DECISION ON MOTION TO DISMISS THE CASE AND THE ADVERSARY COMPLAINT, TO LIFT THE AUTOMATIC STAY AND FOR ADEQUATE PROTECTION
This оpinion deals only with three of the issues raised by the parties: (i) Under New York law is the appointment of a receiver of rents and profits considered perfection of an assignment of rents as additional security contained in a mortgage of real property; (ii) Can the appointment of a receiver of rents and profits in a mortgage foreclosure within the statutory period be avoided as preferential; and (iii) To what extent, if any, is a pre-payment charge binding and enforceable pursuant to 11 U.S.C. § 506(b) and New York law.
We hold that the appointment of a receiver to collect rents is not considered “perfection” of the assignment of rents, that no avоidable preferential transfer ensues from the appointment of a receiver, and that the pre-payment charge herein is not avoidable.
These proceedings are subject to bankruptcy court jurisdiction pursuant to 28 U.S.C. §§ 1334(b), 157(a) and the Order of Referral of Matters to Bankruptcy Judges for this District,
Background
1. On December 8, 1989 TNE Funding Corporation (hereinafter “TNE”) commenced an action to foreclose its mortgage on the Debtor’s only substantial asset, its leasehold estate in the property known as 90 Merrick Avenue, East Meadow, New York (hereinafter “the Real Property”).
2. On September 11, 1991 an order appointing a reсeiver to collect rents and other income from the Real Property was entered in New York State Supreme Court, Nassau County. The receiver did not take possession of the property.
3. On October 1,1991 the Debtor filed a voluntary petition under Chapter 11 of the Bankruptcy Code (11 U.S.C. § 101 et seq.).
4. By a notice of motion dated November 8, 1991 and an amended notice of motion dated November 22, 1991, TNE moved for the following relief: (i) dismissal of the case for bad faith filing; (ii) in the alternative, vacatur of the automatic stay to permit the receiver to collect the rents issuing from the Real Property and to permit TNE to proceed with its foreclosure action; and (iii) granting TNE adequate prоtection for its interest in the Real Property and in the rents which constitutes cash collateral.
5. The Debtor filed papers in opposition to TNE’s motion as well as an adversary proceeding. The Debtor argued: (i) the petition was filed in good faith; (ii) acceleration of the Debtor’s debt upon default triggers an unconscionable payment charge which if voided would leave the creditor oversecured; (iii) the Debtor has equity in the Real Property and the Real Property is essential for effective reorganization; (iv) *831 the appointment of a receiver in the state court proceeding is a perfection of the rent assignment which should be avoided as preferential.
Although TNE did not file a formal motion to dismiss the adversary complaint, it was agreed at the December 18, 1991 hearing that TNE’s reply memorandum would be treated as a motion to dismiss.
6. On February 6, 1992 the court ruled from the bench in favor of TNE by refusing to invalidate the pre-payment clause, holding that the appointment of a receiver not be considered as perfection of the assignment of rents and cannot be avoided as preferential transfer. The court did not rule on the good faith argument as no evidence was taken and since the other pending issues may turn the good faith issue moot.
7. This opinion is written at the request of the parties to amplify portions of the court’s bеnch ruling.
8. The court would like to commend both attorneys upon the quality of their presentations and for their professionalism throughout this proceeding.
DISCUSSION
I. Appointment of a Receiver is not Perfection of the Assignment of Rents
For a long period of time courts have failed to distinguish between “perfection” of an assignment of rent and the “triggering event” prerequisite to its enforcement. The cases, many of which are cited in the Debtor’s papers, speak of the appointment of a receiver of rents and profits as a perfection of the assignment. However under New York law, rents are considered interests in real property 1 and as such a security interest in rents is perfected upon recordation. See, N.Y.R.P.L. §§ 291, 294-a (McKinney 1989 & 1991 Supp.); 74 N.Y.Jur.2d, Landlord and Tenant, §§ 334, 335 (1988 & 1991 Supp.).
Sections 547(e)(1) and (e)(2) of the Bankruptcy Code are interrelated. Section 547(e)(2) provides that a transfer is made at the time it takes effect between the parties if it is perfected within ten days, or at the time of perfection
2
; while § 547(e)(1) defines what is considered perfection. Pursuant to § 547(e)(1) a “transfer of real property other than fixtures ... is perfected when a bona fide purchaser ... cannot acquire an interest that is superior to the interests of the transferee.” 11 U.S.C. § 547(e)(1)(A). In the absence of a Bankruptcy Code test to determine the rights of a bona fide purchaser, state lаw controls. See
Butner v. United States,
In New York recordation protects the assignee under an assignment of rents against an intervening bona fide purchaser. N.Y.R.P.L. § 294-a. Since TNE recorded its assignment of rents on September 24, 1985, the transfer of the security interest is considered to have occurred on that date, at the latest. 11 U.S.C. § 547(e)(2)(B). As TNE’s security interest in the rents was perfected some six years prior to the filing of the petition in bankruptcy it cannot now be avoided pursuant to § 547.
