American College of Mortgage Attorneys


Fairmont Chateau Whistler

October 2, 2004

 

 

A Critical Analysis of Recent Cases

 

Roger Bernhardt

Patrick Randolph

Dale Whitman

 

 

 

 


THE SPEAKERS

 

Roger Bernhardt

 

Roger Bernhardt is Professor of Law at Golden Gate University in San Francisco. He is the author of two California Continuing Education of the Bar books: California Mortgage and Deed of Trust Practice, and Bernhardt’s California Real Estate Cases. He is also the Editor (and commentator) of CEB’s California Real Property Law Reporter.  His other publications for attorneys include Bernhardt’s California Real Estate Codes and Deskbook of Federal Real Estate Laws.  In addition to these books for attorneys, Professor Bernhardt has also written for law students: Casebook on Real Property, Real Property in a Nutshell, The Black Letter Law of Real Property, all for West,  and also a Casebook on California Real Estate Finance.

Bernhardt is admitted to practice in the states of California and New York, and is also licensed as a real estate broker in California. He is Advisor to the Executive Committee of the Real Property Section of the California State Bar, Chair of the Legal Education Committee of the Real Property Probate and Trust Section of the American Bar Association, and a member of the American College of Real Estate Lawyers, the American College of Mortgage Attorneys, and the American Law Institute.

 

Patrick A Randolph, Jr.

 

Patrick A.  Randolph, Jr., , a graduate of Yale University and the Boalt Hall Law School at the University of California, Berkeley, is currently the Elmer E. Pierson Professor of Law at the University of Missouri, Kansas City.  He  has taught at UMKC since 1980.   He is of counsel to the law firm of Blackwell Sanders Peper Martin, Kansas City, Missouri.  He has published eight books and scores of articles on real estate topics, and  regularly appears as a speaker on real estate issues around the country.

 

Professor Randolph is particularly well known as the Editor and founder of DIRT, the internet discussion group for real estate legal  professionals. He also has just completed work on a three volume treatise:   Friedman on Leases - Randolph Edition, published by the Practicing Law Institute.  In addition to his American real estate work, he writes and speaks about real estate law in China, and has established and directs  the Peking University Real Estate Law Center in Beijing, China.

 

REALTOR magazine recently named Professor Randolph as one of the 25 Most Influential People in American Real Estate.

 

 

Dale A. Whitman

Dale A. Whitman is the James Campbell Professor of Law at the University of Missouri in Columbia MO.  He received his B.E.S. degree in Electrical Engineering from Brigham Young in 1963 and his law degree from Duke University in 1966.  After practicing for a short period with the firm of O'Melveny and Myers in Los Angeles, Whitman began his academic career at the University of North Carolina in 1967.  He was a member of the original faculty when the Brigham Young University law school was founded in 1973. He has since been a faculty member at the University of Washington (where he served as associate dean) and the University of Missouri-Columbia (where he served as dean from 1982 to 1988).  He has also been a visiting professor at the University of Tulsa, the University of Utah, and UCLA.

Whitman's principal fields of interest are property and real estate finance.  He is a co-author of five books in these areas and has also written numerous articles.  During 1971-73 he was involved with the nation's housing programs, serving in Washington with the Federal Home Loan Bank Board and the Department of Housing and Urban Development.  He was co-reporter, with Professor Grant Nelson of UCLA, of the American Law Institute's Restatement (Third) of Property (Mortgages), published in 1997. He was a member of the Executive Committee of the Association of American Law Schools from 1994 through 1997, and will serve as President of the Association for the year 2002.  He is currently a member of the Joint Editorial Board for Uniform Real Property Acts, and is the reporter for the Uniform Power of Sale Foreclosure Act, currently in the drafting stage.  He is a member of the Order of the Coif, the American Law Institute and the American College of Real Estate Lawyers, and is a Fellow of the American Bar Foundation.


 

1. Omni Berkshire Corp. V. Wells Fargo Bank, N.A., 02 Civ. 7378 ( S. D. N.Y.  2/25/04) (Reported in two parts)

I. Requirement in mortgage instrument that mortgagor acquire “all risk” policy does not obligate mortgagor to acquire all of the coverage available under an “all risk” policy at the time of the mortgage, but only to acquire insurance generally regarded as the equivalent of the “all risk” policy as traded in the marketplace at the time for acquisition of the insurance coverage.

In 1998, Plaintiffs borrowed $250 million under a mortgage loan arrangement secured by five hotels.  The borrower know that the loan was to be securitized.  Wells Fargo acted as the servicing agent for the securitization pool.  The mortgage required “all risk” insurance coverage, and the mortgagor acquired such coverage at a cost of about $360,000 for the year.  The policies included coverage for terrorism.  (Of course, “all risk” policies theoretically cover everything excepts excluded events, but in this case the policies expressly mentioned terrorism as a covered risk.)

After the events of 9/11/2001, insurance companies dropped terrorism from the policies and excluded damages from terrorism as a covered risk under “all risk” policies.  Although, in the immediate aftermath of 9/11, terrorism insurance was either unavailable or available only at astronomical prices, by the time of the dispute here terrorism insurance was commonly available under separate policies.  The lender had agreed to require only $60 million in coverage (the loan was well secured and cross collateralized by hotels in different locations) and the borrower had available to it a separate policy in that amount for an annual premium of about $316,000.  This compared with a cost of about $500,000 for standard “all risk” coverage that the borrower was also required to obtain (but which no longer included terrorism coverage.)

Although, by the time of the dispute, the federal government had weighed in with the Terrorism Risk Insurance Act (TRA), this didn’t solve the problem for several reasons.  First, the

Act requires that terrorism insurance be available, but doesn’t control the price.  Second the Act requires and facilitates  insurance only for Acts of international terrorism, and doesn’t apply to insurance against domestic terrorism.

The lender argued that the requirement for “all risk” insurance meant that the borrower was required to obtain insurance for the risks covered by such policies at the time of the mortgage covenant.

