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Financial Services FLASHPOINTS January 2022

Michael L. Weissman, Levin Ginsburg, Chicago
312-368-0100 | E-mail Michael L. Weissman

Bank and Borrower Did Not Collude To Injure Another Lender

Under §9-332 of the Uniform Commercial Code, a party is liable for colluding with another when there is evidence that the two parties acted pursuant to an agreement or otherwise in concert with each other and the purpose of the concerted action was illegal, fraudulent, or otherwise wrongful toward the injured third party. In NextGear Capital, Inc. v. Bank of Springfield, Case No. 4:18-CV-01086-NCC, 2019 WL 2525753 (Bankr. E.D.Mo. June 19, 2019), the question was whether Bank of Springfield had colluded with its borrower, Gateway Buick GMC, Inc., to injure Gateway’s floor-plan lender, NextGear Capital, Inc.

Gateway operated an automotive dealership in Hazelwood, Missouri, selling new Buick and GMC vehicles. Between August 11, 2015, and January 12, 2016, it executed a series of promissory notes totaling $13,625,000 with Bank of Springfield. The notes were secured by a blanket lien on all of Gateway’s real property.

NextGear provided Gateway with floor-plan financing pursuant to a demand note and a loan and security agreement dated October 27, 2014. Gateway granted NextGear a blanket lien on its personal property, thereby giving NextGear a senior lien position in Gateway’s accounts receivable and any funds Gateway would receive from General Motors. Gateway received two types of payments from General Motors: vehicle rebates and holdbacks that were proceeds from vehicles floor-planned by NextGear; and dealer incentive payments.

With Gateway experiencing financial difficulties, the three parties executed a series of forbearance agreements. On October 1, 2015, NextGear agreed to subordinate its claim to payments Gateway had coming from General Motors, except for the sales proceeds arising from the vehicles NextGear had floor-planned and for which it had not been paid. The parties executed an amended forbearance agreement on May 27, 2016, and another amended forbearance agreement on July 10, 2017. In the last of these agreements, there was a provision prohibiting Gateway from any further borrowing from the bank.

Because NextGear found, as early as May 2016, that Gateway was selling vehicles out of trust and not remitting the sales proceeds, it stationed risk managers at Gateway’s premises to ensure that the sales proceeds were delivered to NextGear. The bank was aware of this as well as Gateway’s financial difficulties.

Gateway had bank accounts with several different banking institutions, including Regions Bank. The NextGear loan documents obligated Gateway to deposit vehicle rebates and holdbacks from the sale of vehicles floor-planned by NextGear into the Regions account. NextGear was party to a tripartite control agreement giving it control over the Regions bank account.

Gateway directed General Motors to deposit rebate, holdback, and incentive payments into Gateway’s account at Bank of Springfield. Bank of Springfield knew the source of the deposits was General Motors. These deposits were a direct violation of the forbearance agreements, the floor-plan financing agreements, and the subordination agreements.

NextGear accused Bank of Springfield of acting purposefully to induce Gateway to deposit monies Gateway received from General Motors into Bank of Springfield for the purpose of making payments due the Bank on its Gateway notes. These moneys were supposed to be placed on deposit at Regions Bank. Despite demands from NextGear, Bank of Springfield refused to turn over the disputed funds. Litigation between NextGear and Bank of Springfield followed.

The decision arose from a motion to dismiss the case filed by Bank of Springfield. The Bank claimed its conduct fell within the protection of §9-332 of the Uniform Commercial Code. The court agreed.

Section 9-332 of the UCC states, “a transferee of funds from a deposit account takes the funds free of a security interest in the deposit account unless the transferee acts in collusion with the debtor in violating the rights of the secured party.” 2019 WL 2525753 at *3. In the view of the court, the decision hinged on whether the bank was acting in collusion with Gateway when it obtained the General Motors payments.

The court said there was an insufficient allegation of collusion and ruled as follows:

[A] junior secured creditor is under no obligation to identify and segregate cash proceeds for the benefit of the senior secured creditor. . . . This is the case even if the junior secured creditor knew of the senior secured party’s interest. . . . The collusion standard in Article 9 does not impose a duty on a transferee of funds to identify and segregate the funds absent a contractual obligation to do so. . . . As long as [Bank of Springfield] acts rightfully, it cannot be responsible for Gateway’s potentially wrongful actions. [Citations omitted.] 2019 WL 2525753 at *4.

What’s the point? Courts do not penalize alleged collusion between a bank and its customer absent definitive proof of concerted conduct with a malicious purpose.

Bank and Borrower Did Collude To Injure Another Creditor

Keeping in mind NextGearCapital, in which a Missouri bankruptcy court rejected an assertion that a bank had colluded with a borrower to injure another creditor, we will revisit the issue of collusion in a Montana federal district court decision that came to quite a different conclusion. Banner Bank v. First Community Bank, 854 F.Supp.2d 846 (D.Mont. 2012).

Banner Bank arose on Banner’s motion for summary judgment. It raised a number of legal issues and ultimately resulted in a judgment in favor of Banner.

Banner was the successor to F&M Bank. F&M loaned $5 million to Superior Propane, LLC, in 2006. Two of the three principals of Superior, Gary Hebener and Dean South (H&S), guaranteed repayment of the loan. F&M was granted a security interest in all of Superior’s assets that it perfected by the filing of a UCC1 Financing Statement with the Montana Secretary of State.

