In re Morgan, 291 B.R. 795 (Bkcy E.D. Tenn. 2003)

* * *

The facts are not in dispute. On January 18, 1999, the Debtor purchased a pre-owned 1998 Chevrolet Malibu (the Automobile) from Beaty Chevrolet. Pursuant thereto, she executed a Sales Contract with Beaty Chevrolet. The Automobile purchase was financed by a loan through First American National Bank (First American) which was secured by the Automobile. First American's lien on the Automobile was noted on the Tennessee Certificate of Title issued on February 1, 1999. On February 12, 1999, the Debtor refinanced the loan with LaSalle and as collateral, LaSalle was granted a security interest in the Automobile pursuant to a Promissory Note and Security Agreement executed by the Debtor. Loan proceeds received from LaSalle were used to fully satisfy the Debtor's obligation to First American. The Debtor commenced her bankruptcy case by the filing of a Voluntary Petition under Chapter 7 on March 27, 2001.

On April 30, 2001, AmSouth Bank, successor in interest to First American, wrote a letter to LaSalle, confirming that it had no interest in the Debtor's Automobile. On May 10, 2001, LaSalle applied to the Tennessee Department of Safety for a duplicate Tennessee Certificate of Title. Likewise, on May 10, 2001, LaSalle executed an Application for Notation of Lien on Certificate of Title evidencing itself as the lienholder, which was received by the Tennessee Department of Title and Registration on May 14, 2001. The State of Tennessee issued a Duplicate Certificate of Title on May 17, 2001. The Certificate of Title evidencing LaSalle as lienholder was issued on May 21, 2001. Until that date, First American was the lienholder noted on the Certificate of Title.

Also in April 2001, the Debtor was involved in an automobile accident resulting in a total loss to the Automobile. The Debtor subsequently conveyed title of the Automobile to State Farm Insurance Company (State Farm), her insurance carrier. In November 2001, State Farm paid LaSalle $7,479.03 in full satisfaction of the Debtor's indebtedness to LaSalle.

On May 11, 2002, and July 12, 2002, the Trustee made written demands to LaSalle for evidence of its perfected security interest in the Automobile and, thus, in the proceeds received from State Farm. LaSalle did not respond to either request, and the Trustee filed the Complaint commencing this adversary proceeding on May 7, 2002.

The Trustee asserts that LaSalle's lien on the Automobile was not perfected as of the date that the Debtor's bankruptcy was filed and, thus, (1) LaSalle's postpetition notation of lien on the Tennessee Certificate of Title for the Automobile was a violation of the automatic stay provisions of 11 U.S.C.A. § 362(a)(4) (West 2003) and should be voided; (2) the Trustee, in his position as a hypothetical lien creditor under § 544, has priority over LaSalle's unperfected security interest; (3) LaSalle's unperfected security interest should be avoided under § 544 and recovered by the Trustee pursuant to § 550; (4) the $7,479.03 payment from State Farm to LaSalle, as a result of the Debtor's automobile accident, was a postpetition transfer under § 549, recoverable by the Trustee pursuant to § 550; and/or (5) the proceeds paid to LaSalle as a result of the Debtor's automobile accident were property of the Debtor's bankruptcy estate, subject to turnover to the Trustee pursuant to § 542.

LaSalle argues that, under the doctrine of equitable subrogation, its lien was perfected prepetition and, accordingly, it did not violate the automatic stay when it obtained a Duplicate Tennessee Certificate of Title evidencing itself as lienholder on the Automobile. Similarly, LaSalle maintains that the insurance proceeds received from State Farm were not property of the Debtor's bankruptcy estate, and it should not be required to turnover the proceeds to the Trustee.

Accordingly, if LaSalle's security interest in the Automobile was properly perfected at the time that the Debtor filed her bankruptcy petition by virtue of subrogation of First American's lien rights, the insurance proceeds were not property of the Debtor's bankruptcy estate, and LaSalle did not violate the automatic stay when it had its lien noted on the Automobile's certificate of title. However, if LaSalle's security interest was not properly perfected, the Trustee has a superior interest in the Automobile, the insurance proceeds received by LaSalle were property of the Debtor's bankruptcy estate, and LaSalle must turnover the proceeds to the Trustee for distribution to the Debtor's creditors.

* * *

The first question before the court is whether LaSalle's security interest in the Automobile was properly perfected. Issues such as the method for achieving perfection of a security interest and the time at which a security interest is perfected are matters of state law. Hendon v. Gen. Motors Acceptance Corp. (In re B & B Utils., Inc.), 208 B.R. 417, 421 (Bankr.E.D.Tenn.1997). In Tennessee, the perfection of a security interest in a motor vehicle is governed by title 55, chapter 3 of the Tennessee Code Annotated (collectively the Tennessee Certificate of Title Statute). Specifically, section 55-3-126, as it existed in 2001, provides, in pertinent part:

(a) A lien or security interest in a vehicle of the type for which a certificate is required shall be perfected and shall be valid against subsequent creditors of the owner, subsequent transferees, and the holders of security interest and liens on the vehicle by compliance with this chapter.

