Court Opinion

ID: 18526
Source: CourtListenerOpinion
Date Created: 2010-04-25 07:16:21+00
Date Added: 2024-06-11T09:37:45.918284
License: Public Domain

UNITED STATES COURT OF APPEALS
                        FOR THE FIFTH CIRCUIT

                               No. 98-60442

         In the Matter of:    THOMAS SHANNON MILLETTE, Debtor.

                     O’NEAL STEEL, INCORPORATED,

                                                Appellant-Cross-Appellee,

                                    v.

                             E B INCORPORATED,

                                                Appellee-Cross-Appellant.

            Appeals from the United States District Court
               for the Southern District of Mississippi

                              August 24, 1999

Before JONES and STEWART, Circuit Judges, and DUPLANTIER,* District
Judge.

EDITH H. JONES, Circuit Judge:

            At issue in this case is whether, under Mississippi law,

an “assignment of rents” clause contained in a properly recorded

deed of trust gives the mortgagee a perfected secured interest in

the rents.1   Although this issue has never been addressed by the

courts of Mississippi, our best Erie guess is that, following the

majority rule, a Mississippi mortgagee’s interest in the rents

     *
           District Judge of the Eastern District of Louisiana, sitting
by designation.
     1
           Since rents generated from real property are considered
realty, assignments of rents are governed by real property law rather
than Article 9 of the Mississippi Uniform Commercial Code. See Miss.
Code Ann. § 75-9-104(j) (Supp. 1998) (stating that the Mississippi
Commercial Code excludes “the creation or transfer of an interest in or
lien on real estate, including a lease or rents thereunder”). Although
the term “perfection” is not typically used to describe a security
interest in realty, we use it here out of convenience to convey the same
meaning as that used in Article 9.
becomes perfected when it properly records the document granting

the assignment. The judgment of the bankruptcy and district courts

is affirmed.

                                BACKGROUND

           Thomas Millette, Ted Millette, William Millette, and

Charles Fridge own a commercial building in Pascagoula, Mississippi

known as the “Market Street Building.”        In August 1992, the owners

executed a promissory note in favor of Eastover Bank in the

principal amount of $ 445,198.71.         As security for the note, the

owners executed a deed of trust in favor of Eastover that contained

the following assignment of rents clause:
           As additional security, Debtor hereby assigns
           to Secured Party all rents accruing on the
           Property.    Debtor shall have the right to
           collect and retain the rents as long as Debtor
           is not in default as provided in Paragraph 9.
           In the event of default, Secured Party in
           person, by an agent or by a judicially
           appointed receiver shall be entitled to enter
           upon, take possession of and manage the
           Property and collect the rents. All rents so
           collected shall be applied first to the costs
           of managing the Property and collecting the
           rents, including fees for a receiver and an
           attorney,   commissions   to  rental   agents,
           repairs and other necessary related expenses
           and then to payment of the indebtedness.

The parties stipulated that the deed of trust securing the Market
Street   Building   was    properly   recorded   in   the   Jackson   County

property records.    MTGLQ Investment, L.P. subsequently purchased

the note and deed of trust from Eastover and retained Security

National to service the loan.2

           In   November    1993,   O’Neal   Steel    obtained   an   Alabama

judgment against Thomas, William, and Ted Millette in the amount of

    2
           For the sake of convenience, this opinion refers to Security
National as the secured party competing with O’Neal for priority over
the rents.

                                      2
$ 164,335.89 plus interest.          O’Neal enrolled the judgment in

Jackson County, Mississippi on January 10, 1994.          In May 1994, the

Millettes, doing business as “Millette & Associates,” entered into

a commercial lease with Jackson County, which became the sole

tenant in the Market Street Building.         After discovering that the

Millettes owned the building and were receiving rental income from

it, O’Neal instituted a garnishment action in the Mississippi

Circuit Court and served a writ of garnishment on Jackson County.

As required by Mississippi law, the County answered the writ of

garnishment, admitting it owed a debt to “Millette & Associates”

under the lease.   The County further stated that Security National

claimed a prior interest in the rents pursuant to the recorded

assignment of rents clause contained in the deed of trust.

