Unpublished Disposition, 923 F.2d 862 (9th Cir. 1988)

MEMORANDUM^* 

The United States of American appeals from the district court's grant of summary judgment to Hawaii Production Credit Association ("HPCA"). The district court held that an assignment provided to HPCA by Raymond and Shannon Berdon gave HPCA a security interest in the Berdons' property and that the security interest was senior to the Government's tax lien. We reverse the judgment of the district court and remand for further proceedings.

BACKGROUND

HPCA and the Government dispute who has priority in the proceeds of property which formerly belonged to the Berdons. The Berdons obtained a revolving line of credit from HPCA for their farming operations.

On September 18, 1986, the Berdons' credit line was increased to $38,390, and they executed a renewal promissory note and a revolving line of credit agreement. They also executed a document entitled an "Assignment of Rents and Agreement Not to Sell or Encumber Real Property" (the "Assignment").

The Assignment is the focus of this action. The document was " [i]n consideration and as security" for the $38,390 loan and referred to the Berdons' real property. The Assignment then provided the following:

2. Owner hereby assigns to Association: (a) All moneys due and to become due to Owner as rental or otherwise for or on account of such real property, reserving unto Owner the right to collect and retain such moneys prior to Owner's default under the terms of the obligation described above; and (b) all moneys due or to become due to Owner upon the sale of the real property hereinabove described.

3. Owner warrants and represents that Owner owns the above-described real propert [y] and will not create or permit any lien or any encumbrance (other than those previously existing) to exist on said real property and will not transfer, sell, assign or in any manner dispose of said real property or any interest therein without the prior written consent of Association; violation thereof will at the option of the Association, accelerate the maturity of the obligation of the Owner.

The Assignment was recorded on October 14, 1986.

On August 20, 1987, a judgment was entered in favor of Hawaiian Trust Co. and Jack Kubota against the Berdons. The judgment was recorded on September 2, 1987. The Government then recorded several tax liens against the Berdons. On September 18, 1987, the Government recorded a tax deficiency of approximately $25,000, which it had assessed on March 8, 1987. The deficiency represented unpaid employment taxes for 1984 and 1985.

On April 29, 1988, the Berdons' farm was sold and prior mortgages were paid with the proceeds. The remaining proceeds totalled $30,685.27. The funds were deposited with defendant Long & Melone Escrow, Ltd. ("Long & Melone"). On June 29, 1988, the Government recorded another tax lien.

HPCA sued Long & Melone, the Government, and Hawaiian Trust Co. and Jack Kubota in interpleader and for declaratory relief as to distribution of the proceeds. Claims were filed by the Government, Hawaiian Trust Co. and Kubota. Long & Melone deposited the interpleaded funds with the district court.

The Government filed a motion for partial summary judgment and HPCA filed a motion for summary judgment. The Government sought an adjudication that its interest in its first tax lien was senior to HPCA's. The Government asserted that the Assignment did not constitute a security interest protected against the Government's interest, although it apparently conceded the seniority of the lien held by Hawaiian Trust Co. and Kubota. Hawaiian Trust Co. and Kubota joined in the Government's motion.

The district court denied the Government's motion and granted HPCA's motion. In its order the court stated that it "looks to the agreement and finds that it was clearly given as security for the loan." Therefore, "the Assignment would be protected under Hawaii law against a subsequent judgment lien arising out of an unsecured obligation." The Government filed a timely notice of appeal from the district court's judgment. It asserts that its lien of September 18, 1987 has priority over HPCA's lien. Neither Hawaiian Trust Co. nor Kubota appealed.

JURISDICTION AND STANDARD OF REVIEW

The district court had jurisdiction under 28 U.S.C. § 2410. We have jurisdiction under 28 U.S.C. §§ 1291 and 2107.

This court reviews the grant of summary judgment de novo. Kruso v. International Tel. & Tel. Corp., 872 F.2d 1416, 1421 (9th Cir. 1989), cert. denied, --- U.S. ----, 110 S. Ct. 3217, 110 L. Ed. 2d 664 (1990). We review de novo, as an issue of law, whether the Assignment constituted a security interest. Interpool Ltd. v. Char Yigh Marine (Panama) S.A., 890 F.2d 1453, 1460 (9th Cir. 1989).

DISCUSSION

Upon a failure to pay taxes after demand, a tax lien upon the taxpayer's property arises in favor of the Government. 26 U.S.C. § 6321. That lien arises at the time of assessment and does not extinguish until the liability is satisfied or becomes unenforceable due to lapse. 26 U.S.C. § 6322. The lien, however, is not valid "as against any purchaser, holder of a security interest, mechanic's lienor, or judgment lien creditor" until notice of the tax lien has been filed. 26 U.S.C. § 6323(a). A "security interest" is defined as:

any interest in property acquired by contract for the purpose of securing payment or performance of an obligation or indemnifying against loss or liability. A security interest exists at any time (A) if, at such time, the property is in existence and the interest has become protected under local law against a subsequent judgment lien arising out of an unsecured obligation, and (B) to the extent that, at such time, the holder has parted with money or money's worth.

