                                                                                                                           Opinions of the United
2005 Decisions                                                                                                             States Court of Appeals
                                                                                                                              for the Third Circuit


7-6-2005

Sovereign Bank v. Schwab
Precedential or Non-Precedential: Precedential

Docket No. 03-4625




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                                      PRECEDENTIAL

       UNITED STATES COURT OF APPEALS
            FOR THE THIRD CIRCUIT




                      No. 03-4625


  SOVEREIGN BANK, successor by merger with Main
Street Bank to Heritage National Bank and the Schuylkill
                    Haven Trust Co.,

                             Appellant

                            v.

         WILLIAM G. SCHWAB, Trustee for
          Keith S. Kirby and Kathy A. Kirby




      Appeal from the United States District Court
        for the Middle District of Pennsylvania
                 (D.C. No. 03-cv-01049)
      District Judge: Honorable James M. Munley
                  Argued: January 10, 2005

    Before: ROTH and CHERTOFF * , Circuit Judges,
RESTANI** , Chief Judge, United States Court of International
                          Trade

                    (Filed: July 6, 2005)

        Douglas M. Marinos (Argued)
        Douglas M. Marinos & Associates, P.C.
        101 North Cedar Crest Boulevard
        Allentown, PA 18104
               Counsel for Appellant

        William G. Schwab
        Michelle Wolfe
        Jason Zac Christman (Argued)
        William G. Schwab and Associates
        811 Blakeslee Boulevard Drive East
        P.O. Box 56
        Lehighton, PA 18235
               Counsel for Appellee




   *
      Judge Chertoff heard oral argument in this case but
resigned prior to the time the opinion was filed. The opinion
is filed by a quorum of the panel. 28 U.S.C.§46(d).
   **
      Honorable Jane A. Restani, Chief Judge of the United
States Court of International Trade, sitting by designation.

                              2
                 OPINION OF THE COURT




RESTANI, Judge.

       Sovereign Bank (“the bank”) appeals the district

court’s final order that affirmed the decision of the

bankruptcy court ordering the bank to turn over rents to the

bankruptcy estate. Because we conclude that the rents were

not the property of the bankruptcy estate, we reverse.




I.     Factual and Procedural History

       The bank held mortgages on three rental properties in

Pennsylvania. The mortgages contained assignment of rents

provisions, and gave the bank the right to take possession of




                                3
the properties and collect the rents upon default.1 After the

owners of the properties defaulted, the bank filed a mortgage

foreclosure action and in April 1999, obtained a default

judgment. In September 2000, the bank sent notice to the

properties’ tenants informing them that it would be collecting

their rental payments.2 Later that month, the court of common


   1
       The mortgages specified that

Lender shall have the right, without notice to Grantor, to take
possession of the Property and collect the Rents, including
amounts past due and unpaid, and apply the net proceeds,
over and above Lender’s costs, against the indebtedness. In
furtherance of this right, Lender may require any tenant or
other user of the Property to make payments of rent or use
fees directly to the Lender. . . . Lender may exercise its rights
under this subparagraph either in person, by agent, or through
a receiver.

[App. Vol. 2 at 89, 117, 126].
   2
     Although the Appellee disputes whether the notice letters
sent by the bank were correctly addressed or in fact received
by all tenants, the record contains copies of 13 letters, and the
                                                   (continued...)

                                 4
pleas granted the bank’s petition for preliminary judgment

and appointed the bank as receiver “to take possession, charge

and control of the mortgaged propert[ies].” [Sept. 21, 2000

Order, App. Vol. 2 at 210]. In January 2001, the mortgaged

properties were sold to the bank for cost by the county sheriff.

       In February 2001, the mortgagors filed a Chapter 7

petition and William G. Schwab was appointed as bankruptcy

trustee (“the trustee”). The trustee commenced a bankruptcy

adversary action seeking turnover of the rental funds collected

by the bank in its capacity as receiver. [App. Vol. 2 at

22–24]. In response, the bank filed an answer and a motion

for summary judgment. [App. Vol. 2 at 31–40, 57–63]. The

bankruptcy court found in favor of the trustee, and ordered the

bank to turn over the rents to the bankruptcy estate, as funds

in the hands of a custodian. The court explained that

“because [the bank] took control of th[e] property as a


   2
   (...continued)
bank received tenants’ rental payments. [App. Vol. 2 at
192–208]. Indeed, those rents are at issue here.

