U.S. 5th Circuit Court of Appeals Reports

F.D.I.C. v. W. HUGH MEYER & ASSOCIATES, INC., 864> <F.2d> <371 (5th Cir. 1989)

F.D.I.C., PLAINTIFF-APPELLANT, v. W. HUGH MEYER & ASSOCIATES, INC., ET AL.,

DEFENDANTS-APPELLEES.

No. 87-1943.

United States Court of Appeals, Fifth Circuit.

February 1, 1989.

Rehearing and Rehearing En Banc Denied March 23, 1989.

T. Ray Guy, Dallas, Tex., Christine M. Anderson, Midland, Tex.,
for plaintiff-appellant.

E.F. Lohman, III, Abilene, Tex., for W. Hugh Meyer.

Jack N. Little, Big Spring, Tex., for Grambling & Mounce.

Harrel Davis, III, Victor M. Firth, Steven L. Hughes, El Paso,
Tex., Richard Andrew Bonner, Odessa, Tex., for Willey F. James.

Appeal from the United States District Court for the Western
District of Texas.

Before GOLDBERG, HIGGINBOTHAM, and DAVIS, Circuit Judges.

PATRICK E. HIGGINBOTHAM, Circuit Judge:

[1] In 1982, Hugh Meyer signed an agreement pledging some stock to
the First National Bank of Midland. The pledge agreement entitled
the bank to a security interest in the dividends upon the stock,
but neither the bank nor the FDIC, the bank's successor in
interest, registered the pledged shares in the bank's name. As a
result, dividends from the pledged stock were delivered to Meyer.
Among these dividends was a stock dividend worth about $500,000.
Meyer eventually pledged these dividend shares to his law firm,
Grambling & Mounce, to secure payment of a $125,000 retainer.
Meyer then went bankrupt. His total indebtedness to the bank is
in the neighborhood of $3 million. First Midland became insolvent
and went into receivership. The FDIC sued Meyer and Grambling &
Mounce to get the dividend shares. The district court held that
the law firm had a perfected security interest in the shares up
to the amount of its retainer, and that the FDIC was an unsecured
creditor of the Meyer estate. The FDIC appeals. Because we find
that possession is essential under Texas law to obtain a secured
interest in securities, and because the bank never obtained
possession of the contested securities, we affirm.

I

[2] Meyer regularly entered into financing agreements with First
Midland. In 1982, he and the bank executed a "Separate Collateral
Agreement," whereby Meyer pledged to the bank some stock (in
Power Test) he owned, and the dividends thereon. Meyer delivered
the base stock — five certificates — to the bank. Meyer testified
that he did not realize that he had also pledged the dividends
from the stock, that he did not intend to do so, and that, as was
customary in the dealings between Meyer and the bank, the bank
did not give Meyer a copy of the pledge agreement.

[3] In September of 1983, various notes owed by Meyer's company,
and personally guaranteed by Meyer, with a combined principal
exceeding $2 million, matured and became due. These debts, plus
interest, remain outstanding. In October of 1983, the comptroller
declared the bank insolvent, and appointed the FDIC as receiver.

[4] Shortly thereafter, Wiley James, a partner at Grambling &
Mounce, met Meyer and began representing him. The FDIC sent Meyer
a letter about the debts he had personally guaranteed. In
December 1983, Grambling & Mounce, on Meyer's behalf, asked the
FDIC for copies of any security agreements executed by Meyer in
the FDIC's favor. In January 1984, the FDIC replied that such
agreements were privileged. The FDIC's local counsel likewise
refused to release the agreements.

[5] The bank, and later the FDIC, could have stopped Meyer from
receiving dividends on the pledged stock by registering its
holding of the pledged stock, or by putting a stop transfer order
on the stock. The bank and the FDIC had on file forms, signed by
Meyer, that would have permitted them to take these actions. The
FDIC finally put a stop transfer order on the stock in June of
1985. But by that time, the horse was out of the barn.

[6] The "horse," for purposes of this suit, is a 19,580 share stock
dividend issued by Power Test in April 1985, and received by
Meyer. Meyer claims, and the district court found, that he
pledged and delivered this dividend stock to Grambling & Mounce
in May 1985 as security for his promise to pay the firm's
retainer. The FDIC hotly contests this claim, arguing that Meyer
did not deliver the dividend stock to the firm until November
1985.

[7] In June 1985, the FDIC notified Wiley James of the FDIC's claim
upon the dividend stock. Meyer claims that he discovered the
FDIC's claim upon the dividend stock when he tried in July 1985
to sell the stock. He was prevented from doing so by the "stop
transfer" order. Meyer claims that upon finding he was unable to
sell the stock, he returned the stock to the law firm, and
informed the law firm of the reasons for his inability to sell
the stock.

