Indiana Commercial Foreclosure Law

Does A Guarantor’s Bankruptcy Stop A Foreclosure Case Against the Borrower?

Sometimes when secured lenders file suit to enforce a note and a guaranty and to foreclose a commercial mortgage, the guarantor (but not the borrower) files a bankruptcy petition.  Pursuant to 11 U.S.C. 362, the collection action, as to the debtor (the guarantor), is stayed.  Some wonder whether the entire case is stayed. 

Borrower idle.  The defendant borrower may not seek bankruptcy protection, for example, if it is a single-asset entity with no value beyond the real estate and whatever cash may be generated by the real estate.  In other words, there are no assets to protect beyond the loan collateral, the value of which may not cover the debt and the collection costs.  So, while the borrower essentially throws in the towel, the guarantor runs for cover in bankruptcy court.

The issue.  The question is whether the bankruptcy stay applies only to the guarantor or whether it extends to the borrower.  The answer, generally, is no, despite the confusion that sometimes arises out of this situation.  Meaning no disrespect to state court judges, but because they rarely deal with bankruptcy issues, they sometimes conclude, perhaps intuitively, that a bankruptcy filing by one defendant will stay the case as to all defendants, at least until the bankruptcy court orders otherwise.  To be fair, this scenario has puzzled lawyers and lender reps too (including me).

General rule.  In Pitts v. Unarco Industries, Inc., 698 F. 2d 313, 314 (7th Cir. 1983), the Seventh Circuit, which includes Indiana, stated that “the clear language of Section 362(a)(1) thus extends the automatic stay provision only to the debtor filing bankruptcy proceedings and not to non-bankrupt co-defendants.”  This is because the language in Section 362 “unambiguously states that the stay operates only as ‘against the debtor.’”  Id.; 555 M Manufacturing, Inc. v. Calvin Klein, Inc., 13 F. Supp. 2d 719 (E.D. Ill. 1998); Federal Land Bank v. Stiles, 700 F. Supp. 1060, 1062-63 (Mon. 1988) (noting generally that stays pursuant to Section 362(a) are limited to debtors and that there are no special exceptions for circumstances involving a co-defendant who is jointly liable on a debt with the debtor). 

LLC’s.  The United States Bankruptcy Court for the Northern District of Iowa in In Re Calhoun, 312 B.R. 380 (N.D. Iowa 2004) addressed the issue of who was covered by the automatic stay.  An individual debtor had sought Chapter 7 bankruptcy relief.  The debtor, however, had an interest in a limited liability company (an LLC).  In Iowa, not unlike Indiana, an LLC is an entity separate and distinct from its members and managers.  The Court held that the automatic stay did not apply to the LLC.  “The separate legal existence of a corporation is respected in bankruptcy.  The automatic stay does not stay actions against separate entities associated with the debtor.”  Id. at 384.  The bankruptcy court concluded, therefore, that only the named petitioner (debtor) is protected by the automatic stay.  “None of the LLCs referred to are parties to the bankruptcy.  They are not proper parties and not protected by the provisions of the automatic stay.”  Id. at 384-385.  See also, In Re Merlyn L. Johnson, 209 B.R. 499, 500 (Neb. 1997) (a creditor generally is permitted to sue a guarantor or a co-debtor and to collect from property of a third party that is pledged to secure debts of the debtor).

Proceed.  Thus the law seems to be clear that, in general, a second lender should be permitted to proceed to judgment against a borrower and to foreclose on a borrower’s mortgage.  Note that courts recognize limited exceptions to this general rule, not to mention the fact that the guarantor could seek an order from the bankruptcy court to extend the stay to the borrower.  There are “special circumstances” that may permit the extension of the stay, but the onus should be on the guarantor or borrower to prove them.  (A couple of recognized exceptions that the guarantor or borrower might seek to prove are, first, where the relationship between the debtor and the third-party defendant is such that a judgment against the third-party defendant will effectively be a judgment against the debtor and, second, where the litigation against the third-party defendant would cause “irreparable harm” to the debtor or estate.)  Otherwise, as long as the plaintiff secured lender and its counsel provide notice to the parties of the intention to proceed with foreclosure despite the bankruptcy filing, the plaintiff lender should be free to continue with the foreclosure case.  Thanks to my bankruptcy colleague, Chris Jacobson, for her insights.

Is The Label “Indiana Lender Liability Act” A Misnomer?

