Equitable Mortgage Doctrine In Illinois - Part 2

This post will address the following two points (one briefly, one not so briefly) regarding the application of the equitable mortgage doctrine in Illinois (Please note that all text appearing in bold, especially when quoting from the court cases are my own attempt to emphasize the text, and are not emphasized in that manner in the statute or court cases being quoted from):

• Whether the new Ilinois Mortgage Rescue Fraud Act (effective 1-1-07) preempts the equitable morgage doctrine, and

• The purported "bona fide purchaser" status of those third parties who purchase, or lend money on, a property from a foreclosure rescue operator ("operator") subsequent to the operator having gotten a homeowner to sign the ownership papers of said property to him/her.

Ilinois Mortgage Rescue Fraud Act

The Mortgage Fraud Rescue Act (765 ILCS 940) was passed by the Illinois legislature to strictly regulate foreclosure rescue transactions and to curb the abuses arising therefrom. After a quick reading of the Act, it appears quite clear that the new law has no effect at all on the future application of the equitable mortgage doctrine. More specifically, the new statute says the following at Section 55(b) of the Act

• "A consumer who suffers loss by reason of any violation of any provision of this Act may bring a civil action in accordance with the Consumer Fraud and Deceptive Business Practices Act to enforce that provision. All remedies and rights granted to a consumer by the Consumer Fraud and Deceptive Business Practices Act shall be available to the consumer bringing such an action. The remedies and rights provided for in this 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." (emphasis added)

A clear reading of the statute appears to indicate that the new statute not only does not preempt the equitable mortgage doctrine, but it specifically preserves it, as well as any other legal claims that may have already been available prior to its passage (ie. fraud, racketeering, conspiracy, etc.).

(It may very well be that equitable mortgage claims and claims of violations of the new law can be brought together, in one lawsuit, either as part of one cause of action or as alternative causes of actions).

Bona Fide Purchaser Issue

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There is, what appears to be, an incorrect belief among many people that if, after a financially strapped homeowner unwittingly signs over title to his/her home to an operator, the operator sells the property to a third party, who then causes the property to be mortgaged, the homeowner automatically loses all possibility of ever getting their home back. Stated another way, the belief is that the purported interests of the subsequent third party "purchasers" (the buyer and any mortgage lender financing the purchase) have priority over any interest that the victimized homeowner may claim inder the equitable mortgage doctrine.

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My assertion is that as long as the financially strapped homeowner retains possession of the home after the purported transfer to the operator, that possession generally imparts "notice to the world" of any interest the homeowner has in the home. Therefore, the subsequent purchaser and mortgagee of the property may not qualify for "bona fide purchaser" status, in which case their interests in the property would be subordinate to the interests of the homeowner. This is generally true even if the homeowner receives a "judicial declaration of equitable mortgage" after the sale and mortgage to the third parties. The judicial declaration, under "relation back" principles, generally will relate back to the date of the homeowner's purported transfer to the operator (which typically pre-dates the subsequent sale and mortgage to third parties).

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One case (a Federal district court case) I came across makes the following observations of the bona fide purchaser issue, emphasizing the "duty of inquiry" imposed on any party claiming to be a "bona fide purchaser" under Illinois law (the case involved a foreclosure rescue situation):

• "A person who takes property for valuable consideration without notice of another's adverse claim is regarded as a bona fide purchaser whose rights are superior to competing claims. Life Savings & Loan Association v. Bryant, 125 Ill. App. 3d 1012, 81 Ill. Dec. 577, 582, 467 N.E.2d 277 (1st Dist. 1984)."

• "A mortgagee of realty is afforded the same protections as a bona fide purchaser if the mortgagee secures the mortgage without knowledge or notice of adverse claims to its mortgage. Id."

• "Notice of a competing interest in the realty may be predicated upon actual or constructive knowledge, and may also be imputed if the circumstances impose a duty of inquiry upon the purchaser/mortgagee. Burnix oil Co. v. Floyd, 106 Ill. App. 2d 16, 23, 245 N.E.2d 539 (1st Dist. 1969)."

• "A person is charged with the duty of inquiry only upon gaining knowledge of facts inconsistent with the mortgagor's claim or those "facts which would make a prudent person suspicious." In re Ryan, 851 F.2d 502, 511 (1st Cir. 1988)."

• "Inquiry notice imputes knowledge of all those facts which a diligent inquiry would have revealed. In re Cutty's-Gurnee, Inc., 133 Bankr. 934, 950 (N.D. Ill. 1991)."

• "The most common example of inquiry notice charged to a mortgagee is when a person other than the vendor is in possession of the property. Life Sav. & Loan Ass'n v. Bryant, supra, 81 Ill. Dec. at 582, 467 N.E.2d 277."

• "However, inquiry notice is imputed whenever the cumulative facts or circumstances create a reasonable suspicion that the mortgagee's interests are subject to an adverse claim. See, e.g., In re Cutty's-Gurnee, Inc., supra, 133 Bankr. at 952-53."

• "Factors, besides possession, which can serve as red flags to place a party on inquiry notice include: the extensive involvement of the putative bona fide purchaser in the transaction; the precarious financial status of the plaintiff; the low purchase price of the property; and the ease at which minimal investigation would uncover the fraudulent nature of the transaction. Shacket v. Roger Smith Aircraft Sales, 651 F. Supp. 675, 691-92 (N.D. Ill. 1986)."

For more, see Newman v. 1st 1440 Invest., Inc., 1993 U.S. Dist. LEXIS 354 (USDC N.D. Ill.)

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In another case, the following observations were made in connection with whether a subsequent claimant had knowledge imputed to it of a prior equitable mortgage (pursuant to the "inquiry notice" principle) :

• "[t]he issue of notice and priority of an equitable lien must be addressed on a case-by-case basis according to the facts and equities. Specifically, the facts must be examined to determine whether the subsequent claimant held actual or inquiry notice of the prior equitable mortgage."

• "Actual notice is that knowledge the subsequent claimant had at the time he acquired his claim. Constructive notice is knowledge that the law imputes to a purchaser or lien claimant, regardless of the actual knowledge held at the time he acquired his claim."

• "There are two kinds of constructive notice: record notice and inquiry notice. Under the doctrine of record notice, when a mortgage is properly recorded, the public record provides constructive notice of this interest to the whole world."

• "Inquiry notice is the knowledge the law imputes to a lien claimant or purchaser of real property when such claimant is under a duty of inquiry. Inquiry notice imputes knowledge of all facts that a diligent inquiry would have brought to light. Miller v. Bullington, 381 Ill. 238, 44 N.E.2d 850 (1942)."

• "The lien claimant's duty of inquiry depends upon all the facts and circumstances.

• It is clear that where a physical inspection of the property would reveal an adverse interest or where there is a party in possession other than the record title owner, the subsequent lien claimant has a duty to inquire of the possessor as to his interest and is charged with knowledge of the facts discoverable from such an inquiry or inspection. Miller, 381 Ill. at 244, 44 N.E.2d at 853; Burnex Oil Co. v. Floyd, 106 Ill. App. 2d 16, 23, 245 N.E.2d 539, 544 (1st Dist. 1969); In re Ehrlich, 59 Bankr. 646, 650 (Bankr. N.D. Ill. 1986)."

• "Outside of these types of obvious inconsistencies, however, it is not so clear what facts will suffice to create a duty of further inquiry."

• The general rule is that where the court is satisfied that the subsequent purchaser acted in bad faith, and that he either had actual notice or might have had that notice had he not willfully or negligently shut his eyes against those lights which with proper observation would have led him to knowledge, he must suffer the consequences of his ignorance and be held to have had notice so as to taint his purchase with fraud in law. . . . The law will not allow him to shut his eyes when his ignorance is to benefit himself at the expense of another, when he would have had them open and inquiring had the consequences of his ignorance been detrimental to himself and advantageous to the other."
  German-American Bank v. Martin, 277 Ill. 629, 115 N.E. 721 (1917) (quoting Doyle v. Teas, 4 Scam. 202).

