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Bankruptcy Proofs Of Claim And Standing/Loan Assignment Issues

Secured lenders faced with loans in default may find themselves entangled in a borrower’s or guarantor’s bankruptcy case and thus forced to file a proof of claim (POC).  In my April 27, 2007 post, I wrote about POCs, including when a creditor should file one.  In the Matter of Larkin, 2010 Bankr. LEXIS 3609 (N.D. Ind. 2010) (click and save for .pdf), Judge Dees provides a thorough opinion surrounding the sufficiency of the documentation needed to support a POC, which opinion also touches upon the “standing” issue that has been prevalent in mortgage foreclosure law for the past three or four years.

POC general rules.  The main POC rule is located at Federal Rule of Bankruptcy Procedure 3001.  A POC, if executed and filed in accordance with the Rules, “shall constitute prima facie evidence of the validity and amount of the claim.”  Fed. R. Bankr. P. 3001(f).  If the claim is based on a writing, the original or a duplicate of the written document must be filed with the proof of claim.  F.R.B.P. 3001(c).  If the creditor asserts a security interest in the debtor’s property, the POC “shall be accompanied by evidence that the security interest has been perfected.”  F.R.B.P. 3001(d).  The POC is deemed allowed, unless a party in interest objects. 

Entire document.  In the Larkin matter, the debtor’s first objection surrounded the mortgagee creditor’s attachment of only certain pages of the underlying loan documents.  The issue was whether this “substantially” complied with Rules 3001(c) and (d).  The Court held that the attachment requirement in Rule 3001(c) mandates specific, not substantial, compliance and, as such, the Court initially ruled that the POC was not valid.  (After a continuance of the hearing on the objection, the creditor corrected the problem by attaching a complete set of documents.  You always should do the same.)

Mortgage assignment.  The creditor in Larkin was an assignee of the loan.  The mortgage assignment had not been recorded.  Indiana’s recording statutes regarding assignments of mortgages “are designed to protect third party purchasers and mortgagees, not mortgagors.”  The recording of an assignment of mortgage “is not necessary to the validity of the mortgage, but is simply a protection to a good-faith purchaser of the mortgage itself . . ..”  Since the debtor was a mortgagor, not a subsequent purchaser, the debtor could not challenge the validity of her properly-recorded mortgage for failure to record a subsequent assignment.  (We would advise recording all mortgage assignments as soon as possible, but the act of recording does not affect the enforceability of the mortgage as between the mortgagor and the mortgagee’s assignee.) 

Post-petition assignment.  The debtor also contended that, because the mortgage assignment was post-petition, it was ineffective because it violated the automatic stay.  Not so, said the Court.  Bankruptcy law provides that “once the original grant by the mortgagor to the mortgagee has been perfected, the later assignment of that mortgage does not involve a transfer of property of the debtor . . . and cannot constitute a violation of the automatic stay.”  Larkin supports the notion that post-petition loan assignments are appropriate. 

Note assignment.  The debtor also attacked the validity of the transfer of the promissory note from the original holder to the current creditor.  This is the “real party in interest” and “standing” defense advanced by debtors over the last few years.  (See my November 15, 2007 post.)  The Larkin opinion provides a solid summary of the law applicable to the assignment of promissory notes via endorsement or allonge.  Endorsement is defined by Black’s Law Dictionary as “the placing of a signature, sometimes with an additional notation, on the back of a negotiable instrument to transfer or guarantee the instrument or to acknowledge the payment.”  “Allonge” is a “French term used in legal contexts for a paper that is annexed to a note.”  In Indiana, an endorsement “on an allonge is valid even though there is sufficient space on the instrument for an indorsement.”  I.C. § 26-1-3.1-204(a).  The Court in Larkin concluded that the subject allonge that was affixed to the debtor’s note (and included with the POC) was a part of the note, and thus constituted a valid endorsement.

POCs filed by our firm, whether secured or unsecured, that are based upon written documents include a complete copy of the underlying loan documents and any assignment papers.  It is also our practice to prepare and attach an “Attachment to Proof of Claim” that gives a brief description of the nature of the claim and references the attachments.  The Attachment would spell out, among other things, the factual and documentary basis that the creditor is the holder of the note and mortgage, and has the present ability to enforce the subject loan. 

