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. 

Status of land contract.  Plaintiff Pramco sought to foreclose on the property Arellano occupied pursuant to the land contract.  Arellano already had made, in addition to a $15,000 down payment, thirty-nine other payments for a total amount paid under the contract of about $45,000.  Remember, the original mortgage between Yoder and Bank was for only $33,000. 

The equitable result.  The trial court held that its equitable powers could prevent the injustice that would result from the foreclosure of the mortgage, including specifically Arellano’s forfeiture of the $45,000 he paid pursuant to the land sale contract.  Yoder had used Arellano’s payments to make mortgage payments to Bank. With a foreclosure, all that money would be lost.  And to add insult to injury, Arellano would lose possession of the property.  The Indiana Court of Appeals reasoned that to grant foreclosure would be to grant Pramco a double recovery.

If forfeiture were allowed, Pramco would have received the benefit of Arellano’s down payment, and subsequent monthly payments, which were taken by Yoder to the Bank, which in turn sold the mortgage to Pramco.  Pramco would then be allowed to sell the Property at sheriff’s sale, as Pramco did with the twelve other parcels of real estate, and retain the proceeds from the sale.

Id. at 14.  The Court of Appeals relied, in part, on the landmark Indiana Supreme Court decision in Skendzel v. Marshall, 301 N.E.2d 641 (Ind. 1973) concerning forfeiture/land sale contracts. 

Fair to the lender?  The mortgage Pramco sought to foreclose had been recorded before the land contract, had never been released and had remained unpaid.  Had the competing lien been another mortgage, Pramco would have prevailed.  Land contracts, however, are treated differently in Indiana, and one must remember that foreclosure actions “are essentially equitable.”  Id. at 11.  When trial courts make decisions with regard to equitable remedies (generally, remedies other than money damages), they are not compelled to strictly follow particular rules of law but rather have great latitude to promote fairness and justice.  (Mortgage foreclosure actions seek an equitable court order to sell real estate to satisfy a debt.)  Lenders thus may not always get what they want or perhaps even deserve.  This is particularly true in Indiana when there is a collision of interests between a mortgage holder and a land contract vendee. 

Inattention To Detail: Another Lesson In Mortgage Loan Documentation

Judge Philip Klingeberger of the U.S. Bankruptcy Court for the Northern District of Indiana addressed a unique situation in In Re Canaday, 2007 Bankr. LEXIS 3121 (N.D. Ind. 2007) (CanadayOpinion.pdf).  The loan transaction involved a note, which identified the holder to be a trust (the Don Wilson Revocable Living Trust), and a mortgage, which identified the mortgagee to be an individual (Don Wilson).  The 19-page opinion provides an impressive summary of various Indiana mortgage laws and illustrates once again the consequences of sloppy transactional work.    

The problem.  Debtor Canaday, the owner of real estate, executed a note in favor of the Wilson Trust and, contemporaneously, a mortgage in favor of Don Wilson, individually.  So, the Wilson Trust held the note, but Wilson individually held the mortgage.  (It also bears mentioning that the mortgage referred to a January 12 note, but the date of the note was January 13.)  When the debtor filed bankruptcy, Don Wilson, as a creditor, filed a secured claim in the bankruptcy case.  The debtor objected to the secured status of the claim and asserted that the mortgage was invalid.  The issue was whether the mortgage was effective against a hypothetical bona fide purchaser under 11 U.S.C. § 544(a)(3).  Canaday at 5. 

Gap in the law.  According to Judge Klingeberger:

  [T]here is an amazing, incredible lack of case law on the issue
  of the validity of a mortgage – both in relation to the parties to
  that instrument and in relation to third parties potentially having
  interests in the real estate subject to the mortgage – in a
  circumstance in which no indebtedness is owed in any manner
  to the designated mortgagee. 

Id. at 11.  The absence of case law probably has to do with the unique set of facts.  How often, if ever, would a lender execute loan documents in which the lender’s name in the note and the mortgage was not identical?  Judge Klingeberger sidestepped the opportunity to create new law as to this issue but instead based his holding on more settled principles.   

Indiana’s mortgage statutes.  The rules upon which the Judge primarily focused can be found in two Indiana statutes, Indiana Code § § 32-21-4-1 and 32-29-1-5. 

     I.C. § 32-21-4-1, Indiana’s recording statute, generally provides that constructive notice sufficient to defeat the interests of a bona fide purchaser is given only if the mortgage is recorded.  Canaday at 9.  The purpose of the recording statute is to give subsequent purchasers constructive notice of a prior conveyance.  Id.  “Constructive notice” means “a legal inference from established facts.”  Id. at 10.  For example “deeds and mortgages, when properly acknowledged and placed on record as required by statute, are constructive notice of their existence.”  Id.  “Actual notice” means that a party actually knows, for instance, of the existence of a mortgage.  In instances of constructive notice, a party may not actually know of a fact but is deemed to know it.

