McFarland v. Brier

Decision Date21 June 2004
Docket NumberNo. 2002-500-Appeal.,2002-500-Appeal.
Citation54 UCC Rep Serv 2d 74,850 A.2d 965
PartiesClifford McFARLAND et al. v. Michael BRIER et al.
CourtRhode Island Supreme Court

John P. Gyorgy, Esq., Providence, for Plaintiff.

Melissa E. Darigan, Esq., Providence, for Defendant.

Present: WILLIAMS, C.J., FLANDERS, GOLDBERG, and SUTTELL, JJ.

OPINION

FLANDERS, Justice.

The annals of corporate finance provide us with this fresh illustration of the old saw that "possession is nine-tenths of the law." A bank, the defendant First Bank and Trust Company (the bank),1 and a garnishing creditor, the plaintiff Read & Lundy, Inc. and its owner, the plaintiff Clifford McFarland (collectively referred to as Read & Lundy), fell out over a certain certificate of deposit2 (CD) that the bank issued to the defendant Michael Brier (Brier), a customer of the bank. In 1996, Brier pledged this $200,000 CD to the bank to secure his personal guaranty for a loan the bank issued to Brier's company, the defendant Consigned Systems, Inc. (CSI). Approximately six months later, Read & Lundy caused the bank to be served with a prejudgment writ of attachment for any of Brier's assets in the bank's possession, up to the amount of $100,000. After the bank received the writ, but before the writ matured into a full right of garnishment, CSI defaulted on the loan and the bank applied the CD to pay down a portion of the balance due on the loan.

Thereafter, Read & Lundy asked the Superior Court to charge the bank as garnishee for the full value of the CD. Finding that Brier and the bank had rescinded the pledge agreement, the court ruled that the bank improperly applied the CD to reduce the balance owed on the CSI loan. Consequently, it ordered the bank to pay Read & Lundy $200,000, the full amount of the CD as disclosed in its garnishee's affidavit, plus the accrued interest on the CD.

Because we conclude that the bank held a prior perfected security interest in the CD and that its possessory interest took precedence over Read & Lundy's later-served writ of attachment, the bank did not have to obtain the approval of the Superior Court before liquidating the CD and paying down the balance due on the defaulted CSI loan. Thus, we reverse the Superior Court decision and vacate the judgment in favor of Read & Lundy.

Facts and Travel

Although this case has a long and convoluted history, it is still but one piece in a jumble of litigation involving one or more of these same parties.3 These disputes all arose after Dennis Bibeau, the former president of Read & Lundy, joined forces with Michael Brier, an accountant, to create a new company, CSI, that would engage in "head-to-head competition" with Read & Lundy. See McFarland v. Brier, 769 A.2d 605, 608 (R.I.2001). The sole issue before us today, however, is whether a Superior Court trial justice properly granted Read & Lundy's motion to charge the bank as a garnishee for the damages judgment that Read & Lundy obtained against Brier and CSI in the underlying litigation.

In March 1996, Read & Lundy filed suit in Superior Court against Brier and CSI, alleging that they had tortiously interfered with its contractual relations, misappropriated its trade secrets, disclosed its confidential information, interfered with its prospective business advantage, and committed unlawful trade disparagement. Shortly thereafter, in May 1996, the Superior Court issued a preliminary injunction, enjoining Brier and CSI from marketing competing products or services to Read & Lundy's customers.

In June 1996, the bank extended a $500,000 loan to CSI — guaranteed, in part, by the Small Business Administration (SBA). When the bank loaned CSI this money, it was aware of the pending litigation between Read & Lundy and Brier. Under an agreement that the parties signed, the bank secured the loan by obtaining a security interest in CSI's accounts receivable, inventory, and certain other collateral. In addition, Brier, who was CSI's president and co-founder, personally guaranteed the CSI loan and pledged a $200,000 CD to the bank as security for his personal guaranty of the loan. The bank had issued this CD to Brier earlier that month, marking on its face a legend stating that it was "nonnegotiable" and "nontransferable." The bank obtained security for Brier's personal guaranty via a pledge agreement with Brier that authorized the bank, inter alia, to apply the CD to the balance due on the loan if CSI committed any event of default specified in the loan agreement. Upon Brier's executing this pledge agreement, the bank immediately took possession of the pledged CD and exercised dominion and control over it until 1999, when it ultimately applied the CD to pay down the balance due on the defaulted loan.

