In r e : Daniel S . Campano CV-02-509-M 05/29/03 UNITED STATES DISTRICT COURT

DISTRICT OF NEW HAMPSHIRE

In r e : Daniel S . Campano, Debtor

Steven M . Notinger, Chapter 7 Trustee for the Estate of Daniel S . Campano, Appellant

v. Civil N o . 02-509-M Opinion N o .

Auto Shine Car Wash Systems, Inc., Appellee

O R D E R

Daniel S . Campano is a Chapter 7 debtor. Trustee Steven M .

Notinger appeals a September 1 3 , 2002, order of the bankruptcy

court (Deasy, J.) overruling his objection to Auto Shine Car Wash

Systems, Inc.’s proof of claim. For the reasons given below, the

order of the bankruptcy court is affirmed.

Standard of Review

A bankruptcy court’s findings of fact are not set aside

unless clearly erroneous. Palmacci v . Umpierrez,

8 1 , 785 (1st Cir. 1997) (citing F E D . R . BANKR. P . 8013; Commerce Bank &

Trust C o . v . Burgess (In re Burgess),

3 4 , 137 (1st Cir.

1992); F E D . R . C I V . P . 52(c), advisory committee’s note to 1991

Amendment). However, a “bankruptcy court’s legal conclusions,

drawn from the facts so found, are reviewed de novo.” Palmacci,

(citing Martin v . Bajgar (In re Bajgar),

(1st Cir. 1997)).

Absent either a mistake of law or an abuse of discretion, the bankruptcy court ruling must stand. See Siedle v . Putnam Invs., Inc.,

, 10 (1st Cir. 1998). A bankruptcy court “may abuse its discretion by ignoring a material factor that deserves significant weight, relying on an improper factor, o r , even if it [considered] only the proper mix of factors, by making a serious mistake in judgment.”

Picciotto v . Salem Suede, Inc. (In re Salem Suede, I n c . ) ,

2 , 44 (1st Cir. 2001). “On an appeal the district court .

. . may affirm, modify, or reverse a bankruptcy judge’s judgment,

order, or decree or remand with instructions for further

proceedings.” F E D . R . BANKR. P . 8013.

Background

The facts of this case, in broad outline, are as follows.

Campano is a former employee of Auto Shine Car Wash Systems, Inc.

2 (“Auto Shine”), a corporation owned and operated by Frank

DiTommaso. Auto Shine sold and serviced car wash systems. On

March 1 0 , 1999, Campano purchased Auto Shine’s sales and service

division, in a seller-financed sale, for $940,000. Campano

executed two promissory notes in favor of Auto Shine, one for

$890,000, the other for $34,000. Those notes were secured by the

business assets Campano purchased, a second mortgage on Campano’s

home, and a limited guaranty from Campano’s spouse. With the

business assets he purchased from Auto Shine, Campano started his

own business, Auto Shine Sales and Service, Inc. (“Sales and

Service”).

In February 2001, Sales and Service defaulted on its

obligations to Auto Shine. On March 2 8 , 2001, in the wake of a

confrontation over unpaid rent between Campano and Sales and

Service’s landlord, Campano vacated the business premises. When

he left, Campano took a laptop computer and some customer and

vendor lists. Employee Sherry Curtis took several boxes

containing paper copies of accounts payable and accounts

receivable, and held those records until July 2 9 , 2002, the date

of the Bankruptcy Court’s hearing on Auto Shine’s proof of claim.

3 Employees Bruce White and Louie Mattia loaded their Sales and

Service trucks with tools, equipment, and inventory.1 They

stored those items at their homes and used them for servicing

Sales and Service customers during the several-week interval

between the demise of Sales and Service and the formation of

DiTommaso’s new business, Car Wash Systems & Equipment, LLC (“Car

Wash”). Car Wash, in turn, hired White and Mattia at some point

in April, 2001. When they came to work for Car Wash, White and

Mattia brought with them Sales and Service’s tools and any

uninstalled inventory they had in their possession. DiTommaso,

who had been present during the confrontation between Campano and

the landlord, took Sales and Service’s computers and telephone

system. The remainder of Sales and Service’s business assets,

principally car wash system parts and office furniture, were left

behind.

It is undisputed that Auto Shine never gave Campano notice

that it intended to retain Sales and Service’s business assets in

full satisfaction of Campano’s debt to Auto Shine. Rather, Auto

1 Some of the inventory that White and Mattia took had already been paid for by customers.

4 Shine notified Campano, by letter, of its intention to collect

collateral and then sell i t . No such sale was ever conducted.