(b)(1) A security interest or lien is perfected by delivery to the division of motor vehicles or the county clerk of the existing certificate of title, if any, title extension form, or manufacturer's statement of origin and an application for a certificate of title containing the name and address of the holder of a security interest or lien with vehicle description and the required fee.

(2) The security interest is perfected as of the time of its creation if the delivery is completed within twenty (20) days thereafter. Otherwise, a security interest is perfected as of the date of delivery to the county clerk or the division of motor vehicles. [FN2]

FN2. The statute has since been revised and the twenty-day language has been deleted. See TENN. CODE ANN. § 55-1-126(b)(2) (Supp.2002) ( "The security interest is perfected as of the date of delivery to the county clerk or division of motor vehicles.").

....

(c) When the security interest is perfected as provided for in this section, it shall constitute notice of all liens and encumbrances against the vehicle described therein to creditors of the owner, to subsequent purchasers and encumbrances, ....

(d) The method provided in this section and § 55-3-125 of obtaining a lien or encumbrance upon a motor vehicle, ... subject to the provisions of chapters 1-6 of this title relative to the issuance of certificates of title, shall be exclusive except as to liens depending upon possession and the lien of the state for taxes[.]

TENN. CODE ANN. § 55-3-126 (1998). As stated by the Tennessee Supreme Court, "a security interest in a motor vehicle is not perfected until a notation of the lien is made on the certificate of title." Still v. First Tenn. Bank, N.A., 900 S.W.2d 282, 285 (Tenn.1995).

LaSalle argues that equitable subrogation of First American's perfected security interest in the Automobile is appropriate because funds loaned to the Debtor by LaSalle were used to pay First American's lien in full, LaSalle was then given a security interest in the Automobile in place of First American, and there was a continuous notation on the certificate of title between First American and LaSalle.

Subrogation is defined as "the substitution of another person in the place of a creditor, so that the person in whose favor it is exercised succeeds to the rights of the creditor in relation to the debt." Castleman Constr. Co. v. Pennington, 222 Tenn. 82, 432 S.W.2d 669, 674 (1968) (quoting 83 C.J.S. SUBROGATION § § 1, 2). The right to subrogation "accrues when one person for the protection of his own interests, pays a debt for which another is primarily liable." Amos v. Cent. Coal Co., 38 Tenn.App. 626, 277 S.W.2d 457, 462 (1954). "A right of subrogation may arise by contract ('conventional subrogation'), by application of equitable principles of law ('legal subrogation'), or by application of statute ('statutory subrogation')." Blankenship v. Estate of Bain, 5 S.W.3d 647, 650 (Tenn.1999). Legal or equitable subrogation "is founded on principles of justice and equity, and its operation is governed by principles of equity." Castleman Constr. Co., 432 S.W.2d at 674; see also Wimberly v. Am. Cas. Co., 584 S.W.2d 200, 203 (Tenn.1979).

In deciding whether to employ subrogation as a remedy, the court should balance the equities involved. Lawyers Title Ins. Corp. v. United Am. Bank, 21 F.Supp.2d 785, 792 (W.D.Tenn.1998). The negligence of a party seeking subrogation is a factor to be considered, along with any harm to be suffered by third parties if subrogation is allowed. Dixon v. Morgan, 154 Tenn. 389, 285 S.W. 558, 561-62 (1926). If "no one is injured by the mistake other than the party himself, ... relief may be granted, even though a high degree of care has not been exercised." Id. at 562.

LaSalle asserts that the Uniform Commercial Code, as adopted in Tennessee, expressly authorizes the court to incorporate equitable principles, which would include equitable subrogation, citing Tennessee Code Annotated section 47-1- 103, which provides that

[u]nless displaced by the particular provisions of chapters 1-9 of this title, the principles of law and equity, including the law merchant and the law relative to capacity to contract, principal and agent, estoppel, fraud, misrepresentation, duress, coercion, mistake, bankruptcy, or other validating or invalidating cause shall supplement its provisions.

TENN. CODE ANN. § 47-1-103 (2002). Stating that security interests in motor vehicles are within the scope of Article 9 of the Uniform Commercial Code, LaSalle argues that equity principles are contemplated concerning the perfection of security interests in motor vehicles, despite the Tennessee Certificate of Title Statute.

