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In re Dennis Mitchell Industries Inc.


decided: December 18, 1969.


Reargued November 5, 1969

Kalodner, Forman and Stahl, Circuit Judges. On Reargument: Hastie, Chief Judge, and Kalodner, Forman, Freedman, Seitz, Aldisert, Stahl and Adams, Circuit Judges.

Author: Stahl


STAHL, Circuit Judge.

This is an appeal from a decision of the district court*fn1 which affirmed an order of the referee in bankruptcy granting seller's reclamation petition for equipment sold to the bankrupt, Dennis Mitchell Industries, Inc. The facts relevant to this controversy are as follows.

Factual Background

The bankrupt, a manufacturer and distributor of metal and plastic products, had its principal place of business in Philadelphia. It also had plants in Woodbury, New Jersey, and Millsboro, Delaware. Pursuant to a conditional sales agreement dated May 20, 1965, Mitchell purchased two hydraulic cutting machines from Herman Schwabe, Inc., appellee. Schwabe's plant is in Brooklyn, New York, and the contract was entered into there. The contract provided that the machines were to be kept in Mitchell's Philadelphia plant until they had been fully paid for and that they could not be placed elsewhere without Schwabe's prior consent.

On May 21, 1965, Schwabe filed a financing statement in the Philadelphia Prothonotary's Office, and on May 24, 1965, in Harrisburg, Pennsylvania, in the office of the Secretary of the Commonwealth.

At or about the time of the purchase, Mitchell had the machines picked up by its truck at Schwabe's Brooklyn location and, despite the contract provisions,*fn2 took them to its plant in Woodbury, New Jersey. The machinery was used exclusively in that plant and was never physically in Pennsylvania. Appellee Schwabe never recorded its security interest in New Jersey.

On August 3, 1966, Mitchell filed a voluntary petition for an arrangement under Chapter XI of the Bankruptcy Act and co-receivers were appointed to take charge of its property. On April 5, 1967, Mitchell was adjudicated a bankrupt with the same receivers continuing to serve. At a meeting of the creditors on August 9, 1967, one of the co-receivers was appointed trustee.

In the meantime, appellee Schwabe had filed a reclamation petition*fn3 for the machinery on April 18, 1967. The receivers, in compliance with an order from the referee directing them to file an answer to the petition,*fn4 averred that Schwabe had failed to comply with the recording provisions of the Uniform Commercial Code of New Jersey, where the property was located. A hearing was held before the referee on September 12, 1967, and on October 25, 1967, the referee granted Schwabe's reclamation petition.*fn5

On June 9, 1967, while Schwabe's petition was pending, a special meeting of the creditors was held at which time the receivers' petition to sell their right, title and interest in all the bankrupt's assets, except cash, subject to liens and claims, to appellant Armstrong, a secured creditor of the bankrupt,*fn6 was granted by an order entered by the referee. The hydraulic cutting machines were included in the sale.

The dispute, then, is actually between the seller, Schwabe, and appellant, Armstrong, with the latter contending that Schwabe's security interest was unperfected and hence subordinate to the rights of the trustee under § 70(c) of the Bankruptcy Act, 11 U.S.C.A. § 110(c) (Supp.1969).*fn7 Armstrong contends, therefore, that it succeeds to the rights of the trustee and takes the property free of Schwabe's lien.

Appellant Armstrong argued before the referee that since the equipment had remained continuously in the bankrupt Mitchell's Woodbury plant, New Jersey law governed the perfection of Schwabe's security interest, and Schwabe should have filed a financing statement in that state in order to perfect its security interest. Schwabe having failed to do so within four months*fn8 after the property was installed in the debtor's New Jersey plant, Armstrong contended that Schwabe's security interest, even assuming it had originally been perfected in Pennsylvania,*fn9 was unperfected and hence invalid against the trustee.

Decision of Referee

The referee's decision was based primarily on § 9-103(3) of the Uniform Commercial Code.*fn10 He ruled that under this section of the Uniform Commercial Code (seemingly New Jersey's) Schwabe had a "valid perfected security interest as against the Trustee and his assignee." (App. 29a). In reaching this result the referee held, in light of the debtor's improper removal of the equipment to New Jersey and Schwabe's filing in Pennsylvania, that "the only proper construction" of the four-month rule of § 9-103(3) was that the time period does not begin to run until "the secured party has been notified of the removal and has failed to re-record the financing statement." (App. 27a-28a). Implicit in this conclusion must have been a determination that Schwabe's filing in Pennsylvania was sufficient to perfect its security interest in that state.

