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Butner v. United States - 440 U.S. 48, 99 S. Ct. 914 (1979)

Rule:

North Carolina is classified as a "title" State, although it does not adhere to this theory in its purest form. Under its case law, a mortgagee is entitled to possession of the mortgaged property upon default, and need not await actual foreclosure. Such possession might be secured either with the consent of the mortgagor or by an action in ejectment. But so long as the mortgagor does remain in possession, even after default, he -- not the mortgagee -- appears to be entitled to the rents and profits. In the absence of a stipulation to the contrary a mortgagor of real property who is permitted to retain possession is entitled to the rents and profits. As between the mortgagor and the mortgagee equity makes the mortgage a charge upon the rents and profits when the mortgagor is insolvent and the security is inadequate but the prevailing rule is that a mortgagee is not entitled to rents until entry is made or a suit for foreclosure is begun.

Facts:

Mortgagor Golden Enterprises, Inc. filed a petition for an arrangement under Chapter XI of the Bankruptcy Act, 11 U.S.C.S. §§ 701-799. In those proceedings, the bankruptcy judge approved a plan consolidating various liens on North Carolina real estate owned by Golden. As a result, Golden acquired a second mortgage securing an indebtedness of $360,000, but Golden did not, however, receive any express security interest in the rents earned by the property. At that time the mortgages were in default. A trustee in bankruptcy was appointed and was ordered to collect and retain all rents from the mortgaged properties to be applied as the bankruptcy court would direct. Golden's properties were later sold to the mortgagee, the price being paid by reducing the estate's indebtedness to the mortgagee. The mortgagee then filed a motion claiming a security interest in the rent fund accumulated by the trustee and seeking to have it applied to the balance of the indebtedness. The bankruptcy judge denied the motion, holding that the balance due to the mortgagee should be treated as a general unsecured claim. The United States District Court for the Western District of North Carolina reversed, concluding that the state-law requirement of a change in possession giving the mortgagee an interest in the rents was satisfied by the appointment of an agent to collect rents during the arrangement proceedings. On appeal, the United States Court of Appeals for the Fourth Circuit reversed, holding that the adjudication of bankruptcy terminated the arrangement agent's relationship, and that because the mortgagee had made no request during the bankruptcy for sequestration of rent or for the appointment of a receiver, the mortgagee had not taken the kind of action North Carolina law required to give the mortgagee a security interest in the rents collected after the bankruptcy adjudication. The United States Supreme Court did not grant certiorari to decide whether the Court of Appeals correctly applied North Carolina law, but rather to resolve a conflict between the Third and Seventh Circuits on the one hand, and the Second, Fourth, Sixth, Eighth, and Ninth Circuits on the other, concerning the proper approach to a dispute of this kind.

Issue:

  1. Should state law control the analysis of the issue at hand?
  2. Was the mortgagee entitled to the security interest in the rents collected after the bankruptcy adjudication?

Answer:

1) Yes. 2) No.

Conclusion:

The Court agreed with the majority view that the question of whether a security interest in property extended to rents and profits derived from the property was one that should be resolved by reference to state law. The Court thus adopted the majority view that the federal bankruptcy court should take whatever steps were necessary to ensure that a mortgagee was afforded, in federal bankruptcy court, the same protection he would have under state law if no bankruptcy had ensued. Therefore, the mortgagee was entitled to the same protection he would have under North Carolina law. Here, the mortgagee had lost his right to rents as a matter of North Carolina law when the bankruptcy frustrated his right to take possession of the mortgaged property. In order to have a right to such rents, the mortgagee had to make a request during the bankruptcy for sequestration of rent or for the appointment of a receiver. The Court affirmed the decision of the Court of Appeals, which found that the mortgagee did not take any of the steps required to give him a security interest in the rents collected after the bankruptcy adjudication.

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