"Motor vehicles are goods for the purpose of Article Nine, and therefore, the Uniform Commercial Code applies to transactions intended to create a security interest in automobiles." Keep Fresh Filters, Inc. v. Reguli, 888 S.W.2d 437, 442 (Tenn.Ct.App.1994). Article 9 of the Uniform Commercial Code, as adopted in Tennessee, discusses the perfection of security interests in motor vehicles, as follows:

(a) Except as otherwise provided ..., the filing of a financing statement is not necessary or effective to perfect a security interest in property subject to:

....

(2)(A) a certificate-of-title statute of this state, covering automobiles, trailers, mobile homes, vehicles or the like, which provides for a security interest to be indicated on the certificate as a condition or result of perfection, under Tennessee Code Annotated, Title 55, Chapter 3[.]

TENN. CODE ANN. § 47-9-311 (2001).

Clearly, Tennessee's Uniform Commercial Code defers its application to the Tennessee Certificate of Title Statute regarding the exclusive method for perfection of a security interest in a motor vehicle. There is nothing in the Tennessee Certificate of Title Statute that allows a court to supplement the Statute with equitable principles. On the other hand,

Article Nine is not, however, the only body of law governing security interests in automobiles. In accordance with [Tennessee Code Annotated section] 47-9-302(3)(b) (1992), [FN3] Article Nine's filing requirements must give way to any statutory scheme that provides for the central filing of security interests or the notation of these interests on a certificate of title. Tennessee's motor vehicle title and registration laws are just such statutes. Thus, compliance with these statutes is the exclusive method for perfecting a security interest in automobiles not part of inventory.

FN3. Section 47-9-302, entitled "When filing is required to perfect security interest--Security interests to which filing provisions of this chapter do not apply," provided as follows:

(3) The filing of a financing statement otherwise required by this chapter is not necessary or effective to perfect a security interest in property subject to:

....

 (b) statutes of this state which provide for central filing of, or which require indication on a certificate of title of such security interests in such property[.]

TENN. CODE ANN. § 47-9-302(3)(b) (1992). This section is similar to section 47-9-311(a)(2)(A), supra; however, the current statute is even more definite, in that it specifically identifies Tennessee Code Annotated Title 55, Chapter 3 as the governing law.

Keep Fresh Filters, 888 S.W.2d at 442 (citations omitted).

LaSalle cites to and urges the court to adopt the reasoning of the Tennessee Court of Appeals' decision in Assocs. Home Equity Servs., Inc. v. Franklin Nat'l Bank, No. M2000-00516-COA-R3-CV, 2002 WL 459007, 2002 Tenn.App. LEXIS 207 (Tenn.Ct.App. Mar.26, 2002), in which the court of appeals allowed an equitable remedy in light of Tennessee's recording statutes. [FN4] In that case, the court applied the doctrine of equitable subrogation in relation to two home mortgages recorded on the same real property, despite the provisions of the recording statute.

FN4. Tennessee's recording statute, section 66-26-101, entitled "Effect of instruments with or without registration," provides as follows:

All of the instruments mentioned in § 66-24-101 [including warranty deeds and deeds of trust] shall have effect between the parties to the same, and their heirs and representatives, without registration; but as to other persons, not having actual notice of them, only from the noting thereof for registration on the books of the register, unless otherwise expressly provided.

TENN. CODE ANN. § 66-26-101 (1993).

Section 66-26-103, entitled "Unregistered instruments void as to creditors and bona fide purchasers," provides as follows:

Any of such instruments not so proved, or acknowledged and registered, or noted for registration, shall be null and void as to existing or subsequent creditors of, or bona fide purchasers from, the makers without notice.

TENN. CODE ANN. § 66-26-103 (1993).

There is a considerable difference, however, between the two situations. As the court of appeals noted, "[c]ourts recognize ... exceptions to the first-filed rule [of Tennessee's race-notice recording statute] which are based upon facts not disclosed by a search of recorded instruments." Assocs. Home Equity Servs., 2002 WL 459007, at *2, 2002 Tenn.App. LEXIS 207, at *8. Conversely, cases dealing with perfection of a motor vehicle have consistently held that notation on the certificate of title is the sole method of perfection, and in fact, even in cases where notation did not occur by mistake of a governmental employee, courts have held that the security interests were not perfected. See, e.g., Schulman v. Ford Motor Credit Co. (In re Leach), 206 B.R. 903, 905, 907 (Bankr.M.D.Tenn.1997) (mistake by creditor in name noted on certificate of title was "fatal" as to section 55-3- 137(b)(1) requirements); Newton v. First Am. Nat'l Bank (In re Webb), 106 B.R. 517, 521-22 (Bankr.E.D.Tenn.1989) (even though dealership made clerical error on application for notation of lien, the creditor was still unperfected under Tennessee law); Waldschmidt v. Smith (In re York), 43 B.R. 36, 37 (Bankr.M.D.Tenn.1984) (because perfection requires both application and notation, creditor's lien was inferior to that of the bankruptcy trustee, despite the fact that the Tennessee Department of Motor Vehicles lost the creditor's application for notation).

