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IN RE DENNIS MITCHELL INDUS.

February 15, 1968

In the Matter of DENNIS MITCHELL INDUSTRIES, INC., Bankrupt


The opinion of the court was delivered by: LORD, JR.

 JOHN W. LORD, Jr., District Judge.

 This case comes before this Court on appeal from an Order of the Honorable Thomas J. Curtin, Referee in Bankruptcy, of October 25, 1967 granting Herman Schwabe, Inc.'s Petition for Reclamation. The Reclamation covered two (2) Hydraulic Cutting Machines with their accompanying equipment sold subject to any liens by the Receiver for the Bankrupt-Dennis Mitchell Industries, Inc. to A. J. Armstrong Co., Inc. The petition was filed on April 18, 1967.

 The facts as found by the learned Referee are as follows: On or about May 20, 1965, Herman Schwabe, Inc. ("Schwabe") sold to the bankrupt, pursuant to a conditional sales contract the two machines in question. Financing statements were filed-both in Harrisburg, Pennsylvania in the Office of the Secretary of the Commonwealth, and in Philadelphia in the Prothonotary's office, the bankrupt's principal place of business. The conditional contract of sale provided, inter alia, that the machines were to be kept in Philadelphia and not elsewhere without Schwabe's prior consent in writing. However, without the knowledge or consent of Schwabe, the machinery was installed, not in Philadelphia, but in New Jersey. Schwabe failed to record his security interest in that state.

 Subsequently, on April 5, 1967, Dennis Mitchell was adjudicated a bankrupt. On June 9, 1967 the Receivers for the bankrupt were granted leave to sell their right, title and interest in all bankrupt's assets, except cash, subject to liens and other claims to Armstrong. Included in the bankruptcy sale was Schwabe's machinery.

 A question presented is: the machinery being in New Jersey, does Schwabe's failure to file there cause its security interest to be unperfected? If such is the case then, is Schwabe's "unperfected security interest" subordinate to the interest of the assignee-Armstrong?

 It is the opinion of this Court that the decision of the Referee in Bankruptcy be affirmed for the reasons stated therein and for the following additional reasons:

 1. Assuming, without conceding, that Schwabe's failure to file in New Jersey rendered its security interest in the machinery unperfected, it then follows that its interest was subordinate to the rights of the Receiver (later Trustee).

 Section 9-301(1)(b) of the Uniform Commercial Code provides that an unperfected security interest is subordinate to the rights of a person who becomes a lien creditor without knowledge of the security interest and before it is perfected. Subsection (3) defines a lien creditor as including a trustee in bankruptcy not having knowledge of the security interest. Unless all the creditors whom he represents have knowledge of the security interest, the trustee is a lien creditor without knowledge even though he personally has knowledge of the security interest.

 Thus an unperfected security interest is subordinate to the rights of a trustee in bankruptcy who personally has knowledge of the security interest, but who represents creditors not sharing this knowledge. The sole issue is does one taking under this trustee prevail over the unperfected security interest, as would the trustee, if he, himself, has knowledge of the security interest? We think not.

 A sale in a bankruptcy proceeding is a judicial sale. In re Superior Mushroom Growers Corp., 228 F. Supp. 372 (E.D.Pa.1964). Under a judicial sale, a purchaser takes title free from liens or outstanding interests of which he was without actual or constructive notice. Follweiler v. Lutz, 102 Pa. 585 (1883).

 There is authority for the view that a purchaser of property from a trustee in bankruptcy takes title thereto free of any unrecorded liens or encumbrances subordinate to the right of the trustee, even though such purchaser has actual knowledge of the same at the time of purchase. Schuch v. Northrup-Jones, Inc., 162 Cal.App.2d 279, 328 P.2d 279 (1958). We do not subscribe to this view. As stated in the Schuch case the rule there is but an application of the principle that a bona fide purchaser "may clothe his transferee with a good title regardless of whether the transferee had notice of adverse claims which were void or unenforceable against the transferor." Id., at 284, 328 P.2d at 286. See also U.C.C. 2-403(1).

 It is submitted that the "shelter" provision of U.C.C. 2-403(1) does not apply to a transferor-transferee relationship arising out of a judicial sale. Indeed, as one commentator has written, when the nature of the sale makes another provision of the Code applicable, such other provision should determine the rights of the purchaser. Anderson, Uniform Commercial Code, 2:403:7 (1961). Accordingly, the rights of a purchaser at a judicial sale should be governed by Article 9 on Secured Transactions and not 2-403(1).

 Thus, the better view is that a purchaser at a bankruptcy sale takes title free from liens or other outstanding interests only of which he was without actual or constructive notice. Since in the instant case, Armstrong had actual notice of Schwabe's unrecorded security ...


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