This post touches on some general principals that I've extracted out of a number of decisions primarily by the Washington Supreme Court that were cited as considerations when determining whether a deed should, in equity, be deemed a mortgage.
This information may be of some value to those involved in the legal issues surrounding "foreclosure rescue" transactions, particularly in the state of Washington. (court case links available courtesy of the Municipal Research & Services Center of Washington (MRSC)).
This case involved an action by a property owner to reform a deed as a mortgage and for redemption. After a bench trial, the lower court ruled against the property owner. The Washington Supreme Court reversed the lower court judgment and remanded the case with instructions to enter a decree adjudging the deed to be a mortgage. In doing so, the court made the following observations (bold text is my emphasis):
1) "In deciding whether it was a mortgage, the principal test to be applied is, whether the relation of the parties towards each other of debtor and creditor continued after the execution of the deed. 20 Am. & Eng. Ency. Law (2d ed.), 940. In McNamara v. Culver, 22 Kan. 661, the court, speaking through Brewer, J., now a member of the supreme Court of the United States, said:
- "The test is the existence or nonexistence of a debt. And equity looks behind the form to the fact. If the transaction was intended as a loan, if there remains a debt for which the conveyance is only a security, and the collection of which may be enforced independent of the security, equity will hold it a mortgage, no matter whether the transaction is evidenced by one or two instruments.""
3) "The doctrine has been firmly established from an early day that when the character of a mortgage has attached at the commencement of the transaction, so that the instrument, whatever be its form, is regarded in equity as a mortgage, that character of mortgage must and will always continue. If the instrument is in its essence a mortgage, the parties cannot by any stipulations, however express and positive, render it anything but a mortgage, or deprive it of the essential attributes belonging to a mortgage in equity."
4) "The debtor or mortgagor cannot, in the inception of the instrument, as a part of or collateral to its execution, in any manner deprive himself of his equitable right to come in after a default in paying the money at the stipulated time, and to pay the debt and interest, and thereby to redeem the land from the lien and encumbrance of the mortgage; the equitable right of redemption, after a default is preserved, remains in full force, and will be protected and enforced by a court of equity, no matter what stipulations the parties may have made in the original transaction purporting to cut off this right." Pomeroy, Equity Jurisprudence (2d ed.), § 1193."
5) "If the transaction between the parties be in fact a mortgage, its character cannot be affected or changed by any agreement entered into at the time between them as to redemption or the other incidents of a mortgage. The right of redemption attaches as an inseparable incident created by law, and cannot be waived by agreement. A mortgage, moreover, depends for its vitality upon the law in force at the time of its execution. The doctrine universally applicable is, if once a mortgage, always a mortgage. Nor can it be made otherwise by any agreement of the parties made at the time of the execution of the deed, nor upon any contingency whatever. Equity will not admit of a mortgagor embarrassing or defeating his right to redeem the estate by any agreement which he may be induced to enter into in order to effect a loan."
6) "Equity regards it as impossible for contracting parties, in a single transaction, by the execution of one or more written instruments to create the relation of debtor and creditor or mortgagor and mortgagee, and at the same time to provide for a conditional sale, or the destruction of the mortgagor's right to redeem after default. The deed having been a mortgage in its inception, appellants are still possessed of their equitable right to redeem, unless such right has been terminated either by foreclosure or some subsequent and independent valid agreement between the parties, neither of which has occurred."
7) "In 2 Washburn, Real Property (6th ed.), § 990, the author uses the following language:
- "On the other hand, if the transaction of the parties actually constitutes a mortgage in terms, it will have that effect, though not so intended by them when it was done. Thus, where one made a deed, and the grantee gave back a bond to reconvey on certain conditions, it was held that, though not intended thereby to create a mortgage, it was one in fact."
9) "The reason of this rule is that courts of equity are ever zealous to preserve to a mortgagor his equitable right of redemption, and to prevent him from entering into any agreement at the time of the execution of the original mortgage having the effect of nullifying such right. If the mortgage exists, the equity of redemption necessarily exists as incidental thereto. Therefore, in passing upon the facts found, we must, in applying these equitable principles, hold the deed to have been a mortgage, although there may have been some seeming intention on the part of one or both of the contracting parties that it should be otherwise considered."
This case involved a title transfer from a property owner who was in default on his mortgage payments to the bank holding the mortgage, coupled with a leaseback and a buy back option. In ruling that the transaction with the bank was not a mortgage, but was in fact a true conveyance, the court made this observations (bold text is my emphasis):
1) "It is the settled law of this state, that the character of such transactions as we have recited is fixed at the time of their inception, and that whether a deed should be construed as a mortgage depends upon the intention of the parties. It is also settled that, when property is conveyed by a deed absolute in form, the presumption of law is that the transfer is what it appears to be, and that he who would assert that it was given as a mortgage must so show by clear and convincing evidence. Johnson v. National Bank of Commerce, 65 Wash. 261, 118 Pac. 21. This case has often been cited by us and its doctrine approved."
