Joseph Braunstein, Chapter 7 Trustee of Coldwave S v. Gateway Management Services, Ltd.

OCR transcription for search; preserved printed pages are authoritative

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UNITED STATES BANKRUPTCY COURT
for the
DISTRICT OF MASSACHUSETTS

In Re: *
* Chapter 7
COLDWAVE SYSTEMS, LLC, * No. 05-11369
Debtor *
JOSEPH BRAUNSTEIN, TRUSTEE, *
* Adversary Proc.
Plaintiff * No. 05-01411
vs. *
GATEWAY MANAGEMENT SERVICES *
LIMITED, *
Defendant *

MEMORANDUM OF DECISION ON LIABILITY ONLY
I. Introduction
Joseph Braunstein, Chapter 7 Trustee (the “Trustee”) of Coldwave Systems, LLC
(the “Debtor”) brought this multi-count adversary proceeding against Gateway Management
Services Limited (“Gateway”) to avoid a security interest whic1 Gateway claimed in a
certain patent (the “Patent”). The Trustee moved to stay so much of the complaint as
seeks damages and to proceed to trial as to liability only. | granted the motion. On April

11, 2007, | held a trial on an agreed statement of facts and agreed exhibits. After

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argument | took the matter under advisement. | now find for the Trustee on liability.
Il. Jurisdiction

The Trustee seeks a determination that the Patent is property of the Debtor’s estate.
As such itis a core matter. 28 U.S.C. § 157. This decision constitutes my findings of fact
and conclusions of law as to the question of liability.

lil. Agreed Facts

The parties have agreed that there are no facts in dispute and rested upon the
admitted facts contained their Joint Pretrial Statement (“PTS”) ard agreed exhibits offered
at trial. | agree that those facts and exhibits are adequate to determine the question of
liability and adopt them as my findings.

Debtor was a Massachusetts limited liability company engaged in the design,
development, manufacture, licensing, and sale of shipping, freezing, and storage systems.
It owned the Patent, which deals with Debtor’s proprietary freezing technology, used in
apparatuses such as shipping containers, for the shipping of frozen foods.

Gateway was in the business of leasing insulated shipping containers into which
Debtor's patented technology was incorporated. Debtor was indebted to Gateway under
the terms of a finance lease and related documents. To facilitate the relationship between
Debtor and Gateway, they entered into a Repayment and Security Agreement dated
January 31, 2003 (the “Agreement”). The Agreement provides that Debtor “hereby grants
and conveys to [Gateway] a continuing lien and security interest in the Collateral” to secure

payment of its indebtedness to Gateway. “Collateral” is defined in the Agreement to

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include the Patent.’ The Agreement provides that it is governed by the laws of California
other than conflicts of laws principles.

To perfect Gateway’s interest in the “Collateral,” including the Patent, Debtor filed
a Recordation Form Cover Sheet with the United States Patent and Trademark Office
(“USPTO”) on June 28, 2003, recording the conveyance of a security agreement dated
January 31, 2003. Gateway filed UCC-1 Financing Statements clescribing the Patent with
the Massachusetts Secretary of State on December 2, 2004, and with the Washington,
D.C., Recorder of Deeds on December 1, 2004.

Debtor was continuously indebted to Gateway at all times after January 31, 2003.
On November 24, 2004, Gateway’s counsel notified Debtor by facsimile that Debtor was
in default of its obligations to Gateway and that Gateway elected to “exercise all of its rights
under the lease and related documents, including exercise of its security interests and all
rights otherwise addressed in Lease paragraph 11 (“Remedies”).” It further provided that
“Gateway elects to accelerate all amounts due under its lease and all other obligations with
[Debtor] and to demand payment now of all amounts accelerated under the leases and
those other obligations.” The lease was not offered as evidence but Gateway’s remedies
upon default are encompassed within the Agreement which inclujes Gateway’s right upon
default, to “(iv) dispose of the Collateral, (v) sell the Collateral at public or private sales, in
whole or in part, and have the right to bid and purchase at said sale, and/or (vi) take control
over, lease or otherwise dispose of all or part of the Collateral, applying proceeds

therefrom to the Indebtedness.”

‘ A scrivener’s error misnumbers the provision in the Agreement in which
capitalized terms are defined as “Section 16"; it was actually Section 17.

