FSM SUPREME COURT
TRIAL DIVISION (Pon.)
Cite as In re Island Hardware,
3 FSM Intrm. 332 (Pon. 1988)

[3 FSM Intrm. 332]
 
In re ISLAND HARDWARE.

CIV. NOS. 1985-038;
1985-043; 1986-056;
1986-057;

OPINION AND ORDER

Before Edward C. King
Chief Justice
FSM Supreme Court
March 28, 1988

*     *     *     *     *

SETS INC.,
Plaintiff,

v.

ISLAND HARDWARE, INC.,
Defendant.

FSM CIV. NO. 1985-038

APPEARANCES:
          For the Plaintiff:               R. Barrie Michelsen
                                                    Attorney at Law
                                                    Ramp & Michelsen
                                                    P.O. Box 1480
                                                    Kolonia, Pohnpei 96941

          For the Defendant:          Maketo Robert
                                                    Attorney at Law
                                                    P.O. Box 979
 
[3 FSM Intrm. 333]

                                                    Kolonia, Pohnpei 96941

*     *     *     *     *

CHUA ENG CHUAN,
Plaintiff,

v.

ISLAND HARDWARE, INC.,
Defendant.

FSM CIV.  NO. 1985-043

APPEARANCES:
               For the Plaintiff:          R. Barrie Michelsen
                                                    Attorney at Law
                                                    P.O. Box 1480
                                                    Kolonia, Pohnpei 96941

               For the Defendant:     Maketo Robert
                                                    Attorney at Law
                                                    P.O. Box 979
                                                    Kolonia, Pohnpei 96941

*     *     *     *     *

BANK OF GUAM,
Plaintiff,

v.

SETS INC., CHUA ENG CHUAN,
FEDERATED STATES OF
MICRONESIA, BANK OF HAWAII,
ISLAND HARDWARE INC.,
and MARIANO HADLEY,
Defendants.

FSM CIV. NO. 1986-056

APPEARANCES:
               For the Plaintiff:       Daniel J. Berman
                                                 Attorney at Law
                                                 P.O. Box 1491
                                                 Kolonia, Pohnpei 96941

[3 FSM Intrm. 334]

          For the Defendants:     R. Barrie Michelsen
          (Sets Inc./Chua             Attorney at Law
          Eng Chuan)                   P.O. Box 1480
                                                 Kolonia, Pohnpei 96941

          For the Defendant:      Jeffrey D. Clason
          (FSM Government)      Assistant Attorney General
                                                 Federated States of Micronesia
                                                 Kolonia, Pohnpei 96941

          For Defendant:             Martin Mix
          (Bank of Hawaii)          Attorney at Law
                                                 P.O. Box 143
                                                 Kolonia, Pohnpei 96941
 
          For the Defendant:       In Pro Per
          (Island Hardware)

          For the Defendant:       In Pro Per
          (Mariano Hadley)

*     *     *     *     *

BANK OF GUAM,
Plaintiff,

v.

ISLAND HARDWARE, INC.,
Defendant.

FSM CIV.  NO. 1986-057
 
APPEARANCES:
          For the Plaintiff:          Daniel J. Berman
                                               Attorney at Law
                                               P.O. Box 1491
                                               Kolonia, Pohnpei 96941

          For the Defendant:     In Pro Per

*     *     *     *     *

[3 FSM Intrm. 335]
 
HEADNOTES
Debtors and Creditors Rights;
Taxation
     Under 54 F.S.M.C. 135(2), government's judgment for wages and salary taxes constitutes a lien that is entitled to highest priority.  In re Island Hardware, 3 FSM Intrm. 332, 337 (Pon. 1988).

Debtors and Creditors Rights;
Taxation
     In order for government's judgment for gross revenue taxes to have a highest priority lien, notice that the tax payments are overdue, not just that tax liability has accrued must be given. In re Island Hardware, 3 FSM Intrm. 332, 338 (Pon. 1988).

Debtors and Creditors Rights
     In absence of an authorized statute, a claim of a chattel mortgage will not be upheld as an equitable lien against third parties who had neither actual notice nor reason to know of the existence of the security claim unless there has been some method of notice so that other interested persons could have a reasonable opportunity to become aware of the security interest.  In re Island Hardware, 3 FSM Intrm. 332, 340 (Pon. 1988).

Debtors and Creditors Rights;
Employer-Employee
     An employee's preference for wage claims is determined by reference to the equities among the parties rather than exclusively by specific dates upon which particular liens were established.  In re Island Hardware, 3 FSM Intrm. 332, 341 (Pon. 1988).

Debtors and Creditors Rights
     A "general security agreement," without more does not establish a lien under common law or pursuant to any statute in the Federated States of Micronesia.  In re Island Hardware, 3 FSM Intrm. 332, 342 (Pon. 1988).