In April 2009, H&S obtained a $400,000 loan from First Community Bank. They granted FCB a security interest in five propane tanks. Superior guaranteed repayment of the loan. FCB filed a UCC1 Financing Statement with the Montana Secretary of State’s office on April 23, 2009, listing four 30,000-gallon tanks and one 60,000-gallon propane tank as collateral. 854 F.Supp.2d at 849 n.2. South and Hebener were listed as debtors. The loan collateral was actually part of Superior’s inventory and had not been purchased by H&S. The $400,000 loan had a term of six months and was supposed to provide funding to assist Superior in making its loan payments to Banner.

The loan proceeds from the $400,000 loan initially were deposited in H&S’s checking account at FCB on April 21, 2009. The following day, South wrote a $200,000 check on that account payable to Superior, and Superior signed the check over to Banner as a partial payment on its debt to Banner. A week later, on April 29, 2009, South wrote another check, this time for $172,000, payable to Superior. Once again, Superior signed the check over to Banner as a partial loan repayment.

On October 8, 2009, South wrote a check for $78,000 on the account of Harold’s Meter Service (an adopted d/b/a of Superior) at Mountain West Bank payable to the H&S account at FCB. Two months later, on December 4, 2009, there was a payment of $80,000 on the H&S personal loan account at FCB from the H&S checking account. The regular monthly payment on the H&S loan was $78,000 and the source of the funds, presumably, was the sale of the propane tanks. (That was confirmed by trial testimony by South that two of the 30,000-gallon tanks had been sold to a party in Wyoming for $80,000.)

Banner was not informed of the sale of the tanks. Before FCB made the personal loan to H&S, H&S told FCB they would get a release from Banner of its security interest in the tanks. But that never happened.

Banner did not learn of the sale until a year had passed. When it did, it demanded the $78,000 from FCB based on its perfected security interest in the tanks. FCB refused, and litigation followed.

FCB’s first defense was that Banner would be unjustly enriched if it were awarded the proceeds of the sale of the tanks because Banner had been compensated by the almost $300,000 payments it received in 2009. The historical background was that when South and Hebener procured their $400,000 loan from FCB, they paid $300,000 to Superior and Superior, in turn, paid those funds to Banner. The remaining $100,000 was paid to Superior to try to keep it going. FCB’s position was that when H&S paid the $300,000 to Banner, they were “paying” for the two propane tanks. The court summarily rejected that contention because when the $300,000 was paid to Banner, South and Hebener “did not tell Banner Bank that the payment was for the two propane tanks.” 854 F.Supp.2d at 852. And in answer to the assertion that the $100,000 payment to Superior was for the tanks, the court said, “South testified that he and Hebener gave $100,000 to Superior for operating expenses, not as payment for the tanks. . . . Banner Bank believed that it was being paid what it was owed on the $5 million note. Banner Bank never granted a release of its security interest; nor did it know that a release was being sought.” Id.

FCB next argued that it had perfected a purchase-money security interest in the tanks. It lost that argument too. The court’s conclusion was that “FCB’s argument that it has a purchase-money security interest is without merit, first because the propane tanks are inventory and second because there is no record of any purchase of the tanks from Superior by South and/or Hebener.” 854 F.Supp.2d at 854. In the view of the court, FCB did not have a valid perfected security interest in the propane tanks because South and Hebener did not have rights in that collateral. It said that “FCB never demanded documentation of ownership in the collateral from [H&S] or any other proof that they had the power to transfer rights in the collateral.” Id.

Advancing to the issue of collusion, the court detailed why a finding of collusion between FCB and South and Hebener was warranted. It said:

The court does not find that FCB intended at the outset of its loan transaction to collude with Superior Propane to the detriment of Banner Bank, but little by little FCB’s conduct during the South/Hebener loan transaction edged toward and eventually transformed into a de facto collusion with Superior against Banner. FCB’s complete failure to ascertain the ownership or power to transfer rights in the collateral as pledged by South and Hebener certainly permitted Superior Propane to defraud its primary secured creditor. Essentially FCB’s inattention to the most important details of the loan transaction allowed South and Hebener to pledge assets they did not own for their $400,000 personal loan. Further, FCB’s failure to require South and Hebener to provide documentation of Banner Bank’s waiver of its security interest effectively kept Banner Bank completely in the dark about a potential bank conflict over Superior’s assets or about a possibility that Superior might want to sell these encumbered assets. 854 F.Supp.2d at 856.

The court’s final comments are worth noting: “FCB either was aware of the wrongfulness of this transaction or chose to remain willfully ignorant.” Such willful ignorance is ample evidence of collusion, said the court. Id.

What’s the point? The Montana court essentially ruled that a bank, acting in concert with one of its borrowers, can be held to have colluded with its borrower if the bank remains passive in the face of mounting evidence that the borrower’s intention is to harm another creditor. That test holds a bank to a far stricter code of conduct than that articulated in the collusion case previously reviewed here.

For more information about financial services, see COMMERCIAL AND INDUSTRIAL LOAN DOCUMENTATION (IICLE®, 2018). Online Library subscribers can view it for free by clicking here. If you don’t currently subscribe to the Online Library, visit www.iicle.com/subscriptions.

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