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What Is A “Purchase Money Security Interest”?

Asset-based lenders with deals in Indiana need to be familiar with Indiana’s definition and application of a “purchase money security interest”.  Fortunately, a recent case from the U. S. Bankruptcy Court for the Southern District of Indiana, In Re:  Myers, 2008 Bankr. LEXIS 2172 (Myers.pdf), helps answer the question of what is a purchase money security interest.

Definition.  The Bankruptcy Code does not define “purchase money security interest”.  The Myers Court thus looked to state law “to fill the void,” including Indiana’s version of the UCC.  Specifically, Ind. Code § 26-1-9.1-103 outlines in detail the definition.  A purchase money security interest “in goods” is defined in section (b):

A security interest in goods is a purchase-money security interest:
(1)  to the extent that the goods are purchase-money collateral with respect to that security interest;
(2) if the security interest is in inventory that is or was purchase-money collateral, also to the extent that the security interest secures a purchase-money obligation incurred with respect to other inventory in which the secured party holds or held a purchase-money security interest; and
(3) also to the extent that the security interest secures a purchase-money obligation incurred with respect to software in which the secured party hold or held a purchase-money security interest.

According to I.C. § 26-1-9.1-103(a), “purchase money collateral” means “goods or software that secures a purchase money obligation incurred with respect to that collateral.”  That statute also provides the definition of “purchase money obligation”, which means “an obligation of an obligor incurred as all or part of the price of the collateral or for value given to enable the debtor to acquire rights in, or the use of the collateral if the value is in fact so used.”  The Court summed things up:

Thus, if the debt created by the money loaned or the credit extended was (1) incurred as all or part of the price of the collateral or (2) for value given by the creditor to the debtor to enable the debtor to acquire rights in or the use of the collateral, the debt so incurred is a “purchase money obligation”; the collateral which was purchased by the debtor and in which the creditor takes a security interest is “purchase money collateral”; and the security interest obtained in the collateral by the creditor is a “purchase money security interest”.

PMSI in action.  The Myers case addressed to what extent a lender had a purchase money security interest in a vehicle.  As part of the subject transaction, negative equity in the debtor’s trade-in was rolled into the loan, so the loan amount far exceeded the price of the vehicle.  (“Negative equity” meant the difference between the value of the trade-in and the amount still owed on it.)  The issue in Myers surrounded whether the creditor’s purchase money security interest extended to the negative equity portion of the loan, which begged the question of whether the negative equity loan was a “purchase money obligation”.  To qualify, the loan must have been either “(1) incurred as all or part of the price of the vehicle or (2) was value given by [creditor] to enable the debtor to acquire rights in [ownership] or the use of the vehicle.” 

After looking at a number of technical, legal bases, the Court concluded:

For the Debtor here to acquire ownership rights in the Vehicle, she needed financing and, under this transaction, she could not get financing without including her trade in . . ..  For her to include the trade in, she had to pay off the debt owed on it, and for her to pay the debt owed on the [trade in], she had to borrow enough funds to cover the trade in debt as well as the price of the Vehicle.  . . .  [T]his Court finds that it is difficult to see how the funds used to pay the negative equity here could not be viewed as an expense incurred in connection with acquiring rights in the Vehicle, and moreover believes the negative equity financing here is “precisely the type” of such expense.

Because the creditor’s purchase money security interest covered the money used to finance the negative equity, the court held the entire loan to be secured. 

Even though the Myers decision involved a consumer transaction, the case could apply to Indiana commercial transactions.  At a minimum, the opinion helps illustrate what a purchase money security interest is.

Off Topic: Appraisers' Role In The Residential Mortgage Meltdown

On August 18, the IBJ's online editor, Norm Heikens, posted on his blog the following:   

Some of the people most familiar with the mortgage foreclosure explosion in the Indianapolis area in recent years have privately pointed fingers at appraisers.

Appraisers too often were in cahoots with lenders to illegally inflate prices of houses, the insiders complained, usually off the record.

Most appraisers are honest, ethical people, of course. But now an Associated Press investigation says the system failed miserably.

What do you think? Have you seen evidence of appraisers’ inflating prices?

Click here for a link to the AP investigation, entitled "Weak Rules Cripple Appraiser Oversight," which telling and a good read even for commercial lenders.  While I completely agree that inflated appraisals contributed to the problem, I respectfully disagree with Mr. Heikens that appraisers were in cahoots with lenders.  It seems to me that there was little incentive for lenders to overvalue their loan collateral and leave themselves undersecured.  I concur with the comment posted by "Don" on Mr. Heikens' blog that independent, third-party mortgage brokers were the ones who stood to profit from the scheme. 

