Recharacterizing An Escrowed Contingent Deed, Required As Condition For Granting Forbearance Agreement, As An Equitable Mortgage: Applicable Illinois Law
Yesterday's post involved a court ruling (In re Primes, 9/26/14) that illustrated the application of Illinois law recharacterizing a deed as an equitable mortgage when a bank requires a defaulting homeowner to sign over a deed to be held in escrow as a condition for granting said homeowner a forbearance agreement. In such a case, the bank will be prevented from taking possession of the premises upon a subsequent default by the homeowner without first bringing a foreclosure action.
As noted in yesterday's post, while the principles that underlie the doctrine of equitable mortgage are the same, the line of cases reviewed by the court in this case (involving a forbearance agreement/payment work-out of an existing mortgage) was different from the line of cases often cited when the equitable mortgage doctrine is invoked in Illinois in the context of a sale leaseback foreclosure rescue scheme (compare the line of cases cited below with the line of cases cited in Hatchett v. W2X, Inc., 993 NE 2d 944 (Ill. App., 1st Dist., 1st Div. 2013), a sale leaseback foreclosure rescue case).
Following below is the court's articulation of the Illinois state law that it applied in this case to find that, where an escrowed contingent deed is required from a homeowner as a condition for granting a forbearance agreement, the arrangement will be treated as an equitable mortgage:
- A. Contingent Transfers of Property Interests and the Equitable Right of Redemption Under Illinois Law.
1. Illinois Disfavors Attempts to Extinguish the Equitable Right of Redemption or Otherwise Evade Judicial Foreclosure.
Illinois law generally requires judicial foreclosure to involuntarily terminate a mortgagor's interest in real property. 735 ILCS 5/15-1106. "The only method by which a mortgagee can enforce a mortgage to collect the mortgage debt, other than with the consent of the mortgagor, is by a filing a complaint to foreclose the mortgage and sell the mortgaged property." 10 Illinois Real Property Service §54:2 (John Francis Major & Steven J. Cone eds., 2014).
Thus, for example, a lender must bring a mortgage foreclosure action and may not proceed with an action for forcible entry and detainer to enforce its rights under a purported deed given by the mortgagor if the court determines the deed to be an equitable mortgage. First Ill. Nat'l Bank v. Hans, 493 N.E.2d 1171, 1174 (Ill. App. Ct. 1986). While a mortgagor can voluntarily transfer or relinquish his or her interest in the real property, Illinois statutes and established case law generally require the purported transfer to be found void or recharacterized, particularly where the transfer is to a lender and contingent on a future default.
First, Illinois law expressly prohibits and renders void agreements "contained in" or made "in connection with" a mortgage that are intended to circumvent judicial foreclosure. The Illinois Mortgage Foreclosure Law states that "[n]o real estate within this State may be sold by virtue of any power of sale contained in a mortgage or any other agreement, and all such mortgages may only be foreclosed in accordance with this Article." 735 ILCS 5/15-1405.
As the Illinois Supreme Court has explained, the purpose of the statutory predecessor to the current section 1405 was "to prevent sales of the equity of redemption, and no scheme or device to evade the statute or circumvent it by providing for a sale depriving the debtor of his equity of redemption will be upheld." De Voigne v. Chicago Title & Trust Co., 136 N.E. 498, 501 (Ill. 1922). As discussed below, a review of the act as amended and the cases construing it reveals this to continue to be the rule.
Illinois courts generally "take a dim view of any attempt to limit or extinguish the mortgagor's equitable right of redemption." Hans, 493 N.E.2d at 1174. In addition to the statutory restriction on powers of sale, Illinois law also invalidates an agreement made in advance to provide or convey a quit claim deed upon future default or to waive the equitable right of redemption where it is "part of" or "in connection with" an original mortgage. See, e.g., Hans, id. at 1174 (finding a purported assignment of rights under installment contract made in connection with and as security for a loan to be an equitable mortgage and an assignment provision purporting to require mortgagor to execute a quit claim deed in lieu of foreclosure to be "null and void"). From its review of Illinois decisions the Illinois Supreme Court has concluded that the cases have "consistently held that the law favors redemptions." Household Bank, FSB v. Lewis, 890 N.E.2d 934, 939 (Ill. 2008) (collecting cases).
