Commercial Mortgage Modifications:

Lien Priority, Title Insurance and

Bankruptcy IssuesStructuring Modification Agreements While Avoiding Legal Pitfalls

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

The audio portion of the conference may be accessed via the telephone or by using your computer's

speakers. Please refer to the instructions emailed to registrants for additional information. If you

have any questions, please contact Customer Service at 1-800-926-7926 ext. 1.

THURSDAY, JANUARY 16, 2020

Presenting a 90-minute encore presentation featuring live Q&A

Aimee Contreras-Camua, Partner, Pircher Nichols & Meeks, Los Angeles

Erin F. Natter, Partner, Pircher Nichols & Meeks, Los Angeles

about:blank

ll USCS § ,547

Curre~i~f tly~•ougl~ PL, 11.5-338; appro~•ed 32/2O!1.$, ~~<ith a gap of 115-:33a.

G~~iterl Slates C=ode SL'1'1'lCL' - T11~e5 I lI1Y011~I2 S4 > TITI_F. I1. BA1VIfRUPTCY > CFI.AP1'TR 5. CREDITORS,

"C"lll DI~'B7'Olt, F1A7) "C"II1 ISI'A1`Is > SC113C:~IA7'IL'RICI. '1"J/L`LS7<~1'1"F.

Notice

Pa~~x 1 of ~3. You are vie~viug a very large document thzt his bee~1 divided iuCo darts.

547. Preferences

(a)LZ this section--

(1)"inventory" ine~ns personal }property leased or fi~rnishecl, held for sale or lease, or Yo be fiirnished

under a contract for sei~rice, rati~~ materials, work iii process, or materials used or consumed in a

business, iuelu~ing fans products such as crops or livestock, held fc~r sale or lease;

(2)"ne~~~ value° means iuoliey or money's worth in goods, services, or new credit, or release by a

transferee of property previously tr~~nsferred to stiiel~ transferee in ~ transaction that is neifl~er z~~id nor

voidable by the debtor or the trustee under anY applicable 11~v, including proceeds of such pi•aper[y, but

does not uicltuie an obligation substih~ted for att existing obligarion;

(3)"receivable" means right to payment, whether c>r not such rig1~t has been earned by performance; and

(4)~~ debt fc~r a tax is incurred on the clay when such lax is last p7yable without penalty, iticlucling arty

estensioil.

(b)Except 1s provided in subseckions (c) aid (i} of this section, tl~,e trustee may avoid any transfer of ~n interest

of the debtor ui property--

(1)to or for the benefit of a creditor;

(2)for or on accotmt of ~n antecedent debt ~~ved by the debtor before such transfer ~v~s mnde;

(3)made while t1~e debtor was insolvent;

(4)m~de--

(A)on or within 90 days before the dote of tl~e filiii; of the petition; or

(B)beriveeu ninety days and one year before the date of the filing of the petition, if such creditor 1t

the time of such transfer was ~n uisider; anct

(5)that enaUles ucl~ creclitoi• to receive more titan such creditor would receive if--

(A)the case were a case under ch~~~ter 7 ofthis title [11 LJSCS ~§ 701 et seq.];

(B)tlie transfer had not been mane; and.

(C)such creditor recei~3ea payment of such debt to the extent provided by the previsions of this title

[11 USCS §§ 101 et seq.].

I of 6 2/6/2019 12:42 PM

about:blank

l USC;S § 547

(c)"I he tnzstee may not avoid under this section atransfer--

(1)to the exteaY that sltch transfer eras--

(A)int~ended by the debtor and tl~e cr~;dilor to or for whose l~eue[it sl~ch transfer ~~°as m~dt to be a

eo~atea~a~~~oraneo~~s excl~au~;e f'or ne~~v valise given to tlae debtor, ~iucl

(I3)i~i fact a substantially conter~lporaueous exc(~~nge;

(2)to the eYtenti that such fr~nsfer w as in paymenC of ti debt inctu-rec3 by the debtor il~i the orduiary course

of business or financial affairs ~f the debtor and the ta<insferee, and such transfer teas--

(11}made in the ordin7ry course of business or fliia~icial ~ffaii•s cif the debtor ~n~j the t~r~msferee; or

(l3)made according to ordinary business terms;

(3)that creates a security interest in property acquired by tl~e debtor--

(E1)to the exteiiY such security interest secures new ~~~lue~ that ~vns--

(i)giv°en at or after die signing of a security agreeme~it that contains a d~scriphio~i of such

property ~s collateral;

(ii)given by or on behalf of the secw ed party under such ~gree~nent;

(iii)given to euablc t1~~ clebtorto acquire such properry; and

(iv)in fact used by the debtoz to acquire such propea~ty; end

(B)tllaf is j~erFect~d on or befi~rc 3U days after the debtor receives possession of such property;

(4)to or for the benefit of ~ creditor, to the e:Yteut that, after suds transfer, such creditor gtive ne~v value

fo or i'or fhe }~enefiY of the debtor--

(A)not s~ctu:ed by an oCl~er~vise unavoidlble sectn~ity interest; Ind

(I3)on account of ~vhicl~ ne~v v~lae the debtor drei xaol make axe other~~~i~e un~~voidab]a tr~insier to or

for the beuef iY of stiel~ crcdi.tar;

(5)t(rit c:reaics a perfceTca sc;curity interest in. iuvet~tory or a receivable oa• tl~e proceeds of either, exce~~t

to the extent t1i~S t~l~.e <~g~r~g~te of all such transfers Yo t9~z transferee caused a rcductio~i, as of Che date

of ChE Elting of the petition and to the prejudice of'other areditors holding wlsecured c)aims, of auy

amount l~~y which fhe debt secured by such sccw-ity interest exceeded the value ~rf all security interests

foz such debt on the later oi;=-

(A)(i) with res~~ect to a transfer to wlaioh subsection (b)(4)(A) ofi this section ~ipplics, 90 days befi>re

[he dtitc of the Citing of the petition; or

(ii)~uitla respect t~o a tra~asfer to ~vlaich stiibseoti<~n (b)(4)(].3) of tlais sectioia ~a~plies, one year

before the date oPYhe filing oFtlie ~~etitiori; or

(I3)the cialc o.ia which new value was .(ix-st given under the security a~rccinent crealanb such security

interest;

(()th~it is the lixin~; oCa st~ltiitory lieu that is nat avoid<iblc tinder section 545 of this Cit9e [l l USC'S §

sash;

(7)t~o ll~e eatc~~t such transfer was 1 boa~a ~#'ide payment of a debt :for a do~~est~ic support obligation;

($)if, in a case ~ted by an individual debtor ~t~lu~se debts are primarily consumer debts, the aggregate

value of al.l properly t}~at constieutes oc is al:le;cteci by such lransPcr is letis than ~$ C00; a~-

Page 2 of 6

2 of 6 2/6/2019 12:42 PM

about:blanl<

11 [7SC;S § 547

(9)ii; i.n a case 'tiled by a dcbt~or whose debts are not ~arimarily consumer debts, the aggregate value of

X11 pro~zrty that cotistit~utes or is alteeted by such transfer is less than ~ 6,4?5.

(d)"Tl1t trustee nay avoid u transfer of an int~i•est i.n property of the debtor transferred to or for the benefit of ~i

surety to secure reimbursement oY such a stiuety that fiuYushed a ba~id or other oblig~ition to dissolve ~ judicial

lien that wonl~l l~zrve been. at~c~idabtc by the tr~istee ~indet• srihsect7on (b) of this seotion. I,he liability of Suc~i

surety m~cicr such bond or ol?li~;at~iori shall be discliargeci to the este:ut of tl~e value of such. ~rol~erty rccoverecl

by the kiustee or the ~unount paid to the tnisYee.

(e)(I) Far tl~e Purposes o:f ~]~.is sact~ion--

(A)z~ transfer oCreal property otter than tistures, bu4 inclncling the interest of ~ seller or }~urcl~~scr under

a contract for the sale o£real property, is perCect~ecl ~~~hen a bona Tide purchaser of s~lch properly Crom

the debtor a~flinst whom applicable law permits suds fcansfer to be perfected c<~unot acquire an interest

that is s~i}~crior to the interest of the transferee; and

(B)a tcailsier of~a tlxtw•~ ar ~roperCy other Phan real property is perfected when a creditor oil a simple

contract cannot acquire a judicial. ireu that is superior to tl~e interest of the: trnnsfcr~e.

(2)l~or the purposes of this section, exceE~t as provided in paragraph (3) oPthis subsection, a fr<msfer

15 11]<1 C1L-^

(A)at the Ci~ne st~c}i transfer takes effect between the trausfei~or and the tratisteree, if~ such

transTer is perfected at, or within 30 days after, such ti~»e, exe~pt as ~~rovide~d rn subsection

(c}(3)(I3);

(B)at t1~e tine such transfi:r is }~erfect~ed, if such Lr~nsfer is perfected after such 30 days; or

(C)iinmediat~ly before the date of the kilin~ of the petition, if such tr~tisfer is not perfected 7t

the later of--

(i)th~ cc~mmenceinent of thr: case; or

(ii)30 days ~f~er such transfer takes effect between the transferor rind the h~ansferee.

(3)1'or the purposes of dais sccCian, ~i ta•aiasfc~r is not u~~ide until the debt«r has ticquir~d righes in the

property transferred,

(t)l~or the p~u•poses of tivs section, tine debtor is presumed i~o have been insolvent nn <ind during the 90 days

immediately preceding the date of the filing of the petition.

(g)I~or the purposes ~~f this serctiou, the Y~~ustc~ has ib,e burden o.f proving the avoidability of a transfer under

subsection (b) of Chic section, cud the creditor or party in interest agaitisl whoiu recovery or avoidance is sottghl

has tl~e burden of'proving the nonavoidability of a transfer under subsection (c) <~>~~tl~i section.

(1~)The Crustee may not avoid a transfer if such transfer ~vae made as ~ part of ~n alteinitive repayment schedule

between t[~e debtor and any creditor of the debtor m-eated ley <lil ~ipproved uo7lpr<~iit budget and credit

counseli,ug agency.

(i)If the trustee avoids under subsection (b) ~ transter made between 90 days and 1 year bel~>re the elate of the

:filing of the petition, by the debtor t~~ tui eittily ll~at is not ail it~sidcr foe the benefit o1`a cr~c~itor that is au

iilsidcr, s~icl~ transfer shall be oonsiciered to bt a~~oided oncler this section only ~~ith respect_to the creditor that is

an insider.

History

Page 3 of 6

3 of 6 2/6/2019 12:42 PM

about:blank

1 ] USCS ti 547

(Nov. 6, 1978,1'.1:,. )5-5~8,'Title I, § 101, )2 Stale. 2597; July 10, 1984, Y.:L. 98-353, "Citle IIl, Sttbt~itle A, y~ 3.t 0,

Stihtiele F~I, §X462, 9S Stt~t. 355, 377; Qct. 27, 1980, P.L. 99-554, T'ifle II, Subtitle C, § 283(m), 100 Stat. 3 L 17; Oet.

22, 1994, P.I,. 1.03-394, 'Title II, § 203, 'Title IIi, § 304(t), 1.08 Stat. 41.2 ] , 4133; April 20, 2O{)5, P.T,. 109-8, "I~iile II,

Subtitle A, § 201(b), SubCitle l3, § 217, "I~i[le IV, Siibtit(e A, §§ 403, 409, 'line XI~I, §§ 1213(~i), 1222, 1l9 Stat. 42,

5.5, 104, 106, 19~,, 196; I'eb. 14, 2007, 72 Pe;d. Reg. 705, I'eb, 25, 2(?10, 7~ F'ed. Reg. 3747; Feb. 21, 2013, 78 Fed.

Reg. 12089.}

(As ail ended Feb. 16. 2016,81 F'ed. Reg. 8748.)

Prior laic find revision:

I egislalil~e .Sicge~rtents

Nn liroifat~ion is provided Por payments to coininodity b.cokcrs as its section 7C6 of the Senate ~wnendinent oLhcr

thin fhe an~cndment to section 54R of title 'll . Section 547(c)(2) protects most paynlci~ts.

Section 547(b)(2) of the Mouse au~endiv~u[ adopts << pre~visiaza co~~tain.ed ia1 tl~e Ho~isc bill and rejects Giza.

~lternaYiF•e contained in Yl~e Senate nmendnlen[ ~~~41~ting Co the avoidance of a preferc~itial trau~fer fhzt is payment of

a tax clni~n ot~,~ittg to a governrneiital unit. As provided, sectio~~ 106(c) of the IIoitse amendment oveiYl~iles coutraiy

l<i~~~ua~e in tl~e House repart ~vit1~ Q~c result that tlac Ciove~7zxnc:nt .is subject to <rvoid~i~~ce ol'prePcrcnl.i~~l trGinyfers.

Contrary to language contained in the House report, payment of ~ debt by ~neaats of a check is equiv<11ent to a cash

payment, uul~ss tl~e check is disl~t~nor~d. Payment is consicicred to he made ~a-he~~ the c(ieck is delivcrccl Igor

Pu~l~oses of s~;ctions 547(c)(1) and (2).

Section 547(c)(6) of the 1-louse hilt is d~(eted and is trctrtecl in a diffe~rci~t fashion in section 553 of tlic I~~ousc

~il~endn~c~~t.

Section 547(c)(6) represents a modi(~icatio.~a of ~ si~~~ilar provision con.tai.necl in the I:Iouse bill ~incl Senate

ainendmc~it~. 'I~lie exception relating to satisf~etion of a statirtory lien is d~leYed. '~Cl~e excepCion for a lien cre~ited

under title I 1 is deleted since such a lieu is ~ sl~~tutoiy lien that Fill not b~ avoidable in a aubsc~luent bankruptcy.

Section 547(e)(1)(B) is adopted from the Mouse bill said Senate amendment without change. It is intended that the

simple contract test used in this sectio~t will be applied as wider se.atiou 544(a)(1) not to require a creditor to perfect

against a creditor nn a sim~ife contract in tlic event a}~plicable la~a~ nl~kcs such perfection iinpossiblc. For cxam~~le, a

Purchaser fi•c~m a debtoL- at an im.properly noticed bulk. sale Lnay Yakc sttbjccY to the ri~1~Ys of ~ creditor on a wimple

contract of ilie debtor for 1 year after the bulls sale. S~nee the purchaser cannot perfect against such a creditor on a

simple c~ufiract, Ile should not he held responsible for f~ili~ig to do the iiiapossible. In the cvent~ t~l~e debtor goes iriY<>

bankruptcy within ~ short time after the balk sale, the trustc~-should i~ot be able to use tl~~ a~~oiding powers under

section 544(x)(1) nr 547 merely because State law has oracle soave trrmsf.'eis of personal property subject to the

rights of a creditor on zi sia~~ple contract to acquire 1 jtiidicill IiEn ~~rit(~ no opportw~ily to perfect~againsl sucl~i

creditor.

]'references: The House amendment deletes from tl~e category of Lrausfea~s o~~ ~ccc>luit of ~intceedeut debts which

m~iy be avoicleci tmdcr the pcelcreuce nilcs, seclic»3 547(l~)(2), the exception iii ll~e Se~~atc az~ictulmcnC for taxes

o~;red to go>>errunent<il authorities. I3owever, for purposes of the "ordinary course" eXception to the preference iztles

contained in section 547(c)(2), the House atnendment specifies that the 45-day period referred to in section

547(c)(2)(.E3) [deleted; see the. 1984 ~unendincnt o#~subsee (c)(2) of t)zis sections is to bcg~in runniia~;, iu t~l~c case of

taxes from the list clue date, includinb extensions, of the return ~~~ith respect to ~~~hich tl~e tat payment was made.

Serrate IZepnr•t :'~'o. 95-949

T}us section is a subst<ultial nz~difie~tion of }resent la~v. It ~nodeinizcs tiie pr•eferei~ae provisions and briu~s then

more into caufor.~zity wikh coinnaercial px~acti,cc; end tl~e IJnifor~u Commercial Cody.

Page 4 of 6

4 of 6 2/6/2019 12:42 PM

about:blank

l l USC'S ~ 547

Subsection (a) contains ihrce de;Cinitions. Im~e~~tc~ry, ne~a value, <ind receivable ~~re defined in,tl~eir ordinary

senses, but. are def~med to lvoid any coi~fiision or uncertainty sun~otiuiding the terms,

Subaeelion (b) is the operative provision of Yh~ secYioi~. It~ <iiitl~orizes the trustee to avoid a transfzr if five

ec~nditions are met. These are the five elements of ~~ preference action. First, khe transfer un1sC be to or for the benefit

o f; a creditor. Second, the transfer n~list be li>r or o~1 account of ~n antecedent debt owed by the debtor before the

tr<tnsi'er vas made. ']'bird, the transfer must lave bcci~ inacic when tl~c debtor ti~~~s iusolvcnt. 1~ o~irt)1, Use transfer

i7nist have been made ~Ituiiig tl~e 90 days imiiiedi~[ely precedi~ig t11e co~mucncement of the case. IPthe tr~nsF~r 4vas

to au insider, the tn~stee may avoid the t~~aatsfea~ if i'k ~n-as made during Ct~e pei~ioci t'hat~ begins ane year before the

fili~a~; of tl~c pctrtioii a~ld ends 90 ciay~s befo~•e the filing, if tl~e iusidcr to ~vhoin the traus:fer vas made l~~td G~easounble

cause Yo believe the debtor was u~solvenl ~t the time the transfer was made see the 198 amenclmenC of sttbsec.

(b)(4)(F3) of this sectian].

I~~ittall_y, the tr<utsfer must enable tl~e creditor to whom or foi• whose benei:it it was made to receive a greater

percentage of his claun than h~ 4vrni(d receive under the clist~ributive provisiozis of the bnt~uptcy codE. Specifically,

t}ie ereclitor n~iii~t resceive n~oxe than he; ~r~~uld if the case ~s~ere a liquidation case, iCL~e transfez~ laaci not becz~ ina~le,

and if tl~e creditor received payment ~~f the debt C~~ Che extent provi~lea by the provisions o:F the code.

"1'he plu~~isiiag oPt(ie final clen~enL cliaiage~ the ap~~licalia~~ oCtl~e grc<iter perceu(~~e lest G•ona tl~~lt cn~ployed under

cur.~•e~it la«~. Under this 1<~~nguage, t1~~ court intxst focus oii the relative distribution heriveen classes as tell as the

~mouut that will 'bc received by the members of the class of which the creditor is a member. The language also

rcc~uires the court to Poeus on the allowabilily of the c(ai~n for ~vhicl~ the }~referenc~ vas ~~~ade. ] f the claim woGtld

have been entirely disallowed, for etianiple, then the test of paragraph (5) «rill he met, because the: creditor ~i~oald

have received nothing undEr the distributive provisions of the baiakiliptcy code.

"I~hc trustee may avoid a rransfcr of a lien under this section even if tl~e lien has been enforced by sale before ll~e

comm~ncecnent of the case,

Subsection (b)(2) of fllis section i~t effect exempts f7•om the preference hales payments by the dcbtoi~ of tax

liabilities, regardless cif their priority status.

Subsection (c) conY~ins execl.~t~iaris to the l~usYee's ~~~voidin~ pot~~er. If a creditor cai~ qualify u~ides- any one of~ tl~e

exceptions, then he is protected to th1Y extent. If he can qualify tinder severll, he is ~rotecte.d by each to the extent

tl~<it he can qualify i~ude.r eac_U.

Tl1e first exception is f'or a transfer that vas intended by all parties to be n coutemporuTieous excha~ige 1'or neti~r

v:~lue, tmcl vas iu fact substantially conte~np<~>rane~aus. Norn~al(y, a c(~eck is a credit Lransaction. I~3owevc;r, for llle

purposes of this p~iragraph, a lr~nsFer in~~ol~~ing a check is considered to be °intended to be contumporai,ieous", and

if Clio check is presented Yor ~aymerit in the ~lormal course of affairs, «~I~ich the Uniform Coi7mierciai Code specifies

~s 30 days, iJ.G.C. ~ 3-503(2)(<t), tliat~ will amount to a trzusfer that is "in fact subst~nti~lly coutui~tporaneous."

The second exception protects transfers in the ordinary course of business (or of financial affairs, Fvhere a

httsiness is ~~ot~ i~lvc~lved) tiansPe;rs. l~~or the ease of a consumer, the para~;ra~~h rises the }~l~~rtise "~ivancial a1:~f~iirs" ro

inchide such nc~nintsitaess aclivities as payment of monthly utility bills. If t11~ debt oi~ account of which khe transfer

vas n~nde ~~~as inciu~red in the ordin~iy course oi~ both tl~ie debtor and the transferee, if the h~~msfer eras ril~de not

later than 45 days aft~a~ t}1e debt ~v1s incurred [see the 1984 <u~ze~tdinent of aitbsec. (c)(2) of this section, if~the

ta•ai~sfer.itsetf w~is made iii the c>rdin<iry eo~u~se of both the debtcir and the tr~u~sf~ree, and i.f the transle3• vas ivadc

accorduig to ordiii~ry business tetras, then Qie transfer is protected.'I'he purpose of this exception is to leave

undisturbed normal financial relations, because it does riot detrack ixoin tl~~ general policy ot~the p~•eferencz section

t~o discour<i~e; umisual action by either the debtor or leis creditors dut•i~~~ Yhc debtor's slick iutc~ b<u~kru~~tcy.

The third e,~oeption is for 4nablin~ loans in connection wikh which the debtor aoquires tl~e pro}~erlti th~rt the loan

ez~ablecl laim to piu~el~,~s~ afl4a~ the loan is actually made.

Page 5 of 6

5 of 6 2/6/2019 12:42 PM

about:blank

i ~ t~scs sa

"1:'he fourth exception codifies the net result nile in section 6~c of current la~v [section 9G(c) of fanner title 11]. I£

the crediTc~r and the debtor h~jve iunre than one e~ch~nge during the 90-day peiiod, the exchanges are netted out

according to the f'ortnul~ ita paragraph (4). 11ny ne~v ~~alue that tiie creditor adv<t~~ces must be unsecured ii1 order for

it to qualify under this exception.

P~ir~grapll (Sj codifies the imprtrvement in position lest, and thereby o~~errules such cases as D«B;~y v. Williams,

4'1.7 1'.2d 1277 (C.~1.9, 19G6), and Ciraiu Merchants oPIndian~i, liaa v. I.tnion T3aii.k end Sa~~in~s C'o., 408 t°.2d 209

(C.A.7, 1969). A creditor with a security interest in a floating mass; such as inventory or accounts receivable, is

subject to prefe~•ence attaelc to the extent he impiroves his position durira~ the 9U-day period before bankni~~tcy. "T'he

tcsY is ~~ ~~~~o-point t~cst, and requires cicterinivation of t~l~.e sec~ired creditox's position 90 cl~lys before Cl~~ petition and

oii the date of Yi1e petition. If new value was first given after 90 days before tl~ie case, the date on ~~~hich if was first

gig%en suhstihites for tl~e 90-day poi~it.

Paragraph (6) cxoepts statutory liens v~lidatcd lender sectio~~ 54~ ti~om preference attack. It also protects T~r~aisfers

in sal~ivfaction of such lis~~s, and the tixin~ of a lien colder section 365{j), ~vliicla protects ti vendee whose contract to

pLirclaase real property Goza~ tlae deUtor _is rejected.

Subsectio~~ (d), derived froul section G7a of the I3anla-uptcy Act [section 1Q7(~) ~~f foi7ner title ll], pernliCs the

trustee tf~ avoid <i transfer to a~einlburse ~ surety that posts a bond to dissol~~c a jtiiclieial lien that ~~,~oulcl have been

a~-oidable tinder this section. The second seutenca prot~ets the sleety ti•om double liability.

Subsectic>i~ (c) cietcnnines ~a~hen <i transfer is made far tl~e piu~~oses of the p~•ei'~rencc secti~>n. Para~;r~ph (i)

d~ilnes ~uli~ii a transfer is perfected. l~~or real property, a t~•ansfcr is perfected ~tirhen it is valid against a bong fide

purchaser. For personal ~a~opex-ky and lixfures, a transfer is perFeefed when it is valid against a creditor on a simple

contract that obtains a iudici~~l lien after the transfer is perfected. "Simple contract" as tiised here is derived froi~~

I3~mkniptcy Act § 60a(4) [section 96(~i)(4) of former tiUc 11]. Paragraph (2) specifies that a transfer is mfide when iY

takes effect between the transfc;ror grid the transferee if it is perfected at or ~~•ithiil 10 days after that tiliie.

