Independence Community Bank v. John M. Catania, et al., No. ESX-L-1344-05 (Law Div.)

SUPERIOR COURT OF NEW JERSEY
LAW DIVISION - CIVIL PART
ESSEX COUNTY
DOCKET NO. ESX-L-1344-05
APPELLATE DOCKET NO.

Place: New Courts Building
50 West Market Street
Newark, New Jersey 07102
Date: April 29, 2005

BEFORE: HONORABLE DONALD W. MERKELBACH, J.S.C.

APPEARANCES:

ANTHONY J. SYLVESTER, ESQ., (Riker, Danzig, Scherer, Hyland Perretti), Attorney for Independence

DAVID P. WADYKA, ESQ., (DiFrancesco, Bateman, Coley, Yospin, Kunzman, Davis & Lehrer, P.C.), Attorney for Commerce Bank

JOHN P. LEONARD, ESQ., (McElroy, Deutsch, Mulvaney & Carpenter, LLP),Attorney for Unity Bank

Audio Recorded by M.J.N. Court Transcribing Services, 217 Orange Avenue, Cranford, New Jersey 07016

THE COURT: Alright, counsel because Mr. Amano (phonetic) is obviously new to this matter, I will spend some time to relate the history of this case.

By orders dated August 21, 2003 and March 12, 2004, Independence Community Bank obtained judgments against among others, First Choice Industries and Kearny (phonetic) Depot. Independence subsequently caused writs of execution to be issued to the sheriff of Union County and levies to be served on accounts containing the judgment debtors' funds maintained at Unity Bank.

By way of the instant application, it is asserted that Independence, having perfected its judgment liens by levying on the debtor's accounts, has priority as a judgment creditor with respect to those accounts. As such, pursuant to N.J.S.A. 2A:17-63, Independence requests a turnover of the funds of Kearny Depot and First Choice maintained at Unity Bank. Notice of this application has been provided to Kearny Depot, First Choice, Unity Bank and Commerce Bank.

Now, Independence's statement of facts. First, in litigation against Kearny Depot and First Choice. This matter arises from a check kite perpetrated by a number of defendants, including Kearny Depot and First Choice, which was discovered in late 2002 as a result of the foregoing Independence claims losses of $3,900,778.81.

Accordingly, on January 6, 2003, Independence filed a verified complaint in the Chancery Division of this vicinage, naming various parties including Kearny Depot. This lawsuit was encaptioned Independence Bank v. Catania, et al., docket number Essex C-5 -- C-5-03. On the same date, the Court entered an order to show cause with temporary restraints immediately and temporarily enjoining and restraining the defendants and any other holder or custodian of other property from disabating or transferring their property.

Thereafter, on January 7, 2003, Unity was served with the order to show cause. On January 13, 2003, Independence filed an amended verified complaint naming additional defendants, including First Choice pursuant to which the Court entered an amended order to show cause with temporary restraints which continued the provisions identical to those recited above, but extended the restraints to the property of the new defendants. The amended order to show cause was served on Unity on January 16, 2003.

On January 13, 2003, the Court issued two writs of attachment directing the Middlesex County sheriff to attach any and all property of Kearny and of First Choice in Middlesex County. And said writs were served on Unity by the sheriff of Middlesex County on January 13, 2003. In accordance therewith, in or about January 2003, Unity froze $2,000 -- $2,466,043.12 that had been in accounts maintained at Unity by Kearny Depot and First Choice, $1,984,288.84 in Kearny Depot's account, and $481,754.28 in First Choice's account. By transferring those funds, the two accounts respectively entitled,

I.) Unity Bank Trustee for Kearny Depot, Inc.; and
2.) Unity Bank Trustee for First Choice Industries, Inc.

By order dated August 21, 2003, judgment by default was granted in Independence's favor against various defendants, including First Choice jointly and severally in the amount of $4,221,514.89. Said judgment was entered on the civil docket of the clerk of the Superior Court of New Jersey on October 6, 2003 and recorded as a lien under docket number D.J. 240688-03.

On December 1, 2003, pursuant to said judgment, the Court issued a writ of execution as to property of First Choice and the other judgment debtors located in Union County, New Jersey. On December 30, 2003, Independence forwarded said writ of execution by overnight courier to the sheriff of Union County. On January 9, 2004, pursuant to said writ of execution, the sheriff of Union County levied upon all funds of First Choice held at Unity Bank.

