In re: Michael W. Endresen and Joanne Maureen Endresen

548 B.R. 258

• Court: United States Bankruptcy Appellate Panel for the Ninth Circuit
• Decided: April 8, 2016
• Docket: OR-15-1141-KiFJu OR-15-1190-KiFJu
• Status: Published

Opinion

FILED APR 08 2016 1 SUSAN M. SPRAUL, CLERK U.S. BKCY. APP. PANEL 2 ORDERED PUBLISHED OF THE NINTH CIRCUIT

3 UNITED STATES BANKRUPTCY APPELLATE PANEL 4 OF THE NINTH CIRCUIT 5 In re: ) BAP Nos. OR-15-1141-KiFJu ) OR-15-1190-KiFJu 6 MICHAEL W. ENDRESEN and ) (cross-appeals) JOANNE MAUREEN ENDRESEN, ) 7 ) Bk. No. 11-35396-RLD Debtors. ) 8 ) Adv. No. 14-3131-RLD ) 9 STEPHEN P. ARNOT, Chapter 7 ) Trustee, ) 10 ) Appellant, ) 11 ) v. ) O P I N I O N 12 ) MICHAEL W. ENDRESEN; JOANNE ) 13 MAUREEN ENDRESEN; GREEN TREE ) SERVICING, LLC; THE BANK OF ) 14 NEW YORK MELLON, f/k/a THE ) BANK OF NEW YORK, as Trustee ) 15 for the Holders of First ) Horizon Mortgage Pass–Through ) 16 Certificates, Series FHAMS ) 2004–AA7; THE BANK OF NEW ) 17 YORK MELLON, as Successor to ) JPMorgan Chase Bank, as ) 18 Trustee for the Holders of ) Bear Stearns Alt–A Trust ) 19 2005–1 Mortgage Pass–Through ) Certificates, Series 2005–1; ) 20 THE BANK OF NEW YORK MELLON, ) f/k/a THE BANK OF NEW YORK, ) 21 as Trustee for the Holders of ) American Home Mortgage ) 22 Investment Trust 2004–4; U.S. ) BANK, NATIONAL ASSOCIATION, ) 23 as Trustee for Adjustable ) Rate Mortgage Trust 2005–2, ) 24 Adjustable Rate Mortgage– ) Backed Pass–Through ) 25 Certificates, Series 2005–2, ) ) 26 Appellees. ) _____________________________ ) 27 28 Argued and Submitted on March 17, 2016, 1 at Pasadena, California 2 Filed - April 8, 2016 3 Appeal from the United States Bankruptcy Court for the District of Oregon 4 Honorable Randall L. Dunn, Bankruptcy Judge, Presiding 5 6 Appearances: David A. Foraker of Greene & Markley, P.C. argued for appellant/cross-appellee Stephen P. Arnot, 7 Chapter 7 Trustee; Michael R. Blaskowsky of Columbia River Law Group argued for 8 appellees/cross-appellants Michael and Joanne Endresen; and David Elkanich of Holland & Knight 9 LLP argued for appellee Bank of New York Mellon. 10 11 Before: KIRSCHER, FARIS and JURY, Bankruptcy Judges. 12 13 KIRSCHER, Bankruptcy Judge: 14 15 Stephen P. Arnot, chapter 71 trustee, appeals a judgment 16 determining that appellees Green Tree Servicing, LLC; The Bank of 17 New York Mellon, f/k/a The Bank of New York, as Trustee for the 18 Holders of First Horizon Mortgage Pass–Through Certificates, 19 Series FHAMS 2004–AA7; The Bank of New York Mellon, as Successor 20 to JPMorgan Chase Bank, as Trustee for the Holders of Bear Stearns 21 Alt–A Trust 2005–1 Mortgage Pass–Through Certificates, Series 22 2005–1; and The Bank of New York Mellon, f/k/a The Bank of New 23 York, as Trustee for the Holders of American Home Mortgage 24 Investment Trust 2004–4 (collectively, “Lenders”) were entitled to 25 settlement funds awarded to debtors Michael and Joanne Endresen in 26 1 Unless specified otherwise, all chapter, code and rule 27 references are to the Bankruptcy Code, 11 U.S.C. §§ 101-1532, and the Federal Rules of Bankruptcy Procedure, Rules 1001-9037. The 28 Federal Rules of Civil Procedure are referred to as “Civil Rules.”

-2- 1 connection with construction defect claims the couple litigated in 2 state court nearly two years after their chapter 7 bankruptcy case 3 had closed. Debtors cross-appeal the bankruptcy court’s decision 4 to award a portion of the settlement funds to Trustee and not to 5 lender U.S. Bank, N.A., which failed to appear in the case. We 6 AFFIRM as to the bankruptcy court’s determination that the 7 settlement funds were part of Lenders’ collateral and REVERSE as 8 to the bankruptcy court’s award of U.S. Bank’s share of the 9 settlement funds to Trustee. 10 I. FACTUAL BACKGROUND AND PROCEDURAL HISTORY 11 A. Prepetition events 12 The facts are not in dispute. In 2004, Debtors purchased ten 13 rowhomes in Portland, Oregon for the purpose of producing rental 14 income (the “Properties”). To purchase the Properties, Debtors 15 obtained several loans from the Lenders2 which were secured by 16 deeds of trust (“Trust Deeds”) recorded on each of the Properties 17 in November 2004. Each of the Trust Deeds is modeled after the 18 Fannie Mae/Freddie Mac Uniform Instrument with MERS for an Oregon 19 Single Family Residence, identified as Form 3038 1/01. The 20 provisions relevant to these appeals are identical in each Trust 21 Deed. Specifically, among the defined terms is “Miscellaneous 22 Proceeds:” 23 (N) Miscellaneous Proceeds means any compensation, settlement, award of damages, or proceeds paid by any 24 third party (other than insurance proceeds paid under the coverages described in Section 5) for: (i) damage to, or 25 destruction of, the Property; (ii) condemnation or other taking of all or any part of the Property; 26 27 2 Lenders either originated the loans made to Debtors or acquired their claims by assignment. No one has questioned the 28 validity of these assignments.

