## Facts

- Waterloo Organ Company, a manufacturing corporation, issued negotiable bonds secured by a corporate mortgage to a trustee, First National Bank of Waterloo, covering all real and personal property and purporting to include after-acquired personal property.
- The mortgage permitted the company to retain possession and full control of its personalty until default, including the unrestricted right to use and sell materials and finished goods in the ordinary course for its own benefit, without limitations on use of proceeds.
- The mortgage was recorded as a real property mortgage under New York’s lien law; no separate chattel mortgage filing was required for the personal property aspects of the instrument.
- After executing the mortgage, the company continued operations and acquired additional inventory and materials; the after-acquired personalty later on hand was valued at $15,480.
- After default on interest, the bank, as mortgage trustee, took possession of stock and materials one day after default and three days before bankruptcy proceedings began.
- In bankruptcy, all real and personal property was sold in one parcel free of liens by order of the federal court; the dispute concerned entitlement to the portion of sale proceeds attributable to after-acquired chattels.
- The bank claimed its after-acquired property clause created an inchoate lien that became perfected upon taking possession and should relate back to the date of the mortgage.

## Issues

1. Whether a corporate mortgage securing negotiable bonds, which leaves the mortgagor free to possess, use, and sell inventory for its own benefit until default, creates an enforceable lien against a trustee in bankruptcy on after-acquired, shifting stock and materials when the mortgagee takes possession shortly before bankruptcy.
2. Whether the mortgagee’s pre-bankruptcy seizure can perfect an inchoate interest in after-acquired inventory so as to defeat the trustee’s rights on behalf of general creditors.

## Decision

- The New York Court of Appeals affirmed the judgment for the trustee in bankruptcy.
- The court held the mortgage did not create, as against the trustee in bankruptcy, a valid lien on after-acquired, shifting stock and materials on hand.
- The bank’s taking possession shortly before bankruptcy did not perfect the claimed lien on after-acquired inventory in a manner that would prevail over the trustee.

## Legal Principles

- An after-acquired property clause in a corporate mortgage is ineffective against a trustee in bankruptcy as to fluctuating inventory and materials when the mortgagor remains in unrestricted possession with liberty to sell and use proceeds for its own benefit.
- A security arrangement that allows the debtor to deal with inventory as owner and then permits the secured party to seize remaining stock on the eve of insolvency is treated as an impermissible floating or secret lien as against creditors represented by the trustee.
- The trustee in bankruptcy may avoid asserted interests that are not present, specific, and effectively perfected against creditors, and is not bound by an inchoate claim that becomes operative only through last-minute seizure.

## Conclusion

The court held that a bond-secured corporate mortgage permitting the mortgagor to freely possess and sell inventory does not, as against a bankruptcy trustee, create an enforceable lien on after-acquired, shifting stock and materials, and that seizure just before bankruptcy cannot retroactively validate such a claim to the detriment of general creditors.


Zartman v. First Nat’l Bank of Waterloo, 189 N.Y. 267 (1907)