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A buyer in ordinary course of business takes free of a security interest created by the buyer's seller, even if the security interest is perfected and the buyer knows of its existence.
Plaintiff debtor, Havens Steel Company was a fully integrated steel construction company which provides a design-build services to contractors and subcontractors. Defendant Commerce Bank, loaned the plaintiff the fund for the operation of its business. The parties have stipulated to the validity of defendant bank’s security interest. Plaintiff debtor entered into a subcontract with the defendant contractor to furnish, fabricate, and erect steel for the construction of a project. The parties agreed that the services portion of the subcontract predominates over the goods portion. In the course of the hearing, the parties argued that two other provisions of the subcontract are germane to the Court's inquiry. Defendant contractor contended that one paragraph controlled the transfer of title for the inventory paid for by them. In response, defendant bank argued that because a subcontract paragraph provided that such payment applications shall not include request for payments of amounts on account of materials and equipment not yet incorporated into the work, defendant contractor was not entitled to apply for payment on account of steel not yet incorporated into the project erected, and, therefore, title did not pass to defendant contactor for any steel not yet erected. Plaintiff filed an adversary proceeding for a declaratory judgment determining the priority of interests in inventory at various locations. Defendant bank claimed an interest in all of the inventory under a security agreement. Defendant contractor, on the other, claimed an interest in the inventory purchased or identified for use on construction projects for which it hired the debtor to design, fabricate, supply, and erect steel structures.
Should the defendant contractor’s claim of interest in the inventory purchase on construction projects for which it hired the plaintiff be granted?
The court held that the identification of goods, rather than title, was key to a buyer's right to recover goods. The court found defendant contractor qualified as a buyer in the ordinary course status when the goods were identified to the subcontract. Since the parties stipulated that all of the steel had been identified to the subcontract. The court further held that defendant contractor had a common law right to replevin the steel for which it had paid and an equitable right to specific performance for delivery of all of the steel in the plaintiff’s possession, although it would have to pay for any steel for which payment was owing. Furthermore, the court held that defendant contractor had a superior possessory right to the steel because it paid for the steel and therefore held title to the steel, as the subcontract indicated the parties intended for the passage of title upon payment. Thus, defendant contractor could apply for payment for goods or services performed before that work was actually incorporated into the project. The court therefore ruled that specific performance was warranted because there was no adequate remedy at law, and, the defendant contractor had constructive possession of the paid-for, undelivered steel.