The debtor cites cases that characterize the appointment of a receiver as perfection of the security interest in rents. Those cases miss the point and their position has been rejected in numerous decisions. See,
In re Vienna Park Properties,
II. Appointment of a Receiver does not Result in a Preferential Transfer
The appointment of a receiver to collect rents cannot be avoided as preferential transfer pursuant to the exception to 11 U.S.C. § 547(c)(5) since this section requires the existence of a transfer which “creates or perfects security interest.” Assuming, arguendo, that an appointment of receiver were to result in a “transfer” under New York law, and further assuming that the conditions which entitle a trustee to avoid the transfer under § 547(c)(5) were met, TNE’s security interest had been created and perfected years prior to the Debt- or’s filing for bankruptcy. Furthermore, we are doubtful whether § 547(c)(5), which specifically refers to “inventory or a receivable”, applies to rents. “Receivables” usually connote choses in action and as such are classified as an intangible personal property while in New York rents are classified as real property interests.
The Debtor next argues that the appointment of a receiver of rents results in an avoidable preference pursuant to 11 U.S.C. § 547(b). There is no real dispute that the conditions set in § 547(b)(1) through (4) were met. Two issues remain however: 1) whether or not a transfer occurs as a result of the receiver’s appointment, and 2) if it does, does this enable the creditor to receive more than it would have received if the case were a Chapter 7 case and the transfer had not been made. 11 U.S.C. § 547(b)(5).
(i) Transfer is defined as “every mode, direct or indirect, absolute or conditional voluntary or involuntary, of disposing of or parting with property or with an interest in property ...” 11 U.S.C. § 101(54)(58). The Debtor appears to argue that even if TNE’s security interest in the rents were perfected prior to the preference period pursuant to §§ 547(e)(1)(A), 547(e)(2)(A) or (B), the appointment of a receiver resulted in a transfer of the Debtor’s property right to collect the rents. .
In order to fully understand this argument, the treatment given to assignments of rents under New York law must be discussed.
As was already seen, rents are сonsidered real property interests in New York State. Creation of a security interest in real property in New York does not transfer ownership of the real property to the mortgagee but rather creates a chose in action secured by a lien upon the land. A mortgage does not create an estate in the mortgagee. “The mortgagor remains the owner of the legal estate, and the mortgagee has only a special or personal interest therein as a security for the debt or obligation.” N.Y.Jur.2d, Mortgages, § 147 (1989 and 1991 Supp.) (citations omitted). Furthermore, “[t]he right of a mortgagee to retain possession lawfully obtained is an incident of the debt and not an attribute of titlе.” Id., § 149.
The issue becomes more complicated when dealing with rents instead of land. It is not disputed that in this case the assignment of rents was not an absolute one but rather as an additional security. The case law distinguishes between these two different types of assignment. See,
In re Vienna Park Properties, L.P.,
The court [in Sullivan v. Rosson ] said that a mortgage of real property is but a pledge of property as security for a debt, *833 and that an assignment of rent of the character above-described is of the like character as the transfer оf the real property, and that a mortgagee desiring to obtain such rents to apply upon his mortgage should actually possess himself of them or the right to them through some mutual arrangement therefor, or he should make application to the court to have the receivership extended to his benefit.
In re Brose,
The court further held that “[t]he case clearly settles the law of New York upon this subject, and establishes the principle that such a clause in a New York mortgage as is herein involved operates merely as a pledge of the rents, to which the pledgee does not become entitled until he asserts his right.”
In re Brose,
In
Vecchiarelli v. Garsal Realty, Inc.,
A mortgagee, even with an assignment of rents as additional security, is nоt entitled to rents and profits until he has reduced them to possession ... The senior mortgagee with a rent assignment has an equitable right to collect, but does not have legal title to rents automatically upon default.
The court also addressed the difference between an absolute assignment and an assignment as an additional security:
The rule was not applied in Harris [v. Taylor,35 A.D. 462 ,54 N.Y.S. 864 (1898) ] because unlike the situation here, the assignment was intended by the parties to be absolute, unqualified and immediately effective. That is to say, the assignment did not merely create a future right which would spring into being upon a later default.
