Case No. BK02-43097, A03-4031.United States Bankruptcy Court, D. Nebraska.
August 26, 2005
MEMORANDUM
TIMOTHY MAHONEY, Chief Judge, Bankruptcy
Trial was held in North Platte, Nebraska, on April 14, 2005, on the plaintiffs’ complaint to determine the validity, priority, or extent of a lien. Allen Fugate appeared for the plaintiffs, and Nora Kane and Don Swanson appeared for the defendant. This memorandum contains findings of fact and conclusions of law required by Federal Rule of Bankruptcy Procedure 7052 and Federal Rule of Civil Procedure 52. This is a core proceeding as defined by 28 U.S.C. § 157(b)(2)(K).
The parties hold competing claims to crop proceeds. The Noltes leased farmland to the debtor and either purchased farm products from the debtor or advanced operating funds to the debtor, and claim an ownership interest in the proceeds by virtue of their lease with the debtor. Riverside Fertilizer Propane claims a security interest in the same proceeds by virtue of a first lien in the crop.
The debtor is a family farm corporation, operated by brothers Russ and Ron Rogers near Ord, Nebraska. Stanley Gladys Nolte own real estate in Valley County, Nebraska, and own Nolte Livestock Company, through which they feed cattle. Riverside Fertilizer Propane, Inc., is a provider of agricultural inputs in the area.
The debtor and the Noltes entered into a verbal lease for two quarter-sections of irrigated farmland (265 tillable acres) in Valley County. As rent, the Noltes were to receive the proceeds of 40 bushels per acre. Some of the corn to be paid for rent was to be delivered to the feed yard where the Noltes fed cattle. The Noltes
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believe that as landlords they hold a tenancy in common interest in the corn they were to be paid, and therefore in the proceeds. In addition, Mr. Nolte wrote three checks to the debtor in January, February, and April 2002, totaling $34,500. The memo line of the checks read “feed,” although Mr. Nolte and the debtor treated them as cash advances for operating funds and intended that the Noltes would be repaid with additional bushels of corn at harvest. They seek to recover $34,500 for the advances and $13,046 for the unpaid balance of the rent.
Riverside is owned by James Trotter. Mr. Trotter, in addition to being in the fuel, fertilizer, and grain business in Valley County, also provides financing for area farmers who are unable to obtain operating funds from conventional sources. Riverside established a $500,000 line of credit for the debtor on March 28, 2002, for crop inputs, cash rents, and other farm expenses. In return, Riverside took a blanket security interest in farm products, equipment, inventory, accounts, chattel paper, notes, intangibles, investment property, commodity accounts, cash and non-cash proceeds, and consumer and household goods, as well as assignments of USDA payments and crop insurance proceeds. To facilitate the new lending arrangement, the debtor’s previous lender, Sherman County Bank, subordinated its security interest and lien position in the 2002 farm products, all crop inputs, and all rights to proceeds from the 2002 crops. The lender specifically excepted from subordination its security interest and lien position in real estate, machinery and equipment, and livestock. In September 2003, Riverside purchased the Sherman County Bank’s rights under its security interests in the debtor’s assets, including real estate.
In the fall of 2002, Riverside paid for the crop to be harvested and delivered it to the Cargill grain elevator in Ord. When the grain was sold, checks were made payable jointly to the debtor and Mr. Trotter. Net sale proceeds amounted to $235,000. The disputed $34,500 is escrowed; the remaining funds were applied to the debtor’s debt to Riverside. The Noltes argue that their rights to the $34,500 are superior to Riverside’s rights in the same. The Noltes also make alternative arguments that Riverside’s security interests should be subordinated to theirs, or Riverside should have to satisfy its claim from other assets of the debtor in which it is secured.
Riverside and Mr. Trotter also exercised their rights under the deeds of trust on some of the debtor’s real estate and sold it. The seven tracts of land which were auctioned were first offered individually, and then as a whole. Riverside purchased the whole, then privately resold each of the tracts for $48,000 more than it paid for them. The Noltes assert that the sale was not properly
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conducted and resulted in a profit to Riverside which should have gone to the debtor’s estate. They want Riverside’s claim to be reduced by $48,000.
