Fitzpatrick v. Philco Finance Corp., 73-1161.

• Decision Date: 21 February 1974
• Docket Number: No. 73-1161.,73-1161.
• Citation: 491 F.2d 1288
• Parties: James R. FITZPATRICK, as Trustee of A. W. Sikking Co., Bankrupt, Plaintiff-Appellee, v. PHILCO FINANCE CORP., Defendant-Appellant.
• Court: U.S. Court of Appeals — Seventh Circuit

491 F.2d 1288 (1974)

James R. FITZPATRICK, as Trustee of A. W. Sikking Co., Bankrupt, Plaintiff-Appellee, v. PHILCO FINANCE CORP., Defendant-Appellant.

No. 73-1161.

United States Court of Appeals, Seventh Circuit.

Argued January 10, 1974.

Decided February 21, 1974.

Robert C. Walbaum, Richard R. Grummon, Springfield, Ill., for defendant-appellant.

Conrad Noll, Jr., Robert E. Davlin, Springfield, Ill., for plaintiff-appellee.

Before SWYGERT, Chief Judge, KILEY, Senior Circuit Judge, and SPRECHER, Circuit Judge.

SPRECHER, Circuit Judge.

This appeal concerns the right to proceeds from secured collateral following the debtor's bankruptcy.

Prior to 1969, A. W. Sikking Co. was a large and established appliance store in Springfield, Illinois. For some years Sikking had financed its purchase of Philco appliances through an agreement with Philco Finance Corp. Pursuant to that agreement, Philco had properly filed financing statements showing its secured interest in the appliances and in the proceeds of the collateral. As soon as Sikking sold an applicance, it was obligated under the agreement to pay the amount due on that item to Philco.

Philco products were distributed in the Illinois-Iowa area by Hardware Products Co. in Sterling, Illinois. Philco Finance had extended a credit line of $275,000 to Sikking as Hardware Products' largest retail dealer.

Sikking's practice in handling Philco sales was to write up a sales receipt on each appliance sold. The receipt noted the brand and kind of appliance, its model number, total price, cash down payment and financing arrangement. All cash payments were deposited in Sikking's general account at Springfield Marine Bank.¹ Much of the Philco merchandise was financed on retail installment contracts, which were sold to a finance company not affiliated with Philco. Proceeds from these contracts were deposited in the same account.

Sikking then drew checks on its account to pay Philco Finance under the security agreement. It appears that the checks usually noted separate Philco invoice numbers and amounts due for each transaction.

In 1969 several officers and directors of Sikking apparently became aware of mismanagement of the business by its president and general manager, Edward Curry. On July 15 they asked Curry to resign. At the urging of another secured creditor, two vice-presidents, Smith and Reilly, hired an accountant to determine the financial condition of the business.

The accountant, Harold Cox, began work on August 11. Although the books were in bad shape and he could not ascertain or verify the value of certain items, Cox prepared a "tentative" balance sheet which he reviewed with Smith and Reilly on September 3. It showed Sikking's liabilities exceeded its assets by more than $160,000.

Smith arranged for a meeting the next day, September 4. Those attending included Smith, Reilly and Cox; H. R. Bertolet, manager of the Philco Finance office in Rock Falls, Illinois; Peter Wheeler, an officer of Hardware Products Co.; several men from General Electric Credit Corp.; and Robert Saner, an officer of Springfield Marine Bank. Cox distributed copies of the balance sheet and led a discussion of Sikking's financial status. No decision about the future of the business was reached at the meeting.

Less than two weeks later, on September 16, Sikking's officers filed a petition in bankruptcy.

The trustee in bankruptcy filed this action against Philco Finance to recover most of the funds Sikking paid to Philco during the ten-day period before bankruptcy was instituted. The trustee's theory was that Philco's security interest in proceeds was limited by Ill.Rev. Stat. ch. 26, § 9-306(4):

In the event of insolvency proceedings instituted by or against a debtor, a secured party with a perfected security interest in proceeds has a perfected security interest

(a) in identifiable non-cash proceeds;

(b) in identifiable cash proceeds in the form of money which is not commingled with other money or deposited in a bank account prior to the insolvency proceedings;

(c) in identifiable cash proceeds in the form of checks and the like which are not deposited in a bank account prior to the insolvency proceedings; and

(d) in all cash and bank accounts of the debtor, if other cash proceeds have been commingled or deposited in a bank account, but the perfected security interest under this paragraph (d) is

