Butner v. United States – Oral Argument – November 27, 1978

Media for Butner v. United States

Audio Transcription for Opinion Announcement – February 21, 1979 in Butner v. United States

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Warren E. Burger:

We’ll hear arguments, next, in Butner against the United States.

Mr. Brackett, I think you may proceed whenever you are ready.

J. Steven Brackett:

Mr. Chief Justice and may it please the Court.

This case arose as a controversy between a mortgagee and the bankrupt estate as to whether or not the mortgagee of the bankrupt estate was entitled to rent realized for mortgaged property between the time of the mortgagor’s bankruptcy and the sale of this property pursuant to an order of bankruptcy court.

I think it’s necessary preliminarily that we discuss some of the facts in this case as I relate to the North Carolina law and if the Court will indulge me I would like to discuss these facts in detail.

This case began as a Chapter XI proceeding, that is a plan of arrangement under the Bankruptcy Act wherein the bankrupt estate in this case owned tracts of real estate as well as personal property which was sold as merchandise in a retail business.

Only at real estate owned by the bankrupt estate there existed a first deed of trust and also a second deed of trust.

During the period of arrangement after the commitment of the Chapter XI proceeding work was done and performed at the instruction of the bankruptcy court by various attorneys, certified public accountants and others.

There was about $800,000 worth of personal property which was inventory of the bankrupt estate which was disposed off during this period of arrangement.

No proceeds were deducted from the sale of this personal property in inventory to be applied to at the cost of administrating a bankruptcy estate or as payments for any of the attorneys, accountants and various other employees engaged by the bankrupt estate.

During the period of bankruptcy some one year after the bankruptcy had been initiated, the second holders of deeds of trust in the property perceived that the bankrupt estate under its plan for arrangement was not able to keep current the first deeds of trust or the first security on the real estate.

Therefore, these first and second mortgage holders through the bankrupt debtors attorney sought the appointment of a receiver who was to receive and collect all income produced by the estate that is the rental income from the real estate and apply that pursuant to the order of the bankruptcy court to federal and state income taxes, to the monthly mortgage payments due to the first mortgagors, to the ad valorem taxes, the payment of fire insurance and to the interest and principal payments due to the second mortgage holders.

There was also within a period of a few months later a standby trustee appointed.

This stand by trustee is the trustee defendant in this case.

Also, at the time this receiver was appointed for the collection of the rents, the bankruptcy court specifically ordered that the second secured parties in the real estate not attempt in any way to petition or foreclose their property in the state courts without the specific permission of the bankruptcy court.

This of course was in addition to the general stay order that is executed against the creditors when the bankruptcy proceeding is initiated.

Because of default by several of the bankrupt — the debtor in possessions creditors that is several tenants on their real estate and the mortgage — in the rental payments, the tenant and other financial reversals there was not sufficient cash flow being generated by the debtor in possession to comply with the bankruptcy, with the bankruptcy judge’s order regarding payment of the various four payments that I previously mentioned to the Court.

Therefore, this petitioner who is here before you today filed an application with the bankruptcy court on the 30th day of December 1974 to have one of three acts performed by the bankruptcy court.

That is to convert the Chapter XI proceeding, that is the plan of arrangement to a liquidating bankruptcy.

Two; to remove the stay outstanding against these second deeds of trust holders in order that they can pursue their state remedies under the state law of North Carolina or three to convert the proceeding from a Chapter XI to a Chapter X proceeding under the Bankruptcy Rules.

At this time, the second deeds of trust outstanding to the petitioner in this case were not in default.

They were paid current.

On the 14th day of February, 1975, the bankrupt, that is the debtor possession was adjudged to be a bankrupt was adjudged bankrupt.

A trustee was appointed that is the trustee who is defendant in this case, was appointed to proceed with the bankruptcy proceedings.

He was ordered in that — in his order — in the order appointing him as trustee to collect and receive all rents, issue, income and profits and to hold and retain all moneys and profits received to the end that the same may be applied under this or different or further orders of the court.

On April the 16th of 1975 some two months after the trustees’ appointment, there was a first meeting of creditors.

It was suggested that at this time by the trustee as well as your petitioner in this case, who was a second mortgage holder that there was no equity in the property and that the property should be conveyed, not abandoned, but conveyed to the second mortgage holders in order that they could workout arrangements with their first security holders under the real estate.

At this time, the bankruptcy court in its hearing as documented in the appendix in this record suggested that there were substantial amount of administration cost of bankruptcy which had accrued during the period of the arrangement and was curious as to what source would produce the moneys to satisfy these costs of administration and indicated also that the economic conditions were bad at that time and perhaps that would improve within the next several months and indicated therefore to the second mortgage holder and to the trustee that he was not inclined to convey the property to the second secured parties in the real estate.

Thereafter, the property was sold pursuant to the order of the bankruptcy judge late in July of that year.

At the time of the sale which was a public sale after due notice there was a substantial deficiency that is in about and sum of approximately $213,400, that is that the second deeds of trust holders were without their security to that extent.

J. Steven Brackett:

The petitioners in this case again approached the bankruptcy court, moved that the bankruptcy court not confirm the sale and that they abandoned the property to the bank — to the second secured holders.

The bankruptcy court declined this.

The petitioner in this case appealed to the District Court, and the District Court remanded to the bankruptcy court with the instruction that the bankruptcy court order the property sold again with the petitioners that is the second mortgage holders being allowed to use the credit due them on their deeds of trust to the extent of $360,000.

Under these conditions your petitioner in this case purchased the property having a deficiency owned under his debt of $186,000.

Thereafter the trustee in this case drew a deed conveying all four tracts of property to the petitioner in this case.

The trustee also had that deed recorded and delivered it to the petitioner in this case.

Soon after the petitioner made claim for disbursement of the funds on hand, some $160,000 plus accrued interest which were collected by the trustee as a rental on the property it which had said the petitioner held a security interest.