2) "In determining whether a deed was intended as a mortgage, all surrounding circumstances may be inquired into; such, for illustration, as
- the conduct of the parties,
- the value of the property as compared to the indebtedness which the deed is supposed to have liquidated, and
- whether the relationship of debtor and creditor continues to exist."
The court in this case focused, in large part, on the value of the property involved relative to the amount that was paid for the property. It commented as follows (the appellant in this case was the property owner asserting that the deed was a mortgage):
- "Appellants further contend that the difference in the actual value of the property deeded and the amount of the indebtedness is so great as to show that the deed was intended as a mortgage, and not an absolute transfer of the title."
- "The authorities quite generally hold that, where the disparity between the amount of the indebtedness and the value of the property is so great as to necessarily lead to the conclusion that the deed was intended as security, the courts will, without hesitation, so declare."
- "The appellants cite a number of cases where this court has so held. For illustration, In the case of Collins v. Denny Clay Co., 41 Wash. 136, 82 Pac. 1012, the indebtedness was less than $8,000, and the value of the property conveyed was in excess of $20,000. In the case of Hoover v. Bouffleur, 74 Wash. 382, 133 Pac. 602, property worth $4,000, but subject to a $2,000 mortgage, was deeded in consideration of $250. In Beverly v. Davis, 79 Wash. 537, 140 Pac. 696, a somewhat similar condition existed."
- "In each of these cases, we held that the disparity was so great as to overcome all presumptions that the deed was what it purported on its face to be."
- "But such is not the situation here...[T]here was testimony, upon which the trial court greatly relied, to the effect that the mortgaged property was worth but a little more than the mortgage indebtedness. The trial court, who knew, of course, much more about the value than we can know, said that he believed the property was worth approximately $40,000 at the time the deed was given. The testimony further showed that the appellants, before giving the deed, tried to sell the property for $60,000 and were unable so to do.There was testimony to the effect that this property was not well located for warehouse purposes, that it had been vacant for a considerable time, that it was very much out of repair, and that property of that character in the city of Spokane had, during recent years, very considerably decreased in value. Under these circumstances, we cannot say that the property was actually worth, or could have been sold in the market for very materially more than, the indebtedness against it."
In this case, the court believed that the property value was $40,000. At the time of the transfer to the bank:
- there was an indebtedness owed to the bank of $33,000, which was more than a year overdue,
- the interest (about $1,000) and taxes ($1,600) had accumulated,
- the mortgage security was unoccupied and in considerable disrepair, depreciating in value and was not bringing in any rents,
- immediate foreclosure was inevitable,
- the most the appellants could hope for was a year for redemption,
- a foreclosure would entail a very considerable additional expense for attorney's fees and costs, and would interfere more or less with a sale of the property
Unlike the cases cited above where there was a significant disparity in the value of the property and the price paid for its purchase, in this case the court found that there was no such disparity.
It appears that Pittwood, along with the cases cited therein and above noted, stand for the significance that Washington courts place on the value of the property being conveyed relative to the price paid when considering whether a deed, absolute on its face, should, in equity, be deemed a mortgage.
Pittwood v. Spokane Savings & Loan Society, 141 Wash. 229, 251 Pac. 283 (1926)
This case (decided 16 years after Pittwood) involved a property owner ("Phillips") who:
- Facing a tax foreclosure on his property for a delinquency of approximately $900, appoached a certain Wenzelburger for a loan of money to stop the sale,
- Wenzelburger claimed to be uninterested, but referred Phillips to Blaser (Wenzelburger's sister-in-law, who worked and lived in the Wenzelburger home),
- Phillips ultimately "sold" the property for approximately $300 to Blaser, said money being promptly paid (as partial payment) to the taxing authority, thereby averting the tax sale,
- Contemporaneously with the execution of the quitclaim deed, Blaser and Phillips entered into a written agreement for the sale of the section of land in question by Miss Blaser to Phillips for approximately $600 (twice as much as it just sold for), payable in one year. The agreement provided that, unless the payment was made within the one year period, the buy back contract would be void.
- Phillips, who at all times remained in possession of the land, exercised the right of leasing the land to a third party for farming; all parties in this case were aware of the lease.
- After the expiration of the one year buy back period, Blaser sold the property to a certain Edwards for $4,000 (Edwards was aware of Phillips possession of the premises, aware of the farming lease of the premises to the third party, and aware that Phillips was unwilling to sign a "correction deed" shortly before his (Edwards) purchase from Blaser).
- Ultimately, a successful action was instituted by Phillips to have his quitclaim deed and the contemporaneously executed contract construed as a mortgage, and his title to the section of land in question quieted.
