Bankruptcy Court Voids Foreclosure Rescue Sale Leaseback; Calls It A Fraudulent Conveyance - Part 1
A 1992 New York Federal bankruptcy case involving a homeowner facing foreclosure who, in the context of a Chapter 13 bankruptcy, successfully voided a foreclosure rescue, sale leaseback transaction may be of some interest to those representing homeowners in the context of a Federal bankruptcy court proceeding.
The homeowners sought to void the deed transferring their home (property in which they could have claimed a bankruptcy exemption) to the foreclosure rescue operator and to have the property returned to them pursuant to 11 U.S.C. § 550. They successfully attacked the conveyance of their house to the foreclosure rescue operator as a fraudulent conveyance voidable:
- under 11 U.S.C. § 548, and
- under 11 U.S.C. § 544(b) as violative of § 273 of the New York State Debtor Creditor Law.
What follows below are some highlights and quotes from the case (bold text is my emphasis) and is provided for general information purposes only. Please note that the Federal Bankruptcy Code has been subject to several legislative amendments since this case was decided. If there is anything contained herein that may be of interest to you, please seek out a qualified bankruptcy attorney to determine continued applicability.
Along this vein, one point I want to highlight is that this case makes reference to certain specific Code provisions that, as a result of subsequent amendments, have been repositioned. For example, references made herein to the relevant provisions contained in Section 548 in effect at the time this case was decided are now found in Section 548(a)(1), Section 548(a)(1)(B)(i), and Section 548(a)(1)(B)(ii)(I).
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148 B.R. 165
(Bankr. E.D.N.Y. 1992)
Description of the homeowners and family, the foreclosure rescue operator and the transaction & legal documents used therein
On the background, education and existing family situation of the homeowners, the court stated:
1) Living in the house at the [time of the bankruptcy court proceeding] are Mrs. Davis, her two grown daughters, four grandchildren and a greatgrandson, eight people in all. Until the Davises bought the house here involved, they had never bought a home. Apart from the FHA mortgage they had never borrowed money. Mr. Davis has a tenth grade education, obtained in North Carolina, and works as an orderly at a local hospital.
2) In 1982 Mr. Davis moved out of the marital residence and sometime later began divorce proceedings which are still pending. After the divorce action began, he stopped making payments toward the FHA mortgage which fell into arrears.
3) For some years now Mrs. Davis' sole income has been the disability allowance she receives from Social Security. One daughter and her four children also live on an allowance made them by Social Security. The only member of the family living in the house and currently employed is Tammy Davis [one of the Davis' daughters].
4) By 1991 arrears on the mortgage, on which the payments were $195 per month, had grown to approximately $10,000 and FHA commenced a foreclosure proceeding.
5) Depending upon what appraisal is used, the Davises by that time had an equity in their house of somewhere between $19,260 and $49,260.
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On the background and experience of the foreclosure rescue operator, the court stated:
6) Mrs. Suderov is a sophisticated and experienced lender. She has entered into at least eight or nine of these sale leaseback transactions. Currently she owns eight houses and three parcels of vacant land and holds five to six mortgages. What her husband holds was not disclosed. Over the years she has developed form documents and rubber stamps calculated to insulate her transactions from legal challenge.
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On the sale transaction, and the lease and option agreement, the court said:
7) The documents consisted of a deed, and a twelve page agreement with forty five numbered paragraphs entitled "Agreement with Option to Purchase," ("Agreement") to which was annexed an "Agreement Receipt and Statement," a "Memorandum of Municipal Requirements," and an "Insurance and Option Memo Excerpt." The Agreement is in fact both a lease and an option.
8) In essence, what these documents embody is a sale by Mr. and Mrs. Davis of their house to Mrs. Suderov and a leaseback of the premises to Tammy Davis [the Davis' daughter] with payment of the rent guaranteed by Mr. and Mrs. Davis. Contained in the lease is an option to buy back the premises (but not the fixtures in the house or related personalty) on extremely onerous terms at a price four to five times what the Suderovs were paying.