For example, My partner Dale Eikenberry has handled a number of mortgage fraud recovery cases, and I assisted him with one of his larger suits for an Indiana-based mortgage lender against an Indianapolis-based mortgage broker.  The theory of the case centered upon the broker's breach of its contractual representations and warranties concerning the truth and accuracy of the appraisals it ordered and supplied to the lender.  In our opinion, there was strong evidence that certain appraisers may have been in cahoots with the defendant broker to improperly inflate prices of houses.  We contended that our lender client had been damaged, to the tune of seven figures, by the bad appraisals, upon which the lender relied in underwriting about three dozen loans that never should've been made and ultimately went into default.   

Admittedly, the appraisal problem addressed in the AP investigation doesn't have much applicability to commercial mortgage loans, mainly because there really aren't independent, third-party brokers selling loans to commercial property owners or developers.  In the commercial setting, the lenders themselves (the funders of the loans) usually originate the loans and order the appraisals, not an independent third party who simply earns a commission if he or she closes the deal and suffers no harm if the customer (borrower) defaults on the loan. 

Certainly inflated appraisals can be a problem for commercial lenders, who are advised to scrutinize appraisal reports and utilize only trusted, experienced appraisers.  But, in my view, unlike the meltdown in the consumer industry, losses associated with commercial defaults really don't stem from appraisal-based fraud.  If others have had different experiences, please post a comment or email me, thanks.   

Writ Of Assistance: Timing And Other Practical Tips

This will expand upon my March 2, 2007 and April 28, 2008 posts relating to Indiana Trial Rule 70(A) writs of assistance, a tool secured lenders can use when they've acquired a sheriff's deed but have been unable to secure possession of the property.  Essentially, a writ of assistance is the method by which one can evict those unlawfully on, or in control of, the real estate.  The prior posts dealt with how writs of assistance can and should be executed.  The subject of today's post is more practical in nature.  The question is how quickly can the writ be executed or, in other words, once one triggers the process, how long will it take before the eviction occurs. 

Recent experience.  Last Fall, I tried a contested residential foreclosure case in Marion Superior Court (Indianapolis) and, with the help of my colleague Jeff Hammond, prevailed on all issues.  A sheriff's sale occurred, and our client obtained a sheriff's deed to the property at the sale.  The defendant/borrower refused to vacate the premises, so we initiated writ of assistance proceedings with the Marion County Civil Sheriff's Office.  Here is a brief summary of the steps involved:

  1. A $100 fee had to be paid;
  2. The sheriff sent a letter to the borrower, almost immediately, informing the borrower that she had ten days to vacate the property;
  3. About three days after the mailing of the letter, a deputy went to the property and posted a notice on the front door informing the borrower that she must vacate;
  4. On about the eleventh day, a deputy went back out to the property to determine whether it had been vacated; since in our case it was not, the sheriff scheduled a "move out date"; the sheriff determined the move out date by the volume of move out orders, usually seven to fourteen days later;
  5. Before the move out date, we (the plaintiff) had to contract with, and schedule, a bonded mover and locksmith to be present (a client represented had to be scheduled to be present at the move); and
  6. On the move out date, a deputy was present to ensure the borrower vacated all persons from the property and stayed to oversee the removal of the personal property and the changing of the locks. 

All told, in our case, it took twenty-nine days to evict the borrower and repossess the property. 

Remember, this was in Marion County, and, as noted in my April 14, 2008 post Indiana Sheriff's Sales - Local Rules, Customs and Practices Control, there are ninety-two counties in Indiana and thus ninety-two different sets of applicable rules.  As such, the timing may and likely will vary from county to county.   

Skip a step.  With the standard language we built into the post-trial order signed by the judge, we were not required to separately file for a writ of assistance in order to trigger the process.  According to the Marion County Sheriff, the order had already provided the office with the authority to proceed.  Here's what our order said:

Immediately after the sale and foreclosure, the Sheriff of Marion County, Indiana shall execute and deliver to the purchaser a deed of conveyance to the Real Estate and upon the request of the purchaser, shall eject and remove [defendant/borrower] and any party claiming from or through her that occupies any part of the Real Estate, and shall remove therefrom the personal property of any such person or entity and shall, in all other respects, deliver and place the purchaser in possession.

I would encourage the use of such language as it should enable one to bypass a step in the process.

