May 31, 2012
Lender’s Preservation Expenses Prime Mechanic’s Lien
Problems with construction mortgage loan defaults can be compounded by deterioration in the collateral when contractors stop working due to non-payment. In certain cases, a lender might utilize a formal receivership to finish the project during the pendency of a foreclosure case. In other cases, the expense of a receivership may not be warranted, or the lender may have no interest in funding the completion of the job. Sometimes, only short-term repairs such as winterization are needed. Does a lender’s claim for such direct advancements have priority over a mechanic’s lien claim? Robert Neises Construction v. Kentland Bank, 2010 Ind. App. LEXIS 2449 (Ind. Ct. App. 2010) addressed that issue.
05/13/08 The borrower executed promissory note in favor of the bank in the amount of $193,000 and simultaneously delivered a mortgage against the subject real estate. The $193,000 was to be used to construct a single-family residence.
04/2008 The borrower hired a contractor to construct the residence, and work began.
07/07/08 The bank recorded its mortgage.
07/14/08 The contractor filed a mechanic’s lien against the subject real estate in the amount of $22,369.
10/21/08 The contractor filed a complaint to foreclose its mechanic’s lien and named the bank.
12/11/08 The bank filed a counterclaim, crossclaim and third-party claim seeking to foreclose its mortgage on the subject real estate.
12/23/08 The bank filed an emergency motion to access the subject real estate and asserted that, pursuant to the terms of its mortgage, the bank had a right to preserve and protect the subject real estate. The bank alleged that the contractor had stopped construction and had left the property in jeopardy of being destroyed or damaged due to weather. Subsequently, the bank paid a separate contractor $20,188.91 to install a roof on the subject real estate and protect the structure from the elements.
Preservation expense super priority lien? The question was whether the bank’s expenditures to protect the subject real estate from damage during the foreclosure case had priority over the mechanic’s lien. There was no Indiana precedent or any specific statute providing the basis for the “preservation expenses” to be a super priority. The Court in Neises Construction relied on the general principle that trial courts in Indiana mortgage foreclosure actions have “full discretion to fashion equitable remedies that are complete and fair to all parties involved.”
Ruling. Here is how the Court ruled:
It is undisputed, then, that [the bank] paid for the installation of a roof and other protective measures meant to preserve the integrity of the unfinished house, which benefited each of the lienholders. There is no suggestion that the expenses were unreasonable or that the protective measures were otherwise ill-conceived. Indeed, [the contractor] never objected to [the bank’s] emergency motion, so it cannot now complain. Because [the bank], [the contractor] and the other lienholders were engaged in a common enterprise, and each benefited from the protective measures for which [the bank] bore the full expense, the trial court properly exercised its equitable powers to give [the bank] priority for preservation expenses over [the contractor] and the others in its distribution of the proceeds from the sheriff’s sale.
In short, since the bank’s “new money” helped everyone, the lien for the preservation expenses was senior.
Parity scenario. The Court noted that, in Indiana, a mortgage for construction of a house has the same priority as a mechanic’s lien where the mortgagee and the mechanic’s lien holder are engaged “in a common enterprise and neither of them is in a position to claim priority.” Pursuant to Ward v. Yarnell, about which I have discussed previously, the bank’s and the contractor’s underlying liens were held in parity, but the bank’s preservation expense advancement maintained a separate and distinct senior status. The contractor felt that even the new money to winterize the house should fall into the parity calculation, but the Court rejected the argument. (Had Neises Construction been a commercial project, there would have been no dispute because parity wouldn’t enter the equation. Pursuant to a separate statutory provision, the lender’s mortgage lien would be senior. Since Neises Construction involved a residential project, Ward’s parity rule applied and thus created the opening for the contractor to at least fashion an argument.)
In similar situations, and assuming a mortgage provision supports it, lenders involved in failed construction projects in Indiana can be assured that preservation expenses they advance will hold super priority status, generally superior to most all other liens except for delinquent real estate taxes. Neises Construction also illustrates that a formal receivership isn’t always necessary to preserve and protect the property during foreclosure.
Posted at 01:21 PM in Mechanic's Liens
May 21, 2012
Criminal Bank Fraud As A Collection Tool?
