Mortgage Lien Second In Line, Because Small Claims Court Judgment Never Fully Satisfied

Lesson. Look for a filed satisfaction of judgment to conclusively determine whether a judgment lien has been extinguished. A small claims court judgment, properly indexed and unreleased, will have senior priority over a subsequently-recorded mortgage.

Case cite. Herron v. First Financial Bank, 91 N.E.3d 994 (Ind. Ct. App. 2017)

Legal issue. The issue in Herron was whether a judgment lien was effective as of May 14, 2013, when a small claims court entered its judgment, or as of November 17, 2015, following an appeal of the small claims court’s ruling during proceedings supplemental. If the judgment lien was effective as of the earlier date, then it would have senior priority over the competing mortgage lien. If the judgment lien was not effective until the later date, then the mortgage lien would have first priority.

Vital facts. Herron, a contractor, repaired a church’s roof in March 2011. In 2013, the Lawrence Township small claims court (Marion County) entered judgment for Herron against the church. The Township recorded the judgment in its Judgment Book on May 14, 2013. There was no appeal. Proceedings supplemental ensued and resulted in payments that satisfied the principal amount of the judgment and filing fees. However, on November 14, 2014, the court awarded additional damages to Herron for attorney’s fees and collection costs. Several months later, the small claims court, apparently sua sponte (on its own), rescinded the November 2014 order. Herron appealed that ruling to the Marion Superior Court, and on November 17, 2015, the superior court (a) reversed the small claims court’s rescission of its 2014 damages ruling and (b) entered a $10,000 award for Herron. Meanwhile, in November 2014, First Financial Bank (FFB) entered into a mortgage loan with the church and recorded its mortgage on February 23, 2015 – after the May 2013 Herron small claims judgment but before the November 2015 superior court judgment.

Procedural history. Herron filed an action to foreclose his judgment lien and named FFB as a defendant. FFB contended that its mortgage was senior to Herron’s lien. Both FFB and Herron filed summary judgment motions claiming that their respective liens had senior priority. The trial court determined that FFB’s mortgage had priority and granted FFB’s motion for summary judgment. Herron appealed.

Key rules. Indiana Code 34-55-9-2 provides that a money judgment becomes a lien on the defendant’s real property when the judgment is entered and indexed in the judgment docket in the county where the property is located. Indiana Code 32-21-4-1 states that a mortgage takes priority according to the time that it was filed in the recorder’s office of the county where the property is located. Generally, in Indiana, “priority in time gives a lien priority in right.” 

Holding. The Indiana Court of Appeals reversed the trial court and held that Herron’s judgment lien was first in time and thus senior to FFB’s mortgage.

Policy/rationale. FFB based its argument on the fact that the file of the small claims court contained a November 7, 2014 receipt that showed the 2013 judgment balance to be zero, which suggested that there was no judgment lien as of that date. FFB further asserted that the November 14, 2014 award for fees during proceedings supplemental constituted a new judgment that was later rescinded. According to FFB, therefore, on November 17, 2015, when the superior court overturned the rescission and awarded damages, a second judgment lien was created, nine months after FFB perfected its mortgage lien.

The Indiana Court Appeals rejected each of FFB’s points. Although the record from the small claims court proceedings was not crystal clear, there was nothing “determinative” showing that the original judgment for Herron had been paid in full or was otherwise satisfied or released. Also, through proceedings supplemental, Herron had an ongoing claim for attorney fees and interest that related back to the original judgment. The Court also found that the small claims court’s rescission of its prior fee award did not go into effect because the superior court ultimately overturned the rescission on appeal. In the end, the Court concluded that Herron had a single judgment lien, created May 14, 2013, which had not been satisfied. As such, Herron’s judgment lien preceded FFB’s February 23, 2015 mortgage lien and had first priority.

Related posts.

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I represent judgment creditors and lenders, as well as their mortgage loan servicers, entangled in lien priority and title claim disputes. If you need assistance with a similar matter, please call me at 317-639-6151 or email me at john.waller@woodenlawyers.com. Also, don’t forget that you can follow me on Twitter @JohnDWaller or on LinkedIn, or you can subscribe to posts via RSS or email as noted on my home page.


Reminder Of Indiana's View Of MERS

I've been pressed for time of late but wanted to post some material today.  The article that follows is from my October, 2012 post prepared in the wake of the Indiana Supreme Court's landmark decision involving Mortgage Electronic Registration Systems, Inc. (aka MERS).  

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What is Mortgage Electronic Registration Systems, Inc. (“MERS”)?  More specifically, what does mortgage language identifying MERS “as nominee” mean?  The Indiana Supreme Court in Citimortgage v. Barabas, 2012 Ind. LEXIS 802 (Ind. 2012) dealt with those and other questions surrounding the role of MERS in the foreclosure world about which I wrote following the Indiana Court of Appeals' opinion, which the Supreme Court ultimately reversed. 

Setting the table.  In Citimortgage, junior mortgagee ReCasa initiated a foreclosure action and named only Irwin, the purported senior mortgagee, as a defendant.  The language in the subject mortgage stated that Barabas, the mortgagor, granted the mortgage to MERS “as nominee” of Irwin, identified as the lender.  Upon being sued to answer as to its interests in the subject real estate, Irwin quickly filed a disclaimer of interest, and the court dismissed Irwin from the case.  The trial court later entered judgment for ReCasa, which acquired the real estate at the sheriff’s sale.  ReCasa then sold the real estate to a third party, Sanders.  A month later, Citimortgage filed a motion to intervene in the action and asked the trial court to set aside the judgment and sheriff’s sale. 

Defining MERS.  In its rationale, the Court came to terms with the reality that “about 60% of the country’s residential mortgages are recorded in the name of MERS rather than in the name of the bank, trust, or company that actually has a meaningful economic interest in the repayment of the debt.”  The Court pronounced that “a MERS member bank appoints MERS as its agent for service of process in any foreclosure proceeding on a property for which MERS holds the mortgage.”  The Court found that:

the relationship between Citimortgage and MERS was one of principal and agent.  Clearly, one of the primary purposes of that agency relationship was to facilitate efficient service of process.  . . .  By designating MERS as an agent for service of process, as Irwin did in the Barabas mortgage, lenders can have their cake and eat it too; they free themselves from burdensome, expensive recording requirements but still receive notice when another lienholder seeks to foreclose on a property in which they have a security interest.

Senior mortgage survives.  The core question in Citimortgage was whether ReCasa’s failure to name MERS as a defendant impacted the rights, if any, of Citimortgage, which at some point appears to have acquired the senior mortgage.  Although the Court of Appeals affirmed the trial court’s decision in favor of ReCasa, the Supreme Court ruled for Citimortgage.  ReCasa’s failure to name MERS as a defendant or, more specifically, failure to serve MERS with a summons and complaint, prevented ReCasa from terminating the senior mortgage and leapfrogging into the first lien position.  In short, the judgment was void as to Citimortgage. 

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I represent lenders, as well as their mortgage loan servicers, entangled in lien priority disputes and contested foreclosures. If you need assistance with a similar matter, please call me at 317-639-6151 or email me at john.waller@woodenlawyers.com. Also, don’t forget that you can follow me on Twitter @JohnDWaller or on LinkedIn, or you can subscribe to posts via RSS or email as noted on my home page.


Indiana’s “Lender Exception” Applicable To Leasehold Mortgage In Priority Dispute With Mechanic’s Lien

Lesson. A leasehold mortgage constitutes a valid mortgage lien and can be senior to a mechanic’s lien, if the facts otherwise meet the so-called “Lender Exception.”

Case cite. Kellam Excavating v. Community State Bank, 82 N.E.3d 928 (Ind. Ct. App. 2017)

Legal issue. Whether a leasehold mortgage or mechanic’s lien had priority in title.

Vital facts. A lessee of real estate and a contractor entered into a construction contract on 7/30/13 to build a fertilizer plant. Construction began on 10/25/13. Lessee later needed additional financing for the construction. On 5/16/14, the lessee granted a bank a leasehold mortgage as collateral for some financing the bank offered through a series of master leases between the bank and the lessee. The bank recorded its mortgage on 6/24/14. Following the lessee’s failure to pay the contractor in full, the contractor recorded a mechanic’s lien on 3/6/15. Collection and foreclosure litigation subsequently commenced against the lessee that included a lien priority dispute between the bank and the contractor.

Procedural history. The bank filed a motion for summary judgment claiming that its mortgage should receive priority over the contractor’s mechanic’s lien. The trial court granted the motion, and the contractor appealed.

Key rules.

    Three statutes: There are three Indiana statutes that govern priority between a mortgage and a mechanic’s lien: Indiana Code Sections 32-21-4-1(b), 32-28-3-2 and 32-28-3-5(d).

    Lender Exception: The Court in Kellam incorporated its prior decision in Harold McComb v. JP Morgan Chase that “discussed the interplay between the three relevant statutes and the question of mortgage lien priority versus a later-recorded mechanic’s lien as to improvements provided on commercial property.” That holding “is commonly referred to as the Lender Exception,” and I wrote about the McComb opinion on 9/6/08. In short, the Lender Exception provides:

With regard to commercial property, where the funds from the loan secured by the mortgage are for the specific project that gave rise to the mechanic’s lien, the mortgage lien has priority over the mechanic’s lien recorded after the mortgage.

    Mortgage defined: The definition of a mortgage is a “conveyance of title to property that is given as security for the payment of a debt or the performance of a duty and that will become void upon payment or performance according to the stipulated terms” and as a “lien against property that is granted to secure an obligation (such as a debt) and that is extinguished upon payment or performance according to stipulated terms.”

Holding. The Indiana Court of Appeals affirmed the trial court’s summary judgment in favor of the bank/mortgagee. The Indiana Supreme Court denied transfer.

Policy/rationale. The heart of the Kellam dispute surrounded the nature of the financing. The contractor argued, among other things, that the lessee did not execute a promissory note and that the security agreement was not a qualifying mortgage because the document’s title was a “leasehold” mortgage. The Court, however, found that the agreement operated like a typical mortgage by granting a lien on the lessee’s property rights and by obligating the lessee to repay the bank for funds the bank expended. Moreover, there was no authority for the proposition that a promissory note is required for a valid mortgage.

In the final analysis, despite the unconventional (my term) nature of the financing arrangement, the Court in Kellam was convinced that the lessee sought a loan from the bank for construction of the facility and that the bank’s funds were used for that purpose. Since the Lender Exception applied, the bank’s mortgage was superior to the contractor’s mechanic’s lien.

Related posts. The Mechanic's Liens category to your right contains all of my posts about these kinds of priority disputes.
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I represent lenders, as well as their mortgage loan servicers, entangled in lien priority disputes and contested foreclosures. If you need assistance with a similar matter, please call me at 317-639-6151 or email me at john.waller@woodenlawyers.com. Also, don’t forget that you can follow me on Twitter @JohnDWaller or on LinkedIn, or you can subscribe to posts via RSS or email as noted on my home page.


Indiana Federal Court Dismisses Borrower’s Contract Claim Against Lender Because Lender Never Executed The HAMP Trial Period Plan

Lesson. Absent a fully-executed TPP, signed by a lender or its mortgage loan servicer, no enforceable contract exists, and a borrower’s claim against a lender based upon a TPP, or under HAMP, will be dismissed. In other words, an alleged loan modification agreement requires the signature of the lender.

Case cite. Taylor v. JP Morgan, 2017 WL 3754607 (N.D. Ind. 2017) (Judge Lozan's opinion); Taylor v. JP Morgan, 2017 WL 7370978 (N.D. Ind. 2017) (Magistrate Judge Martin's order)

Legal issue. The main question in Taylor was whether the Home Affordable Modification Program's Trial Period Plan constituted an enforceable contract between a lender and a borrower. A secondary issue was whether the lender was liable for breach of an implied covenant of good faith and fair dealing.

Vital facts. Borrower and his residential/consumer lender discussed a loan modification pursuant to the Home Affordable Modification Program (“HAMP”). Specifically, the lender sent the borrower a letter offering a HAMP Trial Period Plan (“TPP”). The TPP had certain terms and included certain steps for the borrower to complete before the lender would modify the mortgage loan. One of the conditions to the TPP was that the lender must provide the borrower with a fully-executed copy of the TPP; otherwise, there would be no loan modification. In Taylor, the borrower purportedly submitted the necessary paperwork, but the lender never returned an executed copy of the TPP. The borrower claimed that he qualified for a loan modification under HAMP but that the lender improperly denied the request.

Procedural history. The borrower filed a breach of contract action against the lender. The lender filed a motion for judgment on the pleadings. The U.S District Court for the Northern District of Indiana granted the lender’s motion and dismissed the borrower’s case.

Key rules.

Indiana case law involving HAMP provides that the language of the TPP is clear that it is not an offer by lenders that borrowers can accept simply by providing further documentation. Instead, the TPP is an invitation for borrowers to apply to the program, which requires the borrowers’ compliance to be considered. Cases around the country generally provide that a TPP does not take effect until the lender provides a signed copy.

There is no separate cause of action in cases like these for breach of an implied covenant of good faith and fair dealing.

Holding. Since the lender was required to execute the TPP but did not, no contract was formed and thus no viable breach of contract claim existed. Also, the Court rejected the borrower’s claim breach of good faith and fair dealing. (This case is now on appeal to the 7th Circuit.)

Policy/rationale.

TPP’s are not agreements to provide borrowers with a loan at a specified date, but rather are agreements governing obligations of both lenders and borrowers over a trial period after which lenders may extend a separate permanent loan modification should lenders determine that borrowers qualify.

The alleged contract was not for the sale of goods governed by the Uniform Commercial Code and was not the sale of insurance. Moreover, the mortgage did not give rise to any fiduciary or other special relationship. Thus the borrower’s complaint did not articulate the independent tort of breach of good faith/fair dealing.

Related post. Indiana Upholds Dismissal Of Residential Borrower’s Tort Claims Arising Out Of Alleged HAMP Violations
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I represent lenders, as well as their mortgage loan servicers, in connection with contested mortgage foreclosures and related litigation. If you need assistance with a similar matter, please call me at 317-639-6151 or email me at john.waller@woodenlawyers.com. Also, don’t forget that you can follow me on Twitter @JohnDWaller or on LinkedIn, or you can subscribe to posts via RSS or email as noted on my home page.


Indiana Court Finds That Large Crane And Saw For Stone Fabricating Business Were Not "Fixtures"

Lesson. In title and priority disputes surrounding alleged “fixtures,” the parties’ intention is the controlling factor.

Case cite. 11438 Highway 50 v. Luttrell, 81 N.E.3d 261 (Ind. Ct. App. 2017).

Legal issue. Whether certain pieces of equipment were fixtures subject to a lender’s mortgage.

Vital facts. This case dealt with a crane and a saw owned by a limestone sawing business. The business operated out of a building the partners constructed on the back edge of some real estate owned by a separate corporation. A lender held a mortgage on the real estate and also had on file a UCC financing statement claiming an interest in, among other things, equipment and fixtures of the corporation (but not the sawing business).

Procedural history. The lawsuit started when one of the two partners in the limestone sawing business sued the other partner for, among other things, possession of the crane and the saw. Later, the lender (mortgagee) intervened in the action, foreclosed on the real estate and asserted a first-priority security interest in the crane and the saw. The trial court awarded the equipment to the plaintiff (the partner), and the lender/mortgagee appealed.

Key rules. Indiana case law generally provides that “a fixture is a former chattel or piece of personal property that has become a part of real estate by reason of attachment thereto.”

Indiana’s three-part test for whether something “has become so identified with real property as to become a fixture” is “(1) actual or constructive annexation of the article to the realty, (2) adaptation to the use or purpose of that part of the realty with which it is connected and (3) the intention of the party making the annexation to make the article a permanent accession to the freehold.”

The intention factor is controlling and “may be determined by the nature of the article, relation and situation of the parties making the annexation, and the structure, use, and mode of annexation.” If there is doubt regarding intent, “the property should be regarded as personal.”

Holding. The Indiana Court of Appeals affirmed the trial court’s determination “that the crane and the saw should be regarded as the personal property of [the limestone sawing business] rather than a fixture subject to the lender’s mortgage lien.”

Policy/rationale. The equipment in Luttrell was annexed to the real estate and assembled in a building meant to accommodate it. However, the saw (14’x7’) could be disassembled in two days and transferred to a new place via semi-truck. The crane weighed 50 tons, but also could be moved if needed. The sawing business purchased the equipment, and the partners intended for it to remain their personal property after installation. Also, the sawing business and the borrower’s/mortgagor’s business were independent from one another, and the original plan of the partners was to save up money to buy the building.

Seemingly most fixture-related disputes are between creditors who are fighting over the debtor’s property. Here, the dispute was between a creditor and a third-party owner (not a borrower). The fact that the mortgagor/borrower did not own the equipment, and thus could not have pledged it as collateral, probably carried the day.

Related post. What Is A Fixture?
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I represent creditors, as well as mortgage loan servicers, entangled in lien priority and title disputes. If you need assistance with a similar matter, please call me at 317-639-6151 or email me at john.waller@woodenlawyers.com. Also, don’t forget that you can follow me on Twitter @JohnDWaller or on LinkedIn, or you can subscribe to posts via RSS or email as noted on my home page.


Absence Of Legal Description Dooms Mortgage In Lien Priority Dispute

Lesson. First, if you are in the business of drafting and recording mortgages, make sure they contain legal descriptions of the subject real estate.  Common (street) addresses technically are inadequate to provide notice of a lien.

Case cite.  U.S. Bank v. Jewell, 69 N.E.3d 524 (Ind. Ct. App. 2017).

