KENTUCKY HIGHLANDS INVESTMENT CORPORATION v. BANK OF CORBIN, INC.
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RENDERED:
SEPTEMBER 15, 2006; 10:00 A.M.
TO BE PUBLISHED
Commonwealth Of Kentucky
Court of Appeals
NO. 2005-CA-000686-MR
KENTUCKY HIGHLANDS INVESTMENT
CORPORATION
v.
APPELLANT
APPEAL FROM WHITLEY CIRCUIT COURT
HONORABLE JERRY D. WINCHESTER, JUDGE
ACTION NO. 04-CI-00131
BANK OF CORBIN, INC.
APPELLEE
OPINION
AFFIRMING
** ** ** ** **
BEFORE:
JUDGE.
COMBS, CHIEF JUDGE; GUIDUGLI, JUDGE; HUDDLESTON,1 SENIOR
COMBS, CHIEF JUDGE:
Kentucky Highlands Investment Corporation
(“Kentucky Highlands”) appeals from a summary judgment granted
by the Whitley Circuit Court in favor of the Bank of Corbin,
Inc., (“the Bank”).
The appeal involves a priority dispute
between Kentucky Highlands and the Bank of Corbin.
1
The Bank
Senior Judge Joseph R. Huddleston sitting as Special Judge by assignment of
the Chief Justice pursuant to Section 110(5)(b) of the Kentucky Constitution
and KRS 21.580.
claimed a right of set-off against funds in a commercial deposit
account.
Kentucky Highlands asserted a perfected security
interest in the same funds.
After considering the relevant
provisions of Kentucky’s commercial code together with the
arguments of counsel, we affirm the summary judgment of the
trial court.
Kentucky Highlands was the primary lender to TriCounty Manufacturing and Assembly Incorporated (“Tri-County
Manufacturing”) and its affiliates, including Tritech
Electronics, LLC (“Tritech”).
Various loans extended to these
debtors by Kentucky Highlands totalled more than five million
dollars.
Kentucky Highlands contended that the loans were
secured by a properly perfected security interest in all of the
debtors’ personal property and an assignment of the debtors’
customer accounts receivable.
Tritech maintained a commercial deposit account with
the Bank of Corbin.
The Bank obtained a security interest in
the deposits held at the Bank pursuant to a loan agreement dated
April 6, 2001, between Tritech and the Bank, and it held a wellestablished right of set-off against the account.
Customer payments generally were not deposited into
Tritech’s account.
Instead, provisions of its loan agreements
with Kentucky Highlands required Tritech to direct customers to
remit their payments directly to Kentucky Highlands.
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The
Tritech deposit account was funded primarily by transfers from
an account held by Tri-County Manufacturing.
Tri-County
Manufacturing funded those advances on a line of credit provided
by Kentucky Highlands.
Kentucky Highlands was aware of
Tritech’s account with the Bank of Corbin.
Pursuant to the
provisions of KRS2 355.9-104(1), it could have taken steps to
protect itself by taking control of the account.
attempts to do so.
(1)
But it made no
KRS 355.9-104 provides as follows:
A secured party has control of a deposit account if:
(a)
(b)
(c)
The secured party is the bank with which the
deposit account is maintained;
The debtor, secured party, and bank have
agreed in an authenticated record that the
bank will comply with instructions originated
by the secured party directing disposition of
the funds in the deposit account without
further consent by the debtor; or
The secured party becomes the bank’s customer
with respect to the deposit account.
(Emphasis added).
In March or April of 2002, the relationship between
Kentucky Highlands and its debtors began to deteriorate.
An
audit conducted by Kentucky Highlands in mid-July 2002 indicated
that its debtors had overstated available accounts receivable
and inventory by nearly 1.5 million dollars.
In a meeting held
on July 24, 2002, the debtors were instructed by Kentucky
Highlands not to collect any accounts receivable.
2
Kentucky Revised Statutes.
