SALINE STATE BANK v. MAHLOCH, 834 F.2d 690 (8th Cir. 1987)

SALINE STATE BANK, APPELLANT, v. RICHARD MAHLOCH, EUNICE MAHLOCH, DENNIS MAHLOCH AND FIRST NATIONAL BANK OF CHICAGO, ILLINOIS, APPELLEES.

No. 86-2458.United States Court of Appeals, Eighth Circuit.Submitted June 12, 1987.
Decided November 23, 1987.

Jerrold L. Strasheim, Omaha, Neb., for appellant.

Joseph M. Russell, Chicago, Ill., for appellees.

Appeal from the United States District Court for the District of Nebraska.

Before LAY, Chief Judge, HEANEY, Circuit Judge, and LARSON,[*] Senior District Judge.

LAY, Chief Judge.

[1] Saline State Bank entered into a mortgage agreement with the debtors, Richard, Dennis, and Eunice Mahloch, on January 12, 1982. After meeting their obligations under the mortgage agreement for eleven months, the Mahlochs filed a petition in bankruptcy under chapter 11 of the Bankruptcy Code on November 30, 1982. Even though the Mahlochs had declared bankruptcy,

Page 691

however, they continued to meet their obligations under the mortgage agreement with Saline State Bank (“Saline”) for several months.

[2] On September 28, 1983, Saline, as mortgagee, filed an application with the bankruptcy court to sequester rents and profits from the property. This claim to rents and profits was based on the language of the loan agreement, which expressly provided:

[U]pon such default the Mortgagee, or a receiver appointed by a court, may at its option and without regard to the adequacy of the security, enter upon and take possession of the Property and collect the rents, issues and profits therefrom and apply them first to the cost of collection and operation of the Property and then upon the indebtedness secured by this Mortgage; said rents, issues and profits being hereby assigned to the Mortgagee as further security for the payment of the indebtedness secured hereby.

[3] On November 10, 1983, a hearing was held before bankruptcy Judge Crawford.[1] Judge Crawford ruled that Saline’s interest would not be recognized in Nebraska, and that the automatic stay provision of 11 U.S.C. § 362(a) (1982) would prevent Saline from perfecting its interest after the Mahlochs filed in bankruptcy. Accordingly, the bankruptcy court denied Saline’s applications to sequester rents and profits and ruled in favor of the Mahlochs and the First National Bank of Chicago (“FNB”), an unsecured creditor. [4] On appeal to the district court, Judge Beam[2] reversed the bankruptcy court’s decision and remanded for further proceedings to determine if the value of the property was insufficient to secure Saline’s interest. Saline was opposed on remand, once again, by FNB and the Mahlochs. After considering additional documentary evidence and stipulations of fact, Bankruptcy Judge Mahoney[3] entered an order denying Saline’s applications.[4] [5] On appeal to the district court for the second time, Judge Strom[5] affirmed the bankruptcy court’s decision even though the Mahlochs did not enter an appearance. First National Bank of Chicago, representing the unsecured creditors, asserted that it could avoid the interest claimed by Saline because Nebraska law did not recognize interests in rents and profits as perfected until the mortgagee actively pursues its interest. In ruling in favor of FNB, Judge Strom relied on 11 U.S.C. § 544, which allows the trustee or debtor in possession to avoid perfection of liens arising subsequent to the filing of the bankruptcy petition. [6] On appeal from Judge Strom’s ruling, Saline asserts that the district court committed reversible error in relying on section 544.[6] Saline also argues that the express

Page 692

provision relating to rents and profits is a self-executing lien, effective henceforth at the time of the agreement. This latter argument, in effect, adopts the rationale that under Nebraska law, which both parties agree controls the question of the validity of the lien interest, no further act of perfection is necessary by Saline, and they are entitled to claim the rents and profits as cash collateral under 11 U.S.C. § 363(a).

