Friday, February 8, 2008

State Court Judge Rejects Ohio AG's "Real Party In Interest" Issue In Foreclosure; Allows Action To Continue

In Hamilton County, Ohio, The Enquirer reports:

  • Ohio Attorney General Marc Dann suffered his first setback Monday in a novel effort to slow foreclosure filings in the state – and in doing so had his ethics questioned by a Hamilton County magistrate. Dann argues that lenders can’t foreclose unless they can prove they own the mortgage they say is in default. Paperwork proving ownership often lags behind as lenders buy and sell mortgages. The result is that foreclosing lenders don’t always have the paperwork to prove that they’re the mortgage owners. Traditionally, courts have allowed the foreclosures to proceed anyway. [...] Monday, however, Common Pleas Court Magistrate Michael Bachman rejected Dann’s argument.


  • Monday’s decision comes in case filed by Deutsche Bank National Trust Co. against Telisa Barnes. She bought a $128,000 home in Northside a year ago with the help of a mortgage from Equifirst Corp. Five months later, Deutsche Bank filed to foreclose, saying she owed $127,892 – plus interest. The state of Ohio had an interest in the property because Barnes put the house up as part of a $20,000 bond in an aggravated menacing case against another defendant. Dann argued that Deutsche Bank was not a “real party in interest” because it didn’t own the mortgage paper when it filed its foreclosure case. The magistrate ruled federal precedents don’t apply because federal courts have limited jurisdiction in foreclosure cases, while state courts are required to take them.

For more, see AG's foreclosure gambit shot down.

Go here for other posts on mortgage lenders missing foreclosure documents. missing mortgage foreclosure docs alpha

Sunday, February 3, 2008

Equitable Mortgage Doctrine Difficult To Grasp For Some Judges (Draft)

This is a draft, and subject to minor revisions. Upon completion, this post will be marked "Final."
The equitable mortgage doctrine is an area of law that, despite the number of court cases available that illustrate its application, is one that many struggle with. Among those that struggle with understanding and applying its principles are some of the very judges who are called upon to carefully consider a fact pattern in a case and decide whether or not the doctrine is applicable to it. Unfortunately for litigants seeking to invoke these equitable principles in a given case, they not uncommonly run into a judge who, for whatever reason, doesn't fully comprehend the doctrine. When called upon to issue a ruling in an equitable mortgage case, the judge sometimes just simply gets it wrong.

Two relatively recent cases involving the equitable mortgage doctrine in which the judges appear to have simply gotten it wrong come from the Federal district courts in Minnesota (Wilkinson v. Ordway Group, LLC, Civil No. 07-2678, 2007 U.S. Dist. LEXIS 76857, (D. Mn. 2007)) and Virginia (Clemons v. Home Savers, LLC., No. 2:07 cv-244, 2008 U.S. Dist. LEXIS 3304, (E.D. Va. 2008)). The cases involved foreclosure rescue operators, the very type of people whose business practices caused the equitable mortgage doctrine to evolve in the first place well over 500 years ago,(fn1) who successfully caused two homeowners facing foreclosure to sign away their homes at a price that bore no relation to the value of the property in an arrangement purportedly designed to help the desperate homeowners "save their homes" from foreclosure.

(fn1) In Merryweather v. Pendleton, 91 Ariz. 334; 372 P.2d 335; (Az. 1962), the Arizona Supreme Court cited English common law dating back over 500 years when making the following observation, "The ruse of an absolute deed or deed with an option to repurchase has long been used in attempts to cut off a mortgagor's equity of redemption. Equity courts created the concept of equitable mortgages to avoid such abuses". Y.B. 9 Edw. IV 25, 34, (1470).
The concept of equitable mortgage has also been used to stop those attempting to artfully dance around usury statutes. See, for example, Moran v. Kenai Towing & Salvage, 523 P2d 1237 (Ak. 1974); Mobile Bldg. & Loan Asso. v. Robertson, 65 Ala. 382; (Al. 1880); Kawauchi v. Tabata, 49 Haw. 160, 413 P.2d 221, 231 (Haw. 1966); SAL Leasing v. State ex rel. Napolitano, 10 P3d 1221 (Ariz. Ct. App. 2000).

Maybe someday I'll put up a post on the Minnesota case in Wilkinson, but for now, I'm going to take a look at this Virginia case and make observations as to where, in my humble judgment, the flaws in the decision are.
Clemons v. Home Savers, LLC
No. 2:07 cv-244, 2008 U.S. Dist. LEXIS 3304
E.D. Va. 2008
Point #1: The Erie Doctrine, or What's With Seven Springs, Inc. v. Abraham?

