Llewellyn, Adam K.

English

University of Miami School of Law

University of Miami Law Review Volume 27 Number 3 Volume 27 Numbers 3-4 (Spring & Summer 1973) Article 14 7-1-1973 Merchant-Buyer's Good Faith Duty to Inquire Under 9-307: A Confusion of Concepts Adam K. Llewellyn Follow this and additional works at: https://repository.law.miami.edu/umlr Recommended Citation Adam K. Llewellyn, Merchant-Buyer's Good Faith Duty to Inquire Under 9-307: A Confusion of Concepts, 27 U. Miami L. Rev. 524 (1973) Available at: https://repository.law.miami.edu/umlr/vol27/iss3/14 This Case Noted is brought to you for free and open access by the Journals at University of Miami School of Law Institutional Repository. It has been accepted for inclusion in University of Miami Law Review by an authorized editor of University of Miami School of Law Institutional Repository. For more information, please contact library@law.miami.edu. UNIVERSITY OF MIAMI LAW REVIEW [Vol. XXVIIThis is questionable in that the ordinance clearly provides for controlby a committee of not less than ten."6 It also defines the type of housingto be controlled,47 establishes the basis for the maximum rent to becharged, 48 defines the circumstances under which adjustments of maxi-mum rents may be made by the city rent agency,49 and finally the provi-sions state objective guidelines for the exercise of power by the city rentagency.In sum, while Fleetwood precludes the establishment of rent con-trols by a municipality in the absence of enabling state legislation, ithas far broader implications. The judicial limitation on the home rulepowers of municipalities, imposed by the creation of a local-state functiontest for allocating power, effectively places basic policy choices on thejudicial branch of the government. It is submitted that the courts areneither the proper forum for such decisions to be made, nor are theythe best mechanism for determining the needs of the people at anyparticular time.RICHARD A. HERMANMERCHANT-BUYER'S GOOD FAITH DUTY TO INQUIREUNDER 9-307: A CONFUSION, OF CONCEPTSThe plaintiff, J. I. Case Company, sold a tractor to Florida TractorMart, Inc., and took back a security agreement (a conditional salescontract), and a financing statement which it recorded.' Florida Tractorthen delivered possession of the tractor to Gator Tractor Companypursuant to an oral lease.2 Shortly thereafter Gator Tractor traded thetractor to the defendant, Swift, in exchange for three other items ofequipment46. Section 16.A.3.C. of Ordinance 1791, provides:There shall be an advisory committee composed of not less than 10 members whoshall be appointed by the city council. The committee shall be provided by the ad-ministrator with all data necessary for it to advise and consult with the Mayor andCity Council for all its actions. (Emphasis added.)Mr. Justice Ervin, in his dissent, points out that the city rent agency is a branch of theMiami Beach government and as such is subject to the controls of, and accountable tothe Mayor and city council. 261 So.2d at 811.47. See note 1 supra.48. See note 41 supra.49. See note 39 supra.1. See FLA. STAT. § 679.302(1) (1971). Florida has adopted the Uniform CommercialCode in cbs. 671-79 FLA. STAT. (1971). The Code sections correspond to the last fournumbers of the statute section.2. Once Case Company's security interest was perfected, it continued, despite theleasing of the tractor by Florida Tractor to Gator Tractor. FLa. STAT. § 679.306(2) (1971).3. The exchange of equipment between Swift and Gator Tractor constituted a "buying"and therefore Swift became a "buyer" of the tractor. FLA. STAT. § 671.201(9) (1971).CASES NOTEDPlaintiff's replevin complaint charged that its perfected securityinterest in the controverted tractor was superior to any rights subse-quently acquired by Swift Ford Tractor, Inc. The trial court enteredpartial summary judgment for the plaintiff, holding that it was entitledto recover immediate possession of the tractor and damages for itsdetention. Defendant took an interlocutory appeal. The District Courtof Appeal, First District, held, affirmed: A commercially prudent tractormerchant may not purchase a tractor from another dealer and therebyacquire title free of a prior recorded security interest without first mak-ing a good-faith inquiry into the existence and terms of such previouslyperfected security interest. Swift v. J. I. Case Company, 266 So.2d 379(Fla. 1st Dist. 1972).The holding in Swift that a merchant has a duty to inquire into theexistence of previously perfected security interests was precipitated bythe court's misapplication of section 9-307(1) of the Uniform Commer-cial Code. This section states:A buyer in ordinary course of business . . . [subsection (9) ofSection 1-201] other than a person buying farm productsfrom a person engaged in farming operations takes free of asecurity interest created by his seller even though the securityinterest is perfected and even though the buyer knows of itsexistence.4The court stated the thrust of that section as follows: "In this state abuyer of goods in the ordinary course of business takes free of a perfectedsecurity interest.' 