[7] According to FNB’s argument under section 544, however, the security agreement affecting rents and profits is not a lien under Nebraska law until Saline perfects that interest in state court by appointing a receiver and foreclosing on the property. FNB argues that Saline could not do this until after the Mahlochs filed their bankruptcy petition because there was no default pre-petition. FNB also finds that the district court did not err in invoking section 544 which precludes Saline from perfecting its lien. [8] The overall effect of the district court’s ruling, then, is that Saline has no further security interest in the rents and profits and the fund must be applied to satisfy the general creditors (one of whom would now be Saline). Alternatively, FNB asserts that if Saline is able to perfect its lien, it cannot do so retroactively and any enforcement of the lien must be as of September 28, 1983, when Saline moved in bankruptcy court to have the funds sequestered. [9] After Butner v. United States, 440 U.S. 48, 99 S.Ct. 914, 59 L.Ed.2d 136 (1979), the rights of a secured creditor must be determined according to the applicable non-bankruptcy law of the state wherein the debt arises. Once bankruptcy intervenes, the bankruptcy trustee can avoid only those security interests which could not have been perfected under state law. At least in the case of a pre-petition default, Butner states emphatically that: “the primary reason why any holder of a mortgage may fail to collect rent immediately after default must stem from state law.” 440 U.S. at 57, 99 S.Ct. at 919. [10] The Pre-Petition Security Interest Under Nebraska Law
[11] Saline argues that its interest was perfected pre-petition, and, therefore, it is entitled to collect subsequent rents and profits. In support of its argument, Saline refers to established Nebraska law which recognizes the validity of assignment of rents clauses. Central Sav. Bank v. First Cadco Corp., 186 Neb. 112, 114, 181 N.W.2d 261, 264 (1970); Penn. Mut. Life Ins. Co. v. Katz, 139 Neb. 501, 504, 297 N.W. 899, 901 (1941). [12] Notwithstanding Saline’s persuasive argument, we find that Nebraska law requires us to hold that Saline did not have a lien until their interest was fully perfected, i.e., by filing a petition to sequester rents and profits. Neb.Rev.Stat. § 25-1081
(Reissue 1985) and Neb.Rev.Stat. § 25-1082 (foreclosure proceeding). Only by this method could the mortgagee exercise ownership over the rents and profits. See Prudential Ins. Co. of Am. v. Farm Inv. Co., 123 Neb. 578, 586, 243 N.W. 842, 846
(1932); Huston v. Canfield, 57 Neb. 345, 348-49, 77 N.W. 763, 764 (1899). Furthermore, under the express terms of the mortgage agreement, this procedure to perfect the lien can be invoked only upon default of the mortgagor. Nebraska law makes clear that perfection of this type of interest may happen only when the mortgaged property is insufficient to discharge the mortgage debt. Federal Farm Mortgage Corp. v. Ganser, 146 Neb. 635, 639, 20 N.W.2d 689, 692 (1945); Prudential Ins. Co. of Am. v. Farm Inv. Co., 123 Neb. at 586, 243 N.W. at 846; Huston v. Canfield, 57 Neb. at 348-49, 77 N.W. at 764; Jacobs v. Gibson, 9 Neb. 380, 387-88, 2 N.W. 893, 894 (1879). In the present case, it was stipulated that Saline was undersecured. [13] Saline argues that the agreement’s assignment of rents clause creates a self-executing

Page 693

lien and, therefore the appointment of a receiver is a mere procedural step. This position is contrary to established Nebraska law.[7] As stated by the Nebraska Supreme Court:

The general rule is that a junior mortgagee who obtains a receiver of the rents and profits in aid of a bill to foreclose his mortgage is entitled to the rents and profits at the hands of such receiver up to the time of appointing a receiver upon a bill of a prior mortgagee not a party to the original suit. High on Receivers, § 688. And the prior mortgagee is only entitled to have of the receiver such rents and profits as accrue after the appointment in aid of such prior mortgage, although one and the same person is appointed in both cases. The rule is based upon the consideration that, until the elder mortgagee sees fit to assert his right to the rents and income, a junior encumbrancer has a right to do so; and the first mortgagee not being a party to the former suit and having no lien on the rents and profits, and no right to recover the back rents, he can only assert his right thereto as against the receiver from the date of the appointment in his own suit.

[14] Goddard v. Clarke, 81 Neb. 373, 376, 116 N.W. 41, 42 (1908) (emphasis added). [15] Subsequent cases have enforced the same requirements. See Penn. Mut. Life Ins. v. Katz, 139 Neb. at 504, 297 N.W. at 901
(widow executed mortgage on property which, upon thirty days default, assigned to plaintiff mortgagee the rents due and delivered to plaintiff a written assignment of the mortgaged property). In Penn. Mut. Life Ins. v. Katz, the court observed that:

Defendant contends, relying upon Huston v. Canfield, 57 Neb. 345, 77 N.W. 763, that in a foreclosure action the court cannot divert the rents of the mortgaged premises from the tenant in possession claiming title under the mortgagor, except by the appointment of a receiver pursuant to statutory provisions. Of course, this contention is true unless the stipulation inter partes makes the rule otherwise.

