DD 3/29 Security Interests in Installment Contract Proceeds MORTGAGES; SECURED TRANSACTIONS: A mortgage recorded in the land records may not sufficiently perfect a mortgage creditor's interest in the proceeds of an installment land contract on the mortgaged property if the contract is entered into prior to the mortgage. Finch v. Beneficial New Mexico, Inc., 905 P.2d 198 (N.M. 1995).

Lender obtained a recorded mortgage on an owner's property after the owner had entered into an installment land contract to sell the property. Thereafter the owner filed for bankruptcy. During the pendency of the bankruptcy, the buyer under the installment land contract unexpectedly paid it off early. The owner argued in the bankruptcy court that the mortgagee had no right to the sale proceeds because it had not properly perfected its interest in the proceeds by recording its interest in the personal property records.

The bankruptcy court certified to the state court the question of whether the lender had a properly perfected claim.

The court here held that the mortgage would not have been valid as against the installment contract buyer if the lender had attempted to recover from that buyer for wrongfully paying the proceeds over to the seller. But it held that, as between the seller/mortgagor and the mortgagee, the mortgage would be viewed and an appropriate means of establishing a security interest in the proceeds of the sale.

"The [Seller/Mortgagors] claim that the mortgage could not serve as a security agreement because it did not expressly include the contract proceeds. If a third party made this argument, we would be hard-pressed to disagree, because the purpose of a security agreement is to give notice to third parties that an interest may be claimed in the collateral by another . . . However, the [Sellers] not only had actual notice of [mortgagee's] lien on their interest, but in fact they offerred their whole interest to secure the loan . . . We agree with [Lender] that the mortgage served as a written security agreement attaching to the proceeds of the contract, and that the filing of the mortgage in the county records perfected that interest as to the [Seller/Mortgagors]."

Comment 1: The court's analysis is not likely to be very helpful to the lender in bankruptcy court. The state court here seems to view itself as answering "yes" to the question of whether the mortgage "perfected" the mortgagee's interest. But the question in bankruptcy is whether the trustee can avoid the secured party's interest because the trustee stands in the shoes of a hypothetical bona fide purchaser, not because the trustee stands in the shoes of the debtor. The court appears to say that the appropriate way to perfect a security interest in proceeds of an installment land contract is to take an assignment of the contract interest and to file it in the UCC personal property records. Otherwise, third parties establishing an interest in the proceeds (such as by assignment) would have priority as to those proceeds. If this is the case, then the mortgagee's interest is not "perfected" for bankruptcy purposes and the proceeds will belong to the estate.

Interestingly, the court does not seem to realize that the critical question is that of third party claimants to the proceeds. It focusses on the question of whether the lender would have a right against the seller for misdirection of the payments. This is a distinct question from the question of "perfection" of the mortgagee's interest for bankruptcy purposes.

Comment 2: If the lender's mortgage had attached before the execution of the installment land contract, then the lender would not have to perfect its interest in the UCC records because, under 553b of the bankruptcy statute, it would have a claim to the "proceeds" of the collateral merely because it had a claim against the collateral itself. But in this case, the debtor's interest, at the time of the mortgage, had already been "converted" by process of equitable conversion to an interest in personalty, not a real property interest, and a UCC recording was appropriate.

It may not have been necessary to have an assignment for security of the land sale agreement, as opposed to a mortgage on the land, for the lender to establish its interest as against the borrower. But it would appear that, whatever, the nature of the interest, a UCC filing should have been made to perfect the interest in the proceeds for bankruptcy purposes and otherwise.

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