas Production Credit Association, Appellees, v. JOHN DEERE COMPANY, Third-party Defendant-Appellee.
• Court: Kansas Supreme Court

Page 381

715 P.2d 381

238 Kan. 809, 59 A.L.R.4th 553, 42

UCC Rep.Serv. 1185

EXECUTIVE FINANCIAL SERVICES, INC., Appellant, v. Donald H. PAGEL, Henry D. Pagel, d/b/a Pagel and Sons, a

partnership; the John Deere Company; Gene R.

Mohr, James B. Loyd, d/b/a Mohr-Loyd

Leasing; and Dennison State

Bank, Appellees.

EXECUTIVE FINANCIAL SERVICES, INC., Appellant, v. Paul S. MORSE, Ted R. Morse, and Fred S. Morse, d/b/a

Riverview Farms; Marvin Allen, Jr.; James B.

Loyd and Gene R. Mohr, d/b/a Mohr-Loyd

Leasing; First National Bank of Olathe;

and

Northeast Kansas Production Credit Association, Appellees, v. JOHN DEERE COMPANY, Third-party Defendant-Appellee.

Nos. 58045, 58046.

Supreme Court of Kansas.

Feb. 21, 1986.

Syllabus by the Court

1. A document denominated a "lease" may be construed to create a "security interest" if the terms and contents thereof are more consistent with a security interest than a lease.

2. The entrustment doctrine, codified at K.S.A. 84-2-403(2) and (3), provides that the entrustment of goods to a merchant who deals in goods of that kind accords to the merchant power to transfer all the entrustor's rights in the goods to a buyer in ordinary course of business.

3. The entrustment doctrine operates on the assumption that both the entruster and the buyer have been equally harmed by the dishonesty of the merchant-dealer, and resolves the issue in favor of the buyer.

4. A buyer in ordinary course may prevail on an entrustment theory under K.S.A. 84-2-403(2) and (3) even though the buyer cannot prevail under K.S.A. 84-9-307(1).

5. For K.S.A. 84-2-403(2) to be applicable, three steps are required: (1) an entrustment of goods to (2) a merchant who deals in goods of that kind followed by a sale by such merchant to (3) a buyer in ordinary course of business.

6. A buyer of goods from a merchant in ordinary course of business takes the goods free of a security interest where the goods are entrusted to the merchant by the secured party pursuant to K.S.A. 84-2-403(2).

Michael E. Whitsitt, Overland Park, argued the cause and was on briefs, for appellant.

John L. Vratil of Lathrop, Koontz, Righter, Clagett & Norquist, Overland Park, argued the cause and Gordon E. Wells, Jr., and Daniel M. Dibble, Kansas City, Mo., were with him on brief, for appellees John Deere Co., Marvin Allen, Jr., and Donald H. Pagel and Henry D. Pagel d/b/a Pagel and Sons.

Martin R. Ufford of Redmond, Redmond, O'Brien & Nazar, Wichita, was on brief, for appellee Northeast Kan. Production Credit Ass'n.

HERD, Justice:

These are consolidated actions by Executive Financial Services (EFS) for possession of three tractors and for a determination that it is the owner of the tractors or, in the alternative, that its security interest therein be adjudged prior to the rights of defendants. The district courts granted summary judgment to the defendants and these appeals followed. These actions arise out of the same facts as those set out in Executive Financial Services, Inc. v. Loyd, 238 Kan. 663, 715 P.2d 376, this day decided, which are repeated here for convenient analysis.

EFS purchased three tractors from Tri-County Farm Equipment Company (Tri-County), a John Deere dealership owned by James Loyd and Gene Mohr. EFS then leased the tractors to Mohr-Loyd Leasing, a partnership between Mohr and Loyd. The first transaction involved John Deere Tractor model No. 8640. On July 19, 1982, on behalf of Tri-County, James Loyd sold the No. 8640 tractor to EFS for $48,000. At the same time, EFS leased the tractor to Mohr-Loyd Leasing. Tri-County gave a corporate guarantee of the lease as authorized by a corporate resolution furnished by Loyd. It was later learned that James Loyd deposited the EFS check to his personal business account.

Similar transactions occurred with regard to two other John Deere tractors. The second sale and lease was completed on August 30, 1982, for $19,000. The third transaction involved a purchase price of $38,000 and was completed on November 3, 1982.

Within two months Loyd sold all three tractors to third parties and Mohr-Loyd Leasing and Tri-County defaulted on the leases. This default was the subject of another action wherein EFS obtained a judgment against Mohr, Loyd, Mohr-Loyd and Tri- County for breach of contract. See Executive Financial Services, Inc. v. Loyd, 238 Kan. 663, 715 P.2d 376, this day decided. That judgment is still unsatisfied, making recovery of the tractors important to EFS.