Througout the judge's Opinion and Order in Clemons, reference is made to a 1993 Virginia Federal bankruptcy case ("Seven Springs")(fn2), decided by one sole Federal bankruptcy judge, that concluded that the equitable mortgage doctrine did not apply to the facts and circumstances before it. He cites Seven Springs as if it represents binding, or at least guiding and persuasive, Virginia state law precedent in reaching his conclusion that the equitable mortgage doctrine (a doctrine of substantive state law) was not applicable. The judge cites some of the Virginia Supreme Court equitable mortgage cases for some broad general principles, and then seems to simply accept and follow the rationale of Seven Springs as if it represents the correct application of the broad principles laid out by the Virginia high court.

(fn2) Seven Springs, Inc. v. Abraham, 159 B.R. 752, 755 (E.D. Va. 1993)


Under the Erie Doctrine, when asked to decide an issue of substantive state law, it has been said that the federal court's task is not to reach its own judgment regarding the substantive state law, but simply to ascertain and apply the state law.(fn3) When there is no controlling state court decision to apply, it is up to the Federal court to attempt to predict what the state's highest court would do (to my knowledge, there is no Virginia Supreme Court decision that addresses the equitable mortgage doctrine in the specific context of one doing business as a foreclosure rescue operator entering into a "rescue" transaction with financially strapped homeowners facing the loss of their homes due to an imminent foreclosure).


(fn3) While Erie's application is most often seen in cases of diversity jurisdiction, the U.S. Supreme Court has pointed out that Erie is equally applicable in non-diversity cases as well. See Commissioner v. Estate of Bosch, 387 U.S. 456 (1967) ("This is not a diversity case but the same principle may be applied for the same reasons, viz., the underlying substantive rule involved is based on state law and the State's highest court is the best authority on its own law.").


When making the prediction (often referred to as an "Erie guess") as to what the state high court would do, the U.S. Court of Appeals for the Fourth Circuit has pointed out:

  • It is axiomatic that in determining state law a federal court must look first and foremost to the law of the state's highest court, giving appropriate effect to all its implications. A state's highest court need not have previously decided a case with identical facts for state law to be clear. It is enough that a fair reading of a decision by a state's highest court directs one to a particular conclusion. Only when this inquiry proves unenlightening, as we find it does in this case, should a federal court seek guidance from an intermediate state court. When seeking such guidance we defer to a decision of the state's intermediate appellate court to a lesser degree than we do to a decision of the state's highest court. Nevertheless, we do defer. Assicurazioni Generali, S.p.A. v. Neil, 160 F.3d 997 (4th Cir. 1998):
The 4th Circuit subsequently added (presumably when there are no state high court or intermediate appellate court decisions on point) in Wells v. Liddy, 186 F.3d 505, 528 (4th Cir. 1999):

  • To forecast a decision of the state's highest court we can consider, inter alia: canons of construction, restatements of the law, treatises, recent pronouncements of general rules or policies by the state's highest court, well considered dicta, and the state's trial court decisions. See Liberty Mut. Ins. Co. v. Triangle Indus., 957 F.2d 1153, 1156 (4th Cir. 1992).
In a case specifically concerning the application of Virginia state law, the 4th Circuit has also pointed out:

  • In the absence of any relevant Virginia law, we naturally look to the practices of other states in predicting how the Virginia Supreme Court would rule. Wade v. Danek Med., Inc., 182 F.3d 281 (4th Cir. 1999).
In listing all the sources of law that a Federal judge can look to when making an Erie guess, it appears clear that no weight at all is assigned by the 4th Circuit to the value of prior Federal court cases as authority when making an "Erie guess." Further, at least one Federal appeals court that I know of has come pretty close, in my view, to saying that the Federal cases are pretty much worthless as substantive state law precedent.(fn4) In light of where the 4th Circuit directs federal judges to go to for guidance in making an "Erie guess", why the judge in Clemons seems to place so much reliance on the rationale of one Federal bankruptcy judge's decision in Seven Springs is beyond me; it appears misguided and in direct conflict with what the Erie Doctrine stands for. On this basis alone, the decision in Clemons appears to be seriously flawed.


(fn4) In ascertianing the state law of California, the 7th Circuit Court of Appeals in United Airlines v. HSBC Bank, 416 F.3d 609 (7th Cir. 2005) observed, "Like the district judge, the parties in this court seek to find California's law in the decisions of federal bankruptcy judges sitting in California, and they debate the significance of what these judges have said about the subject. Yet federal judges are not the source of state law or even its oracles. To find state law we must examine California's statute books and the decisions of its judiciary."