(i) subject to any right of setoff; and

(ii) limited to an amount not greater than the amount of any cash proceeds received by the debtor within 10 days before the institution of the insolvency proceedings and commingled or deposited in a bank account prior to the insolvency proceedings less the amount of cash proceeds received by the debtor and paid over to the secured party during the 10 day period.²

The trustee showed that between September 8 and 15 nine checks totaling $44,766.84 were charged against the Sikking bank account payable to Philco Finance. He also proved that proceeds from the sales of Philco appliances between September 6 and 15 totaled $4,513.44 ($664.95 cash down payments + $3,848.49 proceeds from retail installment contracts). Since section 9-306(4)(d) limits the security interest in proceeds to "an amount not greater than the amount of any cash proceeds received by the debtor within 10 days of the insolvency proceedings," the trustee asked for the return of $40,253.40, the difference between the payments to Philco and the proceeds from Philco sales after September 5. The trustee claimed the $40,253.40 was a voidable preference under section 60 of the Bankruptcy Act, 11 U.S.C. § 96.

Philco's contention on appeal is simple. Ignoring section 9-306(4)(d), it says there can be no voidable preference because the first element under section 60(a) — "a transfer . . . within four months before the filing" — is missing. Philco relies on Grain Merchants v. Union Bank & Savings Co., 408 F.2d 209 (7th Cir.), cert. denied, 396 U.S. 827, 90 S.Ct. 75, 24 L.Ed.2d 78 (1969), and similar cases. Grain Merchants holds that the transfer of a security interest in after-acquired collateral occurs at the time the financial statement is filed. When filing predates the bankruptcy by four months, the transfer of property such as accounts receivable in a "floating lien" situation does not constitute a voidable preference under the Bankruptcy Act. 408 F.2d at 212-215.

The gap in Philco's reasoning is that the state law which creates the security interest also limits its application to commingled proceeds in the event of insolvency. Under section 9-306(4)(d), Philco does not have a perfected security interest in the cash in Sikking's bank account beyond the amount of cash proceeds Sikking collected after September 5. The financing statement does not cover the overage of $40,253.40, so the transfer of that amount in checks to Philco occurred within the four-month period.

Nor do the two alternative rationales of Grain Merchants advance Philco's position. There was no transfer "on account of an antecedent debt" in Grain Merchants because the accounts receivable that arose within the four-month period were part of the entity of collateral that was transferred to the secured creditor when the financing statement was filed. 408 F.2d at 215-217. The "entity theory" does not apply here because, by definition of section 9-306(4)(d), the overage is not a part of the collateral originally transferred to Philco.

The "substitution of collateral doctrine" was used in Grain Merchants to show that the transfer to the creditor was for a substantially contemporaneous advance and did not deplete the estate. 408 F.2d at 217-218. The arrangement in Grain Merchants required the debtor to deposit all collections from its accounts receivable in an account at the creditor bank; the debtor was allowed to withdraw from that account to meet current expenses. During the four-month period preceding bankruptcy, the withdrawals were in line with the proceeds from new accounts receivable. There was always an excess of collateral over the secured debt. Because the relative positions of the creditor and debtor were unaltered, the other creditors were not harmed by the substitution of new collateral for prior released accounts.

In a sense, section 9-306(4)(d) is an implementation of the substitution of collateral doctrine. It allows a debtor to pay a secured creditor from commingled funds during the ten days before bankruptcy to the extent that the debtor has received cash proceeds within that period. But the doctrine cannot be extended to benefit a creditor such as Philco which persuades a failing business to remit almost ten times the amount of current proceeds from the secured collateral, to the detriment of other secured creditors who were paid nothing from the bank account in the weeks before bankruptcy. Because of section 9-306(4)(d), proceeds collected before the ten-day period and commingled with other funds are not collateral which may be substituted for other collateral.

We conclude that the theories of Grain Merchants do not apply to commingled proceeds beyond the security interest granted in section 9-306(4)(d).

Finally, acknowledging section 9-306(4)(d) in its reply brief, Philco argues that the limitation in subsection (ii) to an amount not greater than the amount of "any cash proceeds" refers to all receipts from any source deposited in the bank account, rather than to receipts from the sale of Philco collateral. Such an interpretation ignores the definition of "proceeds" and perverts the intent of the legislature in adopting section 9-306. The current definition of "proceeds" in section 9-306(1) states: "`Proceeds' includes whatever is received upon the sale, exchange, collection or other disposition of collateral or proceeds."³ The grant of a security interest in commingled funds under section 9-306(4)(d) is not an expansion of the pre-Code right of a secured creditor to trace proceeds from the disposition...