Valley Nat. Bank of Arizona v. Cotton Growers Hail Ins., Inc.

• Decision Date: 15 December 1987
• Docket Number: No. 1,CA-CIV,1
• Citation: 155 Ariz. 526,747 P.2d 1225
• Parties: , 5 UCC Rep.Serv.2d 735 The VALLEY NATIONAL BANK OF ARIZONA, a national banking association, Plaintiff- Appellee, v. COTTON GROWERS HAIL INSURANCE INC., an Arizona corporation; and the Continental Insurance Company, a New York corporation, Defendants-Appellants. 9183.
• Court: Arizona Court of Appeals

Page 1225

747 P.2d 1225

155 Ariz. 526, 5 UCC Rep.Serv.2d 735

The VALLEY NATIONAL BANK OF ARIZONA, a national banking association, Plaintiff- Appellee, v. COTTON GROWERS HAIL INSURANCE INC., an Arizona corporation; and the Continental Insurance Company, a New York corporation, Defendants-Appellants.

No. 1 CA-CIV 9183.

Court of Appeals of Arizona Division 1, Department A.

Dec. 15, 1987.

[155 Ariz. 527] Snell & Wilmer by Peter J. Rathwell, Eileen J. Moore, Phoenix, for plaintiff-appellee.

Robbins & Green, P.A. by William P. Hovell, Robert H. Green, Mark W. Romney, Phoenix, for defendants-appellants.

OPINION

JACOBSON, Judge.

This appeal presents the question, under the Uniform Commercial Code, of whether a bank holding a secured interest in growing crops is entitled to proceeds of insurance covering that crop as against the insurer of the crop, who has not received a premium for the insurance.

The pertinent facts are not in dispute. In April, 1984, appellant, Continental Insurance Company, issued a cotton hail insurance policy through its broker, Cotton Growers' Hail Insurance, Inc., (hereinafter collectively referred to as appellants) to Paloma Ranch Development Corp. covering its 1984 cotton crop. The policy was to take effect immediately, although the $501,147.00 premium was not due until August 31, 1984. The appellants contend that this deferred premium payment plan was part of an industry custom which allowed the farmer to obtain insurance at the start of the crop growing season, but deferred payment of the premium until the crop was harvested and sold, at which time the farmer would be in a more liquid cash situation. According to appellants, this custom adjusted losses during the growing season by allowing the insurer to offset any losses against premiums owed.

Appellee, Valley National Bank, financed Paloma Ranch's cotton crop. On February 1, 1984, the bank and Paloma Ranch entered into a security agreement covering the cotton crop and "the proceeds (including, without limitation, proceeds under insurance policies....) of farm products." The bank had previously recorded a financing statement, dated May 27, 1983, covering Paloma Ranch's farm products, crops and their proceeds. The bank was a loss payee under the Continental cotton hail policy.

On July 27, 1984, a hailstorm damaged the Paloma Ranch cotton crop. Cotton Growers adjusted the loss and determined that damages in the amount of $300,277 were suffered by Paloma Ranch. Pursuant to the alleged industry custom and with Paloma Ranch's consent, Cotton Growers credited the $300,277 loss against the $501,147 due on the premium, leaving a balance due on the premium of $200,820.

Paloma Ranch did not pay the balance due on the premium and it defaulted on its obligation owed the bank. Upon default, the bank demanded that the appellants pay to it the $300,277 loss under the hail insurance policy, contending that it constituted proceeds of the Paloma Ranch crop in which it had a security interest. The appellants refused, contending they were entitled "to an offset in the amount of the loss for unpaid premium."

This litigation ensued. The trial court granted the bank's motion for summary judgment, holding:

The insurance proceeds payable to Paloma Ranch as a result of hail damage to its cotton crop are proceeds within the meaning of Arizona Commercial Code A.R.S. § 44-3127(A) [now A.R.S. § 47-9306(A) ] in which [the bank] had a perfected security interest and to which [appellants], as unsecured creditors hold a subordinate claim.

This appeal followed in which the appellants contend:

(1) That the failure of Paloma Ranch to pay the premium on the policy excused appellants' obligation to pay the loss.

(2) That the appellants' right to offset its obligation to pay against the insureds' indebtedness for unpaid premiums was superior to the bank's secured interest; and

(3) That appellants had a "pledge interest" in the loss payable that was superior to the bank's interest.

The Effect of Paloma Ranches' Failure to Pay Premiums

Appellants first argue that their obligation to pay any loss under the policy was subject to a condition precedent--the payment of the insurance premium. This argument is premised upon the previously described "industry custom" and the following language in the policy:

"AGREEMENT TO INSURE: We will provide the insurance described in this policy in return for the premium and compliance with all applicable provisions." (Emphasis Added.)