9) Execution of these documents gave rise to an immediate liability in Tammy Davis, guaranteed by her parents, to pay $ 12,719 to Mrs. Suderov. This is because the lease makes the first year's rent payable in its entirety upon execution of the Agreement.
10) These documents are not only complex, they are unintelligible. When Mrs. Suderov was asked at the trial to explain the paragraph calling for a recomputation of the option price each year she was totally unable to do so, offering as a lame explanation that the language represented Mr. Naeder's [her attorney] "legalese."
11) Although Mr. Wiener [the Davis' attorney] claims that he explained the documents to the Davises so that they would understand to what they were committing themselves, it is clear that he did not understand the transaction himself, since it was only at the trial that he realized that the option to buy the property back was given only to Tammy Davis and not to his clients, Mr. and Mrs. Davis. Furthermore, it was doubtful that Mr. Wiener, based on a few hours' examination of the complex documents in a tumultuous atmosphere, could have even understood, let alone intelligently explained, provisions which are so garbled and unintelligible that this Court has been unable to resolve their meaning after reviewing them carefully.
12) Mrs. Davis says that she did not understand what was taking place, that she simply signed where she was told to sign. She admits that she knew that she was transferring title but she relied on Mr. Suderov's representations that the transfer was only a formality necessary to satisfy the FHA and the house would continue to belong to her.
13) Execution of the lease, which was part of the transaction, generated an immediate obligation to pay $ 12,719 to Mrs. Suderov [the entire first year's rent payment was due immediately], dischargeable through equal monthly payments, described as an accommodation to the lessee. [...] The named lessee is Tammy Davis with payment guaranteed by both her parents.
14) The lease and option agreement are so full of penalties, escalation clauses, and monthly increases that it is impossible even for the most sophisticated lawyer to calculate exactly what the rent or the option price is or will be at any point in time.
15) When the transaction was completed, the house in which the Davises were living was the property of Phyllis Suderov and the Davises owed her $ 12,719 for the first year's rent on their former home with a first payment of $ 1,106 per month due two weeks after the closing. No money was given the Davises. They received not a penny for the transfer of an equity in the Bridgehampton home of a value of between $ 19,000 to $ 49,000 to Mrs. Suderov.
16) [O]ne month after the closing and two weeks after the first rental payment was due, Phyllis Suderov perfected a judgment against the Davises for a full year's rent and costs, $ 14,779.56. On that same date, she got a warrant of eviction for nonpayment. In addition, Tammy Davis was served by the Suffolk County sheriff with an income execution.
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Voluntary Transfer
One issue that the court addressed was whether the sale of the home by the homeowner to the foreclosure rescue operator, according to the court:
- "was a voluntary transfer within the meaning of Section 522(g)(1). The Bankruptcy Code does not define the word "voluntary," In re Tackett, 21 Bankr. 107 (Bankr. D.N.M. 1982), and the legislative history accompanying § 522(g) sheds no light on its meaning. In re Seidel, 27 Bankr. 347 (Bankr. E.D. Pa. 1983)."
1) By and large, the bankruptcy courts have refused to consider any transfer other than one that takes place by operation of law to be necessarily a voluntary transfer for purposes of Section 522(g)(1).
2) Economic coercion or fraud and misrepresentation have been held to render a transfer involuntary. In re Seidel, 27 Bankr. 347 (Bankr. E.D. Pa. 1983); In re Taylor, 8 Bankr. 578 (Bankr. E.D. Pa. 1981); In re Reaves, 8 Bankr. 177 (Bankr. D.S.D. 1981).
3) The following cases have recognized that general rule, but have concluded that the transfers there at issue were voluntary on the facts: In re Corwin, 135 Bankr. 922 (Bankr. S.D. Fla. 1992); In re Wernly, 91 Bankr. 702 (Bankr. E.D. Pa. 1988); In re Wernly, No. 88-0391 S, 1988 WL 96198 (Bankr. E.D. Pa. Sept. 16, 1988); In re Porter, 40 Bankr. 646 (Bankr. N.D. Tex. 1984); In re Dargis, 36 Bankr. 866 (Bankr. E.D. Pa. 1984); In re Evingham, 27 Bankr. 128 (Bankr. W.D.N.Y. 1983); In re Tackett, 21 Bankr. 107 (Bankr. D.N.M. 1982); In re Echoles, 21 Bankr. 280 (Bankr. D. Ariz. 1982).