The bankruptcy judge held a hearing regarding this and found that the petitioner in this case was an unsecured creditor to the extent of $186,000.

And this ruling, petitioner appealed to the District Court and District Court reversed the finding of the bankruptcy judge.

This order was appealed to the Fourth Circuit.

The Fourth Circuit reversed the District Court’s order determining that the petitioner in this case had not complied with the state law of North Carolina in seeking to sequester and have these rentals set aside and help for his benefit and therefore declaring him to be an unsecured creditor.

Harry A. Blackmun:

Mr. Brackett, let me interrupt you at this point.

J. Steven Brackett:

Yes sir.

Harry A. Blackmun:

Do you have any comment with respect to the passage of the new Bankruptcy Act and its bearing on this case?

J. Steven Brackett:

Your Honor, we felt like that was probably that one of the reasons that why we are here on this case.

I don’t — in my opinion I don’t see the bearing of passages of the new Bankruptcy Act on this case other than perhaps Paragraph 57 (H), which has been cited by the government in their brief here.

That might have some bearing and also I think we need to have a resolution of the diversion between the circuits here in order that the secured creditors can know what their standing is and what is going to be required of them to protect their interest when their moneys are in the hands of a trustee.

Harry A. Blackmun:

Well, if it does have a bearing it may make this case a lot less important than it might otherwise be.

Let me leave just one provision?

The commencement of a case creates an estate.

Such estate is comprised of the following property; proceeds, product, offspring and rents which would cut against you?

J. Steven Brackett:

Yes sir.

To that extent again reiterate to His Honor that to the extent of the new Bankruptcy Act, we are not that familiar with the proposed new Bankruptcy Act to the extent that this effects or the new draft of the Bankruptcy Act would affect the rights of secured debtors then yes, this case is of extreme importance to the drafters in new Bankruptcy Act to this Court in considering this case.

William H. Rehnquist:

Do the Courts of Appeals in their split treat it as a question of federal law on which that they disagree or do they treat it as questions of state law arising within their various circuits?

J. Steven Brackett:

Your Honor, I think that is the split of the cases.

I think it’s a perception of the various circuits as to what bankruptcy is.

Apparently the Third and Seventh circuits perceived bankruptcy to be an equitable remedy and therefore the Third and Seventh circuits tend to apply equitable principles.

The remaining, the Second, Eighth and Ninth Circuit, I think if the circuits are involved here in these particular cases follow the principle that so far a state law is not in conflict with the federal bankruptcy law, they are going to apply the state law in recognition of the secured creditors rights only being consistent with those product real estate that is located in their states.

William H. Rehnquist:

Do any of the Courts that Appeals take the position that if the creditor had provided for in the mortgage agreement that the rent should secure the security that would not be followed by the bankruptcy court?

J. Steven Brackett:

No sir, I don’t believe so.

J. Steven Brackett:

I don’t think we have — they have disregarded that principle in any case to apply a so called federal Rule.

As a matter of fact they have adhered to that principle.

That has been a consideration in a number of cases.

William H. Rehnquist:

So, the mortgagee can protect himself within any other circuits by putting a provision in the mortgage agreement?

J. Steven Brackett:

Skillful drafting of the mortgage agreement would be the first step that mortgagor would have him protect himself, yes.

As I have attempted to point out to the court, there is a split among the circuits and that the circuits that follow the so called equitable Rule would be the Third and Seventh Circuits.

This case was the case, the principle case set out there as the Bindseil v. Liberty Trust Co.

This case says that in essence that bankruptcy interferes with state remedies to such an extent that a debtor or a creditor is prohibited from exercising certain rights that he might have under state law and in cases such as this where equitable principles would allow the bankruptcy court will allow his lien to the extent that it is deficiency to follow the rentals that are turned over to the hands of a trustee.

The remaining circuits, that is the Second Eighth and Ninth Circuits adhere to the Rule that they will follow the state law and that law is to be applied carefully.

Under either comprehension of the law, we suggest that the petitioner has complied with under the diversion of both circuits and in any event in this case the petitioner should be granted a security interest in these rents and the primary basis for this is the cases Parker Co. versus Commercial Bank of High Point.

This is cited in 204 North Carolina 432.

We contend this is the law in the state of North Carolina and that the Fourth Circuit failed to properly address itself to this case in determining that the bank or that the petitioner in this case had not complied with the state law.

In the Parker case, there was a judgment creditor that is a creditor who had pursued his remedy to a judgment, it was outstanding mortgage held by a first deed of trust against an automobile company or motor company.

The mortgagor under the deed of trust began, initiated a foreclosure proceeding.

The judge Macdader (ph) in that case filed an action to enjoin the foreclosure proceeding.

Rents were accumulated while this action was pending in the courts of North Carolina.

Subsequently the mortgage holder obtained a deficiency judgment and reduced it to judgment.

The judge Macdader (ph) who had initiated the action to enjoin the foreclosure had had a receiver appointed who collected these rents.

The court held that the mortgage creditor was entitled to satisfy his deficiency judgment from the funds collected by the receiver during the pendency of the action.

We contend that this case is directly analogous to the case before the Court here.

The opposition would contend that we have failed to take steps as required in the North Carolina state law to protect ourselves.

Citing the case of Greg versus Williams which places North Carolina in alignment with the majority of states in this country that require that a mortgagee in order to assert a security interest in the real estate, in the rentals collected, take some into which substitutes for taking possession of the property.

That is ordinarily the mortgagee would have to take possession of the property and these courts have held that where taking of the property is not possible as in a bankruptcy case, the mortgagee must take some other action to perfect his security interest.

That is he must seek to have the rental sequester or seek to have a receiver appointed in the bankruptcy proceeding.

In this case —

John Paul Stevens:

Can I just interrupt?

J. Steven Brackett:

Yes sir.

John Paul Stevens:

You are relying on the Parker case is it?

