In re Suprema Specialties, Inc., 06 Civ. 6021 SAS.

• Court: United States District Courts. 2nd Circuit. United States District Courts. 2nd Circuit. Southern District of New York
• Citation: 370 B.R. 517
• Docket Number: No. 06 Civ. 6021 SAS.,Adversary No. 02 02293 JMP.,06 Civ. 6021 SAS.
• Parties: In re SUPREMA SPECIALTIES, INC., et al., Debtors, HARLEYSVILLE WORCESTER MUTUAL INSURANCE COMPANY and Lumbermens Mutual Casualty Insurance Company, Plaintiffs-Appellants, v. BANK OF AMERICA, N.A., as successor by merger to Fleet National Bank, as agent for the Senior Secured Lender Group, Suprema Specialties, Inc., Suprema Specialties West, Inc., Suprema Specialties Northeast, Inc. and Suprema Specialties Northwest, Inc., Defendants-Appellees.
• Decision Date: 07 May 2007

370 B.R. 517 In re SUPREMA SPECIALTIES, INC., et al., Debtors,
HARLEYSVILLE WORCESTER MUTUAL INSURANCE COMPANY and Lumbermens Mutual Casualty Insurance Company, Plaintiffs-Appellants,
v.
BANK OF AMERICA, N.A., as successor by merger to Fleet National Bank, as agent for the Senior Secured Lender Group, Suprema Specialties, Inc., Suprema Specialties West, Inc., Suprema Specialties Northeast, Inc. and Suprema Specialties Northwest, Inc., Defendants-Appellees. No. 06 Civ. 6021 SAS. Adversary No. 02 02293 JMP. United States District Court, S.D. New York. May 7, 2007.

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David Westermann, Jr., Matthew Didora, Westermann Hamilton Sheehy, Aydelott & Keenan, LLP, Garden City, New York, for Plaintiffs-Appellant, Harleysville Worcester Mutual Insurance Company.

Thomas A. Draghi, John E. Westerman, Westerman Ball Edefer, Miller & Sharfstein, LLP, Mineola, New York, for Plaintiff-Appellant Lumbermens Mutual Casualty Insurance Company.

Brian Trust, Laura D. Metzger, Mayer, Brown, Rowe & Maw LLP, New York, New York, David M. Gossett, Tai Lui Tan, Mayer, Brown, Rowe & Maw LLP, Washington, D.C., for Defendants-Appellees.

OPINION AND ORDER

SCHEINDLIN, District Judge.

Plaintiffs, Harleysville Worcester Mutual Insurance Company ("Harleysville") and Lumbermens Mutual Casualty Insurance Company ("Lumbermens") (collectively, "the Sureties"), have appealed an Order of the United States Bankruptcy Court, Southern District of New York, dated June

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27, 2006 (the "Order").¹ In that Order, United, States Bankruptcy Judge James M. Peck: (1) granted summary judgment in favor of the Bank Group;² (2) denied the Sureties' motion for summary judgment; and (3) dismissed the Sureties' Third Amended Complaint with prejudice. The issue raised in this appeal is whether the Bankruptcy Court erred in granting summary judgment in the Bank Group's favor with respect to the Sureties' equitable subrogation and express trust claims. For the following reasons, the Order of the Bankruptcy Court is affirmed.

I. BACKGROUND³

A. The Parties to this Proceeding

The debtors in this case, Suprema Specialties, Inc., Suprema Specialties West, Inc., Suprema Specialties Northeast, Inc., and Suprema Specialties Northwest, Inc. (collectively "Suprema") were manufacturers, marketers and distributors of soft cheeses, licensed by the New York Commissioner of Agriculture and Markets (the "Commissioner") as milk dealers.

Appellee, Fleet National Bank, subsequently succeeded through merger by Bank of America, N.A., (the "Agent"), is a member of and agent for the Bank Group. The Agent, on behalf of the Bank Group, is a secured lender holding priority liens on Suprema's assets, including accounts receivable. At the time Suprema filed its Chapter 11 petition for bankruptcy protection on February 24, 2002, Suprema was indebted to the Bank Group in the principal amount of approximately $97,565,837.50, plus interest and fees.

Appellants, Harleysville and Lumbermens, are two surety companies that executed a bond on behalf of Suprema for the payment of Suprema's obligations to milk suppliers. Months after Suprema's Chapter 11 bankruptcy filing and subsequent conversion to Chapter 7, the Sureties were called upon to pay $3,882,571.19 under the bond. The Sureties claim that they are entitled to recover this amount from Suprema and/or the Bank Group notwithstanding the Bank Group's first priority lien on all of Suprema's assets.