                               5
custodian and not the owner . . . the legal interest did not

transfer . . . .” [App. Vol. 2 at 456]. The district court

affirmed the bankruptcy court’s decision. [App. Vol. 1 at

2–6]. The bank now appeals to this court.3

II.       Discussion

          The issue on this appeal is whether rents collected by

the bank are property of the bankruptcy estate. Property of

the bankruptcy estate is defined as “all legal or equitable

interests of the debtor in property as of the commencement of

the case” wherever located by whomever held. 11 U.S.C. §

541(a)(1) (2000). Thus, determining whether the rents here

are the property of the bankruptcy estate requires an inquiry


      3
     We have jurisdiction over this matter pursuant to 28
U.S.C. § 158(d) (2000). Because the district court acted as an
appellate court in reviewing the final order of the bankruptcy
court, our review of its determination is plenary. Manus
Corp. v. NRG Energy, Inc. (In re O’Brien Envtl. Energy,
Inc.), 188 F.3d 116, 122 (3d Cir. 1999). In reviewing the
decision of the bankruptcy court, we exercise the same
standard of review as the district court. Id. Legal
determinations are reviewed de novo. Id. Factual
determinations are reviewed under the clearly erroneous
standard. Fed. R. Bankr. P. 8013.

                                  6
into whether the debtor had any legal or equitable interests in

those rents as of the date of the bankruptcy petition.4

       The bank argues that the debtor’s interest in the rents

was extinguished pre-petition when the owner defaulted and

the bank exercised its rights under the mortgage’s assignment

of rents provision. The trustee, on the other hand, contends

that the debtor maintained an interest in the rents because they

were collected by the bank in its capacity as a receiver.

       We conclude that the debtor had no interest in the rents

when the petition was filed, because (A) the bank took title to

the rents pre-petition, and (B) its subsequent appointment as

receiver did not affect that title. Accordingly, we hold that



   4
     Contrary to the district court’s finding, the “property of
the estate” at issue in this case is not the underlying real
estate, but rather the rental funds it generated. See Complaint
to Require Turnover of Property By Custodian, App. Vol. 2 at
23 (requesting that the bank turn over “rental payments,
security deposits and investment income” representing
property of the estate under § 541). See also 11 U.S.C. §
541(a)(6) (defining property of the estate as “[p]roceeds,
product, offspring, rents, or profits of or from property of the
estate . . .”).

                                7
the rents are not the property of the bankruptcy estate.

       A.     Title to the Rents

       The bank argues that it took the necessary and

appropriate steps to obtain legal title to the rents, thereby

extinguishing the debtor’s interest in the funds. The bank

relies on Commerce Bank v. Mountain View Village, Inc., 5

F.3d 34 (3d Cir. 1993). In that case, we considered the

ownership of assigned rents in bankruptcy under Pennsylvania

law.5 After the owner of rental properties defaulted on a

mortgage, the mortgagee, who held a mortgage containing an

assignment of rents provision, obtained constructive

possession of the properties by sending notice to the tenants

and collecting the rents. The owner then filed for Chapter 11

protection and sought use of the rents. We held that the

mortgagee obtained title to the rents by taking the steps that it


   5
    The property interests of mortgagor and mortgagee are
created and defined by state law. Butner v. United States, 440
U.S. 48, 55 (1979). Pennsylvania follows the title theory
whereby the mortgage is considered a conveyance in fee
simple to the creditor. Commerce Bank, 5 F.3d at 38.

                                8
did, and as a result, the rents were not the property of the

debtor’s estate available for use in its reorganization plan.

Id. at 38.

       The facts in this case are similar to those in Commerce

Bank. The bank held mortgages containing provisions

assigning the rents in the event of default. The owners did

default, and the bank sent notice to the tenants informing

them that it would be collecting their rents. In doing so, the

bank enforced its rights under the mortgage, and obtained

constructive possession of the properties and title to the rents.

