In re Scottsdale Medical Pavilion

• Decision Date: 27 September 1993
• Docket Number: BAP No. AZ-92-1743-PRV,Bankruptcy No. 92-1006 PHX RTB.
• Citation: In re Scottsdale Medical Pavilion, 159 B.R. 295 (B.A.P. 9th Cir. 1993)
• Parties: In re SCOTTSDALE MEDICAL PAVILION, an Arizona limited partnership, Debtor. SCOTTSDALE MEDICAL PAVILION, Appellant, v. MUTUAL BENEFIT LIFE INSURANCE COMPANY IN REHABILITATION, successor to Mutual Benefit Life Insurance Co., Appellee.
• Court: U.S. Bankruptcy Appellate Panel, Ninth Circuit

159 B.R. 295 (1993)

In re SCOTTSDALE MEDICAL PAVILION, an Arizona limited partnership, Debtor SCOTTSDALE MEDICAL PAVILION, Appellant, v. MUTUAL BENEFIT LIFE INSURANCE COMPANY IN REHABILITATION, successor to Mutual Benefit Life Insurance Co., Appellee.

BAP No. AZ-92-1743-PRV, Bankruptcy No. 92-1006 PHX RTB.

United States Bankruptcy Appellate Panel of the Ninth Circuit.

Argued February 19, 1993.

Submitted May 10, 1993.

Decided September 27, 1993.

David W. Eagle, Phoenix, AZ, for appellant.

Paul E. Tang, Tucson, AZ, for appellee.

Before: PERRIS, RUSSELL, and VOLINN, Bankruptcy Judges.

OPINION

PERRIS, Bankruptcy Judge:

Scottsdale Medical Pavilion ("debtor") appeals an order concluding that rents collected by it prepetition are cash collateral as defined by 11 U.S.C. § 363(a) and denying the debtor use of that collateral. We AFFIRM.

FACTS

The debtor executed a promissory note payable to the order of Mutual Benefit Life Insurance Company ("Mutual")¹ secured by a deed of trust on the debtor's rental property. To further secure the obligation the debtor also executed an assignment of rents and leases (the "Assignment"). The Assignment provided that the debtor

does hereby irrevocably grant, assign, transfer, convey and set over to THE MUTUAL BENEFIT LIFE INSURANCE COMPANY ... all the right, title and interest of the debtor in and to all the existing and future leases ... and all rents, issues and profits ... and other monies now due and payable and/or hereafter to become due and payable to the debtor ....

The Assignment was duly recorded in the real property records of the county in which the property was located. The Assignment contained provisions, discussed more fully below, allowing Mutual to collect the rents directly from tenants upon delivering notice to them.

The debtor failed to make payments when due, and on January 24, 1992, Mutual sent a letter to the tenants instructing them to forward all rent payments to Mutual. Three days later, the debtor filed a Chapter 11 petition. On the date of the petition, the debtor held approximately $15,000 in a bank account, all of which was from prepetition rental income.²

The debtor filed its motion for authority to use cash collateral on January 30, 1992. On June 23, 1992, the trial judge entered an order which treated the prepetition rents as cash collateral by requiring their sequestration and prohibiting their use by the debtor. The debtor timely filed its notice of appeal on July 2, 1992.

ISSUES

When faced with questions concerning a debtor's entitlement to use rents, many decisions collapse all steps of the analysis into one question — is the creditor's interest perfected? See Wattson Pacific Ventures v. Valley Federal Savings & Loan (In re Safeguard), 2 F.3d 967, 969 (9th Cir.1993). While the determination of whether a debtor may use cash collateral may ultimately boil down to that question, skipping the intermediate steps in the analysis may result in the confusion or blending together of different concepts with independent significance. See In re Park at Dash Point L.P., 121 B.R. 850, 855 (Bankr.W.D.Wash. 1990); aff'd 152 B.R. 300 (W.D.Wash.1991), aff'd 985 F.2d 1008 (9th Cir.1993) (noting that as caselaw dealing with assigned rents has developed, the distinction between the concepts of perfection and enforcement has become blurred). To avoid any confusion, we separately consider each of the following issues:

1. Whether, under Arizona law, the rents collected by the debtor prepetition constitute cash collateral as defined in § 363(a); and,

2. If so, whether the court erred in ordering the funds sequestered and denying the debtor use of those funds.

In addition, we consider whether the debtor is entitled to an award of attorney fees.

STANDARD OF REVIEW

We review de novo the legal standard used by the trial judge in determining whether the funds in question are cash collateral. In re Zeeway Corp., 71 B.R. 210, 211 (9th Cir. BAP 1987). Resolution of the issues before the Panel also involves contract interpretation, which we review de novo where resort to extrinsic evidence is not necessary. Jeff D. v. Andrus, 899 F.2d 753, 759 (9th Cir.1989). Whether the debtor is entitled to its attorney fees for litigating cash collateral issues presents a question of law which we also review de novo. In re Fobian, 951 F.2d 1149, 1151 (9th Cir.1991), cert. denied, ___ U.S. ___, 112 S.Ct. 3031, 120 L.Ed.2d 902 (1992).

