In re Cohutta Mills, Inc.

• Decision Date: 12 December 1989
• Docket Number: Civ. A. No. 4:89-CV-56-HLM.
• Citation: 108 BR 815
• Parties: In re COHUTTA MILLS, INC., Debtor. Howard W. JONES, Trustee in Bankruptcy of Cohutta Mills, Inc., Plaintiff-Appellant, v. SMALL BUSINESS ADMINISTRATION, Defendant-Appellee.
• Court: U.S. District Court — Northern District of Georgia

108 B.R. 815 (1989)

In re COHUTTA MILLS, INC., Debtor.

Howard W. JONES, Trustee in Bankruptcy of Cohutta Mills, Inc., Plaintiff-Appellant, v. SMALL BUSINESS ADMINISTRATION, Defendant-Appellee.

Civ. A. No. 4:89-CV-56-HLM.

United States District Court, N.D. Georgia, Rome Division.

December 12, 1989.

Howard W. Jones, Office of Howard W. Jones, Calhoun, Ga., trustee.

Dennis M. Hall, Office of U.S. Trustee, Atlanta, Ga., for U.S. Trustee in bankruptcy.

James Randolph Schulz, Office of U.S. Atty., Atlanta, Ga., for Small Business Admin.

Joseph Morgan Seigler, Jr., Rogers Magruder Sumner Brinson & Seigler, Rome, Ga., for Cohutta Mills, Inc.

William Lee Rothschild, Wildman Harrold Allen Dixon & Branch, Atlanta, Ga., for Beaulieu of America, Inc.

ORDER

HAROLD L. MURPHY, District Judge.

Facts and Procedural History

Bankruptcy Trustee Jones appeals the Bankruptcy Court's decision that the Small Business Administration (SBA) has a perfected security interest in personalty of Bankruptcy Debtor Cohutta Mills, Inc. The trustee had honored the SBA's claim to a security interest in realty, but objected to the SBA's claim to a security interest in personalty on the ground that it was not perfected.

The Bankruptcy Court held a hearing on the trustee's objection, where it heard argument from counsel and testimony from a representative of SBA, and received documentary evidence. The proof adduced shows that, in 1977, King's Tuft, Inc. borrowed money from Cohutta Banking Company (Cohutta Bank), and the loan was guaranteed by SBA. Cohutta Bank secured the note with equipment, machinery, and after-acquired property of King's Tuft and filed financing statements that perfected its interests.

In 1979, Cohutta Bank assigned the note and security interests to SBA, and filed statements reflecting those assignments.

Subsequently, to resolve financial problems of King's Tuft, its owners created a new corporation, Cohutta Mills, and transferred King's Tuft's assets to Cohutta Mills. On April 22, 1980, Cohutta Mills entered into an "Assumption Agreement" wherein it assumed King's Tuft's obligations under SBA's note. In the same document, SBA consented to the transfer on the condition that Cohutta Mills assumed those obligations. King's Tuft ceased to exist at that point.¹

Cohutta Mills had the same president as King's Tuft and pursued the same line of business at the same location using the same machinery and equipment. SBA did not file new financing statements when the new corporation was formed, although it did send letters to King's Tuft's creditors. Approximately two years later, on August 16, 1982, SBA filed a continuation statement indicating that it retained a security interest in the property of King's Tuft. Cohutta Mills filed for bankruptcy on February 6, 1987.

Issue on Appeal

Under 11 U.S.C. § 544(a)(1), a bankruptcy trustee has the rights of a hypothetical lien creditor as of the filing of the bankruptcy petition. The rights of a lien creditor are determined pursuant to state law. In re Kors, Inc., 819 F.2d 19, 22-23 (2d Cir.1987); Matter of Chaseley's Foods, Inc., 726 F.2d 303, 307 (7th Cir.1983). Under Georgia's version of the Uniform Commercial Code (hereinafter referred to as "UCC"), a lien creditor has priority over an unperfected, though secured, creditor. Ga. Code Ann. § 11-9-301(1)(b), (3). In the bankruptcy context, therefore, if the secured creditor's interest is not perfected, the creditor "stands as a general unsecured creditor who must defer to the trustee." In re Merts Equipment Co., 438 F.Supp. 295, 298 (M.D.Ga.1977).

The Parties' Arguments

The trustee argues that SBA's interest is unperfected because SBA filed the continuation statement in the name of King's Tuft instead of Cohutta Mills. He stresses that Cohutta Mills was a new corporation, as opposed to change of name of King's Tuft, and reasons that a prospective creditor searching the files under the name of Cohutta Mills would not locate SBA's interest.

The trustee argues further that Cohutta Mills assumed SBA's note and not the security agreement and that, in any event, a security interest would not attach to afteracquired property of Cohutta Mills. Lastly, the trustee claims the SBA breached a contractual agreement to file financing statements in the name of Cohutta Mills.

SBA responds that it was not required to file a new financing statement when the property was transferred and that its continuation statement was effective. SBA contends further that this Court cannot consider the trustee's argument concerning after-acquired property because the trustee did not develop a factual record thereon.

Discussion

1. Did Cohutta Mills acquire King's Tuft's property subject to SBA's security interest?

"A security interest continues in collateral notwithstanding sale, exchange or other disposition thereof unless the disposition was authorized by the secured party in the security agreement or otherwise." Ga. Code Ann. § 11-9-306(2). In the instant case, SBA, the secured party, clearly authorized the disposition of the collateral from King's Tuft to Cohutta Mills. At first glance, therefore, it would seem that the security interest did not continue in the collateral.

However, Ga.Code Ann. § 11-9-402(7) provides that "a filed financing statement remains effective with respect to collateral transferred by the debtor even though the secured party knows of or consents to the transfer." This language conflicts with § 9-306(2) insofar as it assumes that a security interest can remain perfected after a transfer even if the secured party has consented to, i.e., authorized, the transfer.

The conflict between these sections has been resolved in different ways by the courts:

Several decisions . . . hold that a transfer of collateral is not `authorized\' under § 9-306(2) if the secured party consents to the transaction on the condition that its security interest continues after transfer. See, e.g., Wegner v. Grunewaldt, 821 F.2d 1317, 1320-22 (8th Cir. 1987); Loeb v. Franchise Distributors, Inc. (In re Franchise Systems, Inc.), 46 B.R. 158 (Bankr.N.D.Ga.1985); Richmond Fixture & Equipment Co. v. Hyman (In re Southern Properties, Inc.), 44 B.R. 838 (Bankr.E.D.Va.1984). These courts believe that treating such conditional consent as authorization under § 9-306(2) is highly artificial because to do so would give effect to one aspect of the consent while ignoring the other. They reconcile § 9-306(2) with § 9-402(7) by construing the latter as applying only to such conditional authorization. Other decisions arrive at the opposite result. Some do so because the lien is hidden after the conditional transfer from a potential creditor examining the records unless the record search includes the collateral\'s entire chain of title. See, e.g., Trustee Services Corp. v. East River Lumber Co., Inc. (In re Hodge Forest Industries, Inc.), 59 B.R. 801 (Bankr.D. Idaho 1986).

In re Martin Specialty Vehicles, Inc., 87 B.R. 752, 761 (Bankr.D.Mass.1988). The Martin Court adopted the former rule for the following reason:

Official Comment No. 8 to U.C.C. § 9-402 anticipates the necessity of searching the entire chain of title.² . . . A construction of § 9-306(2) as excluding conditional assent from its operation and of § 9-402(7) as referring to such assent, therefore, not only puts the two statutes in harmony, but is also consistent with Official Comment 8 to § 9-402. This type of conditional consent should be distinguished from the situation where the secured party permits a sale on the condition that it be paid from the proceeds. There the condition relates to an event occurring after the transfer so that it can be logically separated from the consent. See, e.g., Moffat County State Bank v. Producers Livestock Association, 598 F.Supp. 1562 (D.Colo.1984).

Id. at 761-62 (footnote added).

This Court agrees that §§ 9-306(2) and 9-402(7) are best read as providing that a security interest terminates upon the transfer of the collateral unless the secured creditor unambiguously authorized the disposition subject to its security interest. Cf., Matter of Franchise Systems, 46 B.R. 158, 162 (Bankr.N.D.Ga.1985), citing In re Matto's, Inc., 8 B.R. 485, 489 (Bankr. E.D.Mich.1981) (a security interest continues in collateral unless it is clear that the parties intended otherwise).³

A review of the record reveals that SBA's consent to the transfer of the collateral was conditioned on the continuation of its security interest. The Assumption Agreement states that SBA was consenting to the "sale and transfer" of the assets subject to the "terms and conditions" of the note, "as modified, restated and renewed" pursuant to the Assumption Agreement. The agreement modified the note to the extent of redetermining the payment amounts and dates only. The note, which was attached to the Assumption Agreement as Exhibit A, recites that Cohutta Bank had transferred its "rights, titles, interest, powers and options in, to and under the within promissory note" to SBA. One of those "rights" was that upon non-payment of the indebtedness, the creditor could proceed against the collateral. "Collateral," in turn, was defined as property hypothecated as security for the note.

The Court concludes that all the parties unambiguously agreed that SBA's security interest would continue in the collateral. Cohutta Mills therefore acquired King's Tuft's property subject to SBA's security interests.

2. Was the Filed Financing Statement Effective to Perfect SBA's Security Interest in the Property After the Property had been Transferred to Cohutta Mills?

Under Georgia law, a financing statement, among other things, must give the correct name of the debtor. Ga.Code Ann. § 11-9-402(1). A financing statement that misnames the debtor is nevertheless effective so long as the error is not "seriously misleading." See § 11-9-402(8) ("A financing statement that substantially complies with the requirements of this Code sec...