Co-Alliance, LLP v. Monticello Farm Service, Inc.

FOR PUBLICATION
ATTORNEYS FOR APPELLANT: ATTORNEY FOR APPELLEE:
BRIAN R. GATES ELIZABETH B. SEARLE
TIMOTHY W. WOODS Ball Eggleston PC
J. THOMAS VETNE Lafayette, Indiana
Jones Obenchain, LLP
South Bend, Indiana
Apr 23 2014, 10:14 am
IN THE
COURT OF APPEALS OF INDIANA
CO-ALLIANCE, LLP, )
)
Appellant, )
)
vs. ) No. 91A05-1312-PL-607
)
MONTICELLO FARM SERVICE, INC., )
)
Appellee. )
APPEAL FROM THE WHITE CIRCUIT COURT
The Honorable Robert W. Thacker, Judge
Cause No. 91C01-1102-PL-10
April 23, 2014
OPINION - FOR PUBLICATION
SHEPARD, Senior Judge
We conclude that Indiana should follow the majority rule on agreements to modify
the priority of liens securing interests in a borrower’s assets.
Here, the lender in first position agreed to subordinate part of its lien in favor of a
third-position lender, in effect a partial assignment that reduced the extent of its first
position. Such a contract should neither harm nor help the second-position lender, who
was not a party to the agreement.
We think recognizing such agreements is consistent with the Uniform Commercial
Code and Indiana common law. We therefore affirm the trial court’s decision.
FACTS AND PROCEDURAL HISTORY
Timothy, Lisa, Ross, and Dane Clark and their farming operations pledged their
2010 crops as well as other farm products and equipment as collateral to obtain loans
from three different creditors, who perfected their security interests in the following
order: First Farmers Bank & Trust, Co-Alliance, LLP, and Monticello Farm Service, Inc.
In June 2010, the Bank and Monticello entered into an agreement in which Monticello
agreed to finance the Clarks’ 2010 crops, and in turn, the Bank agreed to subordinate its
interests in those crops to Monticello’s interests in the same:
WHEREAS, Monticello in consideration for certain financial
accommodations to Borrower for the purpose of financing their 2010 crop,
said financial accommodations including, but not limited to, monies
dispersed, or to be dispersed, under a note or open account not to exceed
the principal sum of Three Hundred Forty Thousand and 00/100 Dollars
($340,000.00), as well as any extensions, modifications or renewals thereof,
has or may acquire a security interest or interests in the Borrower’s 2010
crops grown or to be grown (together with any additions or accessions
thereto as well as all proceeds and products thereof) and shall perfect said
security interest by duly filing a financing statement or statements; and,
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WHEREAS, the Subordinating Creditor, in order to induce
Monticello to make the aforementioned financial accommodations to
Borrower, desires and intends to subordinate and postpone the priority,
operation and effect of its security interest in Borrower’s 2010 crops
growing or to be grown even though it, the Subordinating Creditor, has
duly filed a financing statement or statements and perfected its security
interest therein, and thereby may have priority over the security interests of
Monticello in said 2010 crops whether by order of priority or purchase
money status.
NOW, THERFORE, parties hereto, agree that all security interests
of the Subordinating Creditor in any Borrower’s 2010 crops growing or to
be grown shall be subordinate, junior and inferior and postponed in priority
to the priority, operation and effect of any security interest or interests of
Monticello in Borrower’s 2010 crops growing or to be grown, regardless of
the order of filing or purchase money status.
This Agreement shall be binding on the parties hereto, their heirs,
representatives, successors and assigns.
Appellant’s App. pp. 204-05.
Timothy and Lisa filed for bankruptcy in November 2010. At that time, the Bank
was owed $2,382,000, Co-Alliance was owed $221,000, and Monticello was owed
$216,000. In December 2011, the Clarks and the three creditors entered into a settlement
agreement in which the Clarks and the Bank waived any claim to $181,000 of the 2010
crop proceeds. The Bank “assign[ed] any interest it may have in those remaining
proceeds to Co-Alliance subject to the rights and interests of Monticello pursuant to the
Subordination Agreement dated June 25, 2010.” Id. at 308. For their part, Co-Alliance
and Monticello waived any claim to 2010 crop proceeds exceeding $181,000. The Clarks
agreed to hold $181,000 in the escrow account of their attorney.
