Indiana Commercial Foreclosure Law

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.

Indiana Banks, As Garnishee Defendants, Need Not Restrict Withdrawal Of Subsequently-Deposited Funds

From time to time, the enforcement of secured loans will evolve into the collection of  deficiency judgments.  One of the available collection tools is a garnishment order.  The Indiana Court of Appeals in JPMorgan Chase v. Brown, 2008 Ind. App. LEXIS 1029 (Ind. Ct. App. 2008) (Chase.pdf) recently interpreted Ind. Code § 28-9-4-2 and addressed the question of whether a depository financial institution, which has received notice of garnishment proceedings, is required to restrict withdrawal of funds that are subsequently deposited into the account.  Surprisingly, the answer is no.

What happened.  Collection agency filed a motion for proceedings supplemental naming Chase as a garnishee defendant and asserting that Chase possessed deposit accounts in which the defendant/judgment debtor had an interest.  (A “garnishee” essentially is an entity, like a bank, that has money in its possession belonging to a defendant.)  In answers to interrogatories, Chase confirmed that the judgment debtor maintained an account with the bank that had a balance, as of March 5, 2007, of $20.61.  Furthermore, the bank confirmed that it immediately restricted the withdrawal of those funds.  Later, the judgment debtor made four deposits totaling over $1,000 to the account.  Because the collection agency sought about $2,200, the court signed an order requiring Chase to pay over to the clerk approximately $2,200 from the account.  Chase did not do so, however, and only restricted the account balance of $20.61.  The trial court thereafter found Chase in contempt and entered a judgment against Chase for $1,045.99, the balance of the account that included the subsequent deposits.  

Chase’s position.  On appeal, Chase argued that it only was required to restrict withdrawal of funds “in an amount equal to the balance of  [judgment debtor’s] account at the time [Chase] received notice of the garnishment proceedings.”  Chase based its contention on a 1998 amendment to the operative statute.

The statute.  I.C. § 28-9-4-2 provides in part that a depository financial institution shall restrict deposit account withdrawals in an amount equal to “the balance in the account at the time of receipt of the documents in process . . ..”  I.C. § 28-9-4-2(a)(2)(B).  The pre-1998 version of the statute specifically provided for restriction of additional funds “subsequently deposited into” the account.  When the legislature amended the statute, it deleted those words. 

When courts interpret statutes, their goal is to determine and give effect to the intent of the legislature.  In this case, the Court would “not simply re-read language into a statute that the legislature has deleted.”  The Court therefore held:

In light of the legislature’s amendment to I.C. § 28-9-4-2, we agree with [Chase] that the statute only required it to restrict withdrawal of the balance in [judgment debtor’s] account at the time it received the documents and process required by I.C. § 28-9-3-4(d).  The legislature’s decision to omit the words “or subsequently deposited into” from I.C. § 28-9-4-2 is irrefutable and, as required by the rules of statutory construction, we will not reinsert the omitted language into the statute when construing the statute.  Thus, we agree with [Chase] that the trial court erred by finding it in contempt for failing to restrict withdrawal of funds that were subsequently deposited into [judgment debtor’s] account. 

Odd result.  The Indiana Court of Appeals clearly did the right thing in this case.  The question for me is whether Indiana’s General Assembly did the right thing when, in 1998, it deleted from the operative statutory section the words “or subsequently deposited into” from the law.  The statutory amendment means that lenders attempting to collect deficiency judgments through the garnishment of judgment debtors’ bank accounts may need to issue multiple garnishment requests to the same bank.  Otherwise, the bank only is compelled to restrict the withdrawal of funds in the account at the time of a particular request.  While there may have been good reasons for the 1998 statutory amendment, the consequences for debt collectors – whether intended or not – appear to be unfavorable and impractical. 

Indiana Mortgage Foreclosure Sales: Buyers Beware

Do junior lenders/mortgagees need to disclose, in the statutory notice of sheriff’s sale, that the real estate is being sold subject to a senior mortgage?  On April 22, 2008, the Indiana Court of Appeals in Indi Investments v. Credit Union 1, 2008 Ind. App. LEXIS 793 (Ind. Ct. App. 2008) said no (Indi.pdf).  Indiana law generally places the onus on buyers at sheriff’s sales to bid with their eyes wide open. 

Those involved.  Indi Investments, LLC purchased the property at a sheriff’s sale following a mortgage foreclosure action brought by Credit Union 1, which held a second mortgage.  Waterfield Mortgage held the first mortgage on the property but did not foreclose.

Procedural background.  Indi filed suit to foreclose its second mortgage and ultimately obtained a judgment, which ordered a sheriff’s sale of the property subject to Waterfield’s first mortgage.  Indi purchased the property and obtained a sheriff’s deed that Indi recorded on August 18, 2006.  Despite the fact that the sheriff’s deed contained language indicating the property had been acquired subject to Westfield’s mortgage, it was not until June, 2007 that Indi filed a petition to set aside the sheriff’s sale.  Indi generally claimed it didn’t know about Waterfield’s mortgage and wanted to unwind the sale.  The trial court and the Court of Appeals refused to set aside the sale, however. 

Ignorance is not bliss.  Indi asserted a number of arguments, all of which centered on its claim that it lacked knowledge of the Waterfield mortgage when it purchased the property.  Indiana requires the publication of a notice of sale in advance of sheriff’s sales.  In this case, the notice did not mention Waterfield or its senior mortgage.  At the sale itself, nothing was disclosed with regard to the Waterfield mortgage.  Although the language in the sheriff’s deed identified the Waterfield mortgage, Indi claimed that it “was not immediately aware of the content of the Sheriff’s Deed or the legal impact of the statement.”  The Waterfield mortgage, however, had been properly recorded and was in title.  What's more, the trial court’s judgment stated that the property was to be sold subject to Waterfield’s interests.  In other words, there were at least two places for Indi to have discovered, pre-sale, that Waterfield held a mortgage on the property:  the county recorder’s office and the trial court.

Technical arguments rejected.  Should Credit Union 1 have disclosed in the notice of sale that the property was being sold subject to the Waterfield mortgage?  No.  Ind. Code § 32-29-7-3 governs notices of mortgage foreclosure sales and does not require the notice to contain information concerning senior mortgages.  Did the judgment mandate that information related to Waterfield’s mortgage be included in the notice?  No.  The judgment only required the property to be sold subject to the mortgage and did not require any such language in the notice of sale.  Should the sale have been set aside because Indi was unaware of the Waterfield mortgage?  Not in this case.  Generally, there is no warranty in judicial sales in Indiana.  The doctrine of caveat emptor (buyer beware) applies “with all its force” to sales made by virtue of an execution.

Indi not a bona fide purchaser.  Indiana has an exception to the caveat emptor rule, however.  Indiana cases have held that buyers in good faith and without notice are protected as bona fide purchasers for valuable consideration against prior equities and unrecorded deeds.  Indiana defines a “bona fide purchaser” as “one who is given value and acted in good faith without actual or constructive notice.”  Constructive notice is provided when a mortgage is properly acknowledged and placed in the record as required by statute.  Actual notice is when notice has been directly and personally given to the person to be notified, and actual notice may be implied or inferred “from the fact that the person charged had means of obtaining knowledge which he did not use.”  The Court of Appeals concluded that Indi had the means of obtaining information regarding the Waterfield mortgage.  First, it could have performed a title search.  Second, it could have reviewed the trial court’s file.  Indi evidently did neither.  As such, “Indi Investments is charged with actual notice of the Waterfield mortgage and, consequently, is not a bona fide purchaser.” 