Debtors and Creditors Rights
     Unless a statute or common law principle expressly says otherwise, disclosure is a prerequisite for making a lien effective against other creditors.  In re Island Hardware, 3 FSM Intrm. 332, 342 (Pon. 1988).

Debtors and Creditors Rights
     Secured transactions within the Federated States of Micronesia remain subject to the policies applied elsewhere prior to the adoption of the Uniform Commercial Code.  In re Island Hardware, 3 FSM Intrm. 332, 342 (Pon. 1988).

[3 FSM Intrm. 336]

Debtors and Creditors Rights
     Under pre-UCC principles which continue to apply within the Federated States of Micronesia, lack of transfer of dominion over assets triggers strong policy reasons why courts should not invoke equitable powers to uphold the creditor's claims.  In re Island Hardware, 3 FSM Intrm. 332, 343 (Pon. 1988).

Debtors and Creditors Rights
     A "floating lien" has historically been viewed with "hostility" by the law and was generally prohibited.  In the absence of statute, the law of the Federated State of Micronesia retains this aversion and a floating lien cannot, without more, create an equitable lien.  In re Island Hardware, 3 FSM Intrm. 332, 345 (Pon. 1988).

Debtors and Creditors Rights;
Constitutional Law - Due Process
     Private parties in private debt disputes are not subject to constitutional obligation to provide notice.  In re Island Hardware, 3 FSM Intrm. 332 346 (Pon. 1988).

*        *        *        *

COURT'S OPINION
EDWARD C. KING, Chief Justice:
     This is another case in which the Court must determine priorities and the proper procedure for distribution of assets and enforcement of claims of creditors of an insolvent corporation.  The corporation here is Island Hardware, Inc.

     This is the third opinion concerning dissolution of the company.1  The Court has proceeded with Island Hardware in substantially the same way as has been explained in the opinion issued recently concerning Mid-Pacific Construction Co. Inc. ("Mid-Pac").2

     Island Hardware is closely linked with Mid-Pac in that the same person, Mr. Herman Semes, is the president and primary stockholder of both companies. The two companies to some extent have had common management.

     The economic experience of the two companies has also been parallel.  Like Mid-Pac, Island Hardware is an insolvent, or bankrupt corporation.  Island Hardware too is unable to pay its debts as they become due, and has

[3 FSM Intrm. 337]

liabilities far exceeding its assets.  Numerous lawsuits have also been filed by creditors of Island Hardware during the past several years.  The plaintiffs in the cases whose captions are included in this opinion have obtained judgments.

     This opinion is similar also to the recent Mid-Pac opinion in that this is an effort to sort out the various claims being asserted by creditors of Island Hardware and to arrive at a legally proper and equitable formula for the distribution of Island Hardware's assets.

I.  Claims
     Analysis of the claims of the various parties follows.

A.     FSM National Government
     All parties have stipulated to the following amounts owing to the national government for wage and salary, and gross revenue, taxes.

     a.     $1,415.67 for wages and salaries tax;

     b.     $1,005.78 for interest and penalties on wages and salaries tax;

     c.     $12,618.33 for gross revenue tax;

     d.     $11,303.18 for interest and penalties on gross revenue tax.

     Judgment was entered on March 11, 1988.

     1.  Wage and salary tax lien - The government's judgment for wages and salaries taxes constitutes a lien against all assets of Island Hardware by virtue of 54 F.S.M.C. 135(2) and is entitled to highest priority.3  Bank of Guam v. Island Hardware, Inc. (II), 3 FSM Intrm. 105, 110 (Pon. 1987); In re Mid-Pacific Constr. Co., 3 FSM Intrm. 292, 296-97 (Pon. 1988).

     2.  Gross revenue tax lien - The lien specified in 54 F.S.M.C. 153 for gross revenue taxes does not arise instantaneously with the tax claim itself but becomes effective only when the government has taken reasonable steps to notify other parties of its tax claim.  Bank of Guam (II), 3 FSM Intrm. at 109; Mid-Pacific, 3 FSM Intrm. at 297.

     The first possible notice pointed to by the government is reference to "accrued taxes" of $4,518 as part of the current liabilities shown in Island

[3 FSM Intrm. 338]

Hardware's annual corporate report dated June 30, 1983, and filed with the FSM Registrar of Corporations on about December 23, 1983.  This notice is inadequate to establish the national government lien for it does not reveal whether the taxes are owing to the national government, or to a state or local government.

     Moreover, the required notice is that tax payments are overdue, not just that tax liability has accrued.  Section 153 is included within the subchapter of the tax law entitled "Enforcement."  These enforcement provisions apply upon failure of a taxpayer to act in accordance with the requirements of the Code.  Plainly it was not anticipated by the drafters that the 54 F.S.M.C. 153 lien could apply, or that the government could levy for payment, before the accrued tax is actually due and payable.  It follows that the notice necessary to establish a lien under 54 F.S.M.C. 153 is notice that taxes are overdue.