4) In re Reaves, applied a two prong test. In that case a debtor had given, pre-petition, a third mortgage on her real property to a bank. An employee of the bank had contacted the debtor, and had pressured the debtor into signing the mortgage by telling her that her estranged husband's business would fail unless she executed the mortgage. The debtor had no legal connection with the business, but was unemployed and dependent solely upon her husband for her income. In considering whether the debtor could avoid the mortgage under Section 522(g)(1), the bankruptcy court stated:
- An 11 U.S.C. Section 522(g)(1)(A) voluntary transfer occurs when a debtor, with knowledge of all essential facts and free from the persuasive influence of another, chooses of her own free will to transfer property to the creditor. A voluntary transfer does not occur where a creditor has harassed, insulted, and shamed a debtor into transferring the property to the creditor. Nor has a voluntary transfer occurred where a creditor has concealed or failed to inform a debtor of essential facts necessary for the debtor to make an intelligent decision on whether to transfer the property to the creditor. This is especially true where a debtor can show that she would not have made the transfer had she been informed of all the essential facts.
6) Other courts have adopted the approach in Reaves, or cited it with approval. In re Corwin, 135 Bankr. 922 (Bankr. S.D. Fla. 1992); In re Evingham, 27 Bankr. 128 (Bankr. W.D.N.Y. 1983); In re Echoles, 21 Bankr. 280 (Bankr. D. Ariz. 1982); In re Tackett, 21 Bankr. 107 (Bankr. D.N.M. 1982).
7) At least one court has gone further, and held that the pressure present in Reaves is not prerequisite to a finding of an involuntary transfer where there has been misrepresentation. In In re Seidel, 27 Bankr. 347 (Bankr. E.D. Pa. 1983), the court concluded that a voluntary transfer does not occur where a debtor does not have knowledge of all of the essential facts pertaining to the transfer, the creditor to whom the transfer is made fails to inform the debtor of any essential facts within the creditor's knowledge, and the debtor would not have made the transfer had he been aware of all of the essential facts.
8) In In re Wernly, No. 88-0391 S, 1988 WL 96198 (Bankr. E.D. Pa. Sept. 16, 1988), a Chapter 13 debtor sought to avoid his purchase of a home on the ground that it was a fraudulent conveyance. He contended that the seller and real estate broker had misrepresented the cost of necessary repairs. Recognizing that the purchase could be considered an involuntary transfer where "the wrongdoing on the part of the seller, or the seller's agent, [is] manifest, raising to the level of fraudulent conduct, or [is] at least manifested by the application of extraordinary sales pressure," the court held that in the case before it the transfer was voluntary, because the misstatements "were relatively innocent." See also In re Wernly, 91 Bankr. 702 (Bankr. E.D. Pa. 1988).
9) The misrepresentations by Richard Suderov, acting on behalf of his wife, can hardly be termed "innocent" and they were accompanied by "extraordinary sales pressure." In this case there was fraud and misrepresentation, coupled with the economic coercion inherent in the fact that the Davises thought they were facing foreclosure of their mortgage and the Suderovs were aware of that fact. Considering the totality of the circumstances present here, the transfer to Phyllis Suderov of the deed to the Davis residence was not a voluntary transfer.
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Fraudulent Conveyance
The court then had to decide whether the transfer of the home to the foreclosure rescue operator was a fraudulent conveyance within the meaning of the Bankruptcy Code or New York's Debtor & Creditor Law.
The court made the following statements in connection with this issue:
1) Indisputably, the transfer was made within one year [Editor's note: now two years, under current law] before the date of the filing of the petition. Therefore, it is avoidable under Section 548(a)(2) if (1) the Debtors received less than a reasonably equivalent value for the transfer and (2) they were then or were rendered thereby insolvent.
