#1991 Aff'd 3-22-95 (Rogers, J.) (adopts this opinion)
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS
HARLEN O. ELLIOTT, and THERESA M. ELLIOTT,
CASE NO. 92-40891-11
ITT COMMERCIAL FINANCE CORP.
TRANSAMERICA COMMERCIAL FINANCE CORPORATION, et al.,
ADVERSARY NO. 92-7102
MEMORANDUM OF DECISION
This adversary proceeding is before the Court to prioritize the security interests of First National Bank and Trust Company of Leavenworth (FNB) and Transamerica Commercial Finance Corporation (Transamerica) in inventory of Harlen O. and Theresa M. Elliott, Debtors in the related bankruptcy proceeding. FNB appears by John F. Thompson of Davis, Beall, McGuire & Thompson of Leavenworth, Kansas. Transamerica appears by Joel Pelofsky of Shugart, Thompson & Kilroy of Kansas City, Missouri. Debtors do not appear in this proceeding.
The dispositive issue in this matter is whether a trade name used in a security agreement and financing statement strictly limits the scope of attachment of a creditor's interest to inventory of the business operated under that trade name. This issue arises from the assertions of Transamerica, which claims a purchase money security interest in inventory of Harlen O. Elliott d/b/a Midwest Marine, that FNB's security interest failed to attach to Midwest Marines's inventory because FNB's underlying security agreement and financing statement name only Harlen O. Elliott d/b/a Midwest Distributing Company as the debtor. If FNB's security interest properly attached and was perfected as to Midwest Marine, then FNB will prevail over Transamerica under the first to file rule of K.S.A. 1992 Supp. 84-9-312(5).
Mr. Elliott sells boat and marine accessories through a sole proprietorship comprised of a wholesale operation and a retail operation.(1) The trade name of the wholesale operation is Midwest Distributing Company (Midwest Distributing). The trade name of the retail operation is Midwest Marine. The operations are run out of separate locations in Leavenworth, Kansas. FNB and Transamerica financed the operations, taking security interests in, among other things, inventory.
FNB was the first to file a financing statement, which occurred on July 1, 1988. This financing statement named Harlen O. Elliott d/b/a Midwest Distributing as the debtor and covered "[a]ll Shorelander boat trailers now owned or hereafter acquired for the purpose of wholesale financing" (emphasis added). On December 30, 1988, FNB and Harlen O. Elliott d/b/a Midwest Distributing entered into a promissory note and security agreement which covered inventory, accounts, equipment, general intangibles, and additional property, including "all Shorelander boat trailers now owned and hereafter acquired." The security agreement was signed by Mr. Elliott, d/b/a Midwest Distributing. FNB subsequently filed another financing statement on January 5, 1989, which named Harlen O. Elliott d/b/a Midwest Distributing as debtor. There is no description of collateral on the front page of this financing statement, but attached pages describe the collateral which includes "All inventory of the borrower whether now owned or hereafter acquired and wherever located."
Later, Transamerica also provided Mr. Elliott with financing. On January 19, 1991, it executed a security agreement with Harlen O. Elliott d/b/a Midwest Marine with the intention of taking a purchase money security interest in "[a]ll inventory of goods of whatever description held for sale or lease by the Debtor, now or hereafter owned, . . . wherever located . . . ." Transamerica's financing statement covered "[a]ll inventory of goods . . . held for sale or lease by the Debtor, . . . now or hereafter acquired, . . . wherever located . . ." and was filed May 9, 1990. In order to perfect its purchase money interest pursuant to K.S.A. 1992 Supp. 84-9-312(3), Transamerica sent notice to prior creditors of Harlen Elliott d/b/a Midwest Marine on or about May 20, 1991. The notice listed Midwest Marine as the debtor,(2) and indicated Transamerica's intent to acquire a purchase money interest in inventory. The notice, however, was not sent to FNB.
Transamerica did not send FNB notice of its intent to acquire an interest in the Midwest Marine inventory because Transamerica assumed FNB was not a Midwest Marine creditor. Transamerica obtained a UCC search report from the Kansas Secretary of State which listed FNB as a creditor of Harlen O. Elliott d/b/a Midwest Distributing. However, the clerk who gave a copy of FNB's January 5, 1989, financing statement to Transamerica failed to provide the pages describing the collateral that FNB had filed with it. Consequently, Transamerica was in possession of a copy of an FNB financing statement that lacked any description of collateral. From this information, Transamerica concluded that FNB was a creditor of Midwest Distributing, not Midwest Marine, and that it was not required to notify FNB of its intent to acquire a purchase money interest in Midwest Marine inventory.