Further, Illinois law treats a purported transfer of deed as a mortgage if it is intended as security to secure a loan. Section 1207 of the Illinois Mortgage Foreclosure Law defines "mortgage" to include "without limitation ... every deed conveying real estate, although an absolute conveyance in its terms, which shall have been intended only as a security in the nature of a mortgage"). 735 ILCS 5/15-1207(c). See also 735 ILCS 5/15-1207(d), (e) (term "mortgage" also includes "equitable mortgages" and "instruments which would have been deemed instruments in the nature of a mortgage prior to the effective date of this amendatory Act of 1987"). As noted in Hans, "[e]xpress words are not necessary to create an equitable mortgage; the only requirement is that it clearly appear from the document that the parties intended that an identifiable parcel of property `be held, given or transferred as security' for the payment of a debt." 493 N.E.2d at 1174 (quoting Hibernian Banking Ass'n v. Davis, 129 N.E. 540 (Ill. 1920)).
Where it is demonstrated that the consideration for the deed is a prior indebtedness and it is demonstrated that the indebtedness was not satisfied by the purported conveyance "it will be presumed that a mortgage was intended." Wiemer v. Havana Nat'l Bank, 335 N.E.2d 506, 511 (Ill. App. Ct. 1975) (citing Wallace v. Greenman, 152 N.E. 137 (1926)). The party asserting that a transfer occurred bears "the burden of proving otherwise." Id. This is because a purported transferee "cannot hold the land absolutely, and at the same time retain the right to enforce payment of the debt, on account of which it was made." Id. at 586 (quoting Sutphen v. Cushman, 35 Ill. 186 (Ill. 1864)).
2. The Doctrine of Equitable Mortgage and Related Principles Apply to Forbearance Agreements.
The doctrine of equitable mortgage applies not only to purported transfers executed at the time money is lent, but also to deeds executed after the time the debt is created such as in the context of an amendment, a refinancing, a forbearance agreement or other work-out situation. "If there is an indebtedness or a liability between the parties, either a debt existing prior to the conveyance or from any other cause, and this debt is still left subsisting ... then the whole transaction amounts to a mortgage." Warner v. Gosnell, 132 N.E.2d 526, 529 (Ill. 1956) (emphasis added). See also Wynkoop v. Cowing, 21 Ill. 570 (Ill. 1859) ("[T]he unrestricted right of redemption will be extended to transactions between the parties, in the nature of security for the debt, subsequent to the original mortgage.").
In such cases, the most important factor used in determining whether a purported deed was intended as a mortgage is whether there remains a debt for which the deed serves as security. The Illinois Supreme Court identifies the essential criterion to bethe continued existence of a debt or liability between the parties, so that the conveyance is in reality intended as a security for the debt, or indemnity against the liability. If that liability is left as subsisting, and if the grantor is regarded as still owing, and bound to pay it at some future time, ... then the whole transaction amounts to a mortgage, whatever language the parties may have used, and whatever stipulations they may have inserted in the instruments.
Schwartzentruber v. Stephens, 133 N.E.2d 33, 36 (Ill. 1956) (quotation marks omitted). (quoting Warner, 132 N.E.2d at 529). See also Illinois Trust Co. of Paris v. Bibo, 159 N.E. 254, 257 (Ill. 1927)).