J. Steven Brackett:

Yes sir.

John Paul Stevens:

Did you cite that in your brief?

J. Steven Brackett:

No sir, we did not.

It was cited by the government and we think it was favorable to our position.

John Paul Stevens:

Oh I see.

Thanks, alright, the government brief.

J. Steven Brackett:

Yes sir.

It is to be found in the Williams and line of cases cited by the government and it’s the best case we contend on this — what the standing what the requirements of North Carolina law are.

As to whether or not we have done the things necessary or required by North Carolina law we contend that we have and that’s the factual issue that was addressed in the dissent in the Fourth Circuit by Judge Brown.

Our opponents in this case would have a court Rule that actions taken by the petitioner during the plan of arrangement were not taken during bankruptcy.

We have of course have cited in our brief that proper – the applicable Bankruptcy Rules which say of course that and there are a number of cases so holding that actions taking during the plan of arrangement are of course equivalent to those actions which are taken after the adjudication of bankruptcy.

We say that the real crux of this case as it relates to the petitioner is that he had a receiver appointed by making request of the attorney for the debtor.

Our opponents would argue to the court that because the attorney for the debtor actually filed the motion that the petitioner should not be allowed to benefit from that.

I asked the Court to address themselves in particular to that application which recites the fact that the secured creditors had approached the attorney for the debtor and requested this and the reasons therefore.

Subsequently in the chapter —

John Paul Stevens:

Brackett, just a second to follow it?

J. Steven Brackett:

Yes sir.

John Paul Stevens:

It’s rather complicated case.

J. Steven Brackett:

It’s a complicated set of facts.

John Paul Stevens:

Two questions on that.

First, where in the record is the document you just described and secondly in that document did they request an assignment of the rent?

J. Steven Brackett:

No Sir.

What the document is to be found in the record,bear with me for just a moment, at 204 A in the appendix.

This was a petition by the attorney for the debtor and it recites in the petition that the petition was made because of the request of the secured creditor.

Thurgood Marshall:

I thought you said North Carolina required you to get the rents to request?

J. Steven Brackett:

North Carolina requires that you take possession, that the mortgagee take possession or otherwise seek to protect himself by having a receiver appointed.

Thurgood Marshall:

But you didn’t request the rents, you could have?

J. Steven Brackett:

No sir, we contend what we did here was address the attorney for the debtor, ask him to have a receiver appointed and that the receiver’s instructions from the Bankruptcy Court were to collect the rents and then they established a priority as to how those rents would be disposed off.

John Paul Stevens:

What you call our attention to in the record is the order appointing the trustee or whatever he is to act for Court and that order recites that the motion was made by the attorney for the debtor and you are telling us that motion was made by attorney for the debtor because you requested him to do so.

Where is your request to him to do so in the record?

J. Steven Brackett:

Your Honor, if you look two pages before that in record, I believe at 202.

John Paul Stevens:

Several parties shall be savings, they all the same second mortgagees at the —

J. Steven Brackett:

No, sir.

Your Honor shall be, as I pointed out to the Court, again this is a complicated fact situation.

John Paul Stevens:

But this is Acadia (ph) case as I understand.

J. Steven Brackett:

Yes sir, there are four, there were four tracts of line, four different institutions held first deeds of trust on those properties.

The petitioner held a so called blanket deed of trust which was secured by all four tracts of property, yes sir.

John Paul Stevens:

And the point is that the second mortgagee or second deed of trust holders requested this procedure and that the first land holders would be taking care of and first (Inaudible) would be paid to your people.

J. Steven Brackett:

Yes sir.

John Paul Stevens:

I see.

J. Steven Brackett:

Yes sir.

It might be important to note and I think the record again —

Byron R. White:

You really just ask that the mortgage payments be made, do you?

J. Steven Brackett:

Yes, sir.

Byron R. White:

And any balance to unsecured creditors?

J. Steven Brackett:

No sir.

Byron R. White:

Well, that’s what your request was?

J. Steven Brackett:

I think the request is to be taken in context with order and request was —

Byron R. White:

For the benefit of secondary lien holders and the unsecured creditors.

J. Steven Brackett:

Yes sir, to the extent that’s the as a Court, as a Court can see from the order, they were four priorities set up and the unsecured creditors were not part of the priorities ordered by the bankruptcy Court at all.

Byron R. White:

But the trustee didn’t have to pay or they didn’t have to do anything more than pay the payments as they can do?

J. Steven Brackett:

Yes sir, he was required under the order to collect the rents, to sequester those to keep proper ledger cards and then to apply them in accordance with order of the bankruptcy judge.

We say that was a sufficient action on our part to comply with North Carolina’s requirements and receiver be appointed.

Byron R. White:

Well suppose there was more current income than necessary to pay the mortgage payments.

J. Steven Brackett:

Yes sir.

Byron R. White:

What happens to the balance?

J. Steven Brackett:

Then that it would my contention that would accumulate until the conclusion in the bankruptcy and that may be dispersed.

Byron R. White:

That doesn’t sound like but you ask for here.

You didn’t accel — was the — did you accelerate the — did you declare all of the entire balance due in these mortgages?

J. Steven Brackett:

No sir, as I stated to the Court in trying to recite to facts in this case what brought about this request for receiver was the fact that the bankrupt debtor in possession was not able from the cash flow to keep the mortgage payments current.

Byron R. White:

I understand that.

This occurred after – did this petition and order occur after bankruptcy, after straight bankruptcy?

J. Steven Brackett:

No sir, that’s another significant fact.

This occurred during the plan of arrangement, when the second creditors perceived that their security was in peril, they requested that a receiver be appointed.

This would say —

Byron R. White:

But after straight bankruptcy occurred, you could have asked that their property be abandoned to you and I guess you did?

J. Steven Brackett:

Yes sir we did.

The court would say —

Byron R. White:

But until you did that you did nothing else in order to try to get the rents?

