In Re Oriental Rug Warehouse Club, Inc.
1997 Bankr. LEXIS 111, 31 U.C.C. Rep. Serv. 2d (West) 1187, 205 B.R. 407 (1997)
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Rule of Law:
Under UCC § 9-306, a creditor claiming a security interest in proceeds bears the absolute burden of tracing and identifying those proceeds back to the original collateral. A creditor's inability to trace is fatal to its claim in the proceeds, and equitable principles cannot be invoked to bypass this statutory requirement.
Facts:
- Oriental Rug Warehouse Club, Inc. ('Debtor') and Yashar Rug Co., Inc. ('Yashar') entered into a 'consignment agreement' whereby the Debtor took possession of Yashar's rugs to resell them.
- Yashar filed a UCC-1 financing statement to perfect its interest in the consigned rugs.
- The Debtor sold some of Yashar's rugs but failed to remit the sales proceeds to Yashar as required by their agreement.
- Instead of paying Yashar, the Debtor used the proceeds from the sale of Yashar's rugs to purchase new, different rug inventory or otherwise retained the funds.
- A representative for Yashar later went to the Debtor's business and repossessed all of the original, unsold consigned rugs.
- Following the repossession, the Debtor no longer possessed any rugs that had been supplied by Yashar.
Procedural Posture:
- Oriental Rug Warehouse Club, Inc. ('Debtor') filed a petition for relief under Chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the District of Minnesota.
- Yashar Rug Co., Inc. filed a proof of secured claim in the amount of $64,243.00.
- The Debtor objected to Yashar's secured claim.
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Issue:
Does a creditor have an enforceable secured claim in a debtor's current inventory as "proceeds" under UCC § 9-306 when the creditor concedes it cannot trace the funds from the sale of its original collateral to the purchase of that current inventory?
Opinions:
Majority - Judge Nancy C. Dreher
No. A creditor does not have an enforceable secured claim in proceeds under UCC § 9-306 if it cannot meet its burden of tracing and identifying those proceeds back to the disposition of the original collateral. The court first determined that the agreement between the Debtor and Yashar was a secured financing arrangement governed by UCC Article 9, not a true consignment, based on factors showing the Debtor had control over pricing, commingled goods and funds, and was billed on shipment rather than sale. Under UCC § 9-306, a security interest continues only in 'identifiable proceeds.' The burden to identify proceeds through tracing rests squarely on the secured party, Yashar. Since Yashar conceded that it was impossible to trace the proceeds from the sale of its original rugs to the Debtor's current inventory, it failed to meet this burden. The court rejected Yashar's argument that this burden should be lifted in a dispute against the debtor, noting that in bankruptcy the debtor-in-possession holds the powers of a trustee and hypothetical lien creditor. Finally, the court dismissed Yashar's request for an equitable lien, holding that the specific provisions of UCC § 9-306 displace general equitable principles, as allowing such a lien would undermine the certainty and predictability Article 9 is designed to create.
Analysis:
This decision reinforces a fundamental principle of secured transactions law: the burden of tracing proceeds lies strictly with the creditor. The court clarifies that this burden is not excused even when the debtor's poor record-keeping or commingling of funds creates the tracing problem. The ruling serves as a strong caution to creditors, underscoring the importance of implementing protective contractual measures, such as requiring segregated accounts for proceeds, rather than relying on courts to create equitable remedies after a default. It solidifies the UCC's preference for clear, predictable rules over vague equitable arguments to maintain stability in commercial finance.
