Feresi v. The Livery LLC

RENEE FERESI,

Plaintiff and Respondent,

v.

THE LIVERY, LLC et al.,

Defendants and Appellants.

2d Civil No. B248607

(Super. Ct. No. 56-200900362200-

CU-CO-VTA)

California Courts of Appeal

Second Appellate District

Division Six

Filed January 8, 2015

ORDER MODIFYING OPINION

[NO CHANGE IN JUDGMENT]

THE COURT:

It is ordered that the opinion filed herein on December 15, 2014, be modified as follows:

1.  On page 1, the first paragraph is deleted and the following paragraph is inserted in its place:

The Commercial Code¹ provides that "a financing statement must be filed to perfect all security interests . . . ."  (§ 9310, subd. (a).)  It further provides, "A perfected security interest . . . has priority over a conflicting unperfected security interest . . . ."  (§ 9322, subd. (a)(2).)  This order of priority is not immutable and in some circumstances must yield to principles of equity.  Here two parties hold security interests in the same entity.  One party perfected his security interest by breaching a fiduciary duty owed to the party whose security interest was unperfected.  We conclude that equity compels the subordination of the perfected interest to the holder of the unperfected interest.

2.  On page 2, the first sentence in the first paragraph, beginning "This dispute arises," is deleted, and the following sentence is inserted in its place:  "The security interests held by the parties to this dispute attach to James Mesa's (Mesa) membership share in The Livery, LLC (the LLC)."

3.  On page 2, the second paragraph, beginning "The LLC and Harley appeal," is deleted and the following paragraph is inserted in its place:

The LLC and Hartley appeal the trial court's judgment in favor of Feresi.  Hartley contends his perfected security interest in Mesa's ownership share of the LLC has statutory priority over Feresi's preexisting but unperfected security interest.  Feresi contends Hartley's security interest is invalid because he created the priority of his interest by breaching the fiduciary duty of good faith and fair dealing that he owed to her as a member of the LLC.

4.  On page 3, in the first full paragraph, add the words "and other creditors" to the end of the first sentence, so that the sentence reads:  "By 2008, Mesa was struggling financially and fell behind on his obligations to Feresi and other creditors." 

5.  On page 3, in line 4 of the first full paragraph, the word "he" is changed to "Hartley" so that the sentence reads:  "Although Hartley knew Mesa's membership share in the LLC secured his financial obligations to Feresi, Hartley nevertheless secured the loan from his pension plan by the same 12.5 percent membership share Mesa pledged to Feresi in 2006." 

6.  On page 6, the first heading titled "Hartley's Business Relationship with Feresi as a Fiduciary" is changed to "Hartley's Duties as a Fiduciary."

7.  On page 6, the following paragraph is inserted as the second full paragraph under the (new) heading Hartley's Duties as a Fiduciary:

The animating principle of a fiduciary?s duties to his charges is unfaltering loyalty and honesty.  ?Many forms of conduct permissible in a workaday world for those acting at arm?s length, are forbidden to those bound by fiduciary ties.  A trustee is held to something stricter than the morals of the market place.  Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior.  As to this there has developed a tradition that is unbending and inveterate.  Uncompromising rigidity has been the attitude of courts of equity when petitioned to undermine the rule of undivided loyalty by the ?disintegrating erosion? of particular exceptions [citation].  Only thus has the level of conduct for fiduciaries been kept at a level higher than that trodden by the crowd.?  (Meinhard v. Salmon (1928) 249 N.Y. 458, 464.)

8.  On page 7, in the first full paragraph beginning "Feresi had no reason to protect," the following sentence is added before the last sentence:  "The primacy of Hartley?s security interest in Mesa?s share of the LLC must succumb to the infection of his duplicity and silence."

     Also, in the same paragraph, the words "Under these circumstances" are deleted, so that the last sentence reads:  "The trial court properly refused to enforce the security interest held by Hartley's pension plan."

9.  On page 7, the heading titled "The Commercial Code (UCC) Filing Scheme" is changed to "Equitable Subordination."

10.  On page 8, the following two paragraphs are added after the first paragraph ending "(Knox, supra, at pp. 1364-1365.)":

   We conclude that if a fiduciary engages in inequitable conduct with respect to a person to whom a fiduciary duty is owed, then its claim, lien or security interest may be wholly or partially subordinated.  The doctrine of equitable subordination has deep common law roots and is based upon the inherent power of a court of equity to do justice as circumstances dictate.  While the doctrine is most frequently asserted in bankruptcy court because it has statutory support in section 510 of the Bankruptcy Code, it has also been employed, though sparingly, in other contexts.  (See, for example, General Ins. Co. v. Lowry (1978) 570 F.2d 120.)

   As the Knox court observed, equity and thus equitable subordination should be invoked with caution by the courts.  But where, as here, a petitioner has shown: (1) the fiduciary engaged in inequitable conduct; (2) the misconduct resulted in injury to the petitioner or conferred an unfair advantage on the fiduciary; and, (3) invocation of the remedy of equitable subordination will not be inconsistent with the Commercial Code, then the remedy has a place.

11.  On page 8, the first two full paragraphs are deleted, and the following paragraph is inserted in its place:

The UCC itself acknowledges that its provisions are to be supplemented by "principles of law and equity."  (§ 1103, subd. (b).)  The UCC filing system provides a mechanism for creditors to establish the priority of security interests they secure from debtors and allows them to determine if others already have a claim on collateral.  It sets the priority of valid security interests in the same collateral through a registration system.  The statutory scheme is not intended to provide a vehicle for creditors to take advantage of persons with whom they have a fiduciary relationship.  The application of equitable principles in this case strengthens the statutory scheme.  Not rewarding the product of sharp practices in the creation of a security interest lends stability and security in commercial transactions among fiduciaries.

There is no change in the judgment.

¹   All statutory references are to the Commercial Code unless stated otherwise.