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If Requested, Receiverships In Indiana Commercial Mortgage Foreclosure Actions Are Mandatory

There are many scenarios when a secured lender might want a receiver to take possession and control of commercial real estate loan collateral in order to preserve and protect the property during the pendency of a foreclosure suit.  The purpose of today’s post is to explain that, in Indiana, a motion for the appointment of a receiver should be granted every time.

What controls.  Indiana’s receivership statute, Ind. Code § 32-30-5, including specifically section 1(4), governs the appointment of a receiver:     

IC 32-30-5-1
 Appointment of receivers; cases
  Sec. 1. A receiver may be appointed by the court in the following cases:

    (4) In actions in which a mortgagee seeks to foreclose a mortgage.

However, upon motion by the mortgagee, the court shall appoint a receiver if, at the time the motion is filed, the property is not occupied by the owner as the owner’s principal residence and:

        (C) either the mortgagor or the owner of the property has agreed in the mortgage or in some other writing to the appointment of a receiver. . . .

Most loans secured by commercial real estate will have a loan document containing a receivership provision, which is a clause stating that the lender/mortgagee is entitled to the appointment of a receiver if the borrower/mortgagor is in default.  In such cases, Indiana’s legislature has left no doubt that lenders are entitled to a receivership.

(Please note that subsection (B) provides another basis when “it appears that the property may not be sufficient to discharge the mortgaged debt” or, in other words, when the amount owed is greater than the value of the real estate.)

The essentials.  In order to have a receiver appointed in an Indiana commercial mortgage foreclosure action, mortgagees simply need to show:

 1.  the lender/mortgagee has filed a lawsuit seeking to foreclose a mortgage;
 2.  the property is not occupied by the owner as the owner’s principal
  residence; and
 3.  the borrower/mortgagor has agreed in a written loan document to the
  appointment of a receiver.

Not discretionary.  How do we know a receivership is mandatory in such cases?  Because the Indiana Court of Appeals has said so.  In Citizens Financial v. Innsbrook, 833 N.E.2d 1045 (Ind. Ct. App. 2005) (Innsbrook.pdf), the trial court refused to appoint a receiver in the plaintiff bank’s action to foreclose a mortgage on the real property of a country club.  On appeal, the Court examined the mortgage language, as well as I.C. § 32-30-5-1(4)(C): 

To meet the requirements of Ind. Code § 32-30-5-1(4)(C), Citizens must show:  (1) that it, as mortgagee, sought to foreclose the mortgage; (2) at the time the motion is filed, the property is not occupied by the owner as the owner’s principal residence; and (3) either the mortgagor or the owner of the property has agreed in the mortgage or in some other writing to the appointment of a receiver.

The evidence in Innsbrook established these requirements.  The Court of Appeals thus reversed the trial court and held that the court had abused its discretion by not appointing a receiver.  The Court of Appeals focused upon the “shall” language in the operative statute and noted  that the appointment of a receiver is mandatory if section 4, and any one of its conditions, which include subsection (C), are met. 

If you’re wondering whether your institution is entitled to the appointment of a receiver, or how difficult it may be to have one appointed, you can see that in Indiana it’s practically automatic.  If your loan is nonperforming and presents problems that call for the solutions provided by a receivership, then don’t hesitate to pursue a court-appointed receivership.  Should you need additional details about the process, or to discuss strategies surrounding whether or when to seek a receivership in the first place, stay tuned for future blog posts or, as always, feel free to contact me.

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

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

Borrower idle.  The defendant borrower may not seek bankruptcy protection if, for example, there are no assets to protect beyond the loan collateral, the value of which may not cover the debt and the collection costs.  So, while the borrower essentially throws in the towel, the guarantor runs for cover in bankruptcy court.

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

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

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

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

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

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

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

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

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

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

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

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

Factual Questions Remain In Indiana Fraudulent Transfer Case

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

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

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

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

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

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

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

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

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

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

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