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United States v. Dunlap

argued: June 5, 1986.


Appeal From the United States District Court for the Eastern District of Pennsylvania, D.C. Civil Nos. 83-6230, 83-6232.

Author: Weis


WEIS, Circuit Judge.

The question in this appeal is whether federal agency regulations or state law give content to federal law in determining the status of a lien on collateral for a loan made by the Farmers Home Administration. The district court chose the agency regulations as appropriate, but we decide that the controlling Supreme Court decision requires resort to state law. We also conclude that even under its own regulations, the Farmers Home Administration is not entitled to prevail. Accordingly, we will reverse the summary judgment in favor of the government and direct entry of judgment in favor of defendants.

The parties filed cross-motions for summary judgment. After consideration of the material in the record, the district court granted the government's motion but denied the defendants. The court also declined reconsideration and defendants have appealed.

Defendants are commission brokers in Pennsylvania who sell livestock at auctions. Customarily, the farmers bring livestock to defendants the day before the scheduled sale, and in accordance with the dictates of the Packers and Stockyards Act, 7 U.S.C. § 228b (1982), the brokers pay the farmers in full within twenty-four hours of the sale.

The controversy here stems from the defendants sale of livestock owned by Mark Noll, which was collateral for loans from the Farmers Home Administration (FmHA).*fn1 In August 1979, Noll borrowed $90,000 from the FmHA as an operating loan for his farm in Lancaster County, Pennsylvania, and in December 1980, he secured $230,360 as an emergency loan. As part of the transactions, Noll granted FmHA a security interest in existing and after-acquired livestock, crops, and farm equipment. FmHA filed financing statements in the local court office in accordance with state law.

Noll signed a form which provided that the collateral could "not be sold, transferred, or encumbered . . . without the written consent of the Government." Included in the form was another provision that obligated him to "comply with such farm and home management plans as may be agreed upon from time to time by Debtor and Secured Party."

Noll and the local representative of FmHA prepared a "Farm and Home Plan", form No. FmHA 431-2, which listed in detail the debtor's assets, liabilities, living expenses, and other expenditures including feed and supplies. That document also projected selling dates for cattle an crops, anticipated receipts, and outlined repayment of the FmHA loans. The plan authorized Noll to sell the cattle as they became ready for market and to pay FmHA as per a schedule.*fn2 Receipts in excess of the payments to FmHA were available for normal farm operating and living expenses.

Defendants did not have actual knowledge of the FmHA liens, and they, along with other brokers, sold all of Noll's cattle in 1981.*fn3 After deducting commissions, they paid Noll $224,791.39. He in turn deposited the funds in his bank account, and remitted $155,00 to FmHA and $21,486 to an approved secured creditor. He used the balance of $42,485.39 to purchase livestock feed and pay farm and living expenses.

Because of falling cattle prices, the actual receipts were less than those outlined in the Farm and Home Plan. In August 1981, the FmHA county supervisor met with Noll to discuss the status of the loan in view of the amount still due after the sale of all the cattle. Noll asked for another loan to pay for the expenses of harvesting his tobacco crop but that request was denied.

Soon afterward, Noll filed a petition in bankruptcy and in due course the FmHA debt was discharged. The government then filed these actions for conversion against defendants to recover the gross proceeds each had received form the sale of the cattle.

In addressing the cross-motions for summary judgment, the district court concluded that whether FmHA's security interest in the cattle had been released was a matter to be determined under federal law. However, since no relevant federal legislation existed, the court applied FmHA regulations governing the disposition of collateral as the rule of decision rather than state law.

The court rejected use of the Uniform Commercial Code because in its view United States v. Kimbell Foods, Inc., 440 U.S. 715, 59 L. Ed. 2d 711, 99 S. Ct. 1448 (1979), permits the invocation of state law only in the absence of a controlling federal rule. When, as here, FmHA regulations specifically addressed the release of collateral, the district court believed it had no choice but to incorporate those regulations as the rule of decision. The district judge cited this court's precedent in United States v. Kennedy, 738 F.2d 584 (3d Cir. 1984), and United States v. Sommerville, 324 F.2d 712 (3d Cir. 1963), as generally supporting this conclusion.

The district court found that even though FmHA had acquiesced in the sales, the government's security interest nonetheless was not released because the proceeds from the cattle had not been applied in accordance with 7 C.F.R. §§ 1962.17 and 1962.18 (1985). Finding that the cattle were "basic" rather than "normal" security, as defined by the regulations, the district court ruled that the proceeds could not be used to pay routine living and farm maintenance expenses.

Following conferences with the court on damages, the parties stipulated the amounts due, and judgments were entered against defendants.

On appeal, defendants contend that the district court erred in failing to adopt state law as the rule of decision. In the alternative, they argue that even if the FmHA regulations were applicable the court erred in not characterizing the collateral as "normal income security." Under such a designation, Noll would have been permitted to apply the proceeds as he did. Defendants further assert that the prompt payment provisions of the Packers & Stockyards Act exempt them from liability, and that market conditions, not the cattle sales per se, were the cause of FmHA losses.

Preliminarily, we believe it important to put the holdings in Kennedy and Sommerville in context.