     Mere notice of accrued tax liability is inadequate for this purpose.  Tax liability, commonly reflected on corporate financial statements, is of little moment since liability typically accrues before the taxes are actually due and payable.  As a practical matter, then, notice of accrued tax liability is not notice that the taxpayer is failing to pay taxes as they become due.

     The Court therefore concludes that Island Hardware's reference in its 1983 annual report to accrued taxes did not establish 54 F.S.M.C. 153 lien rights for the national government.

     The government has shown no other attempted notice.  The Court concludes that the 54 F.S.M.C. 153 lien became effective on August 28, 1986, when the government filed crossclaims in civil action 1986-056 for taxes owing by Island Hardware.  The lien will be secondary to rights of other creditors who by then had established liens or had obtained writs of execution.

     The government has not sought a writ of execution against Island Hardware and therefore, aside from the tax lien, retains the status of a judgment creditor.4

B.     Employee
     Mariano Hadley seeks payment of wages in the amount of $1,344.  No party has contested the amount of his claim and the Court has entered judgment for him in that amount.

     Sets and Chua Eng Chuan point out that the work for which Mr. Hadley

[3 FSM Intrm. 339]

seeks compensation was performed during the period from September through November, 1986, after writs of execution were issued, and that he was actually assisting the Division of Security and Investigation, not Island Hardware.  Even so, this does not weaken Mr. Hadley's claim.  Courts have routinely granted preference to wage claims arising out of the administration of an insolvent debtor on the grounds that such services are necessary to preserve assets for the benefit of creditors.  Annot., 5 A.L.R. 690 (1920).

     There is no indication that Mr. Hadley was an officer or supervisory staff person.  His petition indicates that he was employed by Island Hardware at a rate of $2.00 per hour, six days per week.  This wage rate indicates that Mr. Hadley should be considered a lower level employee.  The Court concludes that his claim is entitled to priority as wages and should be paid immediately after any payment of wage and salary taxes owing to the national government.  In re Mid-Pacific Constr., 3 FSM Intrm. at 300-01.

C.     Bank of Hawaii
     The Bank of Hawaii claims a priority right for the unpaid balance on an August, 1984 loan made to enable Island Hardware to purchase an Isuzu pickup truck.  The loan agreement, entitled "Note and Chattel Mortgage," states that Island Hardware gave the bank a chattel mortgage in the truck as security for its repayment obligations.

     The bank has established through an affidavit, which no party contests, that $696 remains owing on the loan.  There appears to be no dispute that the sale of the Isuzu pickup produced proceeds of at least $696.

     Whether deemed to have been accomplished by statute, equitable lien doctrine5 or contract,6 this loan agreement indisputably established security rights in the pickup truck which the bank could invoke against Island Hardware.

     The issue here though is whether the bank has security rights which may be upheld as against other creditors of Island Hardware.  No statute answers that question.  The FSM personal property secured transactions statute says

[3 FSM Intrm. 340]

that it applies to chattel mortgages,7 but is silent about the method for creating a chattel mortgage and does not address the rights of the mortgagee as against other creditors.  Bank of Guam v. Island Hardware, Inc. (I), 2 FSM Intrm. 281, 286 (Pon. 1986).  The bank has not attempted to employ the foreclosure rights provided in 33 F.S.M.C. 928-933.  All other sections of the statute, 33 F.S.M.C. 922-27, relate only to the rights of creditors and debtors as against each other.

     The bank's contract rights against Island Hardware also are of no value against the other creditors for those creditors were not parties to the agreement and made no promises to the bank.

     The only remaining basis for enforcement of the bank's claim against the other creditors would be as an equitable lien.  The limiting factor here is the failure to use any method to notify other interested parties of the existence of the chattel mortgage.8  Understandably enough, since there is no designated place for filing personal property lien claims, no filing of notice occurred.  Moreover, Bank of Hawaii admits that it did not require that notice of its chattel mortgage claim be noted on the certificate of title for the truck.  In practical effect then, this was a secret lien.

The policy against secret liens applies to equitable lien claimants as well.  The majority rule, and one to which this Court will adhere, is that non-possessory equitable liens will not be found to exist against another who had neither actual notice nor reason to know of the existence of the security claim.

Bank of Guam v. Island Hardware Inc. (I), 2 FSM Intrm. 281, 290 (Pon. 1986).

     Two parties, Sets and Chua Eng Chuan, had at least some knowledge of the

[3 FSM Intrm. 341]

bank's chattel mortgage claim by virtue of a schedule of Island Hardware's accounts payable introduced during the November 22, 1985 hearing in civil action 1985-038.  Those parties have stipulated to the bank's claim so we need not determine whether that notice would have been a sufficient basis for upholding the bank's claim against them.

     There was also testimony that previous counsel for the Bank of Guam agreed that the "note and chattel mortgage" gave the Bank of Hawaii first right to the sale proceeds from the Isuzu pickup truck.  That testimony, uncontradicted by other evidence and accepted by the Court as true, is sufficient to permit the Bank of Hawaii's claim to be upheld against the Bank of Guam.

