U.S. v. Walter Dunlap & Sons, Inc.

Decision Date24 November 1986
Docket Number85-1673,Nos. 85-1671,s. 85-1671
Citation800 F.2d 1232
Parties1 UCC Rep.Serv.2d 1618 UNITED STATES of America v. WALTER DUNLAP & SONS, INC., Appellant in 85-1671. UNITED STATES of America v. NEW HOLLAND SALES STABLES, INC., Appellant in 85-1673.
CourtU.S. Court of Appeals — Third Circuit

James T. Malysiak (argued), Freeman, Freeman & Salzman, P.C., Chicago, Ill., James A. Strazzella, Law Center, Philadelphia, Pa., E. Lawrence Oldfield, Chicago, Ill., for appellant Walter Dunlap & Sons, Inc.

James H. Thomas, Wenger, Byler & Thomas, Lancaster, Pa., for Holland Sales Stables, Inc.

Edward S.G. Dennis, Jr., U.S. Atty., Stanley Weinberg (argued), Asst. U.S. Atty., Walter S. Batty, Jr., Asst. U.S. Atty., Philadelphia, Pa., for appellee U.S.

Before ADAMS, WEIS, and HIGGINBOTHAM, Circuit Judges.

OPINION OF THE COURT

WEIS, Circuit Judge.

The question in this appeal is whether federal agency regulations or state law give content to federal law in determining the status of a lien on collateral for a loan made by the Farmers Home Administration. The district court chose the agency regulations as appropriate, but we decide that the controlling Supreme Court decision requires resort to state law. We also conclude that even under its own regulations, the Farmers Home Administration is not entitled to prevail. Accordingly, we will reverse the summary judgment in favor of the government and direct entry of judgment in favor of defendants.

The parties filed cross-motions for summary judgment. After consideration of the material in the record, the district court granted the government's motion but denied the defendants'. The court also declined reconsideration and defendants have appealed.

Defendants are commission brokers in Pennsylvania who sell livestock at auctions. Customarily, the farmers bring livestock to defendants the day before the scheduled sale, and in accordance with the dictates of the Packers and Stockyards Act, 7 U.S.C. Sec. 228b (1982), the brokers pay the farmers in full within twenty-four hours of the sale.

The controversy here stems from the defendants' sale of livestock owned by Mark Noll, which was collateral for loans from the Farmers Home Administration (FmHA). 1 In August 1979, Noll borrowed $90,000 from the FmHA as an operating loan for his farm in Lancaster County, Pennsylvania, and in December 1980, he secured $230,360 as an emergency loan. As part of the transactions, Noll granted FmHA a security interest in existing and after-acquired livestock, crops, and farm equipment. FmHA filed financing statements in the local court office in accordance with state law.

Noll signed a form which provided that the collateral could "not be sold, transferred, or encumbered ... without the written consent of the Government." Included in the form was another provision that obligated him to "comply with such farm and home management plans as may be agreed upon from time to time by Debtor and Secured Party."

Noll and the local representative of FmHA prepared a "Farm and Home Plan", form No. FmHA 431-2, which listed in detail the debtor's assets, liabilities, living expenses, and other expenditures including feed and supplies. That document also projected selling dates for cattle and crops, anticipated receipts, and outlined repayment of the FmHA loans. The plan authorized Noll to sell the cattle as they became ready for market and to pay FmHA as per a schedule. 2 Receipts in excess of the payments to FmHA were available for normal farm operating and living expenses.

Defendants did not have actual knowledge of the FmHA liens, and they, along with other brokers, sold all of Noll's cattle in 1981. 3 After deducting commissions, they paid Noll $224,791.39. He in turn deposited the funds in his bank account, and remitted $155,000 to FmHA and $21,486 to an approved secured creditor. He used the balance of $42,485.39 to purchase livestock feed and pay farm and living expenses.

Because of falling cattle prices, the actual receipts were less than those outlined in the Farm and Home Plan. In August 1981, the FmHA county supervisor met with Noll to discuss the status of the loan in view of the amount still due after the sale of all the cattle. Noll asked for another loan to pay for the expenses of harvesting his tobacco crop but that request was denied.

Soon afterward, Noll filed a petition in bankruptcy and in due course the FmHA debt was discharged. The government then filed these actions for conversion against defendants to recover the gross proceeds each had received from the sale of the cattle.