Lender protected.  While it may not be feasible or cost effective for a third party to order a title insurance policy commitment before bidding at a sheriff’s sale, a title search would have informed Indi of the Waterfield mortgage.  An easier and cheaper method for Indi to protect itself would have been to visit the court and review the judgment.  By doing neither, Indi assumed the risk of acquiring the property subject to any liens that were not wiped out in the foreclosure action.  Junior mortgagees that struggle with the decision of whether to publicize, in the notice of sheriff’s sale, that the property is being sold subject to a senior mortgage can take comfort in the Indi decision.  The Court of Appeals, based largely upon I.C. § 32-29-7-3, confirms that such notice need not be given.  Lenders generally are protected by the procedures applicable to this scenario.  Sheriff’s sale buyers are not.

Seventh Circuit: Indiana Writs of Assistance Do Not Need To Be Executed In A Commercially-Reasonable Manner

This supplements my March 2, 2007 post:  The execution of a writ of assistance need not be "commercially reasonable."  Please click here for that post, which in part dealt with the federal district court's February 16, 2007 conclusion that Indiana Trial Rule 70(A) writs of assistance should be executed by the county sheriff immediately and without regard to commercially-reasonable standards.  The Seventh Circuit agreed with the opinion of Judge Tinder (who is, incidentally, now a Seventh Circuit Judge).

Affirmed.  At issue was the timing of an eviction of a property owner after after an execution sale of the real estate.  The owner, Mr. Dempsey, cried foul because JP Morgan Chase refused to delay the eviction to allow Mr. Dempsey to attend a funeral.  Here's what the Seventh Circuit said regarding the appeal of that issue: 

We likewise agree with the district court that there is no merit to Dempsey’s claim that the writ of assistance was executed unfairly because Chase refused to delay the eviction to allow Dempsey to attend a funeral. Dempsey has provided no support whatsoever for his contention that the writ must be executed in a commercially reasonable manner. “A writ of assistance is an equitable remedy used to transfer real property, the title of which has been previously adjudicated, as a means of enforcing the court’s own decree” where the party that the writ is issued against has refused to obey that decree—like Dempsey did here. See TeWalt v. TeWalt, 421 N.E.2d 415, 418 (Ind. Ct. App. 1981); see also IND. R. TRIAL P. 70(A). Thus, it is not surprising that the sheriff has the “right and duty” to execute the writ immediately upon receiving it. 7 C.J.S. Writ of Assistance § 14. As the district court noted, “Dempsey could have avoided his trouble by moving out voluntarily and promptly when Chase obtained title to the property as opposed to forcing Chase to utilize the sheriff’s department to enforce the court’s decision.”

For a .pdf of the entire March 31, 2008 decision in Dempsey v. JP Morgan Chase, 2008 U.S. App. LEXIS 7707 (7th Cir. 2008) click here.pdf.

Tool for creditors.  Again, if you acquired title to real estate at a sheriff's sale and if the owner will not vacate voluntarily, your remedy is a writ of assistance.  Dempsey provides powerful legal precedent, favorable to creditors, associated with how Indiana writs of assistance can and should be executed.

Memo To Title Insurers: Disclose All Recorded Liens, Even Legally-Deficient Ones

As reported on this blog, over the past several months the Indiana Court of Appeals has issued a number of opinions directly or indirectly related to defective titles searches.  On March 31, 2008, in House v. First American Title, et. al., 2008 Ind. App. LEXIS 618, the Court again provides guidance to commercial lenders and other parties affected by title defects post-foreclosure.  As always, I provide .pdf's of the opinions I discuss:  House.pdf.

Situation.  The facts of House are straightforward.  Plaintiff Wayne House bought a home from Centex, which held title after foreclosing on the prior owners.  Defendant Security Title had performed a title search for House and reported no liens on the property.  House improved the property and then attempted to flip it.  A prospective buyer wouldn't close upon learning that judgment liens existed on the property.  The judgment liens were held against the prior owners - the owners upon which Centex foreclosed.  House filed suit to clear title.

Security Title exposed to liability.  Security Title claimed it did not have to disclose the judgment liens because they were legally deficient.  The Court noted, however, that neither Indiana law nor Security Title's contract with House supported the proposition that Security Title was not required to disclose recorded liens it believed were legally deficient.  Moreover, given the procedural context of the decision - a Trial Rule 12(B)(6) motion to dismiss - the Court could not at the pleading stage determine as a matter of law, without further factual inquiry, whether the liens were in fact legally deficient. 

Some Indiana lien laws.  Security Title asserted that a handful of well-settled laws applicable to judgment liens, and enforcement of such liens, warranted a dismissal of House's case.  It's helpful to be reminded of these Indiana legal principles:

• Real property held by the entireties is immune to seizure and satisfaction of the individual debts of the husband or wife.  A husband and wife are presumed to hold real property as tenants by the entireties.  Ind. Code 32-17-3-1.
• A purchase money mortgage has priority over a prior judgment.  Ind. Code 32-29-1-4. 
• Liens on real property expire ten years after judgment is rendered.  Ind. Code 34-55-9-2. 
• A judgment lien can be executed after ten years, however, upon leave of court.  Ind. Code 34-55-1-2. 

The litigation continues....  Given the nature of the subject liens, Indiana's laws seemingly should protect Security Title from liability stemming from the judgment liens.  Nevertheless, issues regarding whether the prior owners held the property as tenants by the entireties and/or the priority or enforceability of the judgment liens were factual and thus inappropriate for a T.R. 12(B)(6) dismissal.  The House case generally teaches us that companies conducting title searches should disclose all recorded liens, regardless of whether the searchers believe such liens are deficient.  Indeed this is one of the primary reasons why foreclosing lenders order title work in the first place - to determine whether there are liens on the property that need to be dealt with during the foreclosure suit.       

Sheriff’s Sales Of Separate Tracts: Principal’s Real Estate First, Surety’s Second

The Keesling v. T.E.K. Partners case has produced a second appellate court opinion.  I wrote about Keesling I on March 23, 2007.  That post dealt with the liability of sureties (or accommodation parties) when an original obligation is materially altered.  The latest opinion, decided March 6 (2008 Ind. App. LEXIS 431) (KeeslingII.pdf), discusses among other things the order (sequence) of the sheriff’s sales when there are multiple tracts to be sold.  So, Keesling I discusses liability issues, and Keesling II addresses judgment enforcement-related matters.  Commercial lenders may want to note Keesling II in the event they need guidance where there is more than one parcel of real estate subject to a foreclosure sale. 

Overview.  The Keeslings and Heritage Land were the defendants in the case and were deemed to be accommodation parties/sureties on the original note.  The collateral in question consisted of two separate tracts, a thirty-six-acre tract and a ten-acre tract.  The Court stated that the thirty-six-acre tract was the “property of the surety,” while the ten-acre tract was determined to be the principal collateral for the original note.  The specific issue in Keesling II was whether the thirty-six-acre tract or the ten-acre tract should be sold at a sheriff’s sale first.  The defendants clearly wanted to protect their interests in the thirty-six-acre tract.  The primary contention of the Keeslings/Heritage Land in the appeal was that, if the thirty-six-acre “surety collateral” was to be sold at all, then it should only be sold to satisfy any deficiency that remained on the original note after the ten-acre “primary collateral” posted by them had first been sold.

