Munao v. Lagattuta

THIRD DIVISION
February 18, 1998

No. 1-96-1990

MICHAEL MUNAO and CHARLENE MUNAO,

Plaintiffs and
Counterdefendants-Appellees,

v.

NICHOLAS LAGATTUTA, DENNIS J. LULLO, and
LULLO FOOD SERVICE COMPANY, an Illinois
Corporation,

Defendants and
Counterplaintiffs-Appellants.

)
)
)
)
)
)
)
)
)
)
)
)
)
Appeal from the
Circuit Court of
Cook County

No. 91 L 4908

Honorable
Kenneth L. Gillis,
Judge Presiding.
 JUSTICE CAHILL delivered the opinion of the court:
After defendants defaulted on a note and lease, plaintiffs,
Michael and Charlene Munao, sued to recover the balance owed on the
note and lease. After a bench trial, the trial court ruled for
plaintiffs on a deficiency claim and against defendants, Nicholas
Lagattuta, Dennis J. Lullo, and Lullo Food Service Company, on
their counterclaim for surplus received by plaintiffs from
retention of the security. The trial court found that defendants
were entitled to a credit on the note in the amount of $9,067.07.
The trial court entered judgment for plaintiffs in the amount of
$83,483.38 on the note and $13,093.81 on the lease. Defendants
appeal. We affirm.
Between 1980 and 1990 plaintiffs owned and managed a
restaurant known as "Dilly Deli" in Des Plaines, Illinois. On
August 24, 1990, the plaintiffs sold Dilly Deli to defendants for
$104,000. Defendants paid $46,000 at closing and gave plaintiffs
a note for the balance, $58,000.
The individual and corporate defendants signed a security
agreement with the note. Collateral for the security agreement
included "[a]ll equipment, inventory, fixtures used in connection
with 'the Dilly Deli'" but did not include goodwill.
Defendant corporation Lullo Food Service Company signed a
lease for $2,000 rent per month plus taxes and insurance. The
lease was guaranteed by individual defendants Lullo and Lagattuta.
Defendant Lullo and his wife, Lillian Lullo, managed the
restaurant. Lagattuta was a silent partner. Shortly after the
sale, defendants changed the name of the restaurant to "Papa D's."
For six days after closing, plaintiffs spent time at the
restaurant teaching the Lullos how to manage the restaurant. The
transition is relevant to a collateral issue raised by defendants:
that the trial court's judgment ignored goodwill in calculating the
value of collateral.
Plaintiffs observed changes in the way the restaurant was run
in the course of these six days. Instead of cooking homemade soup
and preparing food to order, defendants served canned soup and
precooked food. They served hot dogs that had been cooked the day
before and bread that was not fresh. Instead of buying meat and
cheese from restaurant purveyors, they bought food from a discount
warehouse. They bought less expensive brownies and tuna. The
system of taking orders changed and mistakes were made in taking
orders. Food was served in paper bags rather than on dishes or in
baskets. Lillian and Dennis Lullo smoked while they worked.
A former customer, George Heyman, also noticed changes in the
restaurant. He ate at the restaurant several times a week when
plaintiffs owned it. He said that, after defendants took over, the
restaurant was smoky, tables were not kept as clean, the restroom
was dirty and the food quality declined. He eventually stopped
eating there.
Defendants paid the first two months' rent and tax payments
late. They claimed that business was slow because of road
construction in front of the restaurant. Plaintiffs accepted the
late payments and agreed to defer real estate tax payments until
the road construction ended. In November defendants failed to pay
rent and to make payment on the note.
Defendant Lagattuta testified that he met with plaintiff
Michael Munao in November or December. They agreed that if the
restaurant was returned to the plaintiffs, defendants would be
released from their obligation on the note and lease. Plaintiff
Michael Munao denied that the conversation took place.
Plaintiff's attorney, Joseph Mulhern, testified that he spoke
with defendant Lagattuta. Mulhern told Lagattuta that surrender of
the keys was a condition precedent to a settlement discussion.
