September 14, 2012
Indiana Attorney Fee Liens In Commercial Cases

Can attorneys for parties to Indiana commercial foreclosure actions file liens for unpaid legal fees?  Miller v. Up In Smoke, 2011 U.S. Dist. LEXIS 80684 (N.D. Ind. 2011) (rt click/save target as for pdf) sheds light on the matter. 

Context.  In Miller, the Court ultimately appointed a receiver to oversee the management and operation of a defendant company.  Attorneys representing the defendants contested the receivership proceedings.  The attorneys did not get paid and filed notices of attorney fee liens in the case.  The attorneys then filed a motion to enforce their liens.  The receiver opposed the motion, resulting in the Miller opinion. 

Retaining lien.  Indiana law recognizes only two kinds of attorney’s liens.  The first is a “retaining” lien, which prevents a client from utilizing materials held by the attorney until the client either settles the fee dispute or posts security for payment.  The existence of a retaining lien depends upon the attorney’s possession “of money, property or papers of the client.”  Basically, attorneys can retain their clients’ stuff until they get paid.  As a practical matter, this lien acts as a leverage tool, but is unlike a more traditional lien that can be foreclosed. 

Charging lien - generally.  The second and potentially more meaningful lien is a “charging” lien for “services rendered in a particular cause of action or proceeding to secure compensation for obtaining a judgment, award or decree on the client’s behalf.”  Indiana case law says that an attorney “has a lien for his costs upon a fund recovered by his aid, paramount to that of the persons interested in the fund or those claiming as their creditors.”  This lien is based upon the idea that “the client should not be allowed to appropriate the whole of the judgment without paying for the services of the attorney who obtained it.”  The Court explained that “an attorney’s charging lien attaches to the fruits of the attorney’s skill and labor . . . [but] if the attorney’s work produces no fruit, then the attorney has no lien.” 

Charging lien - statute.  Indiana’s charging lien is statutory:  Ind. Code § 33-43-4.  The statute provides that an attorney “may hold a lien for the attorneys’ fees on a judgment rendered in favor of a person employing the attorney to obtain the judgment.”  The lien arises if the attorney files a written notice on the docket of an intention to hold a lien on the judgment, along with the amount of the claim, no later than sixty days after the date of the entry of judgment.  I.C. § 33-43-4-2.  I.C. § 33-43-4-1 expressly states that “no lien can be acquired before judgment . . ..”  Indiana law strictly enforces this “judgment” requirement.

No judgment = no charging lien.  The attorney fee claim in Miller was an alleged charging lien.  But the services of the attorneys did not produce a “fund” upon which they sought to impose the lien.  The alleged fund was the receivership estate (property of) the defendant company.  The attorneys’ efforts, however, did not secure or create the receivership estate.  If anyone deserved a lien, it would be the receiver and the receiver’s counsel, not the counsel of the defendants, who resisted the appointment of the receiver. 

Lender’s counsel.  Miller tells us that lender’s counsel can file a charging lien against a judgment that counsel secures for its client.  Miller even hints that lender’s counsel could file a lien on real estate acquired by the client at a sheriff’s sale.  The point is that plaintiff lenders can be exposed to attorney/charging liens if they don’t pay their lawyers.  Alas, lenders typically possess both the willingness and capacity to pay. 

Borrower’s counsel.  Unlike lenders, defendant borrowers and guarantors come to attorneys already in financial distress.  Getting paid can be a challenge, no question.  As stated in Miller, very rarely can defense counsel assert a charging lien.  Essentially, counsel must obtain an affirmative judgment in favor of their client, such as in a case of set-off or counterclaim.  (The Court cited to a Georgia case for the proposition that a defense attorney could obtain a lien on a client’s land if he successfully defended an adverse claim on such land.)  The bottom line is that, even assuming the defendant won the case, there still must be a judgment or fund to which a defense counsel’s charging lien could attach.  This is why, in the vast majority of cases, defense counsel at best may have a retaining lien on the client’s money, property or papers (usually, the file and attorney work product), but this lien is not particularly valuable.  Hence the need for up-front retainers.

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Posted at 04:19 PM in Other Liens  |  Permalink

September 07, 2012
Indiana District Court Examines “Material Adverse Change” Default Provision

The most common loan default is for non-payment.  But there are many other events that can trigger a default.  Indeed loan documents, including guaranties, typically contain a multitude of default-related provisions.  One provision that we often see, but rarely apply, looks something like this:

Insecurity.  Lender determines in good faith that a material adverse change has occurred in Guarantor’s financial condition from the conditions set forth in the most recent financial statement before the date of the Guaranty or that the prospect for payment or performance of the Debt is impaired for any reason.

Greenwood Place v. The Huntington National Bank, 2011 U.S. Dist. LEXIS 78736 (S.D. Ind. 2011) (rt click/save target as for .pdf) addresses a similar material adverse change (“MAC”) clause. 

