ROBERT E. GRANT, Bankruptcy Judge.
This matter is before the court following the trial of the issues raised by the debtor's motion, filed pursuant to 11 U.S.C. § 543, for turnover from a custodian and Travelers Insurance Company's objection thereto, as well as Travelers' motion to dismiss this case.
Debtor is the owner of an upscale apartment complex in Fort Wayne, Indiana. The property is encumbered by a mortgage in favor of Travelers which secures payment of a debt that, as of the date of the petition, was in excess of $14,000,000.00. Travelers also holds an "assignment of leases and collateral assignment of rents" with regard to this property. Prior to the date of the petition, Travelers declared debtor in default and initiated proceedings to foreclose its mortgage. In doing so, it also requested and received an order appointing a receiver to take possession of the property. On March 31, 1993, debtor filed a voluntary petition for relief under Chapter 11.
Although both motions ultimately turn upon the same issue, the moving party in each bears the burden of proof. Travelers bears the burden of showing cause to dismiss this case under 11 U.S.C. § 1112(b). In re Klein, 100 B.R. 1004, 1008 (D.N.D.Ill. 1989); Matter of Berryhill, 127 B.R. 427, 430 (Bankr.N.D.Ind.1991). In the turnover proceeding, on the other hand, the moving party bears the burden of proving:
Therefore, the debtor bears the initial burden on these two points. In re Redman Oil Co., 95 B.R. 516, 521 (Bankr.S.D.Ohio 1988), aff'd on reh'g, 100 B.R. 945 (Bankr. S.D.Ohio 1989). Once it has presented a
The parties agree that the resolution of the issues presented by debtor's motion for turnover and Travelers' motion to dismiss turns primarily upon the question of who is entitled to possession of the rents generated by the apartment complex. Travelers contends that those rents do not constitute property of the bankruptcy estate, while the debtor contends they do.
Property of the bankruptcy estate is defined by § 541(a) of the United States Bankruptcy Code. The estate is comprised of "all legal or equitable interests of the debtor in property as of the commencement of the case" wherever located and by whomever held. 11 U.S.C. § 541(a)(1). A determination that the rents in question are not property of the estate requires the court to conclude that the debtor had no legal or equitable interest in those rents as of the date of the petition.
The starting point for any analysis of the competing rights of debtors and creditors is state law. Bankruptcy begins with these state law entitlements and then adjusts them in order to equitably distribute the assets of the estate and provide relief to the debtor.
Consequently, this court must begin by analyzing the relative rights of the debtor and Travelers as they would otherwise exist under Indiana law and then determine whether federal law has altered those rights.
Travelers bases its argument that the rents are not property of the estate upon the rights it exercised under an "Assignment of Leases and Collateral Assignment of Rents" it received from the debtor on March 24, 1988 and which was recorded with the Allen County Recorder on the next day. Reduced to its essence, this rather lengthy document reads:
The debtor defaulted in the performance of its obligation to Travelers under the note and mortgage prior to March 29, 1993. On that date, Travelers initiated proceedings with the Allen Superior Court in order to foreclose its mortgage upon the apartment complex. In doing so, pursuant to the authority granted by the note and mortgage and in accordance with Indiana law, it requested and received, without notice, an order appointing Revel Companies, Inc. as a receiver in order to "take possession of [the apartment complex] manage same and collect the rents therefrom, all until further order of the court." (Travelers' Exhibit "3"). This order also directed the debtor to "surrender possession of and management of the property to the receiver. . . ." Id. The appointment became effective the next day, when Travelers posted the bond required by the state court. Debtor's petition for relief under Chapter 11 was filed on March 31, 1993, after the receiver went into possession of the property in question.
Given what transpired prior to the date of the petition, the court is required to determine whether the appointment of a receiver, debtor's default, the assignment of rents, and/or Travelers' exercise of its rights thereunder terminated debtor's interest in the rents and other income generated by the mortgaged property.
As a matter of Indiana law, the appointment of a receiver does not effect title to the property over which the receiver is given authority.
The purpose of a receiver is "to preserve the property pending its final disposition." Johnson v. LaPorte Bank & Trust Co., 470 N.E.2d 350, 353 (Ind.App.1984). Thus, the receiver only "holds possession of the property for the benefit of the party or parties ultimately determined to be entitled thereto. His custody is considered to be the custody of the court." Parfenoff v. Kozlowski, 218 Ind. 154, 161, 31 N.E.2d 206, 208 (1941).
