Court of Appeals Construes Collateral Description in Financing Statement
 
October 31, 2002
 
Michael Weissman - Chicago

When a secured creditor describes the collateral subject to its security interest as: [a]l] inventory, including but not limited to agricultural chemicals, fertilizers and fertilizer materials sold to Debtor by [Creditor] whether now owned or hereafter acquired, including all replacements, substitutions and additions thereto, and the accounts, notes, and any other proceeds therefrom," does the security interest attach to all inventory of the debtor or simply to the inventory sold by the creditor to the debtor?  That was the question before the United States Court of Appeals for the Seventh Circuit in Shelby County State Bank v. Van Diest Supply Company, (No. 01-2250, September 17, 2002).  The issue was raised by another of the debtor's creditors, Shelby County State Bank. 

The bankruptcy judge who first ruled on the issue held that the security interest of the creditor, Van Diest Supply Company, was limited to products Van Diest sold to the debtor, Hennings Feed & Crop Care, Inc.  The district court disagreed and held that Van Diest's security interest extended to all of Henning's inventory.  The Court of Appeals reinstated the ruling of the bankruptcy judge, but not before engaging in some microscopic examination of the language employing Iowa law.  (The security agreement stipulated that Iowa law would control).

Last Antecedent Rule

The Court of Appeals began by characterizing the language that referred to after-acquired inventory "…a textbook example of ambiguous language… ."  It reached this conclusion by applying an arcane rule of statutory construction called the last antecedent rule dating back to Sim's Lessee v. Irvine, 3 U.S. (3 Dall. 425, 444 n.a. (1794).  This rule, to which Iowa adheres (see e.g., State v. Lohn, 266 N.W. 2d 1, 3 (Ia. 1978), states that where two modifiers appear in a row, the last modifier applies only to its immediate antecedent.  This meant that "sold to Debtor by Van Diest" applied only to "including all" and not to "all inventory." 

The court next observed that the last antecedent rule identified an ambiguity, but did not resolve it.  It also noted there was nothing in the security agreement's other language that provided clarity.  Musing further, the court postulated that if it was intended that a blanket lien be obtained, why was there a detailed description of only a part of it? 

Continuing its opinion the court noted that "…it would be  bizarre as a commercial matter to claim a lien in everything, and then describe in detail only a part of that whole."

Conduct of the Parties

Looking further for clues, the court referred to the parties' conduct (as permitted by Iowa law) in an effort to resolve the ambiguity.  It noted that earlier security agreements between these same two parties had created a blanket lien.  But it said that that proved little except that the parties knew how to create a blanket lien when they wanted to do so. 

Looking once again to the conduct of the parties, the court observed that after the security agreement was signed, Van Diest sent notice of a purchase money security interest to other creditors claiming only the inventory it sold to Hennings.  Iowa law permitted reference to said conduct without violating the partial evidence rule.

Ambiguous Language Is Construed Against the Drafters

Next, the court turned to the doctrine of contra proferentem, the rule that requires ambiguous language to be strictly construed against the drafters – a rule still followed in Iowa.  Utilizing this rule, the court said that when Van Diest perfected its security interest, "a prospective creditor should have been able to look at Van Diest's filing and determine on that basis whether to extend credit to Hennings."  Presumably, said the court, Shelby County State Bank did so after it received Van Diest's notice claiming a security interest only in goods sold to Hennings. 

Concluding its opinion the court said: "…for the notice requirement to be a valid instrument of protection for potential creditors, that notice must be clearly expressed, and it must be such as is needed to inform the behavior of the potential creditor."  The result was that Van Diest's security interest was confined to goods it sold to Hennings. 

What's the Point? 

Did the court miss the point?  Isn't the UCC financing statement primarily a means of alerting the third-party creditors of the existence of a security interest rather than its precise parameters?  Isn't it the duty of a potential new secured creditor to make inquiry of the secured creditor of record to determine the exact extent of the previously perfected security interest?  If these questions are answered in the affirmative, the decision of the Seventh Circuit is debatable.

For more information, contact Michael Weissman, toll free at 888-688-8500, or via e-mail at michael.weissman@hklaw.com.