Commercial Mortgage Modifications:
Lien Priority, Title Insurance and
Bankruptcy IssuesStructuring Modification Agreements While Avoiding Legal Pitfalls
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THURSDAY, JANUARY 16, 2020
Presenting a 90-minute encore presentation featuring live Q&A
Aimee Contreras-Camua, Partner, Pircher Nichols & Meeks, Los Angeles
Erin F. Natter, Partner, Pircher Nichols & Meeks, Los Angeles
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ll USCS § ,547
Curre~i~f tly~•ougl~ PL, 11.5-338; appro~•ed 32/2O!1.$, ~~<ith a gap of 115-:33a.
G~~iterl Slates C=ode SL'1'1'lCL' - T11~e5 I lI1Y011~I2 S4 > TITI_F. I1. BA1VIfRUPTCY > CFI.AP1'TR 5. CREDITORS,
"C"lll DI~'B7'Olt, F1A7) "C"II1 ISI'A1`Is > SC113C:~IA7'IL'RICI. '1"J/L`LS7<~1'1"F.
Notice
Pa~~x 1 of ~3. You are vie~viug a very large document thzt his bee~1 divided iuCo darts.
547. Preferences
(a)LZ this section--
(1)"inventory" ine~ns personal }property leased or fi~rnishecl, held for sale or lease, or Yo be fiirnished
under a contract for sei~rice, rati~~ materials, work iii process, or materials used or consumed in a
business, iuelu~ing fans products such as crops or livestock, held fc~r sale or lease;
(2)"ne~~~ value° means iuoliey or money's worth in goods, services, or new credit, or release by a
transferee of property previously tr~~nsferred to stiiel~ transferee in ~ transaction that is neifl~er z~~id nor
voidable by the debtor or the trustee under anY applicable 11~v, including proceeds of such pi•aper[y, but
does not uicltuie an obligation substih~ted for att existing obligarion;
(3)"receivable" means right to payment, whether c>r not such rig1~t has been earned by performance; and
(4)~~ debt fc~r a tax is incurred on the clay when such lax is last p7yable without penalty, iticlucling arty
estensioil.
(b)Except 1s provided in subseckions (c) aid (i} of this section, tl~,e trustee may avoid any transfer of ~n interest
of the debtor ui property--
(1)to or for the benefit of a creditor;
(2)for or on accotmt of ~n antecedent debt ~~ved by the debtor before such transfer ~v~s mnde;
(3)made while t1~e debtor was insolvent;
(4)m~de--
(A)on or within 90 days before the dote of tl~e filiii; of the petition; or
(B)beriveeu ninety days and one year before the date of the filing of the petition, if such creditor 1t
the time of such transfer was ~n uisider; anct
(5)that enaUles ucl~ creclitoi• to receive more titan such creditor would receive if--
(A)the case were a case under ch~~~ter 7 ofthis title [11 LJSCS ~§ 701 et seq.];
(B)tlie transfer had not been mane; and.
(C)such creditor recei~3ea payment of such debt to the extent provided by the previsions of this title
[11 USCS §§ 101 et seq.].
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l USC;S § 547
(c)"I he tnzstee may not avoid under this section atransfer--
(1)to the exteaY that sltch transfer eras--
(A)int~ended by the debtor and tl~e cr~;dilor to or for whose l~eue[it sl~ch transfer ~~°as m~dt to be a
eo~atea~a~~~oraneo~~s excl~au~;e f'or ne~~v valise given to tlae debtor, ~iucl
(I3)i~i fact a substantially conter~lporaueous exc(~~nge;
(2)to the eYtenti that such fr~nsfer w as in paymenC of ti debt inctu-rec3 by the debtor il~i the orduiary course
of business or financial affairs ~f the debtor and the ta<insferee, and such transfer teas--
(11}made in the ordin7ry course of business or fliia~icial ~ffaii•s cif the debtor ~n~j the t~r~msferee; or
(l3)made according to ordinary business terms;
(3)that creates a security interest in property acquired by tl~e debtor--
(E1)to the exteiiY such security interest secures new ~~~lue~ that ~vns--
(i)giv°en at or after die signing of a security agreeme~it that contains a d~scriphio~i of such
property ~s collateral;
(ii)given by or on behalf of the secw ed party under such ~gree~nent;
(iii)given to euablc t1~~ clebtorto acquire such properry; and
(iv)in fact used by the debtoz to acquire such propea~ty; end
(B)tllaf is j~erFect~d on or befi~rc 3U days after the debtor receives possession of such property;
(4)to or for the benefit of ~ creditor, to the e:Yteut that, after suds transfer, such creditor gtive ne~v value
fo or i'or fhe }~enefiY of the debtor--
(A)not s~ctu:ed by an oCl~er~vise unavoidlble sectn~ity interest; Ind
(I3)on account of ~vhicl~ ne~v v~lae the debtor drei xaol make axe other~~~i~e un~~voidab]a tr~insier to or
for the beuef iY of stiel~ crcdi.tar;
(5)t(rit c:reaics a perfceTca sc;curity interest in. iuvet~tory or a receivable oa• tl~e proceeds of either, exce~~t
to the extent t1i~S t~l~.e <~g~r~g~te of all such transfers Yo t9~z transferee caused a rcductio~i, as of Che date
of ChE Elting of the petition and to the prejudice of'other areditors holding wlsecured c)aims, of auy
amount l~~y which fhe debt secured by such sccw-ity interest exceeded the value ~rf all security interests
foz such debt on the later oi;=-
(A)(i) with res~~ect to a transfer to wlaioh subsection (b)(4)(A) ofi this section ~ipplics, 90 days befi>re
[he dtitc of the Citing of the petition; or
(ii)~uitla respect t~o a tra~asfer to ~vlaich stiibseoti<~n (b)(4)(].3) of tlais sectioia ~a~plies, one year
before the date oPYhe filing oFtlie ~~etitiori; or
(I3)the cialc o.ia which new value was .(ix-st given under the security a~rccinent crealanb such security
interest;
(()th~it is the lixin~; oCa st~ltiitory lieu that is nat avoid<iblc tinder section 545 of this Cit9e [l l USC'S §
sash;
(7)t~o ll~e eatc~~t such transfer was 1 boa~a ~#'ide payment of a debt :for a do~~est~ic support obligation;
($)if, in a case ~ted by an individual debtor ~t~lu~se debts are primarily consumer debts, the aggregate
value of al.l properly t}~at constieutes oc is al:le;cteci by such lransPcr is letis than ~$ C00; a~-
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11 [7SC;S § 547
(9)ii; i.n a case 'tiled by a dcbt~or whose debts are not ~arimarily consumer debts, the aggregate value of
X11 pro~zrty that cotistit~utes or is alteeted by such transfer is less than ~ 6,4?5.
(d)"Tl1t trustee nay avoid u transfer of an int~i•est i.n property of the debtor transferred to or for the benefit of ~i
surety to secure reimbursement oY such a stiuety that fiuYushed a ba~id or other oblig~ition to dissolve ~ judicial
lien that wonl~l l~zrve been. at~c~idabtc by the tr~istee ~indet• srihsect7on (b) of this seotion. I,he liability of Suc~i
surety m~cicr such bond or ol?li~;at~iori shall be discliargeci to the este:ut of tl~e value of such. ~rol~erty rccoverecl
by the kiustee or the ~unount paid to the tnisYee.
(e)(I) Far tl~e Purposes o:f ~]~.is sact~ion--
(A)z~ transfer oCreal property otter than tistures, bu4 inclncling the interest of ~ seller or }~urcl~~scr under
a contract for the sale o£real property, is perCect~ecl ~~~hen a bona Tide purchaser of s~lch properly Crom
the debtor a~flinst whom applicable law permits suds fcansfer to be perfected c<~unot acquire an interest
that is s~i}~crior to the interest of the transferee; and
(B)a tcailsier of~a tlxtw•~ ar ~roperCy other Phan real property is perfected when a creditor oil a simple
contract cannot acquire a judicial. ireu that is superior to tl~e interest of the: trnnsfcr~e.
(2)l~or the purposes of this section, exceE~t as provided in paragraph (3) oPthis subsection, a fr<msfer
15 11]<1 C1L-^
(A)at the Ci~ne st~c}i transfer takes effect between the trausfei~or and the tratisteree, if~ such
transTer is perfected at, or within 30 days after, such ti~»e, exe~pt as ~~rovide~d rn subsection
(c}(3)(I3);
(B)at t1~e tine such transfi:r is }~erfect~ed, if such Lr~nsfer is perfected after such 30 days; or
(C)iinmediat~ly before the date of the kilin~ of the petition, if such tr~tisfer is not perfected 7t
the later of--
(i)th~ cc~mmenceinent of thr: case; or
(ii)30 days ~f~er such transfer takes effect between the transferor rind the h~ansferee.
(3)1'or the purposes of dais sccCian, ~i ta•aiasfc~r is not u~~ide until the debt«r has ticquir~d righes in the
property transferred,
(t)l~or the p~u•poses of tivs section, tine debtor is presumed i~o have been insolvent nn <ind during the 90 days
immediately preceding the date of the filing of the petition.
(g)I~or the purposes ~~f this serctiou, the Y~~ustc~ has ib,e burden o.f proving the avoidability of a transfer under
subsection (b) of Chic section, cud the creditor or party in interest agaitisl whoiu recovery or avoidance is sottghl
has tl~e burden of'proving the nonavoidability of a transfer under subsection (c) <~>~~tl~i section.
(1~)The Crustee may not avoid a transfer if such transfer ~vae made as ~ part of ~n alteinitive repayment schedule
between t[~e debtor and any creditor of the debtor m-eated ley <lil ~ipproved uo7lpr<~iit budget and credit
counseli,ug agency.
(i)If the trustee avoids under subsection (b) ~ transter made between 90 days and 1 year bel~>re the elate of the
:filing of the petition, by the debtor t~~ tui eittily ll~at is not ail it~sidcr foe the benefit o1`a cr~c~itor that is au
iilsidcr, s~icl~ transfer shall be oonsiciered to bt a~~oided oncler this section only ~~ith respect_to the creditor that is
an insider.
History
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1 ] USCS ti 547
(Nov. 6, 1978,1'.1:,. )5-5~8,'Title I, § 101, )2 Stale. 2597; July 10, 1984, Y.:L. 98-353, "Citle IIl, Sttbt~itle A, y~ 3.t 0,
Stihtiele F~I, §X462, 9S Stt~t. 355, 377; Qct. 27, 1980, P.L. 99-554, T'ifle II, Subtitle C, § 283(m), 100 Stat. 3 L 17; Oet.
22, 1994, P.I,. 1.03-394, 'Title II, § 203, 'Title IIi, § 304(t), 1.08 Stat. 41.2 ] , 4133; April 20, 2O{)5, P.T,. 109-8, "I~iile II,
Subtitle A, § 201(b), SubCitle l3, § 217, "I~i[le IV, Siibtit(e A, §§ 403, 409, 'line XI~I, §§ 1213(~i), 1222, 1l9 Stat. 42,
5.5, 104, 106, 19~,, 196; I'eb. 14, 2007, 72 Pe;d. Reg. 705, I'eb, 25, 2(?10, 7~ F'ed. Reg. 3747; Feb. 21, 2013, 78 Fed.
Reg. 12089.}
(As ail ended Feb. 16. 2016,81 F'ed. Reg. 8748.)
Prior laic find revision:
I egislalil~e .Sicge~rtents
Nn liroifat~ion is provided Por payments to coininodity b.cokcrs as its section 7C6 of the Senate ~wnendinent oLhcr
thin fhe an~cndment to section 54R of title 'll . Section 547(c)(2) protects most paynlci~ts.
Section 547(b)(2) of the Mouse au~endiv~u[ adopts << pre~visiaza co~~tain.ed ia1 tl~e Ho~isc bill and rejects Giza.
~lternaYiF•e contained in Yl~e Senate nmendnlen[ ~~~41~ting Co the avoidance of a preferc~itial trau~fer fhzt is payment of
a tax clni~n ot~,~ittg to a governrneiital unit. As provided, sectio~~ 106(c) of the IIoitse amendment oveiYl~iles coutraiy
l<i~~~ua~e in tl~e House repart ~vit1~ Q~c result that tlac Ciove~7zxnc:nt .is subject to <rvoid~i~~ce ol'prePcrcnl.i~~l trGinyfers.
Contrary to language contained in the House report, payment of ~ debt by ~neaats of a check is equiv<11ent to a cash
payment, uul~ss tl~e check is disl~t~nor~d. Payment is consicicred to he made ~a-he~~ the c(ieck is delivcrccl Igor
Pu~l~oses of s~;ctions 547(c)(1) and (2).
Section 547(c)(6) of the 1-louse hilt is d~(eted and is trctrtecl in a diffe~rci~t fashion in section 553 of tlic I~~ousc
~il~endn~c~~t.
Section 547(c)(6) represents a modi(~icatio.~a of ~ si~~~ilar provision con.tai.necl in the I:Iouse bill ~incl Senate
ainendmc~it~. 'I~lie exception relating to satisf~etion of a statirtory lien is d~leYed. '~Cl~e excepCion for a lien cre~ited
under title I 1 is deleted since such a lieu is ~ sl~~tutoiy lien that Fill not b~ avoidable in a aubsc~luent bankruptcy.
Section 547(e)(1)(B) is adopted from the Mouse bill said Senate amendment without change. It is intended that the
simple contract test used in this sectio~t will be applied as wider se.atiou 544(a)(1) not to require a creditor to perfect
against a creditor nn a sim~ife contract in tlic event a}~plicable la~a~ nl~kcs such perfection iinpossiblc. For cxam~~le, a
Purchaser fi•c~m a debtoL- at an im.properly noticed bulk. sale Lnay Yakc sttbjccY to the ri~1~Ys of ~ creditor on a wimple
contract of ilie debtor for 1 year after the bulls sale. S~nee the purchaser cannot perfect against such a creditor on a
simple c~ufiract, Ile should not he held responsible for f~ili~ig to do the iiiapossible. In the cvent~ t~l~e debtor goes iriY<>
bankruptcy within ~ short time after the balk sale, the trustc~-should i~ot be able to use tl~~ a~~oiding powers under
section 544(x)(1) nr 547 merely because State law has oracle soave trrmsf.'eis of personal property subject to the
rights of a creditor on zi sia~~ple contract to acquire 1 jtiidicill IiEn ~~rit(~ no opportw~ily to perfect~againsl sucl~i
creditor.
]'references: The House amendment deletes from tl~e category of Lrausfea~s o~~ ~ccc>luit of ~intceedeut debts which
m~iy be avoicleci tmdcr the pcelcreuce nilcs, seclic»3 547(l~)(2), the exception iii ll~e Se~~atc az~ictulmcnC for taxes
o~;red to go>>errunent<il authorities. I3owever, for purposes of the "ordinary course" eXception to the preference iztles
contained in section 547(c)(2), the House atnendment specifies that the 45-day period referred to in section
547(c)(2)(.E3) [deleted; see the. 1984 ~unendincnt o#~subsee (c)(2) of t)zis sections is to bcg~in runniia~;, iu t~l~c case of
taxes from the list clue date, includinb extensions, of the return ~~~ith respect to ~~~hich tl~e tat payment was made.
Serrate IZepnr•t :'~'o. 95-949
T}us section is a subst<ultial nz~difie~tion of }resent la~v. It ~nodeinizcs tiie pr•eferei~ae provisions and briu~s then
more into caufor.~zity wikh coinnaercial px~acti,cc; end tl~e IJnifor~u Commercial Cody.
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l l USC'S ~ 547
Subsection (a) contains ihrce de;Cinitions. Im~e~~tc~ry, ne~a value, <ind receivable ~~re defined in,tl~eir ordinary
senses, but. are def~med to lvoid any coi~fiision or uncertainty sun~otiuiding the terms,
Subaeelion (b) is the operative provision of Yh~ secYioi~. It~ <iiitl~orizes the trustee to avoid a transfzr if five
ec~nditions are met. These are the five elements of ~~ preference action. First, khe transfer un1sC be to or for the benefit
o f; a creditor. Second, the transfer n~list be li>r or o~1 account of ~n antecedent debt owed by the debtor before the
tr<tnsi'er vas made. ']'bird, the transfer must lave bcci~ inacic when tl~c debtor ti~~~s iusolvcnt. 1~ o~irt)1, Use transfer
i7nist have been made ~Ituiiig tl~e 90 days imiiiedi~[ely precedi~ig t11e co~mucncement of the case. IPthe tr~nsF~r 4vas
to au insider, the tn~stee may avoid the t~~aatsfea~ if i'k ~n-as made during Ct~e pei~ioci t'hat~ begins ane year before the
fili~a~; of tl~c pctrtioii a~ld ends 90 ciay~s befo~•e the filing, if tl~e iusidcr to ~vhoin the traus:fer vas made l~~td G~easounble
cause Yo believe the debtor was u~solvenl ~t the time the transfer was made see the 198 amenclmenC of sttbsec.
(b)(4)(F3) of this sectian].
I~~ittall_y, the tr<utsfer must enable tl~e creditor to whom or foi• whose benei:it it was made to receive a greater
percentage of his claun than h~ 4vrni(d receive under the clist~ributive provisiozis of the bnt~uptcy codE. Specifically,
t}ie ereclitor n~iii~t resceive n~oxe than he; ~r~~uld if the case ~s~ere a liquidation case, iCL~e transfez~ laaci not becz~ ina~le,
and if tl~e creditor received payment ~~f the debt C~~ Che extent provi~lea by the provisions o:F the code.
"1'he plu~~isiiag oPt(ie final clen~enL cliaiage~ the ap~~licalia~~ oCtl~e grc<iter perceu(~~e lest G•ona tl~~lt cn~ployed under
cur.~•e~it la«~. Under this 1<~~nguage, t1~~ court intxst focus oii the relative distribution heriveen classes as tell as the
~mouut that will 'bc received by the members of the class of which the creditor is a member. The language also
rcc~uires the court to Poeus on the allowabilily of the c(ai~n for ~vhicl~ the }~referenc~ vas ~~~ade. ] f the claim woGtld
have been entirely disallowed, for etianiple, then the test of paragraph (5) «rill he met, because the: creditor ~i~oald
have received nothing undEr the distributive provisions of the baiakiliptcy code.
"I~hc trustee may avoid a rransfcr of a lien under this section even if tl~e lien has been enforced by sale before ll~e
comm~ncecnent of the case,
Subsection (b)(2) of fllis section i~t effect exempts f7•om the preference hales payments by the dcbtoi~ of tax
liabilities, regardless cif their priority status.
Subsection (c) conY~ins execl.~t~iaris to the l~usYee's ~~~voidin~ pot~~er. If a creditor cai~ qualify u~ides- any one of~ tl~e
exceptions, then he is protected to th1Y extent. If he can qualify tinder severll, he is ~rotecte.d by each to the extent
tl~<it he can qualify i~ude.r eac_U.
Tl1e first exception is f'or a transfer that vas intended by all parties to be n coutemporuTieous excha~ige 1'or neti~r
v:~lue, tmcl vas iu fact substantially conte~np<~>rane~aus. Norn~al(y, a c(~eck is a credit Lransaction. I~3owevc;r, for llle
purposes of this p~iragraph, a lr~nsFer in~~ol~~ing a check is considered to be °intended to be contumporai,ieous", and
if Clio check is presented Yor ~aymerit in the ~lormal course of affairs, «~I~ich the Uniform Coi7mierciai Code specifies
~s 30 days, iJ.G.C. ~ 3-503(2)(<t), tliat~ will amount to a trzusfer that is "in fact subst~nti~lly coutui~tporaneous."
The second exception protects transfers in the ordinary course of business (or of financial affairs, Fvhere a
httsiness is ~~ot~ i~lvc~lved) tiansPe;rs. l~~or the ease of a consumer, the para~;ra~~h rises the }~l~~rtise "~ivancial a1:~f~iirs" ro
inchide such nc~nintsitaess aclivities as payment of monthly utility bills. If t11~ debt oi~ account of which khe transfer
vas n~nde ~~~as inciu~red in the ordin~iy course oi~ both tl~ie debtor and the transferee, if the h~~msfer eras ril~de not
later than 45 days aft~a~ t}1e debt ~v1s incurred [see the 1984 <u~ze~tdinent of aitbsec. (c)(2) of this section, if~the
ta•ai~sfer.itsetf w~is made iii the c>rdin<iry eo~u~se of both the debtcir and the tr~u~sf~ree, and i.f the transle3• vas ivadc
accorduig to ordiii~ry business tetras, then Qie transfer is protected.'I'he purpose of this exception is to leave
undisturbed normal financial relations, because it does riot detrack ixoin tl~~ general policy ot~the p~•eferencz section
t~o discour<i~e; umisual action by either the debtor or leis creditors dut•i~~~ Yhc debtor's slick iutc~ b<u~kru~~tcy.
The third e,~oeption is for 4nablin~ loans in connection wikh which the debtor aoquires tl~e pro}~erlti th~rt the loan
ez~ablecl laim to piu~el~,~s~ afl4a~ the loan is actually made.
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i ~ t~scs sa
"1:'he fourth exception codifies the net result nile in section 6~c of current la~v [section 9G(c) of fanner title 11]. I£
the crediTc~r and the debtor h~jve iunre than one e~ch~nge during the 90-day peiiod, the exchanges are netted out
according to the f'ortnul~ ita paragraph (4). 11ny ne~v ~~alue that tiie creditor adv<t~~ces must be unsecured ii1 order for
it to qualify under this exception.
P~ir~grapll (Sj codifies the imprtrvement in position lest, and thereby o~~errules such cases as D«B;~y v. Williams,
4'1.7 1'.2d 1277 (C.~1.9, 19G6), and Ciraiu Merchants oPIndian~i, liaa v. I.tnion T3aii.k end Sa~~in~s C'o., 408 t°.2d 209
(C.A.7, 1969). A creditor with a security interest in a floating mass; such as inventory or accounts receivable, is
subject to prefe~•ence attaelc to the extent he impiroves his position durira~ the 9U-day period before bankni~~tcy. "T'he
tcsY is ~~ ~~~~o-point t~cst, and requires cicterinivation of t~l~.e sec~ired creditox's position 90 cl~lys before Cl~~ petition and
oii the date of Yi1e petition. If new value was first given after 90 days before tl~ie case, the date on ~~~hich if was first
gig%en suhstihites for tl~e 90-day poi~it.
Paragraph (6) cxoepts statutory liens v~lidatcd lender sectio~~ 54~ ti~om preference attack. It also protects T~r~aisfers
in sal~ivfaction of such lis~~s, and the tixin~ of a lien colder section 365{j), ~vliicla protects ti vendee whose contract to
pLirclaase real property Goza~ tlae deUtor _is rejected.
Subsectio~~ (d), derived froul section G7a of the I3anla-uptcy Act [section 1Q7(~) ~~f foi7ner title ll], pernliCs the
trustee tf~ avoid <i transfer to a~einlburse ~ surety that posts a bond to dissol~~c a jtiiclieial lien that ~~,~oulcl have been
a~-oidable tinder this section. The second seutenca prot~ets the sleety ti•om double liability.
Subsectic>i~ (c) cietcnnines ~a~hen <i transfer is made far tl~e piu~~oses of the p~•ei'~rencc secti~>n. Para~;r~ph (i)
d~ilnes ~uli~ii a transfer is perfected. l~~or real property, a t~•ansfcr is perfected ~tirhen it is valid against a bong fide
purchaser. For personal ~a~opex-ky and lixfures, a transfer is perFeefed when it is valid against a creditor on a simple
contract that obtains a iudici~~l lien after the transfer is perfected. "Simple contract" as tiised here is derived froi~~
I3~mkniptcy Act § 60a(4) [section 96(~i)(4) of former tiUc 11]. Paragraph (2) specifies that a transfer is mfide when iY
takes effect between the transfc;ror grid the transferee if it is perfected at or ~~•ithiil 10 days after that tiliie.
Other~~ise, it is made ~n~hen tl~e 1~rausfer is perfected. If it is not per1.'ected before fhe conm~e;ocenlent of the case, it is
made i~nmecliately beti?re the cot~uvea~ce~uenf of the c~ise. P~iragr~ph (:i) specifies that ~i transfer is not made u~~~Pil
the debtrn• has acquired rights in the ~~roperly transfeil•ed. 'Phis provision, inol~e than any otlie:r in the section,
overntles DcrBc»~ end Groin Merchara~s, and iu combinx~tiot~ ~v~iCh subsection (b)(2), ove~7ules In re King-Porter Co.,
44C 1~.2d 722 (Stl~ fir. l a71).
Subsectioxi (e) is designed tc> reach the diflerenl~ r~s~ilis wader the 1962 version of Article 9 o~tl~e ZJ.C.C. and
Luider the 1972 version because di ~cre~at actions ire required tiincier each vcrsiau rn o~rdcr to ~iziake ~~ sec~GG~ity
agreement effective bet~~~een the ~~artics.
Subsection (f.) creates tt presumption of insolvency for khe 90 days preceding the bai~knzptcy case. ̀I'h.e
presumption is as defined in Rnlc 301 of tli~ federal Rules of Evidence, made applicable iii bankruptcy cases by
sections 224 end 225 of khe bi1.1. The prestiunptiou ~-egairev the party against whom the prestiixnption exists to come
far~vaa-cl ~vit}a some evide~lcc t<i rcbL~t the presumption, Uut the btudcn c~Fp~~oof renaai~~s on tl~.G party in 4vhose favor
the i~resuinpfion exists.
UN:['1"I~aD S"I'r1'I'ES COT)Ti Sk;R~\-"ICE
Cbpy7~iglAt 4~ 20191~1atdieFv I3endez &Company, lizc. a ~zzozzahcr of the Lexishrexis Group T~' ;111 z'iglus resea~~~ed.
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11 USCS § 548
CYu7~~nt tl~rougl~ PI: 115-33$, a~~E~r~ived 12/20/1,, rr~itl~ a gap of 1.1~-334.
United St«tes Gbde Bernice - Tr~les 1 throu~lt S4 > TI7I_E ll. B~fNKRUPTCY > CII9]'TER 5. C:RTDIT'ORS,
rrrr:~ nr~x~'OX, ~f[\'I) 7711x" 1~`,S'C'A7"I` > SUBC"flAl'Trx rrr: rr~~~ r:s~~r
Notice
Pcn z 1 of~~. I'ou are ~'ie~viiig a very large document that leas been divided into parts.
~ 548. Fraudulent transfci°s end ohli~atio~~s
(a)(i) The trustee ma}' avoid any tr-~nsfer (including any transfer to or for the benefit of tin insider under a~~i
employment contract) of 1n interest of t11e debtor in ~~roperty, or piny ob(igntion (inclucliug any oUligation to or
for the benefit of an insider uiulec an employment contract) incurred by the debtor, that vas made or incurred
on or t~ithin 2 years before the date ~f the tiling of the p~;titio», if the debtor vohmtarily or involuntarily--
(A)n~acle such Yr~nsfer or incurred such obligation ~~,~itl~ actual intent to hinder, delay, or detrltiid ally
eiltit5~ to tivliich the debtor ~~~as or became, on o1• a8er the date that such transfer ~uas made ~~r such
obliglYion was incurred, indebted; car
(B)
(i)received less than a reason~bl5~ equivalent value in exchange for such transfer or obligltic~n; and(")
(I)~v~s insolvent on the date that such hansfer ~~+1s made ar snch obligation vas incun-ed, or
bec~une insolvent as a result of such transfer or obligation;
(II)wxs engaged u~ business or a transaction, car eras about to engage in business ar a
transaction, for ~vhicl~ any property reil~~7inin5 ~~~it~h dle debtor vas ~u ~ulrea~onably small
capital;
(III)intended to incur, or believed that the; debtor would incur, deUts that ~voulcl be Uey~~nd the
debtor's ability Co pay as such debts n7atured; or
(I~')~uacle such [ransfe~r to or for the benefit of an insider, or incilrred such ol~ligatio~l to or fi r
the benefit of ~n insider, tinder an eiuployrnent canti•act ntid not in the ordinary course c~F
business.
(2)A transfer of a charitable contribution tc~ n qualified religious or ch~rit~ble entity ar
c~cganization shall not ~be eontiidered to be~ a traYusfer covered timder paragraph (1)(B) in 7uy
case in which--
(A)the amount of that contribution does riot exceed 15 percent of the gross annul
inco~7ie of the deUtor for the year in ~~~hich the h•ansfer of the contribution is rn~de; or
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(B)the contribution made by a dehtor escecded Lhe perccnt<ige ~unouut oI'~ro5s an.nu~~l
ince~mz specitied in subparagraph (A), if the transfer.vas c~~nsistent with the practices
of the cicbt~>r in ~uakin~ charitable contributions.
(b)Tl~e tiuslee of a partnership debtor may lvoid a~~y transfer of an interest of~ the debtor in property, or any
obligation incurred by tl~e debtor, that vas r»ade or incttn~ed oar o~• ~vitilin 2 years b~L'orc the elate oP tine filing of
the petition, ~c~ ei general p~rtnc~• in tl~e debtor, if the debtor was insolvent on the dlle such tr<~nsfcr toes made or
such obligation ~~>as inetim•ed, oi• beoame insolvent as a result of such transfer or obligatio~l.
(c)}:~;xcept to the extent t}~at~ a trai~sFcr or oblig<iYion voidable uncicr this section is voidable under section 544,,
545, or 5~7 cif dais title [I t USCS § 544, 545, or 547], a tc~nsfer~e rn• obligee of such a tr~ttsfer ar obligation
that tikes for value ~~ld i1~ go~x[ f nth lies a Lien on or may a~4t~i~ii any interest transfen~ecl or may enl:orce ~+ny
obligaki.on incurred, as the case in~~y be, fo the extent tlr3[ such transferee or oblibee gave vahie Lo the debtor in
exchange for such transfer or obligation.
~a~(1)I~or the ~~u,rposes oFthis section, a h-ansfcr is made when suc(1 trauste~~ is so perfected th~it a bona fide
purchaser ti~om the debtor a~aiiist ~~~l~oi1~ ~ipplicable lzi~v petn~its such transfer to be pecfecied cant~oY
<~cquire an interest in the gcoperty transfei7e~l t~iaC is superior to the interest in such pcoper-ty of tl~e
traz~skeree, but i:~siich transf~z•.i:; not sc~ pc.a~fected before ll~e cox~a.i.nence_xa~ent of tl~.~ t.ase, tiu4h transfer is
m~cle immedilt~ly before the da[e of the filing of the petition.
(2)Li this secliou--
(A)"value" means property, or satisf~etion ar securing of a present or antecedent debt of ll~e debtor,
bait does i~ot ii~chidc a~1 ui~perfor~z~uci }~roznise Co f.'ui7lish support to ll~e dcbt~o~r yr to a rclat~i~re oPthe
debtor;
(S)zi con~~nodity broker, Pot~~arcl conC~act n~ercl~~li~Y, stockbr~~kcr, financial instilnYion, financial
participant, or securities clearing agency that receives ~~ marg~ii~ payment, as deti~led i.r~ secCion 101,
741, or 7C1 of this title ~I1 USGS § 101, 741, ~>r 7Gl ], or seUlemenY payment, pis cleline~-1 in section
10] ~>c~ 741 ol'tliis title [7 1 USCS y~ .101 or 741 ~, takes fors v~l~ic t~~ the extent of such paymcx~t;
(C)a repo p~rt~icip<~nt or 1-financial participant that receives ~ i~~lar~iu payuient~, na detined iu eclion
7~}J. oa- 7Cl of kris title [Ll. U~CS ~ 741 or 7C l~, ~~r setticin~ntpa}nT~ent, as dekined iia scet~on 741. of
this tit1~ [.I.1 USCS ~ 711], in connection with a reptu•chase agreement, Y~jkes for value to t}.fie extent
of such payruent;
(D)~ swap participant or fmanci~~l participant that receives ~ tr~~nsfer in coru~ectioti with a swap
~~reenient tnlies fi r value to the eaten# of~ such tra~isier; and
(E)a r~~aster netCi»g a~eement plrticipant that receives a tr~~nsfer i~~ connection ~vieh a master•
nettia~g a~rcement or a~ay ii~d~ivid~i~] contract covered thereby talcs f<~i• value to Y6e exfelit <~f'sttch
transJ'er, except that, ~~itl~ respect Yo a Lrausfer under ac~y incli~~icival contract covered thereby, to tl~e
extent that such mister netting :~g~reemenC participant otherwise did not take (oi• is othei~~ise not
dc.e~ned to ha~re taken) suctl transfer for value.
(3)Li this section, the te~7n "charitable contr~irtttion" means a charitable contrit~uti~il, ~s that term is
defined in section 170(c} of the Internal Revenue Codc of 19$C [2C L7SCS § 170(c)], if that
conll~ibution--
{A)is made by a tlatural person; and
(B)cot~sists of--
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1 ] I.lSCS ~ 5~4h
(i)a iiilaucial instrument (as that lernl is dellu~d iz~ section 731(c)(2)(C) of the Int~rilal ReveAlue
Coc1e of 1986) [26 USCS § 731(c)(2)(C)]; oi•
(ii)cash.
(4)In this scetio~~, the term "e~u~lified rcligiotis or charitat~le ~ritity or org~Gnir.,~it~ion" ~nc~ins--
(E1)an entity described rn section 170(c)(t) of the Inte~•a1a] Revenue Cade of 198G [2G USCS §
(B)~in entity or organization described in sectioaa 170(c)(2) of the Internal Revenue Code of 19H~
~2c ~rscs y ~ ~o(~)(a)]_
(e)(]) I~~i additicm t~o aj~y irzlnsfer that the trustee in~ty t~lh~r~vise a~=c~icl, the trustee nay avoid any transfer «Ptm
i~aterest of tl~c debtor in property that vas in~de on or ~~ithin 10 }ears before tl~e date of the filiia.g oPthe
peCition, if--
(A)s~ich transfer ~a~as made t~o a self-settled tr~ist or similar device;
(13)sncl~ transl:er tivas by tl~e debtor;
(C')the debtor is a benefci<uy of such trust oi~ siniilai device; end
(D)the debtor mnd~ such h~anster with actual intent Yo hinder, delay, or defi~altd any entity to ~~~hieli the
debtor was or bec<in~e, ova or after t(~e date that such h~ansfer was made, indebted.
(2)For the purposes of this subsection, ~ transfer includes a ti~ar~sfer made in anticipation of any
uloney.judg~roeut, settlement, civil penalty, eq~utabte ~~rder, or criminal title iilcmred by, ~~r ~vhiala
die debtor believcci ~•voulcl be iucurz-ecl by--
(A)~ny violation ot'tl~e securities laws (as de#used in seetio~~ 3(a~)(47) of'the Secnri~ties
Ixc~rt~an~e Act o1' 1934 (:I5 I.S.C. 78c(~)(47))), any Stale seclu•ities laws, or auy.reg~tlation or
order issued iuider F~eder~l securities ln«%s or State securities laws; or
(13)frtrucl, deceit, or m<mipula~ic» ~ in a fiduciary capacity or in connection wit~ll tl~t~ purchase or
sale of any security registered under section 12 or 15(d) of the Securities Exchange AcY of 1934
(15 U.Q.C. 7K( cud 78o(d)) or under section C oi'the Securities net cif 1.933 {15 iJ.S.C. 77t).
History
(Nov. G, 197$,P.I.., 95-5)S, Title 1, § ] 01, 92 Stat 2600,, .iuly 27, 19H2, P.T.,. 97-222, § ~, J6 Stat. 2_i G; July 10,
1984, P.I.,. 98-35 j,'I'itla III, Subtiklcl~~, ~ 3)4, Subtitle H;. ~ 4C3, 9~i Shat. 3C5, :37R; Oct. ?7, 1986, 1'1.,. 99-554,':['iilc
II, Subtitle L, ~ 283(n), 100 Stat. 3117; June 25, 1990, P.L. 101-~ ll, Title I, ~ 104, I~itle II, § 204, 104 St:it. 268,
269; Oct. 22, 1994, F'.I.-. 103-394, Title V, ~S SU1(b)(S), lOS Stet. 41x2; June 19, 1998, P.L. 105-183, ~~ 2, 3(a), 112
Sl~~t. 517; April 20, 2005, 1?.[.,. 109-8, "I"it1~;1X, ~ 9070, (o)(4j-(6), "Citle XIV, ~~' 1402, 7.19 Stet. 177, 182, 2.14.)
Prior• lai~~v anc( revision:
1:egisl~~[ri~e Staterrienls
Section 5~44(d)(2) is modified to reflect general application of a provision contained in section 76G of Yl1e Senate
az~aea~da~~ecat ~~~ill~ a~cs~~ecl to conam<adily broken. lea parti~al~ir, section S48(d)(2)(.L3) o.f the I I<~usG ai~~e:~acia~aeait makes
cleaf~ that a coentnodity Uroker ~vho receives a margin payment is considered to receive flee mlr~in paytnent ui
return for "value" for purposes of section 548.
S'ei~nle Report Vn. 95-98>
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1 ~ t7scs § sas
'Phis section is derived ial larbe Part fi~oin scc[ion 67d of the I3ankruplcy Act [section ] 07(d) of forn~~r t~iklc 11 ~. Il
permits Che tnistee to zooid transfers by the debtor in fraud of his creditors. Its history dates fi~orn the staCute of 13
131iz. c. 5 (I 570).
The Gustee may avoid fi~attdulent h~ansfers or obligations if' ~1~»de ~vitl~ aclul] intent to hinder, delay, or defraud a
past car .future creditor. '['~ansfers made for less th~i~ a reason~ihly equivatent consideratio~a are also v~il~lerable if the
debtor was or [hereby b~eomes insolvent, was engaged in business ~~~i[li au i~nr~asonably small capital, or intended
to incur• debts tl~nt would be beyond leis ability to relay.
'I~he trustee of a partucrship debCor i~n~y avoid airy trans.fei• of partnei•shi~ property to a partner in the debtor i.f the
debtor vas or thereby became insol~reut.
If a trai~s.teree's only liability t~ the tnAstee is under this section, and it he~ hakes for value and in good faith, then
subsection (c) ~r lnts h~i~n a lien on the p~•operty Transiened, or other similar pi•otectioti.
Subsection (cl) specifies that for the ptiu-poses of fraudulent h~ansfer section, a transfer is .made when iY is valid
against ~~ subsequent bony tide purchaser. Ik~not made hetore the commencement of the case, it is considered n~acie
i~nn~ediately before then. Subscctio~i (d) also d~fiucs "valise" to ~ncan ~~roperty, or tl~e satisfaction or sec~u~ing oi'~i
present or ~ir~;cecleiit deUt, taut does not include au unperforined pi•oniise to Furnish support to the debtor or a
relative of the debtor.
i~rrrrr;i~ s~r,a~r~;s cone: si~.tiv[c;r.'.Gopyrighl S~ Z019 Matthew I3endcr ~ Company, [nc. a meil~ibcr of~d~c L,exisNesis Group ~~'~ X111 ri~l~is reserved.
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CautionAs of: February 6, 2019 6:36 PM Z
~ er~ e i
Supreme Court of South Carolina
October 5, 1981
No. 21578
Reporter277 S.C. 162 "; 284 S.E.2d 770 ~`; 1981 S.C. LEXIS 500 *'~
The CITIZENS AND SOUTHERN NATIONAL BANK OF
SOUTH CAROLINA, Appellant, v. Stephen D. SMITH;
Thaddeus E. Williams; Smith-Williams &Associates,
Inc.; St. John's Episcopal Church; University of South
Carolina Educational Foundation for the benefit of
Maximillian LaBorde Scholarship Fund; University of
South Carolina Gamecock Club, Athletic Fund; First
Palmetto Bank &Trust Company, Inc.; Hellams-Ullman,
Inc.: South Carolina Employment Security Commission;
United States Leasing Corporation; Robert F. Lindsey;
and Pierre F. LaBorde, Jr., Defendants, of whom First
Palmetto Bank and Trust Company and Pierre F.
LaBorde, Jr., Stephen D. Smith; Thaddeus E. Williams,
Smith-Williams &Associates, Inc.; St. John's Episcopal
Church, University of South Carolina Educational
Foundation for the Benefit of Maximillian LaBorde
Scholarship Fund and the University of South Carolina
Gamecock Club Athletic Fund are Respondents
Prior History: [***1] Appeal From Richland County,
William P. Donelan, Special Circuit Judge
Disposition: Affirmed in part and reversed in part.
Core Terms~~.~ ~,~a~a ,~ ~,~~.~. ~ ~~~~.~y~,~u~~~~~
mortgage, acres, subordination, purchase money
mortgage, developers, acre tract, mortgagee's
Case Summary
Procedural Posture
Appellant bank challenged a decision from the trial
court, Richland County (South Carolina) in favor of
respondent seller, who had agreed to subordinate
certain purchase money mortgages from the buyers in a
foreclosure action.
Overview
The seller agreed to subordinate his purchase money
mortgages in order for the buyers to obtain money to
develop the land. He agreed to execute documents as
might from time to time, be required to perfect such
subordination. The buyers placed additional mortgages
on the land without advising the seller or obtaining his
consent. When he discovered this he entered into a new
agreement under which the buyers would satisfy the
purchase money mortgages, new mortgages would be
executed for the purchase money mortgages, the seller
would subordinate the new mortgages provided the
buyers would, inter alia, satisfy the outstanding
mortgages within three months. The buyers extended
the mortgages without telling the seller. On appeal, the
court found the trial court erred in finding that the seller
did not acknowledge the superiority of the bank's
mortgage in the new agreement. But the court found the
bank subsequently extended the time for payment of its
mortgage for one year without the seller's knowledge
and consent. Thus, the bank lost its priority vis-a-vis the
seller by doing that and the seller would be allowed to
foreclose his liens in priority over the bank.
OutcomeThe court reversed insofar as the trial court found the
seller did not acknowledge the superiority of the bank's
mortgage in a new agreement. But the court affirmed
the way in which the seller would be allowed to
foreclose his liens.
