DALE L. SOMERS, Bankruptcy Judge.
The question before the Court is the priority of the mortgage liens on Debtor's fee interest in real property located at 7335 W. 119th Street, Overland Park, KS (hereafter the "Overland Park Property"), which was one of the locations from which Debtor operated a Back Yard Burger restaurant. CEF Funding, L.L.C. (hereafter "CEF") claims a first priority lien by virtue of after acquired property provisions in a ground lease mortgage of the same property. People's Bank (hereafter "Peoples") claims a first priority lien by virtue of a mortgage granted to Peoples by Debtor to secure a loan of funds to purchase the fee interest.
The question of lien priority arose during resolution of CEF's motion for relief from stay to exercise its right under loan documents with the Debtor, including mortgages on four tracts, one of which is the Overland Park Property. Peoples objected to the motion with respect to the Overland Park Property, in which it asserted a mortgage interest. A consent order was approved on the motion for relief providing for the payment of adequate protection as a condition to the stay remaining in place, defining CEF's allowed secured claim, establishing procedures for Debtor's marketing of the Overland Park Property, and establishing a schedule for disposition of the following issues relating to the Overland Park Property:
This opinion addresses the foregoing issues, which have been fully briefed by the parties.
The parties entered into a stipulation of fact for purposes of resolution of the issues before the Court, which is hereby adopted as the Court's findings of fact. The stipulations are as follows:
1. In June, 2001, Black Angus Holdings, LLC (the "Debtor") acquired four existing, operating Back Yard Burger restaurants located in Johnson County, Kansas at the following addresses: (i) 124 N. Clairborne, Olathe, Kansas; (ii) 5959 Barkley, Mission, Kansas; (iii) 7404 Nieman Road, Shawnee, Kansas; and (iv) at 7335 W. 119th Street, Overland Park, Kansas (the "Overland Park Property")(collectively, the "Four Restaurants"). The assets acquired by the Debtor consisted primarily of: (i) leasehold, but not fee ownership, interests in the real estate upon which the Four Restaurants were located; (ii) the buildings and improvements at the Four Restaurants locations; (iii) the furniture, fixtures and equipment at the Four Restaurants locations; (iv) inventories and supplies located at the Four Restaurant locations; and (iv) franchise rights to operate Back Yard Burger restaurants at the Four Restaurants locations.
2. The Debtor's acquisition of the Four Restaurants was accomplished through an Asset Purchase Agreement (the "Asset Purchase Agreement") by and among McNicoll Developments, Inc., as seller of the Four Restaurants, the Debtor, as buyer, and Michael McNicoll as shareholder of the Seller.
3. The Debtor used proceeds of a loan from CEF's predecessor in interest to acquire the Four Restaurants. Specifically, in June 2001, CEF's predecessor in interest loaned Black Angus Holdings, LLC the aggregate principal sum of $2,570,000 (the "CEF Loans").
4. The CEF Loans are evidenced by, inter alia, (i) a Master Loan Agreement (the "Loan Agreement") dated April 23, 2001; (ii) a Promissory Note ("CEF Note 1") dated as of June 19, 2001, in the original principal amount of $990,000.00; (iii) a Promissory Note ("CEF Note 2") dated as of June 20, 2001, in the original principal amount of $1,580,000; and (iv) a Leasehold Mortgage, Security Agreement, Assignment of Leases and Rents, and Fixture Filing (the "CEF Mortgage") dated as of June 19, 2001 and filed of record with the Register of Deeds of Johnson County, Kansas on June 21, 2001 in Book 7109, at Pages 700 et seq.
5. CEF is the holder of CEF Note 1, CEF Note 2 and is the assignee of the CEF Mortgage.
6. The CEF Mortgage was signed and acknowledged by the Debtor and filed in the records of the Register of Deeds of Johnson County, Kansas maintained for the real property described as:
7. As part of the Debtor's acquisition of the Four Restaurants, the Debtor obtained a leasehold interest in the Overland Park Property. Specifically, through an Assignment and Assumption of Lease Agreement dated June 11, 2001, (the "Overland Park Lease Assignment") by and among NTW Incorporated, as assignor, McNicoll Developments, Inc., as landlord, and the Debtor, as assignee, NTW Incorporated assigned all of its right, title, estate and interest in a Lease Agreement (the "Overland Park Lease") for the Overland Park Property.
8. The Overland Park Lease Assignment was recorded in the records of the Register of Deeds of Johnson County, Kansas on June 21, 2001, at Book 7109, Page 680 et seq. The Overland Park Lease Assignment was indexed in the records of the Register of Deeds of Johnson County, Kansas maintained for the real property defined by the Overland Park Property Legal Description.
