The matter came to the Seventh Circuit Court of Appeals from a federal diversity suit Caterpillar brought against People’s National Bank in the U.S. District Court for the Southern District of Illinois.
The bank’s appeal over Murphy’s judgment presented “a variety of issues of secured transactions law,” according to the 14-page opinion delivered by Seventh Circuit Judge Richard Posner.
Judges Ann Claire Williams and Charles Norgle rounded out the federal appeals panel that affirmed Murphy’s judgment awarding Caterpillar $2.4 million in damages, as well as prejudgment interest.
Caterpillar accused the bank, which operates in southern Illinois and eastern Missouri, of converting proceeds from the sale of mining equipment that served as collateral for loans to S Coal.
The southern Illinois coal company, according to the federal appeals opinion, borrowed about $7 million from Caterpillar in 2006 and took out a $1.8 million loan two years later from the bank, both of which were secured by the same mining equipment.
In addition, the company was indebted to Peabody Energy Corporation for an earlier loan. S Coal, at Peabody’s request, had transferred the title to the same mining equipment to an affiliate of Peabody.
That affiliate, according to the opinion, was a “special purpose” entity with the intention of trying to prevent creditors other than Peabody from seizing the equipment.
When the bank loaned the company money in 2008, it discovered that S Coal had given Peabody a security interest in all of its assets. Wanting its security interest to have priority over Peabody’s, the bank negotiated a subordination agreement.
After S Coal defaulted on its loans, the bank and Caterpillar started fighting over the same assets of the coal company: the mining equipment that had secured its loans.
The bank eventually obtained possession of the equipment and told Caterpillar it would try to sell it for $2.5 million. Caterpillar, according to the opinion, didn’t object, but reserved the right to sue the bank if it didn’t hand over proceeds of the sale.
After it sold the equipment for $2.5 million, the bank sent Caterpillar a $1.1 million check and kept the remaining $1.4 million to cover what the coal company owed it.
Caterpillar didn’t cash or return the check to the bank, asserting that its security interest in the collateral was senior to the bank’s security interest in the same equipment.
The bank, however, claimed that Peabody had priority over the interest in the equipment given that it loaned S Coal money before Caterpillar did in 2006. The bank further argued that it actually had priority over Caterpillar based on the subordination agreement.
On behalf of the federal appeals panel, Posner wrote that courts have disagreed on how subordination agreements affect priority when the agreements do not explicitly say so.
“Complete subordination,” Posner wrote, would give Caterpillar first priority, followed by the bank and then Peabody while “partial subordination” would put the bank first, followed by Caterpillar and then Peabody.
“So far we have seen Caterpillar’s arguments for priority over the bank falling like lynchpins,” Posner wrote for the panel in its analysis of the rather complicated issues of security interest and subordination agreements.
“But,” he added, “the bank’s argument for priority encounters a greater obstacle – in fact an insurmountable one.”
That obstacle, according to the panel’s opinion, deals with the security agreement between Peabody and S Coal.
While the panel didn’t cast doubt that such an agreement was in fact made, Posner noted that such an agreement “hasn’t surfaced in this litigation.”
He also stressed that under the Uniform Commercial Code, “security interest is not enforceable ‘unless the debtor has authenticated a security agreement that provides a description of the collateral.’”
Because of the “missing security agreement between S Coal and Peabody, the panel determined that Caterpillar’s security interest in the equipment was prior to the bank’s” and “Caterpillar’s security interest, with its priority, continued into the proceeds when the bank sold the equipment.”
Saying that the bank had no right to those proceeds, the federal appeals panel found that the damages, as well as prejudgment interest, Murphy awarded Caterpillar were proper.
Electronic court documents show that Missouri attorney Daniel D. Doyle represented Caterpillar and Centralia attorney Elvie Horn represented the bank in arguments before the Seventh Circuit.