Vecchiarelli,
Pursuant to New York law, therefore, an assignment of rent as an additional security is similar to a mortgage; even though a seсurity interest may be perfected upon recordation, full enjoyment of the benefits of the security is not available until additional legal steps are undertaken. Just as a the holder of a properly recorded mortgage may not take possession and sell mortgaged property merely upon a default without a foreclosure and sale, so an as-signee of rents as additional security may not receive those rents without the additional step of obtaining possession through the appointment of a receiver. Just as a subsequent encumbrancer of mortgaged property may enforce that encumbrance so long as such enforcement does not interfere with rights that the prior recorded mortgagee has elected to pursue, so may either the assignor or a subsequent assign-ee of rents for additional security pursue collection of those rents until a prior perfected assignee elects to pursue them by the appointment of a receiver to take possession of the property and collect the rents. See,
In re Brose,
Both the mortgage and the assignment of rent as additional security involve multiple transfers: one taking place at the time of the perfection of the security device
*834
by establishing its priority; and another occurring upon the completion of the legal procedure upon which enforcement of the security is conditioned — the so-called “triggering event.” See, e.g.,
Durrett v. Washington National Insurance Co.,
Moreover, had the trustee in a chapter 7 case been interested in using the rents he or she would have been compelled to provide TNE with some type of adequate protection of its interest in the rents. The same applies to the Debtor herein sincе there is no doubt that the valid security interest held by TNE renders the rent cash collateral pursuant to 11 U.S.C. §§ 363(a), 552(b). See,
In re Vienna Park Properties, L.P.,
11 U.S.C. § 363(e) enables an entity that holds an interest in cash collateral to obtain adequate protection. As TNE correctly states it is entitled to adequate protection of two distinct interests: its mortgage on the property and its right to collect the rents flowing from the рroperty or, at the very least, its security interest in such rents. TNE also correctly argues that the usual remedy of sequestration of rents and their limited use for expenses necessary to maintain the mortgaged property, see
United States Savings Assoc. v. Timbers of Inwood Forest Assoc.,
We conclude, therefore, that the appointment of a receiver to collect rents in New York is not avoidable as a preferential transfer pursuant to 11 U.S.C. § 547(b).
III. Avoidability of the Pre-Payment Charge
The loan agreement between the parties provides for a pre-payment charge computed as follows:
“The present value, computed on a monthly basis as of the date of pre-payment, at the yield on the Treasury Bond as most recently reported in the Wall Street Journal (or a similar publication selected by lender) as of the date of prepayment of (1) the monthly installments from the date of рre-payment to, but not including the maturity date; (2) plus the amount of interest and principal due on the maturity date pursuant to the terms of this note; (3) multiplied by a fraction, the numerator of which is the amount prepaid and the denominator of which is the unpaid principal sum as of the date of pre-payment; (4) less the amount paid;
*835 (5)plus ... reasonable costs and expenses ...”
Debtor’s Memo, in Opp., pp. 22-23.
The Debtor seeks disallowance of that portion of TNE’s secured claim based on the pre-payment charge on two grounds: (i) The pre-payment charge is unenforceable since it was occasioned by TNE’s acceleration of the debt; and (ii) The pre-payment charge clause is a penalty not allowable by either New York Statе law or 11 U.S.C. § 506(b). We reject both arguments.
(i) Debtor argues that “[t]he right to receive a pre-payment premium is not absolute even if contained in the terms of the mortgage note. The lender loses its right to a pre-payment premium when it elects to accelerate the debt.” In support of its position the Debtor cites to
In re LHD Realty Corp.,
It is not disputed that the agreement between the parties specifically provides for the pre-payment charge even in the event of acceleration. The cases cited by the Debtor do not appear to address this issue and none of them specifically hold that a contractual provision allowing collection of a pre-payment charge upon lender’s acceleration is prohibited or void. The
LHD
court cites exceptions to the general rule that voluntary acceleration denies the lender the right to collect the charge,
Moreover,
United Merchants and Manufacturers, Inc. v. Equitable Life,
(ii) The real thrust of Debtor’s argument in seeking to invalidate the pre-payment charge is that in light of the current market condition the formula chosen by the parties will result in a very large pre-payment charge. The Debtor argues that had the parties chosen an interest rate based upon mortgages of real property rather than upon United States Treasury Bonds, the pre-payment charge would have been considerably smaller. This argument is unpersuasive.
As set forth in
United Merchants,
“[wjhether a contract clause which nominally prescribes liquidated damages is in fact an unenforceable penalty provision is a question of state law.”
Under New York law a contractually agreed upon sum for liquidated damages will be sustained where (1) actual dam *836 ages may be difficult to determine and (2) the sum stipulated is not “plainly disproportionate” to the possible loss.
