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Fraudulent Transfer Claims Within Post-Judgment Collection Proceedings

Lender (judgment-creditor) obtained a $1+MM judgment against guarantor (judgment-debtor).  Guarantor allegedly transferred millions of dollars to guarantor’s spouse.  Lender, in proceedings supplemental, filed a motion seeking to avoid the transfer and targeted the spouse (garnishee-defendant).  Was a separate cause of action (lawsuit) required?  Did the spouse have a right to a jury trial?  Did the spouse have to file a response to the lender’s motion?  In PNC Bank, 2011 U.S. Dist. LEXIS 99917 (S.D. Ind. 2011) (rt click/save target as for pdf), Magistrate Judge Baker addressed those questions in his report and recommendations, which District Court Judge Pratt subsequently adopted.

General parameters.  In response to the lender’s motion to set aside the alleged fraudulent transfers, the guarantor objected on three grounds.  PNC relied on the Indiana Supreme Court’s decision in Rose v. Mercantile National Bank, about which I wrote on June 29, 2007.  The PNC case noted several basic rules that applied:

 1. A motion to avoid a fraudulent conveyance can be invoked in proceedings supplemental because the claim’s “sole purpose [is] the removal of obstacles which prevent enforcement of a judgment.” 

 2. A garnishee-defendant (third party) can be named for the first time during proceedings supplemental. 

 3. To proceed, the garnishee-defendant must have “property of the judgment-debtor, regardless of whether the judgment-debtor himself could have pursued the garnishee-defendant or whether the garnishee-defendant was a party to the underlying lawsuit.” 

 4. A court need not make a preliminary determination that a garnishee-defendant violated the Fraudulent Transfer Act before requiring the garnishee-defendant to appear.

Objection 1 – new claim?  The first issue in PNC was whether the lender’s fraudulent transfer theory was a “new claim” that warranted the filing of a separate lawsuit. 

 1. Generally, when a judgment-creditor proceeds against a garnishee-defendant, the proceedings merely are a “continuation of the original cause of action, not a new and independent civil action.” 

 2. On the other hand, if a judgment-creditor introduces new claims “unrelated to the enforcement of a judgment,” or if the judgment-creditor “seeks damages greater than the original judgment,” then the judgment-creditor has moved the case outside of proceedings supplemental, and a new cause of action is required. 

3. Although proceedings supplemental can include a fraudulent conveyance claim, the recovery is not for the alleged wrong or for damages.  Rather, “proceedings supplemental seek to continue the original cause of action by enforcing a previously granted judgment.”  If the judgment-creditor is successful, the conveyance remains valid, and the only effect of the judgment is to subject the property to execution “as though it were still in the name of the grantor [judgment-debtor].”  I interpret this to mean that the result is an order subjecting the transferred funds to further judgment execution proceedings (collection).

In PNC, unlike Rose, the lender’s original judgment amount and the amount targeted in its motion were precisely the same.  Accordingly, Indiana law did not require a new cause of action (separate lawsuit). 

Objection 2 – jury trial?  The guarantor also asserted that the law required a new cause of action because the spouse had a right to a jury trial.  Since proceedings supplement derive from equity, they usually should be conducted by the judge.  Nevertheless, jury trials are not completely precluded.  If questions of fact arise as to the claim involving the garnishee-defendant, then the parties may demand a jury trial.  The Court in PNC recognized and preserved the spouse’s right to a jury trial.

Objection 3 – garnishee response required?  In PNC, the lender wanted the Court to compel the spouse to file a written response (an answer) to the lender’s motion.  Once a verified motion triggers proceedings supplemental, pursuant to Trial Rule 69(E) courts shall order garnishees to appear for a hearing or to answer interrogatories, but “no further pleadings shall be required.”  Responsive pleadings are not required unless a new claim arises.  Since there were no new issues of liability as to the spouse in PNC (see Objection 1), the Court did not require the spouse to file a response.   

The upshot of the ruling in PNC was that the Court temporarily denied the lender’s motion pending discovery into whether a factual basis existed for setting aside the disputed transfers.  The proceedings supplemental therefore continued, albeit without a new action against the spouse and without the spouse needing to respond to the motion.  The Court contemplated that the lender would file a renewed motion following limited discovery.  (The case has since been settled.)  

Unreleased Line of Credit Mortgage Lien Negated By Payoff

U.S. Bank v. Seeley, 953 N.E.2d 486 (Ind. Ct. App. 2011) sheds light on what a “payoff” might mean in Indiana.  The case also reminds purchasers, their lenders and their title insurance companies to obtain releases of prior mortgages at the closing table. 

The story.  In 1998, Seeley obtained a home equity line of credit (HELOC).  In 1999, Seeley entered into an agreement to sell the subject real estate.  In advance of the closing, the title company discovered the HELOC mortgage and sent a “mortgage payoff request” to the HELOC lender.  The next day, the HELOC lender sent a “consumer loan payoff request” that listed the payoff amount, with a per diem.  The transaction closed, and the title company sent the HELOC lender a check for the full amount identified in the HELOC lender’s payoff request.  In the transmittal letter, the title company instructed the HELOC lender to “close account and release mortgage.  This property has been sold.”  The HELOC lender cashed the check but did not release its mortgage or close the line of credit.  The HELOC lender’s successor subsequently allowed Seeley to draw on the line of credit.  Seeley later defaulted, causing the HELOC lender to file suit to foreclose on the real estate, which a subsequent purchaser owned at the time.

“Payoff.”  In the trial court proceedings, the subsequent owner argued that the HELOC mortgage should be released.  The owner submitted an affidavit from the 1999 title agent stating, in part:

[t]he word “payoff” has a particular meaning in the real estate mortgage and title industry.  When a closing agent . . . receives a “payoff” figure, it understands that to be the amount the lender requires for a release of its mortgage, especially when the payoff figure contains no other instructions.

The evidence also showed that, after the closing, the HELOC lender never contacted the title company to advise that the payoff check or delivered documents were insufficient to obtain a release.

Obligation to release?  The subsequent owner argued that the payment, at closing, of the then-existing obligation, together with the circumstances surrounding it, obligated the HELOC lender to release its mortgage.  The HELOC lender contended that Seeley was required to provide a termination statement before it was bound to record a release. 

Rule 1 – not automatic.  The Court first noted that “unlike a term note, a [HELOC] is not automatically terminated when the balance is paid down to zero . . ..”  Such a rule would violate the very nature of the credit.  The Court in U.S. Bank concluded that the post-closing payment to the HELOC lender did not in and of itself terminate the HELOC. 

The real issue.  On the other hand, the Court said that the HELOC did not necessarily survive.  The test is whether the evidence establishes that the parties intended for the payment to terminate the HELOC.  The evidence in U.S. Bank showed just that - the “payoff” was the amount required to secure a release of the mortgage.  The title company remitted the requested amount, and the HELOC lender accepted it.  The icing on the cake was the title company’s letter, with the check, stating “please close account and release mortgage.  This property has been sold.”  Since the HELOC lender did nothing other than accept the cash, the payment obligated the HELOC lender to release its mortgage. 

Distinguishing Ping.  The HELOC lender relied on the 2008 Ping opinion, the subject of a prior blog post.  Under somewhat similar circumstances, the Ping Court did not require the release of the HELOC mortgage, even though there were payments that reduced the balance to zero.  The distinguishing factor between U.S. Bank and Ping was that the loan documents in Ping specifically required the mortgagor/owner to terminate the credit agreement before the mortgagee was required to release.  The mortgagor in Ping took no such action.  In U.S. Bank, the loan documents contained no such special requirements, but even so, unlike in Ping, the title company in U.S. Bank specifically requested a release of the mortgage. 

If you or your counsel are ever faced with a situation in which a line of credit mortgage was not released at a closing, despite a payoff, you should read the U.S. Bank and the Ping decisions for how Indiana courts might resolve the issue.  One way to prevent the problem in the first place is to require the lender to deliver an executed release at closing.  That way, the title company or the purchaser’s lender can control its recording, rather than relying upon the prior mortgagee/ lender to do so post-closing. 

Indiana Attorney Fee Liens In Commercial Cases

Can attorneys for parties to Indiana commercial foreclosure actions file liens for unpaid legal fees?  Miller v. Up In Smoke, 2011 U.S. Dist. LEXIS 80684 (N.D. Ind. 2011) (rt click/save target as for pdf) sheds light on the matter. 

Context.  In Miller, the Court ultimately appointed a receiver to oversee the management and operation of a defendant company.  Attorneys representing the defendants contested the receivership proceedings.  The attorneys did not get paid and filed notices of attorney fee liens in the case.  The attorneys then filed a motion to enforce their liens.  The receiver opposed the motion, resulting in the Miller opinion. 

Retaining lien.  Indiana law recognizes only two kinds of attorney’s liens.  The first is a “retaining” lien, which prevents a client from utilizing materials held by the attorney until the client either settles the fee dispute or posts security for payment.  The existence of a retaining lien depends upon the attorney’s possession “of money, property or papers of the client.”  Basically, attorneys can retain their clients’ stuff until they get paid.  As a practical matter, this lien acts as a leverage tool, but is unlike a more traditional lien that can be foreclosed. 

Charging lien - generally.  The second and potentially more meaningful lien is a “charging” lien for “services rendered in a particular cause of action or proceeding to secure compensation for obtaining a judgment, award or decree on the client’s behalf.”  Indiana case law says that an attorney “has a lien for his costs upon a fund recovered by his aid, paramount to that of the persons interested in the fund or those claiming as their creditors.”  This lien is based upon the idea that “the client should not be allowed to appropriate the whole of the judgment without paying for the services of the attorney who obtained it.”  The Court explained that “an attorney’s charging lien attaches to the fruits of the attorney’s skill and labor . . . [but] if the attorney’s work produces no fruit, then the attorney has no lien.” 

Charging lien - statute.  Indiana’s charging lien is statutory:  Ind. Code § 33-43-4.  The statute provides that an attorney “may hold a lien for the attorneys’ fees on a judgment rendered in favor of a person employing the attorney to obtain the judgment.”  The lien arises if the attorney files a written notice on the docket of an intention to hold a lien on the judgment, along with the amount of the claim, no later than sixty days after the date of the entry of judgment.  I.C. § 33-43-4-2.  I.C. § 33-43-4-1 expressly states that “no lien can be acquired before judgment . . ..”  Indiana law strictly enforces this “judgment” requirement.

No judgment = no charging lien.  The attorney fee claim in Miller was an alleged charging lien.  But the services of the attorneys did not produce a “fund” upon which they sought to impose the lien.  The alleged fund was the receivership estate (property of) the defendant company.  The attorneys’ efforts, however, did not secure or create the receivership estate.  If anyone deserved a lien, it would be the receiver and the receiver’s counsel, not the counsel of the defendants, who resisted the appointment of the receiver. 

Lender’s counsel.  Miller tells us that lender’s counsel can file a charging lien against a judgment that counsel secures for its client.  Miller even hints that lender’s counsel could file a lien on real estate acquired by the client at a sheriff’s sale.  The point is that plaintiff lenders can be exposed to attorney/charging liens if they don’t pay their lawyers.  Alas, lenders typically possess both the willingness and capacity to pay. 

Borrower’s counsel.  Unlike lenders, defendant borrowers and guarantors come to attorneys already in financial distress.  Getting paid can be a challenge, no question.  As stated in Miller, very rarely can defense counsel assert a charging lien.  Essentially, counsel must obtain an affirmative judgment in favor of their client, such as in a case of set-off or counterclaim.  (The Court cited to a Georgia case for the proposition that a defense attorney could obtain a lien on a client’s land if he successfully defended an adverse claim on such land.)  The bottom line is that, even assuming the defendant won the case, there still must be a judgment or fund to which a defense counsel’s charging lien could attach.  This is why, in the vast majority of cases, defense counsel at best may have a retaining lien on the client’s money, property or papers (usually, the file and attorney work product), but this lien is not particularly valuable.  Hence the need for up-front retainers.

Indiana District Court Examines “Material Adverse Change” Default Provision

The most common loan default is for non-payment.  But there are many other events that can trigger a default.  Indeed loan documents, including guaranties, typically contain a multitude of default-related provisions.  One provision that we often see, but rarely apply, looks something like this:

Insecurity.  Lender determines in good faith that a material adverse change has occurred in Guarantor’s financial condition from the conditions set forth in the most recent financial statement before the date of the Guaranty or that the prospect for payment or performance of the Debt is impaired for any reason.

Greenwood Place v. The Huntington National Bank, 2011 U.S. Dist. LEXIS 78736 (S.D. Ind. 2011) (rt click/save target as for .pdf) addresses a similar material adverse change (“MAC”) clause. 

Summary judgment.  In Greenwood Place, Southern District of Indiana Judge Tanya Walton Pratt issued a ruling on a motion for summary judgment filed by a lender against two borrowers based on the theory that there had been a “material adverse change in the financial condition of” the guarantor of the loans.  The opinion did not quote the entire clause, but it was clear that the subject loan agreement provided that “any material adverse change in the financial condition of” the guarantor constituted an event of default.  (Note that an alleged default occurred even though the loan payments were current.) 

The change.  Since the execution of the loan agreement, the guarantor’s cash had been almost completely depleted, his net worth had decreased by 60%, his equity in real estate had diminished by 80%, and he had unpaid judgments against him for several million dollars.  According to the Court, “to be sure, [guarantor] has experienced an adverse change in his financial condition.”  But, “whether this change has been material . . . is a more difficult question.”

The Court’s struggle.  The Court conceded that “at first blush, it would appear that this change has been material as that word is used in common parlance.”  Nevertheless, the Court noted that the loan documents did not define “any material adverse change.”  Evidence from six witnesses suggested different definitions.  Although the lender urged the Court to accept a “know it when you see it” interpretation, the Court was “uncomfortable” with applying such an approach at the summary judgment stage.  “Materiality,” noted the Court, is an “inherently amorphous concept.”  The guarantor still had a sizeable net worth that, based on certain assumptions, could be enough to absorb any liability stemming out of the underlying loans.  “This cushion creates questions as to whether the adverse change in [guarantor’s] financial condition is, in fact, material.” 

Ambiguous.  The Court denied the lender’s motion for summary judgment:

Given the “sliding scale” nature of materiality, coupled with the lack of a definition or objective standard found in the [loan agreement], the Court cannot help but find that the term is ambiguous because reasonable people could come to different conclusions about its meaning.  . . .  [T]herefore, “an examination of relevant extrinsic evidence is appropriate in order to ascertain the parties’ intent.”

Essentially, the Court held that the issue of materiality was a question of fact for trial. 

What we learned.  The Court’s analysis of the relevant financial conditions provides a road map for prosecutors (or defenders) of similar defaults.  The Court’s opinion does not question the fundamental validity or enforceability of MAC provisions.  The opinion does, however, raise the question of whether such a provision can form the basis for a pre-trial disposition of the case:  “when it comes to materiality, it’s all relative.”  The implication is that every case (financial condition) is different, and facts may need to be weighed.  On the other hand, Greenwood Place does not go so far as to proclaim that summary judgment should be denied in every case.  The opinion merely demonstrates how difficult summary judgment might be to achieve.