Commercial cases too.  At the end of the day, in the vast majority of commercial mortgage foreclosure actions, the borrower will cooperate and surrender the property.  Having said that, one never knows when a unique case will arise in which a secured lender may need to resort to the remedy of a writ of assistance.  Thanks to Jeff Hammond for his input into this post.   

Full Judgment Bid = Zero Deficiency

On April 22, 2008, I posted the article “How Much Should A Lender/Senior Mortgagee Bid At An Indiana Sheriff’s Sale?”  The title of today’s post could be “How Much Not To Bid At An Indiana Sheriff’s Sale.”  Recently, the Court of Appeals in Titan Loan Investment Fund v. Marion Hotel Partners, 2008 Ind. App. LEXIS 1608 (Ind. Ct. App. 2008) (Titan.pdf) concluded that a foreclosure judgment “was fully paid and satisfied by [lender/mortgagee’s full judgment] bid at the sheriff’s sale” so as to preclude it from recovering any alleged deficiency. 

Full credit bid.  Titan (lender/mortgagee) secured a judgment in its foreclosure action against Marion (borrower/mortgagor) in the amount of $3,084,758.49.  At the sheriff’s sale, Titan was the sole bidder by “paying” the sum of $3,085,362.49 for the real estate.  Titan did not actually pay cash but rather made a “judgment bid,” also known as a “credit bid,” of the entire amount of the judgment, plus interest and costs.  As noted by the Court, “where the judgment creditor bids the judgment instead of cash, such a credit bid is ‘as effective as payment in actual money would have been . . . inasmuch as there is no reason for going through the empty form and idle ceremony of handing the money over . . . and then receiving it back….’”   

Titan’s point.  After the sale, Titan filed a motion for proceedings supplemental claiming that its judgment had not been fully paid and that it was entitled to pursue other assets of Marion’s to satisfy the alleged deficiency.  Titan contended its bid was not representative of the fair market value of the property.  Presumably, the property was worth much less than the bid, although the Court did not discuss any evidence that may have been submitted concerning the property’s value. 

Satisfaction.  In Indiana, the payment of a bid at a sheriff’s sale “sufficient to satisfy the judgment extinguishes the judgment.”  In other words, as noted in the opinion, “the full amount of the judgment, interest and costs at a sale constitutes a complete satisfaction of the judgment.” 

No deficiency as a matter of law.  The Court relied upon an opinion from the California Supreme Court and held:

The resolution of this case turns on the operation and effect of a “full credit bid.”  The full credit bid rule precludes a lender, for purposes of collecting its debt, from making a full credit bid and subsequently claiming the property was actually worth less than the bid.  The rule applies here because Titan bid and paid the full amount of its judgment, interest, and costs at the sheriff’s sale.  Thus, we hold that the judgment was fully paid and satisfied and that Titan may not pursue a deficiency.

Despite the fact that Titan may have “paid” too much for the real estate, Titan had only itself to blame.  The critical point is that Titan wasn’t required to bid the full amount of its judgment.  Indeed lenders can and probably should bid less than the fair market value of the property, as previously explained in this blog.   

Proceedings supplemental dismissed.  In Indiana, “it is a condition precedent to proceedings supplemental that a valid judgment remains unsatisfied.”  See, Ind. Trial Rule 69(E).  If the judgment has been satisfied, then the judgment debt has been discharged.  As such, the plaintiff no longer owns a judgment against the defendant, and a motion for proceedings supplemental becomes insufficient as a matter of law.  The Court of Appeals affirmed the trial court’s dismissal of Titan’s motion for proceedings supplemental, stating:

Before Titan could recover on an alleged deficiency, it was Titan’s burden to show that its judgment had not been fully paid and satisfied and that its still owned a judgment against Marion.  But Titan could not make that showing because its full credit bid at the sheriff’s sale was conclusive.  The record here affirmatively shows satisfaction of the judgment.

Moral of the story.  If Marion (or a guarantor) had assets in addition to the subject real estate, and if the actual value of the real estate was substantially less than the judgment, then this was an unfortunate result for Titan.  The Titan opinion does not provide any insight into why Titan made a full judgment bid.  In all fairness, Titan may have had legitimate reasons for doing so.  For example, in the residential foreclosure context, a HUD-insured loan may require the lender/mortgagee to bid the full amount of the judgment as a prerequisite to reimbursement by the government.  So, I’m not going to second guess Titan or its lawyers.  My main point is that, barring a reversal by the Indiana Supreme Court, Titan definitively tells us that a full judgment (credit) bid at a foreclosure sale effectively negates any alleged deficiency.  Please see my April 28, 2008 post for more insight or contact me for assistance.