The borrower responded that the generic term “all risk insurance” means in the trade a specific “standard coverage” policy that differs from time to time, and frequently varies as to the risks that are covered.  The borrower noted that recently insurers have removed other types of risks from coverage, including mold and (even prior to 1998) Y2K problems.  Because this policy form had already been altered by insurers in the recent past, the borrower argued, the lender should have been aware that the specific coverage of an “all risk” policy is a moving target, and the lender should have been satisfied with what the market identified as the “standard risks.”

The court, on this point, agreed with the borrower, and held that “all risk” coverage requirements did not refer to the types of risks covered at time of agreement.


II. Insurance requirements clause in mortgage that compels borrower to acquire “all risk” insurance and such other insurance as “lender reasonably may request” justifies lender in requiring some level of terrorism insurance even when “all risk” polices are amended to exclude such insurance.”

Wells Fargo Bank, the servicer of this securitized mortgage pool, indicated that it serviced 3632 loans (presumably commercial loans).  Of these, 2309 had terrorism insurance.  It noted that where it represented its own interests in the loan, Wells Fargo reviewed the need for terrorism insurance on a case by case basis.  But where it represented the interests of securitized mortgage pools, Wells Fargo had a blanket policy of requiring terrorism insurance.

Despite this testimony, Wells Fargo in this case had substantially retreated from its initial position and, as of the time of trial, was requiring terrorism insurance of only about 20% of the total amount of the loan.  Note that there were five properties involved, and, even if one of them was hit directly by a terrorist attack and suffered a catastrophic loss, this likely would be only about 20% of the total security.  The borrower also noted that the loan was heavily oversecured, so that even a total loss of one property might not lead to a major loan to value problem.

The borrower argued that Wells Fargo’s requirement was demonstrably unreasonable because it was part of a blanket policy, and did not take into account the high loan to value ratio in this matter, or the fact that the added cost of terrorism insurance led to a requirement that was more than half again the cost of the “all risk” insurance that it was already required to buy.

Instead of biting on the gambit argument that this decision was not made thoughtfully, the court analyzed the question of whether the outcome of the decision, however reached, could be defended as reasonable.  It noted that the properties in question here were large hotels, and that such hotels have in the recent past either been the target of terrorist attacks directly (the Marriott attack in Jakarta) or have been collaterally damaged in the course of attacks on landmark buildings in the area of the hotel.  In fact, two hotels were destroyed or substantially damaged in the 9/11 attack on the World Trade Center.  The court further noted that many other hotel chains had acquired terrorism insurance, although it didn’t indicate whether these purchases were in response to pressure from lenders.

Finally, the court noted that the $300,000 annual cost for terrorist insurance was “reasonable,” noting that it had cost much more in the months immediately following 9/11.


2. Four Times Square Associates, L.L.C. v. Cigna Investments, Inc. (New York, 2003) 764 N.Y.S. 2d 1.

Mortgagor entitled to preliminary injunction preventing mortgage servicer from holding it in default for its failure to obtain terrorism insurance on the Conde Nast building.

The plaintiff, as holder of a ground lease on the Conde Nast building, executed a $430 million nonrecourse mortgage before September 11th that required the mortgagor to maintain insurance coverage generally available from domestic insurers at commercially reasonable premiums.  At the time of the loan’s origination, the building’s all risk coverage encompassed terrorist acts.  Following September 11th, the proposed renewal policy explicitly excluded terrorism.  The mortgage loan servicer, Cigna, declared an event of default and targeted property lockbox funds for purchase of terrorism coverage.  The plaintiff sought a preliminary injunction preventing the servicer and others from holding it in default and from invading the lockbox funds.  The trial court denied the injunction.

The Supreme Court, Appellate Division, unanimously reversed the trial court and granted the preliminary injunction on condition that the plaintiff post the security of letters of credit in the aggregate amount of $5 million to address the defendants’  threatened expenditure of between $4.5 and $5 million to purchase $400 million in terrorism coverage pending the litigation.  Despite the existence of factual questions such as whether terrorism insurance is generally available and its premiums commercially reasonable, the plaintiff had set forth a prima facie case on the likelihood of its success on the merits.  Further, the equities demanded that the plaintiff not be compelled to purchase terrorism coverage until a final determination on the contractual rights and obligations of the parties to this mortgage loan.


3. Custer v. Homeside Lending, Inc., 858 So. 2d 233 (Ala. 2003). 
 
Under a clause permitting mortgagee to require and  to “force place” insurance in such forms and amounts as it may require, mortgagee can require flood insurance in the amount of the other hazard insurance coverage held by the borrower even though this amount vastly exceeds the amount owed under the mortgage.   

Mortgagors had an old purchase money mortgage that had an initial principle amount of around $18,000 and had been paid down to around $2000.  They had their property insured by hazard insurance for $79,000, but held no flood insurance.  Indeed, their original mortgage had not required flood insurance, but did require that the mortgagor “will keep the improvements now existing or hereafter erected on the mortgage property insured as may be required from time to time by the Mortgagee against los by fire and other hazards, casualties and contingencies in such amounts and for such periods as may be required by the Mortgagee.

The National Flood Insurance Act requires federal regulators to impose upon regulated lenders the requirement that the lenders put in their mortgage agreements provisions requiring flood insurance on mortgaged properties that lie within a federally identified flood zone.  In addition, the Act permits lenders to notify borrowers that their property is within federally identified flood hazard zones and to force place insurance if the mortgagor fails to acquire such insurance.

It is not clear from the court’s statement of facts whether the borrowers property was subject to the requirements of the NFIA when the mortgage was originally written.  Later, however, the mortgage passed into the hands of Homeside, which did an audit that determined that the property was in a federally identified flood hazard zone.  It sent letters to the mortgagee asking that they arrange for their own flood insurance in the amount of the insurance that they had obtained for other hazards - around $79,000.  It was Homeside’s practice to use this figure if it was higher than the loan balance, reflecting a “assumption that a borrower would want the same amount of protection against floods as against other hazards” even if the loan balance was substantially less.

