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Security Interest Can Survive Commingling of
Sale Proceeds
The Arizona Court of Appeals upholds a
secured supplier’s right to a claim of
“conversion” despite its failure to require
segregation of monies
If a supplier has a security interest in
your inventory, does the supplier’s failure
to require you to place the sale proceeds in
a separate account weaken the security
agreement?
One equipment dealer thought so, as did a
Superior Court judge. Unfortunately for the
dealer – and to the delight of wholesale
suppliers – in September 2004 the Arizona
Court of Appeals saw it a different way.
Background. Case Corporation v.
Gehrke involved a debt owed by Utility
Equipment Company (UEC), a dealer of
trenching equipment, backhoes and other
construction equipment, to one of its
suppliers, Case Corporation. In 1990, UEC’s
owner, Duane Gehrke, acting on behalf of UEC,
signed and personally guaranteed a wholesale
financing and security agreement with Case.
The agreement gave Case a security interest
in all inventory (existing and future) that
Case sold to UEC, as well as the proceeds
from sale of the secured inventory. Case was
to be paid the amounts due it within seven
days of sale. The security agreement also
gave Case the right to require UEC to
deposit sale proceeds into a separate
account to avoid commingling with UEC’s
other funds. Case did not exercise that
right, leaving UEC free to deposit proceeds
from the sale of secured inventory into
their general account. Case’s decision not
to require the segregation of funds would
become central to the eventual dispute
between the parties.
In December 2000, ten years after Case and
UEC executed the security agreement, UEC
defaulted on the agreement by failing to
remit full payment for ten pieces of
equipment that UEC had sold. Case sought to
collect, then terminated the security
agreement. A week later, UEC filed for
Chapter 11 bankruptcy. In an attempt to
skirt the protection of the bankruptcy
court, Case sued the Gehrkes personally in
June 2002, seeking to recover against Gehrke
on his guarantee and alleging that Gehrke
had “converted” more than $600,000 in
proceeds from the sale of equipment in which
Case had a security interest.
Conversion. Conversion is defined as
“an act of wrongful dominion or control over
personal property in denial of or
inconsistent with the rights of another.” To
maintain an action for conversion, a
plaintiff (in this instance, Case Corp.)
must have the right to immediate possession
of the personal property when the alleged
conversion occurs. (A secured party like
Case has the right to immediate possession
of all of its collateral upon the dealer’s
default, and that collateral is identified
by serial number in the transactional
documents.) If the dealer defaults but
refuses to allow return of the remaining
collateral, the secured party has a
sufficient possessory interest in that
collateral to bring an action for its
conversion.
It is relatively difficult to sue for
conversion of money. A conversion claim
cannot be maintained to collect on an
ordinary debt. Money can be the subject of a
conversion claim only if a specific fund
“can be described, identified or segregated,
and an obligation to treat it in a specific
manner is established.”
Summary judgment. Gehrke asked for
dismissal of the conversion claim, arguing
that, before a conversion action could be
brought, the proceeds of sale would have to
be placed in a separate, segregated account
or otherwise subject to an express trust.
Citing two Arizona cases, Autoville v.
Friedman and Universal Marketing and
Entertainment, Inc. v. Bank One of Arizona,
Gehrke contended that, since Case had not
required the segregation of sale proceeds
and allowed UEC to commingle those funds
with the other monies in its general
account, Case’s conversion claim should be
dismissed.
Case responded that, non-segregation aside,
its right to an action for conversion was
preserved through its ownership interest in
both the equipment and the proceeds of sale.
Siding with Gehrke, the trial court
dismissed Case’s conversion claim, finding
that “title to the inventory was in [UEC],
and all proceeds were deposited to the
general corporate account of UEC before any
demand was made by Plaintiffs to segregate
the funds.”
Reversal. Case appealed the
dismissal, and the Arizona Court of Appeals
reversed the trial court’s ruling and
remanded it for trial.
The Court found that, when a secured party
holds a security interest in the proceeds of
sale, that security interest is sufficient
to identify non-segregated funds and
preserve a cause of action for conversion of
the money. The Court also ruled that neither
of the decisions cited by Gehrke applied to
this case:
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In Autoville, the plaintiff had no
security interest in either the vehicles
he provided to the defendant or the
proceeds of their sale. The plaintiff’s
relationship with the defendant was no
more than that of creditor and debtor.
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In Universal Marketing, the
plaintiff put $50,000 in an individual’s
bank account to finance purchase of a
business. Before the purchase could be
completed, however, the defendant
garnished the account and seized the
plaintiff’s funds. The plaintiff could not
maintain an action for conversion because
it did not take appropriate steps to
identify and maintain a possessory
interest in the funds it transferred.
The Court held that, in contrast, Case had
perfected a security interest in both the
collateral and the proceeds of sale, and a
security interest in specific proceeds
allows them to be identified even when they
are commingled with other funds:
“Case had a security interest in both the
equipment and in the proceeds from any
sale of the equipment. The agreement
between the parties required that the
proceeds from any sale be deposited into
UEC’s account and electronically
transferred to Case within seven days. On
the eighth day after the sale, if the
funds were not deposited and transferred,
UEC had defaulted on the agreement and
Case had the right to immediate possession
of the equipment or the proceeds.”
“We cannot accept the Gehrkes’ argument
that a security interest in proceeds is
destroyed when the debtor commingles the
proceeds with other funds. Such a decision
would give the debtor the ability to
unilaterally cancel a creditor’s security
interest in the proceeds of sale and would
controvert Arizona law. A.R.S. §
47-9315(B)(2) [2003]. (“Proceeds [that are
not goods] that are commingled with other
property are identifiable proceeds . . .
to the extent that the secured party
identifies the proceeds by a method of
tracing, including application of
equitable principles, that is permitted
under law[.]”)
Gehrke establishes a precedent for a
secured party with a security interest in
sale proceeds to sue a business owner
individually if that owner fails to see that
the company pays the sale proceeds required
by the financing or security agreement. This
individual right of action is separate from
any personal guarantee the owner may have
signed, and it cannot be avoided by putting
the business into bankruptcy. Every owner of
a business that floors vehicles, equipment
or any other personal property under a
financing agreement should be aware of this
potential liability.
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