Legal principles.  An Indiana statute and an Indiana trial rule controlled the appellate court’s decision.  Ind. Code § 34-22-1 et seq. deals with the remedies of sureties against their principals.  Specifically, I.C. § 34-22-1-4 entitled “Order on levy upon property of principal and surety,” section (a), provides that where a court finds in favor of a surety on the question of a suretyship, the court shall make an order directing the sheriff to levy first upon the property of the principal and to exhaust the property of the principal before levying upon the property of the surety.  And, Ind. Trial Rule 69 generally governs sheriff’s sales.  The rule states “unless otherwise ordered by the court, the sheriff or person conducting the sale upon execution shall not be required to offer it for sale in any particular order.”  T.R. 69(A).  The Court stated that this rule applies to the foreclosure of mortgage liens “and in commercial transactions, it is not uncommon for the loan documents to provide that in the event of default the creditor shall have recourse to the collateral in any order, without priority.”  The Court focused on the “unless otherwise ordered by the court” language for its conclusion that, based upon the facts of this case, the order of sale and the allocation of proceeds must correlate with the liabilities of the parties and their collateral.

36 acres saved, perhaps.  A separate entity, Heritage/M.G., was the principal debtor on the original note, and the ten-acre tract was the principal collateral for that debt.  Heritage Land (a connected entity) and the Keeslings merely were accommodation parties, or sureties, on the original note, and the thirty-six-acre tract was the property of the sureties.  Thus the case apparently involved a fairly uncommon scenario where the accommodation parties/sureties pledged real estate collateral to secure the borrower’s note.  Given I.C. § 34-22-1-4(a), the Court concluded that the ten-acre tract must be sold first, and the thirty-six-acre tract was to be sold “only if the sale of the ten acres does not satisfy the debt on the original note.”  This result is consistent with the basic notion that an accommodation party’s liability is secondary to the liability of the principal. 

Indiana Tax Sale And Related Proceedings Violate Bankruptcy Stay

From time to time, rights arising out of property tax liens collide with rights arising out of mortgage liens.  Priority determinations and related issues sometimes can be complicated.  The Indiana Court of Appeals case ATFH Real Property v. Stewart, 879 N.E.2d 1184 (Ind. Ct. App. 2008) (ATFHOpinion.pdf) provides some clarity regarding whether and when formal property tax lien proceedings impact a mortgagor and, in turn, a mortgagee when the mortgagor has filed for bankruptcy protection.

Procedural history.  Mortgagor petitioned for Chapter 13 bankruptcy protection.  Among mortgagor’s assets was mortgaged real estate.  Post-petition, a tax lien on the property was sold to a party in a Marion County, Indiana tax sale.  The County, however, had not applied for relief from the bankruptcy automatic stay.  The purchaser of the tax lien then assigned its lien to another party (assignee).  Months later, mortgagee had the bankruptcy automatic stay lifted so it could foreclose on its mortgage on the property.  After the bankruptcy case concluded, and the mortgagor/debtor was discharged, the Marion County Tax Auditor issued a deed to the property to the assignee of the tax sale lien.  The assignee then conveyed its interests in the property to ATFH, the plaintiff in the current case.  ATFH filed an action to quiet title, essentially claiming that its interest in the property, which arose from the tax lien, was superior to the interests of the mortgage lender that foreclosed on the property. 

Property tax lien primer.  The Indiana Court of Appeals in ATFH Real Property set out the following general rules applicable to property tax liens in Indiana:

 When the owner of real property fails to pay property taxes, the property may be sold to satisfy the delinquent taxes. 

 The process by which property is sold to satisfy delinquent taxes is governed by statute, and a valid sale requires material compliance with those statutes.

 At such a “tax sale,” when a bid from a member of the public equals at least the amount of the delinquent taxes (plus some miscellaneous expenses), the buyer receives a certificate of sale and a lien against the property in the amount paid.  I.C. § 6-1.1-24-5 and 9.

 This lien is superior to all other liens that exist against the property.  I.C. § 6-1.1-24-5.

 Any person, however, may redeem (buy back) the real property in question by paying to the county treasurer an amount specified by I.C. § 6-1.1-25-2.  See, I.C. § 6-1.1-25-1.

 If no redemption is made within the specified period, the purchaser of the tax lien (or his assignee) may then petition the court in which the judgment of sale was entered to order the auditor to issue a tax deed, which, when issued, vests in the grantee an estate in fee simple absolute.  I.C. § 6-1.1-25-4.6.

Bankruptcy automatic stay.  The issue in ATFH Real Property was whether the purchase of the tax lien on the property at the tax sale violated the bankruptcy stay.  More specifically, did the purchase constitute an “act to obtain possession of property” under 11 U.S.C. § 362(a)(3)?  The Court concluded that it did, “even if the immediate result was not actual possession.”  The rationale was that one cannot obtain possession of property from a tax sale without first purchasing the tax lien.  The Court held that the tax sale and all proceedings flowing therefrom were therefore void as violative of the automatic stay.   

Bout Over An Indiana Warehouseman’s Lien

Although the Miller’s Turnkey v. Cybertek case from the Indiana Court of Appeals may not directly affect most commercial lenders, the case does speak to the enforcement of an Indiana lien under the Uniform Commercial Code.  If you happen to be involved in, or want to learn about, the foreclosure of a warehouseman’s lien in Indiana, you or your counsel should review Miller’s Turnkey, 878 N.E.2d 280 (Ind. Ct. App. 2007) (Miller'sOpinion.pdf). 

Punch.  Plaintiff Miller owned a warehouse and stored defendant Cybertek’s equipment for a fee.  Cybertek delivered the equipment to Miller but never paid rent.  Miller sued Cybertek and obtained a judgment for $23,600, presumably the amount owed for storage fees, and a decree authorizing the foreclosure of the possessory lien held by Miller.  To satisfy the judgment, Miller sold Cybertek’s equipment for $45,000 to a third party in a private sale.  (Miller put the proceeds in escrow.) 

Counterpunch.  Thereafter, Cybertek pursued a counterclaim against Miller for damages due to alleged non-compliance with Indiana’s Uniform Commercial Code in the sale of the equipment.  Cybertek’s action sought damages for what it claimed to be the fair market value of the goods - $93,500.  At issue was Indiana Code § 26-1-7-210, which deals with the enforcement of a warehouseman’s lien in Indiana. 

Knockdown.  The Indiana Court of Appeals concluded that defendant Cybertek was correct in that plaintiff Miller didn’t follow the rules when it disposed of the equipment.  First, the Court found Miller did not provide the appropriate notice to Cybertek with regard to the sale.  Second, the Court found that the sale was not “commercially reasonable” as required by statute.  Finally, the Court found that there was sufficient evidence to support the contention that the fair market value of the goods was $93,500, not the $45,000 received in the Miller’s private sale.  The opinion provides a road map for parties and their counsel who need to enforce a warehouseman’s lien, including how to establish a proper sale and sale price.  Please read the opinion for more details.

Split decision.  Although plaintiff/creditor Miller, the warehouse owner, ultimately was defeated by defendant Cybertek, the debtor who did not pay rent, all was not lost.  At the end of the day, Miller will forfeit about $25,000, not $93,500.  This is because Miller will get a credit for the initial $23,600 judgment it obtained against Cybertek.  Furthermore, Miller’s private sale of the equipment, albeit defective, netted $45,000, which will be used to pay Cybertek.  $93,500 – ($23,600 + $45,000) = $24,900, the net amount Miller will be out of pocket to Cybertek. 