As a result, Travelers' success in securing the appointment of a receiver over the apartment complex did not terminate debtor's ownership of the property or the rents it generated. That appointment did nothing more than deprive debtor of its statutory right to possession of the property,
A separate issue is the effect of the debtor's execution of the assignment of rents in favor of Travelers, especially in light of debtor's default in the performance of its obligation to pay Travelers and Travelers' subsequent exercise of its rights under that assignment as a result of that default. It is, unfortunately, an issue on which Indiana law offers little direct guidance because decisional authority concerning the effect of an assignment of rents, such as the one before the court, or the exercise of a creditor's rights thereunder is almost nonexistent. Nonetheless, there are certain fundamental principles which both the courts and the legislature of Indiana have recognized which would appear to be applicable. Primary among them is the principle that the court should give effect to the substance of a transaction rather than its form. Where personal property and interests therein are concerned, the Indiana Legislature has specifically codified this rule in Article 9 of the U.C.C. See I.C. 26-1-9-102 ("I.C. 26-1-9 applies . . . [t]o any transaction (regardless of its form) which is intended to create a security interest in personal property. . . ."). Where interests in real property are concerned, the Indiana courts have come to the same conclusion.
"There is no principle in equity better settled than that every contract for the security of a debt, by conveyance of real estate, is a mortgage. . . ." Turpie v. Lowe, 114 Ind. 37, 15 N.E. 834, 841 (1888). "In equity, if a transaction resolves itself into a security, or an offer to pledge land as a security for a debt or liability it is treated as a mortgage without regard to the form it may assume." Singer v. Burcham, 140 Ind.App. 378, 383, 216 N.E.2d 532, 536 (1966).
Thus, Indiana law gives effect to the intention of the parties and is not controlled by the either the form of the transaction or the names given to the instruments used. Brenneman Mechanical & Electrical, Inc. v. The First Nat'l Bank of Logansport, 495 N.E.2d 233, 238-39 (Ind.App.1986). "No matter what form the transaction may assume, if it appear that the instrument was executed to secure a subsisting debt, it will be adjudged a mortgage." Hanlon v. Doherty, 109 Ind. 37, 9 N.E. 782, 782-83 (1887). This principle is of such importance that, in the case of doubt, the transaction is to be construed as a mortgage. Kerfoot, 227 Ind. at 79, 84 N.E.2d at 199; Singer, 140 Ind.App. at 383-84, 216 N.E.2d at 536.
The question of whether an instrument constitutes a mortgage or an absolute conveyance "depends . . . upon the intention of the parties at the time of its execution." Barber v. Barber, 117 Ind.App. 156, 160, 70 N.E.2d 185, 187 (1946). While parole or extrinsic evidence is admissible to prove that an apparently absolute conveyance is, in reality, a mortgage, Brown v. Follette, 155 Ind. 316, 58 N.E. 197, 199 (1900); Dorweiler v. Rosebush-Sinks, 128 Ind.App. 532, 551-53, 148 N.E.2d 570, 580-81 (1958); Barber, 117 Ind.App. at 160-61, 70 N.E.2d at 187, if the document or documents memorializing the transaction reveal that a mortgage was intended, parole evidence should not be received to prove otherwise. Voss v. Eller, 109 Ind. 260, 10 N.E. 74, 76 (1887).
There is absolutely no reason this court can identify which would indicate that the Indiana courts would not apply these same fundamental principles to an assignment of rents, in connection with determining whether such an agreement constitutes an absolute conveyance or a lien.
When these principles are applied to the agreement between Travelers and the debtor, it is clear, beyond any doubt or debate, that the assignment of rents was intended to be nothing more than a security device. By its very terms, that assignment states that it was made for the purpose of securing a contemporaneously executed note. Furthermore, upon full payment of the note, the conveyance would be defeated because the assignment provided that it was to become void. Under these circumstances, nothing more is required to prove that there was no absolute conveyance to Travelers.
The events that took place following the execution of the assignment of rents did not change its original character as a security device. Indiana follows the simple rule that "[o]nce a mortgage, always a mortgage. . . ." Doyle v. Ringo, 180 Ind. 348, 102 N.E. 18, 20 (1913).
As a matter of Indiana law, the assignment of rents given to Travelers constituted nothing more than a security device. Its original character was not changed by debtor's subsequent default or Travelers' exercise of its right to proceed against its security. Despite the exercise of those rights, debtor remained the owner of the rents. Even the appointment of the receiver by the state court did not terminate debtor's interest as owner. All that changed was the right to possession. Thus, as of the date of the petition, the rents generated by the apartment complex constituted property of the bankruptcy estate, despite the fact that, under state law, the receiver had the right to possession of both the rents and the underlying real estate.
As of the date of the petition, the right to possess both the mortgaged property and the income it produced was in the state court receiver, not the debtor. This, however, is only the first part of the analysis required by Butner. The court must also determine whether federal law has altered those rights. Fortunately, determining whether 11 U.S.C. § 543 alters the rights of the parties as they would otherwise exist under state law is a question more easily answered than determining what those underlying rights might be. Both the Bankruptcy Code and the Supreme Court have explicitly addressed the issue.
