UNITED STATES BANKRUPTCY COURT
EASTERN DISTRICT OF KENTUCKY
MICHAEL DAVID HAMILTON
PATRICIA KAY HAMILTON CASE NO. 89-10298
d/b/a SOUTH SHORE PLAZA, CHAPTER 11
This matter is pending before the Court on Motion of First
American Bank for Relief from Automatic Stay as to Cash
Collateral. First American Bank seeks to continue to receive
lease payments and to proceed to conclude its foreclosure action
filed in Greenup Circuit Court. First American Bank contends
that assignment of lease income constitutes cash collateral and
asks for determination of debtors in possession's rights to said
collateral under 11 USC Section 363.
FINDINGS OF FACT
The debtors in possession, Michael and Patricia Hamilton,
filed their Petition for Reorganization under Chapter 11 of the
Bankruptcy Code on November 29, 1989. First American Bank is a
secured creditor of the debtors in possession which holds
mortgages on their business property, a shopping center in South
Shore, Kentucky, and on their residence. First American Bank
was receiving lease payments from the tenants of the shopping
center pursuant to three Assignments of Lease Income
given by the debtors in possession on September 10, 1987. First
American Bank began receiving assigned payment of rents from the
tenants in July of 1989. The Court sustained a request filed by
the debtors in possession on January 19, 1990, that the rent
payments be turned over to them and issued an Order to that
effect on May 10, 1990. First American Bank filed its Motion for
Relief from Automatic Stay as to Cash Collateral on February 7,
The debtors in possession filed their Response to First
American Bank's Motion for Relief on April 27, 1990, and raised
the question of whether or not the Bank had a perfected
assignment of rents. The debtors in possession contend that the
Bank could not collect rents until it had perfected its
assignment either through the appointment of a receiver or by
concluding its foreclosure action. This issue is now before the
Court for decision.
CONCLUSIONS OF LAW
It is well settled that applicable state law controls the
perfection of a creditor's cash collateral, the determination of
property rights being generally left to state law. Butner v.
United States, 440 US 48, 99 S.Ct 914, 59 L.Ed. 2d 136. Under
Kentucky law, an assignment for rents and profits provision
gives the lender the right to seek possession of those rents
and profits. KRS 425.600 authorizes a state court to appoint a
receiver who has the authority to take charge of the property,
bring and defend actions, keep possession of the property,
collect debts, receive rents and generally do acts regarding
control of the property. This is a form of constructive
possession, and until the secured creditor takes such possession,
the debtor is entitled to use the proceeds generated by the
premises. Southern Trust Co. v. First City Bank of Hopkinsville,
259 Ky. 151, 82 S.W.2d 205 (Ct.App. 1935). See also Watts Admr.
v. Smith, 250 Ky. 617, 63 S.W.2d 796 (Ct.App. 1933).
A secured creditor holding an assignment of rents and
profits generated by the debtor's real estate will not be
entitled to them absent having sequestered them by some
appropriate process prior to the filing of the bankruptcy
petition. Failing this sequestration, whether by actual
possession or constructive possession through the appointment of
a receiver, the creditor will not have an interest in the
proceeds and they will not be considered cash collateral as
defined in'363(a). Instead the creditor has an inchoate lien
which must be perfected by some further act by the creditor. See
Southern Trust Co. at page 207.
A mortgagee is generally regarded under state law as having
no claim to cash proceeds until it takes possession of the
premises which generate the proceeds. Specific assignments of
cash revenues are not looked upon with favor by the courts, and
these provisions are construed to refer to profits accruing after
entry. In cases upholding such clauses, the courts have required
some action by the mortgagee to reduce the rents and profits to
possession, such as physical entry or appointment of a receiver
to collect rents and manage property. These courts view the
right to income as an incident of possession, so that an
assignment of rents and profits does not become activated until
possession. See Wolters Village, Ltd. v. Village Properties,
Ltd.; (In Re: Village Properties, Ltd.), 723 Fd.2d 441 (5th Cir.
1984); In Re: Pine Lake Village Apartment Co., 17 B.R. 829
(Bankr. S.D. NY 1982).
The filing of a Chapter 11 petition perfects the trustee's
rights to rents and profits then on hand pursuant to Bankruptcy
Code Section 544. The trustee can therefore retain all rents and
profits on hand as of the date of the commencement of the case.
Section 544 allows the trustee to avoid liens and security
interests against the debtors estate which were not properly
perfected under state law before the debtor filed bankruptcy.
The trustee prevails over any unenforceable or unperfected
Some creditors have asserted the right to post-petition
profits and proceeds under'546(b). The question of whether
creditors may perfect an inchoate lien under'546(b) has been
considered in: In Re: Prichard Plaza Associates Limited
Partnership, 84 B.R. 289 (Bankr. Mass. 1988); In Re: Association
Center Limited Partnership, 87 B.R. 142 (Bankr. W.D. Wash. 1988);
In Re: T. M. Carlton House Partners, Ltd., 81 B.R. 349 (Bankr.
Pa. 1988); In Re: Metro Square, 93 B.R. 990 (Bankr. Minn. 1988).
All these cases hold that'546(b) does not allow post-petition
perfection of rent assignments.
Without benefit of citation in support of its position,
First American Bank contends that the Kentucky cases cited above
do not apply herein because these cases involve the derivation of
a mortgagee's claim to rents and profits from a mortgage term.
First American Bank argues that the assignments of lease income
are separate and complete security agreements between First
American Bank and the debtors in possession. However, documents
attached to First American Bank's Motion for Relief from
Automatic Stay which partially evidence debtors in possession's
indebtedness to First American Bank suggest otherwise. The
promissory note dated September 10, 1987, states that the loan of
$260,000.00 is secured by "mortgage of even date on real estate
located in Greenup County, Kentucky, assignment of lease income."
The referenced mortgage, also dated September 10, 1987, contains
no specific provision concerning the assignment of rent, issues
and profits to the mortgagee. It does, however, contain a
provision entitled "Option and Securities" which reads: "The
mortgagee may resort for the payment of all or any part of the
debt to any securities a mortgagee may have therefor in such
manner, in such order as the mortgagee may think proper." The
three Assignments of Lease Income, each also dated September 10,
1987, can be nothing other than the "securities that mortgagee
may have therefor". Thus, to argue that these Assignments have
lives of their own, separate and apart from the mortgage, is to
ignore the relationship between the mortgage and the assignments.
First American Bank must therefore be held to the requirements of
Kentucky law as regards perfection of its security interest as
any other mortgagee would be.
The Court is therefore of the opinion that First American
Bank's Assignments of Lease Income were not perfected under
Kentucky law, through either constructive or actual possession of
the premises generating the lease income. Such lease income is
thus property of the estate and not cash collateral which should
be applied to the indebtedness of First American Bank.
Dated: May 30, 1990.
By the Court
John 0. Morgan, Jr.
George P. Stavros
Patricia Meigs Pitt