Meanwhile, in February 2011, the Bank sought foreclosure and a money judgment
against Ross and Dane in the White Circuit Court. Several other parties, including Co-
Alliance and Monticello, were named as defendants due to their interests in the Clarks’
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property. Monticello answered and cross-claimed against the other defendants. After the
settlement agreement was filed in the bankruptcy proceedings, Monticello obtained leave
to amend its cross-claim to join Timothy and Lisa, who had signed certain promissory
notes alongside Ross and Dane, so that Monticello could claim the $181,000 available
from the 2010 crop proceeds.
Co-Alliance counterclaimed against Monticello, asserting that it held the first
priority lien on the $181,000 and further alleging that Monticello converted a number of
checks by depositing them without the necessary endorsements. On Co-Alliance’s
motion, the trial court directed the $181,000 to be transferred to the trial court clerk.
Monticello and Co-Alliance each moved for partial summary judgment, and the
court held a hearing. In October 2012, the court found that Monticello was entitled to the
disputed funds, granted Monticello’s motion, denied Co-Alliance’s motion, and directed
the trial court clerk to continue to hold the $181,000 until further order.
Co-Alliance appealed, but because the trial court’s order was not a final judgment
or an interlocutory order appealable as of right, we dismissed. See Co-Alliance, LLP v.
Monticello Farm Serv., Inc., No. 91A04-1211-PL-606 (Ind. Ct. App. July 22, 2013).
Several months later in November 2013, the parties jointly asked the trial court to revise
its order into a final appealable order, and it did so. The parties then jointly asked the
court to order disbursement, which it also did. Co-Alliance now appeals.
ISSUE
The sole issue is whether the trial court properly determined that the subordination
agreement gave Monticello first claim on the remaining $181,000 in 2010 crop proceeds.
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DISCUSSION AND DECISION
Summary judgment is appropriate only where there is no genuine issue of material
fact and the moving party is entitled to a judgment as a matter of law. Ind. Trial Rule
56(C); Perdue v. Gargano, 964 N.E.2d 825, 831 (Ind. 2012). All facts established by the
designated evidence and reasonable inferences drawn from those facts are construed in
favor of the nonmoving party. Perdue, 964 N.E.2d at 831.
Subordination agreements are nothing more than contractual modifications of lien
priorities. ITT Diversified Credit Corp. v. First City Capital Corp., 737 S.W.2d 803, 804
(Tex. 1987). They can be used to accelerate the flow of cash to troubled projects,
providing financial relief that promotes the development of assets that are then used to
secure payments to all lienholders. Duraflex Sales & Serv. Corp. v. W.H.E. Mech.
Contractors, 110 F.3d 927, 936 (2d Cir. 1997). Exactly how such agreements modify
lien priorities is the question presented in this appeal.
It is undisputed that but for the subordination agreement, the Bank would have had
first claim to the 2010 crops, followed by Co-Alliance, and then Monticello. Co-Alliance
argues that because “subordinate” means to move a right or claim to a lower rank, the
subordination agreement completely reduced the Bank’s security interest in the 2010
crops such that the Bank dropped to the end of the line. Monticello disagrees, arguing the
agreement merely allowed it to momentarily step into the Bank’s first priority status.
Co-Alliance’s approach to subordination agreements, called “complete
subordination,” has been adopted by some courts. See AmSouth Bank, N.A. v. J & D Fin.
Corp., 679 So. 2d 695 (Ala. 1996); Old Stone Mortg. & Realty Trust v. New Ga.
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Plumbing, Inc., 236 S.E.2d 592 (Ga. 1977); Blickenstaff v. Clegg, 97 P.3d 439 (Idaho
2004). In AmSouth Bank, for example, the Alabama Supreme Court held that the first
lienholder’s subordination agreement with the third lienholder “subordinated its first lien
to . . . the third lienholder. The Bank’s lien therefore became subordinate to both [the]
second lien and [the] third lien.” 679 So. 2d at 698. This holding, the court noted, was
consistent with the definition of “subordination,” which contemplates a reduction in
priority and could not involve raising a lower priority lienholder up to the position of the
subordinating party. Id.
