Pubs, Inc. of Champaign, Matter of

• Citation: 6 BCD 119,618 F.2d 432
• Decision Date: 07 March 1980
• Docket Number: No. 79-1296,79-1296
• Parties: , 28 UCC Rep.Serv. 297 In the Matter of PUBS, INC. OF CHAMPAIGN, Bankrupt. Appeal of BANK OF ILLINOIS IN CHAMPAIGN, Reclamation Petitioner.
• Court: United States Courts of Appeals. United States Court of Appeals (7th Circuit)

Page 432

618 F.2d 432

6 Bankr.Ct.Dec. 119, 28 UCC Rep.Serv. 297

In the Matter of PUBS, INC. OF CHAMPAIGN, Bankrupt.

Appeal of BANK OF ILLINOIS IN CHAMPAIGN, Reclamation Petitioner.

No. 79-1296.

United States Court of Appeals, Seventh Circuit.

Argued Nov. 7, 1979.

Decided March 7, 1980.

Bruce Meachum, Meachum & Meachum, Danville, Ill., for petitioner.

James L. Capel, Jr., Champaign, Ill., for bankrupt.

Before FAIRCHILD, Chief Judge, CUDAHY, Circuit Judge, and DUMBAULD, Senior District Judge. ^*

CUDAHY, Circuit Judge.

This is an appeal by a secured creditor, the Bank of Illinois in Champaign (the "Bank"), from an order of the district court denying the Bank's complaint for reclamation of certain collateral in which it claims a security interest. The bankruptcy judge, affirmed by the district court, found that the security interest of the Bank never attached to the collateral (nor was the security interest enforceable) because the debtors Ronald L. Hein and Robert D. Richardson, did not have "rights in the collateral" when they granted the security interest in the collateral to the Bank. Instead, before the security interest was granted, Hein and Richardson had transferred their interest in the collateral to the bankrupt, Pubs, Inc. of Champaign ("Pubs"). We find that Pubs was estopped to deny the attachment of the security interest and that this estoppel gave Hein and Richardson "rights in the collateral" to which the Bank's security interest attached so that the Bank obtained an enforceable security interest. Since the Bank perfected its security interest prior to bankruptcy, we hold that the security interest was valid against the claim of the trustee, and we, therefore, reverse.

I.

Sometime before November 5, 1976, Hein and Richardson, who were then, or who were to become, directors, officers, and the sole shareholders of the bankrupt corporation, Pubs, agreed to purchase certain restaurant equipment to be used in a restaurant then under construction in Champaign, Illinois. Shortly before the equipment was due to arrive in Champaign, Hein and Richardson explored the possibility of obtaining a loan to be used for the purchase of the equipment. It was the intention of both Hein and Richardson to borrow the money personally from the Bank, grant a security interest ¹ in the equipment to the Bank and then transfer the equipment to Pubs in exchange for certain common stock of Pubs.

On November 5, 1976, Hein executed a collateral promissory note (due in six months) in favor of the Bank, which, inter alia, granted to the Bank a security interest in certain scheduled equipment, fixtures, furnishings and supplies (the "collateral") in consideration of $60,000 to be advanced by the Bank. Richardson was absent on November 5, 1976 and did not sign the collateral promissory note until November 16. The Bank deleted the date of November 5, 1976, which originally appeared on the collateral promissory note and substituted, as the date of execution, the date of November 16, 1976, and the $60,000 was advanced on that date. ² On November 9, 1976, meanwhile, Hein and Richardson had executed a bill of sale and conveyance of the collateral to Pubs. The bill of sale and conveyance expressly stated that the collateral was transferred subject to the security interest in favor of the Bank.

The transfer to Pubs was made in consideration of certain of its shares of stock. Obviously, it had been the intention of Hein, Richardson, the Bank and Pubs that the security interest in the collateral be created prior to the transfer of the collateral to Pubs and that Pubs take the collateral subject to the security interest. In the event, Richardson did not sign the collateral promissory note which purported to create the security interest until after transfer of the collateral to Pubs.

Financing statements with respect to the collateral were properly filed by the Bank with the Recorder of Deeds of Champaign County, Illinois, on November 19, 1976, and with the Illinois Secretary of State on November 22, 1976. On May 16, 1977, the note, when due, was renewed by the Bank for an additional three months. Pubs filed a voluntary petition in bankruptcy on April 5, 1978, at which time the bankrupt was in possession of the collateral, and Hein and Richardson were in default under the terms of the collateral promissory note.

Pursuant to order of the bankruptcy judge, the collateral was later sold, and the question now presented is the respective rights to the proceeds of the sale, of the Bank and of the trustee.

