Rinn v. First Union Nat. Bank of Maryland, Civ. A. No. MJG-94-2030.

CourtUnited States District Courts. 1st Circuit. United States District Court (Maine)
Citation176 BR 401
Docket NumberCiv. A. No. MJG-94-2030.
PartiesMichael G. RINN, Trustee, Appellant, v. FIRST UNION NATIONAL BANK OF MARYLAND, Appellee.
Decision Date05 January 1995



Paul D. Trinkoff, Mary Fran Ebersole, Baltimore, MD, for appellant.

Lawrence J. Gebhardt, Gebhardt & Smith, Baltimore, MD, for appellee.

GARBIS, District Judge.

The Court has before it the Appeal of Michael G. Rinn, Trustee ("Trustee"), from a Memorandum Opinion issued by James Schneider, United States Bankruptcy Judge for the District of Maryland, on June 28, 1994, denying Trustee's motions to dismiss and for summary judgment, and dismissing Trustee's complaint to avoid the liens of First Union National Bank of Maryland ("First Union"). 176 B.R. 390. The Court has considered the materials submitted by the parties and finds a hearing unnecessary to resolve the matter.


Ruppert Brothers of Maryland, Inc. ("Ruppert Brothers"), a Maryland corporation, served as a holding company for the assets of four subsidiaries. The subsidiaries, Baltimore Home Insulation, Inc. (a Maryland corporation), Advance Insulation & Supply, Inc. (a Virginia corporation), Colonial Insulation, Inc. (a Virginia corporation), and Wade Insulation, Inc. (a Delaware corporation) (collectively referred to as "the subsidiaries") were residential insulation contractors and installers of windows and doors.

On January 6, 1989, First American Bank of Maryland, now known as First Union National Bank of Maryland ("First Union"), extended credit facilities to Ruppert Brothers in the principal amount of $5.5 million. These facilities consisted of two lines of credit, a term loan, and vehicle financing. Ruppert Brothers used a substantial portion of the First Union loan and lines of credit to refinance an outstanding indebtedness of Ruppert Brothers to Maryland National Bank ("Maryland National"); in accordance with the parties' intent, First Union transferred a portion of the loan proceeds directly to Maryland National to satisfy the Ruppert Brothers' $4.05 million debt.1 Prior to the refinancing, Maryland National had a perfected, first-priority security interest in the inventory and accounts receivable of Ruppert Brothers and the four subsidiaries.

On November 7, 1988, before the closing of the January, 1989, loans, First Union issued a commitment letter expressly providing that, as security for the loans, Ruppert Brothers would grant First Union a first-priority lien on all accounts receivable and inventory of Ruppert Brothers and the subsidiaries, as well as upon certain real property of Ruppert Brothers and certain affiliate entities. According to the commitment letter, Ruppert Brothers agreed to execute at closing all documents "as may be reasonably required by First American including Uniform Commercial Code Financing Statements." Due to an oversight however, the loan documents executed at the closing did not provide for the granting or perfection of a security interest by the Ruppert Brothers subsidiaries.2 In short, upon the January 6, 1989, closing, the subsidiaries never executed any document granting to First Union a security interest in their assets. In addition, no financing statements were recorded in the appropriate registries indicating that First Union held a security interest in the subsidiaries' assets.

When this oversight was eventually discovered, the subsidiaries voluntarily granted a security interest to First Union in all of their assets. The grant occurred on or about February 7, 1992, and financing statements were filed to perfect the security interest on February 12, 1992. Importantly, the financing statements originally filed by Maryland National to perfect its earlier security interest in the subsidiaries' assets were never terminated or released and remained on record.

On March 25, 1992, within ninety days of the filing date of the First Union financial statements, the subsidiaries sold all of their tangible assets by bulk sales, with proceeds totalling $755,043.82. These proceeds are currently held by the Trustee. On May 5, 1992, also within ninety days of the filing date, involuntary Chapter 7 bankruptcy petitions were filed in Bankruptcy Court against the four subsidiaries (hereinafter "the debtors"). On September 15, 1992, Michael G. Rinn, the Plaintiff in this case, was appointed Charter 7 trustee ("Trustee") for the debtors' jointly-administered estates.