When the borrower failed to obtain the required insurance, Homeside force placed the insurance, charging an additional fee for doing this.  The total cost of such forced placement (including the insurance premium) was $717 for a year.  At the time the balance on the loan was less than $2000.  The borrowers elected to pay off the loan, but still were required to pay the pro rata portion of the annual premium plus the loan charge.  They instituted this action against the lender as a class action, alleging breach of contract, unjust enrichment, breach of implied duty of good faith and fair dealing, fraud by suppression, breach of a duty to third party beneficiaries and breach of an implied contract.

The trial court granted summary judgment and denied class certification.

Upon appeal from the summary judgment - held: Affirmed. The Alabama Supreme Court concluded that the lender was free to force place more insurance than the amount of the loan, under both federal law and Alabama contract law.

The plaintiffs cited a 1999 Louisiana case, Norris v. Union Planters Bank, 739 So. 2d 869 (A. App. 1999), which apparently held that the provision of the NFIA permitting the lender to force place flood insurance for the amount of the outstanding balance of the loan imposed not only a minimum authorization but also a cap on the amount of flood insurance that could be required.  The Alabama court, noting that this was a matter of first impression in Alabama, rejected this authority and concluded instead that the NFIA was a minimum authorization and did not limit a lender from charging additional amounts and force placing that insurance if the borrower failed to pay it.  Apparently the court was of the view that this would be possible under the “force placement” provisions of the NFIA even if there were no force placement or insurance requirement in the loan itself.  It noted that the purpose of the loan was to protect federal emergency response funds from being drained by constant uninsured flooding claims in areas known to be flood prone.

In addition, the Alabama court concluded that the specific language of the mortgage in this case was an independent basis for authorizing an insurance requirement in excess of the amount of the loan.  It cited Alabama authority to the effect that if the mortgage agreement says that the mortgagee can require insurance as it sees fit, that is how it is:

“Under the language of the mortgage [in the precedent case], the right of [the mortgagee] to fix the amount of the insurance was absolutely discretionary at any time.  It had the right to determine, unilaterally, the amount of the insurance and even had the right under the provisions of said mortgage to reduce the coverage to zero.”

Despite this strong language, however, the precedent case dealt with a claim that a mortgagee had failed to acquire enough insurance, not that it had acquired too much.  As to the claim that there was an overcharge, the court addressed this only in connection with the mortgagor’s claim that there was a “wagering contract,” - a form of insurance agreement invalid under Alabama law.  In response to this, the court noted that any insurance required in excess of the insurable interest of the party obtaining the insurance might be invalid if the party arranging the insurance got a pecuniary benefit.  Here, however, the court noted that the mortgagors would get the excess of any insurance proceeds over the amount of the mortgagee’s claim, so that there was no pecuniary benefit resulting from the proceeds.


4. RGS Contractors, Inc. v. GC Builders, Inc., 348 F.3d 897 (10th Cir. 2003).  
 
Where builder's loss insurance proceeds are used to restore project damaged during course of construction,  excess proceeds belong to contractor, and cannot be applied to mortgage debt notwithstanding language in the mortgage giving mortgagee option to apply insurance proceeds to satisfy indebtedness.   
 
Contractor and Owner entered into a construction contract to build an  apartment project.  Contractor maintained a builder's risk insurance  policy, in which Contractor was "named insured" under the policy and  Mortgagee was listed as "additional insured."  The policy, according to  the court, contained a "standard mortgage clause" that identified the  mortgagee as an insured "as its interests may appear." 
 
Prior to substantial completion, a portion of the Project was damaged by  fire.  Insurance Company paid more than was required to rebuild the  Project, including ten percent profit and ten percent overhead.  All the  parties agreed to use the proceeds to rebuild the Project.  Contractor and  Owner entered into a Memorandum of Understanding concerning how to  apply the excess proceeds, and the money was placed in escrow, pending  the outcome of binding arbitration.  Arbitrator granted the funds to  Contractor, but mortgagee refused to distribute the funds to the  contractor. 
 
A year after reconstruction was completed, Owner defaulted on the loan.  The district court held that the proceeds were subject to Mortgagee's  perfected security interest and Mortgagee was not bound by the  arbitration award because it was not a party to the arbitration and it was  not in privity with the Owner.  The Court of Appeals reversed, holding  that under the mortgage, Mortgagee had an interest in the proceeds at the  time of payment and, according to the Note, had the option of satisfying  the interest by paying down the Note or releasing the proceeds to repair  the Project.  Once the Mortgagee had agreed to repair, the proceeds were  released from the lien of the Mortgagee's security interest, and  Mortgagee's remaining interest was in the completion of the Project to  pre-fire specifications. 
 
The court noted that this result obtained because of the special nature of  the insurance policy here.  It was insurance taken out by the Contractor,  and the surplus resulted, apparently, from the fact that the insurance  proceeds included a 10 percent profit and ten percent overhead  allowance. 

5. In re Fleet National Bank v. Whippany Venture I case (In re The IT Group Inc.) (D. DE., March 16, 2004).

Secured creditor's security interest in proceeds of a real estate sale contract is not an "interest in or lien on real estate" of the kind specifically excluded from the scope of Article 9 of the UCC, but was in the nature of a general intangible interest.  Consequently, it can be "perfected" only by filing in the home state of the debtor, and if the creditor files in the wrong state because it was misled by the debtor as to the proper address, the creditor's interest is still not perfected.

The court also ruled that the debtor had failed to properly perfect its interest in the sale contract, and that "good faith reliance" on the address provided by the debtor is no defense to a failure to file a financing statement in the proper jurisdiction.