Summary judgment.  In Greenwood Place, Southern District of Indiana Judge Tanya Walton Pratt issued a ruling on a motion for summary judgment filed by a lender against two borrowers based on the theory that there had been a “material adverse change in the financial condition of” the guarantor of the loans.  The opinion did not quote the entire clause, but it was clear that the subject loan agreement provided that “any material adverse change in the financial condition of” the guarantor constituted an event of default.  (Note that an alleged default occurred even though the loan payments were current.) 

The change.  Since the execution of the loan agreement, the guarantor’s cash had been almost completely depleted, his net worth had decreased by 60%, his equity in real estate had diminished by 80%, and he had unpaid judgments against him for several million dollars.  According to the Court, “to be sure, [guarantor] has experienced an adverse change in his financial condition.”  But, “whether this change has been material . . . is a more difficult question.”

The Court’s struggle.  The Court conceded that “at first blush, it would appear that this change has been material as that word is used in common parlance.”  Nevertheless, the Court noted that the loan documents did not define “any material adverse change.”  Evidence from six witnesses suggested different definitions.  Although the lender urged the Court to accept a “know it when you see it” interpretation, the Court was “uncomfortable” with applying such an approach at the summary judgment stage.  “Materiality,” noted the Court, is an “inherently amorphous concept.”  The guarantor still had a sizeable net worth that, based on certain assumptions, could be enough to absorb any liability stemming out of the underlying loans.  “This cushion creates questions as to whether the adverse change in [guarantor’s] financial condition is, in fact, material.” 

Ambiguous.  The Court denied the lender’s motion for summary judgment:

Given the “sliding scale” nature of materiality, coupled with the lack of a definition or objective standard found in the [loan agreement], the Court cannot help but find that the term is ambiguous because reasonable people could come to different conclusions about its meaning.  . . .  [T]herefore, “an examination of relevant extrinsic evidence is appropriate in order to ascertain the parties’ intent.”

Essentially, the Court held that the issue of materiality was a question of fact for trial. 

What we learned.  The Court’s analysis of the relevant financial conditions provides a road map for prosecutors (or defenders) of similar defaults.  The Court’s opinion does not question the fundamental validity or enforceability of MAC provisions.  The opinion does, however, raise the question of whether such a provision can form the basis for a pre-trial disposition of the case:  “when it comes to materiality, it’s all relative.”  The implication is that every case (financial condition) is different, and facts may need to be weighed.  On the other hand, Greenwood Place does not go so far as to proclaim that summary judgment should be denied in every case.  The opinion merely demonstrates how difficult summary judgment might be to achieve. 

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Posted at 09:39 AM in Guarantors , Mortgages , Promissory Notes  |  Permalink

August 31, 2012
Guarantor Strikes Out With Defenses To Guaranty

Defenses to liability under a guaranty are few and far between in Indiana.  General Electric Capital v. Delaware Machinery, 2011 U.S. Dist. LEXIS 53897 (S. D. Ind. 2011) (.pdf) illustrates this. 

Set up.  The General Electric opinion dealt with a lender’s motion for summary judgment against a guarantor.  In 2003, the lender and the borrower entered into a master lease agreement that obligated the borrower to make payments on certain equipment in eighty-three monthly installments.  The lender obtained a guaranty in connection with the master lease agreement.  In 2009, the borrower failed to make lease payments, so the lender accelerated the amounts due and filed suit against the guarantor.  The Court concluded that, under the unambiguous language of the guaranty, the guarantor was liable to the lender for the borrower’s obligations.  (The opinion quotes the operative language of the guaranty.) 

The guarantor asserted three arguments as to why, despite the language in the guaranty, he should not be liable: 

Fraudulent inducement.  The guarantor’s first argument was that the lender fraudulently induced him to enter into the guaranty through representations that the master lease agreement would constitute a lease agreement, and not a purchase or security agreement.  The lender countered that fraudulent inducement based on misrepresentations “of the legal effect of a document” are not recognized in Indiana.  Indiana law generally recognizes fraudulent inducement as a defense to a contract, but one exception to the rule is:

when the representation at issue, though false, relates to the legal effect of the instrument sued on.  Every person is presumed to know the contents of the agreement which he signs, and has, therefore, no right to rely on the statements of the other party as to its legal effect.

Since the alleged characterization of the subject contract was a question as to the contract’s legal effect, the guarantor had no right to rely on the alleged misrepresentations of the lender.  Strike one.

Judicial estoppel.  The guarantor’s second defense was that the lender was judicially estopped from claiming damages for more than the amount claimed in the complaint.  In Indiana, “judicial estoppel prevents a party from pursuing a theory incompatible with its original theory in the same litigation.”  The opinion sets out three factors to be considered by courts, including whether the party’s later position was “clearly inconsistent” with its earlier position.  In its complaint, the lender stated that “at present, the amount due . . . totals not less than $279,074.43.”  In its subsequent motion for summary judgment, the lender sought over $415,000.00.  The operative language in the lender’s complaint was “at present.”  The guarantor could not show that the lender’s current position was “clearly inconsistent” with its position in the complaint.  Strike two. 