J. Steven Brackett:

Yeah, sir we did.

If the Court would review the record, the Court will find in addition to the appointment of receiver that on December the 30th of 1974 and there is a petition application filed by petitioner in this case to have three things done by the bankruptcy court.

That is to convert it to a straight bankruptcy to allow the second secured creditors to be allowed pursue their state remedies or to convert it to a Chapter X proceeding under the bankruptcy laws, so those things were done.

Byron R. White:

I know but and the Judge said well and what happened was it was put into straight bankruptcy?

J. Steven Brackett:

Yes, sir.

Byron R. White:

And what does a secured creditor if he doesn’t want to file a security claim and proceed, what do they usually do?

J. Steven Brackett:

In this case —

Byron R. White:

In straight bankruptcy?

J. Steven Brackett:

In this case if there is no equity in the property for the general creditors or beyond his own, he ask that the property be abandoned.

Byron R. White:

And did you?

J. Steven Brackett:

Yes sir.

There was a petition for abandonment filed, there was also an oral request made at hearing which is the transcript of hearings and opinions and the bankruptcy court at that time indicated and I think this is an overwhelmingly significant fact that there were not sufficient funds on hand to pay the cost of administering the arrangement proceeding.

There were not sufficient moneys to do that, even though $800,000 worth of inventory had been sold.

William H. Rehnquist:

What are the priority — what are comparable priorities between cost of administration and rents in a situation like that?

J. Steven Brackett:

We contend that where you have a — where there is a secured creditor who didn’t realize the full extent of his debt that the priorities for the rents generated by the real estate lies with the secured creditor on the deficiency of his debt.

William H. Rehnquist:

So the bankruptcy judge is not entitled to say there is not enough to pay the cost of administration, so I won’t abandon the property for that reason?

J. Steven Brackett:

In my opinion that was a gross abuse of discretion on the part of bankruptcy judge.

He issued — what they did — what he did in doing following this procedure is he kept a security of a secured creditor away from hand in an attempt to generate funds to cover the cost of administering a bankruptcy procedure.

William H. Rehnquist:

Well, it wouldn’t be the first time a bankruptcy judge had done that?

J. Steven Brackett:

No, sir he would not, he would not and it is particularly significant that the fact of the bankruptcy court had approved and confirmed the sale of a tremendous amount of retail sales inventory without taxing that property and the funds derived from that property with any cost of the administration.

I think it’s very significant in this case.

Byron R. White:

Well, that the Court of Appeals, I gather that Court of Appeals thought that you had not then whatever is that North Carolina law should do?

J. Steven Brackett:

Yes sir.

Byron R. White:

And are you asking us to disagree with the Court of Appeals as to what North Carolina law is?

J. Steven Brackett:

Yes sir.

I’m not asking you to disagree as to what North Carolina law is.

I am asking this Court to examine carefully the Parker case and find that to be the law in North Carolina and find that to be a case on all force with the situation we have here.

Byron R. White:

Well, then you are saying that the Court of Appeals made a mistake as to North Carolina law?

J. Steven Brackett:

I think there was a misapprehension of law in North Carolina.

William H. Rehnquist:

Are you – three North Carolina judges on the Court of Appeals panel you have the opinion, District Courts of North Carolina the back yet.

J. Steven Brackett:

Yes sir.

Judge Jones, our preceding District Court Judge is an experienced attorney in North Carolina.

I contend his perception of law in North Carolina was more clear than that of the Fourth Circuit with all due respect and discretion that spots on.

I think Judge Brain’s opinion and I ask the Court to take particular note of it, the dissenting opinion in this case from the Fourth Circuit is very perceptive as to the whether or not this was done during bankruptcy or not during bankruptcy and that seems to be the fulcrum that the Fourth Circuit swung on as well or not this was done during bankruptcy or not bank during bankruptcy and I don’t think there is any question that the actions taken during plan of arrangements were during bankruptcy.

I only have a brief minute with Court so with the permission I would like to reserve that for rebuttal.

Warren E. Burger:

Very well.

Mr. Ryan.

Allan A. Ryan, Jr.:

Mr. Chief Justice and may it please the Court.

I think it’s fair to say that all sides agree that this case has not answered the issue in this case, is not answered by the Bankruptcy Act as such and if I may refer to a question that Mr. Justice Blackmun posed earlier, I think that the new Bankruptcy Act will not be anymore helpful than the old one was.

I don’t think the new Bankruptcy Act will answer this question anymore clearly than it is answered now so that although rents specifically are mentioned, the question is whether the mortgage interest overrides that right to rents.

I think it’s also fair to say that all sides agree in this case that had Golden Enterprises not gone into bankruptcy, the petitioner as mortgagee would have had no right under North Carolina law to the rents unless and until he instituted a foreclosure action and obtained the appointment of a receiver to collect the rents for him and where we part company in this case is that the petitioner says that bankruptcy makes all the difference after that fact and we say it really makes no difference at all.

Specifically we recognize that once the property here came under the aegis of the bankruptcy court, which in this case was when the Chapter XI petitioner’s filed, the petitioner was no longer free to begin foreclosure and seek the appointment of a receiver without the permission of the bankruptcy court.

The petitioner argues that from that fact alone he was entitled to the rents as an equitable matter and we believe on the other hand that just as the petitioner would have been required under state law to take some affirmative step to reach the rents in the absence of bankruptcy so he should be required to take some affirmative step to reach them once bankruptcy occurred.

Although foreclosure in the State Court and appointment of receiver in a State Court were barred to him, other steps were not as I will discuss in a moment.

The petitioner argues and he places a great deal of emphasis on this that even if we are correct in that reading of North Carolina law and I don’t understand him to disagree with us on that, he did pursue an alternate course sufficient to protect his interest.