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On November 30, 2004, Gateway filed a Transfer Statement with the USPTO
indicating the transfer of ownership of the Patent from the Debtor to Gateway. Gateway
notified Debtor of this action on December 8, 2004 (the “December 8 Letter’). The
December 8 Letter also provided that “further pursuant to applicable law, Gateway without
prejudice, offers to place a value of $300,000 (Three Hundred Thousand Dollars) on the
patent in partial satisfaction of the debt overdue to Gateway from [Debtor]. Please let us,
for Gateway, have [Debtor’s] timely response to this offer.”

Debtor filed its petition under Chapter 11 on March 1, 2005. The case was
converted to Chapter 7 on April 14, 2005, and the Trustee was duly appointed and
qualified.

The parties have stipulated that Debtor was insolvent as cf December 1, 2004, and
that Gateway received more value from the transfer of the Patent pursuant to its
foreclosure than it would have received in distribution from Debtor's estate pursuant to
Chapter 7 had the transfer not been made.

Not included in the stipulated facts, but a matter of record in the principal case, is
the fact that Gateway filed a proof of claim on August 11, 2005, asserting an unsecured
claim of $462,388.07 and a priority claim of $44,204.77, for an aggregate claim of
$506,592.84.”

It may be useful to summarize the time line of relevant events:

2 In re Coldwave Systems, LLC, No. 05-11369, Claim No. 3. As | have
previously held, | can take judicial notice of the contents of the case file in the principal
case. In re Pomeroy, 353 B.R. 371, 373 n.2 (2006); In re Marrama, 345 B.R. 458, 463
n.11 (2006).

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Date Everit

January 31, 2003 Agreement executed

June 28, 2003 Cover Sheet filed with USPTO

November 24, 2004 Notice of default given; asserted date of
foreclosure

November 30, 2004 Transfer Statement filed with USPTO

December 1, 2004 UCC-1 filed in District of Columbia

December 2, 2004 UCC-1 filed in Massachusetts

December 8, 2004 Strict foreclosure offer

March 1, 2005 Chapter 11 petition filed

April 14, 2005 Case converted, Trustee appointed and
qualified.

IV. Positions of the Parties

The Trustee asserts that, as a matter of law, the filing with the USPTO was
ineffective to perfect a security interest in the Patent; that perfection of a security interest
in a patent is governed by state law; and that Gateway’s security interest was not perfected
until December 2, 2004, 89 days before the Debtor filed its petition, and hence its
perfection was preferential and the foreclosure under that security interest was an
avoidable preferential transfer.

Gateway contends that its security interest in the Patent was perfected when Debtor
filed the Recordation Form Cover Sheet with the USPTO on June 28, 2003, well before the
preference period. It further asserts that the November 24, 2004 letter constituted
foreclosure of its security interest and that it took possession of the Patent by the filing of
the Transfer Statement outside of the preference period, and hence became its owner, a

fact which it contends Debtor acknowledged by not listing the Patent as an asset in its

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bankruptcy schedules, creating an estoppel against Debtor.
V. Discussion

A. Applicable Law

The relationship between the parties is, by agreement, governed by the laws of
California. The applicable California law is its version of the Uniform Commercial Code as
a patent falls within the Uniform Commercial Code definition of ‘a “general intangible.”*

The Agreement provides for an interest in personal property which secures payment
or performance of an obligation.* The facts summarized above demonstrate that the
security interest has become enforceable and has attached to the Patent:> An agreement
was reached, value was given,® and the Debtor, as owner of the Patent, had rights in the
collateral.’

At the time of the purported foreclosure, the Trustee was not a party in interest. His

rights as a lien creditor, as successor to the debtor in possessio), arise at the date of the

3 CAL. Com. Cope § 9102(a)(42); id., cmt. 5d. The California version of the
Uniform Commercial Code differs in some particulars from the official text of the U.C.C.,
beyond deleting hyphens from section numbers. References tc “the Commercial Code”
are technically to the California Commercial Code but are generally consistent with the
official version of the Uniform Commercial Code. Any relevant differences will be
noted.

4 CaL. Com. CODE §§ 1201(36)(a), 9102(a)(73) (2006). The amendment to the
former section, effective January 1, 2007, changes the citation :o CAL. COM. CODE §
1201(35) but makes no substantive change.