[8] In November 1985, Meyer and his lawyers executed a written
retainer agreement which they claim memorializes the May 1985
pledge of the securities. The agreement recites that the pledged
securities were deposited at Grambling & Mounce contemporaneously
with the execution, in November, of the agreement. The law firm
and Meyer say that this recital is erroneous. They say that the
pledge and delivery both took place in May, but that no written
agreement was necessary until November, when James decided that
it was likely that Meyer would go into bankruptcy. The FDIC
contends that the recital is accurate, or, alternatively, that
Meyer and the law firm should not be heard to contest the
accuracy of the recital.

[9] Meyer did go into bankruptcy in December 1986.

[10] The FDIC also filed this suit in December 1986. A bench trial
was had on October 19, 1987, on which date the value of the
contested shares declined significantly. On October 26, 1987,
Judge Bunton rendered judgment for defendants, holding that
Grambling & Mounce had a perfected security interest in the
shares, and that the FDIC was an unsecured creditor of the
bankrupt estate. The FDIC appeals.

II

[11] The outcome of this case turns upon interpretation of Article 8
of the Uniform Commercial Code, as amended in 1977 and enacted
into Texas law in 1983. See Tex. Bus. & Com.Code Ann. §
8.101-8.408 (Vernon 1988 Supp.). That article governs security
interests in securities. The key question is whether the Code
recognizes a security interest in stock shares — more precisely,
in the language of the code, "certificated securities"[fn1] — if
the holder of the putative security interest has never possessed
the shares. If not, then the FDIC is an unsecured creditor with
respect to the dividend shares, and Grambling & Mounce is
apparently the only secured creditor. Resolving this question of
UCC law requires this court to write upon a rather clean slate.

[12] There is a preliminary dispute between the parties as to the
proper order of the issues. The FDIC asks the Court to consider
first whether Grambling & Mounce took the stock as a bona fide
purchaser, and then, if the Court finds that Grambling & Mounce
did not, whether the FDIC had a perfected security interest in
the stock. Meyer and the law firm contend that if the District
Court was correct in its finding that the FDIC had no security
interest in the stock and that Grambling & Mounce did have a
perfected security interest, it is irrelevant whether or not
Grambling & Mounce took without notice of any claims that the
FDIC was trying to make.

[13] We agree that we should first determine which, if any, parties
developed security interests in the stock, and that we may
thereby avoid the bona fides purchaser issue. Mere knowledge of a
possible but as yet uncreated security interest does not suffice
to defeat the perfected security interest of a later creditor. A
contrary rule would undermine the "race of diligence among
creditors" contemplated by the U.C.C. See Matter of E.A. Fretz
Co., Inc., 565 F.2d 366, 371 (5th Cir. 1978).

[14] The FDIC suggested, at oral argument and without elaboration,
that if the FDIC never developed a security interest in the
contested shares, the bona fides issue was nonetheless relevant
because "there was a conversion" of the shares. This argument
begs the question. There can have been a conversion of an FDIC
property interest only if the FDIC had such an interest. A mere
unexercised contractual right to create a property interest is
not itself a property interest. The question of whether the FDIC
ever developed a security interest in the shares is thus
necessarily antecedent to the question of whether a conversion
occurred. Again, a contrary rule would undermine the incentives
carefully established by the UCC's distinctions among secured
interests, perfected secured interests, and other interests. If
the FDIC never developed a security interest in the shares, and
the law firm did develop a perfected security interest, it is
plain that the district court's judgment is correct.

[15] Article 8 of the Uniform Commercial Code, as amended in 1977
and enacted into Texas law in 1983, governs the creation and
perfection of security interests in investment securities. The
meaning of Article 8 is a question of law, and consequently we
subject the district court's conclusions to de novo review.
Under § 8.321(a), "A security interest in a security is
enforceable and can attach only if it is transferred to the
secured party or a person designated by him pursuant to a
provision of § 8.313(a)." As applied to this case, the provision
just quoted means that the FDIC, and similarly Grambling &
Mounce, can claim a security interest in the contested stock only
if it took that interest pursuant to a valid "transfer" as
defined elsewhere in the Code.