Point #2: Burden of Proof On Party Seeking To Establish An Equitable Mortgage

The Clemons court cites Pretlow v. Hopkins, 30 S.E.2d 557, 558 (Va. 1947) in setting forth the standard of proof necessary to establish an equitable mortgage:

  • For a deed absolute on its face is presumed absolute unless the party challenging the presumption can prove by "clear, unequivocal and convincing evidence" that the instrument is something other than what it purports to be.
While sounding like a stringent burden, what is not noted by the court, however, is this earlier statement made by the Virginia Supreme Court in Snavely v. Pickle, 70 Va. 27, 29 Gratt. 27 (Va. 1877) indicating that the standard of proof is not quite as absolute as it initially sounds:(fn5)

  • There is a well defined distinction between a mortgage and a conditional or defeasible sale, but it is often very difficult to determine whether a particular transaction amounts to the one or the other; and, after all, each case must be decided upon its own circumstances, and in doubtful cases the courts incline to construe the transaction to be a mortgage rather than a conditional sale. Russell v. Southard, 53 U.S. 139; Earp v. Boothe, 24 Gratt. 368, 374, et seq.
(my emphasis added) (fn6)


(fn5) Courts in other jurisdictions have made the similar observations: Tullis v. Weeks, Iowa App. Ct.; 2007 ("It is a well-established rule that, where a conveyance absolute upon its face is accompanied by a contract or agreement, by which the grantee undertakes to reconvey the land to the grantor on specified conditions, and the terms of such agreement or the circumstances under which it was made render it doubtful whether a mortgage or conditional sale was intended, the courts will hold it to be a mortgage." (citations omitted)); Rockwell v. Humphrey, 57 Wis. 410, 15 N.W. 394 (1883) ("The difficulty of discriminating between mortgages and conditional sales grows out of the fact that either through a misapprehension of the law by one or both of the parties, or a design on the part of one or both to conceal the real purpose of the transaction, it is often found to be mixed and confused, and hence containing some of the incidents of a mortgage, and also of a conditional sale. As a way out of this difficulty, courts have generally held the transaction to be a mortgage in all doubtful cases, because the ends of justice are the more apt to be attained, and fraud and oppression more likely to be prevented, by such a construction. Russell v. Southard, supra"; (other citations omitted)); Coates v. Marsden, 142 Wis. 106, 124 N.W. 1057 (1910) ("[S]uch transactions will be closely scrutinized by the court, that it must appear that the consideration of the transfer was adequate and that no advantage was taken of the debtor's necessities to drive a hard bargain, and that in doubtful cases the courts incline to hold that the mortgage relation still exists."); Merryweather v. Pendleton, 91 Ariz. 334; 372 P.2d 335; (Az. 1962) ("In cases of doubt the courts tend to hold the agreement to be a mortgage since this protects all parties and prevents forfeiture of the pledged property.")

(fn6) To the same effect is Tuggle v. Berkeley, 101 Va. 83; 43 S.E. 199 (Va. 1903) ("It is a well established rule of equity that in cases of doubt such instruments are construed as mortgages. All the authorities agree as to that."); Johnson v. Johnson, 183 Va. 892; 33 S.E.2d 784 (Va. 1945) ("But doubtful cases are generally declared to be mortgages.").


Point #3: The Existence Of A Debt

The Clemons court here states that there was no equitable mortgage because there was no debt owed by the homeowner to Home Savers. In reaching this conclusion, it relies solely on the written documents executed as part of the foreclosure rescue transaction. In Virginia, however, the existence of a debt need not be expressed(fn7); a promise to pay a debt can be implied(fn8).


(fn7) Snavely v. Pickle, 70 Va. 27, 29 Gratt. 27 (Va. 1877) ("The absence of a written obligation is sometimes adverted to as tending to show that a conditional or defeasible sale, and not a mortgage, was intended. This circumstance is certainly entitled to some weight, but alone has no great significance.")

(fn8) Tuggle v. Berkeley, 101 Va. 83; 43 S.E. 199 (Va. 1903) (The Virginia Supreme Court asked itself, "[W]ill a court of equity, in the interest of a wise and humane and just exercise of its jurisdiction, imply a promise to pay this debt on the part of the grantor in the deed, or will it become narrow and technical in order that the grantee may claim an absolute title to property worth double what he paid for it?" - The Virginia high court answered this question in the affirmative.)


In Tuggle v. Berkeley, the Virginia Supreme Court ruled that, in the interest of equity, it would imply that a debt existed where, had they failed to imply the existence of such debt, the grantee would end up with absolute title to property worth at least double what he paid for it and the homeowner would get nothing.

In Clemons, the court characterized the purchase price of the homeowner's property as $114,624.71 where Home Savers had estimated its value at between $150,000 and $190,000.
Assuming Home Savers' fair market value estimates are correct (and possibly not understated), they paid between 60.3% and 76.4% of the value of the home. However, the case also tells us that Home Savers took title to the property by taking over an existing mortgage of $108,576.81, that they paid out of pocket $4,247.90 that was applied to the current and back payments on the mortgage, and that an additional $800 was paid by Home Savers to pay a pressing debt of the homeowner unrelated to the property.

In reality, from Home Savers' view, they acquired between approximately $41,000 ($150K minus $108.6K) and $81,000 ($190 minus $108.6K) of home equity for a cash outlay of $5,047.90; in effect, they obtained equity in the home of between 8 and 16 times what they paid out of pocket -- far more than double the cash outlay involved in Tuggle.