In the past, I’ve heard things from secured lenders like:  “you don’t see any exposure to our bank under the Lender Liability Act, do you?” or “surely the borrower won’t countersue us under Indiana’s lender liability statute.”  People are sometimes surprised to learn that the so-called “Indiana Lender Liability Act” (“ILLA”), Ind. Code § 26-2-9, doesn’t list claims or causes of action that can be asserted against a lender.  The ILLA primarily deals with the issue of evidence, specifically the inadmissibility of oral testimony about the terms of a loan.  (Interestingly, the statute’s official title in the Indiana Code is “Credit Agreements.”)  The definitive ILLA case is Sees v. Bank One, 839 N.E.2d 154 (Ind. 2005) (Sees.pdf).  Somewhat amusingly, the Indiana Supreme Court itself struggled with the label: 

In the first reported opinion discussing the statute since its 2002 re-codification, the Court of Appeals refers to it as the “Indiana Lender Liability Act.”  . . .  Sees refers to the statute alternatively as the “Indiana Lender Liability Act” and the “Credit Agreement Statute.”  . . .  Bank One refers to the statute as the “Credit Agreement Statute of Frauds.”  . . .  We agree with the Court of Appeals’ designation and thus refer to the statute as the Indiana Lender Liability Act.

Lender liability, generally.  It is true that “lender liability” is a common phrase used to describe a borrower’s potential claims against a lender due to the conduct of the lender with regard to a particular loan relationship.  Capello & Komoroke, Lender Liability Litigation: Undue Control, 42 Am. Jur. Trials 419 § 1 (2005).  This body of law comprises a wide variety of both statutory and common law causes of action.  One of many examples is the Fair Debt Collection Practices Act.  There are, in fact, a multitude of federal and state laws that could form the basis of a lawsuit against a lender.  The ILLA is not one of those laws, however. 

The ILLA rule.  The essence of the ILLA can be found in section 4, which provides that “a [borrower] may assert a claim . . . arising from a [loan document] only if the [loan document] . . . [1] is in writing; [2] sets forth all material terms and conditions of the [loan document] . . . ; and [3] is signed by the [lender] and the [borrower].”  The ILLA effectively protects lenders from certain kinds of liability.  That’s why the label “Lender Liability Act” seemingly is inconsistent with the law’s true nature. 

Statute of frauds.  Sees provides an excellent discussion of the statute, its history and its policies.  In a broad sense, the legislative intent behind the statute is to protect lenders from lawsuits by borrowers (or guarantors) asserting fraudulent claims.  Hence the “in writing” requirement in the ILLA.  As such, the ILLA actually is a “statute of frauds,” which at its core is a procedural law about the exclusion of certain testimony of a witness at trial.  Black’s Law Dictionary defines “statute of frauds” as “. . . no suit or action shall be maintained on certain classes of contracts or engagements unless there shall be a note or memorandum thereof in writing signed by the party to be charged . . ..”  As noted by Judge Posner in Consolidated Services, Inc. v. KeyBank, 185 F.3d 817 (7th Cir. 1999):

 [T]he principle purpose of the statute of frauds is evidentiary.  It is to protect contracting or negotiating parties from the vagaries of the trial process.  A trier of fact may easily be fooled by plausible but false testimony to the existence of an oral contract.  This is not because judgment or jurors are particularly gullible, but because it is extremely difficult to determine whether a witness is testifying truthfully.  Much pious lore to the contrary notwithstanding, ‘demeanor’ is an unreliable guide to truthfulness.

Be a wise guy.  Next time someone asks you whether your commercial lending institution may have exposure to a lawsuit or a counterclaim based on Indiana’s Lender Liability Act, you can explain to them that the ILLA does not really articulate any theories of liability.  Rather, the ILLA limits breach of contract actions to the terms of the loan that are memorialized.  Again, this is not to say that there is no “lender liability” in Indiana.  The generic term “lender liability” is proper when referring to the many possible claims of wrongdoing that exist.  In short, lenders can be exposed to liability, but they shouldn’t be held liable in Indiana for any alleged violations of loan terms unless such terms (promises or duties) are in writing, signed by all parties. 

Factual Questions Remain In Indiana Fraudulent Transfer Case

A secured lender’s efforts to collect a debt can from time to time evolve into a cause of action for fraudulent transfer.  As noted by the Indiana Court of Appeals in its May 20, 2008 decision in Hoesman v. Sheffler, 2008 Ind. App. LEXIS 1031 (Ind. Ct. App. 2008), “the purpose of a fraudulent transfer claim is the removal of obstacles which prevent the enforcement of the judgment … [and, if successful,] will subject the [transferred] property to execution….”  For secured lenders, normally a fraudulent transfer claim will come into play, if at all, when a lender is attempting to enforce a deficiency judgment. 