-3- 1 (iii) conveyance in lieu of condemnation; or (iv) misrepresentations of, or omissions as to, the value 2 and/or condition of the Property. 3 Section 11 of each Trust Deed, entitled “Assignment of 4 Miscellaneous Proceeds; Forfeiture,” provides in relevant part: 5 All Miscellaneous Proceeds are hereby assigned to and shall be paid to Lender. 6 If the Property is damaged, such Miscellaneous Proceeds 7 shall be applied to restoration or repair of the Property, if the restoration or repair is economically 8 feasible and Lender’s security is not lessened. During such repair and restoration period, Lender shall have 9 the right to hold such Miscellaneous Proceeds until Lender has had an opportunity to inspect such Property 10 to ensure the work has been completed to Lender’s satisfaction, provided that such inspection shall be 11 undertaken promptly. Lender may pay for the repairs and restoration in a single disbursement or in a series 12 of progress payments as the work is completed. Unless an agreement is made in writing or Applicable Law 13 requires interest to be paid on such Miscellaneous Proceeds, Lender shall not be required to pay Borrower 14 any interest or earnings on such Miscellaneous Proceeds. If the restoration or repair is not 15 economically feasible or Lender’s security would be lessened, the Miscellaneous Proceeds shall be applied 16 to the sums secured by this Security Instrument, whether or not then due, with the excess, if any, paid 17 to Borrower. Such Miscellaneous Proceeds shall be applied in the order provided for in Section 2. 18 In the event of a total taking, destruction, or loss in 19 value of the Property, the Miscellaneous Proceeds shall be applied to the sums secured by this Security 20 Instrument, whether or not then due, with the excess, if any, paid to Borrower. 21 22 Unbeknownst to either Debtors or Lenders, the Properties had 23 defects in their construction that resulted in significant water 24 and mold damage. 25 B. Postpetition events 26 Debtors filed their chapter 7 bankruptcy case on June 21, 27 2011. On October 17, 2011, Debtors received their discharge and 28 the case was closed as a “no asset” case.

-4- 1 On November 9, 2011, Debtors filed a chapter 13 petition. 2 The claims of the Lenders are provided for in Debtors’ confirmed 3 chapter 13 plan and remain unsatisfied. 4 In May 2013, Debtors were added as co-plaintiffs in a civil 5 action pending against the builder of the rowhomes in Oregon state 6 court. The plaintiffs alleged that the Properties, built in 2003, 7 were negligently constructed and that the construction defects in 8 the Properties and related damage were discovered in 2012 after a 9 consultant’s evaluation. 10 The bankruptcy court reopened Debtors’ chapter 7 bankruptcy 11 case on February 3, 2014. On that same date, Debtors’ part of the 12 state court action for the construction defect claims was settled 13 for $318,200. The bankruptcy court entered an order approving the 14 settlement. After payment of attorney’s fees and costs, the 15 balance of the proceeds to Debtors was $185,525.47 (“Settlement 16 Proceeds”). The Settlement Proceeds are being held in trust by 17 Debtors’ state court attorney pending the outcome of this appeal. 18 1. Trustee’s adversary complaint and the cross-motions for summary judgment 19 20 Trustee sought a determination that Lenders had no 21 enforceable security interests in the Settlement Proceeds.3 22 Trustee contended that the description of Lenders’ personal 23 property collateral in the definition of “Miscellaneous Proceeds” 24 in the Trust Deeds did not reasonably identify the construction 25 26 3 Trustee also contended that the Settlement Proceeds were property of the estate, which Debtors and Lenders opposed. 27 Ultimately, the bankruptcy court agreed with Trustee, granting him summary judgment on that issue. Because no party has appealed 28 that ruling, we do not address it or discuss it any further.

-5- 1 defect claims and, for that reason, the Trust Deeds did not create 2 an enforceable security interest in those claims or the derived 3 Settlement Proceeds. Alternatively, Trustee argued that even if 4 the description in the Trust Deeds reasonably identified the 5 construction defect claims as collateral, Lenders had no 6 enforceable security interest in the Settlement Proceeds because 7 (1) the construction defect claims were commercial tort claims 8 that did not exist when Debtors executed the Trust Deeds, (2) 9 under Oregon law, an after-acquired property clause in a security 10 agreement is ineffective to create an enforceable security 11 interest in a commercial tort claim that is after-acquired 12 collateral, and (3) the Settlement Proceeds were proceeds of, or a 13 right arising out of, these commercial tort claims. 14 Debtors and Lenders (except for U.S. Bank) filed answers 15 denying Trustee’s claims, contending that the Trust Deeds gave 16 Lenders an enforceable interest in the Settlement Proceeds, which 17 was superior to Trustee’s interest. Despite being properly served 18 with the complaint, lender U.S. Bank did not respond to Trustee’s 19 amended complaint, and a default order was entered. 20 Trustee then moved for summary judgment. He contended that 21 the Uniform Commercial Code (“UCC”), as adopted in Oregon, 22 determined the validity and scope of the security interest granted 23 by Debtors in their personal property under the Trust Deeds. 24 Trustee argued that because the definition of Miscellaneous 25 Proceeds in the Trust Deeds did not identify the Settlement 26 Proceeds sufficiently to create an enforceable security interest 27 in them and because the Settlement Proceeds were derived from 28 commercial tort claims (the construction defect claims), the tort

-6- 1 claims and derived proceeds constituted “after-acquired” property 2 of the estate. Accordingly, the Settlement Proceeds were 3 “property acquired by the estate . . . after the commencement of 4 the case” as that phrase is used in § 552(a).4 Trustee argued 5 that Lenders’ Article 9 security interests, if any, were not 6 created until after Debtors filed their chapter 7 petition. 7 Therefore, their purported interests did not “attach” — and thus 8 could not have become enforceable against Debtors — until Debtors 9 collected the Settlement Proceeds postpetition. Thus, argued 10 Trustee, Lenders’ security interest in the Settlement Proceeds, 11 even if otherwise enforceable under Oregon law, did not attach 12 until “after the commencement of the case.” Consequently, the 13 Settlement Proceeds were “not subject to any lien resulting from” 14 the prepetition Trust Deeds within the meaning of § 552(a). 15 Debtors and Lenders opposed Trustee’s motion and filed cross- 16 motions for summary judgment. Lenders contended they had a 17 continuing security interest in the Settlement Proceeds under 18 § 552(b)(1)5 because they were “proceeds” of the original, damaged 19 4 20 Section 552(a) provides: 21 Except as provided in subsection (b) of this section, property acquired by the estate or by the debtor after the 22 commencement of the case is not subject to any lien resulting from any security agreement entered into by the debtor before 23 the commencement of the case. 5 24 Section 552(b)(1) provides, in relevant part: 25 [I]f the debtor and an entity entered into a security agreement before the commencement of the case and if the 26 security interest created by such security agreement extends to property of the debtor acquired before the commencement of 27 the case and to proceeds, products, offspring, or profits of such property, then such security interest extends to such 28 (continued...)