The referee also noted that under the Article 9 section on rules of priority, § 9-301(1), "the assignee in this particular case [Armstrong] is not a person who takes priority over an unperfected security interest."*fn11

Finally, the referee said that under "Section 9-401(2), since this was a filing made in good faith, it is effective against the assignee or the trustee, who had knowledge*fn12 of the contents of the financing statement," App. 28a, citing In the Matter of Komfo Products Corp., 247 F. Supp. 229 (E.D.Pa.1965).

Section 9-401(2) provides as follows:

(2) A filing which is made in good faith in an improper place or not in all of the places required by this section is nevertheless effective with regard to any collateral as to which the filing complied with the requirements of this Article and is also effective with regard to collateral covered by the financing statement against any person who has knowledge of the contents of such financing statement.

Even if appellant Armstrong had actual knowledge of Schwabe's unperfected security interest, which appellant denies, we are concerned primarily with the knowledge of the trustee to whose rights the appellant, Armstrong, succeeded. Both under § 70(c) of the Bankruptcy Act and under § 9-301(3)*fn13 of the Uniform Commercial Code the trustee has the status of an ideal lien creditor. Under the Code section the trustee can be affected with "knowledge" if it is shown that every creditor of the bankrupt had such knowledge, which has not been shown here. Under § 70(c) of the Bankruptcy Act, however, the trustee may have the status of an ideal lien creditor even if all the creditors do in fact have actual knowledge.*fn14 We need not reach the possible conflict between the Uniform Commercial Code and the Bankruptcy Act on this point because there is no evidence in the record to indicate that every creditor of the bankrupt had actual knowledge of appellee's unperfected security interest.

Komfo, supra, relied upon by the referee as well as by appellee, is clearly distinguishable. In Komfo, which involved an assignment of accounts receivable as security, the financing statement had not been properly recorded prior to the time that the debtor had made an assignment for the benefit of creditors. The security interest was perfected prior to the subsequent bankruptcy of the debtor.

In resisting the creditor's reclamation petition for the accounts receivable in Komfo, the trustee relied on § 70(c) and § 70(a) (8) of the Bankruptcy Act. The court summarily rejected the § 70(c) claim because the security interest in the accounts receivable had been perfected prior to the date of bankruptcy.

Section 70(a) (8) created a somewhat more difficult problem not present in the instant case. This provision of the Bankruptcy Act gives the trustee title to "property held by an assignee for the benefit of creditors appointed under an assignment which constituted an act of bankruptcy * * *," 11 U.S.C.A. § 110(a) (8) (1953), as was the case in Komfo.

While it was true that the security interest had not been perfected prior to the assignment for the benefit of creditors, the status of the assignee as an ideal lien creditor under § 9-301(3) of the Uniform Commercial Code*fn15 was dependent upon whether all of the creditors represented by the assignee had knowledge of the unperfected security interest. The court, in Komfo, found strong evidence in the record that this was so and remanded the case to the referee for "a determination of whether all the creditors had knowledge of the security interest prior to the execution of the assignment for the benefit of creditors." 247 F. Supp. at 240.

The gist of Komfo, then, was that while the trustee could not prevail under § 70(c) of the Bankruptcy Act, he may have been able to succeed to the rights of the assignee in bankruptcy if the latter had priority over the holder of the unperfected security interest under § 70(a) (8). Komfo, therefore, is wholly inapposite to the direct § 70(c) problem we have here.*fn16

The referee also held the "equitable doctrine" of Bank of Marin v. England, 385 U.S. 99, 87 S. Ct. 274, 17 L. Ed. 2d 197 (1966), to be an alternative ground for his decision, finding the bankrupt's action in placing the equipment in New Jersey in violation of the conditional sales agreement, coupled with Armstrong's "knowledge"*fn17 of Schwabe's security interest, to be a sufficient basis for granting the reclamation petition.

Decision of District Court

The district court affirmed*fn18 the referee's order on the grounds stated by the referee and for some additional reasons. The court held that assuming, without conceding, that Schwabe's failure to file in New Jersey rendered its security interest unperfected and hence subordinate to the rights of the trustee, appellant Armstrong would still not prevail because it had knowledge*fn19 of Schwabe's security interest. This result was based on the court's conclusion that a sale in bankruptcy is a judicial sale, and that a purchaser at a judicial sale takes free from liens only if he was without actual or constructive notice of them.*fn20

The district court also seemed to adopt the referee's conclusion that under Article 9 priority rules Armstrong's knowledge prevented it from taking title free of the security interest even though it purchased the machinery from the trustee.*fn21

As an alternative ground for affirming the referee's decision, the district court held that because Mitchell was able to transport the machinery to New Jersey, Armstrong should not be permitted to argue that the equipment was not mobile, and construing the Code liberally this equipment could be characterized as "goods of a type which are normally used in more than one jurisdiction" within the meaning of § 9-103(2).*fn22 That being the case, the district court reasoned that Schwabe's filing in Pennsylvania was effective to perfect its security interest as the debtor Mitchell's chief place of business was in Pennsylvania.