Kennedy presented a very narrow question -- whether the complaint stated a claim for conversion against the buyer of collateral that secured FmHA loans. Applying the rule of conversion enunciated in Sommerville, we held that "under the general federal law the Government's complaint . . . alleged sufficient facts to withstand [a] motion to dismiss." Those facts included the purchase of collateral by defendants, the debtors' failure to apply all of the proceeds toward repayment of the loan, and the defendants' refusal to pay the amount the debtors misapplied. the procedural posture of the case required that the allegations of the complaint be construed in favor of the government. Reading the complaint in that fashion permitted an inference that despite knowledge of the FmHA lien, the purchaser nevertheless made some payments directly to the debtor and ignored the FmHA's interest.

After resolving the issue presented, the panel went on to discuss why state law was inapplicable.*fn4 Referring to Kimbell and Sommerville, the panel noted that "because we are not acting in the absence of an existing federal rule, we are not at liberty to adopt state law as the measure of the federal rule. Instead, we must apply the federal rule [of conversion] as articulated in Sommerville." 738 F.2d at 586 n.3. That statement, being unnecessary to the holding in Kennedy, was dictum which has led to some uncertainty. Therefore, a detailed discussion of Kimbell and Sommerville may help clarify those misconceptions.

The debtor in Sommerville had an auctioneer sell livestock encumbered by an FmHA loan. But unlike the situation in this case, FmHA had not approved the sale and did not have any knowledge of the transaction at the time.

Citing Clearfield Trust Co. v. United States, 318 U.S. 363, 87 L. Ed. 838, 63 S. Ct. 573 (1943), Sommerville stated that the need to protect the United States fisc required the application of federal law to questions arising under FmHA programs. In determining what principles to incorporate as the content of that federal law, the Court concluded that the "interest of the United States in the administration of the loan program would be undermined and its power to protect its purse limited if disparate laws of individual states were applied to substantially identical loan transactions." 324 F.2d at 716.

Although it conceded that the Uniform Commercial Code in effect in Pennsylvania would set the conditions for recordation of the security agreement and perfection of the lien, the panel expressly rejected use of any other state law. The court noted that "absent express congressional declaration of intent that state law shall be applicable, we are reluctant to subject federal rights and duties to the exceptional uncertainty and heterogeneity which may ensue in many cases. We will not do so." 324 F.2d at 717.

Sommerville thus adopted general federal common law as the content of the rule of decision. This court was jointed in that approach by the Sixth, Ninth, and Tenth Circuits.*fn5 Two courts of appeals held that priority conflicts should be determined under state law.*fn6 One other court, the Court of Appeals for the Fifth Circuit in United States v. Hext, 444 F.2d 804 (5th Cir. 1971), used the Uniform Commercial Code as the source of federal law. For a review of the disagreement among the circuits, see Clark. The Law of Secured Transactions Under the Uniform Commercial Code P8.4[3][d] (1980); Note, Adopting State Law as the Federal Rule of Decision: A Proposed Test, 43 U. Chi. L. Rev. 823 (1976).

In United States v. Kimbell Foods, Inc., 440 U.S. 715, 59 L. Ed. 2d 711, 99 S. Ct. 1448 (1979), which involved the priority of federal and private liens, the Supreme Court resolved the conflict among the courts of appeals. In conformity with Clearfield Trust, the Court held that the issues had to be decided with reference to federal law. To that extent, the Supreme Court approved the Sommerville approach.

However, Kimbell disagreed with the premise that nationwide standards were necessary for the federal lending programs and hence disapproved Sommerville's creation of federal common law principles. Rather the Court concluded that "state law may be incorporated as the federal rule of decision" because "state commercial codes 'furnish convenient solutions in no way inconsistent with adequate protection of the federal interest.'" 440 U.S. at 729. Furthermore, the Court declined "to override intricate state laws of general applicability on which private creditors base their daily commercial transactions." Id.

The Court emphasized that "had Congress intended the private commercial sector, rather than taxpayers, in general to bear the risks of default entailed by these [specialized loan] programs, it would have established a priority scheme displacing state law." 440 U.S. at 735. "The prudent course [therefore] is to adopt . . . state law as the federal rule of decision until Congress strikes a different accommodation." Id. at 740. Hence, the Court held that in the absence of "a congressional directive, the relative priority of private liens and consensual liens arising from these Government lending programs is to be determined under nondiscriminatory state laws." Id.

Kimbell is not a conversion case, but its discussion and holding undermine the validity of Sommerville's rejection of the Uniform Commercial Code as a source of the federal rule of decision. Accord United States v. Progressive Farmers Marketing Agency. 788 F.2d 1327 (8th Cir. 1986); United States v. Tugwell, 779 F.2d 5 (4th Cir. 1985); United States v. Public Auction Yard. Billings, Mont., 637 F.2d 613 (9th Cir. 1980); United States v. Southeast Miss. Livestock Farmers Ass'n., 619 F.2d 435 (5th Cir. 1980); United States v. Friend's Stockyard, Inc., 600 F.2d 9 (4th Cir. 1979). Clark, The Law of Secured Transactions P8.4[3][d] (1980). Cf. United States v. Missouri Farmers Ass'n., Inc., 764 F.2d 488 (8th Cir. 1985); United States v. Farmers Co-Op Co., 708 F.2d 352 (8th Cir. 1983).

Relying on Kimbell, defendants here cite § 9-306 of the Uniform Commercial Code, which states that "a security interest continues in collateral notwithstanding sale, exchange or other disposition thereof unless the disposition was authorized by the secured party in the ...

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