Other~~ise, it is made ~n~hen tl~e 1~rausfer is perfected. If it is not per1.'ected before fhe conm~e;ocenlent of the case, it is

made i~nmecliately beti?re the cot~uvea~ce~uenf of the c~ise. P~iragr~ph (:i) specifies that ~i transfer is not made u~~~Pil

the debtrn• has acquired rights in the ~~roperly transfeil•ed. 'Phis provision, inol~e than any otlie:r in the section,

overntles DcrBc»~ end Groin Merchara~s, and iu combinx~tiot~ ~v~iCh subsection (b)(2), ove~7ules In re King-Porter Co.,

44C 1~.2d 722 (Stl~ fir. l a71).

Subsectioxi (e) is designed tc> reach the diflerenl~ r~s~ilis wader the 1962 version of Article 9 o~tl~e ZJ.C.C. and

Luider the 1972 version because di ~cre~at actions ire required tiincier each vcrsiau rn o~rdcr to ~iziake ~~ sec~GG~ity

agreement effective bet~~~een the ~~artics.

Subsection (f.) creates tt presumption of insolvency for khe 90 days preceding the bai~knzptcy case. ̀I'h.e

presumption is as defined in Rnlc 301 of tli~ federal Rules of Evidence, made applicable iii bankruptcy cases by

sections 224 end 225 of khe bi1.1. The prestiunptiou ~-egairev the party against whom the prestiixnption exists to come

far~vaa-cl ~vit}a some evide~lcc t<i rcbL~t the presumption, Uut the btudcn c~Fp~~oof renaai~~s on tl~.G party in 4vhose favor

the i~resuinpfion exists.

UN:['1"I~aD S"I'r1'I'ES COT)Ti Sk;R~\-"ICE

Cbpy7~iglAt 4~ 20191~1atdieFv I3endez &Company, lizc. a ~zzozzahcr of the Lexishrexis Group T~' ;111 z'iglus resea~~~ed.

Page 6 of 6

6 of 6 2/6/2019 12:42 PM

about:blanl<

11 USCS § 548

CYu7~~nt tl~rougl~ PI: 115-33$, a~~E~r~ived 12/20/1,, rr~itl~ a gap of 1.1~-334.

United St«tes Gbde Bernice - Tr~les 1 throu~lt S4 > TI7I_E ll. B~fNKRUPTCY > CII9]'TER 5. C:RTDIT'ORS,

rrrr:~ nr~x~'OX, ~f[\'I) 7711x" 1~`,S'C'A7"I` > SUBC"flAl'Trx rrr: rr~~~ r:s~~r

Notice

Pcn z 1 of~~. I'ou are ~'ie~viiig a very large document that leas been divided into parts.

~ 548. Fraudulent transfci°s end ohli~atio~~s

(a)(i) The trustee ma}' avoid any tr-~nsfer (including any transfer to or for the benefit of tin insider under a~~i

employment contract) of 1n interest of t11e debtor in ~~roperty, or piny ob(igntion (inclucliug any oUligation to or

for the benefit of an insider uiulec an employment contract) incurred by the debtor, that vas made or incurred

on or t~ithin 2 years before the date ~f the tiling of the p~;titio», if the debtor vohmtarily or involuntarily--

(A)n~acle such Yr~nsfer or incurred such obligation ~~,~itl~ actual intent to hinder, delay, or detrltiid ally

eiltit5~ to tivliich the debtor ~~~as or became, on o1• a8er the date that such transfer ~uas made ~~r such

obliglYion was incurred, indebted; car

(B)

(i)received less than a reason~bl5~ equivalent value in exchange for such transfer or obligltic~n; and(")

(I)~v~s insolvent on the date that such hansfer ~~+1s made ar snch obligation vas incun-ed, or

bec~une insolvent as a result of such transfer or obligation;

(II)wxs engaged u~ business or a transaction, car eras about to engage in business ar a

transaction, for ~vhicl~ any property reil~~7inin5 ~~~it~h dle debtor vas ~u ~ulrea~onably small

capital;

(III)intended to incur, or believed that the; debtor would incur, deUts that ~voulcl be Uey~~nd the

debtor's ability Co pay as such debts n7atured; or

(I~')~uacle such [ransfe~r to or for the benefit of an insider, or incilrred such ol~ligatio~l to or fi r

the benefit of ~n insider, tinder an eiuployrnent canti•act ntid not in the ordinary course c~F

business.

(2)A transfer of a charitable contribution tc~ n qualified religious or ch~rit~ble entity ar

c~cganization shall not ~be eontiidered to be~ a traYusfer covered timder paragraph (1)(B) in 7uy

case in which--

(A)the amount of that contribution does riot exceed 15 percent of the gross annul

inco~7ie of the deUtor for the year in ~~~hich the h•ansfer of the contribution is rn~de; or

1 of 4 2/6/2019 12:45 PM

about:blank

l ] 1JSCS ti Sd8

(B)the contribution made by a dehtor escecded Lhe perccnt<ige ~unouut oI'~ro5s an.nu~~l

ince~mz specitied in subparagraph (A), if the transfer.vas c~~nsistent with the practices

of the cicbt~>r in ~uakin~ charitable contributions.

(b)Tl~e tiuslee of a partnership debtor may lvoid a~~y transfer of an interest of~ the debtor in property, or any

obligation incurred by tl~e debtor, that vas r»ade or incttn~ed oar o~• ~vitilin 2 years b~L'orc the elate oP tine filing of

the petition, ~c~ ei general p~rtnc~• in tl~e debtor, if the debtor was insolvent on the dlle such tr<~nsfcr toes made or

such obligation ~~>as inetim•ed, oi• beoame insolvent as a result of such transfer or obligatio~l.

(c)}:~;xcept to the extent t}~at~ a trai~sFcr or oblig<iYion voidable uncicr this section is voidable under section 544,,

545, or 5~7 cif dais title [I t USCS § 544, 545, or 547], a tc~nsfer~e rn• obligee of such a tr~ttsfer ar obligation

that tikes for value ~~ld i1~ go~x[ f nth lies a Lien on or may a~4t~i~ii any interest transfen~ecl or may enl:orce ~+ny

obligaki.on incurred, as the case in~~y be, fo the extent tlr3[ such transferee or oblibee gave vahie Lo the debtor in

exchange for such transfer or obligation.

~a~(1)I~or the ~~u,rposes oFthis section, a h-ansfcr is made when suc(1 trauste~~ is so perfected th~it a bona fide

purchaser ti~om the debtor a~aiiist ~~~l~oi1~ ~ipplicable lzi~v petn~its such transfer to be pecfecied cant~oY

<~cquire an interest in the gcoperty transfei7e~l t~iaC is superior to the interest in such pcoper-ty of tl~e

traz~skeree, but i:~siich transf~z•.i:; not sc~ pc.a~fected before ll~e cox~a.i.nence_xa~ent of tl~.~ t.ase, tiu4h transfer is

m~cle immedilt~ly before the da[e of the filing of the petition.

(2)Li this secliou--

(A)"value" means property, or satisf~etion ar securing of a present or antecedent debt of ll~e debtor,

bait does i~ot ii~chidc a~1 ui~perfor~z~uci }~roznise Co f.'ui7lish support to ll~e dcbt~o~r yr to a rclat~i~re oPthe

debtor;

(S)zi con~~nodity broker, Pot~~arcl conC~act n~ercl~~li~Y, stockbr~~kcr, financial instilnYion, financial

participant, or securities clearing agency that receives ~~ marg~ii~ payment, as deti~led i.r~ secCion 101,

741, or 7C1 of this title ~I1 USGS § 101, 741, ~>r 7Gl ], or seUlemenY payment, pis cleline~-1 in section

10] ~>c~ 741 ol'tliis title [7 1 USCS y~ .101 or 741 ~, takes fors v~l~ic t~~ the extent of such paymcx~t;

(C)a repo p~rt~icip<~nt or 1-financial participant that receives ~ i~~lar~iu payuient~, na detined iu eclion

7~}J. oa- 7Cl of kris title [Ll. U~CS ~ 741 or 7C l~, ~~r setticin~ntpa}nT~ent, as dekined iia scet~on 741. of

this tit1~ [.I.1 USCS ~ 711], in connection with a reptu•chase agreement, Y~jkes for value to t}.fie extent

of such payruent;

(D)~ swap participant or fmanci~~l participant that receives ~ tr~~nsfer in coru~ectioti with a swap

~~reenient tnlies fi r value to the eaten# of~ such tra~isier; and

(E)a r~~aster netCi»g a~eement plrticipant that receives a tr~~nsfer i~~ connection ~vieh a master•

nettia~g a~rcement or a~ay ii~d~ivid~i~] contract covered thereby talcs f<~i• value to Y6e exfelit <~f'sttch

transJ'er, except that, ~~itl~ respect Yo a Lrausfer under ac~y incli~~icival contract covered thereby, to tl~e

extent that such mister netting :~g~reemenC participant otherwise did not take (oi• is othei~~ise not

dc.e~ned to ha~re taken) suctl transfer for value.

(3)Li this section, the te~7n "charitable contr~irtttion" means a charitable contrit~uti~il, ~s that term is

defined in section 170(c} of the Internal Revenue Codc of 19$C [2C L7SCS § 170(c)], if that

conll~ibution--

{A)is made by a tlatural person; and

(B)cot~sists of--

Page 2 of 4

2 of 4 2/6/2019 12:45 PM

about:blanl<

1 ] I.lSCS ~ 5~4h

(i)a iiilaucial instrument (as that lernl is dellu~d iz~ section 731(c)(2)(C) of the Int~rilal ReveAlue

Coc1e of 1986) [26 USCS § 731(c)(2)(C)]; oi•

(ii)cash.

(4)In this scetio~~, the term "e~u~lified rcligiotis or charitat~le ~ritity or org~Gnir.,~it~ion" ~nc~ins--

(E1)an entity described rn section 170(c)(t) of the Inte~•a1a] Revenue Cade of 198G [2G USCS §

(B)~in entity or organization described in sectioaa 170(c)(2) of the Internal Revenue Code of 19H~

~2c ~rscs y ~ ~o(~)(a)]_

(e)(]) I~~i additicm t~o aj~y irzlnsfer that the trustee in~ty t~lh~r~vise a~=c~icl, the trustee nay avoid any transfer «Ptm

i~aterest of tl~c debtor in property that vas in~de on or ~~ithin 10 }ears before tl~e date of the filiia.g oPthe

peCition, if--

(A)s~ich transfer ~a~as made t~o a self-settled tr~ist or similar device;

(13)sncl~ transl:er tivas by tl~e debtor;

(C')the debtor is a benefci<uy of such trust oi~ siniilai device; end

(D)the debtor mnd~ such h~anster with actual intent Yo hinder, delay, or defi~altd any entity to ~~~hieli the

debtor was or bec<in~e, ova or after t(~e date that such h~ansfer was made, indebted.

(2)For the purposes of this subsection, ~ transfer includes a ti~ar~sfer made in anticipation of any

uloney.judg~roeut, settlement, civil penalty, eq~utabte ~~rder, or criminal title iilcmred by, ~~r ~vhiala

die debtor believcci ~•voulcl be iucurz-ecl by--

(A)~ny violation ot'tl~e securities laws (as de#used in seetio~~ 3(a~)(47) of'the Secnri~ties

Ixc~rt~an~e Act o1' 1934 (:I5 I.S.C. 78c(~)(47))), any Stale seclu•ities laws, or auy.reg~tlation or

order issued iuider F~eder~l securities ln«%s or State securities laws; or

(13)frtrucl, deceit, or m<mipula~ic» ~ in a fiduciary capacity or in connection wit~ll tl~t~ purchase or

sale of any security registered under section 12 or 15(d) of the Securities Exchange AcY of 1934

(15 U.Q.C. 7K( cud 78o(d)) or under section C oi'the Securities net cif 1.933 {15 iJ.S.C. 77t).

History

(Nov. G, 197$,P.I.., 95-5)S, Title 1, § ] 01, 92 Stat 2600,, .iuly 27, 19H2, P.T.,. 97-222, § ~, J6 Stat. 2_i G; July 10,

1984, P.I.,. 98-35 j,'I'itla III, Subtiklcl~~, ~ 3)4, Subtitle H;. ~ 4C3, 9~i Shat. 3C5, :37R; Oct. ?7, 1986, 1'1.,. 99-554,':['iilc

II, Subtitle L, ~ 283(n), 100 Stat. 3117; June 25, 1990, P.L. 101-~ ll, Title I, ~ 104, I~itle II, § 204, 104 St:it. 268,

269; Oct. 22, 1994, F'.I.-. 103-394, Title V, ~S SU1(b)(S), lOS Stet. 41x2; June 19, 1998, P.L. 105-183, ~~ 2, 3(a), 112

Sl~~t. 517; April 20, 2005, 1?.[.,. 109-8, "I"it1~;1X, ~ 9070, (o)(4j-(6), "Citle XIV, ~~' 1402, 7.19 Stet. 177, 182, 2.14.)

Prior• lai~~v anc( revision:

1:egisl~~[ri~e Staterrienls

Section 5~44(d)(2) is modified to reflect general application of a provision contained in section 76G of Yl1e Senate

az~aea~da~~ecat ~~~ill~ a~cs~~ecl to conam<adily broken. lea parti~al~ir, section S48(d)(2)(.L3) o.f the I I<~usG ai~~e:~acia~aeait makes

cleaf~ that a coentnodity Uroker ~vho receives a margin payment is considered to receive flee mlr~in paytnent ui

return for "value" for purposes of section 548.

S'ei~nle Report Vn. 95-98>

Page 3 of 4

3 of 4 2/6/2019 12:45 PM

about:blank

1 ~ t7scs § sas

'Phis section is derived ial larbe Part fi~oin scc[ion 67d of the I3ankruplcy Act [section ] 07(d) of forn~~r t~iklc 11 ~. Il

permits Che tnistee to zooid transfers by the debtor in fraud of his creditors. Its history dates fi~orn the staCute of 13

131iz. c. 5 (I 570).

The Gustee may avoid fi~attdulent h~ansfers or obligations if' ~1~»de ~vitl~ aclul] intent to hinder, delay, or defraud a

past car .future creditor. '['~ansfers made for less th~i~ a reason~ihly equivatent consideratio~a are also v~il~lerable if the

debtor was or [hereby b~eomes insolvent, was engaged in business ~~~i[li au i~nr~asonably small capital, or intended

to incur• debts tl~nt would be beyond leis ability to relay.

'I~he trustee of a partucrship debCor i~n~y avoid airy trans.fei• of partnei•shi~ property to a partner in the debtor i.f the

debtor vas or thereby became insol~reut.

If a trai~s.teree's only liability t~ the tnAstee is under this section, and it he~ hakes for value and in good faith, then

subsection (c) ~r lnts h~i~n a lien on the p~•operty Transiened, or other similar pi•otectioti.

Subsection (cl) specifies that for the ptiu-poses of fraudulent h~ansfer section, a transfer is .made when iY is valid

against ~~ subsequent bony tide purchaser. Ik~not made hetore the commencement of the case, it is considered n~acie

i~nn~ediately before then. Subscctio~i (d) also d~fiucs "valise" to ~ncan ~~roperty, or tl~e satisfaction or sec~u~ing oi'~i

present or ~ir~;cecleiit deUt, taut does not include au unperforined pi•oniise to Furnish support to the debtor or a

relative of the debtor.

i~rrrrr;i~ s~r,a~r~;s cone: si~.tiv[c;r.'.Gopyrighl S~ Z019 Matthew I3endcr ~ Company, [nc. a meil~ibcr of~d~c L,exisNesis Group ~~'~ X111 ri~l~is reserved.

Page 4 of 4

4 of 4 2/6/2019 12:45 PM

CautionAs of: February 6, 2019 6:36 PM Z

~ er~ e i

Supreme Court of South Carolina

October 5, 1981

No. 21578

Reporter277 S.C. 162 "; 284 S.E.2d 770 ~`; 1981 S.C. LEXIS 500 *'~

The CITIZENS AND SOUTHERN NATIONAL BANK OF

SOUTH CAROLINA, Appellant, v. Stephen D. SMITH;

Thaddeus E. Williams; Smith-Williams &Associates,

Inc.; St. John's Episcopal Church; University of South

Carolina Educational Foundation for the benefit of

Maximillian LaBorde Scholarship Fund; University of

South Carolina Gamecock Club, Athletic Fund; First

Palmetto Bank &Trust Company, Inc.; Hellams-Ullman,

Inc.: South Carolina Employment Security Commission;

United States Leasing Corporation; Robert F. Lindsey;

and Pierre F. LaBorde, Jr., Defendants, of whom First

Palmetto Bank and Trust Company and Pierre F.

LaBorde, Jr., Stephen D. Smith; Thaddeus E. Williams,

Smith-Williams &Associates, Inc.; St. John's Episcopal

Church, University of South Carolina Educational

Foundation for the Benefit of Maximillian LaBorde

Scholarship Fund and the University of South Carolina

Gamecock Club Athletic Fund are Respondents

Prior History: [***1] Appeal From Richland County,

William P. Donelan, Special Circuit Judge

Disposition: Affirmed in part and reversed in part.

Core Terms~~.~ ~,~a~a ,~ ~,~~.~. ~ ~~~~.~y~,~u~~~~~

mortgage, acres, subordination, purchase money

mortgage, developers, acre tract, mortgagee's

Case Summary

Procedural Posture

Appellant bank challenged a decision from the trial

court, Richland County (South Carolina) in favor of

respondent seller, who had agreed to subordinate

certain purchase money mortgages from the buyers in a

foreclosure action.

Overview

The seller agreed to subordinate his purchase money

mortgages in order for the buyers to obtain money to

develop the land. He agreed to execute documents as

might from time to time, be required to perfect such

subordination. The buyers placed additional mortgages

on the land without advising the seller or obtaining his

consent. When he discovered this he entered into a new

agreement under which the buyers would satisfy the

purchase money mortgages, new mortgages would be

executed for the purchase money mortgages, the seller

would subordinate the new mortgages provided the

buyers would, inter alia, satisfy the outstanding

mortgages within three months. The buyers extended

the mortgages without telling the seller. On appeal, the

court found the trial court erred in finding that the seller

did not acknowledge the superiority of the bank's

mortgage in the new agreement. But the court found the

bank subsequently extended the time for payment of its

mortgage for one year without the seller's knowledge

and consent. Thus, the bank lost its priority vis-a-vis the

seller by doing that and the seller would be allowed to

foreclose his liens in priority over the bank.

OutcomeThe court reversed insofar as the trial court found the

seller did not acknowledge the superiority of the bank's

mortgage in a new agreement. But the court affirmed

the way in which the seller would be allowed to

foreclose his liens.

LexisNexisO Headnotes

Real Property Law > ... > Liens > Nonmortgage

Liens > Lien Priorities

Real Property Law > Financing > Mortgages &

Other Security Instruments > Purchase Money

Mortgages

277 S.C. 162, '"162; 284 S.E.2d 770, "*770; 1981 S.C. LEXIS 500, *'`*1Page 2 of 5

1°~P~['"] Nonmortgage Liens, Lien Priorities

At common law and in equity a purchase money

mortgage will ordinarily be given priority over other

security instruments in realty, but it may be

subordinated by agreement of the parties. Because it

alters the normal priority of the mortgagees, priority

under a subordination agreement is strictly limited by

the express terms of the agreement.

Civil Procedure > ... > Pleadings > Time

Limitations > Extension of Time

Real Property Law > ... > Liens > Nonmortgage

Liens > Lien Priorities

Civil Procedure > ... > Pleadings > Time

Limitations > General Overview

[*163] [*"770] This appeal involves the priorities of

several mortgages.

[**771] This foreclosure, involving a most complex

factual situation, began in 1973 when the respondent

Dr. Pierre F. LaBorde owned three parcels of

undeveloped land in Richland County (132.9, 489 and

490 acres). He sold this land to Stephen D. Smith and

Thaddeus Williams only receiving purchase money

mortgages in return. He agreed to subordinate these

purchase money mortgages in order for the developers

to obtain money to develop the land. This provision

read in part:

"(A)nd the [***2] seller agrees to execute such

documents as may from time to time, be required to

perfect such subordination."

Real Property Law > Financing > Mortgages &

Other Security Instruments > Purchase Money

Mortgages

~t~J[] Time Limitations, Extension of Time

As a matter of law, a lender and a borrower may not

bilaterally make a material modification in the loan to

which the seller has subordinated without the

knowledge and consent of the seller to that modification,

if the modification materially affects the seller's rights. If

the terms of the debt are materially altered without the

subordinated mortgagee's consent, the priority of the

mortgages will be reversed in favor of the subordinated

purchase money mortgage.

Counsel: John S. Taylor, Jr., of Robinson, McFadden,

Moore &Pope, Columbia, for appellant.

John Gregg McMaster, Timothy G. Quinn, Frank E.

Robinson, ll, Joe E. Berry, Jr., Walter B. Todd, Jr., Harry

M. Lightsey, Jr., James B. Richardson, Glenn Bowers,

and Robert G. Horine, Columbia, and Philip Wittenberg,

Sumter, for respondents.

Judges: J. Woodrow Lewis, C.J., Bruce Littlejohn, A.J.,

J. B. Ness, A.J., George T. Gregory, Jr., A.J., David W.

Harwell, A.J.

Opinion by: PER CURIAM

The precise meaning of this provision is in dispute.

Subsequently, LaBorde was informed that the

developers had placed additional mortgages on the land

without advising him or obtaining his consent.

Upon contacting the developers a new agreement was

entered into in March, 1974 in which they agreed:

(1) The purchase money mortgages would be satisfied.

(2) New mortgages were to be executed in place of the

purchase money mortgages.

(3) LaBorde would in writing subordinate these new

mortgages to any other mortgages provided the

developers would satisfy the outstanding mortgages (to

C & S Bank, and to Ira Miller) within three months and to

pay to LaBorde $ 4,000.00.

Pursuant to this agreement LaBorde executed a

complete release to Smith & Williams, and fully

complied with the terms of the new (March 1974)

agreement. Smith &Williams agreed [*164] to pay off

the mortgages. Instead they extended the mortgages

without the knowledge of LaBorde.

LaBorde has not been paid anything by Smith &

Williams on any mortgage, new or old.

While there are numerous foreclosures ["**3] relating to

this financial debacle, here we are only concerned with

the foreclosure by LaBorde, and others, on the 490 acre

tract which was subdivided into four tracts of 130, 160,

160 and 40 acres.

Opinion

277 S.C. 162, "164; 284 S.E.2d 770, **771; 1981 S.C. LEXIS 500, *`*3

C & S is involved because it loaned the developers Two

Hundred and Fifty Thousand ($ 250,000.00) Dollars,

took a mortgage on the 490 acres and extended this

mortgage. The three charities, St. John's Episcopal

Church, University of S.C. Educational Foundation and

University of S.C. Gamecock Club are involved because

as soon as LaBorde gave undivided portions of the 490

acre tract to each of them, they, in turn, deeded it over

to the developers, taking purchase money mortgages

from the developers.

The appellant Citizens and Southern National Bank of

South Carolina asserts the original subordination

agreement was self-executing. The respondents

contend they had to consent in writing for the

subordination to be effective. In view of our resolution

of this case it is not necessary to pass on this issue.

~-}+1[] At common law and in equity a purchase

money mortgage will ordinarily be given priority over

other security instruments in realty. Cyr stal Ice Co. of

Scala. v. ~ir~sf c~(~arti~! ~~ ~~~~ 273 .5. C. 3D6, 390

257 ~.~. 2d 496 9979 ,but it may be subordinated by

agreement of the parties. ~;iver~ v. Rice 233 Gam= ~19~

X19 `.~. (2d~_X7£3 197 ; 55 Am. Jur. (2d), Mortgages,

§ 314, 344. Because it alters the normal priority of the

mortgagees, priority under a subordination agreement is

strictly limited by the express terms of the agreement.