We perceive this approach, held by some respectable authorities, to be the
minority position in the field—and one that conflicts with a bedrock principle in Indiana
law that the intent of the parties controls the contract. See City of Jeffersonville v. Envtl.
Mgmt. Corp., 954 N.E.2d 1000, 1008 (Ind. Ct. App. 2011) (“In Indiana, the interpretation
of a contract is controlled by the intent of the parties as expressed by the clear language
of the contract.”).
In the subordination agreement here, the Bank and Monticello agreed that the
Bank was “subordinat[ing]” and “postpon[ing]” the priority of its security interest in the
Clarks’ 2010 crops to the priority of Monticello’s security interest in those same crops “in
order to induce Monticello to make” “certain financial accommodations to [the Clarks]
for the purpose of financing their 2010 crop.” Appellant’s App. pp. 204-05.
The clear language of the subordination agreement shows that the parties’ intent
was for the Bank to assign to Monticello a portion of any 2010 crop proceeds received by
the Bank based on its status as the first lienholder. How else could the Bank have
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induced Monticello to make a loan but to guarantee it the right of first payment? Under
these circumstances, treating a subordination of an interest differently from an
assignment of that interest would add confusion to the law, not clarity, and would allow
an intervening lienholder to obtain a windfall by becoming a senior lienholder through no
action of his own. Put another way, the agreement in this case is the functional and legal
equivalent of a partial assignment. 1
And in fact, such “partial subordination” is the majority approach to subordination
agreements. Caterpillar Fin. Servs. Corp. v. Peoples Nat’l Bank, N.A., 710 F.3d 691,
693-94 (7th Cir. 2013); see, e.g., Duraflex Sales & Serv. Corp. v. W.H.E. Mech.
Contractors, 110 F.3d 927 (2d Cir. 1997); In re Cliff’s Ridge Skiing Corp., 123 B.R. 753
(Bankr. W.D. Mich. 1991); In re Price Waterhouse Ltd., 46 P.3d 408 (Ariz. 2002); ITT
Diversified Credit Corp. v. First City Capital Corp., 737 S.W.2d 803 (Tex. 1987). The
court in ITT Diversified Credit described partial subordination in this way:
A, B and C have claims against the debtor which are entitled to priority in
alphabetical order. “A” subordinates his claim to “C.” After foreclosure of
the secured interest, the resulting fund is insufficient to satisfy all three
claims. The proper distribution of the fund is as follows.
1. Set aside from the fund the amount of “A”’s claim.
2. Out of the money set aside, pay “C” the amount of its claim,
pay “A” to the extent of any balance remaining after “C”’s
claim is satisfied.
3. Pay “B” the amount of the fund remaining after “A”’s claim
has been set aside.
4. If any balance remains in the fund after “A”’s claim has been
set aside and “B”’s claim has been satisfied, distribute the
balance to “C” and “A.”
1
Moreover, as the Bank lowered its priority up to a certain amount in favor of Monticello, even a rigid
definition of “subordinate” is appropriate here. The partial subordination says nothing about the Bank’s
position vis-à-vis Co-Alliance, who was not even a party to the subordination agreement.
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Thus, “C,” by virtue of the subordination agreement, is paid first, but
only to the amount of “A”’s claim, to which “B” was in any event junior.
“B” receives what it had expected to receive, the fund less “A”’s prior
claim. If “A”’s claim is smaller than “C”’s, “C” will collect the balance of
its claim, in its own right, only after “B” has been paid in full. “A,” the
subordinator, receives nothing until “B” and “C” have been paid except to
the extent that its claim, entitled to first priority, exceeds the amount of
“C”’s claim, which, under its agreement, is to be first paid.
737 S.W.2d at 804 (citation omitted). As clarified by the court, “the third lienholder
should be able to succeed to that part of the interest that was subordinated by the first
lienholder, so long as the second lienholder is neither burdened nor benefitted by the
subordination agreement.” Id.
We embrace this approach, rather than the minority position that says any such
agreement between “A” and “C” moves “A” to the back of the line as respects the full
extent of its security. Co-Alliance was not a party to the subordination agreement, gave
no consideration, and should not be entitled to a windfall. Moreover, the Bank and
Monticello clearly did not intend to make Co-Alliance a third-party beneficiary of their
subordination agreement.