B. The Bank Group's Perfected Security Interests in Suprema's Assets

On September 23, 1999, the Bank Group entered into a Third Amended and Restated Revolving Loan, Guaranty and Security Agreement ("Loan Agreement") with Suprema as borrower. Under the Loan Agreement, Suprema could borrow up to $140,000,000 from the Bank Group. To obtain loans under the Loan Agreement, Suprema had to submit a "Borrowing Base Certificate," certified by its chief financial officer each calendar month, demonstrating that Suprema maintained an appropriate ratio of loans outstanding to eligible receivables and eligible inventory, as

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defined in the Agreement. As customary in the asset-based financing arena, the Loan Agreement required Suprema to maintain its operating accounts with the Agent. The Loan Agreement also granted the Agent, on behalf of the Bank Group, a right to set off obligations clue to it under the Loan Agreement against Suprema's deposits held by the Agent or any other member of the Bank Group. Finally, the Loan Agreement provided that the line of credit extended to Suprema was secured by a first priority lien and security interest on all of Suprema's assets, property and proceeds thereof, including accounts receivable, inventory, contract rights, and deposits.⁴

C. The Sureties' Relationship to Suprema

To obtain a license as a milk dealer in New York State, section 258-b of New York's Agricultural and Markets law required Suprema to provide the Commissioner with a bond or other security guaranteeing the prompt payment of its obligations to milk suppliers.⁵ That statute also establishes procedures for a milk supplier to recover payment from the Commissioner in the event of a payment default by a milk purchaser. Under the statute, the milk supplier must first file a claim with the Commissioner, which prompts an audit and investigation of the claim. After completion of the audit and a determination and certification of the amount due, the Commissioner then makes a demand to the surety that provided the bond as a guarantee for payment.⁶

On October 15, 2001, almost two years after the Bank Group perfected its security interest in Suprema's assets, the Sureties issued such a bond in the amount of $5,100,000 to Suprema Northeast, Inc., as principal, naming the Commissioner as the beneficiary (the "Bond"). By its terms, the Bond was in effect between July 1, 2001 and June 30, 2002. Suprema also executed two indemnity agreements⁷ to protect the Sureties in case they were required to make payment under the Bond. By their terms, each indemnity agreement inures to the benefit of both sureties. For purposes of this appeal, the Sureties rely solely on the language in the Harleysville General Agreement of Indemnity (the "Indemnity Agreement").⁸

The Indemnity Agreement seeks to create collateral security for the benefit and payment of all obligations for which the Sureties may be liable under the Bond. Section 2 of the Indemnity Agreement provides that upon the Sureties' demand to establish a reserve deposit, Suprema would be required to deposit with the Sureties a sum of money equal to such reserve as collateral security. The Sureties made no demand for a reserve deposit and Suprema did not deposit funds with

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the Sureties. The Sureties claim that Section 4 of the Indemnity Agreement creates a trust consisting of "[a]ll payments received for or on account of any CONTRACT" and "[a]ll monies due and to become due under any CONTRACT" — and provides that, upon demand by the Sureties and "in implementation of the trust," Suprema would open an account designated as a trust fund. The Indemnity Agreement, however, did not restrict Suprema's use of any payments it received under the Bond. Furthermore, Section 4 expressly provides that the alleged trust funds could be commingled with other funds.

As the Bankruptcy Court found — and the Sureties do not dispute — at the time the Sureties posted the Bond and entered into the Indemnity Agreement, the Sureties knew that the Bank Group had a perfected security interest in all of Suprema's assets. At no time, however, did the Sureties ever file UCC financing statements to perfect their interests under the Indemnity Agreement. The Sureties made no demand that Suprema segregate any funds for the Sureties' benefit and Suprema did not segregate any funds. Furthermore, the Sureties made no demand that Suprema open an account designated as a trust fund and Suprema never established such an account.

D. Events Leading to Suprema's Bankruptcy Petition

On December 21, 2001, Suprema issued a press release disclosing the sudden resignations of its Chief Financial Officer, Steven Venechanos, and Comptroller, Arthur Christensen. On the same day, the Securities and Exchange Commission commenced an investigation of Suprema while NASDAQ suspended trading in the company's stock. By the end of January 2002, the Federal Bureau of Investigation, the Food and Drug Administration, the New Jersey Department of Health, and the New Jersey Department of Agriculture each had started their own investigations of Suprema. These investigations ultimately revealed that Suprema's reported growth in the past was illusory and was produced, in large part, by a fraudulent scheme carried out by its officers. Indeed, the fraud was in large part directed at the Bank Group. The Borrowing Base Certificate for the month ending December 31, 2001, delivered to the Bank Group on January 23, 2002, indicated that Suprema had an outstanding debt of $94,942,557 to the Bank Group and that it was eligible to borrow an additional $13,342,938. The Bank Group subsequently discovered that certain items listed as Eligible Receivables and Eligible Inventory on the previously submitted Borrowing Base Certificates were fictitious and that the collateral securing loans made under the Loan Agreement was worth significantly less than Suprema had represented to the Bank Group.

On January 30, 2002, the Agent, on behalf of the Bank Group, sent Suprema a reservation of rights letter advising Suprema that it was in breach of the Loan Agreement and that the Bank Group had decided to discontinue extending credit to Suprema, as was permitted under the Loan Agreement. In early February 2002, the Bank Group commenced a review of Suprema to determine the extent of the Bank Group's exposure on Suprema's outstanding indebtedness. As provided in the Loan Agreement, the Bank Group received confidential information relating to...