• "Whatever is notice enough to excite attention and put the party on his guard and call for inquiry is notice of everything to which such inquiry might have led, and every unusual circumstance is a ground of suspicion and prescribes inquiry. . . . One having notice of such facts as would put a prudent man on inquiry is chargeable with the knowledge of other facts which he might have discovered on diligent inquiry." Blake v. Blake, 260 Ill. 70, 102 N.E. 1007 (1913).

For more, see In re Cutty's-Gurnee, Inc., 133 B.R. 934 (USBC N.D. Ill. 1991)

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In a third case, decided by an Illinois appellate court, the following observation is made regarding possession of real estate and its effect on providing "notice to the world" of the rights of the possessor.

• The final question to be answered then is, exactly to what priority was the Bryants' interest restored upon negation of the subordination agreement in relation to the subsequently executed mortgage. The answer turns on whether Life, as Mortgagee, was a bona fide purchaser such that its interest was protected by the recording act. Metcalf v. Altenritter (1977), 53 Ill. App. 3d 904, 369 N.E.2d 498.

• A bona fide purchaser is one who takes without notice of a prior claim or encumbrance. (Guard ex dem. Robinson v. Rowan (1840), 3 Ill. (2 Scam.) 499.) A mortgagee of realty is regarded as a purchaser, and, if the mortgage is supported by consideration and is taken in good faith, the mortgagee will be protected against adverse claims of which it has no notice. (59 C.J.S. Mortgages sec. 232 (1949).)

• Where, however, the mortgagee, at the time of taking the mortgage, has knowledge or legal notice of a prior conveyance, it is not entitled to the protection of a bona fide purchaser. (Fidelity Trust & Savings Bank v. Williams (1936), 285 Ill. App. 131, 1 N.E.2d 739.) One who takes a mortgage upon property with knowledge, either actual or constructive, of an earlier although unrecorded conveyance of it, takes it subject thereto and will not be permitted by placing his mortgage first on the record to gain priority over the earlier lien. St. Boniface Building & Loan Association v. Demopoulos (1939), 302 Ill. App. 614, 24 N.E.2d 171.

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• "Illinois courts have uniformly held that the actual occupation of land is equivalent to the recording of the instrument under which the occupant claims interest in the property. (Bullard v. Turner (1934), 357 Ill. 279, 192 N.E. 223; Beals v. Cryer (1981), 99 Ill. App. 3d 842, 426 N.E.2d 253). The open and visible possession of land by the equitable owner is sufficient to charge a mortgagee with notice of the rights of such owner, and the mortgagee will take subject to the rights of the person in possession. Williams v. Spitzer (1903), 203 Ill. 505, 68 N.E. 49."

For more, see Life Savings & Loan Association v. Bryant, 125 Ill. App. 3d 1012, 81 Ill. Dec. 577, 467 N.E.2d 277 (1st Dist. 1984)

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Based on the foregoing judicial observations in these three cases, it appears clear that in the State of Illinois a subsequent claimant (either purchaser or mortgagee) of property that is purchased from a foreclosure rescue operator (where the homeowner who unwittingly signed over his title to the operator is still in possession) has a duty not only to physically inspect the property, but also, to inquire of the person in possession as to what rights to the property the possessor has. Failing that, the rights of subsequent buyers and mortgagees will be subject and subordinate to any rights the homeowner may have pursuant to the equitable mortgage doctrine.

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Conclusion

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Given that the observations made in these court decisions seem so fundamentally basic, my guess is that one can readily find the same or strikingly similar observations made by courts in applying the state law in most, if not all, of the other 49 states. For all the non-Illinois readers, I do not wish to create the impression that the foregoing presentation of the "bona fide purchaser" issue and the principle of the "duty to inquire" is somehow limited or unique to Illinois law.

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Finally, the reason I included two Federal court cases for this post is not because of any force as binding precedent that they may have (since they are Federal cases applying state law, they probably have no weight as precedent; see the Erie Doctrine). Setting aside the fact that I just happened to "stumble into them", the observations made in both cases are either based on, or are quotes, from decisions of the Illinois judiciary (decisions which probably are binding precedent in the state of Illinois). Accordingly, these cases represent a handy summary of what some earlier Illinois state court decisions have said regarding these issues. For anyone looking to quickly get up to speed on the issues discussed herein, the two Federal cases may provide an acceptable alternative for gaining a quick perspective of the issues involved in lieu of digging up all the Illinois cases cited therein, and then reading them.

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Addendum (2-4-10)

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Fidelity Trust & Savings Bank v. Williams (1936), 285 Ill. App. 131, 1 N.E.2d 739:

• The rule of law which seems to control in a like situation is that the retention of possession by the grantor of the property conveyed is notice of his or her interest in the property, and to those claiming under the grantee, and such rule is laid down in the case of Ford v. Marcall, 107 Ill. 136, wherein the court said: "The law is, as this court has declared in White v. White, 89 Ill. 460, that when the grantor of real estate remains in possession, all persons acquiring title from the grantee are chargeable with notice of all the claims of the grantor."

• This rule was followed and approved in the case of Ronan v. Bluhm, 173 Ill. 277, where the court said: "It is proper we should remark, in answer to the discussion upon the point, that as it is conceded by all parties that the said Thomas Ronan did not deliver possession of the premises in question to the grantee, Carbine, but remained in the open and exclusive occupancy thereof, appellee, Bluhm, is deemed, as matter of law, to have taken the conveyance from Carbine with full notice of all the rights and equities of said Ronan in the premises. Illinois Central Railroad Co. v. McCullough, 59 Ill. 166; White v. White, 89 id. 460; Ford v. Marcall, 107 id. 136." It is to be noted from what the court said in this opinion that Bluhm was deemed as a matter of law to have taken the conveyance from Carbine, the grantee of Ronan, with full notice as to all the rights and equities of Ronan in the premises.

• This rule has been passed upon by the courts of this State, and the law is again discussed and approved in the case of Rock Island & Peoria Ry. Co. v. Dimick, 144 Ill. 628. The court in this opinion said: "The law is well settled in this State, as generally elsewhere, when not changed by the recording acts, that open and exclusive possession of lands, under an apparent claim of ownership, is notice to those subsequently dealing with the title of whatever interest the possessor has in the premises, whether the interest be legal or equitable in its nature. Wade on Notice, sec. 273; Davis v. Hopkins, 15 Ill. 519; Truesdale v. Ford, 37 Ill. 210; Smith v. Jackson's Heirs, 76 Ill. 254; Partridge v. Chapman, 81 Ill. 137. It has been held also in this State, that if the grantor remains in possession after conveyance, purchasers from the grantee are affected with notice of the grantor's rights in the land. White v. White, 89 Ill. 460; Ford v. Marcall, 107 id. 136."

• In the case of Porter v. Clark, 23 Ill. App. 567, this rule was also approved, and in discussing the subject matter of the litigation, the court there stated what we regard as pertinent in its application to the instant case. This statement is: "If Porter, knowing as he did that Clark was in possession, had gone to him and inquired as to his rights, he would undoubtedly have been told that the purchase money had not been paid, and that he, Clark, claimed a vendor's lien on the land."

Illinois equitable mortgage beta Illinois bona fide purchaser alpha

Equitable Mortgage Doctrine In Illinois - Part 1

While not to be misinterpreted as an exhaustive, thoroughly researched presentation on the Equitable Mortgage Doctrine in Illinois, this post will attempt to present a general review of how some Illinois courts have described and applied this doctrine. For ease of reading, all citations and internal quotations have been omitted.

