O'Neal Steel v. E.B. Incorporated

• Decision Date: 24 August 1999
• Docket Number: No. 98-60442,98-60442
• Citation: 186 F.3d 638
• Parties: (5th Cir. 1999) In the Matter of: THOMAS SHANNON MILLETTE, Debtor. O'NEAL STEEL, INCORPORATED, Appellant-Cross-Appellee, v. E B INCORPORATED, Appellee-Cross-Appellant
• Court: U.S. Court of Appeals — Fifth Circuit

Page 638

186 F.3d 638 (5th Cir. 1999)

In the Matter of: THOMAS SHANNON MILLETTE, Debtor.

O'NEAL STEEL, INCORPORATED, Appellant-Cross-Appellee, v. E B INCORPORATED, Appellee-Cross-Appellant.

No. 98-60442

UNITED STATES COURT OF APPEALS FOR THE FIFTH CIRCUIT

August 24, 1999

Rehearing Denied Sept. 21, 1999.

Appeals from the United States District Court for the Southern District of Mississippi

Before JONES and STEWART, Circuit Judges, and DUPLANTIER,^* District Judge.

EDITH H. JONES, Circuit Judge:

At issue in this case is whether, under Mississippi law, an "assignment of rents" clause contained in a properly recorded deed of trust gives the mortgagee a perfected secured interest in the rents.¹ Although this issue has never been addressed by the courts of Mississippi, our best Erie guess is that, following the majority rule, a Mississippi mortgagee's interest in the rents becomes perfected when it properly records the document granting the assignment. The judgment of the bankruptcy and district courts is affirmed.

BACKGROUND

Thomas Millette, Ted Millette, William Millette, and Charles Fridge own a commercial building in Pascagoula, Mississippi known as the "Market Street Building." In August 1992, the owners executed a promissory note in favor of Eastover Bank in the principal amount of $ 445,198.71. As security for the note, the owners executed a deed of trust in favor of Eastover that contained the following assignment of rents clause:

As additional security, Debtor hereby assigns to Secured Party all rents accruing on the Property. Debtor shall have the right to collect and retain the rents as long as Debtor is not in default as provided in Paragraph 9. In the event of default, Secured Party in person, by an agent or by a judicially appointed receiver shall be entitled to enter upon, take possession of and manage the Property and collect the rents. All rents so collected shall be applied first to the costs of managing the Property and collecting the rents, including fees for a receiver and an attorney, commissions to rental agents, repairs and other necessary related expenses and then to payment of the indebtedness.

The parties stipulated that the deed of trust securing the Market Street Building was properly recorded in the Jackson County property records. MTGLQ Investment, L.P. subsequently purchased the note and deed of trust from Eastover and retained Security National to service the loan.²

In November 1993, O'Neal Steel obtained an Alabama judgment against Thomas, William, and Ted Millette in the amount of $ 164,335.89 plus interest. O'Neal enrolled the judgment in Jackson County, Mississippi on January 10, 1994. In May 1994, the Millettes, doing business as "Millette & Associates," entered into a commercial lease with Jackson County, which became the sole tenant in the Market Street Building. After discovering that the Millettes owned the building and were receiving rental income from it, O'Neal instituted a garnishment action in the Mississippi Circuit Court and served a writ of garnishment on Jackson County. As required by Mississippi law, the County answered the writ of garnishment, admitting it owed a debt to "Millette & Associates" under the lease. The County further stated that Security National claimed a prior interest in the rents pursuant to the recorded assignment of rents clause contained in the deed of trust.

When Security National learned of the garnishment action on January 4, 1995, it immediately served written notice and demand on Jackson County and ultimately intervened as a party in the garnishment action.³ Months later, Security National instituted foreclosure proceedings, but before it could complete the foreclosure, Thomas Millette filed for Chapter 7 bankruptcy,⁴ staying the foreclosure and all activity in the state court garnishment proceeding. The present adversary proceeding was commenced in bankruptcy court to determine the extent and priority of the competing liens on the rents.

O'Neal argues here, as it did in the bankruptcy and district courts, that it had a perfected interest in the Market Street Building's rents from the date it served its writ of garnishment on Jackson County. O'Neal contends that its lien has priority over Security National's lien because Security National failed to take the necessary steps to perfect its interest. According to O'Neal, under Mississippi law, a mortgagee must not only record its assignment of rents, it must also take "additional action," like appointing a receiver, to perfect its interest in rents. Therefore, because O'Neal served its writ of garnishment before Security National took the requisite additional action, O'Neal's interest in the rents should be superior.