[16] The shares of Power Test dividend stock are certificated
securities: that is, they are investment securities represented
by physical certificates. Section 8.313(a)(1) specifies how one
may effect a valid transfer of a security interest in such shares
of stock. There must be a physical transfer of the shares from
the pledgor to the pledgee: "Transfer of a security or a limited
interest (including a security interest) therein to a purchaser
occurs only at the time he or a person designated by him acquires
possession of a certificated security." Tex.Bus. & Com.Code Ann.
§ 8.313(a)(1) (Vernon's 1988 Supp.). The section goes on to
provide means by which security interests in uncertificated
securities may be transferred, and to discuss how security
interests in either certificated or uncertificated securities may
be transferred through a financial intermediary. These
provisions of § 8.313 are facially irrelevant to this case.
However, § 8.313(a)(9) might appear to have some bearing upon
First Midland's claim. That subsection provides that a transfer
of a security will occur "with respect to the transfer of a
security interest where the transferor has signed a security
agreement containing a description of the security, at the time
new value is given by the secured party." This subsection, which
does not expressly distinguish between certificated and
uncertificated securities, appears to permit a creditor to
develop a secured interest in stock shares without obtaining
physical possession of those shares. By its terms, the subsection
applies when, as in this case, a security interest is created by
a written, signed agreement.

[17] We need not, however, consider the application of § 8.313(a)(9)
to this case. The parties have not even mentioned the subsection,
much less briefed its significance. To apply the subsection, we
would have to resolve two questions not presented to the district
judge: (1) whether the security agreement "contains a
description" of the dividend stock; (2) and when, if at all, "new
value" was provided by First Midland. Both issues might be
legitimately contested. The collateral agreement lists
specifically only the base shares; dividend shares are mentioned
only by reference to "profits, interest, and income [from] the
listed property ..." Meyer signed the collateral agreement to
secure promissory notes he had already issued. We do not reach
these issues, because the FDIC did not raise them before the
district court and so has not preserved them on appeal. Indeed,
the FDIC expressly renounced any possible reliance upon §
8.313(a)(9) when, in its supplemental post-trial brief to the
district court, it stated

FDIC agrees completely with Defendants' position that
there is no such thing as an unperfected security
interest in a security. A secured party has a
perfected security interest in a security or no
interest at all. FDIC also agrees with Defendants'
position that § 8.321(a) of the Texas Business and
Commerce Code provides that a security interest in a
security is created only when the secured party
takes possession of the security.

[18] FDIC Supplemental Trial Brief at 6 (filed Oct. 23, 1987). We need
not pass on the legal merits of this theory. The position
asserted precludes the FDIC from raising, and us from
considering, the import of § 8.313(a)(9) on appeal.

[19] Our analysis of this case thus depends upon the interaction
between §§ 8.313(a)(1) and 8.321. The implication of these two
sections is that no party in this case can have acquired a
security interest in shares of (certificated) stock without
having taken actual possession of the stock certificates. The
district court reached the same conclusion. Although there is
little case law on this point, the relevant decisions do seem to
assume that physical delivery is necessary to create a secured
interest in certificated securities under the relevant provisions
of Article 8. See, e.g., United States v. Doyle, 486 F. Supp.
1214, 1220 (D.Minn. 1980) (applying amended version of UCC as
enacted into Minnesota law; the case involves a "financial
intermediary"). Every security interest transferred for value
pursuant to § 8.313(a)(1), and thus any security interest created
in this case, is a perfected security interest. See Tex.Bus. &
Com.Code Ann. § 8.321(b) (Vernon's 1988 Supp.).

[20] The FDIC proposes two ways to defeat this argument. First, the
FDIC argues that an interaction between Article 8 and Article 9
gives it a perfected security interest in the dividend stock.
Section 8.321(c)(2) provides, "A security interest in a security
is subject to the provisions of Chapter 9, but no written
security agreement signed by the debtor is necessary to make the
security interest enforceable.... The secured party has the
rights and duties provided under Section 9.207, to the extent
they are applicable, whether or not the security is certificated,
and, if certificated, whether or not it is in his possession."
The FDIC draws attention to the concluding phrase. Section 9.207
provides in part that "unless otherwise agreed, when collateral
is in the secured party's possession the secured party may hold
as additional security any increase or profits (except money)
received from the collateral...." Tex.Bus. & Com.Code §
9.207(b)(3) (Vernon Supp. 1988).

