In re Tower Air, Inc.

• Decision Date: 10 February 2005
• Docket Number: No. 03-3101.,03-3101.
• Citation: 397 F.3d 191
• Parties: In re: TOWER AIR, INC., Debtor Charles A. Stanziale, Jr., Chapter 7 Trustee of Tower Air, Inc., Appellant v. Finova Capital Corporation.
• Court: U.S. Court of Appeals — Third Circuit

Page 191

397 F.3d 191

In re: TOWER AIR, INC., Debtor

Charles A. Stanziale, Jr., Chapter 7 Trustee of Tower Air, Inc., Appellant v. Finova Capital Corporation.

No. 03-3101.

United States Court of Appeals, Third Circuit.

Argued October 26, 2004.

Decided February 10, 2005.

COPYRIGHT MATERIAL OMITTED

Diane E. Vuocolo (Argued), Duane Morris, Philadelphia, PA, for Appellant.

Jeffrey M. Schlerf, The Bayard Firm, Wilmington, DE, Jill Levi (Argued), Todd & Levi, New York, NY, for Appellee.

Before: SCIRICA, Chief Judge, FISHER and BECKER, Circuit Judges.

OPINION OF THE COURT

BECKER, Circuit Judge.

This appeal by Charles Stanziale, the Chapter 7 trustee ("the Trustee") of debtor Tower Air, Inc., presents a question of first impression for us: whether a secured creditor in a Chapter 7 bankruptcy may recover the insurance proceeds intended to pay for damage to its collateral, while retaining the fully repaired collateral. We conclude that, under the circumstances of this case, it can. More specifically, we are satisfied that, under the language of section 9-306 of the Arizona Uniform Commercial Code (UCC) in effect at the relevant times, appellee FINOVA Capital Corporation, as an undersecured and cross-collateralized creditor, is entitled to recover both the collateral (an aircraft engine) and the proceeds. This conclusion is also supported: (1) by the language of the controlling agreements between Tower and FINOVA, which grant FINOVA a right of approval over any use of insurance proceeds; and (2) by the fact that the insurance documents conferred upon FINOVA the status of a mortgagee payee, and not a mere loss payee. Finally, we reject the Trustee's contention that the equitable exception of § 552(b) of the Bankruptcy Code applies to prevent this result. We will therefore affirm the order of the District Court, which affirmed the order of the Bankruptcy Court awarding some $950,000 in insurance proceeds to FINOVA.

I. Facts

On May 6, 1996, Tower, a then-solvent airline, borrowed $21 million from FINOVA to finance the purchase of a Boeing 747 and four aircraft engines. In connection with this transaction, Tower entered a series of agreements — including a security agreement, a promissory note, and a mortgage — giving FINOVA a security interest in the financed collateral, including the aircraft engine at issue in this case. The agreements specified that insurance proceeds of the engines were part of FINOVA's collateral.¹ Tower also covenanted to maintain insurance on the aircraft, and to submit any plans for use of insurance proceeds to FINOVA for approval.²

FINOVA also financed a number of Tower's other purchases, and had cross-collateralization agreements on all of those borrowings. Under these agreements, FINOVA's collateral for previous loans would become collateral for the May 6 loan, and the May 6 collateral (including the engine) would become collateral for the previous loans.³

FINOVA perfected its security interest by filing UCC financing statements with the State of New York and with Queens County, and by filing the mortgage with the FAA.⁴ Both the financing statements and the mortgage explicitly provide for a security interest in any insurance proceeds arising from the aircraft and engines.

On August 23, 1997, the engine at issue in this appeal was severely damaged in an in-flight accident. Tower fully repaired the engine at a total cost of $2,251,747.51, of which $1,951,503.26 was directly attributable to the accident.

On February 29, 2000, Tower filed a voluntary Chapter 11 petition in the Bankruptcy Court for the District of Delaware. Tower operated as a debtor-in-possession until December 2000, when it converted to Chapter 7. Charles A. Stanziale, Jr., who had been the Chapter 11 trustee, was appointed Chapter 7 trustee. FINOVA claims that, at the time of the bankruptcy, Tower owed FINOVA some $56 million under various loan agreements collateralized by, among other assets, the engine at issue here. During the bankruptcy proceedings in 2004, the engine was returned to FINOVA, in partial satisfaction of FINOVA's secured claim. Some of FINOVA's other collateral was apparently destroyed or impaired by Tower, but there is no dispute that the engine was returned in fully repaired condition. FINOVA contends that the total value of all returned collateral was some $36 million, leaving it undersecured by some $20 million.

In performing his due diligence, the Trustee discovered that Tower maintained an accident insurance policy on the engine. He therefore submitted a claim for $1,951,503.26 to the insurers. The insurers agreed to settle the claim for $951,503.26 — the claim amount minus the policy's $1 million deductible — in May 2001. The Trustee then filed a motion in the Bankruptcy Court seeking approval to enter the settlement. FINOVA timely objected, claiming that it, not the estate, was entitled to the insurance proceeds. The Bankruptcy Court approved the settlement, but directed the Trustee to hold the funds in escrow pending a decision on this issue.

