In re Skagit Pacific Corp., BAP No. WW-03-1637-MaSP.

• Decision Date: 06 October 2004
• Docket Number: Bankruptcy No. 02-25027.,BAP No. WW-03-1637-MaSP.,BAP No. WW-04-1021-MaSP.
• Citation: 316 B.R. 330
• Court: U.S. Bankruptcy Appellate Panel, Ninth Circuit
• Parties: In re SKAGIT PACIFIC CORPORATION, Debtor. Peter H. Arkison, Chapter 7 Trustee, Appellant/Cross Appellee, v. Frontier Asset Management, LLC, Appellee/Cross-Appellant, v. Sundt Construction, Inc., Appellee.

316 B.R. 330

In re SKAGIT PACIFIC CORPORATION, Debtor.

Peter H. Arkison, Chapter 7 Trustee, Appellant/Cross Appellee, v. Frontier Asset Management, LLC, Appellee/Cross-Appellant, v. Sundt Construction, Inc., Appellee.

BAP No. WW-03-1637-MaSP.

BAP No. WW-04-1021-MaSP.

Bankruptcy No. 02-25027.

United States Bankruptcy Appellate Panel of the Ninth Circuit.

Argued and Submitted on June 25, 2004.

Filed August 25, 2004.

Ordered Published October 6, 2004.

COPYRIGHT MATERIAL OMITTED

Alan J. Wenokur, Seattle, WA, for Peter H. Arkison, Ch. 7 Trustee.

Craig S. Sternberg, Sternberg, Thomson, Okrent & Scher, Seattle, WA, for Frontier Asset Management, LLC.

Before MARLAR, SMITH and PERRIS, Bankruptcy Judges.

OPINION

MARLAR, Bankruptcy Judge.

The chapter 7¹ trustee (the "Trustee") appeals the bankruptcy court's recognition of a security interest in proceeds from an account receivable. The Trustee contends that the receivable was generated from post-petition cash proceeds and had not been properly traced to pre-petition collateral. The secured creditor cross-appeals as to the amount of its traceable interest. The secured creditor also appeals the bankruptcy court's denial of a security interest in vehicles whose titles were never changed to reflect its liens. We REVERSE the recognition of a security interest in the post-petition account receivable as being improperly traced to pre-petition collateral, and AFFIRM the denial of a security interest in the titled vehicles.

FACTS

Skagit Pacific Corporation ("Debtor" or "Skagit") manufactures and sells modular offices and trailers.

Skagit executed promissory notes, secured by certain property of the Debtor, in favor of Frontier Bank. The notes were personally guaranteed by Douglas Peterson, president of Skagit, and his wife, Jean ("the Petersons"). Skagit subsequently delivered, on the demand of Frontier Bank, the titles to 10 vehicles and trailers. Frontier Bank took possession of the titles but did not change the name on the certificate of title, nor did it have its lien placed thereon as required to perfect under Washington law.

In October 2002, Skagit defaulted on the note obligations to Frontier Bank and the bank sued the Debtor and the Petersons in state court. Skagit filed for chapter 11 bankruptcy protection on December 11, 2002.

In February or March 2003, the Petersons settled their portion of the Frontier Bank lawsuit. As part of the settlement, the Petersons took an assignment of Frontier Bank's secured position with respect to Skagit, including the notes and security agreements. Frontier Bank also delivered the vehicle titles to the Petersons. The Petersons formed Frontier Asset Management LLC ("FAM") to hold and manage the interests purchased from Frontier Bank.

The parties agree that Frontier Bank held a valid and enforceable pre-petition security interest in owned or after-acquired equipment, inventory, accounts receivable, chattel paper, general intangibles, and all proceeds of such collateral; and, that the assignment to the Petersons was adequate. The parties also agree that FAM holds whatever interest Frontier Bank had in the titled vehicles.

Although FAM allowed the Debtor to use cash collateral after the commencement of the chapter 11 case, it did not (nor did the Debtor or Frontier Bank) seek an order allowing the use of cash collateral or providing adequate protection. FAM holds no replacement liens. No segregated account was designated for cash proceeds of collateral.

At some time late in the fall of 2002, pre-petition, the State of Alaska Department of Transportation sought bids for the construction and delivery of four modular trailers (the "DOT Contract"). The Debtor made a bid on the project post-petition, on January 21, 2003, and was awarded the DOT Contract on February 10, 2003. The Debtor began performance on the contract in April and completed its performance in July, 2003.

The case was converted to chapter 7 on July 21, 2003 and the Trustee was appointed. On August 12, 2003, the Trustee received a check for $207,000 on the completed DOT Contract from the State of Alaska ("DOT Account Receivable").

FAM moved for relief from the automatic stay on August 8, 2003 in order to foreclose on its collateral. The bankruptcy court granted partial relief. On October 9 2003, FAM filed a Supplemental Motion for Relief From Stay, in which it asserted it held a lien in all of the Debtor's assets, including the 10 titled vehicles; and listing, as part of its collateral, the post-petition DOT Account Receivable, maintaining that it was property of the estate covered by its lien. The Trustee opposed the motion on the basis that FAM did not have a security interest in post-petition property unless FAM could prove that such property constituted traceable proceeds of pre-petition collateral.

