This case is before the court on summary judgment motions by the plaintiff bankruptcy trustee and the defendant Kentucky Finance Company, Inc. The court is to determine the priority and extent of the judicial lien of the trustee vis-à-vis the subrogation claim of Kentucky Finance Company, Inc. Kentucky Finance Company, Inc. voluntarily paid in full the prior mortgage of Berea National Bank on the debtor’s residence and claims to be subrogated to the bank’s mortgage.

On November 20, 1997 the debtor, Emma Schrea Stone, filed a petition for relief under chapter 7 of title 11 of the United States Bankruptcy Code. She listed as encumbrances on her residence known as 306 Center Street, Berea, Kentucky, two mortgages, a mortgage dated June 20, 1996 to Berea National Bank and a junior mortgage dated March 17, 1997 to Kentucky Finance Company, Inc. According to proofs of claim filed by these mortgage holders, the balance due on the first mortgage indebtedness to Berea National Bank was $70,305.17, and the balance due on the second mortgage indebtedness to Kentucky Finance Company, Inc. was $23,209.27. In the schedules to her petition the debtor valued her residential real property at $99,000.00. Upon the commencement of her bankruptcy case the debtor’s interest in her real property became property of the bankruptcy estate. On December 16, 1997, almost one month after the debtor filed for bankruptcy protection, while the real property in question was property of the bankruptcy estate subject to the aforementioned mortgages, Kentucky Finance Company, Inc. paid the Berea National Bank the full amount remaining due on the senior mortgage. Kentucky Finance Company, Inc. claims this was done to protect its interests in the real property. Neither the debtor nor the trustee had knowledge of the transaction whereby Kentucky Finance Company, Inc. paid off the mortgage of Berea National Bank.

Berea National Bank did not assign its note and mortgage to Kentucky Finance Company, Inc.

On December 23, 1997, upon payment in full of its mortgage by Kentucky Finance Company, Berea National Bank executed a release of its mortgage. The release was notarized on December 23, 1997 and recorded in the Madison County Clerk’s office on December 31, 1997 in Book 117 at page 7. On February 3, 1998, Berea National Bank filed in the bankruptcy case a Withdrawal of Claim and Notice of Satisfaction.

On January 15, 1998 Kentucky Finance Company, Inc. moved for relief from stay in order to enforce its mortgage against the debtor’s residence. On January 29, 1999 the trustee in bankruptcy objected to Kentucky Finance Company’s request for relief from stay on the grounds that because of the release of Berea National Bank’s mortgage there was substantial equity in the property. The trustee takes the position that he holds a judicial lien which replaces the released consensual lien of Berea National Bank on the property.

At a hearing held on February 9, 1998 the court overruled the motion of Kentucky Finance Company, Inc. for relief from stay and authorized the trustee to sell the debtor’s residence at public auction free and clear of liens and encumbrances.

At a public auction held February 21, 1998 Kentucky Finance Company, Inc., as high bidder, purchased the property for $64,500, against which Kentucky Finance Company was permitted to credit bid the balance due on its mortgage. The trustee credited the purchase price with the amount of Kentucky Finance Company’s secured claim but not the amount Kentucky Finance Company had paid to retire the mortgage of Berea National Bank. The trustee is holding the proceeds of sale for distribution pending a determination of the status of claim of Kentucky Finance Company.

After it paid off the mortgage of Berea National Bank, Kentucky Finance Company obtained a quit claim deed from the debtor. This deed was executed after bankruptcy while the automatic stay was in effect. The deed has not been recorded. The debtor never requested that Kentucky Finance Company pay off the mortgage to Berea National Bank and had no knowledge of its actions until asked to sign the quit claim deed. Kentucky Finance seeks subrogation for its payment of the first mortgage debt on the property.

Upon the filing of the debtor’s petition the debtor’s legal and equitable interest in her residence became property of her bankruptcy estate. 11 U.S.C. § 541.

Her interest in the residence passed to the estate subject to liens, including the judicial lien of the trustee which attached to the property simultaneously with the commencement of the case. 11 U.S.C. § 544(a).

The trustee’s judicial lien was subordinate to the first mortgage indebtedness of Berea National Bank in the approximate amount of $70,305.17 and the second mortgage indebtedness of Kentucky Finance Company, Inc. in the approximate amount of $23,209.27. These non-avoidable, consensual mortgage liens had become affixed to the property well in advance of bankruptcy.

Both Berea National Bank and Kentucky Finance Company, Inc. promptly filed proofs of claim on December 3, 1997, establishing the allowed amount of their secured claims.

