Matter of May

• Decision Date: 03 May 1994
• Docket Number: Bankruptcy No. 93-41430.
• Citation: 169 BR 462
• Parties: In the Matter of Michael George MAY, Debra Ann Pace May, Debtors.
• Court: U.S. Bankruptcy Court — Southern District of Georgia

169 B.R. 462 (1994)

In the Matter of Michael George MAY, Debra Ann Pace May, Debtors.

Bankruptcy No. 93-41430.

United States Bankruptcy Court, S.D. Georgia, Savannah Division.

May 3, 1994.

Bradley L. Cooper, Alston & Bird, Atlanta, GA, for plaintiff/movant.

C. James McCallar, Jr. and Mark Bulovic, Savannah, GA, for defendant/respondent.

MEMORANDUM AND ORDER ON MOTION FOR SEQUESTRATION OF RENTS AND REQUEST FOR ADEQUATE PROTECTION

LAMAR W. DAVIS, Jr., Chief Judge.

This matter came before the Court on the Motion of California Federal Bank, FSB for Sequestration of Rents and Request for Adequate Protection. On January 12, 1994, a hearing was held on the Motion. Based upon the evidence presented at the hearing, the parties' briefs, and the applicable authorities, I make the following Findings of Fact and Conclusions of Law.

FINDINGS OF FACT

On August 24, 1993, Debtors in the abovecaptioned case filed a petition under Chapter 11 of the Bankruptcy Code. Debtors remain in possession of the bankruptcy estate as debtors-in-possession under 11 U.S.C. Sections 1107 and 1108.

California Federal Bank, FSB ("California Federal") holds a balloon note ("Note"), dated October 16, 1991, which Debtors executed in its favor in the original principal amount of $600,000.00. The Note is secured by a Security Deed, dated October 16, 1991, that was duly recorded with the Clerk of Superior Court for Chatham County on October 17, 1991. The Deed grants California Federal a first priority security interest in 18 duplex units, which are located at 1401 King George Boulevard, Chatham County, Georgia, and known as Hunters Green Townhomes ("Hunters Green"). Debtors also executed an instrument entitled "Multi-Family Rider — Assignment of Rents" ("Assignment"), which assigns the rents derived from Hunters Green to California Federal under the following terms:

F. ASSIGNMENT OF RENTS. Borrower unconditionally assigns and transfers to Lender all the rents and revenues of the Property. Borrower authorizes Lender or Lender\'s agent to collect the rents and revenues and hereby directs each tenant of the Property to pay rents to Lender or Lender\'s agent. However, prior to Lender\'s notice to Borrower of Borrower\'s breach of any covenant or agreement in the security agreement, Borrower shall collect and receive all rents and revenues of the Property as trustee for the benefit of Lender and Borrower. This assignment of rents constitutes an absolute assignment and not an assignment for additional security only.

If Lender gives notice of breach to Borrower;

(i) all rents received by Borrower shall be held by Borrower as trustee for benefit of Lender only, to be applied to the sum secured by the security instrument;

(ii) lender shall be entitled to collect and receive all of the rents of the Property; and

(iii) each tenant of the Property shall pay all rents due and unpaid to Lender or Lender\'s agent on Lender\'s written demand to the tenant.

At some point in the early part of 1993, Debtors defaulted under the Note and Security Deed when they ceased making payments to California Federal. On May 17, 1993, California Federal sent, by certified letter, notice to the Debtors that their failure to make timely payments under the Note placed them in default under the terms of the Security Deed. On August 5, 1993, California Federal sent a second certified letter to the Debtors notifying them that the amount owing under the Note was being accelerated and that California Federal intended to assess fees pursuant to O.C.G.A. § 13-1-11. As previously set forth, Debtors filed their bankruptcy petition in this Court on August 24, 1993.

Cross examination of Mrs. May revealed that, since filing their Chapter 11 petition, Debtors have been using a portion of the rents derived from Hunters Green to pay for their personal expenses. These personal expenses included tithing at Debtors' church, as well as servicing a second mortgage encumbering Debtors' personal residence.

California Federal brought this Motion seeking possession of the rents, or alternatively, a classification of the Hunters Green rents as "cash collateral" under 11 U.S.C. § 363. In support of the motion, California Federal asserts that the Assignment is unconditional and absolute, and as a result, it became entitled to sole possession of the rents from the date on which it notified Debtors of their default. Thus, according to California Federal, the Assignment divested Debtors, and therefore the Chapter 11 estate, of any interest in the rents.