Codification of the Equitable Mortgage Doctrine

Like many, if not most, other states, the Illinois legislature has codified this doctrine into its statute, which can be found in the Illinois Mortgage Act at § 765 ILCS 905/5.

Nave v. Heinzmann

344 Ill. App. 3d 815; 801 N.E.2d 121; (Ill. App. Ct., 5th Dist., 2003)

In this case, the Illinois appellate court ruled that, under the specific facts of this case, a contract to sell property containing a clause in the contract granting the seller a right to repurchase the property within six months after closing supported a reading that the transaction was actually a loan. Accordingly, the court denied the purported buyer's request for specific performance.

The court made the following observations regarding the existence and application of the equitable mortgage doctrine:

1- "Under the [Mortgage] Act, however, a contract for the transfer of a deed is to be considered as a mortgage and not as a land sale contract if the parties intended the land to function as security."

2- "The Act codifies the longstanding concept of equitable mortgage."

3- "The relevant factors in determining whether a deed that is absolute in form was intended to be a mortgage include:

• the relationship of the parties,
• the circumstances surrounding the transaction,
• the adequacy of the consideration, and
• the situation of the parties after the transaction."

4- "The declaration that a deed, which is otherwise absolute in form, is a mortgage does not require the existence of fraud, accident, or mistake."

5- "The question of whether a deed is a transaction in real estate or is to be taken as a mortgage depends on the intention of the parties at the time of the execution."

6- "Agreements to reconvey are an indication that the parties intended the transaction to be a mortgage and not a conveyance."

7- "The determinative question is the intent of the parties. Under the doctrine of equitable mortgage, in order for a court to convert a deed that is absolute on its face into a mortgage, the proof must be clear, satisfactory, and convincing. This proof can come from almost every conceivable fact that could legitimately aid that determination, and the decision in each case will depend on its own circumstances."

8- "Although no particular kind of evidence is required for this determination, it is essential for a mortgage that there be a debt relationship. In this case, a debt relationship was formed under a contract. The parties agreed that the defendants would be indebted to the plaintiff. The parties intended for the land to serve as security for what was in essence a loan under the contract. The record supports the trial court's finding that the parties intended to create a loan with the property being security.

Robinson v. Builders Supply & Lumber Co.

223 Ill. App. 3d 1007, 586 N.E.2d 316 (Ill. App. Ct. 1st Dist. 1991)

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This case involved a review of summary judgment motions made in the lower court and simply concluded that genuine issues of material fact existed in this case, making the lower court's disposition by summary judgment inappropriate. In reaching this conclusion, the court conducted an examination and analysis of the Illinois equitable mortgage doctrine and, in that regard, it made the following observations:

1- "Whether a deed is to be considered as an equitable mortgage depends on the parties' intentions. 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."

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2- "Indeed, our courts have recognized and considered a number of factors including the following:

• the existence of an indebtedness,
• the close relationship of the parties,
• prior unsuccessful attempts for loans,
• the circumstances surrounding the transaction,
• the disparity of the situations of the parties,
• the lack of legal assistance,
• the unusual type of sale,
• the inadequacy of consideration,
• the way the consideration was paid,
• the retention of written evidence of the debt,
• the belief that the debt remains unpaid,
• an agreement to repurchase,
• and the continued exercise of ownership privileges and responsibilities by the seller."

3- "Our courts have repeatedly considered the adequacy of consideration in determining whether to apply the equitable mortgage theory. Where the consideration is grossly inadequate, a mortgage is strongly indicated."

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Responding to the assertion that no debt in this transaction actually existed, the court made the following observations:

• "While a debt relatonship is essential to a mortgage, direct evidence is not necessary, and, in fact, no particular type of evidence is required. Although plaintiff never executed a note or other document which demonstrates the existence of a debt, a number of factors here might suggest a debt relationship. Plaintiff signed the deeds after she told Willens that she needed a loan, and Willens responded that Builders could assist her. Moreover, plaintiff stated that she never intended to sell her property and believed at all times that the transaction constituted a loan. Bruno acknowledged that she initially came to Willens to save her property. Although the documents do not appear to create indebtedness between the parties, the record suggests that the parties' primary intent was to effect a security agreement, rather than an outright sale of the properties."

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Flack v. McClure

206 Ill. App. 3d 976, 565 N.E.2d 131, 151 Ill. Dec. 860 (Ill. App. Ct., 1st Dist. 1990)

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There were several issues involved in this case. I've limited this presentation to the equitable mortgage issue. In this case, the property owner asserting equitable mortgage conveyed a deed to property to the grantee in exchange for $9,000. Both parties to the transaction acknowledged that the property was worth $80,000. In addition, the property owner engaged in the transaction without the benefit of an attorney; the grantee of the deed, however, did have legal representation. The property owner also remained in possession of the property after receipt of the $9,000 payment. The appellate court affirmed a lower court decision that the transaction was a mortgage, and not an absolute sale, notwithstanding the conveyance to the grantee evidenced by a deed.

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The court's examination and analysis of the Illinois equitable mortgage doctrine included the following observations:

1- "Every 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."

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2- "Whether a deed is to be taken as a mortgage depends on the intentions of the parties."

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3- "In order to convert a deed absolute on its face into a mortgage, the proof must be clear, satisfactory and convincing and can come from almost every conceivable fact that could legitimately aid that determination."

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4- "The burden of proof rests upon the party asserting a mortgage where a deed absolute was conveyed."

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5- "Since the question of whether to impose an equitable mortgage is based on fact, consideration of the trial testimony is essential. Deeds have been set aside where evidence showed a preexisting debt and the grantee retained a promissory note or other evidence of the debt where an agreement to reconvey was entered into at the same time or where the price paid was far below the fair value of the property."

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6- "In a bench trial it is within the province of the trial court to determine the credibility and weight of testimony, to resolve inconsistencies and conflicts and to render its decision accordingly. Though conflicts in evidence exist, a court can still find an equitable mortgage."

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7- "Six factors are to be considered by the trial judge to determine whether an equitable mortgage exists. Those factors include

• whether a debt exists,
• the relationship of the parties,
• whether legal assistance was available,
• the sophistication and circumstances of each party,
• the adequacy of the consideration and
• who retained possession of the property."

8- "The existence of a debt is the essential element to establish an equitable mortgage. But 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."

9- "The existence of a debt here does not appear to be in doubt. The court in McGill found an indication of a debt relationship in a defendant's attempt to collect and held that an agreement to reconvey has long been considered a significant factor in distinguishing a sale from a mortgage."

10- "Where the grantor is indebted to the grantee at the time of the conveyance, and the grantee retains the note evidencing the indebtedness, then the indebtedness was not satisfied by the conveyance, and, until the contrary is shown, it will be presumed that a mortgage is intended."

11- "The court should also consider whether or not the parties had the benefit of legal assistance at the time of the occurrence. The record indicates that plaintiff did not have advice of counsel when she accepted the $ 9,000, signed the note and relinquished the quitclaim deed to the defendants whereas the defendants were represented by counsel."

12- "Beelman and McGill identify a fifth factor: the adequacy of consideration. Where consideration is grossly inadequate, a mortgage is strongly indicated. Here, the defendants signed an $ 80,000 contract on the home at the same time they gave plaintiff $ 9,000. Defendants argue that, in light of the building's poor condition, "it is clear the actual value of the property was significantly less." However, in his deposition testimony, John McClure acknowledged that he still would have gone through with the $ 80,000 contract if he could have obtained a mortgage. Clearly, the $ 80,000 price was the agreement of the parties, and the defendant may not now argue that the value of the property was "significantly less."

13- "The final factor the McGill court considered is whether the grantor of the deed remained in possession of the property. In her analysis, the trial judge noted that plaintiff stayed in the home for a year after she gave the defendants the quitclaim deed. Plaintiff remained in the home until the defendants successfully obtained a court order requiring plaintiff to vacate the premises, and this occurred after the defendants had recorded the quitclaim deed and redeemed the property from the foreclosure sale."