Debtor entered into a contract to sell approximately 35 acres of real property in New Jersey to Sterling.   In connection with the sale, Debtor obtained a loan from Fleet, which was evidenced by a Line of Credit Note. Debtor also executed an Assignment Agreement (which was recorded in New Jersey), whereby Debtor assigned its rights under the Sterling sale contract, including all sales proceeds. Before the sale was consummated, Debtor filed bankruptcy. The bankruptcy court subsequently approved and conducted an auction of all of Debtor's assets, subject to an escrow of funds sufficient to satisfy Fleet's claim. Debtor assumed the Sterling sale contract and assigned its rights thereunder to the successful bidder at the auction. Fleet then filed an action for "Determination and Payment of Secured Claim" and sought summary judgment.

The bankruptcy court denied Fleet's request for relief, ruling that Fleet did not have a perfected security interest in the Sterling sale contract. As a threshold matter, the court concluded that Article 9 of the UCC applied to Fleet's interest in the Sterling sale contract. (The court quoted sec. 9-104(j) of the U.C.C., which "excludes the creation or transfer of an interest in or lien on real property.") The court noted that Fleet had acknowledged at the bankruptcy court hearing that its interest was not an interest in real property but an interest in the sale proceeds, and was thereby correctly characterized as an intangible interest under the UCC.

The district court agreed with the bankruptcy court that Fleet failed to perfect its security interest as required by Article 9-103(3)(b) of the UCC, which governs the perfection of a security interest in general intangibles and provides, in pertinent part, "the law (including the conflict of law rules) of the jurisdiction in which the debtor is located governs the perfection ... or nonperfection of the security interest."  The court noted that the location of a debtor maintaining multiple places of business is the debtor's chief executive office. (As the comments to the U.C.C. explain, the term "chief executive office" means the place from which the debtor manages its business operations). The court further noted that this analysis applied under both Colorado and New Jersey law. The court concluded, based on the facts in this case, that Fleet was required to perfect its security interest in Colorado, because the debtor's chief executive office was in that state. In reaching this conclusion, the court stated that "the Bankruptcy Court correctly considered the manner in which Whippany managed its business and examined this issue from the perspective of where a creditor would normally look for credit information on the debtor. (citation omitted). The Court agrees with the Bankruptcy Court's conclusion, in light of the factual circumstances in this case, that Fleet was required to file its financing statement in Colorado to perfect its security interest."  Furthermore, according to the district court, "the question is not where the main part or main asset of the debtor's business is located, but rather, from where the main part of the debtor's business is managed. . . . [H]ere, the main business of the debtor is the management of real estate."

The district court held that a secured creditor is not excused from the filing requirements for perfecting a security interest as a result of the creditor's error in filing its financing statement in the wrong jurisdiction, even where that creditor's error was based on its good faith reliance on the address provided by the debtor. The court ruled that public policy supports the conclusion that the correct location for filing should not turn on the private representations of the parties, but on the public and objective information available to all creditors concerning where the debtor manages its business. At the time of the transaction, counsel for the debtor issued an opinion letter directed to Summit Bank, the predecessor in interest to Fleet, stating (erroneously) that perfection of the security interest required filing of the requisite statements with the Office of the Department of the Treasury of New Jersey (where the collateral was located).

Fleet filed its financing statements in New Jersey, consistent with the opinion letter rendered by the debtor's counsel. The district court noted that, "[w]ith respect to the opinion letter specifically, Fleet contends that the Bankruptcy Court's decision will have a chilling effect on commercial lending practices, because lenders will be less likely to make loans if they cannot rely upon the four corners of an opinion letter." The debtor responded that "Fleet cannot perfect its interest through an opinion letter, and the opinion letter never gave an opinion on perfection of interests." As to the relevance of reliance on the opinion letter, the district court agreed with the Bankruptcy Court that the opinion letter was not dispositive on the issue of location for filing. According to the district court, "As courts have recognized, a secured creditor is not excused from the filing requirements for perfecting a security interest as a result of the creditor's error in filing its financing statement in the wrong jurisdiction, even where that creditor's error was based on its good faith reliance on the address provided by the debtor."


6. Bank Midwest, Minnesota, Iowa N.A. v. Lipetzky,  2004 Minn. LEXIS 4 (Minn. 1/15/04).  
 
Mortgaging of the interest of a installment contract purchaser is a “transfer of [the] property” within the meaning of a due on transfer clause in the contract.   

The court takes pains to tell us that this particular contract for deed involved the transfer of a family farm from one generation to the next, and that the contract price was for less than half the appraised value.  Unfortunately, the court never makes anything of these facts, and its holding certainly is not limited to that special situation.

The caption above says it all.  The contract’s anti-transfer clause stated:  "Buyer [sic] agrees they cannot sell, transfer or assign this property without written permission or consent of seller."

The contract also prohibited prepayment of any kind for seven years.  After five years, the buyers entered into several mortgages of their interest to secure substantial loans.  In addition, in connection with the last mortgaging, the borrowers also assigned their interest in the contract for deed as “additional security.”

Originally, there seemed to be some judicial interpretations that even if the mortgages didn’t violate the clause, the assignment for security did.   Ultimately, in the final iteration of the case, however, the trial court concluded that the simple mortgage of the interest violated the clause.  [The editor fails to see why there should be any distinction.] The court of appeals disagreed, holding that the grant of a mortgage is not a "transfer." The rationale of the appeals court was based upon the Minnesota statute establishing the lien theory of mortgages in that state, which declares that a mortgage is not a “conveyance.”

The Minnesota Supreme Court reversed the Court of Appeals and reinstated the trial court opinion.  In the last line of the decision, the court states that, since the “anti-transfer” clause applies, the “mortgage is invalid.”  We are not told enough about the trial court decision to know whether the court really means what it says - that the mortgage itself is invalid and the buyer’s interest intact, or whether the court simply is stating that the seller had the remedy to declare the buyer’s contract interest under the contract forfeit, and the mortgage fell with the interest to which it was attached.


