Martin Grinding & Mach. Works, Inc., Matter of, 85-1666

• Decision Date: 23 June 1986
• Docket Number: No. 85-1666,85-1666
• Citation: 793 F.2d 592
• Parties: Bankr. L. Rep. P 71,216, 1 UCC Rep.Serv.2d 1329 In the Matter of MARTIN GRINDING & MACHINE WORKS, INC., an Illinois corporation, Debtor. Appeal of FOREST PARK NATIONAL BANK.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 592

793 F.2d 592

Bankr. L. Rep. P 71,216, 1 UCC Rep.Serv.2d 1329

In the Matter of MARTIN GRINDING & MACHINE WORKS, INC., an Illinois corporation, Debtor Appeal of FOREST PARK NATIONAL BANK.

No. 85-1666.

United States Court of Appeals Seventh Circuit.

Argued Nov. 7, 1985.

Decided June 23, 1986.

Stephen A. Snakard, McCarthy Duffy Neidhart & Snakard, Chicago, Ill. for appellant.

David K. Welch, Dozoryst, Cosby & Brustein, Chicago, Ill. for appellee.

Before WOOD, Circuit Judge, ESCHBACH, Senior Circuit Judge, and CAMPBELL, Senior District Judge. ^*

ESCHBACH, Senior Circuit Judge.

The primary issue presented by this appeal is whether, under the Illinois Uniform Commercial Code, loan documents can supplement a security agreement to create a security interest in property inadvertently omitted from the security agreement's enumeration of secured collateral. The bankruptcy court dismissed a secured party's claim of a security interest in property not described in the security agreement. The district court affirmed the dismissal. For the reasons stated below, we hold that the loan documents cannot expand the scope of the security agreement and will affirm the district court's judgment.

I

In 1977 Martin Grinding & Machine Works, Inc. ("debtor") received a Small Business Administration ("SBA") guaranteed loan in the amount of $350,000 from Forest Park National Bank ("Bank"). In return, the debtor executed a security agreement dated October 7, 1977, granting the Bank a security interest in the debtor's machinery, equipment, furniture, and fixtures. The security agreement, however, inadvertently omitted inventory and accounts receivable from its description of the secured collateral. In addition to the security agreement, the debtor executed other loan documents (collectively referred to as "loan documents"), ¹ each of which included inventory and accounts receivable as secured property.

In 1981 the debtor obtained a second SBA guaranteed loan from the Bank. This loan, in the amount of $233,000, also was secured by the October 7, 1977, security agreement.

In 1983 the debtor petitioned for voluntary reorganization under Chapter 11 of the Bankruptcy Code, 11 U.S.C. Secs. 1101-74. The debtor denied that the Bank held a security interest in its inventory and accounts receivable. The Bank filed a complaint in bankruptcy court to determine the extent of the security interest. The bankruptcy court granted the debtor's motion to dismiss the complaint for failure to state a claim upon which relief could be granted. Forest Park National Bank v. Martin Grinding & Machine Works, Inc. (In re Martin Grinding & Machine Works, Inc.), 42 B.R. 888, 892 (Bankr.N.D.Ill.1984). The district court affirmed in an unpublished opinion. The Bank now appeals.

II

The precise issue to be decided is whether the Bank holds a security interest in the debtor's inventory and accounts receivable. The Bankruptcy Code defines a "security interest" as a "lien created by agreement." 11 U.S.C. Sec. 101(43). Whether an agreement creates a lien depends upon state law. See Butner v. United States, 440 U.S. 48, 54-57, 99 S.Ct. 914, ---, 59 L.Ed.2d 136 (1979). In this case, Illinois law determines the scope of the Bank's security interest.

The Illinois Uniform Commercial Code provides that a security interest is not enforceable against the debtor or third parties with respect to the collateral and does not attach unless

(a) the collateral is in the possession of the secured party pursuant to agreement, or the debtor has signed a security agreement which contains a description of the collateral ...; and

(b) value has been given; and

(c) the debtor has rights in the collateral.

Ill.Rev.Stat. ch. 26, p 9-203(1). The parties agree that the debtor has signed a security agreement, that value has been given, and that the debtor has rights in its inventory and accounts receivable. Moreover, they agree that the loan documents provided for a security interest in the debtor's inventory and accounts receivable, and that the security agreement did not describe inventory and accounts receivable as secured collateral. They, however, differ as to whether the Bank's security interest extends to collateral beyond that described in the security agreement to include inventory and accounts receivable. The Bank argues that the loan documents must be considered in determining the scope of its security interest. We disagree.