At the outset we note a dispute between the parties as to which law governs the validity and perfection of Schwabe's security interest.*fn23 Appellant Armstrong, noting that both New Jersey and Pennsylvania have enacted the Uniform Commercial Code, claims that New Jersey law governs because the equipment was physically present in that state.*fn24 And §§ 9-302(1) and 9-401 of the Code, as adopted in New Jersey, require that a financing statement be filed in the state where the collateral is located in order to perfect a security interest in the type of equipment involved here (assuming for present purposes that these machines are not mobile goods of a type which are normally used in more than one state). As no financing statement was ever filed in New Jersey, Armstrong contends that Schwabe's interest is not perfected. To Schwabe's argument that the Pennsylvania filing perfected its security interest, Armstrong replies that even if that is correct, such perfection lapsed after the machinery had been in New Jersey more than four months. See § 9-103(3), supra note 10.

Schwabe asserts that its security interest was perfected in Pennsylvania, as held by the referee, and that it could not become unperfected solely by reason of Mitchell's removal of the equipment to New Jersey without the seller's knowledge.

Despite the seemingly harsh result, we believe that neither a liberal construction of the relevant provisions of the Uniform Commercial Code nor the Bank of Marin declaration that "equitable principles govern the exercise of bankruptcy jurisdiction"*fn25 can avail the appellee-seller on the facts of this case.

Because, as explained later, we do not consider the machines in question here as "goods of a type which are normally used in more than one jurisdiction," § 9-103(2), we hold, under any choice-of-law criterion, that Schwabe's security interest was unperfected as of the date of bankruptcy, i.e., when Mitchell filed its Chapter XI petition. The states which have any connection with the transaction are New York, Pennsylvania and New Jersey, and each has enacted the Uniform Commercial Code. In our view, § 9-103(3) precludes the recognition of appellee's security interest as perfected regardless of which state's law is deemed controlling.

Even if we assume that § 9-102(1) (a)*fn26 is not applicable because of the multi-state nature of Schwabe's original agreement with the bankrupt Mitchell, we must look to § 9-103(3) for resolution of the perfection problem. Had the machinery been taken to Mitchell's Philadelphia plant within 30 days after the security interest had attached,*fn27 it is clear that Pennsylvania law would control, and Schwabe's Pennsylvania filing would have perfected its security interest as the parties intended that the property be kept in Pennsylvania (see § 9-103(3); In re Kokomo Times Publishing & Printing Corp., 301 F. Supp. 529, 5 U.C.C. Reporting Service 954, 963 (S.D.Ind.1968)). Or, had the property remained in New York for not more than 30 days, not in the seller's possession, the Pennsylvania filing would probably have been sufficient to perfect the security interest in New York as well for that period. (See 1 Gilmore, Security Interests in Personal Property § 22.9 (1965)). The second sentence of § 9-103(3) seems to suggest that where the parties understood at the time that the security interest attached that the goods would be kept in Pennsylvania, if the property is not taken into Pennsylvania within 30 days after the security interest attached Pennsylvania law would no longer govern the validity and perfection of the security interest. (Id.) Had the equipment remained in New York beyond 30 days, it seems fair to say that New York law would then govern the validity and perfection of Schwabe's security interest.

If the goods had remained in New York more than four months, not in the seller's possession, there is little doubt that under New York law the Pennsylvania filing would not have served to perfect the seller's security interest in light of the rather clear intent expressed in § 9-103(3) that the secured party is under a duty to keep himself informed of his debtor's dealings with the collateral. But here, the goods having been removed directly to New Jersey, under § 9-103(3) the failure to file a financing statement in that state clearly rendered the security interest unperfected at the end of four months even were we to consider the security interest to have been originally perfected in Pennsylvania.

Contrary to the position of the referee, the four months' period, when applicable,*fn28 begins to run whether or not the secured party has notice that the collateral has been removed to another jurisdiction. Uniform Commercial Code, § 9-103, Comment 7;*fn29 In re Welker, 2 U.C.C. Reporting Service 169 (W.D.Pa.1964) (decision of referee); Churchill Motor, Inc. v. A. C. Lohman, Inc., 16 App.Div.2d 560, 229 N.Y.S.2d 570, 577 (1962), reviewed in Hogan and Penney, Commercial Law, 14 Syr.L.Rev. 248, 256 (1962); First National Bank of Bay Shore v. Stamper, 93 N.J.Super. 150, 225 A.2d 162, 169 (1966), discussing § 9-103(3) of the New Jersey Uniform Commercial Code; 1 Gilmore, Security Interests in Personal Property § 22.8, p. 626 (1965).

