In re Freeman, Bankruptcy No. 86-00472-R

• Decision Date: 22 April 1987
• Docket Number: Bankruptcy No. 86-00472-R,Adv. No. 86-00257-R.
• Citation: 72 BR 850
• Court: U.S. Bankruptcy Court — Eastern District of Virginia
• Parties: In re Claude Martin FREEMAN, Katherine Riggs Freeman, Debtors. Claude Martin FREEMAN, Katherine Riggs Freeman, Plaintiffs, v. ELI LILLY FEDERAL CREDIT UNION and American Lenders Service, Inc., Defendants.

72 B.R. 850 (1987)

In re Claude Martin FREEMAN, Katherine Riggs Freeman, Debtors Claude Martin FREEMAN, Katherine Riggs Freeman, Plaintiffs, v. ELI LILLY FEDERAL CREDIT UNION and American Lenders Service, Inc., Defendants.

Bankruptcy No. 86-00472-R, Adv. No. 86-00257-R.

United States Bankruptcy Court, E.D. Virginia, Richmond Division.

April 22, 1987.

James R. Sheeran, Richmond, Va., for plaintiffs.

Kay Wesley Hardy, Richmond, Va., for defendants.

MEMORANDUM OPINION

BLACKWELL N. SHELLEY, Bankruptcy Judge.

This matter comes before the Court upon the filing by Claude Martin Freeman and Katherine Riggs Freeman ("Freemans" or "Debtors"), the debtors herein, of a complaint to compel turnover of property and for a determination that Eli Lilly Federal Credit Union ("Eli Lilly"), the defendant herein, does not hold a claim secured by said property. A pretrial conference was convened in this proceeding on July 30, 1986, and upon the representation of the parties that the facts were substantially uncontroverted, and upon ordering the submission of briefs on the issues of perfection and secured status, this matter was taken under advisement. Accordingly, based upon the facts as jointly stipulated by the parties, and upon the briefs filed, the Court makes the following findings of fact and conclusions of law.

FINDINGS OF FACT

On or about September 13, 1984, Claude M. Freeman purchased a 1984 Nissan 300ZX automobile from Neil Huffman Datsun, Inc., in Jefferson County, Kentucky. The debtor obtained financing for the purchase of that automobile to the extent of $19,756.93 from the Eli Lilly Federal Credit Union. On September 13, 1984 Mr. Freeman executed a promissory note to the order of Eli Lilly in the amount of $19,756.93. The note provided for interest on the unpaid principal balance at a rate of 11.5% per annum and for payment of the obligation through 128 bi-weekly installments of $201.00 each and a final installment of $153.34. Payments were to commence September 20, 1984. On September 17, 1984, Claude M. Freeman and Katherine R. Freeman voluntarily granted a security interest in the Nissan automobile to secure repayment of the note of September 13, 1984, in the amount of $19,756.93.

The Kentucky Department of Motor Vehicles issued and delivered to the Freemans title to the automobile showing ownership by Claude M. Freeman and Katherine R. Freeman, but no notation of lien was stamped on the title. Eli Lilly never reported to the Kentucky Department of Motor Vehicles that it had a security interest in the vehicle.

The Freemans made payments to Eli Lilly from the date of purchase until September 5, 1985 at which time the payments ceased altogether. On February 22, 1986, five months after receiving the last payment from the Freemans, Eli Lilly directed American Lenders Service, Inc., in Richmond, Virginia, to take possession of the Nissan automobile for the purpose of selling it at auction and distributing the proceeds therefrom to Eli Lilly. Eli Lilly gave notice to the Freemans that the vehicle would be sold at auction on March 17, 1986.

The Freemans filed this Chapter 13 proceeding on March 11, 1986, and as a result, the sale of the automobile was stayed. As of the date of the Chapter 13 filing the principal balance on the debt owed by the Freemans to Eli Lilly was $18,032.11. The value of the vehicle at the time this proceeding was filed was $12,500.00.

The Freemans' Chapter 13 plan was filed with this Court on March 11, 1986, together with the debtor's original petition. Eli Lilly has filed an objection to confirmation of the debtors' plan on the basis of its treatment as an unsecured rather than a secured creditor. The Court has deferred a ruling on confirmation pending the outcome of this adversary proceeding.

CONCLUSIONS OF LAW

In Lewis v. Manufacturers National Bank of Detroit, 364 U.S. 603, 81 S.Ct. 347, 5 L.Ed.2d 323 (1961), the Supreme Court determined that the law of the state where the transaction occurred governs the issue of perfection. The Nissan automobile which is the subject of dispute in this case was purchased and titled in Jefferson County, Kentucky; therefore, Kentucky law controls the issue of perfection.

