Bank of Guam v Island Hardware Inc [1986] FMSC 22; 2 FSM Intrm. 281 (Pon. 1986) (26 December 1986)

THE SUPREME COURT OF THE
FEDERATED STATES OF MICRONESIA

Cite as Bank of Guam v. Island Hardware Inc.,
[1986] FMSC 22; 2 FSM Intrm. 281 (Pon. 1986)

[1986] FMSC 22; [2 FSM Intrm. 281]

BANK OF GUAM,
Plaintiff,

vs.

ISLAND HARDWARE, INC., MID-PAC
CONSTRUCTION CO., INC., SETS INC.,
CHUA ENG CHUAN and the FEDERATED
STATES OF MICRONESIA,
Defendants.

CIVIL NO. 1986-056

OPINION
Before Edward C. King
Chief Justice
December 26, 1986

APPEARANCES:

For the Plaintiff: Michael Berman
(Bank of Guam) Attorney-at-law
P.O. Box 1491
Kolonia, Pohnpei 96941

For the Defendant:
(Island Hardware)

For the Defendant: R. Barrie Michelsen
(Sets Inc., Chua Attorney-at-Law
Eng Chuan) Ramp & Michelsen
Kolonia, Pohnpei 96941

For the Defendant: Jack Warndof
Chief of Litigation
FSM Attorney General's Office
Kolonia, Pohnpei 96941

[2 FSM Intrm. 282]

and

Bruce Turcott

Assistant Attorney General

FSM Attorney General's office

Kolonia, Pohnpei 96941

* * * *

HEADNOTES

Civil Procedure - Summary Judgment
Facts and inferences are to be viewed in the light most favorable to the party against whom summary judgment is sought and the motion may then be granted only if it is clear that there is no genuine issue of material fact and the moving party must prevail as a matter of law. Bank of Guam v. Island Hardware, Inc., [1986] FMSC 22; 2 FSM Intrm. 281, 284 (Pon. 1986).

Attachment and Execution
The statutes concerning writs of execution protect certain property of the debtor from execution but contain no suggestion that other creditors can obtain rights superior to that of the judgment creditor in property covered by a writ of execution. Bank of Guam v. Island Hardware, Inc., [1986] FMSC 22; 2 FSM Intrm. 281, 285 (Pon. 1986).

Attachment and Execution
While the statute authorizing execution against "the personal property of the person against whom the judgment has been rendered" contains no exceptions for third party creditors, neither does it purport to sweep away pre-existing property rights, including security interests, of such creditors, nor does the statute authorize the sale of property owned by others which happens to be in possession of the debtor at the time of execution. 6 F.S.M.C. 1407. Bank of Guam v. Island Hardware, Inc., [1986] FMSC 22; 2 FSM Intrm. 281, 285 (Pon. 1986).

Secured Transactions
The common law of the United States today concerning secured transactions is the Uniform Commercial Code (UCC), a comprehensive statute covering commercial transactions. Bank of Guam v. Island Hardware, Inc., [1986] FMSC 22; 2 FSM Intrm. 281, 287 (Pon. 1986).

Secured Transactions
Absence in the Federated States of Micronesia of any filing requirement to notify others of a security interest, and of a designated place for filing, which provisions are at the heart of the UCC statutory scheme, virtually precludes any judicial attempt to draw heavily on UCC principles in fashioning an approach to secured transactions. Bank of Guam v. Island Hardware, Inc., [1986] FMSC 22; 2 FSM Intrm. 281, 287 (Pon. 1986).

Secured Transactions; Common law
In considering the law concerning secured transactions, the FSM Supreme

[2 FSM Intrm. 283]

Court must look for guidance of the pre-UCC common law and may only declare the existence of such security interests as have been found by other courts to exist in the absence of statutes. Bank of Guam v. Island Hardware, Inc., [1986] FMSC 22; 2 FSM Intrm. 281, 288 (Pon. 1986).