     I.C. § 32-29-1-5, the second statutory piece of the puzzle, defines both the elements of a mortgage that is valid between the mortgagor and the mortgagee, and – in conjunction with I.C. § 32-21-4-1 – also defines the requirements for a mortgage to be valid against a bona fide purchaser of the subject property from the mortgagor.  Canaday at 10.  At issue in Canaday were requirements surrounding the description of the indebtedness.  “Indiana has a long line of cases which cogently define the elements of the description of an indebtedness in a mortgage which caused that mortgage to be valid both between the parties, and with respect to third persons . . ..”  Id. at 13.  Judge Klingeberger ultimately concluded that the indebtedness description in the mortgage instrument, for purposes of giving rise to a secured claim, was insufficient:

Indiana case law … requires far more than the mortgage instrument at issue in this case provides in order to sustain the validity of that mortgage against a bona fide purchaser.  The mortgage instrument in this case does not direct an individual reviewing the real property records with respect to the subject real estate to an individual who can be assumed, based upon this record, to have knowledge as to the indebtedness secured by the mortgage.  The mortgage instrument in this case describes a promissory note which does not exist – there is simply no evidence of any obligation evidenced by a promissory note dated January 12, 2005, and the mis-description of the date of the actual note evidencing the underlying obligation secured by the mortgage creates exactly the situation in which Indiana case law seeks to avoid with respect to substitution of indebtedness.  In similar manner, even apart from the erroneous designation of the date of the promissory note, there is insufficient information in the mortgage to clearly identify the indebtedness to which it relates.  Finally, there is no statement in the mortgage of “the date of the repayment” of the indebtedness which the mortgage purports to secure.

Id. at 18-19 (emphasis in original). 

Canaday is another example of the consequences of inattention to detail in the preparation of loan documents.  The creditor’s secured claim was relegated to an unsecured claim with significantly less value, if any value at all.  It’s hard for lien enforcement lawyers like me to meet the needs of banking clients when the underlying loan documents are flawed.  Remember – enforcement of a creditor’s rights begins when the parties initially draft the docs. 

Indiana Receivers Can Sue For Damages Suffered By The Receivership Entity

What happens if, as a secured lender, you file a foreclosure suit and have a receiver appointed, and during that process you learn of circumstances in which your borrower (a/k/a the receivership entity) has a claim for damages against a third party?  Because the financial wellbeing of a borrower usually inures to the benefit of the lender, it may be in the mutual best interests of the secured lender and the borrower to pursue a lawsuit against that third party.  Judge Hamilton of the USDC for the Southern District of Indiana addressed some general principles surrounding this issue in his September 5, 2007 opinion, Marwil v. Kluff, 2007 U.S. Dist. LEXIS 65996 (MarwilOpinion.pdf).  Marwil illustrates how a receivership might help a secured creditor get paid.   

Not a foreclosure, but applicable nonetheless.  The backdrop to the Marwil case was a civil enforcement action brought by the SEC.  The Court had appointed a receiver for the Church Extension of the Church of God, Inc. (CEG), an Indiana non-profit corporation founded to raise funds for an Indiana-based church with more than 230,000 members nation-wide.  CEG, the receivership entity, allegedly had been mixed up in multiple fraudulent conveyances associated with a highly complicated loan and real estate transaction scheme.  The specific issue in the Marwil opinion was the validity of the receiver’s suit against third parties based upon Indiana’s fraudulent transfer statute, Indiana Code §§ 32-18-2-14 and 15. 

Receivership rules and analysis.  The third parties (the defendants in Marwil) that allegedly participated in the fraud filed a motion to dismiss.  They argued that the receiver did not have standing to bring suit because the suit, in reality, was for the benefit CEG’s creditors, not CEG itself.  Judge Hamilton held, however, that the Complaint asserted CEG, the receivership entity (not the creditors), suffered actionable injuries.  Based upon those assertions in the Complaint, he denied the motion to dismiss.  Here are some of the general receivership rules that applied:

 The role of the receiver is to promote orderly and efficient management of property involved in a dispute for the benefit of the creditors.  Id. at 10.

 The benefit to creditors contemplated by receivership law, however, is only a derivative one.  The general rule is that a receiver may pursue only the rights and claims that belong to the receivership entity itself.  Id.

 For a receivership entity to possess claims, the entity itself must have suffered a cognizable, redressable injury reasonably traceable to the challenged action of the defendants.  Id. at 11.

 Fraud on the receivership entity that operates to its damage is for the receiver to pursue (and to the extent that investors as the holders of equity interests in the entity may ultimately benefit from such pursuit, that does not alter the proposition that the receiver is the proper party to enforce the claim).

Judge Hamilton concluded that “so long as the claims themselves seek redress for injuries suffered by CEG, [the receiver] can assert and pursue them against the defendants.”  Id. at 12. 