Lagattuta never told Mulhern he had an agreement with plaintiffs to
be released from his obligations in exchange for return of the
restaurant. Lagattuta delivered the keys to Mulhern's office on
January 3, 1991. Mulhern then had several settlement discussions
with Lagattuta and his attorney.
After plaintiff Michael Munao received the keys, he hired
Burton Tunick to appraise the restaurant equipment and to determine
the fair market value. Tunick appraised the fixtures, furniture
and equipment at a fair market value of $8,590. Michael Munao
testified that based on prices he paid for similar merchandise, the
useable inventory left had a value of $477.07.
On March 15, 1991, plaintiffs reopened the restaurant under
the name of "C & M." Plaintiff Michael Munao claims that he then
credited the balance due on the note with the appraised fair market
value of the fixtures, equipment and furniture, and $477.07 for
inventory. Munao testified that he did this because he believed
plaintiffs "bought" the equipment and inventory when they used it
after the restaurant was returned. In October 1991, after losing
$42,023, plaintiffs closed the restaurant. The building was then
leased to Roger Walsh until April 1992. In November 1993, the
plaintiffs sold the real estate, equipment and furniture.
At trial, two witnesses testified about the value of the
collateral. Tunick testified for plaintiffs about the method he
used to calculate the fair market value of the equipment. After
looking at the equipment on site, he called manufacturers and
dealers of used restaurant equipment to learn the resale value.
Erwin Linkman testified for defendants that the value of the
equipment and furniture was $71,500. He based this estimate on the
inventory, equipment, and "key value" of the restaurant. He
defined "key value" as the earning power of the business. He did
not examine the equipment or inventory, but used the 1988 and 1989
financial statements for Dilly Deli to support his evaluation.
Linkman testified that his method of evaluating Papa D's
differed from the way he normally evaluated restaurants. He
normally used three years' income to evaluate a business. His
opinion here, however, was based only on Dilly Deli's income for
two years. He did not consider 1990 income, which reflected losses
under Lullo's management. His opinion was also based on the
assumption that "no significant operational changes were made in
the 120 day period between September 1, 1990 and December 27,
1990."
Defendants argue on appeal that plaintiffs should be barred
from a deficiency judgment because their actions after defendants
returned the keys established one of the following: (1) an election
to retain the collateral in full satisfaction of the debt under
section 9-505(2) of the Uniform Commercial Code (the Code) (810
ILCS 5/9-505(2)(West 1996)); or (2) a sale of the collateral either
to themselves or to the November 1993 purchasers, in violation of
section 9-504 of the Code (810 ILCS 5/9-504 (West 1996)). They
also argue that the court failed to account for the restaurant's
goodwill and erred in finding for plaintiffs on defendants'
counterclaim.
We first address defendants' argument that plaintiffs'
behavior after return of the keys established an election to retain
the collateral in full satisfaction of the debt under the
provisions of section 9-505(2) of the Code. Section 9-505(2)
provides that "a secured party in possession may, after default,
propose to retain the collateral in satisfaction of the
obligation." 810 ILCS 5/9-505(2) (West 1996).
Defendants contend that when the plaintiffs took the keys
back, reopened the restaurant, leased the restaurant, and finally
sold the property, their actions established an election to retain
the collateral in satisfaction of the debt.
Plaintiffs contend that they did not accept the collateral in
full satisfaction of the debt. They argue that they disposed of
the collateral by selling it to themselves when they credited the
amount due on defendants' note with the appraised value of the
equipment and inventory.
Defendants respond that plaintiffs could not have purchased
