Reset A A Font size: Print

Court of Appeal, Fourth District, Division 2, California.

AMERICAN STATE BANK, a California Banking Corporation, Mobile Service Consultants, Inc., a California Corporation;  Plaintiffs and Respondents, v. AVCO FINANCIAL SERVICES OF the UNITED STATES, INC., a corporation, Westinghouse Credit Corporation, a corporation, Defendants and Appellants.

Civ. 17162.

Decided: July 14, 1977

Pagter, Gillette & Bowne, and Ralph G. Pagter, Santa Ana, for defendants and appellants. Virtue & Scheck, and Joseph A. Walker, Newport Beach, for plaintiffs and respondents.

Opinion Ordered Not for Publication, See 141 Cal.Rptr. 447.


This case was presented to the trial court on a stipulated set of facts upon which extensive findings were made.   To summarize the findings, Western Travel Center, Inc. (dealer), was in the business of selling recreational vehicles (motorhomes) and in discounting to banks conditional sales contracts covering such vehicles.   Defendants Avco Financial Services of the United States, Inc., and Westinghouse Credit Corporation (flooring lenders) held security interests in the dealer's resale inventory of motorhomes by reason of the filing of UCC–1 financing statements covering that inventory.   At the outset, these security interests extended to two motorhomes, the proceeds of sale of which are the subject of this litigation.

Fairfield, the president of the dealer, entered into fraudulent schemes with Jackson and McCullough which included sham sales of a motorhome to each.   All the paper work in the form of credit applications and conditional sales contracts were fixed up showing Jackson and McCullough as conditional purchasers of the respective motorhomes and as having made down payments of $1,269.75 and $1,450.   However, neither of them had made the down payment or ever took delivery.

Nevertheless, the dealer took the two conditional sales contracts to plaintiff American State Bank (bank) who accepted assignment of them without recourse and paid the dealer $8,044 and $8,409.   A report of sale was submitted to DMV by the dealer, and the motorhomes were registered to show Jackson as the registered owner of one and McCullough as the registered owner of the other.   The bank appeared as legal owner of both on the California Ownership Certificates (pink slips).

Fairfield did make a few payments on the conditional sales contracts but eventually they lapsed into default.   For reasons not fully explained by the record, the motorhomes were seized and impounded by the police about seven months after the pink slips were issued.   The flooring lenders and the bank agreed that the motorhomes should be sold and the priority of the competing security interests and hence the right to the proceeds of such sales be determined in a declaratory relief action.

In that action the trial court held for the bank, concluding that this result was called for by section 9307 of the Commercial Code 1 and “California Case Law.”   The flooring lenders appealed.

 Briefly stated, the appeal by the flooring lenders challenges the application of section 9307 2 mainly because the findings, according to these defendants, do not support a conclusion that the plaintiff bank was a buyer of the motorhomes “in ordinary course of business.”   We agree.

The findings clearly establish that there was no valid sale or even transfer of possession to Jackson and McCullough, and although there is no California case precisely elaborating on the definition of a “[b]uyer in ordinary course of business” as set forth in section 1201, subdivision (9), a fair reading of the text writers and the California Code comments leads to the conclusion that “business” as used in the “course of business” language of that section means the seller's business.   If this interpretation is correct, then the sham sales by the dealer to Jackson and McCullough did not amount to the kinds of transactions which invoke the operation of section 9307, subdivision (1).

As one of its contentions, the bank argues that because the dealer never transferred title to Jackson and McCullough and then assigned the purported conditional sales contracts to the bank, that it (the bank) acquired title to the motorhomes and hence was a buyer in the ordinary course of business.   This, it argues, put the bank in a position to enjoy the operation of section 9307, subdivision (1).   This also was the conclusion of law reached by the trial court.   The difficulty we have with this view of the case is that banks are not in the business of buying motor vehicles;  they are in the business of lending money.   Accordingly, although it is not necessary to our ultimate disposition of the appeal, it is our view that banks which variously finance retail purchases of motor vehicles by others, and end up appearing as the legal owners thereof on the pink slips issued by the DMV for those motor vehicles, are not “buyers in ordinary course of business” as defined in section 1201, subdivision (9) and as used in section 9307, subdivision (1).