We instead adopt the majority rule, which allows for partial subordination of the
first lienholder’s interest. The Bank could induce Monticello to finance the Clarks’ 2010
crops by giving Monticello its right to first payment. By virtue of the subordination
agreement, Monticello would be paid first, but only up to the amount of the Bank’s senior
claim, to which Co-Alliance was in any event junior. Co-Alliance would still receive
what it expected to receive had there been no subordination agreement.
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Even under the partial subordination rule, though, Co-Alliance argues summary
judgment was still improper because Monticello failed to show that Co-Alliance was not
burdened by the subordination agreement. Specifically, Co-Alliance claims that if the
Bank was oversecured, partial subordination could reduce the amount ultimately
collected by Co-Alliance. It provides the following scenario in its brief:
LIABILITIES ASSETS
The Bank $2,500,000 Real Estate $2,000,000
Co-Alliance $250,000 Equipment $250,000
Monticello $340,000 Inventory $100,000
Total: $3,090,000 Accounts $50,000
Hogs $100,000
Crops $340,000
Total: $2,840,000
Had there been no subordination agreement, the Bank would take $2,500,000, Co-
Alliance would take $250,000, and Monticello would take the remaining $90,000.
Co-Alliance claims that with the subordination agreement, using the partial
subordination rule, Monticello would be the first to collect, taking the $340,000 in 2010
crop proceeds for which it stepped into the Bank’s first priority status. Co-Alliance then
claims that since the remaining assets amount to $2,500,000 and the Bank still holds a
first priority security interest in those remaining assets (it had only subordinated its
priority as to the 2010 crops), the Bank would take the remaining $2,500,000 and Co-
Alliance would be left with nothing.
But partial subordination cannot work that way, consistent with the Uniform
Commercial Code or the common law rule, “priority in time gives a lien priority in
right.” Johnson v. Johnson, 920 N.E.2d 253, 256 (Ind. 2010).
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Instead, the first step is to set aside from the total assets the amount of the Bank’s
claim, $2,500,000. Out of that $2,500,000, Monticello is paid $340,000 in 2010 crop
proceeds, and the Bank is then paid the remaining $2,160,000. At this point, Monticello
has been paid off, Co-Alliance is still owed $250,000, the Bank is still owed $340,000,
and there are $340,000 left in assets. From the $340,000 left in assets, Co-Alliance is
paid the amount of its claim, $250,000. The Bank then collects the remaining $90,000.
The undisputed designated evidence shows that the $181,000 in 2010 crop
proceeds does not exceed either the amount of the Bank’s first lien or the amount the
Bank subordinated to Monticello. There is no evidence that Co-Alliance was burdened
by or that it benefitted from the subordination agreement. Rather, as the second-priority
creditor, Co-Alliance was unaffected.
Co-Alliance also argues summary judgment was improper because even if the
subordination agreement gave Monticello a superior right to the 2010 crop proceeds, it
was only entitled to collect $148,000. Specifically, Co-Alliance says Monticello gave the
Clarks $308,000 in 2010 crop inputs, and Monticello had already received payments
amounting to $160,000.
The subordination agreement, though, does not limit Monticello’s senior priority
to the $308,000 for crop inputs. Instead, the agreement clearly states that “all security
interests of the Subordinating Creditor in any Borrower’s 2010 crops growing or to be
grown shall be subordinate, junior and inferior and postponed in priority to the priority,
operation and effect of any security interest or interests of Monticello in Borrower’s 2010
crops growing or to be grown.” Appellant’s App. p. 205. The designated evidence
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shows that the 2010 crops secured not only the credit Monticello extended to the Clarks
to fund the 2010 crops but also a $200,000 line of credit the Clarks obtained from
Monticello in 2009. Id. at 189-96. Co-Alliance does not dispute that the designated
evidence shows the Clarks still owed Monticello $44,000 on their 2009 credit line.
Appellant’s Br. p. 23; Appellant’s App. p. 447.
The trial court properly found that the subordination agreement gave Monticello
first priority in the remaining $181,000 in 2010 crop proceeds. It therefore correctly
granted Monticello’s motion for partial summary judgment and denied Co-Alliance’s.
CONCLUSION
We therefore affirm.
NAJAM, J., and KIRSCH, J., concur.
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