It's even worse from the homeowner's standpoint. Her home equity immediately before the so-called foreclosure rescue, using Home Savers' (presumably not understated) fair market value estimates, was approximately between $37,000 ($150K minus $108.6K minus $4.2K) and $77,000 ($190K minus $108.6K minus $4.2K). From the homeowner's viewpoint, she signed away the entire equity in her home for a meager $800 benefit (the payoff on an unrelated payday loan) for her accumulated equity in her home.(fn9)


(fn9) Interestingly, the court misstates throughout its decision the amount that the homeowner received in the foreclosure rescue as $5,047.90. While this may have been the amount that Home Savers paid out of pocket to acquire title to the home in question, all of this amount except $800 went toward the arrearage due on the mortgage plus the current mortgage payment due on a home that they ended up with title to. The fact of the matter is that the homeowner only received a benefit of $800 of debt relief unrelated to the mortgage in exchange for the equity in her home.


If the Virginia Supreme Court found the implied existence of a debt in Tuggle, it would be difficult to believe that they wouldn't also imply the existence of a debt if they were presented with the facts and circumstances in Clemons, given the gross disparity between the value of the equity acquired and the amount paid for it.(fn10)


(fn10) Other cases involving sales and repurchase options have found the implied existence of a debt where there was a great disparity between the amount advanced and the value of the property acquired. For example, in Hoover v. Bouffleur, 74 Wash. 382, 133 Pac. 602 (Wn. 1913), property worth $4,000, but subject to a $2,000 mortgage, was deeded in consideration of $250. In Browner v. Dist. of Columbia, 549 A.2d 1107 (D.C. 1988), the court stated, "It is absurd to suggest that Mrs. Carroll would knowingly sell her home, in which she had an equity of more than $36,500.00, for $ 8,100.00."


In ruling that there was no debt, the Clemons court points to several facts. First, nothing in the written agreements required Clemons to repay the $ 5,047.90 or any other sum. Second, there was nothing in the agreements requiring Clemons to repurchase the property. Third, if Home Savers sold the property, it would have no recourse against Clemons if it was unable to recover its expenses. What the Clemons court ignores is that all these factors were present in Tuggle and the Virginia Supreme Court found the existence of an equitable mortgage.

In addition, the Clemons court points out that if Clemons decided to repurchase the property, the parties never agreed to a fixed repurchase price. The Option Agreement permitted Clemons to repurchase the property for 90 percent of its then appraised fair market value. The court distinguishes this case from the Virginia cases cited in support of estabishing an equitable mortgage in that, in the cited Virginia cases, the amounts involved were fixed amounts whereas, in Clemons, the amount was not fixed, but dependent on a future valuation.

What the Clemons court fails to point out here is where exactly in the Virginia Supreme Court jurisprudence (or, for that matter, the jurisprudence of other states) does it make any distinction between a repurchase price being fixed and one being "non-fixed." Further, the Clemons court fails to consider that the Virginia Supreme Court will disregard both the form of a transaction and a contingency related to the value of property in a financing arrangement if the transaction was nothing more than a device to cover a loan subject to the usury statutes.(fn11)

Further, to support its decision that the transaction was not an equitable mortgage, the Clemons court uses an unrealistic hypothetical to illustrate the risk that Home Savers was taking by making this transaction with Clemons. Rather than overanalyze this point, I think it suffices to say that when when one acquires between $41,000 and $81,000 in immediate home equity for an out-of-pocket cash outlay of about $5,100, the risk being taken by Home Savers in this transaction is somewhere between negligible and none (I'll do that deal every day of the week).(fn12)


(fn11) In Smith v. Nicholas, 35 Va. 330 (Va. 1837), the Virginia Supreme Court addressed a financing arrangement involving a loan concealed under cover of a pretended sale of stock, the price of which being in continual fluctuation. The Virginia high court ruled that neither the form of the transaction nor the contingent nature of the value of the stock operated as protection against an allegation of a usurious loan where the principal advanced was not at risk and the transaction was used as a device to cover an otherwise usurious transaction. The court pointed out:

  • "Positive proof is rarely to be expected; and hence the courts have always rested upon circumstantial evidence. Thus, where the bargain originates in a loan (1 Call 81); where the seller is an habitual usurer (2 Rand. 112); where the buyer of an article is in distress, and the price grossly inadequate (Gilm. 86); where the party is needy and already in the power of the lender; where the hazard is slight, and the disproportion of price so great as to afford evidence of corrupt intention, -- suspicion is very reasonably converted into conviction of the illegality of the transaction. See Ord 69. It would indeed be absurd, if the mere form of a stock transaction should be a sufficient veil for such a bargain as this."

(fn12) See footnote 11, supra.


Point #4: Factors To Be Considered In Evaluating An Equitable Mortgage Claim

In addressing the factors to be considered when assessing the existence of an equitable mortgage, the Clemons court cites Seven Springs, Inc. when making this statement:

  • Only after a borrower-lender relationship is established, may the court take account of whether the following additional factors also support the existence of a mortgage: (1) the intentions of the parties; (2) the adequacy of consideration; (3) the retention of possession by the grantor; and (4) the satisfaction or survival of the debt.