Mr. Elliott's operations began to founder, and on May 7, 1992, the Elliotts sought relief under Chapter 11 of the Bankruptcy Code. Pursuant to this Court's October 28, 1992, order determining most of the priorities in the bankruptcy proceeding, FNB and Transamerica, being among the creditors whose interests could not be prioritized, were allowed to go forward with their claims to determine their priorities with respect to Mr. Elliott's inventory. Transamerica claims FNB's interest never attached to, and thus was not perfected in, Midwest Marine inventory. FNB asserts that its interest in Midwest Marine inventory attached pursuant to its December 30, 1988, security agreement, that its interest was perfected by its January 5, 1989, financing statement, and that Transamerica's failure to give notice to FNB renders Transamerica's purchase money interest inferior to FNB's interest.
Transamerica claims FNB's security agreement and financing statements are inadequate for a number of reasons. First, FNB's security agreement and financing statements name the debtor with reference to Midwest Distributing, the wholesale operation, rather than Midwest Marine, the retail operation. This, Transamerica reasons, establishes that the parties intended that only Midwest Distributing's collateral would be encumbered. Second, FNB filed a later financing statement naming Midwest Marine, which further indicates its prior intent was to take interests only in collateral owned by Mr. Elliott d/b/a Midwest Distributing. Third, the separation of the sole proprietorship into wholesale and retail operations precluded FNB from taking an interest in Midwest Marine inventory without expressly identifying Midwest Marine. Fourth, FNB's January 5, 1989, financing statement is seriously misleading because it contains no description of inventory on its first page and identifies only Midwest Distributing. This caused Transamerica to forgo giving FNB notice.
FNB counters that trade names are irrelevant in determining the extent of secured
interests. Further, its financing statement cannot be misleading simply because it did not
contain a description of collateral on its first page. It argues that the Kansas Uniform
Commercial Code does not require that descriptions be on the first page of a financing
DISCUSSION AND CONCLUSIONS
A security interest is not enforceable against the debtor or third parties unless it attaches. K.S.A. 1992 Supp. 84-9-203(1). When security agreements are used, attachment occurs as of the date of the agreement if it contains a description of the collateral, is signed by the debtor, value has been given, and the debtor has rights in the collateral. 84-9-203(1) and (2). In this matter, Transamerica questions whether the security interest granted in the security agreement between FNB and Harlen O. Elliott d/b/a Midwest Distributing, dated December 30, 1988, attached to inventory owned by Harlen O. Elliott d/b/a Midwest Marine. The resolution to this issue requires an analysis of who the debtor is and what collateral is described in that agreement.
For purposes of the Kansas UCC, "debtor" is defined as "the person who owes payment or other performance of the obligation secured . . . ." K.S.A. 1992 Supp. 84-9-105(d). A "person" can be "an individual or an organization." 84-1-201(30). However, no new entities were created by Mr. Elliott's use of two trade names. A person who individually owns all of and operates two or more unincorporated businesses, no matter how independently maintained, legally owns and operates a single sole proprietorship. If FNB had sued Mr. Elliott and obtained a judgment against him, even with no security interest in any of his property, it could have executed on any nonexempt property he owned to satisfy its judgment. See K.S.A. 1992 Supp. 60-2401(a). Mr. Elliott, therefore, is the debtor, not Midwest Marine or Midwest Distributing. Individual debtors who run sole proprietorships may contract using trade names, but this does not change the debtor's nature or his responsibilities. Unless FNB agreed to exclude some of Mr. Elliott's property from the assets it could attach to satisfy its claim against him, the separation of his assets into two businesses could have no affect on FNB's ability to reach the assets of both.
Further, when a creditor is giving notice to third parties about its arrangements with an individual debtor by filing a financing statement, a trade name does not adequately identify the debtor if it is not similar to his or her name. Kansas law is clear with regard to financing statements that a debtor's name is sufficiently shown if the statement shows "the individual, partnership or corporate name of the debtor, whether or not it adds other trade names . . . ." K.S.A. 1992 Supp. 84-9-402(7). The Tenth Circuit agrees. "[Section 84-9-402(7)] undertakes to deal with some of the problems as to who is the debtor. In the case of individuals, it contemplates filing only in the individual name, not in the trade name." Pearson v. Salina Coffee House, Inc., 831 F.2d 1531, 1533 (10th Cir. 1987); See also K.S.A. 84-9-402, Kansas Comment 1983, Subsection (7) ("Adding the trade name [to a financing statement] is neither necessary nor sufficient for perfection.")