the collateral under these facts because the Code restricts a
secured party's right to purchase collateral at a private sale. A
secured party may purchase collateral at a private sale only "if
the collateral is of a type customarily sold in a recognized market
or is of a type which is the subject of widely distributed standard
price quotations." 810 ILCS 5/9-504(3) (West 1996). Defendants
argue that the collateral here is of neither type, and that because
plaintiffs were not allowed to purchase the property under the
Code, their actions must be read in only one way: as an election to
retain the collateral. But plaintiffs' sale of the collateral to
themselves does not compel such a conclusion. It only compels a
conclusion that plaintiffs concede: that the sale of the collateral
to themselves violated section 9-504(3) of the Code.
Plaintiffs further argue that there can be no retention since
there was no written notice of plaintiffs' intention to retain the
collateral in satisfaction of the debt as required by the Code.
Plaintiffs cite Stensel v. Stensel, 63 Ill. App. 3d 639, 380 N.E.2d 526 (1978), for the proposition that an implicit or constructive
retention is not possible. In Stensel, the fourth district held
that a section 9-505(2) retention could not occur absent the
written notice required by the Code. 63 Ill. App. 3d at 642. Cf.
Patrick v. Wix Auto Co., 288 Ill. App. 3d 846, 681 N.E.2d 98 (1997)
(requiring strict compliance with statutory notice requirement in
debtor's suit for damages based on creditor's noncompliance with
section 9-505(2)). This view is shared by courts of several other
jurisdictions. See, e.g., In re Nardone, 70 B.R. 1010, 1016-17
(Bankr. D. Mass. 1987); Alamosa National Bank v. San Luis Valley
Grain Growers, Inc., 756 P.2d 1022 (Colo. App. 1988); S.M.
Flickinger Co. v. 18 Genesee Corp., 71 A.D.2d 382, 423 N.Y.S.2d 73
(1979). These courts reason that section 9-505(2) was not designed
to protect the debtor. See Jones v. Morgan, 58 Mich. App. 455,
461, 228 N.W.2d 419, 423 (1975); S.M. Flickinger, 71 A.D.2d at 386,
423 N.Y.S.2d at 76. They note that a debtor's remedies do not lie
in section 9-505(2), but in section 9-507. The debtor may restrain
or compel disposition of the collateral or charge the creditor with
the loss that results from an unauthorized disposition. 810 ILCS
5/9-507 (West 1996).
Defendants direct us to cases in other jurisdictions that
reject this approach. Other jurisdictions take two alternative
approaches. Some courts hold that a section 9-505(2) election to
retain collateral in satisfaction of a debt can be implied from an
unreasonably long retention of collateral. See, e.g., In re Boyd,
73 B.R. 122, 124-25 (Bankr. N.D. Tex. 1987); Moran v. Holman, 514 P.2d 817, 820-21 (Alaska 1973). See also Schultz v. Delaware Trust
Co., 360 A.2d 576, 578-79 (Del. Super. Ct. 1976); Service
Chevrolet, Inc. v. Sparks, 99 Wash. 2d 199, 203, 660 P.2d 760, 763
(Wash. 1983). These courts are generally guided by a concern that
the creditor may profit by his own failure to give notice. See
Service Chevrolet, 99 Wash. 2d at 203, 660 P.2d at 763.
Other courts require the debtor to prove that the creditor
intended to accept the collateral in satisfaction of the
obligation. Proof of intent is required under common law accord
and satisfaction. See Nelson v. Armstrong, 99 Idaho 422, 430, 582 P.2d 1100, 1108 (Idaho 1978); Winters National Bank & Trust Co. v.
Saker, 66 Ohio App. 2d 31, 35, 419 N.E.2d 890, 893-94 (1979).
We see no reason to deviate from the rule set out in Stensel
that a retention cannot be imputed to the creditor without written
notice to the debtor of the intent to retain. Section 9-505(2)
states that a creditor may elect to retain the collateral in
satisfaction of the debt. The Code creates a statutory presumption
that the creditor elected to retain the collateral in satisfaction
of the debt when notice is given. Absent written notice, a debtor
is not entitled to the presumption. He has the burden of
establishing that the parties agreed to a retention of the
collateral in full satisfaction of the debt. This reading of