-7- 1 collateral. Lenders maintained that the Settlement Proceeds fell 2 within the definition of “proceeds” under Oregon Revised Statutes 3 § 79.0102(kkk)(B) & (D).6 Oregon law further provided that a 4 security interest in proceeds is a perfected security interest if 5 the security interest in the original collateral was perfected. 6 Or. Rev. Stat. § 79.0315(3). Lenders argued that because they had 7 perfected their security interests in the Properties by recording 8 the Trust Deeds, they had also perfected their security interests 9 in the Settlement Proceeds intended to be an award for damage to 10 and diminution in value of the original collateral Properties. 11 Trustee disputed Lenders’ contention that the Settlement 12 Proceeds were “proceeds” of their original, damaged collateral. 13 He maintained that Oregon UCC law applied only to the extent 14 Lenders were granted security interests in the Miscellaneous 15 Proceeds as original collateral; it did not apply to the extent 16 they were granted a lien on real property as original collateral. 17 18 5 (...continued) 19 proceeds, products, offspring, or profits acquired by the estate after the commencement of the case to the extent 20 provided by such security agreement and by applicable nonbankruptcy law, except to any extent that the court, after 21 notice and a hearing and based on the equities of the case, orders otherwise. 22 6 Or. Rev. Stat. § 79.0102(kkk)(B) and (D) provide that 23 “proceeds” means: 24 (B) Whatever is collected on, or distributed on account of, collateral; 25 . . . . 26 (D) To the extent of the value of collateral, claims arising 27 out of the loss, nonconformity or interference with the use of, defects or infringement of rights in, or damage to, the 28 collateral.

-8- 1 Lenders’ personal property collateral was that which was described 2 in the definition of “Miscellaneous Proceeds” contained in the 3 Trust Deeds. Thus, argued Trustee, to the extent the definition 4 of “Miscellaneous Proceeds” could be interpreted to encompass the 5 Settlement Proceeds, which Trustee disputed, the Settlement 6 Proceeds themselves constituted the Lenders’ original personal 7 property collateral, and Article 9 applied only if Lenders had 8 enforceable security interests in the construction defect claims 9 as original collateral, as opposed to the real property. Because 10 Lenders never had a security interest in the defect claims, argued 11 Trustee, they could not have an interest in the Settlement 12 Proceeds as “proceeds” of those claims. 13 Accordingly, Trustee disputed that § 552(b)(1) applied 14 because Lenders did not have enforceable security interests in the 15 Settlement Proceeds as “proceeds” of any original collateral. 16 2. The court’s tentative ruling and the parties’ supplemental briefing 17 18 After the bankruptcy court issued its tentative ruling in 19 favor of Lenders, it invited supplemental briefing before issuing 20 its final decision. 21 Trustee filed his supplemental brief along with a motion for 22 leave to file a second amended complaint. In his supplemental 23 brief, Trustee argued that for the proceeds exception under 24 § 552(b)(1) to apply, the court had to determine that (1) the 25 Settlement Proceeds are “proceeds” of Lenders’ prepetition 26 collateral (as that term is used in § 552(b)(1)) and (2) their 27 security interests under the Trust Deeds “extend” to the 28 Settlement Proceeds as “proceeds” of such prepetition collateral.

-9- 1 Trustee contended that the § 552(b)(1) exception did not apply 2 because Lenders’ security interests in the Settlement Proceeds 3 attached to that postpetition estate property as original 4 collateral for the loan, not as proceeds of their prepetition real 5 property collateral. 6 To explain, Trustee contended that although under Oregon law 7 a secured party with a security interest in personal property has 8 an automatic right to proceeds of that personal property 9 collateral, no comparable Oregon statute gives a mortgagee an 10 automatic right to proceeds of real property collateral. 11 Specifically, asserted Trustee, UCC Revised Article 9 did not 12 apply to the “creation or transfer of an interest in or lien on 13 real property . . . and the proceeds thereof.” Or. Rev. Stat. 14 § 79.109(4)(k). Trustee contended that liens on real property 15 were governed generally by the laws relating to mortgages and 16 trust deeds. Thus, it followed that the automatic proceeds 17 provision in UCC Revised Article 9 did not apply to Lenders’ real 18 property collateral. 19 Trustee contended that if Lenders had a security interest in 20 any proceeds of their prepetition real property collateral, it 21 could be only because Debtors granted them such interest under the 22 Trust Deeds. Trustee maintained that only two grant clauses 23 existed in the Trust Deeds, and arguably the only one applicable 24 here was the Assignment of Miscellaneous Proceeds clause, wherein 25 Debtors assigned any Miscellaneous Proceeds to Lenders. Trustee 26 argued that the “proceeds” described there essentially consisted 27 of proceeds realized from causes of actions relating to real 28 property – e.g., tort claims for “damage to, or destruction of,

-10- 1 the Property,” or fraud-based or breach of contract claims for 2 “misrepresentation of, or omissions as to, the value and/or 3 condition of the Property.” Trustee argued that because the Trust 4 Deeds failed to include the necessary “link” between the real 5 property collateral and the Settlement Proceeds — i.e., Lenders’ 6 right to Debtors’ tort causes of action — the Settlement Proceeds 7 could not be traced to any collateral from which the tort claim 8 might have derived. 9 In summary, Trustee contended that in construing § 552(b)(1) 10 in the context of real property collateral, “proceeds” should mean 11 proceeds under state common law principles, as opposed to the UCC. 12 In Oregon, which has no statute defining the scope of proceeds for 13 secured transactions in real property, Trustee contended that the 14 term “proceeds,” as used in § 552(b)(1), means proceeds under 15 applicable state common law principles. Under Oregon common law, 16 as argued by Trustee, proceeds of a payment intangible that arises 17 from the settlement of commercial tort claims for construction 18 defects are not “proceeds” of the real property collateral that 19 was defectively constructed. Accordingly, Lenders’ security 20 interest did not “extend” to the Settlement Proceeds as “proceeds” 21 of any of their prepetition collateral, and the requirements of 22 § 552(b)(1) had not been met. 23 Lenders maintained that the bankruptcy court’s tentative 24 ruling correctly categorized the Settlement Proceeds as a 25 prepetition assignment to Lenders, which was bargained for by the 26 parties in the Trust Deeds. Lenders contended that nothing in 27 Oregon UCC law prevented the parties from assigning the Settlement 28 Proceeds to Lenders under the Trust Deeds. Furthermore, Oregon

