author: OAKES, Circuit Judge: MULLIGAN, Circuit Judge

text:
    REPUBLIC TECHNOLOGY FUND, INC., Plaintiff-Appellant, v. The LIONEL CORPORATION, Defendant-Appellee. The NEW ENGLAND INDUSTRIES, INC., Plaintiff-Appellant, v. The LIONEL CORPORATION, Defendant-Appellee.
    Nos. 529, 530, Dockets 72-1901, 72-1902.
    United States Court of Appeals, Second Circuit.
    Argued March 13, 1973.
    Decided July 17, 1973.

      Sheldon H. Elsen, Orans, Elsen & Pol-stein, New York City (Lewis Shapiro and Leslie A. Lupert, New York City, on the brief), for plaintiffs-appellants.
    James E. Tolan, Olwine, Connelly, Chase, O’Donnell & Weyher, New York City (Judith S. Kaye, New York City, on the brief), for defendant-appellee.
    Before HAYS, MULLIGAN and OAKES, Circuit Judges.
   OAKES, Circuit Judge:

This case is the unhappy aftermath of a corporate marriage gone sour, with the bride’s family claiming that the groom failed to disclose a number of liabilities at the time of the negotiations leading up to the nuptials. The appeal is from a judgment absolving the appel-lee from liability under either contractual or securities law in connection with an interim (six months’) financial statement, used in proxy materials and in a registration statement, prepared relative to the merger of Hathaway Instruments, Inc. (“Hathaway”), into The Lionel Corporation (“Lionel”). Appellants were stockholders in Hathaway. Their principal claim below and here is that the interim statement (and hence the proxy materials and registration statement) was misleading in that it artificially inflated earnings because it did not reflect $2,221,000 of adjustments that at year’s end were ultimately required and also because it contained no write-off of good will of a subsidiary that was losing money at the time. The case essentially involves, therefore, the scope of a corporation’s duty to make its interim financial statements accurately reflect the real state of fiscal affairs prior to a merger, or, put another way, the extent to which in an interim statement adjustments that are or should be made at year’s end must be anticipated.

I. FACTUAL BACKGROUND AND PROCEEDINGS BELOW.

Appellants are both investment funds. Appellant Republic Technology in July, 1960, purchased 25,000 shares of common stock in Hathaway. This stock was not registered but Hathaway had agreed to use its best efforts to cause it to be registered on request from Republic Technology. Appellants between them later purchased another 40,000 shares of Hathaway stock in March, 1961. In return, Hathaway agreed that it would prepare and file with the SEC a Registration Statement for the stock on or before May 15, 1961, and that it would use its best efforts to the end that such registration would become and remain effective for a period of not less than 24 months from the effective date thereof. No request to register was required under the March, 1961, purchase.

Lionel was the well-known toy and train manufacturer that, after some years of successful operations, entered into a program of corporate acquisitions, one of which was Anton-Imco Electronics Corp., which in turn owned Intercontinental Manufacturing Co., Inc., and Anton Electronics Laboratories Inc. (Anton-Imco and its two subsidiaries are sometimes collectively referred to herein as the “Anton-Imco” or “electronics division” of Lionel.) Further to complicate matters a little, the Anton Electronics Laboratories Inc. corporate name was changed in March of 1961 to Lionel Electronic Laboratories Inc. (hereinafter “Lionel Labs”), but it remained with Intercontinental a subsidiary of Anton-Imco. Lionel Labs made “radiation detection and measuring devices” and “electronic and electro-me-chanical devices.” Intercontinental manufactured aircraft and missile components. These last two together provided, apparently, some “glamor” to the corporate package. Other Lionel acquisitions included Airex, a fishing tackle concern, and Telerad, a “microwave components” concern. Up to the ultimate Hathaway merger in November, 1961, the stock of Lionel had been selling at two to four times its book value despite the fact that even on the June 30, 1961, interim statement here in dispute Lionel was losing money during the first six months of 1961.

Prior to the Lionel merger, appellant Republic Technology exercised its option to request registration of its Hathaway shares and on or about May 7, 1961, Hathaway filed a registration statement. When merger discussions with Lionel commenced in June of 1961, however, Hathaway requested permission from the SEC to withdraw this registration statement. This permission was not granted until late September when Lionel filed its registration statement with the SEC.

Meanwhile, however, unaudited financial statements for the six months’ period ending June 20, 1961, had been prepared for Lionel and Hathaway and a combined pro forma for that period had also been prepared. These figures showed a six months’ loss for Lionel of $84,000 or $.06 per share and a combined pro forma profit of $245,000 or $.08 per share. It is the omission of the Lionel statement to show certain adjustments made at year’s end or to take into account by way of adjustment to Anton-Imco good will that subsidiary’s losses that is the crux of the controversy here.

The interim statements were used in connection with the agreement of merger dated September 15, 1961. Under its terms Lionel agreed to file on or before October 15, 1961, a registration statement covering all stock acquired by Hathaway stockholders which by previous agreement Hathaway was legally obligated to register. Lionel also agreed to undertake Hathaway’s obligations to effectuate and maintain the effectiveness of a registration statement. The same six months’ figures were used in the proxy materials submitted to Hathaway and Lionel stockholders to obtain their approval of the merger, which approval ensued on October 25, 1961, effective on November 6, 1961. They also were used in the registration statement, Form S-l, filed with the SEC on September 28, 1961, by Lionel. Pursuant to the merger appellants exchanged their 65,000 shares of Hathaway common for 21,667 shares of 3%'% convertible preferred stock of Lionel.

There were a number of adjustments recorded as of December 31, 1961, as a result of the year-end audit or of events occurring during the fourth quarter of 1961. Of these, the ones appellants most insistently claim should have been reflected in the June 30 interim statement are:

1. Inventory write-downs: In Lionel’s toy and train division $262,830 for inventory obsolescence was written down in the fourth quarter or written off as at December 31; $140,000 was a write-off- as “raw material price variance,” $77,946 was a write-down to lower of cost or market; and the rather remarkable sum of $256,000 was written off as “unlocated difference between December 31, 1961 book and physical inventory.” In Lionel’s Telerad division $100,000 of inventory was written off in the fourth quarter and $440,000 was required to be written off at year’s end. In Lionel Labs $200,000 was written down in inventory at year’s end. The total of these year-end write-offs yras $1,476,776.

2. Sales returns and allowances: A total of $106,000 was provided at year’s end for sales returns and allowances in the toy and train division and the Airex division.

3. Research and development: Research and development costs totaling $226,983 in the toy and train division and $163,000 in Lionel Labs were written off at year’s end.

4. Deferred selling, advertising and service expense: Lionel wrote off $249,000 of these expenses in its toy and train division at year’s end.

The total of the above adjustments which were made at year’s end is $2,221,659.

Appellants also claim that the interim statement:

5. Should have reflected a write-off in good will attributable to Lionel’s Anton-Imco division, which was carried at $998,000, despite a $189,000 loss for the first six months of 1961;

6. Should have reflected a greater reserve for bad debts, sales returns and allowances;

7. Should not have included two credit items (one for sales returns and allowances of $24,000 and one for cooperative advertising expense at $19,234) and one government contracts item of $51,369.

Appellants point out that each $30,000 of adjustments would have reduced profits shown in the proxy materials and registration statement by one cent per share (of the merged company). Indeed, after the year-end adjustments were actually made, without even counting any write-down of Anton-Imco good will, the consolidated profit expected to be shown in the interim statement became a loss in the sum of $1,898,609, and when added to this were $633,668 of special charges, the overall loss totaled over $2.5 million or $1.71 per share.

The district court, sitting without a jury, took' testimony both from appellants’ accounting expert, Mr. Duchan, and from Mr. Easton, the senior managing accountant for S. D. Leidesdorf & Co. (“Leidesdorf”), independent certified public accountants, who worked on the Lionel audits in 1960 and 1961. Mr. Easton testified both to his preparation of the financial statements in question and as an accounting expert. It may not come as a surprise that while Mr. Duchan testified that in his opinion the June 30 statement should have reflected a substantial portion of the adjustments that were actually made at year’s end, Mr. Easton’s testimony was to the effect that the interim statement was accurate (in addition to being in accordance with the same generally accepted accounting principles used in Lionel’s year-end statements and its prior financial statements).

The district court in an opinion printed at 345 F.Supp. 656 (S.D.N.Y.1972) held that plaintiffs (appellants) had “not established by a fair preponderance of the evidence that the June 30 Financial Statements were materially false or that Lionel omitted to state any material fact necessary to make the statements not false or misleading.” 345 F.Supp. at 662. It sought to distinguish Kaiser-Frazer Corp. v. Otis & Co., 195 F.2d 838 (2d Cir.), cert. denied, 344 U.S. 856, 73 S.Ct. 89, 97 L.Ed. 664 (1952), on the ground that the Kaiser-Frazer management used figures in its interim statement that they knew to be untrue while there was no evidence that the Lionel management acted similarly. 345 F. Supp. at 663. It found no violations of § 17 of the Securities Act of 1933, 15 U.S.C. § 77q, or of § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder. While holding that the Hathaway proxy statement was not subject to § 14 of the 1934 Act, 15 U.S.C. § 78n(a), and Rule 14a-9, 17 C.F.R. § 240.14a-9 (since the Hathaway common was not registered), the court also held that plaintiffs had failed to establish that the proxy statement was materially misleading or that it had omitted material facts necessary to make it not false or misleading. 345 F.Supp. at 663 n.6. With respect to the contractual claims, the court found that the interim financial statements were not materially misleading, and that the Lionel registration statement and prospectus did become effective within a reasonable time. Further, the court held that Lionel had discharged its obligation as Hathaway’s successor to use best efforts to keep the registration statement and prospectus effective, because it was the unwillingness of the auditor to certify the necessary financial statements due to Lionel’s accumulating losses that largely led to delay in registration and the ineffectiveness of the registration. The complaint was accordingly dismissed. We will discuss the securities law claims separately from the contractual law claims, and in that order.

