Recent State Appeals Court Ruling Reviews Application Of Equitable Mortgage Doctrine In Illinois To Foreclosure Rescue Sale Leaseback Scheme

A sale leaseback equity stripping, foreclosure rescue scheme was at the center of a 2013 case addressed by an Illinois appeals court in Hatchett v. W2X, Inc., 993 NE 2d 944 (Ill. App., 1st Dist., 1st Div. 2013).While the appeals court addressed a number of issues, this post will focus solely on the scammed homeowner's assertion, made in a quiet title claim against a straw buyer purchaser and the mortgage lender that financed the transaction, that the deal was an equitable mortgage. (Note that the rest of the court's ruling on other issues arising in connection with the subject transaction may make for interesting reading for those in the business of undoing these ripoffs.)

In this case, after a bench trial, the trial court granted a directed finding in favor of the lender and against the screwed over homeowner on the quiet title claim, finding that the homeowner did not establish a prima facie case for equitable mortgage.

In reversing this aspect of the trial court's ruling, the appeals court reviewed the Illinois case law on the doctrine of equitable mortgage, and applied the principles embodied therein to the facts of the case, ultimately finding that the homeowner had, in fact, made a prima facie case for equitable mortgage.

From the appeals court's opinion ("Kendra" is the straw buyer who took title to the home in question; "Chase Bank" is the original lender that financed the scheme; "BONY" is Bank of New York, Chase Bank's successor-in-interest via a mortgage assignment; "Helen" is the screwed-over homeowner; "Jackson" is the foreclosure rescue operator who orchestrated the scheme; "Gaston" is the attorney who purportedly provided legal representation to homeowner/Helen, and to whom Helen was referred by Jackson, the scheme's orchestrator):

• ¶ 38 Count II of the second amended complaint sought to quiet title to the property on the basis that Kendra had only acquired an "equitable mortgage" on the property, rather than an outright purchase of the property; that Kendra's subsequent attempt to encumber the property with the mortgage interests was void; and that Chase Bank, as predecessor-in-interest to BONY, had notice that its mortgage interest was subject to Helen's claims in the instant case.
  
  ¶ 39 The Illinois Mortgage Act defines a "constructive mortgage" as "[e]very deed conveying real estate, which shall appear to have been intended only as a security in the nature of a mortgage, though it be an absolute conveyance in terms, shall be considered as a mortgage." 765 ILCS 905/5 (West 2010). "To convert an absolute deed into a mortgage, the proof must be clear, satisfactory and convincing and may come from `almost every conceivable fact that could legitimately aid that determination.'" Robinson v. Builders Supply & Lumber Co., 223 Ill.App.3d 1007, 1014, 166 Ill.Dec. 358, 586 N.E.2d 316, 320 (1991) (quoting McGill v. Biggs, 105 Ill.App.3d 706, 708, 61 Ill.Dec. 417, 434 N.E.2d 772, 773 (1982)); 765 ILCS 940/55(b) (West 2010) ("[t]he remedies and rights provided for in [the Mortgage Rescue Fraud Act] are not exclusive, but cumulative, and all other applicable claims, including, but not limited to, those brought under the doctrine of equitable mortgage, are specifically preserved").
  
  In determining whether an equitable mortgage exists, courts consider several factors, including a debt relationship; close relationship of the parties; prior unsuccessful attempts for loan; the lack of legal assistance; the inadequacy of consideration; an agreement to repurchase; and the continued exercise of ownership privileges and responsibilities by the seller. Gandy v. Kimbrough, 406 Ill.App.3d 867, 876-77, 346 Ill.Dec. 771, 941 N.E.2d 329, 336-37 (2010). "The parties' intentions are the key consideration and the proof of these factors must be clear, satisfactory and convincing if they are to overcome a written instrument." (Internal quotation marks omitted.) Id. at 877, 346 Ill.Dec. 771, 941 N.E.2d at 337.
  
  Further, the existence of a debt relationship is essential to establish an equitable mortgage. Nave v. Heinzmann, 344 Ill.App.3d 815, 823, 279 Ill.Dec. 829, 801 N.E.2d 121, 127 (2003) (citing McGill, 105 Ill.App.3d at 708, 61 Ill.Dec. 417, 434 N.E.2d at 774); Flack v. McClure, 206 Ill.App.3d 976, 985, 151 Ill.Dec. 860, 565 N.E.2d 131, 136 (1990).
  
