## Facts

- Oriental Rug Warehouse Club, Inc. (Oriental), a retailer of oriental rugs, entered a written consignment agreement with Yashar Rug Co., Inc. (Yashar) on April 29, 1993.
- Under the agreement, Oriental took possession of Yashar’s rugs for resale and agreed to pay Yashar a total consignment price of $106,073, applying resale proceeds against Oriental’s debt to Yashar.
- On May 7, 1993, Yashar filed a UCC-1 financing statement with the Minnesota Secretary of State to perfect its interest in the rugs in Oriental’s possession.
- Oriental sold some of the consigned rugs but did not remit the resale proceeds to Yashar as agreed.
- Instead, Oriental deposited resale receipts into its general account and used the money in its business, including purchasing additional rugs to increase or replace inventory.
- Around May 1995, a representative connected to Yashar repossessed the consigned rugs that remained in Oriental’s possession; thereafter, Oriental’s inventory contained rugs, but none of Yashar’s original rugs.
- Oriental filed a Chapter 11 petition on April 15, 1996.
- On August 20, 1996, Yashar filed a proof of claim asserting a secured claim of $64,243, representing the remaining balance owed for rugs sold without remitting proceeds (after credit for repossessed rugs).
- Oriental objected to the secured status of the claim, arguing Yashar had no lien on the estate’s current inventory because the original rugs were gone and any proceeds had been commingled and spent.
- Yashar contended that Oriental’s current rug inventory was acquired with money generated by reselling Yashar’s rugs and therefore should be treated as proceeds subject to Yashar’s security interest.
- Yashar conceded it was impossible to reconstruct exactly what happened to the proceeds from the sale of its rugs, but argued the debtor should bear the burden of tracing.

## Issues

1. Whether Yashar proved that Oriental’s current rug inventory (or other estate property) constituted “identifiable proceeds” of Yashar’s original collateral under U.C.C. § 9-306, such that Yashar held a perfected security interest in that property.
2. In a bankruptcy claim objection to secured status, whether the creditor or the debtor bears the burden of tracing proceeds where sale proceeds were commingled and later used to buy replacement inventory.

## Decision

- The court sustained Oriental’s objection to the secured status of Yashar’s claim.
- The court disallowed Yashar’s secured claim because Yashar failed to prove that any current estate property was identifiable proceeds of the consigned rugs.

## Legal Principles

- A properly filed proof of claim is prima facie evidence of validity and amount, but once the debtor produces evidence rebutting the asserted secured status, the claimant bears the ultimate burden of proving the secured claim by a preponderance of the evidence.
- Under 11 U.S.C. § 502(b)(1), a claim (including a claimed lien or secured status) is not allowed to the extent it is unenforceable against the debtor or the debtor’s property under applicable nonbankruptcy law.
- Under former U.C.C. § 9-306, a security interest continues in proceeds only to the extent the proceeds are “identifiable”; the secured party must trace the alleged proceeds back to the original collateral.
- When proceeds are placed into a commingled account, Article 9 may allow a presumption that proceeds remain in the account so long as the account balance equals or exceeds the amount of the proceeds, but the secured party still must present evidence sufficient to apply that rule to the facts.
- A creditor cannot obtain a lien on later-acquired inventory merely by showing that the debtor operated a business that recycled money from sales into new stock; without tracing, later inventory is not shown to be identifiable proceeds of the original collateral.
- When the creditor concedes it cannot reconstruct the path of funds from the sale of its collateral into specific current assets, the creditor fails to prove identifiable proceeds and therefore fails to prove a secured claim in those assets.

## Conclusion

The bankruptcy court disallowed Yashar’s secured claim because, although Yashar had perfected an interest in the original consigned rugs and their proceeds, Yashar could not trace the proceeds from sold rugs—commingled and used in ongoing operations—into any identifiable property of the estate, including Oriental’s current inventory, and the creditor bore the burden of that proof after the debtor’s objection.


In re Oriental Rug Warehouse Club, Inc., 205 B.R. 407 (1997)