While the Virginia Supreme Court has repeatedly stated that the existence of a debt is required to have an equitable mortgage (as have courts in other jurisdictions), the Clemons court fails to point out where, in the Virginia Supreme Court jurisprudence, does it say that one must first determine the existence of a debt before the other factors are considered. It simply cites Seven Springs for this proposition. Further, the court's statement above creates the impression that the above four factors are the only other factors to consider, and that the determination of the existence of a debt is made independently of any of its enumerated, or other, factors.(fn13)

Unless I'm missing something, the weight of the equitable mortgage doctrine jurisprudence throughout the country requires that you look at all the factors, all the facts and circumstances surrounding a particular transaction taken together (not each in isolation) in determining whether the transaction constitutes a sale transaction, or a secured loan transaction. (I can understand, however, those who advocate on behalf of foreclosure rescue transactions wanting to consider each factor in isolation and attempt to explain each away. If I was advocating in defense of these transactions, I'd probably try and get away with the same thing.)


(fn13) In Earp v. Boothe, 65 Va. 368 (Va. 1874), the court considered the facts that (1) there was no negotiation between the parties as to the price of the subject property, and that (2) nothing was said during the negotiation as to the subject property's value, as being factors weighing in favor of its decision that the transaction was a loan and not a sale.

In Snavely v. Pickle, 70 Va. 27, 29 Gratt. 27 (Va. 1877), the court again observed that, "The negotiations between the parties have always been much looked to and regarded as important in determining whether they contemplated a mortgage or sale." The court also identified "[t]he great disproportion between the value of the land and the amount of money advanced" as an additional factor.

This factor (which for ease of reference, I'll call the "how the consideration was paid" factor) should be distinguished from the "adequacy of consideration" factor. The latter factor addresses whether the price itself was inadequate; the former, however, addresses the actual payment terms of the transaction and to whom the money advanced was paid. In the Clemons case, for example, the consideration paid by Home Savers was $114,000+ for a property worth (according to Home Savers) between $150,000 and $190,000. In terms of how the consideration was paid, however, the amount actually advanced by Home Savers amounted to only $5,000+ for equity they valued at between $41,000 and $81,000 (the entire amount of which was applied against existing debts of the homeowner). The balance of the price was paid in the form of a closing statement credit for an existing mortgage that Home Savers took over. Further, the entire $5,000+ was paid to creditors, not to the homeowner.

As a side note, I find it interesting that, as noted in the Clemons opinion (at footnote 1), the original closing statement falsely (either inadvertently or intentionally) reflected an "all-cash" purchase by Home Savers when such was not the case. The Clemons court curiously places no significance on this, apparently being satisfied that the closing agent issued a corrected closing statement - after the commencement of the litigation - and that the inaccuracy was explained away as being nothing more than a scrivener's error. A court more aware of "the ways of the world" in the real estate business would have looked at the so-called "scrivener's error" on the closing statement, together with the other obvious factors surrounding the subject transaction, as a possible attempt to inappropriately hide the true nature of the transaction, and in the process, neutralize to their benefit the "how the consideration was paid" factor.

For a list of at least 13 factors that courts have considered when performing an equitable mortgage analysis, see Gregory A. Thorpe and John C. Murray, When is a Sale-Leaseback an Equitable Mortgage?


Point #5: Sophistication Of The Parties Involved In An Equitable Mortgage Transaction

One factor to be considered in an equitable mortgage analysis is the sophistication of the parties involved. The lack of sophistication on the part of the homeowner seeking to invoke the equitable mortgage doctrine was given much weight by the Virginia Supreme Court in Tuggle, supra, as well as in Magee v. Key, 168 Va. 361, 191 S.E. 520 (Va. 1937) when declaring the transactions involved in each case equitable mortgages. The Clemons court appears to completely ignore this factor when making its ruling.


Point #6: The Sale-Leaseback, Sale-Repurchase Foreclosure Rescue Transaction As A Device to Lend Mortgage Money While Evading The Borrower's Equitable Right Of Redemption.

As noted in footnote 1, supra, this type of transaction has been used by many as a way to obtain title to property from another at a grossly inadequate price when the intent of the property owner was not to sell property, but to merely use it as security in exchange for needed funds. By dressing up the transaction as a sale with an option to repurchase, the expectation was money lenders can use this as a device to evade the laws governing a mortgagor's right of redemption, a right that a mortgagor has to tender payment of a debt even after a default has occurred, and prohibiting a lender to take title to property without first initiating a foreclosure action and conducting a public sale of the property.