Legal issue.  Whether the omission of a legal description of the real estate rendered the mortgage insufficient to charge a competing mortgagee with notice.

Vital facts.  This case involved a mortgage lien priority dispute and dealt with Indiana’s bona fide purchaser (BFP) doctrine.  Jewell held a mortgage that it recorded but that failed to contain a legal description.  The mortgage only identified the common address a/k/a the street address.  When the owner later sold the real estate, the buyer obtained financing from a lender, which conducted a title search before ultimately making the mortgage loan.  The evidence established that the lender’s title search did not disclose Jewell’s mortgage.

Procedural history. Jewell filed suit to foreclose its mortgage and named the lender.  The lender filed a motion for summary judgment claiming that it was a bona fide purchaser and was entitled to senior lien status.  The trial court denied the motion.  The lender appealed.

Key rules.  The Jewell opinion contains an excellent summary of Indiana’s rules, exceptions and tests related to the bona fide purchaser doctrine.  The opinion also provides a really good analysis of Indiana’s summary judgment standard, and related burdens of proof, as applicable to our BFP laws. Without regurgitating all of the law from the opinion (see other posts noted below), here are some of the key rules in play in Jewell:

1. Prospective purchasers of real estate must search the grantor-grantee and the mortgagor-mortgagee indexes for the period that the mortgagor holds title.

2. On the matter of “constructive” notice, “a mortgage must be recorded [in the chain of title] in the proper county and must contain an accurate legal description of the property.”

3. In the absence of contructive notice, there is Indiana law supporting the notion that, in certain circumstances, subsequent purchasers may be charged with “inquiry” notice, sometimes called “implied or inferred” notice:

Notice is actual when notice has been directly and personally given to the person to be notified.  Additionally, actual notice may be implied or inferred from the fact that the person charged had means of obtaining knowledge which he did not use.  Whatever fairly puts a reasonable, prudent person on inquiry is sufficient notice to cause that person to be charged with actual notice, where the means of knowledge are at hand and he omits to make the inquiry from which he would have ascertained the existence of a deed or mortgage.  Thus, the means of knowledge combined with the duty to utilize that means equates with knowledge itself.  Whether knowledge of an adverse interest will be imputed in any given case is a question of fact to be determined objectively from the totality of the circumstances.

Holding. The Indiana Court of Appeals reversed the trial court and granted summary judgment for the lender.

Policy/rationale. Jewell dealt mainly with the inquiry notice matter.  Jewell contended that, had the lender searched the mortgagor-mortgagee index, it would have discovered Jewell’s mortgage.  However, the lender submitted affidavits establishing that it conducted such a search, which did not reveal the Jewell mortgage due to the omission of the legal description.  The problem was that Jewell merely argued that the common address was sufficient to defeat the summary judgment motion.  Jewell’s failure to submit evidence to prove its theory was the deciding factor.

Related posts.

Indiana Court Discusses Whether A Lender Was A “Bona Fide Mortgagee”

BFP Defense Denied, And IRS Lien Prioritized

What Does “Chain Of Title” Mean?
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I frequently represent lenders, as well as their mortgage loan servicers, entangled in lien priority and title claim disputes.  If you need assistance with a similar matter, please call me at 317-639-6151 or email me at John.Waller@WoodenLawyers.com Also, don’t forget that you can follow me on Twitter @JohnDWaller or on LinkedIn, or you can subscribe to posts via RSS or email as noted on my home page.


Hybrid Tax Sale/Mortgage Foreclosure Case Goes Off The Rails For Lender

Lesson. If a mortgagee acquires title to the mortgaged property via tax deed, the mortgage lien will be extinguished. For lenders and their servicers, be careful when making deals with tax sale purchasers while also negotiating loan modifications with borrowers. Best to include everyone in a global negotiation.

Case cite. Bayview v. Golden Foods, 59 N.E.3d 1056 (Ind. Ct. App. 2016).

Legal issues. Whether the lender’s mortgage merged with a tax deed, which the lender acquired from the tax sale purchaser. Also, whether the lender committed conversion of the mortgaged property.

Vital facts. The Bayview facts and procedural history are quite involved and unique. The borrower and the lender had a commercial mortgage loan secured by the borrower’s restaurant property. The borrower became delinquent in the real estate taxes, and the property later was sold at a tax sale. The lender sought to capitalize the delinquent taxes and enter into a loan modification with the borrower. Under the terms of the deal with the borrower, the lender agreed to redeem the property from the tax sale. However, the lender failed to do so and never told the borrower. When the tax sale purchaser petitioned for the issuance for a tax deed, the lender contested the proceeding on the basis that the purchaser failed to give certain required notices. The lender and the tax sale purchaser then entered their own settlement negotiations, without involving the borrower, that ultimately resulted in an agreed order. The Bayview opinion is a little unclear as to whether the lender got the tax deed directly from the auditor or from the tax sale purchaser through a quitclaim deed. Either way, the lender settled with the purchaser and got title. The lender then filed an action to quiet title to the property, which included a count to foreclose the mortgage, alleging that its interest in and title to the property was “superior to all persons who have an interest therein.” Adding to the confusion was the fact that the borrower made a series of loan mod payments to the lender after the lender became the owner of the property. Whew.

Procedural history. The trial court held a bench trial that included the lender’s mortgage foreclosure claim and the borrower’s counterclaim for conversion. The court ruled in favor of the borrower.

Key rules.

• A mortgage involves two entities: (1) the mortgagee, which holds the mortgage that serves as a lien on the property and (2) the mortgagor, who holds title to the property with the right of redemption.

• When one of the parties to a mortgage acquires both the mortgage lien and the legal title to the property, “the two interests are said to merge.” This means that the mortgage lien is extinguished.

• The key factor in deciding whether a merger has occurred is “determining what the parties, primarily the mortgagee, intended.” For more on Indiana’s anti-merger rule, click on the posts below, which discuss the key cases in detail.

Ind. Code 35-43-4-3 states that a “person who knowingly or intentionally exerts unauthorized control over the property of another commits criminal conversion.”

Holding. The Indiana Court of Appeals held that the evidence supported the trial court’s conclusions. As such, the Court affirmed the trial court’s ruling that the mortgage had been extinguished and that the lender committed conversion.

Policy/rationale.

The lender in Bayview asserted that it did not intend to merge its mortgage with the tax deed. The borrower responded that the lender “clearly intended to take title and extinguish the underlying mortgage and note when it surreptitiously acquired title.” The Court of Appeals pointed to evidence at the trial showing that the lender viewed the transaction similar to a deed in lieu of foreclosure “with no residual obligation for the borrower.”

The Bayview opinion also addressed in detail the borrower’s conversion claims against the lender. In a nutshell, the trial court found that the lender converted (stole) the subject real estate from the borrower. The court awarded the borrower treble damages for criminal conversion based on the amount of equity in the property, plus reimbursement for the loan mod payments made by the borrower.

Although not expressly spelled out in the opinion, the practical outcome of the case seemed to be that, on the one hand, the lender (holding a tax deed) remained the owner of the property while, on the other hand, the borrower’s debt was extinguished. On top of that, the lender had to pay the borrower substantial damages.

Related posts.

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I frequently represent lenders, as well as their mortgage loan servicers, entangled in loan-related litigation, including disputes arising out of tax sales. If you need assistance with such a matter, please call me at 317-639-6151 or email me at john.waller@woodenmclaughlin.com. Also, don’t forget that you can follow me on Twitter @JohnDWaller or on LinkedIn, or you can subscribe to posts via RSS or email as noted to your left.


Success Following Trial And Appeal Of Contested Foreclosure, Including Defense Of Constructive Fraud and Bad Faith Claims

In February 2016, my partner Matt Millis and I tried a contested commercial foreclosure case.  Following the four-day trial, the court entered judgment in our clients’ favor.  Click here to see the judgment.  The trial mainly was about the borrower’s counterclaims against our clients, an originator of hard-money commercial mortgage loans and the company that funds the loans, as well as the borrower’s defenses to the foreclosure.

The borrower appealed.  Yesterday, the Indiana Court of Appeals affirmed the trial court’s judgment.  Here is the opinion.  The Court’s opinion summarizes some of the key facts and, of note, addresses two of the borrower’s defenses: (1) that our clients breached a “duty to speak,” which arose out of the borrower’s allegations of constructive fraud, and (2) that our clients violated the “Hamlin Doctrine,” which dealt with the borrower’s assertion that our clients breached a duty to act in good faith.

The Court of Appeals decided that our clients did not breach any alleged duty to speak about certain loan-to-value requirements for the deal.  In other words, the Court found that the judgment was supported by the findings of fact (the evidence at trial) and was not clearly erroneous.  In addition, the Court held that the trial court’s findings of fact supported the conclusion that our clients did not act in bad faith with respect to the fulfillment of a broker’s price opinion contingency.  For more about the case, please read the trial court’s judgment and the appellate court's memorandum decision – links above.

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I frequently represent lenders, as well as their mortgage loan servicers, in connection with contested mortgage foreclosure actions.  If you need assistance with a similar matter, please call me at 317-639-6151 or email me at john.waller@woodenmclaughlin.com.  You may also follow me on Twitter @JohnDWaller or on LinkedIn, or you can subscribe to my blog posts via RSS or email as noted on my home page.


Mortgagee Prevails In Claim For Indiana Tax Sale Surplus

What happens if a lender’s real estate collateral is sold at a tax sale, which nets a surplus (funds remaining over and above payment of the tax lien)?  Does the money go back to the owner, or can the lender/mortgagee recover it?  Beneficial Indiana v. Joy Properties, 942 N.E.2d 889 (Ind. Ct. App. 2011) helps answer these questions.

Course of events.  In 2003, lender made a mortgage loan to borrowers.  In 2008, following the failure by the borrowers to pay real estate taxes, the county held a tax sale that resulted in a $42,000 surplus.  No party redeemed within the one-year period, so the county issued a tax deed in November of 2009.  However, the tax sale purchaser did not immediately record it.  In December of 2009, lender filed a motion in the county trial court for the auditor to hold the surplus.  At the hearing on the motion, the lender established a default under the mortgage loan and losses of approximately $100,000.  Shortly after the hearing, borrowers, who did not participate in the hearing, deeded the real estate to a third party, which recorded the deed in January of 2010.  In February of 2010, lender filed a motion to compel the auditor to turn over the surplus, and then the the tax sale purchaser recorded its tax deed.

The problem.  Who should have received the $42,000 tax sale surplus - the lender or the third party (subsequent owner)?

Statute.  I.C. § 6-1.1-24-7 is the provision within Indiana’s tax sale statutory scheme that speaks to the surplus issue, and subsection (b) authorizes a claim by the:

 (1) owner of record of the real property at the time the tax deed is issued who is divested of ownership by the issuance of a tax deed; or
 (2) tax sale purchaser or purchaser’s assignee, upon redemption of the tract or item of real property.

Since there was no redemption, subsection (b)(2) did not apply.  Beneficial Indiana focused on subsection (b)(1), which seems to suggest that the borrowers would be entitled to the funds because they were the owners of record at the time the tax deed was issued.  Since they had conveyed their interests to a third party by the time the matter came before the trial court, the third party essentially stepped into their shoes and claimed subsection (b)(1) mandated the turnover of the surplus to it.

Statutory work around.  In Indiana, persons with “an interest in the real estate, including those who did not own the real estate at the time of the tax sale or who did not purchase the real estate at the tax sale, may assert a claim for a tax sale surplus directly with the trial court.”  The lender asserted that it was entitled to the surplus because its mortgage lien attached to the surplus.  Indiana law indeed provides that, even though the lender’s lien against the real estate was extinguished by the tax sale deed, its lien “attached to the tax sale surplus, and has priority over the interest conveyed to [the third party].”

More substantial interest.  The Court’s rationale rested upon the following test:  “which claimant has the more substantial interest in the real estate?”  The Court’s ruling in favor of the lender was, in my view, fair and sensible:

It is undisputed that [lender’s] mortgage was duly recorded on April 21, 2003.  It is further undisputed that the [borrowers] not only failed to pay their property taxes but also were in default on their mortgage, owing a balance that greatly exceeded the tax sale surplus held by the auditor.  Hence, [lender] had a substantial interest in the real estate prior to the issuance of the tax sale deed.  [Third party] acquired its interest in the real estate by a quitclaim deed executed by the [borrowers] after they had failed to make mortgage payments to [lender’s] for more than a year; and they had failed to redeem the real estate during the statutory one-year period following Allen County’s tax sale of real property due to the owners’ failure to pay real estate taxes.  Thus, at the time of the conveyance to [the third party] by the [borrowers], the interest conveyed was subject to the issuance of a tax deed to [the tax sale purchaser] and to [lender’s] recorded security interest.  In other words, the interest conveyed to [the third party] by the [borrowers] is significantly less substantial than and inferior to the interest of [lender].

Favorable to lenders.  As suggested here before on November 16, 2010 and most recently on March 19, 2012, delinquent real estate taxes and resulting tax sales can be a minefield for lenders in Indiana.  In Beneficial Indiana, the lender lost its loan collateral and incurred damages of about $100,000.00.  Luckily, the somewhat unique set of circumstances opened the door for the lender’s recovery of the surplus that mitigated its losses.


Borrower’s “Mutual Mistake” Defense Fails Under Indiana Law

Lesson. To set aside a loan document based upon the defense of mutual mistake, there first must be a mistake concerning a vital fact upon which the parties based the loan. Second, the mistake must be on the part of both parties.

Case cite. Williamson v. U.S. Bank, 55 N.E.3d 906 (Ind. Ct. App. 2016).

Legal issue. Whether a loan modification agreement should have been reformed or rescinded based upon an alleged mistake of fact.

Vital facts. In 2008, borrower defaulted under a promissory note and mortgage, and in 2009 lender obtained a default judgment against him. The day before the scheduled sheriff’s sale, lender notified the sheriff that the sale should be cancelled due to ongoing settlement negotiations. Nevertheless, the sheriff inadvertently held the sale, and the lender’s pre-sale written bid prevailed. The sheriff’s processed and recorded the sheriff’s deed. About three months later, lender discovered the mistake and ultimately got a court order vacating the deed. In 2010, borrower and lender executed a loan modification agreement that amended the note and mortgage, and set up a new payment plan. For three years, borrower made the payments under the loan mod. At some point, borrower discovered information leading him to believe that he was not on the deed to the property. He also had been denied his homestead exemption multiple times. About the same time, lender notified borrower that he needed to make an additional payment into escrow to cover real estate taxes. In response, borrower told lender he would not pay anything further until lender assured borrower “his name was back on the deed….” Lender then filed an affidavit with the county assessor reaffirming that the court had vacated lender’s title to the property and that the assessor’s records should reflect that title was with borrower. Despite lender’s action, borrower made no further mortgage payments.

Procedural history. Lender initiated a foreclosure lawsuit and filed a motion for summary judgment. In response, borrower filed an affidavit stating that he did not know that his name had been taken off the deed to the property when he signed the loan mod. Borrower argued that he would not have entered into the loan mod knowing his name had been taken off the deed. He essentially asserted that the loan mod was not enforceable against him. The trial court rejected borrower’s position and granted lender summary judgment.

Key rules. A contract may be reformed on grounds of mistake upon clear and convincing evidence of both the mistake and the original intent of the parties. Stated differently, “where both parties to a contract share a common assumption about a vital fact upon which they based their bargain, and that assumption is false, the transaction may be avoided if, because of the mistake, a quite different exchange of value occurs from the exchange of values contemplated by the parties.”

Ind. Code 32-30-10-3 provides that “if a mortgagor defaults in the performance of any condition contained in a mortgage, the mortgagee … may proceed in the circuit court of the county where the real estate is located to foreclose the equity of redemption….” If a lender produces evidence of a demand note and mortgage, it establishes the prima facie evidence supporting foreclosure. That shifts the burden to the borrower to prove payment of the note or any affirmative defense to foreclosure.

Holding. The Indiana Court of Appeals affirmed the trial court’s summary judgment in favor of lender.

Policy/rationale. Borrower contended that he should not have been held to the terms of the loan mod, and thus his mortgage should not have been foreclosed, because the parties mistakenly believed his name was on the deed when they executed the loan mod. But the alleged mistake of fact did not exist upon execution of the loan mod. Borrower did in fact have a valid deed at the time. Although borrower was temporarily divested of ownership through the sheriff’s sale, the trial court later set the sale aside and vacated the deed. That happened in December of 2009. The loan mod didn’t occur until December of 2010. Since borrower’s name was on the deed upon execution of the loan mod, “there was no basis to reform or rescind the agreement.”

This seemed to be a fairly straightforward decision, but I suspect there may have been more to the story. (It’s common for appellate court opinions to distill the facts to their essence.) In any event, despite borrower’s obvious frustrations arising out of the 2009 sheriff’s sale and the resulting confusion with the county’s records, the loan mod had to be enforced.

Related posts.

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I frequently represent lenders, as well as their mortgage loan servicers, in connection with contested mortgage foreclosure actions. If you need assistance with a similar matter, please call me at 317-639-6151 or email me at john.waller@woodenmclaughlin.com. Also, don’t forget that you can follow me on Twitter @JohnDWaller or on LinkedIn, or you can subscribe to posts via RSS or email as noted on my home page.


Defective Legal Description Will Not Necessarily Invalidate Mortgage

Lesson.  As long as the legal description within the mortgage sufficiently describes real estate owned by the mortgagor, the mortgage itself will be valid, even if the legal description is flawed in other respects. 