Debtors and Creditors Rights
Because courts generally were concerned that third parties, especially other potential creditors, might rely to their detriment on assets which are in the possession of the borrower but, unknown to the other parties, are subject to a secret lien, there exists in the law a strong general policy against non-possessory and secret liens. Bank of Guam v. Island Hardware Inc., [1986] FMSC 22; 2 FSM Intrm. 281, 279 (Pon. 1986).

Secured Transactions
When a party agrees to create a security interest to secure his debt but then refuses to do what is necessary to vest the other party with statutory or common law lien rights in the property, courts can find that the other party has an equitable lien in property even if statutory or common law lien requirements have not been met. Bank of Guam v. Island Hardware, Inc., [1986] FMSC 22; 2 FSM Intrm. 281, 290 (Pon. 1986).

Secured Transactions
Non-possessory equitable liens will not be found to exist against another who had neither actual notice nor reason to know of the existence of the security claim. Bank of Guam v. Island Hardware, Inc., [1986] FMSC 22; 2 FSM Intrm. 281, 290 (Pon. 1986).

* * * *

COURT'S OPINION

EDWARD C. KING, Chief Justice:
This litigation involves the struggle among various creditors of Island Hardware, Inc., for the remaining assets of that failing corporation. The issues raised are of first impression and are important not only for the parties themselves but for the jurisprudence and economy of the Federated States of Micronesia.

Writs of execution were issued on June 19, 1986 by this Court in two separate cases to enforce judgments obtained against Island Hardware by Sets, Inc. and Chua Eng Chuan. The Federated States of Micronesia Division of Security & Investigation has filed a return of execution from the sale and seizure of Island Hardware assets indicating receipt of cash proceeds in the amount of $26,002.41 from sales of inventory and equipment and seizure of receivables totalling approximately $74,000. The aggregated claims of the various parties here considerably exceed $100,000 and each creditor claims a right of priority to the proceeds of the execution sale.

I. Procedural Background

This lawsuit was instituted on August 5, 1986 by the Bank of Guam

[2 FSM Intrm. 284]

seeking a ruling that the bank has a security interest pursuant to a June 20, 1984 general security agreement between the bank and Island Hardware which should be given priority over the claims of the other creditors.

Sets, Inc. and Chua Eng Chuan are the judgment creditors for whom the writs of execution were issued on June 19, 1986. They have filed a motion for summary judgment against the bank contending that it is clear as a matter of law that the bank has no rights under the general security agreement which could be superior to their rights under the writs of execution.1 The bank has countered with a cross-motion of its own, seeking summary judgment.

The judgment creditors filed no affidavits and submitted no evidence in support of their motions. In considering the judgment creditors' motion then the Court may rely only upon those facts admitted by the bank and any additional facts of which the Court may take judicial notice. The entire record in this case, including the affidavits previously filed by the bank in support of earlier motions for temporary restraining order and preliminary injunction, is to be considered. FSM Civ. R. 56. The facts, and any inferences therefrom, are to be viewed in the light most favorable to the party against whom summary judgment is sought. FSM v. Ponape Builders Constr., Inc., 2 FSM Intrm. 48 (Pon. 1985). Therefore the cross-motions here should be viewed separately, construing the facts in each motion most strongly against the party seeking summary judgment. A motion for summary judgment may then be granted only if it is clear that there is no genuine issue of material fact and that the moving party must prevail as a matter of law. Id.

Applying these principles I conclude, for the reasons stated here, that a partial summary judgment may be granted to the judgment creditors as to the nonexistence of any statutory or common law lien in favor of the bank, but factual questions remain unanswered concerning the bank's equitable lien claims and the balance of the motions must be denied.

II. Legal Analysis

A. Claims of the Judgment Creditors

The security claims of the judgment creditors are based upon writs of execution issued pursuant to 6 F.S.M.C. 1407, which says: "Every court, at the

[2 FSM Intrm. 285]

request of the party recovering any civil judgment in that court for the payment of money, shall issue a writ of execution against the personal property of the party against whom the judgment has been rendered...."