Lest we forget the attorneys’ fees and litigation costs both parties incurred in fighting one another.  Neither the trial court nor the Court of Appeals awarded Cybertek attorney’s fees as a part of the judgment against Miller.  Cybertek, in the end, probably lost money because it likely spent more than $25,000 in defending Miller’s lien foreclosure claim and in prosecuting its counterclaim.  The same can be said for Miller –not only did it lose net $25,000, but it surely lost more when attorney’s fees and litigation costs were considered.  The result of this case brings to mind a quote from our sixteenth president, Abraham Lincoln:  “Discourage litigation.  Persuade your neighbors to compromise whenever you can.  As a peacemaker the lawyer has superior opportunity of being a good man.  There will still be business enough.”  Perhaps the lawyers followed Lincoln’s advice in Miller’s Turnkey.  Maybe the parties – the litigants themselves – just didn’t heed it. 

An Indiana Federal Court Discusses Strict Foreclosure

If you’re wondering what “strict foreclosure” means in Indiana, look no further than Judge Barker’s opinion in the CIT Group v. United States of America, 2007 U.S.Dist. LEXIS 96180 (S.D. Ind. 2007) (CITOpinion.pdf) case.  The opinion provides a straightforward discussion of strict foreclosure, with a federal tax lien twist. 

What happened.  Lender entered into a purchase money mortgage transaction with borrower.  Borrower defaulted, and lender foreclosed.  The real estate was sold at a sheriff’s sale, and the lender was the successful bidder.  Unbeknownst to the lender, a federal tax lien had been filed against the borrower and had been recorded before the filing of the foreclosure action, albeit after the recording of the lender’s mortgage.  Presumably due to inadvertence, the lender failed to name the United States in its foreclosure action, so the tax lien survived the foreclosure case.  The lender brought an action for strict foreclosure against the federal government with the goal of cutting off the federal tax lien.

Strict foreclosure, generally.  In Indiana, strict foreclosure is defined as “the means by which a party, who acquires title through or after a foreclosure sale (or by deed in lieu of foreclosure), may cut off the interests of any junior lienholders who, for some reason, were not parties to the foreclosure action.”  Strict foreclosure is a remedy that operates to cut off the right of junior lienholders to redeem.  In CIT, seemingly the lender (senior lien holder) should have been entitled to strict foreclosure because it purchased the property at the sheriff’s sale after foreclosure of the borrower’s/owner’s/mortgagor’s interests. 

The rub.  Only later did the lender discover that the United States had recorded a tax lien on the property.  Even though the lien undoubtedly was junior to the lender’s mortgage lien, the United States argued that its lien should not be extinguished in the strict foreclosure action given its unique, statutorily-protected nature.  The statue at issue was 26 U.S.C. § 7425(a) entitled “Discharge of Liens.”  The United States argued, based on the statute, that because the government was not joined as a party to the action, the judicial sale should be subject to the federal tax lien.  Judge Barker adopted this “defense” and concluded that the federal tax lien should survive and continue to encumber title to the property, no matter who holds title, until it is satisfied.  Judge Barker stated “but for the fact that, by federal statute, primacy is given to the federal tax lien, we believe strict foreclosure likely would be available to a mortgagee so as to extinguish any other junior lienholders’ interests.” 

Survival.  As explained in CIT, strict foreclosure normally provides a remedy to senior lienholders, after the sale of the property at a foreclosure sale, to bring an action for the purposes of clearing title and extinguishing any subordinate liens or interests.  But the CIT case illustrates a unique scenario involving the treatment of a federal tax lien.  Here is Judge Barker’s explanation of, in essence, the upshot of her decision:

Provided [lender] continues to hold title to the real estate it acquired by Sheriff’s Deed at the foreclosure sale, equity allows it to assert its mortgage lien position as against the United States even though the United States was not named in the foreclosure action.  If title to the property is thereafter conveyed to a third-party purchaser, however, that purchaser would no longer be able to assert [lender’s] mortgage lien priority so as to extinguish the federal tax lien.  So long as [lender] continues to hold legal title to the real estate, the United States’s lien remains in effect, but inchoate – dormant, as it were – because it is uncollectible against [lender].  Should the property be sold by [lender] to a third party, the government is entitled to execute on its lien and be paid, presumably from the proceeds of the sale.

Do due diligence.  This was a bad result for the lender because it acquired the property at the sheriff’s sale subject to a $10,200 lien, which will have to be satisfied when the lender liquidates the property.  It is my understanding the result could have been avoided had the United States been made a party to the foreclosure action, although rules and exceptions surrounding federal tax liens could be (and someday will be) the subject of their own blog post.  The failure to name the United States in CIT probably stemmed from a defective title insurance policy commitment (title search) or possibly the lender’s failure to order a title search to begin with.  Lenders and Indiana counsel should remain mindful to purchase a title insurance policy commitment before filing a complaint, with a “date down” thereafter, which commitment will help identify all parties, with interests in the property, that should be named in the suit.  If that was in fact done by the lender in CIT, and if the title company missed the federal tax lien, then the lender may have been indemnified by the title insurance company for the loss associated with the $10,200 tax lien. 

Termination Of Mortgages In Indiana

As promised, this post will speak to the second issue in the Bank of America case that was the subject of my February 15 post.  This discussion will help secured lenders who may struggle with knowing whether Indiana law permits the release of a prior mortgage when such mortgage secured a revolving line of credit that has been paid in full.

Contracts and performance.  Due to the importance of the language in the 1999 Bank One mortgage, I must outline it here:

[W]ithout limitation, this Mortgage secures a revolving line of credit, which obligates [Bank One] to make future obligations and advances to [borrower] up to a maximum amount of $ 80,000.00 so long as [borrower] complies with all the terms of the Credit Agreement.  . . .  It is the intention of [borrower] and [Bank One] that this Mortgage secures the balance outstanding under the Credit Agreement from time to time from zero up to the Credit Limit as provided above and any intermediate balance.  . . .

PAYMENT AND PERFORMANCE. Except as otherwise provided in this Mortgage, [borrower] shall pay to [Bank One] all amounts secured by this Mortgage as they become due, and shall strictly perform all of [borrower's] obligations under this Mortgage.  . . .

FULL PERFORMANCE.  If [borrower] pays all the indebtedness when due, terminates the Credit Agreement, and otherwise performs all the obligations imposed upon [borrower] under this Mortgage, [Bank One] shall execute and deliver to [borrower] a suitable satisfaction of this Mortgage and suitable statements of termination of any financing statement on file evidencing [Bank One's] security interest in the Rents and the Personal Property. [Borrower] will pay, if permitted by applicable law, any reasonable termination fee as determined by [Bank One] from time to time.  . . .

In 2001, when a portion of the proceeds from the Bank of America loan was used to pay the entire outstanding balance of the Bank One loan, Bank One did not send “correspondence or instructions” to Bank of America or the borrower.  In addition, neither the borrower nor Bank of America took action to terminate the Bank One credit agreement. 

