Law Research Service, Inc. v. Hemba

• Decision Date: 31 October 1974
• Docket Number: No. 71 B 598.,71 B 598.
• Citation: 384 F. Supp. 729
• Parties: In the Matter of LAW RESEARCH SERVICE, INC., Debtor-Appellee, v. Alton W. and Evelyn K. HEMBA, Claimants-Appellants.
• Court: U.S. District Court — Southern District of New York

384 F. Supp. 729

In the Matter of LAW RESEARCH SERVICE, INC., Debtor-Appellee, v. Alton W. and Evelyn K. HEMBA, Claimants-Appellants.

No. 71 B 598.

United States District Court, S. D. New York.

October 31, 1974.

Otterbourg, Steindler, Houston & Rosen, P. C., New York City, for claimants-appellants; Jonathan N. Helfat, New York City, of counsel.

Krause, Hirsch & Gross, New York City, for debtor-appellee; Ellias C. Hoppenfeld, New York City, of counsel.

OPINION

WERKER, District Judge.

Appellants Alton and Evelyn Hemba seek review of the Bankruptcy Judge's decision in an arrangement proceeding under Chapter XI of the Bankruptcy Act reclassifying their secured claim against the debtor as an unsecured claim because of failure to perfect by proper filing in accordance with § 9-103 of the New York Uniform Commercial Code. A summary of the history of this case is essential to an understanding of this court's decision on appeal.

Prior to initiating the Chapter XI proceeding below, Law Research Service (LRS) was in the business of providing attorneys with legal materials which it maintained on a computer owned and operated by Western Union Telegraph Company of New York. In 1966 debtor contracted to provide appellants with exclusive distributorship rights to its services in the Jacksonville, Florida area.

Western Union subsequently withdrew the use of its computer, and LRS was unable to perform its duties under the franchise contract. Appellants commenced proceedings before the American Arbitration Association against LRS for breach of contract and damages, and at approximately the same time LRS began a separate action in New York Supreme Court against Western Union. While the Western Union action was pending, and before an arbitration hearing could be held in the Hemba case, the debtor and appellants began settlement negotiations, based in part upon LRS's expectation of recovery in its suit against Western Union.

The settlement agreement reached provided that a consent judgment for $22,500 in appellants' favor would be entered in New York Supreme Court, with the understanding that appellants would not issue execution on it until determination and payment of damages in the Western Union suit, and that debtor would immediately deliver to appellants "an assignment of any recovery it may have in the aforementioned action against Western Union" up to the amount of the consent judgment plus interest. These terms were carried out, and appellants filed a notice of assignment with Western Union and its attorneys. LRS won a judgment in its suit against Western Union which was on appeal when LRS filed a petition for Chapter XI arrangement on June 18, 1971.

In order to assure effectuation of an arrangement, debtor in April 1972 settled the Western Union appeal with the approval of the Bankruptcy Court. According to this settlement, part of the proceeds from Western Union were to be used to pay unsecured creditors under a plan of arrangement yet to be determined, and part was to be deposited in a special bank account for the purpose of satisfying the claims of debtor's secured creditors. In his order approving the settlement Bankruptcy Judge Herzog required that withdrawals from the special bank account be made only over his countersignature. Debtor and its unsecured creditors¹ thereafter agreed upon a plan of arrangement, which was confirmed by the Bankruptcy Judge on June 20, 1972. The plan did not contain provision for retention of jurisdiction by the Bankruptcy Court after confirmation.

On July 6, 1972 the Bankruptcy Judge amended his order of confirmation to allow LRS to file objection to "claims proved and filed but not allowed or disallowed herein prior to the date hereof." As a result of the amendment, debtor applied to reduce or expunge claims by creditors who asserted a security interest in its assets, objecting to appellants' claim on the ground that "claimant did not perfect lien and said alleged lien is voidable under Section 60 of the Bankruptcy Act"². In December 1972 appellants filed an answer to debtor's application asserting as an affirmative defense the Bankruptcy Court's lack of jurisdiction. The answer contended that (1) the debtor's plan of arrangement did not specifically provide for post-confirmation jurisdiction; (2) the signing of the order of confirmation divested the court of jurisdiction to decide the debtor's application; and (3) the amendment to the order of confirmation did not confer jurisdiction to determine their status as secured creditors because by its language it only applied to unsecured claims previously filed during the arrangement proceeding.³

