## Facts

- A debtor in Chapter XI proceedings owned income-producing real property in North Carolina.
- William E. Butner held a second mortgage securing a \$360,000 debt but had no express assignment or security interest in rents.
- The bankruptcy court appointed an agent to collect rents and apply them to taxes, insurance, and mortgage payments.
- After the debtor was adjudicated bankrupt and both mortgages were in default, the trustee was ordered to collect and retain all rents.
- The estate later sold the properties to Butner for \$174,000, satisfied by reducing the secured debt from \$360,000 to \$186,000 rather than by a cash payment.
- By the time of sale, the trustee had accumulated nearly \$163,000 in rents.
- Butner claimed the accumulated rents should be applied to the remaining \$186,000 mortgage debt; the bankruptcy court denied the claim and treated the \$186,000 balance as unsecured.
- Under North Carolina law as understood in the litigation, the mortgagor in possession is entitled to rents and profits after default unless the mortgagee takes steps (such as obtaining a receiver or equivalent relief) to secure the rents.

## Issues

1. Whether a mortgagee’s entitlement to rents and profits from mortgaged real property during bankruptcy is governed by federal equitable principles or by the law of the state where the property is located.
2. Whether a bankruptcy court may expand or alter a mortgagee’s state-law property rights in rents solely because the debtor is in bankruptcy.

## Decision

- The Supreme Court unanimously held that, absent a specific contrary provision in the Bankruptcy Act, state law governs a mortgagee’s interest in rents and profits during bankruptcy.
- The Court rejected an independent federal equity rule that would grant or deny mortgagees rights in rents without regard to state law.
- The case was remanded for application of the governing state law to determine whether Butner was entitled to the rents on these facts.

## Legal Principles

- Property interests in bankruptcy are generally created and defined by state law; they are not recharacterized merely because the dispute arises in bankruptcy.
- Unless a federal statutory directive or federal interest requires otherwise, a bankruptcy court should determine and protect parties’ rights in property as they would exist outside bankruptcy under applicable state law.
- A bankruptcy court’s equitable powers do not authorize rewriting state-created property rights, including rights to rents and profits from mortgaged real property.
- Bankruptcy administration should avoid conferring windfalls or creating incentives for forum selection based on differing property-rights outcomes in bankruptcy versus nonbankruptcy litigation.

## Conclusion

The Court held that state law, not a federal rule of equity, determines a mortgagee’s entitlement to rents collected during bankruptcy unless federal bankruptcy law provides otherwise, and it remanded for the lower courts to apply the relevant state-law rules to the mortgagee’s claimed interest in the accumulated rents.


Butner v. United States, 440 U.S. 48 (1979)