Court Opinion

ID: 4165237
Source: CourtListenerOpinion
Date Created: 2017-05-02 16:04:59.39718+00
Date Added: 2024-06-11T14:38:06.225784
License: Public Domain

RECOMMENDED FOR FULL-TEXT PUBLICATION
                              Pursuant to Sixth Circuit I.O.P. 32.1(b)
                                     File Name: 17a0099p.06

                  UNITED STATES COURT OF APPEALS
                                  FOR THE SIXTH CIRCUIT

 IN RE: TOWN CENTER FLATS, LLC,                         ┐
                                       Debtor.          │
  ___________________________________________           │
 TOWN CENTER FLATS, LLC,                                │       No. 16-1812
                                                         >
                                     Appellant,         │
                                                        │
                                                        │
       v.                                               │
                                                        │
 ECP COMMERCIAL II LLC,                                 │
                                            Appellee.   │
                                                        ┘

                        Appeal from the United States District Court
                       for the Eastern District of Michigan at Detroit.
                 No. 2:15-cv-11881—Bernard A. Friedman, District Judge.
                           United States Bankruptcy Court for the
                           Eastern District of Michigan at Detroit.
                           No. 15-41307—Walter Shapero, Judge.

                                   Argued: March 8, 2017

                               Decided and Filed: May 2, 2017

                    Before: CLAY, GIBBONS, and STRANCH, Circuit Judges.

                                     _________________

                                         COUNSEL

ARGUED: Robert N. Bassel, Clinton, Michigan, for Appellant. Jeremy S. Friedberg, LEITESS
FRIEDBERG, P.C., Baltimore, Maryland, for Appellee. ON BRIEF: Robert N. Bassel,
Clinton, Michigan, for Appellant. Jeremy S. Friedberg, LEITESS FRIEDBERG, P.C.,
Baltimore, Maryland, for Appellee.
 No. 16-1812                          In re Town Center Flats                              Page 2

                                       _________________

                                            OPINION
                                       _________________

       JANE B. STRANCH, Circuit Judge. This bankruptcy case centers on property rights in
an assigned stream of rents. The extent of a debtor’s rights in those rents under Michigan law
determines whether the rents are properly included in a Chapter 11 bankruptcy estate. The
bankruptcy court decided that an assignment of rents creates a security interest, but does not
change ownership, and held that an assignor continues to have a property interest in the rents.
Accordingly, the bankruptcy court included the rents in the bankruptcy estate. The district court
vacated the order of the bankruptcy court, finding that an assignment of rents is a transfer of
ownership under Michigan law and thus the rents should not be included in the bankruptcy
estate. Agreeing with the district court’s reasoning, we hold that the debtor, Town Center Flats,
LLC, did not retain sufficient rights in the assigned rents under Michigan law for those rents to
be included in the bankruptcy estate. We therefore reverse the order of the bankruptcy court.

                                       I. BACKGROUND

       A.      Factual History

       The parties do not dispute the underlying facts. Debtor Town Center Flats, LLC owns a
53-unit residential complex in Shelby Township, Michigan. Town Center financed construction
of the building with a $5.3 million loan from KeyBank that was later assigned to ECP
Commercial II LLC. The loan was secured with a mortgage and an agreement to assign rents to
the creditor in the event of default. In the agreement to assign rents, Town Center “irrevocably,
absolutely and unconditionally [agreed to] transfer, sell, assign, pledge and convey to Assignee,
its successors and assigns, all of the right, title and interest of [Town Center] in . . . income of
every nature of and from the Project, including, without limitation, minimum rents [and]
additional rents . . . .” The agreement purported to be a “present, absolute and executed grant of
the powers herein granted to Assignee,” while simultaneously granting a license to Town Center
to collect and retain rents until an event of default, at which point the license would
 No. 16-1812                          In re Town Center Flats                             Page 3

“automatically terminate without notice to [Town Center].” Rents from the residential complex
are Town Center’s only source of income.

       On December 31, 2013, Town Center defaulted on its obligation to repay the loan. On
December 22, 2014, ECP sent a notice of default and a request for the payment of rents to all
known tenants of the Town Center property.         The notice complied with the terms of the
agreement and with Mich. Comp. Laws § 554.231, which allows creditors to collect rents
directly from tenants of certain mortgaged properties. The following day, ECP recorded the
notice documents in Macomb County, Michigan, completing the last step required by the statute
to make the assignment of rents binding against both Town Center and the tenants of the
property.