LexisNexisO Headnotes
Real Property Law > ... > Liens > Nonmortgage
Liens > Lien Priorities
Real Property Law > Financing > Mortgages &
Other Security Instruments > Purchase Money
Mortgages
277 S.C. 162, '"162; 284 S.E.2d 770, "*770; 1981 S.C. LEXIS 500, *'`*1Page 2 of 5
1°~P~['"] Nonmortgage Liens, Lien Priorities
At common law and in equity a purchase money
mortgage will ordinarily be given priority over other
security instruments in realty, but it may be
subordinated by agreement of the parties. Because it
alters the normal priority of the mortgagees, priority
under a subordination agreement is strictly limited by
the express terms of the agreement.
Civil Procedure > ... > Pleadings > Time
Limitations > Extension of Time
Real Property Law > ... > Liens > Nonmortgage
Liens > Lien Priorities
Civil Procedure > ... > Pleadings > Time
Limitations > General Overview
[*163] [*"770] This appeal involves the priorities of
several mortgages.
[**771] This foreclosure, involving a most complex
factual situation, began in 1973 when the respondent
Dr. Pierre F. LaBorde owned three parcels of
undeveloped land in Richland County (132.9, 489 and
490 acres). He sold this land to Stephen D. Smith and
Thaddeus Williams only receiving purchase money
mortgages in return. He agreed to subordinate these
purchase money mortgages in order for the developers
to obtain money to develop the land. This provision
read in part:
"(A)nd the [***2] seller agrees to execute such
documents as may from time to time, be required to
perfect such subordination."
Real Property Law > Financing > Mortgages &
Other Security Instruments > Purchase Money
Mortgages
~t~J[] Time Limitations, Extension of Time
As a matter of law, a lender and a borrower may not
bilaterally make a material modification in the loan to
which the seller has subordinated without the
knowledge and consent of the seller to that modification,
if the modification materially affects the seller's rights. If
the terms of the debt are materially altered without the
subordinated mortgagee's consent, the priority of the
mortgages will be reversed in favor of the subordinated
purchase money mortgage.
Counsel: John S. Taylor, Jr., of Robinson, McFadden,
Moore &Pope, Columbia, for appellant.
John Gregg McMaster, Timothy G. Quinn, Frank E.
Robinson, ll, Joe E. Berry, Jr., Walter B. Todd, Jr., Harry
M. Lightsey, Jr., James B. Richardson, Glenn Bowers,
and Robert G. Horine, Columbia, and Philip Wittenberg,
Sumter, for respondents.
Judges: J. Woodrow Lewis, C.J., Bruce Littlejohn, A.J.,
J. B. Ness, A.J., George T. Gregory, Jr., A.J., David W.
Harwell, A.J.
Opinion by: PER CURIAM
The precise meaning of this provision is in dispute.
Subsequently, LaBorde was informed that the
developers had placed additional mortgages on the land
without advising him or obtaining his consent.
Upon contacting the developers a new agreement was
entered into in March, 1974 in which they agreed:
(1) The purchase money mortgages would be satisfied.
(2) New mortgages were to be executed in place of the
purchase money mortgages.
(3) LaBorde would in writing subordinate these new
mortgages to any other mortgages provided the
developers would satisfy the outstanding mortgages (to
C & S Bank, and to Ira Miller) within three months and to
pay to LaBorde $ 4,000.00.
Pursuant to this agreement LaBorde executed a
complete release to Smith & Williams, and fully
complied with the terms of the new (March 1974)
agreement. Smith &Williams agreed [*164] to pay off
the mortgages. Instead they extended the mortgages
without the knowledge of LaBorde.
LaBorde has not been paid anything by Smith &
Williams on any mortgage, new or old.
While there are numerous foreclosures ["**3] relating to
this financial debacle, here we are only concerned with
the foreclosure by LaBorde, and others, on the 490 acre
tract which was subdivided into four tracts of 130, 160,
160 and 40 acres.
Opinion
277 S.C. 162, "164; 284 S.E.2d 770, **771; 1981 S.C. LEXIS 500, *`*3
C & S is involved because it loaned the developers Two
Hundred and Fifty Thousand ($ 250,000.00) Dollars,
took a mortgage on the 490 acres and extended this
mortgage. The three charities, St. John's Episcopal
Church, University of S.C. Educational Foundation and
University of S.C. Gamecock Club are involved because
as soon as LaBorde gave undivided portions of the 490
acre tract to each of them, they, in turn, deeded it over
to the developers, taking purchase money mortgages
from the developers.
The appellant Citizens and Southern National Bank of
South Carolina asserts the original subordination
agreement was self-executing. The respondents
contend they had to consent in writing for the
subordination to be effective. In view of our resolution
of this case it is not necessary to pass on this issue.
~-}+1[] At common law and in equity a purchase
money mortgage will ordinarily be given priority over
other security instruments in realty. Cyr stal Ice Co. of
Scala. v. ~ir~sf c~(~arti~! ~~ ~~~~ 273 .5. C. 3D6, 390
257 ~.~. 2d 496 9979 ,but it may be subordinated by
agreement of the parties. ~;iver~ v. Rice 233 Gam= ~19~
X19 `.~. (2d~_X7£3 197 ; 55 Am. Jur. (2d), Mortgages,
§ 314, 344. Because it alters the normal priority of the
mortgagees, priority under a subordination agreement is
strictly limited by the express terms of the agreement.
Gluskin v. Atlantic Savings &Loan Association, 32 Cal.
App. (3d) 307, 322, 108 Cal. Reptr. 318, 323 (1973).
Here, LaBorde consented to the subordination of his
mortgage to C &Sand acknowledged in writing that his
mortgage would be subordinate to the bank's until the
latter had been satisfied, at which time LaBorde's
mortgage would become a "first mortgage." This
agreement was drafted by LaBorde's attorney and
signed by LaBorde with full knowledge of the facts and
circumstances. This written acknowledgment of [*165]
subordination makes it immaterial whether the original
subordination clause was "self-executing" or required
LaBorde's [''*772] written consent. We hold the circuit
court erred in finding that LaBorde did not acknowledge
the superiority of the C & S mortgage in the March 7,
1974 agreement.
[***5] Subsequently, C & S extended the time for
payment of the $ 250,000.00 mortgage for one year
without LaBorde's knowledge and consent and we hold
C & S lost its priority vis-a-vis LaBorde by doing this.
~3T[] As a matter of law,
"[A] lender and a. borrower may not bilaterally make a
material modification in the loan to which the seller has
Page 3 of 5
subordinated without the knowledge and consent of the
seller to that modification, if the modification materially
affects the seller's rights." Gluskin v. Atlantic Savings &
Loan Association, supra.
If the terms of the debt are materially altered without the
subordinated mortgagee's consent, the priority of the
mortgages will be reversed in favor of the subordinated
purchase money mortgage. See Remodeling &
Construction Corp. v. Melker, 65 N.Y.S. (2d) 738; 59
C.J.S. Mortgages, § 276; Osborne on Mortgages, (2d)
Ed., § 212, p. 386. The trial court held that the bank's
extension of time past June 7, 1974 prejudiced
LaBorde. This finding is supported by evidence that
LaBorde considered repayment of the debt of June 7,
1974 a material inducement for subordinating his
mortgage to the banks. We hold on the particular facts
of this case, [***6] the bank lost its priority by modifying
the terms of the loan to Smith-Williams in a manner that
prejudicially affected LaBorde's rights without his
knowledge or consent.
The trial judge concluded, and we agree, the
mortgagees should be allowed to foreclose their liens on
the respective tracts as follows:
(1) as to the 130 acre LaBorde tract, LaBorde's lien shall
be first in priority and C & S's lien second in priority;
(2) as to the 160 acre tract on which St. John's Church
has a mortgage, the C & S lien shall be first, St. John's
lien shall be second, First Palmetto's lien shall be third;
[*166] (3) as to the 160 acre tract which the USC
Educational Foundation has a mortgage, C & S lien
shall be first, USC Educational Foundation lien shall be
second, First Palmetto shall be third;
(4) as to the 40 acre tract on which the Gamecock Club
has a mortgage, C & S lien shall be first, Gamecock
Club second, First Palmetto third;
(5) the amount of LaBorde's lien is $ 117,000.00 plus $
41,000.00 interest making a total of $ 158,000.00; the
amount of USC Educational Foundation lien is $
220,620.57 plus interest and a reasonable attorney's
fee; USC Gamecock Club's lien is $ 51,574.44; [***7]
St. John's Episcopal Church lien is $ 204,264.72; First
Palmetto Bank's lien has not been proven, this
mortgagee can make its claim to the surplus proceeds
as allowed by the master pursuant to Circuit Court Rule
53.
(6) the original amount of the C & S lien was $
277 S.C. 162, '`166; 284 S.E.2d 770, *'`772; 1981 S.C. LEXIS 500, '`**7
250,000.00. LaBorde acknowledged a debt of $
200,000.00 to C & S Bank in the March 7, 1974
agreement. It is also undisputed that two payments of $
50,000.00 have been made. The only issue left to be
resolved is when the payments were made.
If both payments were made prior to the March 7, 1974
agreement, C & S would have a lien for $ 200,000
apportioned among the four tracts of the 490 acres as
follows:
-0"- Go fo t~,~1e 1
If one payment was made prior to the March 7, 1974
agreement, and one payment after C & S would have a
lien for $ 150,000 apportioned as follows:
FGo tc~ t~k~le~
If both payments were made after the March 7, 1974
agreement, C & S would have a lien for $ 100,000
apportioned as follows:
~. ~~iUo to f~b1~3
[***8] [*167] [**773] To each lien should be added
the cost and expenses of collection except USC
Educational Foundation which costs and expenses have
been included, in the stipulated amount. To each lien a
reasonable attorney's fee should attach.
This resolution, of course, does not affect any of the
mortgagee's rights, if any, against Smith-Williams,
individually or incorporated.
Appellant's remaining exceptions are without merit and
are dismissed pursuant to Rule 23 of the Rules of
Practice of this Court.
Page 4 of 5
Affirmed in part and reversed in part.
277 S.C. 162, *167; 284 S.E.2d 770, **773; 1981 S.C. LEXIS 500, ***8
Tablet (F~e~urr~ tc~ re~l~#c;d r~cacirmer~t text)
Tablet (Refurn to ref~afi~c~ clocum~r~fi t~x~)
160 acres $ 65,306.00160 acres $ 65,306.00
130 acres $ 53,061.5040 acres $ 16,326.50
Page 5 of 5
Tablet (Refurrr tai r~l~fed c~c~curr~erat text)
Tablet (f~~turn to s~~l~fed docur~~ent texf)
160 acres $ 48,979.50
160 acres $ 48,979.50
130 acres $ 39,795.80
40 acres $ 12,244.80
--Table3 (~~turr7,_tc~,rel~tr~~`_ciacumerrt,t~xt)
Tabie3 (~~turi~ to rc~l~i~:~` dc~c~arr~crr~ fie~xt)
160 acres $ 32,652.90160 acres $ 32,652.90130 acres $ 26,530.40
40 acres $ 8,163.24
lr~~~ sat i~tss'~~€aai~3y%
CautionAs of: February 6, 2019 6:49 PM Z
~`
Court of Appeal of California, Second Appellate District, Division Five
May 14, 1973
Civ. No. 39381
Reporter32 Cal. App. 3d 307 "; 108 Cal. Rptr. 318 '"; 1973 Cal. App. LEXIS 983 "`
JACK J. GLUSKIN et al., Plaintiffs and Appellants, v
ATLANTIC SAVINGS AND LOAN ASSOCIATION,
Defendant and Respondent
Subsequent History: [*'"*1] A petition for a rehearing
was denied June 13, 1973, and respondents petition for
a hearing by the Supreme Court was denied July 25,
1973.
Core Terms
trust deed, subordination, seller, lender, modification,
joint venture, partnership, disbursements, funds,
modification agreement, default, loans, trial court,
foreclosure, Borrower, modified, premises,
subordination agreement, consented, recorded, partner,
buyer
Prior History: Superior Court of Los Angeles County,
No. 894932, Edward J. O'Connor, Judge.
Disposition: In sum, we are faced with a trial court
decision based on several erroneous premises of law
and on factual testimony which is marginal at best. We
are not the fact finders. We cannot tell from this state of
affairs whether, given the principles of law set forth in
the opinion the trial court would have reached the same
result. It is therefore necessary that the judgment be
reversed. ~ ~
~***2l
connection between the modification and the foreclosure andconsequently that the modification did not prejudice D-B'ssecurity interest. These conclusions are apparently premisedon the theory that Pathfinder would have defaulted anyway.
Be that as it may, it was the modified agreement that wasforeclosed and it is this foreclosure which, under the trial
court's reasoning, has caused Atlantic to cut off D-B's rights in
the property. D-B therefore has been prejudiced by themodification. We cannot tell what it would have done with its
loan not been modified.
It is intriguing to note that Atlantic itself states in its brief that
"[the] modification agreement itself was conditioned on therebeing no junior lien, so that as far as D-B was concerned,there never was a modification ." That concessionseemingly recognizes the principles which we haveenunciated herein and seemingly makes this entire litigationan exercise in superfluity.
Case Summary
Procedural PosturePlaintiff sought review of the judgment from the Superior
Court of Los Angeles County (California), which held in
defendant's favor in plaintiff's action against defendant
seeking a declaration that the lien of deed of trust held
on lots in a tract of land was superior to the liens of two
deeds of trust held by defendant.
OverviewPlaintiff sold land to a corporation. The corporation then
obtained a construction loan from defendant. In the
transaction between plaintiff and the corporation,
plaintiff received a note secured by a deed of trust
containing a provision in which plaintiff subordinated
priority of its trust deed to defendant's trust deeds.
Defendant and the corporation then modified the note
securing defendants loan to the corporation by an
agreement in which the corporation stated that no one
else had any interest in the premises securing the deed
of trust. Plaintiff then sued defendant asserting that that
modification so prejudiced plaintiff that it gained priority
over defendant. The trial court held in favor of defendant
and found plaintiff, through a joint venture with the
corporation, had knowledge of the modification. Plaintiff
appealed. The court held that whether a joint venture
existed depended upon the intention of the parties from
the facts of the case. Here, the evidence did not support
the trial court's implied finding the corporation had the
authority to commit plaintiff to the modification that was
32 Cal. App. 3d 307, *307; 108 Cal. Rptr. 318, **318; 1973 Cal. App. LEXIS 983, "*"2
undertaken. Accordingly, the judgment from the trial
court was reversed.
OutcomeJudgment in defendant's favor reversed where there
was no evidence to support the trial court's implied
finding that corporation had authority to commit plaintiff
to a loan modification which plaintiff asserted prejudiced
its position as a junior lien holder.
LexisNexisO Headnotes
Real Property Law > ... > Damages > Types of
Damages > Compensatory Damages
Real Property Law > Financing > Construction
Loans
Real Property Law > Financing > Mortgages &
Other Security Instruments > Mortgagee's Interests
Real Property Law > ... > Liens > Nonmortgage
Liens > Lien Priorities
Business &Corporate Law > Joint
Ventures > General Overview
Page 2 of 9
h1~[] Types of Contracts, Joint Contracts
Whether a joint venture exists must largely depend upon
determining the intention of the parties from the facts of
a particular case because there is no certain and all-
inclusive definition to be applied.
Business &Corporate Compliance > ... > Contracts
Law > Types of Contracts > Joint Contracts
Business &Corporate Law > Joint
Ventures > Formation
Business &Corporate Law > Joint
Ventures > General Overview
1#IV3[ ]Types of Contracts, Joint Contracts
Each joint venturer has authority only to bind the others
to contracts reasonably necessary to carry out the
enterprise.
Real Property Law > Purchase &Sale > Contracts Business &Corporate Law > Joint
of Sale > General Overview Ventures > General Overview
tfTi~~["] Types of Damages, Compensatory ~~ Business &Corporate Law, Joint Ventures
Damages ~See C~a/. Ccar~s. ~cad~ ~ 16~0(~~.
Subordination arrangements are in the nature of a
mutual enterprise, wherein the vendor provides the land,
the purchaser the know how and the purchaser's
lending agency the capital, for the mutually beneficial
purpose of developing the land and disposing of it to
provide a fund out of which the vendor is paid for his
land, the lender is repaid its loan with interest, and the
purchaser receives compensation for his efforts and
skill. Because of their nature, the law is well settled that
rights of priority under an agreement of subordination
extend to and are limited strictly by the express terms
and conditions of the agreement.
Business &Corporate Compliance > ... > Contracts
Law > Types of Contracts > Joint Contracts
Business &Corporate Law > Joint
Ventures > Formation
Headnotes/Summary
SummaryCALIFORNIA OFFICIAL REPORTS SUMMARY
The trial court entered judgment in favor of a lender of
construction funds in an action by the vendor of real
property seeking a declaration that the lien of its deed of
trust on certain lots was prior and superior to the liens of
deeds of trust held by the construction lender. The land
had been sold for development of residences and the
vendor agreed to subordinate its deed of trust to those
of the construction lender. It expressly waived any right
to require the lender to look to the application of loan
funds by the developer. As a result of a poor market for
sale of residences, the lender and the developer later
modified one of the promissory notes so as to reduce its
32 Cal. App. 3d 307, '`307; 108 Cal. Rptr. 318, ""318; 1973 Cal. App. LEXIS 983, *'`*2
amount, increase the interest rate, and shorten the
maturity, with a balloon payment at the end.
Construction of homes was postponed, the developer
ultimately defaulted, and the lender purchased the
property at a foreclosure sale. The court found that the
vendor, through both a joint venture relationship with the
developer and direct communication with it, had
knowledge of all of its activities and of the modification
agreement and consented thereto, that it was the
developer's default and not the modification that caused
the foreclosure, and that the modification did not
prejudice the vendor. (Superior Court of Los Angeles
County, No. 894932, Edward J. O'Connor, Judge.)
The Court of Appeal reversed, holding that the record
did not support the trial court's finding of the vendor's
knowledge of and consent to the modification. It found
no evidence of ponderable legal significance to support
a finding of knowledge and consent by direct
communication, and it viewed the evidence as negating
any authority in the developer to bind the vendor as to
the modification, even assuming the parties were joint
venturers. Despite the waiver as to application of loan
proceeds, the court held that public policy requires
protection of subordinating sellers and that a lender and
a borrower may not bilaterally make a material
modification in the loan to which the seller has
subordinated, without the knowledge and consent of the
seller to that modification, if the modification materially
affects the seller's rights. The modification and the
circumstances surrounding it were regarded as clearly
enhancing the likelihood of the developer's default and
the consequent foreclosure. (Opinion by Cole, J., ~ with
Stephens, Acting P. J., and Ashby, J., concurring.)
HeadnotesCALIFORNIA OFFICIAL REPORTS HEADNOTES
Classified to McKinney's Digest
Ll (~ )
Liens § 22—Priorities—Subordination Agreements.
--Rights of priority under an agreement of subordination
extend to and are limited strictly by the express terms
and conditions of the agreement.
~t{[l (2)
Page 3 of 9
Trust Deeds § 39—Agreements as to Priority.
--Though a vendor of real property that had
subordinated its rights under a trust deed executed by
the purchaser-developer to trust deeds in favor of the
lender of construction funds had expressly waived any
right to require the construction lender to look to the
application of loan proceeds by the developer, the
construction lender had a duty to protect the vendor's
security interest when it entered into an agreement with
the developer modifying one of its loans. Public policy
requires protection of subordinating sellers, and a lender
and a borrower may not bilaterally make a material
modification in the loan to which the seller has
subordinated, without the knowledge and consent of the
seller to that modification, if the modification materially
affects the seller's rights.
~~ ~ [l (3)
Trust Deeds § 39—Agreements as to Priority.
--In a declaratory relief action by a vendor of real
property that had subordinated its rights under a trust
deed executed by the purchaser-developer to those of
defendant construction lender, the record did not
support the trial court's finding that the vendor knew of
and consented to a modification of one of the
construction loans under an agreement between the
construction lender and the developer both by reason of
a joint venture relationship and direct communication
with the developer. Even assuming that there was a
joint venture, a provision of the modification agreement
that no one other than the developer had any interest in
the security clearly negated any authority in the
developer to bind the vendor, and, since the agreement
and the circumstances accompanying it clearly
enhanced the likelihood of foreclosure of the
construction loan, it could not be regarded as an act
apparently for carrying on the business in the usual way
so as to constitute the developer the agent of the vendor
under ~ar~~~c~c5t1t~~. Moreover, there was no
evidence of any ponderable legal significance to uphold
the finding of knowledge and consent of the vendor
through direct communication.
Counsel: Graham &James, Leo J. Vander Lans, Don
A. Proudfoot, Jr., David A. Hayden, John R. Hetland
and Anne T. Kneeland for Plaintiffs and Appellants.
Kellett, Oksner &Spada, Fitzpatrick &Wiley and D.
Joseph Spada for Defendant and Respondent.
'Assigned by the Chairman of the Judicial Council.
32 Cal. App. 3d 307, '`307; 108 Cal. Rptr. 318, **318; 1973 Cal. App. LEXIS 983, "**2
Judges: Opinion by Cole, J., ~ with Stephens, Acting P
J., and Ashby, J., concurring.
Opinion by: COLE
Opinion~~~ ~~~~.a~~.~.~~ ~ ,~~ ate.,
[*309] [**319] Plaintiff (a limited partnership,
hereinafter called "D-B") sought a judgment in
declaratory relief that the lien of a deed of trust held by it
on 172 lots in a tract, was prior and superior to the liens
of two deeds of trust held by defendant Atlantic Savings
and Loan Association (Atlantic). The judgment was
adverse to D-B and it appeals.
The issues arise out of a transaction wherein D-B was
the seller of land to Pathfinder Development Co.
(Pathfinder). ~ Pathfinder in turn borrowed substantial
amounts of money from Atlantic for the purpose of
constructing single family residences and allied
improvements on the property. The precise controversy
is whether a modification of one of the Atlantic-
Pathfinder [*310] [**320] loans 2 disturbed the
priority [***3] that Atlantic had by reason of a
subordination agreement or so prejudiced D-B as a
junior lienor that it gained priority over Atlantic. The land
sold amounts to 63 acres. The transaction between D-B
and Pathfinder was reflected in a written agreement.
The basic sales price was $ 400,000. D-B received a
negotiable non-interest bearing promisory note secured
by deed of trust for $ 175,000. The deed of trust
contained a subordination provision in which D-B stated
that it expressly subordinated the priority of its trust
deed to Atlantic's two trust deeds which were "being
recorded concurrently herewith." The subordination
provision further provided that D-B understood that
specific loans and advances were being made in
reliance upon its agreement to subordinate. The
subordination provision further stated that D-B had
personal knowledge of and approved and consented to
'Assigned by the Chairman of the Judicial Council
~ Pathfinder was an original defendant in the action. It
stipulated to judgment against itself and is not a party to this
appeal.
2 The second loan was also modified but not in any substantial
way. This minimal modification is not attacked by D-B. The
trust deed securing this loan may have retained its priority in
any event. (Cf. Carz~en~an v. N~j~ri~r7, r~~ 4 G~I.Ap~.?d E35~
I&2 cal.h{~rr. 6ft71.)
Page 4 of 9
the provision of the loan agreement and escrow
between Atlantic and Pathfinder. Among other things
the agreement provided that Pathfinder was to pay to D-
B as "additional consideration for and on account of the
purchase price of the property, fifty percent .. of all
profits earned by [Pathfinder] from the [***4]
construction and sale of single family homes upon the
property." All funds from the sale of homes were to be
deposited in a trust account to be disbursed over the
joint signatures of D-B and Pathfinder. The agreement
provided that disbursements were first to be made to
pay amounts required to carry the land, second to pay
to D-B the balance on its deed of trust, third to repay to
Pathfinder certain funds advanced by it and "Finally,
additional funds representing profits shall be disbursed
equally to [D-B] and [Pathfinder], except that when it is
known that the project will earn less than $ 400,000, $
10,000 shall be distributed from the trust account to [D-
B]." It was anticipated that construction loans would be
sufficient to carry the project. All costs of ownership
were the sole obligation of Pathfinder and it agreed to
hold D-B harmless from them.
[***5] The general partners of D-B were one individual
and three California corporations. There were a number
of limited partners. In their dealings with Pathfinder the
partnership was represented solely by David Zerner.
Zerner was a lawyer whose practice included many
years of experience in real estate investment. He was
president of one of the corporations which was a
general partner in the D-B limited partnership. He was
the individual who was action on behalf of D-B in
entering into the agreement just described. D-B had
acquired title to the land involved in this litigation by
[*311] reason of a prior investment in the Diamond Bar
area. The main interest of the D-B partners in entering
into the current transaction with Pathfinder was to get
back their investment in the land. There had been a
previous Diamond Bar venture between D-B and
Pathfinder which D-B conceded was a joint venture.
Pathfinder secured two construction loans from Atlantic.
One, in the face amount of $ 1,142,560 was secured by
a trust deed on 44 of the 172 lots; the other in the face
amount of $ 2,426,580 was secured by a trust deed on
the remaining 117 lots. Each note was payable in 30
years. Atlantic [***6] required that its deeds of trust be
recorded prior to D-B's. In the borrower's instructions
Atlantic also caused Pathfinder to represent that no one
other than Pathfinder had any interest in the premises.
The note for $ 2,246,580 was payable in 30 years and
bore interest at the rate of 6 1/4 percent and called for
monthly payments in excess of $ 15,000. The loan
32 Cal. App. 3d 307, "311; 108 Cal. Rptr. 318, "*320; 1973 Cal. App, LEXIS 983, '`*'`6
documents between Atlantic and Pathfinder were all
furnished to Zerner and he looked at them before the
subordination agreement was signed.
[**321] The escrow instructions between Pathfinder
and D-B contained language dealing with subordination
of D-B's deed of trust. 3 Among the provisions was D-
B's agreement that Atlantic had no obligation or duty in
disbursing the loan proceeds to see to their application
by Pathfinder and the further agreement that any
diversion by Pathfinder of such funds would not defeat
the subordination agreement.
[***7] [*312] The controversy in this case comes from
the fact that as of March 1, 1966, and as a consequence
of a very poor market for the sale of single family
residential homes 4 Atlantic and Pathfinder modified this
note in what the trial court mildly referred to as a
substantial and drastic manner. The principal amount of
the loan was reduced to $ 712,530, the interest rate was
raised from 6 1/4 percent to 10 percent, the monthly
3 "Beneficiary declares and acknowledges that he hereby
intentionally waives, relinquishes, and subordinates the priority
and superiority of the lien or charge of this deed of trust, in
favor of the lien or charge upon said land of the deed of trust
in favor of Atlantic Savings and Loan Association, a
corporation, being recorded concurrently herewith, and that he
understands that in reliance upon and in consideration of this
waiver, relinquishment and subordination specific loans and
advances are being and will be made, and as part and parcel
thereof specific monetary and other obligations are being and
will be entered into by third parties which would not be made
or entered into but for said reliance upon this waiver,
relinquishment and subordination.
"The Beneficiary does hereby declare that Beneficiary has
personal knowledge of and does hereby approve and consent
to all the provisions of the loan, escrow and loan agreement
between Owner and Lender for the disbursement of the
proceeds of the loan of the Lender, and further agrees that the
Lender in making disbursement pursuant to said loan
agreement is under no obligation or duty nor has the lender
made any representation that it will see to the application of
such disbursement by the Owner and any diversion by the
Owner will not defeat this Agreement of Subordination as to
the funds so diverted.
"This Agreement contains the whole agreement between the
parties hereto as to the deed of trust loans, and the priority
thereof, herein described and there are no agreements written
or oral outside or separate from this Agreement and all prior
negotiations, if any, are merged into this Agreement."
4 The trial court found to this effect and its finding is properly
grounded in the testimony of a former officer of Pathfinder.
Page 5 of 9
payments reduced to approximately $ 5,900 and the
maturity of the note shortened to 10 months (with a
balloon payment at the end). The modification
agreement contained Pathfinder's representation that no
one else had any interest in the premises securing the
deed of trust.
D-B argues that this change was made "in utter
disregard" of its rights. It asserts that the modification
allowed Atlantic to escape its obligation to disburse
construction funds [***8] and to obtain the property for
itself without having to pay D-B the balance owing on
the sales price. This latter contention is based on the
fact that Pathfinder ultimately defaulted in payment of its
two notes and that Atlantic purchased the property at a
foreclosure sale.
The trial court entered judgment for Atlantic. It found
that "D-B through both a joint venture relationship with
Pathfinder and direct communication with Pathfinder
had knowledge of all of Pathfinder's activities and of the
modification agreement and consented thereto." It
further found that it was Pathfinder's default and not the
modification that caused the forseclosure. It found and
concluded that the modification did not prejudice D-B.
Its conclusions are set forth in full in the margin. 5
[***9] [*313] [**322] We pause but briefly to recite
the law applicable to 9[] subordination
arrangements. They "...are in the nature of a mutual
enterprise, wherein the vendor provides the land, the
purchaser the 'know how' and the purchaser's lending
agency the capital, for the mutually beneficial purpose of
5 "1. The subordination provision in D-B's trust deed did not
condition the priority of Atlantic's deeds of trust.
"2. Atlantic deeds of trust had priority over D-B's trust deed by
virtue of the fact of prior recordation.
"3. Atlantic's deeds of trust had priority over D-B's trust deeds
by virtue of the subordination provision in D-B's trust deed.
"4. None of the agreements or acts of Atlantic subsequently to
the execution of D-B's trust deed containing the subordination
provision in any way altered or affected the priority of Atlantic's
deeds of trust.
"5. D-B and Pathfinder were joint adventurers in connection
with the 172 house project.
"6. There was no causal connection between the modification
of Loan Nos. 15455 and 15456 and the foreclosure of the
deeds of trust securing the loans.
"7. The modification of the two loans did not prejudice D-B's
security interest under its deed of trust."
32 Cal. App. 3d 307, '`313; 108 Cal. Rptr. 318, '`*322; 1973 Cal. App. LEXIS 983, ***9
developing the land and disposing of it (usually by sale;
occasionally by rental), to provide a fund out of which
the vendor is paid for his land, the lender is repaid its
loan with interest, and the purchaser receives
compensation for his efforts and skill. 4 9 [] (1)
Because of their nature, 'The law is well settled that
rights of priority under an agreement of subordination
extend to and are limited strictly by the express terms
and conditions of the agreement. [Citations.]' (Prvinc_ v~
~~~liforr~r~ Gc~ttorr credit ~orp.~. l9 J3T) 7 ~3 Cai.App. ~d
I69 I63 (64 P.2c1 IS2 .)~~ (11~Iiller v, citizens S~v. l.a~t7
,~sst7.,_2~~3 ~~at.~~a~v2d,6~5, ~E?2-5~~~ ~~t,R~?tr.. ~3~~1.)
A perceptive summary of the obligations of lenders to
sellers in connection with subordination arrangements is
set forth in ~li~f~'l~~rc~o~s-,~r7de~r~~rT c~. v. Sr~uthwc~t
~ay. & Lr~~n Ass~~. `1~3 Cat.A .~3c~ 90~`~.~ ~6 *""`
C~°~t.,~~a#r. 3~~3~, We agree with the principles of law set
forth in Middelbrook. 6
We recognize [***11] the vulnerable position in which a
seller who agrees to subordinate his purchase money
deed of trust may find himself. The "strong public policy
reasons" to protect the seller in subordination situations
( !~)idrit~l~raok-Ar~c~~r~an Ca, v. ~c~uthv~est S~v, z~ Lr~~r1
Assn.,... ~upr~~,..... f S C 1;~4~~._3r1 of ~~ _ 036) clearly spelled
out in }~a`~r~d_y v. t~nrcfon~__6, Cal._2c1 _~IS_,~t_~a.__,~1 _j5
~~I.R tr, I69 422 P.~c~ 329 26A.LF~.3c~ 848, do not
need to be repeated here.
The seller's vulnerability has most often been the
subject of discussion in cases where the issue was the
lender's responsibility to see to it that funds advanced to
the developer-buyer were used by the latter for the
construction purposes contemplated by the
subordination transaction. (See [*314] cases
discussed in Midc~lc~arc~t~~. su r~ 9F3 ~~~•!1 .~•3d ~f
4 "'In effect, the seller is assisting in the financing of the buyer's
development and becoming a quasi "joint venturer" in the
project. The safety of his "investment" depends upon the
success of the development, for as soon as the new lien is
imposed on the property to secure the construction loan, the
property is over-encumbered. .. .
s Our agreement with Middlebrook explains why we disagree
with the trial court's second conclusion of law -- that Atlantic's
deeds of trust had priority over D-B's trust deed by virtue of the
fact of prior recordation. As Middlebrook clearly points out ". .
. there is no justification, legal or otherwise, which would call
for a different result whether the seller in a joint transaction
records first and then agrees that this lien will be subordinated
or whether he agrees that the lender may achieve priority
through first recording." (9t3 Crr1.,4~ap.,~c9~t~?03~.)
Page 6 of 9
10)31-1(?~3.) It is in that context that Middlebrook
imposed on the lender the obligations of an implied
agreement that the lender's priority extended only to
loan amounts properly expended for construction
purposes and it is in that context that a seller needs
protection. In Middlebrook (which involved dismissal
after demurrers were sustained without leave [***12] to
amend) the court was concerned with allegations that
the lender voluntarily undertook to control
disbursements from the construction loan fund; that the
seller did not attempt to follow the progress of the
construction or the status of the disbursements because
it relied on the lender's controls, and that the lender
owed a duty to the seller because the lender voluntarily
assumed control of the disbursements, knew of the
seller's security interest and knew that the seller's lien
was subordinated only on condition that loan [**323]
funds were to be used just for construction purposes.
The court held that the loan "under the circumstances"
(1S ~~(.A .3d of `ft?~7) could not be viewed other
than as subject to fair application of the construction
proceeds and accordingly a cause of action arose in
favor of the seller. In the instant case D-B expressly
waived any rights to require Atlantic to look to the
application of the loan funds by Pathfinder. D-B thus
gave up the major protection to which sellers who
subordinate their otherwise prior liens are entitled. ~
[***13] ~ 2 ['] (2) In this light if Atlantic has a duty
to protect D-B's security interest that duty must be
based on considerations other than those involved in
the cases relied upon by D-B (Midcfl~brc~~ilc-,~r]der~r~n
Cc~. v. c~u~hwest S~v. ~ Lain Assn. su ra 98
Cal., ~ .3rf 1023, /~Iit/~r v Cifir_erts S~v. & Lc~~n ~t~sra.
2~1~ G~(.~6 .2d X55 5~ Ccal.#~ tr. X344 ; ~'~c~uni~tl v.
~3~~sv 2~~ Caf=,~ .2c~ S26 4~ ~al,l~ fr. 824 ;Collins v.
f~lvrrre Davin s ~ Loan Assn. 2~5 ~a1.A .2d X36 22
~~I.~;~P~-~~397) since in each of them the lender had an
express or implied duty to the seller to see to the proper
application of the loan funds. We hold that those other
considerations are found in the public policy which
requires protection of subordinating sellers and that a
lender and a borrower may not bilaterally make a
material modification in the loan to which the seller has
subordinated, without the knowledge and consent of the
seller to that modification, if the modification materially
affects the seller's rights. If convinced that there is a
'This case does not present questions related to the
definitiveness and specificity required in subordination
agreements as to the terms and provisions of the loans and
similar matters. (See f-landv v, ~or'dan suar~ 65 C~1.2c~ 573.)
32 Cal. App. 3d 307, "314; 108 Cal. Rptr. 318, ""'323; 1973 Cal. App. LEXIS 983, "'`13
sound business reason for a modification a prudent
seller presumably ably will consent to it. If not so
convinced, he will not consent and will be [**'"14] faced
with no greater risk to his subordinated loan than was
inherent [*315] in the very nature of the transaction. If
dispute results from an unconsented to modification it is
of course a question of fact whether the modification
materially affected the rights of the subordinated seller.
The risk that the buyer-borrower will default in its
obligation to the lender and that a foreclosure by the
lender will follow is, of course, the very hazard to which
a subordinating seller exposes himself by reason of a
subordination agreement. In the abstract, there is no
obligation on a lender to protect a subordinating seller
from this risk. If an obligation to prevent a default of any
sort was automatically created in every subordination
situation no subordination arrangement could ever
effectively accomplish its purpose. But this is not to say
that a lender and a buyer can enter into an agreement
or a course of conduct between themselves whose
result is to destroy a seller's interest. Such an
agreement or conduct if deliberately undertaken would
entitle the seller, depending upon the facts of the case,
to secure relief either upon the ground of fraud or
pursuant to the requirement [***15] of fair dealing
inherent in all contracts in general (see 1 Witkin,
Summary of Cal. Law, pp. 271-272) and inherent in "the
philosophy of fair dealing" ( IV1idclfet~rac~k~Ant~~rsan ~c~.
v~._.~ocitl7wcsP S~v._ Lo~r~ ,Q~~r7., supra, ~8 ~~l.A~p~3~1
~t_,~~ 1037) expressed in N~~~cly, v~ Gr~rdar7a ~cr~r~,r, 65
Ca1,2d ~Ib' and Middlebrook as to subordination
arrangements in particular. $The absence of malevolent
purpose does not itself immunize the buyer and the
lender. If, however innocently, their bilateral agreement
[**324] or conduct os modifies the terms of the senior
loan that the risk that it will become a subject of default
is materially increased, then the buyer and the lender
may subject themselves to liability to the seller if they
proceed without the tatter's consent, and if the seller's
otherwise junior loan is to be adversely affected.
[***16] [~~] (3) Here, as noted above, the trial
e No fraud on the part of Atlantic is claimed in this. Thepossibility that in any subordination situation the lender and
the buyer may so act as to create an obligation on the part of
the lender to the setter explains in part our disagreement with
the trial court's first conclusion in this case that thesubordination provision in D-B's trust deed did not condition
the priority of the Atlantic deed of trust. The possibility ofliability in the event of improper conduct must always condition
the lender's priority.
Page 7 of 9
court found that D-B knew of and consented to the
modification agreement both by reason of a joint venturerelationship and direct communication with Pathfinder.
D-B attacks this finding. As to the existence of a joint
venture, D-B spends a good portion of its brief urging
that there is a difference between the "quasi joint
venture" inherent in any seller-buyer-lender
subordination situation and a standard or classic joint
venture. Of course there is. "Quasi joint venture" is no
more ["316] than a loose description, not a definition of
the relationship between the parties to a subordination
transaction.
D-B asserts that there was no evidence whatsoever of
the existence of a standard joint venture. "H~
Whether a joint venture exists must largely depend upon
determining the intention of the parties from the facts of
a particular case because there is no certain and all-
inclusive definition to be applied." (Nr~ltz v. Unit~c~
,~'Itrrrabin & Ne~tirt Co. 49 C~l.c~ a0t. 5d6 399 f~.2d
6~• )
We need not pause to examine the testimony to see if
there is substantial evidence to support the trial courts
finding of the existence of a joint venture (***17]
because it is clear to us that there is no substantial
evidence to support the implied finding that Pathfinder
had authority to commit D-B to the modification that was
undertaken in this case. Assuming the existence of a
joint venture, 3[ each joint venturer would have
authority only to bind the others to contracts reasonably
necessary to carry out the enterprise. (E.g., Med~k v.
Cow, 92 C~f~~.3d 7U, 76e~9t? CG~l.~tr. ~~~ and case
cited.) The applicable statute is #-1[] Cor~arar~tiQns
o~`~ sec~i~r7 15~JD9 which provides in relevant part: °(1)
Every partner is an agent of the partnership for the
purpose of its business, and the act of every partner,
including the execution in the partnership name of any
instrument, for apparently carrying on in the usual way
the business of the partnership of which he is a member
binds the partnership, unless the partner so acting has
in fact no authority to act for the partnership in the
particular matter, and the person with whom he is
dealing has knowledge of the fact that he has no such
authority. (2) An act of a partner which is not apparently
for carrying on of the business of the partnership in the
usual way does not bind the partnership unless [*'""18]
authorized by the other partners. (3) Unless authorized
by the other partners or unless they have abandoned
the business, one or more but less than all the partners
have no authority to: (a) Assign the partnership property
in trust for creditors or on the assignee's promise to pay
the debts of the partnership. (b) Dispose of the good will
32 Cal. App. 3d 307, *316; 108 Cal. Rptr. 318, "'`324; 1973 Cal. App. LEXIS 983, '""`18
of the business. (c) Do any other act which would make
it impossible to carry on the ordinary business of apartnership...."
It is noteworthy that the modification agreement
provided in part "Borrower expressly represents, and
this agreement is executed by the Beneficiary and is to
be effective only upon the condition, that the premises
described in said deed of trust are subject to no
encumbrance subsequent to said deed of trust and that
no one other than the Borrower has any interest in the
premises securing said deed of trust; except: no
exceptions." This [*317] language appearing in the
bipartite agreement between Atlantic and Pathfinder 9
could be read as negating the existence of a joint
venture. We need not further inquire into this question,
however, because in any event the language is a clear
negation of any authority in Pathfinder [***19] to bind D-
B. The only evidence of which we are aware which
[**325] could possibly be construed to support a
finding that D-B consented to Pathfinder's acting for it in
connection with the modification agreement is found in
Zerner's testimony set out in the footnote. ~ o
[***20] Zerner expressly testified that D-B did not
consent to the modification and that he would not have
9 Similar language appears in the borrower's instructionsearlier executed by Pathfinder to Atlantic.
~~"Q After the transfer of the property from D-B to Pathfinder,
what part did D-B play in making any decisions regarding the
project?
"A Nothing. The funds came out of the sales. I mean, I had
that agreement, you know, that they wouldn't take the money
which I felt, you know, to be sure I got my money out first.
"Q What about as far as making any decisions?
"A I don't know anything about that.
"Q I take it then you were leaving all the decisions in that
regard to Pathfinder?
"A Absolutely.
"Q You were satisfied from previous dealings with Pathfinder
that they were competent and would act in the best interests of
the project?
"A They are experienced builders.
"Q Were you satisfied with their competence?
"A Yes.