How does this impact FNB's security agreement? It indicates that Mr. Elliott, not his wholesale or retail operation, is the debtor under it. Transamerica, however, contends that the use of the Midwest Distributing trade name indicates the intent to limit the security agreement to cover only the inventory Mr. Elliott used in the wholesale operation. This Court cannot agree. Since Mr. Elliott, not his retail or wholesale operation, is the debtor, all inventory he owned in both operations is subject to the security agreement unless the description of collateral limits the extent of FNB's security interest. Therefore, if the description of the collateral in the December 30, 1988, security agreement limits the security interest to inventory used in the wholesale operation, then the intent to exclude Midwest Marine collateral will be established. See Farmers State Bank v. Haflich, 10 Kan. App. 2d 333, 338, 699 P.2d 553 (1985) ("A security interest which does not list items as secured collateral does not give a creditor a secured status with respect to them."); see also, In re Metzler, 405 F. Supp. 622 (N.D. Ala. 1975) (security interest was limited by specific language in security agreement's collateral description to a part of a sole proprietorship run under certain trade name).
In the December 30, 1988, security agreement, the description states in part:
Inventory: All inventory wherever it is located which I now own or may own in the future, which I will sell or lease, or which has been or will be supplied under contracts of service, or which are raw materials, work in process, or materials used or consumed in my business.
This description follows the definition of inventory provided for in K.S.A. 84-9-109(4). "I" is defined in the security agreement to include each borrower, jointly and severally. As discussed above, the borrower is Mr. Elliott, not the wholesale or retail operation. His business being the sale of boats and marine accessories at the wholesale and retail level, "inventory" includes all of the inventory in the business, i.e., both Midwest Marine and Midwest Distributing inventory.
Transamerica argues that In re Metzler, supra, a case similar, though not directly on point to this matter, should control and limit FNB's security interest to include only Midwest Distributing inventory. Metzler involved a debtor, Robert A. Metzler, who ran a sole proprietorship separated into a wholesale furniture manufacturing business and a retail furniture outlet. Like Mr. Elliott, Metzler kept separate books for each operation and ran each out of separate locations. He also gave security interests under the different trade names of the two operations. When Metzler declared bankruptcy, a creditor who had taken a security interest in inventory used in his wholesale operation claimed an interest in inventory used in the retail operation. The district court affirmed the bankruptcy court's finding that the security agreement did not attach to the retail inventory. 405 F. Supp. at 625.
Although the situation in Metzler is similar to this matter, there are important differences. Searching the record for evidence to support the lower court's finding, the court quoted Metzler's testimony that he did not intend to give an interest in the retail operation and that he had shown the creditor his separate retail operation to demonstrate his ability to pay, but not to secure the debt. The Court has no such testimony from Mr. Elliott and believes the mere addition of a trade name to the debtor's name in a security agreement is not sufficient to limit the security interest to property that he holds under that name and exclude property he holds under another name. The law simply does not allow a lone individual to group his property under separate names that may be known only to him and thus limit the reach of his agreements with creditors unless they clearly agreed to accept his attempted division. While this court agrees with the Metzler court that a sole proprietor may give separate security interests as he pleases and his creditors accept, id. at 625, the December 30, 1988, security agreement does not include any wording that would indicate this was intended, and it is not ambiguous in its description. Therefore, in matters involving sole proprietorships run under more than one trade name, the scope of attachment may be limited with regard to collateral of a particular operation with a particular trade name only if such limitation is clearly stated in the agreement. Ruling otherwise would allow debtors to hide assets under various trade names in order to avoid the valid interests of creditors who have not agreed to have their rights restricted by the trade names.
Transamerica also contends that FNB's use of both trade names in a later security agreement and financing statement establishes by course of performance that the parties intended in the December 30, 1988, security agreement to create interests only in collateral owned by Mr. Elliott for Midwest Distributing. The Court does not agree. The later documents might just as easily mean Mr. Elliott disclosed his other trade name after the earlier financing was completed. Even if FNB knew of the other trade name from the beginning, it could have relied on the fact a sole proprietor cannot make his businesses legally separate without incorporating one or both to assure it the inventory of both businesses was covered by the security interest it received. The single trade name might have been included simply for Mr. Elliott's personal bookkeeping purposes.
Transamerica further argues that FNB's January 5, 1989, financing statement is seriously misleading because it contains no description of inventory on its first page and it identifies only Mr. Elliott's Midwest Distributing trade name. These shortcomings, Transamerica asserts, caused it to forgo giving FNB the notice required by K.S.A. 1992 Supp. 84-9-312(3). FNB claims that the additional pages it included in its filing contain the description and satisfy the formal requirements in the UCC for financing statements.
The rules governing financing statements are found in K.S.A. 1992 Supp. 84-9-402. Financing statements "may be in a form prescribed by the secretary of state . . . and shall contain a statement indicating the types, or describing the items, of collateral." 84-9-402(1). The UCC does not require that a person use the form provided by the secretary of state, place the collateral description at a particular spot on the financing statement, or limit the statement to a certain number of pages. Thus, a document that contains the information required by 84-9-402 may qualify as a financing statement in order to perfect a security interest regardless of the placement of the description.
