WHITE v. HOUSEHOLD FINANCE CORPORATION

STATON, Judge.

I.

STATEMENT ON THE APPEAL

Charles and Catherine White's nephew, Rickey L. Butzin, was under twenty-one (21) years of age. He wanted to purchase a 1968 Dodge Charger automobile. Charles and Catherine White signed a promissory note and security agreement so that the automobile could be financed. The 1968 Dodge Charger was destroyed in a single car accident. The insurance company paid $1,850.00 for the loss which was applied by Rickey L. Butzin and Household Finance Corporation to a second automobile, a 1969 Plymouth. Rickey L. Butzin defaulted upon his payments and Household Finance Corporation filed a complaint against Charles and Catherine White to recover $2,094.25 plus $10.20 interest due on the promissory note. The trial court heard the evidence and entered judgment for Household Finance Corporation in the sum of $2,094.25. The Whites' motion to correct errors presents this question for our review on appeal:

Our opinion concludes that the endorsement of the insurance check by Household Finance Corporation and the purchase of a second automobile was not a substitution of collateral but constituted an impairment of the collateral. We reverse the judgment of the trial court with instructions.

II.

STATEMENT OF THE FACTS

On October 5, 1970, Household Finance Corporation loaned Rickey L. Butzin $2,484.00 to purchase a 1968 Dodge Charger. The loan agreement was signed by Charles J. White, Catherine L. White and their nephew, Rickey L. Butzin, who was under the age of twenty-one. Also on this date, Charles White and Catherine White signed a security agreement covering the 1968 Dodge Charger. Rickey Butzin took out insurance on the Dodge Charger and had Household Finance Corporation named a beneficiary. This appears not to have been a requirement of Household Finance Corporation. The title to the Dodge Charger was in the names of Charles J. White and Rickey Butzin and showed a lien in favor of Household Finance Corporation.

In November, 1970, the Charger was destroyed in a single car accident. The insurance company paid Rickey Butzin and Household Finance Corporation $1,850.00. Charles White, Rickey Butzin and Household Finance Corporation released their respective interests on the title to the 1968 Dodge Charger. Upon receiving the insurance check, Rickey Butzin went to Household Finance Corporation to inquire about using the insurance proceeds to purchase a 1969 Plymouth. Without executing a new promissory note or security agreement, Household Finance Corporation endorsed the check payable only to Hendrickson Motor Sales from whom Rickey Butzin then purchased a 1969 Plymouth with the $1850.00 insurance check. The title to the 1969 Plymouth was also in the names of Charles White and Rickey Butzin with Household Finance Corporation listed as a lienholder. Mr. and Mrs. White were not notified by Household Finance Corporation or their nephew, Rickey Butzin, that the insurance check had not been applied to their loan until Rickey Butzin stopped making payments and Household Finance Corporation contacted the Whites about the delinquent note. The Whites refused to make payments contending that the insurance check should have been applied to their indebtedness, and Household Finance Corporation sued the Whites on the promissory note.

III.

STATEMENT OF THE ISSUE

The issue to be decided by this appeal is:

Our opinion concludes that the release of the insurance proceeds was not a substitution of collateral but an impairment of collateral. We reverse.

IV.

STATEMENT ON THE LAW

The Whites contend that they are accommodation makers on the note which was also signed by their nephew, Rickey L. Butzin. They further contend that the release of the insurance proceeds to Hendrickson Motor Sales released them on the promissory note pro tanto.

We agree with the Whites' contention that they are accommodation makers under I.C. 1971; 26-1-3-415; Ind. Stat. Ann. § 19-3-415 (Burns 1964):

It is clear from the record that the Whites signed the promissory note only to enable their twenty (20) year old nephew, Rickey Butzin, to buy a car.1 Rickey Butzin testified:

Mr. White testified as follows:

The importance of determining the status of the Whites for the purposes of this appeal has been adequately expressed by J. White and R. Summers, Uniform Commercial Code, 428-429 (1972):

When a creditor releases or negligently fails to protect security put in his possession by the principal debtor, the surety is released to the extent of the value of the security so impaired. Stewart v. Davis (1862), 18 Ind. 74; Sample v. Cochran (1882), 82 Ind. 260; Crim v. Fleming (1885) 101 Ind. 154; Owen County State Bank v. Guard (1940), 217 Ind. 75, 26 N.E.2d 395.3 This right to discharge is also available to any party to a promissory note with a right of recourse4 under I.C. 1971, 26-1-3-606(1)(b); Ind. Stat. Ann. § 19-3-606(1)(b) (Burns 1964) which provides:

Household Finance Corporation contends that the signature of Mr. White on the title to the 1968 Dodge Charger was a consent to release of the insurance proceeds. At common law and under I.C. 1971, 26-1-3-606(1), supra, consent to the release of collateral operates as a waiver of a right to discharge. This consent may be given in advance by a consent to release of collateral provision in the instrument5 or it may be given after the release of collateral.6 However, there was no advance consent to release of collateral provision in the promissory note signed by the Whites and Rickey Butzin. Also, there was no subsequent consent to release of collateral by the Whites. We cannot agree that the signature of Mr. White on the title to the 1968 Charger was an implied release of the insurance proceeds. As accommodation makers, the Whites are entitled to a right of subrogation to any rights in the collateral that the creditor obtains from the principal debtor. This right of subrogation has been described by L. Simpson, Handbook on the Law of Suretyship, 370 (1950) as follows:

This right of subrogation has also been defined by the Supreme Court of Indiana in Peirce v. Higgins (1884), 101 Ind. 178, 180, as follows:

See also Gerber v. Sharp (1880), 72 Ind. 553; Fast v. State ex rel. Bd. of Comm. of the County of Allen (1915), 182 Ind. 606, 107 N.E. 465; and National Mutual Insurance Co. of Washington, D.C. v. Maryland Casualty Co. (1963), 136 Ind.App. 35, 39-40, 187 N.E.2d 575.

The security agreement covering the 1968 Dodge Charger was between the accommodation makers, the Whites, and the creditor, Household Finance Corporation. Charles White's signing of the title to this first automobile did not involve the release of any subrogation rights and did not impliedly release any security Household Finance Corporation might later obtain from the principal debtor, Rickey Butzin. The rationale for this conclusion is discussed below.

IMPAIRMENT OR SUBSTITUTION OF COLLATERAL:

The creditor has a duty to preserve security or collateral in his possession under I.C. 1971, 26-1-3-606, supra, and under the common law.7 The standard of care that a creditor is held to respecting collateral is set out in I.C. 1971, 26-1-9-207(1); Ind. Stat. Ann. § 19-9-207(1) (Burns 1964):

See also First National Bank, Giddings v. Helwig (1971), Tex. App., 464 S.W.2d 953, approving the use of this standard.

Although there are no cases in Indiana discussing impairment of collateral under I.C. 1971, 26-1-3-606(1), supra, the Georgia Court of Appeals in Hunter v. Community Loan & Investment Corp. (1972), 127 Ga.App. 142, 193 S.E.2d 55 has held that a mere substitution of collateral is not an impairment under the Uniform Commercial Code provision 3-606. In that case, the Defendant signed a note with his daughter for the purchase of a 1965 Mustang which was pledged as collateral. The purpose of the loan was to finance an automobile for the daughter. The automobile burned and the insurance company provided the daughter with a 1966 Mustang in substitution. The Georgia Court of Appeals held there was no unjustifiable impairment of the collateral since there was no showing of an increased risk to the unconsenting father by the substitution.

In the present case, however, Household Finance Corporation released insurance proceeds in the amount of $1850.00 so that Rickey Butzin could buy a second automobile. No security agreement was executed, but the title to the second automobile was placed in the names of Charles J. White and Rickey L. Butzin with a first lien shown to Household Finance Corporation. Impairment of collateral under I.C. 1971, 26-1-3-606, supra, is not limited to diminishment of the physical value of the property itself but has been extended to encompass impairment of the security interest in the collateral. Shaffer v. Davidson (1968), Wyo., 445 P.2d 13; First Bank & Trust Co., Palatine v. Post (1973), 10 Ill.App.3d 127, 293 N.E.2d 907.8 Failure to execute a security agreement preserving a security interest in collateral is an impairment rather than being a mere substitution of one type of collateral for another. Household Finance Corporation failed to execute a security agreement on the second automobile. Even though a second security agreement is not executed, there can be no impairment of collateral if the first security agreement is sufficient to cover a second automobile purchase or if the application for certificate of title showing a lien in favor of a creditor is sufficient to create a security interest. We will examine both of these exceptions and their applicability to the facts in the case before us.

Sufficiency of the First Security Agreement to Cover the Second Automobile. Under I.C. 1971, 26-1-9-204(1), Ind. Stat. Ann. § 19-9-204(1) (Burns 1964), a security interest does not attach until the debtor has rights in the collateral. It is arguable that the Whites did not in fact have an interest in the 1968 Dodge Charger to give as collateral since Rickey Butzin was expected by all the parties to make the payments to Household Finance Corporation and the car was purchased solely for the use of Rickey Butzin. However, assuming arguendo that Rickey Butzin intended to give his uncle an interest in the 1968 Dodge Charger by putting his uncle's name on the first title, the security agreement in the case at bar signed by the Whites is not sufficient to cover the second automobile. Although the security agreement signed by the Whites does contain an after-acquired property clause covering after-acquired "household and consumer goods," it does not give Household Finance Corporation a right to a security interest in consumer goods (except accessions) acquired by the Whites ten (10) days after Household Finance Corporation gave value. See I.C. 1971, 26-1-9-204(4)(b); Ind. Stat. Ann. § 19-9-204(4)(b) (Burns 1964). Even if the trial court determined that Mr. White has an after-acquired interest in the second automobile, the October 5, 1970 security agreement is not sufficient to cover this interest acquired over two months after Household Finance Corporation gave value.