       On January 23, 2015, ECP filed a complaint in the Circuit Court for Macomb County
alleging breach of contract, initiating foreclosure on the mortgage, and requesting appointment of
a receiver to take possession of the Town Center property. Approximately one week later on
January 31, 2015, Town Center filed for Chapter 11 bankruptcy relief. At the time Town Center
filed its petition, Town Center owed ECP $5,329,329 plus attorney’s fees and costs. The parties
have reached an interim agreement to allow Town Center to continue to collect rents from the
tenants of the complex, with $15,000 per month used to pay down the debt to ECP and the
remainder of the rents used for authorized expenses.

       B.      Procedural History

       Town Center’s bankruptcy petition resulted in an automatic stay on the state-court case
filed by ECP. See 11 U.S.C. § 362(a) (placing a stay on most judicial actions involving the
debtor when a bankruptcy petition is filed). In February 2015, ECP filed a motion to prohibit
Town Center from using rents collected after the petition was filed. Town Center opposed the
motion and pointed out to the bankruptcy court that the company would have no income to work
with in its Chapter 11 reorganization plan if the rents were not part of the bankruptcy estate. The
bankruptcy court agreed with Town Center and denied ECP’s motion. The bankruptcy court
determined that the assigned rents would qualify as cash collateral in the bankruptcy estate,
 No. 16-1812                          In re Town Center Flats                              Page 4

meaning, under Chapter 11, that Town Center must provide “adequate protection” to ECP before
using the cash. In re Buttermilk Towne Ctr., LLC, 442 B.R. 558, 565 (B.A.P. 6th Cir. 2010).

       ECP appealed to the district court and argued that Michigan law established a transfer of
ownership in the assigned rents from Town Center to ECP. The district court agreed with ECP
and vacated the bankruptcy court’s decision. Town Center appealed to this court. ECP moved to
dismiss the appeal for lack of jurisdiction, arguing that the decisions of the lower courts were not
final because the bankruptcy case is still open. A motions panel of this court decided that
additional proceedings in the bankruptcy court would be purely ministerial and that we have
jurisdiction over an appeal from a final order. We therefore reach the merits to decide whether
the assigned rents are property of ECP or are part of Town Center’s bankruptcy estate.

                                         II. ANALYSIS

       A.      Standard of Review and Applicable Law

       This court has jurisdiction under 28 U.S.C. § 158(d)(1) over appeals of final orders from
district courts that have reviewed bankruptcy court decisions. We review the decision of the
bankruptcy court “rather than the intermediate decision of the district court.” Lowenbraun v.
Canary (In re Lowenbraun), 453 F.3d 314, 319 (6th Cir. 2006). Findings of fact are reviewed
for clear error and conclusions of law are reviewed de novo. Id.

       Property rights are determined under the law of the state in which the real property is
located, which in this case is Michigan. Using state law to define rights promotes the “[u]niform
treatment of property interests by both state and federal courts,” which serves to “reduce
uncertainty, to discourage forum shopping, and to prevent a party from receiving ‘a windfall
merely by reason of the happenstance of bankruptcy.’” Butner v. United States, 440 U.S. 48, 55
(1979) (quoting Lewis v. Mfrs. Nat’l Bank of Detroit, 364 U.S. 603, 609 (1961)). When the
highest court of a state has not spoken directly on an issue, this court must make an Erie guess as
to how that court would resolve it and may look to decisions of intermediate state appellate
courts as persuasive authority. Conlin v. Mortg. Elec. Registration Sys., Inc., 714 F.3d 355, 358-
59 (6th Cir. 2013); see also Erie R.R. Co. v. Tompkins, 304 U.S. 64, 78 (1938). Once property
rights have been determined under state law, “federal bankruptcy law dictates to what extent that
 No. 16-1812                           In re Town Center Flats                                Page 5

interest is property of the estate.” Bavely v. United States (In re Terwillinger’s Catering Plus,
Inc.), 911 F.2d 1168, 1172 (6th Cir. 1990) (quoting N.S. Garrott & Sons v. Union Planters Nat’l
Bank of Memphis (In re N.S. Garrott & Sons), 772 F.2d 462, 466 (8th Cir. 1985)).