Gluskin v. Atlantic Savings &Loan Association, 32 Cal.

App. (3d) 307, 322, 108 Cal. Reptr. 318, 323 (1973).

Here, LaBorde consented to the subordination of his

mortgage to C &Sand acknowledged in writing that his

mortgage would be subordinate to the bank's until the

latter had been satisfied, at which time LaBorde's

mortgage would become a "first mortgage." This

agreement was drafted by LaBorde's attorney and

signed by LaBorde with full knowledge of the facts and

circumstances. This written acknowledgment of [*165]

subordination makes it immaterial whether the original

subordination clause was "self-executing" or required

LaBorde's [''*772] written consent. We hold the circuit

court erred in finding that LaBorde did not acknowledge

the superiority of the C & S mortgage in the March 7,

1974 agreement.

[***5] Subsequently, C & S extended the time for

payment of the $ 250,000.00 mortgage for one year

without LaBorde's knowledge and consent and we hold

C & S lost its priority vis-a-vis LaBorde by doing this.

~3T[] As a matter of law,

"[A] lender and a. borrower may not bilaterally make a

material modification in the loan to which the seller has

Page 3 of 5

subordinated without the knowledge and consent of the

seller to that modification, if the modification materially

affects the seller's rights." Gluskin v. Atlantic Savings &

Loan Association, supra.

If the terms of the debt are materially altered without the

subordinated mortgagee's consent, the priority of the

mortgages will be reversed in favor of the subordinated

purchase money mortgage. See Remodeling &

Construction Corp. v. Melker, 65 N.Y.S. (2d) 738; 59

C.J.S. Mortgages, § 276; Osborne on Mortgages, (2d)

Ed., § 212, p. 386. The trial court held that the bank's

extension of time past June 7, 1974 prejudiced

LaBorde. This finding is supported by evidence that

LaBorde considered repayment of the debt of June 7,

1974 a material inducement for subordinating his

mortgage to the banks. We hold on the particular facts

of this case, [***6] the bank lost its priority by modifying

the terms of the loan to Smith-Williams in a manner that

prejudicially affected LaBorde's rights without his

knowledge or consent.

The trial judge concluded, and we agree, the

mortgagees should be allowed to foreclose their liens on

the respective tracts as follows:

(1) as to the 130 acre LaBorde tract, LaBorde's lien shall

be first in priority and C & S's lien second in priority;

(2) as to the 160 acre tract on which St. John's Church

has a mortgage, the C & S lien shall be first, St. John's

lien shall be second, First Palmetto's lien shall be third;

[*166] (3) as to the 160 acre tract which the USC

Educational Foundation has a mortgage, C & S lien

shall be first, USC Educational Foundation lien shall be

second, First Palmetto shall be third;

(4) as to the 40 acre tract on which the Gamecock Club

has a mortgage, C & S lien shall be first, Gamecock

Club second, First Palmetto third;

(5) the amount of LaBorde's lien is $ 117,000.00 plus $

41,000.00 interest making a total of $ 158,000.00; the

amount of USC Educational Foundation lien is $

220,620.57 plus interest and a reasonable attorney's

fee; USC Gamecock Club's lien is $ 51,574.44; [***7]

St. John's Episcopal Church lien is $ 204,264.72; First

Palmetto Bank's lien has not been proven, this

mortgagee can make its claim to the surplus proceeds

as allowed by the master pursuant to Circuit Court Rule

53.

(6) the original amount of the C & S lien was $

277 S.C. 162, '`166; 284 S.E.2d 770, *'`772; 1981 S.C. LEXIS 500, '`**7

250,000.00. LaBorde acknowledged a debt of $

200,000.00 to C & S Bank in the March 7, 1974

agreement. It is also undisputed that two payments of $

50,000.00 have been made. The only issue left to be

resolved is when the payments were made.

If both payments were made prior to the March 7, 1974

agreement, C & S would have a lien for $ 200,000

apportioned among the four tracts of the 490 acres as

follows:

-0"- Go fo t~,~1e 1

If one payment was made prior to the March 7, 1974

agreement, and one payment after C & S would have a

lien for $ 150,000 apportioned as follows:

FGo tc~ t~k~le~

If both payments were made after the March 7, 1974

agreement, C & S would have a lien for $ 100,000

apportioned as follows:

~. ~~iUo to f~b1~3

[***8] [*167] [**773] To each lien should be added

the cost and expenses of collection except USC

Educational Foundation which costs and expenses have

been included, in the stipulated amount. To each lien a

reasonable attorney's fee should attach.

This resolution, of course, does not affect any of the

mortgagee's rights, if any, against Smith-Williams,

individually or incorporated.

Appellant's remaining exceptions are without merit and

are dismissed pursuant to Rule 23 of the Rules of

Practice of this Court.

Page 4 of 5

Affirmed in part and reversed in part.

277 S.C. 162, *167; 284 S.E.2d 770, **773; 1981 S.C. LEXIS 500, ***8

Tablet (F~e~urr~ tc~ re~l~#c;d r~cacirmer~t text)

Tablet (Refurn to ref~afi~c~ clocum~r~fi t~x~)

160 acres $ 65,306.00160 acres $ 65,306.00

130 acres $ 53,061.5040 acres $ 16,326.50

Page 5 of 5

Tablet (Refurrr tai r~l~fed c~c~curr~erat text)

Tablet (f~~turn to s~~l~fed docur~~ent texf)

160 acres $ 48,979.50

160 acres $ 48,979.50

130 acres $ 39,795.80

40 acres $ 12,244.80

--Table3 (~~turr7,_tc~,rel~tr~~`_ciacumerrt,t~xt)

Tabie3 (~~turi~ to rc~l~i~:~` dc~c~arr~crr~ fie~xt)

160 acres $ 32,652.90160 acres $ 32,652.90130 acres $ 26,530.40

40 acres $ 8,163.24

lr~~~ sat i~tss'~~€aai~3y%

CautionAs of: February 6, 2019 6:49 PM Z

~`

Court of Appeal of California, Second Appellate District, Division Five

May 14, 1973

Civ. No. 39381

Reporter32 Cal. App. 3d 307 "; 108 Cal. Rptr. 318 '"; 1973 Cal. App. LEXIS 983 "`

JACK J. GLUSKIN et al., Plaintiffs and Appellants, v

ATLANTIC SAVINGS AND LOAN ASSOCIATION,

Defendant and Respondent

Subsequent History: [*'"*1] A petition for a rehearing

was denied June 13, 1973, and respondents petition for

a hearing by the Supreme Court was denied July 25,

1973.

Core Terms

trust deed, subordination, seller, lender, modification,

joint venture, partnership, disbursements, funds,

modification agreement, default, loans, trial court,

foreclosure, Borrower, modified, premises,

subordination agreement, consented, recorded, partner,

buyer

Prior History: Superior Court of Los Angeles County,

No. 894932, Edward J. O'Connor, Judge.

Disposition: In sum, we are faced with a trial court

decision based on several erroneous premises of law

and on factual testimony which is marginal at best. We

are not the fact finders. We cannot tell from this state of

affairs whether, given the principles of law set forth in

the opinion the trial court would have reached the same

result. It is therefore necessary that the judgment be

reversed. ~ ~

~***2l

connection between the modification and the foreclosure andconsequently that the modification did not prejudice D-B'ssecurity interest. These conclusions are apparently premisedon the theory that Pathfinder would have defaulted anyway.

Be that as it may, it was the modified agreement that wasforeclosed and it is this foreclosure which, under the trial

court's reasoning, has caused Atlantic to cut off D-B's rights in

the property. D-B therefore has been prejudiced by themodification. We cannot tell what it would have done with its

loan not been modified.

It is intriguing to note that Atlantic itself states in its brief that

"[the] modification agreement itself was conditioned on therebeing no junior lien, so that as far as D-B was concerned,there never was a modification ." That concessionseemingly recognizes the principles which we haveenunciated herein and seemingly makes this entire litigationan exercise in superfluity.

Case Summary

Procedural PosturePlaintiff sought review of the judgment from the Superior

Court of Los Angeles County (California), which held in

defendant's favor in plaintiff's action against defendant

seeking a declaration that the lien of deed of trust held

on lots in a tract of land was superior to the liens of two

deeds of trust held by defendant.

OverviewPlaintiff sold land to a corporation. The corporation then

obtained a construction loan from defendant. In the

transaction between plaintiff and the corporation,

plaintiff received a note secured by a deed of trust

containing a provision in which plaintiff subordinated

priority of its trust deed to defendant's trust deeds.

Defendant and the corporation then modified the note

securing defendants loan to the corporation by an

agreement in which the corporation stated that no one

else had any interest in the premises securing the deed

of trust. Plaintiff then sued defendant asserting that that

modification so prejudiced plaintiff that it gained priority

over defendant. The trial court held in favor of defendant

and found plaintiff, through a joint venture with the

corporation, had knowledge of the modification. Plaintiff

appealed. The court held that whether a joint venture

existed depended upon the intention of the parties from

the facts of the case. Here, the evidence did not support

the trial court's implied finding the corporation had the

authority to commit plaintiff to the modification that was

32 Cal. App. 3d 307, *307; 108 Cal. Rptr. 318, **318; 1973 Cal. App. LEXIS 983, "*"2

undertaken. Accordingly, the judgment from the trial

court was reversed.

OutcomeJudgment in defendant's favor reversed where there

was no evidence to support the trial court's implied

finding that corporation had authority to commit plaintiff

to a loan modification which plaintiff asserted prejudiced

its position as a junior lien holder.

LexisNexisO Headnotes

Real Property Law > ... > Damages > Types of

Damages > Compensatory Damages

Real Property Law > Financing > Construction

Loans

Real Property Law > Financing > Mortgages &

Other Security Instruments > Mortgagee's Interests

Real Property Law > ... > Liens > Nonmortgage

Liens > Lien Priorities

Business &Corporate Law > Joint

Ventures > General Overview

Page 2 of 9

h1~[] Types of Contracts, Joint Contracts

Whether a joint venture exists must largely depend upon

determining the intention of the parties from the facts of

a particular case because there is no certain and all-

inclusive definition to be applied.

Business &Corporate Compliance > ... > Contracts

Law > Types of Contracts > Joint Contracts

Business &Corporate Law > Joint

Ventures > Formation

Business &Corporate Law > Joint

Ventures > General Overview

1#IV3[ ]Types of Contracts, Joint Contracts

Each joint venturer has authority only to bind the others

to contracts reasonably necessary to carry out the

enterprise.

Real Property Law > Purchase &Sale > Contracts Business &Corporate Law > Joint

of Sale > General Overview Ventures > General Overview

tfTi~~["] Types of Damages, Compensatory ~~ Business &Corporate Law, Joint Ventures

Damages ~See C~a/. Ccar~s. ~cad~ ~ 16~0(~~.

Subordination arrangements are in the nature of a

mutual enterprise, wherein the vendor provides the land,

the purchaser the know how and the purchaser's

lending agency the capital, for the mutually beneficial

purpose of developing the land and disposing of it to

provide a fund out of which the vendor is paid for his

land, the lender is repaid its loan with interest, and the

purchaser receives compensation for his efforts and

skill. Because of their nature, the law is well settled that

rights of priority under an agreement of subordination

extend to and are limited strictly by the express terms

and conditions of the agreement.

Business &Corporate Compliance > ... > Contracts

Law > Types of Contracts > Joint Contracts

Business &Corporate Law > Joint

Ventures > Formation

Headnotes/Summary

SummaryCALIFORNIA OFFICIAL REPORTS SUMMARY

The trial court entered judgment in favor of a lender of

construction funds in an action by the vendor of real

property seeking a declaration that the lien of its deed of

trust on certain lots was prior and superior to the liens of

deeds of trust held by the construction lender. The land

had been sold for development of residences and the

vendor agreed to subordinate its deed of trust to those

of the construction lender. It expressly waived any right

to require the lender to look to the application of loan

funds by the developer. As a result of a poor market for

sale of residences, the lender and the developer later

modified one of the promissory notes so as to reduce its

32 Cal. App. 3d 307, '`307; 108 Cal. Rptr. 318, ""318; 1973 Cal. App. LEXIS 983, *'`*2

amount, increase the interest rate, and shorten the

maturity, with a balloon payment at the end.

Construction of homes was postponed, the developer

ultimately defaulted, and the lender purchased the

property at a foreclosure sale. The court found that the

vendor, through both a joint venture relationship with the

developer and direct communication with it, had

knowledge of all of its activities and of the modification

agreement and consented thereto, that it was the

developer's default and not the modification that caused

the foreclosure, and that the modification did not

prejudice the vendor. (Superior Court of Los Angeles

County, No. 894932, Edward J. O'Connor, Judge.)

The Court of Appeal reversed, holding that the record

did not support the trial court's finding of the vendor's

knowledge of and consent to the modification. It found

no evidence of ponderable legal significance to support

a finding of knowledge and consent by direct

communication, and it viewed the evidence as negating

any authority in the developer to bind the vendor as to

the modification, even assuming the parties were joint

venturers. Despite the waiver as to application of loan

proceeds, the court held that public policy requires

protection of subordinating sellers and that a lender and

a borrower may not bilaterally make a material

modification in the loan to which the seller has

subordinated, without the knowledge and consent of the

seller to that modification, if the modification materially

affects the seller's rights. The modification and the

circumstances surrounding it were regarded as clearly

enhancing the likelihood of the developer's default and

the consequent foreclosure. (Opinion by Cole, J., ~ with

Stephens, Acting P. J., and Ashby, J., concurring.)

HeadnotesCALIFORNIA OFFICIAL REPORTS HEADNOTES

Classified to McKinney's Digest

Ll (~ )

Liens § 22—Priorities—Subordination Agreements.

--Rights of priority under an agreement of subordination

extend to and are limited strictly by the express terms

and conditions of the agreement.

~t{[l (2)

Page 3 of 9

Trust Deeds § 39—Agreements as to Priority.

--Though a vendor of real property that had

subordinated its rights under a trust deed executed by

the purchaser-developer to trust deeds in favor of the

lender of construction funds had expressly waived any

right to require the construction lender to look to the

application of loan proceeds by the developer, the

construction lender had a duty to protect the vendor's

security interest when it entered into an agreement with

the developer modifying one of its loans. Public policy

requires protection of subordinating sellers, and a lender

and a borrower may not bilaterally make a material

modification in the loan to which the seller has

subordinated, without the knowledge and consent of the

seller to that modification, if the modification materially

affects the seller's rights.

~~ ~ [l (3)

Trust Deeds § 39—Agreements as to Priority.

--In a declaratory relief action by a vendor of real

property that had subordinated its rights under a trust

deed executed by the purchaser-developer to those of

defendant construction lender, the record did not

support the trial court's finding that the vendor knew of

and consented to a modification of one of the

construction loans under an agreement between the

construction lender and the developer both by reason of

a joint venture relationship and direct communication

with the developer. Even assuming that there was a

joint venture, a provision of the modification agreement

that no one other than the developer had any interest in

the security clearly negated any authority in the

developer to bind the vendor, and, since the agreement

and the circumstances accompanying it clearly

enhanced the likelihood of foreclosure of the

construction loan, it could not be regarded as an act

apparently for carrying on the business in the usual way

so as to constitute the developer the agent of the vendor

under ~ar~~~c~c5t1t~~. Moreover, there was no

evidence of any ponderable legal significance to uphold

the finding of knowledge and consent of the vendor

through direct communication.

Counsel: Graham &James, Leo J. Vander Lans, Don

A. Proudfoot, Jr., David A. Hayden, John R. Hetland

and Anne T. Kneeland for Plaintiffs and Appellants.

Kellett, Oksner &Spada, Fitzpatrick &Wiley and D.

Joseph Spada for Defendant and Respondent.

'Assigned by the Chairman of the Judicial Council.

32 Cal. App. 3d 307, '`307; 108 Cal. Rptr. 318, **318; 1973 Cal. App. LEXIS 983, "**2

Judges: Opinion by Cole, J., ~ with Stephens, Acting P

J., and Ashby, J., concurring.

Opinion by: COLE

Opinion~~~ ~~~~.a~~.~.~~ ~ ,~~ ate.,

[*309] [**319] Plaintiff (a limited partnership,

hereinafter called "D-B") sought a judgment in

declaratory relief that the lien of a deed of trust held by it

on 172 lots in a tract, was prior and superior to the liens

of two deeds of trust held by defendant Atlantic Savings

and Loan Association (Atlantic). The judgment was

adverse to D-B and it appeals.

The issues arise out of a transaction wherein D-B was

the seller of land to Pathfinder Development Co.

(Pathfinder). ~ Pathfinder in turn borrowed substantial

amounts of money from Atlantic for the purpose of

constructing single family residences and allied

improvements on the property. The precise controversy

is whether a modification of one of the Atlantic-

Pathfinder [*310] [**320] loans 2 disturbed the

priority [***3] that Atlantic had by reason of a

subordination agreement or so prejudiced D-B as a

junior lienor that it gained priority over Atlantic. The land

sold amounts to 63 acres. The transaction between D-B

and Pathfinder was reflected in a written agreement.

The basic sales price was $ 400,000. D-B received a

negotiable non-interest bearing promisory note secured

by deed of trust for $ 175,000. The deed of trust

contained a subordination provision in which D-B stated

that it expressly subordinated the priority of its trust

deed to Atlantic's two trust deeds which were "being

recorded concurrently herewith." The subordination

provision further provided that D-B understood that

specific loans and advances were being made in

reliance upon its agreement to subordinate. The

subordination provision further stated that D-B had

personal knowledge of and approved and consented to

'Assigned by the Chairman of the Judicial Council

~ Pathfinder was an original defendant in the action. It

stipulated to judgment against itself and is not a party to this

appeal.

2 The second loan was also modified but not in any substantial

way. This minimal modification is not attacked by D-B. The

trust deed securing this loan may have retained its priority in

any event. (Cf. Carz~en~an v. N~j~ri~r7, r~~ 4 G~I.Ap~.?d E35~

I&2 cal.h{~rr. 6ft71.)

Page 4 of 9

the provision of the loan agreement and escrow

between Atlantic and Pathfinder. Among other things

the agreement provided that Pathfinder was to pay to D-

B as "additional consideration for and on account of the

purchase price of the property, fifty percent .. of all

profits earned by [Pathfinder] from the [***4]

construction and sale of single family homes upon the

property." All funds from the sale of homes were to be

deposited in a trust account to be disbursed over the

joint signatures of D-B and Pathfinder. The agreement

provided that disbursements were first to be made to

pay amounts required to carry the land, second to pay

to D-B the balance on its deed of trust, third to repay to

Pathfinder certain funds advanced by it and "Finally,

additional funds representing profits shall be disbursed

equally to [D-B] and [Pathfinder], except that when it is

known that the project will earn less than $ 400,000, $

10,000 shall be distributed from the trust account to [D-

B]." It was anticipated that construction loans would be

sufficient to carry the project. All costs of ownership

were the sole obligation of Pathfinder and it agreed to

hold D-B harmless from them.

[***5] The general partners of D-B were one individual

and three California corporations. There were a number

of limited partners. In their dealings with Pathfinder the

partnership was represented solely by David Zerner.

Zerner was a lawyer whose practice included many

years of experience in real estate investment. He was

president of one of the corporations which was a

general partner in the D-B limited partnership. He was

the individual who was action on behalf of D-B in

entering into the agreement just described. D-B had

acquired title to the land involved in this litigation by

[*311] reason of a prior investment in the Diamond Bar

area. The main interest of the D-B partners in entering

into the current transaction with Pathfinder was to get

back their investment in the land. There had been a

previous Diamond Bar venture between D-B and

Pathfinder which D-B conceded was a joint venture.

Pathfinder secured two construction loans from Atlantic.

One, in the face amount of $ 1,142,560 was secured by

a trust deed on 44 of the 172 lots; the other in the face

amount of $ 2,426,580 was secured by a trust deed on

the remaining 117 lots. Each note was payable in 30

years. Atlantic [***6] required that its deeds of trust be

recorded prior to D-B's. In the borrower's instructions

Atlantic also caused Pathfinder to represent that no one

other than Pathfinder had any interest in the premises.

The note for $ 2,246,580 was payable in 30 years and

bore interest at the rate of 6 1/4 percent and called for

monthly payments in excess of $ 15,000. The loan

32 Cal. App. 3d 307, "311; 108 Cal. Rptr. 318, "*320; 1973 Cal. App, LEXIS 983, '`*'`6

documents between Atlantic and Pathfinder were all

furnished to Zerner and he looked at them before the

subordination agreement was signed.

[**321] The escrow instructions between Pathfinder

and D-B contained language dealing with subordination

of D-B's deed of trust. 3 Among the provisions was D-

B's agreement that Atlantic had no obligation or duty in

disbursing the loan proceeds to see to their application

by Pathfinder and the further agreement that any

diversion by Pathfinder of such funds would not defeat

the subordination agreement.

[***7] [*312] The controversy in this case comes from

the fact that as of March 1, 1966, and as a consequence

of a very poor market for the sale of single family

residential homes 4 Atlantic and Pathfinder modified this

note in what the trial court mildly referred to as a

substantial and drastic manner. The principal amount of

the loan was reduced to $ 712,530, the interest rate was

raised from 6 1/4 percent to 10 percent, the monthly

3 "Beneficiary declares and acknowledges that he hereby

intentionally waives, relinquishes, and subordinates the priority

and superiority of the lien or charge of this deed of trust, in

favor of the lien or charge upon said land of the deed of trust

in favor of Atlantic Savings and Loan Association, a

corporation, being recorded concurrently herewith, and that he

understands that in reliance upon and in consideration of this

waiver, relinquishment and subordination specific loans and

advances are being and will be made, and as part and parcel

thereof specific monetary and other obligations are being and

will be entered into by third parties which would not be made

or entered into but for said reliance upon this waiver,

relinquishment and subordination.

"The Beneficiary does hereby declare that Beneficiary has

personal knowledge of and does hereby approve and consent

to all the provisions of the loan, escrow and loan agreement

between Owner and Lender for the disbursement of the

proceeds of the loan of the Lender, and further agrees that the

Lender in making disbursement pursuant to said loan

agreement is under no obligation or duty nor has the lender

made any representation that it will see to the application of

such disbursement by the Owner and any diversion by the

Owner will not defeat this Agreement of Subordination as to

the funds so diverted.

"This Agreement contains the whole agreement between the

parties hereto as to the deed of trust loans, and the priority

thereof, herein described and there are no agreements written

or oral outside or separate from this Agreement and all prior

negotiations, if any, are merged into this Agreement."

4 The trial court found to this effect and its finding is properly

grounded in the testimony of a former officer of Pathfinder.

Page 5 of 9

payments reduced to approximately $ 5,900 and the

maturity of the note shortened to 10 months (with a

balloon payment at the end). The modification

agreement contained Pathfinder's representation that no

one else had any interest in the premises securing the

deed of trust.

D-B argues that this change was made "in utter

disregard" of its rights. It asserts that the modification

allowed Atlantic to escape its obligation to disburse

construction funds [***8] and to obtain the property for

itself without having to pay D-B the balance owing on

the sales price. This latter contention is based on the

fact that Pathfinder ultimately defaulted in payment of its

two notes and that Atlantic purchased the property at a

foreclosure sale.

The trial court entered judgment for Atlantic. It found

that "D-B through both a joint venture relationship with

Pathfinder and direct communication with Pathfinder

had knowledge of all of Pathfinder's activities and of the

modification agreement and consented thereto." It

further found that it was Pathfinder's default and not the

modification that caused the forseclosure. It found and

concluded that the modification did not prejudice D-B.

Its conclusions are set forth in full in the margin. 5

[***9] [*313] [**322] We pause but briefly to recite

the law applicable to 9[] subordination

arrangements. They "...are in the nature of a mutual

enterprise, wherein the vendor provides the land, the

purchaser the 'know how' and the purchaser's lending

agency the capital, for the mutually beneficial purpose of

5 "1. The subordination provision in D-B's trust deed did not

condition the priority of Atlantic's deeds of trust.

"2. Atlantic deeds of trust had priority over D-B's trust deed by

virtue of the fact of prior recordation.

"3. Atlantic's deeds of trust had priority over D-B's trust deeds

by virtue of the subordination provision in D-B's trust deed.