In the context of disguised loans used as devices to evade the usury statutes, the Virginia Supreme Court has spoken quite clearly, recognizing its duty to determine, and be controlled by, the substance of a transaction, rather than its form:

In 1941, Van Dyke v. Commonwealth, 178 Va. 418, 17 S.E.2d 366 (1941), the court made the following observations in connection with analyzing a particular financing arrangement:

  • Contracts of this character are scrutinized with care, and courts are alert to discover specious devices. The debtor often belongs to a class which needs protection, and his needs are sometimes so urgent as to extort from him any conditions which the creditor seeks to impose ...

  • The cupidity of lenders, and the willingness of borrowers to concede whatever may be demanded or to promise whatever may be exacted in order to obtain temporary relief from financial embarrassment, as would naturally be expected, have resulted in a great variety of devices to evade the usury laws; and to frustrate such evasions the courts have been compelled to look beyond the form of a transaction to its substance, and they have laid it down as an inflexible rule that the mere form is immaterial, but that it is the substance which must be considered.

Forty-four years later in Valley Acceptance Corp. v. Glasby, 230 Va. 422; 337 S.E.2d 291 (Va. 1985), after quoting the above language from Van Dyke, the Virginia high court added the following:

  • The need to scrutinize with care loans made to borrowers caught in financial distress continues to be a valid concern. Moreover, it remains necessary today, as in 1941, for courts to look beyond the mere form of a transaction and analyze its substance.

A doctrine based in equity, the equitable mortgage doctrine, likewise, requires a court to look behind the form of a transaction to determine, and be controlled by, its substance in order to prevent the abuses and frustrate the evasions of using a deed and a repurchase option, or other legal maneuvers as a device to improperly cut off a homeowner/borrower's equitable right of redemption. Inasmuch as the legal principles are the same or substantially similar, the foregoing cases may provide some guidance as to how the Virginia high court would rule when analyzing devices used by a money lender to circumvent a mortgagor's equitable right of redemption.


Point #7: Observations On The Equitable Mortgage Doctrine By The U.S. Supreme Court.

The U.S. Supreme Court has, in a couple of 19th century cases, expressed its general views with regard to the considerations to be taken into account when applying the equitable mortgage doctrine. Below are some excerpts from these cases.

Russell v. Southard, 53 U.S. 139, 12 How. 139, 13 L. Ed. 927 (1851):

  • To insist on what was really a mortgage as a sale is in equity a fraud, which cannot be successfully practiced under the shelter of any written papers, however precise and complete they may appear to be.


  • 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. Conway v. Alexander, 7 Cranch 241; Morris v. Nixon, 1 How. 126; Vernon v. Bethell, 2 Eden, 110; Oldham v. Halley, 2 J.J.Marsh. 114; Edrington v. Harper, 3 id. 354.


  • 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. Conway v. Alexander, 7 Cranch 218; Flagg v. Mann, 2 Sumn. 533; Secrest v. Turner, 2 J.J.Marsh. 471; Edrington v. Harper, 3 id. 354; Crane v. Bonnell, 1 Green 264; Robertson v. Campbell, 2 Call. 421; Poindexter v. McCannon, 1 Dev.Eq. 373.

  • 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 the 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. Floyer v. Lavington, 1 P.Wms. 268; Lawley v. Hooper, 3 Atk. 278; Scott v. Fields, 7 Watts. 360; Flagg v. Mann, 2 Sumn. 533; Ancaster v. Mayer, 1 Bro.C.C. 464. 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 forms 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.

  • It has been made a question, indeed, whether the absence of the personal liability of the grantor to repay the money, be a conclusive test to determine whether the conveyance was a mortgage. In Brown v. Dewey, 1 Sandf.Ch. 57, the cases are reviewed and the result arrived at, that it is not conclusive. It has also been maintained that the proviso or condition, if not restrained by words showing that the grantor had an option to pay or not, might constitute the grantee a creditor. Ancaster v. Mayer, 1 Bro.C.C. 464; 2 Greenl.Cruise 82 n, 3. But we do not think it necessary to determine either of these questions, because we are of opinion that in this case there is sufficient evidence that the relation of debtor and creditor was actually created, and that the written memorandum ascertains the amount of the debt, though it contains no promise to pay it. In such a case it is settled that an action of assumpsit will lie. Tilson v. Warwick Gas-Light Co., 4 Barn. & C. 968; Yates v. Aston, 4 Ad. & El.N.S. 182; Burnett v. Lynch, 5 Barn. & C. 589; Elder v. Rouse, 15 Wend. 218.


  • The conclusion at which we have arrived on this part of the case is that the transaction was in substance, a loan of money upon the security of the farm, and being so, a court of equity is bound to look through the forms in which the contrivance of the lender has enveloped it and declare the conveyance of the land to be a mortgage.


