Knox v. Phoenix Leasing Inc., A062177

• Citation: 29 Cal.App.4th 1357,35 Cal.Rptr.2d 141
• Decision Date: 31 October 1994
• Docket Number: No. A062177,A062177
• Court: California Court of Appeals Court of Appeals
• Parties: , 24 UCC Rep.Serv.2d 1049 Mel KNOX, Plaintiff and Respondent, v. PHOENIX LEASING INCORPORATED, Defendant and Appellant.

Page 141

35 Cal.Rptr.2d 141

29 Cal.App.4th 1357, 24 UCC Rep.Serv.2d 1049

Mel KNOX, Plaintiff and Respondent, v. PHOENIX LEASING INCORPORATED, Defendant and Appellant.

No. A062177.

Court of Appeal, First District, Division 4, California.

Oct. 31, 1994.

Certified for Partial Publication. ^*

Rehearing Denied Nov. 22, 1994.

Joseph N. Demko, Chantal M. Eldridge, Frandzel & Share, San Francisco, for appellant.

John G. Warner, Law Offices of John G. Warner, Corte Madera, for respondent.

POCHE, Associate Justice.

The issue presented is whether a secured creditor who obtains a defaulted debtor's property can be subject to restitution for the amount of the value of goods furnished the debtor by a third party. The answer is no: unless there are unusual circumstances the equitable remedy of restitution must defer to the rights given a secured creditor by the California Uniform Commercial Code. ¹

BACKGROUND

In March of 1990 as part of a concerted effort to expand the capacity of its plant in Sonoma County, Domaine Laurier Winery (Domaine) contracted with Mel Knox to purchase 200 seasoned oak wine barrels made in France. Four months later Domaine executed an agreement with Phoenix Leasing Incorporated (Phoenix) whereby Phoenix undertook to provide financing for the expansion. Phoenix was protected by (among other things) a security agreement covering all personal property, including "all equipment ... whether now owned or hereafter acquired" by Domaine.

The wine barrels came in two shipments. Upon arrival of the first lot, Knox sent an invoice to Domaine; Domaine forwarded the invoice to Phoenix, which paid it in August of 1990. With the second lot, Knox sent the invoice for $33,011.37 directly to Phoenix. Domaine also requested Phoenix to pay Knox. Approximately two months after the second shipment was delivered, but before any payment for it, Phoenix declared Domaine in default of their agreement. The barrels were included in Phoenix's subsequent liquidation of Domaine's assets. ²

By the time Knox's complaint came on for trial it had been reduced to a single cause of action for "Restitution--Unjust Enrichment" against Phoenix. The case was tried on the short cause calendar following denial of Phoenix's motion that, because it was a secured creditor while Knox was not, it was entitled to judgment on the pleadings. The trial did not produce a statement of decision, simply the court's announcement that Knox was entitled to judgment for $21,350 (70 percent of the original cost of the barrels, which was essentially their undisputed resale value).

Phoenix perfected this timely appeal from the ensuing judgment.

REVIEW

I

According to the California Uniform Commercial Code, Domaine's execution of a security agreement describing the property covered gave Phoenix a security interest in that collateral (§§ 9203, subd. (1), 9402, subd. (1)). Phoenix perfected that security interest when it filed a financing statement with the Secretary of State (§§ 9302, subd. (1), 9401, subd. (1)(c)). Phoenix thus acquired priority over other Domaine creditors (§§ 9201, 9301, 9312, subds. (3)-(5)), including the right to take possession and sell the collateral if Domaine defaulted (§§ 9503, 9504, subd. (1)). It being undisputed that Phoenix complied with all of these steps, Phoenix maintains that it is immune to Knox's restitution claim. ³

The opposing argument, which springs from the code's general directive that its provisions are to be supplemented by "principles of law and equity" (§ 1103), has divided courts considering whether restitution can be had from a code-protected secured creditor. On the one hand, a decided majority of jurisdictions have disallowed the equitable remedy of restitution (whether termed unjust enrichment, quantum meruit, contract implied in law, etc.). ⁴ They are willing to accept occasionally harsh results as the price to be paid for preserving the integrity of the Uniform Commercial Code's scheme for secured transactions, encouraging compliance with the code, and thereby ensuring a predictable system of creditor priorities. (E.g., Evans Products Company v. Jorgensen (1966) 245 Or. 362, 421 P.2d 978, 983; Peerless Packing Co. v. Malone & Hyde (1988) 180 W.Va. 267, 376 S.E.2d 161, 164-165 [text & fn. 4]; National Bank & T. Co. of So. Bend v. Moody Ford, Inc. (1971) 149 Ind.App. 479, 273 N.E.2d 757, 760; SMP Sales Management, Inc. v. Fleet Credit Corp. (5th Cir.1992) 960 F.2d 557, 560 [applying Louisiana law].) On the other hand, California and more recently Colorado, while conceding considerable soundness to the majority position, have permitted restitution from a secured creditor. (Producers Cotton Oil Co. v. Amstar Corp. (1988) 197 Cal.App.3d 638, 242 Cal.Rptr. 914; Ninth Dist. Prod. Credit v. Ed Duggan (Colo.1991) 821 P.2d 788; see also Borg-Warner v. Valentine Associates Ltd. (1989) 192 Ga.App. 123, 384 S.E.2d 223.) An examination of these decisions demonstrates that their disagreement with the majority position is one of degree and is not nearly so profound as appears at first glance. ⁵ Recovery is clearly the exception, not the norm, and is subject to stern limitations.