       We begin by analyzing the extent of property rights held by the assignor and assignee of
rents under Michigan law. We then answer the ultimate question—whether the rights retained
by the assignor are sufficient for those rents to be included in the bankruptcy estate.

       B.      Assignment of Rents in Michigan

       As with many issues of property rights, the history of the legal doctrine sheds light on the
traditional legal rule, which serves to illuminate more recent developments. The traditional rule
in Michigan, created by statute in 1843, was that an assignment of rents was unenforceable
because it would interfere with a mortgagor’s right of redemption. Smith v. Mut. Ben. Life Ins.
Co., 106 N.W.2d 515, 518 (Mich. 1960). The default rule in Michigan is therefore that an
assignment of rents is unenforceable. Id. A 1925 statute subsequently created a right to assign
rents for properties subject to trust mortgages. Id. at 518-19. The Michigan Supreme Court
determined that the statute made the “[c]ollection of rents . . . not merely an incident to the right
of possession of the land, but . . . a distinct remedy and additional security.” Security Trust Co.
v. Sloman, 233 N.W. 216, 219 (Mich. 1930).             Central to this case, a 1953 statute titled
“Assignment of Rents to Accrue from Leases as Additional Mortgage Security” extended the
ability to assign rents to additional categories of property:

       Hereafter, in or in connection with any mortgage on commercial or industrial
       property . . . it shall be lawful to assign the rents, or any portion thereof, under any
       oral or written leases upon the mortgaged property to the mortgagee, as security in
       addition to the property described in such mortgage. Such assignment of rents
       shall be binding upon such assignor only in the event of default in the terms and
       conditions of said mortgage, and shall operate against and be binding upon the
       occupiers of the premises from the date of filing by the mortgagee in the office of
       the register of deeds for the county in which the property is located of a notice of
       default in the terms and conditions of the mortgage and service of a copy of such
       notice upon the occupiers of the mortgaged premises.

Mich. Comp. Laws § 554.231.
 No. 16-1812                           In re Town Center Flats                                Page 6

       The Michigan statute also contains a provision about the validity of the assignment:

       The assignment of rents, when so made, shall be a good and valid assignment of
       the rents to accrue under any lease or leases in existence or coming into existence
       during the period the mortgage is in effect, against the mortgagor or mortgagors
       or those claiming under or through them from the date of the recording of such
       mortgage, and shall be binding upon the tenant under the lease or leases upon
       service of a copy of the instrument under which the assignment is made, together
       with notice of default as required by [the above section].

Id. § 554.232.

       1.        Assignment of Rents

       Michigan courts generally discuss assignments of rents under § 554.231 as ownership
transfers. The Michigan Supreme Court held that this statute puts the assignee “in the shoes of
the mortgagor until the debt is paid, with all his rights to the rents and profits as long as he, under
the general law of mortgages, could enjoy them.” Smith, 106 N.W.2d at 520 (quoting Sloman,
233 N.W. at 220). In 1994, the Michigan Court of Appeals held that a prior-perfected interest in
assigned rents had priority over an interest held by a judgment creditor who sought to garnish
rents. Otis Elevator Co. v. Mid-America Realty Investors, 522 N.W.2d 732, 733 (Mich. Ct. App.
1994). The judgment creditor “could not garnish rents because [the assignor] no longer had an
interest in the rents.” Id. Once an assignee has: 1) entered into an agreement to assign rents;
2) recorded that agreement; and 3) default has occurred, then the assignee’s rights “are perfected
and binding against the assignor” and the assignor “no longer ha[s] a valid property interest in
the rents.” Id. at 734. The assignor has the legal right to collect the rents directly from tenants
once notice of the default has been filed in the county’s register and served on the tenants. Mich.
Comp. Laws §§ 554.231, 554.232. Michigan courts have generally treated the assignment of
rents as a transfer of ownership once the agreement has been completed and recorded and a
default has occurred. See Otis Elevator, 522 N.W.2d at 733 (stating “once [the assignee]
recorded the mortgage and the mortgagor’s default, the assignment of rents was valid and
enforceable as between the mortgagor . . . and the mortgagee.”). Otis Elevator implies that this
should be regarded as a transfer of all rights in the rents. 522 N.W.2d at 733 (finding that the
assignor “no longer had an interest in the rents.”). A more recent decision of the Michigan Court
of Appeals confirmed that the assignor loses “any right to collect the rents” after the assignee has
 No. 16-1812                                 In re Town Center Flats                                        Page 7

perfected its rights following an event of default. Ashley Livonia A&P, L.L.C. v. Great Atl.
& Pac. Tea Co., Inc., No. 319288, 2015 WL 3757546, at *5 (Mich. Ct. App. June 16, 2015) (per
curiam).1 We therefore predict, under Erie v. Tompkins, that the Michigan Supreme Court would
treat a completed assignment of rents as a transfer of ownership.

