« May 2007 | Main | July 2007 »

INDIANA SUPREME COURT DISCUSSES PROCEEDINGS SUPPLEMENTAL

Do you know what “proceedings supplemental” are?  If you are in the business of collecting judgments in Indiana, and from time to time virtually all secured lenders are, then the June 20, 2007 opinion by the Indiana Supreme Court in Rose v. Mercantile National Bank, 2007 Ind. LEXIS 471 provides a great primer on the subject.  (RoseOpinion.pdf).   

Facts of Rose.  Plaintiffs sued an S-Corp, and the trial court entered judgment against S-Corp for $159,581.  During the litigation, the owners of S-Corp sold the company in an asset sale to Corporation I for $475,000.  Corporation I then transferred its rights and obligations under the asset-purchase agreement to Corporation II, a wholly-owned subsidiary of Corporation I.  After the sale, the owners of S-Corp deposited the sale proceeds into S-Corp’s bank account and, within three days, issued checks to themselves for the entire sale price.  The closing occurred approximately one month after the trial court entered judgment for Plaintiffs.   

About a year later, presumably because the judgment had not been paid, Plaintiffs moved for proceedings supplemental and brought fraudulent transfer claims against S-Corp, Corporation I, Corporation II, and S-Corp’s owners.  Plaintiffs asserted that assets had been transferred out of S-Corp to avoid paying the judgment.  During the proceedings supplemental, Plaintiffs sought to amend the complaint to add additional claims and to recover new damages.  The result was a new judgment for Plaintiffs for $542,435.49 plus attorney’s fees of $162,730.  The Indiana Supreme Court affirmed the trial court’s finding that the two owners of S-Corp fraudulently transferred assets, but the Court set aside the new claims for new damages. 

Proceedings supplemental generally.  Proceedings supplemental are designed to help judgment creditors enforce judgments – for discovering assets and to set aside fraudulent conveyances.  Proceedings supplemental are merely the continuation of an original action.  Ind. Trial Rule 69(E) generally governs proceedings supplemental, and the motion is made in the court where judgment was rendered.  Discovery is permitted, and a hearing must be conducted, after which certain property is to be applied toward the judgment.  Id. at 4-5. 

Fraudulent transfer.  Judgment creditors often use proceedings supplemental to bring fraudulent transfer actions, the purpose of which is to remove “obstacles which prevent the enforcement of the judgment . . . through the levy of execution.”  The essence of a fraudulent transfer action is not to attack the transfer or to recover damages.  Instead, the action “is to subject property to execution as though it were still in the name of the grantor.”  Id at 6-7.

New claims.  Unlike Plaintiffs’ fraudulent transfer claims, Plaintiffs also sought new damages from the S-Corp owners by adding a new cause of action under Indiana’s Crime Victims’ Compensation Act, which allows for treble damages and attorney’s fees.  The Court said this was a no-no: 

  Allowing a new claim to be tacked on at this stage would be just as
  unfitting as opening up any other litigation to add new claims after
  judgment.  Such an approach to collections would lay the
  groundwork for perpetual motion-a far cry from the timely and
  efficient system of conflict resolution the nation’s judiciary strives
  to provide.  Proceedings supplemental are appropriate only for
  actions to enforce and collect existing judgments, not to establish
  new ones. 

Id. at 7.  So, a new claim for new damages, and thus the imposition of a new judgment, should be filed in a new lawsuit.  On the other hand, “any action to assist in collection of an original judgment [like a proceeding supplement] must be filed under the same cause number as the original action.”  Id

In addition to addressing the generalities of proceedings supplemental, the Indiana Supreme Court provides clarity for lenders concerning fraudulent transfer actions, which can be appropriately prosecuted in proceedings supplemental or, in other words, in a continuation of the same case and in the same trial court that rendered the judgment.  Any new claims or, in other words, actions for separate and distinct damages, however, must be the subject of another lawsuit.


EQUITABLE SUBROGATION AND OTHER TIDBITS FROM GIBSON V. NEU

Commercial lenders operating in Indiana can take away a few nuggets of useful information from the May 30 Indiana Court of Appeals opinion in Gibson v. Neu, 2007 Ind. App. LEXIS 1140 (GibsonOpinion.pdf).  Among other things, the Court talks about default, notice and, most prominently, the doctrine of equitable subrogation, which provides relief in certain priority disputes where a lien is missed in a pre-closing title search.

Factual background.  The dispute in Gibson arose out of defaults on a note and real estate mortgage that were a part of a stock purchase transaction.  As a part of the deal, the purchaser gave the seller a junior mortgage on his $600,000 residence.  During a time period in which the purchaser was not consistently making note payments (defaulting), the purchaser sold his home and paid off the senior mortgage, but failed to address the seller’s junior mortgage.  In fact, the buyer of the home’s title insurance company missed the seller’s junior mortgage in the title search.  When the seller went to foreclose on that mortgage, the seller learned that the purchaser had sold the home and that there existed a new mortgage on the property.  A fundamental issue in the lawsuit was which mortgage had priority – the stock seller’s or the home buyer’s.  Although these title goof-ups occur mainly in the residential mortgage arena, commercial lenders are not immune to such problems and therefore should have a working knowledge of the doctrine of equitable subrogation.

Two minor points.  A couple things are worth mentioning here: 

1. A default is a default.  The purchaser’s monthly payments under the note were $7,000.  At the time of the default in question, the purchaser only was $500 behind, and the purchaser made a $5,000 payment the next month.  The purchaser tried to claim that he had “substantially performed” under the note and thus should not have been deemed in default.  The Court of Appeals rejected the argument and followed the strict language in the loan documents, concluding that the purchaser was not current in his payments.  Id. at 10-12.  So, at least according to Gibson, payments mean “full” payments, not “substantial” payments. 