  ¶ 40 Helen argues that the evidence established that the conveyance of her property was an equitable mortgage, whereby the warranty deed was executed as security in exchange for a loan to save her home from foreclosure, rather than an outright sale. In response, BONY mainly argues that the evidence failed to establish the essential element of a debt relationship between Helen and Kendra.

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After a review of the trial record, the appeals court reached the following conclusion that Helen made a prima facie case for equitable mortgage, articulating its legal and factual basis in support thereof:

• ¶ 45 Based on our review of the record, we find that Helen has made a prima facie showing of the essential elements of an equitable mortgage.
  
  First, although Helen had never made any payments to Kendra or Jackson with regard to the property, we find a number of factors in the evidence to suggest the existence of a debt relationship. While a debt relationship is essential to establish an equitable mortgage, direct evidence is not necessary to prove the relationship and no particular type of evidence is required. Robinson, 223 Ill.App.3d at 1017, 166 Ill. Dec. 358, 586 N.E.2d at 322; McGill, 105 Ill.App.3d at 708, 61 Ill.Dec. 417, 434 N.E.2d at 774. Further, "the fact that the mortgage was made for a future debt or that there was no fixed time for repayment does not affect the status of an instrument as a mortgage." Flack, 206 Ill.App.3d at 985, 151 Ill.Dec. 860, 565 N.E.2d at 136.
  
  ¶ 46 It is undisputed that Helen's home was in the process of being foreclosed at the time she met Jackson. Helen presented evidence that the solicitation flyer sent to her by Jackson offered to save her home from foreclosure. Helen testified that she, in hopes of avoiding foreclosure, signed documents which Jackson presented to her under the belief that he would add his name to the title of her property, that she would make no payments on her loan for a year, and that she would regain sole ownership of her home after a year.
  
  Helen testified that she never intended to relinquish complete ownership of her home. Helen also presented evidence that Kendra was an employee of Jackson, that he provided a "lump sum of money" to Kendra for the purpose of paying the first six months of mortgage debt acquired by Kendra on the property, and that Kendra received a salary from Jackson for her help in each real estate "deal." Kendra's testimony revealed that she did not plan to keep, rehabilitate, or resell the property she acquired, testifying that the property would be reconveyed to the original owner after a period of six months. Kendra also testified that Helen was to live rent free in the home for six months after the conveyance at issue, and that she had a discussion with Helen regarding the amount of monthly rent to be paid by Helen at the end of the six-month period. See Robinson, 223 Ill.App.3d at 1017, 166 Ill.Dec. 358, 586 N.E.2d at 322 (factors suggesting a debt relationship even though the documents did not appear to create indebtedness between the parties included plaintiff's need of a loan and desire to save her property; her lack of intent to sell her property; her belief that the transaction constituted a loan); McGill, 105 Ill.App.3d at 708-09, 61 Ill.Dec. 417, 434 N.E.2d at 774 (defendant's attempt at collection and own characterization of an agreement to reconvey the property suggested the existence of a debt relationship). Thus, we find that, in the first step of the directed finding analysis, Helen presented sufficient evidence of a debt relationship which constitutes an essential element of an equitable mortgage.
  
  ¶ 47 Second, the adequacy of consideration is another factor used to determine the existence of an equitable mortgage. Robinson, 223 Ill.App.3d at 1014, 166 Ill.Dec. 358, 586 N.E.2d at 320. "Where consideration is grossly inadequate, a mortgage is strongly indicated." Flack, 206 Ill.App.3d at 986, 151 Ill.Dec. 860, 565 N.E.2d at 137.
  