However, the trial court reached a further conclusion of law which in effect stated that as between the flooring lender and the bank which “purchased legal title [to the collateral] from a dealer,” the bank takes free of any security interest in the collateral running in favor of the flooring lender.   In reaching this conclusion, the trial court can be taken as invoking section 9308 which reads, “[a] purchaser of chattel paper ․ who gives new value and takes possession of it in the ordinary course of his business has priority over a security interest in the chattel paper ․ [¶] (a) Which is perfected under Section 9304 (permissive filing and temporary perfection) or under Section 9306 (perfection as to proceeds) if he acts without knowledge that the specific paper or instrument is subject to a security interest;  or [¶] (b) Which is claimed merely as proceeds of inventory subject to a security interest (Section 9306) even though he knows that the specific paper or instrument is subject to the security interest.”

The application of section 9308 has not yet been the subject of appellate review in California, but it has in several other states which have enacted the Uniform Commercial Code and particularly the language of section 9308 as it appears on California's statute books.   The competing priorities dealt with in this section usually collide in situations where the dealer gets into financial difficulty and for a variety of reasons will have the collateral or its proceeds in his possession thereby precipitating a contest for the collateral or its proceeds between the flooring lender who held a security interest in the collateral before its retail sale and the bank who financed the retail sale.

In the several cases which have come to our attention where this issue has been presented, the courts have applied the equivalent of California's section 9308 and held for the bank which financed the retail purchase.   Such a case was Rex Financial Corp. v. Great Western Bank & Trust (1975), 23 Ariz.App. 286, 532 P.2d 558.   To summarize the facts in Rex using the same generic terms as we have been using, there was a flooring agreement between the dealer and the flooring lender who had a perfected security interest in the dealer's inventory of mobilehomes.   Four mobilehomes were sold by the dealer to retail purchasers in the regular course of the dealer's business and the sales were covered by conditional sales contracts.   These contracts were sold and assigned to the bank in the regular course of the bank's business for current value paid to the dealer.   To quote from the opinion, “[u]fortunately, the dealer did not use these funds to pay off its outstanding loans owed to the [flooring lender].”  (Id. at p. 560.)   It further appears that in this case the bank even had knowledge of the security interest claimed by the flooring lender.

In deciding Rex, the court was first concerned with whether the conditional sales contracts involved were “chattel paper” as defined by Arizona Revised Statutes, section 44–3105(A)(2), which is substantially the same as California section 9105, subdivision (b).3

 The court had no difficulty in deciding that the documents involved came within the definition, and clearly, in the case before us, on their faces the conditional sales contracts presented to the bank by the dealer were chattel paper as defined in section 9105, subdivision (b).

 The next subsidiary issue in Rex was to determine the meaning of the statutory language “in the ordinary course of his business.”   The court rejected a contention that what was meant was a practice which should have been followed and not the practice of this particular purchaser of chattel paper.   We agree;  otherwise the use of the word “his” would have no significance.   Digressing briefly to the case before us, the evidence will support an inference that the bank purchased the two conditional sales contracts in the ordinary course of its business.

This brought the Rex court to the final issue which required an application of the equivalent of section 9308, subdivision (b), namely “[a] purchaser of chattel paper ․ who gives new value and takes possession of it in the ordinary course of his business has priority over a security interest in the chattel paper ․ [w]hich is claimed merely as proceeds of inventory subject to a security interest (Section 9306) even though he knows that the specific paper ․ is subject to the security interest.”   In the case before us, there was no finding on the factual issue of whether the bank had knowledge that the conditional sales contracts were subject to the security interest of the flooring lender.   However, for purposes of our decision, we shall presume such knowledge on the part of the bank, either actual or constructive, because of the flooring lender's UCC–1 filing on which was checked “Box A,” the proceeds of collateral.   In its analysis of the operation of this statutory provision, the Rex court took the position that the more likely or probable expectation of the flooring lender in making its loans to the dealer was a reliance upon the collateral itself before its retail sale, and then on the cash proceeds of such sale rather than on any chattel paper that might be generated from time to time on the sales of collateral.