II. SECURITIES LAW CLAIMS.

A. Section H and Rule Har-9. We commence by agreeing with the district judge in respect to his treatment of the claim under Securities Exchange Act § 14 and Rule 14a-9. The claimed violation of the proxy rules must fail because proxies were not solicited “in respect of any security . . . registered pursuant to section 12” of the Act. Securities Exchange Act of 1934, § 14(a), 15 U.S.C. § 78n(a); SEC Rule 14a-2, 17 C.F.R. § 240.14a-2. See 5 L. Loss, Securities Regulation 2835-36 (1969). Thus, whatever the scienter requirement in respect to a private action for damages to redress a § 14 and Rule 14a-9 violation, see Gerstle v. Gamble-Skogmo, Inc., 478 F.2d 1281 at 1299-1301 (2d Cir., May 9, 1973), there is simply no liability in respect to proxy-rule violations here.

B. Rule 1 Ob-5, § 17 and Lionel’s Interim Accounting. Under both Rule 10b-5 and § 17 of the Securities Act of 1933, 15 U.S.C. § 77q(a), however, it is necessary to determine whether Lionel made “any untrue statement of a material fact” or an omission “to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading. . . .” Were the interim financial statement and the proxy statement and initial registration statement which utilized the interim statement “misleading” in view of “the circumstances” underlying the transacaction ? In answering this question we must, of course, give full weight to the district court’s findings of fact, even while we are free to look to the application of the securities law to the facts found. See Chris-Craft Industries, Inc. v. Piper Aircraft Corp., 480 F.2d 341 at 364 (2d Cir., 1973), (opinion of Timbers, J.). Taking the evidence in the light most favorable to the defendant, Lionel, we nevertheless find certain omissions in the interim statement to have been misleading.

1. Anton-Imco Good Will. We commence with the $998,000 item for good will of Anton-Imco Electronics Corp., as to which the interim statement of earnings reflected no discount even though this subsidiary had sustained a loss of $188,842 as of June 30. Mr. Easton, Lionel’s auditor, acknowledged that the operating loss of Anton-Imco was a “factor to be considered” in deciding whether there was a diminution of the good will. He felt, however, that this single factor was outweighed by the fact that Anton-Imco was only in its first year of operation as a Lionel subsidiary and in his words was “engaged in the development of a new machine — I believe it was a money sensor, a money changing device — and based on all the information that was available at that time the prospects for success seemed very reasonable.” Thus, in the opinion of Mr. Easton, credited by the district court, despite Anton-Imco’s losses there was no “diminution in value” of its good will.

We cannot accept Mr. Easton’s evaluation as a matter of law. The notes to the consolidated interim statements of income contain the following statement:

This company recently designed and developed a currency recognizing device, several prototype models of which have been built up to this time. The device has not yet been marketed and there is no assurance at this time as to whether it will be a profitable item.

Nowhere do the notes in any way indicate that Anton-Imco had shown a $189,000 loss as of June 30 or that the retention of $998,000 as its good will was based upon the prospects of success of this currency recognizing device which had not yet been marketed. Cf. Petersen Engine Co., Inc., 2 S.E.C. 893, 906 (1937); Lewis American Airways, Inc., 1 S.E.C. 330, 342 (1936) (misleading to designate “patent applications” as “patent rights” or “patents” under intangible assets heading in a balance sheet). Indeed, since the interim statements do not include a balance sheet but only consolidated statements of income they contained no reference at all to the good will item. This makes them, in our view, all the more misleading. The person viewing the statements would have no reason to suspect that the consolidated earnings were at least subject to question since despite a loss on the part of a major division for the first half-year, its good will was still being carried at a full initial valuation equivalent to about 8 per cent of the Lionel total book value. Cf. R. Mautz, Financial Reporting by Diversified Companies 157-58 (1968) quoted in T. Fiflis & H. Kripke, Accounting for Business Lawyers 556-57 (1971) (investor needs to know “relative importance” of several industries comprising a diversified corporation accurately to forecast future prospects). This is particularly so when the notes emphasize optimistic items, e. g., calling attention to the fact that the interim statement did not include certain “special items” (including such things as elimination of a $22,444 reserve for certain employee benefits) that would have improved the earnings by $.10 per share in toto for the first six months of 1961. In other words, the voters on the merger were being shown the frosting on the cake with no allusion in the statements to the fact that a substantial part of the cake itself was dried out, if not mildewed. Cf. Globe Aircraft Corp., 26 S.E.C. 43, 46-47 (1947).

At the very least, good disclosure accounting would have required the notation of some uncertainty regarding the overall interim Lionel profit picture based on this item alone, uncertainty which should have been footnoted, to avoid misleading the stockholder. See SEC Accounting Series Release No. 62, 4 CCH Fed.Sec.L.Rep. ¶ 72,081 at 62,149 (1947) (footnoted explanation must be included in a summary earning statement if the information it would contain is of such “special significance [that] ... its omission would be likely to give rise to misleading inferences”). Cf. Metropolitan Personal Loan Corp., 7 S.E.C. 234, 239 (1940) (even assuming deferred asset account could be written off in a single year, footnoted explanation required to make income statement not misleading). While stockholders who are voting on a merger are not to be treated like “children in kindergarten,” cf. Gerstle v. Gamble-Skogmo, Inc., supra, 478 F.2d at 1297, they are entitled to disclosure of the bitter with the sweet. They are at least entitled to assume that the interim financial statements furnished them by their own company or the other party to the merger will give them better than “ballpark” figures and be based on principles of conservatism which the American Institute of Certified Public Accountants speaks of as “a general tendency toward early recognition of unfavorable events and minimization of the amount of net assets and net income.” I APB Accounting Principles § 1022.27 at 140 (CCH ed. 1971). The stockholders are entitled to assume that uncertainty concerning profit or loss should be at least footnoted in the first financial statement issued after the uncertainty arises.

This is, perhaps, another way of saying that in a day and age of mergers and conglomerates — Lionel in the 1960 era was what might be called a baby conglomerate, branching out from toy trains to outboard motors, fishing tackle, electronic and nuclear instruments, and educational science toys, among other things, in addition to “currency sensors” — it is as important to shareholders, perhaps more so, that interim statements issued for merger approval purposes accurately reflect corporate events as that the year-end financial statement dressed in the pretty package of an annual report be in accordance with sound or generally accepted accounting principles. Fairly to be able to vote on a merger requires accurate information. Perhaps nothing is more relevant to a vote on whether or not to approve a merger than the earnings picture of the acquiring company, at least to the stockholder of the company being acquired. As was said by Judge Augustus Hand in the somewhat different but nevertheless analogous situation of a registration statement regarding stock in a new automobile company, “it is evident that the prospective purchaser of . stock would rely heavily on the corporation’s sales and earnings during the last quarters . . . without a favorable picture of earnings for that period the proposed stock issue could not have been made.” Kaiser-Frazer Corp. v. Otis & Co., supra, 195 F.2d at 840. Here, as there, sales and earnings were set forth in summarized form in a table and “[i]t is apparent, then, that the table summarizing earnings was an important factor in the sale of the stock (or merger, as the case might be) . . . .’’Id. Here, as there, “failure to make full disclosure therein of all the facts bearing upon the Corporation’s earnings” was misleading. Id. We do not agree with the district court that Kaiser-Frazer is distinguishable from this case. Here, as there, the accounting presentation in the summary income statement did not disclose facts of real significance to the voting stockholder. Issues of scienter are and should be separable from the question whether the financial statements were in fact misleading. (See Part IIC of this opinion infra.) We hold that the omission by Lionel to make any reference in the interim statement to the substantial good will item and the significant interim loss, when ■ coupled with mention of the unmarketed “currency recognizing device” was misleading as a matter of' law.

2. Inventory Write-downs. The same does not hold true, however, for the extraordinarily high inventory adjustments made at year’s end in reference to the toy and train division and the Lionel Labs. Only a year’s end physical inventory was taken; the interim statements point this fact out and indicate that merchandise inventories in the interim statements were “estimated by the management by adding purchases, direct labor and factory overhead . and deducting therefrom estimated cost of goods sold,” the interim overhead being allocated to the cost of goods sold on the basis of 1960 and 1961 estimated annual production and sales. This disclosure makes virtually unassailable the district court finding that at least as regards the $77,946 “shrinkage” and the $256,000 “unlocated difference” items in the toy and train division there was nothing misleading. To discover a shrinkage or lost (or stolen) merchandise requires a physical inventory, and there is no contention here, nor was there any below, that a physical inventory should have been taken as of June 30.

The statement in the notes also supports the findings in reference to the $540,000 written off at year’s end in the Telerad Division; according to Easton’s testimony he made inquiry in connection with the June 30 statement and ascertained that the general manager of the Telerad Division expected the rather large inventory accumulation to be recoverable in future sales. The notes to the interim statement indicate that the inventory figures were based on management estimates and there was no evidence from which the court below could have found that the Telerad estimate was unreasonable at the time it was made.

There was also a $262,830 year-end adjustment in the toy and train division for “inventory obsolescence” and an unexplained $200,000 write-down in the Lionel Labs inventory. Besides a passing reference to the existence of the $200,000 Lionel Lab inventory write-down in a footnote, however, the court’s opinion or findings do not mention it further. But the trial court found that because the toy and train business was seasonal, the season being a Christmas one, with less than 10 per cent of the company’s business emanating from the spring toy sale, the obsolescence could not have been anticipated as of June 30; again we cannot disregard this finding, one of fact. From this, coupled with the court’s other findings in respect to inventory write-downs and the absence of any evidence indicating that something occurred prior to June 30 to warrant a write-down for obsolescence or the like, we believe that the court below treated this write-down as similar to others. If we are wrong, however, the district court will have an opportunity to correct us on the remand of the case.

The inventory adjustment most difficult to deal with is the year-end $140,000 “raw material price variance,” because it would seem fairly certain that manufacturing and raw material purchases must have occurred well before June 30, even in the Christmas seasonable toy and train division. The court’s “finding” that “there was no evidence presented from which the need of such an adjustment could be determined, or any evidence as to Lionel’s raw material purchases during the six-month period,” 345 F.Supp. at 660, must be examined in the light of the expert testimony that generally accepted accounting principles require interim inventory adjustment and the likelihood that a substantial portion of the raw material purchase price variance was known to Lionel before June 30. These facts seem to us to place on Lionel the burden of going forward with evidence to show that no adjustment needed to be made; here there was every reason to suppose that a substantial portion of the variance occurred prior to the date of the issuance of the statements for merger purposes. Cf. Bowman & Bourdon, Inc. v. Rohr, 296 F. Supp. 847 (D.Mass.), aff’d per cu-riam, 417 F.2d 780 (1st Cir. 1960) ; T. Fiflis & H. Kripke, supra at 237-38.

