Helms v. Certified Packaging Corp.

• Decision Date: 30 December 2008
• Docket Number: No. 08-1017.,No. 08-1119.,08-1017.,08-1119.
• Parties: Brenda P. HELMS, Trustee, Plaintiff-Appellant, Cross-Appellee. v. CERTIFIED PACKAGING CORPORATION, Defendant, and CPC Acquisition, Inc., Intervenor-Appellee, Cross-Appellant.
• Court: U.S. Court of Appeals — Seventh Circuit

551 F.3d 675

Brenda P. HELMS, Trustee, Plaintiff-Appellant, Cross-Appellee. v. CERTIFIED PACKAGING CORPORATION, Defendant, and CPC Acquisition, Inc., Intervenor-Appellee, Cross-Appellant.

No. 08-1017.

No. 08-1119.

United States Court of Appeals, Seventh Circuit.

Argued November 4, 2008.

Decided December 30, 2008.

Rehearing Denied January 21, 2009.

Steven B. Towbin (argued), Gordon E. Gouveia (argued), Shaw, Gussis, Fishman, Glantz, Wolfson & Towbin, Chicago, IL, for Trustee, Plaintiff-Appellant, Cross-Appellee.

Ralph J. Schindler, Jr. (argued), Chicago, IL, for Intervenor-Appellee, Cross-Appellant.

Before POSNER, WOOD, and TINDER, Circuit Judges.

POSNER, Circuit Judge.

Sarah Michaels, Inc., a manufacturer of bath products and a customer of a packaging manufacturer named Certified Packaging Corporation, declared bankruptcy together with affiliated corporations unnecessary to discuss separately. The trustee in bankruptcy brought an adversary proceeding against Certified seeking to avoid transfers that Michaels had made to that company to pay for packaging. The trustee obtained a default judgment for some $2 million but in an effort to collect the judgment collided with LaSalle Bank, which, as the assignee of a loan to Certified, claimed a security interest in Certified's assets. LaSalle in turn assigned its claim to CPC Acquisition, which is the successor to Certified and which has intervened in the bankruptcy proceeding to assert the priority of its lien over the trustee's judgment lien. For the sake of simplicity we'll pretend that LaSalle was and remains the lender to Certified and thus the adversary of the trustee in bankruptcy.

In December 2000, after LaSalle had made the loan, a fire broke out at one of Certified's plants and damaged equipment in it. The plant was shut down for several weeks, and the business losses resulting from the shutdown greatly exceeded the damage to Certified's property. Certified brought two lawsuits (both in Illinois state courts) in the wake of the fire. One was against its insurance broker, Rothschild, for negligence in having failed to list the plant on a business-losses insurance policy that Rothschild had procured for Certified. That suit was settled for $88,000 after deduction of attorneys' fees. The trustee contends that the settlement money should belong to the bankrupt estate, LaSalle that the money should belong to it as proceeds of the collateral damaged in the fire. The bankruptcy judge agreed with the trustee but was reversed by the district judge, and the trustee appeals.

Certified's other suit was against Commonwealth Edison and claimed that the fire had been due to Com Ed's negligence in maintaining one of its power lines. In that suit, which is pending, Certified seeks damages of $2,000,000 for property damage and business losses, the latter accounting for about 90 percent of the claimed damages. The bankruptcy judge, seconded by the district judge, ruled that the business-losses part of Certified's claim against Com Ed belongs to the trustee in bankruptcy, not to LaSalle. The cross-appeal challenges that ruling.

So we must decide whether the negligence claim against Rothschild for business losses, and the parallel claim against Certified, or either, or neither, are part of LaSalle's security interest. The issues are governed by the Uniform Commercial Code, as interpreted by the Illinois courts.

The loan agreement between LaSalle and Certified gave LaSalle a security interest in the equipment damaged in the fire. If a suit against someone who steals or damages collateral eventuates in an award measured by the diminution in the value of the collateral caused by the defendant's wrongdoing, so that the award restores the original value of the collateral, the award, like an insurance payment for damaged collateral, constitutes "proceeds" of the collateral and is therefore covered by the lender's security interest. UCC §§ 9-102(a)(64)(D) (proceeds include, "to the extent of the value of collateral, claims arising out of the loss, nonconformity, or interference with the use of, defects or infringement of rights in, or damage to, the collateral"), (E); McGonigle v. Combs, 968 F.2d 810, 828-29 (9th Cir.1992); In re Wiersma, 324 B.R. 92, 106 (9th Cir.BAP 2005), reversed on other grounds, 483 F.3d 933 (9th Cir.2007); In re Territo, 32 B.R. 377, 379-80 (Bkrtcy.E.D.N.Y.1983); Richard F. Duncan et al., The Law and Practice of Secured Transactions: Working with Article 9 § 2.05[3], pp. 2-57 to 2-58 (2008); R. Davis Rice, "McCullough v. Goodrich & Pennington Mortgage Fund, Inc.: Are Secured Creditors Really `Secure' from Third Party Impairment of Collateral?," 59 S. Car. L.Rev. 455, 467-70 (2008); Lynn M. LoPucki & Elizabeth Warren, Secured Credit: A Systems Approach 205-06 (2d ed.1998).