14- "We find that the trial evidence clearly supports the finding of an equitable mortgage and that the trial court's decision was consistent with the manifest weight of the evidence. We find no error."

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For an online article that discusses the equitable mortgage doctrine in Illinois, see:

When is a Sale-Leaseback an Equitable Mortgage?, by Gregory A. Thorpe and John C. Murray

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Click here for links to other general Online References On Sale Leaseback Recharacterization. Illinois equitable mortgage beta

Equitable Mortgage Defense In Homeowner - Tenant Eviction - Part 3

This is Part 3 of a multi part post. Click here to read Part 2.

California

In an unlawful detainer (tenant eviction) proceeding, a California Appellate Court ruled that a property owner, who lost his property in foreclosure and then "rented" it back from the subsequent purchaser, had a triable issue of fact as to whether a landlord-tenant relationship existed between him and the subsequent purchaser which forms the basis of unlawful detainer. (According to property owner, the rental agreement was a "sham" to shield a usurious mortgage of the property to which the subsequent purchaser held title only to secure payment for the loan.) The court reversed a judgment of eviction and remanded the case to the lower court for consideration of whether the transaction between the parties was really a usurious loan secured by a mortgage.

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There are several issues involved in this case unrelated to the equitable mortgage issue. I've tried to isolate the equitable mortgage issue in this case and list the facts below. The basic facts of this case relating to the issue of whether a deed merely constituted security for a loan, and whether a purported rental agreement was a shield to disguise a usurious mortgage, follow below (while this case was not a typical foreclosure rescue situation, the logic and rationale stated therein appears to be equally applicable to such a situation):

1- Property Owner owned and operated a 317-acre ranch that included a prune processing and packing plant.

2- Property Owner lost the property in a foreclosure sale in April, 2003

3- Within a month (May 2003), a "Subsequent Buyer" of the foreclosed property entered into an agreement entitled "Month-to-Month Rental Agreement and Security Agreement" with Property Owner.

4- In October, 2004, Subsequent Buyer filed an unlawful detainer action against Property Owner (in order to evict Property Owner and gain possession of the property).

5- In responding to Subsequent Buyer's summary judgment motion, "[Property Owner] opposed the motion, arguing, among other things, there was a triable issue of fact as to whether the "transaction" was "not that of landlord tenant, but was of a loan of funds with the rental agreement being used to disguise a possible usurious transaction."

6- Property Owner then filed a declaration in opposition to the motion for summary judgment wherein he stated that prior to the foreclosure sale, he and Subsequent Buyer agreed that he (Subsequent Buyer) would "be present at the foreclosure sale and bid funds to obtain the property" and that [Subsequent Buyer] would hold title "only as security . . . and that the property would be returned to [Property Owner] upon full repayment of the loan."

Also, Property Owner stated that he entered into the subsequent rental agreement only because Subsequent Buyer said he "only needed this agreement for both our protection" and never stated anything that this agreement was in any way changing their original loan agreement.

7- Property Owner contends it should be permitted to use the declaration to prove that the transaction was intended as a mortgage. In support of this argument, property owner cites Civil Code section 2925 and existing case law. Civil Code section 2925 provides as follows:

• "The fact that a transfer was made subject to defeasance on a condition, may, for the purpose of showing such transfer to be a mortgage, be proved (except as against a subsequent purchaser or encumbrancer for value and without notice), though the fact does not appear by the terms of the instrument."

8- The California court observed as follows:

• "Given the alleged relationship between the parties, [Property Owner] was allowed to introduce parol evidence to show what it believed was the true nature of the transaction in an attempt to prove the rental agreement was really a shield for a usurious mortgage. (See Workmon Constr. Co. v. Weirick (1963) 223 Cal.App.2d 487, 490, 36 Cal. Rptr. 17 [cases since 1867 have held that a court "can declare a deed absolute on its face to be a mortgage executed as security for the payment of a debt, and that parol evidence is admissible to show the real nature of the transaction without regard to the mode or form in which the instruments in writing were executed"]."

9- The court ultimately concluded as follows:

• "We therefore conclude that [Property Owner] was allowed to assert, in essence, that it was not a tenant under the lease agreement because the rental agreement was really a shield for a usurious mortgage."

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In this case (unlike the Minnesota case in Part 2), there is an indication at the end of the case that the property owner in this case posted an appeal bond, so presumably, he never actually lost possession of the property during the appeals litigation. In the Minnesota case, the property owner did not post bond and ultimately, vacated the premises in anticipation of execution of the judgment of eviction before the appeals litigation reached completion.

Case Law Citation:

North State Land Management v. Calprune, (Cal. App. Ct. 3rd Dist. 2006 unpublished)

For addendum to this post, see Equitable Mortgage Defense In Homeowner - Tenant Eviction - Part 3 Addendum

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Go here for other posts on the equitable mortgage doctrine in California. California equitable mortgage valedictorian emdefense.

Equitable Mortgage Defense In Homeowner - Tenant Eviction - Part 2

(Part 2 of a multi part post)

Click here to read Part 1 of Equitable Mortgage Eviction Defense

This recent court case dealing with the equitable mortgage doctrine and evictions of homeowners in the context of foreclosure rescue situations where a Minnesota appellate court affirmed a lower court judgment of eviction of the homeowners.

Minnesota

In a Minnesota case, an eviction action was brought against two homeowners (husband and wife) after they defaulted on the leaseback agreement. In response, the homeowners filed a separate equity-stripping action (in front of a different judge) against the foreclosure rescue operator and related entities under Minn. Stat. §§ 325N.01-.18, alleging among other things, that the transaction was a prohibited equity stripping transaction and that the arrangement was an equitable mortgage, and not an absolute conveyance. The homeowners also filed an answer in the eviction proceeding noting the pendency of the chapter 325N action and moved for the district court to dismiss the eviction proceeding or to stay it pending resolution of the chapter 325N action. The district court denied that motion and awarded the foreclosure rescue operator an eviction judgment.

In affirming the lower court judgment of eviction, the appellate court addresed a couple of issues:

1) Subject Matter Jurisdiction

The homeowner cited old case law for the proposition that the eviction court did not have subject matter jurisdiction to hear the eviction action because, in essence, the relationship between the parties was not that of a conventional landlord-tenant, and the question of the validity of landlord's title was at issue. The appellate court rejected the argument on the grounds that, at the time the old cases were decided, the eviction courts were of limited jurisdiction and, accordingly, those courts lacked jurisdiction to hear a case like the one at bar.

The court hearing the eviction in this case was not of limited jurisdiction. Stated another way, because of the changes in the structure of the Minnesota judiciary over the years, the court in this case (unlike the courts in the old cases) had jurisdiction to hear both the eviction case and the case disputing the landlord's title and could have heard them together (the homeowner did not file counterclaims in the eviction action asserting violations of 325N / equitable mortgage; those claims were made in a separate action). On this basis, the claim of lack of subject matter jurisdiction in the eviction case failed.

2) Section 504B.121 Issue

Minnesota Section 504B.121, contained in the Minnesota Landlord Tenant law, in essence appears to allow a "tenant" to dispute the title of a "landlord" in a "foreclosure rescue" situation (the only exception to the rule that prohibits a tenant from disputing a landlord's title in an eviction action). The homeowners' request for either a dismissal or a stay of the eviction action pending the conclusion of the equity stripping / equitable mortgage action under Section 325N was rejected by the appellate court, not based on the substance of the statute, but on procedural grounds. The court said the following:

• "While the question of a stay or dismissal was presented to the district [lower] court, the record shows that Minn. Stat. § 504B.121 was not mentioned, either as the basis for a stay or a dismissal, or for any other reason. Therefore, we conclude that the impact of Minn. Stat. § 504B.121 on the question of whether the eviction court should have stayed the eviction proceeding is not properly before this court, and we decline to address it."