          When Security National learned of the garnishment action

on January 4, 1995, it immediately served written notice and demand

on Jackson County and ultimately intervened as a party in the

garnishment action.3    Months later, Security National instituted

foreclosure   proceedings,    but    before    it    could      complete    the

foreclosure, Thomas Millette filed for Chapter 7 bankruptcy,4

staying the   foreclosure    and    all   activity   in   the    state     court

garnishment proceeding.      The present adversary proceeding was

     3
           Due to the dispute between O’Neal and Security National,
Jackson County paid its rent into the court’s registry. The rents from
the building, which totaled $ 173,739.24 as of January 1997, are now
being held by the trustee in bankruptcy in an interest bearing account.
     4
           Thomas Millette filed for bankruptcy on July 6, 1995. On
October 4, 1995, William Millette and his wife also filed for Chapter
7 bankruptcy protection. Ted Millette, one of the other owners and
judgment debtors of O’Neal, did not file for bankruptcy protection.

                                     3
commenced in bankruptcy court to determine the extent and priority

of the competing liens on the rents.

            O’Neal argues here, as it did in the bankruptcy and

district courts, that it had a perfected interest in the Market

Street Building’s rents from the date it served its writ of

garnishment on Jackson County.          O’Neal contends that its lien has

priority over Security National’s lien because Security National

failed to     take   the   necessary    steps     to     perfect    its     interest.

According to O’Neal, under Mississippi law, a mortgagee must not

only record its assignment of rents, it must also take “additional

action,” like appointing a receiver, to perfect its interest in

rents.     Therefore, because O’Neal served its writ of garnishment

before Security National took the requisite additional action,

O’Neal’s interest in the rents should be superior.

            The bankruptcy court disagreed with O’Neal’s construction

of   Mississippi     law   and   granted    summary      judgment      in   favor    of

Security    National,      holding    that,      based     upon    a    then-recent

Mississippi    Supreme     court     decision,    Security        National     had   a

perfected interest in the rents when it recorded its deed of trust

containing the assignment of rents clause.5               Although the district

court disagreed with the bankruptcy court’s legal analysis, it

     5
           The bankruptcy court (and the district court) also concluded
that, because O’Neal did not strictly comply with Mississippi
garnishment procedures by properly objecting to Jackson County’s answer,
O’Neal failed to perfect its interest in the rents. Because we hold
that Security National had a perfected security interest in the rents
that primes O’Neal in any event, it is unnecessary to decide the
garnishment procedure issue.    And the interpretation of 11 U.S.C. §
552(b) is also irrelevant.

                                        4
reached the same result.           It held that an assignment of rents

clause is not perfected upon recordation; instead, a mortgagee must

take “additional steps” to perfect its interest.                According to the

district court, Security National’s actions upon learning of the

garnishment were sufficient to perfect its previously recorded

assignment of rents.

                              STANDARD OF REVIEW

            This court reviews the district court’s legal conclusions

on a grant of summary judgment de novo, and it views the facts in

the light most favorable to the non-moving party. Summary judgment

is     proper    if    “the     pleadings,          depositions,      answers    to

interrogatories,      and     admissions       on   file,    together    with    the

affidavits, if any, show that there is no genuine issue as to any

material fact and that the moving party is entitled to judgment as

a matter of law.”      Fed. R. Civ. P. 56(c); see also Horton v. City

of Houston, 179 F.3d 188 (5th Cir. 1999).

                                  DISCUSSION

            Whether a Mississippi mortgagee, which has obtained an

assignment of rents, is perfected in the rents when the assignment

is recorded, or whether it must take additional steps to perfect

its interest in the rents, is an issue of first impression both in

this   court    and   the   courts   of       Mississippi.     This     court   must

anticipate what the Mississippi Supreme court would decide if the

issue were before it.         See Free v. Abbott Labs., 176 F.3d 298, 299

(5th Cir. 1999); F.D.I.C. v. Abraham, 137 F.3d 264, 268 (5th Cir.

1998).     With little to go on, our best judgment is that the

                                          5
Mississippi Supreme Court would follow the modern trend of the law

and hold that a mortgagee obtains a perfected lien on rents when it

properly records an assignment of rents in the property records.

           O’Neal, on the other hand, advocates the older common law

approach, which a minority of states continue to follow.6         Under

the older rule, an assignment of rents gives the mortgagee an

inchoate lien which is perfected only when the mortgagee takes

additional action to enforce it.        In Texas, for instance, “an

assignment of rentals does not become operative until the mortgagee

obtains possession of the property, or impounds the rents, or

secures the appointment of a receiver, or takes some other similar

action.”   Taylor v. Brennan, 621 S.W.2d 592, 594 (Tex. 1981).

