Leasing Service Corp. v. First Tennessee Bank Nat. Ass'n, s. 86-5345

• Decision Date: 13 August 1987
• Docket Number: Nos. 86-5345,86-5510,s. 86-5345
• Citation: 826 F.2d 434
• Parties: , Bankr. L. Rep. P 71,925, 4 UCC Rep.Serv.2d 621 LEASING SERVICE CORPORATION, Plaintiff-Appellee (86-5345), Plaintiff-Appellant (86-5510), v. FIRST TENNESSEE BANK NATIONAL ASSOCIATION, Defendant-Appellant (86-5345), Defendant-Appellee (86-5510). . Cause
• Court: U.S. Court of Appeals — Sixth Circuit

Page 434

826 F.2d 434

16 Bankr.Ct.Dec. 628, Bankr. L. Rep. P 71,925,

4 UCC Rep.Serv.2d 621

LEASING SERVICE CORPORATION, Plaintiff-Appellee (86-5345) Plaintiff-Appellant (86-5510), v. FIRST TENNESSEE BANK NATIONAL ASSOCIATION Defendant-Appellant (86-5345), Defendant-Appellee (86-5510).

Nos. 86-5345, 86-5510.

United States Court of Appeals Sixth Circuit.

Cause Argued May 18, 1986.

Decided Aug. 13, 1987.

Stephen G. Anderson, Knoxville, Tenn., for First Tennessee Bank Nat. assn.

Celeste H. Herbert, Egerton, McAfee, Armistead, Davis, Knoxville, Tenn., Louise S. Meller, argued, New York City, for Leasing Service Corp.

Before KEITH and NORRIS, Circuit Judges, and PECK, Senior Circuit Judge.

KEITH, Circuit Judge.

Appellant-cross appellee First Tennessee Bank National Association ("Bank") appeals the district court's grant of summary judgment in favor of appellee-cross appellant Leasing Services Corporation ("LSC"). In its ruling, the court held that LSC was the holder of a security interest, senior to the Bank's own security interest, in the collateral of Metler Crane and Rigging Co. ("Metler"). The court reasoned that the rejection by the trustee-in-bankruptcy of unexpired portions of certain lease agreements between Metler and a third party did not alter the relative priorities between the secured creditors of Metler. The court also held that the public sale by LSC of equipment that had been leased to Metler was commercially reasonable. Following the grant of summary judgment, LSC filed a motion to alter or amend judgment, seeking an award of attorney fees. The district court denied the motion and LSC cross-appeals on this issue. For the reasons set forth below, we affirm the judgment of the Honorable Thomas G. Hull.

I.

On October 23, 1980, Chatham Machinery, Inc. leased two cranes to Metler. The leases were assigned to LSC. The amounts due under the leases were secured by a security interest in Metler's inventory, goods, equipment and machinery. LSC perfected its security interest by filing the appropriate UCC-1 financing statements.

After LSC had perfected its security interest, the Bank made several loans to Metler and obtained a security interest in the same collateral. The Bank perfected its security interest by filing the appropriate financing statements.

On December 11, 1984, Metler was placed into involuntary bankruptcy pursuant to Chapter 7 of the Bankruptcy Code. Metler surrendered all of its equipment and machinery, except the two cranes, to the Bank. Pursuant to an order in the bankruptcy proceedings, the Bank sold this collateral and realized $443,895.00 from the sale. The trustee-in-bankruptcy later abandoned these assets, thereby leaving the parties to sort out their claims to these funds. Also, the trustee-in-bankruptcy did not assume Metler's obligation under the lease agreements and was deemed to have rejected these contracts. LSC therefore reclaimed possession of the cranes and sold them, establishing a deficiency balance in the amount of $81,492.88.

On July 8, 1985, LSC made a demand upon the Bank for payment of $81,492.88, plus interest and attorney fees. LSC asserted that Metler was indebted to LSC in that amount under the leases, and that LSC had a security interest in the proceeds realized from the sale of Metler's collateral that was superior to that of the Bank. The Bank refused to pay LSC.

On October 1, 1985, LSC filed suit against the Bank seeking $81,492.88, plus interest from April 11, 1985, and attorney fees. LSC claimed that the Bank, by refusing to recognize LSC's prior lien, had converted to its own use funds which LSC was entitled to receive. The Bank answered LSC's complaint by denying that LSC possessed a superior security interest. The Bank also alleged that Metler's indebtedness to LSC was overstated because LSC's conduct in connection with the sale of the cranes was commercially unreasonable.

On March 4, 1986, the district court granted summary judgment in favor of LSC, holding that LSC's security interest was superior to that of the Bank, and that the sale by LSC of the cranes was conducted in a commercially reasonable manner. Judgment was entered in the amount of $81,492.88, plus interest. On March 14, 1986, LSC moved the court to reconsider its judgment and award attorney fees in the amount of $16,298. This motion was denied.

