Summary of a Recent
Judicial Development in
Secured Transactions

Creditor Must Take Affirmative Action to Perfect Security Interest Arising
From Collateral Assignment of Rents

Walt McCarter
National AgLaw Center Research Associate

Summary of Decision

In In re Spears, 352 B.R. 83 (Bankr. N.D. Tex. 2006), the United States Bankruptcy Court for the Northern District of Texas, Lubbock Division determined that a certain assignment of rents clause was not absolute and thus, since the mortgagee had not taken affirmative action to perfect its interest in the property, sustained the Chapter 7 trustee's objection to its claim.

Background

The Spears filed for Chapter 7 bankruptcy in August 2004, and AgTexas asserted a claim in the amount of $563,896 secured by a third priority deed of trust lien against certain real property in Yoakum County. Id. at 85. AgTexas subsequently purchased the Yoakum County properties in a foreclosure sale held by the second lienholder, and obtained the note and lien against the properties from the first lienholder. Id. A later court order confirmed AgTexas's unsecured claim in the amount of $289,771. Id. at 86. In the month before the foreclosure sale, a petroleum company paid the Trustee $10,500 for surface damage caused by drilling wells on the Yoakum County properties. Id. AgTexas claimed it was entitled to the payment, and the Trustee objected. Id.

Arguments

AgTexas argued that the payments were proceeds of its pre-petition security interest. Id.

The Trustee argued that AgTexas's interest in the payment must arise under the assignment of rents clause contained in the deed of trust held by AgTexas and that AgTexas failed to timely and properly perfect its interest in the funds. Id.

Analysis and Holdings

The issue before the court was whether AgTexas's interest in the payments was superior to the Trustee's. Id. The court decided that § 552 of the Bankruptcy Code controlled. Id. Section 552(a) cuts off liens against property acquired after the bankruptcy case is filed, but § 552(b)(1) provides an exception if a debtor acquires property post-filing and such property constitutes proceeds, product, offspring or profits of property covered by a valid pre-petition security interest. Id.

The deed of trust acquired by AgTexas contained an assignment of rents clause, which provided that the debt would be secured by

all the bonuses, rentals, royalties, damages, and delay monies that may be due or that may hereafter become due and payable to the mortgagors or their assigns under any oil, gas, mining or mineral lease or leases of any kind now existing, or which may hereafter come into existence (including agricultural contracts of every kind) covering the above described land or any part thereof.
Id. at 88.

The court noted that Texas law does not consider such payments (bonuses, rentals, damages, etc.) to be proceeds, product or profits of the land itself, so AgTexas had to rely on the assignment of rents provision in the deed of trust. Id.

The court recognized that there are two types of assignment of rents clauses: (1) an assignment intended as additional security and part of a lien, and (2) an absolute assignment that transfers title. Id. at 89. Texas courts follow the common law rule that for rents assigned as security, the assignment does not become effective until the mortgagee takes affirmative action to enforce the lien, such as taking possession of the property, impounding the rents or securing the appointment of a receiver. Id. An absolute assignment, however, automatically transfers the right to rents upon the occurrence of a specific condition. Id. When an assignment of rents is issued contemporaneously with a deed of trust, the type of assignment is determined by the parties' intent. Id. The court pointed out that "[e]xplicit language in the deed is required to justify finding an absolute assignment of rents." Id. at 90. Therefore, since AgTexas did not take any affirmative action to perfect its interest prior to the payment being made to the Trustee, the court sustained the Trustee's objection to AgTexas's claim. Id. at 90-91.

The case was decided on July 19, 2006.