A creditor completes filing simply by the "[p]resentation for filing of a financing statement and tender of the filing fee to the filing officer." K.S.A. 1992 Supp. 84-9-403(1). The secured party has no duty to prospective creditors willing to finance the debtor, and "does not bear the risk that the filing officer will not properly perform his duties" of filing the statement or searching the records for third parties. In re Air Vermont, 40 B.R. 323, 334 (Bankr. D. Vt. 1984); In re Flagstaff Foodservice Corp., 16 B.R. 132, 135 (Bankr. S.D.N.Y. 1981). The main function of the financing statement is to provide notice to third parties, who have the burden of learning from the secured creditor the extent of his interest:
[A filed financing statement] indicates merely that the secured party may have a security interest in the collateral described. The burden is placed upon other persons to make further inquiry from the parties concerned in order to obtain a disclosure of the complete state of affairs. The code philosophy is that a simple, filed notice that the secured party and debtor may be financing with respect to collateral described in the financing statement should be a 'red flag' warning to third parties not to proceed with any financing on the same collateral of the debtor until investigation is made to see that the road ahead has been cleared.
Allis-Chalmers Credit Corp. v. Cheney Inv., Inc., 227 Kan. 4, 8, 605 P.2d 525, (1980).
The foregoing rules placed the responsibility on Transamerica to contact FNB to ascertain the extent of its interest in Mr. Elliott's property. Transamerica's claim that FNB mislead it is incorrect. FNB is not responsible for the filing officer's failure to produce the sheets describing the collateral that FNB had filed with its January 5, 1989, financing statement. In re Air Vermont, supra. Transamerica could have sought more information from either the secretary of state or FNB. A reasonable prospective creditor should have questioned the filing of a financing statement with no collateral description and should have inquired further.
FNB's security interest extends to all inventory owned by Mr. Elliott in his wholesale and retail operations, and its interest was properly perfected by the filing of the January 5, 1989, financing statement. Consequently, Transamerica's purchase money security interest is subordinate to FNB's interest because Transamerica failed to notify FNB pursuant to K.S.A. 1992 Supp.
84-9-312(3). FNB, the first of these creditors to file, holds the superior interest. K.S.A. 1992 Supp. 84-9-312(5)(a).
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.
Dated at Topeka, Kansas, this ____ day of February, 1994.
THE HONORABLE JAMES A. PUSATERI
CHIEF BANKRUPTCY JUDGE
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS
IN RE: )
HARLEN O. ELLIOTT, and ) CASE NO. 92-40891-11
THERESA M. ELLIOTT, ) CHAPTER 11
ITT COMMERCIAL FINANCE CORP. )
vs. ) ADVERSARY NO. 92-7102
TRANSAMERICA COMMERCIAL )
FINANCE CORPORATION, et al., )
JUDGMENT ON DECISION
This adversary proceeding was before the Court to prioritize the security interests of First National Bank and Trust Company of Leavenworth (FNB) and Transamerica Commercial Finance Corporation (Transamerica) in inventory of Harlen O. and Theresa M. Elliott, Debtors in the related bankruptcy proceeding. FNB appeared by John F. Thompson of Davis, Beall, McGuire & Thompson of Leavenworth, Kansas. Transamerica appeared by Joel Pelofsky of Shugart, Thompson & Kilroy of Kansas City, Missouri. Debtors did not appear in this proceeding.
The Court considered the pleadings, materials, and arguments presented by the parties and has issued a Memorandum of Decision. For the reasons stated therein, judgment is hereby entered establishing that FNB's security interest in the inventory of debtor Harlen O. Elliott's sole proprietorship, operated under the trade names of Midwest Marine and Midwest Distributing Company, has priority over Transamerica's security interest in that inventory.
IT IS SO ORDERED.
Dated at Topeka, Kansas, this _____ day of February, 1994.
JAMES A. PUSATERI
CHIEF BANKRUPTCY JUDGE
1.1Although Mrs. Elliott also signed some of the relevant loan documents, the parties agree Mr. Elliott ran both businesses as a sole proprietor. Because it will therefore have no effect on this decision, the Court will make no further mention of Mrs. Elliott's participation in the financing arrangements.
2.2Because the Court finds that FNB's interest is superior to Transamerica's interest on other grounds, the Court does not address the issue of whether Transamerica's notice was adequate under K.S.A. 1992 Supp. 9-312(3) because it stated the trade name (Midwest Marine), rather than the debtor's name (Harlen O. Elliott) as required by this section.