           The majority of courts and legislatures have abandoned

the “additional action” rule in favor of a rule analogous to those

governing perfection of secured interest in personal property under

     6
           See, e.g., Bevins v. Peoples Bank & Trust Co., 671 P.2d 875,
879 (Alaska 1983) (“The beneficiary must take some action to acquire
possession of the property or the rents before the rent clause becomes
operative.”); Martinez v. Continental Enter., 730 P.2d 308, 316 (Colo.
1986) (en banc) (“[U]ntil the mortgagee takes some effectual step to
subject the rents to the payment of the debt, . . . the mortgagee has
but an inchoate right to the rents.”).
      Several federal courts, while interpreting state law, have also
followed the old rule. See, e.g., In re Century Inv. Fund VIII L.P.,
937 F.2d 371, 377 (7th Cir. 1991) (Wisconsin); In re 1301 Conn. Ave.
Assocs., 126 B.R. 1, 3 (D.D.C. 1991) (District of Columbia); First
Federal Savings and Loan Assoc. of Toledo v. Hunter (In re Sam A. Tisci,
Inc.), 133 B.R. 857, 859 (N.D. Ohio 1991) (Ohio); Condor One, Inc. v.
Turtle Creek, Ltd. (In re Turtle Creek, Ltd.), 194 B.R. 267, 278 (Bankr.
N.D. Ala. 1996) (Alabama); In re Mews Assocs., L.P., 144 B.R. 867,
868-69 (Bankr. W.D. Mo. 1992) (Missouri); Drummond v. Farm Credit Bank
of Spokane (In re Kurth Ranch), 110 B.R. 501, 506 (Bankr. D. Mont. 1990)
(Montana); Armstrong v. United States (In re Neideffer), 96 B.R. 241,
243 (Bankr. D.N.D. 1988) (North Dakota); Ziegler v. First Nat’l Bank of
Volga (In re
Ziegler), 65 B.R. 285, 287 (Bankr. D.S.D. 1986) (South Dakota).

                                   6
the Uniform Commercial Code.7          Under the modern approach, the

recording of a mortgage document containing an assignment of rents

“gives the mortgagee rights superior to any subsequent third party

who would seek to take a security interest in the leases and

rentals pertaining thereto as a type of collateral.”        O’Nei1l v.

Carlson, 608 A.2d 858, 861 (N.H. 1992) (quoting In re Rancourt, 123
B.R. 143, 147 (Bankr. D.N.H. 1991) (quotations omitted)).       Several

state legislatures have also rejected the old common law rule.8      In

Florida, for example, an assignment of rents is “perfected and

      7
           See, e.g., Travelers Ins. Co. v. First Nat’l Bank of Blue
Island, 621 N.E.2d 214-15 (Ill. App. Ct. 1993) (holding that, in
Illinois, the mortgagee perfects “a first priority security interest”
in rents by recording the loan documents); Teachers Ins. and Annuity
Ass’n of Am. v. Oklahoma Tower Assocs. L.P., 798 P.2d 618, 622 (Okla.
1990) (“[T]he [Oklahoma] Legislature expressed its intent that
mortgagees should be entitled to rents under valid rent assignments
prior to foreclosure or the appointment of a receiver.”).
      Several federal courts have also opted for the modern approach
while interpreting state law. See, e.g., Commerce Bank v. Mountain View
Village, Inc., 5 F.3d 34, 39 (3d Cir. 1993) (Pennsylvania); Scottsdale
Med. Pavilion v. Mutual Benefit Life Ins. Co. (In re Scottsdale Med.
Pavilion), 52 F.3d 244 (9th Cir. 1995), adopting as its own opinion, 159
B.R. 295, 302 (B.A.P. 9th Cir. 1993) (Arizona); In re Sansone, 126 B.R.
16, 19 (Bankr. D. Conn. 1991) (Connecticut); In re May, 169 B.R. 462,
467 (Bankr. S.D. Ga. 1994) (Georgia); Federal Land Bank v. Terpstra (In
re Porter), 90 B.R. 399, 404 (N.D. Iowa 1988) (Iowa); First Nat’l Bank
of Bar Harbor v. United States Dep’t of Agric. (In re Dorsey), 155 B.R.
263, 268 (Bankr. D. Me. 1993) (Maine); In re Coventry Commons Assocs.,
143 B.R. 837, 838 (E.D. Mich. 1992) (Michigan); New York Life Ins. Co.
v. Bremer Towers, 714 F. Supp. 414, 418 (D. Minn. 1989) (Minnesota);
Midlantic Nat’l Bank v. Sourlis, 141 B.R. 826, 834 (D.N.J. 1992) (New
Jersey); 641 Avenue of the Am., L.P. v. 641 Assocs., Ltd., 189 B.R. 583,
590 (S.D.N.Y. 1995) (New York); In re KNM Roswell L.P., 126 B.R. 548,
554 (Bankr. N.D. Ill. 1991) (New Mexico); SLC Ltd. V v. Bradford Group
West, Inc. (In re SLC Ltd. V), 152 B.R. 755, 761 (Bankr. D. Utah 1993)
(Utah).
    8
           See, e.g., Cal. Civ. Code § 2938(a) (West 1993) (California);
Del. Code Ann. tit. 25, § 2121(a) (Supp. 1998) (Delaware); Kan. Stat.
Ann. § 58-2343(b) (1994) (Kansas); Md. Code Ann., Real Prop. § 3-204
(1996) (Maryland); Neb. Rev. Stat. § 52-1704 (1998) (Nebraska); N.C.
Gen. Stat. § 47-20(c) (Supp. 1998) (North Carolina); Tenn. Code Ann. §
66-26-116(a) (1993) (Tennessee); Va. Code Ann. § 55-220.1 (Michie 1995)
(Virginia); Wash. Rev. Code Ann. § 7.28.230(3) (West 1992) (Washington).