On the issue of a landlord’s interest in a crop, crop-share leases are treated differently than cash-rent leases. The rule in Nebraska is that:
where land is leased and rent is to be paid by a share or specified amount of the crops to be raised, the landlord and tenant are tenants or owners in common of the growing crops until such time that the crop is harvested and divided. The tenant may mortgage or sell his interest in the crops, but his mortgagee is charged with notice of the landlord’s interest. The tenant’s interest is determined by the terms of the lease, and his mortgagee can take no greater interest in the crop as against the landlord than could be asserted by the tenant himself.
If, on the other hand, the lease is on a cash rent basis, the cotenancy relationship does not exist. In this situation the landlord’s only recourse in the crops would be through an agreement with the tenant to give a security interest in the crops.
Lone Oak Farm Corp. v. Riverside Fertilizer Co., 229 Neb. 548, 552-53, 428 N.W.2d 175, 178 (1988) (internal citations omitted).
In the present case, there is a dispute as to how the rental arrangement was treated by the parties. Mr. Nolte testified that he and the debtor’s principal with whom he dealt agreed, as they have each year they enter into a leasing agreement on this property, to divide the crop, with the Noltes receiving 40 bushels per acre at harvest. Mr. Trotter testified that the expense was presented to him in the debtor’s cash-flow statement as one for cash rent, and it was paid accordingly. He testified that he would have obtained a subordination agreement from the Noltes and he would have reduced the debtor’s cash-flow needs by the amount of the rent if he thought they had a crop-share lease. One of the debtor’s principals testified that the debtor had always had a crop-share arrangement with Mr. Nolte, but in preparing the cash-flow statement for Mr. Trotter, he converted the number of bushels owed to the Noltes to a cash figure. As a result, Mr. Trotter believed the lease to be for cash rent. The debtor’s principal admits he “probably [did] not” disabuse Mr. Trotter of that notion.
Because Mr. Trotter believed the landlord and tenant to have a cash-rent arrangement, he caused a check to be issued to Mr. Nolte in April 2002 for $12,500 to pay the rental amount for the first half of the year. Mr. Nolte deposited the check in the Nolte
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Livestock bank account. While Mr. Nolte did not intend that action to change the nature of his agreement with the debtor, it did. A landlord “cannot accept from his tenant money in lieu of a rent in kind or undivided interest in a crop, and at the same time seek to establish such interest in the crop, or his right to the rent in kind.” Conner v. Schricker, 42 Neb. 656, 60 N.W. 891, 892 (1894). The landlord’s acceptance of the cash is an abandonment of his claim to a portion of the crop and evidences a new contract for rent as to the leased land. Id. See alsoLone Oak Farm, 229 Neb. at 553, 428 N.W.2d at 178-79 (where lease called for rent in either corn or cash at landlord’s option, and landlord collected cash, he gave up his ownership interest in the corn).
If a landowner holds a landlord’s lien created by the lease agreement, it is governed by the U.C.C. and the landlord must file a financing statement and perfect that security interest prior to one of the tenant’s creditors doing so. Ag Servs. ofAm., Inc. v. Empfield, 255 Neb. 957, 960, 587 N.W.2d 871, 873-74
(1999); McCoy v. Steffen, 227 Neb. 72, 416 N.W.2d 16 (1987) (security interest of tenant farmers’ creditor had priority over interest of tenants’ landlord where creditor’s financing statement was filed earlier); Todsen v. Runge, 211 Neb. 226, 318 N.W.2d 88 (1982) (under § 9-312(5), the secured party who is first to perfect or file security interest will have priority over all unperfected security interests even though such party had actual or constructive knowledge of a prior unperfected security interest). Here, the Noltes did not obtain or record a security interest in the crops to protect their interest. Therefore, Riverside’s lien attached first, because it was perfected first, and it has priority over the Noltes’ interest in the escrowed funds.