"4. None of the agreements or acts of Atlantic subsequently to

the execution of D-B's trust deed containing the subordination

provision in any way altered or affected the priority of Atlantic's

deeds of trust.

"5. D-B and Pathfinder were joint adventurers in connection

with the 172 house project.

"6. There was no causal connection between the modification

of Loan Nos. 15455 and 15456 and the foreclosure of the

deeds of trust securing the loans.

"7. The modification of the two loans did not prejudice D-B's

security interest under its deed of trust."

32 Cal. App. 3d 307, '`313; 108 Cal. Rptr. 318, '`*322; 1973 Cal. App. LEXIS 983, ***9

developing the land and disposing of it (usually by sale;

occasionally by rental), to provide a fund out of which

the vendor is paid for his land, the lender is repaid its

loan with interest, and the purchaser receives

compensation for his efforts and skill. 4 9 [] (1)

Because of their nature, 'The law is well settled that

rights of priority under an agreement of subordination

extend to and are limited strictly by the express terms

and conditions of the agreement. [Citations.]' (Prvinc_ v~

~~~liforr~r~ Gc~ttorr credit ~orp.~. l9 J3T) 7 ~3 Cai.App. ~d

I69 I63 (64 P.2c1 IS2 .)~~ (11~Iiller v, citizens S~v. l.a~t7

,~sst7.,_2~~3 ~~at.~~a~v2d,6~5, ~E?2-5~~~ ~~t,R~?tr.. ~3~~1.)

A perceptive summary of the obligations of lenders to

sellers in connection with subordination arrangements is

set forth in ~li~f~'l~~rc~o~s-,~r7de~r~~rT c~. v. Sr~uthwc~t

~ay. & Lr~~n Ass~~. `1~3 Cat.A .~3c~ 90~`~.~ ~6 *""`

C~°~t.,~~a#r. 3~~3~, We agree with the principles of law set

forth in Middelbrook. 6

We recognize [***11] the vulnerable position in which a

seller who agrees to subordinate his purchase money

deed of trust may find himself. The "strong public policy

reasons" to protect the seller in subordination situations

( !~)idrit~l~raok-Ar~c~~r~an Ca, v. ~c~uthv~est S~v, z~ Lr~~r1

Assn.,... ~upr~~,..... f S C 1;~4~~._3r1 of ~~ _ 036) clearly spelled

out in }~a`~r~d_y v. t~nrcfon~__6, Cal._2c1 _~IS_,~t_~a.__,~1 _j5

~~I.R tr, I69 422 P.~c~ 329 26A.LF~.3c~ 848, do not

need to be repeated here.

The seller's vulnerability has most often been the

subject of discussion in cases where the issue was the

lender's responsibility to see to it that funds advanced to

the developer-buyer were used by the latter for the

construction purposes contemplated by the

subordination transaction. (See [*314] cases

discussed in Midc~lc~arc~t~~. su r~ 9F3 ~~~•!1 .~•3d ~f

4 "'In effect, the seller is assisting in the financing of the buyer's

development and becoming a quasi "joint venturer" in the

project. The safety of his "investment" depends upon the

success of the development, for as soon as the new lien is

imposed on the property to secure the construction loan, the

property is over-encumbered. .. .

s Our agreement with Middlebrook explains why we disagree

with the trial court's second conclusion of law -- that Atlantic's

deeds of trust had priority over D-B's trust deed by virtue of the

fact of prior recordation. As Middlebrook clearly points out ". .

. there is no justification, legal or otherwise, which would call

for a different result whether the seller in a joint transaction

records first and then agrees that this lien will be subordinated

or whether he agrees that the lender may achieve priority

through first recording." (9t3 Crr1.,4~ap.,~c9~t~?03~.)

Page 6 of 9

10)31-1(?~3.) It is in that context that Middlebrook

imposed on the lender the obligations of an implied

agreement that the lender's priority extended only to

loan amounts properly expended for construction

purposes and it is in that context that a seller needs

protection. In Middlebrook (which involved dismissal

after demurrers were sustained without leave [***12] to

amend) the court was concerned with allegations that

the lender voluntarily undertook to control

disbursements from the construction loan fund; that the

seller did not attempt to follow the progress of the

construction or the status of the disbursements because

it relied on the lender's controls, and that the lender

owed a duty to the seller because the lender voluntarily

assumed control of the disbursements, knew of the

seller's security interest and knew that the seller's lien

was subordinated only on condition that loan [**323]

funds were to be used just for construction purposes.

The court held that the loan "under the circumstances"

(1S ~~(.A .3d of `ft?~7) could not be viewed other

than as subject to fair application of the construction

proceeds and accordingly a cause of action arose in

favor of the seller. In the instant case D-B expressly

waived any rights to require Atlantic to look to the

application of the loan funds by Pathfinder. D-B thus

gave up the major protection to which sellers who

subordinate their otherwise prior liens are entitled. ~

[***13] ~ 2 ['] (2) In this light if Atlantic has a duty

to protect D-B's security interest that duty must be

based on considerations other than those involved in

the cases relied upon by D-B (Midcfl~brc~~ilc-,~r]der~r~n

Cc~. v. c~u~hwest S~v. ~ Lain Assn. su ra 98

Cal., ~ .3rf 1023, /~Iit/~r v Cifir_erts S~v. & Lc~~n ~t~sra.

2~1~ G~(.~6 .2d X55 5~ Ccal.#~ tr. X344 ; ~'~c~uni~tl v.

~3~~sv 2~~ Caf=,~ .2c~ S26 4~ ~al,l~ fr. 824 ;Collins v.

f~lvrrre Davin s ~ Loan Assn. 2~5 ~a1.A .2d X36 22

~~I.~;~P~-~~397) since in each of them the lender had an

express or implied duty to the seller to see to the proper

application of the loan funds. We hold that those other

considerations are found in the public policy which

requires protection of subordinating sellers and that a

lender and a borrower may not bilaterally make a

material modification in the loan to which the seller has

subordinated, without the knowledge and consent of the

seller to that modification, if the modification materially

affects the seller's rights. If convinced that there is a

'This case does not present questions related to the

definitiveness and specificity required in subordination

agreements as to the terms and provisions of the loans and

similar matters. (See f-landv v, ~or'dan suar~ 65 C~1.2c~ 573.)

32 Cal. App. 3d 307, "314; 108 Cal. Rptr. 318, ""'323; 1973 Cal. App. LEXIS 983, "'`13

sound business reason for a modification a prudent

seller presumably ably will consent to it. If not so

convinced, he will not consent and will be [**'"14] faced

with no greater risk to his subordinated loan than was

inherent [*315] in the very nature of the transaction. If

dispute results from an unconsented to modification it is

of course a question of fact whether the modification

materially affected the rights of the subordinated seller.

The risk that the buyer-borrower will default in its

obligation to the lender and that a foreclosure by the

lender will follow is, of course, the very hazard to which

a subordinating seller exposes himself by reason of a

subordination agreement. In the abstract, there is no

obligation on a lender to protect a subordinating seller

from this risk. If an obligation to prevent a default of any

sort was automatically created in every subordination

situation no subordination arrangement could ever

effectively accomplish its purpose. But this is not to say

that a lender and a buyer can enter into an agreement

or a course of conduct between themselves whose

result is to destroy a seller's interest. Such an

agreement or conduct if deliberately undertaken would

entitle the seller, depending upon the facts of the case,

to secure relief either upon the ground of fraud or

pursuant to the requirement [***15] of fair dealing

inherent in all contracts in general (see 1 Witkin,

Summary of Cal. Law, pp. 271-272) and inherent in "the

philosophy of fair dealing" ( IV1idclfet~rac~k~Ant~~rsan ~c~.

v~._.~ocitl7wcsP S~v._ Lo~r~ ,Q~~r7., supra, ~8 ~~l.A~p~3~1

~t_,~~ 1037) expressed in N~~~cly, v~ Gr~rdar7a ~cr~r~,r, 65

Ca1,2d ~Ib' and Middlebrook as to subordination

arrangements in particular. $The absence of malevolent

purpose does not itself immunize the buyer and the

lender. If, however innocently, their bilateral agreement

[**324] or conduct os modifies the terms of the senior

loan that the risk that it will become a subject of default

is materially increased, then the buyer and the lender

may subject themselves to liability to the seller if they

proceed without the tatter's consent, and if the seller's

otherwise junior loan is to be adversely affected.

[***16] [~~] (3) Here, as noted above, the trial

e No fraud on the part of Atlantic is claimed in this. Thepossibility that in any subordination situation the lender and

the buyer may so act as to create an obligation on the part of

the lender to the setter explains in part our disagreement with

the trial court's first conclusion in this case that thesubordination provision in D-B's trust deed did not condition

the priority of the Atlantic deed of trust. The possibility ofliability in the event of improper conduct must always condition

the lender's priority.

Page 7 of 9

court found that D-B knew of and consented to the

modification agreement both by reason of a joint venturerelationship and direct communication with Pathfinder.

D-B attacks this finding. As to the existence of a joint

venture, D-B spends a good portion of its brief urging

that there is a difference between the "quasi joint

venture" inherent in any seller-buyer-lender

subordination situation and a standard or classic joint

venture. Of course there is. "Quasi joint venture" is no

more ["316] than a loose description, not a definition of

the relationship between the parties to a subordination

transaction.

D-B asserts that there was no evidence whatsoever of

the existence of a standard joint venture. "H~

Whether a joint venture exists must largely depend upon

determining the intention of the parties from the facts of

a particular case because there is no certain and all-

inclusive definition to be applied." (Nr~ltz v. Unit~c~

,~'Itrrrabin & Ne~tirt Co. 49 C~l.c~ a0t. 5d6 399 f~.2d

6~• )

We need not pause to examine the testimony to see if

there is substantial evidence to support the trial courts

finding of the existence of a joint venture (***17]

because it is clear to us that there is no substantial

evidence to support the implied finding that Pathfinder

had authority to commit D-B to the modification that was

undertaken in this case. Assuming the existence of a

joint venture, 3[ each joint venturer would have

authority only to bind the others to contracts reasonably

necessary to carry out the enterprise. (E.g., Med~k v.

Cow, 92 C~f~~.3d 7U, 76e~9t? CG~l.~tr. ~~~ and case

cited.) The applicable statute is #-1[] Cor~arar~tiQns

o~`~ sec~i~r7 15~JD9 which provides in relevant part: °(1)

Every partner is an agent of the partnership for the

purpose of its business, and the act of every partner,

including the execution in the partnership name of any

instrument, for apparently carrying on in the usual way

the business of the partnership of which he is a member

binds the partnership, unless the partner so acting has

in fact no authority to act for the partnership in the

particular matter, and the person with whom he is

dealing has knowledge of the fact that he has no such

authority. (2) An act of a partner which is not apparently

for carrying on of the business of the partnership in the

usual way does not bind the partnership unless [*'""18]

authorized by the other partners. (3) Unless authorized

by the other partners or unless they have abandoned

the business, one or more but less than all the partners

have no authority to: (a) Assign the partnership property

in trust for creditors or on the assignee's promise to pay

the debts of the partnership. (b) Dispose of the good will

32 Cal. App. 3d 307, *316; 108 Cal. Rptr. 318, "'`324; 1973 Cal. App. LEXIS 983, '""`18

of the business. (c) Do any other act which would make

it impossible to carry on the ordinary business of apartnership...."

It is noteworthy that the modification agreement

provided in part "Borrower expressly represents, and

this agreement is executed by the Beneficiary and is to

be effective only upon the condition, that the premises

described in said deed of trust are subject to no

encumbrance subsequent to said deed of trust and that

no one other than the Borrower has any interest in the

premises securing said deed of trust; except: no

exceptions." This [*317] language appearing in the

bipartite agreement between Atlantic and Pathfinder 9

could be read as negating the existence of a joint

venture. We need not further inquire into this question,

however, because in any event the language is a clear

negation of any authority in Pathfinder [***19] to bind D-

B. The only evidence of which we are aware which

[**325] could possibly be construed to support a

finding that D-B consented to Pathfinder's acting for it in

connection with the modification agreement is found in

Zerner's testimony set out in the footnote. ~ o

[***20] Zerner expressly testified that D-B did not

consent to the modification and that he would not have

9 Similar language appears in the borrower's instructionsearlier executed by Pathfinder to Atlantic.

~~"Q After the transfer of the property from D-B to Pathfinder,

what part did D-B play in making any decisions regarding the

project?

"A Nothing. The funds came out of the sales. I mean, I had

that agreement, you know, that they wouldn't take the money

which I felt, you know, to be sure I got my money out first.

"Q What about as far as making any decisions?

"A I don't know anything about that.

"Q I take it then you were leaving all the decisions in that

regard to Pathfinder?

"A Absolutely.

"Q You were satisfied from previous dealings with Pathfinder

that they were competent and would act in the best interests of

the project?

"A They are experienced builders.

"Q Were you satisfied with their competence?

"A Yes.

"Q Were you satisfied they would make the correct decisions

in your behalf?

"A Yes, I left it to them."

Page 8 of 9

approved it if he had been consulted about it. He alsotestified that Pathfinder was competent to do the project

but not to decide what should be done as far as D-B

was concerned.

Pathfinder's consent to the modification agreement is

clearly at the very least "[an] act .which is not

apparently for carrying on of the business of the [joint

venture] in the usual way....° (Cr~rt~. ~oc/e, ~ 15tJt79,

scrod. ? .) Atlantic suggests to us that implicit in the

agreement between Pathfinder and D-B was an

agreement that houses would not be constructed if they

would not sell. Since a representative of Pathfinder

testified that at the time of the modification it was

contemplated that construction on the tract covered by

the modified trust deed would be postponed, Atlantic

argues that the poor climate for selling houses makes

the decision to postpone construction a reasonably

necessary one, and one within Pathfinder's authority.

We do not agree. The postponement, coupled with the

tremendously shortened term of the loan and the very

large balloon payment due at the end of that term,

clearly [***21] enhanced the likelihood of a default by

Pathfinder and the consequent foreclosure.

[*318] The court also founded that by direct

communication with Pathfinder D-B had knowledge of

Pathfinder's activities and of the modification

agreements and consented thereto. We have examined

the portion of the transcript relied upon by Atlantic to

support that finding and find that there is no evidence at

all of any ponderable legal significance to uphold the

finding.

In sum, we are faced with a trial court decision based on

several erroneous premises of law and on factual

testimony which is marginal at best. We are not the fact

finders. We cannot tell from this state of affairs whether,

given the principles of law set forth in the opinion the

trial court would have reached the same result. It is

therefore necessary that the judgment be reversed. ~ ~

~~ The trial court also concluded that there was no causal

connection between the modification and the foreclosure and

consequently that the modification did not prejudice D-B's

security interest. These conclusions are apparently premised

on the theory that Pathfinder would have defaulted anyway.

Be that as it may, it was the modified agreement that was

foreclosed and it is this foreclosure which, under the trial

courts reasoning, has caused Atlantic to cut off D-B's rights in

the property. D-B therefore has been prejudiced by the

modification. We cannot tell what it would have done with its

right of reinstatement (Civ. Code, § 2924, subd. (c)) had the

loan not been modified.

32 Cal. App. 3d 307, *318; 108 Cal. Rptr. 318, **325; 1973 Cal. App. LEXIS 983, *'`*21

~***22~

Page 9 of 9

It is intriguing to note that Atlantic itself states in its brief that

"[the] modification agreement itself was conditioned on there

being no junior lien, so that as far as D-B was concerned,

there never was a modification ." That concession

seemingly recognizes the principles which we have

enunciated herein and seemingly makes this entire litigation

an exercise in superfluity.

about:blank

Caukio«As uf: Fcbronry C, 201 7:34 PNI Z

Senior Transeaste~-n Lenders v. Of~eial Comm. of Unsecured Creditors (Iri reTOUSA, inc.)

LTz~~itEd States Curt of Appeals !o~• Cl~c~ ~lecenth Ciz•cuit

M~iy 15, 2012, Decided; May I5, 2012, Filed

No. ll.-1.1071

Reporter

C80 F.:~d 12)8 *; 2012 U.S. App. LEXIS 9796 **; 67 Collier F3aukr. Cas. 2d (ME3) 1035; Bankr. L. Rep. (CCH) P£32,276; 5(i

Ba~ilcr. Ct. Dec. 135; 23 Fla. L, Weekly Fed. C 1042; 2012 WL 1(73910

[n r~: 'I'OUSA, INC., et al., Debtors. 51NIOR

"17:21~NSI:;AS'I'[:iR:N 1:.,Ei,N:U[.;TtS, l:)efendant -Appellee,

CI'i"CU12P NORTTI AMl-RICA, TNC., C};RTAIN

1~IRST I..IF;N'T'£~,RM I.,I~;NDF.,RS, Int~;rven~~rs

Appellees, vertius OF1'T(~IA1., COM:M:I I.̀.1'1:;I; OF;

UNS1;C[TRI->I) CRLI)T"TORS, T'IaintiPf - Appell~t~lt.

Pa•ior llistot•y-: [**1J Elppeal i~roin the United States

17istrict Court fir the Southern I:)ish~ict o£Plot•ida. I).C.

locket Nos. 0:10-cv-E2035-ASG; 0:08-hkc-10928-

;1K0.

3V Capita]. Master t~und T.,id. v. OPf~iai~ll Coixnn. oC

Uusecui~ed Creditors of Tousa, iiac. (In re "I'o~rsa, Izic.),

44~.Ii.R (13, 2011 t1.S. Dist. L] XIS 14019 (S.D. I'la.,

2011)

Official Cox»m, oEUnsecurea Creditors of~Cousa, Ix~c. v.

Citicoi-~~ N~. ~~n., Ina (In re "1"oasa, li~c.), 422 E3.It. 7$3,

200)13ankr. LI~XIS 4355 (I3ankr. S.l~. Fl~i., 2009)

llisposit~iou; R1iVI;RSI3D AND IZI~MANDk;[~.

Core Terms

1.,euclers, Subsidiaries, Uaukruptcy court, Conveyiu~;,

liEns, district aottrY, l~cnEtits, t~~nsfin~~d, entities,

seltlexa~ent, equivalent value, fiizads, znsolvent,

Conditioni~lg, revolving, joint venture, tiu,aucin~,

percent, proceeds, housing, issue~, bails, proceedings,

def~ttlt, z~atin~s, Eiaudtilez~t t~~nsf~z•, hoxnebuildiizg,

obli~;atic~ns, renied~ies, advisor

Iu an adversary action, the bankruptcy coiut avoided a

transfer of liens by debtor subsidiaries, to seclu•e

payailent ol~ a debt owed h}' another d~bloa~, lhe:ir parent,

as 1~xaudulenC timder 11 U.S,C.S. § 548. '1'hc l)nited

States Dis~r~ct Court Eor the Southern District of l~lorida

quashed ihe; bankr~iptcy court's order. The transferees

appealed. 'I~hc ansect~red credit~c~rs' coinniiltc~ aE~pe~~led.

Overview

1'lic stibsicliari~s otivn~d most of~ Che enterprises assets

and generated virtually all of its re:v~mie. During a

husi~less do~ruturn, the I.~arc;nt conlpu~y paid a X421

million s~ttleiu~~nt Co the h~FinsfErees with loin ,proceeds

fi-otn ne~~~ lenders seeurecl px•iauarily by tl~e subsiclaa~•ies'

assets. Six mouths later, the ~arei~t company ai d

subsidiaries filed for bankruptcy. The soinmitt~;e

chime<t the subsid.ia~•ies' t~•a~~asFer of the lietls fn the netiv

lenders ryas fraadrrleni under l ] j1.S.C.S. § 548(a)(I)(:13)

because the subsidiaries ~~rcre insolve~~t when the

tr•~nsfer occul~•ed, were made insolvent: b}~ the trantifcr,

.had tm.rcason<ibly small capital, or were unable to pay

thci~~ debts when due; and did not receive reasonably

equiv<<l~nt value in exchange for the transfer. Inter alia,

tl~e appelltrte cc>urC I~el<J th~it bankruptcy court did not

clearly erg• when it found that the sulasidiaries did not

receive reasonably equivalent v11ue fir the liens and

ruled that tk~e iranst'~:rees were entities "[i>r whose

b~ucfit" the lie~~s were tran5ferc~d. Finally, [he aJ,~pcllate

court would not consider, in t11c first instance,

ch~ill~;nges Yo rern~di~s the bankru~~tcy court irnpased yr

issues oP judicial <~ssig~ninent~ pr consolidation ~>t'

proceedings.

Case Sum►nary

Procedural T'osh~e~e

"Che ttpk~ellate court reversed chc judgment c~f~ ilie district

court, a~fCrrned the liability findings of the bank~-upfcy

2 of 17 2/6/2019 11:34 AM

about:blank

G$0 F'.3d 1298, x`1.298; 201 ~ i.]~.5. ApP. T.,I:'..X~IS 97g6, *~" 1

court, and remanded for fiutlier proceedings a~nsist~nt transfer whioh confers an economic benetlt t~~~on tl~e

Gvith fins opinion. debYar, either directly or itidirecYly.

LexisNexis~~) Heldnotes

Ba~ikruptcy I.aw =~ ... =- A~roiiiaiic~ ~ fraudulent

Tr~nsf'ers % Vahie

HNI ~ ~ I1 ruudulent Transfers, Vailue

"Value" is destined in 11 ZI.S.C.S. S 548 tis being

property or sat~isfactio~l or ~~:curing of a prese:nt~ or

~r~tecec~eyit debt of the debtor. 11 tJ.S.C.S. §§

548(~)(~)(~)(i), (~)(~)(n).

Bankruptcy L~n~~ % ... =' Avoidance > Fraucttilent

Tr~risfers > Value

fI[\~2['] rrnucluleut Trsinsfers, Vfllue

Tli~ mere opportunity to receive an ecouornic benefit ire

the fuhire constitutes "value" cinder the B~nlcruptcy

Cocie.

]3aaikrri}~tcy ]:.aw > ... > ,~1~roidance; > 1^'r<iudulent

'[1~ansters> Value

HN3[ ~~ li`ruudulent "1'rausfers, Valtae

"["he correct ~x~ay to determine ~r<sli.Y~; is not to define it

only ii1 terns oP tau~;ible propc.ily or marketable

lu~zuici<<l v~~luc, bttt instead t~> e:taini~~~ all aspects ~~f the

transaotinn and eareflrlly ulcasure the ~raluc cif all

benefits and Unrdc.ne to the: debtor, direct or inciir~ct,

iaacl~xcli~~~ inc~irect~ ~co~~omic beu~:fits.

I31nk.iuptcy La~~~ > ... > Avoidance % Frauduleril.

Transfers > General Qver~~ie~v

FIN4[~] A~~oicla~ince, Fr~adulent'P►~ansfe~•s

11 [I.S.C.S. ~ S48(~} does iaot auth~ariz,c voiding a

Banl~ntptcy La~v %Procedural Matters > Judicial

Kevie~,ti~ > Bvil~~uptcy Appeals Procedures

I3aiilnitptcy Law > ... ~ Judicial Review > Staudarcls

of Revie~~~ -> Clear En or I2eviejv

H~'VS[ ] Judici~il Revie~~~, Bankruptcy Appeals

Praceclures

As the second court to review the judgment of tl~e

baiilu-uptcy court, ari ~ppell~te court re~~iewa the order of

tl~e bankruptcy court independently <~f tl~e district ccnut.

The 1~pellate ec7urt retiriews de.terminatic~ns c>f ]~~v made

by either court de uovo. An appellate court reviews tl~e

findings of fact of the banl.~uptcy court for clear en•or.

Tlie fncfual tlndinrs of tl~e bankruptcy court are not

clearly erroneotiis unless, in the light of all the evidence,

ti~ve are left with the detiriite and Firm com~ictioil that a

mistake has been made. Neither the district ec>urt nor tl~e

appellate court is ~tiithorized fo make independent

fach~al finduigs; that is the fiinetiori cif the b1t~~u~tcy

court. An appellate court. reviews equit~iUle

delernlinalic~ns of lh~ be~ril:ruptey ec.~url fear abuse of

discretion.

13an.kiupcoy I.,aw % ... > Avoidnncc, > F'rairdulei~t

Transfers > L;]cmenCs

IING[ .~ l~a~atulule~~t'1't•~nsfcrs,l?,lezneats

1l. U.S.G.S. § 548(t~)(1)(B) of the I~~zakniptcy Code

px-ovides for ll~e- avoida~icc of any transfer of an int~er~*sY

of tliv c~ehtor in 1~>r~~perfy, or z~uy oi~ligation incurred by

Che debtor, that was ~n~de or i~lcurrad within two years

b~Porc the date of the citing of the bankriiptc~~ ~~etiticm, if

the debtor recei~~ed less thaai r~;i~son~ibl_y egtrivalcnt

value in exeh~n~e Yor the ti•ansFcr or obligation, Find t1~c

d~;bior (1) vas i~i:;o(v~nt on ttte d~rte such tr<insfcr 4v~~s

~~~ade or s~~cli obligatio» ~~~as incurred, or became

in,olvcnt as a result of Such tir~jusler oi• obligation; (2J

was en~ag~d in business or ~ transac[ion, ar ~~as about

fio engage in business or a trz~a~sactic» ~, for which any

~~r~perty cei~iaiirii~g with the del>far ~~~~s an unreasonably

smell capital; or (3) inten~lecl to incur, ar• believed that

Page 2 of 16

3 of 17 2/6/2019 11:34 AM

about: blank

C,$0 l~.:id l?98, *1298; 2012 i1.S. f1pP. T_,I.~;~CiS 979(, **I

the del7tor ~~oulcl incur; debts th~Y ~~roulz~l be beyond the

debCor's ai~ility to pay ~s stick deUts mah~red. 11

iJ.5.C.5. ~ 5~8(a)(1)(B)•

Baiilcrul~tcy Lair > .,.:> A~~oidance ~ Fraudulent

Transfers =~ General Overview

HN7["] Avuid~nc~e, Fraudulent Trnnsfe~s

The piu~pose of voiding transfers unsupported by

reasonably equivalent value is to protect credicoi:s

agairisk Che ~1el~letion of ~ baytkiupt's estate.

Bankruptcy :C,a~~~ > ... %~ Avc>idancc > Ft~ancl~ilent

"I"ransfers => General Overview

HtVB[""J rArotdnnce~, I~raudulent'I'~•~~~sfers

A banlavptny courk ~is entitled ko find that the benefits ot~

a transaction ~~~ere. iiz~k reasan~ibly ec~uivalcnt in value. to

what vas surrendered.. It leas Ic>n~ been cstablisl~ed that

whet~hca• Lair consideration lass been given for a transfez•

is 1~3rgely a question of~ far-t, as to ~vl~iie-h cc~r~sitlexabl~

la~ti.tude must b~~ allowed tip the trice• oL tl~e ~~aci~.

I3anluuptcy Law > ... y Av~idanc.e > 1"r<~udulent

1'r~uisfers > G~z~u~•~tl. Ovetvae~v

l/;V9~,~f .flvoiclr►nce,.I~rriudulent'.Ci•:insfers

-~ corpoaation is n.ot ~l bic>logica] entity for which it can

be jzeesinned tl~~t any act whioh extends its existence is

beneficial to it, In other words, plot every h~ansfer that

decreases the adds of b~~~k:rnk~tcy fur a cc~rpc~ratiou can

be justifi.cd.

}3nnkruptcy Lt~w > ... > Avoidance > Pr~uduleut

'Transfers y C~enerul O~~ervie~v

13aultruptcy La~v %~ ... > Avoida~ice > F~ra~tdtilcnt

Transfers > Value

H~V~O[~ ~voi~anc~e, Fr.~uci~lent Transfers

The oppc~rfunit5~ to avoid bai~kr~tptcy clues nc>t tine a

coanpany Y~ pay any ~ai•ice car Ue1r any Utitrdcil. After a11,

(here is iio reason fo treat bankniptcy as ~ boge~nu~~n~ as

a I.'ate wof•se than death.

Banluuptcy La~v %• ,.. > ,Avoidance > Fraudulent

Transfers > General Oveivie~~-~

HA'll[] Avoidfl~ce,FrauclulentTransfecs

It~ a transfer is avoide~! under 11 U.S.C.S. § 5~~ or one

of several other provisions of the Banla•u17[cy Gode, I 1

U.S.C.S. § 550(a)(1) allows flee recovery of the property

transferred or its value from the initial transferee or

from an entity For whose benefit such ki~ansYer was

made. 11 LJ.S.C.S. § 550(x)(1).

T3ankr•~iptcy I.,arr > ... > ~~~oidauc~ > f~ra~ichtle~~t

'Transfers > G~ne~~al Overview

I3anki~i}~tcy Law > Instate

Property > .~~voidance > TraL~isfaree L.i~bilities &

Rights

I/iVl2[] Avoidance, I~'r•audulent'Tr:insfers

'Tlle paradigm case of a bene~~i tGnd~r 11 L1.S,C..S. §

55~(a) is the benetii to a guarai~itor by tha payment o#~

the i~nde~~lyin~ debt of the debtor. The guartYr~t~or

reaei~~e~ an immediate lieneiit when t~hc ciebi<>r pays

back a creiiitot•, ~n-l~ich reduces the liability of~ fhc

~;u~u•antar. Althcnigh the, relati~>nship may he the

~.7araclignaatic case, It is not the Duly ciroumsta~lc~ t~l~at

can give rise to "far ~~~hose bcncfit" lis~bility.

PanlinipTcy I.aw > ... > Preferential

`I'rttnsl:ers > t:lcr~~eufs > Ge:neral Overview

I~NZ3[~'~,] P~•eterenti~l'l'ranst'ers, F,leinents

1'lic transfer of a security interest canstittites air

<tvoiclable pref'erenee under 11 ti.S.C.S. ~ 547(b) where

it ~~~as a trausfcr of property of the dcbtnr to 1 c;reditc.n•

wi[hui 90 days of 1i ling for t~ank:ruptcy that provided

1nor~ val~~e to the creditor than it would kiave receis~ed

tu~de:r el~a~7ter 7 ofthe Bankruptcy Code.

Page 3 of 16

4 of 17 2/6/2019 11:34 AM

about:blanl<

C~iO F.3d 1?98. *J.29R; ?012 iJ.S. /lpp. T.;.f'3C.iS 9796, ~* 1

Bankniptcy La~~~ ?EstateProperly > Avoidance > Transferee Liabilities ~C.

Rights

HtVl~l[` ] Avoidance, T►~~nsferee Liabilities &

Rights

"I71e text of 11 IJ_S.G.S. ~ 550(x)(1) a]I~ws the tnisC~e io

recover from ~ creditor tivhen it was an entify for whose

benefit ~ transfer tivas m1de.

k3F~aikiul~tcy La~v > IwstatcProperty ? t~voidance ?Transferee T.iabilities &eights

IL'VZS~ J Avoidance, 'I'r.insfe.ree I:.iabilitics &

Ri~lits

Cntuls must amply a very 17exibie, ~t~agu7titic test thatlooks beyond the ptu-ticular h~1ns~Ers in question to the

entire^ circ~tmst~~nc~; c7f the trt~nsactiox~s ~t~hen d4ciding

v~~hethex• clebtc~x•s controlled a7ro~~e:rtiy later sought by their

trustees.

Civil Procedure > /-Appals >.Reviewability of

Lover Court Decisions > Preseivatioli for Review

Civil Procedure > Appeals ~ Remands

HNIG[~'~.~~ Revicwabilit~ of Lower Court Decisiot►s,F'resetv.iticrn for Review

nn appellate court «gill trot address an issue that the

district court has ti~~t yet consiclei•ed. When the district

court does clot address an issue. it Dismissed as moot, the

~7roper course of action oFten is to vactitc tl~e ~7rder o:C~the

disti~i~t court and remand.

Caunsel:.1~or SENIOR TRANSI~AS`I'GRN LENDERS,

Plaintiff- Appellee: Geci Beat~ititi, Dan~en D. t~a~•I~i~rie,

1-'o~~~lcr White Bobgs, 1'n, "f'[1:MPA, F'[.; Andrew N1.

Leblanc, Nlilhnnk T'weea II~tdley & McCloy, LLP,

WASHNGTQN, DC, Nancy A. Capperkli~vaite,

Akerm~n SeuYerCtt, I:,I_,P, MIAMI, ~~[,; Michael I.

Goldberg, Akerniau Sentcrfitt, LLP, 1~nK7'

LAUDF;RI)AI.,I, I~•'L.; Stel7hei~ M. I~lertz, laaegr•e F3aker

llaniels, LLP, MINNEAPOLIS, MN; ACa~•~ Miller,

Crabri~~lLe I.yun Ruha, Milb~artk Tweed II~ciley

McCloy, [.,I.:l', Nl~;w' YOItK, NY.

l~or Cl'I'COR:[' I~T01~T1:~] r1M1;IZTC~1, INC., C•F+:ItTAINFIRS"I~ LIEN ̀['Ii;RN[ I.,E~;N1)J;I2.S, I,titccv~iaars

flppellees: '1"homas J. Hill, T}iomas J. McCor~ilaek,

Seven Rivera, Chddbotti7~e &Parke, T_,T.P, NEW YQRK,

NY; Richard C.1'rosser, Stichter Riedel 131~tin &Prosser, PA, TAMPA, FL.

I~or SIiCOND LIEN AYPI;LLEIN'1'S, Iutetvenor -Ap7.~ellee: Evan Daniel Fl~schen, Raynor NI. Cann~tn,

Gregory W. N_yv, Bracewell & Gitili~ni, I.LP,

HAR`I .t~C):E~:l:?, L"l~; Sec~tti 1,. Bti~~~a, Jel7'i~e}~ 7:rc~ Snyder,

~3ilzici Swnbe! g Baeila Price &Axelrod, LLP, MIAMI,

FL; .Tusti» 13reCt Busby, Bracewell & Giulilni, I.I,P,

For TRILQGY PORTI=OI~IU COMPANY, ['"~2~ LLC,

[nte~venor - n}~pellec: Yl~ilip Korolo~as, r;ric k3renner,

Boies Schiller S; ~~lexner, LLP, NLW YORK, NY;

Jennifer G. Altrna~~, Stephen N. Zack, Boies Schiller &

I~'lexner, I,I.,P, .MIAIv[l, FL.

I'ar UL'1~ICIAL COMMI7"IEiE (7TH tINSL"-CLII2~D

CR1~,DIT~ItS, Defend~mt -11}~pellaTzt: I.,awrez~ce S~iul

Robl~iiis, Nl~i~k A. Biller, Donalcl J. Russell, Michael I.:.

W<~ldntati, I2obbiias Russell l?nglert Orseck t)ntereiner

8c Satrber, LI,P, We1S]-~1NG'I'QN, D~.'; David C.

7'ollcick, P~Ltricia Ann Kedinou.d, Stcc~~s Waver Mtller

Weissler All~adeff'& Sifterson, i'A; MIAMI, FL,.

I~orNt11'IONAL ASSOCIA"1'IQN OI~ F3A~II<Rt_~P"]:'CY

IRtISTE ES, Aizlicus Curia: ChrisCopher J. V~,'right,

}~arris Wiltshire; 8i Cirannis, I.I..I', W~ISHINGTON, DL.

I~orI3ANKItL7YTC1' SCHOLARS, AmictGs Ciuiac~:

James $. Heaton, Ashley Coux~d Keller, Bartlit t3eck

~Ierauarl:Pal~ucl~ar &Scott, [,I,1?, C:HICAGC), II,.

l~or'1~1-I1; LOAN SYNDICn'1"IONS AND 7'RAI)ING

/1SSOC[i1'] I(.)N, Ainicus Curiae: "I~homas M. Mess~n~i,

Iviessana, PA, PORT Lr~I.7DLRDALL, F~L; Elliot Canz,

Tlie Loan Syr~dicatians anct Trading Association, NEW

1"ORK, NY'; Mark. A. M:cDernu>tt, (icor~;e A.

Limmerm~n, S~fidden Arps Slate Nlcfighcr c~ 1^loin,

l I,P, NEW YQRK, NY.

Judges: Selore -I'J()FI:AT, PRYQR 1Gtd FAY, Circuit

Judges.

Page 4 of 16

5 of 17 2/6/2019 11:34 AM

about:blank

6801~.3d 1298, *1298; 2012 il.S. App. I.,I~.~{iS 9796, **2

Opinion by: PRYOK

Opinion

[~ 1301] PRYOR, Circuit Judge:

This barilu-uptcy appeal in~-ol~res a transfer of liens by

subsidiaries [*~3] of TOLJSA, Inc., to .secure the

payment of ~ deUt owed only by their p~Yrent, TOi.1SA.

Qn Jii1y 31, 2007, TOLJSA paid a settlement of $421

million to the Senior Transeastein Lenders with loan

proceeds from the Ne~t~ Lenders secured primarily by

the assets of several subsidiaries of TOUSA. Six months

later, TOLJSA and the Conveying Subsidiaries filed for

b~t~uptcy. In an ldversary proceeding filed by the

Committee of Unsecured Creditors of TOUSA, the

baiilcniptcy court avoided the liens as a fraudttlent

transfer because the Conveying Subsidiaries did riot

receive reasont7bly equivalent value; ordered the

Trinseastern Lenders to disgorge $403 million cif the

loan proceeds because the transfer of the liens was for

the Uenefit of the Trinseastem Lenders; and fl~varded

damages fo die Conveyvig Subsicjiaries. The

Trinse~stern Lenders and the Ne~~~ Lenders, as

intervenors, appealed. The clistriet court c7uashed the

judgment 1s to the Transeastern Lenders and stayed the

appeal of the Ne~v Lenders. This 1ppeal Uy the

Couimittec of Lhisecured C,reditot:s presents t~vo i5sucs:

(1) whether the bankruptcy court clearly erred ~~,~Ilen it

found that the Conveying Subsidiaries did not receive

reasonably equivalent value in exchange ~*'~4] for fire

liens to secure loans used to pay ~ debt o~vea only by

TOLJSA, 11 IJ.S.C'. §5~8; and (2) ~~~hether the

Trinseastern Lenders were entities "for whose benefit"

the Com-eying Subsidiaries h•~nsferrea the liens, 11

U..S.C. § 550(x)(1). We hold that bankruptcy courk slid

not clearly err when it found that the Conveying

Subsidiaries did not receive reasonably equivalent v11ue

fc~r the liens and that the b~nlcniptcy court correctly

rtGled that the Ti•anse~stein Lenders «sere entities "fog•

whose 1~enefit" the liens ~~>ere transferred. We reverse

the judgment of the district court, ~ffu•m the lilbility

i`uiduigs of khe barilcnrptcy court, ~n~l remand for Further

proceedings consistent with this opinion.

I. BACKGROUND

VJe divide oiu summary of the events tl~.at led to ibis

appeal iii[o three parts. We ~irsC recount the uncontested

t<icts that underlie this appeal_ We then review Yh~

iudinbs of fact and conchisions of law of Ulc

bat~•uptcy c~~urt. P'iil~lly, eve review the decision of tl~e

distx~icl court.

,~4. f~iicl~~al13ac7cgroriy~c~

As of 2006, "1'OUSl1, ]nc., ~~as tUe thirteenth largest.

homebuilding enterprise in the country, with operations

in Tlorida, Texas, the mid-Atl~utic states, and the

~vesten~ United States. T(~ie coi~lpluy ~**5~ I~ad gown

z~piclly, cliicfty by acgturi_ug independent hoivebuildcrs

that became subsidiaries of "I'OLTSA. These subsidiz~~iet

oti~vned most oFtl~e assets of the enterprise and generated

virtu<~lly gill of its reveizue.

To finance its gi•o~vth, TOUSA bono~~,~ed a lot, TOUSA

issued i,nore than ̀ ~l billion of public bends. "I'ha# ct~bt

vas unsecured, but ~~~as gu~iranteed by tl~e Conveying

Subsidiaries. TULJSA also bon•o~~ed funds under

revolviu~ line oP credit agree~ueut ldminist~reci by

Citicorp Nort11 America, Ine. "l he Conveyin.

SuUsidiaries and 'fOUSA ~~~ere .joi~itly as~d severally

liable :tor repayment of the revolving 1oau, wliicl~ ~t~as

secured by lie~is on flee assets of the compluies, Bc>th

the bond debt and revolving loan agreements provided

that an adcrerse judgment for more than $10 million

agai~~sl "I'Oi.ISA or any ~~~f its subsidiaries oc a

bankruplay Piling by TOUSEI or any of its subsidiaries

would constitute an event of defatitlt, which ~vou(d

permit the baadholders and Citicorp to decllre ~Il

outstaiidinb aniounYs of debt due immediately. As of

July 31, 2007, TOLISA had 1pproxuilately 51.061

billio~~ of ~~rinci}~~1 [ * 1302) outstanding on its bo~~d

ciobY and X224 milli~>n o~iY~Stauciing ou its revolving loaia.

Tu .Tune ?005, "I'OUSA entered a joint ~**C] venture

witi~ F'aloonG/Ritchie :L,L,C to acquire l~o~vebuilding

assefs o«~ned by Transeasteni Properties, [nc., in

Florida. TOUSA incuzz•ed tnore debt, this time from the

1'ransc~slern benders, to fiu~d the "I'rauscastcr~~ Joint

VenCure, Uul none of the Conveying Subsidiaries

becataie a~i abli~or or guaranCor of the Transeast~a~n debt.

The downturn in the lousing market soon tlu~eatened the

"Tr~nseastern Joint Venhtre. By October 4, 2006, the

Joi~ak venture had d~f~ultecl nn several obli~atiotas. At

Page 5 of 16

6 of 17 2/6/2019 11:34 AM

about:blank

c,Ho r.~a 12~s, * t_,o~; 20 2 u.s. n~p.1.~-.ors ~~~~c, ~*c

the end of that month, the '1`ranseastern Lenders allcgc~

defaults end <lem~nded payment from 'TOtJSA. In

I~ecetnber 2000, the Transeastern Lenders sued

1'O[JSt\, aiicl .iu. Jlnuary 2O07, tl~e "I:'ranscastcrn L,end~rs

alleged that TOUSA ~~as responsible for damages oi'

nve~ $2 billiaii.

Ou hily 31, 2007, TOUSA executed settlements ~viCh its

partilei° i» Ylie joust venture and the 'Tx~ansenstern

I_,enders. '1~he settlements ~~equir~d '1~OL1SA to pay snore

than $42l iniliioi~ to tl~~ 1'raneastern Lenders. '1'0

(~ivance the settlements, `I'C)iJSA end some of its

siibsicliaries inc~iared new d~t~t. Citicorp Narti~ nnacaic~,

Inc. agreed to syndicate hvo new tC1711 ~08t1S t0 I~OUSA

and ehe Conveying Subsidiaries: a $200 ~~~iilion loan

lio~~a the First I.,ie~a. Lexaders, to be sec~~red ~~*7~ by

first-priority liens <>n il~e assets o:l the Con~~eying

Sut~sidiaries and "1'OUSA; and t} $300 million loan from

the Second l ~ien lenders, to b~ secured by secoud-

priority ].leas. I3c~th loan. agreements with il~cse Nety

L,~uders required that tl~e funds Ue tiisecl to pay the $421

~Uillion setfl~inent with ttie 'lr~nselstern I,~nders.

TOLJSA also aan~udecl its revolving credit agreement

with Cificoip.

'Ihe trans~iction vas executed iu several Parts. Fizst,

Citicorp transferred $47G,418,784.~0 to ilniversal Lair

'Title, Inc., awholly-owned subsidi~cy of TOUSA that

vas i.~ol <>z~e c>f the Couvey.i.zig Subsidiari4s. lJniversa]

I.;aud'1'iUe then sent a wire transfer of X426,383,828.08

to CIT, the admiiiistr~tive agenC for the Transeastern

benders. CTT disbursed the k~roceeds of that transfer on

July 3l and August 1, 2007. "['he `Cranseaslcrn I.,enders

mceived 5421,015,089.15 and the remaining funds were

dispersed. to third parties to cover p~~ofession~l, ~idvisory,

and okhec fees.

B. 13anl~rz~ptcy C:oiir•t Proceedings

Six moisths later, "I'Oi.TSA duel Clue Conveying

Subsidiaries filed petitions for bankruptcy under

Chapter 11. The Comrniltee ot~ Unsecured Creditors of

":COiJSA, nn behalf of the estate of "!'OUSA, Itrtca~ filed

an adversary proccedinb against [**8] the Ne«~ Lenders

and tYie Traaiseastern I.eilders to a~'oid ~s a fa~a~idYrletrt

transfer, see 1 1 U.S.C. § 548(a)(1)(B), the tr:luster of the

]sells to fl1e Nei;~ Lend~is and to recover th3 value of the

Liens 1iom the Transea~tein Lenders, sec ll U.S.C. §

5500)(1}. The Coinn~ifYae sllcged that the transfer of

the liens by the Conveying Subsidiaries to tl~e Nei

Lenders vas ~ fi•audiilent u~ans('er under section

548(a)(])(B) because the Conveying Subtiidaaries were

ii~sol~~ent when Q~e transfer occtnred, ~ti~ere nude

ins~~lvenf by the Cransfer, had unreasonably small

capital, or were unable to pay their debts when due; and

the Conveyi~~g Subsidiaries did ❑ot rece;ive reasonablyegtiiivalent value iii exchange for their trnnsfer. See l l

iJ.S.G. § 548(1)(1)(E3). The Committee demanded that

tlac bankruptcy court avoid the ]leas and order the

I'ranscastcrn Lenders, pis the entities "fc~r whose bencl:it"

the transfer was made, ll U.S.L. $ 550(x)(1), to

disgorge tl~e proceeds o(~tihe loans.

[*1303] '1-he "1~runseasCern Lende~•s an<I Nc:w Z,enders

responded that the tr~~ns:fer of - tlae lie~~s ~~~as .not

fraudulent because the Conveying Subsidiaries had

received reasonably equivalent value in exchange for

their liens. The 'Traiiseastez~al Lenders and New LEnders

[**9] hi.~;hli~l~ted nuinerc~us ~~uiported benefits oP the

transaction, but the c~~ucial som•ce of alleged ̀ ~a1ue for

the Conveying Subsidiaries was the economic benefit of

a~~oiding default and baukrttptcy. `['he 'Transe~stcrn

Leudei:s and Ne~v Lenders contended that the

1"ranseastern Lenders were likely to secure a judgment.

againsk "COt1S~, which would have cc~nstilufed a~~ event

of def~tilt ou tnorc than .~h~1 billion of debt that the

Conveying Subsidiaries had guaranteed. The default

would have likely f2~rcecl 'IOiJSA and the Conveying

Subsidiaries into ba~~kruptcy. 7'he h•ansaclion st~ive:d o:lf

this event aid gave 'I'OUSA and the Conveying

Subsidiaries an opportunity ko aonYinue as ~n enterprise

anti possibly become prol'~tablc again. "I'he '1'ranseastern

L,endei•s and New Lenders cont4nded that this

opportunity ~~-as reasonably equivalent in value to the

ol2ligations tUe Conveying Snbsidiarics incYlrred. 'T.he

"I`rauseastern I.,enders and New Lenders also argued Heat

t}ie Conveying; Subsidiaries received numerous other

benefits, iucludin~ a hi~;tier, debt ceiling oi~ the revolviaa~

loan, nee-v lax hene:Fi.ts, the al~imination o:f adverse

business effects fro1~n the ̀ 1'ranseastern litigation, and d1e

opportunity to retain access fo ~raeious centralized

[**10] services provided by "I`OU:SA such as cash

management, purchlsiug, cud payroll administraYian.

The Tra~lseastez-n i.,enders nrgtied altenz~tively that, ii'

tl~e tr~~nsfcr of liens was frzruduleut, they could not be

liable as entities for ~vl~ose benefit the transfer was made

because they ~verc subsequent u•ansferees of the loan

proceeds Iaoan ~~OUS~1, not F;ntili~s that i~4nc:(itted

Page 6 of 16

7 of l7 2/6/2019 11:34 AM

about:blank

(fi0 F.3tt 1298, *1303; 2012 U.S. A~~p. I.,~';XIS 9796. *~10

immediately from ~1~~, transte~•. See I 1 U.S~C. ~ equi~~nlent value.

S50(al(1),

A#der a '13-ctay t.ri~l, chiriz~g wl~icl~ the U~a~ka-uptcy court

heard ezt~nsive ftict and expert i~sfim~ny and admitted

Dues '1800 eYh~bits, ll~e bankruptcy court issued its

rncG~i~gs of fait and co~elus~ons of law, 5e.c O~Ttic~ial

Coil~tiittee of Unsecured Creditors of 'TorEsn Irtic. v

Citicorp North America, Tnc., (In re "1 OL1Sl1~n~, 42'2

I.R. 783 (13aa~kz•, ~ :i~. Pla. ?009j_ "fltie bai3hx~€ipt~cy courC

found t}iaC tl~~ Goi3veyittg Subsicliax~ics wzrE un~bl~ to

pay their clebls ~vhc;n due, had unreasar~ably srna(1

capit~i(, z~uc~ ~~~r~ l.i~solve~nt befin~e a~~d rilZer the

transaction; that the Cortveying SuUsidi~ries did pint

receive value re3sonll~ly equivalent to the ~40:i uiiilion

ak' obli.~a[ion~ they incurx~:d; a.nd that khe "]'r7ilseasternI.,enders ~~sere entities for whose benefit llac C~omcying

Subsidiaries gra~ited liens to [**11J the Ne~~~ Leaders.

"Che bank.~~a~~tcy cnurt credited c:~p~a-t o~ini<~c~ tcstian<>z~y

that trio Convcyin~ Subsidili°ies were insc~lv~nt t~oi7i

b~fare ai~~d after fl~~ transachi~~n at .luly 31, 2-QO`7_

Experts m .reel ~SCEtf~ v~ltie, public accounting, and

insolvency examined the tilanci~ilrecords of T{)C1SA

end the Gom•~;yin~ Subsidiaries anc~ cancltided that the

li:it~il:ities ~F each o.[' ibe Goi~veyin~! Sut7sizl[aries

4xceede~l the fair vnlue ~f their assuis before the

t1•flnsact~ioi~. The trankru~tcy com-t found fllat the

Cazaveyin~ Subsidin~-ieti becrin~e even x~~a~•c deeply

i~~solveni Aficz~ incu~7•i.tag additional debt througi~ lt~c

transaction. I"he t~~ukal~ptcy coiu•t also credited e~pei•t

Qpizii~i~ tesCinaouy that, after the transaction, the

Conveying 5ubsi.diarics laid imrcasot~t~l7ly small capitt~l

an~~ were iznlble to pay their debts as 11icy o~me due.

"1"he hank:~•upicy court tl~e~~ assessed wl~ethcr the

Conveying Sul7sidial•ies r~;ceived r~asotiably equivnl~i~t

value from the Crana~ctinn. The har~k~~uptey curt firsC

nc>te<I that lLN7~ f ~ "v~ilue" is dc~necl in secti.c>u S48 as

ta4ilig °pr~~rerty" or "sat7sfaction [* 13~~] or seouruig of

a present or flntecedent debt ~f the debCor." 1 t U.S.C. y~~~

S48(a)(1)(~3)(~), (d)(2)(e1). 't'i~e~ bankruptcy court

deteriiiined lliak "tl~e Con~~eyiri~ S~ibsidiarics could

[~~12] nc~t rcevive 'property' nnIess they ~~l~taiued some

kind of enforceable entitlement to soma t~n~ibl~ Ur

intan~ihie article.° In re '1'OLJSA, 422 13. R. at R68 ~a.SS.

F_Tix~lel• t~1is c~et~3ziiiion of "value," kl~e bankruptcy ce~ut~t.

fou~~d tl~~t, because tl~e C~~nveying Subsidiaries chid not

receive piny property, they ctici nc~t receive reasonably

Tha bankrul7tcy courk ~ilso iss~ied alterna[ive l~aa~diia~s in

~vl~ich it assessed tlic value tlic Cai~vcying Subsidiaries

ceceiveel under r}ie broadest deti~tilion of "vahie"

prt~l~oseJ bV fl~c~ Transeastern I:endcrs and New

I.,cnd~rs. "~lic bankx•uptcy court found thal, ~vei~ if ail] the

benefits highlighted by the TrFinse~stei~ti Lei2ders and

New I.ei~aers were 1e~ally cognizable, their ~~~h~e

~~~onsideeEd ... ~s a ~v1~nl~, , . i1e]11CJ ~~rell s]i~ri of

`reasonably equivalent' vahie." Id. at $59. `I7ie

bank~tiiptcy court determined t71e value tha Conveying

~ub:~i~l.iirie~ ]osY .iz~ t]ic tr~ms~tet~ion ~nt~ o<~n.~pt~red tlr~t~

vatt2e ~~-itli d}ie value of the benefits titiey rccei~=eel. The

1raY~~uptcy eo~u-t determisted that tlYe tax hen~flts,

properly, end sear ces that the ̀ Cr~nseastero. I.,enclers €~~ci

New I.,cndexs pt'ofrered dill not• provide rea5on~bly

equivalent vakie to t11e Conveying Subsidiaries. "The

bankk~liptcy churl [**13] also fom~cl ilia dze transaction

c~~uld not Uave ~~rovidcd substanital value pa~edicatcd on

the opportunity to avoid l>a~iki-c~ptc~~ because the filing

of baiilcri~ptcy became "inevit~b(e." I~t. at fi46. The

bankruptcy court ca~edited the ~;x~~art' npinioi~ testimony

of an ~c,c~unt~~~t tiul~o }tad c~lcul~tecl that t11e Conv~yitig

Subsidiaries had incun~ed ` 403 million of abligatinns

when tl~c:y granted liens fo hc;lp secure ~5f~0 mil]ion. <~~f'

loans Ft~aul t}~e New I,end~rs.

`.Clio bankruk~tcy coua•t 1:outad [list the willeged bexxe~ts cif

tl~~ tran.sactic~n ~vece irisuhstan.tial. "I'he '1'rf~~~seastern

Lenders and Ne~v Lenders alleged kliat one of die

Conveying Subsidiaries received control of ~roy~rty

feozn tl~e: "I'raixseastern vcnYi~re, bait the bank.~•u~~tcy coiu~t

found 11iat d1e property vas worth only S2~S million and

was burdened with $3" million in liabilities in accounts

payable end ~ust~7mer ~Jepo~ii~s. "I.~hc; btnak~a~uptcy c~~urt

i-~fused t~7 4tedit the prv~eiKy as value. '1~lio t7a~ikG2ipYcy

court also rejected the ~rgtmient [~ 13A5] of Yl~e

I.'r~mseastern I:,et~ders ~nct Ne~v I.,en~ters that il~~

Gon~~cying Stiib~idiariis received vt~llti~hle fax benefits

fi•~~m the transaction. 'I~l~ie Transzattef-n I,e~i-lers anti

New LEndexs argt«d that losses ou the Traiis~~stern

venture could reduce p~tsl aid future ['~*.l~F] taa

liability, b~1t the bankruptcy coiu~t found tliaf the

C-onveying Subsidiaries received no bei7e~ts because tl~e

l~ene(iks would accrue to TOI1S.n, not t7ie C'oi~~eyin.~

~;ul~5icli<iries, nYid rill cif tl~~ substantial loss-generating

~vEnts that ostensibly prose fiom the transaction ~~ould

hive :iccr~iect ~~~ithouf tla.c~ traa~saction. (I'lae `I'r~nse~istarn

Page 7 of 16

8 of 17 2/6/2019 11:34 AM

about:blank

(iR0 F.3d ]29ft, *1.30 ; 2012 T?.S. App. T.,I:iX.iS 9790, *'`14

I,endeis and New Lenders argued that the '1'rauseastern

litigation had izegative effects on the day-to-day

business optratians aC the Conveying Subsidiaries end

that Che; ,luly 31 iransactic~n conl;crred au i.udirect benefit

on the Conveyi~ig Subsidi~-ies try elii~~inating those

eflects, l~uC ilie baiilcn~ptcy cotirC found t(ial those

arbun~ents ~~~erc unsupported by the evidence. The

blrilcruptcy cotut also found that the purparted benefits

~~f' cax~tit~ued access to TOUSA corporate services, such

as purchasing rind payro]l administration, were not

received by the Conveyinb SuUsidi<iries in exchange for

their liens I~ecatise Yl~e Conveying Subsidiaries enjoyed

<ill of these benei~its be.fo~r~; the transaction and co~ntiuued

to enjoy the corporate services even aRer ~I~Oi.JSA filed

far bankruptcy. "I"he bzrilciliptcy cotiirt rejected the

argttinents of the 'I'r<~nseastern I,enct~rs and Ne~~~

I.eudcis tl~trt the Com-eying [**]5] Subsidiaries

obYnined value because the transaction allowed tl~eConveying Subsidiaries access to an enhanced revolvi~i~oredit facility. "1'l~c '('ranseastein l,e;nders and Nc~~~

Lenders asserted th~rt, when "TOUSA acquired assets

ti~om tl~e Transeastern .Toint Venhire, tke borro~~~ui~ li~aait

on the revolving loan incre~~secl, but the bazikniptcy

court found that there was no 4vidence Yhat the

Conveying Subsidiaries had any need fora higher

borrowing; limit on khe revolving loan.

"I'he bai~uptcy court found that an earlier bankntptcy

liar T'OTJSA would not have seriously lia~lnea the

Conveying Subsidiaries. Two ex~~ei•ts testi:ticd Yi~1t a

TOUSA bai~•uptcy would not necess<~rily have caused

the Conveying Sub~idia~•ies to declare binkruptcy

because they held 95 pezcent c>f' tl~e clssets o1~ tlae

"I'OUSA enterprise, which they could have used to

obt~~in new finavcin~. The b~nk~uptcy eoui•E credited this

testimony ~» d (i~und llaG~t Cc~nveyiug Subsiaiaz~ies would

not have bee~1 forced into banknipfcy by a "I~(~USA

b~t~uptey. T'he banknrptcy eo~trC ~ilso found that tt~e

Co~aveyin~ Stiibsidi.aries c~~u1d l~a~~e opar~ted asindependent entities ~~~ithout the sea>ices provided by

"I~OUSA.

T'he hank:ruptcy coLu-t found that °even assuming ll~at all

of t}ie '1'OLJSA [*'" 16J entities would have spiraled

~i~nmedi~tely into bnuknipicy ~vitliouf tl~e July 31

'1'x•~Ltasaction, thu "Tratisactio~~ lvas still ftae more I~aanaful

onion." Id. zt 847. Thy Uanlrrtiiptcy court foiu~d tl~aY

bankruptcy for the Conveying Stibsidiaries was

"inevitable° i[' TOIJSA executed lla.e lransticti~~n, id. al

84(, so the tr~usaction could not h;~~re conferred value

by giving the Conveying Subsidiaries an opportunity to

avoid btnikruptcy. The banitruptcy court [i>und Chat tha

mauage~nent and coutrollinb sl~arei~olders at 'I'OU;SA

decided to risk h~uidreds of millions cif dollars of their

cieditoa~s' ~z~oney despite the impending disa,~teC• tl~e

cc>tnpany faced.

These 6ndin~s by the bankniptcy court ware supported

by public data and iutcx•nal analyses and

communicaCio~is from "T'OiJS11 insiders that s2io~ued Yh~t

tl~e tra~asaction ~~~otiild almost certainly fail to keep

"1'OU;SA acacl the Conveying Subsicli.aries out of

ba~ila•uptcy. fay the end of 2000, it was cle~~r that

TOUSA ~~~as liable to the Transeastei7z Lenders fot~

defaults oia floe joint ~re~ature, but the extent of ll~at

(iabiliiy ~~ud ~vl~.elher 'I~Oi.JSA could pay brick ifs

creditors and, if' so, how quicldy, t~~cre still in doubt.

Ia~t~rnal documents revealed tl~~t T~L.JSn insiders

realized tl~~lt the liability o:f [**17] the company to the

1~rinseastern Lenders could force 'I'OUSE1 iirto

bankniptcy. L~hnaan Brathez-s prepared a bankniptcy

~~alerl~ll .~ii~,alysis [or TOjISA fit Fcb~~uary 2007. Day>id

Kaplan, a senior financial advisor to the CEO of

TOUSA, suggested in early 200"7 that the company

needed a Chief Restruotut7cig Officer. Chi April 1.~,

2(?07, harry Young, an advisor to '1'OLISA foam

AlixPartneis I~LP, wrote to Stephen GVa€man, the C1=Q

of "1'O[ISA, °~W~l~.y rush to restructure in a ~to~~,~u n.~arket

~~-itU a bad set of terms ,just to t71e in 3 months. If we

need to file due to the lenders/sh~rehold~r issues, then

lefs [sic] do ii~ no~v and szve ourselves about $50 million

i~a tt-nnsactic~n cost!" Wa~;naa~i a~reeci ~~,~ilh the

assessment. On May I, 2007, Klplaii sent 'T'ony Mote,

the CEO of TOUS~1, a financial analysis of TOUSA th~~t

ack.~ao~vled~ed the dec(iniaa~ liotising markets aucl skated,

"[A]IYhough we can agree to ply Creditors in full and

wiCh interest if p~y7i~ents are postponed, eve caimot

a~~focd to pay them cash u}~ fro~al."

Min end Wngitizan both lrgued that TOUSA should pay

pert of tine sett(enlent with an iufiision of equity to avoid

taking nn mare d~bY. Both ~;acre concerned that [* 1306]

increased debt 1i~om tl~e settlement confer severely

constrai~a tl~e conap~ny. [**14~ Notes nn a Mon's drift

pa'eseukatlo.n to the Board warned, "~ W ~e must build ixa

the c~~pacity in this model so t11at when the msirket does

hirn, the have access fo capital to build/sell product. If

w~ can't do t~lais, we are to~ist~." In ~1pri1 al' 2007, Nion

Page 8 of 16

9 of 17 2/6/2019 11:34 AM

about:blank

680 F'.3d ]2)8, *]30C; 2012 U.S. r~F~p. i.,f.iXiS 979C, *~14

sent information t~ ~i financial ~dvisoc of the controlling

shareholders stating Yhat the settlement ~n~ould lea~~e

"IOiJS[1 ~~~it1a excessive debt; tht~t post-settl~uient

"I~C)[JSt1 would Have limited access fo the eapit<il it

would need to Qrow its business; and [hut Che ability of

'I'OLJSf1 to escape frvin under iCs debt cotila tie inhibitee:!

by sibnific~int risks i.nc]Lidii~~ :firrtla~r deterior~rtiou its the

housing market, filling land and borne values, and

ftu•tlier we~ke.uin~ in credit markets. Waltman likewise

ti~rged the co~~frollin~; sh~irel~oldcrs to cc~usider a

setYleizient that would include little or no neu~ debt for

I'OUS,~1.

Despite the ob~~ious risks posed by taking nn more debt

during a housing rn~cket decline, the controlling

slaareh<~Iders of TO[.ISA, t11c Stetagos i'~naily, ~~Pposec!

piny setflemcnY deal ti~at diluted their egliily position.

They directed Mon to terminate discussions with

potential iir~~estors until neev tluancing and tl~e

1'r~inseastezn settl.e~veut closed. Due Lo constraints

[**19] imposed by the Stengos family, 'TOUSA

decided to fund the settlement solely t~itl~ ne~~ debt. The

deal would make 7~OLJSn fhe most hi~l~ly-leveraged

company in tl~.e industry.

in the months p.xEcudi.xag Uie July 31 closing of the

transaction, public and pi•iv~te assessments ivade clear

Chat the ti~iancill position of TOLJSA ~~~as moving, as

oa~e secu~~ities aa~alyst wa-ote, ~~froaa~ bad to ~~~orse.~~

Investors recognised the dire sh-ait5 iliat ':COi.1S.~1 faced,

as evidenced by die drop ii1 TOtJSA stock prices from a

lugl~ c>f "x"23 per shire in 2000 tc~ just $4 per share by

April ?007. 'I'Oi.7SA bc~iids traded at discounts <~f 30 to

40 ~~ercent of face value in May 2007. After "1'OLJS~1

presented tl~e proposed July 31 tr~usactioil to ratings

agencies, its corporate credit rating dropped.

In the same period, tt~e national housing market was fast

~ipE~ro<icliing collapse. (.)n :May 29, 2007, Mc~a~ az~ci other

TOiJSA executives received a report that Standard and

I'oor's had do~~mgraded the bond ratings ou several

major ho~n~biiilders front stable to negative. (7n 7tm~; 6,

2007, TOL7SA executives received a .report that the

National Association of Realtors vas predicting that

prices of ne~v h~~ines 4vould fall 2.3 percent, and prices

of existing .iaoaiaes would fall .1.3 [**20~ percen.t. Mora

1.'or~va~-ded the report to the Board and doted, "PYI, this

represents [ ~ the first time iii 40 years that the US

naedztua hone p~~ices h<ti~~e decli.nect."

'1'OL1S~1 man~g~meiit recognized the implications of

this iiur~nci~l trews for• the proposed settleu7ent. In an

e.nlGiil to hiulself~ ou Mtiy 25, 2007, Waltman notett ti~at~

tl~c otirClook of the ratinb agencies 1'or tl~e i~omebuilding

industry «~~s "grim and getting grimmer," with

down«~~rd pressure on prices and mat•~ins. IIe expressed

liis cot.~cet7is about the pre;carioiis 15nancitil positio» of

T'OI.JSA end the proposed settlement in especi<<lly

colarfiil language thlt ~~ould prove prophetic' "As CFO,

and in li,~lif of all of this market imcerCainty, I have

absolutely no desire Yo 17y this plane too close to the

gro~u~c{, achieve some froan ~sic~ of cozisensu~l

settlement today tmd crash within the upcoiniiig year.

"That ~~rould he a clusterfuck." In an email to the 13oaA•d

on Juue 14, 2007, Mon stated that the company had not.

anticipated the degree to which problems in the

subprin.~u i~~ortga~e segroeixts were spreading to less

risky mortgage segments. Mortgage lenders began to

iaaiplement nia~~e restrictive imder~vriting practices for

r~sidentiril tno~~tg~~e loan zipplicotions, deana3~d

higher ~*1307] ~**21] interest _rates, and revoke

coirmiitments to homebttyers. These dev°elopme~its, Mon

obset~ved, "could Rave a cascading effect down the true."

Mon told the 13oacd, °dais housing correction is f it from

over." At the Board meeting on June 20, 20 7, ~t~ which

the Board apa~roved tlae July 37 kransaction, Mon

in:l.'oriucd the Board that the U.ti. laousin~; market was at

its io~vest point since 1991.

On Julie 22, 2007, Mon. sent the Sten;.;os :lainily's

tinF~ncifll zidvisor a m~~no ~ entitled "St~~ztegic

Alternatives," ~y~hich bean by acl~ziowledging that

°[f]Ixc 'I'1; settlex~ae~at leaves 'COUSFI in ~ vexy diflicnit

position." Past-trinsactio~i T~OUSA would be "[o]ver-

leveraged," °[~v]ithrnrt access to the capital markets,"

"~i]n tl~e middle: ot~ a serious laoltsing correction,"

"[f]orced in reduce assets at Yhe'wron~ time,"' °[i]n need

of a si~ciificant equity inrusion," and °[u]nabla to

sua-vive sh<:>uld laousin~ cociditiozas dega~adc; fiirtlier c>r the

hotisiug cocrectio.r~ lcn~thcn tipprcciably." Moo's

mernorF~ndum predicted that zj "Stay the Course"

str~te~y—even when co~tF~led with the coi~~pauy's de-

leverabing p1~n- ~~~ould leave "I'OL1SA imahle to service

its $7 laillioii of bond debt, at a "competitive

dis~dvantnge," with "[a~apitail [c7onstr~ints° Cl~~t would

allo~e (**22~ ~~[h]tjrely eut~ugll oxygen' t~o sluv.i~ve,~~

"[I]ittle room fir• error; increased risk of crashing ana

bainin~," "[limited ability to re-in~t~est in the business,"

az~ci °[a]l~tirays on the brink o(' 4lefaulf." Tlae °[e~~~ci

Page 9 of 16

10 of 17 2/6/2019 11:34 AM

about:blank

Aso r~.sd ~~~~s, *~so~; zo~z u.s. n~~p. r.,~ xTs ~~~c,, ~~zz

[r]esult" of the strategy, Moil :~ckuowledged, ~voulcl he

°[i]ncreased risk of failure and inability to ~vithsland

~vors~;nii~~ t~usiuess conditi~>its."

The ba~ilcruptcy court found that Mon reached these dire

conclusions before tihe Junr; 20 Bo<ircl meeting <rt ~-vhicil

the transaction was approved, Mori exchanged a

stiibstantially identical version of ttze memo with Tommy

McAllen, then ~n e:cecutive vice president of TQt7SA

and ►'resident of the "1'r~t~~seasfern :loint Vcnhire, as early~~s Juna 17, 2007. 'l~he banluu~tcy coLtrt found that "raj

more complete end prescient pr~dictiol~ (fhlt tine ekl'e-ct

oP tl~e "l'rauseaste~x~ transziction would be to leave

"I'O[JSA ~~~ith unreasonably small capital) would he hard

to imagine.° In re TOUSA, 422 B.R. at 795.

to the six weeks betwccn Mon's assessment that the

transaction ~a~ould leave Z'OUSA "[u]uable to survive

should l~c~using conditions degrade frn•tlier" turd the

closing of the July 3.1. transaction, lZousing conditions

unquestionably degraded further. On June 27, ?007,

Mon sidvised the Board ~**23] that I.:enuar, a national

l~onle bt~ilclez b~isEcl i~~ Miami, rapox•ted a "veay u~,ly

quarter" ~~~itli "more ugliness to come" zs "housing

~uarkels ...continued to deteriorate." Mon testified that

"il~.z~ougho~it llie summer eve co~atixau4d to see a

downward slope in the housing ulark~t." Ou July 9,

2007, Mon sent the Board copies ot~ lrticles from

13arrc~n's aunt l'he Wall Street Jounaal ll~at Mc>n

described as providing "nu-relenting negative news oia

housing." Bairon's foresl~~~ that 11c~me sales voluule

would decline another 2Q to 25 percent. The Wall Street

Jotu:uzil reported flat declininW hotnc prices would

increase impairnients f'or Iic.~meUuilders end decrease

their book valises "for the foreseeable fiiture." By late

July 2007, McAdea.~ aescti~.ibed the Florida laomelniilding

market as havuig gone from the "hottest market" to

being "at the bottom," ~~vith the worst yet to come for

Sotttlawesl ~~ lorida.

Financial reports fi•om TOIJSA revealed the effects the

housing dot~nturn ~~~as linving on f6e con~p~ny, '['OiJ4A

sales in the 17rst quarter of 2007 plunged more than 1G

percent ti~om the comparflble gix~rter the previous year,

tl~e number of homes iu de~~elopment fell more than 20

pez•cent, ,:nod its profit n~ar~;ica declined. 'I'l~e cz-ash

continued in [~"~24] tl~e second quarter. On July 12,

2007, 'I'pt,JSA notified investors that its ~*1308]

deliveries ~i~aci sales dropped I S pc~~cenl, homes under

construction. fell 29 percent year over year, flee

cancellation r~~fe on s~1e contracts rose to 33 percent,

end l~roPit marlins coiatiilued to fall. Intern~i) financial

reporting shoved similar cieclia~es fi~oin the k~rior year.

Ntttnerous a~aalysts, slings agencies, and inarkc;t

participtints recc>goiud tl~cit 7'OL7S~1 vas deeply

troubled. (fin May 16, Debt~vice reported that TOUSA

bond(~olders 11~id warned that the company would be

entezin~; the "cone of insoh~ency" if it took on ne~t~ cleht

fo settle with the "1'i-~nseastern Lenders, and flat sonic

cr~dit~ars of TO[JSA "believe[d~ thaC the proposed

seCtle~~ae-apt could force the company into ~~n eventual

~iaukruptcy." Iu July 2007, ratings agencies Moody's and

SYflndflrd & P~~or's both do~~ngraded their ratings of

"I'OUSn bonds i.xa contemp]<itioa~ of the July 3 ]

tr~i~saotioi~, concluding lhat'('OLJSA was "noY li.k~ly° to

be 2t~le tc~ meet its tin~ncial obligations. I3y July 31,

2Q07, uuseoured TQUSA bonds were selling at

discounts as ]o~~~ as $O.45 oia [he do]]ar.

T1~e bankruptcy court also round that tl~e sy~~dication

process .for the zae~~ lo~ius in tlae transaction rel]e;cted

[~*25] the perilous position of TOLJSA. As the l~ousit~g

sector and `TOUSA continued their decline, the

syndication. market kirr the ne4v loazas became "(~n)ore:

challenging,° znd the cost ~~f the transaction loans to

"I'OUSA increased. At le~lst as early as July 24, lenders

were ciroppiug out oP tlis deal. ()zae of ll~e Lead bankers

ou the deal far Citicorp, Svetoslav Nikov, informed his

colleagues that. they ~~ere losing syndicate plrticipants,

and "[t~l~ings ~uo~•e looking ugly out there." Mani

McManus, the Citicozp eng~Lgcment lc~tder, descril~eci

leaving "panicky" messages about t1~e deal as the market

got ~~rorse. Tn a July 24 ezuail tc~ TOI7SA uianngement,

McM~inus urged "I~Ot15A to be prepared to close the

loan deals soon because "tl~e [mark~E] ]1as completely

dried up," and °~t~he market is going from horrendous to

worse." Neax•ly Ralf of Q~e ~~rospeckive lenders for tl~e

3~irst Lien'l~eilu Loan dropped out of the deal in the Polu

days preceding Jtily 31. Citicorp had to proti~ide

significant pricing i~acenCives for the leaad~rs, which

raised borrowing costs 1'~r 7:'Oi.ISn. The final group of

New Lenders included some firms that were lenders on

the Trause<~stern debt that the new loans paid off.

"]'hrougl~ the traa~sactic>n, [liese lenders essentially

**2C] converted their unsecured loans to t1~c

Transeastan~ Joint Venture into secured loans to

"[`OlJS~1 <~nci the G<~.za~reyi~z~; Subsidatiries.

Page 10 of 16

11 of 17 2/6/2019 11:34 AM

about:blank

G~0 F.~d I?94, *1308; 212 U.S..~pp. I.IXtS 97~)(i, **2G

The bank~ztptcy wart ;voided t11e Erai3sfi:r as fi•axidulent

tinder section SAS and held fllat Ilse "l'ranse~stet7i

I,eriders were "c;utities for ~vht~se benefit° il~e liens were

traus.ferred_ See: 7 1 IJ.S.C~. § 55O(~i)(l). "l:he batakniptc_y

co~u-t held fh~~t, under confrollin~ precedent and Qie

plain l~~inguage of sectio~~ ~SSO(a)(1), khe ""Pranseas~kern

L,ende~~s directly received tl~e be~uefit of t9~e "I'c~~is~etinn

and khe Trarrs7etioii vas undeiiaken with the

un~itibigYious irttoc~t that they would do so." In xe

T't)tJStA, X122 i3.R. at 870. "I'l~e bankruptcy cotfrt avoidedthe liens can tl~e assets o1'lhe Conveyii3g Subsidiaries and

ordered the 7~r~nseastern LencJers to disgorev ~4C13

tuillion a~~d prcjlFdgment interest :Fi~~• the periaci behveen

J~~ly '3'l, 2D~7, and October 13, 2009. Trorn klac

disgorged f~mas, the court ~t~arded clte Comtnitt.ee

ciat~t~bes to cover the tr~aisaciian cost:; relaCed to the

causunam~tion of Ll~e July 31 tz•ans~Yction; file costs Ll~e

debtors and tlic Comiuiti~c incutrze~ in the ~rosecutioi~

of the ~~3versai•y proceedi»g, uicludinb fees aril

expct~ses paid to ~iYtoru~ys, advisors, anc~ ~aperts; ttnd

the diinintGtion in t~hr, ~**27J va}u~ of the liens bettr=een

July 31, 20Q7, and Uctol~er Y3, 2009: 1'he banknlptcy

coLtrt l~el~l Ch ~t tl~e t".oi~,ln~ittee was entitled t'o ll~e

diminution in the ~~alue cif the liens because "if tli~ carat

limits the Trustees tc, rec~~veiy [*1309] ~f the property

itselt, ~nct if the property has c~e~]ined iu vttLue, the

csfate ~~c~iil l~sve lost' tlac o}~partunity~ f<> dispose of the

~~t-c~~7~1ty ~.~t7or to its clepreciakiot~~." Id. ~t 853 (+.~uotin~,

I`elfm~an w. Wu-~niis ~ re ~tti. W~~y Setiv. Corp.), 229

13.R. 49(, 532 (F3~nkr. S:D. ~~la. ].499}. "flee l~ankniptcy

ec~urt ordered that the remainir~~ trails be distributes Co

the Pirse and Second Lien Lenders. Eiec~use the

setl(ement lire '('ranseastern i.:enders had reac:hecl tivith

'1'C)USA had been undone, the; baukrttptcy court rest«red

the unsecured claims of the Transeast~iyi Leaders

against ~['OtTSA antl itti partner in. fh~: joinC venture.

C. L7islr~icz Court Pro~eer~iva~s

The l.rtmse~isten~ I:encters anc~ the f=irst rind Seeonci t.,icn

Lenders al~pe~led, ~~nd their cases were aseign~d to tlirec

separate district coirz-i ,judges. After a series of ta•a~i~stzrs,

fine appeals by the 'Traxxseastern I.end~rs were assigned

to wile judge and four appeals by the Netiu I,endei;s were

assigned Co anottYer _j~idge, ~'Iiis appeal arises tr~~m the

live ~k~pe<~Is by [**28~ the ":[~r~nse~stei-~~ benders.

Tlie dis~~ict coiert issued art antler rluashitig the

b~~n~nG~~tcy court decision as it rel~te~ to the liability of

the Ttanseastern I~eaiders, 3V Capital Master Fund Ltd.

v Ol~icizY] Ct~n~in cif llt~seciGred Creditcir~; ~~f '['()11~;t1

Ina, 4~4 .f3.R. C13, (i8(,) (S.l:~..E~la. 2U11). ~I.~Jae district

court }~~ld tint, as a maker of law, the baiil.'~upt~cy court

hnd f.00 ~u~nroy~ ly deline~ "va1Ei~." ~!'h~ ~listrici court

cited 1 '1'l~i.rd C.irctUf decisao❑ that field that NN2~ °J

°[t]he mere opportunity' to receive ~n ecoriotriic berieYit

its the fiiture cunsCin~t:es 'value' trailer f11e Code.° Mellon

T3ank N.!1. v. ()fCxcial Comniitfee o1' i1«secureci

Creditors oi~ R.M.L., lnc. (Ian ~~c R.M.L., Inc.), X32 1'.:~d

13.9, 14~ (3~j Cir. 199Cj. 'The district court also relied on

a cfecisi~n of tl~e l ighth Circuit hurt explained th~~lt

IIN3[ ]the con~ec~t w<~y to dz;tcilnu~e "v~tl~i~;" vas not

to aei~ine it "only in terns ~f' tan~il~ie property or

n~rark,atable financial valEle,," buC insttt~~d to "ex~nune[~]

gill atipects o:f Use h~ansacfior~ and c~zei:ul(y mcasure[f t~l~e

v~h~e oF211 benei~its nn~-1 burdens t.o the debtor, direct ~r

indirect, incluclin~, 'indirect econoiY7ic benefits.'" United

ytates v. Crystal EvanRelicuil li`ree Chiu-ch (Inr~ Youn~1,

82 f~.3d 1407, 1~11~ (&th C-ir. 1996) (inte:n~nl

(*^~29~ c~ttotatiorti marks omitted) t•~acatea_~~_n____._~~ther

ro~~~ls, 5?1 U.S, 1114,, Ill S, Ct. X502, 138 l .Via. 2d

1(307 (1997). "l~~he district cout-t als~~ cited 1 decisio~~ by

our Court tlia( stated CliatHN4[ ] .Section 548(x) "does

not atttlaorize voiding a tr~ns~cr w~ieh 'comers au

ecouc~.mic benefit ~~po~~ tf~e clebior,' eiYhcr darcctly or

indirectly." GIB C.cediC Carp. v. l~i~irplro (Ii1 re.

I~otlrieuez .895 F,2d 725, 727 (111~1i Gir, 1990) (citiu~;

I~ubi~i v. ~l:tr. fi~nover "l.~rusf Co., C6.1. F.2d 979, I91 (?d

Cir. 1981.)); see alsn 5 Collier (~ri I3~nkiuptcy ~ 544.05,

at 548-67 (Alin N. Resiiicic & I-Ienry J. Sumr~~ser eds.,

16th ed. 2OOC) ("'1'ite niture oC the vtilue that i:; recci~~eci

.need not be a f<+ngible, direct e~cmomic bene~k An

indirect econc~mio bene~k can s~rffice, so l~~ng as i~t is

'P~~lirly cc~nerete."':). "[fie ~listriet court caucludecl that

indirect Uenetits, including llae op~orkunity t~~ avoid

l~a~ilu-u~tcy, could c~ustitute "value" nnd~r seotion

548(a).

The district court than determined t13at the I~~ttilcritpYcy

c~7ui-t dearly erred ~~h~u it fntind ll~af the Cote-eying

Sabs.tdiarics hr~d a~ot rec~;ived reasonably equevalenl

vahee fcotn the frazis~ctiaii. ̀ I't~e district court fo~ind Y1~1t

the trai~sacEi,an gave tli~ Gonveyine S~~bsidiari~s thN

opportnnily to avoid bankru~~l~cy, continue as going

[**3O] concerns, and make further paymeilt:s to their

creditors. The ~-lish•icC courC loi~nd that these benefits dici

z~ot uc:ed to be gtrantilied Co establish rea~on~ibIy

Page 11 of 16

12 of 17 2/6/2019 11:34 AM

about blank

f80 F.3d 128, ~1:~09; 2012 U.S. t1pp. I:E:XI'S 9796, *~30

eq~uyalent vahie. "Liherently, lhise l~~nefts have

iin~nense econc~~nie: vzlu~ that ensure ilie debtor's net

~vcn•th has heen pr~sea,ved, and, hss~d on the entirety of

this record, there riot disproportioi~~rCe between ~~hat

[~`131C)] ~i~~s gives up and what tivas received.° ~1 re

'I'QLTSA, 4~4 B.R. at Cfi6.

Tl~e district coiYrt also held that the Trarise~st~ern

Lenders could not, as a matter of la~v, be liable as

"erttiti,es far tiv}a.ose 1~~;~iefit° Uae t~•ansfez~s ~vex~e ta~ade

be~a~ise tlluy did not I.yenefiY froi~i the transfer of the

liens t~~ ttie N~~v I:enders within the mewing of see~tion

~SO(<t)(1'). "['h4 ~l.istriet cc~ut~t }field flat the "['r;~ns~;asterz~

Lenders were subsequent ira~isferees of dii proceeds

backed by the liens, not immediate benet3ciaries of tl~~

tr~nsier of fla.e liEns, and th~i subsec~ue~nt ir4~n5ferees Ire

not uovercd by sccCion 55~(<t)(1). See id. aC C74.

~~inallq, the district court held that retnai~cl vas

u~a.iaeeessaay beca~~s4 "tlic record allo4~~s oialy one

resol~rtion of the factual issues ~~t sz~~ke," i~. at 6fi0, end

t~ecaus~ thu `['rA~sseastet-n Lenclzrs made "eom~~ellin~

arguments" regardii.~g tli.e [**31 ~ ability of tl~e

bankruptcy court °to a~prnach tl~e Defendant's evidence

ai d ~rguiiients fairly." 7d. at G79 n.65. Tlae district aourk.

c~nasl~ed the order of the h,ui.hruptey ec>urt and d~ci.ired

X11 the p~~oceecliugs regarcliitg the Trattseast.ern Lenders

cl~~sed.

Because t~l~.e dish•ict co~irl ruled on issues that were

e:entral to the se~~ar~te appeals of the Neti~~ Lenders, the

district court allowed i~lte Neer l..enaers to intea-veoe in

E~~~~ ~Pl~eal, aild tlaE clisYrict court stayed the a~~peals of

the Ne~v benders l~endi~ig divpositicu~ of kris a~p~.al.

IT. S'Cf1Vi?r112DS (7T lt}?tirIk',~V

IIN_5[ ) As the second court to review the judgiient of

the hankr~~ptcy co~irt, ~4~e .review the order c~1' tl~e

ban.kn~ptcy court icadependenlly a.f tllc dist~~ict oourt.

Westpa€e V~c~Cio7i Villas, Ltd. v. "1"~~b~is (In re Int'1

Phal~nacy &.TaiSc,.II. I~tc. , 443 F.3d 767, 770, 158 Fed.

Appx. 256 (1.l t.}~ C'-i.r. 21705). We revie~i~ detcri~ai~afixi.c~i~s

of 11ti m4ide by either court de nova. ld, We review the

Cindiiags ol~ fact e~i' the bankruptcy court tier clear e~~•ar.

Icl. 'I'hc ftu:hitil findings ~P flee b~iukr~iptcy court are not

cic~rly ~~rone~us ~znless, in tJ~e light of X11 the evidence,

"we ~u•e left ~vit~i YhE definite acid firm com~iatioti thz~t a

i~~istake leas been .t71~~de." Id. "N~~tf~e.r tl~e district co~irt

iior this Conrk is authorized [**3?] to iri~ke independent

Factual ficidings; that is the f'~u~ction of the bankruptcy

ct~urt." r;yuiYahle t.ife Assnranc~ St~c'y v. S~tblett (.lu re

Suhlett , 895 F.2d 1.3fi1, 13~~ (t ltli Ci.r. .199O). We

revie~ti- e~luitlble deten7~i~~ations of lhc, banknipi.cy court

t'or abuse oi~discretion. Bakst v. Wetzel Tn re KinQsleV),

SIS F.3d 371, ~i77 (1 Ifh C'ir. 2008).

III. DISC'LTSSION

We diviau crtu~ discussion into three pa~~Es. We first

ex[71aiu t~i~t klie l7ankiltpt.cy caiu`t did tipt. clearly err

~vl,~en it fouutl th<lt C(~4 Goi~veyipg Subsidiaries did not

receive reasonably cqu vlleuC c=~Itie in e~chanc~c fnr

their liens. We then ex~laiil that the l~~nk~laptcy com-t

did not err when it f"ouncl that the "lranselstei7~ Lenders

were cntrties foz whose bencFit tl~c liens were

transfeY-red. riu111}~, w~. explain tvl~.y w~ ti~~ill not

consider, ii1 the tirs~ iixstanc~, challeii~es to the remedies

in~~osed by the b~i~~knipCcy court or issues of judiai~l

~issi~nment or consolidation of prc~ccedin~s.

.~.i. 7"he Bankrtrptc}~ C'otrrx Did Rr~fi Clearly ~;r•r• Y~hen It

Fn~~ra~c~ 7 hal fhe Corn~evi~z~> ,Svl~.rir~ici~•ies Did :V~! Reeeir~

Rec~,sonc7hly ~'~~~ri~~crlerrt 7%'afire i~~a Exch~c7rrge fQr• tlae Liens

I'hP~v Z'rcrn~ferre~' to dhe rV~~v Lencler•s.

The Comanittee argues that 1114 banla~uptcy curt did nok

clearly err ~ul~en it found [**33~ that the calveya~ice of

the liens by the Conveyir~e; Subsiili~iries to the New

Lencicrs was a fraudulent transfer. IZN6[] Sectia~i

54~+('a)(1)(B) of t1~e Bauk~lipCcy Code provides fc~r the

lvoidunce of "nny fransfer of an interest of the

debtcxx~ in pz•op~x-tY, ~ * 13l l ~ or 1uy obli~atioza .

incurred by the debtor, that eras iii3de ~r incurred .. .

within t~~~o years before the clai~e of the filing° of the

b.tnl:~•aptcy peiil~iti.n, it Clue debtor "received less t}~aai

reasaiiably e~~uivilent v11ue in exc}~aiige for" the

transfer ~~r ~~bligatiori, acid tiie debtor (1) "was u~si~lveitt

on the elate such transfer was zn~de or s~.ich ablig~tion

was incurred, or bect~me ins~lveut as a result of such

trailsfvr ~~r obligation,° (?) °~,°as ~z~~agud in business o~

a iransnet~ion_, or was nboue to en~a~e in t~i~sir~ess or a

transfletion, i'a~• ~vla.i.ch aury p.coperty ~•emai.c~iiag wifla tiae

cicl7t~r wzs an anre~sonably small capital;° ~r (3)

"intended Co incur, or believed that the debtor ~~~ould

incur, debts that world be beyond the dehtc~r's ~l7iGty tz~

Page 12 of 16

13 of 17 2/6/2019 11:34 AM

about:blank

GAO F.3d 12')8, * 1311, 20121?.S. ,~lpp. T~,Fi?CiS 979(, *~33

i>~y as sual~ debts tnattued," 11 L1.S.C. § 548(a)(1)(B).

The ~arkies do noY dispute, u~ t'k~is a17p~a(, that tl~ie

Conve;yint~ Subsidiaries ~~~ere either insolvent, had

unre~son~bly sGnal] capi.itil, or w~ez~e unable to E~ay their

d~Uts ~vlien [~*3~] Clue liens were conveyed, T7ieir

dispute contains ~vhet~lzar Chi C:oiivegiiig Snbsidi~l~ries

recciv~d ]css tl~<iu recisnraal~ly egtiivfilent v~ilue. IlN7[ J

"T17e pui~gse of voidizig transfers tinstippo~-~ed by

'reasonably ~ciuiv7lent valae' is to pr~~tecP creditors

1gai~~st the c~cpl~~t~i<~u of a bznlEnGpY's estate.' (.i.L;. Credit

Corp. v. Murphy (In rc R~dri~ue~). 895 1'.2d 725, 727

(1111 fir, 1990).

"Ilse baiil~7~uptay court endorsed a deti73ition of"v~tu~"

thFit the disCrict court rejeotec-1 ~s too narrow find

potentially ~~in,tubiC~ary of e~~ulemp~~xary t~~n~inci~n~

practices," Irz r•e TDliSi:l, ~4~ t3.R. at fiS9, buf 4ve x~e~~

riot adopt ehe detinitiori of either court. We deiline to

deaidc ~-vhether the po5sibl~ a~~oid~n~:e of bankniptcy

taxi confer "value" bcca~ise Llac t~ank:cuptay court found

that, even if nll ttic ~ucport4d benefits of the transaction

were legrilly cagnizablc, they elid not confer r~lsc~nt~bly

equivalent value. See in re `CC)tJSA, 4?2 B.R at 869.

Because th~st findings are iic,t clearly er~r~~neous, they

settle t7iis itiatter.

ZINR[ J 'I'l~e banknij~i.cy ci~urt ~t~as 4ntitled to find that

the benefits of the. h•~~~sactirni «;ei~e not reasonably

e-<~uiralent in val~ie t~ what (lac: Cc~ya.c~eyin~ Stzbsidiarieti

stirrei~dered. "fit has Ioa~~ bee.ta esttiblisllecl that

'[w~lietlier fair coiisicl~ration [~*~5] has beet! gig-en #or

tra~~sfer is 'largely a gticstian of feel, as tQ ~~hicl~

consitlerabtc (~tititudc: nnist be all~~~~cd to the trier o:t~ the

facts.'° NordUer~~~AraU Rankine Co~.~in re Chase &

~enboin Corp.), 9(~a R2d 588, S93 (llth Cu•. 1990)

(c~uc~fii~~ Mayo v. 1?ioa~eer E3an.(: & 'C~~usf Co., ?7U 1~.2ci

82~, 829-30 (nth Cir.195)) (Wisdom, J.)), The record

sup~ot~C~s tt~e tuidin~ by the bat~lcnip[cy cc~u~t Yh~t, for the

Convc;yi.n~; St~bsidil~•ies, tlae ~ln.~ost~ certain cost~ o1` the€>translction of July 3'l far oui~veig~}~eck any perceived

benefits.

(~1312J The "1rGinse~sfern Fenders ant( Ne~v benders

argue t1~at kh¢ trnrigacCiou of .tiny 31 alin~vee~ the

Conveying Si~bsidiarits to escape the "existentin3 tl~reai"

of tiaw likely bGinkrnpt~cy k}t<it ~uoulcl ensue and eh~~~t Chis

ehan~e to avoi~~l ba~iki-~i~~t.cy ~vas A l.~eiicfit reasoiinl~ly

ae~uivlle~~1 in value to tlxe obligatio~is the Ce~~~veying

SLirsictiaries i.caclirred, lout we urc un.perstiiaded That khe

i~ec~rd o~~nlpels that tindiy~g. IIN9(] "A corporation is

riot a I~iological e~lt'ity for which iY can be prusutz~ed t17at

any Pict which extends its exititei~ce i:s beneficia] to it."

}3(c~or v I)~ulskc~~ (lu rc [t~veseorti 1?unciitl~; Co~~~. of Nee

1'c~rk Sec. LitiQ,, 523 F. Supp. Si:3, 54t (S.I~N.Y.

19b0). In atli~r wort!:,, ❑ot every hansf~:r t}iat decreases[~`*~i(i] kl~c odds c,f b~i_i~.knrploy fog- ~ corporation tau be;

justified. T7ie Uankiu~>kcy court consic[ered the ~otec~ti~l

benefits of the frnnsaefion aild fi~iuid that tl~e~y ~ve~'e

~lawhere close t~-a its expeatecl costs. In tli~ light ~f all th.e

c~~idence, the arc not "left with the definite and firm

crn7viction that" the bankruptcy court clearly zi~red. In re

Iirt'1 Ph~~rnlacy ~~ Disc. 1l, tnc., 44:'~ ~l~.~cl art 77f).

TIIe ".I'ranseasterii Lenders and New Lencle~~s argue (hit

the rec<zrd esk~blishes that an actve.cse; jud~;,iuen.t in tl~e

lrauseflsCert~ litigation ~uc~ulct h.avc caua~d '[~Ot.JS/~ to

1~1e fir hanluuptcy, the re~~olving financing fc~r the

C~~nv~ying ~ubsiciiaries to dis~ppc~r, end the Con~eyiti~

Su6sidiai°.ies to beaoine ~liablc foc .iaT1a»ediatc pay»~uf of

Y7~or titan ~ 1.3 billion to tt~e re~~c~lving loan lenders a~ic~

TI~~JS~ bondholders. They corkten~l th7t Ctie blx~kniptcy

aoYirt elta~°ly erred when it I'<auiul kliaY the Gont~eyin~

Substdi~ries c~~uld hflve survived ~ "1~~C)LJS11 batil:ru~tcy,

They nrgue diet Ctze l7artki•uptcy court fotu3d thaC the

Cc~nveyii~~; Subsidia~~ies were insolvent beti~re the

Grnnsaction, acid they argue tl~~t it is urilikcly that the

insolvent Conveying Subsidiaries could have ol~taii~ed

new- ~inzinoing. "Tl~cy also ergu~e theft the absence ci,f

standalone ~ai<ulcial. [**37) statetneilts vas a °clear

obstacle" Yc~ new tinanciiig~. 'They higltlight t11at cane of

the experks for the Committee deseril~ed the

ii~tercoiupl~~y payll~les and receivables '.for "I~C)t7S~1 at~d

tl~c C.~~nv~ying Subsidiaries as n "hugs pile of tangled

s~s~hetti." The Transe3st.ern Lenders and New Lenders

tisse~-t El~at it would .l~~ave~ taken n~onihs, if not years, to

sorC through the mound of reeor~is, which pra~~~s that the

C~iiveying Subsidiaries had no rl~ance Yo reeeiv~

sitmdal~~ale ftn~ncing.

'l'he bnnl~liptcy court Fauu~-i flits evidence to be:,

in-elevant because, "eve~~ assuming Uiat till of fhe

7't)U~~ ~nfziies «~~uld l~~v~ spiraled ii~unediatoly i.uto

ba7~kY-u~~tcy 4vith~~ut the .iu1y 31 'I~rarrs~ction, the

1a~ansaction vas still kUe snore harnlfiil option." In re

I C)i1SA, X22 13.TZ, et S~k7. "~ Af t most it tlel~syed Qa~

itievital~le." Id. at 8~6. 1~he t~ai~lutiiptcy c~~urk fotuid t13at

the benefits ko the Con~~eying SubSidi.~ries ~~~ere nut

ulo~e to be~in~g xer~saiaab(y ~c~eiiv~lent in v~.lu~ icy the

Page 13 of 16

14 of 17 2/6/2019 11:34 AM

about:blank

(,RO 1~3d ]298, *].312: 201? U.S..~pp. I.,CXFS ~)79C,, *~37

~~F03 n~illi~~n of ~7b1i~~tic~ile that they incui7~ed. "t'kie

'frariseastern Lenders end Ne4v Lenders f~ttack this

lindi~~g as "hindsight ruesc~nin~, ... at its mast ~xtcein~,"

t3iiE t11e bankruptcy court b¢ised its exi'er~sive fisidiilgs on

a T}ioroubh review of pul~Lia l~tto~=ledge ~~v~ilaL7le before

[**3~] July 31, 2QQ7; expert analysis of ~Inta available

before ;fuly 3l, 20(17; and sttrte~zlea~ts by "1'OLISA

in~i~iers m=ide before ,Tiny ? 1, 2007.

The ".l~canseastcru lenders and NG.~v I.~ende~•s <ugue that

Che finding i~f a~i "iuevitab(e" banict~iptcy is ngainst ttie

~~rei~ht of the e~~ idenc~e, but the anly evidence they cite,

in cotat~~ast with the t~t.orc>tiibh ~indin~;s of 11~e bankruptcy

coul-t, ai•e the opiYiioris of <~ "1`OLJSA advisor tl~al the

coYnp~rtiy ~vozil+~ remain via.blw at't~er the translction acid

staten~enis ('r~7m Tc~iry .Mon Gbo~it a com~~rahensive

strategy to shrink'I'OUSA alter Che tr~z~sucti~>a~, shore iip

its finances, ~~iti a•ebuild the Company. Tlie Tr~znseasYer~i

Lenders and New Lenders contend that tlr~ projeet~ions

of ":['OTJSA look uu.reaso~~aF~le ~ioyv nnly bucaus~ weeks

after the tr~nsacti~~iz, "1 tr~~gic gl~~l~al fman.cial crisis of

m1}~~•ececler~ted proportions" bean. They essert that the

ttnet~~ecied do~vtatttrn was describ~:d by Alum. C".rreenspan

~~s "a once iii ~ cenCury credi# ksunt~ni° and by Waz~•cn

~3ufiett as an "econortiic 1'aarl H~urb~~rr." The

"I'zanscatite:r~a I,enciers an<i Ne~v I.,endea~~ a~•gue thrit they

cflr~n.ot l7e held liable for tuili~3g 4cf foresee d~~-

unfoceseeal~le, that their actions were re~soiant~le, find

That the bankruptcy uo~irt clearly should have. fo~md tli~t

[~*39J the transaction «ras ri ~~casou~bte ~•isk fc~r the

Goriveyiii~, Sut~sidi~ries to tike.

't`h~ z~ecc~~cl suppc>z-ls a deter~laination kJ~~t ttu; bankz°uptc:y

~~f 1'C)lJSA vas far in~~rc like, s~ slaw-moving category S

hLin-icane then an uuforseen tsunami. Thy baiilcilipCcy

c:~7u~-t cWnsidered khe evidence fiozn o~,itsi<ie advis~zr;; Y<>

T'<)1_iSA asld found much cif it sL~~pect or based o7t faulty

pre~alises. `The bankruptcy coiurt con~ider~d end

disc:ounteci Mon's cleleveraging slx•ate~y .for 7'OIJ;SA in

t1~e light vC the dire [*1313] Predictions he and oth~:r

insides made regarding the ef~Fects the traiisacYic~u

would havE on "IOtJSA. And the bankruptcy court

fr~und that, even. lhougt~ /11an (ireeiaspan acid Warren.

Buffet enulc9 nt7t fores~~ the gcn~ral ecc~ni~rnic dn~~~utux~n

float began in ean~est in Augt~sf 207, uuttierous exten~al

observers acid insiders at 'fQiJSl~ _reco~nired that tt~e

relevant hoissiiig ruaikets fir '1~OLJ5A haci E~eguil t7~e:ir

free f~11 befora the 1~ily 31 tr~nsaetiois. In contrast with

t,h4 sui~~rzse attack at Pearl T-It~rbor, the ~varnrngs about

tl~e oollapse cif ~I'(JUSA ~~l~de that evei~~t as ft~~•ese~able

a, the hoini>ing of Nagasaki after 1'residenT i't•uiriasi's

ultitn~ttuut.

HN10[ ] Tl1e o~~pc~i•tttnity to uvpid bankruptcy does n~5t

ti•et; Gi company to }gay any price or bear <tny biudan.

AYler ~il.l, ~~tt~Ga~e is ['~*40~ na retison to tx~cat bankruptcy

~s ~ bogeym~ui, as a fs~te wc~r~e tha~i death.° Olvin fa

]~c~t.~iumeiet _Le~sina Co. v. ~'estem linioil Telegraph

Co., 746 1~.2d 7~4, $02 (7th Cr. 1.956) (i:iastert~rook, J.,

eat~curriiig). 'T't~e banki~ti~tey court correctly asked,

"based on the cu~c~imstances that existed ai the time the

n~~est7r.~~nt ~~~is conte:mpl~ited, ~vheCher there ~vtis zmy

elitme~ that tl~e investment would gcrierate ft positive

rett~i7t." See Mellon I3ank, N.A. ~-. Official C'~~rut~itt~e

~~f [Jnsecurecl Gredil~ors c~.f' RM.I,., Ix~c. (In a-e R.M.I...,

Inch, 92 1'.3c~ ].39, 1 S2 (:~rd Cir. ]996). [~1.t~d tl~e record

supports the negltiee ans~i•e.r t`ound by the bankni~~tcy

court.

B. Tl~el3crnlc7-uptcy~ Cr~tirlDicl J~'i~~ 1sr•r IYl~en I~R~rXec~'

Tlrc7t ~h~ C'r~r~z~r~itte<: C'c>rrld Recouer~ fi•orn 1hE

Trr~rrsec~a~ter~7 I„endei~,s ur7der SecPior~ 55(](cr)(1).

UNIT [ ~ If ~ transfer is avoided uYider ~ectic~n S~8 or

oi~e of several other ~~i•~~vi4ious ol'the B~inkniptcy Cade,

section 55i)(fi)(;l) atl<~~vs the r-ecovc;ry of the pro}x;rty

t.r~n~ferred or i#s v~1tGe from the initial transferee or

from an "entity for• whose benefit such transfer ~~r~s

made.” 1 ]. [J.S.C. § 550(x)(1). ~1'.ltl~ougli tb.e ]tens «f tl~e

Conveying Subsidiaries were lrrin~ferred to secure loans

Cu pn}r the Transeas€erii Letjdere, t3i~ Tral7seastern

Tenders gigue that [ **41 ]they are not covcrad by

section 550 l~eeal~~s~ they ~ver~ ~.ibsec~~teril 1~-ansferees,

not entities tli~zt bzilet'it~ted ti•o~n ttte initial franefer. Their

flr~ui7lent is c~rltr~dicted by the login ~green~euts, which

regLtircd that the proceeds cat: tiic lc~anh sec~i.red by tlae

liens tre trausf~n'ed to the Transeastsni Lenders. Under

Yli~ plain language of section 550(1)(1} and the

pre:cude:irC of our C'o~.i~-t, the "J ranve~~stern T..,endcrs cue

entities ~t2n• whose l~enciit the Conveying 5ubsicliaries

ta•~nsferred t}ieir liens.

'I~o he slice, eve have ~;t~ted t~lu~l IIN12~ ] °the paradigm

case of ~ fi~anefiY under § ~Si~(aj is tl~e benafit tc~ n

~;uYu~u~tor by t11~ Payiaieiat of the lti~derlying debt of the

d~btc~r." Rcilx v. Kapi1~ (Ire re InCI Me,~Ytt. Ass'n), 399

I~~.3c1 1288, 129.~~, (iltl~ Cir. 2005). Tl~e guarantor

rec~:i~~us zm i~mmcdiate benefit when 1h~, debtor pays

page 14 of 16

15 of 17 2/6/2019 11:34 AM

about: blank

cso _t~~.sa lz~~s. *i3 ~s; 2n~? t~.s. n~~,. r.:~.xis ~~~<~r, ~~na

baak a creditor, ~vhieh reduces tlic lialarlity ~f tie

guarantor. Althotz~h this relationship n~~~y be the

pt~r~di~m~itic case, i,t is not tl~e ai~ly circunast~anec th~iC

can give: rise to "for ~vliose t~calefiY" liabiliC_y.

We I~tive also (ie1<1 that zi creditor sixnilar[y sieuatect to

tl~e 'frail~castc~na. I,en<lers c~ai ~,e ]i~blc ~s ~~i ~l~tity f<n:

~~hose benefit a transfer vas made. Iii Arnericati Bflrilc

of M~rui Coi~mty z-. Leasing Service Go~..~i _re Aii•

Conditioning, Inc, o~ SCtt~rf , $~5 I~`_2d 2~3 ~I ].th Gi~r.

1)S8), [~*42J Svc ruled that section S50(a)(1) ~Il~~t-ed

the tniscee to recover Che vrjlue nf' a ~ Q,000 c.ertiticnte

of de~~osit fi<~n1 the cred~iYor ~7f a compe~i~y thrtt had

transferree~ ~ 5~eurit_y inYcr~st in t]~4 certif7c<ite oPdeY~osit

to a ~wk, which had Yiansfe~red a $211,000 lett~~• of

credit to the cr~dicor. Imo}. trt 299. 'I'l~e com~~any iia Aii•

Conc~itioa~i~ c~~vec{ its creditor S2(.1,OOQ. Id. at 295.

When thz coinp~ny began falling behind can pa}~tuents,

the parties wori:ed out 1 ae<~l to keep the comp~iry in

bti5ii~ess, Id..As part c>f flie det~l, tl~e coinPany issitea a

~2Q,0()0 promissory note fo ~z bank secured by <~ .2(),(3()0

certificate ~*Y.=31~~ of deposit, 'Id. '1"lle bank, in 1un1,

executed a :620,01)0 letter ot~ credit to the cr4diYor. 1d.

Aber thi c~~r~pany ~:niered b~nkru~a~cy, ~~re ruled that

Il~~'13[~~] fihe Ts-~nstex of Che sectili•ity nit~r~sY i11 the

certificate: oP ct4~~c>Sit to the bztnk consfitui~ed ~❑1voi~nl~lc prcferetacc uz~d~r sectintt 547(b) bec~ztfsc it

vas 1 t1•aitisfer ~f pr~~~erty of t71e rletrtor to a creditor