5The court failed to note the important qualification that the securityinterest must be "created by his [the buyer's] seller." Thus section9-307(1) would allow Swift to take free of a security interest created byhis seller, Gator Tractor, but not free of a security interest created byone other than his seller, in this case, Florida Tractor." Therefore, CaseCompany's perfected security interest was superior to the after-acquiredrights of Swift, although the court did not adopt this rationale.The court, however, reached this same conclusion-that Case Com-pany should prevail-by reasoning that Swift was not a "buyer in ordinary4. FLA. STAT. § 679.307(1) (1971) (emphasis added).5. 266 So.2d at 381.6. This issue has come to the attention of four courts. A recent decision by a Californiaappellate court illustrates the correct application of this aspect of section 9-307(1) inSecurity Pac. Nat'l Bank v. Goodman, 24 Cal. App. 3d 131, 100 Cal. Rptr. 763 (2d Dist.1972). Accord, National Shawmut Bank v. Jones, 108 N.H. 386, 236 A.2d 484 (1967).That it is easy to overlook this limitation "created by his seller" and misapply section9-307(1) is illustrated by the dicta in the decision of the Supreme Court of Nebraska inGeneral Elec. Credit Corp. v. Western Crane & Rigging Co., 184 Neb. 212, 166 N.W.2d 409(1969). The Supreme Court of Iowa recognized this limitation but chose to disregard itbecause of the compelling and unique facts giving rise to the case in General Motors Accep.v. Keil, 176 N.W.2d 837 (Iowa 1970).1973 ]UNIVERSITY OF MIAMI LAW REVIEW [Vol. XXVIIcourse of business"7 and, therefore, was not entitled to take free of CaseCompany's security interest under section 9-307(1). This inquiry intowhether Swift was a buyer in ordinary course was both necessary andproper only assuming Case Company's security interest had been createdby Swift's seller, Gator Tractor, rather than by Florida Tractor. Theconclusion of the court, however, that Swift was not a buyer in ordinarycourse because he failed to inquire into the existence of any prior secu-rity interest appears to have been a misapplication of section 1-201(9)as used in the context of section 9-307(1).Section 1-201(9) of the Uniform Commercial Code defines a buyerin ordinary course of business as one who buys in good faith and withoutknowledge that the sale to him is in violation of the security interest ofa third party.8 Section 9-307(1) of the Code provides that such a buyertakes free of a security interest created by his own seller even though heknows it exists.9 Reading these two provisions together,the buyer takes free if he merely knows that there is a securityinterest which covers the goods but takes subject [to the secu-rity interest] if he knows, in addition, that the sale is in violationof some term in the security agreement not waived by the wordsor conduct of the secured party.1°Thus the duty of inquiry imposed upon merchant buyers by the court inSwift is meaningless unless the duty extends to inquiry into the termsof the security agreement, for mere knowledge of the existence of thesecurity interest does not defeat the priority of the buyer.But must a merchant buyer inquire into the terms of a prior, per-fected security interest in order to qualify for the protection provided forin section 9-307(1)? The answer to this question may be found in ananalysis of the good faith element in the definition of buyer in ordinarycourse of business. The court in Swift reasoned that the requirementsfor establishing one's self as a good faith buyer vary with the commercialstatus of the buyer. Since Swift was a tractor dealer, the court looked tosection 2-103(1) (b) of the Uniform Commercial Code for the require-ments of good faith: " 'Good faith' in the case of a merchant meanshonesty in fact and the observance of reasonable commercial standardsof fair dealing in the trade."'" Thus, concluded the court, commercialreasonableness demands that a merchant buyer make an inquiry, andfailure to do so constitutes bad faith.7. "Buyer in ordinary course of business" means a person who in good faith andwithout knowledge that the sale to him is in violation of the ownership rights orsecurity interest of a third party in the goods buys in ordinary course from a personin the business of selling goods of that kind but does not include a pawnbroker.FLA. STAT. § 671.201(9) (1971) (emphasis