     The Bank of Hawaii's lien claim will not be upheld against any other party.  The government's wage and salary priority tax lien under 54 F.S.M.C. 135(2) is not affected, and the government's lien rights under 54 F.S.M.C. 153 also prevail over the Bank of Hawaii claim.  As already noted, the government's answer, filed on August 28, 1986, provided notice to the public of, and effectively established, the section 153 lien.  There is no indication that the Bank of Hawaii took any step to notify the general public, or the government in particular, of the bank's lien claim until the bank filed its motion to intervene in this litigation on January 29, 1987.  Therefore the government's 54 F.S.M.C. 153 lien claim was established first and prevails over the bank's rights, if any, under the "note and chattel mortgage."

     Mr. Hadley's wage claim also will be granted priority over the bank's equitable lien claim.  An employee's preference for wage claims is determined by reference to the equities among the parties rather than specific dates upon which particular liens were established.  No reason has been shown why the bank's claim should prevail over that of Mariano Hadley.

D.     Bank of Guam
     The Bank of Guam obtained judgment in the amount of $55,744.78 against Island Hardware in civil action 1986-057.  On August 13, 1986 a writ of execution was issued.  This was before the national government gave notice of its gross revenue tax claim so the bank, as an execution creditor, has priority over the government's lien rights under 54 F.S.M.C. 153.

     However, the bank seeks more.  Throughout this litigation the Bank of Guam has persistently claimed lien or other security rights in all assets of Island Hardware, insisting that all claims except the government's wage and salary tax lien must be subordinated to the bank's rights.  This claim is based upon a "general security agreement" dated June 20, 1984, in which Island Hardware purported to give the bank a security interest in all Island Hardware assets.  The stated intention was to secure Island Hardware's repayment obligations under a line of credit extended by the bank at that time.

     The Court has previously held that this security agreement does not

[3 FSM Intrm. 342]

establish a lien under common law principles or pursuant to any statute existing within the Federated States of Micronesia.  Bank of Guam v. Island Hardware (I), 2 FSM Intrm. 281 (Pon. 1986).  The bank requests that the Court nevertheless uphold the agreement as establishing an equitable lien upon all Island Hardware assets, effective retroactively to June 20, 1984.  There are several reasons why the general security agreement does not qualify for such generous treatment.

     1.  Secret lien - The first reason, the secrecy in which the claim originated, was discussed in earlier opinions.  Bank of Guam (I), 2 FSM Intrm at 289-90. See also Bank of Guam (II), 3 FSM Intrm. at 108.  Unless a statute or common law principle expressly says otherwise, disclosure is a prerequisite for making a lien effective against other creditors.

     It is true, of course, that the bank's lien claim has now been made known to the other creditors by the filing of civil action 1986-056 on August 5, 1986.  However, that tardy disclosure does not erase the original secrecy, which continued through the next two years while others were extending credit to Island Hardware without knowledge of the bank's lien claim.  If subsequent disclosure could validate such a lien back to the original date, secret liens would be very attractive and effective security devices.  That would be contrary to the long established and sound policy against secret liens.  It is difficult to envision circumstances in which a security agreement executed without notice to other creditors could be held effective retroactively against those creditors to any time before they were notified of the lien claim.

     2.  No transfer of dominion - There are two other flaws of significance at least equal to the lack of notice.  In Bank of Guam (I), the Court recognized that the Uniform Commercial Code has worked sweeping changes in United States law concerning security interests during the past 30 years.9  There is general agreement that those changes have been improvements that expedited commerce.  Yet, key features of the Uniform Commercial Code do not exist within the statutory law of the Federated States of Micronesia, and the FSM personal property secured transactions statute limits its references to pre-UCC security interests and terminology. 33 F.S.M.C. 921 et seq.  Thus, secured transactions within the Federated States of Micronesia remain subject to the policies applied elsewhere prior to adoption of the Uniform Commercial Code. The court in Bank of Guam (I) pointed to two pre-UCC policies, the rule of Benedict v. Ratner, 268 U.S. 353, 45 S. Ct. 566, 69 L. Ed. 991 (1925) and an aversion to floating liens, which might bar the bank's claim.  2 FSM Intrm. at 289-90.

[3 FSM Intrm. 343]

     In Benedict v. Ratner, the United States Supreme Court considered a written agreement whereby the debtor assigned to the creditor, as collateral for loans, all of the debtor's accounts receivable, present and future.  A list of the accounts was given to Ratner, the creditor, when the agreement was entered into and each month thereafter.  The United States Supreme Court described that arrangement as follows:

The receivables were to be collected by the company.  Ratner was given the right, at any time, to demand a full disclosure of the business and financial condition; to require that all accounts collected be applied in payment of his loans; and to enforce the assignment although no loan had matured.  But until he did so, the company was not required to apply any of the collections to the repayment of Ratner's loan.  It was not required to replace accounts collected by other collateral of equal value.  It was not required to account in any way to Ratner.  It was at liberty to use the proceeds of all accounts collected as it might see fit.  The existence of the assignment was to be kept secret.  The business was to be conducted as theretofore.  Indebtedness was to be incurred, as usual, for the purchase of merchandise and otherwise in the ordinary course of business.