In an oral opinion dated March 12, 2004 in connection with summary judgment motions filed against non-defaulting defendants by Independence and intervening defendant Commerce Bank, this Court found that the defendants had perpetrated a fraudulent check kite as a result of which Independence had incurred losses of $3,900,778.81.

The Court further found that defendants had created artificially inflated balances in accounts at the various banks involved in the check kite among other things by writing checks drawn on accounts in which deposited money was made available to the defendants by the depository banks before the deposit of money had actually been paid by the payor banks.

By order dated March 12, 2004, judgment was granted in Independence's favor against various defendants, including Kearny Depot jointly and severally in the amount of $3,900,778.81. Said judgment was entered on the civil docket of the clerk of the Superior Court of New Jersey on March 16, 2004 and recorded as a lien under docket number D.J. 49685-04.

On July 13, 2004, pursuant to said judgment, the Court issued a writ of execution as to property of Kearny Depot and the other judgment debtors located in Union County, New Jersey. On July 20, 2004, Independence forwarded said writ of execution by overnight courier to the sheriff of Union County. On July 29, 2004, pursuant to said writ of execution, the sheriff of Union County levied upon all funds of Kearny Depot held at Unity Bank.

According to counsel for Unity, no other credits -- no other creditors of Kearny Depot, Inc. or First Choice Industries have levied on their assets held at Unity Bank. This matter has been brought on motion with leave of Court and notice has been provided to Kearny Depot, First Choice, Unity Bank and Commerce Bank. Therefore, based on the foregoing, Independence argues it is entitled to a turnover as a first priority judgment creditor of Kearny Depot and First Choice.

Now, Independence's constructive trust claim. On or about April 7, 2003, Independence filed a second amended complaint asserting, among other things, a claim for imposition of a constructive trust on the funds of Kearny Depot and First Choice being held by Unity. Independence alleged, among other things, that Unity would be unjustly enriched if it were to assert ownership over the funds.

In the spring of 2003, Independence filed an application to enforce litigants' rights against Unity based on Independence's belief that Unity had or intended to exercise purported rights to setoff losses it had incurred in connection with the defendant's banking activities by transferring money from the Kearny Depot or First Choice accounts at Unity.

In an oral opinion dated June 30, 2003, this Court held that any effort by Unity to setoff losses it incurred in connection with the defendant's banking activities in such manner would unjustly enrich Unity. The Court so held because

1. Unity had notice and actual knowledge of the defendant's check kiting scheme; and
2. the other banks defrauded by the check kite had asserted competing claims to the funds; and
3. because Unity froze the funds the bank depositor relationship underlying any right of setoff had ended.

Thus, for the purposes of Independence's motion to enforce litigant's right -- rights, the Court held that a constructive trust encompassed the funds in the accounts of Kearny Depot and First Choice Industries held and maintained at Unity.

Now, Financial Federal Credit, which I'll refer to as F.F.C.I., has cross-moved for an order allowing it to intervene in this matter, pursuant to Rule 4:33-1. If that application is granted, F.F.C.I. further requests a reasonable discovery period to prosecute claims to the funds which are the subject of Independence's motion for turnover.

In support of its application, F.F.C.I. alleges that on December 15, 2000, J.C. Management Leasing Corp., which I'll refer to as J.C.M., and Universal Riteway (phonetic), which I'll refer to as Universal, jointly and severally executed and delivered to F.F.C.I. a promissory note in the original amount of $4,566,504 along with the security agreement. F.F.C.I. further asserts that the indebtedness and obligations of and owed by J.C.M. and/or Universal were unconditionally guaranteed by Kearny Depot, F.D.X. and other entities.

In conjunction with the guarantees, Kearny Depot and F.D.X. each executed a security interest against all of their assets including but not limited to accounts, accounts receivables, deposit accounts, contract rights, and any proceeds thereof. F.F.C.I. claims it perfected its security interest in said assets by filing U.C.C. financing statements on or about March 19, 2002. Allegedly, J.C.M. and Universal defaulted upon the indebtedness and obligations under the aforementioned note and security agreement, or Kearny and F.D.X. defaulted upon their indebtedness and obligations under the guarantees.