5 CaL. Com. CODE § 9201(a), (b).

§ “Value” includes the giving of security for a pre-existing claim. CAL. COM. CODE
§ 1201(b)(43)(b).

7 CaL. Com. CODE § 9203(b).

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filing of the petition.® If, at that time, the security interest had not been foreclosed and was
not perfected, it will be subject to the Trustee’s rights.°

However, the events upon which Gateway relies all antedate the petition date. If
Gateway, even if it held an unperfected security interest, properly foreclosed Debtor’s
rights in the Patent at the time it asserted that it did so, the Patent is beyond the reach of
the Trustee under the California Commercial Code.'° It thus becomes necessary to
examine the sufficiency of the foreclosure.
B. Strict foreclosure

The language quoted from the December 8 Letter indicates Gateway’s attempt to
accept the Patent in partial satisfaction of its claim."’ It proposed a value to be placed on
the Patent “in partial satisfaction of the debt overdue” and asked for Debtor’s timely
response to the offer. There is no evidence that an acceptance of the offer was
forthcoming.

The applicable portion of the Commercial Code provides that a secured party may
accept collateral in full or partial satisfaction of the obligation it secures only if the

conditions of the statute are satisfied. The triggering condition is that “the debtor consents

° CAL. Com. CODE § 9102(a)(52)(A)(iii). A debtor in possession has generally the
rights of a trustee. 11 U.S.C. § 1107.

* CAL. COM. CODE § 9317(a)(2).
© CaL. Com. CODE § 9617(a)(1).

" Gateway’s claim that the November 24 letter served to effect the foreclosure is
incorrect; it could only be notice that Gateway intended to assert its rights as a secured
party. It is the December 8 Letter that sets up the attempted strict foreclosure.

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to the acceptance under subdivision (c).”" Subdivision (c)(1) provides that “a debtor
consents to an acceptance of collateral in partial satisfaction of the obligation it secures
only if the debtor agrees to the terms of the acceptance in a record authenticated after
default.”

It appears that the Debtor did not respond. Silence is not consent in the case of a
acceptance in partial satisfaction of a debt.'* As a result, the attempted strict foreclosure
fails.'° Debtor retains its rights in the Patent, subject Gateway’'s security interest, but it
does retain rights, and it had those rights at the time of the filing. The encumbered Patent
is property of Debtor’s estate."

As agreed by the parties in the PTS, “lf the Patent is determined to be property of
the estate, however, the Trustee would at that point be free to seek to recover monetary
damages from Gateway for its use of the Patent following its alleged foreclosure.” But this
understanding does not go quite far enough. It will be necessary to determine if the
estate’s interest in the Patent is subject to a security interest in favor of Gateway not
subject to attack as a preferential transfer.

C. Perfection

The Commercial Code provides that the general rule for perfection of a security

2 CaL. Com. CODE § 9620(a)(1).
'3 CAL. Com. CODE § 9620(c)(1).
* Id., cmt. 3.

'S Gateway did not attempt to acquire the Patent by a public or private sale, nor
would it have been able to do so. CAL. COM. CODE § 9610(c).

6 41 U.S.C. § 541(a)(1).

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interest in a general intangible is by filing.’ There is an exception for “property subject to
a statute, regulation, or treaty described in section 9311." The referenced section
provides that no filing is necessary to perfect a security interest in property subject to “a
statute, regulation, or treaty of the United States whose requirements for a security
interest’s obtaining priority over the rights of a lien creditor with respect to the property
preempt section 9310.”"? | must determine if Federal legislation cioverning patents is such
a superceding law.

The applicable Federal law, substantively unchanged for over a century, provides
that:

An assignment, grant or conveyance shall be void as against any

subsequent purchaser or mortgagee for valuable consideration without

notice unless it is recorded in the Patent and Trademark Office within three

months from its date or prior to the date of such subsecjuent purchase or

mortgage.”°

The Ninth Circuit addressed the question directly, applying California law, in
Cybernetic Services.*" The issue was whether a chapter 7 trustee could prevail over a

secured party which had perfected its interest in a patent under state law and not by filing

with the USPTO. The trustee argued that the quoted Federal law supercedes Article 9 and

Cac. Com. CODE § 9310(a).