On October 9, 2001, Campano filed a petition for protection

under Chapter 7 of the Bankruptcy Code. Auto Shine filed a

timely proof of claim in the amount of $873,534.55, representing

the balance owing on the larger of the two promissory notes that

Campano gave Auto Shine.2 The Trustee objected to Auto Shine’s

Proof of Claim, arguing that: ( 1 ) Auto Shine fraudulently induced

Campano to purchase its sales and service division; and (2) Auto

Shine was precluded from asserting a claim against the bankruptcy

estate because it had retained the collateral securing its note –

Sales and Service’s business assets – in complete satisfaction of

Campano’s debt, under the doctrine of strict foreclosure. In a

Memorandum Opinion dated December 1 3 , 2002, the Bankruptcy Court

overruled the Trustee’s objection. This appeal followed.

2 At issue is Auto Shine’s right to approximately $94,000 in proceeds from the sale of Campano’s home.

5 Discussion

The Trustee does not appeal the Bankruptcy Court’s decision

with respect to fraudulent inducement. Rather, he asserts four

arguments challenging the Bankruptcy Court’s decision to allow

Auto Shine’s claim, notwithstanding his invocation of the

doctrine of strict foreclosure. Specifically, the Trustee argues

that the Bankruptcy Court: (1) applied an incorrect burden of

proof; (2) committed clear error by finding that he failed to

produce substantial evidence of the invalidity of Auto Shine’s

claim; (3) committed clear error by failing to find that Auto

Shine took possession of substantially all the assets of Sales

and Service, thus precluding Auto Shine’s claim under the strict

foreclosure doctrine, see N . H . R E V . STAT. A N N . (“RSA”) 382-A:9-505

(§ 9-905 of the Uniform Commercial Code ( “ U C C ” ) ) ; and (4)

committed legal error by failing to properly apply controlling

precedent (Lamp Fair, Inc. v . Perez-Oritz,

(1st Cir.

1989), and Banker v . Upper Valley Refrigeration C o . , 771 F . Supp.

6 ( D . N . H . 1991)), which compels a decision in his favor.

6 I. Burden of Proof

The Trustee argues that the Bankruptcy Court’s decision

should be reversed, and the case remanded, because the Bankruptcy

Court committed an error of law when it ruled that “the burden

[was] on [him] to establish that Auto Shine’s claim in the

Debtor’s bankruptcy case should be completely offset by Auto

Shine’s retention of corporate assets” (Mem. O p . at 1 2 ) , and by

finding that the Trustee had not “sustained his burden of

establishing that Auto Shine’s actions constituted strict

foreclosure” (Mem. O p . at 1 6 ) .

The Bankruptcy Court applied the correct burden of proof.

“ A claim [by a creditor of a bankruptcy debtor], . . . proof of

which is filed under section 501 of [the Bankruptcy Code], is

deemed allowed, unless a party in interest . . . objects.” 11

U . S . C . § 502(a). “ A proof of claim executed and filed in

accordance with [the Federal Rules of Bankruptcy Procedure] shall

constitute prima facie evidence of the validity and amount of the

claim.” F E D . R . BANKR. P . 3001(f); see also Juniper Dev. Group v .

Kahn (In re Hemingway Transp., I n c . ) ,

, 925 (1st Cir.

1993). “In order to rebut the presumption that attaches to a

7 proof of claim, a party objecting must produce “‘substantial

evidence.’” United States v . Clifford (In re Clifford),

(D. Mass. 2000) (citing In re Hemingway, 993 F.2d at

925). “If the objecting party sufficiently rebuts the claimant’s

prima facie case, the burden shifts back to the claimant as it is

ultimately ‘for the claimant to prove his claim, not for the

objector to disprove it.’” In re G. Marine Diesel Corp.,

5 1 , 853 (Bankr. E.D.N.Y. 1993) (quoting In re Gorgeous

Blouse Co.,

(S.D.N.Y. 1952)); see also In

re Hemingway, 993 F.2d at 925 (“Once the trustee manages the

initial burden of producing substantial evidence . . . the

ultimate risk of nonpersuasion as to the allowability of the

claim resides with the party asserting the claim.”) (citations

omitted).

Notwithstanding the well-established burden-shifting scheme

outlined above, one additional rule applies. In Raleigh v .

Illinois Department of Revenue, the United States Supreme Court

explained that “[t]he ‘basic federal rule’ in bankruptcy is that

state law governs the substance of claims.”