Case cite.  Samuels v. Garlick, 49 N.E.3d 1116 (Ind. Ct. App. 2016).

Legal issue.  Whether a mortgage is invalid if the legal description of the mortgaged property has defects.    

Vital facts.  Samuels involved a lien priority dispute between two mortgagees.  There was no question that Mortgage 1 was recorded three years before Mortgage 2.  The complicating factor surrounded the legal description contained in Mortgage 1.  The opinion details the history of the subject real estate and the problems surrounding how the deeds and the two competing mortgages described the real estate.  The legals involved both “metes and bounds” descriptions and descriptions by lot after the owners subdivided the property.  In sum, Mortgage 1 (a) described some property that the mortgagors no longer owned, (b) did not describe some of property at issue and (c) described only certain portions of two of the lots at issue.  In short, the mortgage “both over- and under-described the mortgaged property.”  The second mortgagee contented that, with these defects, it was “impossible to determine which property was intended to be mortgaged.”  

Procedural history.  The trial court granted summary judgment for the first mortgagee, and concluded that Mortgage 1 was valid and senior to Mortgage 2 but “only as to that part [of the real estate] covered by the legal description in its mortgage.” 

Key rules. 

  • Generally, in Indiana, to charge subsequent parties with notice, a “mortgage must … contain an accurate legal description of the property.” 
  • “In order for a mortgage to be effective, it must contain a description of the land intended to be covered sufficiently to identify it.”  The test for determining the sufficiency of the description “is whether the tract intended to be mortgaged can be located with certainty by referring to the description.”
  • Indiana case law stands for the proposition that “the fact that the described premises encompasses more real estate than is owned by the mortgagors is relevant only to the issue of whether there is a valid and enforceable lien on the non-owned premises; it does not impair the validity of the lien on the mortgaged premises.” 

Holding.  The Indiana Court of Appeals affirmed the summary judgment.  Mortgage 1 was a prior and superior lien as to that part of the real estate covered by its legal description.  The fact that the description may have been flawed did not render the entire mortgage invalid.    

Policy/rationale.  The Court concluded that it was not impossible to determine which property was intended to be mortgaged by Mortgage 1.  That mortgage, which was in the mortgagors’ chain of title, “put prospective purchasers or mortgagees on notice of an existing mortgage on property commonly known as 8611 West 96th Street, Zionsville – the same address shown on Lot 1 of Copper Ridge Secondary Plat, which [was] also in [the mortgagors’] chain of title.”  Mortgage 1’s metes and bounds description was a “facially valid legal description” with the “same geographic starting point as [the subdivision plat] and encompasse[d] the western 155 feet of said plat.”  The fact that the premises described in Mortgage 1 encompassed more or less real estate than was owned by the mortgagors did not impair the validity of the lien on the described premises that the mortgagors owned. 

Related posts. 

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I frequently represent judgment creditors and lenders, as well as their mortgage loan servicers, entangled in lien priority and title claim disputes.  If you need assistance with a similar matter, please call me at 317-639-6151 or email me at john.waller@woodenmclaughlin.com.  Also, don’t forget that you can follow me on Twitter @JohnDWaller or on LinkedIn, or you can subscribe to posts via RSS or email as noted on my home page.


Will A Mortgage Granted To Fund Renovation Costs Have Priority Over A Pre-Existing Judgment Against A Mortgagor/Purchaser?

Lesson.  If a mortgage is not granted for purchase money, then the mortgage will not have priority over a pre-existing judgment against the mortgagor/purchaser.  The law favors judgment creditors in this instance. 

Case cite.  Amici Resources v. Nelson, 49 N.E.3d 1046 (Ind. Ct. App. 2016).

Legal issue.  If a mortgage is not a “purchase-money mortgage,” will it nevertheless be senior to a pre-existing judgment against the purchaser/mortgagor upon the closing of a sale/loan?

Vital facts.  For background, please see last week’s post about Amici:  What Is A “Purchase-Money” Mortgage, And Does It Have Priority Over A Pre-Existing Judgment Against The Mortgagor? This post deals with a second lender/mortgagee.  Amici loaned money to SFIP, not to buy the real estate, but to fund renovations to the property.  The closing of the Amici mortgage loan appears to have occurred as part of the closing of SFIP’s purchase of the real estate (discussed last week).  Although the Amici opinion did not label this second loan a “home equity line of credit,” I think the reasoning and holding in this case would apply to lines of credit granted simultaneously upon the purchase of the real estate.   

Procedural history.  At the trial court level, in this quiet title action brought by Matthies, Amici prevailed.  Matthies appealed. 

Key rules.  A judgment lien is a lien on the interest the debtor has in the land.  Ind. Code 34-55-9-2 spells out that money judgments become liens on the debtor’s real property when the judgment is recorded in the judgment docket in the county where the realty held by the debtor is located. 

Generally, “priority in time gives a lien priority in right.”  If the facts show that the judgment lien attached to the real estate before the mortgage lien, then the judgment lien has priority over the subsequent mortgage lien.  As noted in last week’s post, however, “quite a different question would be presented if the mortgage had been a purchase-money mortgage, rather than to pay” for other services or products. 

Holding.  The Court of Appeals reversed the trial court and concluded that Amici’s mortgage lien had second priority to Matthies’s judgment lien. 

Policy/rationale.  In Indiana, judgments rendered against an individual will attach to real estate subsequently purchased by that individual instantly upon the acquisition of ownership to the real estate.  Unless the mortgage arose out of a loan to purchase the real estate, the mortgage will be junior to the judgment.    

Related posts. 

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I frequently represent judgment creditors and lenders, as well as their mortgage loan servicers, entangled in lien priority and title claim disputes.  If you need assistance with a similar matter, please call me at 317-639-6151 or email me at john.waller@woodenmclaughlin.com.  Also, don’t forget that you can follow me on Twitter @JohnDWaller or on LinkedIn, or you can subscribe to posts via RSS or email as noted on my home page.


What Is A “Purchase-Money” Mortgage, And Does It Have Priority Over A Pre-Existing Judgment Against The Mortgagor?

Lesson.  If a loan involves a “purchase-money” mortgage, then the mortgage will have priority in title over a pre-existing judgment against the purchaser/mortgagor.  The law favors lenders over judgment creditors in this instance.   

Case cite.  Amici Resources v. Nelson, 49 N.E.3d 1046 (Ind. Ct. App. 2016).

Legal issue.  What constitutes a purchase-money mortgage, and will such a mortgage lien be senior to a pre-existing judgment against the purchaser? 

Vital facts.  Matthies obtained a judgment against SFIP in 2012.  In 2013, HSBC agreed to sell its real estate to SFIP, but HSBC required the transaction to be a cash deal.  SFIP needed financing for the purchase, however, and on April 29, 2013 it executed a mortgage in favor of Nelson for the purchase of the real estate.  Payment for the purchase came via wire transfer from Nelson to SFIP at 4:00 p.m. that day.  However, the actual closing was not until the next day, meaning that SFIP signed the promissory note to Nelson and HSBC executed the deed to SFIP on April 30th.  The Matthies judgment against SFIP remained outstanding following the sale.    

Procedural history.  Matthies sought to enforce her judgment lien against SFIP.  The trial court ruled against Matthies, and she appealed.

Key rules.  A purchase-money mortgage is “one which is given as security for a loan, the proceeds of which are used by the mortgagor to acquire legal title to the real estate.”

The test used to determine whether a mortgage is purchase money is (1) “whether the proceeds are applied to the purchase price” and (2) “whether the deed and mortgage are executed as part of the same transaction.”

Generally, the law protects the superior equity of the mortgagee to be paid the purchase money before the property shall be subjected to other claims against the purchaser:

when the deed and mortgage are executed as part of the same transaction the purchaser does not obtain title to the property and then grant the mortgage; rather, he is deemed to take the title already charged with the encumbrance.  Because there is no moment at which the judgment lien can attach to the property before the mortgage of one who advances purchase money, the prior judgment lien is junior to the purchase-money mortgage.

Holding.  The Indiana Court of Appeals in Amici affirmed the trial court’s finding that Nelson’s mortgage was a purchase-money mortgage, which had priority over Matthies’s judgment lien. 

Policy/rationale.  First, the proceeds of Nelson’s loan to SFIP were applied as payment for the purchase of the property.  Second, the parties executed the deed and the mortgage as part of the same transaction.  In short, the Court concluded that SFIP and Nelson intended for the loan to be used to purchase the property.  “The mere fact that some of the financing documents were signed on the day before the closing took place does not, in and of itself, indicate that the execution of the documents was a separate transaction.”  Additionally, public policy favors providing a system under which a purchaser can obtain funding to purchase property. 

Related posts. 

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I frequently represent judgment creditors and lenders, as well as their mortgage loan servicers, that are entangled in lien priority and title claim disputes.  If you need assistance with a similar matter, please call me at 317-639-6151 or email me at john.waller@woodenmclaughlin.com.  Also, don’t forget that you can follow me on Twitter @JohnDWaller or on LinkedIn, or you can subscribe to posts via RSS or email as noted on my home page.


Defendants’ “Unclean Hands” Defense Fails In Lender’s Indiana Foreclosure Case

Lesson.  Shrewd settlement negotiations by a lender in workout discussions with sophisticated borrowers and guarantors should not amount to “unclean hands” by the lender and should not bar a commercial mortgage foreclosure action if such negotiations reach an impasse. 

Case cite.  East Point Business Park v. Private Real Estate Holdings, 49 N.E.3d 589 (Ind. Ct. App. 2015).   

Legal issue.  Whether alleged “unclean hands” by a bank and its successor-in-interest prohibited the foreclosure of the mortgage. 

Vital facts.  East Point arose out of a failed commercial real estate development project involving both the purchase of land and the construction of improvements on the land.  The East Point case addressed several legal matters, and the facts in the lengthy opinion are dense.  For the purpose of this post, Defendants essentially contended that the plaintiff lender (assignee) and the predecessor-in-interest bank (assignor) (collectively, “Lender”) unfairly negotiated loan renewals, including grouping outstanding loans, transferring debt from one loan to another and asking a guarantor to pay delinquent real estate taxes on property he owned.  Moreover, during the negotiations, Lender allegedly had come to a verbal agreement to renew the loan only to later renege on the agreement – deciding instead to “scrap” the loan renewal process.      

Procedural history.  Lender filed a motion for summary judgment.  The trial court granted the motion.  Defendants appealed. 

Key rules. 

  • Under Indiana law, foreclosure actions are equitable in nature.  Trial courts have full discretion to fashion equitable remedies that are “complete and fair to all parties involved.” 
  • The equitable doctrine of unclean hands provides:  “the party who seeks equitable relief must be free of wrongdoing in the matter before the court.” 

Holding.  The Indiana Court of Appeals affirmed the trial court’s summary judgment for Lender.  Lender’s allegedly unclean hands did not prevent the foreclosure action from occurring.

Policy/rationale.  The Court did not buy into Defendants’ arguments that Lender’s actions constituted unclean hands:

[Defendants were] attempting to negotiate a long-term loan renewal with [Lender].  In exchange, [Lender] was attempting to obtain certain concessions from [Defendants]. …  [Lender’s behavior] was simply part of the negotiation process in the renewal of a multi-million dollar loan among sophisticated parties.

The Court also reasoned that there was no evidence suggesting that Lender was obligated to renew the loan.  “We will not say that [Lender] acted improperly by not renewing a loan it was under no obligation to renew.” 

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Part of my practice is to protect the interests of lenders in contested foreclosures.  If you need assistance with such matters in Indiana, please call me at 317-639-6151 or email me at john.waller@woodenmclaughlin.com.  Also, you can receive my blog posts on Twitter @JohnDWaller or on LinkedIn, or you can subscribe to posts via RSS or email as noted on my home page.

 


In Indiana, An Unrecorded Mortgage Has Priority Over A Subsequent Judgment Lien

Lesson.  While perhaps counterintuitive, in a lien priority dispute between a mortgagee holding an unrecorded prior mortgage and a creditor holding a perfected subsequent judgment lien, the mortgagee will prevail.  

Case cite.  In Re Moss, 2015 Bankr. LEXIS 4413 (N.D. Ind. 2015) (.pdf). 

Legal issue.  Whether an unrecorded mortgage has priority over a subsequent judgment lien.

Vital facts.  The facts were undisputed that the mortgage was not recorded.  There also was no dispute that the judgment lien, which had been created after the execution of the mortgage, was perfected.

Procedural history.  Moss arose out of a Chapter 7 bankruptcy case and specifically an adversary proceeding filed by the Trustee against various creditors.  The opinion dealt with cross-motions for summary judgment filed by the Trustee and a lender/mortgagee.  Without getting too far into the bankruptcy weeds, the opinion in part involved the Trustee’s 11 U.S.C. 544(a)(3) lien avoidance powers, as well as the Trustee’s section 547(b) and 551 powers to avoid preferential transfers. 

Key rules. 

  • Very generally, section 544(a)(3) “empowers a bankruptcy trustee to avoid any transfer of property that is avoidable by a bona find purchaser of real property.”  Indiana real estate law controls who would be a bona fide purchaser and “what constitutes constructive notice sufficient to defeat a bankruptcy trustee’s section 544(a)(3) power.”
  • Mortgages in Indiana take priority according to the time of filing.  Ind. Code 32-21-4-1(b).  This statute’s purpose “is to protect subsequent purchasers, mortgagees, and lessees of real property.” 
  • Indiana judgments constitute a lien upon real estate when the judgment “has been duly entered and indexed in the judgment docket.”  I.C. 34-55-9-2.  However, “a prior equitable interest [in the land] will prevail over a judgment lien.”  In other words, judgment liens are subordinate to prior “legal or equitable liens.” 
  • The Indiana Supreme Court has determined that “the [equitable] lien of an unrecorded mortgage has priority over that of a subsequent judgment.”  As between the parties to a mortgage, the lack of recording does not affect its validity. 

Holding.  The Court granted summary judgment for the Trustee and held that the judgment lien was subordinate to the unrecorded mortgage because the judgment creditor could not be considered a BFP (bona fide purchaser for value).  Again, the bankruptcy aspect of the opinion was somewhat complicated and beyond the scope of my blog.  But, for the record, the Court concluded that the Trustee, itself a BFP as a matter of bankruptcy law, could “effectively recover [the mortgagee’s] priority status for the benefit of the bankruptcy estate” so as to render the interest of the judgment creditor secondary and subject to the Trustee’s “recovered [senior] interest.”  Then, ironically, the Trustee was able to use that senior status to avoid the mortgage as a preferential transfer – read the opinion for a deeper dive into the BK issues.   

Policy/rationale.  The outcome in Moss turned on the purpose of the recording statute, which “operates to protect only subsequent good faith purchasers, lessees, or mortgagees for valuable consideration.”  The statute could not be used as a sword by the judgment creditor.  A judgment lien is not purchased for consideration, unlike deeds, leases or mortgages that are consensual in nature.  Judicial liens are creatures of statute and are not granted “for value.”  Thus the judgment creditor in Moss was not a BFP and, as such, could not defeat the mortgage.  In the context of the bankruptcy, the Court reasoned that “not upholding the unrecorded mortgage … would work to provide a windfall to some creditors at the expense of others who had no part in the failure to record.” 

Related posts. 

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I frequently represent judgment creditors and lenders, as well as their mortgage loan servicers, that are entangled in lien priority and title claim disputes.  If you need assistance with a similar matter, please call me at 317-639-6151 or email me at john.waller@woodenmclaughlin.com.  Also, don’t forget that you can follow me on Twitter @JohnDWaller or on LinkedIn, or you can subscribe to posts via RSS or email as noted on my home page. 


Mortgage On Wife’s Real Estate Discharged Post-Divorce Following Material Alteration Of Underlying Debt Owed By Ex-Husband’s Business

Lesson.  Lenders are well served to get the signatures of all parties to a loan, including all guarantors and mortgagees, if the loan is renewed or modified.  Otherwise, there is a risk that the guarantor or even a mortgage could be released.

Case cite.  First Federal Bank v. Greenwalt, 42 N.E.3d 89 (Ind. Ct. App. 2015).

Legal issue.  Whether a mortgage was discharged due to a material modification of the guaranteed indebtedness. 

Vital facts.  Husband and Wife granted a mortgage in the amount of $300,000 on two properties they owned to secure a promissory note executed by Husband’s business.  Following a divorce, Wife got Property 1, and Husband got Property 2.  Thereafter, Husband’s business and Lender consolidated debts and renewed the note multiple times without Wife’s knowledge.  The debt amount increased to nearly $450,000.  Husband later sold Property 2 and gave about $110,000 in net proceeds to Lender.  Ultimately, Husband was discharged of his debts in a Chapter 7 bankruptcy proceeding.  Lender then sought to foreclose on Property 1 to satisfy the remaining debt owed by Husband’s business.

Procedural history.  The trial court granted summary judgment for Wife, and Lender appealed.

Key rules.  In Indiana, one who mortgages her land to secure another’s debt is called a surety.  Indiana does not distinguish guarantors from sureties.  A surety’s collateral can be released by a creditor’s actions “such as the extension of the time of payment of the debt, the acceptance of a renewal note, or the release of other security.”  When a principal “alters the terms of the contract without the consent of the surety, the surety is discharged, even if the alteration is to the benefit of the surety.”  To result in a discharge, the alteration “must be a change which alters the legal identity of the principal’s contract, substantially increases the risk of loss to the guarantor, or places the guarantor in a different position.”  

Holding.  The Court of Appeals affirmed the trial court’s summary judgment in favor of Wife.