268 U.S. at 359-60, 45 S. Ct. at 567-68, 69 L. Ed. at 997.
 
     The court decided that reservation by the debtor of dominion over the collateral was inconsistent with the ostensible agreement and rendered the attempted security transaction void.  This rule, the court said, "does not raise a presumption of fraud.  It imputes fraud conclusively because of the reservation of dominion inconsistent with the effective disposition of title and creation of a lien." 268 U.S. at 363, 45 S. Ct. at 569, 69 L. Ed. at 999.

     Applying those principles to the agreement between Ratner and Hub Carpet Company, the court said, "the arrangement for the unfettered use by the company of the proceeds of the accounts precluded the effective creation, of a lien and rendered the original assignment fraudulent in law."  265 U.S. at 364-65, 45 S. Ct. at 569, 69 L. Ed. at 999.

     Prior to the Uniform Commercial Code, virtually all states in the United States followed the Benedict v. Ratner dominion rule.  A. Schwartz & R.  Scott, Commercial Transactions 617 (1982).  If no adequate showing was made that dominion over the collateral had been transferred by the debtor, this precluded effective creation of a lien and the attempted assignment was "fraudulent in law."

     Transfer of dominion can be established in several ways.  Requirements that the proceeds from the accounts receivable be turned over to the lender upon receipt by the borrower, or that the account debtors be notified of the assignment and instructed to make all future payments to the lender would be

[3 FSM Intrm. 344]

sufficient.  Other actions which might tend to show that a transfer of dominion had occurred could include close supervision by the lender of the borrower's financial affairs, exercise by the lender of a right to examine the borrower's books at any time, and adjustment of the loan at periodic intervals to reflect an agreed percentage of outstanding accounts.  R. Nordstrom, J. Murray, Jr., & A. Clovis, Secured Transactions 42 (1987).

     Here, Bank of Guam has failed to show any exercise of dominion over the accounts receivable.10  Payments continued to be paid to, and used by, Island Hardware.  There is no indication even that the bank obtained lists of the accounts.  As in the Ratner case, the general security agreement seems to have been nearly a dead letter until the bank happened to learn of Island Hardware's financial crisis.  Perhaps most telling is that although the Island Hardware accounts receivable were assigned to Sets by court order in November, 1985, and the account debtors were notified, the Bank of Guam apparently still remained unaware of the assignment five months later in April, 1986, when it restructured its financial arrangement with Island Hardware.

     Similar considerations apply to Bank of Guam's claimed security interest in Island Hardware's inventory and other assets.  The only exercise of dominion shown concerning the inventory is a requirement that Island Hardware name Bank of Guam as beneficiary of a $160,000 fire insurance policy covering the inventory.  There is no showing that the bank ever inspected the inventory, required periodic reports concerning inventory values or condition, or in any way policed the handling of inventory or sale proceeds.

     Under the pre-Code principles which continue to apply within the Federated States of Micronesia, the fact that there was no transfer of dominion concerning the accounts receivable, and precious little as to the other assets, triggers strong policy reasons why this Court should not invoke equitable powers to uphold the Bank of Guam's claims.

     3.  Floating lien - Another factor against the bank's security claim here is the "floating" nature of the claimed lien.

     The general security agreement attempts to establish a lien on "All fixtures equipment, accounts receivable and inventory now owned and hereinafter acquired" by Island Hardware.

     As noted in Bank of Guam (I), 2 FSM Intrm. at 290-91, under the common law, agreements permitting liens to "float" from property in the inventory at

[3 FSM Intrm. 345]

the time of the agreement but subsequently sold, to replacement inventory were not effective as against other creditors.  See also A. Dunham, supra, 62 Harv. L. Rev. at 595-97; A. Schwartz &  R. Scott, Commercial Transactions, 617 (1982) ("under pre-Code law the original security agreement could not cover subsequently acquired collateral."); cf. In re Middle Atlantic Stud Welding Co., 503 F.2d 1133, 1136 (3d Cir. 1974) (refers to "general prohibition in pre-Code law on including after-acquired property as collateral" and to "the law's historic hostility to such arrangements").

     There are, then, three fundamental problems with the general security agreement relied upon by the Bank of Guam.  First, the agreement was executed secretly without any effort by the bank to notify other creditors until Island Hardware's financial crisis.  Second, there was no transfer of dominion over the collateral.  Finally, the general security agreement is an attempt to create a floating lien, an effort generally prohibited and historically viewed with "hostility" by the law.