Debtors counter the Motion with the argument that the Assignment is not absolute because it expressly requires California Federal to take some action before it is entitled to the rents. Thus, because California Federal failed to demand possession of the rents, Debtors argue that California Federal's interest in the rents remains inchoate and subordinate to that of Debtors'. Debtors apparently do not contest the classification of the rents as "cash collateral," but they do contend that using the rents to service the second mortgage on their personal residence is appropriate because the funds derived from the mortgage were used to purchase the Hunters Green property.

CONCLUSIONS OF LAW

1. Nature of the Hunters Green Rents

Rents derived from property of the estate generally become property of the estate, see 11 U.S.C. § 541(a)(6), and a debtor-in-possession is ordinarily empowered to use such rents in the operation of the Chapter 11 estate. See 11 U.S.C. § 363(b)(1). If the rents are considered "cash collateral" under section 363(a) of the Code, however, a debtor-in-possession's right to use such rents is sharply curtailed. See 11 U.S.C. §§ 363(c)(2), 363(e). Section 363(a) defines "cash collateral" as follows:

In this section, "cash collateral" means cash, negotiable instruments, documents of title, securities, 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.

11 U.S.C. § 363(a). Thus, rents are "cash collateral" only when they are derived from property which is subject to the type of security interest provided for in section 552(b) of the Code.

Section 552(b) provides:

Except as provided in section 363, 506(c), 522, 544, 547, and 548 of this title, if the debtor and an entity entered into a security agreement before the commencement of the case and if the security interest created by such security agreement extends to property of the debtor acquired before the commencement of the case and to . . . rents . . . of such property, then such security interest extends to such . . . rents . . . acquired by the estate after the commencement of the case to the extent provided by such security agreement and by applicable nonbankruptcy law . . .

11 U.S.C. § 552(b). This provision states an exception to the general rule, set forth in section 552(a) of the Code, that property acquired by the estate after the filing of the bankruptcy petition is not subject to a security interest which arose by agreement before the commencement of the bankruptcy case. See 11 U.S.C. § 552(a). Thus, for section 552(b) to apply to rents derived from property of the estate, the following conditions must be present:

1) The debtor and creditor have entered into a security agreement prior to the commencement of the bankruptcy;

2) The security interest created under the agreement extends to property acquired by the debtor prior to the commencement of the bankruptcy case and to the rents derived from such property; and

3) If these two conditions are present, then the security interest extends to post-petition rents derived from the property to the extent that such an interest is contemplated by the relevant security agreement and to the extent permitted under applicable state law.

See generally In re Vienna Park Properties, 976 F.2d 106, 111-12 (2d Cir.1992) (Virginia law).

There is no question that the first two conditions set forth above are present in the instant case. The Security Deed and Assignment covering Hunters Green was executed prior to the commencement of Debtors' Chapter 11 case, and these instruments clearly cover both the underlying property and any rents derived therefrom. As to the third condition, the Assignment clearly grants California Federal the fullest interest in the rents that is available under state law. Thus, the only question under section 552(b) is the extent to which the lender's interest in the rents is affected by "applicable nonbankruptcy law", which in this case is the law of Georgia. See e.g., Butner v. United States, 440 U.S. 48, 54-57, 99 S.Ct. 914, 917-19, 59 L.Ed.2d 136 (1979); Matter of Charles D. Stapp of Nevada, Inc., 641 F.2d 737, 738 (9th Cir.1981); In re Leroy Moore, Ch. 11, No. 488-00105, slip op. at 5 (Bankr.S.D.Ga., October 14, 1988) (J. Dalis).

Under Georgia law, "notice to third parties of the rights conveyed pursuant to a Security Deed or separate assignment is accomplished by filing and recording these instruments in the appropriate real property records." In re Polo Club Apartments Assoc. L.P., 150 B.R. 840, 846 (Bankr.N.D.Ga.1993). See also Cummings v. Johnson, 218 Ga. 559, 560, 129 S.E.2d 762 (1963) ("A duly filed and recorded deed to secure debt is notice of all the rights which the grantee has thereunder."); Padgett v. Butler, 84 Ga.App. 297, 300, 66 S.E.2d 194 (1951); ("It was alleged that the assignment of rents was of record, thereby giving constructive knowledge of the plaintiff's right to the rents."); O.C.G.A. § 11-9-104(h) (specifically excluding assignment of rents from the coverage of Georgia version of the Uniform Commercial Code).¹ As set out above, California Federal properly recorded the Security...