VS. ADV. NO. 91-0166









This matter came on for trial before the Court on February 7, 1992. The Court having considered the testimony offered at trial and by deposition, the joint stipulation of the parties, the briefs of the parties, and the documentary and other pertinent evidence of record in this case, and being otherwise fully advised, now, in accordance with Rule 52 of the Federal Rules of Civil Procedure, as made applicable herein by Federal Rule of Bankruptcy Procedure 7052, makes the following Findings of Fact and Conclusions of Law.


The debtors herein, Thomas and Irene Hinkle, filed their Chapter 11 petition in this Court on October 29, 1990. Listed on their Schedule A-2, "Creditors Holding Security", are debts to the plaintiff, First National Bank ("First National"). The promissory notes in regard to these debts were at one time secured by three separate real estate mortgages on various pieces of property located in Laurel and Jackson Counties.

A mortgage on two parcels in Laurel County was executed on April 11, 1981. The amount secured was $46,500.00. A mortgage on the same two parcels in Laurel County and on three parcels in Jackson County was executed on February 13, 1985. This mortgage was a second mortgage on the Laurel County property and a first mortgage on the Jackson County property. The amount secured was $85,000.00. The Laurel County parcels were the subject of a third mortgage executed on January 31, 1986. The amount secured was $45,000.00.

The Joint Stipulation of the parties indicates that on July 27, 1989, First National executed and recorded a general release of liens with the Laurel County Court Clerk's office concerning fifteen real estate mortgages located in Laurel County. Included within the released liens were two mortgages executed by the Hinkles in favor of First National referred to as Plaintiff's Exhibits 1 and 2. On July 28, 1989, First National executed and recorded a general release of liens with the Jackson County Court Clerk's office concerning a real estate mortgage located in Jackson County. Included within the released lien was the mortgage executed by the Hinkles in favor of First National referred to as Plaintiff's Exhibit 3.

On May 4, 1989, the debtors executed a promissory note and mortgage in favor of defendant Tri-County National Bank ("Tri-County") in the amount of $190,000.00, which gave Tri-County a mortgage interest in the same parcels of property as were the subjects of First National's mortgages. This mortgage was recorded on May 12, 1989, in the Laurel County Clerk's office and on May 22, 1989, in the Jackson County Clerk's office. At the time of the recording of Tri-County's mortgage, First National's three mortgages were of record. Prior to May 4, 1989, Tri-County requested a preliminary title opinion on the debtors' property. This preliminary title opinion showed First National's three mortgages as exceptions. Title updates conducted on July 24, 1989, determined that these mortgages had not been released as of that date.

Avery Perry ("Perry"), currently President of Williamsburg National Bank, was a Vice President of Tri-County from November 1988 to the end of May 1989. Perry worked with the debtors on their loan application with Tri-County beginning in January 1989. (Transcript, p. 47). At the time the debtors applied for the loan, they submitted a financial statement which indicated that $15,000.00 was owed on their residence. Perry testified that he was told that this mortgage would be released by First National at the time of closing. (Transcript, p. 49). He also testified that he was aware from the information contained in the financial statement that $5900.00 was owed on the Jackson County property. (Transcript, p. 54).

Perry testified that he called First National concerning the "paid" mortgages and talked to Wayne Snyder ("Snyder"), a loan clerk. He stated that Snyder told him that the mortgages would be released. (Transcript, p. 58). Perry further stated that the only call to Snyder which he documented was the one he placed on the day of closing, May 4. He stated that he might have called a few more times. (Transcript, p. 58). Perry acknowledged that the final title opinion dated July 24, 1989, noted exceptions to Tri-County's first mortgage lien. (Transcript, p.59). These exceptions included mortgages in favor of First National in the amounts of $45,000.00, $46,500.00, and $85,000.00. These mortgages were noted in the margin of the title opinion as not having been released as of July 24, 1989. (Plaintiff's Exh. 11; Defendant Tri-County's Exh. B).

Snyder testified by deposition that he released the mortgages after someone called in and asked for a mortgage release. He did not remember the transaction, but a "little piece of paper there that someone had called it in" and bank records confirmed it. (Snyder depo., pp. 6-7). Snyder further testified that he was aware that the Hinkle loans were considered problem loans, and that he could not take any independent action as to them, including the release of mortgages, but he did not remember checking with a loan officer before effecting the subject releases. (Snyder depo., pp. 9-10). He stated that he would not have released a mortgage only on the basis of Perry's request. (Snyder depo., p. 11).


This Court has jurisdiction of this matter pursuant to 28 U.S.C. '1334(b); it is a core proceeding pursuant to 28 U.S.C. '157(b)(2)(K). This is a Chapter 11 case, and the debtors in possession have all the rights, powers, functions and duties of a trustee serving in a case under Chapter 11. 11 U.S.C. '1107(a). A debtor in possession is a fiduciary holding the estate's assets and operating its business for the benefit of creditors and under the supervision of the court. A debtor in possession may avoid an unperfected security interest pursuant to the "strong arm clause", 11 U.S.C. '544(a)(1). In re Waldvogel, 125 B.R. 13 (Bkrtcy.E.D.Wis. 1991).

In the context of a bankruptcy case, the order of priority is, of course, determined as of the date of filing of the petition. The arguments of the parties concerning the restoration of the plaintiff's mortgages notwithstanding, the issue to be determined here is the position of each of the principals at the time of filing. When the debtors filed their Chapter 11 petition, the plaintiff had released the mortgages at issue herein and was, therefore, an unsecured creditor of the debtors. At the time of filing of the petition, the debtors assumed the role of debtors in possession who could avoid an unperfected security interest. 11 U.S.C. '544(a), the "strong arm statute", puts the trustee (debtors in possession herein) in the position of a judgment lien creditor on the date of the filing of the bankruptcy petition. An unperfected security interest is subordinate to the rights of a lien creditor. KRS 355.9-301(1)(b). A lien creditor includes a trustee in bankruptcy. KRS 355.9-301(3). The debtors in possession could therefore avoid the unperfected lien of the plaintiff and preserve it for the benefit of the estate. 11 U.S.C. '551.

Defendant Tri-County was a secured creditor on the date of filing of the petition, its mortgage having been executed and recorded more than a year before the filing. The debtors in possession cannot prevail over Tri-County. A bankruptcy trustee who avoids and then preserves the lien of a creditor cannot acquire greater rights in the property than those to which he succeeded. In re Appalachian Energy Industries, Inc., 25 B.R. 515 (Bkrtcy.M.D.Tenn. 1982). Tri-County's position is therefore superior to that of the debtors in possession. The order of priority which results places Tri-County first, the debtors in possession second, and First National as an unsecured creditor.

A judgment in conformity with this opinion will be entered separately.

Dated this _____ day of _______, 1992.

By the Court -





Copies to:


Robert Brown, Esq.

Wesley Tipton, Esq.

Maxie Higgason, Esq.