In affirming the lower court decision, the Washington Supreme Court ruled as follows (bold text is my emphasis):
- "The evidence is clear and convincing that the Wenzelburgers and Miss Blaser made a loan to respondent Phillips, and that there was no intention on the part of the lenders and the borrower that the transaction be an absolute sale rather than an equitable mortgage. To hold otherwise would permit the exaction from Phillips of usurious interest or defeat his equity of redemption and force him to relinquish his rights in the real property without consideration, which would be unconscionable."
- "No other reasonable conclusion may be drawn from the facts in this case than that Wenzelburger and Miss Blaser endeavored to take advantage of the necessitous circumstances of respondent Phillips. The evidence is conclusive that the alleged consideration of $298.60 advanced to Phillips is grossly inadequate. While the section of land was idle for a number of years and Phillips had difficulty in obtaining a loan thereon of three hundred dollars to avert tax foreclosure, appellants had no difficulty in selling the same property to Edwards for cash in the amount of four thousand dollars."
- "The evidence is overwhelming that appellants not only endeavored to defeat the equity of redemption to which respondent mortgagor is entitled as of right, but that in doing this they imposed the payment of an usurious interest rate upon him."
In support of this ruling, the Washington high court reviewed its decisions cited in Pittwood, which follow below:
- "In Collins v. Denny Clay Co., 41 Wash. 136, 82 Pac. 1012, we held, in harmony with the weight of authority, that a mortgagor cannot through any device bargain away his right of redemption at the time of giving the mortgage; that, while a mortgagor may release his equity of redemption to the mortgagee by subsequent agreement, the courts look upon such agreements with distrust, and, if it appears that the mortgagee took advantage of the necessities of the mortgagor, or that the consideration for such release of the mortgagor's equity of redemption is grossly inadequate, the release will be disregarded and the original relationship of the parties held to continue. "
- "In Hoover v. Bouffleur, 74 Wash. 382, 133 Pac. 602, plaintiff, who owned real property, valued in excess of four thousand dollars, which was subject to a mortgage in the amount of two thousand dollars in arrears, attempted, as in the case at bar, to borrow two hundred and fifty dollars to meet overdue installments on the mortgage. Defendant lender testified that he refused to make a loan upon the property but that he informed plaintiff that he would buy the property, advance the two hundred and fifty dollars, and give plaintiff an option to repurchase the property within three months upon payment of three hundred and twenty-five dollars. A deed was executed by the plaintiff conveying the property to defendant subject to the unpaid balance of the mortgage and then an option to repurchase the property was executed. In the case at bar, Phillips executed a quitclaim deed to Blaser and signed a contract in which he promised to buy the land. There was no mention of an option to repurchase. Appellant in that case relied, as appellants in the case at bar rely, upon certain well-settled principles of law. That is, the integrity of a deed is such that, to overcome its terms, testimony must be clear and convincing; that the mere option to purchase will not in itself make a deed a mortgage."
- "See, also, Beverly v. Davis, 79 Wash. 537, 140 Pac. 696, to the effect that a deed with a mere option to repurchase will be construed as a mortgage where there was an existing disparity between the value of the land and the amount of the indebtedness. "
What appears to be of some importance in this case is that, while there is language in Johnson v. National Bank of Commerce, 65 Wash. 261, 118 Pac. 21 (also cited in Pittwood) that was cited by the appellants that appears to favorably support their position that the form of the transaction should be sustained, the court here quotes from its decision in Hoover which, in my view, essentially, operates as a receding from, or modification or clarification of, the language in Johnson. Some of the Hoover language (where the court appears to recede from Johnson) follows below:
- "[I]t was not our intention to hold [in Johnson] that the intent of the parties must necessarily appear upon the face of the collateral paper. To do so would kill that true spirit of equity with which a court should approach cases of this kind. "
- "Viewing the case at bar from all its angles and taking it by its four corners, we have no doubt that the transaction was conceived and carried out with purpose to evade the law designed to prevent the taking of usury. The record shows what seems to be a studied effort on the part of the defendant to bring himself within certain expressions of this court as he has gathered them from our written opinions. "
- "The statements [in Johnson] were pertinent at the time they were employed, but an examination of the cases will show that they were applied as governing rules where there was no such lack of consideration as would shock the conscience, or the case was so wanting in equity or the equities were so balanced as to compel us to look to the instruments alone for guidance. It is certain that we never intended to mark a path around the statutes designed to protect the necessitous borrower from the exactions of those who are disposed to take unlawful return for a loan or forbearance of money."
One last (possibly) notable point here is that, while the court didn't go into any legal analysis on this issue, it also affirmed the part of the lower court ruling deciding that Edwards (the third party purchaser from appellant, Blaser) was not a bona fide purchaser and, accordingly, the equitable mortgage was valid as against him as well and his deed was properly voided. The court simply stated the following on this point:
- "The trial court correctly found that the original transaction was an arrangement to secure repayment of money borrowed instead of a sale, that the subsequent purchaser (Edwards) from the equitable mortgagee (Blaser) was not a purchaser in good faith, and then proceeded to place the parties in status quo."