8 CaL. Com. CODE § 9310(b)(3).
'? CaL. Com. CODE § 9311(a)(1).
2 35 U.S.C. § 261.

21 Moldo v. Matsco, Inc. (In re Cybernetic Services, Inc.), 252 F.3d 1039 (9" Cir.
2001), cert. denied, 534 U.S. 1130 (2002). The court noted that, although it described
the governing state law as “Article 9, it meant only the California version of the Uniform
Commercial Code.” /d. at 1045.

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that a security interest in a patent can only be perfected by filing with the USPTO.
In responding to the Trustee’s position, the Ninth Circuit laid out the basics of
preemption law:

The Supremacy Clause invalidates state laws that interfere with, or any
contrary to, federal law. Congress may preempt state law in several different
ways. Congress may do so expressly (express preemption). Even in the
absence of express preemptive text, Congress’ intent to sreempt an entire
field of state law may be inferred where the scheme of federal regulation is
sufficiently comprehensive to make reasonable the inference'that Congress
left no room for supplementary regulation (field preemption). State law also
is preempted when compliance with both state and federal law is impossible,
or if the operation of state law stands as an obstacle to the accomplishment
and execution of the full purposes and objectives of Congress (conflict
preemption). In all cases, congressional intent to preempt state law must be
clear and manifest.”

It narrowed the issue to this:

if, as the Trustee argues, the Patent Act expressly delineates the place

where a party must go to acquire notice and certainty about liens on patents,

then a state law that requires the public to look elsewhere unquestionably

would undercut the value of the Patent Act’s recording scheme. If, on the

other hand, § 261 does not cover liens on patents, then Article 9's filing

requirements do not conflict with any policies inherent in the Patent Act’s

recording scheme.”?

The Ninth Circuit looked to the phrase in the statute “assignment, grant or
conveyance,” which has been in the act since 1870, to determine its scope. It concluded
that the Patent Act requires parties to record with the USPTO only ownership interests in
patents and does not preempt the Commercial Code as to the perfection of security

interests:

22 Id. at 1045-46 (citations and internal quotes omitted in this and the following
two footnotes).

*3 Id. at 1047.

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[T]he [Federal] statute’s text, context, and structure, when read in the light

of Supreme Court precedent, compel the conclusion that a security interest

in a patent that does not involve a transfer of the rights of ownership is a

‘mere license’ and is not an ‘assignment, grant or conveyance” within the

meaning of 35 U.S.C. § 261. And because § 261 provides that only an

“assignment, grant or conveyance shall be void” as against subsequent

purchasers and mortgagees, only transfers of ownership interests need to

be recorded with the PTO.”

| agree with and adopt that position, which has also been accepted by Judge Deasy
in the only published authority on the point in this circuit.”

This case, of course, is the opposite of Cybernetic Services. The issue here is not
what rights a trustee has against a secured party who did not file with the USPTO, but
against one who did so. The Federal statute does not protect holders of security interests.

An assignment, grant or conveyance (and we have seen what that encompasses)
“shall be void as against any subsequent purchaser or mortgagee for valuable
consideration.” The Ninth Circuit ruled that a chapter 7 trustee is neither a purchaser nor
a mortgagee” but | need not reach that point. There is nothing in § 261 that addresses in
any way with the conflict between one who is not the holder of an interest by way of

assignment, grant, or conveyance and a bankruptcy trustee. W'e must look to other law

for the answer.”

*4 Id. at 1052.

2° Pasteurized Eggs Corp. v. Bon Dente Joint Venture (/r: re Pasteurized Eggs
Corp.), 296 B.R. 283 (Bankr. D. N.H. 2003).

26 “Congress was concerned only with providing constructive notice to
subsequent parties who take an ownership interest in the patent in question.” 252 F.3d
at 1054.