     Adoption by legislatures of the Uniform Commercial Code in the United States and the Companies Act in England has dramatically altered these longstanding judicial policies.  However, no such legislative action has occurred within the Federated States of Micronesia, and we lack the statutory framework essential for use of the principles reflected in the more modern security interest laws.  The traditional, judicially created policies remain intact here.  Under those policies, the bank's general security agreement could not be used to establish priority rights over other creditors.  The Court declines to exercise equitable powers to give effect to an agreement which is contrary to basic legal principles. The bank's request that the security agreement be upheld as creating an equitable lien is denied.

     The Bank of Guam has no equitable lien and holds execution creditor      status.
 
E.     Sets
     Sets initiated civil action 1985-038 against Island Hardware on September 17, 1985, seeking payment for merchandise.  Island Hardware, then represented by attorney Delson Ehmes, submitted an offer of judgment in the amount of $55,744.78.  The Court entered judgment in that amount on October 23, 1985.

     Sets promptly moved for a writ of execution and a hearing was held on November 22, 1985.  The Court did not then grant the writ.  Instead, Island Hardware was ordered to assign to Sets all of its accounts receivable collection rights.  Island Hardware also was instructed not to pay any creditors except Bank of Hawaii and Bank of Guam, identified by Sets as secured creditors, until Sets had been paid $10,000.

     On May 28, 1986, contending that Island Hardware had failed to comply with the order to pay $10,000, Island Hardware again moved for writ of execution. The Court granted writs of execution to Sets and Chua Eng Chuan on

[3 FSM Intrm. 346]

June 18, 1986.  At that time, $50,153.71 of Sets' judgment still remained unpaid.

     On August 5, 1986, the Bank of Guam filed civil action 1986-056.  Aside from reliance on the general security agreement already discussed, most of the bank's arguments pertain to the November 22, 1985 hearing and the order requiring assignment of Island Hardware's accounts receivable to Sets.

     1.  The due process argument - In its trial brief, at page 23, the bank contends that its "constitutional due process rights were violated by the failure of Sets Inc. and Island Hardware, Inc. to notify it of the assignment of the accounts receivable of Island Hardware, Inc."  The bank argues that it should have been notified as soon as the assignment occurred and that the failure of notice deprived the bank of an opportunity to protect itself.

     That contention is unsound.  As private parties, Sets and Island Hardware were subject to no constitutional obligation to provide notice.

     In its post-trial brief, the bank moves toward a different due process position, that it should have been notified of the November 22, 1985 hearing on Sets' motion for writ of execution before Court action was taken.  The bank points to no authority holding, as a general proposition, that other creditors must be notified before one creditor's motion for writ of execution may be considered and acted upon.

     In the particular hearing, all indications were that the bank's security claim related only to the Island Hardware inventory.  Sets made no move to challenge that claim.  Thus, the Court was given no reason to believe that any property interests of the bank were at stake.  As is discussed in the next part of this opinion, the Court does not find that counsel for Sets improperly failed to make necessary disclosure to the Court.
 
     Now that the bank has brought to the Court's attention the bank's claim of a security interest in Island Hardware's accounts receivable, that claim has been considered fully, although rejected.  The Court finds no violation of due process.

     2.  The equitable argument - The precise contours of the bank's  position here are somewhat obscure.  The Court understands the principal argument to be that Sets' failure to notify the Court of all of the bank's security claims, various statements made on behalf of Sets during the November 22, 1985 hearing, and Sets' failure to notify the Bank of Guam of the Court order issued on November 25, 1985, alter the equities between Sets and the Bank of Guam in such a way that the bank's security claims must be given priority over any rights that Sets received by virtue of the November 25, 1985 order or the June 19, 1986 writ of execution.

          a.  Nondisclosure of the bank's claim - Counsel for Sets is deemed to have been aware of the June 20, 1984 general security agreement between the Bank of Guam and Island Hardware at the time of the November 22, 1985 hearing,

[3 FSM Intrm. 347]

and prior thereto.  This finding is based in part on statements made by Sets' counsel during the hearing that the Bank of Guam and Bank of Hawaii were secured creditors.  Tr. 47 (Nov. 22, 1985).

     In addition, the finding is based upon the presumption announced during the October 9, 1987 hearing in this case.  The Bank of Guam subpoenaed counsel for Sets, R. Barrie Michelsen, to testimony, indicating a wish to question him as to when Sets first learned of the bank's security claim.  Mr. Michelsen moved for a protective order based upon ethical prohibitions against an attorney for a party being a witness in the case.

     The Court granted Sets' request for a protective order, but subject to the condition that the Court would make a rebuttable presumption that Mr. Michelsen did have knowledge of the Bank of Guam claims at all pertinent times. Therefore, Sets is charged with knowledge of the general security agreement as of September, 1985.11

     The legal effect of that knowledge however is limited, and some disclosure was made.  The only evidence of action shown to have been taken by the Bank of Guam to exercise dominion over assets of Island Hardware was the requirement of inventory insurance, naming the bank as beneficiary.  That insurance was made known to the Court through an exhibit introduced by Sets in testimony of Island Hardware's general manager during the November 22, 1985 hearing.