This is followed in the Code by a lengthy provision detailing the steps to be taken by police officers upon issuance of a writ of execution. 6 F.S.M.C. 1408. That section explains that police officers are first to attempt to demand of the debtor that he pay the entire amount of the judgment. If full payment is not made, the officers are instructed to seize, or set aside, property of the debtor the sale of which would be sufficient to obtain proceeds to pay the judgment plus any costs or fees incurred in connection with the execution. Id. Public notice of sale is given and then a sale of the property is conducted. Id.

It is this procedure which yielded the cash proceeds and accounts receivable at issue in this use.

Plainly, these procedures are calculated to vest in judgment creditors extensive rights over the property of the debtor. There are provisions in 6 F.S.M.C. §§ 1408 and 1415 to protect selected or exempt property of the debtor but these are only for the debtor's protection. The statute contains no exception or suggestion of any kind that other creditors can obtain rights superior to that of the judgment creditor in property covered by a writ of execution.

It need not be here determined precisely when the sweeping rights of the judgment creditor attach, whether upon issuance of the writ, delivery of the writ to police officers, or actual seizure of particular property. This is so because the bank's claims rest upon the June 20, 1984 security agreement, not any actions which took place after the June 19, 1986 issuance of the writs of execution.

While the statute contains no exceptions for third party creditors, neither does it purport to sweep away pre-existing property rights, including security interests, of others. The execution is against "the personal property of the person against whom the judgment has been rendered." 6 F.S.M.C. 1407. Obviously, the statute does not authorize the sale of property owned by others which happens to be in possession of the debtor at the time of execution. So also, a pre-existing security interest in property of a debtor is not overridden by a subsequent writ of execution.

B. Security Claims of the Bank of Guam

The issue here then is whether the bank had a valid security interest in the "fixtures, equipment, accounts receivable and inventory" formerly in the possession of Island Hardware and levied upon by the Division of Security and Investigation.

[2 FSM Intrm. 286]

As already noted, the bank relies upon the general security agreement, dated June 20, 1984, which recites that the bank receives from the borrower a security interest in all "fixtures, equipment, accounts receivable and inventory now owned and hereafter acquired."2

1. Statutory or common law claims - In most jurisdictions, statutes specify how security interests in property may be obtained. This is because it is widely recognized that availability of credit is crucial to the generation of funds essential for economic development. Financial institutions are notoriously, and understandably, reluctant to make substantial loans without reliable security rights protecting against the possibility of nonpayment. AS will be apparent from this opinion, there are few, if any, reliable nonstatutory methods for establishing a security interest in property which is in the possession of the debtor.

Statutes within the Federated States of Micronesia concerning secured transactions are woefully inadequate. Neither party has brought to the Court's attention any Pohnpei State statute relating to security interests. The only general provisions concerning security interests in the FSM Code, 33 F.S.M.C. §§ 921-933, provide no assistance in determining either how a security interest is to be created or which security interests should have priority over others.

No decisions of this court nor of the Pohnpei State Court have discussed the existence or priority of security interests. The Court therefore looks to common law principles developed elsewhere to determine whether the Bank of Guam received a security interest in the fixtures, equipment, account receivable and inventory of Island Hardware by virtue of the general security agreement.3 Semens v. Continental Air Lines Inc., [1985] FMSC 3; 2 FSM Intrm. 131, 142 (Pon. 1985).

[2 FSM Intrm. 287]

The common law of the United States today concerning secured transactions is the Uniform Commercial Code (UCC), a comprehensive statute covering commercial transactions. The UCC has been adopted by practically every state in the United States. The UCC qualifies as common law guidance because it represents the prevailing and nearly uniform approach to secured transaction within the United States. See Rauzi v. FSM, 2 FSM Intrm. 8, 17 (Pon. 1985).