Policy/rationale.  Wife originally was a surety for Husband’s business’s debt, but she contended that Property 1 was no longer subject to Lender’s mortgage.  Lender argued that there had been no material alteration to the debt but, if there had been, the debt that existed at the time of any material obligation was not discharged.  The First Federal Bank opinion thoroughly outlined the complex facts and applicable law, including the Keesling case (see post below).  The Court concluded that the alteration of the loan terms between Lender and Husband’s business constituted material alterations of the underlying obligation guaranteed by Wife such that both Wife, as a surety, and Property 1 were discharged.    

Related posts. 


Even Though Loan Was Non-Recourse, Court Awards Lender Real Estate Tax Refund Due To Borrower

Lesson.  Depending of course upon the language in a particular mortgage, lenders generally hold a security interest in real estate tax refunds owed to borrowers – even in cases of non-recourse loans.

Case cite.  2513-2515 South Holt Road Holdings v. Holt Road, 40 N.E.3d 859 (Ind. Ct. App. 2015)

Legal issue.  Whether, in the context of a non-recourse loan, the foreclosing lender could recover a $307,193.76 refund paid to the borrower following a successful appeal of a real estate tax assessment.

Vital facts.  Holt Road was a commercial foreclosure case concerning a non-recourse loan.  Black’s defines such a loan as a “type of security loan which bars the lender from action against the borrower if the security value falls below the amount required to repay the loan.”  In the commercial real estate context, this means that the lender’s recovery of the debt is limited to the mortgaged property.  If there is a deficiency, the borrower, personally, is not on the hook.  What made Holt Road unique was that, during the foreclosure case, the borrower received a sizable refund of real estate taxes (aka property taxes) from the county as a result of a tax appeal.  Since the sheriff’s sale of the mortgaged real estate resulted in a deficiency, the lender sought recovery of the refund paid by the county in further satisfaction of the judgment/debt. 

Procedural history.  The trial court entered judgment in the borrower’s favor on the tax refund question, and the lender appealed.  The Holt Road opinion is from the Court of Appeals.  Following the opinion, the Indiana Supreme Court granted transfer, which automatically vacated the opinion.  However, the Supreme Court later reinstated the Court of Appeals opinion, which today is good law. 

Key rules.  Holt Road is not rule heavy.  The opinion slices and dices language in the mortgage.  The Court cites to dictionaries more than law. 

Holding.  The Court reversed the trial court and bought the lender’s argument that the tax refund fell within its security interest, as articulated in Paragraph (K) of the mortgage dealing with “funds,” “claims,” and “general intangibles.”  The Court awarded the refund, which was being held in escrow, to the lender. 

Policy/rationale.  The borrower asserted that the refund was a personal asset that was protected by the non-recourse nature of the deal – sort of like income.  Arguably the outcome was contrary to the essence of a non-recourse loan.  But the lender’s winning argument was that the funds were connected to the real estate, over which the lender held a broadly-defined security interest.  The Court examined in detail the language in the mortgage and found the tax refund to fall within the scope of the applicable lien provisions.  Close call.     

Related posts. 


Indiana’s Remedy For Mechanic’s Lienholder On Property Subject To Mortgage Foreclosure Action

Lesson.  In Indiana lien priority disputes, a purchase money mortgage fares better than a subsequent mechanic’s lien.  Contractors beware. 

Case cite.  Wells Fargo v. Rieth-Riley, 38 N.E.3d 666 (Ind. Ct. App. 2015) .

Legal issue.  As between a mortgagee and a mechanic’s lienholder, whose lien has priority?  And, how does Indiana view each party’s remedy vis a vi the real estate?  Note this case did not involve a construction mortgage (see posts below), which the law treats differently.

Vital facts.  Wells Fargo involved a shopping center.  Lender refinanced the purchase of the subject real estate and held a mortgage, which lender recorded on the real estate in January of 2008.  In 2011, the center’s owner hired contractor to pave the shopping center’s parking lot.  After failing to receive payment, contractor recorded a mechanic’s lien on the real estate.  Neither lender nor contractor got paid, so a foreclosure lawsuit ensued against the center’s owner. 

Procedural history.  The case mainly dealt with the dispute between lender and contractor as to which party’s lien had priority, together with their respective remedies.  The trial court entered a complicated summary judgment spelling out the treatment of the parties’ interests in the real estate.  Lender appealed.

Key rules.  A mortgage takes priority according to the time of its filing.  Ind. Code 32-21-4-1(b).  The effective date of a mechanic’s lien relates back to the date the contractor began work.  I.C. 32-28-3-5.  A mortgage generally takes priority over a mechanic’s lien if the mortgage was recorded before the contractor began its work. 

In instances of a purchase money mortgage, the exception to the general rule arose out of the Provident Bank v. Tri-County Southside Asphalt case decided by the Court of Appeals in 2004 (and discussed in a post below).  That case established that Indiana’s mechanic’s lien statute at I.C. 32-28-3-2 protects contractors by providing priority over a purchase money mortgage “as to the improvement for which he provided the labor and materials.”  Provident Bank went on to hold that the contractor “may sell the improvements to satisfy the lien and remove them” following the sale.  Provident Bank, not unlike Wells Fargo, surrounded paving work (a driveway).  The contractor had a senior lien over the driveway (only) and, as absurd as it seemed, the Court concluded that the contractor could sell and remove the driveway to satisfy its lien. 

Holding.  The Indiana Court of Appeals in Wells Fargo first held that, generally, lender’s mortgage had priority over the contractor’s lien for the simple reason that the lender recorded its mortgage earlier.  Contractor was not entitled to a pro-rata share of the proceeds from the sale of the real estate, as contractor had contended and as other states, such as Illinois, allow. 

The more complicated aspect of the case surrounded contractor’s right to remove and sell the parking lot to satisfy its lien.  Lender asserted that contractor should not be permitted to remove the parking lot because removal would impair the value of the land.  On that issue, the Court remanded the case back to the trial court to determine whether removal of the lot was “practical” and, if so, to allow contractor to exercise its option.  “Otherwise, [contractor’s] lien is junior to [lender’s] mortgage lien, and [contractor] is entitled to proceeds from the sale … only after [lender’s] mortgage has been satisfied.”

Policy/rationale.  Indiana public policy in these cases places the risk of loss on the party best able to avoid the loss.  “A mechanic performing work on property encumbered by a mortgage may easily determine whether the property upon which he will work is encumbered before deciding whether to perform the work.”  Someone has to lose, and Indiana favors lenders.  In my view, the absurdity of the “improvement removal” remedy for contractors serves to force the parties to settle the case. 

Further, I should note that Wells Fargo is a novel decision in that it extends the Provident Bank analysis to mandate a trial court determination of whether removal of the subject improvement is “practical,” which in Wells Fargo meant “that its removal will not substantially impair the value of the land beyond that which it would have been had the parking lot never have been paved.”  Absent a “practical” removal, the mechanic’s lien will be fully primed by the purchase money mortgage. 

Related posts. 


Indiana Leasehold Mortgages Governed By Real Estate Foreclosure Statutes, Not The UCC

Lesson.  In Indiana, the rights of the holder of the “leasehold” mortgage are the equivalent of a mortgagee’s, not a lessor’s, rights.  As such, upon a default, a lender does not have the ability to take immediate possession of the real estate.  Rather, the lender’s rights to the real estate must be asserted at a sheriff’s sale. 

Case cite.  Merrillville 2458 v. BMO Harris, 39 N.E.3d 382 (Ind. Ct. App. 2015).

Legal issue.  Whether UCC Article 9.1 secured transactions law, as opposed to the Ind. Code 32-30-10 mortgage foreclosure statutory law, applies to leasehold mortgages. 

Vital facts.  Borrower executed a promissory note and leasehold mortgage in favor of lender.  Black’s Law Dictionary defines a leasehold mortgage as a “mortgage secured by lessee’s interest in leased property.”  In Merrillville, borrower had entered into a lease for the subject real estate, on which it operated a Golden Corral.  The borrower was not an owner of the real estate but rather a tenant.  Borrower later defaulted under the loan, and the lender sued.      

Procedural history.  At the trial court level, the lender obtained an order of possession of the real estate.  The borrower appealed.

Key rules.  Indiana’s UCC, including I.C. 26-1-9.1, applies to security interests in “personal property or fixtures….”  Sec. 109(a).  Article 9.1 does not apply to leaseholds on real property.  In fact, Sec. 109(d) excludes liens on real property from UCC secured transactional law.  Thus leasehold mortgages are governed by Indiana statutory law regarding real estate mortgages – none of which provide for possession of the real estate before a sheriff’s sale.  

Holding.  If, in Merrillville, the provisions of the Indiana Code applicable to real estate mortgage foreclosures applied, the lender’s remedy would be a sheriff’s sale of the borrower’s interest in the real estate.  If, on the other hand, the provisions of the UCC applied, the lender would have the ability to immediately take possession of the real estate.  Since, in Indiana, a mortgagee has only a lien on, but no right to possession of, the mortgaged premises, the lender’s remedy in Merrillville was limited to purchasing the borrower’s rights of possession to the real estate at a sheriff’s sale.  The Court of Appeals therefore reversed the trial court.      

Policy/rationale.  Indiana law is well settled that mortgages merely are liens upon real estate.  Mortgagors retain legal title until foreclosure transfers title to the mortgagee “who must purchase the property at a [sheriff’s sale] if he wishes to acquire such title.”  Indiana’s policy, which is different than some other states, is that the “right to possession, use and enjoyment of the mortgaged property, as well as title, remains in the mortgagor … and the mortgage is a mere security for the debt.”  Leasehold mortgages, which are a slightly different spin on a standard mortgage, are not treated any differently.  Whatever rights a lessee has to the mortgaged property – possession, mainly – are not legally terminated until a sheriff’s sale.     

Related post.  Indiana Follows The Lien Theory of Mortgages


Single Note/Multiple Mortgages In Different States: Can The Indiana Mortgage Be Foreclosed And, If So, When?

Facts:  A prospective lender client was considering a high-dollar commercial loan to be documented by a single promissory note secured by several mortgages in several states, including Indiana.  In the event of a default under the note, the lawsuit to enforce the note – the action to obtain the judgment under the note – would not be in Indiana. 

Issues:  The lender generally wanted to know whether the Indiana mortgage would be enforceable.  Since Indiana law requires mortgages to be foreclosed in the county where the mortgaged real estate is located (Ind. Code 32-30-10-3), one of my first questions was how, if at all, could the Indiana mortgage be foreclosed, given that the action on the note would be pursued in a different state?  My next thought concerned how any Indiana foreclosure action would be impacted by the promissory note case in the other state? 

Statutes: I reviewed several Indiana statutes for answers, including I.C. 32-30-10 (Mortgage Foreclosure Actions) and I.C. 32-29 (Mortgages).  According to my research, there are no statutes directly on point.  None of the statutes contemplate what to do when there are multiple mortgages in different states securing a single note, although from experience I understand that a debt can be secured by multiple mortgages.  Generally, the structure appeared to be sound.  The enforcement of a default was the trickier matter.  Other than I.C. 32-30-10-3 mentioned above, the only other instructive Indiana statute was I.C. 32-30-10-10, which says in pertinent part:

A plaintiff may not:
(1) proceed to foreclose the mortgagee’s mortgage:
    (A) While the plaintiff is prosecuting any other action for the same debt or matter that is secured by the mortgage; [or]
    (B) While the plaintiff is seeking to obtain execution of any judgment in any other action
(2) Prosecute any other action for the same matter while the plaintiff is foreclosing the mortgagee’s mortgage or prosecuting a judgment of foreclosure.

What I think this statute says is that a lender cannot, in one suit, pursue a judgment under the promissory note while at the same time, in a separate suit, foreclose the mortgage securing the note.  The two actions must occur simultaneously within the same case, or they must be done sequentially – with the note action first to establish the debt to be foreclosed.  Having said this, as noted below, Indiana case law either interpreting or applying Section 10 is extremely limited.  Further, it’s frankly unclear to me what the words “matter” or “same matter” mean in Section 10. 

Case law:  The good news is that there are five Indiana Supreme Court cases that deal with the concepts in Section 10, and one of those cases actually cites to an older version of the statute.  The bad news is that all of the five cases are from the 1800’s.  Assuming the 21st Century courts follow the 19th Century decisions, a lender should be able to obtain a judgment on a note without abandoning its mortgage lien on the mortgaged premises.  In other words, recovery of a judgment on a debt is not a bar to a subsequent action to foreclose the mortgage.  Moreover, a lender, holding a judgment on a debt, may proceed to foreclose the mortgage without going through the judgment execution process. 

Conclusions:  Indiana law appears to be settled that there can be two suits – one on the note and one on the mortgage – as long as the two suits are not pending at the same time.  This principle seems to be supported by the Setree opinion, which I discussed last year - Full Faith And Credit: Indiana Foreclosure’s Die Was Cast By Kentucky Judgment.  Referring back to the original issues above, my opinion is that the Indiana mortgage generally should be enforceable but that the Indiana foreclosure action cannot be commenced until after the entry of the out-of-state judgment on the promissory note.  The unresolved question in my mind is whether the post-judgment Indiana foreclosure action could be prosecuted simultaneously with foreclosure actions in other states. 

If you are aware of any case law to the contrary or have litigated these matters previously, please post a comment or email me at john.waller@woodenmclaughlin.com.  I’d be curious as to any thoughts or input. 

Now, back to March Madness….


Indiana Upholds Dismissal Of Residential Borrower’s Tort Claims Arising Out Of Alleged HAMP Violations

Lesson.  Assorted counterclaims filed by borrowers arising out of alleged failings by lenders to modify mortgages following defaults generally will be dismissed.

Case cite.  Jaffri v. JPMorgan Chase, 26 N.E.3d 635 (Ind. Ct. App. 2015)

Legal issue.  Whether the borrower’s counterclaims for negligence, constructive fraud and intentional infliction of emotional distress should have been dismissed for a failure to state a claim.

Vital facts.  Borrower defaulted on her residential mortgage loan.  Borrower and lender entered into discussions about the possibility of modifying the mortgage based upon the federal government’s Home Affordable Modification Program (“HAMP”).  The loan mod never occurred, and borrower contended that lender “intentionally did not dedicate the resources to HAMP modifications that were necessary to properly comply with the federal program.” 

Procedural history.  Lender filed a Trial Rule 12(B)(6) motion to dismiss borrower’s counterclaims, which motion the trial court granted.  Borrower appealed.

Key rules. 

  • When parties have, by contract, arranged their respective risks of loss, tort law should not interfere.  One cannot negligently breach a contract. 
  • Contractual relationships do not give rise to a fiduciary relationship creating a duty.  Generally, the relationship between a bank and a customer is insufficient to establish a constructive fraud claim. 
  • Intention of infliction of emotional distress claims require proof that the defendant:  (1) engaged in extreme and outrageous conduct, (2) which intentionally or recklessly, (3) caused, (4) severe emotional distress to another. 

Holding.  The Indiana Court of Appeals affirmed the trial court’s dismissal of borrower’s tort claims against lender. 

Policy/rationale.  The Court in Jaffri referred to the widely-recognized rule that alleged violations of HAMP do not give rise to a private right of action.  In other words, HAMP does not establish a duty of care owed by a lender to a mortgagee seeking a modification.  The Court said:  “We cannot perceive that by enacting HAMP, the federal government intended for persons rejected for HAMP assistance to have a private cause of action against the mortgage lender or servicer, unless a contract actually was entered into under HAMP.” 

Related posts. 


Defective Notary Does Not Mean Defective Mortgage

Lesson.  Technical errors in a mortgage instrument will not necessarily invalidate it.  In particular, Indiana mortgages, which almost always are notarized, are not unenforceable simply because the notarization is flawed.

Case cite.  Borgwald v. Old National Bank, 12 N.E.3d 252 (Ind. Ct. App. 2014).

Legal issue.  Whether the lender’s mortgage was invalidated by an alleged violation of an Indiana statute prohibiting a notary from taking an acknowledgement from someone who is blind without first reading the instrument to her. 

Vital facts.  The borrower in this foreclosure case was an elderly woman who, at the time of closing, had difficulties with sight and hearing.  The borrower’s granddaughter was her caretaker, and the granddaughter took the borrower to a bank to apply for a home equity line of credit, the purpose of which, in part, was to pay the granddaughter for the care.  The borrower subsequently passed away, and the line of credit had a sizable balance that the lender pursued against the borrower’s estate.  In defense of the debt, the estate claimed, among other things, theft and undue influence on the part of the granddaughter.  As to the mortgage, the lender’s customer service representative testified that she explained the mortgage to the borrower but did not read it in its entirety to her.  But the bank’s customer service representative, who closed the loan, was not the notary for the mortgage, and the notary did not testify.

Procedural history.  Borgwald was an appeal from a bench trial in which the trial court found that the mortgage was enforceable. 

Key rules.  Indiana Code § 33-42-2-2(a)(4) states, among other things, that a notary public may not “take the acknowledgement of any person who is blind, without first reading the instrument to the blind person.”  On the other hand, in Indiana, “a mortgage need not be notarized in order to be enforceable.”  See, I.C. § 32-29-1-5

Holding.  The Indiana Court of Appeals affirmed the trial court and concluded that the lender’s mortgage was not invalidated by the defective notary. 

Policy/rationale.  The Court reasoned that the problems with the notary only invalidated the notary’s signature, not the mortgage:  “[e]ven assuming that the mortgage was not read to [the borrower] and that [the borrower] could be characterized as being blind . . . the validity of the mortgage would not be affected, only the notary’s signature.”  Very generally, the purpose of a notarization is to create a presumption that a signature on a legal document is authentic.  In Borgwald, there was no question that the borrower executed the mortgage. 