9. The Overland Park Lease provided the Debtor with the right to lease and use the Overland Park property for a term of years.
10. At all times since June 21, 2001, the CEF Mortgage has remained on file with the Register if Deeds of Johnson County, Kansas and indexed in such records for the real property defined by the Overland Park Property Legal Description. At all times since June 21, 2001, Black Angus Holdings, LLC has owed obligations to the holder of Note 1 and Note 2.
11. Black Angus Holdings, LLC is in default of its obligations under the terms of Note 1, Note 2 and the CEF Mortgage, for, inter alia, failing to make principal and interest payments as and when due. The outstanding principal that is due and owing pursuant to Note 1 is at least $760,549.07. The outstanding principal that is due and owing pursuant to Note 2 is at least $910,693.58.
12. In August, 2005, Peoples Bank loaned the Debtor the principal sum of $240,000 (the "Peoples Bank Loan").
13. The Debtor used the proceeds from the Peoples Bank Loan to acquire a fee ownership interest in the Overland Park Property.
14. The Debtor acquired its fee ownership interest in the Overland Park Property through a Special Corporation Warranty Deed (the "Overland Park Property Deed") dated as of August 15, 2005, made and granted by NTW Incorporated, as the fee owner of the Overland Park Property, to the Debtor as grantee. The Overland Park Property Deed was filed of record with the Register of Deeds of Johnson County, Kansas on August 18, 2005.
15. The Peoples Bank Loan is evidenced by, inter alia: (i) a Promissory Note ("the Peoples Bank Note") dated as of August 15, 2005, in the original principal amount of $240,000.00; and (ii) a Mortgage (the "Peoples Bank Mortgage") dated as of August 12, 2005, and filed of record with the Register of Deeds of Johnson County, Kansas on August 18, 2005.
16. The Peoples Bank Mortgage was signed and acknowledged by the Debtor and filed in the records of the Register of Deeds of Johnson County, Kansas maintained for the real property defined by the Overland Park Property Legal Description.
17. At all times since August 18, 2005, the Peoples Bank Mortgage has remained on file with the Register of Deeds of Johnson County, Kansas and indexed in such records for the real property defined by the Overland Park Property Legal Description. At all times since August 15, 2005, the Debtor has owed obligations to Peoples Bank.
18. The Debtor is in default of its obligations under the terms of Peoples Bank Note and the Peoples Bank Mortgage, for, inter alia, failing to make principal and interest payments as and when due. The outstanding principal that is due and owing pursuant to the Peoples Bank Note is at least $213,723.62.
19. All Exhibits attached hereto are incorporated herein by this reference.
20. With respect to the liens granted pursuant to and by the CEF Mortgage, such liens were validly perfected by the filing of the CEF Mortgage.
21. With respect to the liens granted pursuant to and by the Peoples Bank Mortgage, such liens were validly perfected by the filing of the Peoples Bank Mortgage.
This case concerns the extent and priority of third parties' interests in property of the estate. Since the real property is located in Kansas, the law of Kansas controls.
As to CEF, the only unusual aspect of its lien is the fact that Debtor acquired fee interest after the mortgage was executed.
However, the mortgage clearly expressed intent that any after acquired interest in the fee interest would also be subject to the mortgage. The recitals on page one of the mortgage describe the property mortgaged to include all of Debtor's right, title and interest in the Overland Park Property "now owned or hereafter acquired." The terms of mortgage preclude merger of the leasehold estate and the fee interest, if the later is acquired, and provide "if Borrower shall acquire such fee estate [covered by the Ground Lease], then this instrument shall simultaneously and without further action be spread so as to become a lien on such fee interest." Exhibit A to the mortgage, describing the real property subject to the mortgage, states:
Hence, CEF's mortgage provided that the fee interest in the Overland Park Property would be subject to the mortgage lien, if Debtor acquired that interest, which debtor did in August 2005.
Mortgages routinely apply to after acquired property through the doctrines of accessions and fixtures.
Peoples does not challenge CEF's position that its June 2001 mortgage is effective to effect a conveyance of a lien on the after acquired fee interest and the recording of the June 2001 mortgage perfected that interest. This Court has no doubt that the Kansas Supreme Court would find that CEF's mortgage lien, perfected by the recording on June 21, 2001,
As to Peoples, the 2005 mortgage granted a lien in the Overland Park Property, "[t]ogether with all rights, easements, appurtances, royalties, mineral rights, oil and gas rights, crops, timber, all diversion payments or third party payments made to crop producers and all existing and future improvements, structures, fixtures, and replacement that may now, or at any time in the future, be part of the real estate described." Peoples was thus granted a lien in all of Debtor's real property interests
The dispute in this case is over the priority of the liens in Debtor's fee interest in the Overland Park Property. CEF claims a first priority lien under the first to file rule,
The general rule, which is followed in Kansas,
The Restatement of Property, which the Kansas Court of Appeals has found to be consistent with Kansas law,
The comments to the restatement state that the rule is "justified on grounds of fundamental fairness."
