Matter of Willows of Coventry, Ltd. Partnership

• Decision Date: 07 May 1993
• Docket Number: Bankruptcy No. 93-10516.
• Citation: 154 BR 959
• Parties: In the Matter of WILLOWS OF COVENTRY, LTD. PARTNERSHIP, Debtor.
• Court: U.S. Bankruptcy Court — Northern District of Indiana

154 B.R. 959 (1993)

In the Matter of WILLOWS OF COVENTRY, LTD. PARTNERSHIP, Debtor.

Bankruptcy No. 93-10516.

United States Bankruptcy Court, N.D. Indiana, Fort Wayne Division.

May 7, 1993.

Daniel J. Skekloff, Scot T. Skekloff, Fort Wayne, IN, for debtor.

Alen Lobley, Dominic Polizzotto, Indianapolis, IN, for Travelers.

DECISION¹

ROBERT E. GRANT, Bankruptcy Judge.

This matter is before the court following the trial of the issues raised by the debtor's motion, filed pursuant to 11 U.S.C. § 543, for turnover from a custodian and Travelers Insurance Company's objection thereto, as well as Travelers' motion to dismiss this case.

Debtor is the owner of an upscale apartment complex in Fort Wayne, Indiana. The property is encumbered by a mortgage in favor of Travelers which secures payment of a debt that, as of the date of the petition, was in excess of $14,000,000.00. Travelers also holds an "assignment of leases and collateral assignment of rents" with regard to this property. Prior to the date of the petition, Travelers declared debtor in default and initiated proceedings to foreclose its mortgage. In doing so, it also requested and received an order appointing a receiver to take possession of the property. On March 31, 1993, debtor filed a voluntary petition for relief under Chapter 11.

Although both motions ultimately turn upon the same issue, the moving party in each bears the burden of proof. Travelers bears the burden of showing cause to dismiss this case under 11 U.S.C. § 1112(b). In re Klein, 100 B.R. 1004, 1008 (D.N.D.Ill. 1989); Matter of Berryhill, 127 B.R. 427, 430 (Bankr.N.D.Ind.1991). In the turnover proceeding, on the other hand, the moving party bears the burden of proving:

(1) that a custodian has possession, custody or control of property; and

(2) that such property is property of the debtor. In re Lee, 126 B.R. 978, 982 (Bankr.S.D.Ohio 1991).

Therefore, the debtor bears the initial burden on these two points. In re Redman Oil Co., 95 B.R. 516, 521 (Bankr.S.D.Ohio 1988), aff'd on reh'g, 100 B.R. 945 (Bankr. S.D.Ohio 1989). Once it has presented a prima facie case, the burden then shifts to Travelers to prove that turnover should be excused under 11 U.S.C. § 543(d). In re Northgate Terrace Apartments, Ltd., 117 B.R. 328, 332 (Bankr.S.D.Ohio 1990).

The parties agree that the resolution of the issues presented by debtor's motion for turnover and Travelers' motion to dismiss turns primarily upon the question of who is entitled to possession of the rents generated by the apartment complex. Travelers contends that those rents do not constitute property of the bankruptcy estate, while the debtor contends they do.² Thus, the present matter requires the court to enter the debate, which it has heretofore happily avoided, concerning whether or not rents from leased property constitute property of the bankruptcy estate, where those rents are the subject of an assignment in favor of a lienholder who obtained the appointment of a receiver prior to the date of the petition.

Property of the bankruptcy estate is defined by § 541(a) of the United States Bankruptcy Code. The estate is comprised of "all legal or equitable interests of the debtor in property as of the commencement of the case" wherever located and by whomever held. 11 U.S.C. § 541(a)(1). A determination that the rents in question are not property of the estate requires the court to conclude that the debtor had no legal or equitable interest in those rents as of the date of the petition.

The starting point for any analysis of the competing rights of debtors and creditors is state law. Bankruptcy begins with these state law entitlements and then adjusts them in order to equitably distribute the assets of the estate and provide relief to the debtor.

Property interests are created and defined by state law. Unless some federal interest requires a different result, there is no reason why such interests should be analyzed differently simply because an interested party is involved in a bankruptcy proceeding. . . . The justifications for application of state law are not limited to ownership interests; they apply with equal force to security interests, including the interest of a mortgagee in rents earned by mortgaged property. Butner v. United States, 440 U.S. 48, 55, 99 S.Ct. 914, 918 59 L.Ed.2d 136 (1979).

Consequently, this court must begin by analyzing the relative rights of the debtor and Travelers as they would otherwise exist under Indiana law and then determine whether federal law has altered those rights.

