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TIMBER! Creditor’s Alleged Security Interest Falls

In Re: Cruse, 2013 Bankr. LEXIS 360 (S.D. Ind. 2013) (.pdf) is about UCC secured transactions generally, and security interests in timber specifically.  The Court’s opinion is helpful to asset-based lenders and their counsel in Indiana. 

The debt.  In Cruse, a Chapter 13 bankruptcy case, the Debtor was in the business of buying and harvesting timber (living trees) and reselling the timber after it was cut.  The Debtor and the Creditor entered into a contract that allowed the Debtor to harvest timber on the Creditor’s land in exchange for payment, including a percentage of the sales.  Following the filing of the Debtor’s bankruptcy, the unpaid Creditor filed a proof of claim

The objection.  The Debtor did not object to the amount of the Creditor’s claim but rather its alleged secured status.  The Creditor contended that the Debtor’s property (the timber) was subject to the Creditor’s security interest.  The Debtor responded that the Creditor’s proof of claim contained no documentation to support a lien or a security interest. 

The law.  The issue in Cruse was whether the Creditor had a perfected security interest in the timber, which is considered personal property (not real property in this context).  The Court identified the applicable legal rules:

  • Article 9.1 of the Uniform Commercial Code governs the creation and perfection of liens in personal property.
  • Under I.C. § 26-1-9.1-102(44) , both “standing timber that is to be cut and removed under a conveyance or contract for sale” and timber already harvested are classified as “goods.”
  • Both “attachment” and “perfection” of a security interest are needed to enforce a security interest in goods against the debtor (and third parties). 
  • “Attachment” pertains to the creation of the security interest as between the secured party (creditor) and the debtor and requires the debtor to have rights in the collateral he intends to pledge to the secured party.
  • “Attachment” involves the execution of a written security agreement between the debtor and the secured party that describes the collateral (unless the secured party is in possession of the collateral).
  • “Perfection” is an additional step that makes the security interest effective against third parties.
  • A security interest in “timber to be cut” is perfected by filing a financing statement with the office designated for the recording of a mortgage on the related real property, which in Indiana is the county recorder’s office.  I.C. § 26-1-9.1-501(a)(1)(B); I.C. § 32-21-4-1(a)(1).
  • A security interest in timber already cut is perfected by filing a financing statement with the secretary of state’s office.  I.C. § 26-1-9.1-501(a)(2).

The result.  In Cruse, the Creditor provided no evidence of a written security agreement.  Even so, the creation and attachment elements were immaterial because there was “nothing in the record that suggest[ed] [the security interest] was perfected.”  The Creditor offered no evidence of any filing in the county recorder’s office or in the secretary of state’s office.  The Court sustained the Debtor’s objection to the Creditor’s secured claim and rendered the claim unsecured.

The Creditor could have created and perfected an enforceable lien on the Debtor’s timber, but the absence of a written security agreement and appropriate governmental filings was fatal in Cruse.

Indiana Judgment Liens Are Subordinate To Prior Liens, REVISITED

The Indiana Supreme Court in 2010 reversed the Indiana Court of Appeals’ decision that was the subject of my 2009 post, Indiana Judgment Liens Are Subordinate to Prior LiensSee, Johnson v. Johnson, 920 N.E.2d 253 (Ind. 2010).  For purposes of this blog, the essential points in my January 2009 post remain unchanged.  The Indiana Supreme Court’s take on the situation, however, warrants some comment.

The circumstances.  Johnson arose out of divorce proceedings, specifically a settlement and divorce decree.  The husband agreed that the settlement created a judgment lien (under Ind. Code § 34-55-9-2) in favor of the wife on the husband’s farm.  The wife agreed that a bank’s mortgage on the husband’s farm, which mortgage secured a line of credit to operate the farm, had priority over the wife’s judgment lien.  The disagreement surrounded lines of credit entered after the date of the settlement and resulting judgment lien.  The wife essentially argued that her lien was only subordinate up to the historical amount needed for past farm operations.  The husband claimed that the settlement agreement subordinated the wife’s lien priority without limit. 

General priority rules.  The Indiana Supreme Court thoroughly discussed the nature of the wife’s lien.  Indiana common law states that “priority in time gives a lien priority in right.”  Also, a lien is discharged when the underlying debt is paid.  Further, “when a lien with first priority is discharged, the second lien takes its place in priority, and subsequent liens would be junior to it.”  However, by agreement, typically labeled a “subordination agreement,” an individual may waive a lien’s priority.  As noted in my 2009 post, and as reiterated by the Indiana Supreme Court, “the taking of a new note and mortgage for the same debt upon the same land will not discharge the lien of the first mortgage unless the parties so intended.”  Thus if the farm’s debt merely was being renewed, then the bank’s lien would retain its superiority.  In Johnson, instead of merely renewing the debt, the husband sought to incur new debt to pay the wife for her interest in the farm. 

Subordination.  The specific question before the Court was whether the trial court had the authority to modify the wife’s lien to permit the husband to finance his divorce obligations.  The wife, while agreeing to subordinate her lien to the bank’s in an amount sufficient to continue consistent operation of the farm, did not agree to a finance of the divorce settlement.  The Court stated that any order subordinating the wife’s lien to the bank’s for amounts over and above past operational amounts would result in an impermissible modification of the prior deal:

We have already determined that subordinating [wife’s] lien up to an amount necessary to maintain the farm’s operation is not a modification but an enforcement.  Once having approved the parties’ settlement agreement and incorporated it in the device, a court directive compelling [wife] to do more than that by subordinating her lien to allow [husband] to finance his divorce obligations constituted a modification and was impermissible.

Johnson informs parties to divorce proceedings more than it does parties to loan enforcement/foreclosure proceedings.  Nevertheless, the Indiana Supreme Court’s general statements regarding Indiana lien law are important to bear in mind as transactions are closed, loans are enforced and work-outs are accomplished. 

Mortgagee Not Liable For Tragic Drowning

What is the responsibility of an Indiana mortgagee (lender) vis-à-vis the condition of the mortgaged real estate?  Is there a duty to keep the premises safe?  The Indiana Court of Appeals in Erwin v. HSBC, 2013 Ind. App. LEXIS 11 (Ind. Ct. App. 2013) addressed those questions in a challenging case resolved through summary judgment.

Tragedy.  Erwin is a very sad story.  Lender held a mortgage on a home with an in-ground pool.  In 2007, the owner (the mortgagor) filed a Chapter 7 bankruptcy case, and the lender began paying the real estate taxes and had the property inspected.  In early 2008, during the pendency of the bankruptcy, the owner abandoned the real estate and notified the lender that it could have the home.  Later in 2008, the pool and its cover became “openly dangerous” and in need of repair.  One of the neighbors contacted the owner to complain.  The owner, in turn, contacted the lender to inform it of the situation.  On May 31, 2008, a five-year-old girl, who was spending the day at a nearby home, wandered away and drowned in the pool. 

Mother’s contentions.  The mother of the child filed suit against a number of parties, including the lender, for wrongful death (negligence).  She asserted that the lender was a “mortgagee in possession” at the time of the drowning.  She argued that the lender was in the best position to prevent the tragedy “and that public policy supports imposing a duty on [the lender] to protect the child from a danger of which [the lender] had actual knowledge.”

Premises liability law.  Space does not permit a summary of Indiana premises liability law.  For purposes of this post, the important point is that “only a party who possesses the premises owes a duty to persons coming onto the premises.”  The outcome in Erwin hinged on whether the lender possessed the real estate.  Although the owner in Erwin had abandoned the real estate and informed the lender of this, the lender did not act upon the owner’s unilateral actions by later occupying the real estate with the intent to control it.  Further, knowledge of a danger alone is insufficient to impute liability.  The Court said:  “Mother must first establish that [the lender] had control of the property.” 

“Mortgagee in possession.”  Generally, in Indiana a mortgagee may be in possession of the mortgaged property and, under certain circumstances, may assume certain responsibilities concerning the real estate.  But, as written here previously, the lender could not acquire legal ownership of the real estate until it was foreclosed upon.  In Erwin, the lender had not filed a foreclosure suit.  Importantly, a mortgagor cannot unilaterally transform a lender into a mortgagee in possession so as to transfer the mortgagor’s duties as possessor.  In Erwin, the lender took no affirmative action to step in and take possession of the real estate after default and before the drowning.  Although the mortgagor (owner) gave the lender the right to take possession of the abandoned property and secure the pool, that provision did “not equate to a duty to do so.” 

Policy.  The Court of Appeals affirmed the trial court’s summary judgment in favor of the lender.  Here is part of the Court’s rationale:

While we understand Mother’s displeasure with the limbo in which untold numbers of vacant properties find themselves, the legislature is the place to assert her public policy arguments.  On the current state of the law, a phone call such as [the owner’s] does not automatically transform the mortgagee into the possessor of the property.  Rather, the alleged subsequent possessor must take some action to occupy the land with intent to control it.  . . .  Further, actions taken by a vendor/mortgagee to protect its financial investment, such as paying taxes and securing insurance, generally do not establish control over the property rising to the level of a possessor of the property. 

Although the Court left open the possibility of mortgagee liability under a different set of facts, in Erwin the circumstances were clear. 

Happy New Year: 2013's Best Post?

With the holidays and year-end commitments, I failed to put together new material for this week.  Rather than posting a goose egg, I decided to study my forty-one 2013 posts to determine my personal favorite.  Here it is:  Indiana Foreclosures: How Long Do They Take?  That article features links to thirteen other posts and contains lots of information related to a very common question. 

Favorites 2A and 2B are:  Some Tips For Indiana Receivers and Indiana's Pre-Suit Notice And Settlement Conference Statute Not Intended For Commercial Foreclosures.  Those two contain practical tips and specifically resulted from client requests.  Plus, for some reason I have an affinity for receiverships and the law related to them. 

My eighth year at this thing resumes next week, at which time I'll submit my 361st post.  Thanks for reading, and please think of Wooden & McLaughlin and me for any foreclosure or real estate needs you or your clients may have in 2014.  We would appreciate the opportunity to help.