section 9-505(2) is consistent with section 9-504(2) which states
that "[i]f the security interest secures an indebtedness, ***
unless otherwise agreed, the debtor is liable for any deficiency."
(Emphasis added.) 810 ILCS 5/9-504(2) (West 1996).
In some circumstances, a debtor may be able to establish that
the creditor intended to retain the collateral in full satisfaction
of the debt without the statutory presumption operating in the
debtor's favor. Such circumstances do not exist here where there
was no written notice or other clear proof reflecting an intent to
accept the collateral in full satisfaction of defendants' debt.
Without a presumption, defendants undertook a difficult task
in trying to prove that plaintiffs chose to accept $9,067.07 worth
of equipment and inventory in full satisfaction of their $58,000-
plus-interest debt. The disparity between the value of the
collateral and the debt was so great that plaintiffs' acceptance of
the collateral in full satisfaction of the debt would have made
little economic sense. Defendants did not overcome plaintiffs'
evidence that plaintiffs "sold" the collateral to themselves at a
fair price and did not intend to retain the collateral in full
satisfaction of the debt.
We next address the circumstances under which a secured
creditor may obtain a deficiency judgment even though the
collateral was disposed of in violation of section 9-504 of the
Code. Plaintiffs concede, and we agree, that whether plaintiffs
bought the equipment themselves or sold it in November 1993,
plaintiffs were not in compliance with section 9-504. Crediting
the amount due on defendants' note with the equipment's appraised
value and "purchasing" the equipment themselves was improper
because the Code prohibits a secured creditor from purchasing the
collateral at a private sale unless the collateral is customarily
sold in a recognized market or is the subject of widely distributed
price quotations. 810 ILCS 5/9-504(3) (West 1996). Further,
plaintiffs did not give notice to defendants when they decided to
"purchase" the equipment themselves or when they sold the equipment
in November 1993.
But plaintiffs' improper disposition of the collateral does
not "toll the death" of plaintiffs' cause of action as defendants
would have us hold. Defendants urge us to follow Lamp Fair, Inc.
v. Perez-Ortiz, 888 F.2d 173, 176 (1st Cir. 1989), and find that
the plaintiffs cannot maintain a deficiency action here. In Lamp
Fair, the United States Court of Appeals for the First Circuit
concluded, on two alternative grounds, that the secured creditor
could not retain the collateral and also obtain a deficiency
judgment. First, the court found the secured party's actions
amounted to a "retention" under section 9-505(2). Lamp Fair, 888 F.2d at 177. This grounds for denying a deficiency judgment is
inappropriate in light of our conclusion that a section 9-505(2)
election to retain did not occur here.
Lamp Fair also concluded that under section 9-504 the secured
party's failure to dispose of collateral resulted in a loss of the
right to a deficiency judgment because a deficiency judgment would
circumvent "'the Code's mandate that an effective election to
retain the collateral results in a complete discharge of the
underlying obligation.'" Lamp Fair, 888 F.2d at 178, quoting In re
Appeal of Copeland, 531 F.2d 1195, 1207 (3d Cir. 1976).
We reject the second Lamp Fair approach as well. It is
inconsistent with Illinois court holdings that improper disposition
does not bar a plaintiff's deficiency claim. See First Galesburg
National Bank & Trust Co. v. Joannides, 103 Ill. 2d 294, 469 N.E.2d 180 (1984) (failure of secured creditor to give notice of sale does
not bar deficiency judgment); Standard Bank & Trust Co. v.
Callaghan, 177 Ill. App. 3d 973, 980-82, 532 N.E.2d 1015 (1988)
(commercially unreasonable sale does not bar deficiency judgment).
Defendants argue that First Galesburg holds that a deficiency
judgment may be obtained only if the secured creditor shows both
that the value of the collateral was less than the indebtedness and