The opinion reads, should such reliance have been different, “Rex could have protected itself by requiring all security agreements executed on sale of the mobile homes to be turned over immediately to Rex, or if sold, that all payments for the security agreements (chattel paper) be made to itself.”   (Rex Financial Corp. v. Great Western Bank & Trust, supra, 23 Ariz.App. 286, 532 P.2d 558, 561.)   On this reasoning it upheld the judgment of the trial court in favor of the bank.

 We concur with the analysis and reasoning in Rex and hold that where there is financing of resale inventory and a security interest therein perfected by a UCC–1 filing, and where an item of inventory (here motorhomes) is sold on conditional sale and that contract is purchased for new value by a bank in the ordinary course of its business, and where the bank takes possession of the contracts, section 9308 operates to give the bank's security interest in the chattel paper priority over that of the flooring lender who financed that inventory.   Other authorities which support this holding are Commercial Credit Corp. v. National Credit Corp. (1971), 251 Ark. 541, 473 S.W.2d 876, 880;  Chrysler Credit Corporation v. Sharp, 56 Misc.2d 261, 288 N.Y.S.2d 525, 533;  Bank of Beulah v. Chase (N.D.1975), 231 N.W.2d 738, 744–745, and Associates Discount Corp. v. Old Freeport Bank (1966), 421 Pa. 609, 220 A.2d 621, 623–624.   In California, before the adoption of the Uniform Commercial Code, a similar result was reached in Citizens Bank v. Beverly Fin. Co., 127 Cal.App.2d Supp. 835, 273 P.2d 714.  (See also Commercial C. Co. v. Barney M. Co., 10 Cal.2d 718, 76 P.2d 1181, which was decided in favor of the bank on an estoppel theory.)

The foregoing analysis and citation of authority is something of a nod to orthodoxy in dealing with a case of first impression, for it perhaps would have been enough to observe that the result we have reached was clearly indicated by the straightforward language of section 9308 which requires no extended interpretation and which obviously reflects the custom, practice, and usage of the mercantile community followed in thousands of transactions each day from Crescent City and Alturas to San Ysidro and Calexico.

The reader who is primarily interested in the precedential impact of this opinion in the application of section 9308 generally need go no further.   However, for the benefit of the litigants here involved, certain factual aspects of the record unraveled some loose ends which we must tie up.

 The first such question to be resolved is whether the result reached should be different because of the fraudulent schemes concocted by Fairfield which operated to prevent Jackson and McCullough from becoming buyers in ordinary course of business and which in turn precluded there being any valid chattel paper in the hands of the dealer.   Stated otherwise, suppose Fairfield had continued to make the payments to the bank on the two conditional sales contracts, and suppose, because of the dealer's default vis-a-vis the flooring lender, that the latter had seized the dealer's inventory, including the two motorhomes here involved;  under such facts Jackson and McCullough could under no theory have successfully asserted any rights to the motorhomes as against the flooring lender.   With this the situation, what should be the result if as here the contest were instead between the bank which bought the chattel paper and the flooring lender?   This precise question was discussed in Chrysler Credit Corporation v. Sharp, supra, 56 Misc.2d 261, 288 N.Y.S.2d 525.   In the cited case, Mrs. Sharp purported to purchase a 1963 Chevrolet from the dealer.   A credit application was made to Chrysler Credit Corporation (bank) to finance the purchase.   A loan of $1,710 was approved, and a conditional sales contract signed by Mrs. Sharp and endorsed by the dealer to the bank.   The bank then paid the loan proceeds to the dealer who deposited them with Marine Midland Trust (flooring lender).   The conditional sales contract recited that Mrs. Sharp had made a $443 down payment.   In fact, she had not, having arranged with the dealer to bring the money in after receiving an income tax refund.   This arrangement also required that she allow the Chevrolet to remain in the dealer's possession until she brought in the money.   Immediately upon payment of the loan proceeds, the bank completed the UCC–1 filing necessary in New York to perfect its security interest in the Chevrolet.   So far so good, but before Mrs. Sharp could bring in the down payment, the flooring lender with legal justification closed in on the dealer, seizing all the automobiles on its lot, including the 1963 Chevrolet.   It was sold by the flooring lender along with the remaining dealer inventory.   When the bank learned of this, it sued the floor lender for the proceeds of the sale of the Chevrolet.

In its initial treatment of the case, the court dealt with the section 9308 issue upon the assumption that Mrs. Sharp was a buyer in ordinary course of business and decided in favor of the bank.   At the conclusion of its opinion the court addressed itself to the question of whether a different decision should have been reached if the irregularities of the transaction had had the result of characterizing Mrs. Sharp other than as a buyer in ordinary course of business, i.e., had the result of the dealer's selling chattel paper which misrepresented the facts to the bank.   The court determined, even if such were the fact, that it would not make any difference, and its reasoning is expressed where it said “[i]f there is a usage of trade which exposes an entruster on floor plan to certain risks, these are risks against which he can guard by audits and accounting procedures or he can refuse to knowingly expose himself to the risk with the particular dealer.   To fail to place the exposure of such risk with the entruster in such situation would make it impossible for retail finance companies to do business with any dealer unless the entruster were directly a participant.”  (Id. at p. 534.)

An eminent scholar in the field, Professor Robert H. Skilton, writing in the Wisconsin Law Review, deals with the same question couched in somewhat different terms when he asks whether the bank who purchases chattel paper from the dealer must establish that the purchaser who executed the chattel paper be a buyer in the ordinary course of business and thus himself entitled to take free under section 9307 before the bank in turn can claim the benefit of section 9308.   In his comments, Professor Skilton refers to the flooring lender as F–One and the bank as F–Two, and states:  “[u]nless F–Two should have visited the dealer's premises before taking the chattel paper, to discover whether the car was still there—usually a profitless thing to do—or unless we say that F–Two should check with every buyer directly before it takes the chattel paper, there is nothing that F–Two did or failed to do that should make its position of priority dependent on the kind of buyer Mrs. Sharp was.   The question posed by section 9308 is what is, or should be, the ordinary course of business for a retail financer like F–Two.  [¶] Did F–One bear the risk of its dealer-debtor misconduct, in case his dealer-debtor sold to a buyer in ordinary course, as far as F–One's rights against F–Two are concerned?   Yes, says section 9308.   It's not too much to say that F–One's risk versus F–Two should likewise extend to the case where B[uyer] is, unknown to F–Two [,] not a buyer in ordinary course, since F–One already bears the burden of knowing his dealer and keeping an eye on him.”  (Wisc.L.Rev. (1974) 1, 85.)

 In our view, this analysis comports with the modern objectives of the Uniform Commercial Code and the directives for its application as set forth in section 1102.   In other words, what is presented here is not a case where the bank has dealt with and derived its rights through the buyer, but rather where it has dealt with and derived its rights through the seller.   In such instance the risk of dereliction by the seller (dealer) is, for policy reasons, more logically placed on the flooring lender than on the bank.   Accordingly, the result which we have reached, based upon the application of section 9308, is not affected by the fact that Jackson and McCullough were not buyers in ordinary course of business as contemplated by section 9307.

That brings us to the necessity of closing the gap between the prior rights in the chattel paper and the proceeds of the sale of the two motorhomes.   Section 9308 by its terms deals with security interests in chattel paper.   At the outset of the transactions under review, the security interest of the flooring lenders was in the two motorhomes, and it was the motorhomes which remained in the hands of the dealer and were impounded by the police.   One might ask how the phony conditional sales contracts metamorphosed into something which provided the basis for the bank to compete successfully for the motorhomes.   Parenthetically, this was the actual focus of the contest, for the agreement to sell and then resolve the right to the proceeds was a mutual undertaking reached after the real dispute arose over the right to possession of the motorhomes.

 In dealing with this aspect of the case, section 9306, subdivision (2) is of some help.   It provides, “[e]xcept where this division otherwise provides, a security interest continues in collateral notwithstanding sale, exchange or other disposition thereof unless the disposition 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.”   The unstated counterpart of this provision is that the security interest does not continue in the collateral if there is consent to its disposition by the debtor (dealer).

 The record does not disclose any express authorization by the flooring lenders which would permit the dealer to dispose of the collateral.   However, both UCC–1 financing statements by which the flooring lenders perfected their security interests had “Box A” checked, the one which extends the effect of the filing and perfection to proceeds of the collateral.   In a situation of this kind, it has been held that the extension of the security interest to proceeds has impliedly authorized the debtor to dispose of the collateral.  (McFadden v. Mercantile–Safe Deposit & Trust Co., 260 Md. 601, 273 A.2d 198, 207.)   As stated in Commercial Credit Corp. v. National Credit Corp., supra, 251 Ark. 541, 473 S.W.2d 876, “[e]ven if National [flooring lender] had perfected its security interest in the automobile ․ Mathews [dealer] ․ was authorized by National to sell the automobile involved in the case.   It would thus appear that when Mathews sold the automobile to Edgerson [buyer in ordinary course of business] ․ National's security interest would no longer have followed the automobile but would have only continued in the ‘proceeds' of the sale going to Mathews.   The proceeds of the sale going to Mathews included the conditional sales contract [chattel paper] executed by Edgerson ․ while such proceeds were in the possession of Mathews.   Mathews sold Edgerson's contract to Commercial [bank] ․ and ․ National's security interest would not have followed the chattel paper into the hands of Commercial, but would have continued in the proceeds [money] Mathews received from Commercial in the sale of the chattel paper ․”  (Id. at p. 880.)

We read the sense of this to mean that when there is a consent to dispose of the collateral, either express or by implication (arising from a check in “Box A” of the UCC–1), that the debtor-seller (dealer) actually has a kind of power of defeasance or substitution over the security interest as originally perfected in the tangible collateral.   Thus if he subjects that collateral to a conditional sales contract and the buyer walks out with the goods, the security interest moves on to that contract in the hands of the dealer.   Parenthetically, this represents a particular application of section 9307.   However, if the dealer does not carry his own contracts and discounts them to the bank, then the bank, when it pays new value, takes a prior security interest in that contract as against the flooring lender per force of section 9308, and the latter's security interest moves on to the proceeds in the hands of the dealer.   Thereafter, the rights in the chattel paper control the disposition of the tangible property which was the original collateral.

With these the legal consequences of a regular transaction, if the factual circumstances are sufficiently scrambled so that the original tangible collateral (motorhomes) falls back into the possession of the flooring lender and it turns out that the chattel paper was phony, what is to prevent the flooring lender from insisting that its security interest in the tangible collateral was never divested and that it has a prior right to possession of the tangible collateral?   We think the answer to that question must be rationalized just as Professor Skilton did the buyer-in-ordinary-course-of-business issue.   In other words, the effective functioning of the mercantile community in this area requires that those institutions financing retail purchases by means of the purchase of chattel paper be entitled to rely on the represented validity of that paper unless they have such knowledge as to preclude their being bona fide purchasers.   The same reasons for placing the risk on the flooring lender, if the dealer absconds with the funds received from the bank that it was bound to pay to the flooring lender, should apply to the set of facts before us where the sales were dummied up from the start.   Parenthetically, in the reasoning which underlies it, this result parallels the well-established rule in the negotiable instruments field that a drawee who has paid a bill of exchange or check on which the drawer's or maker's signature has been forged cannot recover the payment from a holder in good faith for value and without fault.  (United States v. Chase Nat. Bank, 252 U.S. 485, 494, 40 S.Ct. 361, 64 L.Ed. 675.)   Beyond that, it may be too elementary to observe, but, once this step has been taken to recognize that chattel paper, although irregular in its inception, can become valid and enforceable in the hands of a bona fide purchaser (just as can a forged bill of exchange), it necessarily follows that the right to possession of the tangible property subject to the chattel paper is dictated by the terms thereof.

