GEORGE BRODY, Bankruptcy Judge.
This action involves the relative rights of competing secured creditors to the proceeds of sale of two tractors.
Benton Trucking Service, Inc. (debtor) was in the business of hauling freight. On or about August 16, 1979, the debtor purchased two Kenworth tractors from the Whiteford Sales and Service. The price of each tractor was in excess of $60,000. The debtor made a down payment of $10,000 on each tractor and financed the balance of the purchase price pursuant to retail installment contracts. The contracts provided in pertinent part that
In January of 1980, debtor sold the tractors to a Louis Eicholtz (Eicholtz) and delivered to him the title certificates properly endorsed and containing notarized termination statements ostensibly executed by Paccar certifying that Paccar no longer claimed an interest in the vehicles. Eicholtz financed this transaction by borrowing approximately $70,000 from the defendant Monroe Bank & Trust Company (Bank), using the tractors as collateral. New certificates of title were issued by the State of Michigan showing Eicholtz as owner and the Bank as lienor. The debtor then leased the vehicles from Eicholtz. The debtor defaulted on the required contract payments to Paccar, and Paccar repossessed the tractors in early 1980 and promptly scheduled a foreclosure sale. Prior to the scheduled sale, the debtor filed a voluntary Chapter 11 proceeding, which was subsequently converted to Chapter 7. Upon being informed of the Bank's claim of interest in the tractors, Paccar instituted an action against the debtor, the Bank and Eicholtz to obtain relief from the automatic stay in order to enable it to sell the tractors it had repossessed and to apply the proceeds against its debt of $129,989. The tractors were sold with the consent of all parties for $72,000, and the proceeds are being held pending the outcome of this litigation.
The trustee concedes that he has no interest in the fund. Eicholtz has disclaimed any interest in the trucks and has been dismissed from this action. The Bank filed an answer contending that it had a security interest in the tractors that was paramount to the interest of Paccar. The Bank's contention that its security interest in the tractors is paramount is based upon the following arguments.
Initially, the Bank contends that, by virtue of the termination statement, Paccar released any lien it may have had with respect to the tractors. However, the testimony establishes that there was in fact no release executed by Paccar. The principal stockholder and chief operating officer of the debtor disappeared after the bankruptcy filing and did not testify at the trial. The Notary who notarized the termination statement was called as a witness, but invoked the Fifth Amendment privilege. The termination statement was purportedly executed by a "Robert J. Horbo —".
Additionally, the Bank claims that Paccar was at fault in that Paccar failed to run an adequate credit check, failed to take prompt action upon default of the debtor and should have retained the certificates of title to the vehicles until the loan was repaid. The failure by Paccar to do so made it possible for the debtor to defraud the Bank and, therefore, the loss should fall on the
There has been no showing, however, that Paccar's conduct was careless or culpable, or that a finance company is required to run a credit check of a debtor as a condition of financing a given transaction. A credit check is made by a lending agency solely for its protection. The purpose of a credit check is not to protect third parties. The credit check that Paccar made was sufficient in its opinion to justify financing the debtor's purchase of the tractors. Paccar was required to do no more.
The debtor was in default on the note to Paccar on and off from September, 1979, to the time the tractors were repossessed. The debtor ostensibly refused to make payments on the grounds that the trucks were not mechanically sound. Paccar apparently was satisfied with this explanation. The procedures to be employed to collect a debt in default is a matter of individual business judgment. The fact that Paccar did not take immediate steps to repossess the trailers is not a ground for estoppel.
In support of its contention that Paccar should have retained the certificates of title until the loan was repaid, the Bank relies upon Muir v. Jefferson Credit Corp., 108 N.J.Super. 586, 262 A.2d 33 (1970) and General Motors Acceptance Corp. v. Hill, 95 Ariz. 347, 390 P.2d 843 (1964). On facts similar to the facts of this controversy, the courts in Muir and Hill held that by permitting the purchaser of a vehicle to retain the original certificate of title, the secured creditor "created a risk that the original certificate in the hands of a purchaser might be fraudulently negotiated and that innocent persons might rely thereon to their detriment," and, therefore, the secured creditor was estopped from relying on its security interest. Muir, supra, 262 A.2d at p. 39. However, this conclusion was based upon the fact that the Motor Vehicle Acts in Muir and Hill specifically provided that where a vehicle was sold subject to a lien, the original certificate of ownership was to be retained by the lienholder until the entire amount of the lien was fully paid.