     The key nondisclosure complained of by the bank involved the bank's claim concerning the accounts receivable.  As already discussed, the bank did not actually establish security rights in Island Hardware's accounts receivable.  Thus, even with full knowledge of all facts, counsel for Sets could have concluded that the bank had no security interest in Island Hardware's accounts receivable.  The bank points to no clear ethical or legal obligation of counsel for Sets in that enforcement of judgment proceeding to advise the Court of the existence of the bank's invalid claim concerning accounts receivable.

     The Court concludes that Sets did not mislead the Court during the November 22, 1985 hearing and did not fail to make disclosures required of it at that time.

[3 FSM Intrm. 348]

          b.  Notice of Court order - The bank insists that the Court on November 22, 1985 ordered sets to notify all Island Hardware creditors of the assignment of accounts receivable.  Based upon that premise, the Bank of Guam maintains that Sets' failure to comply with the order prevented the bank from learning of the assignment and from taking timely action to protect its interests.

     The Court has already ruled against the bank on this issue and no extended discussion is needed here.  The basis for the bank's contention that Sets was ordered to notify creditors is a misstatement, substitution of the word "creditors" for "debtors," in the minutes entry of the hearing, prepared by a law clerk.

     The misstatement is regrettable, but a mistaken minutes entry can not be used to overcome or alter the actual oral or written order of the Court.  The transcript of the hearing shows that the Court ordered notice to be given to debtors of Island Hardware, not creditors.  Tr. 46, lines 4-14; 48, lines 5-10.  The written order, dated November 25, 1985, is equally clear.  Failure of Sets to notify the Bank of Guam of the November, 1985 order was not a violation of the order.

     3.  Waiver and estoppel - Finally, the bank argues that Sets either waived its rights to assert claims against assets of Island Hardware, or is estopped from asserting those rights.  The Court finds merit in this contention.  While the failure of Sets at the November 22, 1985 hearing to disclose the scope of the Bank of Guam's security claims was not a clear legal or ethical violation, this nondisclosure does affect the equities bearing upon Sets' claims against assets other than the accounts receivable.

     Sets did expressly say at the November 1985 hearing that the Bank of Guam was a secured creditor and impliedly acknowledged that the bank's security rights were superior to any rights Sets might have.  Tr. 47, lines 1-10.  The implication that there was no conflict between the position being taken by Sets in the hearing, and the bank's security claim, greatly reduced the likelihood that the Court would require notice to the bank before granting Sets' request for assignment of the accounts receivable.

     If Sets wished to oppose the bank's security claims as to other assets of Island Hardware, it should have said as much, rather than contenting itself with acknowledgement that the bank was a secured creditor.  By failing to so state, but instead focusing on the accounts receivable, Sets avoided possible opposition to that assignment and reduced chances that the bank would have the opportunity to protect its interests.  Justice demands intervention on behalf of the bank to estop Sets now from opposing the bank's security claims which it previously acknowledged.  Etpison v. Perman, 1 FSM Intrm. 405, 417 (Pon. 1984).

     In this context Sets must be regarded also as having selected the accounts receivable and having waived any rights it might otherwise have had

[3 FSM Intrm. 349]

to participate in distribution of the proceeds from sale of any other assets of Island Hardware.

     In light of the major gaps in FSM statutory law concerning bankruptcy and security interests, the Court has, and must exercise, broad equitable powers in an effort to reach fair results in cases involving insolvent debtors.  Exercising these powers, the Court confirms the November 1985 assignment of Island Hardware accounts receivable to Sets but holds that Sets shall not receive any other assets, or participate in other distribution of proceeds, of Island Hardware.

F.     Chua Eng Chuan
     Chua Eng Chuan initiated civil action 1985-043 against Island Hardware on November 7, 1985 seeking payment for merchandise sold to Island Hardware. An offer of judgment for $23,620.02 was made by Island Hardware on may 14, 1986.  Judgment in that amount was entered on June 18, 1986 and writs of execution were issued to Chua Eng Chuan and Sets on June 19, 1986.

     Chua Eng Chuan and Sets have been represented by the same counsel throughout, so the knowledge of Sets' counsel is also imputed to Chua Eng Chuan, as of November 1985, when civil action 1985-043 was filed.

     However the actions and circumstances of Chua Eng Chuan are not comparable to those of Sets.  Chua Eng Chuan was not a participant in the November 22, 1985 hearing, made no representations to the Court at that time, and has received no benefit thereby.

     No equities stand in the way of full participation by Chua Eng Chuan as an execution creditor.

II.  Summary of Results
     Based upon the principles discussed and conclusions reached in this opinion, proceeds realized from the sale of assets of Island Hardware, except the accounts receivable assigned to Sets, shall be distributed as follows:

     First priority - The national government shall receive the entire amount of its claim for wage and salary taxes by virtue of its highest priority lien under 54 F.S.M.C. 135(2).  Decision as to whether penalties and interest shall also be given priority is deferred pending separate consideration of that issue.