-11- 1 law provided that the provisions of the UCC may be varied by 2 agreement. Or. Rev. Stat. § 71.3020(1). Thus, argued Lenders, 3 even if a provision of Oregon’s UCC law arguably conflicted with 4 the assignment of the Settlement Proceeds as “Miscellaneous 5 Proceeds,” the parties could agree to modify the effect of any 6 such provisions via their agreement in the Trust Deeds. 7 Debtors contended that even though U.S. Bank had not 8 appeared, it still had an enforceable security interest in the 9 Settlement Proceeds based on the Trust Deeds. Debtors maintained 10 that U.S. Bank’s failure to participate did not terminate or 11 affect that interest and argued that the court would exceed its 12 authority by holding otherwise. 13 Before the bankruptcy court was also Trustee’s motion for 14 leave to file a second amended complaint, which Debtors and 15 Lenders opposed on both procedural and substantive grounds. 16 Trustee explained that while working on his post-hearing brief, he 17 identified a “new theory” for obtaining relief against Lenders. 18 Under Or. Rev. Stat. § 79.0317(1)(a), Trustee as “lien creditor” 19 had priority over the Lenders’ security interests in the 20 Settlement Proceeds, because those security interests were 21 unperfected. Thus, under this new theory, explained Trustee, his 22 rights to the Settlement Proceeds were senior to those of Lenders, 23 even if the bankruptcy court determined that their security 24 interests in the Settlement Proceeds were not cut off under 25 § 552(a). 26 In opposition, Debtors contended that Trustee’s “new theory” 27 failed, because as proceeds from the damaged real property 28 collateral, Lenders’ security interests in the Settlement Proceeds

-12- 1 were perfected when the Trust Deeds were recorded. Debtors noted 2 that Trustee’s new theory was also inconsistent with his argument 3 that Lenders did not have a security interest in the Settlement 4 Proceeds. Lenders argued that Article 9 did not apply in this 5 case because the parties agreed to operate outside of the UCC. If 6 it did apply, Lenders argued that, relying on Wiersma v. O.H. 7 Kruse Grain & Milling (In re Wiersma), 324 B.R. 92, 106 (9th Cir. 8 BAP 2005), rev’d on jurisdictional grounds, 483 F.3d 933 (9th Cir. 9 2007), they had perfected security interests in one of two ways. 10 First, lawsuit settlement funds stemming from destruction of 11 collateral are considered to be proceeds of the original, damaged 12 collateral. Second, if a creditor has a perfected security 13 interest in after-acquired general intangibles, it also has a 14 secured interest in the settlement funds stemming from a tort 15 claim, because once a lawsuit in tort is settled for money, the 16 debtor’s right to payment is converted to a “payment intangible” 17 to which the tort exclusion does not apply. 18 3. The bankruptcy court’s decision on the cross-motions for summary judgment 19 20 In its published opinion on the cross-motions for summary 21 judgment, the bankruptcy court determined that Lenders had a valid 22 and continuing security interest in the Settlement Proceeds as 23 proceeds of their real property collateral. Arnot v. Endresen (In 24 re Endresen), 530 B.R. 856 (Bankr. D. Or. 2015). 25 The court first determined that the Trust Deeds provided for 26 assignment of the Miscellaneous Proceeds for security purposes, 27 thereby creating a security agreement, rather than an assignment 28 of those proceeds outright. Id. at 866. The court further

-13- 1 concluded that the definition of “Miscellaneous Proceeds” in the 2 Trust Deeds “provide[d] an adequate description of the Settlement 3 Proceeds as a settlement or proceeds paid by a third party for 4 damage to the Properties.” Id. at 867. In reaching that 5 conclusion, the court disagreed with Trustee’s contention that the 6 Miscellaneous Proceeds definition failed to “reasonably identify” 7 the Settlement Proceeds. As an initial matter, the court did not 8 believe the Trust Deeds were designed to create a security 9 interest in personal property under Article 9 of the UCC. Id. at 10 866. Moreover, only the Settlement Proceeds remained at issue, 11 not any commercial tort claims; those claims had been settled long 12 before the adversary complaint was filed. Therefore, all the 13 court had to determine was whether the definition of 14 “Miscellaneous Proceeds” in the Trust Deeds, as a matter of 15 general contract interpretation, reasonably identified the 16 Settlement Proceeds as subject to Lenders’ alleged secured claim, 17 which it determined in the affirmative. Id. at 866-67. 18 The bankruptcy court’s conclusion that Lenders had a valid 19 security agreement that properly described the Settlement Proceeds 20 prompted its consideration of (1) whether the Lenders’ security 21 interest properly attached to the Settlement Proceeds and 22 (2) whether that interest was cut off by § 552(a) or saved by the 23 exception in § 552(b)(1). The court concluded that Lenders’ 24 security interest in the Settlement Proceeds attached by virtue of 25 the security arrangements for the assignment of Miscellaneous 26 Proceeds in the Trust Deeds. Id. at 869. In other words, the 27 Settlement Proceeds were identifiable Miscellaneous Proceeds under 28 the Trust Deeds to which Lenders’ security interests attached for

-14- 1 purposes of § 552(b)(1) as “proceeds” of their original, damaged 2 collateral. Relying on Wiersma and Ninth Circuit authority that 3 the term “proceeds” in § 552(b)(1) be given the “broadest possible 4 definition,” the court rejected Trustee’s argument that Lenders’ 5 failure to have an identifiable, properly attached and perfected 6 security interest in the construction defect claims, as commercial 7 tort claims, at the intermediate stage prior to settlement of 8 those claims automatically vitiated their security interest in the 9 Settlement Proceeds vis-a-vis the estate. Id. at 868-69. 10 The bankruptcy court further held that Lenders’ interest in 11 the Settlement Proceeds was perfected because (1) Article 9’s 12 requirement that a secured party file a UCC-1 financing statement 13 did not apply to Trust Deeds, and (2) even if Article 9 did apply 14 to Trust Deeds in general, a financing statement was not required 15 here. Id. at 869-871. The court reasoned that Lenders perfected 16 their interest in the Properties by recording the Trust Deeds in 17 2004. The Trust Deeds in turn contained provisions concerning the 18 assignment of Miscellaneous Proceeds which functioned as a 19 security agreement and created a valid security interest that 20 attached to the Settlement Proceeds. Thus, because the security 21 interest in the original real property collateral was perfected, 22 so were the Settlement Proceeds intended for repair of that 23 damaged collateral. Accordingly, Lenders were entitled to summary 24 judgment. Because the court believed that its decision addressed 25 Trustee’s “new theory” regarding perfection, it denied his motion 26 for leave to file a second amended complaint. 27 Finally, based on the “equities of the case” exception in 28 § 552(b)(1), the bankruptcy court determined that Trustee was