It is important to note that EFS did not take physical possession of the three tractors. Nor did EFS mark or segregate the tractors from other tractors offered for sale by Tri-County to show that either EFS or Mohr-Loyd claimed an interest in them.

EFS filed financing statements on each of the three tractors with the Johnson County Register of Deeds and the Kansas Secretary of State's office. The statements listed "James B. Loyd and Gene R. Mohr d/b/a Mohr-Loyd Leasing" as the debtor, EFS as a secured party, and each tractor as "equipment leased." The financing statements were filed on July 28, 1982 (tractor model No. 8640); September 10, 1982 (tractor model No. 2940); and November 12, 1982 (tractor model No. 4440).

Tri-County sold the model No. 2940 tractor to Thompson Implement Company of Holton, Kansas, on September 24, 1982, in the ordinary course of business. Thompson is a merchant engaged in the business of selling farm equipment and machinery. Thompson later sold the model No. 2940 tractor to appellees Donald and Henry Pagel doing business as Pagel and Sons (Pagel). On January 27, 1983, Pagel executed a variable rate loan contract-security agreement which granted appellee John Deere Company (Deere) a purchase money security interest in the No. 2940 tractor. Deere perfected its security interest in the tractor by filing a financing statement with the register of deeds' office.

Appellee, Marvin Allen, Jr., purchased the model No. 4440 tractor from Tri-County on November 12, 1982. Allen also executed a variable rate loan contract-security agreement granting Deere a purchase money security interest in the No. 4440 tractor. Deere perfected its interest on November 17, 1982, by filing a financing statement with the register of deeds' office.

Appellees Paul, Ted and Fred Morse, doing business as Riverview Farms, acquired the model No. 8640 tractor from Tri-County in October of 1982. Deere, at one time, claimed a purchase money security interest in the same tractor by virtue of a financing statement filed on October 26, 1982. Northeast Kansas Production Credit Association (PCA) had a security interest in "all farm and ranch machinery and equipment" of Riverview Farms, which was perfected as of March 17, 1981. PCA and Deere stipulated to the fact that Deere failed to file a financing statement within ten days following delivery of the No. 8640 tractor as required by K.S.A. 84-9-301(2). Therefore, the trial court found PCA's security interest in the tractor was prior and superior to the security interest of John Deere.

When Tri-County sold the three tractors to third parties, Mohr-Loyd defaulted on the respective leases with EFS. EFS then filed the present action.

In granting summary judgment, the district court of Johnson County found Allen and Riverview Farms were buyers in ordinary course of business from Tri-County and pursuant to K.S.A. 84-2-403(2) took free and clear of the security interest of EFS. The district court of Jackson County made a similar finding with respect to the tractor sold to Thompson Implement Company and later to Pagel and Sons and found EFS impliedly consented to the sale of the tractor by Tri-County to Thompson Implement Company. EFS appeals from both judgments.

There are two theories under the UCC which may entitle the buyers of the tractors to prevail in this case. The trial court found the "entrustment theory," codified at K.S.A. 84-2-403(2), applicable. Appellees argue that even if the trial court erred in applying the entrustment theory, the buyers took free of any security interest of EFS under K.S.A. 84-9-307(1).

Our first concern, however, is whether the transaction between EFS and Mohr-Loyd Leasing is covered by the UCC as a secured transaction since EFS "leased" the tractors to Mohr-Loyd and lease transactions are excluded from Article 9.

This issue was addressed in Atlas Industries, Inc. v. National Cash Register Co., 216 Kan. 213, 531 P.2d 41 (1975), where we stated in Syllabus p 3:

"A document denominated a 'lease' may be construed to create a 'security interest' if the terms and contents thereof ... are more consistent with a security interest than a lease."

K.S.A. 84-1-201(37) provides that whether a lease is intended as security is to be determined by the facts of each case. That section also provides, where the parties have agreed that upon compliance with the terms of the lease the lessee shall become or has the option to become the owner of the property for no additional consideration or for nominal consideration, the lease is intended for security.

EFS admits in its brief on appeal the option price for the tractors is nominal as compared to their anticipated fair market value at the end of the lease term and that the lease agreement creates a security interest in each tractor in favor of EFS. This finding is also supported by the fact that EFS filed UCC financing statements on the three tractors, EFS was not a manufacturer or dealer in like equipment and EFS never took physical possession of the tractors.

We hold the transaction between EFS and Mohr-Loyd Leasing was essentially a financing transaction whereby EFS acquired a security interest in the three tractors. The transaction is therefore subject to the UCC.

Having so determined, we turn to the issue of whether the buyers of the tractors took free of EFS's security interest pursuant to K.S.A. 84-9-307(1), which provides:

"A buyer in ordinary course of business ... other than a person buying farm...