We believe that the transaction herein is squarely within the rationale of
United Merchants
and
Heller.
The transaction herein involved a loan in the principal amount of over $26,000,000.00 secured by a mortgage and an assignment of rents. The note signed by the borrower covers seven printed pages, while the mortgage and the security agreement take up 44 pages inclusive of exhibits. Furthermore, the Debtor holds a leasehold in the property but not title, since the property is titled to the County of Nassau which may terminate the lease upon Debtor’s failure to meet its obligations to the County. We do not see any material fact that distinguishes the $45,-000,000.00 unsecured loan that was dealt with in
United Merchants
or the $9,000,-000.00 loan dealt with in
Heller
from the facts of this case. “Here the nature of the transaction and the amount involved in it convince us that an agreement for liquidated damages was appropriate.”
Heller,
Relying on
In re A.J. Lane & Co.,
First, even though it is not stated whether the loan in
United Merchants
was a fixed interest rate loan, the court acknowledged the existence of many unknown factors which result in great difficulty to determine possible actual damages: the loss upon pre-payment of all of the interest to which the lender is entitled; the cost and expenses of procuring a substitute borrower and the attendant risk and delay involved; the applicable rate of return; the duration of the loan and the risk involved in each specific transaction; the extent and realizability of the collateral; and “other obvious uncertainties inherent in this particular contract.”
United Merchants,
Second, in order to determine the amount of a pre-payment charge that should be allowed, the A.J. Lane court suggested the following:
[T]he difference in the interest yield between the contract rate and the market rate at the time of prepayment, projected over the term of the loan and then discounted to arrive at present value.
A.J. Lane,
It is obvious that this language does not set forth a mechanical formula such that everyone applying it will arrive at precisеly the same result; but rather it is a general description of the factors to be included in a proper approach which at best may only provide an appropriate range within which a particular result may be considered appropriate. For example, the A.J. Lane court did not indicate the appropriate discount rate, which is at the heart of the dispute herein. We believe that while in general terms the formula agreed to by TNE and the Debtor comports with the general test suggested by the A.J. Lane court, the A.J. Lane test does not take into account all of the factors considered by the United Merchants and Heller courts, and thus, is not controlling in this Circuit.
*837 Taking the A.J. Lane reasoning one step further, the Debtor argues that since the actual damages are easily ascertainable using a relatively simple formula, actual damages were not difficult to determine. As we have seen, the requirements of the A.J. Lane “formula” and the additional factors required in this Circuit are far from simple. The question remains though, does the mere existence of a workable formula mandate a conclusion that damages are easily determinable? We think not.
Slight differences in formulating similar formulas will, over long periods of time and when applied to large sums of money, result in pre-payment charges of great disparity. There is no one right formula. All that exists is a long line of contingencies and factors that may be taken into account. There is, and there should be, a wide spectrum of available formulas that are designed to estimate, in any specific case, the possible actual damages. Actual damages in complicated and sophisticated transactions do not lose their character as difficult to ascertain just because formulas may serve as a useful tool to estimate them.
The mere need for a formula, and the existence of different formulas used by different lenders show that the actual loss to be incurred “may be difficult to determine.”
United Merchants,
Addressing the second prong of the United Merchants test, the Debtor neither argued nor attempted to prove that the sum stipulated was plainly disproportionate to the possible loss viewed at the time the contract was entered into.
First, the contract provides for a formula to be used in computing the charge, not for a fixed sum. Second, the Debtor argued that viewed under the current economic climate the formula would provide the lender with a windfall. However, in making such an argument the Debtor is using impermissible hindsight.
United Merchants,
In re Skyler Ridge,
There are additional important elements established by United Merchants and Heller, which mandate a ruling in favor of TNE.
Thus, when these factors are considered together with the fact that the sum arrived at was the product of an arms-length transaction between sophisticated businessmen ably represented by counsel, the sum stated for liquidated damages does not seem to be a sum plainly disproportionate to the possible loss.
Heller,
The magnitude of the loan transaction and quality and quantity of the loan documents leave little doubt that here we have an arms-length transaction between adequately represented sophisticated business
*838
men. See also,
New England Mutual Life Ins. Co. v. Stuzin,
Next, thе Debtor argues that even if the pre-payment charge were valid under New York law, it should be avoided as being “unreasonable” pursuant to 11 U.S.C. § 506(b). It argues that § 506(b) establishes a federal standard independent and apart from the state standard. See,
A.J. Lane,
As the
A. J. Lane
court indicated, some courts have adopted the federal standard approach while some apply a dual, federal and state, standard approach.