If Certified's suit against Com Ed succeeds, it will be as if Com Ed had converted some $200,000 of the collateral for LaSalle's loan and was therefore obliged to repay it; and "an action for conversion is a proper remedy for a secured party to bring against a third party when its collateral has been disposed of by the debtor." Taylor Rental Corp. v. J.I. Case Co., 749 F.2d 1526, 1529 (11th Cir. 1985); see also UCC § 9-315, comment 2; Bartlett Milling Co., L.P. v. Walnut Grove Auction & Realty Co., 665 S.E.2d 478, 488-89 (N.C.App.2008); Farmers State Bank v. Easton Farmers Elevator, 457 N.W.2d 763, 766 (Minn.App.1990). And so the judgment obtained in that suit would constitute proceeds of the collateral up to its value. That is why LaSalle's entitlement to the property-damage component of Certified's claim against Com Ed is unchallenged, and it is why if Rothschild, the insurance broker, had failed to obtain insurance coverage for damage to the physical assets that secured LaSalle's loan, the claim against the broker rather than for loss of business would be a claim to proceeds of the collateral.

But the claim against Rothschild was for failure to obtain business-loss insurance, and we do not see how compensation for that failure can be considered proceeds of collateral. The usual proceeds of collateral are the money obtained from selling it. By a modest extension, as we have just seen, they are money obtained in compensation for a diminution in the value of the collateral. But replacing a business loss is not restoring the value of damaged collateral. There is no necessary relation between the value of collateral and a business loss that results from its being destroyed or damaged—as this case illustrates: the business losses exceeded the impairment of the value of the collateral ninefold. The claim of a secured creditor to the proceeds of collateral cannot exceed the value of the collateral. UCC § 9-102(a)(64)(D), (E); In re Tower Air, Inc., 397 F.3d 191, 199 and n. 10 (3d Cir.2005); In re Stevens, 130 F.3d 1027, 1030 (11th Cir.1997). Recall the qualification in the definition of proceeds in UCC § 9-102(a)(64)(D): "to the extent of the value of collateral."

The district judge was therefore wrong to treat the $88,000 settlement of Certified's claim against Rothschild for failing to procure business-loss coverage as proceeds of damaged collateral. But LaSalle has another ground for claiming a security interest in Certified's business-loss claim against Rothschild, as well as against Commonwealth Edison. A provision in LaSalle's loan agreement with Certified says that the collateral for the loan includes "Commercial Tort Claims listed on Schedule B" of the agreement. Certified's claims against both Rothschild and Com Ed are commercial tort claims. UCC § 9-102(a)(13)(A). So if, as LaSalle contends, the loan agreement gave it a security interest in any tort claim filed by Certified, it is entitled to enforce that interest against the settlement that Certified made with Rothschild and against any judgment or settlement that Certified may obtain from Com Ed.

But Schedule B is a blank piece of paper except for its title ("SCHEDULE B: Commercial Tort Claims"). The agreement was amended after the fire yet states that Certified "has no Commercial Tort Claims pending other than those set forth on Schedule B hereto as Schedule B may be amended from time to time. [Certified] shall notify [LaSalle] promptly upon becoming aware of any Commercial Tort Claims of [Certified] which may arise, which notice shall constitute [Certified's] authorization to amend Schedule B to add such Commercial Tort Claim." Schedule B was never amended to add any claims.

No matter, argues LaSalle. Its UCC financing statement claimed collateral in all of Certified's assets, expressly including "Commercial Tort Claims," and anyway the purpose of providing notice of liens is to protect subsequent creditors, and there were none. "[T]he purpose of the financing statement is to put third parties on notice that the secured party who filed it may have a perfected security interest in the collateral described, and that further inquiry into the extent of the security interest is prudent." Magna First National Bank & Trust Co. v. Bank of Illinois, 195 Ill.App.3d 1015, 142 Ill.Dec. 714, 553 N.E.2d 64, 66 (1990); see also GP Credit Co., LLC v. Orlando Residence, Ltd., 349 F.3d 976, 982-83 (7th Cir.2003). "The financing statement is an abbreviation of the security agreement. It is a streamlined paper to be filed for the purpose of giving notice to third parties of the essential contents of the security agreement." 1 Eldon H. Reiley, Security Interests in Personal Property § 7:3, pp. 7-3 to 7-4 (3d ed.1999).

Because the loan agreement authorized LaSalle to amend Schedule B to add any commercial tort claims that it might acquire, its failure to do so after Certified had notified LaSalle of both commercial tort claims was, LaSalle argues, an innocent mistake that harmed no one, and such mistakes, even when unilateral (that is, made by only one of the parties to the contract), are forgivable; that at least is the standard...