2011 Indiana Enactments

Following-up my April 26th post regarding pending Indiana legislation, here is a listing of banking/foreclosure-related laws that were enacted in the 2011 session of the General Assembly:

HB1244 (Payment plan to remove property from tax sale) and HB1024 (Notice of foreclosure to property insurers) were not enacted.

IBJ.com's Tom Harton wrote a piece entitled "New laws affect commercial property owners" on May 17th, and here's a link to that article:  IBJ.com.

It does not appear that anything terribly significant occurred in this year's session.  If you feel differently, please post a comment or send me an email.


To Be Enforceable, An Indiana Mortgage Must Adequately Describe The Debt It Purports To Secure

It’s pretty rare to read a case in which a court renders a commercial mortgage invalid.  But that’s what happened in SPCP v. Dolson, 2010 Ind. App. LEXIS 1852 (Ind. Ct. App. 2010) (.pdf).  Secured lenders beware:  if your mortgage contains an inaccurate and materially misleading description of the debt, you will lose your foreclosure remedy.

Purported mortgagor was a surety.  In SPCP, the alleged mortgagor, Holland, owned real estate that she leased to Dolson, a company that operated a pub.  The lease provided that Holland and Dolson could participate in a mortgage loan related to the real estate.  In fact, a lender, SPCP, made a $700,000 loan to Dolson.  The Dolls (officers in Dolson) and Thompson (Mrs. Doll’s father) guaranteed the loan.  Holland co-signed a mortgage with Dolson in favor of SPCP.  Holland did not, however, review or sign the underlying promissory note.   

Mortgages 101.  The SPCP opinion outlined the basic statutory requirements for a valid mortgage in Indiana (Ind. Code § 32-29-1-5).  A mortgage must recite both (1) the date for repayment and (2) one or more of:  (a) the sum for which it is granted; (b) the notes or evidences of debt; or (c) a description of the debt sought to be secured.  Mortgages must also be dated and signed, sealed and acknowledged by the grantor. 

Debt description.  With regard to the accuracy of the debt description, Indiana cases say:

literal accuracy in describing the debt secured by the mortgage is not required, but the description of the debt must be correct, so far as it goes, and full enough to direct attention to the sources of correct information in regard to it, and be such as not to mislead or deceive, as to the nature or amount of it, by the language used.  . . .  A reasonably certain description of the debt is required so as to preclude the parties from substituting debts other than those described for the mere purpose of defrauding creditors.

SPCP refined this summary of the law into a two-part test:  (1) whether the debt description was inaccurate and (2) whether the inaccuracy was sufficiently material to mislead or deceive the grantor/mortgagor as to the nature or amount of the debt. 

The inaccuracy.  The mortgage signed in SPCP secured debt “incurred under the terms of ‘a’ Promissory Note dated December 27, 2001 executed by Dolson, the Dolls and Thompson and maturing December 27, 2021.”  This accurately described the date of execution of the subject note and the maturity date but inaccurately described the identity of the note’s makers.  Thompson did not execute the note.  He signed a guaranty.  The Court held that the mortgage’s description of the debt was inaccurate. 

Materially misleading.  Moreover, the Court, in affirming the trial court’s summary judgment for Holland, concluded that the inaccuracy was sufficiently material so as to mislead Holland.  The Court articulated three reasons for its decision, all of which centered on the role of Thompson:

     1. Release.  After Dolson defaulted on the loan, SPCP settled with Thompson for $550,000 and released him from liability.  Holland, in agreeing to the mortgage, acted only as a surety pledging collateral to secure the loan of Dolson.  If Thompson had been liable on the note as a primary obligor (a maker), and not a guarantor, then any release of Thompson would, under Indiana law, have released Holland and her real estate.  Because Thompson was only a guarantor and thus a co-surety with Holland, the release of Thompson did not have that effect. 