7. Valente v. Fleet Nat’l Bank, 2004 WL 383367, (1st Cir. 3/2/04).

Despite adoption of Uniform Fraudulent Conveyances Act, state common law still will set aside fraudulent conveyances using resulting trust theory and other equitable theories even in cases where the Uniform Act would not apply.

Bank foreclosed on certain property owned by Valente and secured a deficiency judgment for about $10,000.  An execution order on this judgment levied all real and personal property of the debtor located in the town of Middleton, and was recorded there.

During the course of the foreclosure proceeding, Valente had owned other property in Middleton that was subject to a mortgage lien with another lender in an amount in excess of its value.  There were also a state tax lien and an IRS lien on the property.  One year prior to the judgment in the foreclosure action and the  recordation of the execution levy described above,  Valente had transferred the property to his son, pursuant to an agreement by which Valente continued to live on the property.  Although Valente offered an “estate planning” explanation for this, his own son stated that the motive for the transfer was that his father “was trying to scam somebody or beat somebody, I don’t know, it wasn’t out of the generosity of his heart.  The trial court and appellate court together concurred that the intent was fraudulent.

Soon after the filing of the execution levy,  Valente filed for bankruptcy, not listing the property in question, where he lived, as part of the bankruptcy estate.  In the course of the bankruptcy both government liens were cancelled. Bank did not list the debt as a claim in the bankruptcy proceeding.  The court commented that this had no impact on the validity of its claim under the levy, however.  In 1994, Valente obtained a discharge.

Over the next few years, Valente operated a business on the Middleton property, and eventually leased it out in his own name, and collected and kept the lease revenues.  Thereafter, he induced his son to transfer title back to him so he could sell the property.  The son complied, and Valente indeed did sell the property, netting a profit over the mortgage lien, as the property had risen in value over the years.  But at closing, a title search disclosed the levy of Bank, and in order to close, the parties stipulated that $18,000 would be held out to cover the current balance on the lien.

Even after the $18,000 was held out, Valente recovered $24,000 after paying the costs of closing and clearing the mortgage.  Guess what?  The son didn’t get a penny.

Then Valente reopened his bankruptcy to try to recover the $18,000 that was still being held in escrow.  He claimed that the lien of the collection levy did not apply to this property, as he did not own the Middleton property when it was filed.  He then claimed that any other rights of Bank had been discharged as part of his general discharge, and sought to have Bank held in contempt for attempting to collect a discharged debt.  Despite the brazenness of Valente’s conduct, the trial court regretfully concluded that Valente had a point.  Reviewing Rhode Island’s Uniform Fraudulent Conveyance Act, the court concluded that it only permitted the setting aside of fraudulent transfers of property in which the debtor had some equity.   At the time Valente transferred the Middleton property to his son, the property was well under water.  The property did not qualify as an “asset” under the Act, and thus was not subject to the operation of the fraudulent conveyance remedies the Act provides.

The Court of Appeals agreed with the interpretation of the Uniform Act, but reversed anyway, concluding that the cat could be skinned another way.  It stated that the adoption of the Uniform Act did not preclude application of the common law concept of fraudulent conveyances that had applied in Rhode Island before the adoption of the Act.  It noted that the Rhode Island courts had used the device of resulting trust to find an interest in a debtor who had arranged for property to be transferred to related parties in order to disguise it from creditors.  Such tactics fell “below the radar” of the state fraudulent conveyance statute existing at the time, since there was no “transfer” by the debtor.  But the courts granted common law relief to the creditors nonetheless.  The court also cited cases in the First Circuit, involving other state’s laws, where the court had found constructive trusts in order to protect creditor’s claims from fraudulent devices.  In these cases, the state’s fraudulent conveyance statute did not apply.

The court cited a 1927 Rhode Island case that recognized an equitable interest in the form of a resulting trust arising where a husband arranged for property to be transferred to his wife.  It concluded that this case provided authority for recognizing a resulting trust in a case like this one as well:

the [precedent case] effectively imposed a resulting trust by holding that an attachable interest is created "when a conveyance for the purpose of defrauding creditors is made of the legal title to real estate without any intention of passing the beneficial interest therein."

As Valente clearly retained all the benefits of ownership in the instant case, he also was viewed as being the beneficiary of an equitable resulting trust.  The Bank’s levy attached to this interest at the time that it was filed, and remained a valid levy through the bankruptcy.

The court noted that normally the concept of resulting trust is used to effectuate the plan of a party in transferring property, rather than to undermine a fraudulent scheme.  But it said that the use of the device in a case like this one is a well established exception to the ordinary use of the constructive trust.

Although there was no value in the property at the time that the levy has filed, this didn’t prevent the Bank from enjoying the benefit of a lien on Valente’s equitable beneficial interest.  Ultimately, of course, the trust asset increased in value and provided a basis for the Bank’s claim.  Although this occurred only after a significant passage of time, the court held that the applicable statute of limitations for the Bank’s claim was the ten year statute of limitations for fraud, and not the shorter limitations period under the Uniform Act, since the Act had no application here.


8. Houston v. Bank of America, 2003 Nev. LEXIS 69 (Nev. Sup. Ct., Oct. 28,  2003).

Where a bank lender refinances a loan and pays off the prior note after a writ of attachment has been recorded against the property, the bank will nonetheless be equitably subordinated to the position of the original lender where there was no evidence of prejudice and the intervening party would be in no worse position because the bank had paid off the prior deed of trust.

Appellants, husband and wife, filed a complaint against Boone based on conversion of $740,000 they had transferred to him in his capacity as their investment advisor. At approximately the time this action was filed by the appellants, Boone and his wife obtained a divorce and Boone quitclaimed his interest in certain real property owned by him to his wife as part of the divorce settlement. The appellants recorded a lis pendens against the property on June 1, 1998 and subsequently obtained a prejudgment writ of attachment against the property, which was recorded on June 26, 1998.