Allis-Chalmers Corp. v. Staggs, 117 Ill.App.3d 428, 432, 453 N.E.2d 145, 148 (1983), holds "that a broader description of collateral in a financing statement is ineffective to extend a security interest beyond that stated in the security agreement." In reaching this result, the court relied upon Ill.Rev.Stat. ch. 26, p 9-201, which provides that a security agreement is effective according to its terms, and upon p 9-203(1)(a), which states that a security interest is not effective against the debtor or third parties unless the debtor has signed a security agreement that contains a description of the collateral. 117 Ill.App.3d at 432, 453 N.E.2d at 148. The court reasoned that "a security interest cannot exist in the absence of a security agreement ..., and it follows that a security interest is limited to property described in the security agreement." It also relied upon the Illinois Code Comment to Ill.Rev.Stat. ch. 26, p 9-110, which states that " [t]he security agreement and the financing statement are double screens through which the secured party's rights to collateral are viewed, and his rights are measured by the narrower of the two." We, therefore, conclude that, under Illinois law, a security interest attaches only to property described in the security agreement. Because the October 7, 1977, security agreement did not include inventory and accounts receivable, the Bank does not hold a security interest in this property.

The Bank, however, seeks to distinguish Allis-Chalmers. First, it asserts that Allis-Chalmers involved a dispute between creditors, rather than between a creditor and the debtor's trustee in bankruptcy. While true, this is a distinction without a difference. The court in Allis-Chalmers decided that a security interest attaches only to collateral described in the security agreement. The Bank's security agreement did not include inventory and accounts receivable. Therefore, a security interest never attached to the debtor's inventory and accounts receivable. Because a security interest did not attach to this property under p 9-203(1), the Bank cannot enforce a security interest in inventory and accounts receivable against either a third-party creditor or the debtor.

Second, the Bank argues that, although the plaintiff in Allis-Chalmers relied upon only the financing statement to expand the scope of the security interest, the Bank relies not only upon the financing statement, but also upon the other loan documents. Nevertheless, Allis-Chalmers's holding that a financing statement cannot extend a security interest beyond that stated in the security agreement is only an application of the general rule that parol evidence ² cannot enlarge an unambiguous security agreement. See, e.g., Shelby v. England (In re California Pump & Manufacturing Co.), 588 F.2d 717, 720 (9th Cir.1978); H & I Pipe & Supply Co. v. First National Bank of Crossville (In re H & I Pipe & Supply Co.), 44 B.R. 949, 950 (Bankr.M.D.Tenn.1984); American State Bank v. Swearingen (In re Swearingen), 27 B.R. 379, 382-83 (Bankr.D.Kan.1983).

The October 7, 1977, security agreement is unambiguous on its face: it grants the Bank "a security interest in all machinery, equipment, furniture and fixtures ... now owned and hereafter acquired by Debtor for use in Debtor's business, including without limitation the items described on Schedule 'A' attached hereto, together with all replacements thereof and all attachments, accessories and equipment now or hereafter installed therein or attached thereto." That the security agreement omits any mention of inventory and accounts receivable as secured collateral is unfortunate for the Bank, but does not make the agreement ambiguous. Since the security agreement is unambiguous on its face, neither the financing statement, nor the other loan documents can expand the Bank's security interest beyond that stated in the security agreement.

Furthermore, Palatine National Bank v. Randall (In re Wambach), 484 F.2d 572 (7th Cir.1973), on which the Bank relies, is inapposite. We held in Wambach, 484 F.2d at 575, that parol evidence may show that a transfer purporting to be absolute was in fact for security, and that an assignment of a beneficial interest, absolute on its face, together with other documents relating to the transaction, may constitute a security agreement. Our holding in Wambach that an assignment absolute on its face, other loan documents, and a financing statement may serve as a security agreement in the absence of a document entitled "Security Agreement" in no way suggests that a financing statement and other loan documents might modify an unambiguous security agreement. Indeed, the Ninth Circuit reached the same conclusion when faced with the same issue and analogous precedent. See California Pump & Manufacturing Co., 588 F.2d at 720 (holding that parol evidence cannot reform a security agreement and distinguishing In re Amex-Protein Development Corp., 504 F.2d 1056, 1060 (9th Cir.1974)).

The Bank also cites Walter E. Heller & Co. v. Salerno, 168 Conn. 152, 362 A.2d 904 (1975). In Heller the Connecticut Supreme Court examined the documents consummating a merger between the debtor and two other companies, and concluded that a security agreement between Heller (the secured party) and the debtor that antedated the merger remained in force as to the debtor's successors following the merger. The Heller court did not, however, use the merger documents to modify the scope of the security agreement. In our case, the debtor...