II.

The trustee, who prevailed below, contends that, since Richardson did not sign the collateral promissory note until November 16, 1976 (and the Bank changed the note to reflect a November 16 date of execution), a security interest could not have attached or become enforceable since, on November 16, Hein and Richardson no longer had "rights in the collateral." With respect to attachment and enforceability, the controlling provision of the Illinois Commercial Code reads in pertinent part as follows:

"(1) Subject to the provisions of Section 4-208 on the security interest of a collecting bank and Section 9-113 on a security interest arising under the Article on Sales, 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 describing the collateral); and

(b) value has been given; and

(c) the debtor has rights in the collateral.

"(2) A security interest attaches when it becomes enforceable against the debtor with respect to the collateral. Attachment occurs as soon as all of the events specified in subsection (1) have taken place unless explicit agreement postpones the time of attaching." Ill.Rev.Stat. ch. 26, § 9-203(1) and (2) ³ (emphasis supplied).

The requirement that the debtor have rights in the collateral is, inter alia, intended to postpone attachment until the property proposed to be subject to the security interest comes into existence or until the debtor acquires rights in it (as with "after-acquired" property, cf. Ill.Rev.Stat. ch. 26, § 9-204). It should be noted also that § 9-203(2) expressly equates the concept of attachment with that of enforceability against the debtor. Ill.Ann.Stat. ch. 26, Comment, p. 109 (Smith-Hurd).

The term "rights in the collateral" is not defined in the Uniform Commercial Code (nor in its Illinois version), but, as will appear, the debtor may clearly have sufficient "rights" for purposes of § 9-203 if the true owner of the collateral has agreed to the debtor's use of the collateral as security or if the true owner has become estopped to deny the creation or existence of the security interest. ⁴ Thus, the requirement that there be "rights in the collateral" illustrates the general principle that "one cannot encumber another man's property in the absence of consent, estoppel or some other special rule." First National Bank and Trust Co. of Augusta v. McElmurray, 120 Ga.App. 134, 138, 169 S.E.2d 720, 724 (1969). The consent of the true owner of the collateral is enough to give the debtor rights in the collateral for purposes of § 9-203. See General Motors Acceptance Corp. v. Washington Trust Co. of Westerly, 386 A.2d 1096 (R.I.1978) and K. N. C. Wholesale, Inc. v. AWMCO, Inc., 56 Cal.App.3d 315, 128 Cal.Rptr. 345 (1976). And, in Avco Delta Corporation Canada Ltd. v. United States, 459 F.2d 436 (7th Cir. 1972), this Court, through Judge Sprecher, held that a security interest, also allegedly unenforceable for lack of attachment in that the corporate debtor had no rights in the collateral, could be created by estoppel through acts or omissions (including silence) of the true corporate owner.

Avco Delta involved the competing claims of a secured creditor and the United States as the holder of a tax lien. The case concerned three closely affiliated corporations ("Ltd.", "Construction" and "Taxpayer" collectively the "Canadian Parkhill companies") one of which, Construction, was the debtor and the purported owner of 29 pieces of heavy construction equipment which it used as collateral to secure a loan from Avco Delta ("Avco"). Construction expressly covenanted to Avco that it owned the mortgaged equipment and provided it with documents to that effect, but, in fact, Taxpayer was the true owner. The alleged intent of the parties had originally been that Construction would own the equipment and lease it to Taxpayer for use on a construction job, but this was not the procedure in fact followed. 459 F.2d 438, 439. Ltd. and Taxpayer had agreed, inter alia, to guarantee payment of debts running from Construction to Avco.

The secured creditor, Avco, had perfected its security interest in the collateral by filing with respect to Construction on November 25, 1969. On the other hand, the United States perfected a tax lien against Taxpayer on the same 29 items of collateral (arising from Taxpayer's delinquent withholding and F.I.C.A. taxes) by filing against Taxpayer on February 16, 1970.

The crucial question in Avco Delta was whether the debtor (Construction) had "rights in the collateral" under Ill.Rev.Stat. ch. 26, § 9-204 (1963 version) so that Avco's security interest would attach and become enforceable even though Construction did not own the collateral. ⁵ Judge Sprecher noted that the "code does not define the word 'rights' except to indicate that it 'includes remedies'." Ill.Rev.Stat. ch. 26, § 1-201(36), Avco Delta at 440. Judge Sprecher then observed that,

"Section 1-103 (of the Code) provides in part, 'Unless displaced by the particular provisions of this Act, the principles of law and equity, including the law merchant and the law relative to . . . estoppel, fraud, misrepresentation, . . . or other validating or invalidating cause shall supplement its provisions.' (footnote...