Related posts. 


Indiana Adopts “Partial Subordination” Approach To Priority Disputes Arising Out Of Subordination Agreements

 

The Indiana Court of Appeals in Co-Alliance v. Monticello Farm Service, 7 N.E.3d 355 (Ind. Ct. App. 2014) discusses subordination agreements, generally, and lien priority disputes arising out of them, specifically.

Three lenders.  Co-Alliance dealt with three lenders, each of which financed the borrower’s farming operations.  Lender 1 had the senior lien on the borrower’s assets, and Lender 2 and Lender 3 held the second and third position liens, respectively.  In 2010, Lender 1 agreed to subordinate part of its senior lien in favor of Lender 3, thereby reducing the extent of Lender 1’s first position.  The subordination agreement was borne out of Lender 3’s stipulation to finance the borrower’s crops for that year.  In turn, Lender 1 agreed to subordinate its interests in the 2010 crops to Lender 3’s interests in them.  Lender 2 was not a party to the subordination agreement.

Subordination agreements, generally.  I touched upon subordination agreements in my September 18, 2013 post.  The Court in Co-Alliance noted that subordination agreements “are nothing more than contractual modifications of lien priorities.”  These types of agreements can “accelerate the flow of cash to troubled projects, providing financial relief that promotes the development of assets that are then used to secure payments to all lienholders.”

Contentions.  The Co-Alliance case was a dispute between Lender 2 and Lender 3.  Lender 2 basically asserted that it jumped into first position and theorized that “subordinate” necessarily means “to move a right or claim to a lower rank.”  Lender 2 took the position that the subordination agreement completely reduced Lender 1’s security interest in the 2010 crops such that that Lender 1’s position dropped to the last (or third) position.  The law commonly refers to this as “complete subordination,” and some states follow this rule.  Lender 3 argued that the subordination agreement “merely allowed [Lender 3] to momentarily step into the [Lender 1’s] first priority status.”  This is commonly referred to as “partial subordination.”  The Indiana Court of Appeals preferred this result.

Intent.  In Co-Alliance, the language of the subordination agreement showed that the parties’ intent was for Lender 1 to assign to Lender 3 a portion of any crop proceeds received by Lender 1 based upon its status as the senior lienholder.  In essence, Lender 1 induced Lender 3 to make a loan by guaranteeing it the right of first payment.  Again, Lender 2 claimed that the subordination agreement moved Lender 1 (and, by extension, Lender 3) to the back of the line, to the full extent of the security.  Yet, Lender 2 was not a party to the agreement and, according to the Court, “should not be entitled to a windfall.”  The Court illustrated the intent of the subordination agreement and how it would work:

Thus, [3,] by virtue of the subordination agreement, is paid first, but only to the amount of [1’s] claim, to which [2] was in any event junior.  [2] receives what it had expected to receive, the fund less [1’s] prior claim.  If [1’s] claim is smaller than [3’s], [3] will collect the balance of its claim, in its own right, only after [2] has been paid in full.  [1,] the subordinator, receives nothing until [2] and [3] have been paid except to the extent that its claim, entitled to first priority, exceeds the amount of [2’s] claim, which, under its agreement, is to be first paid. 

Lender 2 loses.  In Co-Alliance, the evidence showed that the amount of the crop proceeds in question did not exceed either the amount of Lender 1’s lien or the amount that Lender 1 was subordinated to Lender 3.  There was no evidence that Lender 2 was burdened by or benefited from the subordination agreement.  “Rather, [Lender 2] was unaffected.”  Accordingly, the Court held that the trial court properly found the subordination agreement gave Lender 3 a first-priority in the subject proceeds.


What Is A Fixture?

Enforcing commercial loan defaults sometimes involves the foreclosure on, or repossession of, loan collateral called a “fixture,” which is a hybrid of real and personal property.  Given their nature, fixtures can be the subject of disputes between mortgagees and other creditors who argue about who has priority over the fixture or whether there is a security interest in the fixture to begin with.    

UCC.  Indiana’s Uniform Commercial Code, which deals with, among other things, secured transactions (in Article 9.1), talks in detail about fixtures.  Curiously, the UCC does not provide a practical definition of a fixture.  I.C. § 26-1-9.1-102(41) says that a fixture means “goods that have become so related to particular real property that an interest in them arises under real property law.”  Not helpful.

Common law definition.  Indiana case law defines fixtures, and the best discussion comes from the Indiana Supreme Court in Gill v. Evansville Sheet Metal Works, 970 N.E.2d 633 (Ind. 2012).  Citing to older Indiana cases, the Court stated:

A fixture is a former chattel or piece of personal property that has become a part of real estate by reason of attachment thereto.  . . .  As a general matter, personal property becomes a fixture if the following are established:  (1) either actual or constructive annexation of the article to the real property; (2) adaptation of the article to the use of the real property in general or to the part of the real property to which the article is connected; and (3) an intent by the annexing party to make the article a permanent accession to the real property.

In an earlier case, Ind. Dep’t of Natural Res. v. Lick Fork Marina, 820 N.E.2d 152 (Ind. Ct. App. 2005), the Court of Appeals referred to Black’s Law Dictionary, noting that a fixture is “personal property that is attached to land or a building and that is regarded as an irremovable part of the real property.” 

A transformed good.  Here are some examples of fixtures:  underground storage tanks, landscaping, furnaces, sprinkler systems and water softeners.  One specific illustration comes from Conseco Finance v. Old National Bank, 754 N.E.2d 997 (Ind. Ct. App. 2001) dealing with security interests in manufactured homes:

When purchased from a retail establishment, the manufactured home is a “good,” and clearly moveable; but once placed on real estate, attached to a foundation, and connected to utilities, it becomes a fixture.

A fixture starts out as personal property but converts into a fixture when it becomes attached to the real estate.  This is one of the reasons why there can be questions surrounding whether a mortgage, as opposed to a UCC financing statement, creates a lien on a fixture. 

Generalities.  A creditor that obtains a security interest in a fixture should be mindful of competing claims from other secured creditors, such as asset-based lenders, which finance with goods and personal property, and mortgagees, which loan on real estate.  (A creditor can obtain a purchase money security interest in a fixture.)  To perfect a security interest in fixtures, we recommend filing two financing statements:  (i) one with the Secretary of State of the state in which the party assigning a security interest has been organized, and (ii) a “fixture filing” with the pertinent county recorder’s office.  Although a mortgage can double as a fixture filing if it includes the statutory elements of a fixture filing, lender’s counsel usually file a UCC financing statement too.  Here is a short list of the more important provisions of Indiana’s UCC, Article 9.1, that deal with fixtures:

• Priority:  I.C. § 26-1-9.1-334

• Perfecting, generally:  I.C. § 26-1-9.1-310 and 301(3)(a)

• Perfection, where:  I.C. § 9-1-9.1-501

• Enforcement:  I.C. § 9-1-9.1-604

For more on security interests and related issues, click on the UCC/Security Interests category that is along the right side of my home page.  For more on how to finance based on fixtures or enforce loans with fixtures as collateral, please contact me.  Thanks to my colleague Sierra Bunnell for her input into this post.


Lien Priority Dispute: 2005 Mortgage v. 2000 Land Contract

The Indiana Court of Appeals, in Lunsford v. Deutsche Bank, 966 N.E.2d 815 (Ind. Ct. App. 2013), begins its opinion with this legal principle:  “. . . first in time is first in right . . . .”  In Indiana property and debt collection law, this means “a prior lien gives a prior claim, which is entitled to prior satisfaction, out of the subject it binds . . . .”  This rule doomed a land contract buyer (vendee) in his priority dispute with a lender (mortgagee).

The operative dates.  In Lunsford, the owner of the real estate entered into a land contract to sell on August 28, 2000, but the buyer failed to record the land contract until March 8, 2006.  On August 25, 2005, the owner obtained a mortgage loan, and the lender recorded the mortgage approximately six months before the recordation of the land contract.  The owner subsequently defaulted on the mortgage loan, resulting in the lender’s foreclosure suit. 

Priority dispute.  The issue in Lunsford was whether the land contract should have been foreclosed as a junior and subordinate interest to the lender’s mortgage.  In other words, was the land contract buyer’s claim to the real estate subject to the lender’s mortgage, even though the land contract predated the mortgage by five years?

Mortgage superior.  The Court in Lunsford swiftly dispensed with the land contract buyer’s priority contention.  Since the lender recorded its mortgage six months before the buyer recorded its land contract, the mortgage was senior in priority.  Further, since the lender made the buyer a party to the foreclosure action, thereby giving him the opportunity to assert his junior interest in the real estate, the trial court’s foreclosure decree was conclusive as to the buyer.  The Court affirmed the trial court’s summary judgment in favor of the lender accordingly.  Moral:  Don’t Forget To Record.

Different outcome.  While Lunsford appears to be a straight forward case, the Court of Appeals actually reached the opposite result in the 2007 Pramco opinion I discussed here.  The Pramco Court leaned on principles of equity and focused on, among other things, the amount of payments that the land contract buyer had made before the lender’s foreclosure suit.  The Pramco opinion was much more factually involved, while the land contract facts in Lunsford really were not addressed.  Note that the prevailing land contract buyer in Pramco was represented by counsel, whereas the losing buyer in Lunsford was pro se

 


Standing: Bank Merger Rule Same For Corporate Entities

The Court in Beneficial Financial v. Hatton, 998 N.E.2d 232 (Ind. Ct. App. 2013), the case I discussed last week, applied a version of the bank merger rule about which I wrote on 01/25/13 and 09/19/14

Motion to dismiss.  The borrower in Beneficial sought dismissal of the lender’s foreclosure complaint on the theory that the subject promissory note and mortgage were not executed by the plaintiff but rather by its predecessor-in-interest.  The borrower claimed that the law required the lender to attach loan assignment documents to establish standing and thus proceed. 

Merger rule.  The Court concluded that the borrower’s argument was without merit.  Pursuant to Ind. Code § 23-1-40-6(a)(2), when a corporate merger takes effect, title to all real estate and other property owned by each corporate party to the merger is vested in the surviving corporation.  So, a surviving corporation assumes the assets of the assumed corporation as a matter of law.  “This obviates the necessity of creating a separate instrument reflecting the change in ownership of each such . . . asset.” 

No assignments needed.  In Beneficial, no loan assignment document, such as an endorsement, an allonge or an assignment of mortgage, existed.  But the lender was not required to supply such documentation, apart from some proof of the corporate merger itself.  The lender attached to its complaint a certificate of merger issued by the Indiana Secretary of State establishing, among other things, that the lender was the surviving entity, which the Court concluded was sufficient to prove the lender’s interest in the mortgage. 

Beneficial is a slightly different spin on the bank merger rule previously addressed in this blog, but the result is the same.  Assignment documents are not required to establish standing by a successor corporation. 

 


Reformation: How A Mortgage With An Erroneous Legal Description Can Be Foreclosed

Lenders and their foreclosure counsel might be faced with a mortgage with a legal description of the subject real estate that is erroneous.  I’ve seen everything from innocuous typos to descriptions of an entirely separate parcel.  Is foreclosure still a possibility?  Yes.  Beneficial Financial v. Hatton, 998 N.E.2d 232 (Ind. Ct. App. 2013) explains how. 

Approach.  In Beneficial, foreclosure counsel discovered an error in the legal description.  Both the lender and the borrower agreed that the original mortgage identified a parcel of property that neither party intended to mortgage.  So, in addition to filing the standard foreclosure complaint, counsel added a cause of action for “reformation.”  The borrower filed a motion to dismiss, arguing that the mortgage was ineffective “due to the error in the legal description.” 

Reformation law.  Indiana law on reformation is well-settled.  Here are the primary points: 

• Reformation is an equitable remedy to relieve the parties of mutual mistake or fraud.

• In cases involving mutual mistake, the party seeking reformation must establish (1) the true intentions of the parties, (2) that a mistake was made, (3) that the mistake was mutual, and (4) that the instrument did not reflect the true intentions of the parties. 

The Court in Beneficial stated that, to prevail, it was incumbent upon the lender to prove that its original intent, and that of the borrower, “was to describe a different piece of real estate than that which was in fact described in the mortgage instrument.” 

Proving intent.  The tricky thing in these cases can be in proving intent.  Sometimes the borrower is out of the picture, and sometimes the current plaintiff/mortgagee wasn’t the original lender.  Meeting the burden of proof can be difficult.  The Court in Beneficial provided some guidance.  Courts look to the parties’ conduct during the course of the contract negotiations and closing.  The Court hinted that evidence in favor of reformation could include, for instance, (1) the real estate appraisal from the origination file, (2) the HUD-1 settlement statement, (3) the loan application and (4) the loan approval form.  Courts will examine evidence that would be compelling on the question of the identity of the real estate that the parties originally intended to be mortgaged. 

Dismissal overturned.  The Court of Appeals reversed the trial court’s dismissal in Beneficial, reasoning that if the lender “were not allowed to proceed beyond the filing of a complaint merely because the description of the property is erroneous, then the viability of any mortgage reformation action . . . is called into question, and indeed perhaps rendered impossible.”  The Court gave the lender the opportunity to prove that a mutual mistake occurred in its mortgage with the borrower.  If the lender were subsequently able to establish that the mortgage’s legal description was a mistake, and that a different description was intended, then the trial court would be compelled to reform (correct) the mortgage, thereby opening the door to foreclosure of the reformed mortgage on the correct real estate.


Note Assignment (Allonge) And Mortgage Deemed Valid In Recent Opinion

Buchanan v. HSBC, 993 N.E.2d 275 (Ind. Ct. App. 2013) is another decision shooting down a borrower’s defenses to an Indiana mortgage foreclosure action.  In Buchanan, the borrower contested the validity of both the promissory note and the mortgage. 

Assignment defects.  The borrower attacked the legitimacy of the assignment of the promissory note from the original lender to the plaintiff/current lender.  The borrower asserted that (1) the note did not include an endorsement and (2) the allonge was not dated. 

    Allonge application.  The Indiana Court of Appeals first cited to the definition of an “allonge” by referring to Black’s Law Dictionary.  An allonge is a paper “attached to a negotiable instrument [a promissory note] for the purpose of receiving further endorsements when the original is filled.”  The Buchanan Court noted that it was unnecessary to use an allonge because the note did not contain any endorsements (and thus was not “filled”).  Nevertheless, the Court concluded that “we are not aware of any reason to prohibit the use of an allonge in this case.”  In my experience, the use of an allonge, regardless of whether there have been any endorsements, is a common and accepted practice. 

    Allonge okay.  The lender pointed out that the allonge to the subject promissory note was endorsed in blank – a concept about which I discussed on 10/17/14.  Endorsing in blank is a non-issue.  The Court also concluded that the lender’s failure to produce a dated allonge was immaterial.  There is no authority that the lack of a date on an allonge renders it invalid.  (The lender submitted an affidavit showing the year of the transfer of the note.  So, even though there was no date certain in the allonge, there was evidence as to when the transfer occurred.) 

Mortgage acknowledgement.  The borrower contended that the subject mortgage “lacked the requisite acknowledgement” and thus was unenforceable.  Ind. Code § 32-29-1-5(d) requires Indiana mortgages to be “dated and signed, sealed, and acknowledged by the grantor . . . ,” among other things.  The borrower’s argument was that the notary public did not have any authority in Indiana but was limited in its commission to Kentucky.  Indeed there is Indiana case law providing that a notary public’s official activities are limited to the political subdivision for which it is appointed and commissioned and, furthermore, that acts outside of the territorial limits are void.  The Court in Buchanan bypassed the borrower’s argument, stating “we need not decide whether the mortgage was properly acknowledged.”  The Court’s reasoning was that the borrower did not deny that he executed the mortgage and note when he purchased the subject real estate.  Moreover, Indiana case law provides that an “unacknowledged instrument is binding between parties and their privies,” meaning that, as between the borrower and the lender, the notarial acknowledgement was insignificant, according to the Court.

Upheld.  The Indiana Court of Appeals affirmed the trial court’s findings that the lender was the holder of the subject note and that the mortgage was valid despite an allegedly defective acknowledgement.


Indiana Rejects Foreclosure Defenses Based On The Redemptionist Movement And The Vapor Money Theory

Over the years, we have seen borrowers and guarantors defend mortgage foreclosure cases on theories that are pretty out there.  The defenses asserted in Blocker v. U.S. Bank, 2013 Ind. App. LEXIS 396 (Ind. App. 2013) might take the cake.

Payment?  In Blocker, following the initiation of foreclosure proceedings, a Marcus Lenton character sent a personal, non-certified check for the full amount of the debt to the lender, on behalf of the borrowers, to pay off the loan.  In the endorsement box on the back of the check, Lenton wrote, “NOT FOR DEPOSIT EFT ONLY.”  The lender informed the borrowers that a payoff only could occur via certified funds (money order, cashier’s check or wire transfer).  Not to be denied, the borrowers next presented to the lender a “lawful order for money,” directed to the U.S. Treasury, that supposedly drew, on Lenton’s account, a sum in an amount to pay off the debt.  Not surprisingly, the lender did not accept that payment either.  Later, in response to the lender’s summary judgment motion, the borrowers presented a document to the lender labeled “International Promissory Note…” written for an amount sufficient to satisfy the debt.  The document was not written against any bank account but rather against the Lenton Trust as Drawee with Lenton himself as the Drawer.  Again, the lender refused to accept this as payment.