26 U.S.C. § 6323(h) (1). The Government does not dispute that HPCA has parted with "money or money's worth." Thus, the dispute centers on whether the Assignment is "protected under local law against a subsequent judgment lien arising out of an unsecured obligation."

Hawaii courts have not addressed what sort of interest, if any, is created by a negative covenant. Persuasive authority from other jurisdictions, however, supports the conclusion that the Assignment is not a "security interest" under 26 U.S.C. § 6323(h) (1) (A). In California, courts examine the instrument at issue to divine the parties' intent. E.g., Coast Bank v. Minderhout, 61 Cal. 2d 311, 314, 38 Cal. Rptr. 505, 392 P.2d 265 (1964), overruled on other grounds, Wellenkamp v. Bank of America, 21 Cal. 3d 943, 148 Cal. Rptr. 379, 582 P.2d 970 (1978). In Tahoe Nat'l Bank v. Phillips, 4 Cal. 3d 11, 92 Cal. Rptr. 704, 480 P.2d 320 (1971), the California Supreme Court dealt with an assignment similar to the one at issue here. The assignment referred to an underlying obligation, assigned all rents or other amounts due to the borrower, and contained a negative covenant. 4 Cal. 3d at 14 n. 2. The Tahoe Nat'l Bank court rejected the characterization of the assignment as a mortgage. It held that the purpose of the assignment was to provide rents to the creditor and to guarantee that the underlying property remained unencumbered and available for levy. 4 Cal. 3d at 17. The Court also noted that the negative covenant language of the assignment was inconsistent with the purpose of a mortgage, which is to create a senior interest. 4 Cal. 3d at 18-19.

The Court distinguished Coast Bank. In Coast Bank, the narrow issue was whether a negative covenant could possibly be susceptible to interpretation as a security interest. That was because, by failing to deny an allegation that there was a security interest, the defendants had admitted that the negative covenant was intended as security. 61 Cal. 2d at 315. The court noted that the reference to the underlying loan and the restriction of disposition of the property was some indication that the instrument was a security interest. Thus, defendants were bound by their admission. Id.

The Tahoe Nat'l Bank court distinguished the assignment before it from the Coast Bank negative covenant by noting the acceleration clause and statement of purpose in the Coast Bank instrument. Furthermore, the Tahoe Nat'l Bank court distinguished Coast Bank by noting that the property in Coast Bank had been conveyed in violation of the negative covenant and that an equitable mortgage was the only remedy available. 4 Cal. 3d at 21. In addition, Tahoe Nat'l Bank held that there was no possibility that the instrument it was construing could be a mortgage, while Coast Bank only decided that there was some possibility that the instrument it was construing could be.

Other jurisdictions examining the issue have adhered to the rationale of Tahoe Nat'l Bank over that of Coast Bank. See e.g., Equitable Trust Co. v. Imbesi, 287 Md. 249, 412 A.2d 96 (1980) (survey of cases; agreement against conveyance or encumbrance not an equitable lien or mortgage); Hansen v. Five Points Guar. Bank, 362 So. 2d 962 (Fla.Dist.Ct.App.1978) (distinguishing Coast Bank by procedural posture); Weaver v. Tri City Credit Bureau, 27 Ariz.App. 640, 557 P.2d 1072, 1076 (1976) (Coast Bank weakened by Tahoe Nat'l Bank) ; see also Perpetual Fed. Sav. & Loan Ass'n v. Willingham, 296 S.C. 24, 370 S.E.2d 286, 287-88 (1988) (express negative covenant does not create equitable lien, nor does covenant to assign rents and profits confer interest in property itself).

We adhered to the reasoning of Tahoe Nat'l Bank when we decided Browne v. San Luis Obispo Nat'l Bank, 462 F.2d 129 (9th Cir. 1972). We found no evidence of intent to create a power of foreclosure in an assignment virtually identical to the assignment in Tahoe Nat'l Bank. 462 F.2d at 133. We also reached the same conclusion as to a negative pledge agreement in Chase Manhattan Bank, N.A. v. Gems-by-Gordon, Inc., 649 F.2d 710 (9th Cir. 1981). The agreement stated that, in consideration for an underlying loan, the debtors would not mortgage or sell the subject property. Id. at 712. We noted, "Case law in American jurisdictions indicates that property will not be subjected to an equitable mortgage unless the equity court finds that the parties intended to create a legal mortgage but were unsuccessful." Id. at 713. We held that the negative pledge did not evince an intent to create an equitable mortgage. In so doing, we added the observation that, "It is also apparent that American jurisdictions will generally not construe a negative pledge agreement, such as in this case, as evidence establishing that the parties intended to create a legal mortgage." Id.

The same applies here. Neither the transfer of rents and sale proceeds, nor the negative covenant created a security interest, express or equitable, in the underlying property itself. See Weaver, 557 P.2d at 1074-75; see also In re Radice Corp., 88 B.R. 422, 425-26 (Bankr.S.D. Fla. 1988) (security interest in proceeds cannot be created without lien in underlying collateral).

