In re Charles Sings Trustee the Blues As Close Is Still Good Enough for Horseshoes and Certificates of Title

In re Charles Sings Trustee the Blues As Close Is Still Good Enough for Horseshoes and Certificates of Title

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Last month, the Tenth Circuit Court of Appeals decided In re Charles, holding that a secured creditor's notation of itself as "owner" (rather than lienholder) of a vehicle is sufficient to perfect any lien interest that creditor may have in the vehicle, regardless of any statutory requirement that the lien appear on the face of the certificate. In re Charles, _____ F.3d ____, 2003 WL 1384031 (10th Cir. March 20, 2003). In so doing, the Tenth Circuit followed the majority view that the "substantial compliance" doctrine of the Uniform Commercial Code applies to state law certificate-of-title statutes. While the case is not of any landmark or unique precedent, it once again highlights a significant issue of statutory interpretation under state law and the UCC, and it raises certain implications regarding federalism and the purview of bankruptcy "common law."

The facts of Charles are fairly straightforward. The debtor entered into a master lease agreement (MLA) with a putative lessor, which purported to grant the debtor a leasehold interest in four trucks. The lessor was listed as the "owner" of the trucks on the Kansas certificates of title. Three years later, the debtor commenced a chapter 7 bankruptcy case and the trustee brought an adversary proceeding under 11 U.S.C. §544 to recharacterize the MLA as a disguised security agreement and to avoid the lessor/secured creditor's allegedly unperfected security interest in the four trucks. Without reaching the issue as to whether the MLA was a "true" lease, the bankruptcy court granted the lessor summary judgment based on the legal issue that, even if the lease were recharacterized, the lessor "substantially complied" with Kansas law governing perfection of security interests in motor vehicles. Id. at 1.

The Tenth Circuit affirmed, agreeing with the lower courts' analyses that the lessor's notation as "owner" on the certificate of title, although failing the plainly stated requirements of the Kansas statute, satisfied the substantial-compliance standard as the omission of any mention of a lien on the certificates of title constituted "minor errors" that were not "seriously misleading." Id. at 3; see, generally, U.C.C §9-402(8). In reaching that result, the Tenth Circuit rejected the trustee's reliance on two Kansas appellate court decisions that held that notation of a lien on the certificate of title is the exclusive method of perfecting a lien on motor vehicles and other titled vehicles. See Mid American Credit Union v. Bd. of Cnty. Comm'rs. of Sedgwick Cnty., 806 P.2d 479, 484 (Kan. Ct. App. 1991); see, also, Beneficial Finance Co. of Kansas Inc. v. Schroeder, 737 P.2d 52, 55 (Kan. Ct. App. 1987) (involving a priority dispute as to a mobile home and holding that the Kansas certificate of title statute contained to exclusive method for perfecting a security interest therein). The Charles court distinguished these cases factually without addressing the very literal, plain-meaning interpretations of the Kansas statutes applied in both cases.

Specifically, in deciding a negligence case against government officials for failure to list a lien on a motor vehicle, the Mid American court addressed the history of the Kansas certificate of title statute. The court emphasized the literal, plain-meaning interpretation given the lien notation requirement by the Kansas courts, while commenting that federal courts had interpreted the statute "differently." Mid American, 806 P.2d at 484 (citing In re Littlejohn, 519 F.2d 356 (10th Cir. 1975) (holding that listing the lien on the title was not necessary for perfection)). The Mid American court noted that, in response to In re Littlejohn, the Kansas legislature amended the relevant statutes to, in its view, tacitly reemphasize the lien-listing requirement. Id. To relax such a requirement, cautioned the Mid American court, would "endanger the reliability of sales of vehicles by assignment of title" and "diminish the reliability of a certificate of title." Id. Accordingly, the Mid American court reversed summary judgment for the defendants and remanded for a determination of plaintiff's damages. Thus, notwithstanding some factual distinctions, both Mid American and Schroeder demonstrate that it is strict statutory adherence—and not substantial compliance—that is mandated under state law.

Nevertheless, in addition to rejecting the literal, plain-meaning statutory interpretation urged by the trustee and supported by Kansas law, the Charles court also dismissed the trustee's policy argument that adopting the substantial compliance standard in Kansas would result in harm to innocent creditors. Id. at 4. Rather, the Charles court again emphasized the virtual wealth of federal bankruptcy case law applying the substantial compliance standard regardless of the plain meaning of the state certificate of title statute.1 Significantly, these cases were largely influenced by an authoritative treatise suggesting that grafting the substantial compliance standard to such cases is appropriate to "soften the literal requirements of state certificate of title "legislation" and "modernizing" the certificate of title statutes to comply with the policies of Article 9. Id. at 2 (citing 1 Clark, Barkley, The Law of Secured Transactions Under the Uniform Commercial Code, ¶12.03 [1] at 12-14 (1993)). Further, the Charles court opined that, in general, courts should apply the substantial compliance standard "regardless of any express statutory requirements." Id. at 2.2

The rationale of these cases is that a diligent creditor would not be prejudiced by the failure of the secured party to have its lien noted on the certificate of title. See, e.g., In re Circus Time Inc., 641 F.2d 39, 42-43 (1st Cir. 1981). They reason that a creditor would begin its search under the name of the debtor (the ostensible owner of the vehicle) and, failing to locate the collateral under that index, would then turn to the vehicle identification number or other search criteria. Id. Under that search, the creditor would ultimately discover the alleged ownership interest of the lessor/secured creditor and thus be put to notice of that interest and further investigation thereof. Id. Hence, the notation on the certificate serves its "notice" function and that is all that is required under the U.C.C. regardless of any statutory requirement that a lien be listed on such certificate. Id. at 43. Again, these cases characterize the state certificate of title statutes in an almost patronizing way, criticizing a plain-meaning application thereof as "formalistic," "technical" and not comporting with the "real world." Id. (citing 1 Coogan, C P., Hogan, W. and Vagts, D., Secured Transactions Under the Uniform Commercial Code, §29A.04(6) at 2931 (1980).