We believe the Court of Appeals was correct in holding that he did not do so, And finally we believe that even if the minority view of the circuits and the view of the petitioner is correct that equity should prevail the facts of this case demonstrate that petitioner has suffered no loss looking at the transaction as a whole and therefore that equity should not require that the rents be handed to him in this case.

But let me return to my first and most important point.

As this Court has recognized in a series of cases, the nature and extent of a creditor security interest in the property of bankrupt is the matter of State and not Federal Law.

Congress presumably could make it otherwise in its exercise of its powers under the bankruptcy clause, but it has not done so.

In this respect it has chosen to differ to state law.

Under North Carolina Law, if petitioner wished to reach the rents of the property by virtue of his security interest he would have to go to court and request that a receiver be appointed for that purpose.

Such a remedy is provided in North Carolina Law as a part of a foreclosure action.

As I say we recognize that in this case that precise step was not open to him, but we do not believe that by that fact he could vindicate his claim by doing nothing.

Allan A. Ryan, Jr.:

That is essentially what he is arguing here.

He is saying since I could not go to State Court I ought to have the rents as a matter of equity.

We believe that if he wished to reach the rents that he was obliged to take some action in the bankruptcy court.

As far as what the North Carolina law is before I leave that, I don’t think there is any dispute and I don’t think there is any need for this Court to resolve conflicting views of what the law is in North Carolina because the petitioner has said that the Parker case which we cite in our brief is the best case on what the North Carolina law is.

We agree with that and we think that Parker case states the law quite succinctly and I would think that if the Court refers to that case, it will have all the North Carolina law needs to decide this case.

That the my opponent did not quote the whole holding of that case and I will only point out to the Court that the Parker case says “ordinarily a mortgagee or a creditor secured by a deed of trust has no right to collect the rents or other income from property even after default in the payment of secured indebtedness.

This right arises only after the mortgagee or trusty has taken possession of the property conveyed by consent or pursuant to an order or decree of a court of competent jurisdiction.

But where as in the instant case says the court a receiver appointed by the court in a foreclosure action has taken possession of the property and collected the rents, then the rents should be applied as payment on the secured indebtedness.”

And we have no problem with that holding at all.

What —

John Paul Stevens:

Mr. Ryan, why isn’t that happened here?

In that order he calls our attention to that this order at 204 of the record that he requested that a representative of the court be appointed to collect the rents.

Isn’t that – doesn’t that fall within that language you just read?

Allan A. Ryan, Jr.:

In this case no Mr. Justice Steven it does not and the reason it does not is because that request was made during the arrangement proceedings of the case.

In the first place I would not agree that it was a receiver.

It was not a receiver.

It was an agent that was appointed but even assuming that it was a receiver, Rule 201 of the Bankruptcy Rules provides that when a trustee is appointed in a liquidating bankruptcy the receivership is terminated.

So even if there was a receiver appointed during the Chapter XI phase of that case that phase was ended and that receivership was terminated by the appointment actually by the qualification of the trustee.

Not only that, but the trustee and this is why this is a matter of substance and not simply form, the trustee received completely separate and distinct set of marching orders from that had been applied to this agent or receiver or whatever he is called because the agent or receiver was told to pay, to apply the rents in a certain specified priority; taxes, fire insurance so on and so forth with the second mortgagee on the bottom of the list.

The trustee on the other hand was told not to pay any expenses, but to simply accumulate the rents produced by the property until further order of the court.

So by reason first of all of Rule 201 of the Bankruptcy Rules and secondly by the fact that the trustee was given a totally different set of instructions from that received by the receiver in this case we say that action was simply insufficient to govern the rents from the time of bankruptcy until the time that the mortgagee took possession.

That’s the time period we are looking at this case, it opens with the adjudication of the bankruptcy, it closes when the.

John Paul Stevens:

Supposing instead of there being a Chapter XI arrangement before the bankruptcy there had been a state code receivership and pursuant to a petition by the second mortgagee a state court had entered an order verbatim the same as the one 204 A, would that not have entitled to second mortgagee to the rents for —

Allan A. Ryan, Jr.:

I would answer that question by saying that it would depend on what the effect of a adjudication of bankruptcy is on a state court receivership, if as I think it would terminate that receivership then the result would be exactly the same and my argument would be exactly the same.

In other words —

John Paul Stevens:

Even if as a matter of State Law up to the time of adjudication of bankruptcy the ownership of the rents had been in the second mortgagee, it would retroactively extinguish it?

Allan A. Ryan, Jr.:

No, it would not retroactively extinguish it.

As I say we are talking about the period of time in this case beginning with the adjudication of bankruptcy.

In other words the mortgage was not in default prior to the appointment of the receiver.

John Paul Stevens:

Oh!

John Paul Stevens:

I see.

Allan A. Ryan, Jr.:

The second mortgagee, the petitioner received all these rents during that period of time.

He is not asking for that now.

He has already got them.

He is asking for the rents that accrued starting with the adjudication of bankruptcy, starting with the time the trustee was told pay no more rents.

Now since that day no more mortgage has been paid and that’s what petitioner is asking for.

John Paul Stevens:

Oh!

I see, he is talking about — he is relying on an order that was entered before there was any default on the second mortgage.

Allan A. Ryan, Jr.:

Yes sir.

John Paul Stevens:

And that order was complied with and you have a new ball game at the time of the adjudication.

Allan A. Ryan, Jr.:

Absolutely.

John Paul Stevens:

And I am sorry, you can go ahead.

Allan A. Ryan, Jr.:

There are two things I think that the petitioner could have done in the bankruptcy court which we think that he should have done.

Rule 701 provides for adversary proceedings “to determine the validity, priority or extent of a lien or other interest in property.”

Petitioner could have filed an adversary proceeding claiming that his mortgage extended to an interest in the rents.

Under Rule 765 of the Bankruptcy Rules which adopts Rule 65 of the Federal Rules, the Court could have ordered the trustee not to commit the funds pending an adjudication although in fact this is what the Bankruptcy Court had told the trustee anyway.