         Town Center argues that the title and language of the Michigan statute make it clear that
only a security interest, not an ownership interest, is assigned under this law. (Appellant Br.,
App. R. 11, p. 28-29) Section 554.231 is titled “Assignment of Rents to Accrue as Additional
Mortgage Security”2 and the body of the statute says “it shall be lawful to assign the rents . . . as
security in addition to the property described in [the] mortgage.” Town Center would have us
read the statute as expressing the Michigan legislature’s intention to allow only transfers of
security interests, and not ownership, based on its language authorizing assignments “as security
in addition to the property.” Mich. Comp. Laws § 554.231. Town Center reasons that the statute
allows only for a security interest in the assigned rents, so any attempt to transfer ownership of
the rents is blocked by the default rule that an assignment of rents is unenforceable.

         Language that the assignment is “as security,” however, does not foreclose an ownership
transfer. For example, a deed of trust transfers a deed—which is commonly thought of as an
ownership transfer—to a trustee to hold as security for obligations associated with a mortgage on
the property. See Sloman, 233 N.W. at 218-19 (discussing respective rights of the mortgagor,
trustee, and purchaser). And Michigan courts have consistently read § 554.231 as allowing for
assignments of rents to be transfers of ownership once the statutory steps for perfection have
been completed. We follow their lead in interpreting the language of § 554.231 as allowing for
ownership interests to be transferred with an assignment of rents.

         In the agreement at issue in this case, Town Center used broad language to “irrevocably,
absolutely and unconditionally” transfer its right in a “present, absolute and executed assignment

         1
          The statute includes two additional steps regarding service of the notice of default and filing that notice,
Mich. Comp. Laws §§ 554.231, 554.232, that are not at issue here because all five statutory steps were completed
before the bankruptcy petition was filed.
         2
           Under Michigan law, “[a]n act’s title is not itself authority of any sort, but it is properly considered to
assist in determining the act’s purpose and scope.” Cheboygan Sportsman Club v. Cheboygan Cty. Prosecuting
Attorney, 858 N.W.2d 751, 756 (Mich. Ct. App. 2014).
 No. 16-1812                          In re Town Center Flats                              Page 8

of the Rents and of the Leases” from the Town Center property. The only fair reading of this
language is that Town Center assigned the rents to the maximum extent permitted by Michigan
law. Because we hold that Mich. Comp. Laws § 554.231 allows for an ownership transfer in
these circumstances, we find that Town Center did transfer ownership in the assigned rents to
ECP before the bankruptcy petition was filed in this case. The broad language of the agreement
evidences an intention to transfer ownership.

       2.      Residual Rights of Assignor

       Even with a transfer of ownership under § 554.231, Town Center argues that it retains
some rights in the rents under Michigan law. If an assignor cures the default according to the
agreement’s terms, then the assignor is able to start collecting rents again.         See Sloman,
233 N.W. at 220 (noting, under the analogous 1925 statute, that “the purpose of the act is to put
the [assignee] in the shoes of the [assignor] until the debt is paid.” (emphasis added)). Town
Center reasons that if the rents from the property are thought of as a stream of money, Town
Center continues to hold a contingent future interest in collecting those rents. The future interest
is realized if and when Town Center cures the default. On the other hand, if the rents are thought
of as payments that occur during the discrete time period between the event of default and a
(potential) future cure, then ECP has the sole interest in those payments and Town Center has no
interest in them. This holds true even if Town Center later cures the default. We find the latter
conceptualization of a discrete period to be more aligned with the text of the statute. See Mich.
Comp. Laws § 554.232 (creating right to assign “rents to accrue . . . during the period the
mortgage is in effect”).