"Q Were you satisfied they would make the correct decisions
in your behalf?
"A Yes, I left it to them."
Page 8 of 9
approved it if he had been consulted about it. He alsotestified that Pathfinder was competent to do the project
but not to decide what should be done as far as D-B
was concerned.
Pathfinder's consent to the modification agreement is
clearly at the very least "[an] act .which is not
apparently for carrying on of the business of the [joint
venture] in the usual way....° (Cr~rt~. ~oc/e, ~ 15tJt79,
scrod. ? .) Atlantic suggests to us that implicit in the
agreement between Pathfinder and D-B was an
agreement that houses would not be constructed if they
would not sell. Since a representative of Pathfinder
testified that at the time of the modification it was
contemplated that construction on the tract covered by
the modified trust deed would be postponed, Atlantic
argues that the poor climate for selling houses makes
the decision to postpone construction a reasonably
necessary one, and one within Pathfinder's authority.
We do not agree. The postponement, coupled with the
tremendously shortened term of the loan and the very
large balloon payment due at the end of that term,
clearly [***21] enhanced the likelihood of a default by
Pathfinder and the consequent foreclosure.
[*318] The court also founded that by direct
communication with Pathfinder D-B had knowledge of
Pathfinder's activities and of the modification
agreements and consented thereto. We have examined
the portion of the transcript relied upon by Atlantic to
support that finding and find that there is no evidence at
all of any ponderable legal significance to uphold the
finding.
In sum, we are faced with a trial court decision based on
several erroneous premises of law and on factual
testimony which is marginal at best. We are not the fact
finders. We cannot tell from this state of affairs whether,
given the principles of law set forth in the opinion the
trial court would have reached the same result. It is
therefore necessary that the judgment be reversed. ~ ~
~~ The trial court also concluded that there was no causal
connection between the modification and the foreclosure and
consequently that the modification did not prejudice D-B's
security interest. These conclusions are apparently premised
on the theory that Pathfinder would have defaulted anyway.
Be that as it may, it was the modified agreement that was
foreclosed and it is this foreclosure which, under the trial
courts reasoning, has caused Atlantic to cut off D-B's rights in
the property. D-B therefore has been prejudiced by the
modification. We cannot tell what it would have done with its
right of reinstatement (Civ. Code, § 2924, subd. (c)) had the
loan not been modified.
32 Cal. App. 3d 307, *318; 108 Cal. Rptr. 318, **325; 1973 Cal. App. LEXIS 983, *'`*21
~***22~
Page 9 of 9
It is intriguing to note that Atlantic itself states in its brief that
"[the] modification agreement itself was conditioned on there
being no junior lien, so that as far as D-B was concerned,
there never was a modification ." That concession
seemingly recognizes the principles which we have
enunciated herein and seemingly makes this entire litigation
an exercise in superfluity.
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Caukio«As uf: Fcbronry C, 201 7:34 PNI Z
Senior Transeaste~-n Lenders v. Of~eial Comm. of Unsecured Creditors (Iri reTOUSA, inc.)
LTz~~itEd States Curt of Appeals !o~• Cl~c~ ~lecenth Ciz•cuit
M~iy 15, 2012, Decided; May I5, 2012, Filed
No. ll.-1.1071
Reporter
C80 F.:~d 12)8 *; 2012 U.S. App. LEXIS 9796 **; 67 Collier F3aukr. Cas. 2d (ME3) 1035; Bankr. L. Rep. (CCH) P£32,276; 5(i
Ba~ilcr. Ct. Dec. 135; 23 Fla. L, Weekly Fed. C 1042; 2012 WL 1(73910
[n r~: 'I'OUSA, INC., et al., Debtors. 51NIOR
"17:21~NSI:;AS'I'[:iR:N 1:.,Ei,N:U[.;TtS, l:)efendant -Appellee,
CI'i"CU12P NORTTI AMl-RICA, TNC., C};RTAIN
1~IRST I..IF;N'T'£~,RM I.,I~;NDF.,RS, Int~;rven~~rs
Appellees, vertius OF1'T(~IA1., COM:M:I I.̀.1'1:;I; OF;
UNS1;C[TRI->I) CRLI)T"TORS, T'IaintiPf - Appell~t~lt.
Pa•ior llistot•y-: [**1J Elppeal i~roin the United States
17istrict Court fir the Southern I:)ish~ict o£Plot•ida. I).C.
locket Nos. 0:10-cv-E2035-ASG; 0:08-hkc-10928-
;1K0.
3V Capita]. Master t~und T.,id. v. OPf~iai~ll Coixnn. oC
Uusecui~ed Creditors of Tousa, iiac. (In re "I'o~rsa, Izic.),
44~.Ii.R (13, 2011 t1.S. Dist. L] XIS 14019 (S.D. I'la.,
2011)
Official Cox»m, oEUnsecurea Creditors of~Cousa, Ix~c. v.
Citicoi-~~ N~. ~~n., Ina (In re "1"oasa, li~c.), 422 E3.It. 7$3,
200)13ankr. LI~XIS 4355 (I3ankr. S.l~. Fl~i., 2009)
llisposit~iou; R1iVI;RSI3D AND IZI~MANDk;[~.
Core Terms
1.,euclers, Subsidiaries, Uaukruptcy court, Conveyiu~;,
liEns, district aottrY, l~cnEtits, t~~nsfin~~d, entities,
seltlexa~ent, equivalent value, fiizads, znsolvent,
Conditioni~lg, revolving, joint venture, tiu,aucin~,
percent, proceeds, housing, issue~, bails, proceedings,
def~ttlt, z~atin~s, Eiaudtilez~t t~~nsf~z•, hoxnebuildiizg,
obli~;atic~ns, renied~ies, advisor
Iu an adversary action, the bankruptcy coiut avoided a
transfer of liens by debtor subsidiaries, to seclu•e
payailent ol~ a debt owed h}' another d~bloa~, lhe:ir parent,
as 1~xaudulenC timder 11 U.S,C.S. § 548. '1'hc l)nited
States Dis~r~ct Court Eor the Southern District of l~lorida
quashed ihe; bankr~iptcy court's order. The transferees
appealed. 'I~hc ansect~red credit~c~rs' coinniiltc~ aE~pe~~led.
Overview
1'lic stibsicliari~s otivn~d most of~ Che enterprises assets
and generated virtually all of its re:v~mie. During a
husi~less do~ruturn, the I.~arc;nt conlpu~y paid a X421
million s~ttleiu~~nt Co the h~FinsfErees with loin ,proceeds
fi-otn ne~~~ lenders seeurecl px•iauarily by tl~e subsiclaa~•ies'
assets. Six mouths later, the ~arei~t company ai d
subsidiaries filed for bankruptcy. The soinmitt~;e
chime<t the subsid.ia~•ies' t~•a~~asFer of the lietls fn the netiv
lenders ryas fraadrrleni under l ] j1.S.C.S. § 548(a)(I)(:13)
because the subsidiaries ~~rcre insolve~~t when the
tr•~nsfer occul~•ed, were made insolvent: b}~ the trantifcr,
.had tm.rcason<ibly small capital, or were unable to pay
thci~~ debts when due; and did not receive reasonably
equiv<<l~nt value in exchange for the transfer. Inter alia,
tl~e appelltrte cc>urC I~el<J th~it bankruptcy court did not
clearly erg• when it found that the sulasidiaries did not
receive reasonably equivalent v11ue fir the liens and
ruled that tk~e iranst'~:rees were entities "[i>r whose
b~ucfit" the lie~~s were tran5ferc~d. Finally, [he aJ,~pcllate
court would not consider, in t11c first instance,
ch~ill~;nges Yo rern~di~s the bankru~~tcy court irnpased yr
issues oP judicial <~ssig~ninent~ pr consolidation ~>t'
proceedings.
Case Sum►nary
Procedural T'osh~e~e
"Che ttpk~ellate court reversed chc judgment c~f~ ilie district
court, a~fCrrned the liability findings of the bank~-upfcy
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G$0 F'.3d 1298, x`1.298; 201 ~ i.]~.5. ApP. T.,I:'..X~IS 97g6, *~" 1
court, and remanded for fiutlier proceedings a~nsist~nt transfer whioh confers an economic benetlt t~~~on tl~e
Gvith fins opinion. debYar, either directly or itidirecYly.
LexisNexis~~) Heldnotes
Ba~ikruptcy I.aw =~ ... =- A~roiiiaiic~ ~ fraudulent
Tr~nsf'ers % Vahie
HNI ~ ~ I1 ruudulent Transfers, Vailue
"Value" is destined in 11 ZI.S.C.S. S 548 tis being
property or sat~isfactio~l or ~~:curing of a prese:nt~ or
~r~tecec~eyit debt of the debtor. 11 tJ.S.C.S. §§
548(~)(~)(~)(i), (~)(~)(n).
Bankruptcy L~n~~ % ... =' Avoidance > Fraucttilent
Tr~risfers > Value
fI[\~2['] rrnucluleut Trsinsfers, Vfllue
Tli~ mere opportunity to receive an ecouornic benefit ire
the fuhire constitutes "value" cinder the B~nlcruptcy
Cocie.
]3aaikrri}~tcy ]:.aw > ... > ,~1~roidance; > 1^'r<iudulent
'[1~ansters> Value
HN3[ ~~ li`ruudulent "1'rausfers, Valtae
"["he correct ~x~ay to determine ~r<sli.Y~; is not to define it
only ii1 terns oP tau~;ible propc.ily or marketable
lu~zuici<<l v~~luc, bttt instead t~> e:taini~~~ all aspects ~~f the
transaotinn and eareflrlly ulcasure the ~raluc cif all
benefits and Unrdc.ne to the: debtor, direct or inciir~ct,
iaacl~xcli~~~ inc~irect~ ~co~~omic beu~:fits.
I31nk.iuptcy La~~~ > ... > Avoidance % Frauduleril.
Transfers > General Qver~~ie~v
FIN4[~] A~~oicla~ince, Fr~adulent'P►~ansfe~•s
11 [I.S.C.S. ~ S48(~} does iaot auth~ariz,c voiding a
Banl~ntptcy La~v %Procedural Matters > Judicial
Kevie~,ti~ > Bvil~~uptcy Appeals Procedures
I3aiilnitptcy Law > ... ~ Judicial Review > Staudarcls
of Revie~~~ -> Clear En or I2eviejv
H~'VS[ ] Judici~il Revie~~~, Bankruptcy Appeals
Praceclures
As the second court to review the judgment of tl~e
baiilu-uptcy court, ari ~ppell~te court re~~iewa the order of
tl~e bankruptcy court independently <~f tl~e district ccnut.
The 1~pellate ec7urt retiriews de.terminatic~ns c>f ]~~v made
by either court de uovo. An appellate court reviews tl~e
findings of fact of the banl.~uptcy court for clear en•or.
Tlie fncfual tlndinrs of tl~e bankruptcy court are not
clearly erroneotiis unless, in the light of all the evidence,
ti~ve are left with the detiriite and Firm com~ictioil that a
mistake has been made. Neither the district ec>urt nor tl~e
appellate court is ~tiithorized fo make independent
fach~al finduigs; that is the fiinetiori cif the b1t~~u~tcy
court. An appellate court. reviews equit~iUle
delernlinalic~ns of lh~ be~ril:ruptey ec.~url fear abuse of
discretion.
13an.kiupcoy I.,aw % ... > Avoidnncc, > F'rairdulei~t
Transfers > L;]cmenCs
IING[ .~ l~a~atulule~~t'1't•~nsfcrs,l?,lezneats
1l. U.S.G.S. § 548(t~)(1)(B) of the I~~zakniptcy Code
px-ovides for ll~e- avoida~icc of any transfer of an int~er~*sY
of tliv c~ehtor in 1~>r~~perfy, or z~uy oi~ligation incurred by
Che debtor, that was ~n~de or i~lcurrad within two years
b~Porc the date of the citing of the bankriiptc~~ ~~etiticm, if
the debtor recei~~ed less thaai r~;i~son~ibl_y egtrivalcnt
value in exeh~n~e Yor the ti•ansFcr or obligation, Find t1~c
d~;bior (1) vas i~i:;o(v~nt on ttte d~rte such tr<insfcr 4v~~s
~~~ade or s~~cli obligatio» ~~~as incurred, or became
in,olvcnt as a result of Such tir~jusler oi• obligation; (2J
was en~ag~d in business or ~ transac[ion, ar ~~as about
fio engage in business or a trz~a~sactic» ~, for which any
~~r~perty cei~iaiirii~g with the del>far ~~~~s an unreasonably
smell capital; or (3) inten~lecl to incur, ar• believed that
Page 2 of 16
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C,$0 l~.:id l?98, *1298; 2012 i1.S. f1pP. T_,I.~;~CiS 979(, **I
the del7tor ~~oulcl incur; debts th~Y ~~roulz~l be beyond the
debCor's ai~ility to pay ~s stick deUts mah~red. 11
iJ.5.C.5. ~ 5~8(a)(1)(B)•
Baiilcrul~tcy Lair > .,.:> A~~oidance ~ Fraudulent
Transfers =~ General Overview
HN7["] Avuid~nc~e, Fraudulent Trnnsfe~s
The piu~pose of voiding transfers unsupported by
reasonably equivalent value is to protect credicoi:s
agairisk Che ~1el~letion of ~ baytkiupt's estate.
Bankruptcy :C,a~~~ > ... %~ Avc>idancc > Ft~ancl~ilent
"I"ransfers => General Overview
HtVB[""J rArotdnnce~, I~raudulent'I'~•~~~sfers
A banlavptny courk ~is entitled ko find that the benefits ot~
a transaction ~~~ere. iiz~k reasan~ibly ec~uivalcnt in value. to
what vas surrendered.. It leas Ic>n~ been cstablisl~ed that
whet~hca• Lair consideration lass been given for a transfez•
is 1~3rgely a question of~ far-t, as to ~vl~iie-h cc~r~sitlexabl~
la~ti.tude must b~~ allowed tip the trice• oL tl~e ~~aci~.
I3anluuptcy Law > ... y Av~idanc.e > 1"r<~udulent
1'r~uisfers > G~z~u~•~tl. Ovetvae~v
l/;V9~,~f .flvoiclr►nce,.I~rriudulent'.Ci•:insfers
-~ corpoaation is n.ot ~l bic>logica] entity for which it can
be jzeesinned tl~~t any act whioh extends its existence is
beneficial to it, In other words, plot every h~ansfer that
decreases the adds of b~~~k:rnk~tcy fur a cc~rpc~ratiou can
be justifi.cd.
}3nnkruptcy Lt~w > ... > Avoidance > Pr~uduleut
'Transfers y C~enerul O~~ervie~v
13aultruptcy La~v %~ ... > Avoida~ice > F~ra~tdtilcnt
Transfers > Value
H~V~O[~ ~voi~anc~e, Fr.~uci~lent Transfers
The oppc~rfunit5~ to avoid bai~kr~tptcy clues nc>t tine a
coanpany Y~ pay any ~ai•ice car Ue1r any Utitrdcil. After a11,
(here is iio reason fo treat bankniptcy as ~ boge~nu~~n~ as
a I.'ate wof•se than death.
Banluuptcy La~v %• ,.. > ,Avoidance > Fraudulent
Transfers > General Oveivie~~-~
HA'll[] Avoidfl~ce,FrauclulentTransfecs
It~ a transfer is avoide~! under 11 U.S.C.S. § 5~~ or one
of several other provisions of the Banla•u17[cy Gode, I 1
U.S.C.S. § 550(a)(1) allows flee recovery of the property
transferred or its value from the initial transferee or
from an entity For whose benefit such ki~ansYer was
made. 11 LJ.S.C.S. § 550(x)(1).
T3ankr•~iptcy I.,arr > ... > ~~~oidauc~ > f~ra~ichtle~~t
'Transfers > G~ne~~al Overview
I3anki~i}~tcy Law > Instate
Property > .~~voidance > TraL~isfaree L.i~bilities &
Rights
I/iVl2[] Avoidance, I~'r•audulent'Tr:insfers
'Tlle paradigm case of a bene~~i tGnd~r 11 L1.S,C..S. §
55~(a) is the benetii to a guarai~itor by tha payment o#~
the i~nde~~lyin~ debt of the debtor. The guartYr~t~or
reaei~~e~ an immediate lieneiit when t~hc ciebi<>r pays
back a creiiitot•, ~n-l~ich reduces the liability of~ fhc
~;u~u•antar. Althcnigh the, relati~>nship may he the
~.7araclignaatic case, It is not the Duly ciroumsta~lc~ t~l~at
can give rise to "far ~~~hose bcncfit" lis~bility.
PanlinipTcy I.aw > ... > Preferential
`I'rttnsl:ers > t:lcr~~eufs > Ge:neral Overview
I~NZ3[~'~,] P~•eterenti~l'l'ranst'ers, F,leinents
1'lic transfer of a security interest canstittites air
<tvoiclable pref'erenee under 11 ti.S.C.S. ~ 547(b) where
it ~~~as a trausfcr of property of the dcbtnr to 1 c;reditc.n•
wi[hui 90 days of 1i ling for t~ank:ruptcy that provided
1nor~ val~~e to the creditor than it would kiave receis~ed
tu~de:r el~a~7ter 7 ofthe Bankruptcy Code.
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C~iO F.3d 1?98. *J.29R; ?012 iJ.S. /lpp. T.;.f'3C.iS 9796, ~* 1
Bankniptcy La~~~ ?EstateProperly > Avoidance > Transferee Liabilities ~C.
Rights
HtVl~l[` ] Avoidance, T►~~nsferee Liabilities &
Rights
"I71e text of 11 IJ_S.G.S. ~ 550(x)(1) a]I~ws the tnisC~e io
recover from ~ creditor tivhen it was an entify for whose
benefit ~ transfer tivas m1de.
k3F~aikiul~tcy La~v > IwstatcProperty ? t~voidance ?Transferee T.iabilities &eights
IL'VZS~ J Avoidance, 'I'r.insfe.ree I:.iabilitics &
Ri~lits
Cntuls must amply a very 17exibie, ~t~agu7titic test thatlooks beyond the ptu-ticular h~1ns~Ers in question to the
entire^ circ~tmst~~nc~; c7f the trt~nsactiox~s ~t~hen d4ciding
v~~hethex• clebtc~x•s controlled a7ro~~e:rtiy later sought by their
trustees.
Civil Procedure > /-Appals >.Reviewability of
Lover Court Decisions > Preseivatioli for Review
Civil Procedure > Appeals ~ Remands
HNIG[~'~.~~ Revicwabilit~ of Lower Court Decisiot►s,F'resetv.iticrn for Review
nn appellate court «gill trot address an issue that the
district court has ti~~t yet consiclei•ed. When the district
court does clot address an issue. it Dismissed as moot, the
~7roper course of action oFten is to vactitc tl~e ~7rder o:C~the
disti~i~t court and remand.
Caunsel:.1~or SENIOR TRANSI~AS`I'GRN LENDERS,
Plaintiff- Appellee: Geci Beat~ititi, Dan~en D. t~a~•I~i~rie,
1-'o~~~lcr White Bobgs, 1'n, "f'[1:MPA, F'[.; Andrew N1.
Leblanc, Nlilhnnk T'weea II~tdley & McCloy, LLP,
WASHNGTQN, DC, Nancy A. Capperkli~vaite,
Akerm~n SeuYerCtt, I:,I_,P, MIAMI, ~~[,; Michael I.
Goldberg, Akerniau Sentcrfitt, LLP, 1~nK7'
LAUDF;RI)AI.,I, I~•'L.; Stel7hei~ M. I~lertz, laaegr•e F3aker
llaniels, LLP, MINNEAPOLIS, MN; ACa~•~ Miller,
Crabri~~lLe I.yun Ruha, Milb~artk Tweed II~ciley
McCloy, [.,I.:l', Nl~;w' YOItK, NY.
l~or Cl'I'COR:[' I~T01~T1:~] r1M1;IZTC~1, INC., C•F+:ItTAINFIRS"I~ LIEN ̀['Ii;RN[ I.,E~;N1)J;I2.S, I,titccv~iaars
flppellees: '1"homas J. Hill, T}iomas J. McCor~ilaek,
Seven Rivera, Chddbotti7~e &Parke, T_,T.P, NEW YQRK,
NY; Richard C.1'rosser, Stichter Riedel 131~tin &Prosser, PA, TAMPA, FL.
I~or SIiCOND LIEN AYPI;LLEIN'1'S, Iutetvenor -Ap7.~ellee: Evan Daniel Fl~schen, Raynor NI. Cann~tn,
Gregory W. N_yv, Bracewell & Gitili~ni, I.LP,
HAR`I .t~C):E~:l:?, L"l~; Sec~tti 1,. Bti~~~a, Jel7'i~e}~ 7:rc~ Snyder,
~3ilzici Swnbe! g Baeila Price &Axelrod, LLP, MIAMI,
FL; .Tusti» 13reCt Busby, Bracewell & Giulilni, I.I,P,
For TRILQGY PORTI=OI~IU COMPANY, ['"~2~ LLC,
[nte~venor - n}~pellec: Yl~ilip Korolo~as, r;ric k3renner,
Boies Schiller S; ~~lexner, LLP, NLW YORK, NY;
Jennifer G. Altrna~~, Stephen N. Zack, Boies Schiller &
I~'lexner, I,I.,P, .MIAIv[l, FL.
I'ar UL'1~ICIAL COMMI7"IEiE (7TH tINSL"-CLII2~D
CR1~,DIT~ItS, Defend~mt -11}~pellaTzt: I.,awrez~ce S~iul
Robl~iiis, Nl~i~k A. Biller, Donalcl J. Russell, Michael I.:.
W<~ldntati, I2obbiias Russell l?nglert Orseck t)ntereiner
8c Satrber, LI,P, We1S]-~1NG'I'QN, D~.'; David C.
7'ollcick, P~Ltricia Ann Kedinou.d, Stcc~~s Waver Mtller
Weissler All~adeff'& Sifterson, i'A; MIAMI, FL,.
I~orNt11'IONAL ASSOCIA"1'IQN OI~ F3A~II<Rt_~P"]:'CY
IRtISTE ES, Aizlicus Curia: ChrisCopher J. V~,'right,
}~arris Wiltshire; 8i Cirannis, I.I..I', W~ISHINGTON, DL.
I~orI3ANKItL7YTC1' SCHOLARS, AmictGs Ciuiac~:
James $. Heaton, Ashley Coux~d Keller, Bartlit t3eck
~Ierauarl:Pal~ucl~ar &Scott, [,I,1?, C:HICAGC), II,.
l~or'1~1-I1; LOAN SYNDICn'1"IONS AND 7'RAI)ING
/1SSOC[i1'] I(.)N, Ainicus Curiae: "I~homas M. Mess~n~i,
Iviessana, PA, PORT Lr~I.7DLRDALL, F~L; Elliot Canz,
Tlie Loan Syr~dicatians anct Trading Association, NEW
1"ORK, NY'; Mark. A. M:cDernu>tt, (icor~;e A.
Limmerm~n, S~fidden Arps Slate Nlcfighcr c~ 1^loin,
l I,P, NEW YQRK, NY.
Judges: Selore -I'J()FI:AT, PRYQR 1Gtd FAY, Circuit
Judges.
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6801~.3d 1298, *1298; 2012 il.S. App. I.,I~.~{iS 9796, **2
Opinion by: PRYOK
Opinion
[~ 1301] PRYOR, Circuit Judge:
This barilu-uptcy appeal in~-ol~res a transfer of liens by
subsidiaries [*~3] of TOLJSA, Inc., to .secure the
payment of ~ deUt owed only by their p~Yrent, TOi.1SA.
Qn Jii1y 31, 2007, TOLJSA paid a settlement of $421
million to the Senior Transeastein Lenders with loan
proceeds from the Ne~t~ Lenders secured primarily by
the assets of several subsidiaries of TOUSA. Six months
later, TOLJSA and the Conveying Subsidiaries filed for
b~t~uptcy. In an ldversary proceeding filed by the
Committee of Unsecured Creditors of TOUSA, the
baiilcniptcy court avoided the liens as a fraudttlent
transfer because the Conveying Subsidiaries did riot
receive reasont7bly equivalent value; ordered the
Trinseastern Lenders to disgorge $403 million cif the
loan proceeds because the transfer of the liens was for
the Uenefit of the Trinseastem Lenders; and fl~varded
damages fo die Conveyvig Subsicjiaries. The
Trinse~stern Lenders and the Ne~~~ Lenders, as
intervenors, appealed. The clistriet court c7uashed the
judgment 1s to the Transeastern Lenders and stayed the
appeal of the Ne~v Lenders. This 1ppeal Uy the
Couimittec of Lhisecured C,reditot:s presents t~vo i5sucs:
(1) whether the bankruptcy court clearly erred ~~,~Ilen it
found that the Conveying Subsidiaries did not receive
reasonably equivalent value in exchange ~*'~4] for fire
liens to secure loans used to pay ~ debt o~vea only by
TOLJSA, 11 IJ.S.C'. §5~8; and (2) ~~~hether the
Trinseastern Lenders were entities "for whose benefit"
the Com-eying Subsidiaries h•~nsferrea the liens, 11
U..S.C. § 550(x)(1). We hold that bankruptcy courk slid
not clearly err when it found that the Conveying
Subsidiaries did not receive reasonably equivalent v11ue
fc~r the liens and that the b~nlcniptcy court correctly
rtGled that the Ti•anse~stein Lenders «sere entities "fog•
whose 1~enefit" the liens ~~>ere transferred. We reverse
the judgment of the district court, ~ffu•m the lilbility
i`uiduigs of khe barilcnrptcy court, ~n~l remand for Further
proceedings consistent with this opinion.
I. BACKGROUND
VJe divide oiu summary of the events tl~.at led to ibis
appeal iii[o three parts. We ~irsC recount the uncontested
t<icts that underlie this appeal_ We then review Yh~
iudinbs of fact and conchisions of law of Ulc
bat~•uptcy c~~urt. P'iil~lly, eve review the decision of tl~e
distx~icl court.
,~4. f~iicl~~al13ac7cgroriy~c~
As of 2006, "1'OUSl1, ]nc., ~~as tUe thirteenth largest.
homebuilding enterprise in the country, with operations
in Tlorida, Texas, the mid-Atl~utic states, and the
~vesten~ United States. T(~ie coi~lpluy ~**5~ I~ad gown
z~piclly, cliicfty by acgturi_ug independent hoivebuildcrs
that became subsidiaries of "I'OLTSA. These subsidiz~~iet
oti~vned most oFtl~e assets of the enterprise and generated
virtu<~lly gill of its reveizue.
To finance its gi•o~vth, TOUSA bono~~,~ed a lot, TOUSA
issued i,nore than ̀ ~l billion of public bends. "I'ha# ct~bt
vas unsecured, but ~~~as gu~iranteed by tl~e Conveying
Subsidiaries. TULJSA also bon•o~~ed funds under
revolviu~ line oP credit agree~ueut ldminist~reci by
Citicorp Nort11 America, Ine. "l he Conveyin.
SuUsidiaries and 'fOUSA ~~~ere .joi~itly as~d severally
liable :tor repayment of the revolving 1oau, wliicl~ ~t~as
secured by lie~is on flee assets of the compluies, Bc>th
the bond debt and revolving loan agreements provided
that an adcrerse judgment for more than $10 million
agai~~sl "I'Oi.ISA or any ~~~f its subsidiaries oc a
bankruplay Piling by TOUSEI or any of its subsidiaries
would constitute an event of defatitlt, which ~vou(d
permit the baadholders and Citicorp to decllre ~Il
outstaiidinb aniounYs of debt due immediately. As of
July 31, 2007, TOLISA had 1pproxuilately 51.061
billio~~ of ~~rinci}~~1 [ * 1302) outstanding on its bo~~d
ciobY and X224 milli~>n o~iY~Stauciing ou its revolving loaia.
Tu .Tune ?005, "I'OUSA entered a joint ~**C] venture
witi~ F'aloonG/Ritchie :L,L,C to acquire l~o~vebuilding
assefs o«~ned by Transeasteni Properties, [nc., in
Florida. TOUSA incuzz•ed tnore debt, this time from the
1'ransc~slern benders, to fiu~d the "I'rauscastcr~~ Joint
VenCure, Uul none of the Conveying Subsidiaries
becataie a~i abli~or or guaranCor of the Transeast~a~n debt.
The downturn in the lousing market soon tlu~eatened the
"Tr~nseastern Joint Venhtre. By October 4, 2006, the
Joi~ak venture had d~f~ultecl nn several obli~atiotas. At
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c,Ho r.~a 12~s, * t_,o~; 20 2 u.s. n~p.1.~-.ors ~~~~c, ~*c
the end of that month, the '1`ranseastern Lenders allcgc~
defaults end <lem~nded payment from 'TOtJSA. In
I~ecetnber 2000, the Transeastern Lenders sued
1'O[JSt\, aiicl .iu. Jlnuary 2O07, tl~e "I:'ranscastcrn L,end~rs
alleged that TOUSA ~~as responsible for damages oi'
nve~ $2 billiaii.
Ou hily 31, 2007, TOUSA executed settlements ~viCh its
partilei° i» Ylie joust venture and the 'Tx~ansenstern
I_,enders. '1~he settlements ~~equir~d '1~OL1SA to pay snore
than $42l iniliioi~ to tl~~ 1'raneastern Lenders. '1'0
(~ivance the settlements, `I'C)iJSA end some of its
siibsicliaries inc~iared new d~t~t. Citicorp Narti~ nnacaic~,
Inc. agreed to syndicate hvo new tC1711 ~08t1S t0 I~OUSA
and ehe Conveying Subsidiaries: a $200 ~~~iilion loan
lio~~a the First I.,ie~a. Lexaders, to be sec~~red ~~*7~ by
first-priority liens <>n il~e assets o:l the Con~~eying
Sut~sidiaries and "1'OUSA; and t} $300 million loan from
the Second l ~ien lenders, to b~ secured by secoud-
priority ].leas. I3c~th loan. agreements with il~cse Nety
L,~uders required that tl~e funds Ue tiisecl to pay the $421
~Uillion setfl~inent with ttie 'lr~nselstern I,~nders.
TOLJSA also aan~udecl its revolving credit agreement
with Cificoip.
'Ihe trans~iction vas executed iu several Parts. Fizst,
Citicorp transferred $47G,418,784.~0 to ilniversal Lair
'Title, Inc., awholly-owned subsidi~cy of TOUSA that
vas i.~ol <>z~e c>f the Couvey.i.zig Subsidiari4s. lJniversa]
I.;aud'1'iUe then sent a wire transfer of X426,383,828.08
to CIT, the admiiiistr~tive agenC for the Transeastern
benders. CTT disbursed the k~roceeds of that transfer on
July 3l and August 1, 2007. "['he `Cranseaslcrn I.,enders
mceived 5421,015,089.15 and the remaining funds were
dispersed. to third parties to cover p~~ofession~l, ~idvisory,
and okhec fees.
B. 13anl~rz~ptcy C:oiir•t Proceedings
Six moisths later, "I'Oi.TSA duel Clue Conveying
Subsidiaries filed petitions for bankruptcy under
Chapter 11. The Comrniltee ot~ Unsecured Creditors of
":COiJSA, nn behalf of the estate of "!'OUSA, Itrtca~ filed
an adversary proccedinb against [**8] the Ne«~ Lenders
and tYie Traaiseastern I.eilders to a~'oid ~s a fa~a~idYrletrt
transfer, see 1 1 U.S.C. § 548(a)(1)(B), the tr:luster of the
]sells to fl1e Nei;~ Lend~is and to recover th3 value of the
Liens 1iom the Transea~tein Lenders, sec ll U.S.C. §
5500)(1}. The Coinn~ifYae sllcged that the transfer of
the liens by the Conveying Subsidiaries to tl~e Nei
Lenders vas ~ fi•audiilent u~ans('er under section
548(a)(])(B) because the Conveying Subtiidaaries were
ii~sol~~ent when Q~e transfer occtnred, ~ti~ere nude
ins~~lvenf by the Cransfer, had unreasonably small
capital, or were unable to pay their debts when due; and
the Conveyi~~g Subsidiaries did ❑ot rece;ive reasonablyegtiiivalent value iii exchange for their trnnsfer. See l l
iJ.S.G. § 548(1)(1)(E3). The Committee demanded that
tlac bankruptcy court avoid the ]leas and order the
I'ranscastcrn Lenders, pis the entities "fc~r whose bencl:it"
the transfer was made, ll U.S.L. $ 550(x)(1), to
disgorge tl~e proceeds o(~tihe loans.
[*1303] '1-he "1~runseasCern Lende~•s an<I Nc:w Z,enders
responded that the tr~~ns:fer of - tlae lie~~s ~~~as .not
fraudulent because the Conveying Subsidiaries had
received reasonably equivalent value in exchange for
their liens. The 'Traiiseastez~al Lenders and New LEnders
[**9] hi.~;hli~l~ted nuinerc~us ~~uiported benefits oP the
transaction, but the c~~ucial som•ce of alleged ̀ ~a1ue for
the Conveying Subsidiaries was the economic benefit of
a~~oiding default and baukrttptcy. `['he 'Transe~stcrn
Leudei:s and Ne~v Lenders contended that the
1"ranseastern Lenders were likely to secure a judgment.
againsk "COt1S~, which would have cc~nstilufed a~~ event
of def~tilt ou tnorc than .~h~1 billion of debt that the
Conveying Subsidiaries had guaranteed. The default
would have likely f2~rcecl 'IOiJSA and the Conveying
Subsidiaries into ba~~kruptcy. 7'he h•ansaclion st~ive:d o:lf
this event aid gave 'I'OUSA and the Conveying
Subsidiaries an opportunity ko aonYinue as ~n enterprise
anti possibly become prol'~tablc again. "I'he '1'ranseastern
L,endei•s and New Lenders cont4nded that this
opportunity ~~-as reasonably equivalent in value to the
ol2ligations tUe Conveying Snbsidiarics incYlrred. 'T.he
"I`rauseastern I.,enders and New Lenders also argued Heat
t}ie Conveying; Subsidiaries received numerous other
benefits, iucludin~ a hi~;tier, debt ceiling oi~ the revolviaa~
loan, nee-v lax hene:Fi.ts, the al~imination o:f adverse
business effects fro1~n the ̀ 1'ranseastern litigation, and d1e
opportunity to retain access fo ~raeious centralized
[**10] services provided by "I`OU:SA such as cash
management, purchlsiug, cud payroll administraYian.
The Tra~lseastez-n i.,enders nrgtied altenz~tively that, ii'
tl~e tr~~nsfcr of liens was frzruduleut, they could not be
liable as entities for ~vl~ose benefit the transfer was made
because they ~verc subsequent u•ansferees of the loan
proceeds Iaoan ~~OUS~1, not F;ntili~s that i~4nc:(itted
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(fi0 F.3tt 1298, *1303; 2012 U.S. A~~p. I.,~';XIS 9796. *~10
immediately from ~1~~, transte~•. See I 1 U.S~C. ~ equi~~nlent value.
S50(al(1),
A#der a '13-ctay t.ri~l, chiriz~g wl~icl~ the U~a~ka-uptcy court
heard ezt~nsive ftict and expert i~sfim~ny and admitted
Dues '1800 eYh~bits, ll~e bankruptcy court issued its
rncG~i~gs of fait and co~elus~ons of law, 5e.c O~Ttic~ial
Coil~tiittee of Unsecured Creditors of 'TorEsn Irtic. v
Citicorp North America, Tnc., (In re "1 OL1Sl1~n~, 42'2
I.R. 783 (13aa~kz•, ~ :i~. Pla. ?009j_ "fltie bai3hx~€ipt~cy courC
found t}iaC tl~~ Goi3veyittg Subsicliax~ics wzrE un~bl~ to
pay their clebls ~vhc;n due, had unreasar~ably srna(1
capit~i(, z~uc~ ~~~r~ l.i~solve~nt befin~e a~~d rilZer the
transaction; that the Cortveying SuUsidi~ries did pint
receive value re3sonll~ly equivalent to the ~40:i uiiilion
ak' obli.~a[ion~ they incurx~:d; a.nd that khe "]'r7ilseasternI.,enders ~~sere entities for whose benefit llac C~omcying
Subsidiaries gra~ited liens to [**11J the Ne~~~ Leaders.
"Che bank.~~a~~tcy cnurt credited c:~p~a-t o~ini<~c~ tcstian<>z~y
that trio Convcyin~ Subsidili°ies were insc~lv~nt t~oi7i
b~fare ai~~d after fl~~ transachi~~n at .luly 31, 2-QO`7_
Experts m .reel ~SCEtf~ v~ltie, public accounting, and
insolvency examined the tilanci~ilrecords of T{)C1SA
end the Gom•~;yin~ Subsidiaries anc~ cancltided that the
li:it~il:ities ~F each o.[' ibe Goi~veyin~! Sut7sizl[aries
4xceede~l the fair vnlue ~f their assuis before the
t1•flnsact~ioi~. The trankru~tcy com-t found fllat the
Cazaveyin~ Subsidin~-ieti becrin~e even x~~a~•c deeply
i~~solveni Aficz~ incu~7•i.tag additional debt througi~ lt~c
transaction. I"he t~~ukal~ptcy coiu•t also credited e~pei•t
Qpizii~i~ tesCinaouy that, after the transaction, the
Conveying 5ubsi.diarics laid imrcasot~t~l7ly small capitt~l
an~~ were iznlble to pay their debts as 11icy o~me due.
"1"he hank:~•upicy court tl~e~~ assessed wl~ethcr the
Conveying Sul7sidial•ies r~;ceived r~asotiably equivnl~i~t
value from the Crana~ctinn. The har~k~~uptey curt firsC
nc>te<I that lLN7~ f ~ "v~ilue" is dc~necl in secti.c>u S48 as
ta4ilig °pr~~rerty" or "sat7sfaction [* 13~~] or seouruig of
a present or flntecedent debt ~f the debCor." 1 t U.S.C. y~~~
S48(a)(1)(~3)(~), (d)(2)(e1). 't'i~e~ bankruptcy court
deteriiiined lliak "tl~e Con~~eyiri~ S~ibsidiarics could
[~~12] nc~t rcevive 'property' nnIess they ~~l~taiued some
kind of enforceable entitlement to soma t~n~ibl~ Ur
intan~ihie article.° In re '1'OLJSA, 422 13. R. at R68 ~a.SS.
F_Tix~lel• t~1is c~et~3ziiiion of "value," kl~e bankruptcy ce~ut~t.
fou~~d tl~~t, because tl~e C~~nveying Subsidiaries chid not
receive piny property, they ctici nc~t receive reasonably
Tha bankrul7tcy courk ~ilso iss~ied alterna[ive l~aa~diia~s in
~vl~ich it assessed tlic value tlic Cai~vcying Subsidiaries
ceceiveel under r}ie broadest deti~tilion of "vahie"
prt~l~oseJ bV fl~c~ Transeastern I:endcrs and New
I.,cnd~rs. "~lic bankx•uptcy court found thal, ~vei~ if ail] the
benefits highlighted by the TrFinse~stei~ti Lei2ders and
New I.ei~aers were 1e~ally cognizable, their ~~~h~e
~~~onsideeEd ... ~s a ~v1~nl~, , . i1e]11CJ ~~rell s]i~ri of
`reasonably equivalent' vahie." Id. at $59. `I7ie
bank~tiiptcy court determined t71e value tha Conveying
~ub:~i~l.iirie~ ]osY .iz~ t]ic tr~ms~tet~ion ~nt~ o<~n.~pt~red tlr~t~
vatt2e ~~-itli d}ie value of the benefits titiey rccei~=eel. The
1raY~~uptcy eo~u-t determisted that tlYe tax hen~flts,
properly, end sear ces that the ̀ Cr~nseastero. I.,enclers €~~ci
New I.,cndexs pt'ofrered dill not• provide rea5on~bly
equivalent vakie to t11e Conveying Subsidiaries. "The
bankk~liptcy churl [**13] also fom~cl ilia dze transaction
c~~uld not Uave ~~rovidcd substanital value pa~edicatcd on
the opportunity to avoid l>a~iki-c~ptc~~ because the filing
of baiilcri~ptcy became "inevit~b(e." I~t. at fi46. The
bankruptcy court ca~edited the ~;x~~art' npinioi~ testimony
of an ~c,c~unt~~~t tiul~o }tad c~lcul~tecl that t11e Conv~yitig
Subsidiaries had incun~ed ` 403 million of abligatinns
when tl~c:y granted liens fo hc;lp secure ~5f~0 mil]ion. <~~f'
loans Ft~aul t}~e New I,end~rs.