Under the UCC, a general security agreement such as the one relied upon by the Bank of Guam here effectively creates security interests in inventory and accounts receivable and other personal property of the debtor only if the security interest has been "perfected." UCC 9-302. This means that a financing statement confirming that the security interest has been created in such categories of property must be filed with the record keeping agency established in that particular jurisdiction. Id. Unless the filing occurs, the security interest is given no effect against other parties. UCC 9-301.

The general security agreement relied upon by the bank was not "perfected" by the filing method prescribed by the UCC, and therefore, in a jurisdiction which has adopted the UCC, would not be given effect against other creditors who extended credit without knowledge of the bank's claim.

However, neither the Federated States of Micronesia nor Pohnpei has adopted the UCC. more important, no location has been designated for the filing of security claims.

It has been recognized that "Article 9 of the Uniform Commercial Code rewrites the law of secured transactions; it is the most revolutionary of the various articles of the Code." E. Farnsworth, J. Honnold, Commercial Law 763 (2d ed. 1968).4 The UCC's secured transaction provisions have "transmuted" the "underlying issue of policy" so that the critical questions for analyzing security interest claims under the UCC are: "Is the outstanding interest a `security interest' subject to the statutory filing requirements? Have the statutory rules on filing been followed? If not, what are the consequences?" Id. at 765.

The UCC is the most modern version of the common law and surely represents an advance in thinking about secured transactions. Yet the filing requirement and designated place for filing are at the heart of the UCC statutory scheme. The absence of those features in the Federated States of Micronesia virtually precludes any judicial attempt to draw heavily on UCC principles in fashioning an approach to secured transactions.

I conclude therefore that we are relegated to the "underlying issues of policy" which were applied to secured transactions under the pre-UCC common law.

[2 FSM Intrm. 288]

Furthermore, the Court is constrained to focus on nonstatutory common law. This Court has previously drawn on decisions of other common law jurisdictions for limited purposes such as determining the meaning of words and phrases in the Constitution5 and statutes6 of the Federated States of Micronesia. We have also followed the lead of common law courts in adopting broader principles fashioned by those courts in the fields of torts and contracts.7 However, there is no statutory base concerning secured transactions within the Federated States of Micronesia and most of the more modern financing devices existing when the UCC came into being were provided for by statute. This Court should be flexible and imaginative in assisting to fashion a body of law which may guide the conduct of people and institutions within the Federated States of Micronesia. However, to try to develop rules to be used for non-possessory security interests in personal property would not be filling in a few gaps but instead would be creation of an entire body of new law.

Determinations of fundamental policy would have to be made and comprehensive provisions for administration would have to be established. For the judiciary to attempt such a venture would be usurpation of the legislative function. See Semens v. Continental Air Lines, Inc. (II), [1986] FMSC 7; 2 FSM Intrm. 200, 207 (Pon. 1986). In short, this Court considers itself empowered only to declare the existence of such security interests as have been found by other courts to exist in the absence of statutes.

The common law courts did indeed declare into existence several kinds of security interests. These common law liens include: (1) the innkeeper's lien, whereby a hotel owner may take possession of the personal goods found within
the rented premises of a delinquent tenant;8 (2) garageman's and artisans's lien
whereby one who has performed work on a vehicle or other property of another may retain that property to secure payment;9 (3) the landlord's right of distraint;10 and (4) the pledge, whereby the borrower would hand over to the lender certain property to secure repayment of the loan.

Common to all of these devices was possession by the secured party of the property in which he claimed a security interest.

[U]ntil early in the nineteenth century....security interests in personal property which remained in the borrower's possession during the loan period were unknown .... [n]on-possessory interests in personal property were forbidden and there was a conclusive presumption that a seller's retention of possession of goods was fraudulent.

Farnsworth & Honnold at 781-82, quoting Gilmore, Security Interests in Personal Property, ch. 1 (1955).