In Kansas, there is no statute addressing the general principle of priority of purchase money mortgages. However the piecemeal legislation which exists give preference to purchase money interests. The only statute cited by the parties is K.S.A. 58-2305, which provides: "A mortgage given by a purchaser to secure the payment of purchase money shall have preference over a prior judgment against such purchaser." A Kansas homestead is not "exempt from sale for payment of obligations contracted for the purchase thereof,"
The Kansas appellate courts recognize the general rule of priority of purchase money mortgages over other liens attaching through the mortgagor. The Kansas Supreme Court in 1915 stated:
The Kansas Court of Appeals in a 2008 case quoted with favor the following from an unpublished Court of Appeals opinion:
The rationale for the superior status is that the purchase money mortgagor is not regarded as obtaining title to the property and then executing a mortgage; rather he acquires the property already subject to the encumbrance in favor of the purchase money lender.
Litigation of priority issues between conflicting purchase money mortgages and other liens therefore usually pose the question whether there are statutes or other considerations which defeat the special status of the purchase money lien and elevate the priority of the non-purchase money lien. For example, in American General Financial Services,
The question in this case is whether the circumstances of CEF's leasehold mortgage caused Peoples' purchase money lien to lose its priority. If there is a special circumstance here, it must be because the
The fact that the CEF mortgage was recorded first does not cause the later recorded purchase money lien to lose its priority. Purchase money priority is an exception to general rule of priority based upon the time of recording. In fact, the Kansas Supreme Court has held that a purchase money mortgage retains its higher priority even if it is recorded after a second non-purchase money mortgage on the same property.
The Court rejects any suggestion by CEF that its lien on the after-acquired fee interest attached at the time the mortgage was executed rather at the time the fee interest was acquired, thereby giving it priority under the first to file rule. CEF's mortgage identifies the interest as property to be acquired to which the mortgage will spread. Unlike the Chapman case, Debtor's leasehold mortgage did not grant a lien in an option to purchase, which the California court found was itself a real property interest. The CEF mortgage did not grant a lien in a present fee interest; the mortgage included an agreement that an after-acquired property interest would also be subject to the mortgage lien. At the time of the mortgage, Debtor had no interest in the fee simple interest to which the mortgage could attach. CEF provides no authority to support the proposition that the priority of a lien on after acquired property relates back to the date of the recording of the initial mortgage instrument.
CEF also argues purchase money lien priority is limited to a conflict with a judgment lien against the mortgagor's interest. It urges that the Kansas Legislature in K.S.A. 58-2305 specifically chose to limit the priority to judgment liens and if it intended to grant purchase money liens priority over other conflicting interests it would have enacted explicit legislation. The Court rejects this argument as inconsistent with Kansas case law. The statute giving purchase money liens over judgment liens has been in effect since 1868.
The Court therefore concludes that the Kansas Supreme Court would hold that Peoples' mortgage lien securing funds loaned to purchase the Debtor's fee interest in the Overland Park Property is prior to CEF's lien arising under its ground lease mortgage. Even though earlier filed, CEF's mortgage lien on the fee interest is of lower priority. Peoples' priority, however, is limited to the fee interest and does not extend to the improvements, rents, and other real property interests conveyed by the Peoples' mortgage which were not purchased with funds advanced by Peoples. The Court finds this to be a just and equitable result. Peoples advanced the funds which made Debtors' purchase of the fee possible and it relied upon getting paid from that interest. Without Peoples' advance to the Debtor, CEF would have no lien on the fee interest. CEF's predecessor did not rely upon the value of the fee when entering into the transaction; if CEF were to have a first priority lien it would be given a windfall at the expense of Peoples.
For the foregoing reasons the Court finds:
1. CEF holds a valid and perfected mortgage lien and security interest upon Debtor's interests in the Overland Park Property.
3. Peoples Bank holds a valid and perfected mortgage lien and security interest upon Debtor's interests in the Overland Park Property.
4. Peoples Bank's lien in the Overland Park Property is of lower priority than the lien of CEF as to all interests subject to the lien except the fee interest in the Overland Park Property which was acquired with the proceeds of Peoples Bank's 2005 loan.
The foregoing constitute Findings of Fact and Conclusions of Law under Rules 7052 and 9014(c) of the Federal Rules of Bankruptcy Procedure which make Rule 52(a) of the Federal Rules of Civil Procedure applicable to this matter.