On August 27, 2001, the Bankruptcy Court awarded the proceeds to FINOVA. In re Tower Air, Inc., 268 B.R. 404 (Bankr.D.Del.2001). The Trustee appealed to the District Court, which entered an order affirming the Bankruptcy Court's opinion. Stanziale v. Finova Capital Corp. (In re Tower Air, Inc.), No. 01-CV-792, 2003 U.S. Dist. LEXIS 10108, 2003 WL 21398007 (D. Del. June 16, 2003). This appeal followed.

II. Jurisdiction and Standard of Review

The Bankruptcy Court had subject matter jurisdiction pursuant to 28 U.S.C. § 157. The District Court had jurisdiction under §§ 158(a) and 1334, and this Court has appellate jurisdiction under § 158(d). We exercise plenary review of the District Court's conclusions of law. Prof'l Ins. Mgmt. v. Ohio Casualty Group of Ins. Cos. (In re Prof'l Ins. Mgmt.), 285 F.3d 268, 282-83 (3d Cir.2002). Since the District Court sat as an appellate court to review the Bankruptcy Court, "we review the Bankruptcy Court's legal determinations de novo, its factual findings for clear error, and its exercises of discretion for abuse thereof." Id. (citing In re Engel, 124 F.3d 567, 571 (3d Cir.1997)).

The Trustee appeals the Bankruptcy Court's decision that the insurance proceeds were part of FINOVA's collateral under the Arizona UCC. This is a legal determination that we review de novo. The Trustee also appeals the Bankruptcy Court's refusal to grant him equitable relief under 11 U.S.C. § 552(b). The decision whether to apply the equitable exception under § 552(b) is reviewed for abuse of discretion. See Halvajian v. Bank of N.Y. (In re Halvajian), 216 B.R. 502, 508 (D.N.J.1998), aff'd 168 F.3d 478 (3d Cir.1998); Am.Jur. Bankruptcy § 3512.

The parties agree that this dispute is governed by Arizona law, as provided by paragraph 9.4 of the security agreement.

III. The UCC Provisions

This case turns primarily on the provisions of the Arizona UCC that govern a creditor's rights to the proceeds of his collateral.⁵ The default rule is that a security interest in property includes an interest in the proceeds of that property. Ariz.Rev.Stat. § 47-9203(C) (1999) ("Unless otherwise agreed a security agreement gives the secured party the rights to proceeds provided by § 47-9306."). The parties here did not opt out of this default; rather, they explicitly granted FINOVA a security interest in proceeds in the mortgage. The Trustee argues, however, that this security interest does not give FINOVA a right to the disputed insurance money, because that money is not "proceeds" properly understood, and because awarding it to FINOVA would constitute a double recovery forbidden by the UCC. We consider each of these contentions in turn.

A. The Meaning of Proceeds

Our starting point is perforce UCC § 9-306, which defines the term "proceeds" and governs a secured creditor's rights to the proceeds of his collateral. The relevant parts of this section are set forth in the margin.⁶ The definition of "proceeds" is found in subsection (a), the first sentence of which defines the term to include "whatever is received upon the sale, exchange, collection or other disposition of collateral or proceeds." Ariz.Rev.Stat. § 47-9306(A). The following sentence reads: "Insurance payable by reason of loss or damage to the collateral is proceeds, except to the extent that it is payable to a person other than a party to the security agreement." Id.

The plain language of § 9-306(a) leaves no doubt that the insurance money at issue here constitutes proceeds of the engine, because it was "[i]nsurance payable by reason of loss or damage to the collateral." FINOVA, by perfecting its security interest in the engine, was entitled to look to those proceeds as collateral under § 9-306(b). Under 11 U.S.C. § 552(b), prepetition security interests that apply to proceeds of collateral also apply to proceeds of such collateral acquired after the bankruptcy petition. It is undisputed that FINOVA had perfected its security interest in the engine prior to Tower's bankruptcy. FINOVA's interest in those proceeds was therefore also perfected, because Tower had not received them prior to entering bankruptcy. See Ariz.Rev.Stat. § 47-9306(D)(2) & (3).

The Trustee argues that the first sentence of § 9-306(a), which requires a "sale, exchange, collection or other disposition" of property, limits the definition of "proceeds" to encompass only the results of a "transforming event." Under this view, a creditor can obtain the proceeds only as a substitute for the original collateral, not as an addition to it. But this interpretation is contradicted by the clear language of the second sentence ("Insurance payable by reason of loss or damage to the collateral is proceeds ..."), and we have found no case that supports it.⁷

We are also confident that the Arizona courts would reject the Trustee's view. The Arizona Court of Appeals has read the second sentence of § 9-306(a) independently of the first...