A state court receiver constitutes a custodian. 11 U.S.C. § 101(11). Pursuant to § 543 of the Bankruptcy Code:
The Supreme Court has specifically recognized that this portion of the Bankruptcy Code, in conjunction with § 541, "bring[s] into the estate property in which the debtor did not have a possessory interest at the time the bankruptcy proceedings commenced." United States v. Whiting Pools, Inc., 462 U.S. 198, 205 & n. 10, 103 S.Ct. 2309, 2313 & n. 10, 76 L.Ed.2d 515 (1983).
In Whiting Pools the Supreme Court was called upon to decide whether a Chapter 11 debtor could compel the turnover, pursuant to 11 U.S.C. § 542, of property that had been seized by a secured creditor prior to the petition. In answering the question, the Court readily determined that the property in question constituted property of the estate, notwithstanding the prepetition seizure. Whiting Pools, 462 U.S. at 202-09, 103 S.Ct. at 2312-15. In concluding that the turnover order was properly granted the Court stated:
The Court then concluded:
The Court's comments and conclusions in Whiting Pools are equally applicable to the case at hand. Although this court is confronted with turnover from a custodian, pursuant to § 543, rather than § 542, the two cases are functionally identical. The only distinction is that rather than taking possession of the secured property directly, Travelers did so through a state court receiver.
Travelers contends that the Seventh Circuit's decision in Matter of Century Investment Fund VIII, L.P., 937 F.2d 371 (7th Cir.1991) mandates a different result. The court disagrees. To the extent Travelers argues that the Seventh Circuit concluded that a creditor's pre-petition efforts to perfect a lien upon rents and to obtain the appointment of a receiver resulted in the property being excluded from the estate as a matter of federal bankruptcy law, that interpretation of the decision cannot withstand scrutiny. Such a construction would place the Seventh Circuit in conflict with the Supreme Court's decision in Whiting Pools, something this court doubts the Seventh Circuit intended. To the extent the Seventh Circuit may have held that the property in question was not property of the estate, it did so on the basis of Wisconsin law. If this was its conclusion, this court perceives Wisconsin law to be very different from the Indiana law which governs the matter now before us. More importantly, however, when the Century Investment decision is properly understood, in the context of the proceedings which took place before both the Bankruptcy Court and the District Court, this court's decision concerning turnover is entirely consistent with it.
In Century Investment, the Seventh Circuit reversed the District Court's decision and remanded the matter "with instructions to reinstate the [order of the Bankruptcy Court]." Century Investment, 937 F.2d at 380. The issue in dispute before the courts below was not whether rents from leased property were excluded from the bankruptcy estate but only whether or not those rents were cash collateral. See In re Century Investment Fund VIII, L.P., 155 B.R. 1002, 1003 (Bankr.E.D.Wis. 1989); In re Century Investment Fund VIII, L.P., No. 89-C-380, 1990 U.S.Dist. Lexis 8128, at
By reversing the District Court and reinstating the Bankruptcy Court's order, the Seventh Circuit effectively concluded that the rents in question were property of the estate; albeit property encumbered by a lien in favor of the bank and, therefore, cash collateral. This conclusion is precisely the result this court has reached in its analysis of the competing rights of the debtor and Travelers to the rents in issue.
Travelers has also failed to carry its burden of proving that this case should be dismissed. In support of its motion, it argues that debtor's petition constitutes a bad faith filing, when measured by the standards articulated by the district court in Matter of Grieshop, 63 B.R. 657, 663 (D.N.D.Ind.1986). What Travelers fails to appreciate, however, is that those factors are to be balanced in determining the presence or absence of a debtor's good faith in seeking bankruptcy relief; they are not to be applied mechanically. See Matter of Elmwood Development Co., 964 F.2d 508, 510 (5th Cir.1992); In re Clause Enterprises of Ft. Myers, Ltd., 150 B.R. 476, 478-79 (Bankr.M.D.Fla.1993); In re Don Sellers Village Lanes, Inc., 121 B.R. 649, 652 (Bankr.M.D.Fla.1990); In re MGN Co., III, 116 B.R. 654, 658 (Bankr.S.D.Ind.1989); In re Marion Street Partnership, 108 B.R. 218, 223 (Bankr.D.Minn.1989); In re Clinton Centrifuge, Inc., 72 B.R. 900, 905 (Bankr.E.D.Pa.1987). Indeed, the mechanical approach which Travelers apparently urges us to follow would automatically doom almost every single asset case, ab initio.
When the Grieshop factors are properly applied and balanced, Travelers has failed to carry its burden of proving that this case has been filed in bad faith. Quite to the contrary, when the evidence presented is properly weighed and balanced, it is the court's conclusion that Willows' petition represents a good faith effort to attempt to reorganize its financial affairs, in accordance with the spirit and the purpose of the Bankruptcy Code.
Debtor's motion for turnover will be granted and Travelers' motion to dismiss will be denied. An appropriate order will be entered.