Legal Notes

Secured Lender, The, Sep/Oct 2005 by Helfat, Jonathan N, Kohn, Richard M

Gen. Elec. Capital Corp. v. Union Planters Bank, 409 F.3d 1049 (8th Cir. 2005) (Bank providing revolving line of credit not liable for conversion when line is repaid from proceeds of equipment lender's collateral received in ordinary course of business.)

General Electric Capital Corp. v. Union Planters Bank continues a series of cases grappling with the competing interests of an equipment lender and a lender providing a revolving line of credit, when the revolving line of credit is repaid from funds on deposit in bank accounts of the borrower that include proceeds of the equipment lender's collateral.

The two leading cases on this issue prior to this Eighth Circuit decision - both decided under the prior version of Article 9 and both cited in the Eighth Circuit decision - are Orix Credit Alliance, Inc. v. Sovran Bank, 4 F.3d 1262 (4th Cir. 1993) and Barber-Greene Co. v. National City Bank, 816 F.2d 1267 (8th Cir. 1987).

In Orix, the Fourth Circuit, looking principally to Section 9-306 of the former version of Article 9 which was then in effect, concluded that the routine ordinary course transfer of funds from the bank account of the borrower to pay down its credit facility with Sovran meant that Sovran was not liable to Orix when the proceeds of Orix's equipment collateral were remitted to Sovran. The comments to Section 9-306 that provided the basis for the court's decision stated: "Where cash proceeds are covered into the debtor's checking account and paid out in the operation of the debtor's business, recipients of the funds of course take free of any claim which the secured party may have in them as proceeds. What has been said relates to payments and transfers in ordinary course." The rationale is simply that it is not practical to require that anyone who receives a payment must investigate whether the source of the funds used for such payment came from the proceeds of a secured lender's collateral.

By contrast, in the Barber-Greene decision, the Eighth Circuit concluded that the revolving-credit lender was liable, based on the fact that the transfers of funds to it were not "in ordinary course," but were only done sporadically and randomly.

Section 9-306 of former Article 9 has been replaced with Section 9-332 of Revised Article 9, which adopts a similar concept. Section 9-332 ends a security interest in funds on deposit in a bank account upon the transfer of the funds from the account "unless the transferee acts in collusion with the debtor in violating the rights of the secured party."

In General Electric Capital Corp. v. Union Planters Bank, the equipment lender was GECC and the revolving credit lender was Union Planters. The debtor, Machinery, Inc., was in the business of renting, selling and servicing aerial manlift equipment. Machinery financed the purchase of such equipment with various lenders, including GECC, and granted each lender security interests in the inventory it financed. Meanwhile, Machinery had its deposit accounts at Union Planters and funds in the deposit accounts were swept regularly and automatically from the deposit accounts to pay down advances made by Union Planters to Machinery to cover Machinery's checks when there were periodic shortfalls in the balances in Machinery's operating accounts at Union Planters.

Here, as in Om, the financier of specific assets (in this case GECC) and the general working capital lender (in this case Union Planters) had entered into an intercreditor agreement. In the intercreditor agreement, Union Planters subordinated its security interest in the inventory financed by GECC, including all cash, rents and non-cash proceeds arising from such inventory.

As in the prior cases, proceeds of the equipment lender's collateral (in this case, rental payments from customers of Machinery on the GECC-financed inventory) were deposited in Machinery's deposit accounts at Union Planters. As noted above, such funds were regularly and automatically moved from Machinery's deposit accounts to pay down Union Planters.

Following the reasoning of the Fourth Circuit in the earlier Orix decision, the Eighth Circuit determined that, as a result of Section 9-332 of Revised Article 9, common law principles of tracing of proceeds were not applicable unless the payee received the funds "out of ordinary course or otherwise in collusion with the debtor." The Court found that a transferee's knowledge of a prior security interest in proceeds does not, by itself, indicate that the transfer of the proceeds occurred outside the ordinary course of the debtor's business. The equipment lender must establish either a lack of good faith or that the payee knew that the payment was in violation of some term in the security agreement not waived by the words or conduct of the secured party.

In this case, there was no evidence that Union Planters knew that the proceeds of GECC-financed inventory had been deposited in the accounts. And even if Union Planters knew that proceeds of GECC-financed inventory had been deposited in the account, that knowledge, according to the Court, was not enough. Given Machinery's apparent ability to deposit the proceeds of the inventory and use the account to pay creditors, Union Planters could not be expected to know that the sweep of the funds in the deposit accounts to it would violate a term in GECC's security agreement that GECC had not waived.