Collections: Notice of Sale of Security Interest

     The case of The State Bank of the Alleghenies v. Hundall, decided by the United States District Court at Roanoke, Virginia, serves as a good example of what happens where a creditor sells items pledged as security for a loan without making proper notice to all parties. 

     In Hundall, the defendant guaranteed the bank's loan to his brother for a dry-cleaning business, but the defendant guarantor never received notice of how, when and by what manner of sale the bank intended to sell motor vehicles belonging to the brother's business. The evidence taken clearly proved that the bank failed to send notice of the sale of the motor vehicles, which had a fair wholesale value of approximately $8,500.00 in the aggregate. The District Court ruled that this violated the provisions of Virginia Code §8.9-504(3); however, the Code does not provide a remedy for the failure to comply with the statutory provisions for resale, and the appropriate remedy had not been ruled upon by the Virginia Supreme Court. The District Court, in its ruling, cited that courts which have addressed this appropriate remedy for failure to provide notice have adopted one (1) of the following three (3) rules: 

       1. The debtor must prove that he has suffered an injury in order to obtain any recovery against the secured party; 

   2. The secured party is absolutely barred from recovering a deficiency, even if the debtor suffered no injury; and 

     3. A rebuttable presumption is that the collateral was worth the amount of the debt which requires the secured party to prove that the debtor suffered no injury. 

     Virginia Code §8.9-507(1) entitles the debtor, or any person entitled to notification, "to recover from the secured party any loss caused by the failure to comply with the provision of this part". 

     The Court elected the third of the three remedies listed above, and forced the creditor to prove the fair value of the collateral. 

     The lesson of Hundall: creditors should send notice to all parties to the transaction -- the principal debtors, guarantors and the owners of the collateral. 

Bankruptcy: Pre Default Waiver of Notice of Sale is Void

     In the case Woodward v. Resource Bank, from the Circuit Court, City of Virginia Beach, the Virginia Supreme Court reviewed provisions in a promissory note that provided for the debtors' waiver of notice of the default sale of the collateral securing the loan. In Woodward, a married couple operated a gas station and convenience store in Portsmouth and desired to expand. The couple obtained the financing necessary to purchase a store in Virginia Beach (the Pavilion Store) from a bank. In doing so the couple executed a note for $80,000.00 which was secured by a second deed of trust on their home, as well as with security interests in the inventory and equipment at the Pavilion Store. Later the couple decided to purchase a third store in Virginia Beach. They obtained financing from the same bank by executing a note in the amount of $90,900.00, and by signing a security agreement which granted the bank a security interest in the equipment and inventory of all three stores. The bank required the principal shareholders of the corporation to sign a guaranty for $45,000.00 of the $90,900.00 note. The guarantee agreement stated that the liability of the guarantors would not be affected by "any failure to ... give any required notices" by the bank. 

     The couple defaulted on the note and the bank demanded that the guarantors honor their respective guaranties. Thereafter, the bank sold the collateral securing the notes without formal notice. The collateral was sold at prices far below the stated value. The shareholders argued that they were entitled to notice of the sale, notwithstanding that they had signed pre-default waivers of notice, because they were "debtors" within the meaning of Virginia Code §8.9-105(1)(d) and §8.9-504(3). The Virginia Beach Circuit Court agreed with the bank that the waivers precluded the necessity of giving notice, but the Virginia Supreme Court ruled that since the shareholders were "debtors" within the meaning of the statutes, they were entitled to notice of the disposition of the collateral. Applying the plain language of Virginia Code §8.9-504(3), the Virginia Supreme Court held that the notice provision contained therein may not be waived before the occurrence of a default.

     The Virginia Supreme Court further ruled that a rebuttable presumption arose that the value of the collateral that the bank sold equaled the amount of the debt because the bank failed to give notice to the guarantors, and because the sale was thus "commercially-unreasonable". Virginia Code §8.9-504(3) requires that every aspect of the disposition of collateral, including "the method, manner, time, place and terms must be commercially reasonable". Because the bank failed to rebut this presumption by putting on evidence to the contrary, the Court ruled that the indebtedness was extinguished, and the creditor was precluded from further collection. 