`.Clio bankruk~tcy coua•t 1:outad [list the willeged bexxe~ts cif
tl~~ tran.sactic~n ~vece irisuhstan.tial. "I'he '1'rf~~~seastern
Lenders and Ne~v Lenders alleged kliat one of die
Conveying Subsidiaries received control of ~roy~rty
feozn tl~e: "I'raixseastern vcnYi~re, bait the bank.~•u~~tcy coiu~t
found 11iat d1e property vas worth only S2~S million and
was burdened with $3" million in liabilities in accounts
payable end ~ust~7mer ~Jepo~ii~s. "I.~hc; btnak~a~uptcy c~~urt
i-~fused t~7 4tedit the prv~eiKy as value. '1~lio t7a~ikG2ipYcy
court also rejected the ~rgtmient [~ 13A5] of Yl~e
I.'r~mseastern I:,et~ders ~nct Ne~v I.,en~ters that il~~
Gon~~cying Stiib~idiariis received vt~llti~hle fax benefits
fi•~~m the transaction. 'I~l~ie Transzattef-n I,e~i-lers anti
New LEndexs argt«d that losses ou the Traiis~~stern
venture could reduce p~tsl aid future ['~*.l~F] taa
liability, b~1t the bankruptcy coiu~t found tliaf the
C-onveying Subsidiaries received no bei7e~ts because tl~e
l~ene(iks would accrue to TOI1S.n, not t7ie C'oi~~eyin.~
~;ul~5icli<iries, nYid rill cif tl~~ substantial loss-generating
~vEnts that ostensibly prose fiom the transaction ~~ould
hive :iccr~iect ~~~ithouf tla.c~ traa~saction. (I'lae `I'r~nse~istarn
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(iR0 F.3d ]29ft, *1.30 ; 2012 T?.S. App. T.,I:iX.iS 9790, *'`14
I,endeis and New Lenders argued that the '1'rauseastern
litigation had izegative effects on the day-to-day
business optratians aC the Conveying Subsidiaries end
that Che; ,luly 31 iransactic~n conl;crred au i.udirect benefit
on the Conveyi~ig Subsidi~-ies try elii~~inating those
eflects, l~uC ilie baiilcn~ptcy cotirC found t(ial those
arbun~ents ~~~erc unsupported by the evidence. The
blrilcruptcy cotut also found that the purparted benefits
~~f' cax~tit~ued access to TOUSA corporate services, such
as purchasing rind payro]l administration, were not
received by the Conveyinb SuUsidi<iries in exchange for
their liens I~ecatise Yl~e Conveying Subsidiaries enjoyed
<ill of these benei~its be.fo~r~; the transaction and co~ntiuued
to enjoy the corporate services even aRer ~I~Oi.JSA filed
far bankruptcy. "I"he bzrilciliptcy cotiirt rejected the
argttinents of the 'I'r<~nseastern I,enct~rs and Ne~~~
I.eudcis tl~trt the Com-eying [**]5] Subsidiaries
obYnined value because the transaction allowed tl~eConveying Subsidiaries access to an enhanced revolvi~i~oredit facility. "1'l~c '('ranseastein l,e;nders and Nc~~~
Lenders asserted th~rt, when "TOUSA acquired assets
ti~om tl~e Transeastern .Toint Venhire, tke borro~~~ui~ li~aait
on the revolving loan incre~~secl, but the bazikniptcy
court found that there was no 4vidence Yhat the
Conveying Subsidiaries had any need fora higher
borrowing; limit on khe revolving loan.
"I'he bai~uptcy court found that an earlier bankntptcy
liar T'OTJSA would not have seriously lia~lnea the
Conveying Subsidiaries. Two ex~~ei•ts testi:ticd Yi~1t a
TOUSA bai~•uptcy would not necess<~rily have caused
the Conveying Sub~idia~•ies to declare binkruptcy
because they held 95 pezcent c>f' tl~e clssets o1~ tlae
"I'OUSA enterprise, which they could have used to
obt~~in new finavcin~. The b~nk~uptcy eoui•E credited this
testimony ~» d (i~und llaG~t Cc~nveyiug Subsiaiaz~ies would
not have bee~1 forced into banknipfcy by a "I~(~USA
b~t~uptey. T'he banknrptcy eo~trC ~ilso found that tt~e
Co~aveyin~ Stiibsidi.aries c~~u1d l~a~~e opar~ted asindependent entities ~~~ithout the sea>ices provided by
"I~OUSA.
T'he hank:ruptcy coLu-t found that °even assuming ll~at all
of t}ie '1'OLJSA [*'" 16J entities would have spiraled
~i~nmedi~tely into bnuknipicy ~vitliouf tl~e July 31
'1'x•~Ltasaction, thu "Tratisactio~~ lvas still ftae more I~aanaful
onion." Id. zt 847. Thy Uanlrrtiiptcy court foiu~d tl~aY
bankruptcy for the Conveying Stibsidiaries was
"inevitable° i[' TOIJSA executed lla.e lransticti~~n, id. al
84(, so the tr~usaction could not h;~~re conferred value
by giving the Conveying Subsidiaries an opportunity to
avoid btnikruptcy. The banitruptcy court [i>und Chat tha
mauage~nent and coutrollinb sl~arei~olders at 'I'OU;SA
decided to risk h~uidreds of millions cif dollars of their
cieditoa~s' ~z~oney despite the impending disa,~teC• tl~e
cc>tnpany faced.
These 6ndin~s by the bankniptcy court ware supported
by public data and iutcx•nal analyses and
communicaCio~is from "T'OiJS11 insiders that s2io~ued Yh~t
tl~e tra~asaction ~~~otiild almost certainly fail to keep
"1'OU;SA acacl the Conveying Subsicli.aries out of
ba~ila•uptcy. fay the end of 2000, it was cle~~r that
TOUSA ~~~as liable to the Transeastei7z Lenders fot~
defaults oia floe joint ~re~ature, but the extent of ll~at
(iabiliiy ~~ud ~vl~.elher 'I~Oi.JSA could pay brick ifs
creditors and, if' so, how quicldy, t~~cre still in doubt.
Ia~t~rnal documents revealed tl~~t T~L.JSn insiders
realized tl~~lt the liability o:f [**17] the company to the
1~rinseastern Lenders could force 'I'OUSE1 iirto
bankniptcy. L~hnaan Brathez-s prepared a bankniptcy
~~alerl~ll .~ii~,alysis [or TOjISA fit Fcb~~uary 2007. Day>id
Kaplan, a senior financial advisor to the CEO of
TOUSA, suggested in early 200"7 that the company
needed a Chief Restruotut7cig Officer. Chi April 1.~,
2(?07, harry Young, an advisor to '1'OLISA foam
AlixPartneis I~LP, wrote to Stephen GVa€man, the C1=Q
of "1'O[ISA, °~W~l~.y rush to restructure in a ~to~~,~u n.~arket
~~-itU a bad set of terms ,just to t71e in 3 months. If we
need to file due to the lenders/sh~rehold~r issues, then
lefs [sic] do ii~ no~v and szve ourselves about $50 million
i~a tt-nnsactic~n cost!" Wa~;naa~i a~reeci ~~,~ilh the
assessment. On May I, 2007, Klplaii sent 'T'ony Mote,
the CEO of TOUS~1, a financial analysis of TOUSA th~~t
ack.~ao~vled~ed the dec(iniaa~ liotising markets aucl skated,
"[A]IYhough we can agree to ply Creditors in full and
wiCh interest if p~y7i~ents are postponed, eve caimot
a~~focd to pay them cash u}~ fro~al."
Min end Wngitizan both lrgued that TOUSA should pay
pert of tine sett(enlent with an iufiision of equity to avoid
taking nn mare d~bY. Both ~;acre concerned that [* 1306]
increased debt 1i~om tl~e settlement confer severely
constrai~a tl~e conap~ny. [**14~ Notes nn a Mon's drift
pa'eseukatlo.n to the Board warned, "~ W ~e must build ixa
the c~~pacity in this model so t11at when the msirket does
hirn, the have access fo capital to build/sell product. If
w~ can't do t~lais, we are to~ist~." In ~1pri1 al' 2007, Nion
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680 F'.3d ]2)8, *]30C; 2012 U.S. r~F~p. i.,f.iXiS 979C, *~14
sent information t~ ~i financial ~dvisoc of the controlling
shareholders stating Yhat the settlement ~n~ould lea~~e
"IOiJS[1 ~~~it1a excessive debt; tht~t post-settl~uient
"I~C)[JSt1 would Have limited access fo the eapit<il it
would need to Qrow its business; and [hut Che ability of
'I'OLJSf1 to escape frvin under iCs debt cotila tie inhibitee:!
by sibnific~int risks i.nc]Lidii~~ :firrtla~r deterior~rtiou its the
housing market, filling land and borne values, and
ftu•tlier we~ke.uin~ in credit markets. Waltman likewise
ti~rged the co~~frollin~; sh~irel~oldcrs to cc~usider a
setYleizient that would include little or no neu~ debt for
I'OUS,~1.
Despite the ob~~ious risks posed by taking nn more debt
during a housing rn~cket decline, the controlling
slaareh<~Iders of TO[.ISA, t11c Stetagos i'~naily, ~~Pposec!
piny setflemcnY deal ti~at diluted their egliily position.
They directed Mon to terminate discussions with
potential iir~~estors until neev tluancing and tl~e
1'r~inseastezn settl.e~veut closed. Due Lo constraints
[**19] imposed by the Stengos family, 'TOUSA
decided to fund the settlement solely t~itl~ ne~~ debt. The
deal would make 7~OLJSn fhe most hi~l~ly-leveraged
company in tl~.e industry.
in the months p.xEcudi.xag Uie July 31 closing of the
transaction, public and pi•iv~te assessments ivade clear
Chat the ti~iancill position of TOLJSA ~~~as moving, as
oa~e secu~~ities aa~alyst wa-ote, ~~froaa~ bad to ~~~orse.~~
Investors recognised the dire sh-ait5 iliat ':COi.1S.~1 faced,
as evidenced by die drop ii1 TOtJSA stock prices from a
lugl~ c>f "x"23 per shire in 2000 tc~ just $4 per share by
April ?007. 'I'Oi.7SA bc~iids traded at discounts <~f 30 to
40 ~~ercent of face value in May 2007. After "1'OLJS~1
presented tl~e proposed July 31 tr~usactioil to ratings
agencies, its corporate credit rating dropped.
In the same period, tt~e national housing market was fast
~ipE~ro<icliing collapse. (.)n :May 29, 2007, Mc~a~ az~ci other
TOiJSA executives received a report that Standard and
I'oor's had do~~mgraded the bond ratings ou several
major ho~n~biiilders front stable to negative. (7n 7tm~; 6,
2007, TOL7SA executives received a .report that the
National Association of Realtors vas predicting that
prices of ne~v h~~ines 4vould fall 2.3 percent, and prices
of existing .iaoaiaes would fall .1.3 [**20~ percen.t. Mora
1.'or~va~-ded the report to the Board and doted, "PYI, this
represents [ ~ the first time iii 40 years that the US
naedztua hone p~~ices h<ti~~e decli.nect."
'1'OL1S~1 man~g~meiit recognized the implications of
this iiur~nci~l trews for• the proposed settleu7ent. In an
e.nlGiil to hiulself~ ou Mtiy 25, 2007, Waltman notett ti~at~
tl~c otirClook of the ratinb agencies 1'or tl~e i~omebuilding
industry «~~s "grim and getting grimmer," with
down«~~rd pressure on prices and mat•~ins. IIe expressed
liis cot.~cet7is about the pre;carioiis 15nancitil positio» of
T'OI.JSA end the proposed settlement in especi<<lly
colarfiil language thlt ~~ould prove prophetic' "As CFO,
and in li,~lif of all of this market imcerCainty, I have
absolutely no desire Yo 17y this plane too close to the
gro~u~c{, achieve some froan ~sic~ of cozisensu~l
settlement today tmd crash within the upcoiniiig year.
"That ~~rould he a clusterfuck." In an email to the 13oaA•d
on Juue 14, 2007, Mon stated that the company had not.
anticipated the degree to which problems in the
subprin.~u i~~ortga~e segroeixts were spreading to less
risky mortgage segments. Mortgage lenders began to
iaaiplement nia~~e restrictive imder~vriting practices for
r~sidentiril tno~~tg~~e loan zipplicotions, deana3~d
higher ~*1307] ~**21] interest _rates, and revoke
coirmiitments to homebttyers. These dev°elopme~its, Mon
obset~ved, "could Rave a cascading effect down the true."
Mon told the 13oacd, °dais housing correction is f it from
over." At the Board meeting on June 20, 20 7, ~t~ which
the Board apa~roved tlae July 37 kransaction, Mon
in:l.'oriucd the Board that the U.ti. laousin~; market was at
its io~vest point since 1991.
On Julie 22, 2007, Mon. sent the Sten;.;os :lainily's
tinF~ncifll zidvisor a m~~no ~ entitled "St~~ztegic
Alternatives," ~y~hich bean by acl~ziowledging that
°[f]Ixc 'I'1; settlex~ae~at leaves 'COUSFI in ~ vexy diflicnit
position." Past-trinsactio~i T~OUSA would be "[o]ver-
leveraged," °[~v]ithrnrt access to the capital markets,"
"~i]n tl~e middle: ot~ a serious laoltsing correction,"
"[f]orced in reduce assets at Yhe'wron~ time,"' °[i]n need
of a si~ciificant equity inrusion," and °[u]nabla to
sua-vive sh<:>uld laousin~ cociditiozas dega~adc; fiirtlier c>r the
hotisiug cocrectio.r~ lcn~thcn tipprcciably." Moo's
mernorF~ndum predicted that zj "Stay the Course"
str~te~y—even when co~tF~led with the coi~~pauy's de-
leverabing p1~n- ~~~ould leave "I'OL1SA imahle to service
its $7 laillioii of bond debt, at a "competitive
dis~dvantnge," with "[a~apitail [c7onstr~ints° Cl~~t would
allo~e (**22~ ~~[h]tjrely eut~ugll oxygen' t~o sluv.i~ve,~~
"[I]ittle room fir• error; increased risk of crashing ana
bainin~," "[limited ability to re-in~t~est in the business,"
az~ci °[a]l~tirays on the brink o(' 4lefaulf." Tlae °[e~~~ci
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Aso r~.sd ~~~~s, *~so~; zo~z u.s. n~~p. r.,~ xTs ~~~c,, ~~zz
[r]esult" of the strategy, Moil :~ckuowledged, ~voulcl he
°[i]ncreased risk of failure and inability to ~vithsland
~vors~;nii~~ t~usiuess conditi~>its."
The ba~ilcruptcy court found that Mon reached these dire
conclusions before tihe Junr; 20 Bo<ircl meeting <rt ~-vhicil
the transaction was approved, Mori exchanged a
stiibstantially identical version of ttze memo with Tommy
McAllen, then ~n e:cecutive vice president of TQt7SA
and ►'resident of the "1'r~t~~seasfern :loint Vcnhire, as early~~s Juna 17, 2007. 'l~he banluu~tcy coLtrt found that "raj
more complete end prescient pr~dictiol~ (fhlt tine ekl'e-ct
oP tl~e "l'rauseaste~x~ transziction would be to leave
"I'O[JSA ~~~ith unreasonably small capital) would he hard
to imagine.° In re TOUSA, 422 B.R. at 795.
to the six weeks betwccn Mon's assessment that the
transaction ~a~ould leave Z'OUSA "[u]uable to survive
should l~c~using conditions degrade frn•tlier" turd the
closing of the July 3.1. transaction, lZousing conditions
unquestionably degraded further. On June 27, ?007,
Mon sidvised the Board ~**23] that I.:enuar, a national
l~onle bt~ilclez b~isEcl i~~ Miami, rapox•ted a "veay u~,ly
quarter" ~~~itli "more ugliness to come" zs "housing
~uarkels ...continued to deteriorate." Mon testified that
"il~.z~ougho~it llie summer eve co~atixau4d to see a
downward slope in the housing ulark~t." Ou July 9,
2007, Mon sent the Board copies ot~ lrticles from
13arrc~n's aunt l'he Wall Street Jounaal ll~at Mc>n
described as providing "nu-relenting negative news oia
housing." Bairon's foresl~~~ that 11c~me sales voluule
would decline another 2Q to 25 percent. The Wall Street
Jotu:uzil reported flat declininW hotnc prices would
increase impairnients f'or Iic.~meUuilders end decrease
their book valises "for the foreseeable fiiture." By late
July 2007, McAdea.~ aescti~.ibed the Florida laomelniilding
market as havuig gone from the "hottest market" to
being "at the bottom," ~~vith the worst yet to come for
Sotttlawesl ~~ lorida.
Financial reports fi•om TOIJSA revealed the effects the
housing dot~nturn ~~~as linving on f6e con~p~ny, '['OiJ4A
sales in the 17rst quarter of 2007 plunged more than 1G
percent ti~om the comparflble gix~rter the previous year,
tl~e number of homes iu de~~elopment fell more than 20
pez•cent, ,:nod its profit n~ar~;ica declined. 'I'l~e cz-ash
continued in [~"~24] tl~e second quarter. On July 12,
2007, 'I'pt,JSA notified investors that its ~*1308]
deliveries ~i~aci sales dropped I S pc~~cenl, homes under
construction. fell 29 percent year over year, flee
cancellation r~~fe on s~1e contracts rose to 33 percent,
end l~roPit marlins coiatiilued to fall. Intern~i) financial
reporting shoved similar cieclia~es fi~oin the k~rior year.
Ntttnerous a~aalysts, slings agencies, and inarkc;t
participtints recc>goiud tl~cit 7'OL7S~1 vas deeply
troubled. (fin May 16, Debt~vice reported that TOUSA
bond(~olders 11~id warned that the company would be
entezin~; the "cone of insoh~ency" if it took on ne~t~ cleht
fo settle with the "1'i-~nseastern Lenders, and flat sonic
cr~dit~ars of TO[JSA "believe[d~ thaC the proposed
seCtle~~ae-apt could force the company into ~~n eventual
~iaukruptcy." Iu July 2007, ratings agencies Moody's and
SYflndflrd & P~~or's both do~~ngraded their ratings of
"I'OUSn bonds i.xa contemp]<itioa~ of the July 3 ]
tr~i~saotioi~, concluding lhat'('OLJSA was "noY li.k~ly° to
be 2t~le tc~ meet its tin~ncial obligations. I3y July 31,
2Q07, uuseoured TQUSA bonds were selling at
discounts as ]o~~~ as $O.45 oia [he do]]ar.
T1~e bankruptcy court also round that tl~e sy~~dication
process .for the zae~~ lo~ius in tlae transaction rel]e;cted
[~*25] the perilous position of TOLJSA. As the l~ousit~g
sector and `TOUSA continued their decline, the
syndication. market kirr the ne4v loazas became "(~n)ore:
challenging,° znd the cost ~~f the transaction loans to
"I'OUSA increased. At le~lst as early as July 24, lenders
were ciroppiug out oP tlis deal. ()zae of ll~e Lead bankers
ou the deal far Citicorp, Svetoslav Nikov, informed his
colleagues that. they ~~ere losing syndicate plrticipants,
and "[t~l~ings ~uo~•e looking ugly out there." Mani
McManus, the Citicozp eng~Lgcment lc~tder, descril~eci
leaving "panicky" messages about t1~e deal as the market
got ~~rorse. Tn a July 24 ezuail tc~ TOI7SA uianngement,
McM~inus urged "I~Ot15A to be prepared to close the
loan deals soon because "tl~e [mark~E] ]1as completely
dried up," and °~t~he market is going from horrendous to
worse." Neax•ly Ralf of Q~e ~~rospeckive lenders for tl~e
3~irst Lien'l~eilu Loan dropped out of the deal in the Polu
days preceding Jtily 31. Citicorp had to proti~ide
significant pricing i~acenCives for the leaad~rs, which
raised borrowing costs 1'~r 7:'Oi.ISn. The final group of
New Lenders included some firms that were lenders on
the Trause<~stern debt that the new loans paid off.
"]'hrougl~ the traa~sactic>n, [liese lenders essentially
**2C] converted their unsecured loans to t1~c
Transeastan~ Joint Venture into secured loans to
"[`OlJS~1 <~nci the G<~.za~reyi~z~; Subsidatiries.
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G~0 F.~d I?94, *1308; 212 U.S..~pp. I.IXtS 97~)(i, **2G
The bank~ztptcy wart ;voided t11e Erai3sfi:r as fi•axidulent
tinder section SAS and held fllat Ilse "l'ranse~stet7i
I,eriders were "c;utities for ~vht~se benefit° il~e liens were
traus.ferred_ See: 7 1 IJ.S.C~. § 55O(~i)(l). "l:he batakniptc_y
co~u-t held fh~~t, under confrollin~ precedent and Qie
plain l~~inguage of sectio~~ ~SSO(a)(1), khe ""Pranseas~kern
L,ende~~s directly received tl~e be~uefit of t9~e "I'c~~is~etinn
and khe Trarrs7etioii vas undeiiaken with the
un~itibigYious irttoc~t that they would do so." In xe
T't)tJStA, X122 i3.R. at 870. "I'l~e bankruptcy cotfrt avoidedthe liens can tl~e assets o1'lhe Conveyii3g Subsidiaries and
ordered the 7~r~nseastern LencJers to disgorev ~4C13
tuillion a~~d prcjlFdgment interest :Fi~~• the periaci behveen
J~~ly '3'l, 2D~7, and October 13, 2009. Trorn klac
disgorged f~mas, the court ~t~arded clte Comtnitt.ee
ciat~t~bes to cover the tr~aisaciian cost:; relaCed to the
causunam~tion of Ll~e July 31 tz•ans~Yction; file costs Ll~e
debtors and tlic Comiuiti~c incutrze~ in the ~rosecutioi~
of the ~~3versai•y proceedi»g, uicludinb fees aril
expct~ses paid to ~iYtoru~ys, advisors, anc~ ~aperts; ttnd
the diinintGtion in t~hr, ~**27J va}u~ of the liens bettr=een
July 31, 20Q7, and Uctol~er Y3, 2009: 1'he banknlptcy
coLtrt l~el~l Ch ~t tl~e t".oi~,ln~ittee was entitled t'o ll~e
diminution in the ~~alue cif the liens because "if tli~ carat
limits the Trustees tc, rec~~veiy [*1309] ~f the property
itselt, ~nct if the property has c~e~]ined iu vttLue, the
csfate ~~c~iil l~sve lost' tlac o}~partunity~ f<> dispose of the
~~t-c~~7~1ty ~.~t7or to its clepreciakiot~~." Id. ~t 853 (+.~uotin~,
I`elfm~an w. Wu-~niis ~ re ~tti. W~~y Setiv. Corp.), 229
13.R. 49(, 532 (F3~nkr. S:D. ~~la. ].499}. "flee l~ankniptcy
ec~urt ordered that the remainir~~ trails be distributes Co
the Pirse and Second Lien Lenders. Eiec~use the
setl(ement lire '('ranseastern i.:enders had reac:hecl tivith
'1'C)USA had been undone, the; baukrttptcy court rest«red
the unsecured claims of the Transeast~iyi Leaders
against ~['OtTSA antl itti partner in. fh~: joinC venture.
C. L7islr~icz Court Pro~eer~iva~s
The l.rtmse~isten~ I:encters anc~ the f=irst rind Seeonci t.,icn
Lenders al~pe~led, ~~nd their cases were aseign~d to tlirec
separate district coirz-i ,judges. After a series of ta•a~i~stzrs,
fine appeals by the 'Traxxseastern I.end~rs were assigned
to wile judge and four appeals by the Netiu I,endei;s were
assigned Co anottYer _j~idge, ~'Iiis appeal arises tr~~m the
live ~k~pe<~Is by [**28~ the ":[~r~nse~stei-~~ benders.
Tlie dis~~ict coiert issued art antler rluashitig the
b~~n~nG~~tcy court decision as it rel~te~ to the liability of
the Ttanseastern I~eaiders, 3V Capital Master Fund Ltd.
v Ol~icizY] Ct~n~in cif llt~seciGred Creditcir~; ~~f '['()11~;t1
Ina, 4~4 .f3.R. C13, (i8(,) (S.l:~..E~la. 2U11). ~I.~Jae district
court }~~ld tint, as a maker of law, the baiil.'~upt~cy court
hnd f.00 ~u~nroy~ ly deline~ "va1Ei~." ~!'h~ ~listrici court
cited 1 '1'l~i.rd C.irctUf decisao❑ that field that NN2~ °J
°[t]he mere opportunity' to receive ~n ecoriotriic berieYit
its the fiiture cunsCin~t:es 'value' trailer f11e Code.° Mellon
T3ank N.!1. v. ()fCxcial Comniitfee o1' i1«secureci
Creditors oi~ R.M.L., lnc. (Ian ~~c R.M.L., Inc.), X32 1'.:~d
13.9, 14~ (3~j Cir. 199Cj. 'The district court also relied on
a cfecisi~n of tl~e l ighth Circuit hurt explained th~~lt
IIN3[ ]the con~ec~t w<~y to dz;tcilnu~e "v~tl~i~;" vas not
to aei~ine it "only in terns ~f' tan~il~ie property or
n~rark,atable financial valEle,," buC insttt~~d to "ex~nune[~]
gill atipects o:f Use h~ansacfior~ and c~zei:ul(y mcasure[f t~l~e
v~h~e oF211 benei~its nn~-1 burdens t.o the debtor, direct ~r
indirect, incluclin~, 'indirect econoiY7ic benefits.'" United
ytates v. Crystal EvanRelicuil li`ree Chiu-ch (Inr~ Youn~1,
82 f~.3d 1407, 1~11~ (&th C-ir. 1996) (inte:n~nl
(*^~29~ c~ttotatiorti marks omitted) t•~acatea_~~_n____._~~ther
ro~~~ls, 5?1 U.S, 1114,, Ill S, Ct. X502, 138 l .Via. 2d
1(307 (1997). "l~~he district cout-t als~~ cited 1 decisio~~ by
our Court tlia( stated CliatHN4[ ] .Section 548(x) "does
not atttlaorize voiding a tr~ns~cr w~ieh 'comers au
ecouc~.mic benefit ~~po~~ tf~e clebior,' eiYhcr darcctly or
indirectly." GIB C.cediC Carp. v. l~i~irplro (Ii1 re.
I~otlrieuez .895 F,2d 725, 727 (111~1i Gir, 1990) (citiu~;
I~ubi~i v. ~l:tr. fi~nover "l.~rusf Co., C6.1. F.2d 979, I91 (?d
Cir. 1981.)); see alsn 5 Collier (~ri I3~nkiuptcy ~ 544.05,
at 548-67 (Alin N. Resiiicic & I-Ienry J. Sumr~~ser eds.,
16th ed. 2OOC) ("'1'ite niture oC the vtilue that i:; recci~~eci
.need not be a f<+ngible, direct e~cmomic bene~k An
indirect econc~mio bene~k can s~rffice, so l~~ng as i~t is
'P~~lirly cc~nerete."':). "[fie ~listriet court caucludecl that
indirect Uenetits, including llae op~orkunity t~~ avoid
l~a~ilu-u~tcy, could c~ustitute "value" nnd~r seotion
548(a).
The district court than determined t13at the I~~ttilcritpYcy
c~7ui-t dearly erred ~~h~u it fntind ll~af the Cote-eying
Sabs.tdiarics hr~d a~ot rec~;ived reasonably equevalenl
vahee fcotn the frazis~ctiaii. ̀ I't~e district court fo~ind Y1~1t
the trai~sacEi,an gave tli~ Gonveyine S~~bsidiari~s thN
opportnnily to avoid bankru~~l~cy, continue as going
[**3O] concerns, and make further paymeilt:s to their
creditors. The ~-lish•icC courC loi~nd that these benefits dici
z~ot uc:ed to be gtrantilied Co establish rea~on~ibIy
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f80 F.3d 128, ~1:~09; 2012 U.S. t1pp. I:E:XI'S 9796, *~30
eq~uyalent vahie. "Liherently, lhise l~~nefts have
iin~nense econc~~nie: vzlu~ that ensure ilie debtor's net
~vcn•th has heen pr~sea,ved, and, hss~d on the entirety of
this record, there riot disproportioi~~rCe between ~~hat
[~`131C)] ~i~~s gives up and what tivas received.° ~1 re
'I'QLTSA, 4~4 B.R. at Cfi6.
Tl~e district coiYrt also held that the Trarise~st~ern
Lenders could not, as a matter of la~v, be liable as
"erttiti,es far tiv}a.ose 1~~;~iefit° Uae t~•ansfez~s ~vex~e ta~ade
be~a~ise tlluy did not I.yenefiY froi~i the transfer of the
liens t~~ ttie N~~v I:enders within the mewing of see~tion
~SO(<t)(1'). "['h4 ~l.istriet cc~ut~t }field flat the "['r;~ns~;asterz~
Lenders were subsequent ira~isferees of dii proceeds
backed by the liens, not immediate benet3ciaries of tl~~
tr~nsier of fla.e liEns, and th~i subsec~ue~nt ir4~n5ferees Ire
not uovercd by sccCion 55~(<t)(1). See id. aC C74.
~~inallq, the district court held that retnai~cl vas
u~a.iaeeessaay beca~~s4 "tlic record allo4~~s oialy one
resol~rtion of the factual issues ~~t sz~~ke," i~. at 6fi0, end
t~ecaus~ thu `['rA~sseastet-n Lenclzrs made "eom~~ellin~
arguments" regardii.~g tli.e [**31 ~ ability of tl~e
bankruptcy court °to a~prnach tl~e Defendant's evidence
ai d ~rguiiients fairly." 7d. at G79 n.65. Tlae district aourk.
c~nasl~ed the order of the h,ui.hruptey ec>urt and d~ci.ired
X11 the p~~oceecliugs regarcliitg the Trattseast.ern Lenders
cl~~sed.
Because t~l~.e dish•ict co~irl ruled on issues that were
e:entral to the se~~ar~te appeals of the Neti~~ Lenders, the
district court allowed i~lte Neer l..enaers to intea-veoe in
E~~~~ ~Pl~eal, aild tlaE clisYrict court stayed the a~~peals of
the Ne~v benders l~endi~ig divpositicu~ of kris a~p~.al.
IT. S'Cf1Vi?r112DS (7T lt}?tirIk',~V
IIN_5[ ) As the second court to review the judgiient of
the hankr~~ptcy co~irt, ~4~e .review the order c~1' tl~e
ban.kn~ptcy court icadependenlly a.f tllc dist~~ict oourt.
Westpa€e V~c~Cio7i Villas, Ltd. v. "1"~~b~is (In re Int'1
Phal~nacy &.TaiSc,.II. I~tc. , 443 F.3d 767, 770, 158 Fed.
Appx. 256 (1.l t.}~ C'-i.r. 21705). We revie~i~ detcri~ai~afixi.c~i~s
of 11ti m4ide by either court de nova. ld, We review the
Cindiiags ol~ fact e~i' the bankruptcy court tier clear e~~•ar.
Icl. 'I'hc ftu:hitil findings ~P flee b~iukr~iptcy court are not
cic~rly ~~rone~us ~znless, in tJ~e light of X11 the evidence,
"we ~u•e left ~vit~i YhE definite acid firm com~iatioti thz~t a
i~~istake leas been .t71~~de." Id. "N~~tf~e.r tl~e district co~irt
iior this Conrk is authorized [**3?] to iri~ke independent
Factual ficidings; that is the f'~u~ction of the bankruptcy
ct~urt." r;yuiYahle t.ife Assnranc~ St~c'y v. S~tblett (.lu re
Suhlett , 895 F.2d 1.3fi1, 13~~ (t ltli Ci.r. .199O). We
revie~ti- e~luitlble deten7~i~~ations of lhc, banknipi.cy court
t'or abuse oi~discretion. Bakst v. Wetzel Tn re KinQsleV),
SIS F.3d 371, ~i77 (1 Ifh C'ir. 2008).
III. DISC'LTSSION
We diviau crtu~ discussion into three pa~~Es. We first
ex[71aiu t~i~t klie l7ankiltpt.cy caiu`t did tipt. clearly err
~vl,~en it fouutl th<lt C(~4 Goi~veyipg Subsidiaries did not
receive reasonably cqu vlleuC c=~Itie in e~chanc~c fnr
their liens. We then ex~laiil that the l~~nk~laptcy com-t
did not err when it f"ouncl that the "lranselstei7~ Lenders
were cntrties foz whose bencFit tl~c liens were
transfeY-red. riu111}~, w~. explain tvl~.y w~ ti~~ill not
consider, ii1 the tirs~ iixstanc~, challeii~es to the remedies
in~~osed by the b~i~~knipCcy court or issues of judiai~l
~issi~nment or consolidation of prc~ccedin~s.
.~.i. 7"he Bankrtrptc}~ C'otrrx Did Rr~fi Clearly ~;r•r• Y~hen It
Fn~~ra~c~ 7 hal fhe Corn~evi~z~> ,Svl~.rir~ici~•ies Did :V~! Reeeir~
Rec~,sonc7hly ~'~~~ri~~crlerrt 7%'afire i~~a Exch~c7rrge fQr• tlae Liens
I'hP~v Z'rcrn~ferre~' to dhe rV~~v Lencler•s.
The Comanittee argues that 1114 banla~uptcy curt did nok
clearly err ~ul~en it found [**33~ that the calveya~ice of
the liens by the Conveyir~e; Subsiili~iries to the New
Lencicrs was a fraudulent transfer. IZN6[] Sectia~i
54~+('a)(1)(B) of t1~e Bauk~lipCcy Code provides fc~r the
lvoidunce of "nny fransfer of an interest of the
debtcxx~ in pz•op~x-tY, ~ * 13l l ~ or 1uy obli~atioza .
incurred by the debtor, that eras iii3de ~r incurred .. .
within t~~~o years before the clai~e of the filing° of the
b.tnl:~•aptcy peiil~iti.n, it Clue debtor "received less t}~aai
reasaiiably e~~uivilent v11ue in exc}~aiige for" the
transfer ~~r ~~bligatiori, acid tiie debtor (1) "was u~si~lveitt
on the elate such transfer was zn~de or s~.ich ablig~tion
was incurred, or bect~me ins~lveut as a result of such
trailsfvr ~~r obligation,° (?) °~,°as ~z~~agud in business o~
a iransnet~ion_, or was nboue to en~a~e in t~i~sir~ess or a
transfletion, i'a~• ~vla.i.ch aury p.coperty ~•emai.c~iiag wifla tiae
cicl7t~r wzs an anre~sonably small capital;° ~r (3)
"intended Co incur, or believed that the debtor ~~~ould
incur, debts that world be beyond the dehtc~r's ~l7iGty tz~
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GAO F.3d 12')8, * 1311, 20121?.S. ,~lpp. T~,Fi?CiS 979(, *~33
i>~y as sual~ debts tnattued," 11 L1.S.C. § 548(a)(1)(B).
The ~arkies do noY dispute, u~ t'k~is a17p~a(, that tl~ie
Conve;yint~ Subsidiaries ~~~ere either insolvent, had
unre~son~bly sGnal] capi.itil, or w~ez~e unable to E~ay their
d~Uts ~vlien [~*3~] Clue liens were conveyed, T7ieir
dispute contains ~vhet~lzar Chi C:oiivegiiig Snbsidi~l~ries
recciv~d ]css tl~<iu recisnraal~ly egtiivfilent v~ilue. IlN7[ J
"T17e pui~gse of voidizig transfers tinstippo~-~ed by
'reasonably ~ciuiv7lent valae' is to pr~~tecP creditors
1gai~~st the c~cpl~~t~i<~u of a bznlEnGpY's estate.' (.i.L;. Credit
Corp. v. Murphy (In rc R~dri~ue~). 895 1'.2d 725, 727
(1111 fir, 1990).
"Ilse baiil~7~uptay court endorsed a deti73ition of"v~tu~"
thFit the disCrict court rejeotec-1 ~s too narrow find
potentially ~~in,tubiC~ary of e~~ulemp~~xary t~~n~inci~n~
practices," Irz r•e TDliSi:l, ~4~ t3.R. at fiS9, buf 4ve x~e~~
riot adopt ehe detinitiori of either court. We deiline to
deaidc ~-vhether the po5sibl~ a~~oid~n~:e of bankniptcy
taxi confer "value" bcca~ise Llac t~ank:cuptay court found
that, even if nll ttic ~ucport4d benefits of the transaction
were legrilly cagnizablc, they elid not confer r~lsc~nt~bly
equivalent value. See in re `CC)tJSA, 4?2 B.R at 869.
Because th~st findings are iic,t clearly er~r~~neous, they
settle t7iis itiatter.
ZINR[ J 'I'l~e banknij~i.cy ci~urt ~t~as 4ntitled to find that
the benefits of the. h•~~~sactirni «;ei~e not reasonably
e-<~uiralent in val~ie t~ what (lac: Cc~ya.c~eyin~ Stzbsidiarieti
stirrei~dered. "fit has Ioa~~ bee.ta esttiblisllecl that
'[w~lietlier fair coiisicl~ration [~*~5] has beet! gig-en #or
tra~~sfer is 'largely a gticstian of feel, as tQ ~~hicl~
consitlerabtc (~tititudc: nnist be all~~~~cd to the trier o:t~ the
facts.'° NordUer~~~AraU Rankine Co~.~in re Chase &
~enboin Corp.), 9(~a R2d 588, S93 (llth Cu•. 1990)
(c~uc~fii~~ Mayo v. 1?ioa~eer E3an.(: & 'C~~usf Co., ?7U 1~.2ci
82~, 829-30 (nth Cir.195)) (Wisdom, J.)), The record
sup~ot~C~s tt~e tuidin~ by the bat~lcnip[cy cc~u~t Yh~t, for the
Convc;yi.n~; St~bsidil~•ies, tlae ~ln.~ost~ certain cost~ o1` the€>translction of July 3'l far oui~veig~}~eck any perceived
benefits.
(~1312J The "1rGinse~sfern Fenders ant( Ne~v benders
argue t1~at kh¢ trnrigacCiou of .tiny 31 alin~vee~ the
Conveying Si~bsidiarits to escape the "existentin3 tl~reai"
of tiaw likely bGinkrnpt~cy k}t<it ~uoulcl ensue and eh~~~t Chis
ehan~e to avoi~~l ba~iki-~i~~t.cy ~vas A l.~eiicfit reasoiinl~ly
ae~uivlle~~1 in value to tlxe obligatio~is the Ce~~~veying
SLirsictiaries i.caclirred, lout we urc un.perstiiaded That khe
i~ec~rd o~~nlpels that tindiy~g. IIN9(] "A corporation is
riot a I~iological e~lt'ity for which iY can be prusutz~ed t17at
any Pict which extends its exititei~ce i:s beneficia] to it."
}3(c~or v I)~ulskc~~ (lu rc [t~veseorti 1?unciitl~; Co~~~. of Nee
1'c~rk Sec. LitiQ,, 523 F. Supp. Si:3, 54t (S.I~N.Y.
19b0). In atli~r wort!:,, ❑ot every hansf~:r t}iat decreases[~`*~i(i] kl~c odds c,f b~i_i~.knrploy fog- ~ corporation tau be;
justified. T7ie Uankiu~>kcy court consic[ered the ~otec~ti~l
benefits of the frnnsaefion aild fi~iuid that tl~e~y ~ve~'e
~lawhere close t~-a its expeatecl costs. In tli~ light ~f all th.e
c~~idence, the arc not "left with the definite and firm
crn7viction that" the bankruptcy court clearly zi~red. In re
Iirt'1 Ph~~rnlacy ~~ Disc. 1l, tnc., 44:'~ ~l~.~cl art 77f).
TIIe ".I'ranseasterii Lenders and New Lencle~~s argue (hit
the rec<zrd esk~blishes that an actve.cse; jud~;,iuen.t in tl~e
lrauseflsCert~ litigation ~uc~ulct h.avc caua~d '[~Ot.JS/~ to
1~1e fir hanluuptcy, the re~~olving financing fc~r the
C~~nv~ying ~ubsiciiaries to dis~ppc~r, end the Con~eyiti~
Su6sidiai°.ies to beaoine ~liablc foc .iaT1a»ediatc pay»~uf of
Y7~or titan ~ 1.3 billion to tt~e re~~c~lving loan lenders a~ic~
TI~~JS~ bondholders. They corkten~l th7t Ctie blx~kniptcy
aoYirt elta~°ly erred when it I'<auiul kliaY the Gont~eyin~
Substdi~ries c~~uld hflve survived ~ "1~~C)LJS11 batil:ru~tcy,
They nrgue diet Ctze l7artki•uptcy court fotu3d thaC the
Cc~nveyii~~; Subsidia~~ies were insolvent beti~re the
Grnnsaction, acid they argue tl~~t it is urilikcly that the
insolvent Conveying Subsidiaries could have ol~taii~ed
new- ~inzinoing. "Tl~cy also ergu~e theft the absence ci,f
standalone ~ai<ulcial. [**37) statetneilts vas a °clear
obstacle" Yc~ new tinanciiig~. 'They higltlight t11at cane of
the experks for the Committee deseril~ed the
ii~tercoiupl~~y payll~les and receivables '.for "I~C)t7S~1 at~d
tl~c C.~~nv~ying Subsidiaries as n "hugs pile of tangled
s~s~hetti." The Transe3st.ern Lenders and New Lenders
tisse~-t El~at it would .l~~ave~ taken n~onihs, if not years, to
sorC through the mound of reeor~is, which pra~~~s that the
C~iiveying Subsidiaries had no rl~ance Yo reeeiv~
sitmdal~~ale ftn~ncing.
'l'he bnnl~liptcy court Fauu~-i flits evidence to be:,
in-elevant because, "eve~~ assuming Uiat till of fhe
7't)U~~ ~nfziies «~~uld l~~v~ spiraled ii~unediatoly i.uto
ba7~kY-u~~tcy 4vith~~ut the .iu1y 31 'I~rarrs~ction, the
1a~ansaction vas still kUe snore harnlfiil option." In re
I C)i1SA, X22 13.TZ, et S~k7. "~ Af t most it tlel~syed Qa~
itievital~le." Id. at 8~6. 1~he t~ai~lutiiptcy c~~urk fotuid t13at
the benefits ko the Con~~eying SubSidi.~ries ~~~ere nut
ulo~e to be~in~g xer~saiaab(y ~c~eiiv~lent in v~.lu~ icy the
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(,RO 1~3d ]298, *].312: 201? U.S..~pp. I.,CXFS ~)79C,, *~37
~~F03 n~illi~~n of ~7b1i~~tic~ile that they incui7~ed. "t'kie
'frariseastern Lenders end Ne4v Lenders f~ttack this
lindi~~g as "hindsight ruesc~nin~, ... at its mast ~xtcein~,"
t3iiE t11e bankruptcy court b¢ised its exi'er~sive fisidiilgs on
a T}ioroubh review of pul~Lia l~tto~=ledge ~~v~ilaL7le before
[**3~] July 31, 2QQ7; expert analysis of ~Inta available
before ;fuly 3l, 20(17; and sttrte~zlea~ts by "1'OLISA
in~i~iers m=ide before ,Tiny ? 1, 2007.