Borrowers’ contention.  The trial court granted summary judgment in favor of the lender.  On appeal, the borrowers asserted that they tendered three payments to the lender, through Lenton, which should have discharged the debt.  The Indiana Court of Appeals concluded that the borrowers’ payment attempts were not done through normal banking channels but rather a “confusing” effort by Lenton to compel the U.S. Treasury Department to pay off the borrowers’ mortgage.

Redemptionist movement.  The Court wrote that the borrowers’ arguments appeared to be an outgrowth of the so-called “redemptionist movement,” which has been explained as follows:

“[T]he “Redemptionist” theory…propounds that a person has a split personality: a real person and a fictional person called the “strawman.”  The “strawman” purportedly came into being when the United States went off the gold standard in 1933, and, instead, pledged the strawman of its citizens as collateral for the country’s national debt.  Redemptionists claim that government has power only over the strawman and not over the live person, who remains free.

Wow.

Vapor money theory.  The Court also identified a philosophy, closely related to the redemptionist theory, that evidently played a role in the borrowers’ arguments:

The “vapor money” (or “no money lent”) theory posits that Congress has never given banks the authority to extend credit and, thus, banks act beyond their charters when making loans.  Proponents claim banks create money “out of thin air,” through ledger entries and bookkeeping tricks, by “depositing” a borrower’s promissory note without the borrower’s permission, listing the note as an “asset” on the bank’s ledger entries, and then lending a borrower back his own “money.”  Since banks do not have enough “real money in their vaults” to cover the sums lent, loans are not backed by actual money--the only real money is gold or silver; paper money is worthless since it is created by an illegitimate Federal Reserve--making them invalid ab initio and creating no obligation for repayment.

Alrighty then.

Uh, no.  The Court noted that both the vapor money and redemptionist theories have been “roundly rejected by courts across the nation.”  Lenton’s attempts to pay off the borrowers’ mortgage debt “were not only unorthodox but also legally unacceptable.”  The Court’s summary is fairly amusing:

It is unclear who Lenton is or what his relationship to the [borrowers] is and whether he represented to them that he knew the “secret formula” to accessing money locked away in a clandestine Treasury Department account but, in any event, he clearly failed to access or provide the funds needed to pay off their mortgage.

The Court affirmed the trial court’s summary judgment for the lender accordingly.


Borrower’s Claims Of Negligence, Unconscionability And Quiet Title Negated

The Seventh Circuit Court of Appeals put an end to a borrower’s tactics to overcome a mortgage loan default in Jackson v. Bank of America Corporation, 711 F.3d 788 (7th Cir. 2013).  The case provides some good law for lenders/mortgagees.  Specifically, the opinion addresses the claims/defenses of negligence, fiduciary duty, unconscionability and quiet title.  Interestingly, the mortgagee had not yet filed a foreclosure action.  Apparently the borrower attempted a preemptive strike by filing his own lawsuit to thwart any future loan enforcement suit by the mortgagee. 

Negligence/fiduciary duty.  The borrower first contended that the mortgagee “negligently evaluated . . . the ability [of borrower] to repay the loan,” including specifically the utilization of gross income rather than net income.  In Indiana, claims of negligence involve three elements:  duty, breach of duty and injury proximately caused by breach.  To meet the first (relationship-related) element, the borrower contended that the mortgagee owed him a fiduciary duty.  The Court noted that, under Indiana law, such a duty generally does not arise between a lender and a borrower.  “A mortgage contract does not, on its own, create a confidential relationship between a creditor and a debtor.”  Accordingly, the Seventh Circuit affirmed the District Court’s dismissal of the borrower’s negligence claim. 

Unconscionability.  The second assertion of the borrower was that the mortgage was “unconscionable” and should be set aside.  Under Indiana law, an unconscionable (and thus unenforceable) contract is one that “no sensible man not under delusion, duress or in distress would make, and that no honest and fair man would accept.”  The Court rejected the borrower’s claim with a nice discussion of unconscionable-related contract law in Indiana.  The Court’s opinion touched upon the borrower’s suggestions that the mortgagee committed fraud based on the borrower’s lack of “specialized knowledge” required to evaluate whether the loan was in his best interests.  The Court reasoned that the borrower had “not shown how this contract, which is so similar to untold numbers of other mortgage refinancing contracts, could possibly be one that ‘no sensible man not under delusion, duress or in distress would make, and that no honest and fair man would accept.’” 

Quiet title.  The borrower’s quiet title claim was odd, and the Court disposed of  it with brief comments.  From what I can gather, the borrower’s claim was an attempt to extinguish the mortgage from the chain of title.  The borrower’s effort to pound a square peg in a round hole did not survive the mortgagee’s motion to dismiss.  The opinion on this point is not particularly educational, primarily due to what the Court noted to be the borrower’s attempt to “cut new turf” in Indiana quiet title law.  The Seventh Circuit did not allow any new turf to be cut.

Jackson is yet another recent Indiana opinion that helps lenders with early dispositions of borrowers’ attempts to delay the inevitable.  And, federal courts appear to be more receptive than state courts to Rule 12(b)(6) motions to dismiss. 

(Please forgive the absence of posts lately.  My day job has put me on the road a lot this Spring and thus away from my blog.)


Borrowers Sue Lender Over Alleged Wrongs From Loan Modification Agreement

Stender v. BAC Home Loans, 2013 U.S. Dist. LEXIS 30353 (N.D. Ind. 2013) (.pdf) provides a nice summary of how an Indiana federal court dealt with a lender’s efforts to promptly dismiss an assortment of causes of action brought by borrowers in connection with an alleged loan modification agreement. 

Specifics.  The plaintiff borrowers were mortgagors on two separate properties, and the defendant lender was an assignee of the loans.  The plaintiffs had defaulted on the mortgages but claimed that the defendant had agreed to a loan modification agreement.  The gravamen of the plaintiffs’ complaint was that the defendant refused to honor the modification agreement.  The plaintiffs sought damages for breach of contract, negligence, intentional infliction of emotional distress. 

Procedural maneuver.  The procedural context in Stender was important.  The defendant answered the complaint but promptly filed a motion for judgment on the pleadings under Fed. R. Civ. P. 12(c).  A motion for judgment on the pleadings essentially is an effort to get the court to dismiss the case at the outset.  A motion for judgment on the pleadings should not be confused with a motion for summary judgment, which as explained here deals with evidence, as opposed to mere allegations.  In Stender, the defendant moving party relied solely upon the allegations outlined in the complaint and any exhibits attached thereto.  Prevailing on such a motion normally is quite difficult because courts accept the factual allegations as true and look for “facial plausibility” of an alleged claim.  On summary judgment or, certainly, a trial, courts dig much deeper into actual evidence (testimony and exhibits).  In short, prevailing on Rule 12 motions is rare.   

Breach of contract, statute of frauds.  The defendant first asserted that the breach of contract count should be dismissed based upon Indiana’s statute of frauds, a subject I have discussed here previously.  The statute of frauds basically provides that the party against whom the action is brought (the defendant) must sign the alleged agreement that has been breached.  See, Ind. Code §  32-21-1-1(b).  In Stender, the defendant did not sign the loan modification agreement but did sign a cover letter, which plaintiffs contended satisfied the signature requirement.  The question was whether “the signature requirement of the statute of frauds must be satisfied with a pen-and-ink signature at the end of a contract.”  If so, then defendant would be correct that the lack of such signature on the loan modification documents was fatal to plaintiffs’ contract claim.  “But if the signature requirement can be satisfied in other ways, then the defendant’s argument fails.”  The Court denied the defendant’s motion because the defendant failed to demonstrate that the signature requirement had not been satisfied.  In other words, the Court wanted to see the evidence pertaining to the defense. 

Negligence, economic loss doctrine.  The defense associated with the negligence claim surrounded Indiana’s economic loss doctrine, which precludes liability based on certain theories, such as negligence, that seek purely economic loss (any pecuniary loss unaccompanied by any property damage or personal injury).  The Court granted the defendant’s motion and rejected the plaintiff’s argument that intangible alleged harms, such as injuries to credit scores and reputations, could be remedied with a claim for negligence.  The plaintiffs’ claims were purely economic in nature and, as such, Indiana law barred them. 

Intentional infliction of emotional distress.  The Court also dismissed the plaintiffs’ distress claims for similar reasons, namely that Indiana courts generally do not permit such claims based upon contractual or economic harm.  Although the plaintiffs’ allegations that the defendant lured them into signing loan modification agreement suggested that perhaps defendant was dishonest or acted with selfish economic motivation, “plaintiffs’ allegations do not permit any plausible inference that defendant’s intention was to harm plaintiffs emotionally.” 

In the end, the Court negated plaintiffs’ common law tort claims for negligence and emotional distress, which really have no place in a contract action such as Stender.  As to the statute of frauds defense to the breach of contract claim, however, the Court felt it was premature to rule.


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. 


Indiana Condominium Association Liens, Part II: Deeds In Lieu Of Foreclosure

Whereas last week’s post introduced condominium association (“CA”) liens and their priority in title under Indiana law, this week’s post addresses CA liens in connection with a deed-in-lieu of foreclosure (“DIL”).  A DIL can be a relatively simple and positive transaction for a secured lender struggling with an unperforming loan.  But in cases dealing with a condominium property, lenders need to be careful about inheriting unpaid CA assessments. 

Example scenario.  My colleague Sierra Bunnell and I recently worked on a foreclosure lawsuit involving a condominium.  Settlement discussions led to an agreement for a DIL.  Before closing the DIL, our client, the senior lender/mortgagee, learned that there were unpaid and past due CA charges.  (The CA had not recorded a formal lien notice.)  The question was whether our client could take a DIL without inheriting thousands of dollars owed by its borrower to the CA.  (In cases of a recorded CA lien, the foreclosure/settlement analysis would be no different than with any other case involving a recorded lien.)  Again, our case dealt with an unrecorded lien – an unusual concept - which we described in last week’s post. 

DIL – voluntary.  Under both the homeowner’s association (“HOA”) and condominium association statutory regimes in Indiana, a grantee in a voluntary transaction assumes certain liabilities for the subject real estate.  The amount assumed by a voluntary grantee for an HOA assessment will be limited to those unpaid assessments for which a notice of lien has been recorded, while the grantee would be liable for all unpaid assessments owed to a CA.  See, Indiana Code § 32-25-5-2 (CA) and I.C. § 32-28-14-7 (HOA). 

Options.  If a lender/mortgagee is considering a DIL in a condo case, it should undertake the following steps vis-à-vis the CA to guard against unwittingly exposing itself to liability for an unrecorded lien:

 1. Obtain a payoff letter from the CA and determine whether there are any past due and unpaid charges owed by the borrower.  Lenders are entitled to such statements and will not be liable for any unpaid assessments in excess of the stated amount.  I.C. § 32-25-5-2.  Lenders should then weigh the amount of outstanding assessments against the costs involved with the foreclosure.  Remember, a foreclosure and resulting sheriff’s sale (an involuntary transaction) will terminate any lien.  Depending upon the amount due, the time and expense of foreclosure may be warranted.

 2. One way to avoid foreclosure is to obtain, from the county recorder’s office or a title insurance company, the recorded condominium “declaration,” which is “like the constitution of a condo.”  Review the declaration for lien subordination language.  Declarations may expressly terminate a CA’s lien on the property (not the debt owed by borrower) in favor of a first mortgagee taking title through a DIL.  If that option is available, a lender can avoid liability for the debt altogether.  This is what occurred in Sierra’s and my case, and our title company insured the transaction.   

Again, I appreciate the assistance of Sierra Bunnell with my last two posts. 


Indiana Condominium Association Liens, Part I: Foreclosure

I’ve previously written about the priority of homeowner’s association (“HOA”) liens.  Today’s post relates to similar, but not identical, liens arising out of unpaid condominium association (“CA”) fees/assessments.  Like HOAs, CAs also can foreclose their liens.  Because a lender/mortgagee may, in its own foreclosure case, discover a recorded CA lien on the subject real estate, mortgagees and their foreclosure counsel should be mindful of the distinctions between the HOA and CA statutes and how the CA laws affect priority in title. 

Different laws.  In Indiana, different statutes govern the operation of HOAs (Indiana Code § 32-28-14) and CAs (I.C. § 32-25).  I.C. § 32-25-6 specifically deals with liens of CAs. 

Priority of unrecorded liens.  Unlike an HOA lien, a CA, or a so-called “association of co-owners,” maintains a continuous lien against the subject real estate from the date of the assessment of fees, without regard to whether the CA has recorded a lien notice with the county recorder’s office.  By statute, this CA lien “has priority over all other liens except tax liens and all sums unpaid on a first mortgage of record.”  I.C. § 32-25-6-3(a).  Indiana’s recording statute, I.C. § 32-21-4-1(b), does not apply to these liens, which is to say a lender’s mortgage does not take priority according to the date of its filing, but rather takes senior priority automatically by operation of Indiana Code § 32-25-6-3(a)(2).  This means that, when a lender forecloses, the lender will always enjoy priority over any unrecorded claim for past-due charges owed to a CA.  Further, it would not appear that a foreclosing lender needs to name the CA as a defendant to answer as to its unrecorded lien.   

Priority of recorded liens.  The CA has the authority per I.C. § 32-25-6-3(b) to record a lien on the subject real estate and then foreclose upon it, which foreclosure is governed by Indiana’s mechanic’s lien statute.  (In instances where a CA has recorded a lien, a foreclosing mortgagee should include the CA as a defendant in the foreclosure suit to ensure the CA’s lien is terminated by virtue of the sheriff’s sale.)  If the mortgage’s recording date precedes the recording of the CA’s lien, then the mortgage will have priority over the CA’s lien.  But if a CA records a lien notice before a lender records its mortgage, the priority rule becomes less clear.  The statutory language contains some contradictions on this point.  In the final analysis, I and my colleague Sierra Bunnell, who assisted with this post and the client’s case giving rise to it, believe that the CA’s prior recorded lien will maintain priority over a subsequently-recorded mortgage.  We believe this conclusion is reasonable given the policy of the recording statute, and recommend that a potential lender regard a prior recorded CA lien as an encumbrance on title.  Please comment below or email me if you have a different point of view.

Sheriff’s sale purchaser’s exposure.  I.C. § 32-25-6-3(a) provides that “if the mortgagee of a first mortgage of record or other purchaser of a condominium unit obtains title to the unit as a result of foreclosure of the first mortgage, the acquirer of title . . . is not liable for the share of the [CA charges applicable to that unit] due before the acquisition of title to the unit by the acquirer.”  While that language would seem to provide that the pre-sheriff’s sale charges disappear, the statute goes on to state that the unit’s charges fall back into a pool collectible from all co-owners, including the sheriff’s sale purchaser.  We read this to mean that, although a foreclosing mortgagee will not be on the hook for the full extent of the borrower’s unpaid CA charges, the mortgagee may be responsible for its pro rata portion as a new co-owner.

Next week, in Part II, we will address how to approach CA liens when a lender is considering a deed in lieu of foreclosure.  Thanks to my colleague Sierra Bunnell for her research and input.


Indiana Court Orders Release of Mortgage

This is another post about a situation in which an older mortgage had not been released at a prior closing when it should have been.  Tennant v. Fifth Third Bank, 2012 Bankr. LEXIS 4026 (S.D. Ind. 2012) (.pdf) teaches us that the subsequent foreclosing lender may not need to invoke the doctrine of equitable subrogation.  The facts may require that the prior mortgage simply be released. 

Common problem.  Tennant was a battle between Fifth Third, which held a 2002 HELOC mortgage, and Chase, which held a 2007 mortgage loan used to refinance senior debt.  The facts were undisputed that the Fifth Third loan had been paid off in 2005 but that the mortgage remained on title.  The borrower continued to obtain advancements on the line of credit.  The Court teed-up the issues as, first, whether Fifth Third had a valid mortgage lien against the subject property and, second, whether the doctrine of equitable subrogation rendered Chase’s mortgage lien superior to that of Fifth Third.  In the end, the issue of equitable subrogation was “overshadowed” by the matter of whether Fifth Third held a valid mortgage lien.

Two keys.  Fifth Third’s mortgage stated “upon payment of all Indebtedness, Obligations and Future Advances secured by this Mortgage, Lender shall discharge this Mortgage with any costs paid by Borrower.”  Also, Indiana Code § 32-28-1-1(b) provides, in pertinent part, that:  “when the debt . . . that the mortgage . . . secures has been fully paid . . . the holder . . . shall (1) release; (2) discharge; and (3) satisfy of record; the mortgage . . ..”  Chase contended that Fifth Third was obligated to release its mortgage when the 2005 closing fully satisfied the HELOC balance. 

Instructions?  Fifth Third asserted that it was not required to release its mortgage absent explicit instructions from its borrower to do so, which instructions Fifth Third never received.  But unlike in Ping, which was the subject of my 02/15/08 post on a similar issue, there was nothing in the Fifth Third mortgage requiring the borrower to request closure or to release its mortgage.  On the contrary, the mortgage unambiguously stated that Fifth Third “shall discharge” its mortgage on full payment. 

Lien negated.  The Court in Tennant concluded that “Fifth Third was clearly required to discharge its mortgage on or about August 8, 2005, upon full satisfaction of the then outstanding loan balance.”  The Court specifically addressed the Seeley decision, about which I wrote on 09/22/12, and the quandary that, by their nature, lines of credit are not automatically terminated upon a zero balance.  The Court dismissed the problem by suggesting that loan documents should be drafted accordingly.  Pursuant to the mortgage and I.C. § 32-28-1-1(b), Chase was entitled to a release of the Fifth Third mortgage.  The Court did not need to determine whether Chase was entitled to equitable subrogation. 

