7. Financial Management Services, Inc., v. Familian Corporation, and John Doe

SUBSEQUENT HISTORY:  [***1] Petition for Review DENIED on November 21, 1995 by Arizona Supreme Court CV-95-0209-PR.  

PRIOR HISTORY: Appeal from the Superior Court of Maricopa County. Cause No. CV 90-08248. The Honorable Gordon J. Goodnow, Jr., Judge Pro Tempore.  

DISPOSITION: REVERSED  

COUNSEL: Mariscal, Weeks, McIntyre & Friedlander, P.A., by Robert A. Shull, Michael P. West, Attorneys for Appellant, Phoenix.  

Gammage & Burnham, by Ellen Harris Hoff, Phoenix and  

Hammerman & Hultgren, P.C., by Stanley M. Hammerman, Jon R. Hultgren, Phoenix, Attorneys for Appellee.  

JUDGES: PHILIP E. TOCI, Judge. CONCURRING: EINO M. JACOBSON, Presiding Judge. JOE W. CONTRERAS, Judge.  

OPINIONBY: PHILIP E. TOCI  

OPINION:  [**508]   [*499] OPINION  

TOCI, Judge  

Familian Corporation appeals the trial court's judgment in favor of Financial Management Services, Inc. ("FMSI") in FMSI's action to recover sums collected by Familian from accounts receivable of their common debtor, Pima Plumbing Contractors, Inc. ("Pima"). The appeal raises three issues:  

(1) did FMSI's security interest attach to the joint checks, representing accounts receivable proceeds, that Pima's [***2]   account debtors negotiated to Pima and Familian as co-payees;  

(2) was Familian a holder in due course of the joint checks, thus allowing Familian to take the proceeds they represented free of FMSI's security interest; and  

(3) did Familian receive the joint checks through transfers in the ordinary course of Pima's business, thus allowing Familian to take the accounts receivable proceeds free of FMSI's security interest pursuant to UCC section 9-306(2)? n1  

n1 Arizona substantially adopted the 1972 revised version of the Uniform Commercial Code ("UCC") in 1975 Ariz. Sess. Laws 65, by amending and deleting portions of a prior version of the UCC adopted in 1967 Ariz. Sess. Laws 3, and enacting additional sections that were introduced in the 1972 UCC. The legislature renumbered Arizona's version of the UCC to conform to the UCC numbering system. 1984 Ariz. Sess. Laws 77. In this opinion, we refer to the applicable sections of the Arizona UCC according to their designation and numbering in the current version of the UCC: e.g., UCC §  9-306(2) (equivalent to Ariz. Rev. Stat. Ann. ("A.R.S.") §  47-9306(B)). See Deutsche Credit Corp. v. Case Power & Equip. Co., 179 Ariz. 155, 157 n.1, 876 P.2d 1190, 1192 n.1 (App. 1994).  

  [***3]

We hold that although FMSI's security interest continued in the accounts receivable proceeds paid to Familian, Familian took those proceeds free of FMSI's prior security interest because Familian was a holder in due course of the joint checks issued by Pima's account debtors. Because our resolution of the first two issues disposes of this appeal, we need not consider whether the issuance of the joint checks constituted transfers in the ordinary course of Pima's business. Accordingly, we reverse the trial court's judgment.  

I. FACTS AND PROCEDURAL HISTORY

FMSI provides financing for contractors who are customers of construction material wholesalers. One of the wholesalers through which FMSI provided financing was Stapley Wholesale, Inc. ("Stapley"). Like all of FMSI's "member" wholesalers, Stapley entered an agreement with FMSI under which Stapley guaranteed full payment of any loans made by FMSI to Stapley's customers and promised to pay any such loans that might go into default.

In 1985, FMSI began providing financing to Pima, a customer of Stapley, through a series of promissory notes and security agreements. Under this arrangement, Pima granted FMSI a security interest in all [***4]  its accounts receivable, inventory, and equipment. FMSI filed a financing statement with the Arizona Secretary of State in 1986. The security agreements did not restrict Pima's right to use accounts receivable payments that it collected in the ordinary course of its business. FMSI permitted Pima to pay its other creditors (e.g., employees, landlords, utility companies, and suppliers) from amounts that project owners or general contractors paid to Pima on account.

