601 N.E.2d 678

BANK ONE, LIMA, N.A. v. DUFF WAREHOUSES, INC. et al.

No. CV90 12 0850.Court of Common Pleas, Allen County.
Decided May 22, 1992.

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[EDITORS’ NOTE: THIS PAGE CONTAINS HEADNOTES. HEADNOTES ARE NOT AN OFFICIAL PRODUCT OF THE COURT, THEREFORE THEY ARE NOT DISPLAYED.]

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Blair Cornwell and Anthony L. Geiger, for plaintiff.

Hunt, Moritz Johnson and Jerry M. Johnson, for defendants.

RICHARD K. WARREN, Judge.

Defendant, Larc-Star, was in the business of selling computers to consumers and commercial businesses. In order to finance the venture, Larc-Star contacted plaintiff, Bank One, Lima, N.A. On December 13, 1988, plaintiff and defendant executed two promissory notes, one for $107,000 and the second for $25,000. Plaintiff took security in Larc-Star’s inventory, equipment and accounts receivable, as well as a second mortgage on a residence belonging to parties not involved in this suit. Plaintiff properly perfected its security interest on December 27, 1988. This proved to be the only credit plaintiff would extend to Larc-Star.

Approximately six months later, in June 1989, Larc-Star faced serious financial problems. Plaintiff refused to grant any new financing. Larc-Star thereupon approached defendants Kennato Enterprises, Inc., Duff Warehouses, Inc. and Allendale Leasing Co. (hereinafter collectively referred to as “Duff”), seeking financial assistance. Duff agreed to loan Larc-Star $26,000 in exchange for which Larc-Star executed promissory notes, security agreements and financing statements in all of its goods, equipment, inventory, accounts, etc.

Three months later, in August 1989, Larc-Star approached plaintiff for new financing, but was refused, whereupon, Larc-Star sought additional loans from Duff. Duff agreed to make the loans, once again in exchange for Larc-Star’s execution of promissory notes, security agreements, and financing statements in accounts receivable that Larc-Star had generated through sales. Because Larc-Star was on a “cash only” basis with its suppliers, Duff and Larc-Star created the following arrangement: Larc-Star would secure orders for merchandise. Duff would then fund the purchase for Larc-Star’s orders, taking a security interest in the accounts receivable. Larc-Star would deliver to its customer and redistribute the customer’s payment to Duff. Duff perfected each of fourteen separate security interests pursuant to this agreement and R.C. 1309.23. While plaintiff and Duff agree that plaintiff was aware of Duff’s involvement in Larc-Star’s affairs, the extent of that awareness is in dispute.

This arrangement between Larc-Star and Duff continued for approximately seven months, whereupon in March 1992, Larc-Star owed Duff $172,675. Larc-Star was to repay Duff from the accounts receivable which Duff held as security. However, Larc-Star purportedly strayed from its agreement with

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Duff, and diverted the monies from the secured sale to other Larc-Star obligations (which may have included repayment to plaintiff on the December 1988 loan). Pursuant to a voluntary transfer to assigned creditor agreement, Duff repossessed all of Larc-Star’s equipment, inventory, accounts receivable, and franchise. Due to the dispute over which party has priority in the conflicting security interests, particularly in the accounts receivable, plaintiff brought suit against Duff et al., seeking recovery of $89,450.94.

The court sympathizes with Duff and its contention that without its intervention, Larc-Star would certainly have suffered irreparable financial setbacks to plaintiff’s detriment. Although its argument is credible, the relevant statutes, supplemented by their official comments, are clear on their face. Consequently, the court has no alternative but to apply the law accordingly.

Plaintiff’s contract with Larc-Star contains a valid “after-acquired” clause pursuant to R.C. 1309.15(A). Official Comment No. 2 to R.C. 1309.15 states that R.C. Chapter 1309 continues to accept the principle of a continuing general lien. Furthermore, Official Comment No. 1 to R.C. 1309.15 states in part:

“* * * The security interest in after-acquired property is not merely an `equitable’ interest; no further action by the secured party — such as the taking of a supplemental agreement covering the new collateral — is required.”

Both plaintiff and Duff agree that R.C. 1309.05(B) is the relevant code section as to the primary issue: whether Duff had a valid purchase money security interest in its dealings with Larc-Star. R.C. 1309.05(B) states in pertinent part:

“A security interest is a `purchase money security interest’ to the extent that it is:

“* * *

“(B) taken by a person who by making advances or incurring an obligation gives value to enable the debtor to acquire rights in or the use of collateral if such value is in fact so used.”