2) It is likewise avoidable as a fraudulent conveyance under Section 544 by reference to New York's Debtor and Creditor Law, which parallels the Federal statute and makes fraudulent any conveyance made without a fair consideration which renders the transferor insolvent.
3) Since the Debtors received nothing for their equity in the house, there can be no question but that they received less than reasonably equivalent value or fair consideration.
[...]
4) Whatever criterion is employed and however the facts are examined, it is indisputable that the price paid the Davises for the equity in their home was unconscionably low. How could it be otherwise when the Suderovs emerged with title to the property and with the Davises committed to pay Mrs. Suderov $ 1,106 per month for continuing to reside in the property to which Phyllis Suderov now held title and the Davises were left with nothing. Indeed, they were left with less than nothing in the view of the fact that the Suderovs, on one pretext or another, had earlier extracted $4,000 from them. [Editor's Note: Mr. Sudarov received $2,000 - appraisal, and $2,000 - for service rendered in negotiating satisfaction of a second mortgage].
5) Whatever value is placed on the house, since the Debtors received nothing in exchange for the transfer of their equity, Mrs. Suderov did not give the Debtors reasonably equivalent value. Nor did she give them fair consideration under New York law. N.Y. Debt. & Cred. Law, § 272 (McKinney 1990). Nothing was given the Debtors in exchange for their house "as a fair equivalent therefor," nor did Mrs. Suderov act in good faith.
6) Because the transfer was so unfair it rendered the Davises insolvent. It stripped them of their one significant asset, their equity in their house and left them with all their prior debts. That the transaction eliminated their liability on the mortgage and on the mortgage arrears was of no benefit since they no longer owned the house.
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Unconscionability
While the homeowners' complaint in this case did not request the court to void the transaction with the foreclosure rescue operator based on unconscionability, the court's "conscience" was presumably "sufficiently shocked" so as to cause it to address the issue of unconscionability anyway (possibly, this was the judge's attempt to (1) telegraph the legal grounds by which the Davises' counsel could use to go after the Suderovs' supporting cast who assisted in the screwing of the Davises, or possibly to (2) telegraph to future foreclosure rescue victims who are situated similarly to the Davises to include unconscionability in their complaint - maybe both). The court spoke as follows:
1) The Court limited itself to the issue of the existence of a fraudulent conveyance and has not considered whether the entire transaction, including the lease, is voidable as unconscionable. The complaint did not request such a determination.
2) The New York courts will not enforce an unconscionable contract. An unconscionable contract is "one which is so grossly unreasonable or unconscionable in the light of the mores and business practices of the time and place as to be unenforceable according to its literal terms." Sablosky v. Edward S. Gordon Co., 73 N.Y.2d 133, 538 N.Y.S.2d 513, 535 N.E.2d 643 (1989).
3) The doctrine contains both substantive and procedural aspects, and whether a contract is unconscionable is to be determined against the background of the contract's commercial setting, purpose, and effect. Id.
4) In determining whether a contract is substantively unconscionably, courts consider whether one or more key terms are unreasonably favorable to one party. Id.
5) All the elements of an unconscionable contract are present here, including gross imbalance in bargaining power and sophistication and a result which must shock any disinterested observer.
6) Mr. and Mrs. Suderov, under the pretense of helping the Davises, legally stole from them the house which has been home to them for 15 years and which shelters their children and grandchildren. The Suderovs knew that the moment the Davises committed themselves to pay $ 1,100 a month, the house was lost to them.
7) The deal into which the Davises were tricked into entering was worse than usurious. All those who participated deserve to be condemned. The Davises should explore recouping from Fran, from Mr. Naeder, Mr. Golub, Final Touch, Mr. Wiener, the money paid them by Mrs. Suderov for helping victimize the Davises.
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Davis v. Suderov (In re Davis), 148 B.R. 165; (Bankr. E.D.N.Y. 1992).
Go here for Part 2 of this post.
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