Travelers bases its argument that the rents are not property of the estate upon the rights it exercised under an "Assignment of Leases and Collateral Assignment of Rents" it received from the debtor on March 24, 1988 and which was recorded with the Allen County Recorder on the next day. Reduced to its essence, this rather lengthy document reads:

The Assignor Willows . . . hereby grants, transfers, assigns and sets over to the Assignee Travelers the Assignor\'s entire interest as lessor in and to any existing leases and to all other present and future leases and all other rents, issues, income, charges, awards, premiums, proceeds, profits and any other sums which may become payable to the Assignor as lessor of the real estate located in Allen County. . . .

This Assignment is made for the purposes of securing:

A. The payment of the principle sum, interest and indebtedness evidenced by a certain First Mortgage Note and any amendments, extensions or renewals thereof, in the original principle sum of Fourteen Million Two Hundred Thousand Dollars ($14,200,000.00), made by the Assignor to the Assignee of even date herewith. . . .

B. Payment of all other sums, with interest thereon, becoming due and payable to the Assignee under the provisions of this Assignment and of the Note and Mortgage.

* * * * * *

This Assignment is made on the following terms, covenants, and conditions:

1. So long as there shall exist no default by the Assignor . . . the Assignor shall have the right to collect . . . all rents, income and profits arising from the Real Estate, and to retain, use and enjoy the same.

2. At any time permitted by law, and, in any event, upon or at any time after default . . . the Assignee . . . may, at its option, without notice . . . enter upon and take possession of the Real Estate pursuant to the terms of the Mortgage and have, hold, manage, lease and operate the same on such terms and for such period of time as the Assignee may deem proper and, either with or without taking possession of the Real Estate in its own name, demand, sue for or otherwise collect and receive all rents, income and profits of the Real Estate . . . and to apply such rents, income and profits to the payment of:

(a) all expenses of managing the Real Estate . . . and

(b) the principle sum, interest and indebtedness secured hereby. . . .

* * * * * *

4. Upon payment in full of the principal sum, interest and indebtedness secured hereby, this Assignment shall become void. . . . (Travelers\' Exhibit "2").

The debtor defaulted in the performance of its obligation to Travelers under the note and mortgage prior to March 29, 1993. On that date, Travelers initiated proceedings with the Allen Superior Court in order to foreclose its mortgage upon the apartment complex. In doing so, pursuant to the authority granted by the note and mortgage and in accordance with Indiana law, it requested and received, without notice, an order appointing Revel Companies, Inc. as a receiver in order to "take possession of the apartment complex manage same and collect the rents therefrom, all until further order of the court." (Travelers' Exhibit "3"). This order also directed the debtor to "surrender possession of and management of the property to the receiver. . . ." Id. The appointment became effective the next day, when Travelers posted the bond required by the state court. Debtor's petition for relief under Chapter 11 was filed on March 31, 1993, after the receiver went into possession of the property in question.

Given what transpired prior to the date of the petition, the court is required to determine whether the appointment of a receiver, debtor's default, the assignment of rents, and/or Travelers' exercise of its rights thereunder terminated debtor's interest in the rents and other income generated by the mortgaged property.

As a matter of Indiana law, the appointment of a receiver does not effect title to the property over which the receiver is given authority.

The appointment of a receiver effects no change in the title to the property involved. He does not, as a general rule, take a legal title thereto. He is a mere custodian pending the litigation, and his possession is the possession of the court which appoints him. Polk v. Johnson, 76 N.E. 634, 635 (Ind.App.1906). See also Durbin v. Northwestern Scraper Co., 36 Ind.App. 123, 73 N.E. 297, 301 (1905), appeal dismissed, 165 Ind. 237, 75 N.E. 1 (1905).

The purpose of a receiver is "to preserve the property pending its final disposition." Johnson v. LaPorte Bank & Trust Co., 470 N.E.2d 350, 353 (Ind.App.1984). Thus, the receiver only "holds possession of the property for the benefit of the party or parties ultimately determined to be entitled thereto. His custody is considered to be the custody of the court." Parfenoff v. Kozlowski, 218 Ind. 154, 161, 31 N.E.2d 206, 208 (1941).

As a result, Travelers' success in securing the appointment of a receiver over the apartment complex did not terminate debtor's ownership of the property or the rents it generated. That appointment did nothing more than deprive debtor of its statutory right to possession of the property, see I.C. XX-X-XX-X; its ownership interest continued. See Polk, 76 N.E. at 635.

A separate issue is the effect of the debtor's execution of the assignment of rents in favor of Travelers, especially in light of debtor's default in the performance of its obligation to...