Therefore, on or about May 7, 2004, F.F.C.I. filed its complaint in the Law Division of Monmouth County under docket number Monmouth L-2102-04. Soon thereafter, on July 27, 2004, judgment was entered against defendants C.I.T., F.D.X., Florida Direct Express, FICA (phonetic) Transport, J.C. Management Leasing Corp., Kearny Textile Deliveries, Universal Riteway, Universa! Roadmaster, James Catania and John Catania in the amount of $2,054,609 plus late charges, interest, costs and attorneys' fees.

In response to Independence's application for turnover, F.F.C.I. contends that the accounts of First Choice Industries and Kearny Depot at Unity Bank are subject, they claim, to the first perfected security interest that F.F.C.I. holds in to and against, among others, the accounts, accounts receivable, contract rights, general intangibles, and deposit accounts, and the proceeds thereof of no less than Kearny Depot and F.D.X. Accordingly, as noted previously, F.F.C.I. objects to Independence's motion for turnover and seeks to intervene in this lawsuit, number one; and number two, to obtain an order allowing reasonable discovery to prosecute its claim against the subject funds.

Now, Independence seeks an order approving turnover of the Kearny Depot and First Choice funds pursuant to N.J.S.A. 2A:17-63. This statute provides as follows: After a levy upon a debt due or accruing to the judgment debtor from a third person, herein called the garnishee, the Court may upon notice to the garnishee and the judgment debtor and if the garnishee admits the debt, direct the debt to an amount not exceeding the sum sufficient to satisfy the execution to be paid to the officer holding the execution or to the receiver appointed by the Court, either in one payment or an installment as the Courts -- as the Court may deem just. Now, the foregoing statute is applicable to a levy upon a bank account. See All American Auto Salvaqe v. Camps (phonetic) Auto Wreckers, 146 N.J. 15, 1996.

Now, with regard to priority between judgment creditors, the New Jersey Supreme Court in New Brunswick Savinqs Bank v. Morkowski (phonetic), 123 N.J. 402, 1991 noted that pursuant to N.J.S.A. 2A:17-39, the creditor who levies first under a writ of execution has priority over all other judgment creditors. See also Polaski (phonetic) Savinqs and Loan Association v. Aquar (phonetic), 174 N.J. Super 42 at page 49, Chancery Division, 1980, stating N.J.S.A. 2A:17-39 grants a levying judgment creditor a super priority over senior non-levying judgment creditors, citing Burg (phonetic) v. Edmondson (phonetic), iii N.J. Super 82 at page 85, Chancery Division, 1970.

And I quote N.J.S.A. 2A:17-39 gives a judgment junior in time priority of lien over a senior judgment by first levying upon the land under an execution issued on the judgment. Thus, a junior judgment creditor levies has priority over a senior judgment creditor that is not levied, citinq Wolfsen (phonetic) v. Bonello (phonetic), 270 N.J. Super, 274 at 287, Appellate Division 1994, citing Burg supra at page 85.

In this matter, it is undisputed that Independence was the first creditor to levy upon the funds contained within the Kearny Depot and First Choice accounts at Unity Bank. Accordingly, Independence contends that it is entitled to an order directing Unity Bank to turn over those funds as it has complied with the notice provisions of Rule 4:59-2G.

Now, in opposing this application, F.F.C.I., a judgment creditor of Kearny Depot, but not First Choice, does not contend that it is a senior judgment creditor who must take priority over Independence Bank, but, rather, F.F.C.I. argues that it possesses a first perfected security interest in funds contained within the Kearny Depot and First Choice accounts which dates back to March 19, 2002.

As noted previously, F.F.C.I.'s claim arises from certain promissory notes and security agreements executed by entities under the control of the Catania defendants. Essentially, it is F.F.C.I.'s contention that the bulk of the collateral securing the promissory notes was sold out of trust and that the proceeds received may have been deposited into certain accounts, including but not limited to the accounts presently in controversy.

Thus, because F.F.C.I. also took a security interest in the proceeds of all personal property and assets of its judgment debtors, it maintains that it must take priority over Independence as a first perfected security interest holding. In this regard, the Appellate Division has unequivocally held that "In absence of a statutory or common law exception a secured creditor who has duly filed a financing statement is entitled to priority over a subsequent lien creditor seeking to levy on or otherwise claim the same collateral.� And that's from Shawmudqe (phonetic) and Company v. Shearor (phonetic) Mart Manufacturing Company, 132 N.J. Super 517 at page 521, Appellate Division 1975.