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By July 26,
2002, at the latest, Kentucky Highlands believed that its
debtor’s president was engaged in illegal activity.
(Deposition
of Ray Moncrief, Chief Executive Officer of Kentucky Highlands,
at 85.)
Nevertheless, Kentucky Highlands did not invoke or
initiate any judicial process to assert control over Tritech’s
accounts receivable.
Kentucky Highlands alleged that from approximately
July 2, 2002, and continuing through approximately August 2,
2002, Tritech began depositing customer payments totalling
nearly $400,000.00 into its own account at the Bank.
Kentucky
Highlands claimed that the Bank was paying overdrafts on the
account during this period of time.
Kentucky Highlands alleged
that the Bank applied the funds deposited by Tritech to its
overdrafts and to its other credit accounts held by the Bank -despite the Bank’s knowledge that Kentucky Highlands held a
properly perfected security interest in all of the debtors’
accounts receivable.
On February 19, 2004, Kentucky Highlands filed a
complaint against the Bank, alleging that Tritech had breached
several of its agreements with Kentucky Highlands.
Kentucky
Highlands claimed that by depositing customer payments directly
into its account with the Bank, Tritech converted funds
belonging to Kentucky Highlands.
Kentucky Highlands also
alleged that the Bank knew -- or should have known -- that
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Tritech’s deposits amounted to a conversion of its funds.
Kentucky Highlands claimed that the Bank had colluded with its
debtors to divert the proceeds of the collateral assigned to
Kentucky Highlands.
Kentucky Highlands charged that the Bank
had “aided and abetted Tritech in this conversion of funds
belonging to Kentucky Highlands.”
(Complaint at 3.)
Kentucky
Highlands sought recovery of the customer payments deposited
into the subject account.
In its answer, the Bank denied the allegations.
The
Bank claimed that it had a superior right of set-off against the
disputed funds under the provisions of Kentucky’s commercial
code (as amended) and that it had no duty to monitor deposits
being made into the subject account or to scrutinize the status
of the collateral claimed by Kentucky Highlands.
Invoking the
provisions of Kentucky’s commercial code, the Bank filed a
comprehensive motion for summary judgment.
In its response to the Bank’s motion for summary
judgment, Kentucky Highlands argued strenuously and persuasively
that the decision of the Kentucky Supreme Court in General
Motors Acceptance Corporation v. Lincoln National Bank, 18
S.W.3d 337 (Ky. 2000), (“GMAC”), controlled the dispute and that
GMAC had not been superseded by subsequent amendments to the
commercial code.
It also argued that it had offered sufficient
evidence of collusion among the parties and related entities to
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preclude summary judgment on that separate count in the
Complaint.
The trial court granted the Bank’s motion for summary
judgment on November 24, 2004.
It ruled that the 2001
amendments to Kentucky’s commercial code governed the action and
that under these statutory provisions, Kentucky Highlands had no
viable claims against the Bank.
The court reasoned that the
Bank’s security interest in the deposit account had priority
over the security interest held by Kentucky Highlands and that
the Bank had a right of set-off against all of the funds
deposited into Tritech’s account that was superior to any right
possessed by Kentucky Highlands.
In addition, the court
rejected the contention of Kentucky Highlands that the Bank had
a duty to monitor Tritech’s account in an effort to determine if
its deposits might be proceeds of accounts receivable claimed by
another secured creditor (namely, Kentucky Highlands).
This
appeal followed.
The standard of review governing an appeal of a
summary judgment is well settled.
We must determine whether the
trial court erred when it concluded that there was no genuine
issue as to any material fact and that the moving party was
entitled to a judgment as a matter of law.
916 S.W.2d 779 (Ky.App. 1996).
Scifres v. Kraft,
Summary judgment is appropriate:
-6-
if the pleadings, depositions, answers to
interrogatories, stipulations, and
admissions on file, together with the
affidavits, if any, show that there is no
genuine issue as to any material fact and
that the moving party is entitled to a
judgment as a matter of law.