[21] This argument appears question-begging. Section 9.207(b)(3) may
mean only that if the pledgee receives increase or profit upon
pledged collateral, the pledgee may rightfully keep the increase
or profit. There is no dispute here that the FDIC could
appropriately have retained the stock dividend as additional
security had the FDIC ever received it. Rather, the issue is
whether, given that Meyer received the stock dividend while the
FDIC had a contractual claim upon it, the FDIC developed a
security interest in the stock dividend. Section 9.207 does not
appear to speak to that issue, and the FDIC does not cite any
cases suggesting that the Section does so. Moreover, the FDIC's
emphasis upon the concluding phrase in Section 8.321(c)(2)
("whether or not it is in his possession") is misplaced. On the
FDIC's argument, the collateral referred to by that phrase is the
base stock, and that stock was certainly in the FDIC's
possession. The phrase is not a suggestion that a security
interest in certificated securities can be obtained through means
other than those specified in § 8.313. Rather, the phrase takes
into account the possibility that a secured creditor might
temporarily relinquish possession of the certificates after
getting ahold of them.

[22] Second, the FDIC asks the court to hold that its possession of
the base stock impressed an "equitable lien" upon the dividend
stock in favor of the FDIC. The FDIC bases this argument upon
Powell v. Maryland Trust Co., 125 F.2d 260 (4th Cir.) cert.
den. 316 U.S. 671, 62 S.Ct. 1046, 86 L.Ed. 1746 (1942)
(interpreting Maryland law), and upon a line of cases
interpreting Powell: Mathews v. Starr, 475 F. Supp. 37
(E.D.Va. 1979) (following Powell) rev'd sub nom. In re
Mathews, 626 F.2d 862 [Table], 29 U.C.C.Rept.Serv. 684 (4th
Cir. 1980) (ignoring Powell); In re Whitaker, 18 B.R. 314
(Bank.D.Kan. 1982). The underlying ratio of Powell was that the
stock dividend shares "were merely a part of the thing already
pledged. They were not merely something which the Seaboard had
agreed to pledge when they came into existence, but an essential
part of what it had already pledged and which were subject, for
that reason, to the pledge already created." 125 F.2d at 271. All
parties to this suit apparently believe that the district court
in the Mathews litigation accepted the equitable lien theory,
and that the Fourth Circuit, in its unpublished opinion, rejected
the theory and reversed Powell sub silentio.

[23] In our view, the Mathews litigation does not necessarily
overrule Powell, because Mathews involves Virginia law and
Powell applies Maryland law. However, Mathews involved a
stock split, not a stock dividend. 475 F. Supp. at 38. Whitaker
likewise dealt with a stock split. 18 B.R. at 315. Powell also
may have dealt with a stock split. Id.; see discussion of the
character of the "stock dividend" in Powell as a mere
record-keeping device which does not transfer profits to
shareholders, 125 F.2d at 267; see also 18 B.R. at 317.
Moreover, neither the Mathews cases nor Powell expressly
considered the distinction between a contractual right to a stock
dividend and a property (security) interest in the dividend.
Finally, none of the cases was decided under the amended version
of Article 8 of the U.C.C.

[24] For these reasons, the cases cited by the FDIC do not justify
application of the equitable lien theory in this case. Moreover,
the Fourth Circuit's Mathews opinion, applying the unamended
version of the U.C.C., rejected the equitable lien theory, even
in the context of a stock split, precisely because possession is
an absolute prerequisite to the creation of a security interest
in stock shares. 626 F.2d 862, 29 U.C.C.Rept.Serv. at 686.

[25] In summary, neither the language of the Texas code provisions
nor any case law would favor reversing the district court's
decision. The district court's ruling is consistent with the
spirit of the U.C.C., which contemplates a "race of diligence
among creditors." Matter of E.A. Fretz Co., Inc., 565 F.2d at
371. This suit is the product of the FDIC's laxity. A diligent
creditor would register its holdings, thereby guaranteeing its
security and obviating the need for legal inquiry into the
existence of an interest, or into the bona fides of a later
claimant. Application of the general equitable theory proposed by
the FDIC would be particularly inappropriate given the existence
of a statutory scheme encouraging diligence, and given that the
FDIC does not seek equity with "clean hands."

III

[26] The district court concluded from the evidence that Grambling &
Mounce possessed the shares and developed a perfected security
interest in them. First Midland never possessed the shares. In
light of the analysis developed above, the district court's
determination that Grambling & Mounce has a perfected security
interest in the shares while First Midland is an unsecured
creditor is both consistent with the law and supported by the
evidence. The decision of the district court is therefore

[27] AFFIRMED.

[fn1] Both the base stock and the dividend stock in this case
were represented by certificates — i.e., were certificated. The
UCC speaks of "security interests in securities." For the sake of
clarity, we will refer to the contested dividend stock as stock,
or as stock shares, except where it is necessary to invoke the
exact language of the UCC.