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

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May 2003

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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. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
re Charles, _____ F.3d ____, 2003 WL 1384031
(10th Cir. March 20, 2003)</a>. 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
<a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
U.S.C. §544</a> 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. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…; at 1</a>.

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." <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…; at 3</a>; see, generally, <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=U…
§9-402(8)</a>. 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

<a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8…
American Credit Union v. Bd. of Cnty. Comm'rs. of Sedgwick Cnty., 806 P.2d 479, 484 (Kan. Ct. App. 1991)</a>; see, also, <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=7…
Finance Co. of Kansas Inc. v. Schroeder, 737
P.2d 52, 55 (Kan. Ct. App. 1987)</a> (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." <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8…
American, 806 P.2d at 484</a> (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. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8…; 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." <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8…; 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. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8…; at 4</a>. 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.<a href="#1" name="1a">1</a> 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. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8…; at 2</a> (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." <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8…; at 2</a>.<a href="#2" name="2a">2</a>

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., <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=6…
re Circus Time Inc., 641 F.2d 39, 42-43 (1st
Cir. 1981)</a>. 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. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=6…; 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. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=6…; 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. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=6…; at 43</a>. 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." <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=6…; (citing 1 <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=U…,
C P., Hogan, W. and Vagts, D., Secured Transactions Under the Uniform Commercial Code, §29A.04(6)</a> 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. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
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)</a>
(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 <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1….
§9-402(8). Otasco, 111 B.R. at 990</a>. 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.<a href="#" name="3a">3</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=I…;

Id. at 992-993</a>. 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.<a href="#4" name="4a">4</a> 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 <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=U….
§9-402(8)</a> or revised <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=U….
§9-506</a>. It would seem that, in a forum that cites so often to Butner<a href="#5" name="5a">5</a> 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."

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> See <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=7…
Inc. v. VTCC Inc. (In re Load-It Inc.), 774
F.2d 1077, 1078-79 (11th Cir. 1985)</a> (holding a security interest
in motor vehicle perfected under Georgia law where secured creditor identified
as owner on certificate of title); <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=6…
re Circus Time Inc., 641 F.2d 39, 42-44 (1st
Cir. 1981)</a> (same, applying Maine and New Hampshire law); <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=6…
re Nat'l. Welding of Mich. Inc., 61 B.R.
314, 317 (W.D. Mich. 1986)</a> (same, applying Michigan law); <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
re Microband Cos. Inc., 135 B.R. 2, 4-6 (Bankr.
S.D.N.Y. 1991)</a> (same, applying New York, New Jersey, Maryland
and Michigan law); <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
Trucking v. Circle Leasing of Colo. Corp. (In re Yeager Trucking), 29 B.R. 131, 134-35 (Bankr. D. Colo. 1983)</a>

(same, applying Colorado law); <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
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)</a> (same, applying Tennessee law). <a href="#1a">Return to article</a>

<a name="2">2</a> The Charles court, despite Mid American and Schroeder, predicted that the Kansas Supreme Court would adopt the substantial
compliance standard. <a href="#2a">Return to article</a>

<a name="3">3</a> 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). <a href="#3a">Return to article</a>

<a name="4">4</a> See, also, <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=4…
re Manufacturers Credit Corp., 441 F.2d 1313,
1319 (3rd Cir. 1971)</a> (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). <a href="#4a">Return to article</a>

<a name="5">5</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=9…
v. United States, 99 S.Ct. 914 (1979)</a>
(holding that barring some federal interest, interests in property must be
determined in bankruptcy pursuant to state law. <a href="#5a">Return to article</a>

Journal Authors

Edmund S. Whitson

Journal Date

Thursday, May 1, 2003 - 12:00

Bankruptcy Rule

2003