In January 1997, approximately six months after Brier pledged the CD to the bank, Read & Lundy arranged for the service of a prejudgment writ of attachment on the bank for any of Brier's assets in the bank's possession, up to $100,000. The Superior Court originally issued the writ in September 1996, but that court stayed its effectiveness pending a petition for certiorari to this Court. Upon being served with the writ of attachment, the bank responded by filing a garnishee's affidavit with the Superior Court, saying that it held the CD as security for the CSI loan and indicating that it then valued the CD, with accrued interest, at $206,856.87.

Within a brief period after receiving the loan proceeds, CSI was unable to make loan payments to the bank in a timely manner. As the months passed, its payments often were thirty to forty-five days late. CSI also was in default of several other loan covenants and requirements. In late 1997, the bank began making collection calls to CSI concerning the defaults. For most of 1998, the bank classified the loan as delinquent under its internal rating system, which deemed any loan to be delinquent when the borrower submitted payments that were more than fifteen days past the due date. Because of CSI's outstanding defaults, the bank also placed the CSI loan on a watch list.

In December 1998, after the loan had been in default for several months, Brier contacted the bank and requested that it exercise its rights under the pledge agreement and apply the CD to reduce the principal balance due on the CSI loan. He also asked the bank to re-amortize the loan to reduce the monthly payments and thereby improve CSI's cash flow.

In January 1999, the bank acceded to these requests and applied the CD to pay down a portion of the loan balance. At this time, Read & Lundy's $100,000 prejudgment writ of attachment had not yet matured into a right of garnishment. Indeed, Read & Lundy did not obtain a final judgment against Brier and CSI until September 2001. Although in May 1998, the Superior Court found in Read & Lundy's favor on four of five claims that it asserted against CSI and Brier, various post-trial motions, along with an appeal to this Court, delayed the entry of a final judgment. Once the Superior Court entered a final judgment, however, Read & Lundy asked that court to charge the bank as garnishee.

In July 2002, the Superior Court conducted a two-day hearing on Read & Lundy's motion to charge the bank as garnishee. In a bench decision, the trial justice decided that Read & Lundy's later-served prejudgment writ of attachment was entitled to priority over the bank's security interest in the CD that it held as collateral for the CSI loan. Noting that the bank never sought to declare CSI in default and that it applied Brier's CD to the loan balance only at Brier's suggestion, the trial justice ruled that Brier and the bank effectively had rescinded the pledge agreement. Thus, the trial justice concluded, the bank improperly ignored the writ of attachment when it applied the CD to pay down the CSI loan balance. The trial justice, therefore, ordered the bank to pay over to Read & Lundy the full value of the CD, as disclosed in its garnishee's affidavit: namely, $206,856.87. See G.L.1956 § 10-17-7. Thereafter, the court entered a final judgment in favor of Read & Lundy. The bank appealed from this judgment. Read & Lundy also cross-appealed, arguing that the Superior Court improperly calculated the date from which prejudgment interest should run.

The bank contends in its appeal that the trial justice erroneously granted Read & Lundy's motion to charge it as a garnishee with respect to the Brier CD. According to the bank, as a secured creditor, its prior perfected security interest was superior to Read & Lundy's later-served prejudgment writ of attachment. In addition, the bank suggests, it possessed the contractual right to apply the CD to pay down the balance due on its defaulted loan to CSI, and it posits that Read & Lundy's later-served writ of attachment did not alter these rights in any way. The bank also contends that its common-law setoff rights were superior to Read & Lundy's interests as a subsequent judgment creditor. Finally, the bank asserts, even if Read & Lundy's later-served writ of attachment was entitled to precedence over the bank's prior perfected security interest in the CD, the Superior Court improperly charged Read & Lundy the full amount set forth in its garnishee's affidavit, rather than the lesser amount contained in the writ of attachment.

Read & Lundy argues that it is irrelevant whether the bank possessed a perfected security interest in the CD because the bank had not yet declared the CSI loan to be in default when Read & Lundy caused it to be served with the charging order. Moreover, when the bank applied the CD to pay down the loan, it did so, Read & Lundy suggests, only in response to Brier's request, but not in the exercise of its rights as a secured creditor. Read & Lundy further asserts that this loan pay-down amounted to a rescission of the pledge agreement because Brier allowed the bank to apply the CD to the loan balance without first sending him a notice of the loan default and of...

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