The fight.  The litigation surrounded whether the prior Bank One mortgage had priority over the subsequent Bank of America mortgage.  Bank of America contended that, under I.C.§ 32-28-1-1(b), it was entitled to a release of the Bank One mortgage because Bank of America discharged the debt underlying that mortgage and, furthermore, because that mortgage was ambiguous as to whether written notice of termination by the mortgagor was required for the mortgage to be released.  I.C. § 32-28-1-1(b) states, in pertinent part:  “When the debt . . . on . . . the mortgage . . . has been fully paid, lawfully tendered, and discharged, the owner, holder, or custodian shall:  (1) release; (2) discharge; and (3) satisfy of record; the mortgage . . ..”  The Court concluded that the Bank One mortgage stated three requirements for “full performance:”  (1) borrower must pay all the indebtedness when due, (2) borrower must terminate the credit agreement and (3) borrower must perform all other obligations.  Each of those three was required of the borrower before Bank One was obligated to release the mortgage. 

Bank One the winner.  It was undisputed that, even though the indebtedness under the mortgage had been paid, the borrower took no affirmative action to terminate the credit agreement.  As a result, the Court held that Bank One was not required to release its lien on the real estate.  Bank of America complained that the Bank One mortgage did not require written notice of termination and that Bank One failed to notify the borrower or Bank of America what act was required to terminate the credit agreement.  The Court rejected the argument and reasoned that the Bank One mortgage “clearly require[ed] some affirmative act of termination.  . . .  The Bank One mortgage required [borrower] to terminate the Credit Agreement; Bank One did not need to reiterate to [borrower] her contractual obligations.”

Always follow-up.  The important court holding here is that “absent documentation to the contrary, we decline to hold that merely to pay off an outstanding balance is sufficient to terminate a revolving line of credit, as that would violate the very nature of the credit.”  Unlike a mortgage securing a term note, the Bank One mortgage secured a revolving line of credit that contemplated future advances, regardless of whether there was an occasional zero balance. 

Secured lenders operating in Indiana, particularly those involved in refinancing, need to be aware that, if confronted with facts similar to the Bank of America case, merely paying off a line of credit may be insufficient in itself to terminate a prior note/credit agreement/mortgage.  So, review and analyze the loan documents and ensure you jump through all the hoops to terminate the prior transaction and lien.  Otherwise, you may be faced with an unexpected subordinate lien position.

Equitable Subrogation Denied

The January 29, 2008 decision by the Indiana Court of Appeals in Bank of America v. Ping, 2008 Ind. App. LEXIS 71 (BankAmericaOpinion.pdf) provides an interesting contrast to the JPMorgan Chase decision addressed in my February 9 post.  The Bank of America case shows how a refinancing lender’s mortgage failed to leapfrog the priority position of an earlier-recorded junior lender’s mortgage, which secured a line of credit.  The Bank of America result was the opposite of the JPMorgan Chase result, even though the facts were similar.   

Oops.  In 1999, borrower opened an $80,000 revolving line of credit, secured by a mortgage, with Bank One.  In 2001, Bank of America loaned the borrower $103,000, secured by a mortgage, and the borrower used a portion of the proceeds to pay the entire balance on the Bank One line of credit.  However, neither the borrower nor Bank of America took any action to terminate the Bank One credit agreement or to release the mortgage.  The borrower subsequently incurred more than $76,000 in additional debt under the Bank One line. 

Partial subrogation.  Similar to the refinancing lender in JPMorgan Chase, Bank of America argued that the doctrine of equitable subrogation entitled it to place its mortgage “into the shoes” of the prior Bank One mortgage.  Generally, subrogation requires the subrogee (here, Bank of America) to discharge the entire debt held by the original obligor (the borrower).  The Bank of America Court stated: 

  Partial subrogation to a mortgage is not permitted because it would
  have the effect of dividing the security between the original obligee
  (lender/prior mortgagee) and the subrogee (lender/refinancing mortgagee),
  imposing unexpected burdens and potential complexities of division
  of the security and marshalling upon the original mortgagee.

The Court focused on the nature of the loan (a revolving line of credit) and language in the Bank One mortgage regarding termination/release requirements.  (See subsequent post discussing this case.)  The Court also noted that Bank of America’s request for subrogation was for the amount of the “payoff” but not for the amount of the borrower’s subsequent withdraws.  The Court concluded that this constituted a partial subrogation, which is not permitted in Indiana.

Culpable negligence.  Unlike the earlier JPMorgan Chase case, the Court in Bank of America applied the “culpable negligence” exception in refusing to permit equitable subrogation.  Generally, “a volunteer or one charged with ‘culpable negligence’ may not be entitled to equitable subrogation.  . . .  ‘Culpable negligence’ focuses on the activity of the party asserting subrogation and ‘contemplates action or inaction which is more than mere inadvertence, mistake or ignorance’.”  Id.  Here, the Court held that Bank One was culpably negligent in failing to terminate the Bank One mortgage when the payoff funds were submitted. 

Lesson learned.  The Indiana Court of Appeals, in what may have been a close call considering the reasoning and opposite result in JPMorgan Chase, held:

  Bank of America failed to take any affirmative steps to terminate the
  Bank One mortgage after Bank of America had paid in full the line
  of credit.  And, as a result, Bank One held open [borrower’s] line
  of credit, and Bank One continued to advance [borrower] funds
  from the account.  Bank of America’s argument would result in an
  inequitable subrogation.  Indeed, Bank One did not enjoy a windfall
  but advanced additional funds under the line of credit and acted
  properly under its Credit Agreement and Mortgage.  Given the plain
  meaning of the Credit Agreement and the Mortgage that secured it,
  it was incumbent on Bank of America to secure a release of the Bank
  One Mortgage as a condition of its new loan to [borrower].  That
  Bank of America failed to do so should not be allowed to prejudice
  Bank One.  On these facts, Bank of America is not entitled to invoke
  the doctrine of equitable subrogation.

As will be alluded to more in my subsequent post about this case, the lesson for lenders is to obtain and review the loan documents applicable to the loan that is being paid off.  There may be, and usually is, language in the agreements mandating that measures be undertaken to secure a release of the prior mortgage and/or to terminate the prior loan agreement.  Lenders normally are aware that it’s in their best interests to ensure the prior mortgage has been released.  Why that didn’t happen in this case was not explained in the opinion.   

Illustrating Indiana’s Doctrine Of Equitable Subrogation

On November 21, 2007, the Indiana Court of Appeals issued a decision that applied the rules of equitable subrogation.  JPMorgan Chase v. Howell, 2007 Ind. App. LEXIS 3055 (JPMorganOpinion.pdf) shows how a refinancing lender’s mortgage can leapfrog the priority position of an earlier-recorded junior lender’s mortgage.      

Chronology.  Defendant Bank One held a mortgage recorded in October of 1999 that secured a line of credit.  Plaintiff Equity One held a mortgage recorded in May of 2004 that secured a loan to pay off a prior senior mortgage lender and the Bank One line of credit.  For a variety of reasons, the $42,000+ payoff amount sent to Bank One was short by about $300.  Bank One did not close the borrower’s line of credit, and thereafter the borrower ran up a balance on the Bank One line of approximately $43,000.  The borrower defaulted on the notes and mortgages held by both Equity One and Bank One.  Equity One filed a foreclosure action seeking the foreclosure of its mortgage and a declaration that its mortgage was a first priority lien.  Bank One countered by asserting that its mortgage had priority.  The question, therefore, was whether Bank One’s October, 1999 mortgage had priority over Equity One’s May, 2004 mortgage. 