LaSalle also argues that because First American never released its perfected lien on the Automobile, perfection was continuous between the two entities, such that First American's perfection should be subrogated to LaSalle. Indeed, the parties have stipulated that First American's perfected security interest was noted on the Automobile's certificate of title until the duplicate title noting LaSalle's interest was issued by the State of Tennessee on May 17, 2001.

As to this argument, the court takes notice that the Certificate of Title issued on May 21, 2001, evidencing LaSalle as lienholder on the Automobile states that the "Date of First Security Interest" was May 14, 2001, approximately seven weeks after the Debtor filed her bankruptcy petition. This was the date in which the Application for Notation of Lien was received by the State of Tennessee and, pursuant to section 55-3-126(b)(2) is the date that LaSalle perfected its security interest in the Automobile in the eyes of the State of Tennessee. Likewise, that is the date of perfection in the eyes of the court.

Finally, LaSalle argues that it should not be penalized because First American failed to deliver the certificate of title to LaSalle after the refinancing took place. LaSalle correctly states that, pursuant to Tennessee Code Annotated section 55-3-114(c), First American had a duty to release the certificate of title to LaSalle, upon request by LaSalle. See TENN. CODE ANN. § 55-3-114(c) (1998). However, even though First American had a duty to deliver the certificate of title to LaSalle, it was ultimately LaSalle's responsibility to get the title from First American or to obtain a duplicate title, as it eventually did, more than two years after the fact. The only party that penalized LaSalle was LaSalle, and "the risk of loss ... should be borne by the secured party who is ultimately responsible for seeing that the lien is properly noted." York, 43 B.R. at 38. [FN5] In the court's opinion, that party is LaSalle. [FN6]

FN5. The York court noted that "[i]n this case neither the debtor nor the lienor (the debtor's brother-in-law) demonstrated any particular diligence about the notation of the lien. The debtor waited more than seven months after signing the note to make the application for notation of lien. The lienholder-to-be, defendant Smith, apparently waited several years to check whether his lien was noted and even then not until after the issue was joined in this bankruptcy." York, 43 B.R. at 38 n. 3.

FN6. The court notes that even if it could entertain equitable subrogation as a remedy, in this situation, LaSalle's carelessness in obtaining notation of its lien on the certificate of title, coupled with the harm that subrogation would cause to the unsecured creditors in this case, combine to weigh in the Trustee's favor in the equity arena.

Under the laws of the State of Tennessee, the date upon which LaSalle perfected its security interest in the Automobile was May 14, 2001.

IV

Having determined that LaSalle's security interest in the automobile was not perfected until after the commencement of the Debtor's bankruptcy case, the second question before the court is whether LaSalle's actions in having the lien noted on the Automobile's certificate of title postpetition was a violation of the automatic stay.

The commencement of a debtor's bankruptcy case triggers the protection of the automatic stay provisions set forth in § 362(a), which states in pertinent part:

(a) Except as provided in subsection (b) of this section, a petition filed under section 301, ... operates as a stay, applicable to all entitles, of--  ....

(4) any act to create, perfect, or enforce any lien against property of the estate[.]

11 U.S.C.A. § 362 (West 1993 & Supp.2002). "A specific intent to violate the stay is not required, or even an awareness by the creditor that [its] conduct violates the stay. It is sufficient that the creditor knows of the bankruptcy and engages in deliberate conduct that, it so happens, is a violation of the stay." In re Printup, 264 B.R. 169, 173 (Bankr.E.D.Tenn.2001).

LaSalle did not seek to perfect its security interest in the Automobile until after the filing of the Debtor's bankruptcy case. Regardless of its intent, this action constituted a violation of the automatic stay, and it shall be voided. [FN7] See also Webb, 106 B.R. at 520 n. 4 (the creditor's postpetition attempt to cure clerical error on certificate of title and perfect lien violated the automatic stay provisions of § 362(a)).

FN7. As stated by the Sixth Circuit,

[A]ctions taken in violation of the stay are invalid and voidable and shall be voided absent limited equitable circumstances. We suggest that only where the debtor unreasonably withholds notice of the stay and the creditor would be prejudiced if the debtor is able to raise the stay as a defense, or where the debtor is attempting to use the stay unfairly as a shield to avoid an unfavorable result, will the protections of section 362(a) be unavailable to the debtor. Easley v. Pettibone Michigan Corp., 990 F.2d 905, 911 (6th Cir.1993).

[Discussion of the application of BRA § 544 omitted.]