In re Litwiller; Iowa Bankruptcy Court Calls Conditional Sale Contract An Equitable Mortgage

A Federal Bankruptcy Court in Iowa ruled last month that the equitable mortgage doctrine was applicable to a somewhat complicated real estate transaction between a "financially strapped" farmer and an investor involving a contract of sale coupled with a simultaneously executed lease agreement, the subject matter of which was an operating farm owned by the farmer. Accordingly, the court disrgarded the form of the transcaction as portrayed by the executed documents and called the entire transaction a mortgage.

While this case may not constitute binding authority on anyone other than the parties in the case, the Iowa Supreme Court cases that this court based its decision on arguably do constitute such authority (at least in Iowa).

This case is pretty "fact heavy" and involves contract terms that are unique to the farming business. A very basic, skeleton outline of the transaction follows:

1) A financially strapped farmer ("farmer") was indebted to a local individual ("investor") who, apparently, was also in the farming business.

2) The two entered into a conditional contract of sale for the operating farm, which did not require the investor, as purchaser, to pay any financial consideration upon signing the contract.

3) The contract contained a clause whereby the farmer, as seller, could cancel the contract upon complying with certain conditions, among which was the repayment of the pre existing debt owed to the investor and payment of other "items" listed in the contract that the investor ultimately was not able to adequately "identify" or "explain" to the court.

4) Simultaneously with the execution of this contract, the parties entered into a lease agreement whereby the farmer, as owner and landlord, turned over possession of the farm to the investor, as tenant-lessee.

5) The lease gave the investor credit for "prepaid rent" in the amount of the existing debts and other items that the farmer purportedly owed him.

6) Apparently, there was no provison for how the financially strapped farmer was going to make the payments on an existing bank mortgage because, within six months of this tranaction, the bank commenced foreclosure proceedings, which ultimately resulted in the bank being the successful bidder at a sheriff's sale of the farm (the investor didn't pay any rent during this period, other than the prepaid rent credit, above).

7) Within four months after the sale, the investor paid the Bank money in exchange for an assignment of the sheriff's certificate of purchase.

8) After the foreclosure redemption period expired, the investor received a sheriff's deed to the property.
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Bankruptcy Trustee Seeks To Invoke The Equitable Mortgage Doctrine

Interestingly in this case, it wasn't the financially strapped farmer who sought the application of the equitable mortgage doctrine. It was the bankruptcy trustee who sought it. As best as I can tell from the case, there where creditors of the farmer's bankruptcy estate who, put bluntly, stood to get screwed out of their money if the "artful" transaction structuring and maneuvering by the investor was allowed to stand.
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The Iowa Equitable Mortgage Doctrine

The bankruptcy judge made the following statements in identifying (or describing) the equitable mortgage doctrine as it is applied in Iowa:

"A transaction involving the transfer of real property may be deemed a mortgage if it is shown by clear and convincing evidence that the instrument was intended as security for debt."

Steckelberg v. Randolph, 404 N.W.2d 144, 148 (Iowa 1987); Greene v. Bride & Son Construction Co., 252 Iowa 220, 226-27, 106 N.W.2d 603, 607-08 (1960).

"In order for a deed or real estate contract to be deemed a mortgage, the party asserting an equitable mortgage must show

• (1) That the consideration for the [instrument] was an existing indebtedness, together with the amount of such indebtedness; and
• (2) that such indebtedness was not extinguished by the conveyance, but was kept alive."

Steckelberg v. Randolph, 404 N.W.2d at 148; Greene v. Bride & Son, 252 Iowa at 224, 106 N.W.2d at 606.

"Other factors may support the finding of an equitable mortgage."

"[T]he execution and delivery of an option to repurchase, the unavailability of legal advice for the grantor, and financial hardship as an inducement to the grantor in entering the agreement, all constitute classic circumstances pointing to a debtor-creditor relationship."

Steckelberg v. Randolph, 404 N.W.2d at 149.

"Iowa courts are reluctant to construe an agreement that continues a debtor-creditor relationship as an absolute conveyance. If it is unclear what the parties intended, the court should "resolve the doubt in favor of an equitable mortgage."

Id.;

"see also

Greene v. Bride & Son, 252 Iowa at 226-27, 106 N.W.2d at 207 ("absolute deed accompanied by a contract to reconvey on specified conditions . . . will be construed to be a mortgage rather than a privilege to repurchase or a conditional sale");

Cullen v. Butterfield, 178 Iowa 621, 160 N.W. 125, 129 (1916)("If there be doubt on the question, courts almost universally hold that the transaction should be construed to be a mortgage, and not a conditional sale.")"
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The Bankruptcy Court Declares The Contract Between The Farmer & The Investor Be Deemed A Mortgage

The court identified the following facts that show that the contract in this case was to be disregarded and treated as an equitable mortgage:

• "[The farmer & his wife] were in a desperate financial situation at the time of entering into the Contract, and their situation was an inducement to enter into the agreement."

• "There was no contemporaneous exchange of consideration for the Contract. The down payment under the Contract was described in a list of existing debts and obligations."

• "The Contract was subject to cancellation if Litwillers as Sellers repaid the down payment."

• "[The farmer & his wife] did not have separate counsel during the negotiation and execution of the documents."

• "The parties executed the Contract on the same date that they executed a lease of the same property."

• "Under the lease, nearly all the debts and obligations making up the down payment under the Contract were to be credited toward rent of the Farm for 2001. Exhibit 100, attachment. Therefore, contrary to paragraph (1)(b) of the Contract, cancellation of the Contract would not necessarily require repayment of the entire down payment. It appears that the parties' intent was for [investor] to rent [farmers'] farmland in 2001. The Contract seems designed to secure the repayment of existing debt and the receipt of what [investor] would have been entitled to receive if the 2000 farm lease had been performed conventionally, that is, the crop and government payments."

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Conclusion of Court's Decision Regarding The Equitable Mortgage Doctrine

The court concluded its opinion as to the equitable mortgage issue with the following paragraph:

"An equitable mortgage in the form of a conditional sale does not become a sale upon the grantor's failure to perform the condition. "If the transaction was a loan in the first instance, it will be treated as such to the end, unless it be shown that the parties afterwards bargained for the property independently of the loan." Greene v. Bride & Son, 252 Iowa at 224, 106 N.W.2d at 606; see also Richardson v. Barrick, 16 Iowa 407, 1864 WL 206 at *2 ("it is a universal rule in equity that once a mortgage, always a mortgage"). Litwillers' failure to make the payments due March 1, 2001, did not effect a transfer of the equitable title to Wollesens. Litwillers retained redemption rights in the property which were not foreclosed. Cullen v. Butterfield, 178 Iowa 621, 160 N.W. at 129; Fort v. Colby, 165 Iowa 95, 144 N.W. 393, 403 (1913)("the equitable right of redemption after default is preserved, remains in full force, and will be protected and enforced by a court of equity"); Richardson v. Barrick, 1864 WL 2 06 at *2 ("the equity of redemption is inseparable from [a mortgage], and every attempt to limit or defeat that right must fail")."

Case Law Citation:

In re Litwiller, (Bankr. N.D. Ia. Adversary No. 03-9209F, 2006 Bankr. LEXIS 3751 (Dec. 19, 2006) (available online, opinion is available free, PACER registration required. Or you can just drop me me a line and I'll e-mail it to you; either click "comments" below or e-mail me at HomeEquityTheft@yahoo.com).

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