added).8. See note 7 supra.9. FLA. STAT. § 679.307(1) (1971).10. FLA. STAT. ANN. § 679.9-307, Comment 2 (1966) (Comments to the UCC are notcontained in Florida Statutes).11. FLA. STAT. § 672.103(1)(b) (1971).CASES NOTEDThe section 2-103(1)(b) definition of good faith utilized by thecourt to impose upon Swift the duty of inquiry as an observance of rea-sonable commercial standards is not applicable to the section 1-201(9)definition of buyer in ordinary course when used in the context of section9-307(1). That this Article 2 definition of good faith is not applicableto Article 9 is suggested by section 9-105(4), which states that Article 1contains the general definitions applicable in Article 9.12 Article 1, section1-201 (19) of the Code defines good faith as "honesty in fact in the conductor transaction concerned, 18 and does not include the requirement ofcommercial reasonableness. That the Article 2 definition of good faith,including commercial standards, is inapplicable to Article 9 is furthersuggested by the official commentary:"Good faith," whenever it is used in the Code, means at leastwhat is here stated [honesty in fact]. In certain Articles, byspecific provision, additional requirements are made applicable.See, e.g., Secs. 2-103(1) (b) . . . [observance of reasonablecommercial standards]. To illustrate, in the Article on Sales,Section 2-103, good faith is expressly defined as including inthe case of a merchant observance of reasonable commercialstandards of fair dealing in the trade, so that throughout thatArticle wherever a merchant appears in the case an inquiry intohis observation of such standards is necessary to determine hisgood faith."4The Supreme Court of Delaware recently passed on this preciseissue in Sherrock v. Commercial Credit Corp.5 Reversing both lowercourts, the court said:The error we find here lies in the Trial Court's misapplicationof the Sales Article definition of "good faith," set forth in§ 2-103(1)(b), instead of the Secured Transaction Articledefinition of "good faith," set forth in § 1-201(19). In so doing,the Trial Court found that, although the appellants were honestin fact, they did not act "in a commercially reasonable manner."The Trial Court reasoned that, in substance, this secured trans-action revolved around a sale of the automobiles; that sinceArticle 2 of the Code deals with the sale of goods, the definitionof "good faith" in that Article must be applied; with the resultthat a merchant-buyer's "good faith" is to be distinguishedfrom the "good faith" of a consumer-buyer under Article 9 ofthe Code. In the view of the Trial Court, it was not reasonableto conclude that the drafters of the Code intended to applymore than one standard of "good faith" to the same individualin related transactions and that, therefore, the definition in12. FLA. STAT. § 679.105(4) (1971).13. FLA. STAT. § 671.201(19) (1971).14. FLA. STAT. ANN. § 671.1-201, Comment 19 (1966) (emphasis added).15. - Del. -, 290 A.2d 648 (1972).1973]UNIVERSITY OF MIAMI LAW REVIEW [Vol. XXVII§ 2-103 (1) (b) must be applied to merchant-buyers throughoutthe entire Code. See 269 A.2d 407. We are unable to approvethat rationale.Article 2 of the Code concerns itself with the rights andobligations of buyer and seller, one to the other. Here we areconcerned with the rights and obligations of buyer and securedcreditor, one to the other-a transaction expressly controlledby Article 9.18In this situation, 17 when a buyer meets the qualifications of section9-307, he takes free of the security interest in the goods. Nevertheless,the creditor's security interest still continues in the proceeds of the salein the hands of the debtor-seller." When a buyer is denied the protectionof section 9-307, the creditor's security interest continues in both theproceeds and the collateral goods. 19 Thus to impose a duty of inquiryto any extent, on any buyer, which will act to defeat his status as abuyer in ordinary course of business, is in effect to require the buyer toassume the economic risk that a debtor-seller will fail to apply the pro-ceeds from an unauthorized sale toward the satisfaction of his debt.When a buyer has actual knowledge that the sale to him is inviolation of the security interest of a third party and still elects to buy,the buyer is in effect consciously assuming the risk that the debtor-sellerwill satisfy his debt from the proceeds, and is thus denied the protectionof section 9-307. But where the buyer does not have actual knowledge,why should he be burdened, under the guise of good faith, with an eco-nomic risk that should rightfully fall on the creditor?"0Thus, the court in Swift reached the correct result-that Case Com-pany's prior perfected security interest should prevail over the rights