And then if petitioner had prevailed in this adversary proceeding the Bankruptcy Court could have entered an order of sequestration or attachment, telling the trustee to pay the rents over to the mortgagee or as a second course of action the petitioner could have gone in under Rule 601 (C) of the Bankruptcy Rules and ask for relief from the stay of state court proceedings which Rule 601 imposes.

The Rule 601 says you will not enforce any action against the property in a state court, but there is a provision, Section C of that Rule, that says on application of any party or any creditor the state Bankruptcy Court may lift the stay and permit the creditor to go to state court.

So he could have done either one of those two things.

We are not asking for a feudal or a ceremonial gesture.

We are asking for very real and substantive compliance in this case.

Byron R. White:

Mr. Ryan what about the provision in the mortgage that the mortgagee will have benefit of the rents?

Allan A. Ryan, Jr.:

There was no such provision.

Byron R. White:

I know, what if there is?

Allan A. Ryan, Jr.:

If there is that question as to whether he is in fact entitled to them would be decided under state law.

If that —

Byron R. White:

Well, suppose it’s valid under the state law then automatically in bankruptcy the secured creditors gets the benefits of the rents?

Allan A. Ryan, Jr.:

If it is a clause that is valid under State Law then I would think that absence some supervening reason for order whatever that it would be enforced in the bankruptcy court.

Byron R. White:

So that this whole argument is settled by careful drafting?

Allan A. Ryan, Jr.:

Well it may be and that certainly is the —

Byron R. White:

Well, may be, I wonder what’s your government position is?

Allan A. Ryan, Jr.:

Well, the government’s position is that it would have to be determined under state law.

Now if you assume that state law would give affect to that provision and give the rents to the mortgagee then that’s our position that it would be done.

That’s the Fidelity Banker’s case, Judge Haynsworth’s opinion.

Warren E. Burger:

Does it make some difference whether that effort is made before or after bankruptcy proceedings are commenced?

Allan A. Ryan, Jr.:

I think it has be made in the — when the mortgage is drafted.

It has to be included in the mortgage.

Warren E. Burger:

You are exercising from that power.

Let’s assume it’s in the mortgage, explicit, may it be exercised after the bankruptcy proceeding starts in the same way it could be exercised before bankruptcy or this bankruptcy have no impact on that at all.

Allan A. Ryan, Jr.:

I would think that, that if the claim is made after bankruptcy begins that the Bankruptcy Court would have to give effect to that insofar as the state law would.

Byron R. White:

You wouldn’t say that in a Chapter XI proceeding, not in straight bankruptcy?

Allan A. Ryan, Jr.:

I would not say it in the Chapter XI.

I would say again here only under – – only under state law.

I think there are two reasons that we are asking that the Court require the petitioner to take some action.

In the first place it is not the scheme of the Bankruptcy Act, it is not the intend of Congress to give the creditor any enhancement of the remedies he otherwise would have merely by virtue of the fact that his debtor is in Bankruptcy Court.

He could not reach these rents in the absence of a specific action namely appointment of a receiver in state court.

He should not be able to do so in Federal court absent at comparable action.

The second reason and one that I think is most important here is that the petitioner’s acts in this case or lack of acts have really disrupted the orderly administration of this bankruptcy because the first time that petitioner ever came in and said I have a right to these rents was after the property had been sold, after his proof of claim had been submitted, in fact in his proof of claim he specifically disclaimed any interest in these rents.

What he said was I have no interest other than “that in the note and deed of trust.”

Neither of those documents said anything about security interest in rents.

So he presented this to the trustee and said here is my proof of claim.

The trustee looked at it and said fine and acted on that basis and then some six months afterwards he comes back in and says, well I also have a proof, I also have a claim on the primary source of income from this estate.

That is simply confounding the trustee and will continue to confound the trustee in future cases if that is the result that is allowed here.

I will yield the remaining time of my argument to Mr. Cagle.

Warren E. Burger:

Mr. Cagle?

Joe N. Cagle:

Mr. Chief Justice, may it please the Court.

Speaking of trustee as my colleague just stated it is important for the trustee in the Bankruptcy Court and creditor’s committee and others interested in a bankruptcy to know as soon as possible what the liens or security interests are on assets in a particular bankruptcy case and this need to know we suggest is amply satisfied by reliance on local law.

The local law is the source that we contend should be applied in this case.

Reliance on local law gives the debtor creditor relationship emphasis or it gives them the knowledge that they need in the transactions and dealing with real estate and mortgages on them so that when there is a bankruptcy case everybody knows what their liens and what their status their rights are with respect to certain assets in the bankrupt estate.

Everybody in this particular case relied upon that fact that is that the local law was governing and the fact of the matter is that under local law, the petitioner had has no lien on the rent.

Joe N. Cagle:

The petitioner had a second mortgage on the real-estate not a lien on the rents.

Bankruptcy intervening should not expand any of the rights of a second mortgagee and grant to him any lien that he did not have and that would be inconsistent.

We suggest that the bankruptcy law, the bankruptcy court should follow the jurisdiction of the situs of the property and I do not believe that we really have any dispute about the law of North Carolina, Greg versus Williamson or the Parker case as we have cited in our brief.

In North Carolina just to simply be redundant if I will if you permit me a mortgagee has to file an action in state court to foreclose his mortgage.

As a part of the foreclosure he can obtain as an ancillary remedy the appointment ordering receiver.

The law is that he must obtain possession, that is he must acquire a deed before he is entitled to the rents under the law of North Carolina.

The analogous part in bankruptcy, if you want to talk about due process a mortgagee has remedies available, procedures available to it in the existing Bankruptcy Act that is Part VII of the Bankruptcy Act, Rule 701 in the subsections and sections thereafter allows a trustee or creditor to institute an adversary proceeding which is called a complaint, the service like our adversary proceeding before the court in North Carolina to foreclose a mortgage.

