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.


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.


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

security interest.

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




Copies to:

John 0. Morgan, Jr.

George P. Stavros

Patricia Meigs Pitt