Perfected Security Interest Yields to Breach of Fiduciary Duty

If a party succeeds in perfecting a security interest in personal property by breaching a fiduciary duty, the security interest may be disregarded for the benefit of the person owed the fiduciary duty.

In Feresi v. The Livery, LLC (2014) 232 Cal. App. 4th 419, Renee Feresi and James Mesa were a married couple who during the term of their marriage acquired a 25% interest in The Livery, LLC. The LLC began with four investors who owned equal shares. Mark Hartley’s family trust was an investor, and he served as the LLC’s president and managing member.

In May 2006, Feresi and Mesa were divorced, and Feresi was awarded one-half of the community’s interest in the LLC. Mesa was also required to make the monthly payments on Feresi’s home mortgage and to pay it off within five years. Mesa’s financial obligations to Feresi were secured by Mesa’s interest in the LLC and other properties.

Feresi did not file a Uniform Commercial Code Financing Statement (UCC-1) to perfect her security interest in Mesa’s share of the LLC. She instead gave Hartley and the other members of the LLC written notice that the dissolution judgment awards her one-half of Mesa’s share of the LLC and that Mesa pledged his retained share as security for his financial obligations to her. Amendments to the books and records of the LLC showed Feresi as a member with a 12.5 percent ownership interest. Corporate tax returns identify Feresi as an LLC member.

By 2008, Mesa was struggling financially and fell behind on his obligations to Feresi, his ex-wife. In October 2008, Hartley made a short-term loan to Mesa of $200,000 from the Fitzgerald-Hartley Pension Plan. Although Hartley knew Mesa’s membership share in the LLC secured his financial obligations to Feresi, Hartley nevertheless secured the loan from his pension plan by the same 12.5% membership share Mesa pledged to Feresi in 2006.

Hartley did not disclose to Feresi either that his pension plan intended to loan money to Mesa or that it would be secured by Mesa’s membership share.

Later that month, Feresi notified Hartley (as president and manager of the LLC) that she intended to enforce Mesa’s obligations to her by taking the 12.5% share of the LLC and certain other properties he pledged. She asked the family law court to compel Mesa to convey his 12.5% membership share in the LLC to her. Hartley determined that Feresi had not filed a UCC-1 financing statement to perfect her security interest in Mesa’s membership share of the LLC.

Hartley took advantage of this circumstance by filing a UCC-1 financing statement to perfect his pension plan’s security interest.

The family court subsequently ordered Mesa to transfer his interest to Mesa, which he did, and Feresi notified Hartley and the other LLC members that Mesa’s transfer was complete and that the LLC’s records should be amended to identify her as the owner of a 25% membership interest.

Several months later, Mesa failed to repay the loan from Hartley’s pension plan, and Hartley took action to foreclose on the security interest held by his pension plan. Feresi sued to stop the foreclosure. The court granted an injunction and ruled that Feresi took her interest free and clear of the security interest of Hartley’s pension plan.

On appeal, the court held that if a perfected security interest is created by breaching a fiduciary duty owed to another person, then equitable principles may be applied to give priority to an earlier unperfected security interest. The court said that Hartley was obligated to act with the utmost loyalty and in the highest good faith when dealing with any member of the LLC, including Feresi.

Hartley was not permitted to obtain any advantage over Feresi (or any other member of the LLC) by even the slightest misrepresentation or concealment. Hartley breached his fiduciary duty to Feresi by destroying the value of her security interest in Mesa’s LLC membership interest to advance his own. Hartley had actual knowledge of Feresi’s security interest in Mesa’s membership interest, knew that Mesa was in default on his obligations to Feresi, and knew that Feresi’s security interest was immediately enforceable. Hartley loaned money to Mesa, created a conflicting security interest in Mesa’s membership interest, and then surreptitiously perfected it to gain an advantage over Feresi.

Hartley took advantage of Feresi’s ignorance by concealing this from her, and betrayed her trust and confidence by perfecting his pension plan’s security interest ahead of hers. In doing so, Hartley breached the fiduciary duties of loyalty and good faith he owed to Feresi. Under these circumstances, the trial court properly refused to enforce the security interest held by Hartley’s pension plan.

Although the UCC gives statutory priority to the holder of a perfected security interest even if the holder is unjustly enriched at the expense of an unsecured creditor, the court found that the provision of the UCC that its provisions are to be supplemented by “principles of law and equity” allowed for the security interest of the pension plan to be disregarded.

Contact the offices of Richard Burt Attorney and Counselor at Law with your questions regarding Perfected Security Interests.