This common characteristic, possession by the lender, in turn reflected an abhorrence of "secret liens." In re Fountain, Inc., 282 F. 816 (2d Cir. 1922). Courts generally were concerned that third parties, especially other potential creditors, might rely to their detriment on assets which are in the possession of the borrower but, unknown to the other parties, are subject to a secret lien. It is for this reason that there exists in the law a strong general policy against secret liens. United States v. Speers, [1965] USSC 185; 382 U.S. 266, 275[1965] USSC 185; , 86 S. Ct. 411, 416[1965] USSC 185; , 15 L. Ed. 2d 314, 320 (1965).

During the nineteenth and early twentieth century several specialized financing devices were developed which enabled the borrower to retain possession of property in which the lender had a security interest. These include the trust receipt, the factor's lien, the equipment trust, the bailment lease, the chattel mortgage and the conditional sale. Farnsworth & Honnold 783.

Yet, protection of creditors against undisclosed interests in property has remained "one of the most firmly rooted of the common law doctrines." Id.
at 787. Where newer financing devices permit possession of property subject to a
security interest to remain with a merchant debtor, some method is employed to provide other creditors a reasonable opportunity to become aware of the existence of the security interest. Northeast Kansas Production Credit v. Ferbrache, 693 P.2d 1152 (Kan. 1985). The principal method is to require filing of notice of the security interest in some central location, but other methods, such as possession by the secured party of a bill of lading or warehouse receipt, are sometimes employed. None of these methods are provided for in the statutory law here and there is no suggestion by the bank that any such procedure was followed.

The general security agreement relied upon by the bank in this case faces yet another obstacle. The security arrangement sought to cover not only the Island Hardware inventory and assets as of June 20, 1984 but also any such assets thereafter acquired. Such a lien has been commonly referred to in the law as a "floating lien" because it is not fixed upon specific assets but floats from sold items to new ones as they are introduced into the inventory.

[2 FSM Intrm. 290]

The law found such liens particularly difficult to fit into established legal concepts, not only because the borrower retained possession of the secured goods but also because the parties could not identify with specificity the items subject to the security agreement. Legalization of floating liens required special attention and efforts of legal thinkers, and specific legislation.

The bank has been unable to point to, and the Court in its own research has been unable to locate, any case anywhere in which an unrecorded general security agreement such as this one seeking to establish a floating lien has been upheld as a common law lien without statutory sanction. I find that this security is not authorized by statute within the Federated States of Micronesia and also can not be upheld as a common law lien.

2. The Equitable lien claim - The bank vigorously contends that even if the agreement can not be viewed as creating a statutory or common law lien, the equities are such that the Court should uphold the bank's claims as an equitable lien. Where circumstances warrant, courts can find that a party has an equitable lien in property even if statutory or common law lien requirements have not been met. Farmers & Merchants Bank v. Commissioner, 175 F.2d 846 (8th Cir. 1949). Such a lien is commonly found, for example, when a party agrees to create a security interest to secure his debt but then refuses to do what is necessary to vest the other party with statutory or common law lien rights in the property. Holder v. Williams, 334 P.2d 291 (Cal. 1959).

However, for many of the same reasons already mentioned as preventing the agreement from being upheld as any form of common law lien ' it appears unlikely that the bank can establish existence of an equitable lien effective as against the judgment creditors. The policy against secret liens applies Lo equitable lien claimants as well. The majority rule, and one to which this Court will adhere, is that non-possessory equitable liens will not be found to exist against another who had neither actual notice nor reason to know of the existence of the security claim. Stepp v. McAdams, 85 F.2d 925 (5th Cir. 1937); General Ins. Co. v. Lowery, 412 F. Supp. 12 (S.D. Ohio 1976).

Other factors too may affect whether an equitable lien will be declared. For example, was the assignment of accounts receivable intended seriously? Were the identities of the account-debt4ors obtained and were they notified? Were proceeds received from the account-debtors turned over to the bank? See Benedict v. Ratner, [1925] USSC 138; 268 U.S. 533, 45 S. Ct. 566, 69 L. Ed. 991 (1925).