Regarding the three checks from the Noltes to the debtor, Mr. Nolte testified that on three separate occasions in the first few months of 2002, one of the debtor’s principals informed him that the debtor needed money to operate, and as a result Mr. Nolte, on behalf of Nolte Livestock Company, agreed to advance cash in exchange for additional bushels of corn at harvest. Mr. Nolte did not charge interest on these transactions; the repayment was calculated by dividing the loan amount by the market price of corn at the time of harvest to determine how many bushels should go to the Noltes. Mr. Nolte also testified that the memo lines on the checks say “feed” for accounting purposes, because Nolte Livestock is not in the business of lending money and does not have a bookkeeping category for advances or loans, but the checks had to be posted to some category. Also, he intended to use his share of the corn to feed his cattle.
The parties characterize the substance of these transactions differently. Mr. Nolte considers them to be advances, and intended
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them to be part of the lease arrangement. Riverside argues they are either loans or purchases. Regardless of what appellation is used, the outcome is the same.
If the payments are considered to be advances, then arguably the Noltes’ right to repayment attached at the time to the future crop as part of the crop-share lease. However, as discussed above, that interest in the crop was subsequently surrendered, so there is no longer an ownership interest to which the Noltes’ interest could attach.
Alternatively, if the payments are considered loans, there was no documentation executed to memorialize that, or to record the Noltes’ security interest. Mr. Nolte did not file a U.C.C. financing statement or an Effective Financing Statement regarding his interest in the crop or proceeds thereof. There was nothing on record as of the date in March 2002 when Riverside took its security interest in the debtor’s property to put it on notice that anyone other than Sherman County Bank claimed a superior interest in the collateral. By the same token, when Mr. Nolte wrote the check for the third advance in April 2002, Riverside had already taken its security interest and filed a U.C.C. financing statement and an Effective Financing Statement (“EFS”) with the Nebraska Secretary of State. In that regard, the Sherman County Bank’s financing statement and EFS had been on file since 2000, so had the Noltes conducted a lien search, they would have been aware of the claims of at least one prior lender. Under the circumstances, the Noltes’ security interest is junior to Riverside’s.
The plaintiffs also challenge the amount of Riverside’s claim against the estate, asserting that it should be reduced by the $48,000 profit Riverside made when it resold the debtor’s real estate. A claim asserted in a bankruptcy case through the filing of a proof of claim is deemed allowed, unless a party in interest objects. 11 U.S.C. § 502(a). A proof of claim which comports with the requirements of Bankruptcy Rule 3001(f) constitutes prima facie evidence of the validity and amount of the claim. In reSendMyGift.com, Inc., 280 B.R. 667, 674 (Bankr. D. Minn. 2002) (quoting In re Brown, 82 F.3d 801, 805 (8th Cir. 1996)). To rebut the presumptive validity of the asserted claim, the objecting party must bring forward “substantial evidence,” which then shifts the burden of production back to the claimant. Id.
With court permission, the debtor sold the land by auction, with each of the seven tracts first offered individually and then offered as a whole. Riverside was the successful bidder on the whole, with a bid nearly $50,000 higher than the total sum of the bids for each tract. The auctioneer closed the auction with an announcement that the property was sold to Riverside. Mr. Trotter
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then immediately began reselling various of the tracts, often to those individuals who had bid on the tracts at the auction. Six of the seven tracts were resold on the date of the auction, and the seventh was sold three days later. The gross sale proceeds from these private sales were $48,000 more than Riverside paid for the property.
The Noltes allege that the auction was improperly conducted and resulted in a lower recovery for the estate than it should have. Specifically, the plaintiffs allege that the auctioneer, after obtaining bids by the tract and by the whole, should have gone through another round of bidding on the individual tracts, allowing the individual high bidders to raise their bids. Failure to do so “chilled” the bidding, according to the plaintiffs, and resulted in an inadequate sales price.