CR 56.03.
It is a stringent standard in Kentucky law.
In Paintsville Hosp. Co. v. Rose, 683 S.W.2d 255 (Ky.
1985), the Supreme Court of Kentucky held that summary judgment
was proper only where the movant could show that the adverse
party could not prevail under any circumstances.
The Supreme
Court has also stated as follows:
...the proper function of summary judgment
is to terminate litigation when, as a matter
of law, it appears that it would be
impossible for the respondent to produce
evidence at the trial warranting a judgment
in his favor.
Steelvest, Inc. v. Scansteel Service Center, Inc., 807 S.W.2d
476, 480 (Ky. 1991).
Because factual findings are not at issue
in this case, there is no requirement that we defer to the
conclusions of the trial court.
Since we are dealing solely
with matters of law, our review is de novo.
Therefore, we must
determine if the Bank was entitled to judgment as a matter of
law.
The parties agree that the issues before us are
governed by the provisions of Revised Article 9 of the Uniform
Commercial Code (the UCC) as adopted by Kentucky and which
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became effective on July 1, 2001.
Kentucky Highlands contends
that the decision of the Supreme Court of Kentucky in GMAC,
supra, a case factually similar to the one before us, remained
intact and unaffected precedentially -- even after the General
Assembly adopted revisions to Kentucky’s commercial code in the
wake of GMAC.
Conversely, the Bank argues that the revisions to
Article 9 rendered the decision in GMAC meaningless with respect
to this case.
In GMAC, the Supreme Court of Kentucky was asked to
decide whether a deposit bank could apply the cash proceeds of a
creditor’s collateral to cover its depositor’s overdrafts.
Id.
Relying on a decision rendered by the Supreme Court of Iowa in
1989, our Court concluded that the secured creditor had priority
over the interest of the deposit bank in the account by virtue
of its security agreement with the depositor, metaphorically
holding that the bank could not bypass or “leapfrog” the secured
creditor by reimbursing itself for overdrafts taken from
deposits which were derived from identifiable cash proceeds of
the secured creditor’s collateral.
Id.
Kentucky Highlands argues that the decision “could
hardly be more clear, or more clearly applicable to the case
presented . . . against the Bank.”
Brief at 4.
Applying the
reasoning of GMAC to the facts of the case before us, Kentucky
Highlands essentially contends that the Bank of Corbin could not
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reimburse itself for Tritech’s overdrafts from an account into
which customer payments had been deposited -- payments (or
collateral) that belonged to (and should have been paid directly
to) Kentucky Highlands under its loan agreements with Tritech.
The Bank contends that the drafters of the UCC (and
Kentucky legislators adopting and incorporating its provisions
in our statutes) clearly intended to reverse the prevailing
trend in existing law.
That is, their adoption of the revisions
to Article 9 was directly aimed at undoing the effects of the
Supreme Court’s decision in GMAC.
According to the Bank,
[t]he drafters of Revised Article 9 and the
legislature determined that the interests of
depository banks, the free flow of commerce
and the checking system are superior to the
interest of secured creditors in funds
deposited into accounts at depository banks.
Appellee’s Brief at 1.
Consequently, the Bank argues that a new
presumption of priority has been conferred upon depository banks
and that secured creditors are required to take specific steps
to preserve their interest in funds held by a bank.
We agree with the Bank’s argument.
By enacting the
revisions, the drafters of Revised Article 9 and the legislature
of Kentucky have clearly and deliberately shielded depository
banks from claims and priority disputes with secured creditors.
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Addressing the priority of conflicting security
interests in a deposit account, KRS 355.9-327 provides as
follows:
(1)
(2)
(3)
(4)
A security interest held by a secured party
having control of the deposit account under KRS
355.9-104 has priority over a conflicting
security interest held by a secured party that
does not have control.
Except as otherwise provided in subsections (3)
and (4) of this section, security interests
perfected by control under KRS 355.9-314 rank
according to priority in time of obtaining
control.
Except as otherwise provided in subsection (4) of
this subsection, a security interest held by the
bank with which the deposit account is maintained
has priority over a conflicting security interest
held by another secured party.
A security interest perfected by control under
KRS 355.9-104(1) has priority over a security
interest held by the bank with which the deposit
account is maintained. (Emphasis added.)
The official commentary to the UCC explains the bank’s superpriority status as follows:
Under paragraph (3), the security interest of the bank with
which the deposit account is maintained normally takes
priority over all other conflicting security interests in
the deposit account, regardless of whether the deposit
account constitutes the competing party’s original
collateral or its proceeds. A rule of this kind enables
banks to extend credit to their depositors without the need
to examine either the public record or their own records to
determine whether another party might have a security
interest in the deposit account.
* * * *
A secured party who claims the deposit account as proceeds
of other collateral can reduce the risk of becoming junior
by obtaining the debtor’s agreement to deposit proceeds
-10-
into a specific cash-collateral account and obtaining the
agreement of that bank to subordinate all its claims to
those of the secured party. But if the debtor violates its
agreement and deposits funds into a deposit account other
than the cash-collateral account, the secured party risks
being subordinated.
(Emphasis added).
[KRS 355.1-110 permits the use of the
official comments in the construction and application of Chapter
355.]
KRS 355.9-340 establishes similar priority rules with
respect to the depository bank’s right of set-off against funds
in a customer account that might be subject to a claim by a
secured creditor.
(1)
(2)
(3)
KRS 355.9-340 provides as follows:
Except as otherwise provided in subsection (3) of
this section, a bank with which a deposit account
is maintained may exercise any right of
recoupment or set-off against a secured party
that holds a security interest in the deposit
account.
Except as otherwise provided in subsection (3) of
this section, the application of this article to
a security interest in a deposit account does not
affect a right of recoupment or set-off of the
secured party as to a deposit account maintained
with the secured party.
The exercise by a bank of a set-off against a
deposit account is ineffective against a secured
party that holds a security interest in the
deposit account which is perfected by control
under KRS 355.9-104(c), if the set-off is based
on a claim against the debtor.
KRS 355.9-340 places a bank’s right of set-off ahead
of the security interest of a secured party in the deposit
account.
Under this provision, a secured party’s interest in
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the account will be subordinate until and unless the security
interest in the deposit account is perfected “by control under
KRS 355.9-104(c).”
Kentucky Highlands contends that the priority rules
established by KRS 355.9-340 do not apply where a secured party
claims a security interest in the cash proceeds deposited into
the commercial account rather than a security interest in the
deposit account itself.
We disagree.
That construction would
fail to distinguish between a creditor who neglected to protect
its interests and a conscientious secured party that took the
necessary steps to establish its priority.
The revisions to
Article 9 recognize that very distinction.
The result urged by
Kentucky Highlands conflicts with the clear intention of revised
Article 9:
to provide a comprehensive and predictable framework
by which parties may avoid priority disputes and to protect the
interests of depository banks.
Under the revised portions of the UCC, depository
banks receive an automatic perfected interest in the accounts of
their customers.
Kentucky Highlands was aware of its debtors’
deposit account with the Bank of Corbin and yet acquiesced in
its use without taking any action to assert priority as to
proceeds to which it claimed entitlement.
Kentucky Highlands
was on notice that the Bank could assert a claim against the
deposit accounts at any time.
Although Kentucky Highlands was
-12-
in a position to protect its priority through a variety of
means, it nonetheless risked becoming subordinate by doing
nothing.
It is true that the Bank might have protected itself
by simply refusing to honor its customer’s overdrafts.
However,
the revised statute required Kentucky Highlands as a secured
creditor to monitor its debtor’s business and to police its own
collateral -- not to shift such duties onto the Bank.