See id. at 39; see also Robin Assocs. v. Metro. Bank & Trust

Co. (In re Robin Assocs.), 275 B.R. 218, 221 (Bankr. W.D.

Pa. 2001) (explaining that “under Pennsylvania law, a

mortgagee . . . obtains ownership of assigned rents from the

moment that notice is served by the mortgagee to a

mortgagor’s tenants to commence making rental payments to

the mortgagee”); J.H. Streiker & Co. v. SeSide Co. (In re

SeSide Co.), 152 B.R. 878, 883 (E.D. Pa. 1993) (citations


                                9
omitted) (“The right of a mortgagee to receive rents, even

when the mortgage contains an assignment provision, is

grounded on ‘possession’ of the underlying realty. A

mortgagee can obtain ‘possession’ of realty and consequently

obtain a present right to receive rents . . . by taking

‘constructive possession’ of the realty by serving demand

notices on the mortgagor’s tenants.”). Therefore, when the

debtor filed for bankruptcy protection four months later, it no

longer possessed an interest in the rents.6

       B.      The Bank’s Appointment as Receiver


   6
     The trustee argues that because ownership of the rents
was not previously raised by the bank or addressed by the
lower courts, this court need not address this issue. The
trustee insists that the only relevant issue is whether the bank,
as a custodian, had the duty to turn over the rental funds.
Contrary to the trustee’s assertion, however, this issue was
raised by the bank as an affirmative defense, [App. Vol. 2 at
38–39], and addressed by both the bankruptcy and district
courts. [App. Vol. 2 at 456; App. Vol. 1 at 2–6]. Moreover,
determining whether a custodian must turn over certain
property requires an inquiry into the ownership of the
property. See 11 U.S.C. § 543(b)(1) (requiring a custodian to
“deliver to the trustee any property of the debtor held by or
transferred to such custodian, or proceeds, product, offspring,
rents, or profits of such property . . .”) (emphasis added).

                                10
       The lower courts held, and the trustee argues, that

Commerce Bank is inapplicable to this situation, because

unlike the mortgagee in that case, the bank here sought and

was appointed as receiver of the mortgaged properties. The

trustee asserts that the bank had several options, including

exercising its rights under the assignment of rents provision,

requesting that the court appoint a third party receiver, or

seeking appointment of itself as receiver. In doing the latter,

the trustee contends, the bank became an officer of the court

with a fiduciary duty to turn over the funds to the bankruptcy

trustee.

       A receiver owes a fiduciary duty to the owners of the

property under his care. Under the bankruptcy code, a

receiver is a custodian “that is appointed or authorized to take

charge of property of the debtor . . . for the benefit of the

debtor’s creditors.” 11 U.S.C. § 101(11)(C). Similarly,

courts applying Pennsylvania law have emphasized the

fiduciary responsibility held by a receiver. See Warner v.


                                11
Conn, 32 A.2d 740, 741(Pa. 1943) (citations and quotations

omitted) (explaining that a receiver has the duty “to protect

and preserve, for the benefit of the persons ultimately entitled

to it, an estate over which the court has found it necessary to

extend its care”); Seidler v. Gayville Supply Co., 10 Pa. D. &

C. 200, 201 (Pa. D.&C. 1927) (“A receiver represents not

only the corporation but all its creditors, and, as to the latter, it

is his duty to secure all the assets available for their

payment.”).

         As conceded by the trustee, however, notwithstanding

this fiduciary duty, the requirement to turn over property

under 11 U.S.C. § 543 is triggered only if (1) the custodian

has possession, custody, or control of the property; and (2)

such property is the property of the debtor.7 See Appellee’s


   7
       Section 543(b)(1) specifies that a custodian shall

deliver to the trustee any property of the debtor held by or
transferred to such custodian, or proceeds, product, offspring,
rents, or profits of such property, that is in such custodian’s
possession, custody, or control on the date that such custodian
                                                     (continued...)

                                 12
Counter Statement at 20. In this case, the second prong was

not met. The bank obtained title to the rents before its

receivership appointment.8 As a result, the rental funds were

not the “property of the debtor” required to be turned over by

the bank under § 543(b)(1).