The record is silent concerning these matters. The Court could perhaps infer that neither notice nor any of the other actions referred to above were carried out. Such an inference seems especially apt since the bank has moved for summary judgment and presumably has placed before the Court all that is in its favor concerning the equities.

However, this is a case of first impression and it is possible that there could have been reasonable doubt as to which information would be thought relevant. Moreover, as already noted, the Court on a motion for

[1986] FMSC 1; [2 FSM Intrm. 291]

summary judgment should draw all reasonable inferences against the movant. The record is unclear as to whether facts exist which could justify an equitable lien.

Accordingly, I am not satisfied that there are no genuine issues of material fact or that the judgment creditors are entitled to judgment as a matter of law. The judgment creditors' motion will be denied as to the possible existence of an equitable lien.

It follows from what has been said that the bank's motion must be denied.

Conclusion

Partial summary judgment, that the June 20, 1984 general security agreement does not establish a statutory or common law lien, is granted in favor of Sets Inc. and Chua Eng Chuan. The balance of their motion is denied.

The motion of the Bank of Guam for summary judgment is denied.

______________________________________________________________
ENDNOTES:
1. The judgment creditors' motion was filed before the Federated States of Micronesia had filed an answer to the bank's complaint. The motion was silent as to the Federated States of Micronesia and mounted arguments only against the bank. Despite subsequent contentions of the judgment creditors, I conclude that their motion was only against the bank. The bank's motion is expressly against the judgment creditors only. Therefore this opinion does not address the right of any party as against the Federated States of Micronesia.

2. The security agreement bears the apparent signatures of only Herman P.
Semes and his wife, each over the printed word "Borrower." The agreement does not name or refer to Island Hardware Inc. Neither the borrower conveying the security interest nor the financing arrangement being secured are specifically identified in the agreement. However, uncontested affidavits of Herman Semes, as president of Island Hardware, and Juan Sanchez, the bank's Pohnpei branch manager, state that the general security agreement was entered into by Herman Semes on behalf of Island Hardware Inc. to permit that firm to establish a $50,000 line of credit with the bank. These assertions are accepted as true for purposes of this motion.

3. No party has asserted that any principle of custom or tradition
applies. The business activities which gave rise to this lawsuit, that is, the attempted establishment of a floating lien by a bank incorporated in Guam, as part of a financing arrangement for a hardware retail sales company, are not of a local or traditional nature. I conclude that there is no applicable Micronesian custom or tradition. See generally Semens v. Continental Air Lines Inc., [1985] FMSC 3; 2 FSM Intrm. 131, 140-41 (Pon. 1985).

4. Hereafter Farnsworth & Honnold 763.

5. See, e.g., FSM v. Alaphonso, [1982] FMSC 22; 1 FSM Intrm. 209 (App. 1983).

6. FSM v. Jorg, [1983] FMSC 13; 1 FSM Intrm. 378 (Pon. 1983) Rauzi v. FSM, 2 FSM Intrm. 8
(Pon. 1985); Luda v. Maeda Road Constr. Co., [1985] FMSC 20; 2 FSM Intrm. 107 (Pon. 1985).

7. Semens v. Continental Air Lines, Inc. (I), [1985] FMSC 3; 2 FSM Intrm. 131 (Pon.
1985); Panuelo v. Pohnpei (I), [1986] FMSC 2; 2 FSM Intrm. 150 (Pon. 1986).

8. See Anastasia v. Cosmopolitan Nat'l Bank of Chicago, [1976] USCA7 86; 527 F.2d 150 (7th
Cir. 1975).

9. See Parks v. "Mr. Ford"[1977] USCA3 322; , 556 F.2d 132 (3d Cir. 1979).

10. Shalat v. Klauder, 34 F.2d 594 (3d Cir. 1929).