5 , 20

(2000) (quoting Butner v . United States,

8 , 57 (1979)).

8 The substance of a claim, in turn, includes its burden of proof.

Raleigh,

(citations omitted). The Court went on

to explain that “[u]nless some federal interest requires a

different result, there is no reason why [the state] interests

should be analyzed differently simply because an interested party

is involved in a bankruptcy proceeding.” Raleigh,

(quoting Butner, 440 U.S. at 55) (alteration in the original).

Based on those principles, the Raleigh court held that when the

Illinois Department of Revenue made a claim against a bankruptcy

estate, the trustee bore the burden of proof because the Illinois

tax code placed the burden of proof on the taxpayer when he or

she has been served with a notice of deficiency.

7 .

While the underlying state law at issue in Raleigh was the

Illinois tax code, its holding has been applied in other state-

law contexts as well. See, e.g., In re Cantrell,

5 1 ,

556 n.13 (Bankr. D. Conn. 2001) (“With respect to the standard of

proof required to establish the existence of the [resulting]

trust, the same standard applies in bankruptcy as outside of

bankruptcy.”).

9 In light of Raleigh’s holding that “one who asserts a claim

is entitled to the burden of proof that normally comes with it,”

1 , it is necessary to examine the state-law basis

for Auto Shine’s claim in order to determine the burden of proof

to which Auto Shine is entitled. Both parties agree that Auto

Shine’s rights as a secured creditor are governed by New

Hampshire’s version of UCC (before the amendments effective on

July 1 , 2001).

Under New Hampshire’s UCC, a secured creditor has three

avenues of recourse against a debtor in default. First, the

secured creditor may “reduce his claim to judgment, foreclose or

otherwise enforce the security interest by any available judicial

procedure.” RSA 382-A:9-501(1) (1994). Second, the secured

creditor “may take possession of the collateral,” RSA 382-A:9-503

(1994), “sell, lease or otherwise dispose of any or all of the

collateral,” RSA 382-A:9-504(1) (1994), and then apply the

proceeds to “the satisfaction of indebtedness secured by the

security interest under which the disposition is made,” RSA 382-

A:9-504(1)(b) (1994). O r , third,

10 a secured party in possession may, after default, propose to retain the collateral in satisfaction of the obligation. Written notice of such proposal shall be sent to the debtor and except in the case of consumer goods to any other secured party who has a security interest in the collateral and who has duly filed a financing statement indexed in the name of the debtor in this state or is known by the secured party in possession to have a security interest in i t . If the debtor or other person entitled to receive notification objects in writing within 30 days from the receipt of the notification or if any other secured party objects in writing within 30 days after the secured party obtains possession the secured party must dispose of the collateral under Section 9-504. In the absence of such written objection the secured party may retain the collateral in satisfaction of the debtor’s obligation.

RSA 382-A:9-505(2) (emphasis added). Section 9-505(2) of the UCC

is alternatively known as “the ‘retention’ or ‘strict

foreclosure’ option.” LaRoche v . Amoskeag Bank (In re LaRoche),

(1st Cir. 1992).

The legal effect of exercising the retention or strict

foreclosure option has been described as follows:

[t]he Code makes clear . . . that retention of the collateral normally completely satisfies the debt; the secured party must abandon any claim for deficiency (unless the debtor signs a written statement permitting such a claim . . . ) . U.C.C. § 9-505, comment 1 ; 2 J. White and R. Summers, Uniform Commercial Code 585; Tanenbaum v . Economics Laboratory, Inc.,

(Tex. 1982). The Code also states that the

11 secured party must give notice of its intention to retain the collateral in satisfaction of the obligation, so that the debtor may object to retention and demand that the collateral be sold.

Lamp Fair,

(interpreting Connecticut’s UCC)

(emphasis in the original); see also Banker, 771 F. Supp. at 8

(“The New Hampshire U.C.C. provisions applicable to the instant

case [§§ 5 0 1 , 5 0 4 , and 505 of Article 9 ] are identical in all

material respects to those construed in Lamp Fair, and this Court

is unaware of any reason why New Hampshire’s reading of these

provisions would differ from Connecticut’s.”).

The § 9-505 retention option provides a method for

satisfying a secured debt, but it also provides an affirmative

defense that may be raised by a debtor when a creditor attempts

to use the § 9-501 reduction-to-judgment option. See, e.g.,

LaRoche,

(“LaRoche raised the defense of payment

[to Amoskeag’s action to collect on a debt], arguing that

Amoskeag’s reregistration of the pledged shares . . . constituted

a proposal to accept and retain the collateral in full

satisfaction of the indebtedness pursuant to Article 9 of the New

Hampshire Uniform Commercial Code.”); Lamp Fair,

-

12 75 (defendant/debtor asserted § 9-505 as defense against

plaintiff/creditor’s suit for judgment on the debt); Banker, 771

F . Supp. at 7 (same).