A
depository bank no longer bears the burden to ascertain the
source of funds deposited into its customers’ accounts and to
determine whether there is a creditor who may have a lien on
those funds before a bank can assert its rights as a secured
creditor -- namely, its rights to set-off against the account.
We conclude that the provisions of KRS 355.9-340
directly govern this priority dispute.
A depository bank may
properly exercise its right of set-off against a secured party
who seeks to assert an interest in a commercial deposit account
-- regardless of whether the secured party claims a security
interest in the deposit account as original collateral or as its
proceeds.
The trial court did not err by granting summary
judgment to the Bank on this issue.
Next, Kentucky Highlands contends that the trial court
erred by granting summary judgment to the Bank because it had
offered sufficient evidence of collusion between the Bank and
Tritech to deprive Kentucky Highlands of the value of its
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collateral.
In support of its argument, Kentucky Highlands
relies on the following provisions of KRS 355.9-332:
(1)
(2)
A transferee of money takes the money free of a
security interest unless the transferee acts in
collusion with the debtor in violating the rights of
the secured party.
A transferee of funds from a deposit account takes the
funds free of a security interest in the deposit
account unless the transferee acts in collusion with
the debtor in violating the rights of the secured
party.
The Official Comment explains as follows:
[T]his section does not cover the case . . . in which
a bank debits an encumbered account and credits
another account it maintains for the debtor.
A transfer of funds from a deposit account, to which
subsection (b) applies, normally will be made by
check, by funds transfer, or by debiting the debtor’s
deposit account and crediting another depositor’s
account. . . .
We are not persuaded that KRS 355.9-332 is applicable
to this case.
By its terms, the statute is intended to provide
broad protection for transferees of funds from a deposit account
representing the proceeds of a secured creditor’s collateral.
More significantly, we are not persuaded that these provisions
pertain to priority conflicts between a depository bank and a
secured creditor concerning funds in the deposit account.
A
depository bank is not a transferee as described by the language
of the statute.
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Finally, we note that the provisions of KRS 355.9-341
set forth the rights and duties of a bank with respect to
deposit accounts as follows:
Except as otherwise provided in KRS 355.9-340(3)[where the
secured party has become the bank’s customer under 9104(1)(c)], and unless the bank otherwise agrees in an
authenticated record, a bank’s rights and duties with
respect to a deposit account maintained with the bank are
not terminated, suspended, or modified by
(1)
(2)
(3)
The creation, attachment, or perfection of a security
interest in the deposit account;
The bank’s knowledge of the security interest; or
The bank’s receipt of instructions from the secured
party.
Again, the Official Comment provides a helpful explanation:
This section is designed to prevent security interests in
deposit accounts from impeding the free flow of funds
through the payment system. Subject to two exceptions it
leaves the bank’s rights and duties with respect to the
deposit account and the funds on deposit unaffected by the
creation or perfection of a security interest or by the
bank’s knowledge of the security interest. In addition,
the section permits the bank to ignore the instruction of
the secured party unless it had agreed to honor them or
unless other law provides to the contrary. A secured party
who wishes to deprive the debtor of access to funds on
deposit or to appropriate those funds for itself needs to
obtain the agreement of the bank, utilize the judicial
process, or comply with procedures set forth in other law.
. . .
(Emphasis added).
The Bank was statutorily authorized to ignore even
direct “instructions” from Kentucky Highlands with respect to
its conduct toward the deposit account.
Kentucky Highlands
failed to avail itself of direct agreement with the Bank or to
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become the Bank’s customer as provided by statute in order to
protect its interests.
The Bank was entitled to judgment as a
matter of law with respect to this issue, and the trial court
did not err by granting the summary judgment.
The judgment of the Whitley Circuit Court is affirmed.
ALL CONCUR.
BRIEF AND ORAL ARGUMENT FOR
APPELLANT:
BRIEF AND ORAL ARGUMENT FOR
APPELLEE:
D. Duane Cook
Stamping Ground, Kentucky
Randy D. Shaw
Adam R. Kegley
Lexington, Kentucky
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