The stipulation resolving Riverside’s objection to the debtor’s motion to sell the property described the sale process as follows: “The parcels will be offered for sale individually and then offered together for sale as a single sale. Whichever process results in the highest net return to the bankruptcy estate will be used[.]” Stipulation at ¶ 5f. (Fil. #252 in Case No. BK02-43097). The auctioneer then prepared a sale bill for advertisement purposes. The language of the sale bill, which was approved by the debtor’s attorney and Riverside’s attorney, described the “sale order” as follows: “Tracts offered 1-7, then as a whole. If a whole bid is received we will not go back to tracts. If a whole bid is not received we will go back to the tracts and offer them full and final.” (Fil. #117).
At trial, the plaintiffs called several of the people who had been the high bidders on individual tracts, who testified that they would have raised their bids if given a chance to do so after the high bid on the whole came in. The auctioneer and his assistant at the sale, however, testified that they announced during the bidding process on the whole that the bidders on the individual tracts could get together and bid on it as well, and they took recesses during the auction during which bidders could have made the necessary arrangements.
Although there was another bidder on the whole, none of the high bidders on the individual tracts bid against Mr. Trotter. The auctioneer testified that to conduct a third round of bidding to permit bidders to raise their bids on the individual tracts “would be a train wreck” (Fil. #148 at 106:22-107:14), although he later conceded it would be time-consuming but not impossible (Id. at 111:14-112:4).
It is apparent from the parties’ testimony that the entire
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transaction was a battle of wills. Mr. Trotter had previously inquired of the debtor about buying the real estate, and had even made offers prior to the auction on two tracts as well as on the whole. The debtor did not want to sell to him at any price. Some of the bidders testified that, at the auction, it was clear Mr. Trotter wanted to protect his interest in the real estate and was willing to spend the money necessary to do so. See testimony of Matt Alexander (Fil. #148 at 147:15-18) and Robert Sevenker (Fil. #148 at 169:16-21, 172:9-14). Even Mr. Nolte suggested that he might have felt better, even if the outcome were the same, if someone other than Mr. Trotter had been the high bidder. (Fil. #148 at 192:17-21).
Despite the plaintiffs’ insinuations, both the auctioneer and Mr. Trotter flatly deny having made any agreements to control the outcome of the sale. There is no evidence that the court-approved manner of sale was not followed or that anyone objected to the sale or the manner in which it was conducted prior to the filing of this lawsuit. It is unclear how this could be considered substantial evidence that the amount of Riverside’s claim is improper. The crux of the problem seems to be with Mr. Trotter’s manner of doing business. The way he conducted business at the auction may not win him any fans, but it does not run afoul of the law.
The Noltes next assert that Riverside’s claim should be subordinated to theirs pursuant to 11 U.S.C. § 510(c), based on Riverside’s alleged inequitable conduct. Section 510(c) provides that “after notice and a hearing, the court may . . . under principles of equitable subordination, subordinate for purposes of distribution all or part of an allowed claim to all or part of another allowed claim or all or part of an allowed interest to all or part of an allowed interest.”
The purpose of equitable subordination is to “undo or offset any inequity in the claim position of a creditor that will produce injustice or unfairness to other creditors in terms of the bankruptcy results.” Bunch v. J.M. Capital Fin., Ltd. (In reHoffinger Indus., Inc.), 327 B.R. 389, 415 (Bankr. E.D. Ark. 2005) (quoting Bostian v. Schapiro (In re Kansas CityJournal-Post Co.), 144 F.2d 791, 800 (8th Cir. 1944)).
The courts have adopted a three-part test for determining whether equitable subordination is appropriate:
(i) The claimant must have engaged in some type of inequitable conduct.
(ii) The misconduct must have resulted in injury to the creditors of the bankrupt or conferred an unfair advantage on the claimant.
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(iii) Equitable subordination of the claim must not be inconsistent with the provisions of the Bankruptcy Code.
Bergquist v. Anderson-Greenwood Aviation Corp. (In re BellancaAircraft Corp.), 850 F.3d 1275, 1282 (8th Cir. 1988).
