Summary of a Recent
Judicial Development in
Bankruptcy

Bank Has Priority over Supply
Company's Secured Interest

Harrison M. Pittman
Staff Attorney

In an action brought by a secured creditor against an agricultural supply company that allegedly committed a conversion when it removed agricultural chemicals from the debtor's facility, the Kansas Court of Appeals has ruled that the secured creditor had priority over the supplier because it was the first to file a financing statement, and the supplier failed to give proper notice of its purchase money security interest claim in the debtor's inventory. Guaranty State Bank & Trust Co. v. Van Diest Supply Co., 55 P.3d 357, 362-63 (Kan. Ct. App. 2002).

The Barnard Grain Company ("Barnard"), debtor, obtained loans from Guaranty State Bank & Trust Co. ("GSB") and the North Central Regional Planning Commission ("Commission"). See id. at 359. GSB properly filed a financing statement on May 24, 1994, "perfecting a security interest in certain collateral, including all of Barnard's inventory now and hereafter owned." Id. The Commission filed a financing statement that perfected its security interest in the same collateral on June 28, 1995. See id.

After Barnard failed to make timely payments for agricultural chemicals he obtained from the Van Diest Supply Company ("Van Diest"), Van Diest had Barnard's president sign documents establishing that it had a security interest in any chemicals that Barnard purchased from Van Diest in the future. See id. The security agreement and financing statement, filed on January 26, 1998, stated that it covered

[A]ll of debtor's property (including without limitation all inventory of agricultural chemicals and additives thereto) purchased or otherwise acquired from Secured Party; all cash and non-cash proceeds arising from or received upon the sale, exchange, or other disposition of such inventory or other property or of the proceeds thereof (including without limitation insurance proceeds payable by reason of loss or damage and returned or repossessed goods), whether such inventory, property or proceeds are now or hereafter acquired, existing or arising and wherever they may be located; and all substitutions therefore and additions and accessions thereto.

Id. 359-60.

Barnard began selling off its assets in December, 1999. See id. From February 22 through February 29, 2000, Van Diest removed $44,636.80 worth of agricultural chemicals from Barnard's facility. See id. Van Diest subsequently delivered a refund check to Barnard because the value of the chemicals it removed exceeded the amount of Barnard's debt of $31,872.14. See id.

The Commission released its security interest on June 15, 2000. See id. GSB brought an action shortly thereafter alleging that Van Diest had committed a conversion when it removed the agricultural chemicals from Barnard's facility. See id. GSB filed a motion with the district court to have the Commission joined in the action as an additional plaintiff because the Commission allegedly held a prior security interest in Barnard's inventory. See id. The district court granted this motion. See id.

Van Diest filed a motion for summary judgment, arguing that it had a purchase money security interest "that took priority over GSB's security interest." Id. GSB and the Commission filed an amended complaint, "jointly claiming their security interests were prior to Van Diest's." Id. The district court ruled that "because Van Diest's security interest was perfected after the perfection of the security interests of GSB and the Commission, Van Diest's removal of the chemicals from the Barnard facility was a conversion." Id. Van Diest appealed the district court's decision to the Kansas Court of Appeals. See id.

Van Diest argued that because it complied with the notice requirements of Kan. Stat. § 84-9-312(3), it acquired a purchase money security interest in the chemicals removed from Barnard's facility and therefore had priority over GSB. See id. 361. Van Diest also argued that the district court's decision with respect to the Commission was void because it awarded "a single amount to GSB and the Commission, who have conflicting claims;" the Commission was improperly joined as a plaintiff because it did not have capacity to sue in its own name since it was "a voluntary, unincorporated association;" and it had released its security interest prior to being awarded summary judgment. Id.