The continuing debt factor "furnishes a sufficient test in the great majority of cases" and it is only "when application of this test leaves a doubt [that it is] necessary to consider other circumstances surrounding the transaction." Wiemer, 335 N.E.2d at 511 (reversing trial court for its reliance on testimony about statements made at the time of the transaction, and finding that plaintiff had failed to overcome presumption that purported deed was a mortgage). These include "every fact or circumstance tending to illustrate the purpose and intent of the parties," such as: (i) the fact of an existing indebtedness in respect to which the deed was executed; (ii) the retention of the evidence of such indebtedness by the grantee in the deed; (iii) that the deed was procured by fraud or oppression or undue advantage; (iv) that there was a loan of money; and (v) the subsequent conduct of the parties in respect to the land. Schwartzentruber, 133 N.E.2d. at 36. The question of whether a document is a deed or a mortgage "depends upon the intentions of the parties in that regard at the time of its execution" and "its character at the time of such delivery becomes fixed as of that time." Id. at 35 (quoting Warner, 132 N.E.2d at 529) (emphasis added).
More than a century ago, the Illinois Supreme Court determined that a conditional quit claim deed executed in connection with a forbearance agreement is a mortgage. Bearss v. Ford, 108 Ill. 16 (Ill. 1883). In Bearss, a landowner borrowed money, giving the lender two promissory notes secured by two deeds of trust in a certain parcel of land. Several years later, the landowner defaulted on required tax and interest payments due under the notes and his lender threatened to foreclose. The lender eventually agreed to accept instead the borrower's quit claim deed conveying the property to the lender subject to the proviso that if the landowner paid the taxes and repaid the amounts owing on the notes and trust deeds within one year with interest, the conveyance would be void and the lender would reconvey the property back to the landowner. In connection with this arrangement the parties also executed a one-year lease whereunder the debtor, to maintain possession of the land, paid to the lender monthly rent which rent was "to be deemed and applied as interest, under the conditions of" the quit claim deed. Bearss, 108 Ill. 16.
The court began its analysis with the acknowledgment of the well-established rule in the law of mortgages "which permits the showing of a deed plain and unambiguous in its terms, and absolute on its face, to be a mortgage or mere security for the loan of money." Id. The court then held that:in construing instruments of this kind, when the consideration is an existing mortgage indebtedness, [courts] are more inclined to treat them as mortgages than when given upon an original advance, and when so treated they will not be regarded as a substitute for the former security, unless the intention to that effect is manifest, and in such cases the original mortgage may be foreclosed notwithstanding the giving of the new one, hence the principle "once a mortgage always a mortgage," has become a leading fundamental doctrine of the law of mortgages. The most satisfactory, and as a general rule the controlling, test in cases of this kind is, does the giving of the new instrument operate as a satisfaction or extinguishment of the mortgage indebtedness? If it does not, such new instrument will be treated as an additional security for the debt, or, in other words, as an additional mortgage. . . .
Id. (emphasis added).
Thus under Illinois law a deed in escrow given in connection with a forbearance agreement is not presumed out of hand to be a true transfer. The primary question for determining whether to treat the purported conveyance as a true transfer or simply additional security is whether the original indebtedness was satisfied or extinguished.
In Bearss, the court noted that the agreements did not expressly provide for satisfaction or extinguishment of the existing debt, that the original note and trust deeds were not surrendered and that the lease expressly recognized the continuing debt. It concluded that the "so-called quitclaim deed was a mere additional security, and not an absolute conveyance of the property." Id. the court noted that whether the parties intended for title to transfer automatically upon a future default without the need for judicial foreclosure was not dispositive, noting that the "parties may have intended, and doubtless did intend, that if the premises were not redeemed before the 1st of July, 1879, [the instrument should become an absolute deed] in order to avoid the expenses of a foreclosure. But it is evident that parties can not, by mere agreement, change the law of the land." Id. Rather, as the court emphasized:nothing is more firmly established in the law of mortgages than that it is not competent for the parties, even by express stipulation, to cut off the right of redemption, and to permit them to make such an instrument an absolute deed upon some future contingency, would simply be cutting off the right of redemption, which, as we have just seen, can not be done." Id.