To reiterate, since Schwabe never filed a financing statement in New Jersey, we believe that under Pennsylvania, New Jersey or New York law its security interest was unperfected as the equipment had been in New Jersey longer than four months. That being the case, it follows that Schwabe's interest is subordinate to the rights of the trustee under both § 70(c) of the Bankruptcy Act and § 9-301(1) (b) and (3) of the Uniform Commercial Code.

With regard to the applicability of § 9-103(2)*fn30 relating to mobile goods, we think the approach adopted by the district court, however equitable in intent, places too great a strain on the meaning of "goods of a type which are normally used in more than one jurisdiction." While the enumeration of certain types of goods in § 9-103(2) is not intended to be all inclusive, it seems clear that the test for mobile goods turns on the type of goods involved and not on their actual use in or transportation between more than one jurisdiction. To say that goods fall within that section simply because they may be and are easily transported from state to state overlooks the nature of the test for mobile goods and the particular problem § 9-103(2) was intended to resolve.*fn31 In view of the scope of § 9-103(2), we conclude that industrial equipment of the type involved here may not be characterized as mobile goods within the meaning of that section. Therefore, the filings in Pennsylvania did not serve to perfect appellee's security interest under § 9-103 (2).


There remains the issue of Armstrong's title and the effect, if any, of its "knowledge" of Schwabe's unperfected security interest. As already noted, Armstrong disputes the referee's finding as well as that of the district court that it had actual knowledge of Schwabe's security interest. In any event, we believe that a finding of such knowledge or notice, actual or constructive, is immaterial if we decide that a purchaser from a trustee in bankruptcy takes free of the lien invalidated under § 70(c) of the Bankruptcy Act.

Granting that a bankruptcy sale is a judicial sale,*fn32 we see no reason why local law on judicial sales or any other state law, such as Article 9 of the Uniform Commercial Code, should determine what interest a party acquires at a bankruptcy sale. The broad powers which the "strong-arm clause" of § 70(c) confers upon the trustee are intended to be utilized for the benefit of the bankruptcy estate in order "to secure all the bankrupt's property for an equal distribution according to the terms of the [Bankruptcy] Act."*fn33 To allow the lien of an unperfected security interest, invalid as against the trustee, to be resurrected against a purchaser from the trustee will surely inhibit bidding by such prospective purchasers with resulting harm to the bankruptcy estate. While this question does not seem to have arisen with any frequency, there is clear authority for the position we adopt.

In Collier, it is stated,

The fact that a purchaser has acquired knowledge of an unrecorded transfer which is invalid against the trustee under § 70c because of the lack of perfection does not disable the purchaser from acquiring at a bankruptcy sale all of the title which the trustee is authorized to transfer.*fn34

In General Motors Acceptance Corp. v. Raz Delivery, Inc., 238 App.Div. 277, 264 N.Y.S. 412 (1933), noted in 18 Minn.L.Rev. 586 (1934), Raz had purchased two motor vehicles pursuant to conditional sales contracts reserving title in the vendor as security. General Motors was the assignee of the vendor. The conditional sales contracts were recorded subsequent to Raz's filing of a voluntary petition in bankruptcy, and the trustee sold the vehicles free and clear of liens to Weiss. Weiss then sold them to Raz, who had been discharged from bankruptcy and who obviously had knowledge of the conditional sales agreements. In deciding that Raz held the vehicles free of the General Motors' claim, the court did not rely on the fact that the sale to Weiss was free of liens but held that since General Motors was subordinate to the rights of the trustee, "the lien was lost" and could not be asserted against one holding title acquired through the trustee. 264 N.Y.S. at 415.

A similar result was reached in Schuch v. Northrup-Jones, Inc., 162 Cal.App.2d 279, 328 P.2d 279 (1958), where the court held that the purchaser at a bankruptcy sale acquired the property free of liens even though he had knowledge of an unrecorded chattel mortgage and the sale was subject to liens and encumbrances.

In summary we conclude,

(1) that under any interpretation of the Uniform Commercial Code of any of the states which had any contact with this transaction, appellee Schwabe's security interest was unperfected;

(2) that the trustee's status as an ideal lien creditor under § 70(c) of the Bankruptcy Act and under the Uniform Commercial Code enabled him to sell the hydraulic cutting machines free of the unperfected security interest, and

(3) that appellant Armstrong, as a purchaser from the trustee, took title to the machines free of appellee Schwabe's unperfected security interest whether or not Armstrong can be charged with knowledge or notice of such security interest.

Because the result here may seem somewhat harsh, as is not unusual in Uniform Commercial Code cases, we have reviewed with special care the authorities cited by the appellee and we have found none which directly call for a conclusion opposite the one we have reached.*fn35

The order of the district court affirming the order of the referee in bankruptcy will be reversed and the petition for reclamation filed by appellee accordingly denied.

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