Through the FMSI loan program, Pima purchased materials from Stapley over a four-year period. Pima made payments to FMSI through Stapley every month through August 1989. Pima made no payments after September of 1989.

In August of 1988, Pima entered into a security agreement with Familian, and Familian filed a financing statement with the Arizona Secretary of State. Like FMSI's security agreement, Familian's agreement covered Pima's accounts receivable. Thereafter, Familian sold materials and supplies to Pima on open account.

Though Pima, like many in the construction industry, did not always make its loan payments when due, both FMSI and Familian considered Pima a good customer. In fact, neither FMSI nor Familian ever  [***5] suspected  [**509]  [*500]  that Pima was in financial trouble. Furthermore, neither party ever considered Pima to be in default on a loan.

In August 1989, at a time when Pima owed Familian approximately $ 400,000, of which $ 100,000 was thirty days past due, Familian learned that Pima had made a payment of over $ 200,000 to FMSI through Stapley. In response, Familian, concerned about the size of Pima's debt, constructed a debt-reduction plan. Under this plan, Familian and Pima agreed to direct Pima's account debtors to make all further payments jointly to Familian and Pima. In September 1989, Familian and Pima each sent letters to Pima's account debtors directing them to make payments by joint check, naming Familian and Pima as co-payees. The parties also agreed that Familian would not extend Pima any credit until Pima's debt fell below $ 250,000.  

Under the arrangement, Pima would notify Familian each time it received a joint check, and the parties would confer and agree on a percentage split of the funds. Familian would then prepare its own check payable to Pima in the amount of Pima's share. In return, Pima would indorse the joint check and negotiate it to Familian. From September 25 through November [***6]  30, 1989, joint checks totalling $ 1,157,920.95 were received. Familian retained $ 353,327.20 and remitted $ 804,593.75 to Pima.

On about September 20, 1989, Familian received a UCC-1 search that listed FMSI as a prior perfected secured creditor of Pima. Consequently, when Familian received monies from Pima's account debtors it knew that FMSI was a prior secured creditor of Pima. Familian did not inform FMSI about the joint check arrangement or inquire of FMSI about Pima's status.

Familian used the money it retained from the joint checks to pay both Pima's preexisting secured debt and new charges for supplies it sold to Pima on current jobs. At the end of October 1989, Familian notified Pima that its balance was below $ 250,000 and that it would once again sell supplies to Pima on credit as long as the total balance did not exceed that amount. Familian and Pima received their last joint check on November 30, 1989. Familian received no further payments on Pima's debt.  

Pima last paid Stapley toward its indebtedness to FMSI on September 10, 1989. When Stapley later asked Pima about its difficulty making payments, Pima's president assured Stapley that the difficulty resulted from Pima's [***7] expansion into the Phoenix and Las Vegas markets and that business was fine. Consequently, Stapley continued to sell Pima a substantial amount of construction materials.  

In early November, Pima's president called Stapley and agreed to a meeting that afternoon. He did not go to the meeting, however, and was never heard from again. Pima closed down, and Stapley started contacting Pima's account debtors.

  In late 1989 or early 1990, Stapley discovered that Familian had previously instructed Pima's account debtors to pay Familian directly. At that time, Stapley and FMSI notified 115 of Pima's account debtors of FMSI's security interest and directed them to pay FMSI. FMSI requested that Stapley repurchase FMSI's loans to Pima in accordance with its membership agreement, but Stapley was unable to do so. In the end, Pima owed Familian more than $ 100,000 and FMSI more than $ 700,000.

FMSI sued Familian to recover the accounts receivable proceeds that Familian collected from Pima's account debtors. After a bench trial, the trial court ruled in favor of FMSI in the amount of $ 353,327.20 with interest. The trial court concluded:  

1. FMSI and Familian had perfected security interests in [***8]  Pima's accounts receivable.  

2. FMSI had a prior perfected security interest in Pima's accounts receivable.  

3. Familian was not a holder in due course of the Joint Checks and did not take them free of FMSI's security interest.  

4. Familian's collection of the Joint Checks was not a disposition of the proceeds of Pima's accounts receivable in the ordinary course of Pima's business.  

