The Equitable Mortgage Doctrine (in the Context of Deeds Absolute Given As Security For A Loan)

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The "Equitable Mortgage" doctrine is a doctrine that has application in several contexts. This presentation is limited to the context in which "a deed absolute is given as security for a loan" by a property owner to a money lender (i.e. foreclosure rescue operator).

The earliest case in the United States that I could find involving an individual attempting to have a "deed absolute" declared to be a mortgage is the case of Conway's Executors v. Alexander, 11 U.S. 218 (1812), decided by the U.S. Supreme Court in 1812 (and available here, courtesy of Justia - U.S. Supreme Court Center). In reading through this case, the Supreme Court cites old English cases involving facts dating back to the late 1600's. The reason I mention this fact is simply to establish the fact that the "equitable mortgage" doctrine and the doctrine of “deeds absolute given as security for a loan” have been a part of the real estate common law for a minimum of three centuries. Stated another way, there is absolutely nothing new or novel about invoking this doctrine in the context of a property owner who signs over his/her property title as security for a loan to a money lender.

What follows here is an excerpt from the textbook, Real Estate Law (eighth edition, copyright 1983), by Robert Kravotil and Raymond J. Werner, that explains in an academic, “textbook” manner, what generally is meant by a "deed absolute given as security for a loan." The purpose of presenting the following is simply to give the reader some perspective as to what is meant by the phrases “equitable mortgages” and “deeds absolute given as a security for a loan.” The reader must check the laws of his or her home state to determine how the following applies in their states.

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15.09(d) Deeds absolute given as a security

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Often when a landowner borrows money he gives as security an absolute deed to the land. By "absolute deed" is meant a quitclaim deed or warranty deed such as is used in an ordinary land sale. On its face, the transaction looks like a sale of land. Nevertheless, the courts treat such a deed as a mortgage where the evidence shows that the deed was really intended only as security for a debt.
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• EXAMPLE: Owner owns a home, which is already mortgaged to a bank. He needs money for medical expenses and goes to his brother, Lender, for a loan of $1,000. Lender loans Owner the money but insists that Owner sign a simple promissory note and give a quitclaim deed to the home. It is agreed orally that if the debt is paid when due, Lender will quitclaim the property back to the Owner. Owner fails to pay the debt. Lender is not the owner of the land. He merely holds a mortgage on it, which he must foreclose. And remember that all the world has notice of the true nature of his deed, for undoubtedly Owner will remain in possession, and possession imparts constructive notice.
  

A deed such as that described in the above example is regarded by the courts as an attempt to "waive the equitable right of redemption." The courts often use the maxim, "Once a mortgage, always a mortgage." It cannot be converted into a conveyance of absolute ownership by mere default. Hence, it becomes necessary for the courts to go back to the very beginning of the transaction. The task is a simple one. Either the deed was then intended as an absolute transfer of ownership (as in a land sale), or it was then intended merely to provide security to a lender. So the court listens to all the testimony regarding the beginnings of the transaction. Oral testimony is received as to what was said and done. And the court hears testimony as to what occurred thereafter. Usually it is child's play to distinguish between a deed intended to transfer absolute ownership and one that was merely intended to provide a lender with security.

The following circumstances are usually considered:

• 1. Adequacy of consideration. If Owner conveys land worth $10,000 and receives only $5,000, the indication is that the transaction is a mortgage. Normally land will sell for its full value.
  
  2. Prior negotiations between the parties. When Owner applies to Lender for a loan and the transaction is consummated by Owner giving Lender a deed to the land, this tends to show that the transaction is a mortgage. It is as if Lender had said: "I will lend you the money, but give me a deed as security." Of course, if it appears that Lender rejected the application for a loan, this tends to show that the transaction is a sale. It is as if Lender had said: "I will not loan you any money, but I am willing to buy your land."
  
  3. Subsequent conduct of the parties. If Owner receives money from the Lender and gives Lender a deed to Owner's land, but Owner thereafter remains in possession, paying taxes, insurance premiums, and so on, this tends to show that the transaction is a mortgage, for in a normal land sale the buyer takes possession.
  
  4. Possession. If the transaction is merely a security transaction, almost invariably the borrower retains possession of the land, and his possession gives the whole world notice of the fact that the deed was merely a security deed and that foreclosure must take place.
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If the court construes the transaction to be a deed given as security for a debt, the mask of the sale transaction is stripped away and the mortgage aspects of the transaction are exposed. This means that the grantor/borrower has redemption rights according to state law. He may repay the debt and demand reconveyance of the property just as in the case of an ordinary mortgage. If the debt is not paid, the grantee/lender must foreclose just as if a regular mortgage had been made.

The return going to the lender/grantee is also measured against the usury laws to determine whether the charges assessed against the borrower resulted in a greater return than authorized by law. Schulte v. Franklin, 633 P2d 1151 (Kans. 1981). A return greater than the usury laws permit tends to stamp the transaction as a disguised loan.

Another result of a deed being held to be a security device lies in the fact that truth-in-lending requirements may be applicable. If the proper disclosures were not made, the truth-in-lending penalty provisions may be invoked against the lender. Long v. Storms, 622 P2d 731 (Oreg. App. 1981).
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REFERENCE: Cunningham & Tischler, Disguised Real Estate Security Transaction as Mortgages in Substance, 26 Rutgers L. Rev. 1 1972)
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15.10(a) Sale and Leaseback - consequences of transaction being set aside

The sale and leaseback transaction is indeed very complex and is a financing vehicle. It must be distinguished from a deed absolute to secure a debt. Matter of Kassuba, 562 F2d 511 (7 Cir. 1977). Merely labeling a transaction a sale and leaseback will not make it immune from attack and when the transaction is attacked, the courts will carefully analyze the relationship between the seller-lessee and the buyer-lessor to determine whether a sale really occurred or whether the transaction is really a mortgage. Burton v. Smith, 357 So. 2nd 324 (Ala. 1978). If the transaction is found to be a mortgage, consequences befall both the seller-lessee and the buyer-lessor. The relationship of mortgagor-mortgagee with its requirement of foreclosure and redemption rights replaces the relationship of landlord and tenant with its quick possessory remedy of forcible entry and detainer. Usury law may come into play as a standard for evaluating the fairness of the return to the buyer-lessor who has unexpectedly found itself in the role of lender. The income tax treatment that both parties had used and anticipated will not be available, and, indeed, past years'tax returns will have to be amended.

As can be seen, the transaction is quite complex and should only be entered into after careful consultation with an experienced counsel and tax advisor. The consequences of a mistake can be awesome.

(Editor's Note: All emphasis in the original)

The foregoing is presented as a service to the readers of The Home Equity Theft Reporter.

Revised 1/9/07