that the sale was commercially reasonable. 103 Ill. 2d at 298, 469 N.E.2d at 181. We have no quarrel with this reading of First
Galesburg. However, even if the disposition of the collateral were
presumptively a commercially unreasonable sale, plaintiffs are
still entitled to rebut the presumption that the collateral is
equal to the debt and to overcome the presumption of a commercially
unreasonable sale by showing that the sale price for the collateral
was fair. See First Galesburg, 103 Ill. 2d at 300; Standard Bank
& Trust Co. v. Callaghan, 177 Ill. App. 3d at 980-82. As the court
in Callaghan noted, "[r]egardless of whether the impropriety is in
the notice or the reasonableness of the sale itself, absolutely
barring the creditor any deficiency would provide the debtor with
a windfall and arbitrarily penalize the creditor." Callaghan, 177
Ill. App. 3d at 981. Plaintiffs' improper disposition of the
collateral results only in a rebuttable presumption that the
collateral is equal to the debt. If the secured party rebuts this
presumption, he is entitled to recover any proven deficiency. See
First Galesburg National Bank and Trust Co., 103 Ill. 2d at 300-01.
Whether the creditor has overcome the presumptions working against
him with sufficient evidence is for the trier of fact. See A.A.
Store Fixture Co. v. Kouzoukas, 87 Ill. App. 3d 631, 635, 410 N.E.2d 131 (1980).
At trial, both parties presented evidence of the value of the
collateral received by plaintiffs. The trial judge found
plaintiffs' witness to be more reliable and shaped his judgment
around that witness's evaluation. We will affirm a trial court's
valuation on review unless it is against the manifest weight of the
evidence. Kalabogias v. Georgou, 254 Ill. App. 3d 740, 749, 627 N.E.2d 51 (1993). Here, the trial judge carefully reviewed the
content and reliability of each witness's testimony. The trial
judge found Tunick's testimony buttressed by evidence that
defendants significantly changed the business for the worse. By
establishing fair market value, plaintiffs successfully rebutted
the presumption that the value of the collateral is equal to the
debt. The trial court's finding was not against the manifest
weight of the evidence.
Defendants contend that plaintiffs failed to rebut the
presumption that the collateral equals the amount of the debt
because they ignored the goodwill of the restaurant in their
calculations. The Illinois cases relied upon by defendants hold
that the transfer of goodwill is incident to the transfer of a
business in various situations. See In re Fitch, 174 B.R. 96
(Bankr. S.D. Ill. 1994); Weitekamp v. Lane, 250 Ill. App. 3d 1017,
1024, 620 N.E.2d 454 (1993); Russell v. Jim Russell Supply, Inc.,
200 Ill. App. 3d 855, 861, 558 N.E.2d 115 (1990). This case
involves a security agreement separate from the sales contract that
does not mention goodwill or the business itself. The collateral
encompassed by the security agreement includes only equipment,
inventory, and fixtures.
Defendants further argue that the value of the restaurant's
goodwill must be credited to defendants to avoid unjust enrichment.
Defendants only cite Lilly v. Terwilliger, 244 Mont. 93, 98-101,
796 P.2d 199, 202-04 (Mont. 1990), where the trial court used the
value of goodwill to offset a deficiency despite the fact that
goodwill was not part of the security agreement. This offset was
not challenged or discussed on appeal, so the case is of little
precedential value.
Even if we adopt defendants' argument that a credit for
goodwill must be factored in, the record here supports plaintiffs'
position that they were not "enriched" with the goodwill of Papa
D's upon return of the restaurant. The evidence established that
whatever goodwill defendants "purchased" was dissipated by
defendants' conduct of this business.

Based on our conclusion that the trial court did not err in
calculating plaintiffs' deficiency judgment, we need not address
defendants' argument that they are entitled to the value of the
collateral exceeding the amount of their debt.
Affirmed.
GORDON and COUSINS, JJ., concurring.