United States Court of Appeals FOR THE EIGHTH CIRCUIT

_____________ No. 97-2355ND

_____________ In re: Scott Heitkamp and Darcy * Heitkamp, doing business as Wyndmere * Builders, * * Debtors, *

____________________ * * Kip M. Kaler, as trustee for Scott * Heitkamp and Darcy Heitkamp, dba * Wyndmere Builders, * * Plaintiff-Appellee, * * Appeal from the United States
v. * District Court for the District * of North Dakota. Community First National Bank, * * Defendant-Appellant, * * Tim Herbranson, doing business as * Herbranson Cabinets; Strata * Corporation; Northland Truss Systems, * Inc.; Dennis Johnk, doing business as * Dennis' Floor Covering; ABC, Inc., * doing business as ABC Seamless, Inc.; * Fargo Glass & Paint Company; Lincoln * State Bank of Harrison; The Park * Company/Better Homes and Gardens, * * Defendants. *-2- _____________ Submitted: February 12, 1998

Filed: March 11, 1998

_____________ Before FAGG, JOHN R. GIBSON, and MURPHY, Circuit Judges.

_____________ FAGG, Circuit Judge.
Scott and Darcy Heitkamp build and sell homes in Wyndmere, North Dakota

. In the cours e of their business, they borrowed money from Community First National Bank and maintained credit wit h several subcontractors. The bank initially loaned the Heitkamp s $50,000 to build a certain house. A mortgage secured the loan. Th e Heitkamps ran out of cash before comple ting the project and obtained another loan for $40,000 from the bank in November 1995. Rather than giving the Heitkamps th e
mon ey, the bank issued cashier’s checks payable to specific subcontractors wh o supplied goods or services to construct the house. At the bank’s direction, th e Heitkamps o btained mechanic’s lien waivers from the subcontractors in exchange for the checks. The Heitkamps also gave the bank a second mortgage on the house, but because of an oversight, the bank did not record the mortgage until March 1, 1996.

Three da ys later, the Heitkamps filed a Chapter 7 bankruptcy petition. Th e mortgaged house was sold, and the bank and several subcontractors asserted rights to the proceeds. The bankruptcy trustee brought a n adversary proceeding to set aside the Heitkamps ’ transfer of the second mortgage interest to the bank under 11 U.S.C. § 547(b), which permits avoidance of certain transfers of the debtor’s inte rest in property. The ba nkruptcy court set the transfer aside, rejecting the bank’s argument that th e earmarking doctrine prevented avoidance of the mortga ge’s transfer. The district court affirmed. The bank appeals, and we reverse.-3-

Accordin g to the earmarking doctrine, there is no avoidable transfer of th e debtor’s property interest when a new lender and a debtor agree to use loaned funds to pay a specified antecedent d ebt, the agreement’s terms are actually performed, and the transaction viewed as a whole does not di minish the debtor’s estate. See McCuskey v. Nationa l Bank of Waterloo (In re Bohlen Enters., Ltd.) , 859 F.2d 561, 566 (8th Cir

. 19 88). No avoidable transfer is made because the loaned funds never become part of the debtor’s property. See id. Instead, a new creditor merely steps into the shoes of
an old creditor. See Buckley v. Jeld-Wen, Inc. (In re Interior Wood Prods. Co.) , 986 F.2d 228, 231 (8th Cir. 1993). Application of the earmarking doctrine is not limited to situations in which the new creditor is secondarily liable for th e earlier debt, but extends to s ituations where “any third party . . . pays down a debt of the debtor . . . becaus e [the] payments . . . would have no effect on the estate of the debtor.” Stover v

. Ful kerson (In re Bruening) , 113 F.3d 838, 841 (8th Cir. 1997); see Hansen v

. MacDonald Meat Co. (In re Kemp Pac. Fisheries, Inc.) , 16 F.3d 313, 316 n.2 (9th Cir. 1994) (per curiam) (earmarking doctrine not limited to protection of guarantors) ; Steinberg v. NCNB Nat’l Bank of N. C. (In re Grabill Corp.) , 135 B.R. 101, 109 (N.D. Ill. 1991) (same); Tolz v. Barnett Bank of S. Fla., N.A. (In re Safe-T-Brake of S. Fla., Inc.) , 162 B.R. 359, 364 (S.D. Fla. 1993) (“[c]aselaw has extended the earmarkin g doct rine beyond the guarantor scenario”). “[R]egardless of the lender’s prio r relationship with the debtor, or lack thereof, replacing one creditor wi th another of equal priority does not diminish the estate and thus no voidable [transfer] results.” In re SafeT-Brake , 162 B.R. at 364 (citing In re Bo hlen , 859 F.2d at 565-66). Thus, the doctrine applies when a security interest is giv en for funds used to pay secured debts, see id. ; In re Kemp , 16 F.3d at 316, but not when a secur ity interest is given for funds used to pay
an u nsecured debt, see Brown v. Mt. Prospect State Bank (In re Muncrief) , 900 F.2d 1220, 1224 n.4 (8th Cir. 1990).
The earmarking doctrine applies in this case. The bank and the Heitkamps ag reed the secured funds would be used to pay specific preexisting debts, the agreement was performed, and the transfer of the mortgage interest did not diminish the-4-

amount avai lable for distribution to the Heitkamps’ creditors. See In re Bohlen , 85 9 F.2d at 566. Before the loan, the Heitkamps owed subcontractors $40,000 secured by the house for goods and services rendered. Afterwards, the Heitkamps owed the bank $40,000 secured by the house for a cash loan used to pay the subcontractors. Th e Heitkamps’ assets and net obligations remained the same. Essentially, the bank took over the subcontractors’ security interest in the house. See International Ventures, Inc. v. Block Pro ps. VII (In re International Ventures, Inc.) , 214 B.R. 590, 596 (E.D. Ark. 1997). The subcontractors had a statutory lien against the house, see N.D. Cent. Code § 35-27-03 (1987), and c ould have perfected a security interest in the house even after the Heitkamp s filed for bankruptcy, see id. §§ 35-27-13, -14; 11 U.S.C. §§ 362(b)(3), 546(b)(1). The bank required the Heitkamps to obtain mechanic’s lien waivers from the s ubcontractors, and the subcontractors specifically released their interest in th e hou se. Because the transfer of the mortgage interest to the bank merely replaced th e subco ntractors’ security interest, there was no transfer of the Heitkamps’ propert y inte restavoidable under § 547(b). In these circumstances, recognition of the bank’ s security interest does not give the bank an unfair advantage over other creditors.

In sum, the trustee had the burden to prove the earmarking doctrine does no t apply, see In re Inte rnational Ventures , 214 B.R. at 594; In re Safe-T-Brake , 162 B.R. at 364, 365, and failed to do so. The trustee cannot avoid the second mortgage under § 547(b) because the trustee cannot establish the mortgage was a “transfer of an interest of the debtor in property,” an element of § 547(b). See In re Interior Wood Prods. , 986 F

. 2d at 231. We thus reverse and remand for further proceedings consistent with this opinion.
A true copy.

Attest:
CLERK, U.S. COURT OF APPEALS, EIGHTH CIRCUIT.