A.J. Lane,
Upon examining the content of the federal test to be applied in ordеr to determine the reasonableness of a charge, the
A.J. Lane
court adopted a formula similar to the one applied in New York. Although that court adopted the rule presented in § 2-718(1) of the Uniform Commercial Code and § 356(1) of the Restatement (Second) of Contracts,
Two factors combine in determining whether an amount is so unreasonably large as to be a penalty. The first factor is the anticipated or actual loss caused by the breach. The amount fixed is reasonable to the extent it approximates the actual loss that has resulted ... even though it may not approximate the loss that might have been anticipated ... The amount fixed is reasonable to the extent that it approximates the loss anticipated at the time of the making of the contract even though it may not approximate the actual loss.
A.J. Lane,
The Debtor has failed to meet even the A.J. Lane test in another aspect.
The greater the difficulty either of proving that loss has occurred or of establishing its amount with certainty ... the easier it is to show that the amount fixed is reasonable.
A.J. Lane,
The Debtor has nоt attempted to establish the loss incurred by TNE, much less its magnitude. The Debtor bases its argument solely on the relationship between the size of the charge and the balance due. That is far short of what it was required to show even by A.J. Lane.
In light of the above we need not decide whether the enforceability of a pre-payment charge is subject to a federal standard or a dual state-federal standard. We note, however, that we are inclined to favor the dual state-federal standard for the following reasons:
First, the federal approach line of cases was developed in cases dealing with attorneys’ fees. See,
Chase Manhattan v. Wonder Corporation,
Second, bankruptcy courts have considerable experience in assessing the reasonableness of attorneys’ fees. The bankruptcy court is required to approve the retention of attorneys and other professionals and to fix and approve their requested fees. See, 11 U.S.C. §§ 327, 328, 329, 330, 331, Fed.R.Bankr.P. 2014, 2016. The bankruptcy judge, therefore, should not have any difficulty in determining whether requested attorneys’ fees are reasonable. The same may be true with respect to usual charges involved in common transactions. Whenever a transaction can be compared with similar transactions, there should be no difficulty in determining the reasonableness of the charges involved. This is not, however, such a case. Although the transaction involved herein is not unique, it is certainly not common and not easily equated with other large real estate loan transactions. We suggest that there is no uniform federal standard that can assist us in determining the reasonableness of the prepayment charge herein. Therefore, the Debtor’s approach rejects a proper, developed and familiar set of standards and advocates instead a vacuum; a vacuum that would be filled by non-uniform and inconsistent judge-made law.
Relying on
In re Kroh Bros.,
In this case the Debtor owed TNE, as of September 30, 1991, the sum of $38,522,-267.65 consisting of $26,750,000.00 in principal, $6,670,643.04 as the pre-payment charge, and $5,101,624.61 in additional interest and late charges. The pre-payment charge represents therefore 24.9% of the principal amount due and 20.9% of the total balance consisting of principal and additional interest and late charges. While we agree that the prepayment charge is high, we do not agree that it is unreasonable.
New York State law as analyzed above provides for a fairly developed, elaborate and readily applicable method of determining the validity of pre-payment clauses. Inherent in the test applied in New York are notions of reasonableness. We do not believe that such a test should be completely ignored.
At best we are willing to view the “reasonable” standard of § 506(b) in the context of pre-payment clauses as a safety valve which must be used cautiously and sparingly as all discretionary powers that are not subject to close scrutiny and statutory standard. The situation justifying invocation of this power is not easily definable. There may be occasion where although the pre-payment charge may pass the United Merchants muster, the resulting actual charge may be so large and so unjust to the estate and its creditors, that it may be avoided based on § 506(b) reasonableness standard. We do not think, however, that this is such a case.
CONCLUSIONS
1. While the appointment of a receiver to collect rents pursuant to a perfected assignment of rents is a triggering event regarding the secured party’s rights to obtain the rents, it is not a perfection of the security interest and thus is not avoidable as preferential transfer pursuant to the еxception to 11 U.S.C. § 547(c)(5).
2. Although the appointment of a receiver to collect rents pursuant to a prior perfected assignment of rents resulted in a “transfer”, such transfer is not an avoidable transfer under 11 U.S.C. § 547(b).
*840 3.The pre-payment charge is valid and enforceable both under New York law and 11 U.S.C. § 506(b).
Notes
. See, N.Y.R.P.L. § 2(1) (McKinney 1985 & 1991 Supp.), "The terms ‘real property’ and 'lands’ as used in the first eight articles of this chapter are co-extensive in meaning with lands,
tenements
and hereditaments” (emphasis added);
Caufield v. Ford,
. If the transfer is not perfected, see 11 U.S.C. § 547(e)(2)(C).