     2. Subrogation.  Thompson’s status as guarantor, instead of co-maker of the note, changed Holland’s recourse against Thompson.  Under Indiana law, sureties have the right to complete reimbursement and subrogation from makers.  As only a co-surety, Thompson, at most, was exposed to Holland for Holland’s pro-rata contribution to the debt.  Thus the loan structure increased Holland’s risk of loss.  (I discussed suretyship law on 5-23-07.)

     3. Detrimental reliance.  Holland testified it was her understanding that her real estate would be subject to foreclosure only if the Dolls and Thompson failed to pay the debt.  Holland therefore relied to her detriment on the mortgage’s inaccurate description of Thompson as a co-maker.  Holland claimed that she would not have signed the mortgage had she known that Thompson was only a guarantor. 

Over the last few years, I have seen a handful of cases like SPCP in which the mortgagor was not the borrower but merely a pledgor of real estate.  In those cases, unlike SPCP, the language in the mortgage clearly connected the mortgage with the note.  The loan documents in SPCP lacked that clarity, and the alleged mortgagor was able to seize on the inaccuracy to save her commercial real estate from foreclosure.

Standards And Duties Applicable To Indiana Receivers

This post will supplement my November 7, 2006 and December 6, 2007 posts related to court-appointed receivers’ potential for exposure to liability.  The recent opinion by Judge McKinney in PNC Bank v. OCMC, 2010 U.S. Dist. LEXIS 98368 (S.D. Ind. 2010) (.pdf) dealt with a receiver appointed primarily to liquidate the assets of the defendant corporation.  The standards under Indiana law apply with equal vigor to receivers appointed to preserve and protect the subject real estate in mortgage foreclosure cases.  Receivers have certain obligations under Indiana law and are not immune from liability. 

Attempts to sue receiver.  The allegations against the receiver in PNC are not terribly important here.  Various parties and creditors sought to file a complaint against the receiver.  For a variety of reasons (read the opinion for additional details), Judge McKinney ruled in favor of the receiver and denied the parties’ request for leave to sue the receiver. 

Objection to receivership.  Parties that do not object to the appointment of a receiver at the time the appointment is made may be estopped from later raising claims of wrongful receivership.  “An objection to the appointment of a receiver must be raised at the time such appointment is made.”

Rule summary.  Perhaps the most meaningful thing to take away from PNC is the opinion’s outline of assorted Indiana legal principles applicable to receiverships:

  1. The only claims that may be brought against a receiver are those alleging (a) actions outside the scope of the receiver’s authority or (b) misconduct in the performance of receivership duties.  [A] “receiver who acts outside his statutory authority or orders of the appointing court, or who is guilty of negligence or misconduct in the administration of the receivership, is personally liable for any loss resulting therefrom.” 
  2. A court-appointed receiver “may be held liable in negligence when he has breached a duty owed either to creditors or others with whom the receiver is in privity, or held liable for other misconduct in the administration of the receivership.”  The duties inherent in a receivership flow from the receiver to the parties to the underlying suit and not to third-parties. 
  3. In PNC, the receivership order limited negligence suits in the case.  The order clearly stated that the receiver will not be liable for mere negligence but will be liable for actions taken “as a result of malfeasance, bad faith, gross negligence, or reckless disregard of their duties.”  Thus the order of appointment may limit liability.
  4. A receiver owes fiduciary duties to the creditors that the receivership is set up to protect.  “A receiver may not subordinate the interest of one creditor in favor of those of another creditor.”  This duty includes protecting the receivership property such that the claims of creditors may be paid out of it.

As previously noted here, and as reiterated by Judge McKinney in PNC, court-appointed receivers have certain duties with which they must comply.  But the scope of such responsibility is limited under the law and can be further limited by the order appointing the receiver. 

Seemingly, 99% of the time the receiver will be the plaintiff lender’s friend and, as a practical matter, a partner in the foreclosure case.  There are instances, however, when a conflict may arise between those two parties, particularly if a receiver causes damage or loss to the receivership estate or otherwise fails to prevent such damage or loss.  In such cases, lenders have recourse against the receiver.