Expert’s Corner: Court Finds Vehicle with “Clean” Paper Title Subject was Not Free of Security Interest

February 4, 2014

By Paul Hodnefield, Esq.

New technology sometimes complicates the issues surrounding perfection, priority and enforcement of security interests. A recent case that involved conflicting paper and electronic titles to the same motor vehicle provided one such example and offered a matter of first impression for the Supreme Court of Kansas in Stanley Bank v. Parish, 2014 Kan. LEXIS 10 (Kan. Jan. 24, 2014).

In early 2006, Johnny and Kellie Parish (the “Debtors”) borrowed money from Stanley Bank (the “Bank”) to purchase a 2006 GMC Yukon. As security for the loan, the Debtors granted the Bank a security interest in the vehicle. On January 31, 2006, in compliance with state law requirements for perfection of security interests in titled motor vehicles, the bank filed a notice of security interest (“NOSI”) with the Kansas Department of Revenue (the “KDOR”) using the KDOR’s motor vehicle electronic lien filing system.

The Debtors later applied for a certificate of title and registered the vehicle in their name. The KDOR proceeded to issue a title certificate and registration that indicated the Bank’s security interest on the Yukon. In addition, the KDOR electronic lien system reflected the Bank’s security interest on the Debtors’ electronic title.

The Debtors defaulted on the Bank loan in April 2007. A few months later, the former employer of Johnny Parish, Bazin Excavating, obtained a money judgment against him in an unrelated matter. Bazin Excavating obtained a court order authorizing the attachment of Parish’s personal property, including the Yukon.

Bazin Excavating seized the Yukon on July 3, 2007. The following month, Bazin Excavating obtained a court order authorizing the sale of the Yukon and filed a notice of the sale with the district court. Bazin Excavating also sent notice of the planned auction to the Bank and published notice in the local newspaper.

On September 20, 2007, Robert Bazin (“Bazin”), the president and sole owner of Bazin Excavating, went to a KDOR office, provided documentation of the money judgment and requested a title for the Yukon so it could be sold at auction. The clerk issued a certificate of title for the Yukon that indicated Bazin Excavating as the owner and that the vehicle was not subject to any liens.

The auction took place on September 21, 2007. The successful bidder was Bazin, who paid $23,000 to purchase the Yukon on behalf of himself for personal use.

The Bank demanded that Bazin Excavating turn over the proceeds of the sale, but received no response. Consequently, the Bank brought suit against Bazin Excavating and Bazin individually (collectively the “Defendants”), seeking a declaratory judgment that its security interest in the Yukon and sale proceeds was superior to any interest held by the Defendants. Additionally, the Bank claimed the Defendants unlawfully converted the Yukon sale proceeds.

The trial court granted summary judgment in favor of the Bank. The Defendants appealed and the case eventually made it to the Kansas Supreme Court.

The Defendants argued that the Bank was unperfected because the KDOR did not indicate the security interest on the paper certificate of title it issued in the name of Bazin Excavating. Further, Bazin claimed that his purchase of the Yukon made him the buyer of consumer goods and entitled him to take free of the security interest, even if perfected.

The Court first determined that the Bank had done everything necessary to properly perfect its security interest. First, the Debtors granted the Bank a security interest in the Yukon when they executed the security agreement. Then the Bank perfected that security interest by delivering the NOSI to the KDOR through the electronic lien system.

The Bank perfected its security interest before Bazin Excavating became a lien creditor. Thus, the Bank’s perfected security interest clearly had priority over any interest held by Bazin Excavating.

Next, the Court addressed Bazin’s claim that he took free of the Bank’s security interest as the buyer of consumer goods. To take free of a perfected security interest, the buyer of consumer goods must buy: without knowledge of the security interest; for value; primarily for personal, family or household purposes; and before the filing of a financing statement covering the goods. Bazin clearly failed the last part of this test.

The UCC deems perfection under state certificate of title laws as the equivalent of filing a financing statement. The Bank perfected its security interest through the equivalent of filing a financing statement before Bazin bought the Yukon. As a result, the Bank’s security interest took priority over any claim Bazin had on the vehicle.

Finally, the fact that the paper title issued to Bazin Excavating did not indicate the Bank’s security interest had no effect on the outcome. The Court reiterated that the Bank had done everything required by law to properly perfect its security interest in the Yukon before the Defendants gained any interest in the vehicle. Further, the KDOR properly recorded the Bank’s security interest in its electronic lien and title system, which continued to reflect the Bank’s security interest even after Bazin obtained the “clean” paper title from the KDOR. Therefore, the Court held that the Bank-perfected security interest had priority over the Defendants’ claims to the vehicle.

The important thing to take away from this case is that a paper certificate of title may not reliably establish whether a vehicle is subject to a security interest if the state has established an electronic vehicle title and lien system. In states such as Kansas, where the law permits electronic certificates of title, an interested party should examine both the paper certificate, if one exists, and conduct a search of the electronic records to determine whether the vehicle is subject to a security interest.

Paul Hodnefield is Associate General Counsel for Corporation Service Company and a frequent speaker/writer on UCC due diligence issues. Please feel free to contact him with questions or comments at phodnefi@cscinfo.com or 800-927-9801, ext. 62375.