DISCUSSION

I. ARE THE PREPETITION RENTS COLLECTED BY THE DEBTOR CASH COLLATERAL?

A. Definition of Cash Collateral. Section 363(c)(2)³ prohibits a debtor in possession from using cash collateral absent a court order or consent from each entity that has an interest in the cash collateral. Cash collateral is defined in § 363(a) as

cash ... 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 subject to a security interest as provided in section 552(b) of this title, whether existing before or after the commencement of a case under this title (emphasis added).

Thus, if Mutual has any legally cognizable interest in the funds at issue they are cash collateral. To constitute cash collateral, it is not necessary that Mutual show it is entitled to immediate possession of the funds or that the interest is perfected.⁴

The debtor contends that because the funds at issue are held in a bank account,⁵ they no longer constitute "rents" covered by the assignment, but are more properly characterized as an account. That argument is unpersuasive. All "rents" are converted into a different form upon payment. For example, a rent payment represented by a check becomes an "instrument," but is nonetheless covered by a security interest in the rent. If the debtor's argument were accepted, then all assignments of rents would be illusory, as the funds would no longer be rents once paid. We therefore conclude that because all the funds in the account are directly attributable to rents they are rents within the scope of the assignment of rents provisions. The question is whether Mutual had an interest in those rents under Arizona law.

B. Did Mutual Have an Interest in the Rents? Both parties agree the question of whether Mutual had an interest in the rents on the date of the petition is governed by the laws of the state of Arizona. Butner v. United States, 440 U.S. 48, 52, 99 S.Ct. 914, 916, 59 L.Ed.2d 136 (1979); See In re Safeguard, 2 F.3d at 969. Grounding our decision in Arizona law is a challenging task, as the existing Arizona case law dealing with security interests in rents is murky, contradictory and, at times, fails to take into account statutory changes concerning assignments of rents.

1. THE CASELAW. The earliest relevant case decided under Arizona law is Dart v. Western Savings and Loan Assn., 103 Ariz. 170, 438 P.2d 407 (1968). That case holds that a receiver can be appointed pending foreclosure only if the mortgagee showed that his interest in the real property was inadequately protected. After Dart was decided, the Arizona legislature enacted A.R.S. § 33-702(B), which expressly provides for assignments of rent in both mortgages and trust deeds. Prior to the enactment of § 33-702(B), Arizona had no statute specifically dealing with assignments of rent. Section 33-702(B) effectively overruled the Dart case by providing, among other things, that a beneficiary was entitled to enforce its assignment by appointment of a receiver "without regard to the adequacy of the security...."

After enactment of § 33-702(B) the reported cases dealing with Arizona law continued to look for guidance to Arizona case law which predated § 33-702(B) and law imported from other jurisdictions rather than focusing on the language employed by the Arizona legislature.

The stage was set by Prudential Ins. Co. v. Fifty Associates, 503 F.2d 925, 929 (9th Cir.1974), which states

generally, the mortgagee is not entitled to receive the rents from mortgaged property prior to a default or commencement of foreclosure proceedings. However, the mortgage lien on such rents ripens upon the appointment of a receiver. (emphasis added).

The above statement does not provide much guidance in the present case for several reasons. First, we cannot tell what the term "ripens" means as used in that case. Must a lien "ripen" before the lienor has an interest in property, or is "ripening" more akin to perfection? Second, Prudential concerned entitlement to rents collected after the creditor attempted to enforce the assignment of rents. The question in this case is whether the creditor has an interest in rents collected before enforcement proceedings. Finally, Prudential makes no reference to A.R.S. § 33-702(B), and may have been decided under the law as it existed prior to that statute.

In In re American Continental Corp., 105 B.R. 564 (Bankr.D.Ariz.1989) (Curley, Bankr. J.), the court assumed that Prudential was decided under the prior law, but nevertheless appears to fall back upon Prudential's "ripening" concept. The American Continental case interprets "ripening" as synonymous with "choateness." Having introduced the concept of "choateness" into the picture, the American Continental court concludes that under Arizona law, a lien in rents both arises and is perfected by virtue of taking one of the acts set forth in A.R.S. § 33-702(B), and the lien and its perfection relate back to the date of recordation.

The American Continental decision was criticized in several respects (including its reliance on the concept of choateness) by In re Tucson Industrial Partners, 129 B.R. 614 (9th Cir. BAP 1991), vacated as moot, 990 F.2d 1099 (9th Cir.1993). The Tucson Industrial case, though vacated, properly noted that in resolving questions concerning assignments of rent, A.R.S. § 33-702(B) is the "relevant statute."

Finally, In re Multi-Group III...