This procedure and the adversary proceedings allows you to “recover property or money, to determine the validity, priority or extend of the lien or other interest in property, to sell property free of a lien or other interest, to objective or evoke discharge, to obtain an injunction, to obtain relief from a stay that is the injunction under Rule 401 or 406 or to determine the dischargability of a debt.”

That adversary proceedings section Rule 701 under Part VII is the whole mechanical or procedural set up in the Bankruptcy Act in the bankruptcy courts whereby a mortgagee goes in the court, seeks an order from the bankruptcy court to allow him to foreclose on his mortgage under state law.

We believe that adversary proceeding section of the Bankruptcy Act is a critical part of this case, that is the method or the mechanics procedure whatever you want to call it whereby other secured creditors went into this bankruptcy court and filed an action to recover and did recover their —

Byron R. White:

But he cannot move directly in the North Carolina courts, can he?

Joe N. Cagle:

No sir.

Byron R. White:

He must go to — in addition to North Carolina law then he must get permission of the bankruptcy court?

Joe N. Cagle:

Yes sir, but —

Byron R. White:

And it may be quite a while until he can get it?

Joe N. Cagle:

Not necessarily sir.

Byron R. White:

Well, it’s an adversary proceeding.

Joe N. Cagle:

It’s an adversary proceeding which —

Byron R. White:

And meanwhile what happens to the rents?

Joe N. Cagle:

Well, they should not take over 30 days.

Byron R. White:

Well, but what happens to the rents meanwhile?

Joe N. Cagle:

It’s being held in abeyance.

Byron R. White:

Well, can it be spent —

Joe N. Cagle:

No sir.

Byron R. White:

— for administration expenses?

Joe N. Cagle:

Only upon order of the bankruptcy court.

Administration expense is —

William H. Rehnquist:

You argue a [Voice Overlap], is it?

Joe N. Cagle:

No sir.

File a petition and an order.

Byron R. White:

So, what if there is an adversary proceeding and one side or the other wins and the other looses, then there is an appeal.

And what happens to the rents meanwhile?

The secured creditor says I sure would like go into the North Carolina courts and obey North Carolina law, but apparently the bankruptcy act wont let me.

Joe N. Cagle:

If understand your question —

Byron R. White:

And because I need protection meanwhile?

Joe N. Cagle:

As a practical matter I have not seen any case where about the bankruptcy judge did not allow a mortgagee to recover the property from the bankruptcy jurisdiction.

William H. Rehnquist:

But here there was a petition for abandonment that was denied?

Joe N. Cagle:

I disagree that there was a petition for abandonment, Your Honor.

Even if the court abandoned the property that’s not analogous to the state court foreclosure proceedings and even if there was —

William H. Rehnquist:

No my only question to you was with response to your statement that you had never seen a bankruptcy court turn down a petition for abandonment?

Joe N. Cagle:

No, no, no we are talking about scheme, Your Honor.

I have never seen a case where the bankruptcy court disallowed under the Rule 701 and action brought to recover property so that they could foreclose their mortgage under state law.

Byron R. White:

Well, if there is a big equity in the property wouldn’t you suppose the bankruptcy court would deny the right to foreclose.

Joe N. Cagle:

Which is possible, which is interesting because the facts and figures of this case before the bankruptcy judge indicated that there was a huge equity above and beyond the debt of the second mortgage.

The abandonment, if the court had abandoned the property, that was not what the petitioner wanted.

William H. Rehnquist:

Abandonment would have meant there wasn’t sufficient to equity over and above the security to make it worthwhile for the bankruptcy court to hang on to it, wouldn’t it?

Joe N. Cagle:

The abandonment would have required notice to all creditors just like an adversary proceeding before the court would have done that and there was no petition for abandonment filed and then —

John Paul Stevens:

Mr. Cagle, how could you say that the record show there was a huge equity in the property at the time of the sale.

He bought it for about half of the second mortgage indebtedness as I remember at the time of the sale.

Joe N. Cagle:

At the time of the sale.

John Paul Stevens:

There was then nothing in the record to indicate that there was a substantial equity in the property over and above.

Joe N. Cagle:

No that was sub —

John Paul Stevens:

But then we have to look at it at the time of the sale?

Joe N. Cagle:

Well, I don’t think so because you are looking at it in hindsight there.

The time that the petitioner asked —

John Paul Stevens:

So you are looking at it as the benefit of hindsight when you say that later on, it turned out that the property increased in value and the petitioner made a profit out of it.

Joe N. Cagle:

I was saying that the equity was there but reason the appraisals in December of 1974, just a few weeks before it adjudicated in February 75.

John Paul Stevens:

He had a lien, a second mortgage lien for about three hundred and some thousand dollars and he bought the property for 170 or something like that, didn’t he?

Joe N. Cagle:

At the second sale it was — obviously district court had an order allowing the second mortgagees to use their — the amount of their second mortgage to bid at the sale.

John Paul Stevens:

And they didn’t have to use it all?

Joe N. Cagle:

That’s correct, that’s or put it down for the sale, may it please the Court, but the time that the petitioner already requested the court at the first meeting of creditors in April 1975 to abandon the property to him.

That is not sufficient and is the wrong procedure, that was a request or suggestion in the court.

That was not an adversary proceeding to recover the property out of the jurisdiction of bankrupt.

If the court had abandoned the property he would still would have to file an adversary proceeding to get relief from the stay in bankruptcy, from the automatic stay in bankruptcy.

John Paul Stevens:

Tell me one of the thing about the abandonment because I just really didn’t understand.

Had there been abandonment at that particular time, would that have extinguished entirely the second mortgage indebtedness or would there then have still had been some kind of it —

Joe N. Cagle:

They would have to still had to go ahead and just —

John Paul Stevens:

I don’t understand that what would have happened if there has been an abandonment?