The first member of the minority camp--and the sole reported California decision in this area--is Producers Cotton Oil Co. v. Amstar Corp., supra, 197 Cal.App.3d 638, 242 Cal.Rptr. 914 (Producers Cotton ). The Producers Cotton firm held a security interest in the farm crops of its debtor. Amstar bought the crops and paid to have them harvested. Amstar knew of Producers' security interest, but neglected to obtain Producers' agreement to subordinate that interest. Amstar deducted the harvesting costs before remitting the sale proceeds of the crops to Producers. Producers sued Amstar and obtained a judgment on the theory that the deduction constituted conversion of its secured collateral.

Amstar appealed, arguing that the California Code's article 9 governing secured transactions left room for the equitable principle of restitution. It relied on section 1103, which provides: "Unless displaced by the particular provisions of this code, the principles of law and equity, including the law merchant and the law relative to capacity to contract, principal and agent, estoppel, fraud, misrepresentation, duress, coercion, mistake, bankruptcy, or other validating or invalidating cause shall supplement its provisions." Producers responded that "in order to give stability and predictability to commercial transactions, the priorities dictated by article 9 must prevail over equitable principles that might otherwise apply." Concluding that "the facts present a classic case for establishing an implied in law contract, or quasi-contract," the Court of Appeal tersely concurred with Amstar: "We agree with the position of Amstar and hold that when a party possessing a security interest in a crop and its proceeds has knowledge of and acquiesces in expenditures made which are necessary to the development of the crop, and ultimately benefits from the expenditure, a party who, through mistake, pays such costs without first obtaining subordination, is entitled to recover." (Producers Cotton, supra, 197 Cal.App.3d 638 at pp. 658, 660, 242 Cal.Rptr. 914, original emphasis.)

A considerably more detailed discussion of the problem was developed in Ninth Dist. Prod. Credit v. Ed Duggan, supra, 821 P.2d 788 (Duggan ). Like Producers Cotton, the context was agricultural. Duggan furnished feedgrain to a livestock company whose accounts receivable and personal property were the subject of a perfected security interest held by a credit association. In accordance with its standard practice, the association financed the livestock company's operations by paying sight drafts given creditors by the livestock company. Duggan continued deliveries while an unsuccessful effort to sell the livestock company was overseen by the credit association. Cattle fed with Duggan's grain were sold and the proceeds paid to the credit association, which also received payment for feedlot services given cattle awaiting slaughter. When the livestock company became financially unable to pay Duggan, suit was brought against the association.

The Colorado Supreme Court upheld the lower courts' determination that Duggan could obtain restitution from the credit association notwithstanding the latter's superior statutory priority as a secured creditor. It opened its analysis by noting that the central issue "whether a creditor that holds a perfected security interest in collateral can be held liable to an unsecured creditor based on a theory of unjust enrichment for benefits that enhance the value of the collateral ... cannot be answered categorically." (Duggan, supra, 821 P.2d 788 at p. 793.) Recognizing that this problem presented "obvious tension between the doctrine of unjust enrichment and the priority system established by Article 9," the Court reviewed the relevant decisions and discerned that the "central point of distinction ... is the extent to which the secured creditor was involved in the transaction by which the unsecured creditor supplied goods or services that enhanced the value of the secured collateral." (Id. at pp. 795-797.) Acknowledging that the Uniform Commercial Code's priority system "reflects the legislative judgment that the value of a predictable system of priorities ordinarily outweighs the disadvantage of the system's occasional inequities," the Court formulated this rule: "In a situation where a secured creditor initiates or encourages transactions between the debtor and suppliers of goods or services, and benefits from the goods or services supplied to produce such debts, equitable principles require that the secured creditor compensate even an unsecured creditor to avoid being unjustly enriched. The equitable claim is at its strongest when the goods or services are necessary to preserve the security, as in Producers Cotton Oil." ⁶ (Id. at pp. 797-798.)

Producers...