General rule.  Generally, in Indiana, a mortgage takes priority “according to the time of its filing.”  I.C. § 32-21-4-1(b).  Applying that general rule, Bank One’s mortgage would take priority over Equity One’s mortgage.

Exception.  The doctrine of equitable subrogation, however, can trump I.C. § 32-21-4-1(b).  The doctrine is recognized in I.C. § 32-29-1-11(d) and by the Indiana Supreme Court in Bank of New York v. Nally, 820 N.E.2d 644 (Ind. 2005).  Here are some of the principles: 

 Subrogation will arise from the discharge of a debt and will permit the party paying off a creditor to succeed to that creditor’s rights in relation to the debt. 

 “In the case of a purchaser of a note and mortgage for value, the classic formulation is that the purchaser’s right of subrogation to the mortgage he or she discharged includes its priority over junior liens of which he or she did not have actual knowledge, and where he or she was not culpably negligent in failing to learn of the junior lien.”  Nally, 820 N.E.2d at 651.

 A mortgagee (lender) refinancing an existing mortgage is entitled to equitable subrogation even if it had actual or constructive knowledge of an existing lien, unless (a) the junior lien holder is disadvantaged or (b) the mortgagee is culpably negligent.  Id. at 653-54.  (The rationale is that a lender that provides funds to pay off an existing mortgage expects to receive the same security (priority) as the loan being paid off.) 

Why Equity One prevailed.  Equity One paid off the prior senior mortgage, which mortgage was released.  Bank One only held a junior mortgage securing a line of credit.  The Court held there was no disadvantage to Bank One by the application of equitable subrogation.  To the extent Equity One was negligent for failing to confirm whether it had fully satisfied the Bank One mortgage, the Court concluded such negligence did not prejudice Bank One.  Indeed the payoff/refinancing funded by Equity One benefited Bank One “to the tune of over $42,000.”  Absent the application of equitable subrogation, Bank One would have received an unearned windfall, against which the doctrine is designed to protect.

Result.  The Court of Appeals held that plaintiff Equity One was entitled to foreclose its mortgage on the property to the extent of the funds paid to satisfy the prior, senior mortgage, plus interest.  The Equity One mortgage, despite being recorded long after the Bank One mortgage, had priority. 

If as a secured lender you are confronted with a situation in which a prior lien was not released as it should have been and thus an unexpected priority issue arises with regard to your lien position, then one of the first things you should do is put your title insurance company on notice of the problem.  The title insurance company may hire and pay for attorneys to litigate the priority dispute, as I’m virtually certain was the case in JPMorgan Chase.  In addition to incurring litigation costs, the title insurance policy may also provide indemnity (reimbursement for damages).  The reality is that many equitable subrogation cases are prosecuted by title insurance companies in the name of their insured to recoup indemnity payments.

Fried Tomato Grower, Part II: Lack of Consideration

Today’s post will explore the second, and successful, defense asserted by defendant Jackson, namely that the Note was unenforceable for lack of consideration.  Part I of my commentary about Jackson v. Luellen Farms discussed how the Indiana Court of Appeals arrived at its conclusion that Jackson could be personally liable on the Note.  Keep reading, however, to gain an understanding of the concept of “consideration,” particularly in situations involving antecedent debt, and how the Court ultimately ruled in Jackson’s favor.

Consideration, general rules.  Because the Court deemed the Note not to be a negotiable instrument, the UCC and specifically I.C. § 26-1-3.1-303(b) did not apply.  (Section 303 articulates what “consideration” is under the UCC.) 

For a contract to be valid, there must be an exchange of consideration, as noted by the Court in Jackson:

  Consideration is defined as ‘[s]omething of value (such
  as an act, a forbearance, or a return promise) received
  by a promisor from a promisee.’  ‘To constitute
  consideration, there must be a benefit accruing to the
  promisor or a detriment to the promisee.’

The plaintiff creditor, LFI, argued that there was consideration for the Note because of the unpaid balance owed by HPI to LFI at the time of the Note’s execution. 

Past consideration.  In fact, the Note was a promise by Jackson to pay an antecedent (prior) debt of a third party, HPI.  The Indiana Court of Appeals held that the promise was not enforceable because “past consideration” generally cannot support a new obligation or promise.  As stated by the Court, in Indiana:

  if a person has been benefitted in the past by some
  act or forbearance for which he incurred no legal
  liability and afterwards, whether from good feeling
  or interested motives, he makes a promise to the
  person by whose act or forbearance he has benefited,
  and that promise is made on no other consideration
  than the past benefit, it is gratuitous and cannot be
  enforced. 

Neither HPI nor Jackson received any benefit in exchange for the Note.  Jackson, personally, had no liability on the debt when he signed the Note – only HPI did.  There was no evidence that Jackson signed the Note in exchange for LFI’s promise to delay collection (forbear), in which case there would have been consideration.   

Valid guaranty?  LFI actually was angling to assert that the Note was a personal guaranty.  Under Indiana law, “it is not necessary for a guarantor to derive any benefit from the principal contract or the guaranty for consideration to exist.”  But, generally the guaranty must be made “at the time of the principal contract” (for example, when the tomatoes were delivered).  There are exceptions to this general rule, but none of them existed in Jackson.  There was, therefore, no legal consideration to support the alleged guaranty of HPI’s debt to LFI. 

Too late.  The tomato grower lost the case for a lot of reasons, including most importantly the fact that Jackson, individually, did not promise to pay HPI’s debt at the time the tomatoes were delivered.  Even then, once HPI began having trouble paying LFI, there still could have been personal liability had Jackson signed the Note in exchange for LFI’s forbearance in collecting against HPI.  The Court said, “[t]he problem in Jackson is that neither Jackson nor [HPI] received anything of benefit pursuant to the Note.  Instead, the only party that benefitted from the Note’s execution was the promisee, LFI.  Although Jackson had some motive to sign the Note, the Note was not supported by consideration.  Under these circumstances, LFI may not enforce the Note against Jackson.” 

In most commercial cases, there will be appropriate and timely loan documentation.  So, the circumstances present in the Jackson case may not be common in the day-to-day operations of most commercial lending institutions.  If, however, you as a lender agree to forbear on a borrower’s debt and, as a part of that agreement, intend to obtain for the first time some kind of personal guaranty, make sure the loan documents are clear that the parties intend for there to be personal liability and that appropriate consideration (exchange of benefit) exists. 

Fried Tomato Grower, Part I: Personal Liability

Informalities in connection with loans often lead to costly results.  In Jackson v. Luellen Farms, 2007 Ind. App. LEXIS 2754 (JacksonOpinion.pdf), the Indiana Court of Appeals discussed in its December 12, 2007 opinion how a thirty-year business relationship turned into $200,000 in losses for a supplier of raw tomatoes.  This is the first of two posts that address the Jackson case and the efforts of a party owed money to collect an antecedent debt from an owner/operator of a corporation.  Advanced planning and documentation sometimes may be inconvenient, expensive or awkward, but it almost always can help protect lenders against financial losses. 

Context.  The plaintiff was LFI, a grower and supplier of tomatoes.  Defendant Jackson was the owner and operator of HPI, a corporation that purchased and canned tomatoes.  HPI often would not pay LFI on delivery but would wait until the first of the year.  In October, 1999, HPI owed LFI about $225,000 for tomatoes delivered in 1998 and 1999.  LFI evidently became nervous about getting paid, so for the first time the parties executed a Note to memorialize the amount owed.  HPI made some payments on the Note but ultimately went under, owing $2.5-$3.0 million dollars to various creditors.  LFI sought recovery from Jackson individually, and Jackson asserted two defenses:  (1) he was not personally liable on the Note because he signed in a representative capacity and (2) the Note failed for a lack of consideration.  I discuss the first defense in this post.

