Phillip Kunkel v. Sprague Natl. Bank
128 F.3d 636 (1997)
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Rule of Law:
A purchase money security interest (PMSI) in inventory that is perfected by the creditor's possession can achieve superpriority over a prior perfected security interest if the PMSI creditor notifies the prior creditor before the debtor receives actual, physical possession of the collateral.
Facts:
- Beginning in 1990, Sprague National Bank extended loans to John Morken, secured by a perfected security interest in Morken's current and after-acquired farm products, including cattle.
- In five transactions during February and April 1994, Morken purchased interests in approximately 1900 head of cattle from Hoxie Feeders, Inc.
- Hoxie financed these purchases, and Morken granted Hoxie a purchase money security interest (PMSI) in the specific cattle purchased in each transaction.
- Hoxie perfected its PMSI by maintaining continuous physical possession of the cattle at its feedlot pursuant to feedlot agreements with Morken.
- The cattle never left Hoxie's feedlot, and Morken never took physical possession of them.
- Under the agreements, the cattle were identified as belonging to Morken, who bore all risk of profit or loss and determined the timing and price of their eventual sale for slaughter.
Procedural Posture:
- John and Dorothy Morken filed for Chapter 11 bankruptcy in the United States Bankruptcy Court.
- The bankruptcy trustee commenced an adversary proceeding in the bankruptcy court to determine which creditor, Sprague or Hoxie, had priority to the cattle proceeds.
- Hoxie and Sprague filed cross-motions for summary judgment in the bankruptcy court.
- The bankruptcy court granted summary judgment for Hoxie, holding its PMSI had superpriority.
- Sprague (appellant) appealed to the United States District Court for the District of Minnesota.
- The district court affirmed summary judgment for Hoxie, holding that the PMSI notification requirement did not apply, and alternatively, that Sprague never had a security interest.
- Sprague (appellant) appealed the district court's decision to the United States Court of Appeals for the Eighth Circuit.
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Issue:
Does a purchase money security interest (PMSI) in inventory, perfected by the creditor's possession rather than by filing, have priority over a previously perfected security interest in the same inventory under the Uniform Commercial Code's superpriority rules when the debtor never receives actual physical possession?
Opinions:
Majority - Gibson
Yes, a purchase money security interest in inventory perfected by possession can achieve superpriority over a previously perfected security interest. First, the court established that Sprague did have a perfected security interest because Morken acquired sufficient 'rights in the collateral' for Sprague's interest to attach, even without physical possession. A sale occurred through constructive delivery, with Hoxie acting as a bailee; Morken held title, bore the risk of ownership, and controlled the ultimate sale, which constitutes sufficient rights under UCC § 9-203. Second, turning to the priority dispute, the court held that the UCC's superpriority provision for PMSIs in inventory (§ 9-312(3)) is available to creditors who perfect by possession, not just those who perfect by filing. The statute does not expressly exclude perfection by possession, and there is no policy reason to do so. Finally, the court determined Hoxie's notification to Sprague was timely. The statute requires notification to be received before the debtor 'receives possession' of the inventory. Citing the work of UCC Article 9's primary drafter, Grant Gilmore, the court interpreted 'possession' in this context to mean actual physical possession, not constructive possession. Since Morken never took actual physical possession of the cattle, Hoxie's notification, though sent after Morken's bankruptcy filing, was timely, granting Hoxie's PMSI priority over Sprague's earlier interest.
Analysis:
This decision clarifies the application of the UCC's purchase money security interest (PMSI) superpriority rules in the specific context of inventory perfected by possession. The court's key distinction between 'constructive possession' (sufficient for a security interest to attach) and 'actual physical possession' (the trigger for the PMSI notification deadline) creates a significant legal protection for seller-financiers like feedlots who retain the collateral. By defining the notification trigger as actual possession, the ruling potentially extends the notification window indefinitely for creditors who maintain possession, reinforcing the UCC's policy of favoring purchase-money financing that enables debtors to acquire new assets.