3) General Arguments

Additional arguments were made asserting that allowing an eviction proceeding to finish before a chapter 325N action is resolved is inconsistent with chapter 325N because allowing the eviction proceeding to go forward allows the landlord, who may, in the chapter 325N action, be found to lack title to the property, to obtain possession of the property and possibly convey it. Rather than try to summarize the court's response to this point, I will simply say that the appellate court found a way to reach the necessary rationale to support a rejection of this point. The link below will take you to the case and all the details.

Conclusion

This was apparently an extremely important case in Minnesota. In addition to the homeowners being represented by private counsel, they received additional support in the form of a "friend of the court" brief filed jointly by the State of Minnesota (through the Minnesota Attorney General's Office) and Mid-Minnesota Legal Assistance, the primary provider of general civil legal services to low-income and elderly people in 20 central Minnesota counties.

(Editor's Note: After reading this case about a half a dozen times, I still can't figure out how in the world the court could allow an eviction of the homeowner by the foreclosure rescue operator to go forward when the court was aware that the issue of the validity of the operator's title was an issue that was being litigated in another proceeding. The court mentioned that the homeowner could have sought an injunction from the judge in the other proceeding temporarily enjoining the eviction until the title issue was resolved. Why the court in this case didn't just grant a stay of eviction until the title issue was resolved is unbeknownst to me.)

Case Law Citation

Real Estate Equity Strategies, LLC v. Jones, 720 N.W.2d 352; (Mn. App. Ct. 2006) (Available online courtesy of Minnesota State Law Library).

(revised 2-6-07) emdefense Minnesota equitable mortgage sigma

Online References On Federal Truth In Lending Law

Truth In Lending.

1. Regulation Z,
2. Links to Selected Court Decisions (Truth In Lending and various other consumer protection statues),
3. Defense of Mortgage Foreclosures,
4. Predatory Lending Litigation,
5. Discover The Power of The Truth In Lending Act,
6. Truth In Lending Right of Recission,
7. Outline of Issues Related to Truth In Lending and Regulation Z, by Diane L. Drain,
8. The Truth And Nothing But The Truth: Confronting The Challenge In The Truth In Lending Act And Regulation Z, by Elwin Griffith

Online References On Sale Leaseback Recharacterization

Online Articles On Recharacterization Issues In Sale Leaseback & Loan Participation Transactions (Ownership Issues, Title Insurance Problems)

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Sale Leaseback & Loan Participation

Court Clobbers Foreclosure Rescue Plan, Lipson, Neilson, Cole, Seltzer & Garin, P.C.

Michigan Court Finds Deed is a Mortgage, (scroll down to the 3rd captioned article from top of linked page) Lipson, Neilson, Cole, Seltzer & Garin, P.C.

Michigan Appellate Court Sends Warning to 'Foreclosure Consultants', by Albert Rush and John C. Murray

When is a Sale-Leaseback an Equitable Mortgage?, by Gregory A. Thorpe and John C. Murray

Sale-Leasebacks: Things May Not Be What They Seem, by John C. Murray

Recharacterization Issues in Sale-Leaseback Transactions, by John C. Murray

Loan Participations: Recharacterization Issues, by John C. Murray

Recharaterzation Issues In Participating and "Equity Kicker" Mortgages, by John C. Murray

Clogging Revisited, by John C. Murray

To pay or not to pay: Claiming damages for recharacterization of sale leaseback transactions under owner's title insurance policies, by Thomas C. Homburger and Brian P. Gallagher
revised 2-23-07
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Using Equitable Mortgage Defense Against Eviction In A Foreclosure Rescue Situation

(Part 1 of a Multi Part Post)

I came across two (pretty old) court cases (from Florida & New York) which, "in essence," involved the assertion of "equitable mortgage" by a "tenant" as a defense against a "property owner" in an attempted eviction in a landlord-tenant action (the words "equitable mortgage" however, were not actually used in the cases).

(I caution the reader that I have not, in any way, researched this issue, but I've merely "stumbled over" these cases. I've read them, and am simply bringing them to your attention. In quoting from the text of these cases, I've omitted all citations and internal quotations for ease of reading.)

New York

In one case, a New York intermediate appellate court reviewed a case where (according to the court) "[s]ubstantially all the evidence offered by defendant [in asserting an equitable mortgage defense] was excluded by the [lower] court on the theory that being in possession under the lease he was not at liberty to dispute the title of his landlord."

The New York appellate court made the following observation on the foregoing point:

• "That elementary principle does not preclude a tenant when sued for rent from showing as a defense that since the execution of the lease he has acquired a title superior to that of his lessor or has acquired the lessor's title or that the title of his landlord has expired by its own limitations or has been in any manner extinguished subsequent to his entry under the lease or from setting up a title acquired by him since he became tenant, overreaching the title of his landlord, or in any way showing that the relation of landlord and tenant has ceased to exist (my emphasis). Some of the authorities asserting these propositions are here cited."

(citations omitted)

In reversing the lower court's decision, the appellate court stated:

• "It may be that if the evidence of defendant had been received it would fall short of establishing the [equitable mortgage] defense here outlined, but he should have been given the opportunity to establish such defense."

The court also commented:

• "It was not necessary that defendant should surrender possession and institute an action in equity to have his rights formally declared. If unjustly sued for rent he could show the changed character of his possession and assert his rights as a defense."

While this case may not be exactly on point in connection with the typical foreclosure rescue, "sale-leaseback-reconveyance" agreement, it shows the willingness of the court to rule that equitable issues raised by a "tenant" against a "landlord", where the landlord allegedly came about his title by reason of a deed given as security for a loan, are "fair game" in an eviction action.

In the foreclosure rescue context, it seems to me that the equitable argument of the financially strapped homeowner being evicted by a foreclosure rescue operator would simply be that the instrument (the purported "lease") that the operator is trying to enforce in attempting to evict the homeowner is not an agreement to pay rent, but rather, is an agreement to pay interest pursuant to, and a part of, a larger agreement that constitutes an equitable mortgage.

In effect, the homeowner in this scenario is simply arguing that there is no (and never was any) valid landlord-tenant relationship where eviction is appropriate. The relationship between the parties (as the argument would go) is that of a debtor and a secured creditor where the appropriate action to enforce payment would lie in a foreclosure action of the equitable mortgage by the foreclosure rescue operator (notwithstanding the fact that the instrument may actually be "labeled" or "titled" as a "lease").

Kibbe v. Crossman, 139 A.D. 338; 124 N.Y.S. 3; (NY App. Ct., 3rd Dept. 1910)

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Florida

The second case is a decision of the Florida Supreme Court involving the following facts:

1) An eviction action was brought by a "landlord" in a county court (court of limited jurisdiction) which had jurisdiction to hear landlord-tenant disputes, but did not have jurisdiction to hear actions involving the titles to, or boundaries of, real estate.

2) In response to the attempted eviction, the "tenant" pleaded that the dispute was one involving the title to real estate and that the county court did not have jurisdiction over the matter.

3) The following text represents excerpts from the "tenant's" plea, as extracted from the court case:

• "1. The said cause involves the question of the title to the real estate described in the writ in that the defendant claims to be the owner of the said real estate and of the improvements thereon; that he is not the tenant of the plaintiff, has no agreement with him for the payment of rent and is not indebted to him in any sum for rent of said property; that until very recently the plaintiff has not claimed to be the owner of said property but has claimed to be the holder of a mortgage indebtedness against the same and that inasmuch as said cause involves a controversy as to the title of said real estate the circuit court has under Section 11 of Article 5 of the Constitution of the State of Florida exclusive original jurisdiction of said cause."