Finally, the Bank contends that the sale by debtor to Eicholtz, even though fraudulent, deprived Paccar of its security interest in the tractors. This contention is based on
Section 9-307(1) provides that a buyer in the ordinary course of business "takes free of a security interest created by the seller even though the security interest is perfected and even though the buyer knows of its existence." A buyer in the ordinary course of business is "a person who in good faith and without knowledge that the sale to him is in violation of the ownership rights or security interest of a third party in the goods of that kind." § 1-201(9).
To prevail, the Bank, therefore, must establish that Eicholtz was a buyer in the ordinary course of business, and that the debtor was engaged in the business of selling trucks and trailers. It is conceded that Eicholtz purchased the tractors, if in fact he did purchase them, in good faith and without knowledge that the sale was in violation of any rights that Paccar had in the collateral.
The nature of the collateral, whether equipment or inventory, is to be determined by the use intended at the time the security agreement is executed. See, e.g., In re Barnes, 11 U.C.C.Rep.Serv. 670 (D.Me.B.J. 1972); In re Morton, 9 U.C.C.Rep.Serv. 1147 (D.Me.B.J.1971); White and Summers, Uniform Commercial Code § 23-13 (2d ed. 1980). In the instant case, however, it is immaterial whether the test to be applied is intended or actual use, since the debtor at all times held all vehicles as equipment and not as inventory. Whiteford and Paccar reasonably believed that the debtor was purchasing the tractors as equipment and not as inventory for sale. The contracts of sale specifically support this belief by providing that the "buyer promises not to part with possession of, sell or lease the collateral without seller's written approval." The debtor's principal business purpose was to haul freight and not to sell trucks and trailers. Whatever sales were made were merely incidental to that purpose. "A sale incidental to the principal business does not make the seller a person in the business of selling goods of that kind." O'Neill v. Barnett Bank, 24 U.C.C.Rep.Serv. 779, 781, 360 So.2d 150 (Fla.App.1978); Hempstead Bank v. Andy's Car Rental System, Inc., 35 A.D.2d 35, 312 N.Y.S.2d 317 (1970). Equipment is not converted into inventory "even though it is the continuing policy of the enterprise to sell machinery when it becomes obsolete." See Uniform Commercial Code § 9-109, Official Comment 3. The periodic sale of obsolete equipment to enable the debtor to purchase newer and more
The authorities relied upon by the Bank are clearly distinguishable. In American Nat'l Bank v. MAR-K-Z Motors and Leasing Co., Inc., 13 U.C.C.Rep.Serv. 142, 208 N.E.2d 209 (Ill.App.1973), the corporation had a long history of car sales and the articles of incorporation stated that the sales of automobiles was one of the corporate purposes. The corporation depended on sales as well as leasing to generate profits for the business.
In McFadden v. Mercantile-Safe Deposit & Trust Co., 260 Md. 601, 273 A.2d 198 (Md.App.1971), the sellers sold ice cream trucks as part of a franchising plan. Purchasers would then buy ice cream supplies from the seller which they then sold to the public from the trucks. The seller did not use any of the trucks personally. The financing statement filed by the secured creditor identified the trucks as inventory, and the creditor knew that the trucks were for sale to independent operators. In addition, the secured creditor supplied the seller with forms to facilitate the sale of the trucks.
In Kaw Valley St. Bank v. Stanley, 514 S.W.2d 42 (Mo.App.1974), Pioneer Finance v. Dart Nat'l Bank, 365 Mich. 455, 113 N.W.2d 775 (1962), and Daas v. Contract Purchase Corp., 318 Mich. 348, 28 N.W.2d 226 (1947), the secured creditors had actual or constructive notice of the fact that holders of the collateral were retail dealers in the collateral subject to the security interest.
An appropriate order to be submitted.
The Pennsylvania Motor Vehicle Act involved in Hill provided that the certificate of title must be delivered to the lienholder and it shall "be retained by such person until the entire amount of such lien or encumbrance is fully paid by the owner of said motor vehicle, trailer, or semi-trailer." Pa.Stat.Ann. tit. 75 § 33(B) (Purdon).