Madison Capital Co., LLC v. S & S SALVAGE, LLC
765 F.Supp.2d 923, 2011 WL 195634, 2011 U.S. Dist. LEXIS 4791 (2011)
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Rule of Law:
A purchaser of goods subject to a perfected security interest does not qualify as a 'buyer in the ordinary course of business' under UCC § 9-320 if the security interest was created by a party who is not in the business of selling goods of that kind, even if the goods are acquired through an intermediary who is a dealer in such goods.
Facts:
- In February 2005, Community Trust Bank (CTB) issued loans to Timothy P. Smith's coal companies (the 'Smith Companies') and took a perfected security interest in their equipment as collateral, including eighty-five Hemscheidt Shields.
- Smith personally guaranteed the loans.
- A month after securing the loan, CTB explicitly denied Smith's request to sell portions of the collateralized equipment.
- Despite the denial, Smith sold some of the equipment and, in December 2005, arranged for S & S Salvage, LLC to sell the Shields as scrap to River Metals Recycling, LLC.
- River Metals purchased the Shields from S & S Salvage over several days, without knowledge of Smith, and immediately processed them into scrap metal.
- In November 2005, Madison Capital Company, LLC began loaning money to Smith's companies.
- In September 2006, Madison Capital purchased CTB's entire position as a secured creditor of the Smith Companies via an assignment.
Procedural Posture:
- Madison Capital Company obtained a judgment against Timothy Smith on August 26, 2008, for his personal guarantee of the underlying bank loans.
- Madison Capital filed suit against S & S Salvage, LLC in the U.S. District Court for the Western District of Kentucky in November 2008.
- Madison Capital amended its complaint to include River Metals Recycling, LLC as a defendant on February 13, 2009.
- Plaintiff Madison Capital, Defendant River Metals, and Defendant S & S Salvage all filed cross-motions for summary judgment, asking the court to rule on the claims as a matter of law.
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Issue:
Does a company that buys goods for scrap qualify as a 'buyer in the ordinary course of business' under Kentucky's Uniform Commercial Code, thereby taking the goods free of a perfected security interest, when the security interest was created by a mining company not in the business of selling such equipment, and the goods were sold through an intermediary who deals in scrap metal?
Opinions:
Majority - Joseph H. McKinley, Jr.
No. A buyer does not qualify for protection as a 'buyer in the ordinary course of business' unless the security interest was created by the buyer's seller, and that seller is in the business of selling goods of that kind. The court reasoned that the 'buyer in the ordinary course' (BIOC) exception under Ky.Rev.Stat. Ann. § 355.9-320(1) is narrow and requires satisfying two key conditions derived from two different statutory sections. First, under § 355.9-320(1), the security interest must be 'created by the buyer's seller.' Second, under the § 355.1-201(2) definition of a BIOC, that seller must be 'in the business of selling goods of that kind.' Here, the security interest was created by Smith, who was in the mining business, not the business of selling mining equipment. River Metals could not selectively treat Smith as the seller for the 'created by' requirement and S & S Salvage (a scrap dealer) as the seller for the 'in the business of selling' requirement. The policy behind the rule is to protect buyers only when a lender gives a debtor who is a dealer the 'apparent authority' to sell collateral held as inventory, which was not the case here.
Analysis:
This decision strictly construes the 'buyer in the ordinary course of business' (BIOC) defense under the Uniform Commercial Code, reinforcing the 'created by his seller' limitation. It clarifies that a buyer cannot combine the identities of an owner and an intermediary to satisfy the different prongs of the BIOC test. The ruling provides significant protection to lenders with perfected security interests in non-inventory collateral, placing the risk of loss from an unauthorized sale squarely on the subsequent purchaser rather than the innocent secured party. This precedent solidifies that a buyer's innocence or good faith is insufficient to overcome a properly perfected security interest when the debtor is not a dealer in the goods sold.
