Daily Development for Wednesday, April 24, 2002

 

By: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
prandolph@cctr.umkc.edu

 

BANKRUPTCY; AUTOMATIC STAY; FUTURE ADVANCE MORTGAGES: Where mortgage on debtors estate secures future advances to another party, automatic stay does not prevent secured status to advances made after debtor's filing, but where state law is "optional/obligatory" test, any optional advances are primed by the trustee's interest.

 

In re Stanton, 285 F.3d 888 (9th Cir. 2002)

 

Stantons were principles in a corporation that manufactured shoes.   The corporation established a line of credit got a new manufacturing opportunity, and had to borrow money for supplies.  Stantons agreed to a second mortgage securing advances to the corporation to pay for the supplies.  Subsequently, Stantons, but not the corporation, filed for bankruptcy.  After the filing, and apparently with knowledge of the filing, the lender made additional advances to the corporation.  The trustee in bankruptcy argued that the advances violated the automatic stay and were void.

 

The court rejected this argument, concluding that the stay did not bar the attachment of the lien securing the advances because the advances were not the incurring of new debt by the bankrupt, but rather were made to a

third party (the court assumed that no "alter ego" theories applied, and that the corporation and the Stantons were separate interests.)

 

Section 362(a)(4) prohibits any "act to create, perfect or enforce an lien against property of the estate."  But the court held that the funding of the future advance line secured by the mortgage did not create a lien against

the estate.  That had been done earlier, as under state law the mortgage lien was created to the extent of the maximum credit line at the time the future advance mortgages was created.

 

The court cites the 1970 edition of Osborne on Mortgages for the point that a future advance mortgage provides a desirable function that is valuable to the debtor because it permits the debtor to draw only those funds that it needs at the moment, rather than to pay interest from the inception of the mortgage on a larger amount.  But it seems that the policies of the law would not be relevant, because the bankruptcy court here concludes that state law controls, and the relevant jurisdiction, Washington, has authority that the court read to provide that the lien for the entire advance attached as of the time of the mortgage.

 

The court went on, however, to take away what it just gave.  It noted that Washington law follows the "optional/obligatory" rule as to priority of future advances provisions in mortgages.  The mortgage has priority over

interests attaching prior to any advance known to the mortgagee only when such advance is "obligatory" on the mortgagee.  Here, the court concludes that the advances in question were optional to the lender.  As the lender apparently was aware of the bankruptcy filing, it was on notice that the trustee in bankruptcy obtained an interest in the property to satisfy the debts of the bankruptcy estate, and this interest primed the future advance liens.  Thus the mortgagee had priority over the trustee as to advances made prior to the bankruptcy, but the balance of the advances, although still secured by the mortgage, were subordinate to the claims of the estate.

 

A strong dissent argued that an advance under the future advances arrangement is, indeed, the creation of a new debt of the estate.   It rejected both the majority reasoning and its interpretation of Washington law on the point.

 

Comment 1: Note that it is quite likely that the state would "gobble up" all the remaining equity in the property.  How would the advances claims be treated in the bankruptcy?  Could the mortgagee opt for unsecured

status and share with other unsecured creditors?  Here the Stantons had personally guaranteed the corporation's debts to the lender.  What if the sole basis for the lender's claim was in the mortgage?

 

Comment 2: In many jurisdictions, including the editor's home jurisdiction of Missouri, new state statutes give priority for all future advances, optional or obligatory, up to the maximum amount permitted by the mortgage, and beyond that for such items as completion of construction and attorney's fees.  Is the court saying that in such a jurisdiction the mortgagee is free to make even optional advances to the third party after the debtor's bankruptcy?  Apparently so.

 

Comment 3: There is very little discussion in the case of the impact of Section 549, an avoidance section, that permits the trustee to avoid a "transfer of property of the estate" made after the filing of the bankruptcy (subject to exceptions likely not relevant here).  "Transfer" is defined under Section 101(54) to include "every mode, direct or indirect, absolute or conditional, voluntary or involuntary, of disposing of or parting with property or with an interest in property . . . "

 

Perhaps the court would conclude that there is no transfer because, again, the transfer occurred prior to bankruptcy under the future advances lien. But the editor is a Doubting Thomas, he'll believe it when he sees it in a

court decision.

 

Readers are urged to respond, comment, and argue with the daily development or the editor's comments about it.

Items in the Daily Development section generally are extracted from the Quarterly Report on Developments in Real Estate Law, published by the ABA Section on Real Property, Probate & Trust Law. Subscriptions to the Quarterly Report are available to Section members only. The cost is nominal. For the last six years, these Reports have been collated, updated, indexed and bound into an Annual Survey of Developments in Real Estate Law, volumes 1‑6, published by the ABA Press. The Annual Survey volumes are available for sale to the public. For the Report or the Survey, contact Maria Tabor at the ABA. (312) 988 5590 or mtabor@staff.abanet.org

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