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From Banking and Finance Law Daily, September 22, 2016

Settlement funds constituted proceeds of damaged collateral

By Lisa M. Goolik, J.D.

The U.S. Court of Appeals for the Eighth Circuit has held that a creditor, Stearns Bank N.A., could pursue a secured claim against settlement funds paid to a debtor to resolve a commercial tort claim filed by the debtor against Bayer CropScience, LLC. The court concluded that, in accordance with Article 9 of the Texas Uniform Commercial Code, the settlement funds constituted proceeds of the bank’s collateral that may have been damaged as a result of Bayer’s actions. In addition, Stearns Bank’s claims to the proceeds were not extinguished by its prior foreclosure in the debtor’s underlying collateral because the remedies in the UCC are cumulative, allowing the bank to pursue both foreclosure and an action to enforce its rights (Bayer CropScience, LLC v. Stearns Bank, N.A., Sept. 20, 2016, Shepherd, B.).

Disputed settlement funds. In November 2006, Texana Rice Mill and Texana Rice, Inc. sued Bayer CropScience for claims related to the contamination of the U.S. commercial long-grain rice supply by Bayer’s genetically modified rice. Texana and Bayer subsequently reached a settlement for $2.1 million. After two uncontested disbursements, almost $934,000 of the settlement payment remained. Stearns Bank and Amegy Bank claimed priority over those funds—Texana owes separate debts to Stearns Bank and Amegy Bank which total an amount in excess of the remaining settlement proceeds. As a result, Bayer sought a determination as to its obligations with regards to the remaining funds.

Stearns Bank. In September 2002, Stearns Bank made a $2.65 million loan to Texana that was secured by a security agreement which covered, among other items, general intangibles, fixtures, and equipment, as well as "sums due from a third party who has damaged or destroyed the collateral or from that party’s insurer." Stearns Bank perfected its security interest by filing a UCC financing statement with the Texas Secretary of State.

Texana subsequently defaulted on the loans and judgment was entered against Texana in January 2010. After Stearns Bank foreclosed on its security agreement, more than $3.8 million remained on the unpaid judgment.

Amegy Bank. Meanwhile, in February 2006, Amegy Bank loaned Texana $2 million. Texana later defaulted on the Amegy Bank loan. In June 2007, Texana executed a written forbearance agreement with Amegy Bank that provided, in exchange for a security interest in Texana’s Bayer suit, Amegy Bank would forbear on certain of its contractual and legal rights. Amegy Bank perfected its security interest in the commercial tort claim by filing a UCC financing statement.

Competing claims. Stearns Bank argued its security interest had priority because it filed a UCC financing statement covering Texana’s general intangibles before Amegy Bank filed its UCC statement covering the Bayer suit. It also argued it was entitled to the settlement payment as proceeds from its original collateral, which included fixtures and equipment that were damaged by Bayer’s negligence.

Amegy Bank countered that Stearns Bank’s interest in general intangibles could not cover the settlement in a subsequent commercial tort claim and that Stearns Bank’s interest was discharged in the foreclosure.

Cumulative remedies. The Eighth Circuit concluded that Stearns Bank had both the right to foreclose on its collateral, as well as to enforce its security agreement as to the proceeds of its collateral. Section 9-617 of the Texas UCC—which the parties agreed applied to the action—provides that "[a] secured party’s disposition of collateral after default: (1) transfers to a transferee for value all of the debtor’s rights in the collateral; (2) discharges the security interest under which the disposition is made; and (3) discharges any subordinate security interest or other subordinate lien." While the district court interpreted the section broadly to preclude Stearns Bank from seeking proceeds of its original collateral, the Eighth Circuit determined that the remedies are cumulative and may be exercised simultaneously. "Accordingly, Stearns Bank’s foreclosure did not discharge an otherwise valid security interest in the proceeds of the collateral nor did it preclude Stearns Bank from pursuing its rights to such proceeds," wrote the court.

As to whether the settlement funds were proceeds of Stearns Bank’s collateral, the Eighth Circuit determined that when Bayer damaged Texana’s equipment in 2006, Stearns Bank’s interest attached to the right of recovery for damages to the equipment. The court’s finding was supported by Section 9-102 which defines "proceeds" to include "to the extent of the value of collateral, claims arising out of the loss, nonconformity, or interference with the use of, . . . or infringement of rights in, or damage to the collateral." Accordingly, Stearns Bank held a security interest in the proceeds of the Bayer suit as a right of recovery with respect to damage to its original collateral.

Moreover, the court noted, the result was mandated by the language of the security agreement with Texana, which included "sums due from a third party who has damaged or destroyed the Collateral or from that party’s insurer." The court concluded that to the extent that the settlement payment from Bayer to Texana included payment for damages to Stearns Bank’s original collateral, those sums were covered by the original security agreement.

As a result, the Eighth Circuit remanded the matter to the district court to determine what portion of the settlement funds constituted proceeds of Stearns Bank’s original collateral.

General intangibles. While Stearns Banks may have had an interest in the funds as proceeds of its collateral, the bank did not have an interest in the Bayer settlement as a general intangible. The Eighth Circuit concluded that while most debtor property can be secured by referencing its "type," such as "general intangibles," or "fixtures," the UCC imposes heightened identification requirements to encumber commercial tort claims, and proceeds thereof, in order to prevent debtors from inadvertently encumbering commercial tort claims.

The case is No. 15-1967.

Attorneys: John Edward Galvin, III (Fox Galvin, LLC) for Bayer CropScience, LLC. Michael A. Campbell (Polsinelli, PC) for Stearns Bank National Association. Leslie Dean Henke, Jr. (SmithAmundsen LLC) and David M. O'Dens (SettlePou) for Amegy Bank National Association.

Companies: Amegy Bank N.A.; Bayer CropScience, LLC; Stearns Bank N.A.; Texana Rice, Inc.; Texana Rice Mill

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