  ¶ 48 At trial, Helen presented an HUD-1 settlement statement (exhibit K) which listed the purchase price of the property as $145,000, and listed approximately $17,965 as the payoff amount and taxes owed on Helen's home. Helen also presented copies of two checks (exhibits I and J), which were made payable to her in the amounts of $117,959.50 and $3,199.19. Helen's testimony revealed that, following the real estate transaction, she only received $3,000 from Jackson. It is undisputed by the parties that both of these checks were deposited into the bank account of W2X, the company operated by Jackson. Kendra's testimony shows that Helen was expected to pay at least $700 in monthly rent, after the six-month period, toward Kendra's newly acquired mortgage on the property. Helen presented evidence, through bank representative Colon's testimony, that Kendra's mortgage loans on the property amounted to 95% of the value of the property. In granting BONY's motion for a directed finding, the trial court remarked that "this case really comes down to two exhibits, [exhibits I and J]," and the "purported real estate contract." The trial court noted that neither the purchase price of $145,000 nor the debts that were satisfied as a result of the closing could be deemed as unconscionable.
  
  ¶ 49 However, we find that Helen presented sufficient evidence of the inadequacy of consideration. Although Helen's initial debt in the amount of approximately $17,965 was satisfied at closing, Helen only received $3,000 of the remainder of the $145,000 purchase price and was expected to contribute approximately $700 monthly rent toward Kendra's mortgage loans. In essence, Helen only received approximately $20,965 in benefits, while the payback amount required of Helen far exceeded that amount.
  
  Thus, we find that, in the first step of the directed finding analysis, Helen presented sufficient evidence of the inadequacy of consideration which is an essential element of an equitable mortgage. See Gandy, 406 Ill.App.3d at 878, 346 Ill.Dec. 771, 941 N.E.2d at 329, 337-38 (finding a vast disparity of consideration where surrogate buyer paid a purchase price of $90,000, with a net payout to homeowner of the property of $71,000; homeowner sent $22,900 back to surrogate buyer; and surrogate buyer resold property to a third party for a contract price of $170,000).
  
  ¶ 50 Other relevant factors that courts may consider in determining the existence of an equitable mortgage include any prior attempts to obtain a loan; the lack of legal assistance; an agreement to repurchase; and the continued exercise of ownership privileges and responsibilities by the seller. Id. at 876-77, 346 Ill.Dec. 771, 941 N.E.2d at 336-37. At trial, Helen testified that she had not made any prior attempts to obtain a refinance loan to stop foreclosure on her home, and that, after meeting Jackson, she only spoke with Attorney Gaston on one occasion.
  
  Evidence was presented that Helen was an elderly homeowner with an eighth grade education at the time she signed the documents, and that Kendra was a 21-year-old college student who did not intend to keep, rehabilitate or resell Helen's property. Both Helen and Kendra testified that they believed the property would be deeded back to Helen after a certain period of time. Evidence was presented that the relationship between Helen and Kendra was limited to the real estate transaction, which was orchestrated by Jackson. Helen also presented evidence that she continued to live in the home after the transaction took place, but that Kendra, as the new title owner of the property, visited Helen to inquire whether the house needed repairs. Evidence was presented at trial that Kendra never engaged in negotiations over the purchase price of the property, did not meet Helen prior to signing the real estate contract, and did not discuss with Helen the terms for regaining ownership of her home. See id. at 877-78, 346 Ill.Dec. 771, 941 N.E.2d at 337-38 (finding the existence of an equitable mortgage where the parties' relationship was limited to the real estate transaction which was brought together by a third party; an attorney nominally represented the seller; a debt relationship existed; the sophistication of the parties was limited; and consideration was inadequate); see also Robinson, 223 Ill. App.3d at 1016-17, 166 Ill.Dec. 358, 586 N.E.2d at 322-23 (relevant factors include the plaintiff's desperate circumstances, lack of sophistication, and lack of legal representation, and the existence of a debt relationship).
  
  Therefore, we find that, in the first step of the directed finding analysis, Helen presented a prima facie case to suggest that the parties intended the real estate transaction to be an equitable mortgage, rather than an outright sale. Accordingly, we hold that the trial court erred in granting BONY's motion for a directed finding as a matter of law on count II.
  
  In light of this holding, we reject Helen's argument that BONY failed to establish its affirmative defense of bona fide purchaser, where BONY, as a result of the trial court's granting of its motion for a directed finding, had not yet had the opportunity to present its evidence.

For the ruling, see Hatchett v. W2X, Inc., 993 NE 2d 944 (Ill. App., 1st Dist., 1st Div. 2013).