In re AutoStyle Plastics, Inc.

AutoStyle Plastics, Inc. (AutoStyle) filed for Chapter 11 bankruptcy. CIT Group/Credit Finance, Inc. (CIT) had a perfected security interest, and the loan agreement provided that CIT would make advances from time to time to AutoStyle. CIT then entered into subordination agreements with Citicorp Venture Capital, Ltd. (CVC) and the treasurer of the State of Michigan, as custodian of several state retirement systems (SMRS) (defendants). In the first such agreement, CVC paid $2 million to CIT, which allowed CIT to fund more borrowing by AutoStyle. In return, CVC was allowed to participate in the repayment process. CVC would be paid only if CIT was paid and other loan participants received repayment. CVC had no legal recourse against AutoStyle for nonpayment. AutoStyle signed a separate demand note for CVC, and CVC received stock warrants from AutoStyle. The other such transactions followed that same basic pattern. After three of these agreements were made, Bayer Corporation (plaintiff) gave credit to AutoStyle and obtained and perfected its security interest. Two more subordinated agreements were then signed. There were no issues of fact that CIT and Bayer had perfected security interests or that CIT’s interest was ahead of Bayer’s for priority. CVC and SMRS asserted that they had the same priority position as CIT and were ahead of Bayer for receipt of proceeds. Bayer argued that the defendants did not have true participations in the CIT loan arrangement and should not be allowed to leapfrog Bayer for priority. Caselaw provided that a true participation agreement had to fulfill a four-part test: 1) the money was paid by the new participant to the original lender, 2) the participant’s right to repayment only arose when the original lender was repaid, 3) only the original lender had legal recourse against the debtor, and 4) the document was evidence of the true intentions of the parties. CVC and SMRS argued that their participations met the test. Bayer also argued that the UCC did not allow for floating secured parties, meaning an open class of creditors who could transfer their claims and obtain an after-the-fact perfection of their security interests. The trial court granted summary judgment for CVC and SMRS, and Bayer appealed.