In its reply submission, Independence does not dispute that F.F.C.I. has an enforceable security interest in the collateral described in the various agreements between F.F.C.I. and J.C.M., F.D.X., Universal and Kearny Depot. Said collateral includes personal property, assets and the proceeds thereof. It is further uncontroverted that F.F.C.I. has taken all necessary steps for perfecting its security interest, including the filing of a financing statement with the Secretary of State. Rather, Independence asserts that funds contained within the subject accounts do not belong to the judgment debtors and therefore F.F.C.I. cannot possibly have any interest therein.

Pursuant to N.J.S.A. 12A:9-203, and I quote, "A security interest attaches to collateral when it becomes enforceable against a debtor with respect to the collateral. A security interest in turn becomes enforceable only if the debtor has rights in the collateral or the power to transfer rights in the collateral to a secured party."

As set forth in detail in the expert report of Darryl (phonetic) S. Nyer (phonetic), C.F.E., the contents of which were uncontroverted in prior summary judgment motion practice, the funds contained within the Kearny Depot and First Choice accounts represent artificially inflated balances created by the judgment debtors' check kiting scheme. And I call your attention to the Nyer report at page 4.

Further, in granting summary judgment to Independence and Commerce Bank, this Court specifically found that Independence and Commerce's losses were the result of the judgment debtor's check kite. In addition, it is significant to note that the Kearny Depot account had a negative balance just seven days before the check kite was uncovered. And all of the identifiable checks deposited in the Kearny account thereafter were drawn from the accounts of entities involved in the check kite.

In a similar vein, the First Choice account was opened on December 4th, 2002. And during that month, all of the checks deposited therein were drawn from the accounts of entities which have been identified as participants in the check kite. Obviously, these facts also militate in favor of Independence and against F.F.C.I.

Thus, consistent with this Court's prior rulings and in light of F.F.C.I.'s bare allegation that the accounts at issue may contain proceeds from its secured collateral, it must be found that the funds contained within the Kearny and First Choice accounts were the product of the check kite. As such, because the judgment debtors had no right to these funds, F.F.C.I. cannot claim an enforceable security interest therein. Again, referring to the provisions of N.J.S.A. 12:9-203(b).

In addition, pursuant to N.J.S.A. 12A:9-315(a)2, a security interest attaches to any identifiable proceeds of collateral. In this matter, F.F.C.I. has conceded that if there does exist proceeds from the sale of any collateral, they must be intermingled with the funds generated as a result of the check kite. This fact on its face does not prevent -- present a bar to F.F.C.I.'s eventual recovery.

Indeed, pursuant to N.J.S.A. 12A:9-315(b)2, proceeds that are commingled with other property are identifiable proceeds if the proceeds are not goods to the extent that the secured party identifies the proceeds by a method of tracing including application of equitable principles that is permitted under law other than this chapter with respect to commingled property of the type involved. However, as a general proposition in New Jersey, proceeds will have been rendered unidentifiable by having been commingled with other funds in a single bank account. And I cite Morrison (phonetic) Steel Co. v. Girtman (phonetic), 113 N.J. Super 474 at page 481, Appellate Division 1971.

Therefore, F.F.C.I.'s claim that it should be permitted to engage in a tracing for any proceeds in the subject accounts finds no basis in law. Furthermore, in light of the foregoing, F.F.C.I.'s reliance on lowest intermediate balance test is set forth in General Motors Acceptance Corp. v. Norstar phonetic) Bank, N.A., 532 New York Sub. 2nd, 685, Supreme Court 1985 is likely in apposite.

Assuming arguendo that the funds contained within the subject bank accounts are not the product of the check kite, it is clear that Commerce Bank's interest is superior to F.F.C.I.'s because it gave credit to checks drawn on the subject accounts, never received final settlement for those checks, and suffered losses as a result thereof. In this regard, N.J.S.A. 12A:4-210 provides as follows:

A. A collecting bank has a security interest in an item and any accompanying documents or the proceeds of either:

1. in case of an item deposited in an account to the extent to which credit given for the item has been withdrawn or applied;
2. in case of an item for which it has given credit available for withdrawal as a right to the extent of the credit given, whether or not the credit is drawn upon or there is a right of charge back; or
3. if it makes an advance on or against the item.

B. credit given for several items received at one time are pursuant to a single agreement is withdrawn or applied in part, the security interest remains upon all the items, any accompanying documents, or the proceeds of either. For the purpose of this section, credits first given are first withdrawn.