Secured lenders caught up in loan defaults typically pursue the contract-based remedies of damages and foreclosure designed to make lenders whole for their actual losses (unpaid principle balance, interest and attorney fees). In Klinker v. First Merchants Bank, 964 N.E.2d 190 (Ind. 2012), a lender sought statutory-based treble damages for alleged criminal acts of fraud by a guarantor. It was an aggressive strategy, but was it worth it?
Default. Klinker involved a used car dealership that borrowed money from a lender to purchase cars under a floor-plan agreement. The terms of the loan, which the dealership’s principle guaranteed, required the borrower to pay money to the lender whenever it sold a car. Also, the borrower could not transfer title without the lender’s consent. When the lender audited the dealership, it learned that thirty-one cars for which the lender had loaned money were gone. The borrower had failed to turn over any sale proceeds for the thirty-one cars.
CVCA. What was unique about Klinker was the lender’s claims under Ind. Code § 34-24-3-1, known as the Indiana Crime Victims’ Compensation Act (“CVCA”). The CVCA permits one who suffers a pecuniary (monetary) loss as a result of certain property crimes to bring a civil action against the person who caused such loss. The victim can recover up to three times its actual damages. Although a criminal conviction is not required, the plaintiff must prove each element of the underlying crime, including criminal intent.
Claim 1. The lender’s CVCA action asserted two fraud claims based on I.C. §§ 35-43-5-4 and 8, which are criminal statutes. Under the first, the lender could obtain summary judgment only if undisputed facts showed (1) the guarantor (2) concealed, encumbered or transferred property (3) with the specific intent to defraud the lender. The guarantor transferred financed vehicles without the lender’s knowledge and thus concealed them from his creditor. This constituted a breach of contract, but did “not lead inescapably to a finding of criminal fraud.” This is because the lender also must demonstrate undisputed facts showing that the guarantor acted with the requisite “mens rea – the specific intent to defraud.” There must have been undisputed facts to establish that, when the guarantor made the challenged transfers, “his conscience objective was to cause injury or loss” to the lender by deceit.
Mens rea. When judgment creditors bring proceedings supplemental to set aside fraudulent conveyances, fraudulent intent may be inferred from the “8 badges of fraud,” about which I have written previously. In Klinker, the lender designated evidence that established three badges of fraud, but summary judgment was inappropriate due to the absence of the mens rea element:
summary judgment is almost never appropriate where the claim requires a showing that the defendant acted with criminal intent or fraudulent intent. . . . This is particularly so for CVCA claims. The CVCA provides a punitive remedy if the claimant can prove that the defendant violated a penal statute, and, as a punitive measure, it should be strictly construed and applied only where the challenged conduct is clearly proscribed. Moreover, because CVCA claims combine criminal and civil law, they implicate the state constitutional policy favoring jury intervention in both criminal trials and civil trials.
The Court concluded that “drawing all reasonable inferences in favor of the non-moving party, it is possible that the trier of fact could find a simple breach of contract here instead of criminal fraud, regardless of how strong the badges of fraud may be.”
Claim 2. As to the second claim, to be entitled to summary judgment the lender must show undisputed facts establishing that (1) the guarantor (2) knowingly (3) executed or attempted to execute (4) a scheme or artifice (5) to obtain the lender’s money or other property (6) by means of false or fraudulent pretenses, representations, or promises, and (7) that the lender is a state or federally chartered or federally insured financial institution. In Indiana, “a person engages in conduct ‘knowingly’ if, when he engages in the conduct, he is aware of a high probability that he is doing so.” I.C. § 35-41-2-2(b). “The fraudulent-conveyance badges of fraud (circumstantial evidence) are not relevant in this context – other circumstantial evidence must be presented.” In addition to the “knowingly” problem, the lender in Klinkler had a fatal timing issue with this particular claim. The alleged misrepresentations occurred after the guarantor had obtained the loans. The fraudulent activity must have been done at the time of execution.
No summary judgment. The Indiana Supreme Court reversed the trial court’s summary judgment for the lender. The result reveals at least one drawback of the lender’s aggressive loan enforcement approach - CVCA cases virtually guarantee a trial. This means that the case will be lengthier and more expensive. As illustrated by Klinker, although CVCA claims are available to lenders in Indiana, the pursuit of such claims almost certainly will slow down the collection process.