The ".l~canseastcru lenders and NG.~v I.~ende~•s <ugue that
Che finding i~f a~i "iuevitab(e" banict~iptcy is ngainst ttie
~~rei~ht of the e~~ idenc~e, but the anly evidence they cite,
in cotat~~ast with the t~t.orc>tiibh ~indin~;s of 11~e bankruptcy
coul-t, ai•e the opiYiioris of <~ "1`OLJSA advisor tl~al the
coYnp~rtiy ~vozil+~ remain via.blw at't~er the translction acid
staten~enis ('r~7m Tc~iry .Mon Gbo~it a com~~rahensive
strategy to shrink'I'OUSA alter Che tr~z~sucti~>a~, shore iip
its finances, ~~iti a•ebuild the Company. Tlie Tr~znseasYer~i
Lenders and New Lenders contend that tlr~ projeet~ions
of ":['OTJSA look uu.reaso~~aF~le ~ioyv nnly bucaus~ weeks
after the tr~nsacti~~iz, "1 tr~~gic gl~~l~al fman.cial crisis of
m1}~~•ececler~ted proportions" bean. They essert that the
ttnet~~ecied do~vtatttrn was describ~:d by Alum. C".rreenspan
~~s "a once iii ~ cenCury credi# ksunt~ni° and by Waz~•cn
~3ufiett as an "econortiic 1'aarl H~urb~~rr." The
"I'zanscatite:r~a I,enciers an<i Ne~v I.,endea~~ a~•gue thrit they
cflr~n.ot l7e held liable for tuili~3g 4cf foresee d~~-
unfoceseeal~le, that their actions were re~soiant~le, find
That the bankruptcy uo~irt clearly should have. fo~md tli~t
[~*39J the transaction «ras ri ~~casou~bte ~•isk fc~r the
Goriveyiii~, Sut~sidi~ries to tike.
't`h~ z~ecc~~cl suppc>z-ls a deter~laination kJ~~t ttu; bankz°uptc:y
~~f 1'C)lJSA vas far in~~rc like, s~ slaw-moving category S
hLin-icane then an uuforseen tsunami. Thy baiilcilipCcy
c:~7u~-t cWnsidered khe evidence fiozn o~,itsi<ie advis~zr;; Y<>
T'<)1_iSA asld found much cif it sL~~pect or based o7t faulty
pre~alises. `The bankruptcy coiurt con~ider~d end
disc:ounteci Mon's cleleveraging slx•ate~y .for 7'OIJ;SA in
t1~e light vC the dire [*1313] Predictions he and oth~:r
insides made regarding the ef~Fects the traiisacYic~u
would havE on "IOtJSA. And the bankruptcy court
fr~und that, even. lhougt~ /11an (ireeiaspan acid Warren.
Buffet enulc9 nt7t fores~~ the gcn~ral ecc~ni~rnic dn~~~utux~n
float began in ean~est in Augt~sf 207, uuttierous exten~al
observers acid insiders at 'fQiJSl~ _reco~nired that tt~e
relevant hoissiiig ruaikets fir '1~OLJ5A haci E~eguil t7~e:ir
free f~11 befora the 1~ily 31 tr~nsaetiois. In contrast with
t,h4 sui~~rzse attack at Pearl T-It~rbor, the ~varnrngs about
tl~e oollapse cif ~I'(JUSA ~~l~de that evei~~t as ft~~•ese~able
a, the hoini>ing of Nagasaki after 1'residenT i't•uiriasi's
ultitn~ttuut.
HN10[ ] Tl1e o~~pc~i•tttnity to uvpid bankruptcy does n~5t
ti•et; Gi company to }gay any price or bear <tny biudan.
AYler ~il.l, ~~tt~Ga~e is ['~*40~ na retison to tx~cat bankruptcy
~s ~ bogeym~ui, as a fs~te wc~r~e tha~i death.° Olvin fa
]~c~t.~iumeiet _Le~sina Co. v. ~'estem linioil Telegraph
Co., 746 1~.2d 7~4, $02 (7th Cr. 1.956) (i:iastert~rook, J.,
eat~curriiig). 'T't~e banki~ti~tey court correctly asked,
"based on the cu~c~imstances that existed ai the time the
n~~est7r.~~nt ~~~is conte:mpl~ited, ~vheCher there ~vtis zmy
elitme~ that tl~e investment would gcrierate ft positive
rett~i7t." See Mellon I3ank, N.A. ~-. Official C'~~rut~itt~e
~~f [Jnsecurecl Gredil~ors c~.f' RM.I,., Ix~c. (In a-e R.M.I...,
Inch, 92 1'.3c~ ].39, 1 S2 (:~rd Cir. ]996). [~1.t~d tl~e record
supports the negltiee ans~i•e.r t`ound by the bankni~~tcy
court.
B. Tl~el3crnlc7-uptcy~ Cr~tirlDicl J~'i~~ 1sr•r IYl~en I~R~rXec~'
Tlrc7t ~h~ C'r~r~z~r~itte<: C'c>rrld Recouer~ fi•orn 1hE
Trr~rrsec~a~ter~7 I„endei~,s ur7der SecPior~ 55(](cr)(1).
UNIT [ ~ If ~ transfer is avoided uYider ~ectic~n S~8 or
oi~e of several other ~~i•~~vi4ious ol'the B~inkniptcy Cade,
section 55i)(fi)(;l) atl<~~vs the r-ecovc;ry of the pro}x;rty
t.r~n~ferred or i#s v~1tGe from the initial transferee or
from an "entity for• whose benefit such transfer ~~r~s
made.” 1 ]. [J.S.C. § 550(x)(1). ~1'.ltl~ougli tb.e ]tens «f tl~e
Conveying Subsidiaries were lrrin~ferred to secure loans
Cu pn}r the Transeas€erii Letjdere, t3i~ Tral7seastern
Tenders gigue that [ **41 ]they are not covcrad by
section 550 l~eeal~~s~ they ~ver~ ~.ibsec~~teril 1~-ansferees,
not entities tli~zt bzilet'it~ted ti•o~n ttte initial franefer. Their
flr~ui7lent is c~rltr~dicted by the login ~green~euts, which
regLtircd that the proceeds cat: tiic lc~anh sec~i.red by tlae
liens tre trausf~n'ed to the Transeastsni Lenders. Under
Yli~ plain language of section 550(1)(1} and the
pre:cude:irC of our C'o~.i~-t, the "J ranve~~stern T..,endcrs cue
entities ~t2n• whose l~enciit the Conveying 5ubsicliaries
ta•~nsferred t}ieir liens.
'I~o he slice, eve have ~;t~ted t~lu~l IIN12~ ] °the paradigm
case of ~ fi~anefiY under § ~Si~(aj is tl~e benafit tc~ n
~;uYu~u~tor by t11~ Payiaieiat of the lti~derlying debt of the
d~btc~r." Rcilx v. Kapi1~ (Ire re InCI Me,~Ytt. Ass'n), 399
I~~.3c1 1288, 129.~~, (iltl~ Cir. 2005). Tl~e guarantor
rec~:i~~us zm i~mmcdiate benefit when 1h~, debtor pays
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cso _t~~.sa lz~~s. *i3 ~s; 2n~? t~.s. n~~,. r.:~.xis ~~~<~r, ~~na
baak a creditor, ~vhieh reduces tlic lialarlity ~f tie
guarantor. Althotz~h this relationship n~~~y be the
pt~r~di~m~itic case, i,t is not tl~e ai~ly circunast~anec th~iC
can give: rise to "for ~vliose t~calefiY" liabiliC_y.
We I~tive also (ie1<1 that zi creditor sixnilar[y sieuatect to
tl~e 'frail~castc~na. I,en<lers c~ai ~,e ]i~blc ~s ~~i ~l~tity f<n:
~~hose benefit a transfer vas made. Iii Arnericati Bflrilc
of M~rui Coi~mty z-. Leasing Service Go~..~i _re Aii•
Conditioning, Inc, o~ SCtt~rf , $~5 I~`_2d 2~3 ~I ].th Gi~r.
1)S8), [~*42J Svc ruled that section S50(a)(1) ~Il~~t-ed
the tniscee to recover Che vrjlue nf' a ~ Q,000 c.ertiticnte
of de~~osit fi<~n1 the cred~iYor ~7f a compe~i~y thrtt had
transferree~ ~ 5~eurit_y inYcr~st in t]~4 certif7c<ite oPdeY~osit
to a ~wk, which had Yiansfe~red a $211,000 lett~~• of
credit to the cr~dicor. Imo}. trt 299. 'I'l~e com~~any iia Aii•
Conc~itioa~i~ c~~vec{ its creditor S2(.1,OOQ. Id. at 295.
When thz coinp~ny began falling behind can pa}~tuents,
the parties wori:ed out 1 ae<~l to keep the comp~iry in
bti5ii~ess, Id..As part c>f flie det~l, tl~e coinPany issitea a
~2Q,0()0 promissory note fo ~z bank secured by <~ .2(),(3()0
certificate ~*Y.=31~~ of deposit, 'Id. '1"lle bank, in 1un1,
executed a :620,01)0 letter ot~ credit to the cr4diYor. 1d.
Aber thi c~~r~pany ~:niered b~nkru~a~cy, ~~re ruled that
Il~~'13[~~] fihe Ts-~nstex of Che sectili•ity nit~r~sY i11 the
certificate: oP ct4~~c>Sit to the bztnk consfitui~ed ~❑1voi~nl~lc prcferetacc uz~d~r sectintt 547(b) bec~ztfsc it
vas 1 t1•aitisfer ~f pr~~~erty of t71e rletrtor to a creditor
~~~ithin 90 days czf Tiling for b~u~ks~ul~tcy Chat prc~vicled
fuore value to the creditor tla~~~ it would hive received
under 4hrapler 7 oL the I3nnk~liptcy Code. ]d. at ?9(-97;
see also 11 U.S.C, 5~#7~b). We khen rtile~i lhat the
17tmk.n~ptcy tizistee corild a~eeover tl~e ~r~1ue [**43] of
the certificate oi' deposit fi~z~i~n Y11e creditor bec~~.ise tl~e
company granted tl~~e secm~ity interest to the t7auk for the
bene~it~ ~7E' the ca~ediLt>r. Id. ril 299, We explai.nud kl~at
Illl'74[ `J the text of sectii7u 550(a~)('t) a[]o~~~s the
tnist~e Y.o recover from a creditor ~vh~n it ~v~s aii entity
fo.r ~vhos4 benE:lit the trn~s.Ce~~ oE' tl~e certi~c~te oP
cl~posif ~~~~as iziadc. 1d.
Uur decision in Air Couclitiouiil~ c~~ntrols this appeal. In
1~lir Cnnditac~n.ii~~, llie debCor transferred a lien Yo a
lciicl4r ~vho transfci~~ed fiends tc, ~ er~ditor. The transfer
of tl~e lien was avoided end, tinder section 5SO(a)(1~, the
crediT~r was ~n entity :['c~~~ whose ben~:l7.t flay 4r•~asf~i• r~•~s
made. In the same tray, flee Conveyii3b Subsidiaries
trans£eired liens to fete Ne~v I,endcrs, ~~~ho transferred
fi~u~ls to erediCorh, Clie '1"~~~nseeistern L~nciers. '['lie
Uaukrul~tcy coiGrk avoided the transfer of Clue liens and,
under section 550(a}(1), I~lie T~railseaste~7~ Lel~dei.s weX•e
eniilies .for whose benefit the Cran~fer wads roacle.
'llie ~I'r~tiseastein Lenders attempt t~ distinguish their
rtppeal from Air Conditioni»c? in t~4vo ways, but theia~
arguments igA~~~-c tla.c maYecial similarities l~ehveer~ tl7.c
preferertcc; in fh1C decision an~i the fi'atidulent it•~nsfer ~t
isstiie in this appe~L First, the Trinseastet7i
~~`*~!4] I,endet~s cox~tenci that ~1ir Conc~iticini~ ~itavoh~~d
a preference under section 5~7 ins[e~id of a fi~auduler~t
transfer under 54~i, btit °[t he theory ui~d~r which a
tranafer i~~s been avoizleci is in~elevant eo the l.i«~bility c71'
the transferee against ~~rl~om the tilt~tca seeks to r~:covei•
[ln~ider section SSa~." In re I3u(lic~n Res~et~e of North
nmeric~i, 92? 1:'.?~l 544> 54G n.2 ()tl~ C r. 1991). Second,
the "Cza»selste..i.~a I,cndea•s argue tl~al section SSD(a)(1)
3}7plied in Air Conditio7~in~: because a letter of credit
vas i»volved, bait the Transe~steru Lende~•s cannot
presvide x pr,inc~i~~lcd basis .for ~i~~xtiling section 550(a)(1)
to facftiial secz~ari~~s that involee letters of credit.
:I`he '['z-anseastern ~.,endcrs also c<~zate.nd tiaztk they c«~uiaoi
he liah3e under section S50(a)(1} l~ec~t~~e t11ey 1~ciiefitYe~i
fi•oin a sizbyequent irzYi~sfer of fiends iioni TOUS[~, not
ft-~nn tl~te .inifit~l ir~c~sler c~#~ tl~e 1ic~~s, but the recoad
conYraiiiats their assertion, The iiew loan agre~tncnts
required ttiaC 'the loan proce~as be used to pUy the
"I a~anseasttnt settle.menY, aizd tl~e 'i xaz~seastcrn se1t~leuatnt
expressly depended on t11e ne~> lc~titas. ~WJ~c_z~ the liens
~~ere transferred to the Nz~u Le~iilers, the proceei-ts of the
lens ~~ent to tl~e 1"ranseaste,rn Taenders. Tl~e
Transeaslern I.,cnders asserC tl~ak t(~e '.funds
[~`*45] ~~assed from the Ne~z~ Letic~ers Yo a ~vl~olly-
ownecl sut~sieliary aY'1'OLTSA befare the fi~ntLs were paid
to tt~e `('ranse~istern l:,enders, bark the subsidiary khal
~virec~ lhc; money to the "Ii,~nscast:ersi Lenders did i~ot
17ai~e control over flzeFunds. The loan docutner~ts
renuireci the snbsicliary to vice floe fti~acls t~ the
'I~rans~asCern Lenders ii~nmecli~tety. Althc~ugfi i1~e ftincis
tecluiically passed through the 7'OIJ~A subsi~diuy, ibis
formality ciicl not ialnlcE tl~e 'Prans~:~stem Lenders
subsequent trtinsfieees of tl~e funds because '('OETSA
1~c~~e1° lead control over t7ie fui~d~, See Nordt~cr~ t'.
Societe Generals (ln re Chase &Sanborn Carr:), 848
1~.2d I196, .L 199 (i.lth C~ir. 19F3S) (slalia~g that H~'VTS(~`]
ctnuts mast apply a °very fle~iUle, prflgmatic" test t17at.
"lo~~k[s~ beyond the ~ * 1 ~ 15] plrticular transfers in
clueskion to t11e entire circunastanae ~f l~he traz~sactioz~s"
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680 F.3d 1.298, *1.315; 2012 LI.S. App. I„I XiS 979C,, *~4~
when deciding whether debtors lead controlled ~~roperfy
later sought by their hustees); 13~incled Pin. Sews., 838
F2d at 893 (holding that a bank was not xu initial
tr•ausferec because it held :hinds "Duly fc>r the purk~ose of
fulfilling an instrlietion to make tLic fiords ~v~ilable to
someone else"),
The 'I'ranseFistein Lenders tv<irn that our reading of
section 5~0(~) would drastically expand the potential
[~*46~ pool of entities that could be liable for any
ti•lnsactio~i, but these concerns arc utisubstailtiated. The
TranSe~ster~ T.endeis off.'er ex~uizples of a parent
company taking oi~t a loan secaG•ad by itti subsidi~rir;s
with the specific intent of paying a contractoa~ to build a
bltildi~ig for t11e parenT company or paying ttie dry
cle<i~~in~; bill 01.~ ilxe parent conipaxay. 'The '1'ra~~seasiern
I.,cnders c~iution that fhc contractor or dry cleaner could
be forced to return their pay~inents if the loam securing
the money izivolved ~ fiandulez~t txansier, ~~~liicl~ ~~otild
it~~posc "ext~aordivary" ci~uCi,es of dtte diGgencc nn tlac
part of creditors acceptinb repayment. But every creditor
must Exercise soilza diligence ~vh~;n receiving payiuent
fro~ia a stnGg~ling debtor. It is far 1rc~m a dr~itit,ic
obligation to expect saniu diligence from a creditor
when it is being repaid hundreds o~F millions of dollars
by sonaeo~ie other tl~nn its debYo~•.
C. i~'e Rerr~und,for the District C.'ot~r•t 7n Consicle~~ First
the Remedies bnposed by the Bartkr~atptcy Covrr~t aml
~~7atters af.<lssignrnent and Corrsolicfcrtiort.
TYie parties' remaining ligaments pertain to issues that
are not ripe for aux- rcvie~v. The Transeastern I,eiaciers
1sk that ~~-e vacate i7ie remedies orct~red by tl~e
bankniptcy [**A7] court, and bokh p~irCies ask that we
wade into mat~tez•s of ,juciici~l assi~~n~eut timid
consolid~tiou nn remand. "]'hest issues must be r~solvcd
first by the dish~ict courk.
"l'he 7'ranseastcrn I.,end~rs zla~illcnge t(~e remedies
imposed by the bankruptcy court, but IIN16[ ~ eve ~~~ill
not address azz issue that the dish~ict court has not yet
causidercd. See e.~ Driko~a~ski v. Nortl~ci71'l:'nist Bank
of I~loricia, N.E1. (In re Prudential of Florida I.,easine,
Inca, 478 I'.3d 1291, 1303 (11th Cir. 2007) ("Wlaen t}te
~listricl court does aaoC adJress tiu issue [it dismissed its
rnooY], the proper course of ~cfian often is to vacate the
order of the district court and remand."}. The district
court, on rem~ncl,, should review, iii the Iirsl iusta~lce,
the remedies ordared by the b~nkiuptcy court. We
express nn opinion oii that sttE~ject.
'1.7ic p2rtics' rcqucsts about judicial assi~n.n~cnt and
consolidation of proceedings are ~Iso ~nisduected. The
Coilunittee urges us to ~•emand U~~is case to ~ difPerc,zit
district judge; and the "Cranseastct-~~ I.,endcrs and Ne~~-
Lenders argue that, if the case needs to be heard again
by the b~~~lc~u~tcy wart, we should instn~et tl~e district
court to retnaucl the case to a aifler~~~t bankruptcy judge.
Both sides complain that [**4'~] the judge ~~~ho issued a
decision unfavorable to their i~~terests is biased, birt
neither side has est~blishea that "the original judge
would have diFficulty putting; his previous views and
findings aside." C5X Tr•ansp., Inc, v. State Bel. oi'
F?nualir~tion., 52.1. I~.3d 1300, .1.30.1 ('1 ] th Gir. 2008). Tlie
Committee also argues that Lhc; .rein~ining reme;ciial
issues ire: iniert~~~ined with remedial issues ri•om a
related appeal bc;for~ ~ different district judge and that
consolidation of proceedings ~~~ould promote judicial
economy. We leave these matters of future judici~il
administration and inan~gainent for the district court to
tiddress lirsl.
[* 1316 IV. CONCLUSION
We RIi:VI~;RSE; the order of tl~e district court, AFF[Rl~'(
the liability Endings of the banla~uptey coluf, and
I2EVIAND to the district coact for fiirther proceedings
COI]S]til~Ilt ~i'11,~1 t~l]S O~I.111Qi1.
REVERSED AND RFNI~ANDTD.
7;~t! o3 .'k~s~c.u~aeaxt
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Cautionr1s of: Fcbnieit~ 6, 20]9 8:11 PM 1
In rc Xoiaics Phot~~clicmical
CJnited States Court ofAppc~ils Porthe Seventh Circuit
Tanu~~~y G, 1988, Argi~cd ; Maz•eh 8, ] 9~i8> Decidccl
Nc~. 87-? 143
Reporter841 F.2c1 19R *; 19,8 LLS. App. LEXIS 303 **; 1$ Collier Baukr. Cas. 2d (NIB) 711; 17 Ba~il:r. Cl. Dec. (OC; Baiil<r. L. Rep.
(CCH) P72,21 1
In 'l~hc M~jtter Of Xc~alics :Photochemical, Ino., I)eUtox•,
Appeal of Mitsui and Comp~my (TJ.S.~1.), Inc.
T'rior history: (**1'J Ap~»~1 fr~»n il~e United States
District Court 1.'or t~l~t Norlh~iu District of Illinois,
I astei7~ Dig°ision. No. 8C C 737 -I3riaY~ I3aaYlett Duff,
7ucige.
Core Terns
afrGate, coi~tin~ent liability, ii~solvent~, liabilities,
obligations, contingent, debtor in possession,
guarantees, guarantor, voicl~ble, fi~tiuctule»t conr~ey~nce,
subsidiaries, tr~~i~sactions, Accoun[ing
Cass Su►nmary
Procedural Posture
DEf~ndant unsecured creditor sought rep°iew of a
judgn~eut oP tl~e United States District Coart fot~ the
Nortlze,rn District c~t~ Illinois, Lantern .Di~rision, ~uhioh
a~ltinned the decision of the baukrtGptcy cotiu•t to set
aside payments made by plaintiff debtt>r to cl~Pendant as
preferences under 1.1 iJ_S.C.S. § 5~7(b).
Overview
Tl~e debtor br~titght an ldvcrsary p~~oceedin~ against
def'endai~t ~insecured creditor 1<> set aside t~-vo payments
Made to defendant as ~~oid~ible preferences under ].1.
U.S.C.S. ~ 54'7(6). "C`(ic district court afl~ii~i~ad the
bankrt~~~tcy court's determination that 1~he payx»ents ~r~ere
preferences be;causc they were made when tl~c d~Utor
was insolvent. On appeal, the court held ghat the debtor
vas insolvent at tt~c ti7tze the payments ~~-ere mace;
because tl~e deUtar's i~atcraftiliate a6reemeJut to
gttFiraiitee llie debfs of its parent carapany was
cnforceabi~, upo~z lh~ parent ec~rporat~ion's dcfaiult, the
debtcir became insolvei~i because its assets ~n~ere nol
greater than its 1i~ibilities. `The coixrt further found that
defencl~int could not assert that the affiliation a~z-~cments
were fi~audul~~~l convey~mces under ll i.1.S.C.S. §§
5~G(b), 54$(a) beeaus~ the righC t~o invoke those
pa~~visious r~;:~tEd ui either the trustee or tt~6tor ita
possassiou, and not in an unsecured crc~litor. "I~he eoart
aLYiimed, finding that dcfendaiit had provided no
gxolmds upon ~~°liic}i Co tiet aside the voiding of the
payrn~~~fs m~irle t~o it.
Outa~me
'I~I~c court affit7ned, finding tli~t payments m<<dc tc>
dePenclant linsecux-tci caedit~~r wc,re,proparly set ~siel~; as
preferences Uecause they ~-vece made whc;n the debtor's
~issets ~vcre not greater than its li~~bilities due to the
etif'oracablc interaf~liate agrcen~ezit it h~~d t~~ guaa~nnlee
its parent corporation's debts. Only a Gust~;e or tlic
deUcor had tl~c~ riglri to cha]le.nge the ttgreeme~nt as
ti•~tudulc;nC conveyance.
LexisNexisC~> Headnotes
L3ankruplcy I,a~a~~ > ... > 1'ref~rential
7'rarxsfers > I;leme~ntk > Debtor' Tnsoh~ency
k3~iiakl•upccy I.,a~ti > ... > Pa~~;petrtion
"('ransfers > f'reterential 1'rz~usf~z•s > Cicneral
Overview
B~in1cruptey La~v >~ Itcorganizat~ions > Debtors in
Possession > C?auer~l C)vezview
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817. ]~.2d 19R, *19R; 1983 U.S. App. 1,I~.XIS 3():35, **l
I3ankr~il~tcy L1~v ~ ... > R.c:organizations %Debtors 11 U.S.C.S. § 544(b) in effect allo~~s the trustee to i~se
ii1I'o~session> Powers &Rights Che nt~~~licable state's l~i~v ~~l fraudulent coiivey~nces Co
sel aside c~bli~ations incurrrcl by the bankrupt.IINI [' J EIe~Y~er~ts, Debto►• Insolvency
ll TT.S.C.S. ~ 547(b) makes tratas~ictioi~s voidable by the
trustee, but l i 1.7.S.C.S. § l 107(x) gi~~cs tl~~ debtor .iia Btiisuiess ~ Corpnr~te Compliance % ... > Conh~acts
possession the po~~~~Y•s of a trustee. Lnw > Standards of Performznee > Creditors &
Debtors
Bankniptcy La~~~ > ... > Avoidance > Prepetitioti
Transfers =~ Preferential Transfers
FI~~T2[ ] Prepetition Transfe►•s, Preferential
Transfers
It makes no itifference whether the debtor has a
contingent asset or a eantin~ent liability; the asset car
liability must be reduced to its present, or ex~?ected,
value before a determination c<~n be made whether the
debtor's assets exceed its liabilities.
Banking L~u~~~ > Int~znat~ional Rani iia~; > I3~~z~ds,
Guar~xrtees & I.e~tters of Cr~ait > G~;ntral Ov~ivic~v
IIN3~ ] Intcrt~~~tional }3f~nlcit►~, Bonds, Guarsintees& .Letters of` (.`rediY
F~ guax•antee of an af'filiate's debt is ~nl~orceuble,
pa~~vicle~l tt;~Y thG ~u~i~- ii~tor derives 4tnxzc benefit, even 1#~
inclircct, fi-otn the ~uaraiatcc. "T'lje benefit opertttcs 1s a
partial offset to the iinpaii7i~e~~T itt the prospects of the
guaraz~~t.~~x•'s creditors resulting Crony the debt~~r's
assuming a conkin~ent liability.
I~a.nlau~~toy Lativ > ... > A.voidaiice > Traudulvait~
Tr~nsfer~> General Overview
Real Propexcy L,3~v =' Purchase &Sale > Fraudulent
Gr insleis
[3:tnkruptcy I.,avv > ... > 1'repetitiou
Transfers =-~ Voidable Trinsfers > Unsecured
CrediCors
/f1~~4[ ]Avoidance, I~'rtiaduleut'Cr~~nsCers
Contracts La~l~ > Defenses %Failure of.
Consideration
Real Property Lativ > Purchase &Sale > Frauchilent
Transfers
Bankruptcy La`u > ... == Avoidance > Fraudulent
Trantifers ?General C)verview
Cout~acts Law > Contract
Formatioi7 ̀~ Conaidei•atroxi =~ General Overview
Busuiess 8c Co~por~te Ccmipli~nce > ... > Contract
Formatie7n> Consideration> Adequate.
Cousider<ition
Ht~~S[] Standards of Pe~r1'ormance, C`reclitons &
Debtors
A conveyance not supptirte~l by ~idequate consideration
is "fraudulent," that is, tiileiiforceable, as against
existing creditors of 1 debtor who gave up value in
exehan~e for the uiadequ~te consideration. And, even if
the consideration is adequate, the c<7n~reyaiice is
fraudulent if made ~~~idi intent ko defraud ereditoi:s.
I3an.krupecy I.,a~-v > ... > nvoiclance % I~'raudulent
"ir~tnsfers > ;[ntenk
~t~al Property La~r~ %Purchase &Sale > Fraudulent
"('xztnsfers
I'e~x I.:a~~ > ... ?Sales 8z 13xcl~aiages > [nstallmc:nt
Sales ~ l~uturi~ T'~~vments
I3~~nk~uptcy Law > ... > Av~~idance =~ rraudiileilt
1'rarist~rs > General Overview
FIA'6[~ 1+►•autlalent"I'r:titisf~rs,T~~tex~t
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$~11 F.2d 198,, *1.93; 19ki3 U.S. App, I'.,I.~XIS 305, *~l
Tf an obligation is incurred within one year before the
filing ~f the petition Por baril ruptey, and there is actu~il
intent to defi~tua either an existi~~g or a lirture creditor,
t~hc trustee c~~i avoid t}~a obl.i~ation_ 11 IJ.S_C.S.
548(x)(1). Alt~:rnntiv~~~y, if Che debior recEiti~es 1~ss than
a ~easanably ec~~liv~lezit valae in exch~~nge for such
o1~ligatian t~~ad is insolvent o~~ tl~e date Yla~ obligation
vas incurred, the tnistee again can. avoid the c~bligatiurr.
1.1 U.S.C.S. § 54~(a~)(2).
Bankruptcy La~~~ > ... > Yrepetition
Transfers => Voidable Transfers % Unseuure,d
Creditors
Busiciess & C:~~rpc~rate
Ccimpliuuce > ... =~ NegotiaUle
Instruments ~ Enforce~~nent -- pint ~ Seve~r~l
Instruments
P~e~I Property La~v =~ Purchase &Sale > Fraudii(ent
Transfers
B~nluuptcy Lew ~ ... => Avoidance J Fraudulent
Transfers =~ General Over~fiew
Bankruptcy Law > ... =} Keorganizations =Debtors
in Possession > Pcnvers ~~. Rights
H~\'7[.° ]Voidable Transfers, I?nsecured Creditors
Tl~e right to invoke 11 U,S.C.S. §§ 54~#(b) and 548(x)
beIangs not to a p~rticul~r unsecitr~d creditor, but to the
trustee, or debtor in possession, as the representative of
all C(~.e tinsact~red creditors.
Counsel: Attarney'for Pl~inliff: Thomas D. Goldberg,
Hughes HuUU~rcl & keecl, Wushirigton, District of
Colwnbii.
Attorney for• Defendant: Erick S. Rein, Scli~vartz,
Cooper, Kult~ &Gaynor, Clltd., C'liic~go, Illinois.
Judges: Y<~snei-, Coffey, end ElsterUrook, Circuit
Judges.
Opinion by: POSNER
O~~inion
[*l99] PCJSNI:;R,,Circi~itJudg~e.
This bankruptcy case presezzts interesting questions
coi~ceining C1ac: status in t.~ank:ntpfcy of ~antingent
liabilities aid vrterr~ffiliate obligations. Tor backgrotuid
see Comment, ~~~.{i~r~iclubilitr of Ir~tef'eorpar•crte
Gercrt~crrai~ee,s ~(incler• S"ectiofas 54b'{cr)(~j anc~ ~4~(b) gf'tlze
Bm~ikruptcy Cac~'e, ~~ N.C.L. Rev. 1099 (1986). XonicS,
Inc., ~io~~~ in Chapter 11 t~aukruptcy, has several ~a~liolly
o~~~nied subsiditu~ies that are engaged in inaki~~g medical
equipinenY. "I~he lar~cst is Xc~nics Medical Systems, Llc.;
one of the smallest is Y~nics T'l~~tochemic~l, Tug, the
d~btoc i~a the jn'oc~edingbefare u~. I:n. 19$2 ~ii~ci 1~)S~, a
time crf pr•o~perity for tl~~ Xonics faiz~ily, Xonics
Medical Sysfeins boiro«-ed so~r3e $ 15 to $ 20 itrillion
Icon a bank, ~~n a $ ~~*2~ ?S millio~~ czeclit li~~e.
?to7rics, Ii.~a, the pare~lt, closed Xonics Pl~otochcmiczil,
Ina (along 4~~itl~ the other subsidiaries) fo ~i~s~~ntee the
login; a~i the trine Xonics Pl~otoclien~ic~l hid gross assets
of sonac S 2.0 million auci net assets of ~ 1.7 tuillion,
Xauics, :(ne. a(ao caused Xonicti i'lt~tochemica] t~~
becoule 1 co-maker with Xc~nics ivledical Sysiexns of 1
note To secure an adclitionil loan oP$ 3 n~illi<m.
Shortly after these transactions, Mitsui & Co, (LJ.S.A.),
Ii~c., a supplier to ~Coiaics i?hc~iocl~emical, shipped it
s~~me chvanicals, and iitvt~iced it for the ptu•ch~se price
of (flpproxirna~ely) $ 124,000. Xonics Phc~tochetnical
paid tlae invoice ~-vi.tl~ ttvo ehe~ks k'l~at cleared 3u Tanuary
198 . L,css tl~au 90 days ]at r, tonics Plaot~ocheinic~l
~~~as in basil ni~tcy. Xonics Medical Systems had
defaulted on its bnnli lo1r~, h•iggcrin~ the guaranties ~f
ils af:tiliaYes. 7'he total assets cif tl~e Xorrics family -- all
of which were pledged to the creditors of each mtinber
thzougll guarnistees similar to khe one Xonics
I'hc~to~henaical haci signed -- 4ve~•c; sl~o~-t of ll~e total
liabilities liy many millions ~~f do11a~•s; so X11 the
si~Ybsidiaries, as well ns the parent, f~~imd t}lemselvzs in
C`.laa~~ter .I l .
Xoilics Photochemical, as debtor in possessic~zi [**3]
(nee trustee in binkruptcy 11~ci baen appointed), brou~l~t
au adversary proceeding againtil Ivlitsui to set 3sicic the
t~yo payments fls preferences voidable tinder I 1 T_I.S.C. §
547(b). H~'VI ( ] ("['leis provision ~ualces transacfions
voidable by tl~c hust~ee, but 1.1 IJ.S.C. § 1.107(x) E,ives
the debtor in possession the po4~-ers of a t~-uste~.) 'Pile
ctispc~siti~~e issue was ~=1~ether Xonicr; I'hotochcniic~l
lead been i.iasolvei~t wti~:ii llle paya~~enls to Mifsui were
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aai r-~.za i~a, ~1~~; ~~~s4 tl.s. ~~,~. t.r;x~s 3o3s, *~~
made; th~rt is, did the fait value of its liafiilities exceed
the fair v<~lue of its assets (1 L U.S.C. ~ 101(31)(A))? If
sn, the pa}~menls were indeed voidable ~~refere~~ces, see
11 LJ.S.G. 5 547(b)(3), si~lcc tla~e other conditions iu
section 547(b) had been met. The bank~tiiptay judge and
the district jucl~e thought Xonics Pliotochemic~l lead
been insolvent tl~~n; Mitsui disagrees an.ci his appealed.
~T'he startlixtg ieatiire of the case is the Ptjrties' apparent
~issenl to t(~e Proposif.ion that if the login gu~u~a~atee and
Clie note that Xonics 1']iotocheiilical lead co-signed were
valid obli~~tio»s, Xouics Ph~tocheinical (**4~ was
insolvent as o.0 the elate tl~,e obli~ati<>~as were assuinecl,
on ti c theo~.y khat they created liabilit~i~s gre~iter than tl~e
company's net assets (much greater: $ 23 million in
liabilities versus less than $ 2 ~nilli.on .i.i~ ~~ek assets). The
proposition is abstn~d; it ~voutd tne~ix~ that every
individual or l~ii•rn that had contingent liabilities greater
than his or its net ~issets was insoh~ent -- soinetliing no
one be~lie~~es. Evc~y firm (~hal is being sttcd or that ivay~
be sued, every individull ~vho has sibned 1n
accoulai~~oclation note, every baiak tl~~t has issued a letter
of credit, l~tis ~ contingent liability. Such litibiliti~s sire
occasionally [*200] listed on the firm's bala~ice sheet,
f'or e~a~n~le by earmarking a portion vf' surplus for
c~zx~ti.zlge,nt liabilities. (They Gyre supposed to b~. listed "if
the f~rture event is likely to occter and if iCs ainouut cai2
be reasor~c~b/y estimated." Nikolai et al., Intermediate
Accowiiing 611 (3d ccL. 7985) (~nlphasis ~in original).)
More often they are- ]ist~cd in a foohiote, Maus leaving the
Turn's stated iiet ~voi•tli undisturbed. Often they are not
listed ~t all, r~~hen they fire remote or ~vl~en they are too
s.i~aall to effect net ~vo~~t~l~ substantially. Ora khe proper
accounting t~re~tme-nt [**5] of ooiltiugcnt liabilities see
rd. at 610-I4; Faris, Accowiting for La~~~ryers 362-fi4 (3d
eel. ] )75); Williams, St<i~~~;a & H<~lder, Intenvediate
Accounting fi09-17 (1984}; Mei~s, Mosich &Johnson,
Accounting: The B1sis for Business llecisions 288 (3d
ed. 1972); I~ivaiacial Accounting Slandard5 Rc~au~cl,
FASI3 Staterneut of Standards No, S (1975).
Tlicre is a compelling re~ison not to value contingent
liabilities c~❑ tl~e balance sleet al their free amounts,
even if thak would be possible tv do Uecause the
liability, despite being; contin~eut, is fi>r ~ specified
a~~alo~inf (fhat is, even if there is uo uncert~i~nty ab~uC
~vh1t the Erna will owe zf the c~~ntingency .materializes).
Fay definition, a contingent liability is not certain -- and
often is h~igla~ly ur.~la~kcly -- aver to becoane an actual
liability. 'T'n value the contingent liability it is necessary
to discount it by the prob~biliry that the coiitulgency
will occur ~~nd the liability become real. Suppose that on
tl~e d~Lte the obli_r~ations ~verc assua~cd there was ti ].
pe~cceiit chance Ni t Xonics Photochemical would ever
be called on to yield up its assets tip creditors ot'Xo~aics
Medical Syst~ins (oi• ofhca- ~ucmbers oi' tLi~ Xonics
f~~mily, since the systetu of guarantees [~*C>] hsid khe
effect of pe~oling their astieLs Por the benefit of creditors
of: any mc~nber). "l'heil clue true ~nc~istArc of the liability
created by these obligation~ on the d~ite they were
assumed would not be S 28 million; it ti~ould lie a paltry
$ 17,000. Fc>r ~t ~~orst ~ot~ics Photocl~eznical ~~~ould
have co yield uP all of ifs assets (net of other liabilities),
that is, $ 1.7 million and Yl1e probability of this outcome
is by ~isstiinption oxaly 1 perce.i~t (eve are i~nori~ig
iutei~ulediate possibilities -- e.g.,that Xanics
Phc~tochemicll ~t-ottld be forced to pay over $ 1 million
rather than $ 1.7 million). Discounted, the obli~~tions
~~-ould uot~ make Xanics iuso]veut, and s~ctii~n 547(b)
~~ould not come into play furless events occurrinb
betti~~een tl~~ ~ssttmption of the obfigatioias in 1982 and
1983 tiiact t1~e bankruptcy in1984 had tilPered Q~e piclur4.
We aid that 3~onics Photocheiz~ic~l did not in :fact list
these obligations as liabiliTies on its balance sheet.
1~he prinetplc ,just outlined has long beeai .recognized in
cases dealing wiCh the tluestion whether ~ tii7~~ is
insolvent will~in the meaning of tl~e }3ankruptcy Code
(and this is such a case). 1ItV2[ ] It~ makes no
difference whether the Erna has a contiligenC asset or a
contingent liability; [**7~ the asset or 1i<tbility nausf be
recl~iccd fo its present, or expected, value before a
dete~•mination can he made whether fhE tu~li's assets
exceed its liabilities. See, e.g., Syr•nc~~se ~'ngf~~eer~ir~g
Co. v. Haight, 97 ~~.2d 573, 57C (2d Car. 1.93$) (I,.
Band, .1.); In re 011ag Ca~stt~xctior~ 1>gztipn~ierzt Gorp.,
578 P.2d 904, 909 (2a Cir. 1978); In r•e Fatlgha~m
C~m,slr•arclion Co., 7 I3.R. 629, C32-33 (T~<i~akr. M.D.
"[~c;nn. 1980), afEd, 14 13.R. 293 (NI.D. "Tenn. 19R 1); In
re Hernphi!], 18 I3.R. 38, 48-49~ (Bankr. S.D. Iowa
1?82). T'he criticism of this position ix~ the skirdent
Coinn~eiat cited etwlier, 64 N.C.I,. Rcv. at 7115-19, is
perfunctory and unpersuasive.
Occasionally one f.zacls tlae f1aY st<it~eniei~t f1~.at
"contingent or incl~.oate claims of the bankru~Y are not.
included ~s part of the bankrupt's ptroperty." .<Illegaer•t ~-.
Chemical Bank, 4lR .I'. Supp. 690, C92 (l .D.N.Y. 1970).
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841. F.2d 19R, *200; 198 1.1.5. App. L,I>XIS 303, **7
This is the equally untenable opposite extrei~ne from
valuing them at Cheir face amount. Taut the quoted
language appears to be loose; ~~~hat these cases actually
Mean is th~it it; but for fl contii~g~nt clsinl unGk~ly to
yield any cash in the ~**8] near future, the firm would
be cleeuied insc~l~enl, the exi3tenee of ti faint hype --
colcl comfort :for creditors ~vaitiug fo be paid -- ~vi11 i~ot
save it from bankniptcy. Sec Penn i~. Grant, 244 i'.2d
30~ (9th Gtr. 1 57) (hex ctiiriu~l); lip rc: 13ic1~el Qptica~
I;abor•atorzE~s, lric., 299 F. Supp. 545 (T~. Minn. 1969).
[*201] No more should tl~e existence of remote
contingencies, ti~~l~icli do i~ot seriously en,cl~zl~er the
f~rn~'s z~bility to pay its debts, be deemed to make an
otherwise solveiat fn~in bei~lcnipt. Sec Ira r~e F~'aters, 8
B.R. lE>3, if>6 (Bankr. N.D. Ga. 1981).
We have gone into this nou-issue at such length Duly [n
ovoid cresting the unsetkling impression that co~ltingent
liabilities roust for pui-pos~s of detei-~ni~iirig solve~icy be
treated as definite liabi]ities even though tl~c
continScncy has not occurred. Mitsui his chosan not Yo
inak~ an issue oi' the conti~ag~nt n~iturc: of the guarantee
<tind of the co-signahire o:C the note; tu~iybe tonics
Medical Systems vas A~eally insolvent by the time Mitsui
received tl~e payments in issue froi~i Xonies
Yh.<~kochemical, so that tl~e cc>~~tin~ezat liabi~liCy ~~~as no
longer contingent. 'I~l~c Duly ar~utnent Mitsui. tulkes
against t}ie [*~9~ finding th~f the payments Yu it were
voidable preterenc~s is tl~<rC Xonics Photochemical was
not insolvent tivhen they ~verc made because the
trnnsact~ioits liet~veen it and its affiliates were (1) void
u~~ider stlte la~v (ll~e parties agree tl~iat the applicable
state la~v as tl~tit oP Ill.ia~ois), or (2) voidable as fi-aucfiul~nt
eoi~veyances. If cifhcr conteutiou is eon~ect, the
transactions creaCed iio liabilities on the part i~f Xonics
Photoclietnical and tliezefi>re could nc~t ha~~e naadt it
insolvent, whatever fhe plight of X~nics Medical
Systems; Bence section 547(b) 4vould 1~ot be triggered.
