In re Commercial Management Service, Inc., Bankruptcy No. 89-10618-JNG

Citation127 BR 296
Decision Date17 May 1991
Docket Number89-10620-JNG,Bankruptcy No. 89-10618-JNG,Adv. No. A90-1121-JNG.
PartiesIn re COMMERCIAL MANAGEMENT SERVICE, INC., Debtor. In re FINANCIAL EQUITY SERVICE, INC., Debtor. Stephen S. GRAY, Chapter 11 Trustee of Debtor Financial Equity Service, Inc., Plaintiff, v. JEFFERSON LOAN AND INVESTMENT BANK, Defendant. RHODE ISLAND SHARE AND DEPOSIT INDEMNITY CORPORATION, Defendant and Third-Party Plaintiff, v. SHAWMUT BANK OF RHODE ISLAND, Third-Party Defendant.
CourtUnited States Bankruptcy Courts. First Circuit. U.S. Bankruptcy Court — District of Massachusetts

Vincent Pisegna, Looney & Grossman, Boston, Mass., for plaintiff.

Daniel Glosband, Goodwin, Procter & Hoar, Boston, Mass., for defendant.


JAMES N. GABRIEL, Bankruptcy Judge.


On March 10, 1989, Financial Equity Service, Inc. ("FES" or the "Debtor"), filed a petition for reorganization under Chapter 11 of the Bankruptcy Code. FES operated as a debtor-in-possession for approximately eight months. On November 21, 1989, Stephen S. Gray was appointed the Chapter 11 Trustee (the "Trustee") of FES. He initiated the above captioned adversary proceeding by filing a Complaint to Disallow, Subordinate or Otherwise Determine Secured Claim by Jefferson Loan and Investment Bank; for Turnover of Equipment Leases; to Avoid and Recover Fraudulent Transfers; for Breach of Contract and Fiduciary Duty; and Other Claims. On June 5, 1990, Jefferson Loan and Investment Bank ("Jefferson") answered the nine count Complaint. It also filed a Counterclaim and a Third-Party Complaint against Shawmut Bank of Rhode Island ("Shawmut"). Prior to the filing of Jefferson's Answer, Rhode Island Share and Deposit Indemnity Corp. ("RISDIC"), as the successor in interest to the equipment leases that are the subject of the Trustee's Complaint, filed an Answer. It also filed a Counterclaim and a Third-Party Complaint against People's Bank ("People's"), Shawmut's predecessor-in-interest.

Subsequently, RISDIC moved to withdraw its pleadings. On July 30, 1990, RISDIC filed a Motion to Substitute Rhode Island Share and Indemnity Corporation as Defendant in Counts I, II, IV, V, and VI, Plaintiff-in-Counterclaim and Third-Party Plaintiff. The grounds for the Substitution Motion were that RISDIC, as a Rhode Island non-profit corporation created by statute for the purpose of insuring shares and deposits of financial institutions, exercised its statutory duty to assume control over the assets and operations of the insolvent Jefferson and purchased the subject leases as part of its statutorily imposed obligation to formulate a business plan to guaranty payment to insured depositors. The Court allowed RISDIC's substitution motion on September 24, 1990.1 The Court had previously allowed a Joint Motion by RISDIC and Jefferson to transfer Jefferson's claim of approximately $4.5 million against FES to RISDIC.

On October 29, 1990, RISDIC filed a Motion for Partial Summary Judgment. Through its motion, it raises a number of issues for determination, including (a) whether RISDIC has a valid perfected security interest in the rental stream under the subject leases assigned by FES to Jefferson (and by Jefferson to RISDIC); and (b) if so, whether RISDIC's security interest in the leases is superior to the blanket security interest of Shawmut and the rights of the Trustee under 11 U.S.C. § 544. Specifically, RISDIC seeks dismissal of Count I and II of the Trustee's Complaint, the entry of judgment in its favor on its first and second counterclaims, the entry of judgment in its favor with respect to its Third-Party Complaint, and denial of Shawmut's Third-Party Counterclaim.2 The Trustee filed a Cross-Motion for Summary Judgment on November 9, 1990. Both RISDIC and the Trustee filed briefs and reply briefs. The Court heard arguments on the cross motions on November 27, 1990.


On October 16, 1990, RISDIC and the Trustee filed a Stipulation of Undisputed Facts. From the Stipulation, the following facts emerge.

Beginning in 1986, FES was in the business of equipment leasing. On February 8, 1988, People's (now Shawmut) entered into a Security Agreement and Collateral Assignment of Leases and Rents with FES. People's filed UCC-1 Financing Statements with the appropriate filing offices in conjunction with its $2.3 million loan to FES secured by a security interest in all of FES' receivables, general intangibles, leases, inventory, machinery, equipment and fixtures, then owned or thereafter acquired and the proceeds thereof.

On September 22, 1988, FES, by its president, Michael Lolicata ("Lolicata"), and Jefferson executed a Master Sale and Servicing Agreement (the "Agreement"). Pursuant to the Agreement, FES represented that it was "the owner of, and had the right to sell and assign the right to receive, collect and enforce payment of the Leases, free and clear of all security interests, liens, encumbrances, claims or other interests;" and Jefferson represented that it desired "to purchase the payments in respect of the Leases." FES agreed "to repurchase any Lease which might go into default or, at its option, exchange such a Lease with one owned by FES of equal or greater value." FES also agreed to provide billing, accounting and collection services with respect to the Leases. The parties stated:

FES hereby assigns all of its right, title and interest in and to the payments due under the Leases set forth on Exhibit A for an amount payable in cash which is set forth on such Exhibit A; subject however, to the right on the part of FES to retain for its sole and absolute possession, the ownership of the equipment and the rights to any payment in respect thereof by the Lessee thereof (the "Residuals"). In addition to the assignment of the Leases, FES, subject to FES\' right to the Residuals, also assigns all of its rights to the monies due under the Leases and all agreements, documents or instruments related thereto or securing performance by the lessees under the Leases.

Two hundred eighty-one leases were physically transferred to Jefferson. However, only 212 of the 281 leases transferred had original signatures in which FES was the named lessor. Sixteen of the 281 leases had original signatures but FES was not the named lessor. The remaining leases were not original documents. Jefferson did not file any Financing Statements with respect to the leases it acquired pursuant to the September 1988 Agreement.

The price of the package or pool of leases sold to Jefferson was calculated by discounting the value of the remaining payments on each lease in the pool. Jefferson paid more than $4.5 million for the leases it purchased.


The dispute between the parties involves novel and complex issues for which there is little relevant judicial guidance.3 Resolution of the dispute turns upon application of the Rhode Island version of the Uniform Commercial Code, R.I. Gen. Laws §§ 6A-1-101 to 6A-9-507, to the facts of the case. In view of the need to integrate numerous sections of the Uniform Commercial Code, the Court will summarize the arguments advanced by both parties.

Chattel paper is defined as "a writing or writings which evidence both a monetary obligation and a security interest in or a lease of specific goods." R.I.Gen.Laws § 6A-9-105(b). RISDIC maintains that each original lease reflects the lease of one or more items of equipment to a named lessee, for a term of months at a fixed monthly payment. Accordingly, RISDIC, citing Feldman v. First National City Bank (In re Leasing Consultants, Incorporated), 486 F.2d 367 (2d Cir.1973), asserts that since the leases themselves evidence both a monetary obligation and a lease of specific goods, they constitute chattel paper. The Trustee does not dispute that the leases themselves are chattel paper. Rather, the Trustee focuses on the fact that Jefferson only purchased the rental payments due under the leases, not all the rights that inured to FES under them.

In the Leasing Consultants case, the court considered the issue of the extent to which chattel paper embodied rights in the underlying goods. The court concluded that, if the leases were intended for security, the chattel paper embodied all of the debtor's rights in the underlying collateral because the transaction was fundamentally a sale. However, if the leases were true leases, the debtor had two distinct rights in the underlying equipment: the right to get the equipment back upon default and the right to get the equipment back upon termination of the lease. The court concluded that the debtor's reversionary rights were not embodied in the chattel paper. It stated: ". . . the leases themselves were chattel papers . . . by contrast, the machines themselves constituted `equipment.'" Id. at 370. The court emphasized the distinction between rights under the chattel paper and the reversionary interest in the equipment. It quoted Levie, "Security Interests in Chattel Paper," 78 Yale L.J. 935, 940 (1969), as follows:

`the purchaser of a security agreement may have an advantage over the purchaser of a lease. Where he purchases equipment leases, he takes only an assignor\'s interest in the equipment lease itself. If he wishes to be secured by an interest in the goods as well, he must obtain a security interest *** in the goods and perfect it.\'

486 F.2d at 370-71. The Second Circuit thus articulated a dual perfection rule in the case of true leases. Accordingly, a party claiming a security interest in a lease and the reversion, i.e., the equipment subject to the lease, must perfect both its interest in the lease or chattel paper and the equipment.

RISDIC next argues that although Jefferson and FES structured their transaction as a purchase of some of FES' rights under the leases, instead of as a loan with the leases serving as collateral, the Uniform Commercial Code provides that Jefferson, as an assignee of chattel paper, nevertheless is a "secured party" with a ...

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