In November 1973, for reasons unknown to this court, appellants applied to strike their jurisdictional affirmative defense and consent to the Court's jurisdiction. The debtor on the other hand opposed the application, thus urging rejection of the very jurisdiction which it had invoked.⁴ In the interests of expediting the case, Judge Herzog decided the question without benefit of a full hearing. In his Decision on Motion to Amend Answer and Cross Motion to Dismiss Hemba Claim he stated:

First of all, it ill behooves the debtor to question the court's jurisdiction since it was the one who invoked it in the first place seeking relief by way of objecting to the Hemba claim. Second of all, the funds set apart in the escrow account, for the satisfaction of secured claims as they are determined, are subject to withdrawal only upon the countersignature of the referee. Since the funds are subject to the control of this court, it is clear that this court has jurisdiction to determine all claims to participate in such funds. This jurisdiction to determine claims to property remaining in the court's possession or control exists regardless of whether the confirmed arrangement includes express provision for retention of jurisdiction pursuant to § 368 of the Act. In re Kessler, 90 F. Supp. 1012 1013 (S.D.Cal.C.Div. 1950). See also Murphy v. John Hoffman Co., 211 U.S. 562 29 S.Ct. 154, 53 L.Ed. 327 (1909).

With the jurisdictional question thus resolved, the parties proceeded to a trial of the issues in January 1974. In his final decision, dated June 28, 1974, Judge Herzog found: (1) that the assignment of a portion of debtor's recovery from Western Union was one of a general intangible within the meaning of U.C.C. § 9-106; (2) that the purpose of the assignment was to provide appellants with collateral security for collection of their consent judgment; (3) that appellants' assignment from debtor was a valid, existing lien; and (4) that appellants had failed to perfect their security interest by filing pursuant to U.C.C. § 9-103. He then concluded:

UCC § 9-301 (1) (b) renders an unperfected security interest subordinate to the claims of intervening creditors without notice, and by definition in subsection (3) of § 9-301 a trustee in bankruptcy is specifically included within the term "lien creditor." A debtor in possession "has all the powers of an ordinary trustee." Central Hanover Bank & Trust Co. v. Pres. and Directors of Man. Co., 105 F.2d 130, 131 (2d Cir. 1939). He is a court officer "analogous to a receiver or trustee." In re Wil-Low Cafeterias, Inc., 111 F.2d 83 (2d Cir. 1940).

By virtue of § 70 of the Bankruptcy Act, the trustee in bankruptcy, and therefore, a debtor in possession, is accorded an "ideal" status — he is the "perfect" creditor who has complied with all requirements necessary under applicable law for a lien by legal or equitable process. Accordingly, the lien of the Hembas is subordinate to that of the debtor in possession and they cannot assert a claim to the fund set apart for secured creditors.

The issues presented on appeal are whether appellants were required to comply with § 9-103 of the U.C.C. in order to attain a validly perfected security interest, and if so, whether in equity the debtor in possession should be permitted to avoid that lien after the creditors have been paid under a confirmed plan of arrangement, at a time when the benefit of such avoidance would inure only to the debtor himself. Neither party has raised on appeal the question of whether the lower court at that time had jurisdiction to determine the status of appellants' claim against debtor. As noted before, the learned Bankruptcy Judge considered this question and concluded that jurisdiction did exist in the Bankruptcy Court. An appellate federal court, however, must satisfy itself not only of its own jurisdiction, but also of that of the lower courts in a cause under review. Mitchell v. Maurer, 293 U.S. 237, 244, 55 S.Ct. 162, 79 L.Ed. 338 (1934). A recent decision in this district, issued three months after Judge Herzog's decision, casts doubt on his conclusion, and "a federal court which has noted a possible lack of federal jurisdiction must generally decline to proceed further until it has favorably resolved the doubt." Bartle v. Markson, 357 F.2d 517, 520 (2d Cir. 1966).

In In the Matter of Oceana International, Inc., 376 F.Supp. 956 (S.D.N.Y. 1974), on facts very similar to those of the case at hand, Judge Weinfeld found that the Bankruptcy Court lacked jurisdiction to determine a debtor's claim against a secured creditor after confirmation of its plan of arrangement. Briefly, the facts in that case were these: Having failed to devise a viable plan of arrangement, the debtor, Oceana, was adjudicated a bankrupt and deprived of its debtor in possession status. One of its creditors, a bank holding chattel mortgages, received permission from the Bankruptcy Court to sell the chattels at public auction. Subsequently, Oceana filed a second petition for arrangement which Judge Weinfeld found was "predicated essentially upon a claim that at the foreclosure sale the Bank acquired and then sold . . . property . . . not subject to the chattel mortgage, and that a recovery of such property could result in a Plan of Arrangement." 376 F.Supp. at 958. When...