On January 26, 1993, First Union filed a complaint seeking a declaratory judgment that (1) it was entitled to assert, through the doctrine of equitable subrogation, Maryland National's perfected security interest in the accounts receivable and inventory of the Ruppert Brothers subsidiaries, and (2) that its right to these assets was superior to that of the Trustee. In essence, First Union asserted that its security interest was perfected not on February 12, 1992, when its own financing statements were eventually filed, but years earlier when Maryland National had perfected its first-priority lien in the assets. According to First Union, it therefore possessed a first priority security interest in funds held by Trustee as proceeds from the sale of the debtors' collateral. The Trustee moved to dismiss the complaint for failure to state a claim, and argued that even if First Union had an equitably subrogated lien, the "strong arm" clause of section 544 of the Bankruptcy Code gave priority to the Trustee's hypothetical judgment lien.

On March 1, 1993, the Trustee filed a complaint seeking to avoid the security interest in the assets of the subsidiaries granted to First Union in the February 7, 1992, security agreement. According to the Trustee, this transfer was a preference granted within ninety days of the filing of bankruptcy petitions and therefore voidable under sections 544, 547 and 550 of the Bankruptcy Code. First Union answered and filed a counterclaim in which it again sought a declaratory judgment that it had a perfected, non-voidable first-priority security interest because of its equitable subrogation to the position of Maryland National.

On June 29, 1994, the Bankruptcy Court ruled that First Union was equitably subrogated to Maryland National's security interest and that those liens were invulnerable to attack by the Trustee because they were perfected outside the preference period. According to the Bankruptcy Court, when First Union refinanced Maryland National's priority security interest in the subsidiaries' assets, the principles of equitable subrogation effected an assignment of the interests held by Maryland National in the collateral to First Union. Thus, because in the case of assignments no supplemental filing is required to continue the perfected status of a security interest against creditors of and transferees from the original debtor, no formal filing was required for First Union to "continue" Maryland National's earlier perfection. Finding no "intervening equities" in favor of the Trustee, the Bankruptcy Court held that the negligence of First Union's counsel to draw up the necessary documentation did not act as a bar to the application of equitable subrogation. The Bankruptcy Court further relied on Maryland National's unreleased financial statements to satisfy the Uniform Commercial Code requirement of notice to potential creditors of an outstanding perfected priority interest in the debtor's collateral.

In sum, the Bankruptcy Court held that a first-priority security interest in the debtors' assets was perfected by the filing of properly-recorded financing statements by Maryland National. Because First Union agreed to refinance the subsidiaries' debt to Maryland National in 1989 on the express condition that First Union assume that same first-priority secured creditor status, the doctrine of equitable subrogation operated to overcome the parties' negligence in not filing new security agreements or financial statements and to place First Union in the perfected shoes of Maryland National. Consequently, because First Union was entitled to rely upon the perfection obtained by Maryland National years before the ninety day preference period preceding the May 5, 1993 filing of Chapter 7 petitions, the perfected security interest held by First Union was not an avoidable transfer under the "strong-arm" clause of the Bankruptcy Code.

The Trustee brings this appeal pursuant to 28 U.S.C. §§ 158(a) and 1292(b). The Court has before it the following two issues:

1. Whether the doctrine of equitable subrogation permits First Union to assert the perfected security interest of Maryland National, a lender whose debt was refinanced with the proceeds of First Union\'s loan, after First Union failed to obtain its own perfected security interest; and
2. Whether First Union\'s right to assert a prior lender\'s perfected security interest through equitable subrogation defeats the Trustee\'s rights as a judgment lien creditor under § 544(a)(1) of the Bankruptcy Code.

When a district court reviews a bankruptcy court's judgment, it acts as an appellate court. Accordingly, legal conclusions are to be reviewed de novo, whereas factual findings are set aside only if clearly erroneous. Matter of CHG Intern., Inc. 897 F.2d 1479, 1482 (9th Cir.1990); Brown v. Pennsylvania State Employees Credit Union, 851 F.2d 81, 84 (3rd Cir.1988); Wegner v. Grunewaldt, 821 F.2d 1317, 1320 (8th Cir. 1987); In re Columbia Data Products, Inc., 99 B.R. 682, 683 (D.Md.1989), aff'd, 892 F.2d 26 (4th Cir.1989). Mixed questions of fact and law which contain "primarily a consideration of legal principles" are considered de novo. In re Ruti-Sweetwater, Inc., 836 F.2d 1263, 1266 (10th Cir.1988). In this case, the two issues on appeal — the applicability of equitable subrogation and its interrelationship with the "strong-arm" clause of the Bankruptcy Code — are legal issues which this Court will...

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