The bankruptcy court disagreed with O'Neal's construction of Mississippi law and granted summary judgment in favor of Security National, holding that, based upon a then-recent Mississippi Supreme court decision, Security National had a perfected interest in the rents when it recorded its deed of trust containing the assignment of rents clause.⁵ Although the district court disagreed with the bankruptcy court's legal analysis, it reached the same result. It held that an assignment of rents clause is not perfected upon recordation; instead, a mortgagee must take "additional steps" to perfect its interest. According to the district court, Security National's actions upon learning of the garnishment were sufficient to perfect its previously recorded assignment of rents.

STANDARD OF REVIEW

This court reviews the district court's legal conclusions on a grant of summary judgment de novo, and it views the facts in the light most favorable to the non-moving party. Summary judgment is proper if "the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to judgment as a matter of law." Fed. R. Civ. P. 56(c); see also Horton v. City of Houston, 179 F.3d 188 (5th Cir. 1999).

DISCUSSION

Whether a Mississippi mortgagee, which has obtained an assignment of rents, is perfected in the rents when the assignment is recorded, or whether it must take additional steps to perfect its interest in the rents, is an issue of first impression both in this court and the courts of Mississippi. This court must anticipate what the Mississippi Supreme court would decide if the issue were before it. See Free v. Abbott Labs., 176 F.3d 298, 299 (5th Cir. 1999); F.D.I.C. v. Abraham, 137 F.3d 264, 268 (5th Cir. 1998). With little to go on, our best judgment is that the Mississippi Supreme Court would follow the modern trend of the law and hold that a mortgagee obtains a perfected lien on rents when it properly records an assignment of rents in the property records.

O'Neal, on the other hand, advocates the older common law approach, which a minority of states continue to follow.⁶ Under the older rule, an assignment of rents gives the mortgagee an inchoate lien which is perfected only when the mortgagee takes additional action to enforce it. In Texas, for instance, "an assignment of rentals does not become operative until the mortgagee obtains possession of the property, or impounds the rents, or secures the appointment of a receiver, or takes some other similar action." Taylor v. Brennan, 621 S.W.2d 592, 594 (Tex. 1981).

The majority of courts and legislatures have abandoned the "additional action" rule in favor of a rule analogous to those governing perfection of secured interest in personal property under the Uniform Commercial Code.⁷ Under the modern approach the recording of a mortgage document containing an assignment of rents "gives the mortgagee rights superior to any subsequent third party who would seek to take a security interest in the leases and rentals pertaining thereto as a type of collateral." O'Nei1l v. Carlson, 608 A.2d 858, 861 (N.H. 1992) (quoting In re Rancourt, 123 B.R. 143, 147 (Bankr. D.N.H. 1991) (quotations omitted)). Several state legislatures have also rejected the old common law rule.⁸ In Florida, for example, an assignment of rents is "perfected and effective against third parties upon recordation of the mortgage . . . in the public records of the county in which the real property is located . . . ." Fla. Stat. Ann. 697.07(2) (West Supp. 1999).

The recently published ALI Restatement of Mortgages has also adopted the position that a mortgage on rents is perfected when recorded. See Restatement (Second) of Property - Mortgages 4.2(b) (1997). Under the Restatement, a mortgage on rents "is effective as against the mortgagor and, subject to the operation of the recording act, as against third parties, upon execution and delivery." Id. The Restatement's comments make it clear that, upon recordation, the mortgagee will be protected against competing claims by third parties and others claiming priority over the rents. See id. at 4.2 cmt. b.

Public policy considerations weigh in favor of rejecting the old rule. The modern rule best protects diligent mortgagees from competing liens filed by subsequent creditors. Under the prior approach, a mortgagee with a lien on rents or an assignment of rents clause will nearly always lose a priority battle with a judgment creditor when the debtor has not defaulted on its payments under a mortgage. A judgment creditor can perfect its interest at any time by properly serving a writ of garnishment, while a mortgagee is prohibited from taking the requisite "additional action" to perfect until the debtor has defaulted. This leads to a bizarre result: A mortgagee, which has done all it could to secure its interest in the rents, loses priority to a judgment creditor who had constructive knowledge by the recordation of the mortgagee's assignment of rents. The case at hand illustrates this result. Security National was unaware of O'Neal's judgment against the Millettes until after the...