On or about December 18, 1997, approximately one month after the commencement of the bankruptcy case, without knowledge of the debtor or the chapter 7 trustee, Kentucky Finance Company, Inc. voluntarily paid to Berea National Bank the full amount remaining due on the note held by the bank which was secured by the senior or first mortgage on the debtor’s residence.

Kentucky Finance Company, Inc. did not request or receive an assignment of the note and mortgage of Berea national Bank. Rather, Kentucky Finance Company, Inc. requested that Berea national Bank release its mortgage on the debtor’s residence. On December 23, 1997 Berea National Bank caused to be notarized its release of the mortgage, and on December 31, 1997 the release was recorded in Book 117, at page 7 in the Madison County Clerk’s office.

Thereafter, on February 3, 1998, Berea National Bank filed in the debtor’s bankruptcy case a "Withdrawal of Claim and Notice of Satisfaction" indicating the claim had been paid in full. The claim was not assigned to Kentucky Finance Company, Inc.

The only encumbrances remaining on the debtor’s residence were the mortgage indebtedness of $23,209.27, plus accrued interest, owed to Kentucky Finance Company, Inc. and the judicial lien of the trustee created by operation of law by title 11 U.S.C. § 544(a).

After paying and obtaining release of the mortgage of Berea national Bank, Kentucky Finance Company, Inc. caused the debtor to execute a quit claim deed conveying her interest in the residence to Kentucky Finance Company, Inc. This postpetition deed has not been recorded. It is conceded that this postpetition transfer of the debtor’s interest in the residence, to the extent it impairs the bankruptcy estate’s interest in the residence, is void as a violation of the automatic stay under title 11 U.S.C. § 362(a) that was in effect at the time of the transfer, and is also conceded to be a transfer that is voidable by the trustee under title 11 U.S.C. § 549.

Kentucky Finance Company, Inc. sought relief from stay in order that it might enforce its security interest in the debtor’s residence. The court overruled this motion and instead authorized the trustee to sell the property free and clear of liens at public auction. At this public auction held February 28, 1998, Kentucky Finance Company, Inc. purchased the property for $64,500, against which Kentucky Finance Company, Inc. was entitled to credit bid the balance due on its mortgage, and to pay the balance of the bid price to the trustee.

This controversy relates to the disposition of the balance of the purchase price, after payment of the costs of sale and other administrative expenses of this proceeding.

Courts have fashioned a five-part test to determine whether a claimant is entitled to subrogation under section 509(a) of the Bankruptcy Code, 11 U.S.C. § 509(a). To be entitled to subrogation the claimant:

In re Leedy Mortg. Co., Inc., 111B.R. 488, 492 (Bankr. E.D. Pa. 1990); In re Trasks’ Charolais, 84 B.R. 646 (Bankr. D.S.D. 1988); In re Flick, 78 B.R. 204 (Bankr. S.D. Cal. 1987).

Kentucky Finance Company, Inc. made the payment in question as a volunteer.

It is difficult to see how the payment was made to protect the interest of Kentucky Finance Company, Inc. Kentucky Finance Company’s interest in the debtor’s residence was protected by the second mortgage it held on the residence. Kentucky Finance Company could have protected the additional interest in the property it hoped to acquire by paying off the first mortgage indebtedness by taking an assignment of the note, mortgage, and claim of Berea National Bank.

Moreover, Kentucky Finance Company, Inc. could have purchased the debtor’s residence at a state court foreclosure sale in the same manner as it purchased the residence at the auction conducted by the bankruptcy trustee. The argument that Kentucky Finance Company, Inc. paid off the first mortgage debt to Berea National Bank to protect the second mortgage interest of Kentucky Finance Company, Inc. in the debtor’s residence is not persuasive on the facts of this case. It seems more likely that Kentucky Finance Company, Inc. was gambling on reselling the debtor’s residence for profit. Under Kentucky law the payment made by Kentucky Finance Company, Inc. was not necessary to protect its interest in the debtor’s property. Huffman v. Martin, 10 S.W.2d 636, 226 Ky 137 (1928).

Accordingly, Kentucky Finance Company, Inc. is not a claimant entitled to subrogation under title 11 U.S.C. § 509(a).

Dated:

By the court –

_______________________________
JOE LEE, U.S. BANKRUPTCY JUDGE

Copies to:

Ann Samani, Esq.

J. James Rogan, Esq.

Noel M. Botts, Esq.

In conformity with the memorandum opinion of the court this day entered IT IS ORDERED that the subrogation claim of Kentucky Finance Company, Inc. is denied.

Dated:

By the court –

________________________________
JOE LEE, U.S. BANKRUPTCY JUDGE

Copies to:

Ann Samani, Esq.

J. James Rogan, Esq.

Noel M. Botts, Esq.