Goldmann, Leonard and Mountain. The opinion of the court was delivered by Mountain, J.A.D.
Defendants Gurtman and Matthews appeal from a Chancery Division judgment entered against them in favor of plaintiff in the sum of $16,188.66 together with costs.
A brief summary of the facts is necessary to an understanding of the issues involved. Plaintiff was a supplier of steel to Paterson Boiler and Tank, Inc. (Paterson). Defendants Gurtman and Matthews were officers of Paterson. The latter manufactured and sold finished steel and aluminum products to various customers, including York Separators
(York). Paterson had a checking account with Bank of Passaic and Clifton, not now a party to this suit.
In December 1966 plaintiff, under the protection of a perfected security agreement, shipped materials to Paterson which it used in manufacturing a product sold to York. In payment York issued its check to Paterson in the amount of $25,248. The check was deposited by Gurtman, apparently with the knowledge of Matthews, in Paterson's regular checking account in Bank of Passaic and Clifton. Paterson then issued its check in the sum of $22,954.44 to the order of plaintiff in payment of the materials originally received. This check was deposited for collection, but prior thereto and on May 5, 1967 Paterson filed a petition in the Federal District Court for the District of New Jersey under Chapter XI of the Bankruptcy Act. The check issued to plaintiff by Paterson was not paid. The bank then charged Paterson's account by way of set-off with the balance due on a loan owed by Paterson to the bank in the amount of $8,028, together with the sum of $10,320.99 due the bank under a letter of credit it had issued in favor of Paterson. The balance of the account, $9,917, was turned over to the receiver appointed in the Chapter XI proceeding and thereafter, upon application being made by plaintiff in the federal court, was paid to it, less the sum of $750 allocated to administration expense. The present suit was brought against the individual defendants as officers and directors of Paterson, the theory of the case being that they are liable for having converted assets in the hands of Paterson which constituted security properly belonging to plaintiff.
The Chancery Division judge found in favor of plaintiff on the ground that the individual defendants, as such officers and directors, owed a duty to plaintiff, as a secured creditor of Paterson, to protect assets that came through their hands and that were properly subject to its security agreement. The deposit in Paterson's checking account of the funds received from York, thus exposing them to an exercise by the bank of its right of set-off, was held to be a breach
of this duty and to constitute a conversion. In view of the trial judge's conclusion that conversion took the form of subjecting the proceeds received from York to an improper and unacceptable risk, namely, the possibility that the bank might exercise a right of set-off, we are faced with an initial inquiry as to whether the bank did or did not have this right under the facts as they existed when the deposit was made and the bank charged the account. The issue was not determined by the trial judge; it was apparently assumed that the right did exist. It is true that at one point the individual defendants suggested or requested that the bank be made a party to the suit -- presumably to test the validity of its right of set-off -- but no formal motion looking to this end was ever made. Clearly, if the bank had no right of set-off, then the deposit of the proceeds in the account did not subject the funds to this risk and cannot be considered a conversion. We deem it essential, therefore, to determine whether or not the right did actually exist.
In examining this question we think attention must first be focused upon the Uniform Commercial Code. N.J.S.A. 12A:9-306, dealing with a secured party's rights on disposition of collateral, reads in pertinent part, as follows:
(1) "Proceeds" includes whatever is received when collateral or proceeds is sold, exchanged, collected or otherwise disposed of. The term also includes the account arising when the right to payment is earned under a contract right. Money, checks and the like are "cash proceeds". All other proceeds are "non-cash proceeds".
(2) Except where this Chapter otherwise provides, a security interest continues in collateral notwithstanding sale, exchange or other disposition thereof by the debtor unless his action 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.
(3) The security interest in proceeds is a continuously perfected security interest if the interest in the original collateral was perfected but it ceases to be a perfected security interest and becomes unperfected ten ...