The court’s power to exercise equitable subordination is limited; it is “not authorized in the name of equity to make wholesale substitution of underlying law controlling the validity of creditors’ entitlements, but [is] limited to what the Bankruptcy Code itself provides.” Raleigh v. Illinois Dept. ofRevenue, 530 U.S. 15, 24-25 (2000). Therefore, courts have identified certain principles to guide decisions regarding equitable subordination:
First, “inequitable conduct directed against the bankrupt or its creditors may be sufficient to warrant subordination of a claim irrespective of whether it was related to the acquisition or assertion of that claim.” Mobile Steel, 563 F.2d at 700. Second, “a claim or claims should be subordinated only to the extent necessary to offset the harm which the bankrupt and its creditors suffered on account of the inequitable conduct.” Id. at 701. And third, the objecting party must come forward with enough evidence to “`overcome the claimant’s prima facie case and thus compel him to actually prove the validity and honesty of his claim.'” Id. (quoting 3A J. Moore L. King, Collier on Bankruptcy, ¶ 63.06, at 1785 (14th ed. 1976)).
Hoffinger, 327 B.R. at 414-15.
The first issue is whether inequitable conduct occurred. The three broad categories of inequitable conduct are: (1) fraud, illegality, breach of fiduciary duties; (2) undercapitalization; and (3) use of the debtor as a mere instrumentality. Wilson v.Huffman (In re Missionary Baptist Found. of Am., Inc.),712 F.2d 206, 212 (5th Cir. 1983). The Noltes allege that Riverside’s harvest of the debtor’s corn crop on their land, without their knowledge or consent, constitutes inequitable conduct. However, as discussed to some extent above, Riverside was not aware of the Nolte’s claim to the crop. Riverside knew Mr. Nolte rented some farmland to the debtor, but it believed he did so on a cash-rent basis, as neither the debtor nor Mr. Nolte had indicated otherwise. There was no financing statement on file indicating a security interest held by the Noltes. It is unclear on this record how Riverside’s conduct as to the plaintiffs’ claimed interest in the crop could be inequitable when it had no knowledge of that interest. I find no basis for equitably subordinating Riverside’s claim.
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The plaintiffs alternatively suggest that Riverside be ordered to collect from its other collateral before collecting from the collateral in which the Noltes claim an interest. This is known as the doctrine of marshaling, which holds that if a senior lien holder has a lien that extends to two funds or two potential funds, and a junior lien holder has recourse to only one of those funds, the senior lien holder may be required to exhaust the fund to which only it has access before proceeding against the fund that is also available to the junior lien holder. Ramette v.United States (In re Bame), 279 B.R. 833, 837 (B.A.P. 8th Cir. 2002). The idea is to promote fair dealing and justice, so the doctrine may be applied when it can be equitably fashioned as to all parties. Id. It is not appropriately applied when to do so would cause prejudice to other parties. Id. (citing WhittakerCorp. v. St. Cloud Nat’l Bank Trust Co. (In re St. Cloud ToolDie Co.), 533 F.2d 387, 391 (8th Cir. 1976)).
The record indicates that the debtor owes Riverside about $100,000. The record also indicates that Riverside is likely fully secured, if not oversecured. For that reason, the plaintiffs suggest Riverside should be ordered to collect from its other assets, which would likely pay its claim in full, before collecting from the escrowed funds. The marshaling doctrine, however, requires that both parties have a lien on the same property. It is not available to unsecured creditors. In reDealer Support Servs. Int’l, Inc., 73 B.R. 763, 764 (Bankr. E.D. Mich. 1987); In re Mel-O-Gold, Inc., 88 B.R. 205, 207-08
(Bankr. S.D. Iowa 1988). In this case, it has been determined that the Noltes do not have a lien on the $34,500 in escrow. Therefore, the marshaling request must be denied.
Separate judgment will be entered in favor of Riverside Fertilizer Propane, Inc. Each party shall bear their own costs.
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JUDGMENT
Trial was held in North Platte, Nebraska, on April 14, 2005, on the plaintiffs’ complaint to determine the validity, priority, or extent of a lien. Allen Fugate appeared for the plaintiffs, and Nora Kane and Don Swanson appeared for the defendant.
IT IS ORDERED: For the reasons stated in the Memorandum of today’s date, judgment is hereby entered in favor of Riverside Fertilizer Propane, Inc., and against the plaintiffs. Each party shall bear their own costs.
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