5. FMSI did not waive its security interest in the Joint Checks.

  [**510]   [*501]

6. [Familian] impermissibly interfered with Pima's accounts receivable and is liable to [FMSI] for the sums retained through the device of a constructive trust and an equitable lien upon [Familian]'s assets to the extent [FMSI] has been damaged.  

7. [Familian] knowingly interfered with [FMSI]'s security interest with the foreknowledge that it was a junior creditor to [FMSI].  

8. [Familian] committed conversion.  

9. [FMSI] is entitled to an accounting from [Familian] as to monies received.

Familian timely appealed. FMSI filed an untimely notice of cross-appeal, which was dismissed.

II. DISCUSSION  

A.                  Did FMSI's Security Interest Attach to the Accounts Receivable Proceeds Collected By Familian?  

Familian contends that  [***9] FMSI's security interest in Pima's accounts receivable did not "attach" to the proceeds that Familian obtained. Familian relies on UCC section 9-306(2), which provides:

Except where this [chapter] otherwise provides, a security interest continues in collateral notwithstanding sale, exchange or other disposition thereof unless the disposition was authorized by the secured party in the security agreement or otherwise, and also continues in any identifiable proceeds including collections received by the debtor.  

(Emphasis added.) Familian reasons that Pima never "received" the accounts receivable proceeds because Familian deposited those proceeds in its own account and then issued separate checks to Pima for its share. Because Familian, not Pima, cashed the joint checks, Familian concludes that FMSI's security interest in the checks was cut off. We disagree.

Initially, we recognize a conflict in the case law concerning the interpretation of UCC section 9-306(2). For instance, in Centerre Bank v. New Holland Div. of Sperry Corp., 832 F.2d 1415, 1420 (7th Cir. 1987), the court held that under UCC section 9-306(2), a security interest continues only in [***10] proceeds received by the debtor. Accord First Interstate Bank v. Arizona Agrochem. Co., 731 P.2d 746, 748 (Colo. App. 1986). Taking the opposite view, Farmers & Merchants Nat'l Bank v. Fairview State Bank, 766 P.2d 330, 334 (Okla. 1988), held that a security interest attaches to proceeds of collateral even if the debtor did not receive those proceeds. Accord Bank of Okla. v. Islands Marina, Ltd., 918 F.2d 1476, 1481 (10th Cir. 1990). Nevertheless, even if we assume that UCC section 9-306(2) conditions continuation of the security interest on the debtor's actual receipt of the proceeds of accounts receivable collateral, Familian's contention fails in this case.

Pima both legally and physically "received" the joint checks. In Brown Wholesale Electric Co. v. Beztak of Scottsdale, Inc., 163 Ariz. 340, 343, 788 P.2d 73, 76 (1990), our supreme court held that a materialman's indorsement of a joint check payable to him and a subcontractor constituted receipt of payment by the materialman absent a contrary agreement with the owner or the general contractor.  [***11] Here, contrary to Familian's intimation, the proceeds of Pima's accounts receivable were not deposited directly in Familian's account. All account payment checks were first sent to Pima. Pima would indorse the checks and then forward them to Familian. Pima, therefore, had physical possession of the checks. In addition, the checks constituted proceeds because they were received "upon the . . . collection . . . of collateral" within UCC section 9-306(1). Thus, FMSI's security interest attached to the accounts receivable proceeds collected by Familian.  

B.                  Was Familian a Holder In Due Course?  

Familian argues that when it gained possession of the joint checks indorsed by Pima, it became a "holder in due course" of those checks and, therefore, took them free of FMSI's competing interest. Whether a holder is a holder in due course is a factual question. See First Nat'l Bank v. Jarnigan, 794 S.W.2d 54, 58 (Tex. App. 1990). Thus, we are obliged to affirm the trial court  [**511]  [*502]  unless its findings were clearly erroneous.  K & K Mfg., Inc. v. Union Bank, 129 Ariz. 7, 9, 628 P.2d 44, 46 (App. 1981). That is [***12]  the case here. The record lacks evidence sufficient to sustain the trial court's conclusion that Familian was not a holder in due course of the joint checks.

To qualify as a holder in due course, a party must satisfy four requirements. First, the party must be a "holder," defined as a person who possesses an instrument "drawn, issued or indorsed to him or to his order or to bearer or in blank." UCC section 1-201(20). The last three requirements are described in UCC section 3-302(1):