 In summary then, once a dealer has launched even irregular chattel paper in the mercantile stream and into the hands of a bona fide purchaser, chattel paper which covers tangible property which once was collateral of the dealer's financing party, the chattel paper becomes the collateral and the rights in that chattel paper control and represent the power to dispose of the tangible property upon default of the obligation stated in the chattel paper.   This is the expectation under which the mercantile community operates, and the law should reflect it.

This result as to this case is reinforced by the parallel presence of California's certificate of title law applicable to motor vehicles, for to reach a contrary result in favor of the flooring lender would lead to chaos in the form of never knowing for certain whether the legal owner inscribed on the pink slip held paramount right to or interest in the motor vehicle covered by the pink slip.

 This latter reference to pink slips brings us to the remaining specialized factual aspect of the case, namely that the initial collateral consisted of motor vehicles.   This fact calls attention to sections 6301, 6302 and 6303 of the Vehicle Code.   In sum they mandate that the exclusive method by which a security interest is perfected in a motor vehicle after registration 4 is by means of the issuance of a pink slip through the DMV.   When this is accomplished, the bank's appearance on the pink slip as the “legal owner” amounts to perfection of the bank's security interest in the vehicle named on the pink slip.  (Mother Lode Bank v. General Motors Acceptance Corp., 46 Cal.App.3d 807, 811, 120 Cal.Rptr. 429.)

In the case before us, after the bank paid the $8,044 and the $8,409 to the dealer, applications to the DMV were processed and resulted in pink slips issued on November 16, 1973, and November 30, 1973, showing respectively the bank as the legal owner of the two motorhomes.   The seizure by the police was not until June 25, 1974.

What must be recognized here is that the result would have been different if the pink slips had not been issued showing the bank as the legal owner of the two motorhomes.   Otherwise, section 6303 provides that once perfection has been accomplished the “priority and validity of such security interest shall be governed by the Uniform Commercial Code.”   In terms of a rule, therefore, where a motor vehicle is the subject of inventory financing, the application of 9308 in favor of the bank who financed a purchase from the dealer is absolutely predicated upon application for and issuance of a pink slip showing the bank as a legal owner.   This follows, because Vehicle Code section 6303 provides that the procedures in Vehicle Code sections 6301 and 6302 are the exclusive method by which a security interest may be perfected in a motor vehicle after registration.   Thus, before a bank can claim the benefits of section 9308 against the flooring lender in a contest over possession of a motor vehicle or the traceable proceeds of its sale, along with the chattel paper defining its right to possession, the bank must produce a pink slip on which it appears as legal owner of the motor vehicle.

With further reference to the reasons for the trial court's judgment and going back to our principal holding, it is well settled that “a ruling or decision, itself correct in law, will not be disturbed on appeal merely because given for a wrong reason.   If right upon any theory of the law applicable to the case, it must be sustained regardless of the considerations which may have moved the trial court to its conclusion.”  (Davey v. Southern Pacific Co., 116 Cal. 325, 329, 48 P. 117.)   So it is here.   Although a contest between a dealer's flooring lender and a bank which purchased a conditional sales contract covering collateral financed by the flooring lender does not present a case for disposition under section 9307, the trial court did make findings which enable disposition of the case under section 9308.

The judgment is affirmed.


1.   Section 9307 of the Commercial Code in pertinent part reads:  “(1) A buyer in ordinary course of business (subdivision (9) of Section 1201) takes free of a security interest created by his seller even though the security interest is perfected and even though the buyer knows of its existence.”

2.   All statutory references are to the Commercial Code unless otherwise indicated.

3.   Section 9105, subdivision (b) reads:  “ ‘Chattel paper’ means a writing or writings which evidence both a monetary obligation and a security interest in or a lease of specific goods, but a charter or other contract involving the use or hire of a vessel is not chattel paper.   When a transaction is evidenced both by such a security agreement or a lease and by an instrument or a series of instruments, the group of writings taken together constitutes chattel papers[.]”

4.   The Vehicle Code sections here involved deal with “any vehicle registered under this code.”   This qualification made it possible for the flooring lenders to perfect their security interests in the motorhomes by orthodox UCC–1 filings because, until retail sale, the motorhomes were not subject to registration under the Vehicle Code.  (See §§ 4000, 4002.)

Copied to clipboard