Sometimes, it is just impossible to beat the “no-win scenario” by reprogramming a computer simulation or otherwise, as one senior secured creditor recently found out in a case reported as Auto Trakk, LLC v. East Shore Auto, Inc. (In re East Shore Auto, Inc.)., 638 B.R. 324 (Bankr. M.D. Pa. 2022). In East Shore Auto, Dealer Resources, the holder of an enforceable first priority security interest and lien against debtor East Shore, litigated and lost! Relying on the UCC provision that protects innocent buyers of encumbered property who may take such property free and clear of a valid and perfected security interest, the East Shore Auto court entered judgment against Dealer Resources and in favor of Auto Trakk, who purchased vehicles and lease agreements from East Shore.
East Shore was in the business of buying, financing and leasing automobiles. First, East Shore would purchase vehicles at car auctions and finance such purchases with loans, secured by liens on such vehicles, provided by Dealer Resources. The vehicles, after purchase, were held by East Shore as its inventory. It was undisputed that Dealer Resources fully perfected its first priority liens by properly filing UCC-1 financing statements for all vehicles financed—one of the two ways UCC 9-311 provides for perfection of a security interest in certificated vehicles, and the only way to perfect when the collateral is inventory held for sale or lease by a person in the business of selling or leasing inventory of that kind. The other method of perfection—noting the secured party’s interest on the title certificate—would not be available under these circumstances.
After acquiring a vehicle, East Shore would lease such vehicle to a third-party end user pursuant to a written lease agreement and sell both the vehicle and the lease agreement to Auto Trakk. Auto Trakk understood that the money it paid for the leases and vehicles would be used by East Shore to pay off any outstanding liens on the vehicles prior to transferring title to Auto Trakk. It was stipulated that Auto Trakk was unaware that its agreements with East Shore or that the purchase of the vehicles violated any agreement between Dealer Resources and East Shore.
The Statutory Scheme
The Pennsylvania Commercial Code, codified at 13 Pa. C.S.A. § 1101 et seq., conforms to the uniform version of the UCC for all sections relevant to this case. Section 1201(b)(9) of the PA Code defines “a buyer in the ordinary course of business” as “[a] person that buys goods in good faith, without knowledge that the sale violates the rights of another person in the goods, and in the ordinary course from a person . . . in the business of selling goods of that kind.” Further, a person also buys in the ordinary course of business “if the sale to the person comports with the usual or customary practices in the kind of business in which the seller is engaged or with the seller’s own usual or customary practices.” Good faith is defined at section 1201(b)(20) of the PA Code as “honesty in fact and the observance of reasonable commercial standards of fair dealing.”
Under section 9320(a) of the PA Code, a buyer in the ordinary course of business “takes free of a security interest created by the buyer’s seller, even if the security interest is perfected and the buyer knows of its existence.” In addition to actual knowledge of the security interest, the buyer must have actual knowledge that the proposed sale is in violation of the third party’s security interest, for the buyer to lose in ordinary course status.