Until recently, when the Kentucky legislature adopted the Automated Motor Vehicle Registration System Act, Kentucky was a "non-exclusive" title act state in which perfection of a security interest in an automobile could be accomplished by filing and by noting the lien on the certificate of title. This "dual perfection" system led to a great deal of confusion and to the eventual enactment of new legislation, similar to that already in force in the vast majority of states, to remedy the inconsistencies which existed with the former law. The law, as it currently stands, and as it stood in September of 1984 when the Freemans purchased their automobile, states:

186A. 190. Financing statement required on title document. Notice and release of financing statement (Effective until July 1, 1987) — 1) Financing statements relating to vehicles required to be titled in Kentucky through the county clerk of the county in which the debtor resides or, if the debtor is a nonresident, in the office of the county clerk in which the vehicle is principally operated. Notwithstanding the existence of any filed financing statement relating to any vehicle registered or titled in Kentucky, the sole means of determining priority of security interests in which vehicle shall be the notation of the security interest on such vehicle\'s registration or title. (Emphasis added).

Kentucky Revised Statutes 186A. 190.

The final sentence of the statute makes clear that the only act which will allow a creditor to prevail in a priority contest is the notation of his security interest on the automobile's registration or title. Filing a financing statement with the Clerk's Office where the debtor resides will serve some limited purposes but such a filing — by itself — will not be deemed sufficient to permit the creditor to prevail over third parties or other lien creditors who may claim an interest in the vehicle.

The parties have stipulated that Eli Lilly's lien was never placed on the certificate of title to the Nissan automobile, so the Court accepts as fact that the security interest was not perfected by the method prescribed by the Kentucky law.

Eli Lilly alternatively contends that it perfected its security interest when, at the creditor's direction, American Lenders Service, Inc. repossessed the Nissan automobile. Eli Lilly relies on section 9-302(1)(a) and section 9-305 of the Uniform Commercial Code, which permit possession to suffice for perfection in certain instances. This Court has previously held in In re Fregosi, 23 B.R. 641 (Bankr.E.D.Va.1982) that possession is not always a sufficient means of perfecting a security interest. In that case, the creditor took voluntary possession of two of the debtor's trucks as a pledge for an antecedent indebtedness to the creditor. Subsequently, the debtor filed a voluntary petition in bankruptcy and the Court found that, since Virginia law required a lien creditor to "set forth his interest on the vehicle's certificate of title," the creditor's failure to do so rendered his interest unperfected. Id. at 643.¹

It is this Court's opinion that Eli Lilly's perfection-by-repossession argument has no place where, as here, the controlling motor vehicle statute explicitly and unambiguously sets forth the procedure for perfection of security interests in automobiles. Eli Lilly, who is charged with notice of the Kentucky statute, had from the date the Freemans purchased the automobile the opportunity to perfect its interest by noting its lien on the certificate of title. It neglected to do so and, therefore, cannot now be heard to claim a priority status by virtue of repossession upon default. Simply stated, repossession of the automobile does not equate to perfection under the facts of this case.

Having concluded that Eli Lilly's security interest in the automobile was never properly perfected, the Court must next determine what effect that lack of perfection has upon the creditor's status in the Freemans' Chapter 13 proceeding. Eli Lilly maintains that even if it failed to properly perfect its interest, it is still a secured creditor under the debtors' plan by virtue of the security agreement entered into with the Freemans. Since this dispute over secured status involves only the Freemans and Eli Lilly — the parties to the original security agreement — Eli Lilly argues that the debtors should be held to the terms of the contract which they voluntarily negotiated and entered into. Issues of perfection, the creditor claims, are irrelevant unless third parties claim an interest in the same collateral and a priority contest results. See In re Lanctot, 6 B.R. 576, 577 (Bankr.D.Utah 1980); In re Evingham, 27 B.R. 128, 129 (Bankr.W.D.N.Y.1983); In re Chase, 37 B.R. 345, 347 (Bankr.D.Vermont 1983).

The Freemans, on the other hand, contend that an inquiry into the issue of perfection is not only relevant to a determination of Eli Lilly's secured status, but is in fact dispositive of the issue. As the debtors interpret the law, lack of perfection prior to bankruptcy relegates Eli Lilly's claim to that of an unsecured creditor for purposes of treatment under their Chapter 13 plan. Therefore, Eli Lilly, like all other unsecured creditors, should receive only 57% of the value of its claim. See Richlands National Bank v. Smith, 34 B.R. 749 (D.C.W.D.Va.1983).

The complaint filed by the Freemans requests the Court for a declaration that Eli Lilly is an unsecured creditor in this Chapter 13 case. However, the action is, in essence, an attempt by the debtors to avoid an unperfected security interest under § 544(a) of the Code.² Accordingly, the Court will view it as such.

By virtue of section 103(a) of the Code, all provisions of Chapter 5 including the trustee's avoidance powers...