Here, Auto Shine’s claim against the bankruptcy estate

constitutes an “available judicial procedure” for purposes of §

9-501, which makes the Trustee’s § 9-505 argument an affirmative

defense. The debtor would bear the burden of proof with respect

to that defense outside the bankruptcy context. Because the

Trustee’s invocation of § 9-505 is an affirmative defense to Auto

Shine’s § 9-501 claim, the burden does not shift back to Auto

Shine to prove that it did not retain collateral in full

satisfaction of Campano’s debt; the burden remains on the Trustee

to prove that Auto Shine did retain collateral in full

satisfaction of that debt. See Raleigh, 530 U . S . at 17

(“bankruptcy does not alter the burden imposed by the substantive

law”); see also 4 COLLIER ON BANKRUPTCY (Alan N . Resnick & Henry J .

Sommer eds., 15th ed. rev.) ¶ 502.02[3][f] (“The trustee bears

the burden of proving any affirmative defenses . . . ” ) . 3

3 Several state courts have ruled that the debtor bears the burden of proving that a creditor availed itself of the § 9-505 retention option. In Munao v . Lagattuta, the Appellate Court of Illinois held that “[a]bsent written notice [from a creditor

13 Accordingly, the Bankruptcy Court did not incorrectly shift the

burden of proof when it ruled that the Trustee failed to

establish that Auto Shine’s claim was barred by the strict

forfeiture doctrine. It was the trustee’s burden to establish

full satisfaction, not Auto Shine’s burden to disprove i t .

II. Substantial Evidence of the Invalidity of Auto Shine’s Claim

The Trustee also argues that the Bankruptcy Court

incorrectly determined that he failed to produce substantial

evidence that Auto Shine retained its collateral in full

satisfaction of Campano’s debt. There is no need to address the

Trustee’s argument on substantial evidence because the Bankruptcy

Court never decided that the Trustee failed to carry his burden

indicating its intention to proceed under § 9-505], a debtor . . . has the burden of establishing that the parties agreed to a retention of the collateral in full satisfaction of the debt,”

1 8 , 822 (Ill. App. C t . 1998); see also I F G Leasing C o . v . Gordon,

0 7 , 614 n.32 (Utah 1989) (citations omitted); Nelson v . Armstrong,

(Idaho 1978) (explaining that § 9-505(2) is “a statutory analogue to the common law concept of accord and satisfaction” under which burden is on the debtor to “show[] that the creditor definitely assented to that arrangement”) (citations omitted). In New Hampshire, as in Idaho, the burden of proving an accord and satisfaction is on the defendant who asserts accord and satisfaction as a defense against an action for breach of contract. See, e.g., Post Road Realty, Inc. v . Zee-Bar, Inc., 117 N . H . 136, 139 (1977) (citations omitted); Kramas v . Beattie, 107 N . H . 3 2 1 , 324 (1966) (citing 6 ARTHUR LINTON CORBIN, CORBIN ON CONTRACTS, § 1280 (1962)).

14 of production. Rather, the Bankruptcy Court necessarily found

that the Trustee did meet his burden of production, because the

Court went on to resolve the Trustee’s strict foreclosure

argument on its merits. Accordingly, the Trustee’s second ground

for appeal is unavailing.

III. Strict Foreclosure on the Merits

As a preliminary matter, it is not at all clear that the

Trustee is entitled to assert strict foreclosure, because Auto

Shine concededly never provided Campano with written notice of a

proposal to avail itself of the § 9-505(2) retention option.

Notwithstanding the explicit notice requirement in § 9-

505(2), a majority of courts have taken the view that a secured

party’s conduct can, under appropriate circumstances, bring a

transaction with a debtor “within the scope of the § 9-505(2)

‘retention option,’ irrespective of whether or not [the secured

party] consciously chose to invoke this option.” Lamp Fair,

(citations omitted). In a case that post-dated

Banker, the New Hampshire Supreme Court recognized that some

courts have found implicit retention “where the secured party

15 retains the collateral for ‘an unreasonable period of time’

without written notice of intent . . . or when ‘the secured

party, by his actions, manifest[s] an intent to retain the

collateral in satisfaction of the obligation.” Jenkins v . G2S

Constructors, Inc.,

(1995) (quoting Cohen v .