       Furthermore, the trustee’s suggestion that the bank’s

receivership somehow divested it of ownership in the rents, or

transferred title to the estate, is unconvincing. Neither

Pennsylvania nor New Jersey case law supports the trustee’s

position. First, Pennsylvania case law emphasizes that a


   7
   (...continued)
acquires knowledge of the commencement of the case.

11 U.S.C. § 543(b)(1).
   8
     The fact that the bank was appointed as receiver less than
a month after obtaining title to the rents does not mean that it
collected the rents as a custodian. Under Pennsylvania law, a
mortgagee obtains ownership of assigned rents from the
moment that notice is served. See discussion supra Part II.A.
Moreover, once the bank obtained title to the rents, the
owners no longer had an interest in maintaining the
underlying property. As a result, the bank sought to be
appointed as receiver to ensure that the property was properly
managed so as to protect its own financial interests.

                               13
receiver assumes only the interest held by the owner of the

property. See Warner, 32 A.2d at 741 (explaining that a

receiver “takes only the interest of the owner of the property

subject to all valid liens and encumbrances against it”);

Commonwealth Trust Co. v. Harkins, 167 A. 278, 281 (Pa.

1933) (noting that “receivers stand in the shoes of the owner

and take only his interest in the property subject to all valid

liens against it”); Pearson Mfg. Co. v. Pittsburgh Steamboat

Co., 163 A. 680, 682 (Pa. 1932) (explaining that a receiver

takes only the interest of owner of the property). Therefore,

when it was appointed receiver, the bank took only the

debtor’s interest in the property, which no longer included

title to the rents. The appointment did not change the debtor’s

ownership rights.

       In addition, New Jersey case law indicates that a

receivership appointment does not divest a mortgagee’s legal

title to rental funds. In First Fid. Bank, N.A. v. Jason Realty,

L.P. (In re Jason Realty, L.P.), 59 F.3d 423 (3d Cir. 1995), for


                                14
example, after the owner’s default, the mortgagee notified

tenants that it would be collecting the rents pursuant to the

mortgage’s assignment of rents provision. The mortgagee

then filed an application for appointment of receiver and the

owner filed for chapter 11 bankruptcy. We held that, under

New Jersey law, the assigned rents were not property of the

estate, and not available for use in the debtor’s plan. Id. at

429. Under similar facts in MacArthur Executive Assoc. v.

State Farm Life Ins. Co., 190 B.R. 189, 195 (D.N.J. 1995), the

court held that because the mortgagee held title to the rents,

they were no longer property of the bankruptcy estate.

Therefore, once title to rents vests in a mortgagee under New

Jersey law,9 a receivership appointment does not convey that


   9
     Pennsylvania law governs this matter. We discuss New
Jersey law simply because Jason Realty dealt with New Jersey
law. The fact that New Jersey is a lien theory state and
Pennsylvania is a title theory jurisdiction, however, does not
destroy the relevance of these cases. Lien theory states differ
from title theory states in that they “treat a mortgage as
conveying no title to the mortgagee but as creating only the
right to sell the property to satisfy the secured debt in the
                                                    (continued...)

                               15
property back into the debtors’ estate.

       In sum, although the bank—as a receiver—took

possession and control of the mortgaged properties, it did not

obtain any rights to the rents. The bank held title to the rents

by enforcing its rights under the mortgage; it took control of

the real property through its appointment as receiver.




III.   Conclusion

       For the foregoing reasons, we REVERSE the order of

the district court, and REMAND for proceedings consistent

with this opinion.


   9
    (...continued)
event of default . . .” Ann M. Burkhart, Freeing Mortgages of
Merger, 40 Vand. L. Rev. 283, 322 (1987). Thus, once title
has been determined, the distinction between the two theories
becomes moot. What is of note here is that after title vests
under either theory, the appointment of a receiver under the
bankruptcy code does not alter that ownership or expand the
rights of a debtor in the hands of an estate. See United States
v. Whiting Pools, Inc., 462 U.S. 198, 204 n.8 (1983) (“The
legislative history [of §541(a)(1)] indicates that Congress
intended to exclude from the estate property of others in
which the debtor had some minor interest such as a lien or
bare legal title.”).

                               16