                                   7
effective    against     third   parties   upon   recordation    of   the

mortgage . . . in the public records of the county in which the

real property is located . . . .”          Fla. Stat. Ann. § 697.07(2)

(West Supp. 1999).

            The recently published ALI Restatement of Mortgages has

also adopted the position that a mortgage on rents is perfected

when recorded.      See Restatement (Second) of Property - Mortgages §

4.2(b) (1997). Under the Restatement, a mortgage on rents “is

effective as against the mortgagor and, subject to the operation of

the recording act, as against third parties, upon execution and

delivery.”    Id.     The Restatement’s comments make it clear that,

upon recordation, the mortgagee will be protected against competing

claims by third parties and others claiming priority over the

rents.   See id. at § 4.2 cmt. b.

            Public policy considerations weigh in favor of rejecting

the old rule.    The modern rule best protects diligent mortgagees

from competing liens filed by subsequent creditors.             Under the

prior approach, a mortgagee with a lien on rents or an assignment

of rents clause will nearly always lose a priority battle with a

judgment creditor when the debtor has not defaulted on its payments

under a mortgage.      A judgment creditor can perfect its interest at

any time by properly serving a writ of garnishment, while a

mortgagee is prohibited from taking the requisite “additional

action” to perfect until the debtor has defaulted.       This leads to

a bizarre result: A mortgagee, which has done all it could to

secure its interest in the rents, loses priority to a judgment

                                    8
creditor who had constructive knowledge by the recordation of the

mortgagee’s assignment of rents. The case at hand illustrates this

result. Security National was unaware of O’Neal’s judgment against

the Millettes until after the writ of garnishment had already been

served.   Once Security National learned of the garnishment, it

immediately served notice of its interest and intervened in the

garnishment action.      Before O’Neal served the writ of garnishment,

the Millettes were not in default on the lease, and Security

National had no justification for “further action” to perfect its

assignment    of    rents.   In    spite   of   Security     National’s   post-

garnishment    diligence,    its    interest    would   be    subordinate   to

O’Neal’s under the old common law rule.

          Recognizing the inequity resulting from the application

of the old rule, courts that continue to apply it have occasionally

escaped its harsh result by liberally finding “additional action”

of a mortgagee that sufficiently satisfied the rule.             See, e.g., In

re Keller, 150 B.R. 835, 839 (Bankr. N.D. Ga. 1993) (holding that

a mortgagee perfected its right to rents upon filing of a motion

for relief from the automatic stay); In re Mariner Enterprises of

Panama City, Inc., 131 B.R. 190, 193 (Bankr. N.D. Fla. 1989)

(holding that a mortgagee’s demand that the borrower turn over the

rents is sufficient); In re McCann, 140 B.R. 926, 928-29 (Bankr. D.

Mass. 1992) (holding that filing a state foreclosure action is

sufficient).       The district court’s opinion in this case typifies

the approach.      The court held that, although Security National was

not perfected at the time O’Neal served its writ of garnishment, it

                                      9
soon became perfected by taking immediate steps to protect its

interest in the rents.