[16] Recently, the United States Bankruptcy Court for the District of Nebraska observed that, outside of the bankruptcy context, it remains the rule in Nebraska today that a receiver must be appointed:

In Nebraska, the proper procedures to enforce such a lien outside the context of bankruptcy includes the commencement

Page 694

of foreclosure proceedings and requesting the appointment of a receiver to collect the rents and profits.

[17] In re Anderson, 50 B.R. 728, 732 (D.Neb. 1985) (citing Prudential Ins. Co. v. Farm Inv. Co., 123 Neb. 578, 243 N.W. 842
(1932) and Huston v. Canfield, 57 Neb. 345, 77 N.W. 763
(1899)). [18] An analysis of Nebraska cases to date clearly demonstrates that it is only upon default that the assignment clause of the security agreement becomes an equitable lien. Thereafter Nebraska law requires affirmative action on behalf of the lienholder to perfect such lien. [19] Saline argues that despite the Nebraska law discussed above, the express language of the assignment provision creates an immediate lien. See Penn Life v. Katz, 139 Neb. at 504, 297 N.W. at 901. We must disagree. The security agreement must be read as a whole and it is clear that each clause must be read as integrated with every other clause. There should be little doubt that the agreement provides a condition precedent of default to the establishment of an equitable lien. Nebraska law is uniform in requiring further perfection to protect the lien.[8] [20] Avoidance Powers under Section 544
[21] Having determined that Saline’s lien had not been perfected, we turn to the district court’s reasoning that FNB can avoid perfection of the lien under section 544. We find the district court erred in so ruling. [22] FNB asserted in the district court that Saline’s interest was unperfected when the Mahlochs filed their petition in bankruptcy and, therefore, Saline’s lien should have been avoided under 11 U.S.C. § 544. The express terms of section 544, however, are that: “The trustee shall have” the power to avoid liens unperfected at the time of the initiation of bankruptcy proceedings.[9] (Emphasis added). [23] Case law provides ample rationale as to why only the trustee or debtor in possession can invoke the avoidance powers under section 544: (1) general creditors otherwise would hinder plans to reorganize under chapter 11, In re Smythe, 28 B.R. 882, 885
(Bankr.D.Colo.), aff’d, 32 B.R. 736 (D.Colo. 1983); (2) one group of unsecured creditors might benefit to the detriment of other unsecured creditors as a result of piecemeal litigation In re Sweetwater, 55 B.R. 724, 733 (D. Utah 1985); and (3) the various motions and cross claims that would inevitably ensue might create needless confusion and inconvenience for all involved. In re Carbide Cutoff Inc., 703 F.2d 259, 264 (7th Cir. 1983); Gochenour v. Cleveland Terminals Bldg. Co., 118 F.2d 89, 95 (6th Cir. 1941). [24] Despite the language of section 544, a few courts have allowed a creditors’ committee to initiate adversary proceedings on their own. In re Evergreen Valley Resort, Inc., 27 B.R. 75
(Bankr.D.Me. 1983); In re Joyanna Holitogs, Inc., 21 B.R. 323
(Bankr.S.D.N.Y. 1982); In re Monsour Medical Center, 5 B.R. 715
(Bankr.W.D.Pa. 1980). FNB has cited no authority, however, to the effect that a single creditor has standing to invoke section 544. At least two courts have held otherwise. See Boyd v. Martin Exploration Co., 56 B.R. 776, 781 (E.D.La. 1986); In re Smythe, 28 B.R. at 885. But cf. Dehmer v. Temple,

Page 695

44 B.R. 992, 995 (S.D.Miss. 1984), modified, Joe T. Dehmer Distributors, Inc. v. Temple, 826 F.2d 1463 (5th Cir. 1987) (creditors can set aside fraudulent conveyances). FNB did not have standing to initiate adversary proceedings. Furthermore, even if we were to find that FNB could initiate adversary proceedings, they did not do so. Since initiating adversary proceedings is a necessary precursor to bringing a section 544 avoidance action, we hold that section 544 was never properly invoked. See Advisory Committee Notes to Fed.R.Bankr. 7001, 11 U.S.C. and In re Commercial W. Fin. Corp., 761 F.2d 1329, 1336 (9th Cir. 1985) (“[I]f the Trustee wants the benefit of avoiding valid security interests under the strong-arm clause of the Bankruptcy Code, he must carry the burden of following the mandated procedures.” 761 F.2d at 1338.)