In addressing the cross-motions for summary judgment, the district court concluded that whether FmHA's security interest in the cattle had been released was a matter to be determined under federal law. However, since no relevant federal legislation existed, the court applied FmHA regulations governing the disposition of collateral as the rule of decision rather than state law.

The court rejected use of the Uniform Commercial Code because in its view United States v. Kimbell Foods, Inc., 440 U.S. 715, 99 S.Ct. 1448, 59 L.Ed.2d 711 (1979), permits the invocation of state law only in the absence of a controlling federal rule. When, as here, FmHA regulations specifically addressed the release of collateral, the district court believed it had no choice but to incorporate those regulations as the rule of decision. The district judge cited this court's precedent in United States v. Kennedy, 738 F.2d 584 (3d Cir.1984), and United States v. Sommerville, 324 F.2d 712 (3d Cir.1963), as generally supporting this conclusion.

The district court found that even though FmHA had acquiesced in the sales, the government's security interest nonetheless was not released because the proceeds from the cattle had not been applied in accordance with 7 C.F.R. Secs. 1962.17 and 1962.18 (1985). Finding that the cattle were "basic" rather than "normal" security, as defined by the regulations, the district court ruled that the proceeds could not be used to pay routine living and farm maintenance expenses.

Following conferences with the court on damages, the parties stipulated the amounts due, and judgments were entered against defendants.

On appeal, defendants contend that the district court erred in failing to adopt state law as the rule of decision. In the alternative, they argue that even if the FmHA regulations were applicable the court erred in not characterizing the collateral as "normal income security." Under such a designation, Noll would have been permitted to apply the proceeds as he did. Defendants further assert that the prompt payment provisions of the Packers & Stockyards Act exempt them from liability, and that market conditions, not the cattle sales per se, were the cause of FmHA losses.

Preliminarily, we believe it important to put the holdings in Kennedy and Sommerville in context.

Kennedy presented a very narrow question--whether the complaint stated a claim for conversion against the buyer of collateral that secured FmHA loans. Applying the rule of conversion enunciated in Sommerville, we held that "under the general federal law the Government's complaint ... alleged sufficient facts to withstand [a] motion to dismiss." Those facts included the purchase of collateral by defendants, the debtors' failure to apply all of the proceeds toward repayment of the loan, and the defendants' refusal to pay the amount the debtors misapplied. The procedural posture of the case required that the allegations of the complaint be construed in favor of the government. Reading the complaint in that fashion permitted an inference that despite knowledge of the FmHA lien, the purchaser nevertheless made some payments directly to the debtor and ignored the FmHA's interest.

After resolving the issue presented, the panel went on to discuss why state law was inapplicable. 4 Referring to Kimbell and Sommerville, the panel noted that "[b]ecause we are not acting in the absence of an existing federal rule, we are not at liberty to adopt state law as the measure of the federal rule. Instead, we must apply the federal rule [of conversion] as articulated in Sommerville." 738 F.2d at 586 n. 3. That statement, being unnecessary to the holding in Kennedy, was dictum which has led to some uncertainty. Therefore, a detailed discussion of Kimbell and Sommerville may help clarify those misconceptions.

The debtor in Sommerville had an auctioneer sell livestock encumbered by an FmHA loan. But unlike the situation in this case, FmHA had not approved the sale and did not have any knowledge of the transaction at the time.

Citing Clearfield Trust Co. v. United States, 318 U.S. 363, 63 S.Ct. 573, 87 L.Ed. 838 (1943), Sommerville stated that the need to protect the United States fisc required the application of federal law to questions arising under FmHA programs. In determining what principles to incorporate as the content of that federal law, the Court concluded that the "interest of the United States in the administration of the loan program would be undermined and its power to protect its purse limited if disparate laws of individual states were applied to substantially identical loan transactions." 324 F.2d at 716.

Although it conceded that the Uniform Commercial Code in effect in Pennsylvania would set the conditions for recordation of the security agreement and perfection of the lien, the panel expressly rejected use of any other state law. The court noted that "absent express congressional declaration of intent that state law shall be applicable, we are reluctant to subject federal rights and duties to the exceptional uncertainty and heterogeneity which may ensue in many cases. We will not do so." 324 F.2d at 717.

Sommerville thus adopted general federal common law as the content of the rule of decision. This court was joined in that approach by the Sixth,...

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