• "2. That heretofore the defendant has instituted in the circuit court for Pinellas County, Florida, on the chancery side thereof a suit alleging that the plaintiff is the holder of a mortgage indebtedness against said property, that said mortgage indebtedness is usurious to such an extent that both principal and interest are forfeited and asking that a deed under which plaintiff hols (sic) be declared to be a mortgage and that plaintiff be ordered to reconvey and that defendant be decreed to hold said property free and clear from said indebtedness, that the plaintiff herein demurred to such bill of complaint primarily on the ground that this defendant did not offer to repay the principal of such indebtedness and the demurrer was sustained on that ground, no contention being made that the plaintiff herein was the actual owner of said property, that an appeal has been taken from the order sustaining said demurrer and is now pending in the Supreme Court of the State of Florida, that by virtue of such facts this court has no jurisdiction to try this cause."

4) The County Judge disregarded the plea to the jurisdiction, and the circuit court (a higher court) subsequently issued a writ of prohibition upon the County Judge, thereby halting the eviction action.

5) The Florida high court addressed the matter by first reciting a portion of the then-existing unlawful detention proceedings statute, then went on with the following statements:

• "The above statutory provision as to procedure in cases of landlord and tenant, does not preclude the defendant in possession from pleading to the jurisdiction of the court on the ground that he claims title to the real estate, of which subject the County Judge has (n)o jurisdiction to try or determine."

• "When in proceedings in the County Judge's court to recover the possession of land as from a tenant, a pleading is filed which puts in issue the title or boundaries of the land in controversy, it becomes the duty of the County Judge to dismiss the cause for want of jurisdiction."

• "Prohibition is the defendant's remedy where the County Judge does not dismiss an action for unlawful possession of lands when a plea tenders an issue as to the title of the land."

Based on this, it appears to me that, in the foreclosure rescue context, a homeowner finding himself sued for eviction can temporarily stave off eviction merely by asserting the equitable mortgage doctrine. Stated another way, once this doctrine is asserted, it doesn't seem like a court can properly issue a judgment for eviction until the issue of title to the property is first tried. Further, where a court of limited jurisdiction is hearing the eviction action and has no jursdiction over disputes involving title to property, the judge is duty bound (at least according to this case) to dismiss the action, at which point, the case can be refiled in an appropriate court having proper jurisdiction.

One point that I want to highlight is that in both this case and the New York case, the tenants asserting the equitable mortgage doctrine lost their cases in the initial court that heard the matter. It was necessary to file and litigate an appeal (and incur the cost attendant with such an appeal) to arrive at the correct decision (For anyone representing a homeowner in this situation, I hope you win it on the first "go round").

Hewitt v. State, 101 Fla. 807; 135 So. 130; (Fla. 1931)

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Re: Subject Matter Jurisdiction

The Florida case dealt with the issue of the court's jurisdiction over the subject matter. Regarding the issue of subject matter jurisdiction generally (and I'm only thinking out loud here), I pose the following questions:

1) What happens if a homeowner in a foreclosure rescue deal is evicted from his home, does nothing about it for a while (whether it be a few months or a few years), and then goes back into court (through counsel) and files an action for a declaratory judgment, wherein an "equitable mortgage" declaration is sought regarding the "sale-leaseback-reconveyance" arrangement?

2) Does a statute of limitations apply to an "equitable action" such as this? If so, how long do you get to bring an action?

3) If successful in obtaining an equitable mortgage declaration regarding the initial sale-leaseback transaction, does this then make the judgment or order of eviction (wherein the homeowner was forced out of his home by order of the court) "void" for lack of subject matter jurisdiction? (after all, if the deal was actually an equitable mortgage all along and not a true sale, then there shouldn't have been any eviction in the first place).

When a judgment is "void" (as opposed to being merely "voidable"), it generally is void from its inception. Typically, when a judgment is void, then everything that happens after the issuance of the void judgment is also void (ie. subsequent sale by foreclosure rescue operator to third party strangers and mortgage lenders financing the third party sale). Claims of the "bona fide purchaser for value, without notice" status may not prevail when the subsequent purchaser's interest in the property purchased devolved from a void judgment. Further, unless I'm mistaken, claims that a judgment is "void" for lack of subject matter jurisdiction may be brought at any time (no statute of limitations applicable, no laches). Finally, I think that the doctrines of res judicata, law of the case, estoppel, etc. may be inapplicable in a matter involving a void judgment.

Obviously, the answers to the foregoing questions will depend, at a minimum, on the specific laws of your home state. Depending on what those laws say, it may be that there are many victimized (and devastated) homeowners throughout the country that have lost their homes in foreclosure rescue deals that still have viable causes of action, not only against the foreclosure rescue operator personally, but also against the property that they had "stolen" from them. If they do, in fact, have valid claims against the property, it may then be that they are entitled to the return of their homes (or possibly damages against the operator), in which case the subsequent buyer and any mortgage lender financing the purchase, may end up being the victims (and, in essence, left "holding the bag"). Of course, if the subsequent third party buyer and mortgage lender insured their purported interests in the property by obtaining a title insurance policy, it may then be that they have a valid claim for indemnification from their title insurer. It would then be up to the title underwriter to go after the rescue operator to recoup its paid out insurance claims. As a practical matter, if the homeowner in this scenario does, in fact, have a legitimate case, it may very well be that some form of financial settlement involving all the parties, including the title insurer, can be reached (After all, the cost of "unwinding" these transactions and "cleaning up the mess" through protracted litigation could become rather expensive and time consuming).

For Part 2, see Equitable Mortgage Defense In Foreclosure Rescue Eviction Action - Part 2

(revised 2-5-07; 10:26 pm) emdefense Florida equitable mortgage alpha New York equitable mortgage puzzling

Search Tips For Finding Equitable Mortgage Cases On The Internet

For those of you interested in searching for equitable mortgage cases on the Internet, you might want to consider the following:

1) Check out the LexisOne website. Upon compliance with their terms and completing their free registration, they offer free limited case law search capabilities (according to their site, the last five years of state cases and Federal appellate cases; U.S. Supreme Court cases back to 1790).

2) When you get to the page that contains the search box, select the radio button for "Search by keyword(s)". Then select your home state from the "drop down" menu.

3) In the search box, enter the following search command exactly as it appears below:

((deed OR conveyance OR title) w/6 absolute w/10 (mortgage OR debt OR loan)) OR equitable mortgage

What you're trying to accomplish with this search command is to find any cases that contain either the phrase "equitable mortgage," or the phrase "(deed OR conveyance OR title), absolute in form, given as security for a (debt OR loan), shall be deemed a mortgage" (or any similar sounding phrase).

More specifically, in the second part of this compound search command, you're specifically searching for the term "absolute" in any case where it appears within 6 words of either deed, conveyance, or title and, at the same time, within 10 words of either debt, loan, or mortgage.

You can try this search both for the state case law of your home state as well as the Federal appellate cases for the Circuit Court of Appeals within which your home state is located.

If your search fails to find anything meaningful, you can obviously "tinker around" with the search command to see if you have better luck.

When I did it, it returned over 100 cases. However, I searched the state cases for the entire country and with no date restrictions. A search limited to one state will obviously yield less cases; hopefully, it will yield at least one or two.

Ultimately, (unless your local courthouse has a law library with high speed Internet access computers with free access to Westlaw or Lexis), you may need to "spring" for the paid services offered by one of these companies. If you're working within "strict budget parameters," you may want to check out the Loislaw website which, the last time I checked, will give you immediate access to their case law collection for a 24 hour period at a charge of $24.99. See the Loislaw website for more details.
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Equitable Mortgage Cases in Massachusetts

I recently came across a Massachusetts case (decided in 2004) dealing with, among other issues, the equitable mortgage issue in the context of a bitterly contested divorce proceeding. The case involved a title transfer from one party to another where, ultimately, the transfer was held to be an equitable mortgage. The context was significantly different than the context involving a foreclosure rescue sale with a simultaneously executed agreement to reconvey. Nevertheless, this case contains language that indicates to me that there probably are Massachusetts decisions (probably old cases) in the case law that can be used in developing a case in attacking the "sale leaseback with reconveyance" arrangements commonly used in foreclosure rescue situations (I see no reason why Massachusetts would be any different than any of the other states reported on to date in connection with this issue).