Kan. Stat. Ann. § 84-9-312(3) states, in relevant part, that

[a] perfected security interest in inventory has priority over a conflicting security interest in the same inventory and also has priority in identifiable cash proceeds received on or before the delivery of the inventory to a buyer if:
(a) The purchase money security interest is perfected at the time the debtor receives possession of the inventory; and (b) except where excused by [Kan. Stat. Ann. § 84-9-319], and amendments thereto, the purchase money secured party gives notification in writing to the holder of the conflicting security interest if the holder had filed a financing statement covering the same types of inventory (i) before the date of the filing made by the purchase money security interest or (ii) before the beginning of the 21-day period where the purchase money security interest is temporarily perfected without filing or possession . . .; and
(c) the holder of the conflicting security interest receives the notification within five years before the debtor receives possession of the inventory; and
(d) the notification states that the person giving the notice has or expects to acquire a purchase money security interest in inventory of the debtor, describing such inventory by item or type.

Id. (quoting Kan. Stat. Ann. § 84-9-312(3)).

Kan. Stat. Ann. § 84-9-312(5) provides that

in all cases not governed by other rules stated in this section (including cases of purchase money security interests which do not qualify for the special priorities set forth in [subsection] . . . (3) . . ., priority between conflicting security interests in the same collateral shall be determined according to the following rules: (a) Conflicting security interests rank according to priority in time of filing or perfection. Priority dates from the time a filing is first made covering the collateral or the time the security interest is first perfected, whichever is earlier, provided that there is no period thereafter when there is neither filing nor perfection.

Id. (quoting Kan. Stat. Ann. § 84-9-312(5)).

Kan. Stat. Ann. § 84-9-312 "is a 'pure race' statute, and a secured party first in time to perfect its security interest has priority over any prior unperfected security interest." Id. at 362. (citation omitted). Kan. Stat. Ann. § 84-9-312(3) provides an exception to this rule. See id. If a creditor with a purchase money security interest complies with the requirements of § 84-9-312(3), that creditor's interest, "even if perfected later in time, takes priority over an earlier perfected security interest in the same collateral." Id.

Van Diest argued that although the documents signed by Barnard's president, including the security agreement, did not include the term "'purchase money security interest,' they clearly informed GSB that Van Diest expected to 'extend credit and grant other financial accommodations' to Barnard and that Barnard granted Van Diest a security interest 'in all inventory of agricultural chemicals and additives thereto purchased or otherwise acquired' from Van Diest." Id. Van Diest argued that this language gave GSB sufficient notice "'that a purchase money transaction [was] at hand.'" Id.

The court rejected Van Diest's argument, stating that a purchase money security interest creditor "should make its intention to claim priority clear to earlier security interest holders." Id. at 363. The court explained that allowing the holder of a purchase money security interest "to call its interest simply a 'security interest' could mislead the earlier holder, leading it to assume it maintained its priority under the 'first to file' rule and would be secure in making future advances." Id. The court concluded that

[T]o serve the purpose of the notification requirement, we hold that strict compliance with [Kan. Stat. Ann. § 84-9-312(3)] is required to establish a [purchase money security interest] that will enjoy priority over earlier perfected security interests. Absent the explicit written notice required, GSB's security interest took priority over Van Diest's . . . and Van Diest's removal of the chemicals from Barnard's facility was a conversion.

Id.

The appeals court also rejected Van Diest's arguments concerning the Commission's role in the lawsuit. See id. at 363-64. The court stated that when GSB and the Commission were granted summary judgment, "Barnard owed GSB approximately $300,000 and owed the Commission $96,000." It also stated that "GSB had perfected its security interest in Barnard's inventory before the Commission perfected its security interest. Thus, under [§ 84-9-312(5)(a)], GSB's security interest has priority," and the judgment amount must be applied to reduce Barnard's outstanding debt to GSB. Id. at 364. The court added, "[n]o amount will be left over to reduce the debt to the Commission, regardless of whether it was properly or improperly allowed to participate as a party plaintiff." Id.

The case was decided on September 27, 2002; this summary was posted March, 2003