27 See In re Transportation Design & Technology, Inc., 48 B.R. 635 (Bankr. S.D.
Cal. 1985).

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D. The U.C.C. Filings

As noted, Gateway did file two financing statements under the Uniform Commercial
Code, one in the District of Columbia on December 1, 2004, and the second in
Massachusetts on December 2, 2004. The District of Columbia filing was 90 days before
the bankruptcy petition was filed, and the Massachusetts filing just 89 days prior. Both fall
within the preference period as the outer limit is “on or within 90 days before the date of
the filing.’2® As a result, it does not matter which filing was made in the correct location’
E. Perfection by Possession

Gateway further asserts that it obtained perfection by possession of the Patent,
evidenced by the filing of the Transfer Statement on November 30, 2004. As the Supreme
Court pointed out more than a century ago, “a patent-right is incorporeal property, not
susceptible of actual delivery or possession.” There is nothing in the Commercial Code

that excepts general intangibles from the general rule requiring filing for perfection.*’ The

28 41 U.S.C. § 547(b)(4)(A).

29 The Massachusetts filing is in the correct location. When a debtor is located in
a jurisdiction, the local law of that jurisdiction governs perfectior: of a security interest in
collateral. CAL. Comm. CODE § 9301(1). Debtor is a Massachusetts limited liability
company. Massachusetts law specifically provides for the creation of such entities.
Mass. Gen. Laws ch. 156C. Each limited liability company must file its certificate of
organization with the Massachusetts Secretary of State. Mass. Gen. Laws ch. 156C,
§12. As such it is a “registered organization” as that term is used in the Commercial
Code, CAL. Comm. Code § 9102(a)(70), and is located in Massachusetts. CAL. Comm.
CobE § 9307(e). Massachusetts law requires the filing to be with its Secretary of State.
Mass. Gen. Laws ch. 106 § 5-501(a)(2).

3° Waterman v. Mackenzie, 138 U.S. 252, 260 (1891).
31 Cac. Comm. CobE § 9310.

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Code provisions involving “transfer statements,”” cited by Gateway, apply to collateral
covered by a certificate of title.** Gateway’s position is ill taken.
F. Estoppel

Gateway urges that Debtor, by failing to list the Patent as an asset in its schedules,
created an estoppel which denies the Trustee the right to challenge Gateway’s ownership.
This argument, not supported by authority in Gateway’s papers, can be disposed of in short
order.

Certainly this is not a case of judicial estoppel where “a party assumes a certain
position in a legal proceeding, and succeeds in maintaining that position.” Nor is it an
instance of equitable estoppel, which requires that “the party to be estopped must know
the facts; (2) the party to be estopped must intend that his conduct will be acted upon or
must so act that the party asserting the estoppel has the right to believe that it was so
intended; (3) the party asserting the estoppel must be ignorant of the true facts; and (4) the
party asserting the estoppel must rely on the other party’s conduct to his injury.”*>

Gateway’s argument is without merit.

V. Conclusion

The granting of the security interest to Gateway was a transfer under the terms of

32 CAL. COMM. CODE § 9619.
33 CAL. COMM. CODE § 9619, cmt 2. See CAL. Comm. CODE § 9620, cmt. 9.

34 New Hampshire v. Maine, 532 U.S. 742, 749 (2001), quoting David v.
Wakelee, 156 U.S. 680, 689 (1895).

5 See, e.g., Penny v. Giuffrida, 897 F.2d 1543, 1545-46 (10 Cir. 1990).

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the Bankruptcy Code.*° With exceptions not relevant here, the trustee may avoid any
transfer to or for the benefit of a creditor on account of an antecedent debt made while the
debtor is insolvent and on or within 90 days before the date of filing of a bankruptcy petition
that enables the creditor to receive more than it would receive in a chapter 7 case if the
transfer had not been made.*’

The agreed facts demonstrate that the grant of the security interest in the Patent
(and other assets) was preferential and voidable by the Trustee. ** Since there are no
factual disputes, judgment to that effect is appropriate at this time. The Trustee holds title
to the Patent free of the claims of Gateway.

This is a bifurcated trial, and hence this is not a final order. A status conference will

be noticed in ordinary course to schedule further proceedings on damages.

William C. Hillman
United States Bankruptcy Judge

Dated: May 15, 2007

6 41 U.S.C. § 101(54)(A),
7 41 U.S.C. § 547(b).

38 See Ostrander v. Gardner (In re Millivision, Inc.), 474 F.3d 4 (1% Cir. 2007);
City Bank & Trust Co. v. Otto Fabric, Inc., 83 B.R. 780 (D. Kan. 1988).

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