Summary of a Recent
Judicial Development in
Secured Transactions

Payments Received in the Ordinary Course of Business

Walt McCarter
National AgLaw Center Research Associate

Summary of Decision

In Troxel Equipment Co. v. Limberlost Bancshares, 833 N.E.2d 36 (Ind. App. 2005), the Court of Appeals of Indiana held that payment received by a creditor was made "in the ordinary course of business" and belonged to the recipient free and clear of all competing security interests.

Background

The Debtor bought a John Deere combine from Troxel Equipment Co., financed through John Deere Credit, in 2000. Id. at 38. The security agreement and loan contract included a repurchase agreement that required Troxel to repurchase the loan from John Deere Credit if the Debtor defaulted. Id. The Debtor had previously obtained an unrelated loan from Limberlost Bancshares (Bank) using his John Deere grain head as collateral. Id. A few weeks after buying the new combine, the Debtor contacted a local farm auction auctioneer and asked him to sell some farm equipment. Id. The auctioneer told the Debtor that he would be interested in buying the equipment himself rather than auctioning it, and he contacted the Bank and asked if they held liens on the combine and grain head, which they said they dId. Id. The auctioneer purchased the equipment and wrote a check to the Debtor and the Bank. Id. The memo line stated that the check was for the combine and the grain head. Id. The two men executed an agreement that the Debtor would settle all liens that he had on the combine and grain head, and the Debtor subsequently endorsed the check and paid off his debt to the Bank. Id.

The Debtor failed to make his first annual payment to John Deere Credit for the combine, and Troxel filed a foreclosure action and received a default judgment. Id. The Debtor then filed for Chapter 13 bankruptcy and listed the combine as an asset. Id. at 39. Troxel discovered that the Debtor had sold the combine and filed suit against the Bank. Id. The Bank responded that it had accepted the payment free and clear of any secured interest because it was received pursuant to the "ordinary course of business" exception. Id. The trial court found in favor of the Bank, and Troxel appealed. Id.

Arguments

Troxel argued that Comment 2(c) of Indiana Code § 26-1-9-306 (which had since been replaced, but was effective at the time that all relevant events occurred) did not authorize a recipient of the proceeds of secured property to retain the proceeds when they were not deposited into the debtor's checking account and paid out in the operation of the debtor's business. Id.

Analysis and Holdings

Comment 2(c) of Indiana Code § 26-1-9-306 stated in part, "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 take free of any claim which the secured party may have in them as proceeds." Id. at 40. The court rejected Troxel's interpretation of the Comment, and found that the intent was met when the Debtor signed over the check to the Bank, and it was not necessary for the funds to actually be deposited into his account. Id. at 41.

Regarding payments made "in the ordinary course of business," the court explained that "when the recipient has no reasonable expectation of being paid ahead of a secured creditor because of the extent to which the payment was made outside the routine operation of the debtor's business and/or the extent to which the recipient was aware that it was acting to the prejudice of the secured party, the payment is a windfall and may not be kept by the receiver." Id. However, the court found that there was no evidence that the Bank was aware of the Debtor's deception and misuse of the sale proceeds, so it was an "innocent party." Id. The court also found that the Bank's acceptance of the payment was part of its "routine operation," since it had made 27 loans to the Debtor over the years and expected to be paid in full for the one in question just as it had for the previous 26. Id. at 42. Thus the court concluded that the payment was not a windfall, and allowed the Bank to keep the proceeds. Id.

The case was decided on August 12, 2005.