3. Sales Returns and Allowances. One might think indefensible the omission in the interim statements to make any adjustment for sales returns and allowances, items which amounted to $54,000 in the toy and train division and $52,000 in the Airex (sometimes referred to as the fishing tackle) division. An S — 1 Registration Statement requires inclusion of “Gross sales less discounts, returns and allowances.” 17 C.F.R. § 210.5-03-1A. Since the train business is, as we say, “Christmas seasonable,” one would think that returns and allowances would occur early in the following year, and hence would have to be shown in the following interim statement. But the trial court accepted Mr. Easton’s testimony that October, November and December sales would be reduced by January and February returns and allowances as meaning that only the year-end statement would show any substantial amount for returns and allowances. We are bound by that finding, which does not appear to be clearly erroneous.

As to Airex, the so-called fishing tackle division, there was evidence that the fishing tackle business is seasonal in the spring. There was also evidence, however, again from Mr. Easton and again believed by the trial court, that the Air-ex returns and allowances related to Japanese manufactured baseball gloves, golf equipment and some other equipment that Airex sold in the second half of the year, and that Airex had gone out of the fishing tackle business altogether in March of 1961. Here again Easton testified that no June 30 adjustment was required because the great bulk of returns and allowances occurred right after Christmas sales. The trial court accepted the testimony and its finding was not “clearly erroneous.”

4. Research and Development. Research and development (R & D) costs totaling $226,983 in the toy and train division and $163,000 in Lionel Labs were written off at year’s end. It is no answer, we feel, to say as both Mr. Easton testified and the court “found” (again, basically repeating Easton’s testimony) that “Lionel reviewed its research and development projects as at June 30” and when Easton’s firm, Liedesdorf, made the year-end audit it found nothing to indicate that an adjustment for R & D expense write-off should have been made at June 30. Such findings tell us nothing about the basis for Lionel’s and Liedesdorf’s conclusions. It is a partial answer to say, as appellee’s brief points out, that in fact $40,205.99 of R & D expense was written off at June 30, but an examination of the exhibit to which this refers shows that this was in the electronics division, for “abandoned projects.” There remains unexplained why no adjustment was made at June 30 in the toy and train division, and here too we think the burden of going forward was upon Lionel. Here too we are talking about a substantial write-off item which at year’s end represented about 2 per cent of the book value of the company, as well as several cents a share profit (or loss).

5. Deferred Selling, Advertising and Service Expense. Some $249,-000 of selling, advertising and service expenses were treated as “Deferred Charges” at June 30 and written off at the end of the year. The court evidently relied upon Easton’s testimony in respect to the bad debt reserve differential between June 30 (a reserve for “Doubtful Accounts” of $72,000 against accounts receivable of $3,312,000 or 2.1 per cent) and year’s end (a reserve of $315,000 for “Doubtful Accounts, Discounts, Returns and Allowances” against $3,649,000 of accounts receivable or 8.5 per cent). That testimony essentially pointed out that the reserve at year’s end included a reserve for discounts, returns and allowances, items not included as of June 30. Appellants’ response is that to the extent that the understatement in June involved sales returns and allowances it duplicates appellants’ argument that a June 30 adjustment was needed for those items. Again, however, it must be remembered that Lionel’s business was Christmas seasonal. Over-reporting of deferred expenses early in the year might well not have provided an accurate picture of the company’s condition. Appellants failed to present evidence that the year-end reserves were overstated in relation to the full year’s sales. For all we know the entire difference of almost 6 per cent between the ratio of reserve to accounts receivable in the interim and the year-end statements may be explained by the addition of a reserve at the end of the apparently bad selling year of 1961 for sales returns and allowances.

6. Miscellaneous Items. The three miscellaneous items regarding a contract price adjustment on a government contract, a credit balance in sales returns and a credit balance in a cooperative advertising expense account together amount to about $94,000 and were treated by the court below as having been too small to “have materially changed the overall [interim] picture. . . . ” 345 F.Supp. at 662. We are constrained to agree.

7. Summary. In summary, then, we believe that there was a misrepresentation in respect to the $998,000 good will item, the $140,000 raw material price variance and the $226,983 R & D costs in the toy and train division, and that on the basis of the evidence adduced the interim statement should have disclosed uncertainty regarding the first and made some adjustment in respect to the other two. Absent further proof we may assume that the adjustment should have equaled 50 per cent of the last two adjustments that were actually made at year end, or $70,000 and $113,491 respectively, sums which we find substantial enough to warrant consideration on remand.

C. Materiality, Scienter and Reliance. The district court did not consider separately the issues of materiality on the one hand and deceptiveness of the representations in the interim statements on the other hand. Rather, as we have indicated, its findings were basically to the effect that each of the alleged omissions did not involve a “misrepresentation.” Since we have found, however, that in certain respects there were misrepresentations, we must remand unless we can say that under no construction of the evidence could the district court find that the misrepresentations were material or that there was established the necessary culpability on the part of Lionel. We by no means can say so.

We have touched upon the issue of materiality in reference to the Anton-Imco good will issue. Where a merger is in prospect, the earnings picture of the acquiring corporation has to be of real significance to the stockholders of the corporation proposed to be acquired, and the most current earnings are of the highest importance. See Kaiser-Frazer Corp. v. Otis, supra. Accordingly, failure to convey these earnings accurately, if the discrepancy is at all substantial, has to be material to the person being misled. The test in this 10b-5 and § 17 case is the same as set forth (albeit in a 14(e) case) by Judge Timbers:

The concept of materiality focuses on the weightiness of the misstated or omitted fact in á reasonable investor’s decision to buy or sell. We articulated the materiality standard in List v. Fashion Park, Inc., 340 F.2d 457, 462 (2 Cir.), cert. denied, 382 U.S. 811, 86 S.Ct. 23, 15 L.Ed.2d 60 (1965), to be “whether ‘a reasonable man would attach importance [to the fact misrepresented] in determining his choice of action in the transaction in question.’ ” The materiality test is concerned only with whether a prototype reasonable investor would have relied. See Heit v. Weitzen, 402 F.2d 909, 912-914 (2 Cir. 1968), cert. denied, 395 U.S. 903, 89 S.Ct. 1740, 23 L.Ed.2d 217 (1969). Account must be taken of all the surrounding circumstances to determine whether the fact under consideration is of such significance that a reasonable investor would weigh it in his decision whether or not to invest. See SEC v. Texas Gulf Sulphur Co., Supra, 401 F.2d [833], at 849 [(2 Cir. 1968) (en banc), cert. denied sub nom. Kline v. SEC, 394 U.S. 976, 89 S.Ct. 1454, 22 L.Ed. 756 (1969)]. Chris-Craft Industries, Inc. v. Piper Aircraft Corp., supra, 480 F.2d at 341 (footnote omitted).

The district court never reached the question of culpability. On remand it should do so, bearing in mind that to a large extent the accountants preparing the interim figures were relying upon management for information and advice. The test to be applied is clear in terms, if not in application. As explicated most recently in the opinions of Judge Timbers and Judge Mansfield in Chris-Craft Industries, Inc., supra, slip op. at 362 (Timbers, J.) and at 396 (Mansfield, J.), something short oi specific intent to defraud is require'd and something more than “mere” negligence; certainly, knowledge of the fact that the figures created a false picture is enough, and on the part of sophisticated corporate managers a reckless disregard of’the truth is sufficient. See Lanza v. Drexel & Co., No. 35794, 479 F.2d 1277 at 1306 (2d Cir., Apr. 26, 1973), (en banc); Shemtob v. Shearson, Hammill & Co., 448 F.2d 442, 445 (2d Cir. 1971) (dictum) ; Globus v. Law Research Service, Inc., 418 F.2d 1276, 1290-1291 (2d Cir. 1969), cert. denied, 397 U.S. 913, 90 S.Ct. 913, 25 L.Ed.2d 93 (1970); Heit v. Weitzen, 402 F.2d 909, 913-914 (2d Cir. 1968), cert. denied, 395 U.S. 903, 89 S.Ct. 1740, 23 L.Ed.2d 217 (1969); SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 854-855 (2d Cir. 1968) (en banc), cert. denied sub nom. Kline v. SEC, 394 U.S. 967, 89 S.Ct. 1454, 22 L.Ed.2d 756 (1969). See also SEC v. Manor Nursing Centers, Inc., 458 F.2d 1082, 1096 n. 15 (2d Cir. 1972). We are satisfied that on the remand that we require, the district court will treat the issues of materiality and culpability with specificity and in the light of the more recent pronouncements of this court and its various panels.

III. THE CONTRACT CLAIMS.

Appellants below claimed three separate breaches of contract by Lionel that were dealt with by the district court. The first breach claimed was of the Agreement of Merger since the registration statement filed thereunder was materially misleading and hence defective. The trial court held that it was not “materially misleading” and hence against appellants on this claim. Since we have found it to have been misleading and leave open the question of materiality— to be decided under the less strict principles of contract law — we must remand in this respect also.

The second breach of contract claimed was that Lionel did not cause a registration statement to become effective with respect to appellants’ stock within a reasonable time. The district court held that both Hathaway and Lionel filed registration statements within the time they were obliged to do so, and that the former’s was withdrawn on account of the merger. It also found that, while Lionel’s registration statement bécame effective after three amendments some 51 weeks after it was filed, this was not an unreasonable length of time, since Lionel was cooperative and the law firm representing it before the SEC was diligent and competent.

We disagree with the district court in respect to this second alleged breach. To the extent that the delay of one year occurring before the S-l became effective was a result of the originally misleading interim statement accompanying the S-l, the delay may well have been unreasonable. There was expert testimony that six to eight weeks was all that should have been necessary to effectuate the S-l since much of the work going into it had already been done by Hathaway and in connection with the proxy solicitation on the merger vote. In regard to the extent to which delay may have been precipitated by or contributed to by the misleading interim statements, both the findings and the evidence seem to be insufficient. One of the reasons for the delay stated by the court (in accord with the testimony of Lionel’s SEC lawyer) was that based on preliminary figures that Lionel developed with regard to its year-end (1961) results, it became likely that amendment with a year-end audit would be required. Developing the audit, of course, took some additional time (during which a comparison of 1961 with the latest, i.e., 1962, figures also became required). But one of the reasons for the bad-looking year-end figure was that the interim statements filed with the S-l had not truly reflected the worsening financial situation that appears to have been developing through the first half of 1961 while accelerating in the second half. Moreover, while we have said that there was insufficiency of proof to show that the interim statement was misleading in respect to inventory write-downs and sales returns and allowances (and reserves), the write-downs were ultimately rather huge in amount and whatever it was that brought them about may not necessarily be used to justify the delay in filing an effective registration statement that occurred. On remand these issues may be better explored, and the findings in respect to them stated in greater depth.

The third breach claimed was that Lionel did not maintain effective registration for 24 months within the meaning of Hathaway’s obligation to appellants to which by the merger Lionel had succeeded. The trial court held, however, that since the failure to maintain effectiveness was due to the accountants’ “unwillingness to certify the necessary Financial Statements because of Lionel’s accumulating losses” and the institution of a lawsuit in the state courts of New York (said to have been by the appellants here on the same general grounds claimed in this action), 345 F.Supp. at 666, there was, in the district court’s view, no indication that Lionel had not used its “best efforts” to maintain effectiveness, which is all that it was required to do.

Much the same may be said of the alleged third breach as of the second. The court below found that to a certain extent the failure to maintain effectiveness of the registration was owing to the accountants’ unwillingness to certify the necessary financial statements. According to the 1962 annual accountants’ report, that unwillingness was based upon the failure of the company to maintain the net working capital required under the indenture covering its 5% per cent convertible subordinated debentures and “the possible failure to observe other indenture covenants.” Again, however, to the extent to which that unwillingness was precipitated or contributed to by the misleading interim statements, or to faulty information conveyed by management to the certifying accountants, there may have been an omission to use “best efforts” to maintain effectiveness. Here too on remand the issue may be explored in greater depth.

While the parties seek to have us rule on the additional defenses of abandonment, laches, estoppel and the running of the statute of limitations, these are all issues which the district court failed to reach, and absent specific findings we are not inclined to uphold or reject any of these defenses. See note 13, supra.

Reversed and remanded for findings in accordance with this opinion.

MULLIGAN, Circuit Judge

(concurring) :

While I concur in the reversal and remand here, I am not satisfied that the test of culpability under Rule 10b-5 has been articulated adequately in the majority opinion. Judge Oakes adopts the standard explicated in Chris-Craft Industries, Inc. v. Piper Aircraft Corp., 480 F.2d 341 (2d Cir., 1973), in the opinions of Judges Timbers and Mansfield, and characterizes it as something short of specific intent and something more than mere negligence. In fact^ the latest statement of the rule is in’ the en banc opinion of Judge Moore) for this court in Lanza v. Drexel & Co., 479 F.2d 1277 (2d Cir., 1973), where we said: “In sum, we believe that j)roof of a willful or reckless disregard for the truth is necessary to establish liability under Rule 10b-5.” (id. at 1306). Footnote 98 indicates the obvious- — that in detemining the liability of a defendant, his corporate responsibilities must be taken into consideration.

Since this is the latest statement of the rule of this circuit and the en banc was granted primarily to clarify the rule, I see no reason at all for relegating it here to a list of some seven prior cases which we advise the court below to consider. I would now abide by the rule we so recently adopted.

      . There were 1,022,727 shares of Hathaway stock as of the effective date of the Hathaway-Lionel merger on November 6, 1961.

      . The “special charges” apparently did not relate to the items objected to by appellants but to moving, consolidation, contractual and uniform accounting expenses; one might call them the hidden expenses of merger.

      . Securities issued or surrendered in a merger are purchased or sold for 10b-5 purposes. Dasho v. Susquehanna Corp., 380 F.2d 262, 266-267 (7th Cir.), cert. denied sub nom. Bard v. Dasho, 389 U.S. 977, 88 S.Ct. 480, 19 L.Ed.2d 470 (1967). See 1 A. Bromberg, Securities Law Fraud, SEC Rule 10b-5 § 6.5(2) at 138-38.1 & 138.1 n. 95 (1971).

      . For the full 12-month period the loss was some $724,000 and there was apparently considered at year’s end a partial write-down of $307,984 in the good will item, but this was not taken.

      . The exhibits supplied do not contain any balance sheet. But the proxy statement in support of the merger sets forth a $9.89 per share book value for Lionel stock as of June 30, 1961, and that there were 1,138,455 shares of Lionel stock outstanding at that date. This would result in a total Lionel book value of $11,259,519.95.

      . Which is not to imply that negligence alone is enough to support a 10b-5 violation. See Part IIC of this opinion infra.

      . Technically, this was not a finding, but rather a repetition in the court’s findings of Easton’s testimony. This was true in a number of instances, and we would caution that a mere repetition of testimony is not a finding. See generally 2B W. Barron & A. Holtzoff, Federal Practice and Procedure § 1127 (1961).

      . There is some confusion here, both in Easton’s testimony and the court’s findings in the light of a Leidesdorf schedule prepared in April, 1962, indicating that perhaps this item should have been written off as of September 30, 1962. The confusion is not aided by the somewhat arcane accountant’s jargon describing this: “[deferred selling, advertising and service expenses deferred as at September 30, 1961, which should have been expensed at September 30, 1961, if the budgeted sales and expense used in the September 30, 1961, computation of the deferral were actual sales and expense for the year 1961.” Since there is no indication that sales fell off projections before June 30, however, we need not probe the mysteries of this item.

      . The court also said there was “no showing that any of them involved a material misrepresentation.” 345 F.Supp. at 662.

      . All of this relates solely to the alleged securities law violations. The contract claim will be dealt with separately. .

      . As refined in the opinion of Chief Judge Friendly in Gerstle v. Gamble-Skogmo, Inc., No. 72-2259, 478 F.2d 1281 (2d Cir., May 9, 1973), the standard of materiality in a case under § 14(a) where negligence alone suffices to establish culpability, at 1298-1301, is somewhat higher : “ . . . a standard tending toward probability rather than toward mere possibility is,” Judge Friendly said, “more appropriate.” Id. at 1302. Here of course this would be a § 14 action were it not for the fact that the securities were not registered. But to attempt to refine the standard of materiality even further to suit this case would, we think, be distinguishing, and dividing “A hair ‘twixt south, and southwest side.” S. Butler, Hudibras Pt. I, Canto I, 1. 65.

      . Appellants also claimed that the filing of an S-l by Lionel did not really constitute a filing since it contained a materially misleading financial statement. In our treatment of the case this question need not be resolved.

      . The lawsuit was apparently brought on April 2, 1963, and was dismissed on May 11, 1966, for lack of prosecution. Appellee asserts it in bar here. Appellants claim that Lionel subsequently retained their lawyer (cf. Ernie Industries, Inc. v. Patentex, Inc., 478 F.2d 562 (2d Cir., 1973)), and that he told the New York Stock Exchange at a Lionel delisting hearing that the state suit had been abandoned. In any event, the instant federal action was instituted by other counsel at or about the time of the dismissal of the state action in 1966, and after discovery the case was _ not tried under the old master calendar system until June 4, 1971, and not decided until June 21, 1972. The district court did not reach the questions of laches, estoppel, abandonment and expiration of the statute of limitations, see Sack v. Low, 478 F.2d 360 (2d Cir., 1973), raised by appellee here, but these defenses will be available on remand. Cf. Modrey v. American Gage & Machine Co., 478 F.2d 470 (2d Cir., 1973).


source: Caselaw Access Project

author: CLARK, Circuit Judge:

license: Public Domain

text:
    The SOCIALIST WORKERS PARTY et al., Plaintiffs-Appellees, v. Attorney General John L. HILL and Mayor Louie Welch, Individually and in their Representative capacities, et al., Defendants-Appellants.
    No. 73-3325.
    United States Court of Appeals, Fifth Circuit.
    Aug. 6, 1973.
    Rehearing and Rehearing En Banc Denied Nov. 8, 1973.
    Joseph G. Rollins, Senior Asst. City Atty., Houston, Tex., for Welch.
    John L. Hill, Atty. Gen. of Tex., Sam L. Jones, Jr., W. O. Shultz, II, James C. McCoy, Asst. Attys. Gen., Robert W. Gauss, Austin, Tex., for Crawford Martin and Bullock.
    Ronald D. Cohen, Houston, Tex., for plaintiffs-appellees.
    Before WISDOM, GEWIN and CLARK, Circuit Judges.
   CLARK, Circuit Judge:

We are all Republicans — we are all Federalists. If there be any among us who would wish to dissolve this Union or to change its republican form, let them stand undisturbed as monuments of the safety with which error of opinion may be tolerated where reason is left free to combat it. So spoke Thomas Jefferson, the author of the Declaration of Independence, in his first inaugural address as the third President of the United States, March 4, 1801.

(a) No person shall be permitted to have his name appear upon the official ballot as a candidate or nominee for any public office . . . unless and until'he shall have filed a loyalty affidavit as required by this section.

******

(c) The affidavit shall be in the following form:

I -, of the County of ___, State of Texas, being a candidate for the office of - do solemnly swear that I believe in and approve of our present representative form of government, and, if elected, I will support and defend our present representative form of government and will resist any effort or movement from any source which seeks to subvert or destroy the same or any part thereof, and I will support and defend the Constitution and laws of the United States and of the State of Texas.

******

(d) The name of no candidate or nominee of any political party whose principles include any thought or purpose of setting aside representative form of government and substituting therefor any other form of government shall be permitted on the official ballot. It is specifically provided that no candidate or nominee of the Communist Party or the Facist Party or the Nazi Party shall ever be allowed a place on the official ballot at any election in this state.

So spoke the Texas Legislature in Section 6.02 of the Election Code of the State of Texas, V.A.T.S., one hundred and fifty years later.

The individual plaintiffs filed the instant action for themselves and as representatives of a class composed of all candidates or nominees for any public office in the State of Texas without explicit reference to any specific past or future election. They successfully sought an injunction restraining the enforcement of Section 6.02 in connection with the November 1971 elections and their names were placed on the ballot under a single judge injunctive order. After failing at the polls, plaintiffs won from a three-judge district court a judgment striking certain portions of the loyalty oath as unconstitutional. 345 F.Supp. 1132.

Relying on Gunn v. University Committee to End War in Viet Nam, 399 U.S. 383, 90 S.Ct. 2013, 26 L.Ed.2d 684 (1970) the defendant state officials appealed to this court seeking a reversal or in the alternative a remand for construction of Section 6.02 by the courts of the State of Texas. We hold that under the circumstances here present, jurisdiction is vested in this court. We affirm the judgment of the court below.

Jurisdiction — Following a declaration that Section 6.02 abridged the First Amendment of the Constitution, the operative portion of the order appealed from provides:

Thus, by order of this court, the section reading “I believe in and approve of our present representative form of government, and, if elected, I will support and defend our present representative form of government and I will resist any effort or movement from any source which seeks to subvert or destroy the same or any part thereof, and” is struck from the oath leaving the rest intact.

This order does not specifically enjoin either negative or affirmative conduct by state officials as would be required by F.R.Civ.P. 65(d) if it was intended to be injunctive in nature. It is clear that its aim was only to declare the legal effect of the statute under attack. It is equally apparent that no injunctive relief was denied to the appellants, for they sought none. If anyone was denied injunctive relief it was the plaintiff-appellees who have taken no appeal. (See note 5 to Mr. Justice Stewart’s opinion for the court in Gunn, supra, 399 U.S. at 389, 90 S.Ct. at 2017, as well as Mr. Justice White’s concurrence, 399 U.S. at 391, 90 S.Ct. at 2018). There is no basis for asserting that appellate jurisdiction is vested in the Supreme Court under the strictly construed provisions of 28 U.S.C. § 1253. Rather, the order appealed here may very naturally be construed as a final decision by a district court, the appellate jurisdiction of which is vested in this court under 28 U.S.C. § 1291.

Mootness — Because the judgment of the district court was not entered until eight months after the named plaintiffs had convincingly lost in their encounter before the electorate, the defendants contend the cause of action was moot when the final, declaratory order was entered. However, the class defined in their amended complaint was not limited to those who sought ballot positions in the November 1971 election process. Rather, it embraced all Texans, including themselves, who wished to run for public office at any unspecified time. The continuing interest which such a class has in the prerequisite loyalty oath now proscribed provides the necessary degree of concrete adverseness over the subject matter in dispute to support this action as a viable case or controversy. Then too, if the right to challenge this oath were to be limited to persons actively seeking to qualify for ballot positions in some specific forthcoming election, any such statute would be effectively immunized from constitutional attack because of the evanescent quality of standing to mount an attack.

The Merits — In the most recent authority discussing the constitutionality of oaths, Cole v. Richardson, 405 U.S. 676, 92 S.Ct. 1332, 31 L.Ed.2d 593 (1972), The Chief Justice summarized the present state of the pertinent law of oaths as follows:

We have made clear that neither federal nor state governments may condition employment on taking oaths which impinge rights guaranteed by the First and Fourteenth Amendments respectively, as for example those relating to political beliefs. .

Nor may employment be conditioned on an oath that one has not engaged, or will not engage, in protected speech activities such as the following: criticizing institutions of government; discussing political doctrine that approves the overthrow of certain forms of government; and supporting candidates for political office. ******

. . . They put the government into “the censorial business of investigating, scrutinizing, interpreting, and then penalizing or approving the political viewpoint” and past activities of individuals.

(citations omitted)

Applying these and the other principles discussed, the Court concluded that Massachusetts could require a research sociologist to swear or affirm:

That I will uphold and defend the Constitution of the United States of America and the Constitution of the Commonwealth of Massachusetts and that I will oppose the overthrow of the government of the United States of America or of this Commonwealth by force, violence or by any illegal or unconstitutional method.

There can be no room for serious disagreement that both the Massachusetts employment oath and the present Texas election oath are valid insofar as they extract formal promises to support or uphold and to defend the Constitutions of the United States and the State. Bond v. Floyd, 385 U.S. 116, 87 S.Ct. 339, 17 L.Ed.2d 235 (1966).

It is at the point of further comparison that the defendants’ reliance on Cole v. Richardson breaks down. Mrs. Richardson was validly required to swear opposition to the forceful, violent overthrow of the government of each sovereign. In Texas a candidate must swear (a) belief in, (b) approval of, (c) support of, (d) defense of, and (e) resistance against any effort or movement from any source which seeks to subvert or destroy — the present representative form of government. The meaning of “the present representative form of government” to which these comprehensive forms of obeisance and homage are required is made abundantly plain by the legislative proviso which immediately follows the prescribed oath. '

(d) The name of no candidate or nominee of any political party whose principles include any thought or purpose of setting aside representative form of government and substituting therefor any other form of government shall be permitted on the official ballot. It is specifically provided that no candidate or nominee of the Communist Party or the Facist Party or the Nazi Party shall ever be allowed a place on the official ballot at any election in this state.

By this enactment Texas would proclaim that our freedom is too fragile to withstand the onslaught of new political ideologies. (Or at least that no such liberties can be extended to candidates —for, as the district court points out, no such stringent oath is extracted as a condition to holding any office.) Cole v. Richardson demonstrates this thesis is incompatible with our constitutional system. The single greatest source of America’s strength is our basic premise that this government may never close the gateway to free men’s minds to new ideas. The market place of politics has nothing to fear from the unencumbered presentation of novel theories of government. Even a brief glance about discloses that the majority of the civic systems in operation in Texas and in the United States are products of twentieth century solons. The fact that these systems are still embraced within the tent of a republican form of government attests to its enduring utility, but not to any ultimate constitutional prerogative of that system. The surest way to kill a bad idea is to thoroughly expose it. If it can’t stand the heat in President Truman’s kitchen crucible of politics, it’s dead. If it wins acceptance and endures, then constitutional government grows more not less secure. This is what the First Amendment is all about.

No state may condition the right to seek elective office on the willingness of candidates to foreswear their political beliefs and thoughts. The Socialist and the Communist may take their place by the Democrat and the Republican and compete for the ballots of Texans and Americans.

The judgment of the district court expressly declaring the portion of Section 6.02’s oath providing

I believe in and approve of our present representative form of government, and, if elected,'I will support and defend our present representative form of government and will resist any effort or movement from any source which seeks to subvert or destroy the same or any part thereof, and .

to be unconstitutional and implicitly invalidating the succeeding paragraph (d) is

Affirmed.


author: INGRAHAM, Circuit Judge: GODBOLD, Circuit Judge

text:
    In the Matter of SAMUELS & CO., INC., Bankrupt. Curtis R. STOWERS, et al., Appellants, v. James S. MAHON, Trustee, and C. I. T. Corporation, Appellees.
    No. 73-1185.
    United States Court of Appeals, Fifth Circuit.
    Aug. 20, 1973.
    Rehearing and Rehearing En Banc Denied Oct. 31, 1973.

      Lamar Holley, Dallas, Tex., for appellants.
    J. Richard Gowan, Dallas, Tex., for appellees.
    Before AINSWORTH, GODBOLD and INGRAHAM, Circuit Judges.
   INGRAHAM, Circuit Judge:

Since 1921 packers and stockyard men in interstate commerce have been subjected to remedial federal legislation and regulation. This appeal stems from the bankruptcy of one such regulated packer, Samuels & Co., Inc., of Dallas, Texas. The issues raised, however, all question the priority of liens between a class of cattle raisers who sold their cattle to Samuels & Co. and C.I.T. Corporation, which financed their purchase.

Prior to its filing a voluntary petition for an arrangement under Chapter XI of the Bankruptcy Act, 11 U.S.C. § 701 et seq., Samuels & Co. had purchased cattle under a “grade and weight basis,” and C.I.T. had financed those purchases secured by a floating lien on Samuels’s inventory and other property. The cattle thus sold were delivered to the bankrupt, who slaughtered the animals. The carcasses were permitted to cool and were then inspected, graded and weighed. Samuels would then issue its check for the purchase price and further process the meat into finished products. This system is common to the meat packing industry and its conditions are spelled out by regulation published in 9 Code of Federal Regulations. C.I.T. became insecure in this plan upon learning that Samuels intended to file a plan of arrangement under Chapter XI. Thus on May 23, 1969, it refused to advance additional funds for cattle purchased. On the same day Samuels filed its plan of arrangement which ultimately led to an adjudication of straight bankruptcy in April of 1970. Appellants, representing a class of cattle sellers whose cattle were delivered to Samuels before May 23, 1969, and who had received checks in payment therefor but whose checks were returned unsatisfied, filed claims for the amount of the purchase price with the bankruptcy court. That class of cattle sellers asserted a first priority lien and their position was opposed by C.I.T., asserting the superiority of its lien on Samuels inventory.

The bankruptcy court ordered a receiver to dispose of the easily spoiled meat and meat by-products but to hold the proceeds of sale pending resolution of the conflicting claims of the cattle sellers and C.I.T. The referee ultimately held the cattle sellers’ interests to be paramount and subordinated C.I.T.’s lien. C.I.T. sought review in the district court, which reversed the referee, holding:

(a) That C.I.T. had a perfected lien in Samuels’ inventory and other property;

(b) That the cattle delivered by May 23, 1969, and represented by the dishonored checks, were properly includable in Samuels’ inventory, i. e., that C.I.T.’s lien had attached.

(c) That the class of cattle sellers had delivered goods subject to a reservation of title which, under the Uniform Commercial Code as en- ' acted in Texas, was the mere reservation of a security interest which had not been perfected before C.I.T.’s lien attached. See Texas Business and Commercial Code § 9.312(c), V.T.C.A.

The class of cattle sellers appeal. We reverse.

The facts are undisputed. The question is one of law concerning priority of liens in bankruptcy established under the Uniform Commercial Code: Is the reserved purchase money security interest provision, Texas Business and Commercial Code (U.C.C.), § 9 — 107(1) applicable to what would otherwise have given Samuels voidable title under § 2.-403 of the Code, or do the regulations promulgated under the Packers and Stockyards Act, 7 U.S.C.A. § 181, et seq., comprise a course of dealing and usage of trade so as to modify the Code provisions and permit the reservation of title to have effect against C.I.T.’s lien without perfection by filing under the Code, § 9 — 301?

It is clear that between a party whose security interest has attached and been perfected and one whose security interest has merely attached, that the former lien takes priority. U.C.C. § 9 — 301(1)(a). The latter interest is also subordinate to the rights of a person who becomes a lien creditor before the interest is perfected, and who is without knowledge of the prior security interest. § 9 — 301(1)(b). A trustee in bankruptcy meets these requirements. 11 U.S.C. § 107(c)(1)(B); 11 U.S.C. § 110(c). Our concern is, however, for the proper rule to be afforded the remedial legislation of the Packers and Stockyards Act and the valid regulations issued thereunder. 7 U.S.C.A. § 181 et seq., 9 C.F.R. 201.43, 201.99.

Central to the district court’s decision was the belief that the appellants’ delivery of the animals while making a reservation of title acted solely as the taking of a purchase money security interest under § 9 — 107. This would create voidable title in Samuels. § 2— 403. Thus title to the property would be in Samuels’s hands at the time of bankruptcy leaving the unperfected security interest cut off by both C.I.T.’s lien on inventory and a trustee in bankruptcy’s power under §§67 and 70 of the Bankruptcy Act. Where this reasoning breaks down, however, is its failure to properly account for Regulations 201.43 and 201.99 promulgated under the Packers and Stockyards Act (9 CFR, §§ 201.-43 and 201.99). Regulation 201.43 requires a packer to make its payment to his cattle suppliers promptly:

“§ 201.43 ACCOUNTS AND RECORDS, PACKERS AND STOCKYARDS ACT 1921, AS AMENDED
(b) PURCHASERS TO PAY PROMPTLY FOR LIVESTOCK. Each packer, market agency, or dealer purchasing livestock shall, before the close of the next business day following the purchase of livestock and the determination of the amount of the purchase price, transmit or deliver to the seller or his duly authorized agent the full amount of the purchase price, unless otherwise expressly agreed between the parties before the purchase of livestock. Any such agreement shall be disclosed in the purchaser’s records and on the accountings or other documents issued by the purchaser relating to the transaction.”

Regulation 201.99 requires that until the packer pays for the carcasses the carcasses be identifiably held:

“§ 201.99 PURCHASE OF LIVESTOCK BY PACKERS ON A CARCASS GRADE, CARCASS WEIGHT, OR CARCASS GRADE AND WEIGHT BASIS.
(a) Each packer purchasing livestock on a carcass grade, carcass weight, or carcass grade and weight basis shall, prior to such purchase, make known to the seller, or to his duly authorized agent, the details of the purchase contract. Such details shall include, when applicable, expected date and place of slaughter, carcass price, condemnation terms, description of the carcass trim, grading to be used, accounting, and any special conditions.
(b) Each packer purchasing livestock on a carcass grade, carcass weight, or carcass grade and weight basis, shall maintain the identity of each seller’s livestock and the carcasses therefrom and shall, after determination of the amount of the purchase price, transmit or deliver to the seller or his duly authorized agent a true written account of such purchase showing the number, weight, and price of the carcasses of each grade (identifying the grade) and of the ungraded carcasses, an explanation of any condemnations, and any other information affecting final accounting. Packers purchasing livestock on such a basis shall maintain sufficient records to substantiate the settlement of each transaction.
(c) When livestock are purchased by a packer on a carcass weight or carcass grade and weight basis, purchase and settlement therefor shall be on the basis of carcass price. This paragraph does not apply to purchases of livestock by a packer on a guaranteed yield basis.
(d) Settlement and final payment for livestock purchased by a packer on a carcass weight or carcass grade and weight basis shall be on actual (hot) carcass weights determined before shrouding. The hooks, rollers, and gambrels or other similar equipment used at a .packing establishment in connection with the weighing of carcasses of the same species of livestock shall be uniform in weight. The tare weight shall include only the weight of such equipment.
(e) Settlement and final payment for livestock purchased by a packer on a USDA carcass grade shall be on an official (final, not preliminary) grade. If settlement and final payment are based upon any grades other than official USDA grades, such other grades shall be set forth in detailed written specifications which shall be made available to the seller or his duly authorized agent. For purposes of settlement and final payment for livestock purchased on a grade or grade and weight basis, carcasses shall be final graded before the close of the second business day following the day the livestock are slaughtered.”

These regulations had binding effect on Samuels, whose compliance therewith permitted it to continue its operations.

C.I.T. responds to appellants’ arguments under the Code, § 1 — 205, by observing that the regulations are not inconsistently applied and are but a means to implement a seller’s right of reclamation provided by U.C.C. § 2 — 702(b).

Like the district court’s conclusion on the application of § 9 — 107(b), C.I.T.’s argument misses the unique pattern of the Packers and Stockyards Act and Regulations. Meat and meat by-products of like grade and weight are, as the referee found, fungible goods:

“When the livestock has been graded and the yield determined the meat is processed, packaged and sold. After the livestock has been processed and packaged, it is impossible to trace or. identify any seller’s particular livestock.”

The Packers and Stockyards Act regulations are a recognition that once a check has issued from a packer, the carcass will be processed and its identity lost. Consequently, the “hot check” provision of U.C.C. § 2 — 403(a) (2) is an unavailable remedy. The Packers and Stockyards regulations and cases, therefore, consider the packer’s obligation to pay to be that of a fiduciary, Bowman v. U.S.D.A., 363 F.2d 81 (5th Cir., 1966), and the purpose of the act to be the protection of the producer’s and consumer’s purse. Bowman, supra; Glover Livestock Co. v. Hardin, 454 F.2d 109 (8th Cir., 1972); Bruhn’s Freezer Meats of Chicago, Inc. v. U.S.D.A., 438 F.2d 1332 (8th Cir., 1971); Swift & Co. v. United States, 393 F.2d 247 (7th Cir., 1968). The reasoning of these cases and the impact of the Packers and Stockyards Act convinces this court that more than an unperfected security interest subject to reclamation is reserved for the cattle seller. Not by contract but by statute and regulation a packer lacks full dominion over the carcasses until the seller has been paid. Where the packer defaults by the issu-anee of a bad check (and destroys the identity of the security by processing the carcasses into fungible meat products), the seller is the beneficiary of a trust imposed by remedial statute. This we must note was the very statute which permitted the bankrupt to engage as a meat packer in interstate commerce and it is clear that the Packers and Stockyards Act and Regulations 201.42 and 201.99 thereunder comprise a course of dealing and usage of trade known to both the bankrupt packer and C.I.T., which had financed it for an extended period.

The judgment of the district court is reversed and remanded with directions to reinstate the judgment of the referee.

GODBOLD, Circuit Judge

(dissenting) :

I am unable to join with the majority in their decision that the Packers & Stockyards Act, 7 U.S.C. § 181 et seq., and the regulations issued thereunder, prevail over the Uniform Commercial Code by imposing a trust upon proceeds of sale of meat products processed from cattle carcasses delivered by the sellers, thus entitling the sellers to recover as beneficiaries of the trust. Neither the general scope of the Act nor the specific regulations relied upon support the majority’s conclusion. Prior cases in this circuit and elsewhere have rejected contentions that with respect to matters not specifically covered by it, the Act supplanted what might be termed commercial law of the states.

The District Court concluded as a matter of law that CIT had a perfected lien on the inventory and accounts receivable of Samuels & Co., Inc. (“Samu-els”) which prevailed over the rights of the sellers under the U.C.C., as adopted by the State of Texas, Tex.Bus. & Comm.Code Ann. § 1 — 101 et seq. (Tex. U.C.C. 1968) and rejected the conclusion of the referee that the interests of the sellers were paramount. The majority majority revérse the District Court’s conclusion of law and reinstate that of the referee.

The majority conclude that in certain circumstances the Act, considered together with the regulations and the usages of the trade, imposes a trust upon proceeds in the hands of a meat packer, received by the packer from the sale of meat products. The “certain circumstances” are these: the cattle must have been received by the packer in the type of transaction well known to the trade and described by 9 CFR 201.99, pursuant to which regulation the packer is required to maintain the identity of carcasses when the animals are killed and also maintain sufficient records concerning the carcasses; and the packer has destroyed the identity of the, carcasses by processing them into fungible meat products. Under these circumstances the majority impress a trust relationship with the consequence that Samuels has less than full title, and the seller, as beneficiary of the trust, has an equitable interest conferring on him a status superior to that of CIT which, as secured creditor, held a lien on the inventory and accounts receivable of Sam-uels. Obviously this does considerable violence to the state commercial law concerning passage of title to chattels, manner of perfecting liens, and the protective scope of liens. The predicate for this imposition of a trust consists of implications drawn from the overall scheme of the Act and from Regulation 201.99, neither of which expressly makes Samuels a fiduciary.

The Act was promulgated in 1921 as a regulatory and antitrust act to deal with monopolistic and deceptive practices of the major stockyards and meat packers. Stafford v. Wallace, 258 U.S. 495, 42 S. Ct. 397, 66 L.Ed. 735 (1922); Denver Union Stock Yard v. Producers Livestock Marketing Ass’n, 356 U.S. 282, 78 S.Ct. 738, 2 L.Ed.2d 771 (1958). In 1958 and 1968 it was amended to meet changed conditions in the industry by authorizing broader authority for regulation by the Secretary of Agriculture and by more precisely delineating the division of authority between the Federal Trade Commission and the Secretary of Agriculture. 1958 U.S.Code Cong. & Admin.News p. 5213; 1968 U.S.Code Cong. & Admin.News p. 2864.

I am unable to find, nor do the majority refer to any legislative history evidencing Congressional intent that — except to the extent specifically done — the Act should supplant or modify the general body of state laws governing commercial transactions. Congress has not undertaken to regulate every aspect of the packing and stockyards industry, so state law continues to fill out the federal regulatory scheme. Florida Lime & Avocado Growers, Inc. v. Paul, 373 U.S. 132, 83 S.Ct. 1210, 10 L,Ed.2d 248 (1963); Chemical Specialties Manufacturers Ass’n, Inc. v. Clark, 482 F.2d 325 [1973].

In numerous cases the contention has been repeatedly made that the Act, by its overall regulatory sweep of the industry or by implications drawn from its specific provisions, has supplanted or modified commercial law of the states. In Sig Ellingson & Co. v. DeVries, 199 F.2d 677 (CA8), cert. denied, 344 U.S. 934, 73 S.Ct. 505, 97 L.Ed. 719 (1953), plaintiff sold his cattle to Brackey and received a worthless check. Brackey then sold the cattle through defendant Ellingson, a livestock commission merchant licensed as a market agency under the Act. Plaintiff sued Ellingson for conversion. The District Court found that under applicable state law (of Iowa and Minnesota) title does not pass to one paying with a worthless check, so that ownership and right to retake possession remained in plaintiff who was thus entitled to recover from Ellingson. Ellingson recognized that the Act did not purport to declare specifically the respective rights of owners and market agencies in such a situation. It contended, however, that the overall regulatory scheme of the Act, which treats stockyards and market agencies as public utilities and imposes regulations upon them, and the specific provisions of the Act requiring nondiscriminatory practices and prohibiting unjust, unreasonable and discriminatory practices and depriving the commission merchant of the freedom to choose his own customers, overrode the state law which made the market agency liable for conversion of the cattle. The Eighth Circuit rejected this as had the District Court, saying:

But it appeared to the trial court that the liability of the defendant market agency to plaintiffs which resulted from its sale of the cattle under the law of Iowa and of Minnesota was not affected either by the terms or by necessary implications of the federal Act. The services performed by the market agencies were in the nature of public utility services vitally necessary to the movement of livestock in interstate commerce before the passage of the Packers and Stockyards Act. It was on that ground that Congress had and exercised the power to regulate them for the prevention of unjust discriminations and abuses. But Congress made no attempt to declare who should be deemed the owner of cattle turned over for a bad check nor to relieve the market agencies from liability imposed by State law for selling cattle for principals who were not the owners. The Act was aimed at unjust discrimina-tions incompatible with public utility operations, but it in no wise impairs the freedom of the market agencies to adopt proper measures to prevent and suppress frauds. The court was convinced that the Act has not superseded the law of Iowa or of Minnesota under which the defendant in this case became liable to the plaintiffs.

The opinion of the trial court and cases cited reflect that earnest arguments have been presented on behalf of the livestock market agencies to the effect that the law governing their liability or immunity in such a case as is here presented ought to be uniform at all the markets regulated under the federal Act and that the agencies ought not to be held liable for conversion in respect to cattle sales made under such circumstances as are found in this case. There are also cogent considerations of the same abstract character tending strongly to contrary conclusions. But we see no occasion to add further to that discussion. We find no error in the conclusion of the trial court that the Packers and Stockyards Act does not, either by express provision or by necessary implication, establish the rights of the parties to this action resulting from the sale of the 33 head of cattle. State law is controlling and we find no error in the declaration and application of that law by the trial court.

199 F.2d at 679. A companion case reached the same result. Sig Ellingson & Co. v. Butenbach, 199 F.2d 679 (CA8), cert. denied, 344 U.S. 934, 73 S.Ct. 505, 97 L.Ed. 719 (1953).

Subsequently on facts parallel to those of Ellingson the Tenth Circuit gave effect to the law of Arkansas, producing an ultimate result on liability precisely the opposite of the result in Ellingson. Under Arkansas law one giving a worthless check acquires defeasible title, so that a commission agent who sold cattle for such a person was not liable to the original owner who had parted with the cattle for the worthless check. Adams v. Greeson, 300 F.2d 555 (CA10, 1962).

In 1954 this circuit followed the two Ellingson cases and held that the Act did not absolve market agencies from liability under Texas law for sale of cattle obtained by worthless cheek. John Clay & Co. Livestock Commission v. Clements, 214 F.2d 803 (CA5, 1954).

Numerous state cases, including a Texas case, have rejected arguments that the Act has supplanted state law in various commercial transaction contexts. Walker v. Caviness, 256 S.W.2d 880 (Tex.Civ.App.1953), Mason City Prod. Credit Ass’n. v. Sig Ellingson & Co., 205 Minn. 537, 286 N.W. 713, cert. denied, 308 U.S. 599, 60 S.Ct. 130, 84 L.Ed. 501 (1939), and Moderie v. Schmidt, 6 Wash.2d 592, 108 P.2d 331 (1940) [market agent liable for sale of mortgaged or stolen cattle]; Birmingham v. Rice Bros., 238 Iowa 410, 26 N.W.2d 39, 2 A. L.R.2d 1108 (Iowa), cert. denied, 332 U.S. 768, 68 S.Ct. 79, 92 L.Ed. 353 (1947) [same facts as in Ellingson v. DeVries, supra,]. See also, First Nat. Bank v. Siman, 67 S.D. 118, 289 N.W. 416 (1939), and Citizens State Bank v. Farmers Union Livestock Co-op Co., 165 Kan. 96,193 P.2d 636 (1948).

The only federal case contrary to the above body of case law appears to be Sullivan & Co. v. Wells, 89 F.Supp. 317 (D.Neb.1950), decided prior to the Ell-ingson cases, Adams v. Greeson, and the decision of this circuit in John Clay & Co., and relying upon what was recognized to be a minority view originating from state courts in Missouri and Kentucky.

While tangential to the case before us, which does not directly relate to powers of the Secretary of Agriculture, a body of case law points out that certain efforts of the Secretary to act with regard to matters governed by the commercial law of the states are beyond the jurisdiction conferred upon him by the Act. In Guenther v. Morehead, 272 F.Supp. 721 (S.D.Iowa, 1967), Banks falsely represented to plaintiff that he had purchased 64 head of cattle for plaintiff at Milan Livestock Auction, and plaintiff gave Banks a check payable to Milan bearing the notation “for 64 head of cattle.” Instead of applying the check to any account of plaintiff, Banks gave it to -Milan in part payment for hogs he had previously bought. Plaintiff complained to the Secretary of Agriculture who, under 7 U.S.C. § 210(e), ordered Milan to repay plaintiff. Milan refused to pay and plaintiff sued to enforce. The court considered 7 U.S.C. §§ 206, 208, 212 and 213, and concluded that Milan’s wrongful negotiation of plaintiff’s check for a purpose other than that noted on its face was a matter outside the Secretary’s jurisdiction. 272 F.Supp. at 721. In McClure v. E. A. Blackshere Co., 231 F.Supp. 678 (D.Md. 1964), the Secretary of Agriculture had entered an order awarding damages, pursuant to 7 U.S.C. § 210(e), directing a dealer to pay sellers for cattle sold. The defendant refused to comply and the sellers sued on the order under § 210(f). The District Court found that the Secretary had no jurisdiction to enter the order. It considered 7 U.S.C.A. §§ 201-203, 205-207, 211-217 and rejected their applicability. The Secretary had based his order on the theory that an unjustified failure to pay for livestock purchased was a violation of § 208, requiring market agencies to establish and observe just and reasonable practices in respect to the furnishing of stockyard services and forbidding contrary practices. The court found that this was the only section of even arguable application, and, after considering a mass of legislative history and finding it uninformative, at page 682 footnote 3 of 231 F.Supp., found that the section did not relate to ordinary debtor-creditor relationships.

The language of Regulation 201.99 does not specifically make the packer a trustee of either cattle purchased or of the proceeds. It imposes upon the packer duties to make known to the seller the details of the purchase contract, to identifiably maintain the livestock and the carcasses therefrom, to transmit a written account of the purchase, and to maintain sufficient records.

Samuels was a packer, one who buys livestock for slaughter, manufactures and prepares the meat and stock for sale or shipment in commerce, and markets the meat in commerce. 7 U.S.C. § 191. The deleterious acts of packers at which the Act was directed consisted of monopolistic and discriminatory market practices. See Armour & Co. v. United States, 402 F.2d 712 (CA7, 1968); Swift & Co. v. United States, 393 F.2d 247 (CA7, 1968); Swift & Co. v. United States, 317 F.2d 53 (CA7, 1963). The packer’s role in the industry is different from that of market agencies and dealers, and the Act and the regulations recognize this and treat him differently. The financial abuses at which the Act was directed were those of market agencies and dealers and stockyards. A market agency buys and sells cattle on a commission basis or furnishes stockyard services, 7 U.S.C. § 201(c), and a dealer buys and sells cattle, 7 U.S.C. § 201(d). Market agencies and dealers must register, 9 CFR 201.10, and must be bonded to secure their financial obligations. 7 U.S.C. § 204, 9 CFR 201.27-34. As early as 1923 the Secretary promulgated a regulation which prohibited market agencies from using funds of owners or consignors of livestock or mingling such funds with its own, a regulation which made the market agency a fiduciary in relation to the proceeds of sales of livestock handled by it for customers. United States v. Donahue Bros., 59 F.2d 1019 (CA8, 1932). The present regulations continue the fiduciary relationship, forbid the market agency from using customers’ fund for its own purposes either directly or through the “float” in the agency’s bank account, and specifically require maintenance of a separate custodial bank account for these funds held as fiduciary. 9 CFR 201.40, 201.-42; Bowman v. United States Dept. of Agriculture, 363 F.2d 81 (CA5, 1966). The financial practices of packers are not regulated in the same manner, they are not bonded to secure their financial obligations, and they need not segregate funds. The cases which the majority .cite as imposing a fiduciary duty on Samuels involved regulatory violations and financial abuses by stockyard owners, market agencies, and dealers, not by packers. Bowman v. United States, supra; Glover Livestock Commission v. Hardin, 454 F.2d 109 (CA8, 1972); United States v. Donahue Bros., Inc., supra,, The Act gives a private cause of action against stockyards, market agencies and dealers, 7 U.S.C. § 209, but none against packers, who are subject to administrative charges at the hands of the Secretary. 7 U.S.C. §§ 191-95.

At the end of their opinion the majority refer to 9 CFR 201.43 which requires a packer to promptly pay sellers, as a custom and usage of the trade binding on Samuels and CIT. The U.C.C. itself provides for consideration of industry usages and practices, which may constitute part of the agreement made by parties, §§ 1 — 201 and 1 — 205, but the effect of incorporation of usage and practice into the agreement is also governed by the U.C.C. § 1 — 102(c). Delivery of goods with a duty on the recipient to promptly pay does not, under U.C.C., alter the consequence that title passes upon delivery with the seller having only a seller’s security interest, § 2 — 401, which in the circumstances of this case (no financing statement having been filed and no notice given to CIT, § 9 — 312(c)) is junior to the lien of a secured creditor, or having a right to reclaim under § 2 — 507 and 2 — 702 (in this instance, not timely asserted). Thus custom and usage are employed by the majority to override the specific provisions of state law which provide both for giving effect to custom and usage and the consequence of doing so, and to produce an ultimate result the reverse of that commanded by state law.

Of course, there are areas of state commercial laws which are modified or supplanted by federal regulatory measures. The Miller Act, 40 U.S.C. § 270a et seq., and bonds furnished under it, present matters for application of federal law, Indemnity Insurance Co. v. Browning-Ferris Mach. Co., 227 F.2d 804 (CA5, 1955), as do surety bonds required of market agencies and dealers under the Packers & Stockyards Act, USF&G v. Quinn Bros., 384 F.2d 241 (CA5, 1967). But these spring from specific statutory provisions — in the case of the market agency or dealer, 7 U.S.C. § 204 authorizes the Secretary to require the bond under rules and regulations which he may, and has, prescribed, 9 CFR § 201.27, et seq. — or by implication in circumstances different from those here present. The history and the language of the Act, the language of Regulation 201.99, the pattern of regulations making fiduciaries of others in the industry, and the case law all are inconsistent with overriding state law by implication in this instance.

       Numerical citation conforms to Texas Business and- Commercial Code. Quotations are taken from 1962 official draft of U.C.C. and with some numerical changes have been adopted in Texas.

      . “A security interest is a ‘purchase money security interest’ to the extent that it is (a) taken or retained by the seller of the collateral to secure all or part of its price . . . . ”

      . “(1) A purchaser of goods acquires all title which his transferor had or had power to transfer except that a purchaser of a limited interest acquires rights only to the extent of the interest purchased.
      A person with voidable title has power to transfer a good title to a good faith purchaser for value. When goods have been delivered under a transaction of purchase the purchaser has such power even though
      (a) the transferor was deceived as to the identity of the purchaser, or
      (b) the delivery was in exchange for a check which is later dishonored, or
      (c) it was agreed that the transaction was to be a ‘cash sale’ . . . . ”

      . Section 1 — 201(37) of the Uniform Commercial Code defines a security interest as follows:
      “(37) ‘Security interest’ means an interest in personal property or fixtures which secures payment or performance of an obligation. The retention of reservation of title by a seller of goods notwithstanding shipment or delivery to the buyer (Section 2 — 401) is limited in effect to a reservation of a ‘security interest’. The term also includes any interest of a buyer of accounts, chattel paper, or contract rights which is subject to Article 9. The special property interest of a buyer of goods on identification of such goods to a contract for sale under Section 2 — 401 is not a “security interest’, but a buyer may also acquire a ‘security interest’ by complying with Article 9. Unless a lease or consignment is intended as security, reservation of title thereunder is not a ‘security interest’ but a consignment is in any event subject to the provisions on consignment sales (Section 2 — 326). Whether a lease is intended as security is to be determined by the facts of each case; however, (a) the inclusion of an option to purchase does not of itself make the lease one intended for security, and (b) an agreement that upon compliance with the terms of the lease the lessee shall become or has the option to become the owner of the property for no additional consideration or for a nominal consideration does make the lease one intended for security.”
      Its reference to § 2 — 401 includes a seller-’s reservation of title within the Code’s concept of attachment and perfection of security interests. See § 9 — 113. Section 2 — 401 provides in part:
      “Each provision of this Article with regard to the rights, obligations and remedies of the seller, the buyer, purchasers or other third parties applies irrespective of title to the goods except where the provision refers to such title. Insofar as situations are not covered by the other provisions of this Article and matters concerning title become material the following rules apply:
      (1) Title to goods cannot pass under a contract for sale prior to their identification to the contract (Section 2 — 501), and unless otherwise explicitly agreed the buyer acquires by their identification a special property as limited by this Act. Any retention or reservation by the seller of the title (property) in goods shipped or delivered to the buyer is limited in effect to a reservation of a security interest. Subject to these provisions and to the provisions of the Article on Secured Transactions (Article 9), title to goods passes from the seller to the buyer in any manner and on any conditions explicitly agreed on by the parties.”
      Thus where goods are physically delivered but title is delayed past delivery, the Code treats the transaction as the seller’s retention of a purchase money security interest as defined by § 9 — 107(a), which must be perfected by filing before becoming superior to other later perfected liens. See § 9 — 312(c).
      Section 2 — 401 (reservation of title) gives the buyer voidable title until the seller is paid. Section 9 — 113 provides:
      “A security interest arising solely under the Article on Sales (Article 2) is subject to the provisions of this Article except that to the extent that and so long as the debtor does not have or does not lawfully obtain possession of the goods
      (a) no security agreement is necessary to make the security interest enforceable ; and
      (b) no filing is required to perfect the security interest; and
      (c) the rights of the secured party on default by the debtor are governed by the Article on Sales (Article 2).”
      Thus the seller’s remedy is to reclaim the specific goods under the provisions of § 2 — 702(b), which provides in part as follows :
      “(2) Where the seller discovers that the buyer has received goods on credit while insolvent he may reclaim the goods upon demand made within ten days after the receipt, but if misrepresentation of solvency has been made to the particular seller in writing within three months before delivery the ten day limitation does not apply. Except as provided in this subsection the seller may not base a right to reclaim goods on the buyer’s fraudulent or innocent misrepresentation of solvency or of intent to pay.”
      We need not however decide the merits of a conflict between a trustee in bankruptcy and a seller asserting a right of reclamation, cf. In re Kravitz, 278 F.2d 820 (3rd Cir., 1960), and Glessner v. Massey-Ferguson, Inc., 353 F.2d 986 (9th Cir., 1966), for we believe the custom and usage of the meat packing industry takes the asserted reservation of title from within the definition of a security interest.

      . “(1) A course of dealing is a sequence of previous conduct between the parties to a particular transaction which is fairly to be regarded as establishing a common basis of understanding for interpreting their expressions and other conduct.
      (2) A usage of trade is any practice or method of dealing having such regularity of observance in a place, vocation or trade as to justify an expectation that it will be observed with respect to the transaction in question. The existence and scope of such a usage are to be proved as facts. If it is established that such a usage is embodied in a written trade code or similar writing the interpretation of the writing is for the court.
      (3) A course of dealing between parties and any usage of trade in the vocation or trade in which they are engaged or of which they are or should be aware give particular meaning to and supplement or qualify terms of an agreement.
      (4) The express terms of an agreement and an applicable course of dealing or usage of trade shall be construed wherever reasonable as consistent with each other; but when such construction is unreasonable express terms control both course of dealing and usage of trade and course of dealing controls usage of trade.

        (5) An applicable usage of trade in the place where any part of performance is to occur shall be used in interpreting the agreement as to that part of the performance.
      (6) Evidence of a relevant usage of trade offered by one party is not admissible unless and until he has given the other party such notice as the court finds sufficient to prevent unfair surprise to the latter.”

      . Neither the District Court nor this court is bound by the clearly erroneous rule in reviewing conclusions of law made by a district court in its review of a referee’s order. International Minerals & Chemicals Corp. v. Moore, 361 F.2d 849 (CA5, 1966). I perceive no factual problems in this appeal. The District Judge adopted the referee’s findings of fact as not clearly erroneous and the majority, under the same standard of reviewing the underlying facts pursuant to the plainly erroneous rule, Bazemore v. Stehling, 396 F.2d 701 (CA5, 1968), consider the facts as not in material dispute. I do not disagree with that conclusion.

      . The majority opinion refers at one point to the fact that in purported payment for the cattle the packer has issued checks not honored by the bank, as being a factor in triggering the imposition of a trust. This would seem to be a breach of trust rather than an incident giving rise to its existence.

      . Some cases are pre-U.C.C., others post-U.C.C., which is of no moment, since the issue is whether the Act supplants or modifies state laws of commercial transactions, statutory or non-statutory.

      . Some of the history behind Sig Ellingson & Co. v. DeVries is of interest. The court relied in part on Birmingham v. Rice Bros., 238 Iowa 410, 26 N.W.2d 39, 2 A.L.R.2d 1108; 332 U.S. 768, 68 S.Ct. 79, 92 L.Ed. 353 (1947). That case had, in turn, referred to Mason City ’Prod. Credit Ass’n v. Sig EHingson & Co., 205 Minn. 537, 286 N.W. 713, cert. denied, 308 U.S. 599, 60 S.Ct. 130, 84 L.Ed. 501 (1939), which had held the act did not free market agencies of liability under state law for selling mortgaged cattle. According to the court in Birmingham, the Solicitor General of the United States appeared in the Supreme Court in Mason City to oppose the petition for a writ of certiorari, which was refused.

      . Sebastopol Meat Co. v. Secretary of Agriculture, 440 F.2d 983 (CA9, 1971) is not contrary to the above case law. The Secretary issued a cease and desist order against a corporation which was a packer, and an individual who was its alter ego but not a packer, for failure to pay for livestock, in violation of 9 C.F.R. § 201.43(b), thereby violating 7 U.S.C. § 192(b) which authorizes cease and desist orders against packers. The only issue on appeal was whether state law limitations on the alter ego doctrine prevented the cease and desist order from running against the individual. The court held that a remedial order, which the Secretary was empowered by a federal regulatory statute to' issue, and which unquestionably reached the corporation, could not be thwarted by state limitations on the alter ego doctrine which was usually invoked in private litigation.

      . Branscome v. Schoneweis, 361 F.2d 717 (CA7, 1966), sustained an order of the Secretary awarding damages for a bad check given by a market agency. Issues of jurisdiction and authority were not referred to and presumably were not raised.

      . On the record before us it is not shown that Samuels breached any of these duties. All say that it is impossible to trace the carcasses of the livestock sold by plaintiffs into identifiable monetary proceeds, but the reason for this is not shown to be any default by Samuels of its obligations, which do not extend to keeping records that will record the path of specific cattle into identifiable cuts of meat or hamburger or identifiable sales. Samuels’ breach of obligations was by giving a check which the bank would not honor, a matter not governed by this regulation, and, as previously discussed, rejected by several courts as the basis for jurisdiction under the Act.

      . Bruhn’s Freezer Meats v. U. S. D. A., 438 F.2d 1332 (CA8, 1971), refers to the Act’s permitting the Secretary to exercise as broad a control of packers as the Constitution permits. The statement must be considered in the context of the case, which concerned whether a chain of meat freezer plants was a packer and whether its misrepresentations and similar sales tactics were deceptive practices under 7 U.S.C. § 192(a), both of these matters being inquiries plainly within the scope of the Act.