Illinois courts continue to "adhere to the principle ... that a mortgage remains a mortgage until the right of redemption is barred by one of the modes recognized by law and have repeatedly stated that the parties cannot by an express stipulation in the mortgage transform the instrument into an outright conveyance upon default, which would operate to deprive the mortgagor of his redemptive rights." Hans, 493 N.E.2d at 1174 (collecting cases).
For example, in Wiemer v. Havana Nat'l Bank, the court found that a purported deed in connection with a workout agreement was in fact a mortgage. 335 N.E.2d 506 (Ill. App. Ct. 1975). There, a couple executed a trust deed in connection with a refinancing indebtedness secured by real property. The trust deed purported to transfer the real estate into a trust that named one of the debtors' pre-existing lenders as the trustee. The trust deed purported to grant the trustee the power to sell the property and also required the debtors to execute and deliver a quit claim deed. The trust deed further provided that "[a]fter all debts to the banks are paid in full, the trustee shall convey any unsold property to the [debtors]." Id. at 508. When the debtor refused to execute the quit claim deed and challenged the lender/trustee's right to attempt to sell the land, the lender brought an action to compel the debtors to perform and to remove the cloud on the title. On appeal, the reviewing court reversed the trial court's determination that upheld the trust deed was a conveyance, holding that, because the debt to the lender continued after the purported transfer and was not satisfied, the deed must be presumed to be a mortgage. Id. at 511. Further, the appellate court found the power of sale contained in the trust agreement to be void. Id.
Alpine Bank identifies several decisions of lower courts that have upheld the use of a contingent deed in lieu of foreclosure. However, none of these cases directly address the issue now before this court, let alone question the clear authority of the state's highest court. For example, in Joyce v. Fidelity Real Estate Growth Fund II, L.P., 993 N.E.2d 532, 540 (Ill. App. 2013), the appellate court was not asked to examine the nature or effect of the purported deed under Illinois law, but only whether as a matter of Massachusetts contract law there was a breach of the agreement and if so, whether that breach was sufficiently `material' to trigger the lender's right to record the deed.
An earlier appellate decision cited by the bank, Klein v. Devries, concerned a bankruptcy plan provision providing for the debtor to deliver a quit claim deed to be held in escrow. 722 N.E.2d 784 (Ill. App. Ct. 1999). The court held that once the debtor entered into the reorganization plan, "he had no right to cure a default on the mortgage, [the debtor's] title to the property was altered from fee simple to fee simple defeasible." Id. at 787. That case is inapplicable here as it involves the Bankruptcy Code's general pre-emption of state law restrictions on the power to retain, transfer or sell property of the debtor through a plan. See 11 U.S.C. §1123(a)(5). See, e.g., In re Federal-Mogul Global Inc., 684 F.3d 355 (3rd Cir. 2012) (Section 1123(a)(5)(B) preempts anti-assignment clauses in insurance policies).
Here, unlike Klein, the deed in escrow is not a provision of the Debtor's plan. Although the Chapter 13 plan in Ms. Primes' first bankruptcy contained a vague statement that Alpine "has agreed to rewrite the Debtor's mortgage loan," it did not expressly provide for the quit claim deed and her deed and Forbearance Agreement were signed well after the plan was confirmed and automatic stay lifted. (2010 Case, Chapter 13 Plan at §G, ECF No. 38.) In re Prairie Crossing, L.L.C., like Klein, considered issues arising under the Bankruptcy Code and not the effectiveness of a deed under Illinois law. No. 99 Civ. 3558 (N.D. Ill. 2000), 2000 WL 1468755 ("[d]ebtor cites no facts, whatsoever, to support the contention that it retains any interest in the property now that the period for fulfilling the contingency has expired." Id. at *5). Neither Klein nor Prairie Crossing contains any reference to the doctrine of equitable mortgage or to whether a contingent deed in lieu must be recharacterized under Illinois law as a mortgage and, therefore, do not furnish precedent for the issue now before this court. See, e.g., Legal Services Corp. v. Velazquez, 531 U.S. 533, 557 (2001) (Scalia, J., dissent) ("Judicial decisions do not stand as binding `precedent' for points that were not raised, not argued, and hence not analyzed.") (citing United States v. Verdugo-Urquidez, 494 U.S. 259, 272 (1990).