Was the Note a negotiable instrument?   A sub-issue was whether Indiana’s UCC, specifically I.C. § 26-1-3.1-402 dealing with negotiable instruments, applied.  (Typically, the UCC applies because most promissory notes meet the requirements of a negotiable instrument.)  If the UCC applied, the burden of proof was on Jackson to in essence prove a negative:  that both parties did not intend for him to be personally liable under the Note.  Was the document was in fact a “negotiable instrument” as defined in I.C. § 26-1-3.1-104?  The Court of Appeals concluded it was not, essentially because it purported to incorporate by reference the terms of a separate contract.  The Note not only referred to a non-existent mortgage but, more importantly, indicated that all agreements and covenants in that mortgage applied to the Note – a no-no under the UCC.  So, Jackson was not held to the heavy burden “to show that both parties to the Note intended that Jackson not make himself liable.” 

Contract law.  The issue of personal liability thus turned on the common law of contracts, not the UCC.  And, plaintiff LFI had the burden of proof.  In this scenario, courts apply a set of rules of construction and interpretation to arrive at a decision as to what the parties intended in the written document.  The Court weighed a plethora of details about the language in the Note and the circumstances leading up to its execution.  For example, after his signature, Jackson did not have the word “President.”  In the final analysis, the Court concluded that “based on the manner in which Jackson signed the Note and our consideration of the surrounding circumstances, we conclude that the Note evidences a promise on the part of Jackson to pay LFI the amount owed by [HPI].”  So, despite winning on the UCC/burden of proof issue, Jackson still got beat on his first defense.   

On the hook?  The Court’s conclusion in Jackson is favorable to Indiana creditors, particularly in the rare scenario where a Note does not constitute a negotiable instrument under the UCC.  Absent clear and unambiguous language and/or facts showing that the amount of money was owed solely by the corporate entity, owners purporting to sign in a representative capacity could be at risk.  In part II of this post, however, I’ll explain why the Indiana Court of Appeals ultimately found the Note to be unenforceable as to Jackson.  LFI won a battle, but lost the war. 

Lis Pendens Lessons

If you’re wondering what an Indiana lis pendens notice is, look no further than the December 12, 2007 Indiana Court of Appeals opinion in Clarkson v. Neff, 2007 Ind. App. LEXIS 2752 (ClarksonOpinion.pdf).  The opinion provides some history, addresses common law rules and discusses Indiana’s lis pendens statute, I.C. § 32-30-11.  (I previously touched upon a lis pendens issue in my September 20, 2007 post.)

The Clarkson case surrounded a residential construction contract dispute, including an effort to secure a Court order requiring the purchase of a home.  During the pendency of the litigation between the builder and the original buyers (the Clarksons), a third party (Neff) purchased the home from the builder.  The question was whether Neff acquired the property free and clear of any interest of the Clarksons, who had filed a lis pendens notice.

Common laws tidbits.  Indiana’s lis pendens rules require that a separate, written notice of a pending suit be filed with the Clerk of the Court of the county where the real estate is located in order for the lawsuit to affect the interests of third-party purchasers.  Clarkson at 5-6.  The purpose of a lis pendens notice is:

to provide machinery whereby a person with an in rem claim to property, which is not otherwise recorded or perfected, may put his claim upon the public records so that third persons dealing with the defendant . . . will have constructive notice of it.

Id. at 6.  “If a lis pendens notice is properly filed on the public records, a subsequent purchaser will take the property subject to a judgment in the pending claim.”  Id.  “To protect an interest in the property, the subsequent purchaser may either ensure that the grantor does not harm his rights or intervene in the action.”  Id. 

The statute.  I.C. § § 32-30-11-3 and 32-30-11-9 specifically applied to the Clarkson case.  Lis pendens notices are not filed with the County Recorder’s office.  Rather, by statute, they must be filed with the Clerk’s office.  I.C. § 32-30-11-3(b).  Clarkson also illustrates that the validity of a lis pendens notice hinges upon whether there exists a pending lawsuit. 

In Clarkson, a lis pendens notice was properly filed with the appropriate County Clerk’s office thirteen days before third-party Neff closed on the purchase of the property.  The Indiana Court of Appeals concluded that “clearly, Neff had constructive notice of the Circuit Court lawsuit when he purchased the property, as provided by the lis pendens statutes, because the Clarksons correctly filed a lis pendens notice in Hancock County.  Id. at 8.  Neff thus was deemed to be bound by any judgment entered in the suit.  The suit was not yet resolved, so the Court concluded that Neff “does not at this time own the property in question free of any and all claims of the Clarksons as a matter of law.”  Id. at 11. 

Practical application.  A lis pendens filing will provide constructive notice (implied knowledge) that a piece of property is embroiled in litigation.  The notice—the document filed with the Clerk—will lead the researcher to the particular pleadings filed in the pending lawsuit, which pleadings will describe the nature of the legal dispute, including its potential impact upon title to the property.  If the I’s are dotted and the T’s are crossed, a lis pendens notice will demonstrate to a party doing due diligence that the property is or may be encumbered.  Although lis pendens-related matters rarely arise in a commercial foreclosure case, it is important for representatives of commercial lending institutions to be familiar with the concept.  In certain cases, a lis pendens notice could affect a lender’s priority.

Potential Negligence Of An Indiana Receiver

Judge Theresa Springmann of the Northern District of Indiana issued an opinion on November 5, 2007 in the case FTC v. Think Achievement, 2007 U.S. Dist. LEXIS 82621 (N.D. Ind. 2007) (ThinkAchievementOpinion.pdf).  Think Achievement was a negligence case brought against a court-appointed receiver relating to the alleged failure to preserve and protect the assets of the receivership estate.  The opinion addresses some of the general rules in Indiana and the Seventh Circuit that apply to receivers.  Although the underlying case dealt with Federal Trade Commission Act violations, the opinion relates to secured lenders because of their interest in holding receivers accountable for the protection of the receivership estate. 

Why the suit?  The receiver failed to procure insurance for a valuable estate asset, specifically a private residence in Carmel, Indiana.  The residence was damaged by arson, and there was no insurance coverage for the fire-related losses.  The question was whether the receiver should pay for the damage. 

More background.  The court-appointed receiver was an attorney with no prior experience as a receiver.  Interestingly, he also acted as legal counsel for the receiver.  (In essence, he provided legal counsel to himself.)  The receiver understood he had a responsibility to protect the assets in the receivership estate, including keeping insurance on property.  He ultimately dropped the ball, however, despite a seemingly reasonable excuse.  (I won’t bore you with the relevant insurance law.) 

Legal theories.  The case was a negligence action asserting that the receiver breached his duty, owed to the receivership estate, “to exercise reasonable care to protect and preserve the assets of the receivership estate.”  Id. at 8.  Here are a couple important points cited in the opinion:

• Standard:  In carrying out the duties of a receiver, the receiver “must exercise ordinary care and prudence, that is, the same care and diligence that an ordinary prudent person would exercise in handling his or her own estate, or under like circumstances.”  Id.

• Help:  “If a receiver is uncertain how to preserve property, he should petition the court for instructions.”  Id.

