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#2232 signed 5-24-96

IN THE UNITED STATES BANKRUPTCY COURT

FOR THE DISTRICT OF KANSAS



IN RE:

HARLEN O. ELLIOTT, and THERESA M. ELLIOTT,

DEBTOR.

CASE NO. 92-40891-11

CHAPTER 11

ITT COMMERCIAL FINANCE CORP.

PLAINTIFF,

v.

TRANSAMERICA COMMERCIAL FINANCE CORPORATION, et al.,

DEFENDANTS.

ADVERSARY NO. 92-7102



MEMORANDUM OF DECISION

This proceeding is before the Court on a motion to distribute funds, filed by Transamerica Commercial Finance Corporation (Transamerica) and ITT Commercial Finance Corporation (ITT). Transamerica is represented by Donald Loudon of Shughart, Thomson & Kilroy, P.C., of Kansas City, Missouri. ITT is represented by Eric Bruce of Bruce & Davis, L.C., of Wichita, Kansas. First National Bank in Leavenworth (FNB) opposes the motion, and is represented by Betsy Morgan Garvin of Watson & Marshall, L.C., of Kansas City, Missouri. The Court has reviewed the relevant pleadings and is now ready to rule.

FACTS

Debtor Harlen Elliott ran a sole proprietorship selling boat and marine accessories. Since Mrs. Elliott was not involved in the business activities relevant to this proceeding, the Court will use "debtor" to refer only to Mr. Elliott. FNB, Transamerica, and ITT all have perfected security interests in at least some of the debtor's business property.

ITT commenced this proceeding to obtain a determination, among other things, of the relative priorities of parties who claim an interest in certain of the debtor's collateral and cash collateral accounts. Questions concerning the debtors and certain creditors were resolved by agreement of the parties, leaving only a dispute among ITT, Transamerica, and FNB about inventory in which Transamerica had a purchase money security interest (pmsi). Previously, at the parties' behest, the Court determined that Transamerica's pmsi did not have priority over FNB's floating lien in the debtor's inventory. That ruling was affirmed by the district court on appeal. ITT had already conceded that Transamerica's pmsi had priority over its floating lien because Transamerica gave the notice required under K.S.A. 1995 Supp. 84-9-312(3) to move its pmsi ahead of ITT's senior interest. The inventory has been sold and the proceeds are awaiting the Court's resolution of the parties' dispute.

Having lost its dispute with FNB, Transamerica now joins ITT in asking the Court to distribute the disputed money to ITT. The parties contend the Court's earlier decision has created a circular priority problem because ITT's first-filed security interest has priority over FNB's security interest, FNB has been determined to have priority over Transamerica, and Transamerica's pmsi has priority over ITT's security interest.

DISCUSSION AND CONCLUSIONS

ITT and Transamerica first contend that since Transamerica is willing to let the proceeds of the inventory in which it had claimed a pmsi go to ITT, the Court should simply ignore FNB's arguments about a circular priority and give the money to ITT as the holder of the first-filed security interest. The Court believes this could only happen if Transamerica were allowed to withdraw its claim to a pmsi. But if the Court allowed this now, what was the point of the prior decision finding that FNB had priority over Transamerica? The parties presented that dispute to the Court as they did only because ITT conceded Transamerica's pmsi was superior to its floating lien in the debtor's inventory. Without that priority, Transamerica had no reason to litigate its position against FNB because ITT's claim is so large, none of the proceeds of the disputed inventory would have remained to be paid to either Transamerica or FNB. Now, having forced FNB to incur attorney fees and other litigation costs before this Court and on appeal to the District Court to assert successfully its priority over Transamerica, Transamerica suggests it may freely give away its priority over ITT. Equity requires that Transamerica be estopped from adopting this new position at this late date. See Paul v. Monts, 906 F.2d 1468, 1473-1474 (10th Cir. 1990) (party may be estopped from asserting inconsistent position if another reasonably relied on prior position and would be harmed by change).

Even if estoppel would not bar Transamerica's change of heart, the facts themselves do. Transamerica gave notice to ITT in order to gain priority for its pmsi, and it cannot change that fact now that FNB may reap the benefit Transamerica sought for itself. The true events, not a belated litigation tactic, should control the Court's decision. In fact, the Court sees no reason why FNB cannot assert and rely on Transamerica's priority over ITT since FNB may benefit from that priority.

Though the parties discuss their dispute as a circular priority problem, the Court believes it is not.(1) Instead, before Transamerica came along, the debtor's inventory could be considered as a single pool of collateral against which ITT's floating lien had the first priority and FNB's the second. FNB expected to be paid from that pool only after ITT was paid in full. Both of them, of course, rightly expected to be paid before any lender which might later obtain an ordinary lien on the debtor's inventory. However, when Transamerica loaned the debtor money to buy some inventory and took a pmsi in that inventory, it created, to the extent of its claim, a second, separate pool of inventory against which it sought to obtain the first claim. By giving notice to ITT, it successfully moved its pmsi ahead of ITT as to the second pool. ITT therefore knew it could not be paid from that pool until Transamerica's pmsi claim was paid in full. ITT cannot legitimately complain if someone other than Transamerica receives the proceeds that would otherwise have gone to Transamerica. By failing to give notice to FNB, though, Transamerica remained, as to FNB, simply a subsequent lender with an ordinary lien on the second pool of inventory, and FNB could properly expect to be paid out of that pool ahead of that later, ordinary lien. Therefore, to the extent of its claim, FNB is entitled to be paid before Transamerica from the proceeds of the inventory subject to Transamerica's pmsi to the extent of the lesser of the amount of those proceeds or the amount of Transamerica's claim.

The parties' situation and this solution to the problem is similar, though not identical, to that described in Grant Gilmore, 2 Security Interests in Personal Property §39.1 at 1021 (1965). As Professor Gilmore notes, this situation "may be dismissed as not involving a 'true circularity.'" Id. Although Gilmore describes the situation as arising from a contractual subordination or waiver, the same priorities resulted here from the UCC's priority rules and Transamerica's partial satisfaction of the requirements of K.S.A. 1995 Supp. 84-9-312(3). The rules simply allowed Transamerica to subordinate ITT to Transamerica's pmsi without ITT's agreement.

For these reasons, the Court concludes that, to the extent of Transamerica's claim, the proceeds of the debtor's inventory that was subject to Transamerica's pmsi should be paid first to FNB to the extent of its claim, then to Transamerica, and if anything is left, to ITT.

The foregoing constitutes Findings of Fact and Conclusions of Law under Rule 7052 of the Federal Rules of Bankruptcy Procedure and Rule 52(a) of the Federal Rules of Civil Procedure. Within twenty days, the parties should submit a proposed judgment assigning the appropriate dollar amounts to the distribution method the Court has determined. A judgment based on this ruling will then be entered on a separate document as required by FRBP 9021 and FRCP 58. If the parties are unable to determine the appropriate dollar amounts, they should inform the Court within that same time period.

Dated at Topeka, Kansas, this ____ day of May, 1996.











_________________________________

JAMES A. PUSATERI

CHIEF BANKRUPTCY JUDGE

1. For extensive discussions of circular priorities, see 2 Grant Gilmore, Security Interests in Personal Property §39.1, pp. 1020-46 (1965) and M. Stuart Sutherland, Note, Circular Priority Systems Within the Uniform Commercial Code, 61 Tex. L. Rev. 517 (1982).

 

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