Indiana’s receivership statute.  Indiana Code § 32-30-5-7 states, in pertinent part:

The receiver may, under the control of the court or the judge: 
  (1) bring and defend actions;
  (2) take and keep possession of a property;
  (3) receive rents;
  (4) collect debts; and
  (5) sell property;
in the receiver’s own name, and generally do other acts respecting the property as the
court or judge may authorize.

For reasons unclear to me, Judge Hamilton did not cite to this statute in reaching his decision.  The Indiana statute may not have applied because the underlying action in Marwil dealt with SEC violations.  It is significant to note for purposes of this article, however, that the Indiana statute supports the proposition that receivers have the power to file lawsuits.

Jurisdiction Over Out-Of-State Guarantors

In what state can a commercial lender bring its case against an out-of-state guarantor of an Indiana loan?  Judge David Hamilton of the Southern District of Indiana helps answer this question in Automotive Finance v. Aberdeen Auto Sales, 2007 U.S. Dist. LEXIS 60136 (S.D. Ind. 2007) (AutomotiveOpinion.pdf), in which he denied a motion to dismiss filed by a Mississippi defendant/guarantor in an Indiana commercial collection action. 

The status.  Plaintiff lender (Automotive Finance) filed an Indiana federal court foreclosure case against defendant borrower (Aberdeen), a Mississippi entity, for breach of an auto dealer floor-plan financing contract intended to support Aberdeen’s Indiana operations.  In addition to naming Aberdeen as a defendant, the lender named a Mississippi citizen who had guaranteed the deal.  The guarantor (Mitchell) filed a motion to dismiss for lack of personal jurisdiction, asserting that the lender could only sue her in Mississippi to pursue damages based on the guaranty.

The issue.  One of the questions in the case was whether Mitchell’s guaranty of an Indiana debt was sufficient to justify the exercise of specific jurisdiction over her in Indiana.  Mitchell’s only tie to Indiana was that she signed the guaranty – in Mississippi.  She did not communicate with anyone in Indiana or travel to Indiana in connection with the deal.  She received no compensation from the business borrower for the floor-plan financing.  “If the court has jurisdiction over Mitchell, it must be based on the guaranty for the benefit of [borrower], which Mitchell admits she signed.”  Id. at 4. 

The guaranty.  The language of the guaranty was somewhat unique.  Mitchell explicitly agreed in the guaranty to submit to the personal jurisdiction of Indiana.  The guaranty also provided that it shall be governed by Indiana law.  (It also should be noted that Mitchell was a director and/or officer of the borrower.)

The jurisdiction lesson.  Indiana extends its personal jurisdiction to the full extent of the due process clause of the Fourteenth Amendment.  Under applicable constitutional principles and Indiana case law, Judge Hamilton held that the court could exercise personal jurisdiction over the Mississippi guarantor: 

  Plaintiff and the defendants entered into a substantial and
  long-term commercial financing relationship in which a
  lender in Indiana extended credit to a borrower in Mississippi,
  with guaranties from other Mississippi residents, including
  Mitchell.  As part of the guaranty, Mitchell agreed to jurisdiction
  and venue in Indiana.  Based on the clear terms of the guaranty,
  Mitchell obviously had “fair warning,” . . . that she could be sued
  in Indiana with respect to this transaction.  She could reasonably
  anticipate that she would be “haled into court” in Indiana in
  disputes arising out of the guaranty.  The guaranty itself told her
  that she was agreeing to precisely that possibility.  She also
  agreed that if she filed suit herself relating to the guaranty, she
  would file it in Marion County [Indianapolis], Indiana.

Id. at 5.  Judge Hamilton further reasoned that, because the borrower was subject to jurisdiction in Indiana, Mitchell’s guaranty was presumably “an essential term of [lender’s] agreement to extend $100,000 in credit to a corporation whose creditworthiness was uncertain.”  Id. at 7.  From the perspective of the lender, Judge Hamilton concluded, it made “good sense” to secure the agreement of all parties to the transaction so that any lawsuit arising from it could be heard in one venue with all interested parties, including guarantors.  Without such an agreement, credit would be more difficult and expensive to obtain.  Id. 

The upshot.   Automotive Finance is a favorable decision to creditors with Indiana deals involving out-of-state guarantors.  Depending upon the facts of the particular case, Judge Hamilton’s opinion supports the notion that, even though guarantors may have little-to-no contacts with Indiana, the mere fact that the individual guaranteed a loan for an Indiana project may be sufficient to subject that individual to jurisdiction here. 

Normally, it’s in the best interests of lenders to avoid the need to file suits in multiple states for the same debt.  Secured lenders are thus advised to utilize the language mentioned in the Automotive Finance guaranty – that is, have the guarantor stipulate to personal jurisdiction and venue in Indiana (or wherever the loan collateral is).  Without such an express statement, winning the jurisdictional battle may be more difficult.