In this particular case, the plaintiff argued that the scope of the duty included, specifically, a duty to obtain insurance for the protection of the estate assets and that the receiver breached that duty. 

Outcome.  The dispute did not center upon whether a duty existed.  Indeed, the defendant did not deny that he had a duty of care to the receivership estate requiring him to obtain insurance on insurable assets.  Id.  Instead, the issue was whether and to what extent he appropriately carried out that duty, and the Court held there was evidence from which a jury could conclude either way.  Although Judge Springmann pointed to facts unfavorable to the defendant, in the final analysis she held that the facts concerning whether the receiver breached (violated/failed to comply with) his duty did not “lend of themselves to only a single inference.”  Id. at 12.  In other words, whether the receiver conformed his conduct to the applicable standard of care was a triable issue of fact that must be reserved for the jury.   

The upshot for receivers.  There are a handful of points receivers can take away from the Think Achievement opinion.  First, a court-appointed receiver may be exposed to liability for damages if it acts unreasonably with regard to its duty to protect the assets of the receivership estate.  Second, if the receiver is faced with an issue and is unsure as to what to do, the receiver can and should petition the court for direction.  Finally, as suggested by Judge Springmann, it may be prudent to seek the assistance of outside legal counsel. 

Neither receivers, nor parties involved in a receivership, want to see unnecessary or avoidable expenses incurred.  Hiring lawyers and filing motions with courts can become expensive and can, indirectly, dissipate the assets of the receivership estate.  However, reasonable measures need to be undertaken to prevent damage to the property, such as the fire-related losses addressed in the Think Achievement case.  Receivers are well advised to consider the retention of legal counsel when confronted with a tricky issue. 

Lender applicability.  From the perspective of a secured lender, the Think Achievement case is important because it is a reminder that, not only is a receiver’s purpose to protect loan collateral, but an unreasonable failure to do so may expose the receiver to a damages claim.  Secured lenders might be able to seek recourse against receivers that negligently cause losses to the receivership estate.

Effectiveness Of A Release In An Indiana Forbearance Agreement

The September 20, 2007 decision by Judge Barker of the United States District Court for the Southern District of Indiana in Midwest Lumber v. Branch Banking, 2007 U.S. Dist. LEXIS 69924 (S.D. Ind. 2007) (MidwestLumberOpinion.pdf) involves the dismissal of borrowers’ lender liability claims, but it also specifically addresses a release provision in a forbearance agreement.  Even though lender liability is not the primary focus of my blog, certainly forbearance agreements are pertinent.  And the workout industry should be aware of Judge Barker’s holding.  (I’d like to thank my colleague Chris Jacobson for her contributions to this article.)      

Parties.  The plaintiff was borrower Midwest Lumber, a lumber supplier.  Mr. and Mrs. Davis, the principals of Midwest Lumber and guarantors in the subject transactions, also were plaintiffs.  The loans in question involved working capital for the business secured by accounts receivable, inventory and real estate.  The named defendant was Branch Banking and Trust Company, the lender, which refinanced Midwest Lumber’s working capital loan facility.

Defaults/forbearance agreements.  Midwest Lumber couldn’t make its payments, so it and the Davises entered into a series of loan modifications and, ultimately, forbearance agreements with Branch Banking.  As an inducement for Branch Banking to agree to the terms set out in the forbearance agreements, Midwest Lumber and the Davises gave comprehensive written releases to Branch Banking in each forbearance agreement that stated in pertinent part:

  [Midwest Lumber and the Davises] hereby release and forever
  discharge [Branch Banking], its officers, directors, attorneys,
  employees, predecessors and successors (the “Released Parties”) of
  and from any claims, demands, obligations, actions, causes of action,
  damages, costs (including without limitation court costs and attorneys’
  and paralegals’ fees and expenses), expenses and compensation of
  any nature whatsoever (collectively, “Claims”), known or unknown,
  whether based in tort, contract or any other theory of recovery, or which
  may exist or might be claimed to exist at or prior to the date of this
  Letter Agreement on account of or in any way arising out of the
  Banking relationship between [Midwest Lumber], [Branch Banking]
  and its successors . . ..

Id. at 15.

Midwest Lumber/Davises Lawsuit.  The suit giving rise to the opinion originated with the filing of a complaint by Midwest Lumber/the Davises against Branch Banking in which the plaintiffs alleged that Branch Banking should be liable for misrepresentation, breach of the covenant of good faith and fair dealing, interference with business relationships, breach of fiduciary duty, undue control, economic duress and business coercion and negligent misrepresentation.  Significantly, Midwest Lumber/the Davises initiated the lawsuit after they had executed the forbearance agreements containing the release. 

Midwest Lumber filed a motion to dismiss the claims based in part upon the releases in the forbearance agreements.  Branch Banking argued that the forbearance agreements released it of any liability toward Midwest Lumber and the Davises.  Judge Barker agreed.  Midwest Lumber and the Davises made a variety of arguments against the enforceability and effectiveness of the releases, but Judge Barker concluded on page 18:

  having determined that the releases clearly and unambiguously
  released [Branch Banking] from any claim by [Midwest Lumber
  and the Davises] arising out of their banking relationship and
  having further found that [Midwest Lumber and the Davises]
  were not under economic duress when they signed the releases
  and that [Midwest Lumber and the Davises] have not returned
  the consideration they received from [Branch Banking] in
  exchange for signing the releases, all of [Midwest Lumber and
  the Davises] claims in the Second Amended Complaint must
  be DISMISSED.

Message.  The Midwest Lumber case begs the question of whether lenders should demand general releases in all of their forbearance agreements.  Most workout scenarios will not involve questionable conduct on the part of the lender or allegations of lender liability.  So, such a release might not directly apply in many situations.  But there is no downside from the aspect of the lender to include such general releases in the forbearance agreements.  Indeed, there is only upside:  protection.  The time the parties forbear is the time to get a release – even if you don’t think you’ll ever need it.  Midwest Lumber generally supports the proposition that such a release should be effective to bar future lender liability claims brought by the borrowers or guarantors, so releases of liability probably should be negotiated into most if not all forbearance agreements, if possible.

Land Contract Vendee Defeats Mortgagee’s Foreclosure Case

In the event you ever deal with priority disputes involving an Indiana mortgage and a land sale contract, or related issues, the October 15, 2007 opinion of the Indiana Court of Appeals in Pramco v. Yoder, et al., 2007 Ind. App. LEXIS 2320 (PramcoOpinion.pdf) will be instructive.  The Court denied mortgage holder Pramco’s request to foreclose on property occupied by Jose Arellano through a land sale contract. 

The loan and contract.  Steven Yoder entered into a promissory note with Bank in the amount of $33,000, which note was secured by a mortgage on residential real estate Yoder owned.  The Bank recorded the mortgage on July 31, 2001.  Subsequently, Yoder entered into a land sale contract with Arellano in the amount of $54,000 that got recorded on January 16, 2002, after the recordation of Bank’s mortgage. 

Subsequent loans and defaults.  Yoder and Bank later entered into other loan transactions worth several hundred thousand dollars secured by mortgages on thirteen different properties, including the property in question.  Yoder ultimately defaulted on his loan obligations, and Bank sold/assigned the notes and mortgages to Pramco.  Before this particular case, Pramco had foreclosed on and liquidated all the properties except for the property occupied by Arellano.  The residual debt totaled about $415,000.