This case makes mention that Edwards was aware of Phillips continued possession of the property after the sale to the appellant, Blaser, and was also aware of the farming lease that Phillips entered into with a third party (Presumably, Edwards made no attempt to ascertain what other rights or equities Phillips, as a person in possession, may have had in the property, which may have revealed the existence of the equitable mortgage between Phillips and Blaser. The court's decision was silent as to this point).
Phillips v. Blaser, 13 Wn.2d 439, 125 P. 2d 291 (Wa. 1942)
- "In our opinion, there was no intention on the part of either of the parties to do more than on the one part to secure the loan of the money and on the other to loan it and get proper security for re-payment with interest. This being so, the bare fact that they refused to loan the money and take a mortgage only tends to show that they thought they could evade the law, requiring the mortgage to be foreclosed before they could get possession of the property, by taking a deed, as they did, and giving a lease and an option to purchase to the grantors named in the deed."
- "In examining this question it is of great importance to inquire whether the consideration was adequate to induce a sale. When no fraud is practiced, and no inequitable advantages taken of pressing wants, owners of property do not sell it for a consideration manifestly inadequate, and, therefore, in the cases on this subject great stress is justly laid upon the fact that what is alleged to have been the price bore no proportion to the value of the thing said to have been sold."
Again, speaking of the written memorandum, the [Russell] court said:
- "In respect to the written memorandum, it was clearly intended to manifest a conditional sale. Very uncommon pains are taken to do this. Indeed, so much anxiety is manifested on this point, as to make it apparent that the draftsman considered he had a somewhat difficult task to perform. But it is not to be forgotten that the same language which truly describes a real sale, may also be employed to cut off the right of redemption, in case of a loan on security; that it is the duty of the court to watch vigilantly these exercises of skill, lest they should be effectual to accomplish what equity forbids; and that, in doubtful cases, the court leans to the conclusion that the reality was a mortgage and not a sale;"
citing a number of cases. Again [quoting from Russell]:
- "It is true, Russell must have given his assent to this form of the memorandum; but the distress for money under which he then was, places him in the same condition as other borrowers, in numerous cases reported in the books, who have submitted to the dictation of the lender under the pressure of their wants; and a court of equity does not consider a consent, thus obtained, to be sufficient to fix the rights of parties. 'Necessitous men,' says the Lord Chancellor in Vernon v. Bethell, 2 Eden 113, are not, truly speaking, free men; but, to answer a present emergency, will submit to any terms that the crafty may impose upon them."
- "The memorandum does not contain any promise by Russell to repay the money, and no personal security was taken; but it is settled that this circumstance does not make the conveyance less effectual as a mortgage;"
- "And consequently it is not only entirely consistent with the conclusion that a mortgage was intended, but in a case where it was the design of one of the parties to clothe the transaction with the form of a sale, in order to cut off the right of redemption, it is not to be expected that the party would, by taking personal security, effectually defeat his own attempt to avoid the appearance of a loan."
The above is a leading case on the question under consideration, and has been followed and approved in a multitude of cases in both the state and federal courts. See, 5 Rose's Notes, U.S.Reports, p. 77, and cases cited. The conclusion of the trial court that the stock stood as security only is amply sustained by the authorities."
(For the full text of the Russell case, see Russell v. Southard, 53 U.S. 139, 12 How. 139, 13 L. Ed. 927 (1851)).
Hoover v. Bouffleur, 74 Wash. 382, 133 Pac. 602 (Wa. 1913) Responding to the contention that the transaction was strictly a sale with a buyback option, the court stated,
- "Although appellant was careful to refrain from the use of the words "loan" and "mortgage," and to impress upon the plaintiffs that he was buying the property, it is our duty to go beyond his spoken words and review and consider every material circumstance."
- "The fact that the property was worth at least $4,000, and the amount paid by the defendant, or substantially all of it, was paid upon the mortgage thus reducing that encumbrance for the benefit of the defendant if a sale was indeed contemplated, when coupled with the option agreement or defeasance, are circumstances which in our judgment make it the imperative duty of a court of equity to declare the deed executed by respondents to be a mortgage. Otherwise we would be put to the stress of holding that respondents had sold a piece of property worth $2,000 for a cash payment of $7.50 and three months rent."
- "While the existence of a written promise to repay the money advanced is of great evidentiary value in arriving at the intention of the parties, yet the absence of such a promise is not conclusive that no personal debt exists. If the circumstances show a loan, an implied promise to re-pay springs from that fact alone. Kirkpatrick v. Post, 55 N. J. Eq. 591, 32 Atl. 267."