1. When a parent causes one of its subsidiaries to
gu~rnntee anoYl~er's (ar the parent's o~~vn} debts, there is
~n obvious danger -- one: indeed that has materialized in
this case -- Q~at crcd.itors of the guaraiiYor, ~vho nor~~ially
are tuiarvare oP the contingent liability and may not even
he <Y~vare ~f' their debtoa~'s ~ffili~tion ~vitl~ other
ecrrpnratio~~s, will find tl~e.~aiselves, witlao~.il waci~irig,
dealing ~arith a suddenly less solvent (not, as eve have
been 1t pains tc~ stress, necessarily insolvent) debtor.
7`lx: ek'.(eci v~~ tl~t guarantee, especially where as here it
is a part of 1 nef«-ark oP suarantces that have tl~e effect
of making the [~*10] debts of each affiliate debts of all
the other afli(iat~s tis well, is similar to that oP a n~le o1'
laa= that treats the assets of af~Jiated corporations as a
coi~nmoii pool available. to the creditors of each affiliate.
Such rules have someti,cnes been tidvc>cated, but the law
J~~is ~-eFused t~o ~~dopt then, for just tl~e reaso~i stated;
t}iey m<jke it harder for creditors of an affiliated
corporation to assess tl~eiz• debtor's credit~~vorthin~ss. If
such rules ~~~cre in Col•ce, "a sign of weakness in tiny
member ol'a fEimily of cc~iporations ~~ould lc~d creditors
to descend on e~cl~i member, strong or week, to claim
their p<~~md of flesh." Irt re i12~10-rain Cor~z, Trrc., 8] 0
1~.2c1 270, 277 (D.G. Cir. 1987). Ilcnce there is no
automatic "piercing of Uie corporate ~~eil" in affiliatio~l
settings. The ztssets of affiliated coi~aratious are not
treated as a conaino~a pool av~iilable to the creditars of
each affiliate ~mless imtisual circuinst~nces are present
that would make zt inequitable to allow tie other
~fGliatcs to sit up the pcinciplc of limited ]i~bility, tl~c
clearest such circ~unstance Ueing that the creditors of alt
the affiliates had thought they were dealing with a
unitary entetprise. For a ll~orougl~ [**],1] discussion see
Cissel! r•. First Nat'l Bank of Cincinrinti, 476 1~. Supp.
474, 479-81 (S.D. Ohio 1979); sec also !L1ui~a Ban7c cif
Chicago r. I3crkei~, 8F Ill. 2d 1.88, 204-OG, 427 ivr.l?.2d
I4, 7.01-U2, 5(i Ill. ]:)e;c. 1.~4 (.1981); Van Dor•ri Co. i~.
I'r~tcu~e C,7Tenracn! cP~ Orl Corp., 753 I'.2d 565, 569-70
(7t1~ Cir. 1985) (applyiizg Illinois law); cf. Irz re Kniser,
791 1~.2d 73, 75 (7th Cie. 1986).
I3tirt here tlae pooling u✓as accomplished vohintarily, sotl~e focus ol~ Ginalysis switches t~o the c~ucsti.o~a whet~lacr
tl~e policy 'behind generally not piercing the corporate
>>eil precludes ever enforcing a guarantee by one
at'.tiliate of anothec's debts. Courts l~Give nc~t tlacxtgl~t so;
fIN3[~~] a gu~x•antee of an affiliate's deUt is enforcc~Ule
(see Telefest, li~c. i~. t'~r-TV, Inc., 5)1 1'. Supp, 1368,
1.377-8.L (D.N.J. 19&4), a~~d cases cited tla~a~e) provided
that the gu<u~a~ator derives some benc;Cif, even if indirect,
see id. at 1379, from the gulrantee. The benefit operates
as a pa~-tir~i offseC to the impli~nient in the p~~ospeets of
tllc ~uarzintor's or4ditors [** 12] -resulting :fr~n~ kl~e
debtor's assuming a contirzg~nt liability.
[*202] Whefl~ea Xo~~ics Photoclieinical derived a
l~~uetiY 1i~c~m its guaraaitecs vas a factual question, and
we cAunot say that the baiilcrliptcy judge's resolution of
ii vas clearly ~none<~us. Although llae primary benefit
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Kai i~.za i~~, ~,n~; ~~~~ tJ.s. nP~,. i.r~.xts 3o3s, ~~~,
i~f [lie l0~~.1 aeciuca to tl~e t.~orrowcr, X~nies M~dic~l
Systems, t}~af coml>a~3y's fnrCunes were entwined with
those of Xonic~ I'hc~toclae~niefil bec~us~, the sn~allei
aatnp~ny ~tscd its larger t~f~li~ic's disll-ibuYion syste~7~ t~o
clisis•ibi~te its o~vi1 ~~r~~ducts. 'I'lie benefit may not have
bee~i greet l~tit z~eillier ~v~~~ the cost. ~oiiics
~'~iotocl~einical F~~~s taot p~zyixig ~i3y in.tcrest on the loc~ia:,
it just yeas s~ ~niar3nior, and all concerned asstln3e~l t}~t~t
lie loan ~~c~uld be duly repaid acid no gunraiit.or mould
be out oPpockGt. Thu co-~igaiecl i~otc Boras to scctn-c a liue
of credi~C can ~-vhich Xonics Pl~otocliemical as ~i~ell pis
Xonics Meeiical Systems could draw; so again there vas
benefit.
3. Mitsui's second ~eoutt~l 1''or invalidating the
a~t~rGikliliate taansackions is thjt they ~iz~e Gaudtilez~t
co~~veyances ~vitlain the a~~eaning of :l 1 t.J.S.C. ~,'ti 544(h)
«r 548(a). 1'h~se two provisions (tivell discussed ii1 the
shutei~k Conm~~nt cited fti~ fl~~ begi»ling ~**13~ cif 111is
c~~ji.i~ion) Must lac disti.a~guishcd, Seckiou 544~(b) HN4[ ]
iii e1Ye~t allows ttie tnistee to use flee ~r~~~licablc state`s
lati~~ ok frai~idulenr convey2nces to set aside obligations
i,ticurrec3 by ll~e b~~nkru~t. `l'he acCion of a p~reut
corp~i~a~Yion in causi~ig one of its wholly c~~~7ied
suUsidit~ri~s to gt~aranCee t]se deUts of aii+.~tl~er could in
aPp~•o~riate cia~cuxaxst~~lce~ he cte~n~ecJ ~ :fra~id oar ll~~
gu~rauii~r's ~~5~i ar•editors, ~vcu it fliers Was
consider~Yion for the guaranty -- that is, even if the
git~irantor obt<rined .sun~~ bear:#d from the trt~n~acticfu --
s« that il~ would not fail un.<1~r ardiliary cc>~~~ttnct la~~~~. CP.
Ri~hin 4~. !~lrrna~~crcture~•s I~~~rnvver~ Tr~trst Gv., GG1 F.2d
9"11, 993 (2cl Cir. 191). Nominal co~isid~r~ti~n is, in
~unei~l, z~ll t11at is a~c~ded t~~ sr~tis.Cy tfae z-ec~nia~ein~a~ta oP
tlt~: law i7f 4onti-aets (see 2 I3lackstoi~~, Ca~~in.eiitaries
n~i CYie LatiFs of England 440 (17 6) ("peppercorn");
I~anasw~rth, Contracis §y~' Z.-ll.-.14 (.1.98:2)) -~ a
riquuem~.nt of lciec~uate or aaiuiticnstiii~ate cor3siderafi~n
~~ould g~~a~~ely titidenniiie freedom of conu~~ck. -- bi t
[** 14] H.NS~ ~ a couveyanc~ not sa~~pt~ried b_y
1dec~'itatc considcr<iton is °fraudulc~if" (tl~4~t is,
utienfoi•ce7ble) as against existing creditc~is of a debtor
~vho gave up e~lue ui exch7nbe for the inldegci~te
considexati«i~. See Kind v. Zo~~izalinf~ Inlernatio~~erl, I~~c_,
825 F.2d ~11~~, i1f36 (7k1~ Cie. 1987). Anil, e~~i~ if the
consideration is aclec~iiate, the conveyance is fzandulenC
if inacie v~ri~.h intc;nf to defi~~nd creditors. See i~~.
Section 548(x) crates ail atternativE, Ee.deral ec~~~icept of
fi~udt~lent cnnve_ya»ces -- ar ctithez two 7lturnaPive
fe~erlt coi7cepts, IINfi[ ] if an obligaxioal w~is incurred
witl3itl ~n~ year before the Cling of the pekitioii £or
bt~nl;n~ptcy, ~tnd t}te~•~ was ac[util intent t~~z clefrand eithet-
an etisti~,~g or ~ future cr~diTor, the tnistc:e case. avoid tl~c
~bligakiott. 11 [J.S.C. ~ 54R(a)(1). AlYrrliatively, if tl~e
cl~btut "raceivecl less than ~ re~~soiia~bly ecj~tivalen(. v~iltie
in exchange foi si~c}~ ... obll~atioi~" and ~v~~s insolvent
on the date the ot~li~nt~ion was in~ui7•ed, the trustee ~g1in
can avoid t}te oblig~Tion. 11 U,S,C. § 54$ (a)(2).
We sh~11 rnxt l~avi ~ ** 1 ~] ko decide ~vli~tl~er the-
oblignCions that Xonics I'hotocheauical incu~7eci by
viz•tue of its guarantee of the Ic~t~i.a tc~ Xonies Medical
Systems ni~d ~~f its becoming a co-m~~~;er ~~-i~h CMS ~~f a
Vote are vuhlerable Euider either 54~(~) oi• S4$(ii). II`V7[
] "l~l~e rigllP to iny~~kc Lhesc~ ~r~~vi~;ions beloi~~s taot to ~t
particular unsecuccd creditor siicla as Mit~iii but to tlac
tnistee (or del~ior in possession) as the represenfafive of
all the iun4eciu~ed crcctitars; and in this case the. det~tor in
r<>~;scssion Iles uoY im~okud eitl.~cr provision. I~t is x~ot as
if' Mitsui itself had beeei a creditor han7~ied by the
allegedly fi•~udulPnt conveyances; they ~~reeeded the
payments iri istiue. Mitsui is seeking to stand in the
shoes c,f creditors ~vl~o may have been 1~~rmed, but only
the trustee ar cfebt~r in possession cfln da that.
Siitue tlicre is i~o tn~stee aid t7i~ d~btoi• u~ possessic~i~
rei5iains nn ef~fili~te of the turn t~~l~ose debt the ciel~tor
had guKtraz7te;ecl, M:itseri is en.ti.tlecl to Gv<~nder cvlaether the
nfiisal by t~lie debtor ~i~~ posse:ss.ioia to try to void tl~.e
guarantee (and perhaps the co-sibnzct note r~s well) was
really i~~ade in good f~ikl~. I3ut, if' sa, Mitsui
co~~ild [**'I6~ ~havc sought Ylaa appoint~nGnt of ~ irust~~;
in L~ankrupkcy, see 'il iJ.S.C. ~ 11~~4, suet it [~2Q3] liar
ne~~~;r done sc~. Mitsui says it doesn't have ~nougl~ at
stake iax ibis case to ~-van' uil beticin~ the ~x~jense cif
proving the nerd for t}~e ~ppc~intinent of a titiistec:, yet iY
see~n~ ~~;~illing Yo supply the very s~nie proof in order fo
pc.rsuacie ins t1z1t it should he allowed to stand .in tl~e
shoes of the: elebtor in pcassession and invoke fraud~ilent-
convey~nce law.
11n alkc~i~~ative route possibly c7pen tc~ Mitsui, see In ~~e
~~ratornc7r'ec~ I3ar,sine,ss S.ust~~~ras, Inc., 64~ F.2c~ 200 (<~kh
Cir. 1?31); Ir7 re ,Ione.s, 37 I3.R. 9C~ (F3an(:r. N.D. Tex.
19~A), vas to ask 1:(~e bt~nln uptcy co~~a t to allow .it to
bring a Po.rm of dci~ivative suit in kl~e dame of tl~~ detat:or.
13nt bef'c~re it could do any such thing it would hive to
co~i.~~~icze~; iha c<nut tliat~ the deb(~o~• was shizki~G~~ lvs
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841. P.2a 19R, *203; 1988 li.S. /app. I..F;XIS 3035, **l.b
stahrtory responsibilities; and this Mitsui has never
done. Cf. I'ox i~aGlei~ .9A~IC/Jeep, Inc. v. AM Credit
Corgi., 83C> F.2d 3CE (7th Cir. 1988), and cases cited
there..
Iaz these circun~stan.ces a batter argnme.uf :for Mitsui
li~oin sectiolts 544(b) and 548(a), but one Chat Mitsui
does not make, is j ** 17~ that these Provisions supply
a~~otl~er reasoia far ~~~ritulg do~~~n the contingent
]iabi]ities upon which. the liuding cif Xouics
Photochemical's insolvency at the time of the
preferential payments was (in part anyway) based. Por if
by virtue ~f i~~audulent-conveyance 1G~i~v the liabilities
mi~hY not b~ enforceable ~in Yl~~~ evsi~C of ban.kniptcy
(depending of course on «~Iiat a trustee in l~ankrupt~y o~•
debto~~ i~~.~ k~ossessiou mi.~lat choose to do) -- and i~~deect
iuight be voided in an independent action Uefore
bankruptcy -- this ~~~ould be another reason for thinking
that these liabilities should l>e drastically discounted i~~
deciding wl~ethcr they hdd made Ll~e debtor iil~olvent,
acid l~~iicc ~vhcther the ~aymcnts to Mitsui are ~~oidablc
under section 547(b). 1~n unenforceable debt is not
nr~ich of ~ li~bilit}~.
Mitsui has pres~nt~d no grotiind on ~vhieh eve are
autli.oa~ired to set aside the voidii~~ o_f the payaite~ats
made Yo it..
A3~ PIRMI;D.
~~.ard~ oaf I~~st~r~a~er,39~
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CautionAs of: February 7, 2019 1:53 AM Z
~ ~~ k
Court of Appeal of California, Third Appellate District
October 10, 1996, Decided
No. CO21518, No. CO21956.
Reporter49 Cal. App. 4th 1576 "; 57 Cal. Rptr. 2d 435 "; 1996 Cal. App. LEXIS 966 '"'"; 96 Cal. Daily Op. Service 7594; 96 Daily JournalDAR 12463
LENNAR NORTHEAST PARTNERS, Plaintiff andRespondent, v. DeWAYNE A. BUICE as Trustee, etc.,et al., Defendants and Appellants. LENNARNORTHEAST PARTNERS, Plaintiff and Respondent, v.TAHOE VISTA INN AND MARINA, Defendant andAppellant.
Prior History: [***1] Appeal from the judgment of theSuperior Court of Placer County. Super. Ct. No.SCV2117. Hon. James Roeder, Judge.
Disposition: The judgment is reversed and the matterremanded to the trial court with directions to enterjudgment in favor of the Trust on its cross-complaint andto make a declaration of the priority of the liens, treatingthe modification to the Trust's lien separately, inaccordance with the views expressed in this opinion.Since the Trust and TVIM have substantially prevailedon appeal, they shall recover their costs. (Cal. Rules ofCourt, rule 26.)
Core Terms
modification, trust deed, seller, subordinating, senior,lender, junior lienholder, interest rate, contends, default,lien priority, foreclosure, percent, buyer, summaryadjudication, construction lender, junior lien, trial court,materially, advances, senior lien, receiver, lienors,rights, terms, lienholder, argues, lease, amount ofprincipal, real property
Case Summary
Procedural PostureDefendants, trust and borrower, appealed from thejudgement of the Superior Court of Placer County(California), which granted a motion for summaryadjudication in favor of plaintiff junior lienor in an actionbrought by plaintiff to establish lien priorities and
foreclose on defendant borrower's property. Defendantborrower had secured loans purchased by bothdefendant trust and plaintiff with deeds of trust on itsreal property.
OverviewDefendant trust purchased a bank note secured by asenior deed of trust on defendant borrower's property.Defendant trust advanced more money, and amendedthe note, changing the principal amount, interest rate,and maturity date. Plaintiff junior lienor brought anaction to establish priority of its lien and to foreclose onthe property. Defendant trust filed across-complaint.The trial court held that there was a substantialmodification to the senior debt that materially affectedthe security of plaintiff's lien, which caused the seniordeed of trust to lose its priority. The court reversed andremanded to the trial court. The court held that theamendments were material and substantial because theinterest rate increase from prime plus 3 percent to 12percent when coupled with the greater principal amountworsened plaintiff's position. The court ruled, however,that only the increase due to the modifications shouldhave been denied priority. The court found that as themodification had no effect on the value of the underlyingsecurity, by denying the modification priority, plaintiffwas restored to the same position it bargained for byagreeing to accept a second lien.
OutcomeThe court reversed the judgment and remanded to thetrial court with directions to enter judgment in favor ofdefendants and to make a declaration of the priority ofliens, treating the modifications to defendant trusts lienseparately. The court held that the amendments madeby defendant trust to the senior note were substantialand material, but that denying only the modificationspriority restored plaintiff to its bargained for position.
LexisNexisO Headnotes
Page 2 of 10
49 Cal. App. 4th 1576, *1576; 57 Cal. Rptr. 2d 435, x'`435; 1996 Cal. App. LEXIS 966, **"1
Civil Procedure > ... > Summary
Judgment > Entitlement as Matter of Law > General
Overview
Civil Procedure > Judgments > Summary
Judgment > General Overview
Civil Procedure > ... > Summary
Judgment > Motions for Summary
Judgment > General Overview
9~~1[] Summary Judgment, Entitlement as Matter
of Law
In reviewing the propriety of granting a motion for
summary judgment or summary adjudication, the first
step is to identify the issues framed by the pleadings
since it is these allegations to which the motion must
respond.
Real Property
Law > Financing > Foreclosures > Judicial
Foreclosures
Real Property
Law > Financing > Foreclosures > General
Overview
Real Property Law > ... > Liens > Nonmortgage
Liens > General Overview
Real Property Law > ... > Liens > Nonmortgage
Liens > Lien Priorities
Civil Procedure > ... > Pleadings > Time
Limitations > General Overview
Real Property Law > Financing > Secondary
Financing > Lien Priorities
11,3[] Time Limitations, Extension of Time
A senior lienholder may extend the time for payments of
the senior debt provided the extension does not impair
the junior lienholder's rights and security.
Real Property Law > ... > Liens > Nonmortgage
Liens > Lien Priorities
H~[] Nonmortgage Liens, Lien Priorities
An extension of a senior debt that merely alters the date
of payments generally does not adversely affect the
junior lienholders. However, when the obligation is
increased, by an increase in the principal amount or an
increase in the interest rate, the junior lienholder's
position is worsened.
Real Property Law > ... > Liens > Nonmortgage
Liens > Lien Priorities
h'~t['`] Nonmortgage Liens, Lien Priorities
A modification to the senior secured debt, such as an
increase in the interest rate, can affect the income
produced by the property. As the expenses increase,
the value of the property, as measured by its return,
decreases. The decrease in value has a material effect
on the value of any existing junior lien.
1-~~~[] Foreclosures, Judicial Foreclosures
An action for judicial foreclosure must establish the
relative priority of the lien claimants joined as parties so
that any surplus sales proceeds can be paid to junior
lienholders in order of priority.
Civil Procedure > Trials > Bench Trials
Civil Procedure > Trials > Judgment as Matter of
Law > General Overview
#-f~d6['`] Trials, Bench Trials
Civil Procedure > ... > Pleadings > Time
Limitations > Extension of Time
Real Property Law > ... > Liens > Nonmortgage
Liens > Lien Priorities
While a dispute over the effect of an unconsented to
modification often raises a question of fact, where
reasonable minds cannot differ, the question may be
resolved as one of law.
Page 3 of 1049 Cal. App. 4th 1576, ̀1576; 57 Cal. Rptr. 2d 435, '`*435; 1996 Cal. App. LEXIS 966, *`*1
Contracts Law > ... > Perfections &Priorities > Priorities > General Overview
Real Property Law > Financing > SecondaryFinancing > Lien Priorities
substantial modification that caused the senior deed of
trust to lose its priority, and the trial court entered ajudgment of foreclosure on the deed of trust held byplaintiff. (Superior Court of Placer County, No.SCV2117, James L. Roeder, Judge.)
Contracts Law > ... > SecuredTransactions > Perfections &Priorities > GeneralOverview
Real Property Law > Financing > Mortgages &Other Security Instruments > Mortgage Formalities
Real Property Law > ... > Liens > Nonmortgage
Liens > Lien Priorities
~fN7[] Perfections &Priorities, Priorities
It is well established that while a senior mortgagee can
enter into an agreement with the mortgagor modifying
the terms of the underlying note or mortgage without
first having to notify any junior lienors or to obtain their
consent, if the modification is such that it prejudices the
rights of the junior lienors or impairs the security, their
consent is required. Failure to obtain the consent in
these cases results in the modification being ineffective
as to the junior lienors and the senior lienor
relinquishing to the junior lienors its priority with respect
to the modified terms. While this sanction ordinarily
creates only the partial loss of priority noted above, in
situations where the senior lienor's actions in modifying
the note or mortgage have substantially impaired the
junior lienors' security interest or effectively destroyed
their equity, courts have indicated an inclination to
wholly divest the senior lien of its priority and to elevate
the junior liens to a position of superiority.
Headnotes/Summary
SummaryCALIFORNIA OFFICIAL REPORTS SUMMARY
A junior lienholder brought an action for judicial
foreclosure of the encumbered real property and for
appointment of a receiver, after amendments were
made to a note and the senior deed of trust held by the
senior lienholder. The senior lienholder brought a cross-
complaint for judicial foreclosure of its deed of trust, for
declaratory relief regarding the priority of the liens, and
injunctive relief to stop plaintiff's foreclosure action. The
trial court granted plaintiff's motion for summary
adjudication, finding that the amendments were a
The Court of Appeal reversed the judgment andremanded the matter to the trial court with directions to
enter judgment in favor of the senior lienholder on itscross-complaint and to make a declaration of the priorityof the liens, treating the modification to the senior
lienholder's lien separately. The court held that the trial
court did not err in finding that modifications to the note
and the deed of trust held by the senior lienholder were
substantial as a matter of law, thereby requiring an
adjustment of priorities. The effect of the modifications
taken together, which included amendments to the
interest rate and the principal amount of the note, was to
increase substantially the amount of secured debt that
was senior to plaintiffs lien, adversely affecting plaintiffs
rights as a junior lienholder and the value of its security.
However, the court held that the modifications did not
require subordination of the senior lienholder's entire
lien, but rather, only the modifications. By denying
priority only to the modifications, it was possible to
restore plaintiff to its original position: the position it
bargained for by agreeing to accept a second lien on the
property as security for its loan. At foreclosure, the
amount due under the senior lienholder's note,
calculated in accordance with the terms of the note
before it was modified, could be calculated and given
first priority. Any additional amount owing under the
amendment would then be junior to the liens existing as
of the date of the modification. (Opinion by Morrison, J.,
with Sparks, Acting P. J., and Nicholson, J., concurring.)
HeadnotesCALIFORNIA OFFICIAL REPORTS HEADNOTES
Classified to California Digest of Official Reports
~~ A ~l ~~)
Summary Judgment § 25—Appellate Review—Identification of Issues Framed by Pleadings.
--In reviewing the propriety of granting a motion for
summary judgment or summary adjudication, the first
step is to identify the issues framed by the pleadings,
since it is these allegations to which the motion must
respond.
Page 4 of 10
49 Cal. App. 4th 1576, "1576; 57 Cal. Rptr. 2d 435, "`435; 1996 Cal. App. LEXIS 966, *"1
~~ ~ ~l ~2)
Liens § 9—Priorities—As Determined by SummaryAdjudication: Deeds of Trust § 14—Priorities.
--In an action by a junior lienholder for judicial
foreclosure of the encumbered real property and
appointment of a receiver, the issue of the priority of
competing deeds of trust was properly before the trial
court in plaintiff's motion for summary adjudication,
notwithstanding that plaintiff's complaint included
causes of action solely for judicial foreclosure and
appointment of a receiver. In looking at the actual
allegations of the complaint and its answer, the
complaint alleged that defendant, another lienholder,
had a trust deed, and in its prayer asked for adjudication
of priorities of the liens. Defendants answer asserted a
senior lien as an affirmative defense. Thus, the issue of
the priority of the liens was within the general area of
the issues framed by the pleadings. Indeed, an action
for judicial foreclosure must establish the relative priority
of the lien claimants joined as parties so that any
surplus sales proceeds can be paid to junior lienholders
in order of priority.
Liens § 9—Priorities—Adjustment of Priorities Based
on Modification to Note and Senior Deed of Trust:Deeds of Trust § 14—Priorities.
--In an action by a junior lienholder for judicial
foreclosure of the encumbered real property and
appointment of a receiver, the trial court did not err in
finding that modifications to a note and the senior deed
of trust held by defendant on the same property were
substantial as a matter of law, thereby requiring an
adjustment of priorities. The amendment to defendant's
note, which extended its term until the following year,
with an option for a second one-year extension, did not,
by itself, result in a material modification. However, the
note's interest rate was changed from a variable rate of
prime plus 3 percent to a fixed rate of 12 percent,
resulting in a substantial increase from 9 to 12 percent.
The principal of the note was also increased, which
increased the amount of secured debt senior to
plaintiffs lien. The enlarged debt payment also
increased the expenses of the property, thus lessening
the return available to junior lienholders. Further, by
adding accrued interest and prepaid interest to the
principal, the note changed from simple interest to
compound interest. The effect of the modifications taken
together was to increase substantially the amount of
secured debt that was senior to plaintiff's lien, adversely
affecting plaintiff's rights as a junior lienholder and the
value of its security. While a dispute over the effect of
an unconsented-to modification often raises a question
of fact, the question may be resolved as one of law
where, as in this case, reasonable minds cannot differ.
Liens § 9—Priorities—Adjustment of Priorities Basedon Modification to Note and Senior Deed of Trust—Subordination of Modification Only: Deeds of Trust §14—Priorities.
--In an action by a junior lienholder for judicial
foreclosure of the encumbered real property and
appointment of a receiver, after substantial
modifications were made to a note and the senior deed
of trust held by defendant on the same property, the
modifications did not require subordination of
defendant's entire lien, but rather, only the
modifications. By denying priority only to the
modifications, it was possible to restore plaintiff to its
original position: the position it bargained for by
agreeing to accept a second lien on the property as
security for its loan. At foreclosure, the amount due
under defendants note, calculated in accordance with
the terms of the note before it was modified, could be
calculated and given first priority. Any additional amount
owing under the amendment would then be junior to the
liens existing as of the date of the modification.
[See 3 Witkin, Summary of Cal. Law (9th ed. 1987)
Secured Transactions in Real Property, § 38 et seq.]
~l ~5)
Liens § 9—Priorities—Adjustment of Priorities Basedon Modification to Note or Mortgage—Consent.
--While a senior mortgagee can enter into an
agreement with the mortgagor modifying the terms of
the underlying note or mortgage without first having to
notify any junior lienors or to obtain their consent, if the
modification is such that it prejudices the rights of the
junior lienors or impairs the security, their consent is
required. Failure to obtain the consent in such cases
results in the modification being ineffective as to the
junior lienors and the senior lienor relinquishing to the
Page 5 of 10
49 Cal. App. 4th 1576, '`1576; 57 Cal. Rptr. 2d 435, "'435; 1996 Cal. App. LEXIS 966, "*"1
junior lienors its priority with respect to the modified
terms. While this sanction ordinarily creates only thepartial loss of priority noted above, in situations where
the senior lienor's actions in modifying the note or
mortgage have substantially impaired the junior lienors'
security interest or effectively destroyed their equity,
courts have indicated an inclination to wholly divest the
senior lien of its priority and to elevate the junior liens to
a position of superiority.
Counsel: Miller, Starr &Regalia, Edmund L. Regalia,
Chamberlain, Chamberlain & Baldo, Russell Baldo and
Thomas C. Thompson for Defendants and Appellants.
Morrison & Foerster and Douglas Hendricks for Plaintiff
and Respondent.
Judges: Opinion by Morrison, J., with Sparks, Acting P.
J., and Nicholson, J., concurring.
Opinion by: MORRISON
Opinion
Trust asserts equitable subrogation should apply to
restore the priority of its lien. We agree that only themodification to the [***3] Trusts deed of trust should bea junior lien and so reverse the judgment.
FACTUAL AND PROCEDURAL BACKGROUND
The property in question consists of six rental
condominiums, with adjacent docks, parking area, and
related facilities, including a restaurant, in Tahoe Vista,
California.
In 1983, TVIM's predecessor in interest executed a
promissory note in favor of Bank of America. The note
provided that principal amounts advanced would not
exceed $ 600,000, and such amounts were payable on
demand or on December 21, 1984. The note bore
interest of prime plus 2 percent. The note was secured
by a deed of trust on the property.
In March 1984, TVIM gave aone-year promissory note
for $ 700,000 to Chesapeake Savings and Loan. This
note also was secured by a deed of trust on the
property. Both deeds of trust were recorded on April 2,
1984, at 9:35 a.m. The Chesapeake deed of trust stated
it was subordinate to the Bank of America deed of trust.[*1579] [**436] MORRISON, J.
Tahoe Vista Inn and Marina (TVIM) owns real property
located on the shore of Lake Tahoe; the property is
encumbered with several deeds of trust. The Buice
Revocable Living Trust (the Trust) purchased a
promissory note made by TVIM from Bank of America;
the note [***2] was secured by the senior deed of trust
on TVIM's real property. As part of the transaction, the
Trust made additional advances to TVIM and amended
the note and deed of trust, changing the principal
amount, the interest rate, and the maturity date. The trial
court found these amendments were a substantial
modification which caused the deed of trust to lose its
priority. The trial court granted a motion for summary
adjudication by Lennar Northeast Partners (Lennar), the
holder of what had been the second deed of trust on
TVIM's property. A judgment of foreclosure was entered
on the deed of trust held by Lennar.
The Trust appeals from this judgment, advancing
several arguments to restore the priority of all or most of
its lien. It contends the modifications [*1580] were not
so substantial as to require a change in priorities, or the
question of their materiality was a factual one that could
not be resolved by summary adjudication. Even if the
modifications were substantial, the Trust argues only the
modification ["*437] should be a junior lien. Finally, the
In 1988, TVIM entered into loan workout agreements
with Bank of America and Chase Bank of Maryland,
Chesapeake's successor. Both agreements extended
the due date for the loans until December 31, 1988,
changed the interest rate due on the note, and [*"*4]
required a second note for unpaid interest. The new
interest rate on the Bank of America note was prime
plus 3 percent. Bank of America's interest note was in
the amount of $ 126,000; Chase's was $ 157,802.46.
Both workout agreements also required subordination
agreements from junior lienholders to assure the same
priority of the liens. Chase executed a subordination
agreement in favor of the Bank of America deed of trust.
The Chase note and deed of trust were amended.
Junior lienholders executed subordination agreements.
In 1990, TVIM executed a second deed of trust in favor
of Bank of America. This deed of trust stated it was to
secure the $ 600,000 note dated December 21, 1983;
the $ 126,000 note dated March 30, 1988; and a $
72,250 note. This deed of trust was never recorded and
there is no evidence the $ 75,250 note was executed.
The Trust indicates this deed of trust was part of a
second, unsuccessful workout agreement.
[*1581] In 1993, the original Bank of America note for
$ 600,000, the second note for $ 126,000, and the deed
Page 6 of 10
49 Cal. App. 4th 1576, "1581; 57 Cal. Rptr, 2d 435, '`"`437; 1996 Cal. App. LEXIS 966, *"`4
of trust were assigned to the Trust. The amendment to
the note states the unpaid principal and interest under
the note is $ 934,513.16, and that [**'"5] the Trust has
advanced additional funds so the principal balance with
interest through May 15, 1994 is $ 1,075,000. Interest
from that date is 12 percent. The due date of the note is
December 15, 1994; upon payment of $ 10,000, the due
date can be extended to December 15, 1995.
In May 1994, Chase brought suit for judicial foreclosure
and appointment of a receiver, alleging its $ 700,000
note was in default. TVIM and the Trust were named as
defendants. ~ Under the heading "Senior Trust Deed
Lien," the complaint alleged the Trust is the holder of a
trust deed lien. In the prayer, the complaint asks for an
adjudication that the liens of defendants are subsequent
and subordinate to Chase's trust deed.
had priority because the amendment [***7] had
substantially changed its terms and materially affected
the security of Lennar's lien. The court authorized sale
of the property with a listing price of $ 2,400,000.
[*1582] The Trust moved for reconsideration. This
motion was denied.
Lennar moved for summary adjudication, contending its
note was in default and its deed of trust had priority over
the Trusts.
The Trust opposed this motion; it argued the undisputed
facts showed the Trust was entitled to summary
adjudication. The Trust brought across-complaint for
judicial foreclosure of its deed of trust, for declaratory
relief regarding the priority of the liens, and for injunctive
relief to stop Lennar's foreclosure action.
[***6] In its answer to the complaint, the Trust asserted
as an affirmative defense that it held a promissory note
secured by a deed of trust senior to Chase's deed of
trust.
Chase nominated Jon Eicholtz as receiver and he was
appointed by stipulation. The receiver petitioned for
instructions, raising a question as to the priority of the
liens. The receiver also requested authorization to
market the property at a listing price of $ 1,800,000. The
existing listing had a suggested sales price of $
2,950,000, and there had been no valid offers.
[**438] Lennar purchased the loan from Chase and
substituted into the action as plaintiff. Lennar responded
to the receiver's petition contending that the Trust's
deed of trust was entirely subordinate to its deed of
trust.
The Trust argued it had a valid first lien. It explained that
Bank of America's payoff demand was $ 980,654.27,
and $ 14,849.35 was disbursed to TVIM for
improvements and maintenance of the property. The
advances made to TVIM for prepaid interest,
improvements and maintenance totaled $ 90,000 and
were made according to the terms of the note.
The trial court ruled the Trust's deed of trust no longer
~ The complaint named several Doe defendants. The
complaint was later amended to show the true names of four
of these defendants; they were junior lienholders on the
property. Default judgments were entered against three of
these defendants. The fourth had to be served by publication,
and disposition of the matter as to him does not appear in the
record.
The trial court, with a different judge presiding, granted
Lennar's motion for summary adjudication. 2 The court
stated it had reviewed all the papers de novo, not
relying on the prior ruling, and found the substantial
modification of the Trust's deed of trust affected the
junior lienholders' security. The court found the secured
debt had increased $ 140,486.84.
[***8] The Trust moved for reconsideration, arguing
only $ 140,486.84 of the debt to the Trust should be
subordinated to Lennar's deed of trust, and requested
an evidentiary hearing.
The parties agreed the issues of the Trust's cross-
complaint had been adjudicated; a judgment of
foreclosure in favor of Lennar was entered.
The Trust and TVIM appeal. TVIM simply joins in the
Trust's arguments.
DISCUSSION
NT~~(] ~ ~ [] (1) In reviewing the propriety of
granting a motion for summary judgment or summary
adjudication, the first step is to "identify the issues
framed by the pleadings since it is these allegations to
which the motion must respond ." ( AARTS
Prc~cluctar~sIncT_v. „Cracker Natiar~al_~~nk._(~986~_.1.79
~~1.~._3d 1061106 ~22~ Cal. Rptr. 203.) C~ ~ []
(2)The Trust contends the summary adjudication was
ZThe trial judge who ruled on the receiver's petition
disqualified himself from the case.
Page 7 of 10
49 Cal. App. 4th 1576, *1582; 57 Cal. Rptr. 2d 435, **438; 1996 Cal. App. LEXIS 966, ̀'`*8
improper because the issue of the priority of the liens
was not framed by the pleadings. The Trust contends
Lennar's complaint sought only judicial foreclosure and
appointment of a receiver.
In focusing solely on the description of the two causes
of action in Lennar's complaint, the Trust ignores the
actual allegations of the complaint [*1583] and its
answer. The complaint alleges the [*'"*9] Trust has a
trust deed, and in its prayer asks for adjudication of
priorities of the liens. The Trusts answer asserts a
senior lien as an affirmative defense. The issue of the
priority of the liens was certainly "within the general area
of the issues framed by the pleadings." (Masan v.
Su erirlr~ Court 99F3~ 163 C~1. /~ ~d 989 J96 29CJ
Cal, R ir. 63.) Indeed, t-f2[] an action for judicial
foreclosure must establish the relative priority of the lien
claimants joined as parties so that any surplus sales
proceeds can be paid to junior lienholders in order of
priority. (4 Miller &Starr, Cal. Real Estate (2d ed. 1989)
§ 9:165, p. 558.) The issue of the priority of the
competing deeds of trust was properly before the court
in the motion for summary adjudication.
upon the junior lienholders. !-ft~~[] A senior lienholder
may extend the time for payments of the senior debt
provided the extension does not impair the junior
lienholder's rights and security. ( 1nl~stcrr~ F. G. v.
Security Title etc. Cn. X9937) 2Q CSI. gip. 2d 150 155-
15~ r~6 P.2ct 1"*'"~91] 74?I.) In Resolution gust Cora. v.~3V,S Develo n~er~t lnc. 9th Crt~. 1~JJ4 ~2 F.3c~ '(206,
the subordinated lienholder contended the subordination
agreement was nullified by a five-month extension of the
senior loan. The Ninth Circuit, applying California law,
found this extension [*1584] was not the type of
modification that materially increased the risk of default.
Rather, the extension gave the development a greater
chance of turning around and becoming successful,
which gave the subordinated lender a greater chance of
being paid. (lcl. ate. ?2_95.)
Here, too, the extension was made at a time when the
borrower was in difficulty; it could be reasonably argued
the extension gave the borrower a chance to turn itself
around and pay off its debts. By itself, the extension
cannot be said to be a material modification requiring an
adjustment of priorities as a matter of law. At most, it
raises a factual issue of whether it materially affected
the value of Lennar's junior lien.
A~3~[J (3) The Trust contends the modifications to
the Bank of America note and deed of [**439] trust in
1993 were not so substantial as to cause any change in
the priorities of the liens. The Trust argues that instead
of prejudicing Lennar, the modifications benefited the
junior lienholders by curing the default. While conceding
there were modifications to the term, interest rate, and
principal balance of the loan, the Trust disputes ['"**10]
the extent and the effect of each modification. The Trust
urges the modifications, whether taken individually or in
the aggregate, were minor. The Trust argues that since
the question of whether the modification was substantial
and prejudicial is essentially factual, it cannot be
resolved as a question of law.
The Trust does not contend that Lennar or Chase
consented to the modification. Indeed, in its motion for
summary adjudication, Lennar provided a letter from
Chase's counsel to the title company objecting to the
increase in debt secured by the first trust deed. Instead,
the Trust disputes the materiality of the changes
resulting from the modification.
The 1993 amendment to the Bank of America note
extended its term to December 15, 1994, and permitted
an additional one-year extension upon payment of $
10,000. The Trust argues that by extending the loan
rather than simply foreclosing, it bestowed a benefit
The more significant modifications were to the interest
rate and the principal amount of the note. The interest
rate was changed from a variable rate of prime plus 3
percent to a fixed rate of 12 percent. [***12] The Trust
argues this change is immaterial and was not much of
an increase, if at all. It notes the interest rate would be
about the same at the time of briefing, since the prime
rate was then 9 percent. This argument ignores the
effect the rate change had at the time it was made. The
Trusts own undisputed evidence indicated that at the
time of the modification the prime rate was 6 percent.
Thus, the modification increased the interest rate from 9
to 12 percent. This increase was substantial, particularly
when coupled with the increase in the principal amount
of the note.
The trial court found the principal of the note was
increased by over $ 140,000; this figure is taken from
the amendment to the note which states $ 934,513.16 is
the amount then due and additional advances have
increased the principal, with interest through May 15,
1994, to $ 1,075,000. The Trust disputes this finding. It
contends the only additional advance was $ 14,849.35,
which was disbursed to TVIM for repairs and
maintenance, and did not prejudice the junior
Page 8 of 10
49 Cal. App. 4th 1576, *1584; 57 Cal. Rptr. 2d 435, *'`439; 1996 Cal. App. LEXIS 966, *`*12
lienholders. 3 The Trust contends the remaining
difference between the stated amount due on the note
($ 934,513.16) and the ['""440] amount of the amended
note [***13] ($ 1,075,000) was the required payoff to
Bank of America ($ 980,654.27), prepaid interest ($
75,000), and closing costs.
Lennar contends that regardless of what the additional
amounts represent, they still increased the amount of
secured debt senior to its lien. The [*1585] enlarged
debt payment increased the expenses of the property,
thus lessening the return available to junior lienholders.
Lennar points [***14] out that since prepaid interest of
12 percent on $ 1,000,000 for five months would be only
$ 50,000, the additional $ 75,000 represents either
prejudicial usurious interest or an additional advance.
Further, by adding the accrued interest and prepaid
interest to the principal, the note changed from simple
interest to compound interest.
Lennar has the better argument on this point. N~4[]
An extension of a senior debt that merely alters the date
of payments generally does not adversely affect the
junior lienholders. However, when the obligation is
increased, by an increase in the principal amount or an
increase in the interest rate, the junior lienholder's
position is worsened. (3 Powell, Real Property (1996) P
458, pp. 37-258 to 37-259.) The effect of the
modifications taken together was to increase
substantially the amount of secured debt that was senior
to Lennar's lien. As Miller and Starr explain, t~5[] a
modification to the senior secured debt, such as an
increase in the interest rate, can affect the income
produced by the property. As the expenses increase,
the value of the property, as measured by its return,
decreases. The decrease in value has a material effect
on the value of any existing [***15] junior lien. (3 Miller
& Starr, Cal. Real Estate, supra, § 8:83, p. 426.)
