In re Prospect Studios, L.P.

• Decision Date: 24 August 2012
• Docket Number: No. 12–40548.,12–40548.
• Citation: 478 B.R. 367
• Parties: In re PROSPECT STUDIOS, L.P., Debtor.
• Court: U.S. Bankruptcy Court — Western District of Missouri

478 B.R. 367

In re PROSPECT STUDIOS, L.P., Debtor.

No. 12–40548.

United States Bankruptcy Court,

W.D. Missouri.

Aug. 24, 2012.

Jonathan A. Margolies, McDowell Rice Smith and Buchanan, Kansas City, MO, for Debtor.

U.S. Trustee, Kansas City, MO.

ORDER GRANTING APPLICATION BY McDOWELL RICE SMITH & BUCHANAN, COUNSEL FOR DEBTOR, FOR ALLOWANCE OF COMPENSATION FOR SERVICES RENDERED AND FOR REIMBURSEMENT OF ACTUAL AND NECESSARY EXPENSES

ARTHUR B. FEDERMAN, Bankruptcy Judge.

The law firm of McDowell Rice Smith & Buchanan (“MRS & B”), as counsel for Debtor Prospect Studios, L.P., has filed an Application for allowance of compensation for services rendered and for reimbursement of expenses incurred for the period of February 13, 2012 through May 16, 2012. MRS & B also seeks authority to draw down on the prepetition retainer it received from the Debtor to pay its fees. Creditor CSFB 2001–CP4 GLADSTONE COMPLEX LLC (“CSFB”) objects to the Application, not to the allowability or reasonableness of the fees, but to the Debtor's use of the retainer as a source of payment because CSFB asserts a perfected security interest in such retainer. For the reasons that follow, CSFB's objection to the Application is OVERRULED, and the Application is GRANTED.

Prior to the commencement of this bankruptcy proceeding, the Debtor engaged MRS & B as counsel to represent it in these proceedings. In conjunction with that engagement, the Debtor provided MRS & B with a prepetition retainer of $25,000, which MRS & B placed into its trust account. On February 16, 2012, MRS & B filed a voluntary Chapter 11 bankruptcy petition on the Debtor's behalf. The Debtor filed its Application for Authorization to Employ MRS & B as its counsel that same day. On March 14, 2012, this Court granted the Application to Employ MRS & B.

On May 23, 2012, MRS & B filed the instant Application for fees and expenses for the period of February 13, 2012 through May 16, 2012. MRS & B seeks $24,671.50 in fees for professional legal services rendered, and $1,356.54 for actual and necessary expenses, for a total of $26,028.04. Counsel stated at the hearing on the Application that MRS & B will not likely seek additional fees in this case.

No one has objected to MRS & B's application for fees per se, and CSFB stated at the hearing that it did not object to the reasonableness of the requested fees. I have reviewed the billing statements attached to MRS & B's Application and find them to be reasonable under 11 U.S.C. § 330(a)(3). Therefore, the Application for fees and expenses in the total amount of $26,028.04 is granted pursuant to 11 U.S.C. § 330(a)(1).

As stated, MRS & B wishes to draw down on the entire prepetition retainer towards payment of those fees, and CSFB does object to that request. CSFB is a secured creditor with a Deed of Trust dated July 31, 2001, and recorded August 1, 2001, on the Debtor's premises commonly known as “Prospect Studios,” a 200–unit apartment complex located at 2440 NE 68th Street in Gladstone, Missouri. The Debtor is a single asset real estate debtor as defined in 11 U.S.C. § 101(51B),¹ and essentially all of its income comes from rents. CSFB's Deed of Trust includes an assignment of leases and rents clause, and the parties executed a separate Assignment of Leases and Rents, which was also recorded with the Recorder of Deeds in Clay County, Missouri. The Debtor has not disputed that these documents were properly recorded, or that CSFB is the current holder of the loan documents. CSFB asserts that the Debtor owes it approximately $8.5 million.

Inasmuch as essentially all of the Debtor's income comes from rents, it appears to be undisputed that MRS & B's retainer came from post-default, prepetition rents collected by the Debtor from its tenants. The crux of this dispute is the nature of CSFB's interest in those prepetition rents after they were collected by the Debtor and then paid over to MRS & B.

CSFB has maintained, and still maintains, that rather than granting it a security interest in the rents, the assignment of rents is a “pure assignment”—such that CSFB actually owns the rents—and that the Debtor was only able to collect and use the rents under a license granted to it by CSFB. CSFB further asserts that, when the Debtor went into default in about April 2010, the Debtor's license to use the rents was automatically terminated. In other words, CSFB asserts that, under the Deed of Trust and Assignment of Rents, the funds in the MRS & B trust account are its property, and not property of the estate.