[25] We note that the district court’s opinion states that the Mahlochs possessed the section 544(a) avoidance powers. The Mahlochs, however, have not attempted to exercise their powers. Only FNB has argued on behalf of the debtors, the estate, or the unsecured creditors. FNB had several options if they were dissatisfied with the performance of the Mahlochs:

If a creditor is dissatisfied with lack of action on the part of the debtor-in-possession, the creditor may move to replace the debtor-in-possession with a Chapter 11 trustee; or to convert the Chapter 11 case to one under Chapter 7; move to dismiss the Chapter 11 case; or petition the court to compel the debtor-in-possession to act or to gain court permission to institute the action itself.

[26] In re Curry Sorensen, Inc., 57 B.R. 824, 828 (Bankr.App. 9th Cir. 1986). FNB failed to pursue any of the options suggested i In re Curry Sorenson, Inc. [27] Furthermore, there is no merit to FNB’s argument that Saline has waived its ability to challenge the district court’s ruling under section 544(a). Saline is not attacking FNB’s standing to sue. Instead, Saline argues that proper procedures were not followed by any party seeking to avoid Saline’s lien on rents and profits. [28] We conclude that the district court committed an error of law by deciding this case on the basis of section 544 when it had not been properly invoked and, in fact, could not be asserted by FNB. Therefore, the judgment of the district court is reversed. We remand this matter to the district court for proceedings consistent with this opinion. [29] The Petition to Sequester Rents and Profits
[30] Finding that section 544(a) was improperly invoked by the district court, we face the issue whether the bankruptcy court should allow Saline to proceed with its applications to sequester funds from the date of its application. The record is not clear as to whether any of the funds in dispute were earned by the estate after the date of Saline’s application, September 28, 1983. Assuming there were funds earned after that date, the bankruptcy court should proceed with an evidentiary hearing under section 552(b) and determine the equities in allowing Saline to proceed.[10] [31] FNB urges that Saline cannot proceed with further perfection because of the existence of the automatic stay under section

Page 696

362. We note exercise of section 552(b) is subject to section 362 as well as section 544. In re Casbeer, 793 F.2d 1436, 1442-43 (5th Cir. 1986); In re Engstrom, 33 B.R. 369, 373
(Bankr.S.D. 1983). However, since a trustee has not been appointed under section 544(b), and FNB has never moved for such appointment, we address whether Saline may sequester the rents and profits without moving the bankruptcy court to set aside the stay.

[32] After the Mahlochs filed and the automatic stay went into effect, Saline did not make any efforts to perfect until September 28, 1983, when it filed petitions to sequester rents and profits. We must assume the amount that has accrued since Saline filed its petitions to sequester is a readily identifiable amount which the bankruptcy court can easily determine. Furthermore, since the Mahlochs have not been involved with the proceedings, and, in fact, the land has been sold, the money requested by Saline is not necessary to a successful reorganization under chapter 11. Here Saline does not seek to go into the state court, rather it simply requests the bankruptcy court to sequester the rents in the proceeding before it. Accordingly, we hold that the stay need not be formally lifted in order to award the rents and profits to Saline from the date after it filed petitions to sequester rents and profits. See In re Village Properties, Ltd., 723 F.2d at 445-447 (while interest was not a lien until perfected, the court recognized that a petition to sequester rents and profits would perfect mortgagee’s interest even if filed after the automatic stay was effective) Consolidated Capital Income Trust v. Colter, Inc., 47 B.R. 1008
(D.Col. 1985) (a judgment lien creditor can perfect its interest post-petition); In re Oak Glen R-Vee, 8 B.R. 213, 216
(Bankr.C.D.Cal. 1981) (Beneficiary of trust filed action to require debtor to cease spending and to account for “all rents, income, issues, and profits,” 8 B.R. at 215, but in view of equity cushion, debtor was permitted to retain rents and profits for a reasonable time. Filing of complaint, however, was sufficient to enable court to grant request to sequester rents and profits); contra In re Gotta, 47 B.R. 198
(Bankr.W.D.Wis. 1985) (since Wisconsin requires actual possession in order to perfect interest in rents and profits, and creditor could not obtain actual possession during pendency of stay, an interest in rents and profits cannot be perfected post-petition. 47 B.R. at 203. The Gotta court observed, however, that the result might be different in other jurisdictions where actual possession of property was not required to perfect an interest in rents and profits.)[11] [33] We therefore affirm the judgment of the district court that the Saline’s lien was not valid prior to its motion to sequester rents and profits made September 28, 1983, in the bankruptcy court; the district court erred in avoiding the perfection of the lien under section 544 and the court may allow sequestration of the rents and profits subsequent to September 28 as a secured interest in the name of the Saline State Bank. [34] Each party to pay its own costs.

Page 697