The Charles court did acknowledge contrary authority addressing similar facts, where a bankruptcy court rejected the majority view and enforced the lien-listing requirement mandated by state law. In re Charles, 2003 WL 1384031 at 5, n.3, citing Wheels Inc. v. Otasco Inc. (In re Otasco Inc.), 111 B.R. 976 (Bankr. N.D. Okla. 1990), rev'd. on other grounds, 196 B.R. 554 (N.D. Okla. 1991) (reversing based on finding that lease was a true lease). The Otasco court focused its analysis on Oklahoma state law in assessing the creditor's argument, in accordance with the majority view, that the absolute filing requirements of the certificate of title statute must be tempered within the more lenient standard prescribed under U.C.C. §9-402(8). Otasco, 111 B.R. at 990. The court concluded, based on its review of the case law and official comments, that the law was somewhat ambiguous. Id. The court then tested the facts of the case to the requirements of §9-402(8) and found the U.C.C. provision applicable only to "trivial inaccuracies," inadvertent misstatements or those determined errors on a case-specific basis. Id. at 991. However, the court did not find §9-402(8) to have any bearing on what it termed "deliberate and intentional" misstatements and omissions "in furtherance of a scheme to misrepresent the true nature of the transaction." Because, in the court's view, these omissions of the lien-listing requirement were not "errors," §9-402 was inapposite.3 Id. at 992-993. Moreover, the Otasco court warned that the adoption of such a standard would "demolish the UCC's policy of encouraging compliance with clear, simple, statutorily prescribed methods of achieving perfection." Id.

However compelling (or not) the Otasco analysis might be from a policy and well-reasoned analysis of the relevant authority standpoint, it is not the prevailing view and is of doubtful precedential value in the wake of In re Charles. Yet pyrrhicly, Otasco (although somewhat vitriolic) effectively takes the majority view to task for what seems an almost paternalistic bias of the federal courts to impose a more liberal standard on statutes that have a clear, unambiguous mandate, all for the sake of "modernizing and softening" these statutes. The inescapable irony is that it is the federal courts who so often espouse and apply the virtues of the "plain meaning" rule as a constraint to judicial activism and encroachment upon the province of the legislature.4 While Circus Time and its progeny apply the "substantial compliance" standard as an interpretation of state law, the familiar string cite in these opinions contains almost exclusively decisions by federal courts in bankruptcy cases.

There is no question that the practical realities of modern economic transactions demonstrate ample support for the result reached by In re Charles and the majority. It is the means, however, and not the end, that begs more than simply practical, "real world" justification. In a legislative environment that is now acutely attuned to the need to update potentially antiquated legislation, the issue is whether this "modernization" should be left to the state legislatures rather than a somewhat strained application of U.C.C. §9-402(8) or revised U.C.C. §9-506. It would seem that, in a forum that cites so often to Butner5 and is so wed to the plain-meaning rule, the latter would appear preferable to perpetuating the evolution of what is now known as the "bankruptcy common law."


Footnotes

1 See Load-It Inc. v. VTCC Inc. (In re Load-It Inc.), 774 F.2d 1077, 1078-79 (11th Cir. 1985) (holding a security interest in motor vehicle perfected under Georgia law where secured creditor identified as owner on certificate of title); In re Circus Time Inc., 641 F.2d 39, 42-44 (1st Cir. 1981) (same, applying Maine and New Hampshire law); In re Nat'l. Welding of Mich. Inc., 61 B.R. 314, 317 (W.D. Mich. 1986) (same, applying Michigan law); In re Microband Cos. Inc., 135 B.R. 2, 4-6 (Bankr. S.D.N.Y. 1991) (same, applying New York, New Jersey, Maryland and Michigan law); Yeager Trucking v. Circle Leasing of Colo. Corp. (In re Yeager Trucking), 29 B.R. 131, 134-35 (Bankr. D. Colo. 1983) (same, applying Colorado law); Coble Sysl. Inc. v. Coors of the Cumberland Inc. (In re Coors of the Cumberland Inc.), 19 B.R. 313, 320-21 (Bankr. M.D. Tenn. 1982) (same, applying Tennessee law). Return to article

2 The Charles court, despite Mid American and Schroeder, predicted that the Kansas Supreme Court would adopt the substantial compliance standard. Return to article

3 Black's Law Dictionary defines "error" as a mistaken judgment or incorrect belief as to the existence or effect of matters of fact, or a false or mistaken conception or application of the law. 282 (5th Ed. 1983). Return to article

4 See, also, In re Manufacturers Credit Corp., 441 F.2d 1313, 1319 (3rd Cir. 1971) (holding that the application of the UCC's substantial compliance standard to the New Jersey certificate of title statute would effectively rewrite the statute and constitute prohibited judicial legislation). Return to article

5 Butner v. United States, 99 S.Ct. 914 (1979) (holding that barring some federal interest, interests in property must be determined in bankruptcy pursuant to state law. Return to article

Journal Date: 
Thursday, May 1, 2003