However, at an April 2, 2012 hearing on the Debtor's use of cash collateral, I ruled that, despite the loan documents' designation of the assignment as being a “present, absolute and unconditional assignment,” and “not an assignment for additional security,” the assignment was, in fact, a security interest, primarily because the assignment automatically terminated when the loan was paid in full.² Since there was no true assignment of the rents to CSFB, the rents—and therefore the retainer—are property of the Debtor's bankruptcy estate, and not CSFB's property.

CSFB asserts alternatively that even if the rents are an asset of the estate, it has a perfected security interest in them and, thus, the retainer. I note here that the Debtor has never expressly agreed on the record that CSFB has a perfected security interest in the rents being collected postpetition, but has proceeded, particularly in connection with cash collateral issues, as if that is true. Since the retainer came from rents, CSFB asserts that the money being held in MRS & B's trust account, which is the proceeds of rents collected prior to the bankruptcy, is also its collateral. Debtor has never conceded that funds representing the proceeds of rents collected prepetition are CSFB's collateral.

CSFB asserted in its Objection to the Application for fees that the retainer constitutes its cash collateral pursuant to § 363, and that it does not consent to the Debtor's use of the cash collateral to pay fees. At the hearing on the Application, MRS & B asserted that the prepetition rents are not “cash collateral,” inasmuch as “cash collateral” is a distinctly bankruptcy concept, and the funds involved here came to the Debtor, and were paid to MRS & B, prepetition.

Section 363(a) defines “cash collateral” to mean, in relevant part:

cash, negotiable instruments,.... deposit accounts, or other cash equivalents whenever acquired in which the estate and an entity other than the estate have an interest and includes the proceeds, products, offspring, rents, or profits of property ... whether existing before or after the commencement of a case under this title.³

Although counsel for CSFB stated at the hearing that it was not asserting that the retainer constituted “bankruptcy cash collateral” (which appears to be a change in position from that taken in its Objection), courts have held that rents received from a mortgaged property, either before or after a bankruptcy filing, are cash collateral to the extent they are subject to a security interest or lien.⁴ Courts have also held that a lender's security interest may also extend to rents that have been paid over prepetition to debtor's counsel as a retainerfor services to be performed in a bankruptcy case.⁵

Section 363(a) plainly contemplates that “cash collateral” includes rents, proceeds, and other cash equivalents, “ whether existing before or after the commencement of the case,” which would include money sitting in a bank account and a prepetition retainer. However, that is true only to the extent that such funds are subject to a security interest or lien. Thus, the threshold issue here is whether CSFB has a perfected lien in the funds constituting the retainer.

As stated, CSFB's claimed interest in the retainer stems from its claimed interest in the rents. In Missouri,⁶ security interests in rents are unique. Generally speaking, Article 9 of the Uniform Commercial Code excepts from its purview security interests in rents.⁷ Rather, security interests in rents are generally granted through an assignment of rents, either in the deed of trust or in a separate document, which is recorded with the county recorder's office.

However, unlike other security interests in real estate, an assignment of rents clause “lies dormant until certain steps are taken to activate, or perfect, such assignment.” ⁸ In addition to proper documentation and the recording of the assignment documents, the assignment only becomes fully perfected after default and either possession of the premises, or an action equivalent to possession, by the assignee.⁹ Only after such steps have been taken may the assignee collect rents directly from tenants.¹⁰ Until such steps are taken, a judgment creditor can garnish the rents in the hands of the tenants.¹¹

There has been no evidence, or even a suggestion, that CSFB perfected its security interest in the rents by notifying tenants to pay it directly, or taking any other steps to take possession of the premises, such as the appointment a receiver. To the extent that CSFB asserts a perfected security interest in the rents by virtue of its Deed of Trust and Assignment of Rents, I find that such interest was not fully perfected at the time the petition was filed because CSFB had not taken the activation step.¹²

Up until now, the focus in this case, particularly in connection with the cash collateral issue, has been on the ongoing rents and the right to collect them from the tenants. In contrast, MRS & B's retainer came from rents which were paid by the tenants to the Debtor before bankruptcy, which the Debtor had deposited into its bank account, and then paid over to MRS & B. This distinction is important. Generally speaking, I interpret the term “rents” to mean money owed to a property owner by its tenants under leases, which has been the focus of the cash collateral disputes in this case. Once...