Plaintiff and Duff stipulate Duff has a security interest in Larc-Star’s accounts receivable. However, Duff contends its interest in the accounts receivable is a purchase money security interest, which, if true, might give Duff priority over plaintiff’s after-acquired security interest. As Official Comment No. 2 to R.C. 1309.05 states:

“When a purchase money interest is claimed by a secured party who is not a seller, he must of course have given present consideration. * * * [T]herefore

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* * * the purchase money party must be [the] one who gives value `by making advances * * *.'”

Based upon the foregoing facts, Duff satisfies R.C. 1309.05(B) and its consideration requirement. “* * * Value is given when a secured party [Duff] acquires rights `* * * in return for a binding commitment to extend credit * * *.'” Se United States v. Cahall Bros. (C.A.6, 1982), 674 F.2d 578, 581. In order for Duff to acquire rights in the proceeds of Larc-Star’s sales, it had to finance the purchase of the merchandise in question. Hence, Duff has a purchase money security interest in Larc-Star’s accounts receivable.

Now that Duff has proven a purchase money security interest in Larc-Star’s accounts receivable, the remaining issue is whether Duff has priority over plaintiff’s after-acquired security interest in the same collateral. The resolution of this issue requires deciding whether a purchase money security interest in accounts receivable falls within R.C. 1309.31(C), 1309.31(D) or 1309.31(E).

If accounts receivable could be construed as inventory, then R.C. 1309.31(C) would apply. The Revised Code defines “inventory” in R.C. 1309.07(D):

“Goods are:

“* * *

“(D) `inventory’ if they are held by a person who holds them for sale or lease or to be furnished under contracts of service or if he has so furnished them, or if they are raw materials, work in process, or materials used or consumed in a business. * * *”

From this definition, accounts receivable clearly do not constitute inventory. Moreover, Duff’s security is not in computer equipment as inventory, as plaintiff contends, but rather the price at which the computer equipment was already sold to Larc-Star’s customer. Furthermore, Duff contends and the parties stipulate that Duff’s purchase money security interest is in accounts receivable, not inventory. Therefore, accounts receivable are not inventory and R.C. 1309.31(C) is not dispositive of the issue.

Assuming, arguendo, accounts receivable did fall within R.C. 1309.31(C), Duff failed to provide plaintiff with written notice, as expressly required in R.C. 1309.31(C)(2). Consequently, Duff would still lack priority in its purchase money interest in the accounts receivable.

Arguably, accounts receivable used as security for Duff’s loans could be considered “collateral other than inventory,” under R.C. 1309.31(D). According to the second to last paragraph of Official Comment No. 3 to R.C. 1309.31, Duff would have priority under section (D) if accounts receivable are collateral

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other than inventory, and Duff had no ordinary expectation that the goods would be sold. However, Duff had every expectation that the goods would be sold, since Duff would only purchase merchandise for which Larc-Star had a firm order. Instead, the last sentence of the same paragraph states:

“The conflicting rights to proceeds consisting of accounts are governed by R.C. [1903.31] (E).”

By this, R.C. 1309.31(D) is likewise not dispositive of the priority issue.

Turning to R.C. 1309.31(E), the court concludes that plaintiff has retained priority. R.C. 1309.31(E) states in pertinent part:

“In * * * cases of purchase money security interests which do not qualify for the special priorities set forth in divisions (C) and (D) of this section, priority between conflicting security interests in the same collateral shall be determined * * *:

“(1) * * * [A]ccording to priority in time of filing or perfection. * * *”

R.C. 1309.31(E) is supplemented by R.C. 1309.31(F), which adds that:

“* * * [A] date of filing a perfection as to collateral is also a date of filing or perfection as to proceeds.”

Both parties have stipulated that plaintiff perfected its security interest before Duff perfected its own. Consequently, by virtue of perfecting first, pursuant to R.C. 1309.31(E) and 1309.31(F), the court finds that plaintiff has priority on the conflicting security interest over Duff. See Official Comment No. 8 to R.C. 1309.31, Example Nos. 6 and 7.

Parties are requested to file supplemental briefs on the issue of plaintiff’s damages within two weeks of this order.

Judgment accordingly.

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