Moreover, the mere presence of an acceleration clause does not change the analysis. See Manatee Fed. Sav. & Loan Ass'n v. Pace, 378 So. 2d 95, 96 (Fla.Dist.Ct.App.1979) (agreement without more does not create an equitable lien; summary judgment reversed and remanded). All that provision did was allow HPCA to take action to protect its loan if the Agreement was breached. Finally, the mere recitation that the Agreement was consideration for the HPCA loan does not create a security interest. See In re Friese, 28 B.R. 953, 955 (Bankr.D. Conn. 1983) (negative covenant, recital of consideration, and acceleration clause do not create security interest).

The district court also observed that, under Hawaii law, it is not necessary that "there must be a conveyance in order for an agreement to constitute a mortgage." However, the cases cited by the district court indicate that the instrument must at least demonstrate an intent to make a grant. In the cases of In re Oahu Ry. & Land Co., 19 Hawaii 544 (1909) and In re Bolte, 18 Hawaii 241 (1907), the Hawaii Supreme Court stated that a conveyance was necessary to create a mortgage. See also Makuakane v. Tanigawa, 50 Hawaii 493, 443 P.2d 153, 155 (1968) ("mortgage usually contains an outright or absolute conveyance to a mortgagee with a defeasance clause"). Particular words of grant are not required, but there must be an intent to convey. There was no intent expressed in the Agreement that would allow this court to hold that an equitable mortgage was created.

In addition, the district court relied upon three cases interpreting Hawaii law. None are controlling. Castle v. Smith, 7 Hawaii 579 (1889) involved a conveyance of stock by a debtor to a creditor. The envelope containing the stock bore an inscription that the stock was "for security" of the creditor. The debtor's representative contended that the conveyance was intended only to pledge dividends for application to the indebtedness. The court held that the writing evinced an intent to pledge the stock. Id. at 580. Castle is distinguishable from the case at hand, because in that case there was a writing which manifested an intent to convey the stock certificates to the creditor.

The second case cited by the district court was Hess v. Paulo, 38 Hawaii 279 (1949). Hess involved a series of transactions. As relevant here, the court held that, in the first transaction, a finance company, as mortgagee, had a lien secured by the mortgagor's automobile. The mortgagee lent funds to the mortgagor in exchange for a bill of sale and an agreement of resale, conditioned upon the mortgagee's retention of title and right to take possession on default. The court gave effect to the parties' intent to create a mortgage. There was no mere negative covenant in the case. Indeed, the transaction had all of the earmarks of a classic mortgage. Id. at 288.

The third case cited by the district court was In re Zales, 77 B.R. 257 (Bankr.D. Haw. 1987). In Zales, the automatic stay was vacated on the bankrupt's residence. A mortgagee, who apparently also held an assignment of rents as part of the mortgage, attempted to foreclose upon the property, to have a receiver appointed, and to collect reasonable rents on the property from the date the debtor filed a petition in bankruptcy. The court held that the mortgagee was not entitled to collect rents because the mortgage did not pass title; rather, the mortgagee had to first obtain possession. The Zales court observed, "Under Hawaii law, an assignment of rents for security purposes do [sic] not convey title but only creates a lien as security for the obligation." Id. at 258. The mortgagee could collect rents from the date the receiver was appointed. Zales therefore stands only for the proposition that an assignee of rents under a mortgage cannot collect those rents until the mortgagee obtains possession of the property. It does not address what constitutes a valid mortgage.

Therefore, HPCA's Assignment does not constitute a security interest. Because it does not, the Government's first tax lien has priority over HPCA's interest.¹ 

In the alternative, HPCA argues that, by its loan and Assignment, it holds a security interest under a "commercial transactions financing agreement" or a "real property construction or improvement financing agreement" pursuant to 26 U.S.C. § 6323(c) (2) and (3). Whatever lien may have been created in later-created proceeds, HPCA has failed to demonstrate that local law gives it priority over a judgment lien filed before its lien came into existence. 26 U.S.C. § 6323(c) (1) (B). HPCA fails to cite any authority to support the proposition that its purported lien on after-created proceeds would become senior to the Government's lien on the land, nor is there any reason to believe that Hawaii would so conclude. That is especially the case when, as here, a sophisticated lender eschewed taking a mortgage on the borrowers' property, and decided, instead, to use a negative covenant and abide the consequences. In short, HPCA's argument is rather circular, because it depends upon an assertion that the Agreement was intended to create a lien upon the land itself which would then be enforced by Hawaii law. As we have already shown, there was no such lien.

CONCLUSION

The negative covenant agreement entered into between HPCA and the Berdons did not give HPCA a mortgage interest in the Berdons' land despite the fact that it did allow HPCA to acquire a lien in the sales proceeds. The latter lien was, however, subsequent in right to that of the Government lien recorded on September 18, 1987.

REVERSED and REMANDED for further proceedings not inconsistent with this decision, including the making of such accounting and disbursement orders as the court deems proper under the circumstances.