     The lesson of Woodward is simple: always obtain a legal opinion regarding sales of reclaimed security, and always follow the requirements of the applicable statutes.

Bankruptcy: Dischargeability Determination: Willful & Malicious Injury v. Embezzlement

     In the case of Robbins v. The Chase Manhattan Bank, N.A., the United States District Court at Harrisonburg affirmed a bankruptcy court's ruling that a debt was non-dischargeable under Bankruptcy Code §523(a)(6) as willful and malicious injury. The District Court found that the debtor held a 98 percent interest in a limited partnership which owned a shopping center. The partnership had granted to a bank a second deed of trust on the shopping center and assigned to the bank the rents from the shopping center as security for portions of two loans made by the bank. The debtor, however, under a workout agreement, later began receiving rent distributions from the partnership in his capacity as a limited partner, and he used nearly $71,000 of the distributions for personal expenses.  

     The District Court noted from the Bankruptcy Court's finding that the debtor made the determination on his own to take the money without consideration of the workout agreement or of the bank's rights to the rents. The District Court found that the Bankruptcy Court correctly applied the malice standard as established in that circuit.
     Although the Bankruptcy Court did not explicitly state that it found malice, malice could be inferred from debtor's actions in receiving the distributions, placing the rents in his own account and making personal expenditures. The debtor took such actions all in disregard of and without benefit to the bank's security interest in the rents and at a time when he was suffering financially.
     The District Court ruled that the bank needed only to show that the debtor's conversion was in deliberate and intentional disregard of its rights. Even if the debtor's subjective intent was relevant, the defendant's assertion that the Bankruptcy Court failed to consider his state of mind was without merit considering the debtor's own testimony relating to the receipt of the distributions, deposit of the money into his personal account and subsequent expenditures on personal items.
     The District Court ruled that the Bankruptcy Court's finding that debtor's receipt of the rent distributions injured the bank was not clearly erroneous. In receiving the distributions the debtor knowingly disregarded the bank's interest in the rents and breached the workout agreement. The debtor's use of the cash for personal purposes did not benefit but injured the bank to the tune of $297,000. The bank could not exercise control over its collateral at a time when the debtor was experiencing serious financial troubles. Consequently, the District Court found the debt was non-dischargeable as a willful and malicious injury to the bank because the debtor knowingly took the money without concern for the bank's rights.
     The bank, in its cross-appeal, argued that the Bankruptcy Court erred in rejecting its claim that the debt was non-dischargeable as an embezzlement under Bankruptcy Code §523(a)(4).
     The parties treated the bank's interest in the rents assignment and the deed of trust as security for the debt on two loans. That interest did not defeat the partnership's interest in the rents. As a limited partner in the partnership, the debtor was entitled to cash distributions made to partners. Thus, the rents did not constitute property of another which debtor could appropriate, and debtor's embezzlement claim failed. Further, the District Court ruled that the bank failed to sustain its burden of proving debtor acted with fraudulent intent.

Collection: Secured Transaction Proceeds

     In the case of Orix Credit Alliance Inc. v. Sovran Bank, N.A., the United States District Court at Baltimore, Maryland, reviewed a case where Sovran Bank, which had provided the debtor with a line of credit and several bank accounts.  One of which account was a depository "cash collateral" account routinely applied against draws on the line of credit, signed an agreement with Orix, a finance company, to subordinate the bank's security interest in a crane (purchased by the debtor with funds from the finance company) to the finance company's interest in the crane. The Court ruled, however, that the bank was entitled to use the proceeds from the sale of the crane to reduce the debtor's obligation under the line of credit. The Court's decision was based upon a finding that the bank's transfer of the proceeds occurred in the debtor's ordinary course of business under Virginia Code §8.9-306, comment 2(c), which extinguished the finance company's interest in the proceeds from the sale of the crane.

     This case serves as another example as to why competent legal advice should be sought before relying upon a recorded security interest.