In applying the equitable mortgage doctrine, the Massachusetts court observed that:

• "When a deed (absolute on its face) is given at the time a debt is incurred for the purpose of securing payment of the debt, "a court of equity will treat the deed according to its true nature as a mortgage." Fales v. Glass, 9 Mass. App. Ct. 570, 573, 402 N.E.2d 1100 (1980). See Allen v. Mutual Acceptance Corp., 350 Mass. 553, 554, 215 N.E.2d 784 (1966) ("Whether a deed absolute in form is an equitable mortgage depends upon the intention of the parties as shown in the circumstances of its negotiation and execution"); Restatement (Third) of Property (Mortgages) § 3.2(b) (1997)."

• "Under the express terms of the Levensons' separation agreement, the deeds in the present case were intended to serve as additional (or alternative) security for Levenson's obligations under an anticipated loan transaction. Consistent with the provisions of this agreement, when Levenson borrowed funds from Mr. Feuer as trustee of the MB Mortgage Trust, the deeds were placed in escrow as part of the initial loan transaction. The defendants do not argue, and there is nothing in the terms of the separation agreement or the loan documents to suggest, that a conditional sale of the mortgaged property was intended. In these circumstances, delivery of the deeds constituted the delivery of additional instruments of security for the underlying debt. See Carey v. Rawson, 8 Mass. 159, 160 (1811); Woodward v. Pickett, 74 Mass. 617, 8 Gray 617, 618 (1857); Steel v. Steel, 86 Mass. 417, 4 Allen 417, 419-420 (1862)."

• "To the extent that language in the agreement suggests the parties intended to circumvent laws governing foreclosure that otherwise would govern the manner in which title to the properties could be transferred, the language is void as against public policy and we give it no effect. "Though it be ever so strongly expressed that the estate shall be absolute if the money is not paid at the day fixed, such stipulation would be void. It does not depend upon the intent of the parties; because it is an intent contrary to the rules of law, which the law will not carry into effect." Bayley v. Bailey, 71 Mass. 505, 5 Gray 505, 510 (1855). See, e.g., First Ill. Natl. Bank v. Hans, 143 Ill. App. 3d 1033, 1038, 493 N.E.2d 1171, 98 Ill. Dec. 150 (1986) ("parties cannot by an express stipulation in the mortgage transform the instrument into an outright conveyance upon default, [thereby] depriving the mortgagor of his redemptive rights")."

Source:

Levenson v. Feuer, 60 Mass. App. Ct. 428; 803 N.E.2d 341; (Mass. App. Ct. 2004 ) (made available online by Findlaw.com). Massachusetts equitable mortgage saturn

Usurious Loans Masquerading As Sale Leasebacks?

The following collection of cases (available online) involve potential or actual usurious loans that were disguised as sale leasebacks of personal property. While these cases arose in a context that is different from the typical foreclosure rescue "sale, leaseback, buyback, purchase option, etc." transaction (and I don't in any way suggest that there is anything "groundbreaking" or "precedent-setting" about these cases), the persuasiveness of the logic used in the following cases in analyzing and applying the prior case law of the respective states may provide some insight into how courts in those states determine when the form of a "purported sale leaseback" should be disregarded because the deal is nothing more than a contrivance used to evade usury laws (which may be an issue when the application of the equitable mortgage doctrine transforms a foreclosure rescue transaction into a secured loan), and when the form of the sale leaseback transaction should be respected as such.

Maryland

B&S Mktg. Enters., LLC v. Consumer Protection Division, Md. Ct. of Sp. App., 153 Md. App. 130; 835 A.2d 215; 2003

This case involved transactions that involved purported "sale-leaseback-repurchase" agreements involving "home appliances" that were "sold" by financially strapped consumers to a lender for $100 ("regardless of the nature, condition, or actual value of the particular item"), and then "leased back" from the lender until the consumer could afford to "buy back" the appliance. What were dubbed "rental payments" were deemed "interest payments." And those payments were paid at the exorbitant annual interest rate of 730%.

In making its decision, the court in this case relies, in part, on several past decisions of the Maryland high court, and also makes references to court decisions from other jurisdictions that similarly held that, under the facts of those cases, it was proper to declare a transaction clothed as a sale-leaseback a usurious loan.

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Arizona

Sal Leasing Inc. v. State, 198 Ariz. 434; 10 P.3d 1221; (Ariz. App. Ct. 2000 )

The "lenders" in this case "engaged ostensibly in the purchase and lease of motor vehicles." Most of the consumers were in financial trouble and needed "Fast Cash." The transactions in question required a customer to transfer his or her vehicle to the "lender." The lender would then obtain a new vehicle title in its name. Simultaneously, the "lender" and the customer would enter into a lease agreement which allowed the customer to lease the vehicle for one year.

The lease fees amounted to 218% of the sale proceeds received by the lender's customers.

In ruling that the transactions were loans disguised as sale-leasebacks, the court made the following observations (citatations and internal quotations omitted):

• I) "The mere fact that a transaction is characterized as a lease with an option to repurchase does not save it from the operation of the usury statute. Lease-purchase contracts . . . are often used as devices to disguise usurious loans.”

• II) "In Merryweather v. Pendleton, the Arizona Supreme Court set forth six factors that should be analyzed to determine if a transaction structured as a sale with an option to repurchase is actually a security device for a loan:

• (1) the prior negotiations of the parties;
  (2) the distress of the “grantor”;
  (3) the fact that the amount advanced was about the amount that the grantor needed to pay an existing indebtedness;
  (4) the amount of the consideration paid in comparison to the actual value of the property in question;
  (5) a contemporaneous agreement to repurchase; and
  (6) the subsequent acts of the parties, as a means of discerning the interpretation they themselves gave to the transaction."

• III) "No one of these factors is conclusive, but a combination of several will go a long way in showing that an absolute conveyance was actually a security arrangement. In case of doubt, courts tend to hold an agreement to be a mortgage in order to protect all parties and prevent forfeiture of the pledged property."

The court applied the above "Merryweather factors" (which are strikingly similar to the factors used by courts in the equitable mortgage cases that have been referred to elsewhere in this blog) in their analysis of the case at bar and, using the Merryweather analysis, the court concluded that the transactions were, in reality, loans in which vehicle title transfers served as security devices, and not bona fide sales.

Among other cases cited by the court was the Arizona Supreme Court decision in De Wulf v. Bissell, 83 Ariz. 68, 316 P.2d 492 (1957), which affirmed a trial court’s holding that the sale and leaseback of real estate with an option to repurchase constituted a usurious loan. If you're in Arizona and involved in a foreclosure rescue sale leaseback arrangement, this may be an interesting case to take a look at. (You might also take a look at the Arizona high court decision in Britz v. Kinsvater, 87 Ariz. 385, 351 P.2d 986 (1960), which cites to De Wulf, and involves a usurious "sale-buyback" of an executory real estate contract).

Oklahoma

Aple Auto Cash Express, Inc. v. State ex rel. Oklahoma Department of Consumer Credit, 2003 OK 89, 78 P.3d 1231 (Ok. 2003)

The question presented in this case is whether a company's purchase of customers' vehicles at a reduced price and the subsequent leaseback to the customers as rent-to-own vehicles should be respected as such or whether such transactions be treated as loans. The Oklahoma Supreme Court held that the transactions were nothing more than disguised loans, rather than bona fide sales or rental agreements, and should be regulated as such.