Joe N. Cagle:

Okay, the first mortgagees and/or the second mortgagees, one or the other of the several would have had to file an adversary proceeding to get permission from the bankruptcy court, an order removing the jurisdiction of bankruptcy court from the property, that is to get relief from the stay in bankruptcy so that they could foreclose under state law.

John Paul Stevens:

What I am trying to find out is had been there abandonment at that time, what would be the effect of the abandonment have been on the second mortgage indebtedness?

Joe N. Cagle:

I don’t see that there will be any effect.

John Paul Stevens:

You mean he would have taken over the property, he would become the owner of the property and still retained this entire $360,000 claim?

Joe N. Cagle:

If the court — if they had abandoned the property the first mortgagees would have foreclosed under state law of —

Lewis F. Powell, Jr.:

Was there any provision in the mortgage at all with respect to rents?

Joe N. Cagle:

No sir, none.

Lewis F. Powell, Jr.:

Had there been an assignment?

Joe N. Cagle:

No sir.

Lewis F. Powell, Jr.:

Had there been an assignment, what would their situation have been?

Joe N. Cagle:

No sir.

Lewis F. Powell, Jr.:

Assuming that the mortgage contained an assignment of rents —

Joe N. Cagle:

He would still would have had to foreclose to perfect that lien.

He is not, yes sir, he is not entitled to the property until he forecloses, he is not entitled either to the property or to the rents had there been an assignment of rents until he institutes foreclosure proceedings and obtains possession which now a days is a practical matter means a deed to him.

Potter Stewart:

And that he cannot do because of the bankruptcy?

Joe N. Cagle:

But our possession Your Honor please is that he can under the adversary proceedings which he did not utilize.

Byron R. White:

Are you sure — in Chapter XI though the notion is to pay the debts you go along and but at the same time, Chapter XI isn’t supposed to be able to hold off secured creditors unless you pay them, is it?

Now what happens in Chapter XI, if the secured creditor may not move in because it’s an arrangement to pay off the creditors, isn’t it?

Isn’t there and there was an order not to foreclose?

Joe N. Cagle:

Simply an order not to foreclose that was superfluous because the Bankruptcy Act says that he can’t foreclose.

All he had to do even during the arrangement —

Byron R. White:

Exactly, I know there is an automatic stay in Chapter XI case?

Joe N. Cagle:

Alright, even during the arrangement people go in, creditors go in and file an action under —

Byron R. White:

But the plan is scuttled completely if the —

Joe N. Cagle:

That’s correct.

Byron R. White:

— if the property is abandoned.

That’s the end of the plan.

Joe N. Cagle:

Well there is no abandonment during the arrangement period.

The abandonment would have occurred during the straight bankruptcy or liquidation part of the bankruptcy proceedings but even during the arrangement what I wanted to emphasize is the adversary proceedings section is available to all creditors and in fact that does stop a lot arrangements because one of the creditors that are secured, that is secured, does not go along and he files an adversary proceeding.

We suggest that the petitioner took no comparable or analogous action in the bankruptcy court under Rule 701 that is comparable to the state law of North Carolina.

We think that the local law is the law that should be followed in the bankruptcy courts of where the situs of the property is.

That’s where by — should know what the law is and that is what we believe should be applied in this case.

And even if the property had been abandoned that does not automatically give him title or give him a lien on the rents.

That simply is not the North Carolina law and we suggest that abandonment really is immaterial and back up just a minute to from I would say that during the arrangement that was an agent, a disbursing agent.

Now preamble to that, petition to the opponent Simon Joseph Golden, as an agent say that there was only one employee left and that there need to be somebody there to disburse the funds, to collect and disburse funds.

It was not a receiver in any bankruptcy sense.

Thank you, Your Honor.

Warren E. Burger:

Do you have anything further?

J. Steven Brackett:

Your Honor, if I could have just few more moments I want to address my self to —

Warren E. Burger:

You have 2 minutes.

J. Steven Brackett:

Two more minutes, yes sir.

First of all, I would like to address myself to Mr. Justice Stevens’ questions that is I appreciate the fact that he brought to the Court’s attention that this affidavit which takes up a substantial part for perhaps two-thirds on the government’s brief in this case and their argument regarding equity in the property was filed on November the 11.

It was prepared and signed by the trustee on November the 11 and the decision of the district court judge was on November the 12.

I had frankly do not think that was even considered by the District Court Judge and it is a hindsight look at what happened after the petitioner got the property and we argue and contend it should not be considered in any decision of this Court.

Secondly, it is clear from the record in this case that there was no equity in this property.

If that is consideration in the Court, it’s clear that there was no equity.

At the first sale even according to the government’s figures, the deficiency on the petitioner’s debt was substantially more than at the second sale.

Now the trustee would argue that the fact that there was a bankruptcy order involved with that allowing the petitioner to bid in his second deed of trust, chilled a competitive bidding.

In fact, the sale brought more money at the second sale than it did at the first sale.

There was clearly no equity in this case.

I ask that the Court to look at the first meeting of creditors in the appendix where the trustee who is argued to this Court today stated that there was no — in his opinion there was no equity and a property and that it was clear that there was no equity in the property as in December.

The particular arguments I want to address myself, my attention to the Court is that set out on —

Warren E. Burger:

Do that very briefly your time is expiring.

J. Steven Brackett:

Yes sir, pardon me Your Honor.

I like to reiterate Justice Brian’s dissent in the Fourth Circuit regarding continuation of whether it was during or after bankruptcy.

John Paul Stevens:

Can I take five seconds to ask you one question?

J. Steven Brackett:

Yes sir.

John Paul Stevens:

If there has been abandonment what would that have done to the second mortgage indebtedness when you requested it?

J. Steven Brackett:

I think that it would have extinguished the second mortgage.

John Paul Stevens:

Entirely?

J. Steven Brackett:

Yes sir.

John Paul Stevens:

Thank you.

Warren E. Burger:

Thank you gentleman.

The case is submitted.