The Whites did not agree to carry insurance covering destruction of the 1968 Dodge Charger for the benefit of Household Finance Corporation. Household Finance Corporation's right to the insurance proceeds do not arise under the security agreement but under the insurance contract procured by Rickey Butzin naming them a beneficiary.9

Sufficiency of the Application for Certificate of Title to Create a Security Interest. The question of whether a title application showing a lien in favor of the creditor is sufficient to create a security interest has never been answered in Indiana. Other jurisdictions have held that applications for certificates of title are not sufficient to create such an interest. Shelton v. Erwin (8 Cir., 1973), 472 F.2d 1118; In re E.F. Anderson & Son, Inc. (M.D. Ga. January 10, 1973), 12 U.C.C. 567; First County Nat. Bank & Trust Co. v. Canna (1973), 124 N.J.Super. 154, 305 A.2d 442, In re Reese (E.D.Pa. 1960), 1 U.C.C. 450.10 I.C. 1971, 26-1-9-203(1)(b); Ind. Stat. Ann. § 19-9-203(1)(b) (Burns 1964), specifically requires the following to create an enforceable security agreement:

Although the application for certificate of title is signed by the debtor and contains a description of the collateral, it is not the agreement of the parties but only evidence that there may be an agreement. I.C. 1971, 26-1-9-105(1)(h); Ind. Stat. Ann. § 19-9-105(1)(h) (Burns 1964), defines a security agreement as "... an agreement which creates or provides for a security interest." The Statute of Frauds provision in Article 9 of the Uniform Commercial Code, I.C. 1971, 26-1-9-203; Ind. Stat. Ann. § 19-9-203 (Burns 1964), although reducing formal requisites to a minimum, is stricter in its requirements than the Statute of Frauds provision in Article Two, I.C. 1971, 26-1-2-201(1); Ind. Stat. Ann. § 19-2-201(1) (Burns 1964), which requires:

Permitting an application for certificate of title to be sufficient for the purpose of satisfying Article Nine requirements and creating an enforceable security agreement would be, in effect, to adopt the standard in Article Two's Statute of Fraud provision.11 This result was clearly not intended by the drafters of the Uniform Commercial Code. Comment 5 to § 9-203 of the Uniform Commercial Code states:

The requirement of a signed, written security agreement rather than a mere indication of that agreement is mandated by Article Nine. A security agreement usually does more than create a security interest. It settles the important question of what actions by the debtor constitute a default. It is important that this question be settled by the parties at the outset since default is not defined by the Uniform Commercial Code. As in Shelton v. Erwin, supra, Household Finance Corporation has properly perfected a security interest in the second automobile under I.C. 1971, 26-1-9-302(4); Ind. Stat. Ann. § 19-9-302(4) (Burns 1964). However, no underlaying security agreement exists. The Whites' right to be subrogated to the creditor's interest in the collateral has been impaired to the extent of the collateral released. If the Whites, standing in the place of Household Finance Corporation as subrogee, attempted to assert an interest in the collateral, they could be defeated by a trustee in bankruptcy for debtor's estate, Shelton v. Erwin, In re Reese, In re E.F. Anderson & Son, Inc., supra; by a subsequent judgment lienholder, First County Nat. Bank & Trust Co. v. Canna, supra, or by an administrator of deceased debtor's estate.

There is no evidence that Mr. White was instrumental in acquiring the second title in his name or even that he had knowledge of his name being placed on the title to the 1969 Plymouth until after the release of the collateral. Under these facts, there is no showing of the elements of either a waiver or estoppel that would bar the Whites from claiming their right to discharge. See Cleveland, Cincinnati, Chicago & St. Louis R.R. Co. v. Moore (1907), 170 Ind. 328, 345, 355, 82 N.E.2d 52 and Lafayette Car Wash, Inc. v. Boes (1972), Ind., 282 N.E.2d 837, 839.

The judgment of the trial court should be and the same hereby is reversed with instructions to vacate its judgment dated January 3, 1973 and to enter a judgment consistent with this opinion.

HOFFMAN, C.J., and SHARP, J., concur.