Although appellants in this case attempt to apply the condition precedent argument to its obligation to pay losses under the policy, they concede that during the entire period of the crop growing season coverage against hail damage was provided even in absence of premium payment. If, therefore, coverage is provided under appellants' theory, does the contract language make payment of the premium a condition precedent to the payment of a loss under the coverage provided? We hold it does not.

As a general rule, a contractual provision shall not be construed as a condition precedent unless the language of the provision plainly and unambiguously requires that construction. Watson Const. Company v. Reppel Steel & Supply, 123 Ariz. 138, 598 P.2d 116 (App.1979). In this case the language that the appellants will provide insurance "in return for the premium" merely defines the insured's obligation to provide coverage in the first instance and sets forth the consideration for doing so. It wholly fails to inform anyone, let alone do so "plainly and unambiguously", that coverage will be afforded, but accruing payments which are in an amount less than the premium due will be withheld. We therefore reject appellants' contention that the contract language creates a condition precedent.

Likewise, assuming that an industry custom exists which would make "payment" as compared to "coverage" subject to premiums due, we reject that such a custom is binding upon the bank. Custom may not be used to prove the meaning of words and phrases unless all parties are chargeable with knowledge of the custom. Sam Levitz Furniture Co. v. Safeway Stores, Inc., 10 Ariz.App. 225, n. 4 at 228, 457 P.2d 938, n. 4 at 941. There is no evidence that the bank, as a loss payee under the policy, was aware that the insured's obligation to pay a loss was conditioned upon a custom between farmers and insurers to allow coverage but withhold payments for losses in amounts less than the premiums due. The evidence is undisputed that insofar as the bank was concerned, the appellants had simply issued a policy providing present coverage on credit. No conditions precedent to coverage or payment are presented under these facts.

We next deal with appellants' argument that the bank's "security interest never attached to the potential loss payable because Paloma Ranch did not [have rights in] the loss payable." While this argument is made in connection with the argument on conditions precedent, an analysis of its validity bears upon the set-off argument also advanced by appellants.

Of course, the argument depends upon the legal conclusion that Paloma Ranch had no interest in the proceeds from the hail damage at the time the loss occurred. In our opinion, that legal conclusion is not supportable. Under its agreement with appellants, Paloma Ranch was afforded coverage for hail damage during the entire crop growing season. Admittedly, its right to collect on that coverage was subject to an accounting between itself and the appellants for premiums due. But, Paloma Ranch had at least a contingency interest in the proceeds of the insurance at the time the loss occurred. Is such a contingent interest in the debtor sufficient to allow an interest to attach at the time the interest accrues?

In our opinion it is. A.R.S. § 47-9203 provides in part that

A security interest is not enforceable against the debtor or third parties with respect to the collateral and does not attach unless:

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3. The debtor has rights in the collateral.

The nature of the "rights" that the debtor must possess are not absolute, but may be contingent as is illustrated by First National Bank of Arizona v. Carabajal, 132 Ariz. 263, 645 P.2d 778 (1982). In that case, a cash seller delivered a van to its buyer but retained possession of the certificates of title. Without payment and without evidence of title, the buyer sold the van to a third party, took back a security interest and assigned that security interest to a bank. Against the contention that the buyer did not have sufficient rights in the collateral to allow the bank's interest to attach, the Arizona Supreme Court held:

When [the seller] delivered the van without a written agreement signed by the [buyer], [the buyer] obtained sufficient "rights" and "power" to encumber the van, A.R.S. § 44-3116 [U.C.C. § 9-203], and therefore [the bank's] security interest attached.

It is clear that as between the buyer and seller in Carbajal, the buyer's rights were subordinate to those of the seller. However, the buyer had sufficient right in van before the seller again obtained possession, to grant superior rights to a secured creditor.

In the case here, Paloma Ranch at the time the loss occurred had the right to receive any insurance proceeds. This right may have been subject to a condition subsequent--that the premium be paid by August 31. However, this condition subsequent could not excuse appellant's obligation to pay on July 27. In our opinion, this contingent right of Paloma Ranch in the insurance proceeds was sufficient to allow the bank's security interest to attach. See, Morton Booth Co. v. Tiara Furniture, Inc., 564 P.2d 210 (Okla.1977) (holding that any interest of a debtor more than mere naked possession is sufficient to allow a security interest to attach under U.C.C. § 9-203(1)(c)); In re Country Green Ltd. Partnership, 438 F.Supp. 693 (D.C.Va.1977) (holding that delivery of collateral to construction site was...