            Courts also avoid the old rule when it appears that,

instead of receiving an inchoate lien on rents, the mortgagee

received an “absolute assignment” of the rents.                 An absolute

assignment passes title to the rents instead of granting a security

interest    and   “operates      to   transfer   the   right    to     rentals

automatically upon the happening of a specified condition, such as

default.”    Taylor, 621 S.W.2d at 594.          To be absolute, however,

there must be “especially clear evidence that the parties intended

to create such an assignment.”          F.D.I.C. v. International Prop.

Management, Inc., 929 F.2d 1033, 1036 (5th Cir. 1991); see also In

re Century Investment Fund VIII L.P., 937 F.2d 371, 377 (7th Cir.

1991) (Wisconsin law). Words such as “security” or “pledge” in the

loan documents are insufficient to effect an absolute assignment.

FDIC, Id.

            Because   the   perfection-upon-recordation         rule    for   a

mortgagee’s security interests in rents is consistent with modern

secured transaction law and unencumbered by the complexities,

distinctions and harsh results of the common law, we conclude that

the Mississippi Supreme Court would reject the old rule and reward

a diligent creditor, which records its assignment of rents and

protects its lien by giving constructive notice to hypothetical

third-parties. See Mills v. Damson Oil Corp., 720 F.2d 874, 875

(5th Cir. 1983) (recognizing that a recorded deed in Mississippi,

even   if   defective,   gives    constructive    notice   of    the    deed’s

                                      10
contents); McMahon v. McMahon, 157 So. 2d 494, 500-01 (Miss. 1963)

(same).

            There   is    no    contrary    Mississippi    authority.      The

bankruptcy court in this case relied heavily on a Mississippi

Supreme Court decision that interpreted a notice provision of a

mortgagee’s security agreement in light of the competing claim of

a garnishee.    Merchant and Farmers Bank of Koscuisko, Miss. v.

State ex rel. Moore, 651 So. 2d 1060 (Miss. 1995).               But, like the

district court, we fail to see the relevance of that case to the

specific issue before us.         Two Mississippi bankruptcy courts have

addressed   perfection     of    an   assignment   of   rents   clause   under

Mississippi law and followed the old rule.              See In re Crossroads

Market, Inc., 190 B.R. 269, 271 (Bankr. N.D. Miss. 1994); Delta

Plaza Partners v. Minnesota Mut. Life Ins. Co. (In re Delta Plaza

Partners), 133 B.R. 355, 357-58 (Bankr. N.D. Miss. 1991).                 Both

Crossroads Market and Delta Plaza, however, relied on Fifth Circuit

cases interpreting Texas law that do not control a case governed by

Mississippi law.9        Moreover, the only independent justification

noted for the bankruptcy court’s holding that Mississippi would

adopt the old common law rule is that Mississippi, like Texas, is

a “lien theory” state.          See Delta Plaza, 133 B.R. at 358, citing

Myers v. Hobbs, 100 F.2d 822 (5th Cir. 1939).           That premise appears

     9
       Each time this court has addressed perfection of an assignment of
rents, it has been interpreting Texas law. See International Prop., 929
F.2d at 1034; Casbeer v. State Fed. Sav. & Loan Ass’n of Lubbock (In re
Casbeer), 793 F.2d 1436, 1442 (5th Cir. 1986); Wolters Village, Ltd. v.
Village Prop., Ltd. (In re Village Prop. Ltd.), 723 F.2d 441, 443 (5th
Cir. 1984).

                                       11
to have been rejected by the en banc Mississippi Court of Appeals

in   a    recent    decision   concluding    that   Mississippi       is   an

“intermediate theory” state.10       See Anderson v. Kimbrough, No.

97-CA-01169, 1999 WL 435649, at *6 (Miss. Ct. App. June 29, 1999)

(en banc) (slip opinion); Miss. Code Ann. § 89-1-43 (Rev. 1991).

Application of the modern rule is particularly appropriate in an

intermediate theory state.

                                CONCLUSION

             Security National’s interest in the rents was perfected

when it recorded its deed of trust containing the assignment of

rents     clause.    Accordingly,   that    interest   primes   the    later

garnishment lien asserted by O’Neal against the rents.

     The judgments of the district and bankruptcy courts are, for

the foregoing reasons, AFFIRMED.

     10
       In “title theory” states, the mortgagee holds title to the land
from the outset of the loan until the debt has been satisfied. In “lien
theory” states, the borrower holds title to the land and the mortgagee
has a lien on the property. Finally, in “intermediate theory” states,
the borrower maintains title to the property; however, once the loan
goes into default, the mortgagee immediately receive title and the right
to possess the property. See Anderson, 1999 WL 435649 at *6.

                                    12