-15- 1 entitled to U.S. Bank’s share of the Settlement Proceeds. Id. at 2 871. In the court’s view, U.S. Bank should not benefit as a “free 3 rider” from the significant efforts expended by Lenders after it 4 failed to appear and was defaulted. The court noted that U.S. 5 Bank had ample opportunity to appear and defend its interest in 6 the Settlement Proceeds and had chosen not to do so. As such, it 7 entered a default judgment against U.S. Bank. Id. 8 II. JURISDICTION 9 The bankruptcy court had jurisdiction under 28 U.S.C. §§ 1334 10 and 157(b)(2)(A), (B), (C), (K) and (O). We have jurisdiction 11 under 28 U.S.C. § 158. 12 III. ISSUES 13 1. Did the bankruptcy court err in determining that the 14 Settlement Proceeds were “proceeds” of Lenders’ real property 15 collateral and thus “proceeds” for purposes of § 552(b)(1)? 16 2. Did the bankruptcy court abuse its discretion in awarding 17 U.S. Bank’s share of the Settlement Proceeds to Trustee under the 18 “equities of the case” exception in § 552(b)(1)? 19 IV. STANDARDS OF REVIEW 20 We review a bankruptcy court’s grant of summary judgment de 21 novo. Fresno Motors, LLC v. Mercedes-Benz USA, LLC, 771 F.3d 22 1119, 1125 (9th Cir. 2014); Good v. Daff (In re Swintek), 543 B.R. 23 303, 306 (9th Cir. BAP 2015). Likewise, we review a bankruptcy 24 court’s legal conclusions, including its interpretation of the 25 Bankruptcy Code and state law, de novo. Rund v. Bank of Am. Corp. 26 (In re EPD Inv. Co., LLC), 523 B.R. 680, 684 (9th Cir. BAP 2015). 27 The decision whether to apply the equitable exception under 28 § 552(b)(1) is reviewed for abuse of discretion. See J. Catton

-16- 1 Farms, Inc. v. First Nat’l Bank of Chi., 779 F.2d 1242, 1247 (7th 2 Cir. 1985). Accordingly, we reverse where the bankruptcy court 3 applied an incorrect legal rule or where its application of the 4 law to the facts was illogical, implausible or without support in 5 inferences that may be drawn from the record. Ahanchian v. Xenon 6 Pictures, Inc., 624 F.3d 1253, 1258 (9th Cir. 2010) (citing United 7 States v. Hinkson, 585 F.3d 1247, 1262 (9th Cir. 2009) (en banc)). 8 We may affirm on any ground supported by the record, 9 regardless of whether the bankruptcy court relied upon, rejected 10 or even considered that ground. Fresno Motors, LLC, 771 F.3d at 11 1125. 12 V. DISCUSSION 13 A. Summary judgment standards 14 Under Civil Rule 56, applicable here by Rule 7056, “[t]he 15 court shall grant summary judgment if the movant shows that there 16 is no genuine dispute as to any material fact and the movant is 17 entitled to judgment as a matter of law.” Civil Rule 56(a). When 18 deciding a motion for summary judgment, the court does not weigh 19 the evidence to determine the truth of the matter asserted but 20 simply determines whether a genuine issue for trial exists. 21 Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 249 (1986). “Only 22 disputes over facts that might affect the outcome of the suit 23 under the governing law will properly preclude the entry of 24 summary judgment.” Id. at 248. 25 No material facts are disputed in this case. We agree with 26 the parties that the issues presented before this Panel are purely 27 questions of law. 28

-17- 1 B. Analysis 2 We agree with the bankruptcy court’s conclusion that Lenders’ 3 have valid and continuing security interests in the Settlement 4 Proceeds, but on a slightly different basis. The question before 5 us is whether the Miscellaneous Proceeds provisions in the Trust 6 Deeds include the Settlement Proceeds as proceeds of Lenders’ 7 original collateral. If so, did Lenders’ prepetition lien extend 8 to those postpetition proceeds absent a filed UCC-1 financing 9 statement? We conclude the answer to both of these questions is 10 yes. 11 1. Section 552 12 Section 552(a) provides the general rule that property 13 acquired postpetition by the debtor or the estate is not subject 14 to any lien resulting from any prepetition security agreement. 15 However, § 552(b)(1) provides certain exceptions from this general 16 rule. If the security interest created by a prepetition agreement 17 extended to property of the debtor acquired prepetition, and to 18 “proceeds, products, offspring, or profits of such property,” then 19 the security interest extends to such proceeds, products, 20 offspring, or profits of such property acquired postpetition to 21 the extent provided by the security agreement and applicable 22 nonbankruptcy law. § 552(b)(1). In other words, “if a 23 pre-petition security interest encumbers collateral and its 24 proceeds, any proceeds of that pre-petition collateral remain 25 subject to the security interest even if they are received 26 post-petition.” Arkison v. Frontier Asset Mgmt., LLC (In re 27 Skagit Pac. Corp.), 316 B.R. 330, 335 (9th Cir. BAP 2004). The 28 exceptions found in § 552(b)(1) are, in turn, subject to the

-18- 1 exception that the court may order otherwise based on the 2 “equities of the case.” 3 “[T]he purpose of § 552 is to permit a debtor ‘to gather into 4 the estate as much money as possible to satisfy the claims of all 5 creditors[;]’ but § 552(b) ‘balances the Code’s interest in 6 freeing the debtor of prepetition obligations with a secured 7 creditor’s rights to maintain a bargained-for interest in certain 8 items of collateral. It provides a narrow exception to the 9 general rule of [§] 552(a).’” Fin. Sec. Assurance, Inc. v. Days 10 Cal. Riverside Ltd. P’ship (In re Days Cal. Riverside Ltd. 11 P’ship), 27 F.3d 374, 375 (9th Cir. 1994) (emphasis in original) 12 (quoting Philip Morris Capital Corp. v. Bering Trader, Inc. (In re 13 Bering Trader, Inc.), 944 F.2d 500, 502 (9th Cir. 1991) (“Section 14 552(b) clearly contemplates an exception where the parties have 15 bargained for an interest in one of the five types of property 16 listed therein.”)). 17 2. Definition of “Miscellaneous Proceeds” in the Trust Deeds includes the Settlement Proceeds. 18 19 The bankruptcy court correctly concluded that § 552(a) 20 applies. The Settlement Proceeds came into existence 21 postpetition; Lenders had a prepetition security agreement — i.e., 22 the Trust Deeds — which created a lien on the collateral described 23 in the Trust Deeds.7 Trustee does not dispute that Lenders had 24 valid liens on the Properties by way of their recorded Trust 25 Deeds. His dispute is that the Settlement Proceeds are not 26 27 7 The Trust Deeds are prepetition “security agreements” as defined in § 101(50), and the security interests created by the 28 Trust Deeds are “liens” as defined in § 101(37).