C. Receipt by a collecting bank of a final settlement for an item is a realization on its security interest in the item, accompanying documents, and proceeds.

As long as the bank does not receive final settlement for the item or give up possession of the item or accompanying documents for purposes other than collection, the security interest continues to that extent and is subject to chapter 9, but

1. no security agreement is necessary to make the security interest enforceable, 12A:9-203(b)3(a);
2. no filing is required to perfect the security interest; and 3. the security interest has priority over conflicting perfective security interests in the item, accompanying documents, or proceeds, citing 12A:4-210.

In harmony with the foregoing, N.J.S.A. 12A:9-203, which governs attachment of a security interest, provides that an interest of a secured party established pursuant to N.J.S.A. 12A:9-203(b) is subject to 12A:4-2!0 on the security interest of a collecting bank. Significantly, F.F.C.I. has relied upon N.J.S.A. 12A:9-203(b) to establish its purported security interest.

It is well settled in this case that Commerce Bank extended credit to checks drawn on the Kearny Depot and First Choice accounts at Unity Bank and did not receive final settlement with respect thereto. Indeed, Unity has admitted as much in its answer to Commerce's third party complaint.

Therefore, to the extent the deposited balances existed in the Kearny Depot or First Choice accounts at Unity Bank as a result of the check returns, Commerce possesses a secured interest in same which is superior to F.F.C.I.'s alleged secured interest.

In addition insofar as Commerce's losses may be mitigated by its judgment against Unity, the security interest is transferred to Unity pursuant to N.J.S.A. 12A:9-340, which provides in pertinent part that "A bank with which its deposit account is maintained may exercise any right of recoupment or setoff against the secured party that holds a security interest in the deposit account."

Now, this Court has entered judgment against Unity in the amount of $1,850,071.03 on Commerce's third party late return claim. Therefore, although that ruling is on appeal, should Commerce prevail, Unity's right of setoff with respect to any funds that actually belonged to the account holders and thus subjected to F.F.C.I.'s alleged security interest would be superior. Moreover, if Unity prevails on appeal, Commerce's rights under N.J.S.A. 12A:4-!0 would remain intact for the reasons previously discussed.

With respect to F.F.C.I.'s request to conduct discovery on its claim for fraudulent conveyance against F.D.X., it must first be noted that F.F.C.I. did not obtain a security interest in any assets of F.D.X. until July 31, 2003. Therefore, because Independence's writ of attachment against the Kearny and First Choice accounts were served on or about July 13, 2003, any secured interest arising thereafter would be subordinate to Independence's lien, see Wolfsen Super 270 N.J. Super at 289, quoting In Re Boblin (phonetic) Supra at page 263.

See also Shawmudqe and Company Supra at page 522, and I quote, "A secured creditor is entitled to priority over a subsequent lien creditor seeking to levy on or otherwise claim the same collateral." As such, any discovery relating to a possible fraudulent conveyance transaction by F.F.C.I. against F.D.X. is immaterial to the instant application.

Finally, F.F.C.I. requests this Court to invoke the doctrines of equitable subordination and equitable estoppel in light of the gross inequity which would result if it were not provided an opportunity to pursue its claims to these accounts. However, the federal bankruptcy courts developed those doctrines and F.F.C.I. has cited no authority for their application in this arena.

F.F.C.I. also contends that it should be entitled to a share of the funds contained within the accounts at issue under a constructive trust theory. In order to assert such a claim, F.F.C.I. must demonstrate that there was some wrongful act, usually, though not limited to, fraud, mistake, undue influence, or breach of confidential relationship which has resulted in a transfer of property. And I cite Diplio (phonetic) v. Castaro (phonetic), 51 New Jersey, 584 at page 589, 1968 for that proposition. As discussed at length, the funds contained within the Kearny Depot and First Choice accounts are not the fruits of some wrongful act in relation to F.F.C.I.'s collateral, but rather are the result of the check kite.

Now, for all of the foregoing reasons and aside from timeliness issues and pleading issues, which were properly, I think, outlined by Mr. Sylvester, which may in and of themselves bar the relief sought by F.F.C.I., it is held that the cross-motion to intervene in this matter must be denied as F.F.C.I. does not possess a valid interest in the property or transaction which is the subject of this litigation. Accordingly, Independence's motion for turnover pursuant to N.J.S.A. 2A:17-63 is granted.