       Town Center also points to a second residual right: Michigan courts have created
restrictions on how the assignee can use rents collected under the law. In Smith, the court filled
in the “obviously intended requirement that rents collected by the [assignee] shall be applied on
the mortgage debt.” 106 N.W.2d at 519 (quoting Sloman, 233 N.W. at 218). The court approved
use of the collected rents to pay the debt, property taxes, and insurance policy premiums. Id. at
517-18. Neither the Michigan Supreme Court nor the Michigan Court of Appeals has concluded
that these restrictions on the assignee’s use of rent money create a property right vested in the
assignor. We decline to create a new rule of Michigan property law on this issue, especially
 No. 16-1812                            In re Town Center Flats                              Page 9

because such a rule would conflict with language used by Michigan appellate courts. See Otis
Elevator, 522 N.W.2d at 733 (concluding that the assignor “no longer had an interest in the
rents”).

           In summary, Michigan law treats a completed assignment of rents as a change of
ownership and the assignor of those rents does not retain residual property rights in the assigned
rents.

           C.     Scope of Bankruptcy Estates under the Federal Bankruptcy Code

           Federal law determines the scope of the bankruptcy estate, which is broad. Demczyk v.
Mut. Life Ins. Co. of New York (In re Graham Square, Inc.), 126 F.3d 823, 831 (6th Cir. 1997).
The Supreme Court has explained that “[b]oth the congressional goal of encouraging
reorganizations and Congress’ choice of methods to protect secured creditors suggest that
Congress intended a broad range of property to be included in the estate.” United States v.
Whiting Pools, Inc., 462 U.S. 198, 204 (1983). In Whiting Pools, personal property that had
been seized by the Internal Revenue Service under a tax lien was determined to be part of the
bankruptcy estate. Id. at 211. The Court found that the IRS had a secured interest in the
property, but that the debtor still retained an ownership interest until sale to a bona fide purchaser
at a tax sale. Id. A broad definition of the bankruptcy estate was in line with the congressional
intent to allow Chapter 11 reorganization so “the business would continue to provide jobs, to
satisfy creditors’ claims, and to produce a return for its owners.” Id. at 203 (quoting H.R. Rep.
No. 95-595, p. 220 (1977)).

           Despite the broad scope of Chapter 11 bankruptcy estates, the assigned rents in this case
are not properly included in the Town Center estate. As discussed above, Town Center does not
retain ownership of the rents and does not hold residual property rights in those rents. Instead,
the rents belong to ECP. Our holding is in line with the majority of bankruptcy court decisions
that have addressed this issue. In 1992, a bankruptcy court in the Western District of Michigan
held that assigned rents under Mich. Comp. Laws § 554.231 were not part of the bankruptcy
estate because the debtor maintained only an inchoate right to future rents. In re Mount Pleasant
Ltd. P’ship, 144 B.R. 727, 738 (Bankr. W.D. Mich. 1992). A recent decision from the Eastern
 No. 16-1812                         In re Town Center Flats                           Page 10

District of Michigan agreed that assigned rents are property of the assignee, not part of the
bankruptcy estate. In re Madison Heights Grp., LLC, 506 B.R. 734, 744 (Bankr. E.D. Mich.
2014). A bankruptcy court in the Southern District of New York, interpreting § 554.231,
reached a similar conclusion, finding the language in Otis Elevator to be especially persuasive.
In re Woodmere Inv’rs Ltd. P’ship, 178 B.R. 346, 359-60 (Bankr. S.D.N.Y. 1995).

       The bankruptcy court in this case relied on its own previous opinion that came to the
opposite conclusion. In re Town Center Flats, LLC, 531 B.R. 176, 179 (Bankr. E.D. Mich.
2015) (citing In re Newberry Square, Inc., 175 B.R. 910 (Bankr. E.D. Mich. 1994)). These two
decisions were motivated by a policy concern that excluding the assigned rents from the estate
would effectively foreclose Chapter 11 relief for companies like Town Center that own a single
property and receive their sole stream of revenue from rents of that property. Town Center, 531
B.R. at 181-82. We recognize the concern of Town Center—and the bankruptcy court—that
single-asset real estate entities may have limited options under Chapter 11 in this situation.
Michigan law, however, is clear on the matter and governs despite other policy concerns.

                                     III. CONCLUSION

       Mich. Comp. Laws § 554.231 allows for transfers of ownership when an agreement to
assign rents indicates an intention to do that, has been recorded, and default has occurred.
Because Town Center does not have rights under Michigan law in the perfected assignment of
rents here, those rents are not included in the bankruptcy estate. Accordingly, we reverse the
order of the bankruptcy court.