-19- 1 “proceeds” of Lenders’ real property collateral for purposes of 2 § 552(b)(1). 3 The nature and extent of security interests are determined by 4 state law. In re Bering Trader, Inc., 944 F.2d at 502 (citing 5 Unsecured Creditors Comm. v. Marepcon Fin. Corp. (In re Bumper 6 Sales, Inc.), 907 F.2d 1430, 1437 (4th Cir. 1990)). We note that 7 Oregon’s UCC law does not govern in this case. Or. Rev. Stat. 8 § 79.109(4)(k) provides that Article 9 of the UCC does not apply 9 to the “creation or transfer of an interest in or lien on real 10 property . . . and the proceeds thereof.” Put simply, it does not 11 govern trust deeds and mortgages. While that statute lists 12 certain exceptions to this exclusion, none of them apply here.8 13 8 14 Or. Rev. Stat. § 79.0109(4)(k) provides, in full, that this chapter does not apply to 15 "[t]he creation or transfer of an interest in or lien on 16 real property, including a lease or rents thereunder, or a sellers or purchasers interest in a land sale contract 17 and the proceeds thereof, except to the extent that provision is made for: 18 (A) Liens on real property in Or. Rev. Stat. 19 § 79.0230 and 79.0308 (exception for provisions regarding security interests in which the parties’ 20 agreement expressly postpones the time the security interest attaches and the exception for provisions 21 regarding agricultural liens); (B) Fixtures in Or. Rev. Stat. § 79.0334 (no 22 fixtures at issue here); (C) Fixture filings in Or. Rev. Stat. § 79.0501, 23 79.0502, 79.0512, 79.0516 and 79.0519 (same as (B)); 24 (D) Security agreements covering personal and real property in Or. Rev. Stat. § 79.0604[.] 25 Arguably, Or. Rev. Stat. § 79.0109(4)(k)(D) is the only exception 26 that could apply. However, even if it did apply to the Trust Deeds at issue, Or. Rev. Stat. § 79.0604, which covers a secured 27 party’s default rights and procedure, makes clear that the existence of a security instrument securing both real and personal 28 (continued...)

-20- 1 Under Or. Rev. Stat. § 86.715, “[a] trust deed is deemed to be a 2 mortgage on real property and is subject to all laws relating to 3 mortgages on real property” (with certain exceptions regarding 4 foreclosure not applicable here). Accordingly, we look to the 5 language of the Trust Deeds to begin our analysis. 6 The Trust Deeds provided for a lien on the real property and 7 the “Miscellaneous Proceeds” of that property, as defined in the 8 Trust Deeds. The Trust Deeds specifically defined what “proceeds” 9 of the real property would be covered by the Lenders’ liens. The 10 definition of “Miscellaneous Proceeds” includes “any compensation, 11 settlement, award of damages, or proceeds paid by any third 12 party . . . for: (i) damage to, or destruction of, the Property . 13 . . .” Debtors’ state court action involved claims against the 14 builder that the Properties were negligently constructed, 15 diminishing the value of the Property. Those claims were settled 16 and reduced to the Settlement Proceeds. We conclude, as did the 17 bankruptcy court, that the definition of “Miscellaneous Proceeds” 18 in the Trust Deeds includes the Settlement Proceeds as a 19 settlement or proceeds paid by a third party for damage to the 20 Properties. 21 3. The Settlement Proceeds are “proceeds” of Lenders’ real property collateral and are “proceeds” for purposes of 22 § 552(b)(1). 23 Now we must determine whether the Settlement Proceeds are 24 “proceeds” of Lenders’ real property collateral and whether 25 Lenders acquired, through their Trust Deeds, a security interest 26 27 8 (...continued) property does not “prejudic[e] any rights with respect to the real 28 property.” Or. Rev. Stat. § 79.0604(1).

-21- 1 in those proceeds. Again, we conclude the answer to both of these 2 questions is yes. 3 The bankruptcy court noted it was “treading in virgin 4 territory” with this precise issue. Case law on the matter is 5 essentially (and surprisingly) nonexistent. However, we have 6 located persuasive authority that supports our conclusion that the 7 Settlement Proceeds are proceeds of Lenders’ real property 8 collateral and, thus, are “proceeds” for purposes of § 552(b)(1). 9 In Farmer v. Citizens National Bank of Athens (In re Davis), 10 528 B.R. 757 (Bankr. E.D. Tenn. 2015), issued two weeks before the 11 bankruptcy court’s opinion here, the debtors owned real property 12 subject to two deeds of trust held by the bank. Id. at 759. The 13 property was damaged when a dike maintained by the Tennessee 14 Valley Authority was breached, filling the property with coal ash. 15 The debtors sued the TVA and filed for chapter 7 relief. The 16 chapter 7 trustee settled the claim postpetition for approximately 17 $81,000 after attorney’s fees, which the bankruptcy court 18 approved. Id. at 759-60. The trustee then sought to avoid the 19 bank’s interest in the settlement proceeds. He argued the 20 settlement proceeds were personal property, general intangibles or 21 proceeds of litigation; the bank failed to take action to perfect 22 any liens to such personal property vis-a-vis a UCC-1 filing. Id. 23 at 760. Thus, argued the trustee, the bank’s deed of trust did 24 not have priority over his rights as a hypothetical judgment lien 25 creditor or postpetition lien holder under §§ 544 and 549. Id. 26 The bank argued that its lien under the deed of trust attached to 27 the settlement proceeds that arose from damage to the real 28 property collateral. Id.

-22- 1 The issue, as the court saw it, was whether the settlement 2 proceeds had the character of personalty or whether they were 3 substitute collateral for the value of the real property. Id. 4 The operative language in the deed of trust supporting the bank’s 5 position was the definition of “Property,” which included 6 “all . . . rights . . . now or hereafter existing in connection 7 with the property or derived therefrom.” Id. at 762. As in the 8 instant case, the court noted that none of the cases cited by the 9 trustee in support of his argument that the proceeds were subject 10 to the UCC concerned settlement proceeds for damage to real 11 property subject to a deed of trust or mortgage. Id. After 12 reviewing cases analogous to the issue before it (which we discuss 13 below), and determining that the settlement proceeds fit within 14 the definition of “Property” under the deed of trust as a “right . 15 . . derived therefrom,” the court held that the settlement 16 proceeds were substitute collateral for the diminution in value of 17 the real property subject to the bank’s lien under the deed of 18 trust; they were not a general intangible requiring lien 19 perfection under the UCC. Id. Thus, the bank’s interest trumped 20 that of the trustee’s. 21 Wilson v. Mellott (In re Wilson), 2010 WL 5341917 (Bankr. D. 22 Neb. Dec. 21, 2010), presented the same issue regarding the 23 respective rights in postpetition settlement proceeds from a 24 lawsuit involving defective construction claims. In 1997, the 25 debtors had purchased a home subject to a recorded deed of trust. 26 Id. at *2. In 2005, the plaintiff loaned the debtors money and 27 held as collateral a security agreement and assignment from the 28 debtors of certain causes of action against the contractors who