Alexander v. Rodriguez, (aka Villa v. Rodriguez) 79 U.S. 323, 12 Wall. 323, 20 L. Ed. 406 (1870):

  • The law upon the subject of the right to redeem where the mortgagor has conveyed to the mortgagee the equity of redemption, is well settled. It is characterized by a jealous and salutary policy. Principles almost as stern are applied as those which govern where a sale by a cestui qui trust to his trustee is drawn in question. To give validity to such a sale by a mortgagor it must be shown that the conduct of the mortgagee was, in all things, fair and frank, and that he paid for the property what it was worth. He must hold out no delusive hopes; he must exercise no undue influence; he must take no advantage of the fears or poverty of the other party. Any indirection or obliquity of conduct is fatal to his title. Every doubt will be resolved against him. Where confidential relations and the means of oppression exist, the scrutiny is severer than in cases of a different character. The form of the instruments employed is immaterial. That the mortgagor knowingly surrendered and never intended to reclaim is of no consequence. If there is vice in the transaction, the law, while it will secure to the mortgagee his debt, with interest, will compel him to give back that which he has taken with unclean hands. Public policy, sound morals, and the protection due to those whose property is thus involved, require that such should be the law.

Point #8: Other Courts Have Had Trouble Understanding The Equitable Mortgage Doctrine.

The Clemons court is not the only court that has encountered a problem discerning exactly why the equitable mortgage doctrine came about and spotting sale-leaseback-repurchase devices (or other devices) that warrant such treatment. The Minnesota Federal court in Wilkinson v. Ordway Group, LLC, supra, arguably may have had a problem understanding what the equitable mortgage doctrine is all about.

Lest one think I am picking on the Federal judiciary, I hasten to add that state courts have had similar problems.(fn14) However, in one recent Federal bankruptcy case that ended up in a Federal appeals court, the transaction involved was held to be an equitable mortgage at each step of the judicial ladder.(fn15) In another case, a Michigan Federal Court invoked the equitable mortgage doctrine against a foreclosure rescue operator resulting in a finding that a homeowner's rights under the Federal Truth In Lending Act and the Michigan usury statute were found.(fn15a)


(fn14) The following sample of state cases represents reversals, favorable to the party asserting equitable mortgage, of unfavorable lower court decisions:

(fn15) In Christopher v. Cox (in re Cox) Case #04-15891, (11th Cir., July 27, 2007), the 11th Circuit Court of Appeals affirmed the District Court (Christopher v. Cox (in re Cox), Case #1:04-CV-1189-RWS, (N.D. Ga. 2004)), which in turn affirmed a bankruptcy judge's decision in invoking the equitable mortgage doctrine.

(fn15a) Moore v. Cycon Enterprises, Inc., (Case No. 1:04-CV-800), 2006 U.S. Dist. LEXIS 57452 (W.D. Mi. 2006) (unpublished).


Point #9: Seeking Certification Of The Equitable Mortgage Issue In Federal Cases To The State Supreme Courts (or "Fast Track to The State High Court?")

I would be remiss if I didn't briefly mention one possible option for those litigating the equitable mortgage issue in the lower Federal courts and who receive an unfavorable ruling. I recognize appeals aren't cheap and, accordingly, this option may not fit the budget for most financially strapped homeowners who lose their homes in a foreclosure rescue scheme. However, for those who can somehow finance an appeal, or possibly find counsel to take the case "on the arm," filing an appeal with the appropriate Federal Court of Appeals, followed by a motion asking that Federal court to certify the equitable mortgage doctrine question to the state's highest court(fn16) may be an efficient way to get the equitable mortgage issue out of the Federal courts and in front of the state highest court for it to decide.(fn17) As pointed out by the U.S. Supreme Court, it is the state's highest court that is the most qualified to decide state law questions.(fn18)

Getting the equitable mortgage question, as specifically applied in a foreclosure rescue transaction, in front of the state's highest court would give that court the opportunity to review all the existing equitable mortgage jurisprudence, both its own as well as that from other jurisdictions, reconcile any ostensible inconsistencies, enumerate the specific factors (in "bullet" form, hopefully - for ease of reading!) that are to be considered, and essentially, make an authoritative pronouncement as to how the doctrine should be applied in such a context. The hope would be that the state high court would instill the necessary clarity in the application of the law to serve as the kind of needed guidance to the lower courts that will keep them from giving a stamp of approval to a transaction where a desperate homeowner is tricked into giving away his/her home equity (as it appears to have been done in Clemons, as well as in the Minnesota case, Wilkinson v. Ordway Group, LLC, supra).

Important to note, however, is that whether a Federal court certifies a question of state law to a state's highest court is a matter left to the Federal court's "sound discretion."(fn19) Further, assuming the Federal court decides to certify, whether the state's highest court decides to hear the case is subject to their discretion as well. Guessing the odds that a Federal court will certify a state law question, followed by the state high court's willingness to accept the case is outside the scope of this blog. However, the equitable mortgage doctrine applied in the specific context of the modern day foreclosure rescue transaction, in my view, involves a significant state public policy question,(fn20), and is one that does not appear to have been addressed by any of the highest state courts.(fn21) Inasmuch as, under the Erie Doctrine, it is not for the Federal courts to "create or expand [the] state's public policy",(fn22) it may be that the Federal courts will recognize this and will readily certify this public policy question to the state's high court.