2. Notices of default.  Clients sometimes ask whether they need to provide notice of default and an opportunity to cure.  In Indiana, the answer to that question lies in the language of the note and/or mortgage.  There is no statutory or common law requirement to provide notice and an opportunity to cure.  Gibson supports this proposition – “under the plain language of the note and mortgage, [seller] was not required to give [purchaser] notice of default.”  Id. at 12-13.  Notice is not required as a matter of law – only if the loan documents call for it.

Equitable subrogation.  Pursuant to Ind. Code 32-21-4-1(b), a mortgage takes priority according to the time of its filing [a/k/a recording].  In Gibson, the prior mortgage of the seller in the stock purchase transaction generally would have priority over the home buyer/lender’s mortgage.  The home buyer contended, however, that the doctrine of equitable subrogation operated to give him priority.  The application of the doctrine can be a bit clouded and complicated.  The Court of Appeals discusses the doctrine at length on pages 14 through 25 of the opinion and includes in its analysis the Indiana Supreme Court’s 2005 decision in Bank of New York v. Nally, 820 N.E.2d 644 (Ind. 2005).  There are a number of factors to be considered, and it appears the factors could vary depending upon whether the loan was a refinance as opposed to original funding.  For what it’s worth, the “classic formulation” of the doctrine in the case of a purchaser of a note and mortgage for value is that the “purchaser’s right of subrogation to the mortgage he or she discharged includes its priority over junior liens of which (a) he or she did not have actual knowledge, and where (b) he or she was not culpably negligent in failing to learn of the junior lien.”  Id. at 14.  Nally complicated that classic formulation a bit, however.  Some of the other factors the courts will weigh include (a) avoidance of an unearned windfall, (b) absence of prejudice to the interest of junior lien holders, (c) lender’s justified expectation of receiving a security interest in the property and (d) the achievement of an equitable [fair] result.  Gibson is an illustration of the granting of equitable subrogation over a prior mortgage.  The home buyer (and lender) prevailed.

The obvious issue not addressed in the opinion was the role the home buyer’s title insurance company played.  Once the buyer and/or his lender learned that the title work missed the prior mortgage, I suspect someone immediately made a claim to the title insurer and that the title insurer provided some form of coverage for the claim.  In fact, the title insurer very likely covered the costs of the litigation.  Fortunately for the buyer and lender, and also the title insurance company, the Court of Appeals found that their mortgage had priority, so there were no damages.  The home buyer and lender were, therefore, protected from what could have been a disastrous financial result.  So, don’t forget to buy title insurance and, if a title issue arises, don’t forget to immediately assert a claim.


INDEPENDENT CONTRACTOR EARNINGS ARE SUBJECT TO GARNISHMENT IN INDIANA

If as a secured lender you choose to pursue a deficiency judgment, one of the common options to consider is a garnishment proceeding.  Typically, we think of this in terms of garnishing “wages,” but the May 31, 2007 opinion by the Indiana Court of Appeals in Indiana Surgical Specialists v. Griffin, 2007 Ind. App. LEXIS 1151 explained that garnishment can include more than just wages. (ISSvGriffinOpinion.pdf). 

General rule.  Garnishment refers to “any legal or equitable proceedings through which the earnings of an individual are required to be withheld by a garnishee, by the individual debtor, or by any other person for the payment of a judgment.” Ind. Code 24-4.5-5-105(1)(b); Indiana Surgical at 3.  Earnings are “compensation paid or payable for personal services, whether denominated as wages, salary, commission, bonus, or otherwise, and includes periodic payments under a pension or retirement program.”  I.C. 24-4.5-1-301(9); Indiana Surgical at 4.  Addressing a federal counterpart to the Indiana statute, the United States Supreme Court in a 1974 case stated that garnishment should include “periodic payments of compensation.”  Indiana Surgical at 4.  Interestingly, the Indiana Court of Appeals adopted the “periodic payments of compensation” language even though it is not found in the Indiana statute. 

(The Court of Appeals dealt only with I.C. 24-4.5-5, the Uniform Consumer Credit Code, and the garnishment provisions therein.  The remedy of garnishment also is addressed generally in I.C 34-25-3 and Indiana Trial Rule 69(E).  I see no reason why the holding of Indiana Surgical would not apply to all garnishment actions in Indiana.)   

Application to independent contractors.  Indiana Surgical involved a judgment debtor that was an independent contractor of the garnishee defendant.  In other words, the debtor was not an employee and did not earn wages.  She was a courier who received a commission based on the deliveries made.  The Indiana Court of Appeals determined that the commissions were “periodic payments of compensation,” which constituted “earnings” subject to garnishment.  Id. at 4.

I suppose the common label “garnishing wages” really should be “garnishing earnings.”  The more important point here for commercial lending institutions pursuing deficiency judgments in Indiana is that you can institute proceedings supplemental against the principal of an independent contractor (agent) in order to seek satisfaction of the contractor’s debt.  The relief is not limited to an employer/employee scenario.


USA TODAY STORY DISCUSSES AN ASSET PROTECTION SCHEME

A USA Today article from today, "Legal Gaps Help Hide Assets From Creditors, IRS," discusses schemes, and even a business assisting with schemes, to hide assets from creditors.  Here's a link, which has embedded links to prior, related stories.  Among other things, the article reminds us of how difficult and expensive it can be to collect unsecured debt -- perhaps a good lesson for secured lenders as to how important it is to evaluate collateral before making a loan.  Banking on the hope of recovering a deficiency judgment can be a risky proposition.