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WICHITA FED. S&L ASSN. v. COMARK & MARINE MIDLAND

February 26, 1985

WICHITA FEDERAL SAVINGS AND LOAN ASSOCIATION; NORTHWESTERN SAVINGS AND LOAN ASSOCIATION; CITY OF FARMINGTON, NEW MEXICO; MUTUAL FEDERAL SAVINGS AND LOAN ASSOCIATION; FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION OF WATERLOO; and SECURITY FIRST FEDERAL SAVINGS AND LOAN ASSOCIATION, Plaintiffs,
v.
COMARK and MARINE MIDLAND BANK, N.A. Defendants MARINE MIDLAND BANK, N.A., Third-Party Plaintiff, vs. E. KEITH OWENS and ROBERT W. BELL, Third-Party Defendants



The opinion of the court was delivered by: LASKER

LASKER, D.J.

This motion presents the issue, simply stated though analytically complex, of whether defendant Marine Midland Bank, N.A. ("Marine"), or the plaintiffs, five savings and loan associations and a municipality, *fn1" are entitled to priority in claiming ownership of eight government securities worth, according to their face value, $10.5 million. Marine moves for summary judgment to dismiss the claims asserted against it as to these securities on the grounds that, as between the plaintiffs and Marine, both federal and state law establishes Marine, both federal and state law establishes Marine's priority claim over them. *fn2" For the reasons set forth below, the motion is denied because Marine's rights in the securities are determined by state law, specifically the Uniform Commercial Code as incorporated under New York law, and because a question of fact exists as to whether the securities were "delivered" to the plaintiffs within the meaning of U.C.C. § 8-313(1)(c).

I.

 The facts alleged in this case have been discussed in an earlier published opinion, Wichita v. Comark, 586 F. Supp. 940 (S.D.N.Y. 1984). Before it began to liquidate its business in June of 1982, defendant Comark, a California limited partnership, was in the business of buying and selling government securities. Plaintiffs were former Comark customers on whose behalf Comark had purchased, inter alia, a total of eighteen government securities valued at $17 million which Marine foreclosed on in June of 1982. Marine was Comark's clearing agent for all book entry government securities and money market instruments from early 1981 through the middle of 1982.

 Between March of 1981 and June of 1982 Marine executed, pursuant to Comark's instructions, thousands of securities trades for Comark, with an average face value of more than one hundred million dollars per day. Most of these traders, and the ones relevant to this motion, were accomplished through electronic book-entry procedures which establish ownership in a traded security through the use of a computer record, as opposed to paper certificates. *fn3" As part of its clearing agency relationship with Marine, Comark opened demand deposit and clearance accounts with Marine and advised its trading partners to designate Marine as the bank to which all traded securities were to be transferred. Upon receipt of the appropriate instruction from Comark, Marine would effectuate a transfer of securities by electronically instructing the Federal Reserve Bank of New York ("New York Fed") to debit or credit its book-entry account holding government securities and its cash or reserve account. Marine would then also make the appropriate debit or credit to Comark's accounts on Marine's books and any changes would be reflected in daily Account Position and Priced Holding Reports sent by Marine to Comark. While both Comark and Marine recorded on their respective books whether they traded or held securities for themselves or for customers, all of the securities in Marine's New York Fed Book-entry account were held in Marine's name.

 As part of the clearing process, Marine would regularly make overnight "clearance loans" to Comark averaging twelve million dollars per day. These loans were intended to cover the difference between the value of securities received on Comark's behalf and Comark's cash balance with Marine. The terms of the loans were governed by a General Loan and Security Agreement dated January 22, 1981 under which Comark conveyed to Marine a floating security interest and lien on the contents of Comark's security clearance and demand deposit accounts with Marine.

 On June 3, 1982 Marine, concerned that Comark's clearance loan was undercollateralized, made a demand upon Comark to repay immediately its outstanding loans of over $20 million. When Comark failed to make payment, Marine foreclosed on and sold government securities with a face value of $27 Million which, under the terms of the General Loan and Security Agreement, Comark had previously pledged to it as collateral for the loan.

 Plaintiffs claim that they actually owned a substantial portion of these securities, with a combined face value totaling $17 million, that their interests in the securities were superior to Marine's, and that any security interest which Marine might have had in these securities accordingly did not take priority over plaintiffs' ownership interests. The amended complaint alleges that the plaintiffs acquired their interest in the liquidated securities through outright security purchases from, repurchase agreements ("repos"), or matched reverse repurchase agreements ("reverse repos") with Comark, and that Comark retained a security interest in the securities through collateral agreements with the plaintiffs. *fn4" They now sue Comark and Marine to recover and value of the liquidated securities.

 Marine moves for summary judgment to dismiss the claims against it as to those securities with a face value of $10.5 million which, it asserts, Comark, using money advanced by Marine, purchased from third parties unrelated to the plaintiffs. These securities, Marine claims, were pledged by Comark to Marine pursuant to the General Loan and Security Agreement, were continuously in Marine's possession, were never delivered or segregated by Marine for the benefit of any third party, and were all held in Marine's electronic book-entry account at the New York Fed. *fn5"

 II.

 A.

 The threshold issue presented by the motion is whether federal or state law applies. Marines argues that it is entitled to summary judgment as a matter of federal law under Section 306.118(a) of the federal Book Entry Regulations, which govern day to day government securities electronic clearing operations for Federal Reserve ("Fed") member banks. 31 C.F.R. §§ 306.115 - 306.122 (1984). *fn6" Subsection (a) to Section 306.118 provides in relevant part:

 
(a) A transfer or a pledge of book-entry Treasury securities to ... any transferee or pledgee eligible to maintain an appropriate book-entry account in its name with a Reserve bank under this subpart, is effected and perfected, notwithstanding any provision of law to the contrary, by a Reserve bank making an appropriate entry in its records of the securities transferred or pledged. The making of such an entry in the records of a Reserve bank shall: ...
 
(3) constitute the transferee or pledgee a holder; and (4) if a pledge, effect a perfected security interest therein in favor of the pledgee. A transfer or pledge of book-entry Treasury securities effected under this paragraph shall have priority over any transfer, pledge, or other interest, theretofore or thereafter effected or perfected under perfected under paragraph (b) of this section or in any other manner.

 Id. Marine contends that as a result of its advancing overnight loans to Comark, Comark's accompanying pledge to Marine of securities to Marine as collateral under the General Loan and Security Agreement, Marine's holding of the securities in its New York Fed book-entry account, and the operation of the Book ENtry Regulations, Marine became a "holder" of the securities and obtained a security interest superior to "any transfer, pledge, or other interest theretofore or thereafter effected or perfected." Id. Marine relies upon the plain language of subsection (a) which states that the subsection applies to "any transferee or pledgee [which, like Marine, is] eligible to maintain an appropriate book-entry account in its name with a [Federal] Reserve bank under this subpart". Id.

 Plaintiffs contest the applicability of subsection (a) and argue that state law governs the disposition of this motion under subsection (b) of Section 306.118. The ...


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