-23- 1 built the debtors’ home. In particular, those claims alleged 2 losses based on deficiencies in the home’s construction, resulting 3 in significant mold damage. Id. The plaintiff perfected his 4 security interest by filing a UCC-1 financing statement. Id. 5 After the debtors had commenced litigation against the builder, 6 they filed for chapter 7 relief in 2007. Id. A settlement was 7 reached postpetition in 2009, resulting in $129,662.44 to the 8 debtors after attorney’s fees. Id. at *1. 9 A fight ensued about who was entitled to the settlement 10 proceeds – the plaintiff or the defendant holding the trust deed. 11 The parties “characterize[d] the central question . . . as whether 12 the settlement proceeds are the debtors’ personal property or 13 whether the proceeds are substitute collateral for the value of 14 the real property.” Id. at *3. The court reasoned that if the 15 proceeds were personal property, then plaintiff’s lien was 16 superior to defendant’s deed of trust; if the proceeds were for 17 damage to the real property collateral, the defendant’s lien had 18 priority. Id. 19 Relying on a California state court case, the court held that 20 settlement proceeds paid for damage to real property are subject 21 to a mortgagee’s interest in the damaged real property: 22 When a monetary remedy is awarded for damage to real property, it “takes the place of the reduced value of the 23 land.” Am. Sav. & Loan Ass’n v. Leeds, 440 P.2d 933, 937 n.2 (Cal. 1968) (en banc). Accordingly, a lender holding 24 an interest in real estate as collateral would be entitled to damages for injury to his security. 25 Therefore, to the extent any portion of the settlement allocable to property damage represents a reduction in 26 the value of the [defendant’s] collateral, it is subject to the deed of trust lien, which is superior to 27 [plaintiff’s] security interest. 28 Id. at *4.

-24- 1 Next is In re Gilley, 236 B.R. 448 (Bankr. M.D. Fla. 1999). 2 There, the chapter 12 debtor filed a motion under § 506 to 3 determine the secured status of the mortgagee’s proof of claim. 4 The debtor contended that proceeds from the settlement of his 5 claims against a fungicide manufacturer for damage to his real 6 property were personal property not subject to the lien of the 7 mortgagee. Id. at 451. The mortgagee contended the settlement 8 proceeds represented an “interest” in the real property within the 9 meaning of the mortgage and, thus, were included in its 10 collateral. Id. The bankruptcy court rejected the debtor’s 11 argument, noting that the legal description of the real property 12 in the mortgage included the following provision: 13 [T]ogether with all rights, interests, easements, hereditaments and appurtenances thereunto belonging, the 14 rents, issues, and profits thereof and revenues and income therefrom, all improvements and personal property 15 now or later attached thereto or reasonably necessary to the use thereof, including, but not limited to, ranges, 16 refrigerators, clothes washers, clothes dryers, or carpeting purchased or financed in whole or in part with 17 loan funds, all water, water rights, and water stock pertaining thereto, and all payments at any time owing to 18 Borrower by virtue of any sale, lease, transfer, conveyance, or condemnation of any part thereof or 19 interest therein — all of which are herein called “the property”. 20 21 Id. at 450 (emphasis in original). 22 In light of the mortgage’s language describing the property 23 subject to the lien to include “all rights, interests, easements, 24 hereditaments and appurtenances thereunto belonging,” the court 25 held that the mortgagee’s lien attached to the settlement proceeds 26 “on the basis of the express terms of the mortgage contract.” Id. 27 at 452-53. The claims against the manufacturer and the proceeds 28 of that claim constituted a “right or interest” belonging to the

-25- 1 real property within the meaning of the mortgage. 2 Finally, in Ferry Road Properties, LLC v. RL BB ACQ II-TN, 3 LLC (In re Ferry Road Properties, LLC), 2012 WL 3888201 (Bankr. 4 E.D. Tenn. Sept. 7, 2012), the debtor was a party to a state court 5 lawsuit filed prepetition against the builder of the debtor’s 6 retail store, which sought damages resulting from the builder’s 7 negligence. Id. at *1. The debtor’s property was subject to a 8 deed of trust. The debtor filed for chapter 11 relief while the 9 lawsuit was still pending. Id. at *2. The issue was whether the 10 mortgagee’s lien on the real property extended to the debtor’s 11 cause of action for damages to the real property and loss of 12 business income. The operative language in the deed of trust was 13 the following: 14 Grantor hereby conveys to Trustee, in trust, with power of sale, the Real Property described in this Deed of 15 Trust, together with any improvements, equipment and fixtures existing or hereafter placed on or attached to 16 this Real Property, all proceeds thereof and all other appurtenant rights and privileges. The term “the 17 Property” shall include this Real Property, any such improvements, fixtures, and also all appurtenant rights 18 and privileges. 19 Id. The mortgagee argued that based on its deed of trust, it had 20 a lien not only on the real property, but “all proceeds thereof.” 21 Id. The mortgagee argued that the lawsuit represented “proceeds” 22 of the real property because it was a claim for damages and loss 23 associated with the realty. Id. 24 The court agreed with the mortgagee to an extent, limiting 25 its lien to the claim for damages to the real property, because 26 such “damages are viewed as a substitute for the realty itself.” 27 Id. at *7. However, to the extent that the debtor’s state court 28 action encompassed claims beyond property damage — i.e., the loss

-26- 1 of business income — the mortgagee had no interest absent a 2 properly filed UCC-1. Id. The court’s holding with respect to 3 the business income is consistent with Oregon law. See In re 4 Nendels-Medford Joint Venture, 127 B.R. 658, 663-64 (Bankr. D. Or. 5 1991) (when mortgagee intended to obtain not only a lien on the 6 real property but also a security interest in revenue flowing from 7 operations of the business operated on the real property, the 8 function of the transaction changed and the purpose behind Oregon 9 law excepting a real estate interest from the provisions of 10 Article 9 no longer applied) (citing Sec. Bank v. Chiapuzio, 304 11 Or. 438, 448, 747 P.2d 335, 341 (1987), superseded by statute on 12 other grounds as stated in Bedortha v. Sunridge Land Co., Inc., 13 213 Or. 308, 314 n.4, 822 P.2d 694 (1991)). 14 The holdings of these cases, that a mortgagee has a superior 15 interest in proceeds paid on account of damage to or diminution in 16 value of the real property collateral subject to the trust deed or 17 mortgage because such proceeds are a substitute for that realty 18 collateral, is consistent with the Restatement (Third) of Property 19 (Mortgages), which provides, in relevant part: 20 (a) Unless a different disposition is provided in the mortgage, the mortgagee has a right to the following 21 funds paid on account of loss or damage to the mortgaged real estate, to the extent that the mortgagee’s security 22 has been impaired by the loss or damage . . . 23 (1) the proceeds paid by a casualty insurer due to the occurrence of an insured loss to the real estate, if the 24 mortgagor promised the mortgagee, in the mortgage or otherwise, to purchase the insurance; and 25 (2) an award resulting from a taking of all or part of 26 the real estate under power of eminent domain, or the proceeds of a sale to a governmental body in lieu of such 27 taking. 28 Restatement (Third) of Property (Mortgages) § 4.7(a) (1997).