Posted at 01:59 PM in Guarantors
, Procedure/Trial Rules
May 11, 2012
Indiana’s New Strict Foreclosure Statute: Dangling Issues
This post should be read in conjunction with my April 12th post: Indiana Legislation, 2012: Part III of III – Sheriff’s Sale Buyers And Omitted Junior Lienholders Impacted By Creation Of Strict Foreclosure Statute. The good news is that the legislation resolved many important foreclosure and title-related issues that bubbled up over the last few years. Like most legislation, however, Senate Bill 298, which amends Ind. Code § 32-29-8 by adding a new section 4, contains a handful of holes:
1. Interested persons. Section 4’s “interested person” (the “Buyer” in my April 12th post) does not appear to include a plaintiff mechanic’s lien holder. This suggests that the strict foreclosure remedy may not be available in the wake of a sheriff’s sale resulting from a mechanic’s lien action. Does the Section 4 action apply only to mortgage foreclosure sales?
2. Omitted parties. Section 4’s definition of “omitted party” (the “Junior Lienor” in my prior post) appears to exclude senior mortgagees. Thus the strict foreclosure remedy may not relate to situations in which a plaintiff junior mortgagee sues to foreclose, leading to a sheriff’s sale subject to a senior lien not included in the suit. See my 05-07-08 post regarding sheriff’s sales subject to senior mortgage liens. Does Section 4 impact the Indi Investments holding?
3. Forever? The strict foreclosure action can be filed “at any time” after the entry of a foreclosure judgment. Does this mean until the end of time, without any restrictions?
4. No merger, ever? Similarly, Section 4’s anti-merger language provides that “until an omitted party’s interest is terminated . . . any owner of the property as holder of a sheriff’s deed [Buyer] . . . or any person claiming by, through or under such owner is an equitable owner of the senior lien upon which the foreclosure action was based and has all rights against an omitted party as existed before the judicial sale.” The terminology “claiming by, through or under such owner” suggests that the equitable, senior lien endlessly runs with the land or, in other words, inures to the benefit of all subsequent owners holding a link in the chain of title starting with the sheriff’s deed. Is that the intent, with no limitations?
5. Right of payment, generally. The “omitted party” (Junior Lienor) is entitled to payment for any sheriff’s sale proceeds on which it lost out. But the statue does not identify who must pay. My 01-13-11 post notes that any post-sale surplus (a rarity) is paid to the clerk and, in turn, to the mortgagor/owner. Is that who pays? Good luck collecting from that party. Does the “interested person” (Buyer) bear the loss? Will a title policy cover the loss?
6. Right of payment, parity. Mechanic’s lien holders can be Junior Lienors (“omitted parties”) under Section 4. As noted in my 07-03-07 post, in certain circumstances a mechanic’s lien holder and a mortgagee will have equal priority. Section 4 contemplates problems related to senior and junior liens but does not appear to explicitly deal with parity scenarios. Unlike a surplus, sales where parity should have applied are more common and thus could be fertile ground for the losses identified in the statute. Is a clearer identification in the statute of who should pay warranted?
Finally, I’m also left to wonder how strategies of foreclosing lenders and prospective sheriff’s sale buyers, as well as title insurance coverage, might be shaped by the new protections offered by the statute. For example, speed is always a compelling issue for plaintiff lenders. In cases involving multiple liens and thus multiple defendants, Indiana’s judicial foreclosure process can get bogged down, to the chagrin of secured lenders seeking prompt payment or possession. A plaintiff mortgagee theoretically could bypass such delays and foreclose only against the owner/mortgagor so as to more quickly reduce the debt to a money judgment and repossess the property. To clear up title, a subsequent post-sale strict foreclosure action could then be instituted. These and other new approaches could arise out of Section 4.
Posted at 09:44 AM in Strict Foreclosure
May 07, 2012
"Temporary Admissions May Create Problems"
The latest issue of The Indiana Lawyer touches upon a topic about which I've written in past: Pro Hac Vice Admission in Indiana and the Role of Local Counsel. The paper's piece is well done and contains quotes from G. Michael Witte, executive secretary for the Indiana Supreme Court Disciplinary Commission. The story also deals with pro hac vice admission in our federal courts - an area I didn't discuss in my prior posts. Here is a link to The Indiana Lawyer's article: Temporary Admissions May Create Problems.
Posted at 11:11 AM in Procedure/Trial Rules