Matter of Cliff's Ridge Skiing Corp.
1991 Bankr. LEXIS 139, 13 U.C.C. Rep. Serv. 2d (West) 1309, 123 B.R. 753 (1991)
Rule of Law:
When a valid subordination agreement between a senior and a junior creditor creates a circular priority dispute with an intermediate non-subordinating creditor, the ITT Diversified formula should be applied to distribute proceeds, ensuring the intermediate creditor's position is neither adversely nor beneficially affected by the agreement.
Facts:
- On July 24, 1980, First of America Bank-Marquette, N.A. (FOA) loaned Cliffs Ridge Development Co. $300,000, secured by a recorded mortgage on real property, which explicitly included all present and future improvements and fixtures.
- In April or May 1982, Cliff's Ridge Skiing Corporation (Debtor) purchased a chairlift from Breckenridge Ski Area for $65,000 on a cash-on-delivery basis, incurring additional costs for shipping, engineering, and erection.
- The chairlift was delivered in August 1982, and its erection, involving bolting towers to concrete pads and special engineering for the ski hill, commenced in September 1982, concluding with state certification by December 23, 1982.
- On November 22, 1982, Cliffs Ridge Development Co. conveyed the ski hill real property to the Debtor, subject to FOA's prior mortgage, and the Debtor granted Cliffs Ridge Development Co. a second mortgage on the real property, recorded the next day, which covered 'appurtenances' but did not expressly mention fixtures.
- On December 13, 1982, the Debtor, Economic Development Corporation (EDC), and First National Bank & Trust Company of Marquette (First National) executed a Loan Agreement for $175,000 to finance the chairlift, with First National to receive a perfected security interest.
- Also on December 13, 1982, FOA, First National, EDC, and the Debtor entered into a Subordination Agreement, wherein FOA agreed to subordinate its security interest in the chairlift to First National and EDC; Cliffs Ridge Development Co. was not a party to this agreement.
- On December 14 and 15, 1982, First National (as assignee of EDC) filed multiple financing statements, including fixture filings, with the Marquette County Register of Deeds and the Michigan Secretary of State, perfecting its security interest in the chairlift.
- On December 17 and 23, 1982, First National disbursed loan proceeds totaling approximately $149,864.39 to the Debtor.
Procedural Posture:
- On October 28, 1987, Cliff's Ridge Skiing Corporation (Debtor) filed for Chapter 11 bankruptcy relief in the U.S. Bankruptcy Court for the Western District of Michigan.
- On January 4, 1988, the bankruptcy case was converted to a Chapter 7 liquidation.
- On July 28, 1988, the bankruptcy court ordered the sale of the Debtor's assets, including the chairlift.
- On December 27, 1988, the $22,500 proceeds from the chairlift sale were placed into an interest-bearing escrow account by court order, pending a determination of entitlement among competing creditors.
- First National Bank & Trust Company of Marquette (First National) filed a motion asserting its claim to the escrowed proceeds.
- The parties involved—First National, Cliffs Ridge Development Co., and First of America Bank-Marquette, N.A. (FOA)—consented to resolve the dispute as a contested matter under Bankruptcy Rule 9014, applying rules for adversary proceedings.
- On July 27, 1989, a hearing was held in Marquette, Michigan, where the parties submitted a Stipulated Statement of Facts and various exhibits.
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Issue:
How should a circular priority dispute between multiple secured creditors with interests in a fixture be resolved when one senior creditor has validly subordinated its interest to a junior creditor, but not to an intermediate creditor, thus creating an 'A subordinates to C, C is junior to B, B is junior to A' scenario?
Opinions:
Majority - James D. Gregg, Bankruptcy Judge
Yes, the circular priority dispute involving the chairlift sale proceeds should be resolved by applying the ITT Diversified Credit Corp. formula, which ultimately results in First National receiving all proceeds. The court first determined that the chairlift was a fixture under Michigan's three-part test, having been annexed, adapted, and intended as a permanent accession to the realty. All three creditors (FOA, Cliffs Ridge Development Co., and First National) were found to hold valid, perfected interests in the chairlift and its proceeds: FOA and Cliffs Ridge Development Co. through their recorded real estate mortgages (which covered existing and future fixtures/appurtenances, even without explicit item descriptions), and First National through a properly filed UCC fixture filing. However, First National did not qualify for a purchase money security interest because its loan advances occurred after the chairlift was purchased and delivered, meaning the funds did not 'enable' the debtor to acquire the collateral. The Subordination Agreement between FOA and First National was deemed valid and enforceable due to sufficient consideration (detriment to First National in advancing funds, benefit to FOA from property improvement), but it did not affect Cliffs Ridge Development Co.'s priority as a non-party. This created a circular priority: FOA > Cliffs Ridge Dev. > First National > FOA. To resolve this, the court adopted the ITT Diversified Credit Corp. formula. This formula ensures that the intermediate creditor (Cliffs Ridge Development Co.) is not prejudiced by an agreement to which it was not a party. Applying the formula, First National's claim is satisfied from the portion of the fund that would have originally gone to FOA. Since all three creditors had claims exceeding the $22,500 in chairlift proceeds, First National's claim exhausted the entire fund by stepping into FOA's senior position, leaving no proceeds for Cliffs Ridge Development Co. or FOA.
Analysis:
This case provides a crucial illustration of how state real estate law and the UCC interact in fixture disputes, particularly regarding the distinct methods of perfection and the strict requirements for a purchase money security interest. Its most significant contribution is the adoption and detailed application of the ITT Diversified formula for resolving circular priority conflicts arising from subordination agreements. The ruling emphasizes that such agreements only alter priorities between the parties involved and highlights the court's role in devising equitable solutions to maintain the intended priority of non-parties. This approach offers a clear framework for courts to navigate complex lien priority issues without arbitrarily reordering the entire priority chain.