The Flores decision mentioned by Alpine Bank also fails to suggest that Illinois law has changed regarding the Debtor's equitable right of redemption. Eastern Savings Bank, FSB v. Flores, 977 N.E.2d 242 (Ill. App. Ct. 2012), overruled on other grounds by BAC Home Loans Servicing, LP v. Mitchell, 6 N.E.3d 162 (Ill. Mar. 20, 2014). Whether a party can contractually waive service, the question considered by the appellate court in Flores, involves quite different statutes, different doctrines and different policies from those at issue here and cannot support disregarding the principles set down by Bearss and its prodigy as Alpine would now have this court do.
3. Illinois' Statutory Recognition of Deeds in Lieu of Foreclosure Does Not Supplant the Equitable Mortgage Doctrine.
Alpine argues that 735 ILCS 5/15-1401 modifies doctrine of equitable mortgage for post-default transactions because the Illinois Mortgage Foreclosure Law now recognizes quit claim deeds. Section 15-1401, entitled "Deed in Lieu of Foreclosure," provides that a "mortgagor and mortgagee may agree on a termination of the mortgagor's interest in the mortgaged real estate after a default by a mortgagor." 735 ILCS 5/15-1401. Alpine argues that a forbearance agreement, providing as is the case here, for the automatic termination of the mortgagor's interest upon the occurrence of a future contingency is the type of "agreement" contemplated by the phrase "agree on a termination" found in the statute.
This argument does not stand up to close inspection. The term "deed in lieu of foreclosure" as commonly used involves the immediate transfer of the mortgaged property, often in full satisfaction of the debt, by the mortgage in distress. The term involves the procedure whereby a mortgagor/debtor reconveys his equity of redemption in the defaulted property to the mortgagee/creditor in consideration of the creditor's promise to forbear from suing on the debt or foreclosing the security is known as a deed absolute in lieu of foreclosure. R.R. Powell & P.J. Rohan, Powell on Real Property § 37.44 (2014).
Alpine does not identify authority to suggest that Section 15-1401 was intended to permit and make enforceable `contingent' deeds in lieu of foreclosure or that the statute was otherwise intended to modify the doctrine of equitable mortgage. To the contrary, Illinois courts have repeatedly concluded that the Illinois Mortgage Foreclosure Law enacted in 1987 "was intended by its drafters to integrate into one statute as much of the law of mortgage foreclosure as possible" and to "codif[y] the prior statutory law and case law on the subject." Olney Trust Bank v. Pitts, 558 N.E.2d 398, 402 (Ill. App.1990) (internal citation omitted). While the 1987 amendment to the statute for the first time explicitly references deeds in lieu of foreclosure, id., the use of such instruments have long been treated by Illinois common law. See, e.g., Richardson v. Hockenhull, 85 Ill. 124 (Ill. 1877).
Generally, the "premise behind deeds in lieu of foreclosure [was] to allow a borrower to transfer title to the lender in exchange for a release of his or her obligations under the note and mortgage" and the "IMFL does not alter that which had been implicit in prior practice." Olney, 558 N.E.2d at 402. Neither the terms of the 1987 amendments nor their subsequent construction by the courts suggest that the practice or applicable doctrine has been altered. If Section 15-1401 makes any change from prior practice, it is to make "it absolutely clear that a deed in lieu of foreclosure releases all mortgagors from personal liability" except as otherwise provided in the statute. Id. Alpine offers no authority to suggest that the 1987 amendments to the statute were intended to vitiate the doctrine of equitable mortgages as long articulated by Illinois courts or the common law equitable doctrines prohibiting contractual limitations on a mortgagor's equitable right of redemption.