ofSwift-by making two independent mistakes in its application of section9-307(1) of the Uniform Commercial Code to the facts. The second ofthese mistakes cancelled the first. The protection to buyers provided insection 9-307(1) was not available to Swift since the prior perfectedsecurity interest in the tractor was not created by Swift's seller. There-fore, it was unnecessary to deny Swift this protection by holding himnot to be a buyer in the ordinary course of business, which, in theauthor's opinion, he was. The drafters of the Code achieved a delicate16. Id. at 650.17. It must be remembered that the scope of section 9-307 is limited primarily toinventory situations in which the creditor-holder of the security interest-has forbiddenany sale by the debtor or has placed latent limitations upon the debtor's apparent authorityto sell. FLA. STAT. ANN. § 679.9-307, Comment 2 (1966).18. FLA. STAT. § 679.306(2) (1971).19. FLA. STAT. § 679.306(2) (1971).20. It is interesting to note that in two New York decisions, the courts assumed with-out analysis that the Article 2 definition of good faith applied to merchant-buyers inArticle 9, yet expressly held that failure to make an inquiry into the existence of priorperfected security interests did not constitute bad faith. Bank of Utica v. Castle Ford, Inc.,36 App. Div. 2d 6, 317 N.Y.S.2d 542 (1971); Hempstead Bank v. Andy's Car RentalSys., Inc., 35 App. Div. 2d 35, 312 N.Y.S.2d 317 (1970).CASES NOTEDbalance between the rights of a secured party and a subsequent buyerin sections 9-306 and 9-307, and to engraft into either section, by judicialinterpretation, requirements that are not there, upsets this balance. Theproper result in Swift should not be accepted blindly. An understandingof the concepts underlying sections 9-306 and 9-307 is essential to theirproper application.ADAM K. LLEWELLYNTHE RIGHT TO LIGHT: DUE PROCESS ANDPUBLIC UTILITY TERMINATIONColorado gas and electric customers sought declaratory and injunc-tive relief, as well as money damages, against a privately owned Coloradopublic utility company. Their complaint in the federal district courtcharged that the company had violated the customers' rights to proce-dural due process by unlawfully terminating their gas and electric servicewithout a hearing or without providing for one. Plaintiffs contended thatthe public utility's termination of service involved state action within thepurview of the Civil Rights Acts,1 and thus gave federal jurisdiction overthe basic dispute. The company maintained that its policy of terminatingservice for failure to pay bills did not involve state action, and, therefore,that the customers did not have a claim for the taking of property with-out due process. The United States District Court for the District ofColorado, refusing to grant the motion to dismiss,' held: The actions ofa privately owned public utility operating under close supervision of thestate public utilities commission and supplying service under an exclusivefranchise from the state are "state action" under the purview of 42 U.S.C.§ 1983 (1970). Hattell v. Public Service Co., 350 F. Supp. 240 (D. Colo.1972).1. The Civil Rights Acts are 42 U.S.C. § 1983 (1970) and 28 U.S.C. § 1343 (1970).Section 1983 provides a cause of action in the event a state contravenes the Constitution.The act states:Every person who, under color of any statute, ordinance, regulation, custom,or usage, of any State or Territory, subjects, or causes to be subjected, any citizenof the United States or other person within the jurisdiction thereof to the depriva-tion of any rights, privileges, or immunities secured by the Constitution and laws,shall be liable to the party injured in an action at law, suit in equity, or otherproper proceeding for redress.28 U.S.C. § 1343(3) provides federal district courts with jurisdiction to redress deprivationunder color of state law of any right secured by the Constitution. Section 1343(3) reads:The district courts shall have original jurisdiction of any civil action authorizedby law to be commenced by any person: . . . (3) To redress the deprivation, undercolor of any State law, statute, ordinance, regulation, custom or usage, of anyright, privilege or immunity secured by the Constitution of the United States or byany Act of Congress providing for equal rights of citizens or of all persons withinthe jurisdiction of the United States. . ..2. The claim for money damages, however, was dismissed. It was asserted under state1973]

Merchant-Buyer\u27s Good Faith Duty to Inquire Under 9-307: A Confusion of Concepts

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Merchant-Buyer\u27s Good Faith Duty to Inquire Under 9-307: A Confusion of Concepts

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