Keep I.C. 32-28-1-1(b) in mind.  The Tennant predicament essentially was the same as that discussed in my 08/20/13 post that the doctrine of equitable subrogation resolved.  Tennant provides a more powerful argument based on I.C. § 32-28-1-1(b), assuming the prior, unreleased mortgage contains language mandating the release of its mortgage upon payoff.  The prior mortgage is not subordinated -- it’s gone.

If, as a secured lender, you find yourself in the pickle of needing to foreclose over a mortgage that was not released at a closing despite a payoff, study the loan docs for any payoff-related language that might assist.  Even in the absence of language requiring the lender to release its mortgage, I.C. § 32-28-1-1(b) and Tennant suggest that you may be able to obtain a court order terminating the old mortgage.


How Can A Subsequent Mortgage Have Priority Over A Prior Mortgage?

In Indiana, a mortgage lien generally takes priority in title “according to the time of its filing.”  I.C. § 32-21-4-1(b).  In other words, the mortgage that gets recorded first is senior.  But sometimes prior mortgages are not paid off at closings as intended.  In such cases, the doctrine of equitable subrogation can trump the lien priority rule in I.C. § 32-21-4-1(b).  Finance Center Federal Credit Union v Brand, 967 N.E.2d 1080 (Ind. Ct. App. 2012) illustrates this. 

Scenario.  Funds received from GMAC at a refi closing fully satisfied the borrower’s obligations to both Meridian Group, the senior lender, and Finance Center, the HELOC lender.  Finance Center failed to release its mortgage, which contained a provision requiring the borrower to send notice requesting the release of the lien.  Finance Center received no such notice, left the line of credit open, and later advanced additional funds to the borrower.  The borrower later defaulted on the GMAC mortgage, and in the foreclosure action the issue became whether GMAC or Finance Center was first in priority.

Argument.  Generally, as long as the refinancing lender is not culpably negligent, it is entitled to stand in the shoes of the senior lien and retain its priority status. For more on the doctrine, please click on my February 9, 2008 post, which discussed a similar case.  However, culpable negligence, if established, is an exception to the doctrine of equitable subrogation.  Finance Center contended that GMAC was not entitled to a first lien because GMAC was culpably negligent for not ensuring the notice letter got to Finance Center. 

No culpable negligence.  The Brand opinion noted that the “culpable negligence” exception “contemplates action or inaction which is more than mere inadvertence, mistake or ignorance and focuses on the activity of the party asserting subrogation [the subsequent lender].”  Finance Center asserted that GMAC was culpably negligent by failing to obtain a release of the HELOC mortgage.  The Court disagreed and concluded that GMAC’s mere failure to ensure that it had properly paid off Finance Center was not enough to pass the culpable negligence test:

[a]ny negligence in GMAC’s failure to ensure that the [borrower’s] second mortgage with Finance Center was released did not prejudice Finance Center because the Finance Center mortgage was always junior to the senior Meridian Group mortgage, which was fully satisfied with the loan proceeds from the GMAC refinancing.  Allowing GMAC to step into the shoes of the Meridian Group mortgage will leave Finance Center in the very same junior position.  This is a clearly equitable result.  See Nally, 820 N.E.2d at 655 (“The mere fact that a person seeking subrogation was negligent does not bar him or her from relief where such negligence is as to his or her own interests and does not affect prejudicially the interest of the person to whose rights subrogation is sought.”) 

In Brand, the doctrine of equitable subrogation applied, and the Court determined that the refinancing lender’s mortgage (the GMAC mortgage) was a first and senior lien on the subject real estate.

If, as a secured lender, you close a real estate loan thinking that all prior mortgages had been paid off, but you later learn that a mortgage was not released as it should have been, then you and your counsel’s first thought should be to explore the relief afforded by Indiana’s doctrine of equitable subrogation.  The second thought should be to make a claim on your title insurance policy - if you purchased one.


Indiana State Courts Cannot Modify (Cram Down) A Mortgage

Can a borrower convince an Indiana state court to modify or “cram down” a mortgage over the objection of the lender?  According to the Court of Appeals in Nationstar Mortgage v. Curatolo, 2013 Ind. App. LEXIS 284 (Ind. Ct. App. 2013), the answer is “no.” 

Framework.  Nationstar was a residential mortgage foreclosure case.  Five different settlement conferences occurred that, in part, led to the borrower’s allegations of bad faith and request for sanctions.  In the final settlement conference, the trial court issued an order finding that (a) the lender acted in bad faith and (b) the terms of the mortgage were to be modified so as to reduce the principal and interest owed.  This is commonly known as “cramming down” the mortgage.

Settlement conference.  The negotiations in Nationstar and resulting order arose out of a series of I.C. § 32-30-10.5 settlement conferences.  (See my May 19, 2011 post about the 2011 legislation.)  Indiana law mandates settlement conferences in residential foreclosures (but not in commercial cases).  Nationstar provides a nice discussion of the purpose of I.C. § 32-20-10.5:

• The statute is designed to “avoid unnecessary foreclosures” and to facilitate “the modification of residential mortgages in appropriate circumstances.” 
• The purpose of this statute is to “modify the foreclosure process to encourage mortgage modification alternatives.”
• A lender generally must give a defendant borrower notice of the right to participate in a settlement conference, and the borrower then has thirty days to notify the court if he or she intends to partake. 
• If the lender and borrower ultimately agree to enter into a “foreclosure prevention agreement,” the court may dismiss or stay the foreclosure action as long as the borrower complies with the terms of the agreement. 
• Even if the parties agree upon a final agreement, the foreclosure action shall be dismissed or stayed “at the election of” the lender. 
• Although the statute gives the court the right to stay the action pending the negotiation process, the statute does not give the trial court the authority to enter a final order modifying the mortgage agreement.
• Importantly, the statute does not mandate that lenders and borrowers enter into foreclosure prevention agreements.  A lender is under no obligation to enter into a foreclosure prevention agreement.

Some general mortgage law.  Nationstar identifies a couple important principles of Indiana mortgage law:

• Since mortgage agreements are based upon the parties’ mutual intent, those parties both must agree to any permanent modification. 
• When interpreting mortgage agreements, courts are bound to give effect to the plain meaning of the language of the mortgage.  Courts cannot make a new contract for the parties or ignore or eliminate provisions of such instruments.

Issue.  To my knowledge, Nationstar addressed for the first time in Indiana the question of “whether the trial court had the authority to modify the mortgage agreement without the consent of both parties.”  In other words, can an Indiana state court unilaterally change the terms of a mortgage? 

No authority.  The Court in Nationstar concluded that the trial court lacked authority to modify the mortgage.  “The trial court acted in excess of its authority when it ordered the modification.”  The Court remanded the case to the trial court with instructions to allow the foreclosure action to proceed.  Trial court judges cannot effectively rewrite the terms of a mortgage.  At most, they can force settlement discussions, but in the end “a lender is under no obligation to [settle], ill-advised as its refusal to do so may be.” 

(NOTE:  This post is not a comment upon whether, or to what extent, a federal bankruptcy court may or may not modify a mortgage or “cram down” payments.) 


Indiana 2013 Legislation, Part III: Mortgage Statute Of Limitations Amended

This is my third and final post about the relevant Indiana legislation arising out of this year’s session.  At issue is House Bill 1079 and Indiana Code § 32-28-4-1 through 3, which deal with the expiration of mortgage liens, together with the statutes of limitations applicable to foreclosure actions.  Today’s post will supplement my September 3, 2010 post that touches upon the prior statutory language.  (For more on statutes of limitations, including the statute applicable to promissory notes, please read my March 9, 2009 post.) 

Lien expiration/bar date.  There are two components to the provisions in I.C. § 32-28-4.  The first deals with the expiration of a mortgage lien (general rule).  The second involves the deadline to file a foreclosure action (exception to general rule).  In either instance, the applicable time period is the same.  (HB 1079 and I.C. § 32-28-4 also apply to vendor’s liens, which were the topic of my August 7, 2012 post.)

I.C. § 32-28-4-1:  maturity date identified.  As of July 1, 2012, the general rule is that a mortgage lien expires ten years after the maturity date stated in the recorded mortgage.  The exception is if the mortgagee files a foreclosure action within that ten-year period. 

I.C. § 32-28-4-2(a):  maturity date not identified.  If the recorded mortgage does not identify a maturity date (articulated as when “the last installment of the debt secured by the mortgage lien becomes due”), then the expiration of the mortgage depends on the date of the mortgage.  If the parties created the mortgage before July 1, 2012, the lien expires 20 years after the mortgage execution date, unless the mortgagee files a foreclosure action within that 20-year period.  If the parties created the mortgage after June 30, 2012, the mortgage lien expires 10 years after the mortgage execution date, unless the mortgagee files a foreclosure action within that 10-year period.  (Please note that amended I.C. §§ 32-28-4-1(b) and (c) deal with instances in which there is no date of execution in the document.) 

I.C. § 32-28-4-3:  affidavit of maturity date.  Indiana law provides a remedy for situations in which a mortgage fails to identify a maturity date.  The solution is to record an affidavit stating a maturity date.  Such filing triggers the application of 10-year/20-year rules. 

Retroactive?  The General Assembly placed an effective date on the amendment of July 1, 2012.  As a matter of law, post-2012 mortgages omitting a maturity date will expire in 10 years, unless a Section 3 affidavit is recorded.  It’s my understanding there was some confusion about whether a prior change in the law (from 20 years to 10 years) could have applied to pre-2012 mortgages.  The concern was that mortgages over 10 years old suddenly expired with the enactment of the law.  I’m told that, through some litigation that has since been dismissed, the Indiana Attorney General has opined that retroactive application of the date change would be unconstitutional.  In practice, therefore, the 10-year rule does not apply to pre-2012 mortgages (without maturity dates). 

Pointers.  The critical lesson here is that secured lenders should always identify a maturity date in an Indiana mortgage.  Additionally, parties holding mortgages would be wise to examine their Indiana mortgage portfolios to ensure that all mortgages have a maturity date defined.  If the mortgage omits such date, mortgagees should take steps to record the necessary affidavit to protect their lien. 


 


Successor-In-Interest Banks As Plaintiffs In Foreclosure Actions

With bank mergers and takeovers, we sometimes see cases where the name of the plaintiff lender will not be the same as that reflected in the note and mortgage.  This is because, normally, there are not loan assignment documents like those we see when loans are bought and sold.  When lenders are bought or sold, generally speaking, the corporate existence of each bank, and ownership of assets like loans, automatically continue in the receiving entity.  Without the benefit of traditional assignment documents showing the chain of ownership of a loan, how can the successor bank prove that it holds the predecessor’s note and mortgage?  CFS v. Bank of America, 962 N.E.2d 151 (Ind. Ct. App. 2012), settles this question in Indiana. 

Procedural history.  CFS involved a borrower’s appeal of the trial court’s summary judgment in favor of a lender - Bank of America, successor-in-interest to LaSalle Bank Midwest National Association.  In 2007, the borrower executed a promissory note and mortgage in exchange for a loan from LaSalle.  In 2009, Bank of America filed a complaint to foreclose the mortgage, and then moved for summary judgment.  In an affidavit supporting the summary judgment motion, a Bank of America representative testified that Bank of America was the successor-in-interest to LaSalle.  But, Bank of America did not produce any documentation to support or verify that fact.  The borrower objected to the motion on the basis that Bank of America had failed to demonstrate its ownership of the LaSalle note and mortgage, but the borrower didn’t file any evidence to contradict the bank’s affidavit. 

Shift of burden of proof.  The borrower in CFS argued that Bank of America did not sufficiently prove it was entitled to enforce the loan originally held by LaSalle.  (I.C. § 26-1-3.1-301 defines a “person entitled to enforce.”)  The Court disagreed and reasoned that the borrower failed to identify an issue of fact or otherwise designate evidence to show that Bank of America was not the successor of LaSalle.  The law did not require the trial court to consider a certificate of merger or some other document supporting the LaSalle/Bank of America transaction.  “Whether the merger took place was not a disputed issue of material fact.” 

Legal issue.  As to the law regarding whether a successor bank surviving after merger can enforce a note and mortgage of the predecessor, the Court relied upon 12 U.S.C. § 215(a)(e), which states in part:

The corporate existence of each of the merging banks or banking associations participating in such merger shall be merged into and continued in the receiving association and such receiving association shall be deemed to be the same corporation as each bank or banking association participating in the merger.  All rights, franchises and interests of the individual merging banks or banking associations in and to every type of property (real, personal, and mixed) and choses in action shall be transferred to and vested in the receiving association by virtue of such merger without any deed or other transfer.  The receiving association, upon the merger and without any order or other action on the part of any court or otherwise, shall hold and enjoy all rights of property.

Bank of America, as the successor after merger, acquired the rights to LaSalle’s property (i.e. the subject loan) by operation of law. 

No assignment necessary.  CFS was a different scenario from one in which a loan had been sold, and thus assigned, from one existing lender to another existing lender.  As I noted in November of 2007 and again this past November, an institution filing a foreclosure suit must have proof that it owned the note and held the mortgage on the date of the filing of the foreclosure complaint.  When loans are transferred, the plaintiff must produce chain of assignment documents linking the original lender/mortgagee to the holder of the debt at the time.  Without such documentation, the plaintiff lacks standing to file suit.  In CFS, the original lender merged into another lender.  Proof of standing did not involve loan assignment documents but rather testimony that there had been a merger.  CFS therefore supports the idea that a predecessor need not assign its loans to the successor.  Such a transfer occurs by virtue of the merger/acquisition itself pursuant to 12 U.S.C. § 215(a)(e).

Lenders faced with the problem of suing upon loan documents that identify a predecessor-in-interest need not worry in Indiana.  As long as there is testimony to show that the named plaintiff is indeed the successor-in-interest by merger, then the plaintiff should have the right to foreclose.  Absent evidence submitted by the defendant calling into question whether a merger occurred, certificates or other voluminous documents verifying the merger are not necessary.


WSJ: "The States Of Foreclosure"

Today's Wall Street Journal contains an interesting opinion that "housing prices stabilize when lenders can enforce contracts" (in other words, foreclose).  Click here for the piece.  Although the article focuses upon residential real estate, its theme and theory apply with equal vigor to commercial properties.  As you read the opinion, you should remain mindful that Indiana is one of the country's 23 judicial foreclosure states.  Click here for a prior post about what that means.  The nature of Indiana foreclosure law rests, in part, upon the notion that Indiana follows the "lien theory" of mortgages.


Commercial Construction Mortgages Stand Tall Over Later-Recorded Mechanic’s Liens In Indiana

The law is well settled in Indiana concerning the priority of mechanic’s liens and commercial construction mortgages.  The 2011 opinion of City Savings Bank v. Eby Construction, 954 N.E.2d 459 (Ind. Ct. App. 2011) reaffirmed the Court’s 2008 decision in McComb & Son v. JPMorgan Chase, about which I have written.  Construction mortgages prime mechanic’s liens on commercial projects, assuming the lender recorded its mortgage before the contractor recorded its mechanic’s lien.

The usual suspects.  The facts in City Savings were undisputed and not terribly unique.  The case involved a real estate owner/borrower, a lender/mortgagee and a subcontractor/mechanic’s lien holder.  In 2005 and again in 2007, the lender made two construction loans to the owner and contemporaneously filed two mortgages.  The funds from the lender’s mortgage loans were for the specific commercial project that gave rise to the subcontractor’s mechanic’s lien.  In 2008, after failing to get paid, the subcontractor recorded a mechanic’s lien. 

The litigation context.  At the trial court level of the City Savings foreclosure case, both the subcontractor and lender claimed their respective lien had priority over the other.  Despite the McComb precedent in favor of the lender, the trial court gave the mechanic’s lien priority based upon laws of equity.  (Black’s Law Dictionary defines “equity” as “justice administered according to fairness as contrasted with the strictly formulated rules of common law.”)  On appeal, after citing to McComb and the three operative statutes (Ind. Code §§ 32-21-4-1(b), 32-28-3-2 and, most importantly, 32-28-3-5(d)), the Court reversed the trial court in favor of the lender.

Unclean hands.  What distinguishes City Savings from McComb is the Court’s analysis of the subcontractor’s equity-based arguments around Section 5(d).  The subcontractor asserted the equitable doctrine of “unclean hands.”  In Indiana, that doctrine “provides that one who seeks relief in a court of equity – [foreclosure actions are essentially equitable in nature] – must be free of wrongdoing in the matter before the court.”  The subcontractor, Eby, contended:

[Lender] supplied the [owner] with proceeds from a third promissory note to pay a subcontractor, Vendramini, for its improvements to the Real Estate knowing full well that Eby remained unpaid by the [owner] for Eby’s improvements.  The payments to Vendramini occurred after Eby had already recorded its mechanic’s lien and after Eby had filed its complaint to foreclose to which [lender] was made a party.  The trial court frowned upon the fact that [lender] “essentially authorized the payment of a third contractor before the second contractor.”  As [lender] was on notice of Eby’s mechanic’s lien before it disbursed those funds on behalf of the [owner], the trial court concluded that [lender] was in the best position to avoid a loss in this case. 

Equity vs. law.  The Court did not condone the owner’s decision to pay Vendramini when it had not yet paid Eby.  But the Court did not view such a decision as unclean hands on the part of the lender, which was under no obligation to control its borrower’s decisions.  Moreover, the Court did not believe that the owner’s decision to put the lender in a better position than Eby should negate the lender’s statutory priority status.  In a pro-lender, pro-legislature statement, the Court said:

The Real Estate was clearly encumbered by [lender’s] first recorded mortgage at the time Eby contracted with the [owner] to provide improvements.  Eby knew that the Real Estate was commercial property, that it was encumbered by a mortgage, and that the loans secured by the mortgage were for the specific construction project that gave rise to Eby’s mechanic’s lien.  Eby was in the best position to avoid a loss because, at the time of contracting, Eby knew exactly what kind of lien it would be getting regarding its improvements to the Real Estate:  an inferior one.