Indemnification.  The guarantor’s third contention was that he should not be liable due to the lender’s failure to perfect its security interest.  According to the guarantor, “this amounts to seeking indemnification for [lender’s] own negligence in failing to perfect.”  (Evidently, the equipment was not available as a source of recovery.)  The guarantor argued that, had lender perfected its interest, the lender could have sold the subject equipment for in excess of $500,000.00 and therefore covered all of the lender’s alleged damages.  The Court focused on the language of the guaranty, which provided that guarantor’s obligations were not affected by the borrower’s “failure to . . . perfect and maintain a security interest in, or the time, place and manner of any sale or other disposition” of the equipment.  Thus the express terms of the guaranty entitled the lender to recover damages regardless of its failure to perfect its security interest.  Strike three.

Language in guaranties usually rules the day.  That certainly was the case in General Electric.  The defenses asserted by the guarantor, although creative, ultimately did not defeat the lender’s summary judgment motion.

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Posted at 02:56 PM in Guarantors  |  Permalink

August 22, 2012
Lender And IRS Battle Over Rental Income

I previously wrote about the priority of federal and state income tax liens on title to mortgaged real estate.  Generally, an Indiana mortgage lien on title to real estate will trump a tax lien, assuming the lender recorded the mortgage before the taxing authority recorded its lien.  The recent decision in Bloomfield State Bank v. United States of America, 644 F.3d 521 (7th Cir. 2011) involved a priority dispute over rental income arising out of the mortgaged real estate. 

Rents.  In Bloomfield, the borrower, who defaulted, granted the lender a mortgage on the borrower’s real estate plus “all rents . . . derived or owned by the Mortgagor directly or indirectly from the Real Estate or the Improvements” on it.  The IRS filed its 26 U.S.C. § 6321 lien for taxes against the subject real estate several years after the lender recorded its mortgage but before the filing of the foreclosure suit.  The receiver, during the pendency of the foreclosure case, decided to rent some of the real estate and collected about $80,000 in rents. 

Contentions.  The IRS claimed that its tax lien took priority over the mortgage lien on the rentals because they were received after the filing of the tax lien.  The argument of the IRS focused on 26 U.S.C. § 6323(h)(1), which gives a mortgage interest in rentals priority over a tax lien only if the property secured by the mortgage was “in existence” when the federal tax lien was filed.  The IRS asserted that the relevant property was the rentals – which did not exist at the time the federal tax lien attached.  The lender, on the other hand, claimed that the relevant property was the real estate - which did exist 

What existed and when?  The Court sorted through the “existence” issue:

The “property” that must be in existence for a lender’s lien to take priority over a federal tax lien is the property that, by virtue of a perfected security interest in it, is a source of value for repaying a loan in the event of a default; it is not the money the lender realizes by enforcing his security interest.

The Court reasoned that there essentially is no difference between lien-enforcement proceeds taken the form of sale income versus rental income.  “To say that a parcel of land is ‘sold’ rather than ‘rented’ just means that the owner sells the use of the land forever rather than for a limited period.”  In Bloomfield, the real estate that generated the subject rental income existed when the borrower granted the mortgage (and thus before the tax lien attached).  The rental income was proceeds of the such property, which preexisted the tax lien.

Not like A/R.  The result would have been different had accounts receivables been the lender’s collateral.  The Court noted that a security interest in accounts receivables does not exist and thus does not trump a subsequently-filed federal tax lien “until a buyer of goods or services from the grantor of the security interest becomes indebted to the grantor.”  If the lender in Bloomfield did not have a mortgage on its borrower’s real estate, but just a lien on rentals, then until the rentals were received “the property on which the bank had a lien would not have come into existence.”  Instead, the lender had a lien on the real estate.  The rentals provision in the mortgage “created a perfected security interest in rentals received at any time.”  Ind. Code § 32-21-4-2(c).  The Court said:

By virtue of the rental-income provision in the mortgage, the bank had a separate lien on the rents, but that is not the lien on which it is relying to trump the tax lien.  The lien on which it is relying is a lien on the real estate.  If an asset that secures a loan is sold and a receivable generated, the receivables become the security, substituting for the original asset.  The sort of receivable to which the statute denies priority over a federal tax lien is one that does not match an existing asset; a month’s rent is a receivable that matches the value of the property for that month.

The lender thus prevailed in its priority dispute with the IRS.  Bloomfield reminds us that, generally, Indiana is a “first in time is first in right” state.  More specifically, the opinion points out that in Indiana a mortgage attaches, not only to the land and improvements, but also to any proceeds from the sale or rental of the real estate. 

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Posted at 01:04 PM in Mortgages , Other Liens  |  Permalink