In order to demonstrate the assets were proceeds of FAM's collateral, FAM provided a declaration by Mr. Peterson stating that the "funds generated by the sale of six modular units from inventory in June 2003 ($69,750) as well as the collection of pre-petition accounts receivable and on-going equipment sales went directly into the completion of [the DOT Contract]."

The bankruptcy court conducted a hearing on the lift stay motion. Mr. Peterson submitted a second declaration wherein he supplied, as evidence of FAM's proceeds, a "tracing" consisting of a two-page spreadsheet, listing amounts described as "Pre-petition FAM" and referencing deposits from various accounts, material returns, and inventory and equipment sales, totaling $88,939.86. The hearing was continued to provide the Trustee time to review the tracing. Mrs. Peterson then submitted a declaration stating she had revised the tracing of proceeds, going back to January 1, 2003² (instead of April, 2003), increasing the figure to $146,556.73.

At the continued hearing, the Trustee argued that, at the very least, if the court were to accept FAM's tracing and base it upon the company's gross revenue, it should consider all the collected gross revenue. The court agreed that the traced amount should be spread pro-rata between the collected accounts. It entered its Order on FAM's Motion for Relief from Stay on October 31, 2003, finding the traceable interest to be $71,415.00. (The court did not consider Mrs. Peterson's revised calculations).

FAM filed a Motion to Reconsider. At the hearing on that motion, the court back-tracked and adopted the revised tracing calculation. However, the court reduced the net revenue of combined accounts receivable by $9,500 (money from sale of equipment pursuant to settlement with principals) and $10,000 (FAM's payment for attorneys' fees). The court entered an Order on FAM's Motion for Reconsideration on December 17, 2003, finding that $102,099.85 was traceable to FAM's pre-petition assets. The court did not reconsider its ruling that FAM did not hold a security interest in the titled vehicles.

The Trustee timely appealed both the Order on FAM's Motion for Relief from Stay and the Order on FAM's Motion for Reconsideration. FAM cross-appealed beyond the deadline; however, the cross-appeal was allowed to proceed.

ISSUES

1. Whether FAM had a security interest in the DOT Account Receivable, sufficiently traced as a proceed of its pre-petition collateral.

2. Whether FAM had a perfected lien on certain titled vehicles and trailers.

STANDARD OF REVIEW

We review legal issues de novo and the bankruptcy court's factual findings for clear error. Village Nurseries v. Gould (In re Baldwin Builders), 232 B.R. 406, 410 (9th Cir. BAP 1999).

The bankruptcy court's decision to grant a motion for relief from the automatic stay is within its sound discretion and is reviewed for an abuse of discretion. In re Delaney-Morin, 304 B.R. 365, 368 (9th Cir. BAP 2003). A bankruptcy court necessarily abuses its discretion if it bases its decision on an erroneous view of law or clearly erroneous factual findings. Cooter & Gell v. Hartmarx Corp., 496 U.S. 384, 405, 110 S.Ct. 2447, 110 L.Ed.2d 359 (1990). The panel also finds an abuse of discretion if it has a definite and firm conviction that the bankruptcy court committed a clear error of judgment in the conclusion it reached. Beatty v. Traub (In re Beatty), 162 B.R. 853, 855 (9th Cir. BAP 1994).

DISCUSSION

The parties agree that, pre-petition, FAM held a valid perfected security interest in Skagit's inventory, equipment, accounts receivable, chattel paper and general intangibles, including those after-acquired, and the proceeds of such collateral. The parties disagree about whether FAM's security interest extends to the DOT Account Receivable performed and collected post-petition, and to the titled vehicles. Therefore, this matter requires a determination of the nature of the security interest held by FAM in the collateral and whether that interest is limited by bankruptcy and state law. See In re Inv. Hotel Prop., Ltd., 109 B.R. 990 (Bankr.D.Colo.1990).

I. THE DOT ACCOUNT RECEIVABLE

A. Security interests in collateral under § 552.

Section 552(a) provides the general rule that property acquired after the commencement of bankruptcy is not subject to pre-petition liens.³

Section 552(a) cuts off security interests on property acquired by the debtor after the petition date even if there is an "after-acquired" clause in the security agreement. The purpose of § 552(a) is "to allow a debtor to gather into the estate as much money as possible to satisfy the claims of all creditors." In re Bering Trader, Inc., 944 F.2d 500, 502 (9th Cir.1991).

There is an exception to the general rule of § 552(a). Section 552(b) provides that if a pre-petition security interest encumbers collateral and its proceeds, any proceeds of that pre-petition collateral remain subject to the security interest even if they are received post-petition.⁴

Section 552(b) "balances the Code's interest in freeing the debtor of pre-petition obligations with a secured creditor's rights...