II.

On appeal, the Bank initially argues that the district court erred in holding that LSC possessed the superior security interest. It contends that the lease agreements between Metler and LSC (the assignee) were executory contracts, or unexpired leases. The Bank further contends that pursuant to 11 U.S.C. Sec. 365(d)(1), ¹ the rejection of the lease agreements by the trustee operated as a matter of law as a rejection of all covenants contained in the leases, including the grant of the security interest. Thus, the Bank argues that the rejection of the leases constituted a breach of the executory and nonexecutory portions of the contracts, leaving LSC in the position of an unsecured creditor.

LSC argues that while rejection of a lease obligation does have the effect of a breach of the contract, it does not affect the creditor's secured status. We agree.

Section 365 of the Bankruptcy Code, 11 U.S.C. Sec. 365, provides that a debtor-in-possession or a trustee may assume or reject any executory contract or unexpired lease of the debtor. Rejection denies the right of the contracting creditor to require the bankrupt estate to specifically perform the then executory portions of the contract. Rejection also limits the creditor's claim to damages for breach of contract.

The statutory purpose of Section 365 of the Bankruptcy Code is to enable the trustee to assume those executory obligations which are beneficial to the estate while rejecting those which are onerous or burdensome to perform.

The legislative purpose underlying Section 70b [the predecessor to Sec. 365 under the Bankruptcy Act of 1938] was to solve the problem of assumption of liabilities, i.e., excusing or requiring future specific performance by the bankrupt.... [W]hat Section 70b actually proposed to do was to secure this continued mutuality [of obligation and performance] wherever it was felt to be of greater benefit to the estate to proceed in accordance with the bankrupt debtor's plans rather than to freeze his commercial relations as of the filing date.

2 Collier on Bankruptcy, p 365.01 (15th ed. 1987) (emphasis in original).

Thus, rejection or assumption of an executory contract determines only the status of the creditor's claim, i.e., whether it is merely a pre-petition obligation of the debtor or is entitled to priority as an expense of administration of the estate. The extent to which a claim is secured is wholly unaffected. ² See Jenson v. Continental Financial Corp., 591 F.2d 477 (8th Cir.1979) (footnotes omitted); See also 11 U.S.C. Sec. 506.

The Bank strenuously argues that the trustee's rejection of the contracts extended to non-executory as well as executory portions of the agreement. As a result, it argues that LSC was divested of its security interest. The law, however, does not support the Bank's position. In Jenson, the Eighth Circuit held that a security agreement securing debtor's obligations under a rejected class action settlement agreement was nonexecutory and therefore valid. The security agreement had been given to secure debtor's obligations under either the settlement or under any judgment subsequently obtained if the settlement failed. The court found that the settlement agreement entered into by the parties was an executory contract subject to rejection by the trustee. However, the security agreement was found to be non-executory and was not subject to rejection by the trustee. Jenson, 591 F.2d at 482. The court stated:

The consideration given for the security interest was forbearance on the part of the plaintiffs from pressing for the immediate appointment of a receiver for the defendants. This consideration was performed in full by the plaintiffs and the bankrupts have had the full benefit thereof. As such, the trustees have no power to reject the security agreement as executory under Section 70b.

Id., (footnote omitted).

Similarly, in the present case, the security interest granted to LSC to secure Metler's obligation under the leases was fully vested. The consideration for the grant of the security interest was the lessor agreeing to lease the cranes to Metler and LSC agreeing to take an assignment of the leases. Thus, the security interest was non-executory and therefore not subject to the rejection power of the trustee.

The Bankruptcy Code makes clear that Article 9 of the Uniform Commercial Code ("UCC") governs consensual liens in personal property and fixtures. "For the rights and remedies of the parties, other creditors and third parties, Article 9 is the sole source of the law." 4 Collier on Bankruptcy, Sec. 547.49 (15th ed. 1987). Thus, in those states which have adopted the UCC, one looks to applicable state law to determine which party has priority.

Issues as to the extent to which a lien in favor of the creditor secures certain obligations which form a part of an allowed claim may arise in the Section 506(a) [Determination of Secured Status] context, but must be decided by reference to the underlying agreements or judgments and applicable state law.

3 Collier on Bankruptcy, Sec. 506.04 (15th ed. 1987) (footnote omitted).

Applicable state law mandates that the first creditor to perfect a security interest has priority status. See Tenn.Code Ann. Sec. 47-9-312(5)(a). In the present case, LSC was the first to perfect its interest. Thus, the district court was correct in stating that an acceptance of the Bank's argument "would be to advance the Bank's later-perfected security interest above LSC's prior lien, negating the priority provisions set forth in Article 9 of the Uniform Commercial Code." ³

III.

The Bank next...