Indisputably, this change adversely affected Lennar's
rights as a junior lienholder and the value of its security.
~J[] While a dispute over the effect of an
unconsented to modification often raises a question of
3 Where a deed of trust secures optional future advances,
priority of the security for such future advances is determined
by the circumstances when the advances are made; if at that
time the senior lender has notice of other liens, the other liens
have priority. (Pipe v. Tcrttfe (197? 1~ Cal.~p, ~d 746. 759
(;~i Cal. Rptr. X037.) Neither party proposes that this case
should be treated as a future advance case. Thus, we need
not determine whether the original deed of trust authorized
future advances or whether the Trust had actual notice of the
junior liens at the time it made the advances.
fact, where reasonable minds cannot differ, the question
may be resolved as one of law. (K~tz v. Chevrc~rr Cv~p.
f19J~]) 2~ C~1. A,~p. 4tf~ 1X52, 9;~fi~ fig. 92 (27 C<~al. f?ptr.
~d C381 ] ["...where reasonable minds could not differ
on the question, 'materiality' could be determined as a
matter of law."].) Here, there can be no reasonable
dispute as to the effect of the modifications. The trial
court did not err in finding the modifications were
substantial as a matter of law, We must now determine
the effect of the substantial modification on the priorities
of the liens; that is, whether the modifications require
the Trust's entire lien to lose its priority, or only the
modifications.
[] (4a) In finding the modifications resulted in
a loss of priority of the Trusts entire lien, the court relied
upon Glu~kin v. Atlantic ~~vin ~ &Loan Assn, 1973
3.7 Cpl. ,~ ~c~ 307 90 3 ~~1. R tr, 398. In [***16]
Gluskin, the plaintiff sold land to the buyer for $ 400,000
and took back a note for $ 175,000 secured by a deed
of trust on the property. The buyer secured two
construction loans to build houses on the property. The
plaintiff agreed to subordinate its deed of trust to those
of the construction lender. The two notes to the ["1586]
construction lender were payable in 30 years. (/d. ~f..~~~a.
311312.) Due to a poor market for housing sales, the
buyer and the construction lender restructured the loan.
The principal of the larger note was reduced from $
2,246,580 to $ 712,530; the interest increased from 61/4
to 10 percent; the monthly payments reduced; and the
maturity shortened to 10 months with a large balloon
payment at the end. The modification also contained the
buyer's representation that no one else had an interest
in the land. The buyer ultimately defaulted and the
construction lender bought the property at a foreclosure
sale. (lc~. at ~~. 392.)
The plaintiff seller objected the modifications were made
in utter disregard of its rights as the junior lienholder. It
sought declaratory relief that its lien was superior to the
deeds of trust held by the construction [***17] lender.
The trial court entered judgment adverse to the seller.
The appellate court reversed. Recognizing the
vulnerable position of the subordinating seller, it held
that public policy required protection of subordinating
sellers. "(A] lender and a borrower may not bilaterally
make a material modification in the loan to which the
seller has subordinated, [**441] without the knowledge
and consent of the seller to that modification, if the
modification materially affects the seller's rights."
Gi~.r~l<~`r7 v..~tC~rrtic Savin s &Lain ~I ~sn., sc~r~ 32 C~~l.
Page 9 of 10
49 Cal. App. 4th 1576, *1586; 57 Cal. Rptr. 2d 435, "*441; 1996 Cal. App. LEXIS 966, ""*17
Asap. 3d at___„~a. 394.) The court noted that if sound
business required the modification, the seller would
presumably agree. "If a dispute results from an
unconsented to modification it is of course a question of
fact whether the modification materially affected the
rights of the subordinated seller.” (Id. ~~. 39J.)
While there was no general obligation on a lender to
protect a subordinating seller from the risk of the buyer's
default, the requirement of fair dealing prohibits conduct
between a lender and a buyer that results in destruction
of the seller's interest. (Gluskin v. ~1tl~r7fic Scivinps &
l_aar~ ,~ssr~. su ra 3?. dal. **'"9 ,~ . 3d cat .395.)
"If, however innocently, their bilateral agreement or
conduct so modifies the terms of the senior loan that the
risk that it will become a subject of default is materially
increased, then the buyer and the lender may subject
themselves to liability to the seller if they proceed
without the tatter's consent, and if the seller's otherwise
junior loan is to be adversely affected." (Ibid.) The court
found the seller had not consented to the modification
and its drastic terms "clearly enhanced the likelihood of
a default by [buyer] and the consequent foreclosure."
Irl. ~t~317.)
While the Gluskin court did not specify the liability the
buyer and the lender face in making a modification
without consent of the subordinating seller, the case has
been interpreted to permit the loss of the lender's lien
[*1587] priority. (2 Cal. Real Property Financing
(Cont.Ed.Bar 1989) § 1.21, p. 23.) That is how the trial
court applied Gluskin in this case.
While the court in Glcrskin v. Atlantic S~vings &Loan
Assn„_ su~ar~. _32__C~/. A~_ ,~c~, 307 addressed the
particular situation of a subordinating seller, a leading
commentator has suggested that a material [***19]
modification to any senior lien should result in a loss of
priority. "It is submitted that in any case where the
senior lien is modified in any material manner which
produces an important impact on the value of the junior
lien, the modification should be junior to the second lien,
and if that is not practical, the entire senior lien should
become junior to the existing second lien." (3 Miller &
Starr, Cal. Real Estate, supra, § 8:83, p. 426.) Another
authority has stated that "since the junior lienholder had
no notice of the additional indebtedness when the junior
lien arose, only the amount of the original obligation
should enjoy the priority position held by the senior
mortgage." (3 Powell, Real Property, supra, P 458, p.
37-259. )
substantial, the proper remedy requires that only the
modifications lose priority, arguing a total loss of priority
is appropriate only in the case of a subordinating seller,
as in t~ltrs!<i~~ v. Att~ntic S~vings & L.a~an Assn., supra
32 Cpl. 1~~, ~d 3~J7. The Trust asserts that the public
policy need for protection of a subordinating seller does
not apply between two hard money lenders, [''**20] as
here. It cites several cases in which only the
modification was denied priority. For example, in tl~7i~(er
v. Gitizerts S~v. ~ Lc~~r7 Assr7.199~i7) 248 dal. At~z~. 2d
655 rah ~~1. R,~tr. f~4~Z, the seller subordinated its deed
of trust to those of the construction lender. The lender
then advanced sums that were not used for construction
purposes. The court held these amounts were subject to
the deed of trust of the seller. (id, ~i~,_665.)
A similar rule applies to a modification of a lease that is
senior to other encumbrances. A "lessor, by the
extension agreement with the lessee, could not, without
notice, knowledge or consent of the plaintiff, create a
greater burden on the property, or carve any estate
therefrom, other than that reserved to it under the
original lease, without making such extension
agreement and its additional burdens subject to the
superior rights of the plaintiff under the trust deed."
~i~st._N t._ ~a~7k v.__Co~st Consol. 4i/, Co. 1940 8~3 ~al_-
A . 2d 250 25x4256 19D P.2d 29~ .)
In R-Ranch Markets # 2, Inc~ve Otd Star~e_Ei~nk (9993
_1~„Cal. A~~. 4fh 7323121 C~1Rpfr: 2c1 21~j, the lessor
entered into a lease amendment with the lessee that
permitted [*"'*21] assignment or subletting without the
consent of the landlord. The original lease had [*'`442]
prohibited assignment or subletting. When ['"1588] the
secured lender, whose deed of trust was junior to this
lease, foreclosed on the property, the amendment to the
lease was extinguished. The court found the
amendment was made without the lender's consent and
it "substantially increased the burden on the property
and security without [the lender's] consent." (/cam. aim
1;28.)
Lennar urges the Trust has provided no authority for
treating hard money lenders differently than
subordinating sellers. Further, it contends the
modification cannot be easily segregated from the
remainder of the loan. It argues the Trust's suggestion
that only the change in principal lose priority ignores the
changes in the interest rate and the maturity date of the
note.
We need not determine whether a material modification
The Trust contends that if the modifications were to a senior lien may result in a total loss of priority of the
Page 10 of 10
49 Cal. App. 4th 1576, *1588; 57 Cal. Rptr. 2d 435, **442; 1996 Cal. App. LEXIS 966, '``*21
senior lien where the lienholders are hard money
lenders. The equities in this case do not require such a
result. Here, the impairment to Lennar's security and its
rights as a junior lienholder caused by the modification
can be [***22] fully eliminated by denying priority to the
modification. Unlike in C'k skin v. ,~t(~ntic ~avrrr~~~ ~
L.na~~ Assn., supra, 32 Coal. A,np. 3d ~U7, the
modification had no effect on the value of the underlying
security. Denying priority only to the modification
restores Lennar to the same position as before: the
position it bargained for by agreeing to accept a second
lien on the property as security for its loan. At
foreclosure the amount due under the Bank of America
note, calculated in accordance with the terms of the
note before fhe 1993 amendment, can be calculated
and given first priority. Any additional amount owing
under the amendment would then be junior to the liens
existing as of the date of the modification.
When the junior lienholder is a subordinating seller,
equity may require a different result. As the Gluskin
court noted, a subordinating seller is in a particularly
vulnerable position. By subordinating the purchase
money deed of trust to that of the construction lender,
the seller must rely that proceeds from the construction
loan will properly be used to enhance the value of the
property, for only then can the seller be assured the
property will be adequate [*''*23] security for both the
purchase loan and the construction loan. (Glus6crn v.
Atl~~r~~ic SG~av~s &,_L oar? As~sn..z.e supr~r32 C~l.__~_C?~~ 3
3t77. 313 ;314; see also N~t?dY v. ~vr~lcan (1967~6~ Cal.
2d _578,._ ~S1 ~~5 Cal__. R~fr._..rT69~.._422 P.2ct. 32~,, 26
A L.R.3d__ S4$~j.) In Gluskin, the modifications were
"substantial and drastic'; the principal was reduced, the
interest rate increased, and the maturity shortened from
30 years to 10 months. (32 ~aL Abp. 3c~ at~a. 312.) The
effect of these modifications, as the seller alleged, was
to allow the construction lender "to escape its obligation
to [*1589] disburse construction funds and to obtain
property for itself without having to pay [the seller] the
balance owing on the sales price." (Ibid.) The very short
term with a large balloon payment clearly enhanced the
likelihood of default. (Id. ~t,~a. 391.) Moreover, since the
default occurred before construction had enhanced the
value of the property, the seller was left with worthless
security. In the vernacular of the marketplace, the seller
was 'wiped out.' (Middlebrook-Anderson Co. v.
Sauthwcst S~ay. ~ L~a~~rr Assi7. ~~71 9~ Coal. ~f a. ;3c~
9Q~3 10:37 9fi Cal. R tr. 3,~~3 .) ["**24] In this
circumstance, subordinating the entire lien of the
construction lender to those of the existing juniors is fair
and reasonable.
.4 [] (5) The rationale for deciding when to
subordinate only the modification and when the entire
lien loses priority is explained by a New York court.
#~N7[~~] "It is well established that while a senior
mortgagee can enter into an agreement with the
mortgagor modifying the terms of the underlying note or
mortgage without first having to notify any junior lienors
or to obtain their consent, if the modification is such that
it prejudices the rights of the junior lienors or impairs the
security, their consent is required [citations]. Failure to
obtain the consent in these cases results in the
modification being ineffective as to the junior lienors
[citation] and the senior lienor relinquishing to the junior
lienors its priority with respect to the modified terms
[citations]. While this sanction ordinarily creates only the
partial loss of priority noted above, in situations where
the senior lienor's actions in modifying the note or
mortgage have substantially impaired the junior lienors'
security [**443] interest or effectively destroyed their
equity, courts have indicated [***25] an inclination to
wholly divest the senior lien of its priority and to elevate
the junior liens to a position of superiority [citation]."
5hultrs v. V~loc~dstnck L~rrd fJev. Assoc. 1993 ?8~
A ;U. ~d 234,_._236-237.1594 N__d__Y, S. 2cf $94x._89• )
~~~ b [ ] (4b) We need not address the Trust's
contention that equitable subordination should apply.
"The whole theory of equitable subrogation in such
situations is that the junior encumbrancer .. , is left in
exactly the same junior position he had before.
[Citations.]" ( Smifh v. Sf~t~ Sevin s &, Lean Assn.
~~i9&51 17~_ C~(~A~~•_ 3d _1092,_..1097 X223 Cal f~otr.
298~j.) That is accomplished by making only the 1993
modification to the Bank of America note a junior lien.
DISPOSITION
The judgment is reversed and the matter remanded to
the trial court with directions to enter judgment in favor
of the Trust on its cross-complaint and to make a
declaration of the priority of the liens, treating the
modification to [*1590] the Trust's lien separately, in
accordance with the views expressed in this opinion.
Since the Trust and TVIM have substantially prevailed
on appeal, they shall recover their costs. (Cal. Rules of
Court, rule 26.)
Sparks, Acting P. [*"'*26] J., and Nicholson, J.,
concurred.
1satl <si~ ~3ticsarr~en£
CautionAs of: February 7, 2019 1:54 AM Z
t~ ,~ f .
Court of Appeal of California, First Appellate District, Division Four
January 23, 2001, Decided ;January 23, 2001
Nos. A084401, A086021.
Reporter86 Cal. App. 4th 486 *; 103 Cal. Rptr. 2d 421 "'; 2001 Cal. App. LEXIS 33 ""; 2001 Daily Journal DAR 849; 2001 Cal. Daily Op.
Service 692
THE NIPPON CREDIT BANK, LTD., LOS ANGELES
AGENCY, Plaintiff and Appellant, v. 1333 NORTH
CALIFORNIA BOULEVARD et al., Defendants and
Appellants.
Notice: [***1] Opinion certified for partial publication.
Subsequent History: Review Denied May 16, 2001,
Reported at: 2Q01 t. L~XfS ~32~37.
Prior History: Superior Court of Contra Costa County.
Super. Ct. No. C96-02075. Mark B. Simons, Judge.
Disposition: The order denying the motion for judgment
notwithstanding the verdict, and the order for a new trial
on the amount of punitive damages only, are affirmed.
The parties shall bear their own costs on appeal.
Core Terms
Borrowers, Partnership, taxes, bad faith, property taxes,
real property tax, failure to pay, lender, foreclosure, trust
deed, nonrecourse, impairment, damages, default,
installment, mortgage, punitive damages, pay tax,
malice, tenant, unpaid, non payment of taxes, tax
payment, faxed, substantial impairment, credit bid, new
trial, negotiations, fail to pay, contractual
Case Summary
Procedural Posture
Defendants challenged the order of the Contra Costa
County Superior Court (California) denying their
motions for judgment notwithstanding the verdict and
new trial. Plaintiff also challenged the new trial order,
based on refusal to accept remittitur.
Overview
Defendants borrowed money from plaintiff to refinance
an initial construction loan. A large chunk of the
difference between the amounts of the original
construction loan and bank loan was earmarked to
repay the project owner for his investment. Plaintiff sued
for bad faith waste upon defendants' failure to pay
property taxes. They alleged that such failure was not
caused solely or primarily by an economic downturn, but
was intended to harm, and did substantially impair, their
security interest. The trial court denied defendants'
motion for judgment notwithstanding the verdict, but
ordered a new trial, based upon plaintiff's failure to
agree to remittitur. On appeal, the court affirmed the
orders, reasoning that defendants did not have a reason
to commit waste, but a continued obligation to pay
taxes. The project had not reached such dire straits to
merit nonpayment of taxes. Evidence showed that the
project was earning enough money to meet its other
obligations, and failure to pay the taxes amounted to
waste that legitimately caused plaintiff's security to
become substantially impaired.
Outcome
Orders affirmed. Jury could have determined that
defendants' sole aim in defaulting on the taxes was to
extract as much money from the subjected project as
possible, thus punitive damages, denial of judgment
notwithstanding the verdict, and a new trial were
appropriate.
LexisNexisO Headnotes
`Pursuant to California Rules of Court, rules 976(b) and
976.1, this opinion is certified for publication with the exception
of parts II.A., II.C.1. and II.C.2. Real Property Law > Torts > Waste > Elements
Page 2 of 13
86 Cal. App. 4th 486, *486; 103 Cal. Rptr. 2d 421, ""'421; 2001 Cal. App. LEXIS 33, """1
Real Property Law > Financing > Mortgages & An action for waste could be predicated on the failure of
Other Security Instruments > Mortgagor's Interests a trustor of a deed of trust or a mortgagor to pay real
property taxes.
Real Property Law > Torts > General Overview
Real Property Law > Torts > Waste > General
OverviewReal Property Law > Torts > General Overview
tlfV~['"] Waste, Elements
The bad faith waste cause of action, established in
Cornelison and extended in Osuna, exists in situations
where a defendant has failed to pay real property taxes.
Real Property Law > Financing > Mortgages &
Other Security Instruments > General Overview
Real Property Law > Torts > Waste > General
Overview
~B~l2[ '] Financing, Mortgages & Other Security
Instruments
See. ~~l. Civ. Cacfc~ ~ 292.
Tax Law > State &Local Taxes > Administration &
Procedure > Tax Liens
Real Property Law > Financing > Mortgages &
Other Security Instruments > Mortgagor's Interests
Real Property Law > Torts > Waste > General
Overview
t~5[] Real Property Law, Torts
Waste encompasses default on senior tax liens because
the mortgagee has a reasonable and legitimate
expectation that the mortgagor will not place a
governmental entity in a position to destroy the
mortgage. While there may be disagreement as to the
scope of the borrower's obligation to maintain the
property physically, particularly if the documents are
imprecise, there can be little question that the borrower,
as owner, is expected to pay all real estate taxes.
Real Property Law > Torts > Waste > General
Overview
1~,3[] Torts, Waste
Prohibitions against deficiency judgments on purchase
money obligations, under dal. Civ. Proc. Cnde § 580h,
or following trustee's sales under ~l. Civ. f~rac. Cade .~
~~Od would bar an action for impairment of security
where failure to maintain the property was caused by a
general decline of real property values. However, bad
faith waste resulting from reckless, intentional or
malicious conduct would be actionable despite those
prohibitions.
Real Property Law > Torts > General Overview
Tax Law > State &Local Taxes > Real Property
Taxes > General Overview
Real Property Law > Financing > Mortgages &
Other Security Instruments > Mortgagee's Interests
Real Property Law > Financing > Mortgages &
Other Security Instruments > Mortgagor's Interests
Real Property Law > Torts > Waste > General
Overview
Real Property Law > Torts > Waste > General
Overview
Real Property Law > Financing > Mortgages &
Other Security Instruments > Mortgagor's Interests
Real Property Law > Torts > General Overview
~-9~4['°`] Torts, Waste
h'6[" '] Real Property Law, Torts
The tax payment is just another check that a borrower
must write, resembling the obligation to pay principal
and interest for which the nonrecourse borrower is not
personally liable. Moreover, the lender's failure to
require that the borrower expressly assume personal
responsibility for the obligation to pay taxes could be
interpreted to mean that no such liability was intended.
On the other hand, nonpayment of taxes may be just as
Page 3 of 13
86 Cal. App. 4th 486, *486; 103 Cal. Rptr. 2d 421, "*421; 2001 Cal. App. LEXIS 33, '`*'`1
damaging to the security as intentional destruction of
the property, an act which the lender could not have
intended to permit. Moreover, nonrecourse borrowers
have a special responsibility to protect an asset of theirs
that they have pledged to another as the sole security
for repayment of a debt. Thus, there are circumstances
where a nonrecourse borrower should be liable for
waste, including failure to pay real property taxes.
A legal argument may be raised for the first time in a
new trial motion or on appeal only so long as the new
theory presents a question of law to be applied to
undisputed facts in the record.
Real Property Law > Torts > Waste > General
Overview
Real Property Law > Estates > Present
Estates > Life Estates
Real Property Law > Torts > Waste > General
Overview
Real Property Law > Torts > Waste > Remedies
9~N7[] Present Estates, Life Estates
The waste doctrine was developed to mediate between
the competing interests of life tenants and
remaindermen.
Real Property Law > Financing > Mortgages &
Other Security Instruments > General Overview
Real Property Law > Torts > Waste > General
Overview
Torts > Business Torts > Bad Faith Breach of
Contract > General Overview
Real PropertyLaw > Financing > Foreclosures > Private Power of
Sale Foreclosure
#~i~'7!3[] Torts, Waste
A tort action for bad faith waste may be made following
a nonjudicial foreclosure unless the foreclosure results,
by full credit bid or otherwise, in full satisfaction of the
secured debt.
Real Property
Law > Financing > Foreclosures > General
Overview
Real Property Law > Torts > Waste > General
Overview
I~dB[] Financing, Mortgages & Other Security 199[] Financing, Foreclosures
Instruments
The ultimate test for waste liability in connection with a
nonrecourse loan is whether the lender has suffered
losses caused by actions the borrower would not have
taken had it been fully liable.
Where the creditor bids less than the full amount of the
obligation and thereby acquires the property valued at
less than the full amount, his security has been impaired
and he may recover damages for waste in an amount
not exceeding the difference between the amount of his
bid and the full amount of the outstanding indebtedness
immediately prior to the foreclosure sale.
Civil Procedure > Judgments > Relief From
Judgments > Motions for New Trials
Civil Procedure > Judgments > Relief From
Judgments > General Overview
Real Property
Law > Financing > Foreclosures > General
Overview
Civil Procedure > Appeals > Reviewability of Lower
Court Decisions > Preservation for Review
f~9[`] Relief From Judgments, Motions for New
Trials
Tax Law > State &Local Taxes > Administration &
Procedure > Tax Liens
Real Property Law > ... > Liens > Nonmortgage
Liens > General Overview
Page 4 of 13
86 Cal. App. 4th 486, *486; 103 Cal. Rptr. 2d 421, ~*421; 2001 Cal. App. LEXIS 33, '"'`1
Real Property Law > ... > Liens > Nonmortgage
Liens > Tax Liens
~iPJ1[] Financing, Foreclosures
~fl~~4[] Damages, Punitive Damages
Exposure to punitive damages may be as much a
deterrent to bad faith waste as to any other tort.
A requirement that the security impairment be
considerable may put a lender in an untenable position
where the impairment stems from a failure to pay real
property taxes. Given the duty to mitigate damages, a
lender should not be made to wait for the tax lien to
mushroom with multiple unpaid installments, and should
not be penalized for promptly curing a tax default.
Business &Corporate Compliance > ... > Sales of
Goods > Remedies > General Overview
Civil Procedure > Remedies > Damages > Punitive
Damages
Torts > ... > Punitive Damages > Measurement of
Damages > Judicial Review
Civil Procedure > Trials > Jury Trials > Province of
Court &Jury
Civil Procedure > Remedies > Damages > General
Overview
Civil Procedure > ... > Standards of
Review > Substantial Evidence > Sufficiency of
Evidence
Torts > ... > Types of Damages > Punitive
Damages > General Overview
~-d- ~f9[°'"] Sales of Goods, Remedies
Entitlement to punitive damages is generally an issue
for the trier of fact.
Civil Procedure > Remedies > Damages > Punitive
Damages
Real Property Law > Torts > Waste > General
Overview
Torts > Business Torts > Bad Faith Breach of
Contract > General Overview
Torts > ... > Types of Damages > Punitive
Damages > General Overview
Headnotes/Summary
SummaryCALIFORNIA OFFICIAL REPORTS SUMMARY
A partnership borrowed money from a bank to refinance
a construction project. The partnership was required
under the deed of trust securing the loan to timely pay
all property taxes for the project. The partnership did not
pay a $ 358,000 property tax installment, and defaulted
on two loan payments to the bank. In the ensuing tort
action for bad faith waste brought by the bank against
the partnership and the partners, the jury found
defendants liable. The jury also found by clear and
convincing evidence that the failure to pay the taxes
was done with malice, and awarded $ 8,333,333.33 in
punitive damages. The trial court denied defendants'
motion for judgment notwithstanding the verdict, but
granted their new trial motion unless plaintiff agreed to
remit all but $ 1.6 million of the punitive damage award.
Plaintiff declined the remittitur and the trial court ordered
a new trial. (Superior Court of Contra Costa County, No.
C96-02075, Mark B. Simons, Judge.)
The Court of Appeal affirmed the trial court's order
denying the motion for judgment notwithstanding the
verdict and the order for a new trial on the amount of
punitive damages only. The court held that the jury
properly found defendants liable to plaintiff for bad faith
waste. An action for waste can be predicated on the
failure of a trustor of a deed of trust or a mortgagor to
pay real property taxes. Nonpayment of taxes may be
just as damaging to the security as intentional
destruction of the property. Further, the evidence
showed that the partnership had accumulated sufficient
earnings to make the tax payment and meet its other
immediate obligations when it was decided that the
taxes would not be paid. The court held that the trial
court did not err in instructing the jury that substantial
impairment of the bank's security would be impairment
that was more than a slight, trivial, negligible, or
theoretical factor. The court held that the jury, which
could have inferred from testimony that defendants
withheld the tax payment to punish the bank for failing
to agree to their demand for an interest rate concession,
properly found defendants liable for punitive damages.
Page 5 of 13
86 Cal. App. 4th 486, "486; 103 Cal. Rptr. 2d 421,'`*421; 2001 Cal. App. LEXIS 33, '""`1
(Opinion by Hanlon, J., ~ with Reardon, Acting P. J., and
Sepulveda, J., concurring.)
HeadnotesCALIFORNIA OFFICIAL REPORTS HEADNOTES
Classified to California Digest of Official Reports
security. The prohibitions against deficiency judgments
on purchase money obligations ( G~de Giv. Prot.
~~3(7b) or following trustees' sales ( ~'oca'~ GfV. ~'1"DG„ G
580d) bar an action for impairment of security where
failure to maintain the property was caused by a general
decline of real property values. However, bad faith
waste resulting from reckless, intentional, or malicious
conduct is actionable despite those prohibitions.
Waste § 2—Actions: Deeds of Trust § 11—Obligations
of Trustors—To Pay Property Taxes.
--In a bad faith waste action brought by a bank against
a partnership that had obtained a loan from the bank,
secured by a deed of trust, to refinance a construction
project, the jury properly found the partnership and the
partners liable to plaintiff based on defendants' bad faith
failure to pay a $ 358,000 property tax installment. An
action for waste can be predicated on the failure of a
trustor of a deed of trust or a mortgagor to pay real
property taxes. Nonpayment of taxes may be just as
damaging to the security as intentional destruction of
the property. Further, the evidence showed that the
partnership had accumulated sufficient earnings to
make the tax payment and meet its other immediate
obligations when it was decided that the taxes would not
be paid. That decision was apparently made only
because the controlling partner believed that he would
not have to pay for its consequences. In addition, even
though this action followed a nonjudicial foreclosure,
there was no double recovery, since the bank was still
owed millions of dollars after application of the credit
bid at the foreclosure.
[See 3 Witkin, Summary of Cal. Law (9th ed. 1987)
Security Transactions in Real Property, § 74.]
.~[l C2)
Waste § 2—Actions: Deeds of Trust § 11—Obligations
of Trustors—Impairment of Trustee's Security.
~f~L l (3)
Appellate Review § 32—Presenting and Preserving
Questions in Trial Court: New Trial § 1—Raising
Argument for First Time.
--A legal argument may be raised for the first time in a
new trial motion or on appeal only so long as the new
theory presents a question of law to be applied to
undisputed facts in the record.
4~~~4)
Waste § 2—Actions—Jury Instructions: Deeds of Trust
§ 11—Obligations of Trustors—To Pay Property
Taxes—Effect of Failure to Pay on Security Interest.
--In a bad faith waste action brought by a bank against
a partnership that had obtained a loan from the bank,
secured by a deed of trust, to refinance a construction
project, and against the partners the trial court did not
err in instructing the jury that substantial impairment of
the bank's security would be impairment that was more
than a slight, trivial, negligible, or theoretical factor.
Since the alleged waste at issue was defendants' failure
to pay real property taxes, to require a showing of a
more considerable impairment would place the lender in
an untenable position, given the duty to mitigate
damages. In any event, there was no reasonable
probability that a more expansive definition would have
produced a different verdict, since the jury's large
punitive damages award in favor of plaintiff showed that
it regarded defendants' malfeasance to be considerable.
--The common law action for waste is partially codified
in Civ. Code, § 2929, which provides that no person
whose interest is subject to the lien of a mortgage may
do any act that will substantially impair the mortgagee's
Retired Presiding Justice of the Court of Appeal, First
Appellate District, assigned by the Chief Justice pursuant to
r~f"fICIC V( section fi Uf the C~Irforni~ Constitution.
~t Ll (5)
Waste § 2—Actions—Availability of Punitive Damages:
Deeds of Trust § 11—Obligations of Trustors—To Pay
Property Taxes.
--In a bad faith waste action brought by a bank against
a partnership that had obtained a loan from the bank,
Page 6 of 13
86 Cal. App. 4th 486, *486; 103 Cal. Rptr. 2d 421,'"`421; 2001 Cal. App. LEXIS 33, "*"1
secured by a deed of trust, to refinance a construction
project and against the partners, based on defendants'
failure to pay property taxes, the jury properly found
defendants liable for punitive damages. Entitlement to
punitive damages is generally an issue for the trier of
fact (~iv. Cc~d~, ~S X294). Defendants had a legal duty
under tort law, as well as a contractual obligation, to pay
the property taxes. They indisputably breached that
legal duty and contractual obligation in deciding that the
taxes would not be paid. Furthermore, a partner testified
that the taxes would have been paid if the bank had
granted an interest rate concession sought by the
partnership. The jury could have inferred from that
testimony that the defendants withheld the tax payment
to punish the bank for failing to agree to their demand,
and that inference was sufficient to support the finding
of malice. Exposure to punitive damages may be as
much a deterrent to bad faith waste as to any other tort.
It was up to a jury to decide whether those damages
were justified in this case.
Counsel: Senn, Palumbo & Meulemans, Kevin J. Senn,
Catherine S. Meulemans and Michael J. Kerins for
Plaintiff and Appellant.
Miller, Starr &Regalia, Edmund L. Regalia and Lewis J.
Soffer for Defendants and Appellants.
Judges: Hanlon, J., 'with Reardon, Acting P. J., and
Sepulveda, J., concurring.
Opinion by: Hanlon, J.
Opinion
Agency (Bank) for bad faith waste. Bank appeals from
the order granting a new trial, and Borrowers appeal
from a subsequent order involving the order for new
trial.
The principal issues are whether a lender can recover
for waste when the lender's security is substantially
impaired by the borrower's bad faith failure to pay real
property taxes, and whether that failure in this case
supports an award of punitive damages. We answer
both of those questions in the [*"*3] affirmative in the
published portion of this opinion.
(.BACKGROUND
Sunset and Diller were the general and managing
partners, respectively, of the Partnership, which
developed, owned and operated atwo-building office
complex in Walnut Creek (the Project). Diller owned
Sunset and, through [*490] Sunset and the DNS Trust
(DNS), a family trust, he owned over 80 percent of the
Partnership. Diller was the "last word" on all important
financial decisions for the Partnership.
The Partnership borrowed $ 73 million from Bank in
1989 to refinance an initial construction loan of
approximately $ 55 million from another lender and
complete construction of the Project. Bank's loan
officer, [**423] Greg Gillam, testified that a "large
chunk" of the difference between the amounts of the
original construction loan and Bank's loan was
earmarked to repay Diller for his investment in the
Project. Diller acknowledged that the Partnership
received $ 10 million of the proceeds of Bank's loan.
Cal Prom Inc., a construction company wholly owned by
Diller, received $ 5.1 million of the loan proceeds.
[*489] [*'"422] HANLON, J. ~ --Defendants [***2]
1333 North California Boulevard, a limited partnership
(the Partnership), Sunset Ridge, Co., Inc. (Sunset) and
Sanford Diller (Diller; the Partnership, Sunset and Diller
are referred to collectively as Borrowers) appeal from
the order denying their motion for judgment
notwithstanding the verdict after a jury found them liable
to plaintiff The Nippon Credit Bank, Ltd., Los Angeles
Retired Presiding Justice of the Court of Appeai, First
Appellate District, assigned by the Chief Justice pursuant to
article VI, section 6 of the California Constitution.
Retired Presiding Justice of the Court of Appeal, First
Appellate District, assigned by the Chief Justice pursuant to
article Vl s~cfinn 6 of fh~ ~alifawnia Ccanstitution.
Bank's loan was structured as a nonrecourse obligation.
The Partnership paid interest on the [*'"*4] loan at a
variable rate tied to the London Inter-Bank Offer Rate
(LIBOR), and could elect to "lock in" specified rates for
one to six-month periods. The Partnership was required
under the deed of trust securing the loan to timely pay
all property taxes for the Project, and Bank had the right
under the loan documents to pay the taxes if the
Partnership did not. The Partnership was authorized
under the deed of trust to collect and retain rents from
the Project until written revocation of that right from
Bank after an event of default.
The Partnership made all loan and property tax
payments until December 1994, when Diller directed
that the $ 358,000 property tax installment due on the
12th of that month not be paid. Before that decision was
Page 7 of 13
86 Cal. App. 4th 486, *490; 103 Cal. Rptr. 2d 421, ~"423; 2001 Cal. App. LEXIS 33, **'`4
made, the Partnership had asked Bank for a
concession on the rate of interest payable on the loan,
and the request had been denied.
Vicki Mullins, who was the chief financial officer of the
Project's property manager, another Diller-owned entity
called Maxim Property Management, and another
Partnership representative met with Gillam and another
Bank representative on November 15, 1994. Mullins
presented projections showing that, because of
rising [***5] interest rates and other factors, the Project
would have a cash flow shortfall of over $ 1 million in
1995. A number of leases were coming due the next
year, rental rates were decreasing, and tenants were
demanding shorter leases with more tenant
improvements. Mullins and Diller testified that there was
a severe real estate recession at the time. "[T]he state
of the economy was an absolute disaster," Diller said,
and "[d]evelopers were dropping like flies." Appraisals
submitted by the Partnership to Bank showed that the
Project's value had dropped from $ 103 [*491] million
in September of 1989 to $ 52 million in November-
December of 1994.
In his memo of the November 1994 meeting, Gillam said
he thought that the Partnership could pay more interest
than Mullins projected if it paid all tenant improvement
costs, and requested that Diller "use his own cash to
cover deficits of the [P]roject because he has already
earned a large amount of money through the [P]roject."
On December 2, Mullins faxed Gillam a letter stating
that the Project would have a negative cash flow "prior
to any increase in the LIBOR rate" if it paid Bank's loan,
the property tax installment, the operating [*'"*6]
expenses, and the tenant improvements due that
month. The letter requested a "six-month lock" at the
current LIBOR rate. Diller conceded at trial that this
request was for a "below market' interest rate--a
concession Bank was not legally obligated to make.
Gillam called Mullins about five minutes after receiving
the fax and rejected the request.
Diller testified that he would have paid the December
1994 tax installment if Bank had "worked with us," but
he was "convinced that they were not dealing fairly ...."
He said that his decision not to pay the taxes was "very
difficult' and taken with "a lot" of thought. Diller admitted
that the Project had sufficient cash flow that month to
make the payment. There was no dispute that the
Partnership had the means to pay the taxes. On the
date the $ 358,000 tax payment was due, the
Partnership paid Diller's entity DNS over $ 683,000.
Diller said that this payment was made to reduce DNS's
investment in the Partnership.
Diller acknowledged at trial that the unpaid taxes would
be a charge against the [**424] Project, and that Bank
would eventually have to pay the taxes or accept a
reduced sale price for the Project. He also agreed
that [***7] the missed $ 358,000 payment was a
substantial sum of money. However, he thought that the
amount of the unpaid taxes was insignificant compared
to the value of the Project and that the missed payment
did not substantially impair Bank's security. He denied
using nonpayment of the taxes to try to gain leverage to
force Bank to make concessions. However, Diller did
say that he wanted Bank to "share the pain."
In addition to directing that the December 1994 taxes
not be paid, Diller caused the Partnership to default on
the January and February 1995 loan payments to Bank.
He explained: "The reason it was decided [not to make
the January loan payment] was that it was determined
at that time Bank] in negotiations and restructuring this
loan was acting in bad faith, Bank was not dealing
fairly, Bank had no intention of restructuring the loan.
[P] What [*492] Bank intended to do was to bleed the
[P]artnership dry, to have the [P]artnership come up with
outside funds and to convert this loan from a
nonrecourse loan to a recourse loan, and then as soon
as Bank has bled the [P]artnership dry and got all the
money it could out of it through outside sources
so [***8] that the loan would be kept current, then it
would go ahead on its previously-determined course of
action and take the property away from the
[P]artnership. [P] And that's why we felt it was hopeless
to allow this bank to extract all of this money from us
and also throw us off the property. [P] They were not
negotiating in good faith, although negotiations did
continue to try and save the ship after that ...."
The Partnership sent Bank a series of proposals in
January and February of 1995. On January 5, Mullins
faxed Gillam a proposal to purchase the Project at fair
market value. On January 6, Mullins faxed Gillam a
letter stating: "Rather than a deed in lieu, we would like
to propose a cash flow mortgage." On February 3,
Mullins faxed Gillam a term sheet for restructuring
Bank's loan. On February 16, Mullins faxed Gillam a
letter asking for "your thoughts on an outright sale for
cash." On February 28, Mullins faxed Gillam a letter
proposing a deed in lieu of foreclosure.
No agreement was ever reached, other than a "pre-
workouY' agreement which stated that no agreement on
preliminary issues would be binding in the absence of a
Page 8 of 13
86 Cal. App, 4th 486, '`492; 103 Cal. Rptr. 2d 421, '"424; 2001 Cal. App. LEXIS 33, *`*8
global settlement. Gillam testified that Bank [***9]
agreed at one point to take a deed in lieu of foreclosure,
but that arrangement fell through when the Partnership
proposed additional conditions. Gillam said that Bank
would sometimes make concessions if the customer
kept the loan current and generally lived up to its
obligations. Here, Gillam said, "there were so many
proposals and the borrower was still unwilling to pay any
amount of the past due interest, we didn't know whether
he was serious or not." Gillam said he told Diller that he
thought Diller was negotiating in bad faith and trying by
his tactics to hold Bank "hostage." Gillam said Bank
eventually came to believe that "they were not serious
about any kind of negotiation, that they were just intent
on withholding the rent or not paying the interest and on
taking as much cash out of [the] building as they could
before eventually they would--they were going to lose
it."
On February 14, 1995, Bank sent the Partnership an
effective demand to turn over rents from the Project,
and the Partnership thereafter complied with the
demand. Diller testified that, before receipt of that
demand, he regarded the Project's revenue as "our
money." Diller acknowledged that his family trust,
[***10] DNS, received a net amount of $ 1.7 million
from the Partnership from December 5, 1994, to April 1,
1995. He said that he still lost $ 5.2 million in the
Project.
[*493] The Partnership remitted approximately $
300,000 from Project revenues to Bank in March 1995,
and approximately [**425] $ 440,000 in April 1995.
Gillam testified that when these funds were delivered
the outstanding balance of the loan was about $ 1
million. Bank used these funds in April 1995 to pay the
$ 394,713.56 then due for the delinquent December
1994 property tax installment.
The jury awarded this $ 394,713.56 sum to Bank as
compensatory damages for bad faith waste, based on
findings that Borrowers' failure to pay the December
1994 taxes was not "caused solely or primarily by an
economic downturn," and that the failure to make this
payment was intended to harm, and did substantially
impair, Bank's security interest. The jury found by clear
and convincing evidence that the failure to pay the taxes
was done with malice, and awarded $ 8,333,333.33 in
punitive damages. Borrowers' motion for judgment
notwithstanding the verdict was denied, but their new
trial motion was granted unless Bank agreed to ["**11]
remit all but $ 1.6 million of the punitive damage award.
Bank declined the remittitur and a new trial was
ordered.
II. DISCUSSION
A. Motion for Summary Disposition of Appeals "
B. Judgment Notwithstanding the Verdict
1. Liability for Bad Faith Waste
C 9 [] (1 a) Borrowers contend that they were
entitled to judgment notwithstanding the verdict on the
ground that their failure to pay the property tax
installment cannot be deemed to have been an act of
bad faith waste. ~f~fi[] The "bad faith waste" cause of
action was established in Corrtelisor~ v. Kc~rnblufh
197 15 ~9, 3d 59Q 925 ~~C. R tr. 557 512 1~.2d
9~, and extended in C~s~u~~ v. Alk~er#sr~n (1932) 134
mod, ~ ,~. ~d 71 9~3~ ~'~l. R tr. 33 3 , to situations where
the defendant has failed to pay real property taxes.
Borrowers contend that Osuna misconstrued Cornelison
and that ["'"*12] Osuna was incorrectly decided.
The plaintiff in Cornelison sold a residence and took
back a note and deed of trust. The home was
subsequently conveyed by buyers to the defendant
[*494] and eventually condemned as unfit for human
habitation. The plaintiff caused the property to be sold at
a trustee's sale, and bought it for a full credit bid. She
then sued the defendant for breach of contract and
waste. Summary judgment was entered for the
defendant on the contract claim on the ground that he
had not assumed the secured debt and thus was not
liable for breaching covenants in the deed of trust, and
on the waste claim on the ground that plaintiff's full
credit bid precluded any claim that her security had
been impaired. The Supreme Court affirmed, but
concluded that the plaintiff might have had a claim for
bad faith waste had she not made a full credit bid for
the property.
[] (2) The court noted that the common law
action for waste was partially codified in l~€~12[''] Civil
Cc~c~e section 2923, which provides that "[n]o person
whose interest is subject to the lien of a [***13]
mortgage may do any act which will substantially impair
the mortgagee's security." (Corn~tisor,_v~Krarr7biuth
supr~a~ 1_~,_al. 3d _~t~~ 59I.) The court reasoned that
the ~f~[] prohibitions against deficiency judgments
on purchase money obligations (Corse CivW Proc.,__~
'See footnote, ante, page 486.