     Second priority - The employee claimant, Mariano Hadley, shall receive payment of his claim in full.

     Third priority - Remaining funds, except $696, shall be divided on a pro rata basis between the execution creditors, Bank of Guam and Chua Eng Chuan, proportionate to the claim of each party, until their claims are satisfied.  Since the rights of the Bank of Hawaii as a chattel mortgagee have been held

[3 FSM Intrm. 350]

effective as against both, the execution creditors shall leave untouched $696 of the proceeds of the sale of the Isuzu truck.

     Fourth priority - The national government, as to its claim for gross revenue taxes.

     Fifth priority - If funds remain available, $696 shall be paid to the Bank of Hawaii representing proceeds realized from the sale of the Isuzu pickup truck.

     Sixth priority - Any subsequent judgment creditors or other claimants.

     The Court confirms the effectiveness of the previous assignment of Island Hardware's accounts receivable to Sets, but Sets shall not participate in distribution of the proceeds realized from the sale of other assets of Island Hardware.

III.  Further Proceedings
     Before distribution may take place, the precise amounts of claims in each category, and the amount of funds available for payment, must be determined. The National Justice Ombudsman is hereby appointed as a special master to convene a hearing of the parties, to make the calculations, and to file a report proposing the amounts to be distributed to each creditor.  This report shall be filed with the Court, and copies distributed to all parties on or before April 15.

 

Footnotes:

1. The first two opinions are reported at 2 FSM Intrm. 281 and 3 FSM Intrm. 105, respectively.

2. In re Mid-Pacific Constr. Co., 3 FSM Intrm. 292 (Pon. 1988).

3. The question of whether statutory interest and penalties payable for overdue taxes are included within the government's 54 F.S.M.C. 135(2) and 153 lien rights is being addressed separately in combined proceedings for Island Hardware and Mid-Pac.

4. The Court rejects as without merit the arguments of Sets and Chua Eng Chuan that the exclusive method for collecting these taxes is by levy, and that the government's lien rights attach only to property of Island Hardware, not to proceeds realized from the execution sale of that property.

5. Morrison Flying Service v. Deming National Bank, 404 F.2d 855, 861 (10th Cir. 1958) ("[Equitable lien] has been defined as a right, not existing at law, to have specific property applied in whole or in part to the payment of a particular debt or class of debts.  Such a lien may be created by express contract which shows an intention to charge some particular property with a debt or obligation...").

6. The note and chattel mortgage is a promise of Island Hardware to give the bank a security interest in the truck.  That promise was made in exchange for valid consideration, the loan.  Invalidity of the chattel mortgage as to other creditors does not affect validity as between the parties to the loan agreement. Annot., 73 A.L.R. 236, 256-59 (1931).

7. The only reference in the statute to chattel mortgages is at 33 F.S.M.C. 921: "This subchapter shall apply to any agreement, regardless of its form, which is intended to give rights in personal property... as security for the performance of any obligation.  Such agreements include, among others, pledges, conditional sales agreements, chattel mortgages, and leases under which ownership of personal property is to pass upon completion of the terms of the lease."

8. Chattel mortgage statutes historically have mandated some method of notice so that other interested persons would have a reasonable opportunity to become aware of the security interest.  E.F. Farnsworth & J. Honnold, Commercial Law 783 (2d ed. 1982). methods most frequently specified were filing a notice at a designated place or, for motor vehicles, noting the chattel mortgage on the certification of title. See, e.g., In re Tobias, 150 F. Supp. 288 (W.D. Mich. 1957); Annots., 18 A.L.R. 2d 813, 818 (1951) and 58 A.L.R. 2d 135, 1358-60 (1958).

9. Somewhat similar changes, at least as to authorization of floating liens, were wrought by the English Companies Act in England in 1929.  A. Dunham, Inventory and Accounts Receivable Financing, 62 Harv. L. Rev. 588, 595 n.22 (1949), citing Companies Act, 1929, 19 & 20 Geo. V., ch. 23, 266 (Eng.).

10.  Curiously, the Bank of Guam has introduced exhibits concerning assignment of Mid-Pac accounts receivable to the bank.  These assignments, of no value for establishing the bona fides of the assignment of Island Hardware accounts, suggest that the bank was aware that it could have required similar assignments of Island Hardware receivables.

11. The bank in its memoranda has misconstrued the presumption as requiring a finding that Sets knew of the general security agreement as soon as it was executed, in June, 1984.  This is incorrect for two reasons.  First, while the presumed knowledge of Mr. Michelsen must be imputed to his client, there is no showing that the attorney client relationship arose until about September, 1985 when this lawsuit was filed.  Moreover the testimony of Sets' representative, Carol McCord, indicated no knowledge before that time.