Rains,

8 0 , 387 (Tex. C t . App. 1989)). The Court,

however, stopped short of adopting either of those “methods for

avoiding strict compliance with the written notice provisions of

RSA 382-A:9-505,” because it was able to resolve the question

before it on other grounds. Jenkins,

. In other

words, the New Hampshire Supreme Court has not yet read the

notice requirement out of RSA 382-A:9-505(2), and may not do s o .

See LaRoche,

(noting that party seeking to rely

on strict foreclosure doctrine conceded that secured party did

not give written notice, but contended “that the New Hampshire

courts may yet adopt an alternative interpretation of U.C.C. § 9-

505(2), which might save the day”).

The Trustee faces two difficult problems – first, no notice

was given, and, second, even if the New Hampshire Supreme Court

would hold that written notice is not strictly required, and

16 would recognize strict foreclosure by implication, the Trustee

still would not prevail in this case.

A. Factual Matters

The Trustee argues that the following factual findings by

the Bankruptcy Court, relevant to strict foreclosure by

implication, were clearly erroneous:

that Auto Shine did not take possession of substantially all of Sales and Service’s assets

that most of the equipment and inventory removed by White and Mattia on March 2 8 , 2001, had been previously paid for by customers; and

that most, if not all, of the equipment and inventory removed by White and Mattia was installed at customer sites before they went to work for Car Wash.

Based upon the record developed at the July 2 9 , 2002, hearing,

this court’s deferential standard of review on factual matters,

and, given the Trustee’s burden of proving that Auto Shine

retained its collateral in full satisfaction of Campano’s debt,

and, even in light of the April 6, 2001, letter in which

DiTommaso’s attorney stated “[his] understanding that M r . Campano

has voluntarily surrendered substantially all of the corporate

assets to M r . DiTommaso, a secured creditor,” it was still not

17 clearly erroneous for the Bankruptcy Court to find that Auto

Shine did not retain substantially all of Sales and Service’s

business assets. For example, Auto Shine never obtained Sales

and Service’s receivables, nor did it retain or otherwise control

the items of inventory installed by White and Mattia in the

interval between the end of Sales and Service and the formation

of Auto Shine. Given the assets that Auto Shine never possessed

(i.e., the receivables), the assets it possessed but never used

(i.e., the telephone system and computers), and the equipment and

inventory that DiTommaso purchased in order to get Car Wash off

the ground, the two remaining factual determinations are not

critical to determining the ultimate question, which is whether

Auto Shine retained its collateral in full satisfaction of

Campano’s debt. Accordingly, no basis exists upon which to set

aside the Bankruptcy Court’s findings of fact.

B. Legal Questions

The Trustee also argues that the Bankruptcy Court committed

legal error by: (1) ruling, by implication, that pre-paid

inventory items were not subject to the claims of secured

creditors; and (2) failing to correctly apply the holdings in

18 Lamp Fair and Banker. The Bankruptcy Court committed no error of

law.

It was not clearly erroneous for the Bankruptcy Court to

find that Auto Shine did not retain substantially all of Sales

and Service’s business assets, regardless of the status of the

disputed inventory. Therefore, any legal error in characterizing

that inventory would be harmless. But, perhaps more importantly,

as the Trustee himself acknowledges, the Bankruptcy Court did not

issue any ruling of law with respect to the pre-paid inventory.

Even if the Trustee’s legal argument about the status of the pre-

paid inventory is correct, there is simply no ruling of law to be

reversed.

The Bankruptcy Court also correctly distinguished Lamp Fair

and Banker. The creditors in those cases retained substantially

all the business assets of their respective debtors. Auto Shine

did not retain substantially all of Sales and Service’s business

assets. Moreover, the record discloses that for some months

after Sales and Service went under, and Campano found other

employment, Campano continued to work on several accounts for Car

19 Wash, with the understanding that if he were able to bring

sufficient new business to Car Wash, Auto Shine might release its

mortgage on his home. Thus, Campano’s own conduct refutes his

current claim that Auto Shine had been fully satisfied by

retention of Sales and Service’s business assets.

Conclusion

For the reasons given, the order of the Bankruptcy Court is

affirmed.

SO ORDERED.

Steven J. McAuliffe United States District Judge

May 2 9 , 2003

cc: Deborah A . Notinger, Esq. Jack B . Little, Esq. George Vannah, Clerk, US Bankruptcy Court Daniel S . Campano

20