(fn16) (The state "Supreme Court" in most jurisdictions; or the state "Court of Appeals" in some; West Virginia calls their high court the Supreme Court of Appeals).

(fn17) State statutes provide the authority for foreign courts to certify state law questions to the appropriate state high court. State laws typically allow the U.S. Supreme Court and any Federal Circuit Court of Appeals to certify questions to the state's highest court, although some states expand that right to some other courts as well. For example, The District of Columbia allows certifications from the highest appellate court of any State. D.C. Code § 11-723. Virginia also allows certifications from a U.S. district court (but not a Federal bankruptcy court) and the highest appellate court of any state or the District of Columbia. Va. Sup. Ct. R. 5:42. Minnesota allows certifications from any U.S. court and any appellate court of another state. Minnesota Statutes, 480.065, subd. 3. The same for West Virginia (W. Va. Code § 51-1A-3) and Maryland (Maryland Courts And Judicial Proceedings § 12-603).

(fn18) "[T]he State's highest court is the best authority on its own law." Commissioner v. Estate of Bosch, 387 U.S. 456 (1967).

(fn19) Lehman Brothers v. Schein, 416 U.S. 386, 391, 40 L. Ed. 2d 215, 94 S. Ct. 1741 (1974).

(fn20) One need not look any further than the state legislatures across the country that are either passing or considering legislation to regulate and control foreclosure rescue transactions.

(fn21) There have been a number of cases that have treated a sale leaseback as a loan, but, with the exception of Browner v. Dist. of Columbia, 549 A.2d 1107 (D.C. 1988), did not specifically involve the type of "foreclosure rescue" transactions that have been getting much publicity over the last couple of years. See, for example, Moran v. Kenai Towing & Salvage, 523 P.2d 1237 (Ak. 1974); Mobile Bldg. & Loan Asso. v. Robertson, 65 Ala. 382; (Al. 1880); Kawauchi v. Tabata, 49 Haw. 160, 413 P.2d 221, 231 (Haw. 1966).

(fn22) Wade v. Danek Med., Inc., 182 F.3d 281 (4th Cir. 1999) ("[W]e are mindful of the general principle that, "in trying to determine how the highest state court would interpret the law, we should not create or expand that State's public policy."" citing Talkington v. Atria Reclamelucifers Fabrieken BV, 152 F.3d 254, 260 (4th Cir.), cert. dismissed, 119 S. Ct. 634 (1998)).



In the Clemons case, you have a transaction in which there is great disparity in the situations of the buyer and the seller(fn23). The homeowner was (1) unsophisticated, (2) desperate to preserve her home, (3) relied on Home Savers to help her achieve that objective, (4) not represented by an attorney (presumably) when consummating the transaction, (5) engaged in an unusual type of "sale"(fn24), (6) where presumably there was no negotiations leading up to the consummation of the transaction, (7) no discussions as to the value of the home, (8) all documents were presumably prepared by and the structure of the transaction dictated by Home Savers, (9) where the purported "sale price" was between 60% and 76% of what Home Savers would admit to being fair market value, (10) where the buyer's cash outlay went entirely to pay current or past due homeowner debts, (11) where the homeowner signed over her entire home equity (estimated at between $37,000 and $77,000 immediately before the transaction) for a meager $800 (which went directly to pay off another debt), (12) where a contemporaneously executed agreement to repurchase was entered into with the purported sale, and (13) where she remained in possession of the home after the sale.

If ever there were a situation that cried out for a court to use its equitable powers, this was the case. Keeping in mind that the equitable mortgage doctrine arose and evolved over hundreds of years of cases in which a deed with an option to repurchase has been used as a device in attempts to cut off a mortgagor's equity of redemption,(fn25) if the transaction in this case isn't an equitable mortgage, then what transaction is.

Inasmuch as it is the duty of the Federal judge, under the Erie Doctrine, to attempt to predict how the Virginia Supreme Court would rule in a case like this (and not to decide what it independently thinks the correct result should be), the Clemons court is, in effect, saying that it honestly believes that it ruled the way the Virginia Supreme Court would have ruled had it heard the case.

Personally, I think that the Clemons court simply got it wrong in this case. Further, I'm reasonably confident that the Virginia Supreme Court would not have heavily relied (or even cited) the Federal bankruptcy court decision in Seven Springs as precedent in support of any proposition as the Clemons court did.


(fn23) A financially strapped homeowner desperate to keep her home doing business with a company that specializes in buying homes in foreclosure situations. The relative sophistication and bargaining power of the parties have long been factors that courts throughout the country have considered in their equitable mortgage analysis, but apparently not in this case.

(fn24) A transaction where you sell your home, but not receive any actual cash for it despite having tens of thousands of dollars of equity, and get to stay in your home but having to pay rent, would probably be considered an unusual transaction by the average homeowner.

(fn25) See (fn1), supra.


Virginia equitable mortgage yak dropping the ball on equitable mortgage