Page 9 of 13
86 Cal. App. 4th 486, *494; 103 Cal. Rptr, 2d 421,'`*425; 2001 Cal. App. LEXIS 33, *""13
~~Ot.~) or following trustee's sales (id., § 580d) would bar
an action for impairment of security where failure to
maintain the property was caused by a "general decline
of real property values." (Cornelisan, at p~. 6~~-6Q5.)
However, the court concluded that "bad faith" waste
resulting from "reckless," "intentional" or "malicious"
conduct would be actionable despite those prohibitions.
( !d. at pp. ~iO4-605.)
Leipziger, The Mortgagee's Remedies for Waste (1976)
64 Cal. L.Rev. 1086, 1109 [describing Krone as a
"muddled opinion"].) Osuna also observed that cases in
other [*""*16] jurisdictions were split on whether failure
to pay property taxes could constitute waste. (Osuna ~°.
6~Ibertson, scr~ra 134 dal, ~ln,~. 3d ~~. 78.) However,
Osuna correctly anticipated the direction of the law on
this point.
~~4 ~~r [] (1 b) The Osuna case held that tif~[~'] an
action for waste could be predicated on the failure of a
trustor of a deed of trust or a mortgagor (*"426] to pay
real property taxes, finding that this conclusion was
supported by "a fair reading of the holding in
[Cornelison [**'"14] ], in relation to the facts alleged."
C)sun~ ~. ~1lberfson s, u~ 134 Cd,_~~7,~~..._~.~._ ~?~77•)The cause of action for waste in Cornelison "alleged in
substance that defendant owed a duty to properly and
adequately care for the property and that defendant
negligently failed to fulfill this duty, thereby causing
plaintiff to be damaged in specified particulars and
amounts by reason of the loss of improvements to the
real property as well as by reason of the loss of its use."
Cornelison ~. Karr7bluthy_su ram_ 15__Caf.,3d ~t_~:._594.)
While these allegations did not refer to failure to pay
property taxes, the waste claim in Cornelison also
incorporated by reference the material allegations of the
breach of contract cause of action, where the breaches
included failure to pay property taxes as well as failure
to properly maintain the property. (Ibid.) It also appeared
from the trial court ruling quoted in the opinion that the
plaintiff in Cornelison alleged that the defendant had
duties apart from the contract to pay taxes on the
property as well as maintain it. (id, ~~~5~~ fn~9.)
Thus, while Cornelison did ['"'""15] not mention failure to
pay [*495] property taxes in its analysis of the waste
claim, Cornelison's discussion of that claim could
plausibly be construed as it was in Osuna to encompass
that dereliction. Accordingly, we are not persuaded that
Osuna misconstrued Cornelison.
Nor are we persuaded that Osuna was wrongly decided.
Osuna acknowledged that the court in Krar~~ V. C9~~
(997 } 5~ C~1. A,ap. 3d 991. 19~dw195 j92% dal. F~ptr.
3~, a case decided before Cornelison, had found no
authority for the proposition that failure to pay real
property taxes constituted waste. However, that lack of
authority was remedied by the discussion in Cr~rneli~on.
C.3sun~ v. Al~a~rtso~~ su rG~~ 13~ Cal. A . 3c~ ~t . 77
[noting timing of the decisions]; see also 4 Miller &Starr,
Cal. Real Estate (3d ed. 2000) Deeds of Trust, § 10.53,
p. 159, fn. 10 [characterizing Krone's references to
waste liability for nonpayment of taxes as dicta]; cf.
"Relatively few courts have had occasion to consider
whether waste includes nonpayment of real estate taxes
by the mortgagor," but "[t]his broad conception of waste
appears to be part of an emerging legal trend with roots
dating to the 19th Century." (1V. ~r~~errc~r7 Sec. Life v.
Harris Trust & S~v. ~r~lc ~.p.11/. `IJ94 S59 F. Si!
1163 .91. 5.) For example, willful failure to pay property
taxes has been recognized as actionable waste under
New York law on facts much like those presented here,
where the partnership borrower owned an office building
and distributed $ 17 million to its partners shortly after
defaulting on a tax payment. (Travelers lr7s. Co. v. 633
7"l~ird...~lssvcr~tes._.~2d Cir;~99J4~ 14 ~~3d_ 914. 917-91f3.)
The Second Circuit's opinion in the Travelers case
noted that a number of other courts had likewise held
that failure to pay property taxes could constitute waste.
( Id._~t_~a;_~123 [***17] [collecting cases].) Commentators
have recognized the split of authority among the states
Rest.3d Property, Mortgages, § 4.6, reporter's notes, p.
279 [collecting cases]; see also An~7otWf~at
Constitutes Waste Jusfifvinc~ Appninfrnent of Receiver of
Mort~~~~cd_ Prca~e~~j1974~ ~5 A L.R.~r1 1fJ41,._1046~
~(06~~1075 [nonpayment of taxes is generally regarded
as waste justifying appointment of a receiver]), but have
observed that courts are becoming more willing to hold
borrowers who fail to pay real property taxes liable for
waste notwithstanding nonrecourse provisions of their
loans (Stein, The Scope of the Borrower's ["'`527]
Liability in a Nonrecourse Real Estate Loan (1998) 55
V1/ashry & L~~ L.~~v. 92D~921C1 (hereafter Stein)).
[*496] The commentaries persuasively endorse this
liability. The Restatement Third of Property, Mortgages,
section 4.6, subdivision (a), page 262, lists as a form of
waste, along with physical alteration or neglect of
mortgaged property, a mortgagor's failure to pay
property taxes secured by a lien with priority over the
mortgage. (See also id., § 4.6, subd. (b)(3), p. 262
[damages may be recovered to the extent [**'"18] of the
security's impairment].) NnJ[] Waste encompasses
default on senior tax liens because the mortgagee "has
a reasonable and legitimate expectation that the
mortgagor will not place a governmental entity in a
position to destroy the mortgage." (Id., § 4.6, com. b, p.
Page 10 of 13
86 Cal. App. 4th 486, '`496; 103 Cal. Rptr. 2d 421, **527; 2001 Cal. App, LEXIS 33, **`18
265.) "While there may be disagreement as to the scope
of the borrower's obligation to maintain the property
physically, particularly if the documents are imprecise,
there can be little question that the borrower, as owner,
is expected to pay all real estate taxes." (Stein, supra,
55 Wash. &Lee L.Rev. at p. 1275.) As Diller conceded
at trial, amounts secured by a tax lien will either have to
be paid by the lender (Rest.3d Property, Mortgages, §
2.2, com. a, pp. 70-71 [authorizing advances for this
purpose]) or they will reduce the price paid for the
property at foreclosure (Stein, at p. 1269, fn. 169).
Unpaid real property taxes thus reduce the chances of
full recovery of the debt (id. at p. 1270, fn. 171), and
"from the secured creditor's vantage point ...may be as
costly as a leaky [***19] roof' (Travelers lns. ~o, v.
6~3 Tl~~ird ,~ssc~ci~tes ~u ~r~, 14 ~. ~cl of . 1 ? 1).
The Stein article discusses at length why borrowers
should be subject to personal liability for failing to pay
property taxes and other forms of waste even if their
loans are nonrecourse. On the one hand, "f~6[ the
tax payment is just another check that the borrower
must write, resembling the obligation to pay principal
and interest for which the nonrecourse borrower is not
personally liable." (Stein, supra, 55 Wash. &Lee L.Rev.
at p. 1277, fn. 196.) Moreover, the lender's failure to
require that the borrower expressly assume personal
responsibility for the obligation to pay taxes could be
interpreted to mean that no such liability was intended.
Id. at p. 1277.) On the other hand, nonpayment of taxes
may be just as damaging to the security as intentional
destruction of the property, an act which the lender
could not have intended to permit. (See id. at pp. 1275,
fn. 192 & 1277, fn. 196.) Moreover, "nonrecourse
borrowers have a special responsibility [""*20] to
protect an asset of theirs that they have pledged to
another as the sole security for repayment of a debt."
Id. at p. 1245.) Thus, there are circumstances where a
nonrecourse borrower should be liable for waste,
including failure to pay real property taxes. (Id. at p.
1272.)
Such liability redresses the kind of harm the tort of
waste was originally designed to remedy. (See
7~r~v~iers lns. Ca. ~. 63:3 ~~'hird Associates su r~
*97 14 ~'.:3d afi ~. 920 fn. 7.) ff7'[] The waste
doctrine was developed to mediate between the
competing interests of life tenants and remaindermen.
(Stein, supra, 55 Wash. &Lee L.Rev. at p. 1241, fn. 87,
quoting Posner, Economic Analysis of Law (5th ed.
1998) p. 83.) If the income-producing property were a
forest, the life tenant would want to cut down the trees
before their maturity even if the present value of the
timber would be greater if the logging were postponed
beyond the tenant's expected lifetime. (Stein, at p. 1241,
fn. 87.) Similarly, the owner of a distressed property will
be tempted to [***21] "scavenge whatever it can for its
own benefit" and "squeeze as much money out as
possible" before the property is lost, with no regard to
the property's resulting condition. (Id. at pp. 1243 &
1247, fn. 103; see also p. 1243, fn. 92 [likening this
situation to the return of a rental car with an empty gas
tank].) The prospect of tort liability may deter the
borrower from thus behaving "like a life tenant with very
little time left to live." (Id. at p. 1241, fn. 87.)
[**428] Such "milking" of the security has been
recognized as a form of bad faith waste within the
meaning of Cornelison (see in re Mills 9th Cir. 99813)
841 F,2d 9D2, 905}, and a trier of fact could find that the
missed tax payment qualified as "milking" in this
instance. There may be exigent circumstances which
would justify a failure to pay real property taxes; for
example, where a choice must be made between paying
the taxes and making loan payments or necessary
repairs, a tax default might merely rearrange the
lender's loss without increasing it. (Stein, supra, 55
Wash. &Lee L.Rev. at pp. 1273-1274.) In this case,
however, the Project had [***22] not reached such dire
straits when Diller directed that the taxes not be paid.
The evidence shows that Diller caused the Partnership
to pay DNS, his own trust, nearly twice the amount of
the $ 358,000 tax installment on the day the taxes were
due, and that DNS received a total of $ 1.7 million from
the Partnership while the taxes remained delinquent. It
is clear that the Partnership had accumulated sufficient
earnings to make the tax payment and meet its other
immediate obligations when it was decided that the
taxes would not be paid. Thus, the situation here cannot
be distinguished from the one in Travelers, where the
partnership borrower was found subject to waste liability
for neglecting to make a tax payment and then
distributing millions of dollars to its partners.
This case is distinguishable, however, from Ire re NJitls,
s~r~~, ~~1 F.2d 902, where a borrower was found not to
have "milked" the security. The borrower in Mills had
operated the property for only a few months and "lost
the bulk of his investment." (1~(. ~t p. 905.) Here, Bank
officer Gillam's belief that Diller had reaped profits from
the Project was supported by evidence [**"`23] that the
Partnership received $ 10 million of Bank's loan as a
[*498] repayment of Diller's investment in the Project,
that various Diller entities were paid for construction and
management of the Project, and that the Project was
operated successfully fora number of years. Thus,
Page 11 of 13
86 Cal. App. 4th 486, *498; 103 Cal. Rptr. 2d 421, ̀'`428; 2001 Cal. App. LEXIS 33, ""'`23
there were reasons to doubt Diller's claim that he had
lost money on the Project. Viewed in the light most
favorable to the verdict, the record does not establish a
loss of the bulk of Borrowers' investment.
t~~[~~~ The ultimate test proposed in the Stein article
for waste liability in connection with a nonrecourse loan
is whether the lender has "suffered losses caused by
actions the borrower would not have taken had it been
fully liable." (Stein, supra, 55 Wash. &Lee L.Rev. at p.
1244.) Assuming that this test correctly reflects the "bad
faith" standard for liability under Cornelison, it was
satisfied here. Borrowers cannot plausibly claim that the
Partnership would not have paid the property taxes
even if Diller and his partners had been personally liable
on Bank's loan. Taxes on the Project [*"*24] were paid
for years when it appeared that the Partnership had
something of value to lose; only when the Project was
threatened was DNS paid in lieu of the tax authorities.
(Stein, supra, 55 Wash. &Lee L.Rev. at p. 1258, fn. 136
[noting that the nonrecourse borrower is likely to
perform like one who is personally liable as long as the
project is successful].) Diller's decision not to pay the
taxes was apparently made "only because [he] believed
that [he] would not have to pay for [its] consequences."
Id. at p. 1283.)
Borrowers argue that bad faith waste liability under
Osuna for failing to pay real property taxes improperly
"converts" conduct which is only a breach of contract
into a tort. (See ~~ed Egtri meat _Carte_ ~~LittanWSaudi
Arabia Ltd. 1994 7 ~1. 4tf~ 503. 595 2S ~~f. R tr. 2cl
~7~~569 P.2d_,_454~j.) That result, Borrowers submit, is
confined to insurance bad faith cases. Borrowers cite
authorities indicating that there is no personal liability for
real property taxes and that sale of the land is the
state's sole remedy for nonpayment of those taxes.
(E.g., ll~c~'ikc~ v, ti~aton 1900 9~1 ~~f. 909 991 63 ~.
1~; [***25] Marcia v. Count of Santa ~~ara 1975) S7
~~1. A 3c! 319 323324 151 ~ 1. Fr' fr. S0.)
Borrowers ['"*429] reason that in the absence of
personal liability to the state for the taxes, or a statute
which in so many words makes nonpayment of the
taxes a tort, the only possible source of liability for this
neglect must be a contract (in this case the deed of
trust).
This line of argument is unconvincing. Tax policy and
tort law are separate fields. That the state has chosen
not to impose personal liability on property owners for
real property taxes says nothing about owners' liability
to other persons for the tort of waste. The tort codified in
Civil Cac(e s~ctrvn 29?_9 ( Corrre(isc~rr sr. Kornblcrtl~
s~?r~a, 15 ~1, ~3d at Via. 597) has long protected [*499]
lenders from "any act which will substantially impair"
their real property security. That prohibition can properly
be extended to nonpayment of real property taxes
regardless of whether the omission also creates tax or
contract liability. (See ,~cl~roed~r ~. Auto C~riveaw~a,~Gn.
~97~d 11 C~1. 3d 9t18 929 11~ GAL f; fr. C~22 52~
P.2c9 6621 [tort ["**26] damages may be awarded for
conduct which "incidentally involves a breach of
contract"].)
Borrowers contend that Osuna is distinguishable
because the nonpayment of taxes in that case resulted
in tax sales of the properties securing the debt.
However, total loss of the lender's security is not
required; mere impairment of the security constitutes
waste if the impairment is "substantial." (Civ. Crade,~
2929.)
Borrowers argue that the impairment of security in this
case was insubstantial as a matter of law. On the one
hand, as Diller admitted, the unpaid $ 358,000 tax
installment was a "substantial" sum of money. On the
other hand, as Diller also noted at trial, the unpaid taxes
were a small fraction of the value of Bank's security. In
these circumstances, where reasonable minds might
differ as to the substantiality of the impairment, the
question was properly left to the trier of fact.
Borrowers contend finally that, because Bank added the
amount it advanced to pay the real property taxes to the
indebtedness secured by the deed of trust and
conducted a trustee's sale of the property to satisfy that
debt, liability for waste is precluded in this case [***27]
by the one form of action (,Code. Civ. Pr~ac., X726) and
antideficiency (id., § 580d) rules. Borrowers submit that
Bank effectively elected its remedy by pursuing its
contract rights to recover the tax advance, and thus
could not pursue its tort claim for nonpayment of the
taxes.
This argument was raised for the first time in Borrowers'
motion for judgment notwithstanding the verdict; no
evidence concerning the foreclosure was presented at
trial. In connection with the posttrial motion, Borrowers
requested judicial notice of: allegations in Bank's April
1995 verified complaint for judicial foreclosure listing the
$ 394,713.56 tax advance as part of the $ 2,543,797.37
amount then delinquent on the loan; Bank's April 1995
notice of default under the deed of trust listing $
2,543,328.37 as the amount to reinstate as of April 20,
1995; and Bank's January 1996 notice of sale under the
deed of trust. Borrowers renew their request for judicial
Page 12 of 13
86 Cal. App. 4th 486, '`499; 103 Cal. Rptr. 2d 421, **429; 2001 Cal. App. LEXIS 33, "'"*27
notice on appeal, and also refer to Bank's accounting in
its complaint herein of amounts due under the loan after
the foreclosure, which listed the tax advance as part of
the unpaid balance of $ 28,551,390.59
remaining [***28] after [*500] application of the $
52,000,000 credit bid entered by Bank's subsidiary to
purchase the Project at the trustee's sale.
factor test in negligence law. (See com. to k~AJI Nc~.
3.76 (8th ed. 1994) p. 99.) Borrowers submit that the
court should instead have defined "substantial" as "[o]f
real worth and importance; of considerable value; .. .
[s]omething worthwhile as distinguished from something
without value or merely nominal." (Black's Law Dict.
(Abridged 5th ed. 1983) p. 744, col. 2.)
~(3)[ `] (3) 9[ ] A legal argument may be raised
for the first time in a new trial motion or on appeal only
"so long as the new theory presents a question of law to
be applied to undisputed facts in the record." (Noffirr~n-
HC~a ~. Trai~s~merrc~ lips. ~o. ~J91) 1 1. A~l~. 4tf~
9C7 15 9 dal. F~' tr, 2d f305 ;see ice. 96.) ~~ 9c [ ]
(1c) Since evidence for the election of remedies
argument was not brought forth until the motion for new
trial, the argument can be [**430] rejected here, as it
was in the trial court, as unsupported by the record.
This belated argument is contrary to the Cornelison
case in any event. Cornelison provides for #~1V9Q[] a
tort action for bad faith waste following a nonjudicial
foreclosure unless the foreclosure results, by full credit
bid or otherwise, in full satisfaction of the secured debt.
[***29] ~1h119[ Where as here the creditor "bids less
than the full amount of the obligation and thereby
acquires the property valued at less than the full
amount, his security has been impaired and he may
recover damages for waste in an amount not exceeding
the difference between the amount of his bid and the full
amount of the outstanding indebtedness immediately
prior to the foreclosure sale." (~orr~elisar~ ~a~Krarr~l~luth~,.
supra, 15 dal. 3cI at p. ~C?I.) Nothing in this passage
suggests that the "full amount' of the outstanding debt
cannot include money the creditor has advanced for the
unpaid taxes. If the foreclosure results in payment of all
or a portion of that advance, Cornelison's cap on
compensatory damages will preclude any double
recovery in a subsequent waste action. There was no
double recovery in this instance; the figures Borrowers
cite show that Bank was still owed millions of dollars
after application of the credit bid at the foreclosure.
Bank could therefore "recover any provable damages
for waste." (td. ~t p. 608.)
2. Jury Instructions
C~ 4 [] (4) Borrowers contend that the court erred in
its instructions ['`**30] on the issue of substantial
impairment of Bank's security by defining "substantial"
as "more than a slight, trivial, negligible, or theoretical
factor." The court borrowed this language from the
comment to the standard instruction on the substantial
As Bank observes, ~1~l9[ ~] a requirement that the
security impairment be "considerable" may put a lender
in an untenable position where the impairment [*501]
stems from a failure to pay real property taxes. Given
the duty to mitigate damages (Valve Ike Ora dank v.
G~r~7bc~a 1994 26 1. A nth 1~8G 7691 32 fat.
R_~___str,_2d_~~), the lender should not be made to wait for
the tax lien to mushroom with multiple unpaid
installments, and should not be penalized for ["**31]
promptly curing a tax default. We therefore conclude
that in this case the court's instruction was better than
the one Borrowers proposed.
We note further that even if Borrowers' definition would
have been preferable, there is no reasonable probability
that its use would have produced a different verdict.
Soule v. General Motors Car . 7994 8 dad. 4th 515,,
57~_(34,'ltle Ryatr. 2d 607, S&2 P.~c1 29t~1.) The court's
instruction was consistent with the not "merely nominal"
language of Borrowers' definition, and the large punitive
damage award shows that the jury regarded Borrowers'
malfeasance as very "real" and "considerable."
3. Liability for Punitive Damages
~~()~ (5) Borrowers assert that there is no
precedent for an award of punitive damages for waste,
and contend that there was no substantial evidence to
support the jury's finding that the waste in this instance
was malicious. However, 1~1~9~[ °] entitlement to
punitive damages is generally an issue for the trier of
fact (Giv~_Code, ~32~~ subc~:_... a ; B~cksfi v._Cifi~of
p~ri~ ter Goads Co. 9939 94 aJ. 2d 633 &39 96
P.2d 1221; [***32] Stevens v. Owens-Cornin Finer las
C~r.~. 1 ~)9G 4J ~l. A .nth 96~d5 96 a8 57 Cpl. R fr~.
2r1 52~ ), and this case is no exception.
[**431] Borrowers argue that they cannot be held liable
for punitive damages because, in failing to pay the
taxes, they did no more than exercise their contractual
right to retain the rents and profits from the Project. As
has been indicated, Bank did not effectively revoke that
right until two months after the taxes were due.
However, as has also been explained, Borrowers had a
legal duty under tort law, as well as a contractual
Page 13 of 13
86 Cal. App. 4th 486, *501; 103 Cal. Rptr. 2d 421, "*431; 2001 Cal. App, LEXIS 33, *'`*32
obligation, to pay the taxes. They indisputably breached
that legal duty and contractual obligation when Diller
decided that the taxes would not be paid. Borrowers'
right to retain funds from the Project rather than turning
that money over to Bank did not give them a license to
commit waste.
Borrowers argue that "[t]o look back at [their] decision
not to pay the December 1994 installment of property
taxes, and say that it was malicious, and intended to
harm Bank rather than to further the interests of
[Borrowers], is not a permissible inference from the
evidence." There are multiple problems [***33] with this
argument. First, it is not apparent why the aim of
Borrowers' conduct had to be either furthering their own
interest or harming [*502] Bank. Those aims are not
mutually exclusive. Second, no authority supports the
suggestion that a party can escape liability for malicious
conduct merely because it hopes to benefit from its
actions. Third, Diller admitted that the taxes would have
been paid if Bank had granted the interest rate
concession the Partnership sought. The jury could infer
from this testimony that Borrowers withheld the tax
payment to "punish" Bank for failing to accede to their
demand, and that inference was sufficient to support the
finding of malice. (Civ. Code,~,~ 3294 subd. (cam~...~._,...~.~e_r
[malice includes conduct which is intended to injure the
defendant].) ~
[**'"34] Borrowers maintain that "the mere breach of a
contractual obligation, even if committed in order to gain
an advantage in negotiations with the other party to the
contract," cannot support a finding of malice. They
derive this proposition from deck ~. State Farm Ir~i.~f.
/~utn. /t~~. Cc~. X976 a4 ~ 1. ~ ~c~ 347 926 ~/.
Rptr. 6021. This contention also fails for multiple
reasons. First, to reiterate, Borrowers did not merely
breach a contractual obligation; they committed a tort.
Second, the Beck case is inapposite. The court in Beck
found that the defendants bad faith failure to settle an
insurance claim did not support a finding of malice. (lcl,_
~t ~, 356.) The court did not purport to apply any rule
like the one Borrowers' postulate, and instead grounded
its conclusion on the particular circumstances presented
(ibid.), which were not analogous to those here. The
evidence in Beck showed, among other things, that the
defendant had a reasonable doubt as to the extent of its
liability when it asserted a defense it knew to be invalid.
Here, as Bank notes, Borrowers could not claim any
doubt about their obligation to pay the real
property [**''35] taxes, or the amount of that obligation,
when they decided not to pay it.
Third, the evidence does not necessarily justify
Borrowers' assertion that they intended to try to reach
some agreement with Bank after they defaulted on the
tax payment. While conflicting inferences could be
drawn from the evidence, the jury could have
determined that Borrowers' sole aim in defaulting on the
taxes and thereafter was to extract as much money from
the Project as possible before walking away from it. The
jury could have accepted Bank's argument that the
Partnership's flurry of proposals after the tax default was
meant only to delay Bank's demand for the Projects
revenues. We observe that Diller had already
determined by the time he decided not to pay [**432]
the taxes that Bank had no intention of making any fair
[*503] accommodation--that was his professed reason
for withholding the tax payment.
#314[ Exposure to punitive damages may be as
much a deterrent to bad faith waste as to any other tort.
(See Stein, supra, 55 Wash. &Lee L.Rev. at p. 1245, fn.
97.) It was up to a jury [***36] to decide whether those
damages were justified in this case.
C. Motion for New Trial
1., 2. "
III. DISPOSITION
The order denying the motion for judgment
notwithstanding the verdict, and the order for a new trial
on the amount of punitive damages only, are affirmed.
The parties shall bear their own costs on appeal.
Reardon, Acting P. J., and Sepulveda, J., concurred.
The petition of defendants and appellants for review by
the Supreme Court was denied May 16, 2001.
~ Malice also includes despicable conduct taken with a willful
and conscious disregard of the rights of others (Civ. Cc~d~a,
x,294 subd. tc?(~)), and Bank cites authority on this
"conscious disregard" form of malice. However, since the jury
here was not instructed on this form of malice, it will not be
considered.
~s~~ci ~a3' I~r~ca~tt~e~~t
'See footnote, ante, page 486.
See footnote, ante, page 486.
Order No.
I:NDORS~M~NTAttached to Policy No.
Issued byChicago Title Insurance Company
Policy No.
On the representation of the Insured that the Insured has extended the due date of the indebtedness secured by the InsuredMortgage:
The Company insures the Insured that the priority of the Insured Mortgage has not changed by reason of said extension.
This endorsement does not insure against loss or damage based on any statute of limitations.
No coverage is provided hereby in the event the Agreement modifies the Insured Mortgage to any greater extent or in anydifferent way from those ways represented above.
This endorsement is issued as part of the policy. Except as it expressly states, it does not (i) modify any of the terms andprovisions of the policy, (ii) modify any prior• endorsements, (iii) extend the Date of Policy, or (iv) increase the Amount ofInsurance. To the extent a provision of the policy or a previous endorsement is inconsistent with an express provision of thisendorsement, this endorsement controls. Otherwise, this endorsement is subject to all of the terms and provisions of thepolicy and of any prior endorsements to it.
Dated:
Chicago Title Insurance Company
Countersigned:
By.
Authorized Signature
~#
~..,~,....,.,~.._..,~,..,,,,,.,.
Rifi t .v....._-_-.__
Aii65~Y
,..:-~ ~ r
~̀~`j~✓
~.", ~ + ~}
~~~is~y.~~.
5E-251-06 Extension of Due Date of Promissory Note Endorsement (11-17-11) Page 1 of 1
Order No.
ENDOI2S~MENTAttached to Policy No.
Issued byChicago Title Insurance Company
The Company insures against loss or damage sustained by the Insured by reason of:
Policy No.
The invalidity or unenforceability of the lien of the Insured Mortgage upon the Title at Date of Endorsement as a
result of the agreement dated ,recorded ,Instrument No. ,Book ,Page of Official Records
("Modification"); and
2. The lack of priority of the lien of the Insured Mortgage, at Date of Endorsement, over defects in or liens or
encumbrances on the Title, except for those shown in the policy or any prior endorsement and except:
This endorsement does not insure against loss or damage, and the Company will not pay costs, attorneys' fees, or expenses,
by reason of any claim that arises out of the transaction creating the Modification by reason of the operation of federal
bankruptcy, state insolvency, or similar creditors' rights laws that is based on:
the Modification being deemed a fraudulent conveyance or fraudulent transfer; or
2. the Modification being deemed a preferential transfer except where the preferential transfer results from the failure
a. to timely record the instrument of transfer; or
b. of such recordation to irnpart notice to a purchaser for value or to a judgment or lien creditor.
This endorsement is issued as part of the policy. Except as it expressly states, it does not (i) modify any of the terms and
provisions of the policy, (ii) modify any prior endorsements, (iii) extend the Date of Policy, or (iv) increase the Amount of
Insurance. To the extent a provision of the policy or a previous endorsement is inconsistent with an express provision of this
endorsement, this endorsement controls. Otherwise, this endorsement is subject to all of the terms and provisions of the
policy and of any prior endorsements.
Dated:
Chicago Title Insurance Company
Countersigned: ~Y:~..
,r...~,nr~.... ~ ,= ~T4.. t', ~
.~.....~,..._Raai~y C3~sir= a ...~,~,...,.....,n,.
By: ~ ' ,1 l A 1 ~ ~ ~ A9t~s!
Authorized Signature '~~ ,,~..___
72E114 ALTA 11-06 Mortgaqe Modification (06-17-06) Page 1
Copyright American Land Title Association. All rights reserved. The use of this Form is restricted to ALTA licensees and ALTA ,~.,<«~~aN..
members in good standing as of the date of use. All other uses are prohibited. Reprinted under license from the American Land ~""° T'T`F
Title Association. -.0
Order No.
ENDORSEMENTAttached to Policy No.
Issued ByChicago Title Insurance Company
Policy No.
For purposes of this endorsement only:
a. "Modification" means the agreement between and dated and recorded as document number
"Date of Endorsement' means
2. The Amount of Insurance is increased to $
3. Subject to the exclusions in Sections 4 and 5 of this endorsement, the Exclusions from Coverage, the Exceptions
contained in Schedule B, and the Conditions contained in the policy, and any exclusion or exception in any prior
endorsement, the Company insures as of Date of Endorsement against loss or damage sustained by the Insured by
reason of any of the following:
a. The invalidity or unenforceability of the lien of the Insured Mortgage upon the Title as a result of the
Modification;
The lack of priority of the lien of the Insured Mortgage over defects in or liens or encumbrances on the
Title, except:
c. The failure of the following matters to be subordinate to the lien of the Insured Mortgage:
4. This endorsement does not insure against loss or damage, and the Company will not pay costs, attorneys' fees, or
expenses, by reason of any claim that arises out of the transaction creating the Modification by reason of the
operation of federal bankruptcy, state insolvency, or similar creditors' rights laws that is based on:
a. the Modification being deemed a fraudulent conveyance or fraudulent transfer; or
the Modification being deemed a preferential transfer except where the preferential transfer results from the
failure
to timely record the instrument of transfer; or
of such recordation to impart notice to a purchaser for value or to a judgment or lien creditor.
5. This endorsement does not insure against loss or damage, and the Company will not pay costs, attorneys' fees, or
expenses, by reason of the invalidity, unenforceability or lack of priority of the lien of the Insured Mortgage because
all applicable mortgage recording or similar intangible taxes were not paid at time of recording of the Modification.
72E778 ALTA 11.2-06 Mortgaqe Modification with Additional Amount of Insurance (12-2-13) Page 1
Copyright American Land Title Association. All rights reserved. The use of this Form is restricted to ALTA licensees and ALTA n,t~_L«iC.AN
members in good standing as of the date of use. All other uses are prohibited. Reprinted under license from the American Land AND TITLF
~51)f:lAilUN
Title Association. ~.
Order No. Policy No.
This endorsement is issued as part of the policy. Except as it expressly states, it does not (i) modify any of the terms and
provisions of the policy, (ii) modify any prior endorsements, (iii) extend the Date of Policy, or (iv) increase the Amount of
Insurance. To the extent a provision of the policy or a previous endorsement is inconsistent with an express provision of this
endorsement, this endorsement controls. Otherwise, this endorsement is subject to all of the terms and provisions of the
policy and of any prior endorsements.
Dated:
Chicago Title Insurance Company
Countersigned:
.....~.
By:Authorized Signature
:~ ~~`,,, ~~ ~~ ~r , n~ ~:~r~ ~~~ t _._.M.....~. ._._~ _ _.._..........~ _.4
aj A~.. ~ .~ I.~ A. ~ F,.,.,:iavit
~ i1 '.>L 11
A~t~~e
__ .. d : ,,.,.
72E778 ALTA 11 2 06 Mortgaqe Modification with Additional Amount of Insurance (12-2-13) Page 2
Copyright American Land Title Association. All rights reserved. The use of this Form is restricted to ALTA licensees and ALTA .,,.,~a~~,~N
members in good standing as of the date of use. All other uses are prohibited. Reprinted under license from the American Land ~"";°;;i,`
Title Association.x
American Land Title Association Endorsement 32-06 (Construction Loan —Loss of Priority)Adopted 2-3-11
ENDORSEMENT
Attached to Policy No.
Issued by
CHICAGO TITLE INSURANCE COMPANY
1. Covered Risk 11(a) of this policy is deleted.
2. The insurance [for Construction Loan Advances] added by Section 3 of this endorsement is subject to
the exclusions in Section 4 of this endorsement and the Exclusions from Coverage in the Policy, the
provisions of the Conditions, and the exceptions contained in Schedule B. For the purposes of this
endorsement and each subsequent Disbursement Endorsement:
a. "Date of Coverage", is f 1 [Date of Policy] unless the Company sets
a different Date of Coverage by an ALTA 33-06 Disbursement Endorsement issued at the
discretion of the Company.
b. "Construction Loan Advance," shall mean an advance that constitutes Indebtedness made on or
before Date of Coverage for the purpose of financing in whole or in part the construction of
improvements on the Land.
c. "Mechanic's Lien," shall mean any statutory lien or claim of lien, affecting the Title, that arises
from services provided, labor performed, or materials or equipment furnished.
3. The Company insures against loss or damage sustained by the insured by reason of:
a. The invalidity or unenforceability of the lien of the Insured Mortgage as security for each
Construction Loan Advance made on or before the Date of Coverage;
b. The lack of priority of the lien of the Insured Mortgage as security for each Construction Loan
Advance made on or before the Date of Coverage, over any lien or encumbrance on the Title
recorded in the Public Records and not shown in Schedule B; and
c, The lack of priority of the lien of the Insured Mortgage, as security for each Construction Loan
Advance made on or before the Date of Coverage over any Mechanic's Lien, if notice of the
Mechanic's Lien is not filed or recorded in the Public Records, but only to the event that the
charges for the services, labor, materials or equipment for which the Mechanic's Lien is claimed
were designated for payment in the documents supporting a Construction Loan Advance
disbursed by or on behalf of the Insured on or before Date of Coverage.
~~A ht lilU (:~N
I.ANI1 '1'I"I I.I.
\1S(1 (:I,\I Il1N
~" ,
Copyright 2011 American Land Title Association. All rights reserved. r ay
The use of this Form is restricted to ALTA licensees and ALTA members
in good standing as of the date of use. All other uses are prohibited.
Reprinted under license from the American Land Title Association.
American Land Title Association Endorsement 32-06 (Construction Loan —Loss of Priority)Adopted 2-3-11
4. This policy does not insure against loss or damage (and the Company will not pay costs, attorneys'fees or expenses) by reason of any Mechanic's Lien arising from services, labor, material orequipment:
a. furnished after Date of Coverage; or
b. not designated for payment in the documents supporting a Construction Loan Advance disbursed
by or on behalf of the Insured on or before Dafe of Coverage.
This endorsement is issued as part of the policy. Except as it expressly states, it does not (i) modify any
of the terms and provisions of the policy, (ii) modify any prior endorsements, (iii) extend the Date of
Policy, or (iv) increase the Amount of Insurance. To the extent a provision of the policy or a previous
endorsement is inconsistent with an express provision of this endorsement, this endorsement controls.
Otherwise, this endorsement is subject to all of the terms and provisions of the policy and of any prior
endorsements.
CHICAGO TITLE INSURANCE COMPANY
By:
Authorized Signatory
Copyright 2011 American Land Title Association. All rights reserved.
The use of this Form is restricted to ALTA licensees and AI.TA members
In good standing as of the date of use. All other uses are prohibited.
Reprinted under license (ram the American Land Title Association.
~~AMfJU CANLAND "f ff l.I..u~ocinriou
-~
American Land Title Association Endorsement 33-06 (Disbursement)Adopted 2-3-11
ENDORSEMENT
Attached to Policy No.
Issued by
CHICAGO TITLE INSURANCE COMPANY
1. The Date of Coverage is amended to
[a. The current disbursement is: $
[b. The aggregate amount, including the current disbursement, recognized by the Company as
disbursed by the Insured is: $ 1
2. Schedule A is amended as follows:
3. Schedule B is amended as follows:
[Part I]
[Part II]
This endorsement is issued as part of the policy. Except as it expressly states, it does not (i) modify any
of the terms and provisions of the policy, (ii) modify any prior endorsements, (iii) extend the Date of
Policy, or (iv) increase the Amount of Insurance. To the extent a provision of the policy or a previous
endorsement is inconsistent with an express provision of this endorsement, this endorsement controls.
Otherwise, this endorsement is subject to all of the terms and provisions of the policy and of any prior
endorsements.
[Witness clause optional]
CHICAGO TITLE INSURANCE COMPANY
By:
~~A A11:IU (:AN
I.ANC7'fl'ILI-nf~Uc:ldll<lU
Copyright 2011 American Land Title Association. All rights reserved. f "~`
The use of this Form is resiricted to AL.TA licensees and ALTA members
in good standing as of the date of use. All other uses are prohibited.Reprinted under license from the American Land Title Association.
CHICAGO TITLE INSURANCE COMPANYSWORN OWNER'S STATEMENT TO CHICAGO TITLE INSURANCE COMPANY
STATE OF
COUNTY OF
The affiant
} SSGuarantee No.
Escrow No.
being first duly sworn, on oath deposes
held by
_County, Illinois, to wit:
and says that he is the "owner/beneficiary of Trust No _
which is the owner' of the following described premises in
1. That he is thoroughly familiar wish all the facts and circumstances concerning the premises described above;2. That with respect to improvements on the premises the only work done or materials furnished to date are as listed below;
3. That the only contracts let for the furnishing of future work or materials relative to the contemplated improvements are as listed below;A. That this statement is a true and complete statement of all such conVacfs, previous payments and balances due, if any.
ADJUSTED TOTAL PREVIOUSLY AMOUNT OF ggLANCE TO
NAME AND ADDRESS KIND OF WORK CONTRACT INC. PAID THIS g~COME DUE
EXTRAS & CREDITS PAYMENT
ARCHITECT
SURVEYOR
ENGINEER
SOIL TESTS
GENERALCONTRACTOR
OFF SITEIMPROVEMENTS
OTHERS
TOTAL:
"STRIKE ONE` THE UNDER51GNE0 HEREBY APPROVES THE ABOVE AMOUNTS FOR PAYMENT.
SIGNED _
ADDRESS
Subscribed and sworn before me this day of _, 20
ry Public
WO
SWORN STATEMENT OFCONTRACTOR AND SUBCONTRACTOR
TO OWNER AND TO CHICAGO TITLE INSURANCE COMPANY
State of
} ss.County of
The affiantthat he isofcontract with _
Page _ o(_ Pages
being first duly sworn, on oath deposes and says
that hasowner (or
on the following described premises in said County, to wit.
That, for the purposes of saltl contract, the following persons have been contracted with, and have furnished, or are furnishing and preparing
materials tor, and have done or are doing labor on said improvement. That there is due and to become due them, respectively, the amounts set
opposite their names for materials or labor as stated. That this statement is a full, true and complete statement of all such persons, the amounts
paid and the amounts due or to become due to each.
~ y J 4 5 6 7
Amount of Retention NelotPrevious Net Amount Balance to
Name and Address Kind of Work Contract ~inc.cunent) Payrnenis This Payment Become Due
Inc. Rententions
TOTALAMOUNT OF ORIGINAL CONTRACT 5 WORK COMPLETED TO DATE $
EXTRAS TO CONTRACT 8 LESS %RETAINED "5
TOTAL CONTRACT AND EXTRAS $ NET AMOUNT EARNED $
CREDITS TO CONTRACT S NET PREVIOUSLY PAIp 5
ADJUSTED TOTAL CONTRACT S NET AMOUNT OF THIS PAYMENT SBALANCE TO BECOME DUE Inc. Retention ~
i[ is unaers~ooa mai ine wiai a~uo~m Na~u w ~p~o N~~~ ~~ ~~ a~ ~~,,,.~ ~~ ~~y,.~~,,,,, ~~~ ,,,,,, ,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,, ,,,,,,,,,,,, —,~ _....- ---- - -- -completed to date.
agree to furnish Waivers of Lien for all materials under my contract when demanded.
Signed
(Position)
Subscribed and sworn to before me this day of , ~~
Notary Public
The above sworn statement should be obtained by the owner before each and every payment.Provided by Chicago Title Insurance Company
sscTscr
S ~ '"
Date:
LENDER'S DRAW REQUESTPENDING DISBURSEMENT ENDORSEMENTS
{CLTA 122.06 / ALTA 32.2-06 & ALTA 33.0-06 combination)
TO: Chicago Title CompanyAttn:725 S. Figueroa, Ste200, Los Angeles, Ca90017
Reference: Title Policy #for pc•operiy known as:Lender's Loan Number:
Loan Advance/Disbursement Information:
Lo1n Advance Number:
Anticipated Date ofAdvance/Endorsement:
The amount of this loan advance:
Aggregate loan advances (including this advance)
Un-disbursed Loan Amount Prior to this Advance:
Amount of this Advance:
Interest Reserve $ (date)Title End. Fee $ (date)Inspection Fee $ (date)
Other: $ (date)Construction Draw $
Remaining L1n-disbursed (after this advance):
Request is hereby made for one of the following applicable disbursement endorsements - CLTA 122.06/ ALTA 33.0-06 to the above
reference Title Policy bringing current the coverage provided by the applicable interim mechanic's lien coverage endorsement made a part
of the Policy on its original Policy Date.
PLEASE CONTACT THE UNDERSIGNED AS SOON AS PASSIBLE TO COORDINATE FUNDING WITH TfIE ISSUANCE OF
THE applicable ENDORSEN~NT.
The undersigned lender certifies that this ADVANCE is made under the above in accordance with provisions calling for installment
disbursements set forth in the loan agreement between borrower and lender. The undersigned lender is not aware of any existing event
that would result in u default u~:def~ any of the terms of the loan agreement/documents.
Bank;
Executed by: _____
Title:
Address: Telephone: Fax Email address: