REPORT AND RECOMMENDATION NOTICE
David J. Waxse United States Magistrate Judge
Within fourteen (14) days after being served with a copy of this Report and Recommendation, any party, pursuant to 28 U.S.C. § 636(b)(1) and Fed.R.Civ.P. 72(b)(2), file written objections to this Report and Recommendation. A party must file any objections within the fourteen-day period if that party wants to have appellate review of the proposed findings of fact, conclusions of law, or recommended disposition. If no objections are timely filed, no appellate review will be allowed by any court.
REPORT AND PROPOSED FINDINGS
Appellants Southern Fidelity Managing Agency, LLC (“Southern Fidelity”), Northern Capital, Inc. (“Northern Capital”), Security First Insurance Holdings, LLC, and Security First Managers, LLC appeal the United States Bankruptcy Court’s October 5, 2012 Opinion Determining Parties’ Entitlement to Proceeds of FLAC Stock. This interlocutory appeal arises from an adversary bankruptcy proceeding filed by Appellee Citizens Bank & Trust Company (“Citizens Bank”), who sought a declaratory judgment determining its priority rights to the proceeds from the sale of stock in First Life American Corporation (“FLAC”). The bankruptcy debtor, Brooke Capital Corporation (“BCC”), gave security interests in the FLAC stock to secure a loan from its subsidiary, Brook Capital Advisors, Inc. (“BCA”), and later gave a security interest in the stock as part of a workout agreement on a different loan to Citizens Bank. BCA subsequently sold participation interests in the loan secured by the FLAC stock to Appellants and Bank of Kansas. In the adversary proceeding, Citizens Bank and the holders of BCA’s loan participation interests all claimed first priority rights in the FLAC stock.
On October 5, 2012, the bankruptcy court entered an order determining that Citizens Bank’s claim to the proceeds of the sale of FLAC stock was superior to the claims of the Appellants, except for the 14.54% loan participation interest held by Bank of Kansas. The bankruptcy court found, inter alia, that Appellants’ loan participation agreements, unlike the participation agreement entered by Bank of Kansas’s predecessor, were not true participation agreements and recharacterized as them as loans to BCA. The bankruptcy court then concluded that because the participation certificates must be recharacterized as loans, the parties holding those certificates did not have a perfected security interests in the FLAC stock as they had not taken additional steps to perfect their interests.
On October 19, 2012, Security First Insurance Holdings, LLC; Security First Managers, LLC; and Bank of Kansas filed a notice of appeal to the Bankruptcy Appellate Panel (“BAP”).Southern Fidelity and Northern Capital filed their notice of appeal to the BAP the same day. On October 23, 2012, an amended notice of appeal was filed that removed Bank of Kansas as an appellant. On October 26, 2012, Citizens Bank filed an election to have these appeals heard by the District Court pursuant to 28 U.S.C. § 158(c)(1)(B), and the two appeals were opened as Case Nos. 12-cv-2702 and 12-cv-2707. On October 31, 2012, Appellants filed Joint and Unopposed Motions for Leave to Appeal in their respective cases. The motions were granted and on November 13, 2012, the two appeals were consolidated with Case No. 12-cv-2702 designated as the lead case.
The Honorable J. Thomas Marten has referred the appeal in these consolidated cases to the undersigned Magistrate Judge for report and recommendation.
I. Relevant Background
The transactions in question center on the following Brooke group of companies, which conducted business in the insurance industry: (1) Brooke Corporation; (2) Brooke Capital Corporation (“BCC”); (3) Brooke Capital Advisors, Inc. (“BCA”); (4) First Life American Corporation (“FLAC”); and (5) Brooke Credit Corporation, d/b/a Aleritas Capital Corporation (“Aleritas”). Brooke Corporation, the parent company, owned a majority of the shares in BCC and Aleritas. Subsidiary BCC, in turn, wholly owned both BCA and FLAC. Several other parties including Appellants, Bank of Kansas, and Citizens Bank were involved in various transactions relevant to this appeal and will be discussed in relevant order.
A. The BCA Loan
The bankruptcy debtor, BCC, obtained two loans that are at the foundation of the parties’ dispute. Effective December 31, 2007, BCC obtained a loan from its subsidiary, BCA, in the amount of $12.4 million (hereinafter referred to as the “BCA Loan”). As security for the loan, BCC signed a “Commercial Loan Agreement” and “Stock Pledge and Security Agreement” giving BCA a security interest in 100% of its “right title and interest in” the FLAC stock, as well as other collateral. At some time prior to June 25, 2008, BCC delivered the FLAC stock certificate to BCA, which perfected BCA’s security interest in the stock.
In the adversary proceeding, the bankruptcy court found it “more likely than not that the Commercial Loan Agreement documented a valid debt [BCC] owed to BCA” and that the “exhibits evidence[d] a loan from BCA to [BCC] of approximately $12 million, secured by a first priority lien in the FLAC stock and its proceeds.” The bankruptcy court also found in an earlier opinion denying Citizens Bank’s motion for summary judgment that BCA’s perfection by control of the FLAC stock had priority over Citizens Bank’s later perfection.
B. The Citizens Bank Loan
On the same day it executed the BCA Loan, BCC also obtained a $9 million loan from Citizens Bank (hereinafter referred to as the “Citizens Bank Loan”). At the time the loan was originated, it was secured by stock in affiliates of BCC, but not by the FLAC stock.
C. Participation Interests in BCA Loan
In March 2008, BCA began selling participation interests in the BCA Loan secured by the FLAC stock. In a Participation Agreement dated March 6, 2008, BCA sold a 14.54% share of the BCA Loan to First National Bank of Johnson County, the predecessor to Bank of Kansas, for $1.8 million. The Participation Agreement provided that the collateral for the BCA Loan included a pledge of 100% of BCC’s interest in the FLAC stock, and that a “security interest in the collateral is assigned and sold to Purchasers . . . in proportion to each Purchaser’s investment and is held by Seller for the benefit of Purchaser.” On March 28, 2008, BCA executed three documents labeled “Participation Certificate and Agreement” purporting to sell participation interests in the BCA Loan to Appellants Northern Capital, Southern Fidelity, and Security First Insurance Holdings, LLC (“Security First”). At the time they purchased these participation interests, Northern Capital, Southern Fidelity, and Security First each owed a large loan to the related Brook Corporation owned company, Aleritas. The Participation Certificates were executed on identical two-page forms and each stated that BCA was selling to one of the three “Purchasers, ” without recourse to BCA, shares of the BCA Loan. BCA transferred an (1) 8.07% interest in the BCA Loan to Northern Capital for $1 million; (2) a 40.4% interest to Security First for $5 million; and (3) a 24.22% interest to Southern Fidelity for $3 million. Each Participation Certificate included a section labeled “Loan Background Information” that described the BCA Loan. The Participation Certificates also provided that BCA agreed “to repurchase Purchaser’s interest on or before June 30, 2008.” The Certificates called for BCA to share any payments the debtor, BCC, made on the BCA Loan pro rata with the purchasers of the Participation Certificates. They also provided that the BCA Loan was secured by, among other things, 100% of the FLAC stock, and that BCA was assigning a proportionate share of its security interests to each purchaser of participation interests and would hold those shares for their benefit. Finally, the Participation Certificates provided that they are governed by the laws of Kansas.
In late June or early July 2008, BCA and Appellants Northern Capital, Southern Fidelity, and Security First signed addenda to the Participation Certificates, extending their participation interest repurchase date to September 30, 2008. The Security First Addendum was joined by Aleritas, who agreed “in the event of any default on the participation, or failure by [BCA] to repurchase the loan participation as contemplated by the Repurchase Provision, as amended, then the participation amount will be applied to principal and interest on [Security First’s] current loan outstanding with Aleritas Capital.” Section 12 of Appellants’ Participation Certificates, as well as the Bank of Kansas Participation Agreement, included the following provision about the administration of the BCA Loan:
Seller will not, without Purchaser’s written consent, reduce principal or interest with respect to the Loan or release or allow for the substitution of any Property, outside the normal course of dealing with Borrower so as to substantially reduce the possibility of repayment of the Loan. Seller will not, without Purchaser’s written consent, renew, extend or consent to the revision of the provisions of any note or security documents covered or waive any claim against Obligor.
Neither Appellants nor the Bank of Kansas filed a UCC financing statement to perfect any interest received under their respective participation agreements. Appellants and Bank of Kansas ...