This case also involved doing business with financially strapped customers needing "Fast Cash." While there was considerable discussion about the applicability of specific statutes, the Oklahoma high court stated that

• "[t]he crux of the dispute is not about statutory construction...Rather, it is about how Aple's sale and lease-back transactions should be construed; and whether the transactions, when taken as a whole, fall within the parameters of the Rental Act or whether the transactions were actually disguised consumer loans, governed by the Consumer Credit Code."

In ruling that the transactions were disguised loans, the court relied, in part, on the Arizona decision in Sal Leasing, above.

Texas

In re Steven & Vicki Foster d/b/a Cash On Wheels Action (Before the Office of Consumer Credit Commissioner of the State of Texas)

While this case is a decision of an administrative agency of the State of Texas (and without value as binding precedent), I bring it to the readers' attention and include it in this collection of cases for two reasons:

1) The case involves a "sale repurchase agreement" similar to the facts in Sal Leasing and Aple Auto Cash Express, above, in which the customer "sells" his or her automobile to Cash on Wheels for cash and simultaneously "repurchases" the same automobile on credit for a great deal more than they just received for it. The issue in the case is whether these transactions are "sales" or "loans disguised as sales" (in fact, the decision in this case cites to both of these cases),

2) The case contains the following reference to Texas sale leaseback cases involving real estate transactions (which may have value as precedent for those in Texas in the context of a foreclosure rescue, sale leaseback transaction):

• "While the facts of the following Texas cases are not as close to the facts of this case as are the facts of the out-of-state cases discussed above, the same legal principles apply under Texas case law. See, for example, Johnson v. Cherry, 726 S.W.2d 4 (Tex. 1987), Bantuelle v. Williams, 667 S.W.2d 810 (Tex.App. -- Dallas 1983, writ ref'd n.r.e.), and Sudderth v. Howard, 560 S.W.2d 511 (Tex.Civ.App. -- Amarillo 1978, writ ref'd n.r.e.). These cases hold that in Texas, the intent of the parties, rather than the name the parties call the transaction by, will govern. In these cases, the courts held that transactions which the parties called sales of real estate in the legal papers associated with the transactions were, in fact, intended by the parties to be mortgage loans rather than sales. In each case the Texas courts enforced the transaction as a loan rather than as a sale in keeping with the court's findings regarding the intent of the parties."

Georgia

A Georgia Court of Appeals found that transactions entered into by a finance business with the consumer public that were structured as sale leasebacks of personal property were loans that violated the applicable statutes, and not true sales of property.

The case, Clay v. Oxendine, 285 Ga. App. 50; 645 S.E.2d 553, (Ga. App. Ct., 1st Div., 3-27-07), involved a business with a history of being in the consumer finance business who began engaging in "sale/leaseback" transactions with consumers needing funds, whereby their consumer customers purportedly sold personal property items that they owned to the business, then immediately leased the items back from the business. Following an investigation, the State of Georgia concluded that the "sale/leaseback" transactions were nothing more than disguised, illegal payday loans.

The Georgia appellate court affirmed the trial court decision in ruling that the form of the transaction in this case was to be disregarded, finding that the State of Georgia (the plaintiff-appellee) proved its case that the purpose of the sale leasebacks were simply to disguise loans that bore a rate of interest in excess of the maximum allowed by law.

In support of its decision, the Georgia appeals court cited cases from other jurisdictions where lenders used sale leasebacks to disguise loans bearing interest in excess of the maximum allowed by law:

• Alaska - Moran v. Kenai Towing & Salvage, 523 P2d 1237 (Alaska 1974) (real estate)
• Arizona - SAL Leasing v. State ex rel. Napolitano, 10 P3d 1221 (Ariz. Ct. App. 2000) (sale leaseback of automobiles)
• Washington, D.C. - Browner v. Dist. of Columbia, 549 A2d 1107 (D.C. 1988) (real estate)

For the expanded version of this post describing the Georgia case, see Georgia Appellate Court Recharacterizes Sale Leasebacks As Usurious Loans.

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The Equitable Mortgage Doctrine, The Truth In Lending Laws, Usury & Foreclosure Rescue

Foreclosure rescue operators are being sued by financially strapped homeowners around the country for the "sale leaseback" / "lease buyback" arrangements they are entering into. They appear to be represented by consumer protection attorneys. The approach for bringing these actions appears to be pretty straightforward. They begin by seeking to have the transaction declared to be an equitable mortgage. If successful, they seem to essentially have a "slam dunk" case as to violations of the disclosure requirements of the Federal Truth In Lending Act ("TILA") (it seems to me that the operators are in a position where they can't comply with the disclosure requirements of the TILA as part of a typical "rescue" sale leaseback / buyback arrangement without necessarily admitting that the transaction is, in fact, a secured loan; in essence, they're "damned if they do comply with the TILA, and damned if they don't").

Further, if the deal is deemed to be an equitable mortgage, the operators' "profit" or "expected profit" is immediately transformed into "interest" on the "deemed" mortgage loan, possibly subject to the Federal Home Ownership and Equity Protection Act of 1994 ("HOEPA") as well as to the civil and criminal usury statutes of your home state. (See Foreclosure Rescue Operator Violates Federal Law, State Usury Law (Tuesday, January 02, 2007), listed here at the Equitable Mortgage index of posts from this blog).

In addition, it appears that proof of actual fraud, deception, excessive overreaching, or any egregious conduct on the part of the operator in dealing with the homeowner is not necessary in having a deed be deemed a mortgage.

To the extent that there is an organized group of people, working together, that makes up a particular foreclosure rescue "operation," and the group typically does these deals as part of their normal course of business, I suppose this may expose the operator and the entire group to possible additional allegations of impropriety (ie. civil conspiracy, civil racketeering).

I have reviewed some of the actual court documents filed in a number of Federal cases from around the country involving foreclosure rescue operators, and for those of you with a strong interest in this area (attorneys, operators, financially strapped homeowners, and anyone else), I suggest that you may want to do the same.

The court documents can all be found on the Federal Courts' PACER system for electronic court filings; click here for login page; registration necessary, you can register from the login page, if needed. The identifying case information follows below.

The court documents I've looked at are from the following U.S. District Court cases:

Moore v. Cycon Enterprises, Inc., et al., Case No. 1:04-cv-800, Western District of Michigan (Southern Division) (decided as to liability and damages against foreclosure rescue operator, order on attorney's fees pending)

• Moore Complaint
• Moore Summary Judgment on Liability
• Moore Motion For Summary Judgment on Damages
• Moore Brief in Support of Motion For Summary Judgment on Damages
• Moore Summary Judgment on Damages - Order (2-9-07)
• Moore Summary Judgment on Damages - Opinion (2-9-07)
• Moore Order on Plaintiff's Attorney Fees (Pending)

Armstrong v. Real Estate International, Inc., et al., Case No. 1:05-cv-05383, Eastern District of New York (Brooklyn Division) (case settled, settlement agreement between homeowner and foreclosure rescue operator filed and made part of the record)

• Armstrong Complaint
• Armstrong Settlement Agreement
• Armstrong Settlement Letter.

Wilson v. Bel Fury Investment Group, LLC., et al., Case No. 8:04-cv-00640, District of Nebraska (Omaha Division) (case settled privately, no settlement agreement in the record)

• Wilson Amended Complaint

Perry v. Queen, et al., Case No. 3:05-cv-00599, Middle District of Tennessee (Nashville Division) (case settled privately, no settlement agreement in the record)

• Perry First Amended Complaint
• Perry v. Queen - Memorandum decision on foreclosure rescue operator's Motion to Dismiss. Court applied Tennessee's equitable mortgage doctrine in denying operator's motion to dismiss.

(revised 2-9-07)
(revised 12-10-14)

Sample Appellate Briefs:

• Opening Brief,
• Reply Brief.

(revised 11-13-15)

Equitable Mortgage Sample Complaints