A separate equitable doctrine in Indiana provides that “equity follows the law.”  In City Savings, principles of equity could not overcome the clear application of the statutory law in favor of the lender.  There was no evidence that substantial justice could not be accomplished by following the law.  Since Indiana’s priority statutes governed the parties’ actions, “equity must follow the law.”   


How Should A Junior Lender/Mortgagee Respond To An Indiana Foreclosure Suit?

One of our bank clients, which has a home equity line of credit portfolio, recently asked me to give a presentation on how best to deal with foreclosure suits filed by senior lenders (first mortgagees).  Whether junior mortgages are residential or commercial, the basic plan of attack in Indiana is the same:

 1. Email Summons and Complaint filed by senior mortgagee, together with scan of the bank’s loan documents, to foreclosure counsel.  Advise foreclosure counsel of the manner of service of process (certified mail or hand delivery) and date of receipt.

 2. Foreclosure counsel will file an appearance and a motion for extension of time with the court.  Nothing else typically will be due with the court until 50 – 53 days after the date of service of process.

 3. During the 50 – 53 day window, the bank should do the following:

a. Order an appraisal or broker price opinion, and determine the fair market value of the mortgaged property.

b. Create an estimate of the senior mortgagee’s entire indebtedness, including unpaid principal balance, accrued interest, late fees, delinquent real estate taxes, per diem interest and attorney fees/litigation costs.  The complaint will list many of these figures.

c. Create an estimate of carrying costs associated with owning the real estate, including real estate taxes, hazard insurance premiums, maintenance/repair costs, utility expenses and attorney fees/litigation expenses for foreclosure. 

d. Create an estimate of liquidation expenses, including broker fees and closing costs.

e. Determine the bank’s own estimated indebtedness, including unpaid principal balance, accrued interest, per diem interest and late fees.

 4. Before the close of the 50 – 53 day window, the bank should determine whether it would ultimately net any money if it were to acquire the mortgaged property at the sheriff’s sale and then liquidate it.  The question is whether the value of the mortgaged property exceeds the senior mortgagee’s indebtedness, the carrying costs and the liquidation expenses.  Here is a basic formula:  Fair Market Value - (Senior Debt + Carrying Costs + Liquidation Expenses) = Equity.

 5. If the calculation in #4 shows insufficient equity, then the bank should consider instructing foreclosure counsel to file a disclaimer of interest and motion to dismiss.  (The exception to this would be if the bank desires to collect the debt from other assets of the borrower or a guarantor.)  The case might end here.

 6. If the calculation in #4 shows sufficient equity, then the bank should advise foreclosure counsel of its debt figures in #3(e) above and instruct counsel to file an answer to the complaint and a cross claim against the borrower (and guarantor, if applicable).

 7. The bank or foreclosure counsel next should order a title commitment to be effective through the date of the filing of the complaint, and ensure all lien holders are named in the case.

 8. Foreclosure counsel will monitor the lawsuit and obtain judgment/foreclosure decree for the bank.

 9. After the entry of judgment but before the sheriff’s sale, the bank should revisit the equity analysis in #4.  The bank – the junior lender - must decide if it is prepared  to pay off the senior mortgagee’s judgment so that the bank can credit bid its own judgment at the sale. 

 10. The junior lender should communicate its decision regarding #9 to foreclosure counsel, with bidding instructions, if any. 

 11. As applicable, foreclosure counsel will attend the sheriff’s sale, tender a cash deposit sufficient to pay the senior mortgagee’s judgment in full and submit a credit/judgment bid on behalf of the bank, which will acquire title to the property if it’s the winning bidder.  If the bank is outbid, then it will receive cash in the amount of its credit bid (and a refund of the deposit). 

Perhaps the most important thing to bear in mind is that the process requires junior mortgagees to bring enough cash to the sheriff’s sale to pay off the credit (judgment) bid of the senior mortgagee.  A junior lender cannot submit its own credit bid or obtain title to the real estate unless it first outbids the senior lender with cash.  Hence the significance of the analysis in #4. 


Is The Citimortgage Opinion Flawed For Not Requiring Proof Of Assignment Documents?

This is my final post about the Indiana Supreme Court’s opinion in Citimortgage v. Barabas, 2012 Ind. LEXIS 802 (Ind. 2012).  Here are my other three:  10-26, 10-19, 10-12.  The Court’s decision to grant Citimortgage’s motion to intervene was understandable in that it preserved the senior lien.  Based upon the Court’s ruling, a logical outcome would have been to set aside the trial court’s judgment and resulting sheriff’s sale.  But that’s not what happened. 

Result.  The Court didn’t simply remand the case to the trial court - to the prejudgment stage - for further proceedings with Citimortgage as a party.  The Court dispensed with a “do over” and instructed the trial court to amend its judgment “to provide that ReCasa took the [real estate] subject to Citimortgage’s lien.”  What I believe this means is that the litigation (for now) is over but that Sanders, the third-party purchaser, owns the real estate subject to the Citimortgage lien (of an undetermined amount).  Junior mortgagee ReCasa didn’t lose – Sanders did

Absence of proof.  A more curious aspect of the Court’s analysis was the fact that there was no hard evidence of Citimortgage’s lien.  From what I can tell in reviewing all of the Citimortgage opinions, there was no proof of the date upon which Citimortgage acquired the lien or, in other words, when Citimortgage became Irwin’s assignee.  The Court appears to have assumed, based perhaps on the 2009 mortgage assignment, that Citimortgage was the mortgagee at the time ReCasa filed the suit in 2008.

Against the grain.  Setting aside the trial court’s judgment is one thing, but it’s an entirely different matter to effectively grant Citimortgage its own judgment.  This outcome seems to cut against law that has developed in this country over the last several years mandating that lenders/mortgagees actually prove that they hold the mortgage at the time of the filing of a foreclosure claim.  As I noted back in November of 2007, a famous opinion from a federal court in Ohio emphatically held that an institution filing a foreclosure suit must have proof that it owned the note and held the mortgage on the date of the filing of the foreclosure complaint.  This means that the real party in interest must produce, and typically must include as exhibits in its pleadings, chain of assignment documents linking the original lender/mortgagee to the holder of the debt at that time.  Without such documentation, the party lacks standing to file a lawsuit or, in the case of a junior lien holder, to assert a claim in a lawsuit, which is what Citimortgage did.  In the Ohio case, District Judge Boyko lectured:  “unlike Ohio State law and procedure, as the Plaintiffs perceive it, the federal judicial system need not, and will not, be forgiving in this regard.”  In footnote 3, he flatly rejected plaintiff’s “judge, you just don’t understand how things work” argument. 

Seemingly, the Indiana Supreme Court bought the “judge, you just don’t understand how things work” argument in Citimortgage.  Or, to be fair, perhaps the Court knows how things work.  Either way, a compelling contrast exists between Judge Boyko’s uncompromising order dismissing plaintiffs’ cases and the Indiana Supreme Court’s pragmatic decision recognizing Citimortgage’s purported lien. 

 


In Indiana, Name MERS In Foreclosure Suit If Mortgage Does

This follows-up last week’s post regarding the Citimortgage opinion, which circumvented two foreclosure statutes that supported a conclusion opposite of the one the Court reached.  The result preserved the lien rights of the purported senior mortgagee, Citimortgage, even though Citimortgage did not record its assignment of mortgage until months after the subject real estate had been sold at a sheriff’s sale.  How?  Citimortgage had an “ace in the hole” – Mortgage Electronic Registration Systems, Inc. (“MERS”).

Section 1 problem.  The Court wrestled with the applicability of Ind. Code § 32-29-8-1 (“Section 1”), which governs who should be named when a plaintiff seeks to extinguish a mortgage.  That statute currently identifies two options as to whom to sue:

If a suit is brought to foreclose a mortgage, the [1] mortgagee or an [2] assignee shown on the record to hold an interest in the mortgage shall be named as a defendant.

Citimortgage argued that MERS was statutorily entitled to notice under that provision as a “mortgagee.”  The Court stated “that is a bridge too far.”  The Court found that MERS was neither the mortgagee itself nor the assignee of the mortgage.  Yet Citimortgage prevailed.   

Section 1 solution.  The Court plowed new ground by determining that the mortgage designated MERS as the agent of Citimortgage and that MERS as agent was entitled to notice:

Ultimately, we do not believe that the authors of the original version of [Indiana Code § 32-29-8-1], writing in 1877, would have understood the term “mortgagee” to include an entity like MERS that neither holds title to the note nor enjoys a right of repayment.  Thus, our decision here should not be taken to mean that MERS is a “mortgagee” as the term is used in Indiana Code § 32-29-8-1.  All we hold today is that because Citimortgage never received proper notice of the foreclosure proceeding, it lay beyond the jurisdiction of the trial court, and the default judgment is thus void as to Citimortgage’s interest in the Madison County property. 

One might interpret Citimortgage to say that Section 1 includes a third option as to whom to sue:  a nominee (agent) of the mortgagee.

Section 2 problem.  Citimortgage avoided the impact of I.C. § 32-29-8-2(1) (“Section 2”), which states that “a person who is assigned a mortgage and fails to have the assignment properly placed on the mortgage record . . . is bound by the court’s judgment or decree as if the person were a party to the suit.”  At some point, Citimortgage apparently became the assignee of Irwin but evidently did not record the assignment until after ReCasa obtained a judgment (and flipped the house to Sanders).  Yet Citimortgage prevailed. 

Section 2 solution.  The Citimortgage decision carves out an exception to the recording requirement in Section 2 when the mortgage identifies MERS.  The plaintiff must name MERS “as nominee” of the identified lender.  The Court’s rationale appears to be based upon the premise that MERS - identified in the mortgage - is shown on the record to hold an interest in the mortgage.

Statutory amendments coming?  In its opinion, the Court poked Indiana’s legislature about changing I.C. § 32-29-8:

We note in closing that it is both difficult and undesirable to apply such superannuated statues to the modern mortgage industry.  The drafters of the original 1877 version of Indiana Code § 32-29-8-1 envisioned a drama for two, or at most three, actors:  Borrower, Mortgagee, and possibly Assignee.  They could not have imagined our present-day multi-trillion-dollar international mortgage market.  The statute that they drafted, and under which Indiana mortgage transactions still take place, thus leaves unaddressed many issues important to contemporary practice.  We recognize that the General Assembly may soon find it necessary to modernize the statutory script to accommodate this new and larger cast of characters.

How the Indiana General Assembly will tweak Sections 1 or 2, if at all, is guesswork.  Perhaps MERS itself will be written into the statute, or maybe the statute will define “nominee” and add such a party as an option for whom to sue.  Something should be done, and Section 3 should be included in any amendment. 

Name MERS.  What we do know in the wake of Citimortgage is that, under Indiana law, MERS “as nominee” is the actual mortgagee’s agent for service of process.  When a mortgage identifies MERS “as nominee,” the plaintiff creditor must name MERS as a defendant in any foreclosure action and serve MERS with a summons and complaint.  To be safe, both the identified lender and MERS should be named in the suit. 

Next week I’ll address what some may feel to be a flaw with the Court’s ultimate finding.


Indiana Supreme Court Concludes That MERS Is Merely The Agent Of The Actual Mortgagee

What is Mortgage Electronic Registration Systems, Inc. (“MERS”)?  More specifically, what does mortgage language identifying MERS “as nominee” mean?  The Indiana Supreme Court in Citimortgage v. Barabas, 2012 Ind. LEXIS 802 (Ind. 2012) dealt with those and other questions surrounding the role of MERS in the foreclosure world. 

Setting the table.  As noted in my prior posts about Citimortgage, junior mortgagee ReCasa initiated a foreclosure action and named only Irwin, the purported senior mortgagee, as a defendant.  The language in the subject mortgage stated that Barabas, the mortgagor, granted the mortgage to MERS “as nominee” of Irwin, identified as the lender.  Upon being sued to answer as to its interests in the subject real estate, Irwin quickly filed a disclaimer of interest, and the court dismissed Irwin from the case.  The trial court later entered judgment for ReCasa, which acquired the real estate at the sheriff’s sale.  ReCasa then sold the real estate to a third party, Sanders.  A month later, Citimortgage filed a motion to intervene in the action and asked the trial court to set aside the judgment and sheriff’s sale. 

Defining MERS.  In its rationale, the Court came to terms with the reality that “about 60% of the country’s residential mortgages are recorded in the name of MERS rather than in the name of the bank, trust, or company that actually has a meaningful economic interest in the repayment of the debt.”  The Court pronounced that “a MERS member bank appoints MERS as its agent for service of process in any foreclosure proceeding on a property for which MERS holds the mortgage.”  The Court found that:

the relationship between Citimortgage and MERS was one of principal and agent.  Clearly, one of the primary purposes of that agency relationship was to facilitate efficient service of process.  . . .  By designating MERS as an agent for service of process, as Irwin did in the Barabas mortgage, lenders can have their cake and eat it too; they free themselves from burdensome, expensive recording requirements but still receive notice when another lienholder seeks to foreclose on a property in which they have a security interest.

Senior mortgage survives.  The core question in Citimortgage was whether ReCasa’s failure to name MERS as a defendant impacted the rights, if any, of Citimortgage, which at some point appears to have acquired the senior mortgage.  Although the Court of Appeals affirmed the trial court’s decision in favor of ReCasa, the Supreme Court ruled for Citimortgage.  ReCasa’s failure to name MERS as a defendant or, more specifically, failure to serve MERS with a summons and complaint, prevented ReCasa from terminating the senior mortgage and leapfrogging into the first lien position.  In short, the judgment was void as to Citimortgage. 

Next week, I’ll explain how the Court in Citimortgage circumvented two foreclosure statutes that clearly supported ReCasa’s position. 


Post-Sale Redemption Mystery Unsolved

Last week, the Indiana Supreme Court said much about Mortgage Electronic Registrations Systems, Inc. (“MERS”) in Citimortgage v. Barabas, 2012 Ind. LEXIS 802 (Ind. 2012).  The Court also said a lot about who should receive notice of a foreclosure proceeding.  I hope to discuss those matters next week. 

No comment.  Just as important was what Citimortgage didn’t say.  I’m referring to the issue of the enigmatic post-sheriff’s sale statutory right of redemption found at Ind. Code § 32-29-8-3 entitled “Good faith purchaser at judicial sale; right to redeem of assignee or transferee not made a party.”  For background, please click on my August 2 and November 1, 2011 posts regarding Citimortgage.  Subsequently, the Indiana General Assembly amended portions of Section 3, but as I wrote in March of this year the obscure one-year redemption language remained untouched by the legislature.  Here is the statute, and the key language is underlined: 

     Sec. 3. A person who:
        (1) purchases a mortgaged premises or any part of a mortgaged premises under the court's judgment or decree at a judicial sale or who claims title to the mortgaged premises under the judgment or decree; and
        (2) buys the mortgaged premises or any part of the mortgaged premises without actual notice of:
            (A) an assignment that is not of record; or
            (B) the transfer of a note, the holder of which is not a party to the action;
holds the premises free and discharged of the lien. However, any assignee or transferee may redeem the premises, like any other creditor, during the period of one (1) year after the sale or during another period ordered by the court in an action brought under section 4 of this chapter, but not exceeding ninety (90) days after the date of the court's decree in the action.

When the Supreme Court accepted transfer in Citimortgage, many thought the Court would interpret the redemption language in Section 3.  No such luck.  The Court  expressed “no opinion as to whether Citimortgage had the right to redeem the property under [Section 3].”   This is because the Court decided the case on other grounds.  The opinion provided no help with the confusion and uncertainty created by the analysis of the Court of Appeals in Citimortgage, which precedent has now been vacated.

Status.  It’s my understanding Indiana’s legislature may consider clearing up I.C. § 32-29-8-3 in the 2013 session.  For now, while Indiana law is well settled that a sheriff’s sale terminates the right of redemption for borrowers/mortgagors, the law remains unclear as to whether there exists some kind of post-sheriff’s sale right of redemption for mortgage assignees whose assignments were not recorded before the filing of the foreclosure complaint.  As I often say, foreclosing lenders should invest in a foreclosure (title) commitment, and purchasers at sheriff’s sales should buy title insurance. 

NOTE:  In the 2013 session, Indiana's General Assembly deleted much of Section 3(2)(B) so as to resolve the matter once and for all.  My post


Indiana Supreme Court Reverses Trial Court In Landmark Case Involving MERS

Yesterday, the Indiana Supreme Court issued its opinion in Citimortgage v. BarabasClick here to read the case.  I plan on writing about the decision next week and following-up on my 2011 posts regarding the Indiana Court of Appeals' rulings in the dispute:  August 2/time bar, August 10/straw man and November 1/redemption

By rule, the two Court of Appeals' Citimortgage opinions have been vacated in their entirety.  In other words, they are no longer binding precedent in Indiana.  Thus yesterday's decision to a large extent mooted my 2011 posts, particularly because the Supreme Court did not adopt the Court of Appeals conclusions or rationale. 

By way of a preview, MERS appears to be alive and well in Indiana.  The Section 3 post-judgment redemption right, however, may not be.  The Court expressed "no opinion as to whether Citimortage had the right to redeem the property under that statute."  More to come....  


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 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.