-27- 1 . . . Such funds are viewed as substitute collateral, and the mortgagee’s claim on them is sometimes described as 2 an “equitable lien.” This means simply that the mortgagee is entitled to recover the funds to the extent 3 necessary to compensate for the impairment of security that results from the loss or damage, with a maximum 4 recovery equal to the balance owing on the mortgage debt. This result is required to avoid unfairness to the 5 mortgagee through devaluation of the real estate as a consequence of the loss or damage. . . . 6 The principle of Subsection (a) is applicable to other 7 sorts of funds that represent recovery for loss or damage to the mortgaged real estate. For example, if a third 8 party commits waste and the mortgagor sues and recovers damages, the recovery may be regarded as substitute 9 collateral and subjected to the mortgagee’s claim. The mortgagor will still benefit indirectly, since the funds 10 must be applied by the mortgagee toward the debt or made available for restoration of the damage under Subsection 11 (b). 12 Id. cmt. a (emphases added). 13 Although the above cases did not deal expressly with 14 § 552(b)(1), their holdings are relevant and highly persuasive. 15 In each case, the court held that when the mortgagee’s prepetition 16 deed of trust or mortgage lien against the debtor’s real property 17 contains language encompassing the right to payment of settlement 18 proceeds for damages to or diminution in value of the debtor’s 19 real property, the mortgagee’s lien attaches to those proceeds by 20 way of its properly recorded deed of trust or mortgage. These 21 courts either expressly or implicitly found that such proceeds 22 were not personalty subject to the perfection requirements under 23 the UCC. 24 We see no reason why the outcome should be any different when 25 applying § 552(b)(1). Lenders each held prepetition Trust Deeds, 26 which placed a lien on Debtor’s real property and extended to any 27 “Miscellaneous Proceeds” of that property, as defined by the Trust 28 Deeds. By way of the operative assignment language in the Trust

-28- 1 Deeds — “All Miscellaneous Proceeds are hereby assigned to and 2 shall be paid to Lender” — any such proceeds were assigned to 3 Lenders. The definition of “Miscellaneous Proceeds” included the 4 Settlement Proceeds as a settlement or proceeds paid by a third 5 party for damage to the Properties. Lenders’ security interest in 6 the real property and in such proceeds attached by virtue of the 7 security arrangements for the assignment of Miscellaneous Proceeds 8 in the Trust Deeds and were perfected upon recording the Trust 9 Deeds. The postpetition Settlement Proceeds were paid for the 10 purpose of repairing the damage to the real property collateral 11 and thus were substitute collateral subject to the Lenders’ liens 12 under the Trust Deeds. Accordingly, Lenders’ liens “extended” to 13 the Settlement Proceeds as “proceeds” of the real property 14 collateral and thus are “proceeds” for purposes of § 552(b)(1). 15 For these reasons, we AFFIRM the portion of the judgment 16 determining that Lenders have a valid and continuing security 17 interest in the Settlement Proceeds that was not cut off by 18 § 552(a), but saved by the exception in § 552(b)(1). 19 4. The bankruptcy court abused its discretion when it awarded U.S. Bank’s share of the Settlement Proceeds to 20 Trustee. 21 Debtors contend in their cross-appeal that the bankruptcy 22 court erred in holding that based on the “equities of the case” 23 exception to § 552(b)(1), it could void U.S. Bank’s security 24 interest in the Settlement Proceeds because U.S. Bank failed to 25 participate in the litigation and had been defaulted. Debtors 26 contend that if some of the lenders had enforceable security 27 interests in the Settlement Proceeds, then all of them did based 28 on their identical Trust Deeds, regardless of their participation

-29- 1 in the litigation. 2 As noted above, § 552(b)(1) provides that a prepetition 3 security interest will attach to certain types of bankruptcy 4 estate property “except to any extent that the court, after notice 5 and a hearing and based on the equities of the case, orders 6 otherwise.” Although “equities of the case” is not defined in the 7 Code, at least five courts of appeal have assigned a nearly 8 identical meaning to this provision. See Stanziale v. Finova 9 Capital Corp. (In re Tower Air, Inc.), 397 F.3d 191, 205 (3d Cir. 10 2005); N.H. Bus. Dev. Corp. v. Cross Baking Co., (In re Cross 11 Baking Co.), 818 F.2d 1027, 1033 (1st Cir. 1987); United Va. Bank 12 v. Slab Fork Coal Co., 784 F.2d 1188, 1191 (4th Cir. 1986); In re 13 J. Catton Farms, Inc., 779 F.2d at 1246-47; Wolters Vill. Ltd. v. 14 Vill. Props., Ltd. (In re Vill. Props., Ltd.), 723 F.2d 441, 444 15 (5th Cir. 1984). Essentially, these courts have held that the 16 principal purpose of the equities of the case exception is to 17 prevent secured creditors from reaping unjust benefits from an 18 increase in the value of collateral during a bankruptcy case 19 resulting from the (usually) reorganizing chapter 11 debtor’s use 20 of other assets of the estate or from the investment of non-estate 21 assets. See Toso v. Bank of Stockton (In re Toso), 2007 WL 22 7540985, at *13 (9th Cir. BAP Jan. 10, 2007) (citing the above 23 cases and determining that “[n]o circuit case law attributes a 24 different meaning to this phrase.”); All Points Capital Corp. v. 25 Laurel Hill Paper Co. (In re Laurel Hill Paper Co.), 393 B.R. 89, 26 93 (Bankr. M.D.N.C. 2008) (“The cases involving section 552(b)(1) 27 appear to place the most weight on whether a debtor expended 28 unencumbered funds of the estate, at the expense of the unsecured

-30- 1 creditors, to enhance the value of the collateral.”). 2 We agree with Debtors that the policy rationale behind the 3 equity exception is simply inapplicable to this case. Even 4 Trustee concedes that the bankruptcy court’s application of the 5 exception here was a “creative use” of that statutory provision. 6 Here, no rehabilitation of a debtor is at issue, and awarding U.S. 7 Bank its 20% share of the Settlement Proceeds does not afford it 8 any sort of “windfall” at the expense of unsecured creditors, 9 considering that the Settlement Proceeds are earmarked to repair 10 its damaged, real property collateral, which undoubtedly lost 11 value. Further, nothing in the record suggests that U.S. Bank was 12 on notice that its security interest in the Settlement Proceeds 13 would be extinguished if it failed to appear. 14 While we can certainly understand the bankruptcy court’s 15 frustration with a secured lender which failed to defend its 16 security interest, we believe it misapplied the equity exception 17 under § 552(b)(1). Accordingly, we REVERSE that portion of the 18 judgment. 19 VI. CONCLUSION 20 For the foregoing reasons, we AFFIRM the judgment in part and 21 REVERSE the judgment in part. 22 23 24 25 26 27 28

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