Subsequently, a bank refinanced the property and recorded a mortgage from Mr. Boone's wife on June 26, 1998 (apparently right after the appellants' writ of attachment was filed and recorded in the county recorder's office). The appellants ultimately obtained judgment on their action against Boone. Mr. Boone then filed for bankruptcy, but acknowledged that the money he owed the appellants was a nondischargeable debt. The lower court directed a writ of execution against the property and scheduled a sale. The bank brought an action to enjoin the sale, which the lower court granted (the lower court further granted summary judgment in favor of the bank on its equitable subrogation claim).

The bank had hired a local title company to conduct a search of the property, which search was conducted on May 29, 1998, more than one month before the bank refinanced the loan. The bank argued that it had succeeded to the priority position of the original lender, but the appellants argued that the bank was negligent in failing to discover its interest and that they would suffer an injury if the bank were permitted to succeed to the interest of the prior lender. (The Nevada Supreme Court noted, however, that "the [appellants] did not provide the district court with the terms of the former deed of trust or any other evidence of prejudice.")

The Nevada Supreme Court affirmed the holding of the lower court. The Nevada Supreme Court noted initially that, "We have previously applied the doctrine of equitable subrogation, but not in the context presented by this case."

The court then described the "three different approaches" to equitable subrogation adopted by other courts (citing numerous cases in support of each position), to-wit:

1) The "majority rule," i.e., that "actual knowledge of an existing lien precludes the application of equitable subrogation, but constructive knowledge does not." However, the court refused to adopt this approach, finding that it "promotes willful negligence and encourages prospective mortgagees to avoid conducting title searches."

2) Prohibiting a party from invoking the doctrine when "a lien holder possesses either actual or constructive notice of an existing lien." The court also declined to adopt this approach, reasoning that equitable subrogation is an equitable doctrine and that even if the refinancing lender had actual or constructive knowledge the intervening creditor/lienholder would receive an "unjust windfall," and also finding that the lender still should reasonably expect to "step into the shoes" of the lender whose loan it paid in full.  The court stated (somewhat surprisingly) that, "Neither negligence nor constructive notice of an existing lien is relevant to whether the junior lien holder will be unjustly enriched or prejudiced."

(The court notes, in a footnote, that "some courts hold a sophisticated party [presumably an attorney, or a bank] to a higher standard in determining whether to apply equitable subrogation.")

3) The view adopted by the Restatement (Third) of Property, Mortgages, i.e., the approach that "disregards actual or constructive notice if the junior lien holder is not prejudiced." According to the court, "Because the "Restatement approach is the most persuasive, we adopt the view expressed by it."  The court ruled that notice of an intervening lien (either actual or constructive) is simply irrelevant except only where there is proof that the lender specifically intended that the lien of the refinancing mortgage be subordinate to the intervening lien/judgment. The court agreed with the Restatement comment that in such a case the intervening lienholder would be no worse off and remain in the same position as if the original mortgage were still in place.

The Nevada Supreme Court noted that the lower court had found specifically that the bank had paid off the prior mortgage with "the intention and belief" that it would succeed to the position of the original lender. The court stated that "the record does not contain any evidence that [the bank] intended to subordinate its mortgage to the [appellants]."

The court further noted that the appellants had not offered any evidence that they would be prejudiced by permitting the bank to succeed to the priority position of the first loan; the appellants had not even provided the court with the terms of the prior loan to ascertain if there were any substantial modifications in the new loan that could materially prejudice the appellants. The court did, however, state that because the bank's loan was $5000 more than the amount of the prior mortgage, the bank was not entitled to equitable subrogation in excess of the amount of the original loan. The court also found that although (as a result of Mr. Boone's divorce) the mortgagor changed from Mr.Boone to Mrs. Boone, no evidence was presented that this change resulted in any prejudice to the appellants.


9. Dressell v. Americabank, 2003 Westlaw 21456614 (6/24/03).

Preparing standard form legal documents, including residential mortgages, does not constitute the "practice of law" and therefore lender is free to charge a fee for this practice.

This case reverses a Court of Appeals opinion that was the DIRT DD for 10/19/01, which engendered a great deal of attention because it was a class action suggesting that lenders would be liable for the practice of charging borrowers a fee for the preparation of legal documents - the note, mortgage, etc., used in documenting the borrowers' loans.  The Court of Appeals had held that these fees were levied for a service provided to the borrower, and that they were invalid because the service - the preparation of legal documents, constituted the "practice of law" and, of course, banks are not and cannot be licensed to practice law.  The Michigan Supreme Court adopts with approval the opinion of the trial court, Judge Kolenda, in defining what constitutes the "practice of law" in the drafting of legal documents (or, more importantly, what does not).  Judge Kolenda holds that the practice of law does not include: "drafting 'the ordinary run of agreements (used) in the every day activities of the commercial and industrial world.

“Legal training and knowledge are not necessary to properly compose them.  Drafting simple documents, which drafting does not entail giving advice or counsel as to their legal effect and   validity, is not the practice of law .  Specifically, the preparation   of ordinary leases, mortgages and deeds do not involve the   practice of law.  They have become 'so standardized that to   complete them for usual transactions requires only ordinary   intelligence rather than legal training.'  To insist that only a   lawyer can draft such documents would impede numerous   commercial transactions without protecting the public, i.e.  would   not further the purpose of restricting the practice of law to trained   and licensed attorneys." The Supreme Court stated that "a person engages in the practice of law when he counsels or assists another in matters that require the use of legal discretion and profound legal knowledge."  The court noted that in the case at hand the defendant's employees did not in fact draft legal documents, but simply filled in blanks in standard form agreements prepared "by the federal government."  (Apparently the court was thinking of FNMA and FHLLMC, which are not the federal government except when the seek the advantage of government relationships.)    "The bank did not counsel plaintiffs with regard to the legal   validity of the document or the prudence of entering in to the   transaction.  In general, the completion of standard legal forms   that are not available to the public does not constitute the practice   of law.'

A concurring opinion balked at the notion of attempting to define law practice generally, and would have limited the opinion simply to concluding that the present actions did not constitute the prohibited practice of law.


10. LaSalle Bank v. Mobile Home Properties, LLC, 2004 U.S. Dist. LEXIS 14401 (D. La., July 27, 2004), (Reported in two parts)

I.  A "defeasance fee" may be imposed on a mortgagor in default when the mortgagee accelerates the payment of the debt and the mortgagor did not "voluntarily" prepay the mortgage before the maturity date, even where the loan documents do not expressly provide for a defeasance fee in the event of acceleration and foreclosure following default..

LaSalle, acting as a trustee for a securitized loan, accelerated the loan and foreclosed on the property as a consequence of a variety of defaults by the borrower. LaSalle completed its foreclosure of the hotel - with the express consent of MHP and Columbus - with a winning credit bid of $6.9 million, and gave MHP a credit for this amount. (LaSalle eventually resold the hotel for $2.1 million.) LaSalle then demanded payment of a deficiency of approximately $3.1 million, which included "a yield maintenance premium and defeasance fee totaling $2,161,484.00."  (The remaining amount included late fees, default interest, attorney's fees, and other costs and expenses.)

MHP then commenced a declaratory action, claiming inter alia  that it did not owe the yield-maintenance fee and prepayment premium because there was no "voluntary" payment.

MHP argued that the yield-maintenance/prepayment fee was only payable, under the clause in the mortgage note, if it "voluntarily" prepaid the note and not if it defaulted (leading to an acceleration and prepayment through foreclosure).  The court didn't buy this argument, noting that while the note provided that the borrower could repay the note (or release the property from the mortgage lien) prior to the "defeasance option" date set forth in the mortgage, the mortgage stated explicitly the terms and conditions for the release of the property prior to such date "if no default exists." Moreover, the court noted, the note itself further provided that if MHP tendered prepayment of the mortgage loan prior to the defeasance option date, and following the occurrence of any Event of Default," such tender would be deemed voluntary and would require payment of "the yield maintenance premium, if any, that would be required under the Defeasance Option."

The court acknowledged that the loan documents were silent regarding the specific issue of whether payment of the prepayment/defeasance fee would be due if MHP simply defaulted and made no attempt to pay the fee prior to foreclosure. But the court noted that Alabama follows the "majority rule," i.e., "even if the loan documents are silent regarding prepayment, the borrower has no right to repay the mortgage note without payment of unearned interest." The court noted that the imposition of a yield maintenance premium is intended to provide an uninterrupted stream of income of replacement income to lenders equal to the lost interest payments occurring as the result of the borrower's prepayment of the loan, thereby protecting mortgage lenders against the loss of a favorable interest yield. According to the court, the yield-maintenance/defeasance premium "is in effect a payment of the unearned interest due to the lender," and that  "to conclude otherwise would be to reward a borrower who defaults and makes no effort to pay its debt by relieving the borrower of its additional obligations under the loan documents." The court also noted that both MHP and Columbus had consented to LaSalle's foreclosure of the hotel, and that it "construes that consent as a voluntary transfer of a payment of the debt in the form of the mortgaged property in satisfaction of the lien, although not an amount sufficient to pay the debt in full." The court also found to be reasonable the amounts imposed on MHP with respect to late fees, default interest, attorney's fees, and other costs and expenses.


II. Provision in securitized loan transaction stating that borrower will lose benefit of non-recourse protection if it alters its corporate structure so as to lose its "single purpose" status is upheld.

Mobile Hotel executed a promissory note to the LaSalle Bank (as trustee for investors in the loan, which had been securitized), secured by a mortgage on a hotel in Mobile, Alabama, which was operated as a Ramada Inn. Mobile Hotel subsequently delegated the obligations under the loan to Mobile Hotel Properties ("MHP"), a limited liability company. To induce LaSalle to agree to the delegation, Columbus Hotel Properties ("Columbus,") as the sole member of MHP, guaranteed the loan.

Columbus then proceeded to make unauthorized cash advances (eventually exceeding $4 million, evidenced by an unsecured promissory note) to MHP, and ceased making mortgage payments under the loan. Making a bad situation worse, MHP then proceeded to amend its operating agreement (again in violation of a specific mortgage covenant) to provide that MHP was no longer a single-purpose entity and could engage in "any lawful activity." Having seen enough, LaSalle commenced a foreclosure proceeding (which was briefly interrupted by MHP's bankruptcy, which was subsequently dismissed).

LaSalle completed its foreclosure of the hotel - with the express consent of MHP and Columbus - with a winning credit bid of $6.9 million, and gave MHP a credit for this amount. (LaSalle eventually resold the hotel for $2.1 million.) LaSalle then demanded payment of a deficiency of approximately $3.1 million, which included "a yield maintenance premium and defeasance fee totaling $2,161,484.00."  (The remaining amount included late fees, default interest, attorney's fees, and other costs and expenses.)

MHP and Columbia sought a declaratory judgment  that the change in MHP's LLC articles of organization was not material and did not trigger a "full recourse" obligation under the loan documents as provided in the loan documents as a result of the unauthorized amendment.

The court ruled that although the loan was non-recourse to MHP, the carveout in the mortgage (and note) providing that the loan would become fully recourse to MHP if it failed to maintain its status as a single purpose entity was fully enforceable, as the result of MHP's breach of this covenant. The court ruled that the carveout language was specific and unambiguous (and not just "boilerplate"), and that the fact that MHP continued to "operate" as a single purpose entity was irrelevant. (The court found that MHP's motive for making the change was also irrelevant.) According to the court, "the language of the mortgage means what it says." Although LaSalle alleged that MHP had also breached several other warranties and covenants under the loan documents, the court found it unnecessary to discuss these additional violations because of its holding that the loan had become fully recourse because the breach of the "single purpose entity" covenant alone was sufficient to trigger the full recourse provision of the loan documents.

Finally, the court summarily rejected the argument of Columbus, as guarantor of the loan, that it should not be held liable because it did not receive notice of MHP's default. The court pointed to the language in the Guaranty executed by Columbus whereby it "irrevocably and unconditionally" guaranteed the debt and all of MHP's obligations thereunder, which the court reasoned necessarily included MHP's obligation to maintain its SPE status. The further noted that the Guaranty stated that Columbus waived notice of any default or breach my MHP, and contained no right on the part of either MHP or Columbus to receive notice of a breach by MHP that would trigger the full-recourse obligations of MHP or Columbus.


11. Aozora Bank, Ltd. v. 1333 North California Boulevard, 2004 Cal. App. LEXIS 1033 (June 29, 2004).

Attorney fees relating to tortious waste claim are not available where non-recourse carveout excepts liability for waste, but does not specifically mention attorney's fees for tort claims based upon waste.

This case is an interesting postscript to Nippon Credit Bank, Ltd. v. 1333 North California Boulevard, 86 Cal. App.  4th 486 (2001), (the DIRT DD for 1/29/01). In the Nippon case the court affirmed a jury verdict  that the borrower partnership and its general and managing partners were guilty of the tort of bad-faith waste for failure to pay real estate taxes while the nonrecourse mortgage was delinquent.   See John C. Murray, Nonpayment of Taxes as Tortious Waste in Nonrecourse Mortgage Loans, 19 Cal. Real Prop. J. 22 (Spring 2001) (reviewing case law, including Nippon, supra, finding that mortgagor's nonpayment of real estate taxes constitutes actionable waste under contractual or tort theory).

The California appellate court here ruled, however, that the bank lender (now known as Aozora Bank Ltd.,, which was the beneficiary of the court's ruling, was not entitled to attorneys' fees under the contractual language in the loan documents.

The jury at the trial court level had found the defendants liable for approximately $395,000 in compensatory damages and $8,333,333 in punitive damages. But the trial court remitted the amount of punitive damages to $1.6 million. The appellate court (in an unpublished portion of the opinion) upheld the remittur of punitive damages and the order for new trial on the amount of punitive damages only. At the second trial, in which the jury awarded no punitive damages to the bank, the bank moved for an award for the attorney's fees it incurred in the case, in the amount of approximately $1, 434,000. The trial court approved this request by the bank, which included a 1.5 multiplier for "the complex and cutting edge nature of the issues litigated." The borrower then appealed this ruling to the appellate court.

The appellate court reversed the trial court's determination that the bank was entitled to attorney's fees under the contractual language in the loan documents. The court first noted that attorney's fees are not generally available to prevailing parties in tort actions, citing applicable California statutes and case law.  According to the court, "Since there is no statutory or other legal authority for an attorney fee award in this instance, Bank's entitlement to fees hinges entirely on the terms of the parties' contract."

Turning to the contractual language, the court rejected the bank's argument that the borrower was liable under the general attorney's fee provisions contained in the note and mortgage. According to the court, "even if those provisions extended to the fees in question, the Partnership would not be liable for them unless such liability was excepted from the nonrecourse feature of the note and deed of trust," i.e., if the carveouts did not expressly include liability for attorneys' fees, they would only be recoverable from the real estate collateral.

The applicable nonrecourse carveout in the note and deed of trust stated that, "nor shall such limitation of liability apply if and to the extent that [Borrower/Trustor] . . . commits fraud, material representation or waste." The court seized on this language to find the following reasons to reject the trial court's determination that it was broad enough to make the borrower partnership liable for attorney's fees as well as waste damages: (1) the carveout did not specifically refer to attorney's fees, and would not be implied because attorney's fees generally are not awarded in tort actions; (2) given the importance of this issue, which the court noted is one of the key concerns of lenders when negotiating nonrecourse carveouts, "it is unlikely that the carve-out would be silent on attorney's fees if they were intended to be included" (the court noted the uncontradicted testimony of an expert who testified that carveouts were "always expressed, and never implied"), and (3) because the carveout only applied "if and to the extent" that waste was committed, this undercut the bank's argument that the carveout entirely negated the nonrecourse aspect of the agreement when waste is committed. The court summarized by stating that, "the most reasonable reading of the agreement is that the waste carve-out does not implicitly include attorney's fees for prosecuting a waste action. As a consequence, recovery of these fees from the Partnership is barred by the nonrecourse provisions of the note and deed of trust." .

The appellate court also dismissed the bank's argument that if it were precluded from obtaining attorney's fees, it would "void the general purpose" of the general attorneys' fees provisions in the note and mortgage but the borrower would be able to invoke the attorney's fees clause against the lender, thus violating the California statutory provision (Cal. Civ. Code Sec. 1717) that makes attorney's fees clauses reciprocal. The court responded that because the partnership borrower was not the prevailing party in the case, it need not decide the issue of reciprocity, and that the bank still could benefit from the attorney's fees provisions of the note and deed of trust even though the loan was nonrecourse, because it could recover such fees from the mortgage security and add them to the amount required to reinstate the loan or add them to the amount of a credit bid at a foreclosure sale. The court stated that, "If bank wanted additional recourse against the Partnership personally i
t should have negotiated for an attorney fee carve-out in the loan documents."

Finally, the appellate court rejected the bank's argument that it was entitled to attorney's fees as well as waste damages under the reasoning of the court's prior ruling in this case. The appellate court noted that the bank had sued in tort, not under the contract, and had never mentioned the waste carveout. The court stated that, "our analysis was focused on whether the evidence in the first trial supported a bad faith finding," and "[w]e had no occasion in the prior appeal to consider the nonrecourse provisions of the note here - they plainly include a carve-out for waste damages, and no issue was made of them."