Underlying judgment.  In Hoesman, an individual, acting as a trustee for a family trust, stole about $349,000 from the trust.  The trial court entered a judgment against the trustee for about $288,000, which reflected the total damages recoverable under Indiana law minus, among other things, about $300,000 that the trustee put back into the trust after acquiring money from her parents. 

The allegedly-fraudulent transfer.  The Court’s opinion surrounded the impact of the parents’ payment of the $300,000 that the trustee used to “reimburse” the trust.  The potential problem was that, after the trustee acquired the $300,000, she executed a promissory note to her parents for $300,000, together with a security agreement in which the trustee pledged as collateral for the “loan” several vehicles she owned and a mortgage on her residence.  The trustee also transferred all of her shares in a closely-held S-Corp (a farm) to her parents.  A key question in Hoesman was whether the transfer of the stock and the security interests in the vehicles and the residence should be avoided.  If so, then the plaintiff could satisfy the judgment from those assets.  If not, then the parents’ lien or interests in those assets could shield them from collection.   

Gift vs. loan.  The plaintiff contended the transfer of $300,000 from the parents to the trustee was a gift, for which the trustee incurred no legal obligation.  Arguably, therefore, the subsequent stock transfer and security agreement were not given for consideration (value).  On the other hand, if the $300,000 transfer was a loan, then the stock and security agreement were given to the parents in exchange for value, and the parents were competing creditors of the trustee.  The Court summed-up the issue as follows:  “the [plaintiff’s] success under a fraudulent transfer theory depends upon whether [the trustee’s] transfers to her parents were made (1) for a bona fide and honest debt; (2) in good faith; and (3) free of fraudulent intent. 

Fraudulent intent.  As previously documented in this blog, fraudulent intent in Indiana involves a fact-sensitive question and focuses upon certain “badges of fraud,” which include:

 1. Transfer of property by the debtor during the pendency of a suit;
 2. Transfer of property that renders the debtor insolvent or greatly reduces his estate;
 3. A series of contemporaneous transactions which strip a debtor of all property
  available for execution;
 4. Secret or hurried transactions not in the usual mode of doing business;
 5. Any transaction conducted in a manner differing from customary methods;
 6. A transaction whereby the debtor retains benefits over the transferred property;
 7. Little or no consideration in return for the transfer; and
 8. A transfer of property between family members.

The Court noted that “the existence of several of these badges may warrant an inference of fraudulent intent, but no particular badge constitutes fraudulent intent per se.” 

Questions deferred for trial.  The Court denied summary judgment and concluded that material questions of fact remained as to whether the transfers from the trustee to her parents were made in good faith and free of fraudulent intent:

Here, many of the badges of fraud are arguably present . . ..  However, this is not a typical fraudulent transfer case, as the debtor (the trustee) had received (either by gift or by loan) assets that appear to be worth more than those dissipated, and used the received assets to repay the Trust.  On the other hand [the trustee’s] transfer of assets and grant of security came well after [her] parents transferred funds to [her].  If the [plaintiff’s] theory that the transfer of funds was a gift is correct, the subsequent transfers and grant of security could be found fraudulent. 

The case thus must go to trial to examine and weigh the disputed facts.  For more on the elements of a fraudulent claim, please click on the .pdf of the Hoesman opinion, and you can also click on these two statutes – Ind. Code § 32-18-2-14 and § 32-18-2-18 – upon which the plaintiff in Hoesman relied.  These are sections from the Uniform Fraudulent Transfer Act.   

Lookout.  When you’re struggling with a judgment debtor (borrower or guarantor) on the hook for a deficiency judgment, be on the lookout for suspect asset transfers and funny business between family members.  The eight badges of fraud outlined above are a good place to start when analyzing the viability of a fraudulent transfer claim.     

No Answer To Complaint = No Lien On Property

My June 18 post theorized that summary judgment may be preferable to a default judgment in commercial foreclosure proceedings.  The May 23 decision by the Court of Appeals in Irmscher Suppliers v. Capital Crossing, 887 N.E.2d 97 (Ind. Ct. App. 2008) (Irmscher.pdf) supports the notion that an Ind. Trial Rule 56 motion for summary judgment is appropriate against a party eligible to be defaulted.  Specifically, Irmscher illustrates how a competing lien holder’s failure to answer another lien holder’s complaint can result in a summary judgment that negates the competing lien. 

Capital Crossing’s complaint.  Irmscher, a contractor, recorded a mechanic’s lien on the subject property on September 25, 2006.  Capital Crossing, a mortgage lender, recorded a mortgage lien on the subject property on March 6, 2006.  Part of the Court’s opinion deals with the fact that Irmscher and Capital Crossing had each filed their own foreclosure lawsuits within a few weeks of one another.  That procedural wrangling is not particularly relevant to this blog, however.  What is relevant is that, in the suit filed by Capital Crossing, Capital Crossing named Irmscher as a defendant to answer as to its interest in the real estate.  Because Capital Crossing recorded its mortgage before Irmscher recorded its mechanic’s lien, Capital Crossing alleged that the mechanic’s lien was subject and subordinate to the mortgage.  (That may or may not be true – see my July 3, 2007 post “Construction Mortgage vs. Mechanic’s Lien:  Win, Lose or Draw?” and my follow-up post “Lien Priority Follow-up:  The Operative Statutes.”  As you’ll see, we’ll never know who was right in Irmscher.) 

Irmscher’s response, or lack thereof.  Counsel for Irmscher appeared in Capital Crossing’s foreclosure case, but Irmscher never filed an answer to the complaint.  Capital Crossing filed a motion for summary judgment seeking, among other things, a determination that its mortgage lien was a first lien on the subject real estate.  (This is the tactic discussed in my June 18 post.)  Although Irmscher filed a brief in opposition to the motion and a designation of evidence, the Court did not address any evidence in the opinion.  The Court merely mentioned Irmscher’s statement in its brief that the case should be decided in the separate foreclosure action filed by Irmscher.  In any event, counsel for Irmscher did not appear at the hearing on Capital Crossing’s summary judgment motion.  The trial court entered a judgment of foreclosure and decree of sale, finding that Irmscher had no interest in the subject property.  Irmscher appealed. 

Silence equals admission.  On appeal, Irmscher contended that the trial court erred when it found Irmscher had no interest in the real estate.  No so fast, said the Court of Appeals:  “Irmscher did not file an answer to Capital Crossing’s amended complaint and therefore admitted, at the very least, to the superiority of Capital Crossing’s mortgage.”  The Court cited an Indiana Supreme Court decision from 1886:

As applicable however, to a suit to foreclose a mortgage, and other kindred suits in the nature of a proceeding in rem, where a party is made a defendant to answer as to his supposed or possible, but unknown or undefined, interest in the property, we think that, as against him, a default ought to be construed as an admission that, at the time he failed to appear as required, he had no interest in the property in question, and hence as conclusive of any prior claim of interest or title adverse to the plaintiff. 

Ouch.  When a plaintiff lien holder files an action and asserts facts placing the validity, priority and amount of a mortgage lien in issue, a named defendant must file an answer to assert whatever interest it has in the property.  If it fails to do so, the lien of the defendant will be extinguished as a matter of law.  In Irmscher, the Court of Appeals held “in this case, although Irmscher’s counsel entered an appearance, Irmscher failed to file an answer asserting whatever interest it had in the property.  As such, we conclude that the trial court did not err in finding that Irmscher had no interest in the property.” 

Today’s lesson.  The Irmscher opinion is useful to both junior and senior lenders.  If you have a junior lien and are named as a defendant in a senior lien holder’s lawsuit, you need to appear in the action and answer the complaint to assert your interest in the subject real estate.  If you don’t, you can kiss your lien goodbye.  On the flip side, in instances where a defendant has not answered the complaint, senior lien holders involved in Indiana enforcement actions can cite to Irmscher in their summary judgment briefs to persuade the trial court that the defendant’s lien should be extinguished as a matter of law.

Comments Now Welcomed

I've decided after over 1 1/2 years of publishing this blog to try the "Comments" option TypePad offers.  Starting with the recent Premier Properties/Chris White post, readers can click on the "Comments" link at the bottom and provide feedback, etc. on the subject at hand.  I'm hopeful this will be interesting for secured lenders and counsel who regularly read my blog or others who stumble upon it through an internet search.  I'll test this for a period of time and see how it goes.  As always, I welcome your emails, and now look forward to reader's comments....   

In Indiana, A Summary Judgment Is Preferable To A Default Judgment

There are occasions when a defendant does not appear in a lien enforcement lawsuit or otherwise timely respond to the complaint.  Many of us intuitively consider the next step to be an application for default judgment pursuant to Indiana Trial Rule 55.  Recently, my colleague Chris Jacobson and I discussed the benefits of foregoing a T.R. 55 motion and proceeding directly with a T.R. 56 motion for summary judgment.  Secured lenders and their counsel should consider this approach in Indiana matters.

Is it proper?  The first question is whether a plaintiff can file a motion for summary judgment before an answer, or even an appearance, has been filed by a defendant.  The answer appears to be yes.  T.R. 56(A) states that “a  party seeking to recover upon a claim . . . may, at any time after the expiration of twenty (20) days from the commencement of the action . . . move . . . for summary judgment in his favor upon all or any part thereof.”  (Under T.R. 3, an action is commenced by the filing of a complaint, by paying the filing fee and by furnishing the clerk with the required copies of the complaint and summons.)  Nothing in T.R. 56 (or T.R. 55) suggests that a motion for summary judgment cannot be utilized when an application for default judgment could be.  Case law supports the notion that a T.R. 56 motion is appropriate against a party eligible to be defaulted.  Anderson v. The Broadmoor Corporation, 363 N.E.2d 1042 (Ind. Ct. App. 1977); see also, Royalty Vans v. Hill Brothers, 605 N.E.2d 1217, 1219 (Ind. Ct. App. 1993):

[Defendant] very well might have been vulnerable to the entry of a default judgment in this case . . . ..  However, the court clearly acted pursuant to [Plaintiff’s] motion for summary judgment and entered judgment only after [Plaintiff] had met its burden of demonstrating that there was no genuine issue of material fact for trial.

Is it better?  Applying for a default judgment is fairly quick and easy, and courts essentially focus only on whether there has been good service of process and whether the defendant has failed to timely respond to the complaint.  It’s sort of a technical knockout.  (See my post, “What If A Borrower Ignores A Lender’s Foreclosure Suit?”)  A summary judgment, while a bit more labor intensive to obtain, provides a more definitive result.  The court’s decision is on the merits.  The court in Anderson, 363 N.E.2d at 294-95 noted, for example:

A summary judgment qualifies as a final judgment and a trial court may award “the relief to which the party in whose favor it is rendered is entitled, even if the party has not demanded such relief in his pleadings.”  A T.R. 55 judgment is limited to the amount prayed for in the pleadings.   

In addition, Indiana courts are geared toward setting aside default judgments.  T.R. 55 has a specific subsection about setting aside a default and specifically refers to T.R. 60(B).  T.R. 60(B) also applies to summary judgments, but the cases we’ve reviewed show quite clearly that setting aside a summary judgment is a more difficult proposition.  Furthermore, Indiana has specific legal policies stating that default judgments are not favored.  There is a strong judicial preference for deciding cases on their merits and for giving litigants their day in court.  Summary judgments tend to meet those standards.  Default judgments tend not to.

Is notice documented?  An important matter, implicit in the Anderson opinion, is to prove that the defendant had notice of the summary judgment proceedings.  In instances of unrepresented parties, one way to do this is to provide the party, by certified mail, with copies of the motion and any order setting the matter for hearing.  (A hearing is not mandated by T.R. 56, unless a party requests one, but it is fairly common for Indiana trial courts to hold a hearing.)  Lender’s counsel then can attach the letter(s), with the certified mail return receipt(s), to an affidavit for submission to the court.  If the plaintiff can show that the defendant had actual notice of the proceedings, but failed to take any action, then such proof reduces dramatically the chances of setting aside the judgment in the trial court or overturning the judgment on appeal.  Conversely, the easiest way for a defendant to get a second chance is to convince a court that it did not know about a motion or a hearing. 

Think MSJ.  There is no right or wrong answer to the question of whether to pursue relief through a default judgment or a summary judgment.  The circumstances of the particular case should guide the decision.  A T.R. 55 default judgment arguably can occur more quickly and with less expense.  Having said that, a summary judgment, as opposed to default judgment, should result in more conclusive, definitive relief that is less prone to being set aside on technical grounds.  In such cases, the defendant’s recourse may be limited to an appeal, which should be futile if the undisputed facts and the law support the judgment.  Ultimately, my advice for secured lenders and their counsel is to bypass a default and to seek a summary judgment.  (For more on summary judgments in the foreclosure context, please see my post, “Motion For Summary What?”)

I would like to thank my colleague Chris Jacobson for her thoughts on this issue, and I would like to credit our summer associate, Julia Bochnowski, for assisting me with the research for this post, particularly while I was on vacation last week.