~~~ithin 90 days czf Tiling for b~u~ks~ul~tcy Chat prc~vicled

fuore value to the creditor tla~~~ it would hive received

under 4hrapler 7 oL the I3nnk~liptcy Code. ]d. at ?9(-97;

see also 11 U.S.C, 5~#7~b). We khen rtile~i lhat the

17tmk.n~ptcy tizistee corild a~eeover tl~e ~r~1ue [**43] of

the certificate oi' deposit fi~z~i~n Y11e creditor bec~~.ise tl~e

company granted tl~~e secm~ity interest to the t7auk for the

bene~it~ ~7E' the ca~ediLt>r. Id. ril 299, We explai.nud kl~at

Illl'74[ `J the text of sectii7u 550(a~)('t) a[]o~~~s the

tnist~e Y.o recover from a creditor ~vh~n it ~v~s aii entity

fo.r ~vhos4 benE:lit the trn~s.Ce~~ oE' tl~e certi~c~te oP

cl~posif ~~~~as iziadc. 1d.

Uur decision in Air Couclitiouiil~ c~~ntrols this appeal. In

1~lir Cnnditac~n.ii~~, llie debCor transferred a lien Yo a

lciicl4r ~vho transfci~~ed fiends tc, ~ er~ditor. The transfer

of tl~e lien was avoided end, tinder section 5SO(a)(1~, the

crediT~r was ~n entity :['c~~~ whose ben~:l7.t flay 4r•~asf~i• r~•~s

made. In the same tray, flee Conveyii3b Subsidiaries

trans£eired liens to fete Ne~v I,endcrs, ~~~ho transferred

fi~u~ls to erediCorh, Clie '1"~~~nseeistern L~nciers. '['lie

Uaukrul~tcy coiGrk avoided the transfer of Clue liens and,

under section 550(a}(1), I~lie T~railseaste~7~ Lel~dei.s weX•e

eniilies .for whose benefit the Cran~fer wads roacle.

'llie ~I'r~tiseastein Lenders attempt t~ distinguish their

rtppeal from Air Conditioni»c? in t~4vo ways, but theia~

arguments igA~~~-c tla.c maYecial similarities l~ehveer~ tl7.c

preferertcc; in fh1C decision an~i the fi'atidulent it•~nsfer ~t

isstiie in this appe~L First, the Trinseastet7i

~~`*~!4] I,endet~s cox~tenci that ~1ir Conc~iticini~ ~itavoh~~d

a preference under section 5~7 ins[e~id of a fi~auduler~t

transfer under 54~i, btit °[t he theory ui~d~r which a

tranafer i~~s been avoizleci is in~elevant eo the l.i«~bility c71'

the transferee against ~~rl~om the tilt~tca seeks to r~:covei•

[ln~ider section SSa~." In re I3u(lic~n Res~et~e of North

nmeric~i, 92? 1:'.?~l 544> 54G n.2 ()tl~ C r. 1991). Second,

the "Cza»selste..i.~a I,cndea•s argue tl~al section SSD(a)(1)

3}7plied in Air Conditio7~in~: because a letter of credit

vas i»volved, bait the Transe~steru Lende~•s cannot

presvide x pr,inc~i~~lcd basis .for ~i~~xtiling section 550(a)(1)

to facftiial secz~ari~~s that involee letters of credit.

:I`he '['z-anseastern ~.,endcrs also c<~zate.nd tiaztk they c«~uiaoi

he liah3e under section S50(a)(1} l~ec~t~~e t11ey 1~ciiefitYe~i

fi•oin a sizbyequent irzYi~sfer of fiends iioni TOUS[~, not

ft-~nn tl~te .inifit~l ir~c~sler c~#~ tl~e 1ic~~s, but the recoad

conYraiiiats their assertion, The iiew loan agre~tncnts

required ttiaC 'the loan proce~as be used to pUy the

"I a~anseasttnt settle.menY, aizd tl~e 'i xaz~seastcrn se1t~leuatnt

expressly depended on t11e ne~> lc~titas. ~WJ~c_z~ the liens

~~ere transferred to the Nz~u Le~iilers, the proceei-ts of the

lens ~~ent to tl~e 1"ranseaste,rn Taenders. Tl~e

Transeaslern I.,cnders asserC tl~ak t(~e '.funds

[~`*45] ~~assed from the Ne~z~ Letic~ers Yo a ~vl~olly-

ownecl sut~sieliary aY'1'OLTSA befare the fi~ntLs were paid

to tt~e `('ranse~istern l:,enders, bark the subsidiary khal

~virec~ lhc; money to the "Ii,~nscast:ersi Lenders did i~ot

17ai~e control over flzeFunds. The loan docutner~ts

renuireci the snbsicliary to vice floe fti~acls t~ the

'I~rans~asCern Lenders ii~nmecli~tety. Althc~ugfi i1~e ftincis

tecluiically passed through the 7'OIJ~A subsi~diuy, ibis

formality ciicl not ialnlcE tl~e 'Prans~:~stem Lenders

subsequent trtinsfieees of tl~e funds because '('OETSA

1~c~~e1° lead control over t7ie fui~d~, See Nordt~cr~ t'.

Societe Generals (ln re Chase &Sanborn Carr:), 848

1~.2d I196, .L 199 (i.lth C~ir. 19F3S) (slalia~g that H~'VTS(~`]

ctnuts mast apply a °very fle~iUle, prflgmatic" test t17at.

"lo~~k[s~ beyond the ~ * 1 ~ 15] plrticular transfers in

clueskion to t11e entire circunastanae ~f l~he traz~sactioz~s"

Page 15 of 1~

16 of 17 2/6/2019 11:34 AM

about:blank

680 F.3d 1.298, *1.315; 2012 LI.S. App. I„I XiS 979C,, *~4~

when deciding whether debtors lead controlled ~~roperfy

later sought by their hustees); 13~incled Pin. Sews., 838

F2d at 893 (holding that a bank was not xu initial

tr•ausferec because it held :hinds "Duly fc>r the purk~ose of

fulfilling an instrlietion to make tLic fiords ~v~ilable to

someone else"),

The 'I'ranseFistein Lenders tv<irn that our reading of

section 5~0(~) would drastically expand the potential

[~*46~ pool of entities that could be liable for any

ti•lnsactio~i, but these concerns arc utisubstailtiated. The

TranSe~ster~ T.endeis off.'er ex~uizples of a parent

company taking oi~t a loan secaG•ad by itti subsidi~rir;s

with the specific intent of paying a contractoa~ to build a

bltildi~ig for t11e parenT company or paying ttie dry

cle<i~~in~; bill 01.~ ilxe parent conipaxay. 'The '1'ra~~seasiern

I.,cnders c~iution that fhc contractor or dry cleaner could

be forced to return their pay~inents if the loam securing

the money izivolved ~ fiandulez~t txansier, ~~~liicl~ ~~otild

it~~posc "ext~aordivary" ci~uCi,es of dtte diGgencc nn tlac

part of creditors acceptinb repayment. But every creditor

must Exercise soilza diligence ~vh~;n receiving payiuent

fro~ia a stnGg~ling debtor. It is far 1rc~m a dr~itit,ic

obligation to expect saniu diligence from a creditor

when it is being repaid hundreds o~F millions of dollars

by sonaeo~ie other tl~nn its debYo~•.

C. i~'e Rerr~und,for the District C.'ot~r•t 7n Consicle~~ First

the Remedies bnposed by the Bartkr~atptcy Covrr~t aml

~~7atters af.<lssignrnent and Corrsolicfcrtiort.

TYie parties' remaining ligaments pertain to issues that

are not ripe for aux- rcvie~v. The Transeastern I,eiaciers

1sk that ~~-e vacate i7ie remedies orct~red by tl~e

bankniptcy [**A7] court, and bokh p~irCies ask that we

wade into mat~tez•s of ,juciici~l assi~~n~eut timid

consolid~tiou nn remand. "]'hest issues must be r~solvcd

first by the dish~ict courk.

"l'he 7'ranseastcrn I.,end~rs zla~illcnge t(~e remedies

imposed by the bankruptcy court, but IIN16[ ~ eve ~~~ill

not address azz issue that the dish~ict court has not yet

causidercd. See e.~ Driko~a~ski v. Nortl~ci71'l:'nist Bank

of I~loricia, N.E1. (In re Prudential of Florida I.,easine,

Inca, 478 I'.3d 1291, 1303 (11th Cir. 2007) ("Wlaen t}te

~listricl court does aaoC adJress tiu issue [it dismissed its

rnooY], the proper course of ~cfian often is to vacate the

order of the district court and remand."}. The district

court, on rem~ncl,, should review, iii the Iirsl iusta~lce,

the remedies ordared by the b~nkiuptcy court. We

express nn opinion oii that sttE~ject.

'1.7ic p2rtics' rcqucsts about judicial assi~n.n~cnt and

consolidation of proceedings are ~Iso ~nisduected. The

Coilunittee urges us to ~•emand U~~is case to ~ difPerc,zit

district judge; and the "Cranseastct-~~ I.,endcrs and Ne~~-

Lenders argue that, if the case needs to be heard again

by the b~~~lc~u~tcy wart, we should instn~et tl~e district

court to retnaucl the case to a aifler~~~t bankruptcy judge.

Both sides complain that [**4'~] the judge ~~~ho issued a

decision unfavorable to their i~~terests is biased, birt

neither side has est~blishea that "the original judge

would have diFficulty putting; his previous views and

findings aside." C5X Tr•ansp., Inc, v. State Bel. oi'

F?nualir~tion., 52.1. I~.3d 1300, .1.30.1 ('1 ] th Gir. 2008). Tlie

Committee also argues that Lhc; .rein~ining reme;ciial

issues ire: iniert~~~ined with remedial issues ri•om a

related appeal bc;for~ ~ different district judge and that

consolidation of proceedings ~~~ould promote judicial

economy. We leave these matters of future judici~il

administration and inan~gainent for the district court to

tiddress lirsl.

[* 1316 IV. CONCLUSION

We RIi:VI~;RSE; the order of tl~e district court, AFF[Rl~'(

the liability Endings of the banla~uptey coluf, and

I2EVIAND to the district coact for fiirther proceedings

COI]S]til~Ilt ~i'11,~1 t~l]S O~I.111Qi1.

REVERSED AND RFNI~ANDTD.

7;~t! o3 .'k~s~c.u~aeaxt

Page 16 of 16

17 of l7 2/6/2019 11:34 AM

about:blank

Cautionr1s of: Fcbnieit~ 6, 20]9 8:11 PM 1

In rc Xoiaics Phot~~clicmical

CJnited States Court ofAppc~ils Porthe Seventh Circuit

Tanu~~~y G, 1988, Argi~cd ; Maz•eh 8, ] 9~i8> Decidccl

Nc~. 87-? 143

Reporter841 F.2c1 19R *; 19,8 LLS. App. LEXIS 303 **; 1$ Collier Baukr. Cas. 2d (NIB) 711; 17 Ba~il:r. Cl. Dec. (OC; Baiil<r. L. Rep.

(CCH) P72,21 1

In 'l~hc M~jtter Of Xc~alics :Photochemical, Ino., I)eUtox•,

Appeal of Mitsui and Comp~my (TJ.S.~1.), Inc.

T'rior history: (**1'J Ap~»~1 fr~»n il~e United States

District Court 1.'or t~l~t Norlh~iu District of Illinois,

I astei7~ Dig°ision. No. 8C C 737 -I3riaY~ I3aaYlett Duff,

7ucige.

Core Terns

afrGate, coi~tin~ent liability, ii~solvent~, liabilities,

obligations, contingent, debtor in possession,

guarantees, guarantor, voicl~ble, fi~tiuctule»t conr~ey~nce,

subsidiaries, tr~~i~sactions, Accoun[ing

Cass Su►nmary

Procedural Posture

DEf~ndant unsecured creditor sought rep°iew of a

judgn~eut oP tl~e United States District Coart fot~ the

Nortlze,rn District c~t~ Illinois, Lantern .Di~rision, ~uhioh

a~ltinned the decision of the baukrtGptcy cotiu•t to set

aside payments made by plaintiff debtt>r to cl~Pendant as

preferences under 1.1 iJ_S.C.S. § 5~7(b).

Overview

Tl~e debtor br~titght an ldvcrsary p~~oceedin~ against

def'endai~t ~insecured creditor 1<> set aside t~-vo payments

Made to defendant as ~~oid~ible preferences under ].1.

U.S.C.S. ~ 54'7(6). "C`(ic district court afl~ii~i~ad the

bankrt~~~tcy court's determination that 1~he payx»ents ~r~ere

preferences be;causc they were made when tl~c d~Utor

was insolvent. On appeal, the court held ghat the debtor

vas insolvent at tt~c ti7tze the payments ~~-ere mace;

because tl~e deUtar's i~atcraftiliate a6reemeJut to

gttFiraiitee llie debfs of its parent carapany was

cnforceabi~, upo~z lh~ parent ec~rporat~ion's dcfaiult, the

debtcir became insolvei~i because its assets ~n~ere nol

greater than its 1i~ibilities. `The coixrt further found that

defencl~int could not assert that the affiliation a~z-~cments

were fi~audul~~~l convey~mces under ll i.1.S.C.S. §§

5~G(b), 54$(a) beeaus~ the righC t~o invoke those

pa~~visious r~;:~tEd ui either the trustee or tt~6tor ita

possassiou, and not in an unsecured crc~litor. "I~he eoart

aLYiimed, finding that dcfendaiit had provided no

gxolmds upon ~~°liic}i Co tiet aside the voiding of the

payrn~~~fs m~irle t~o it.

Outa~me

'I~I~c court affit7ned, finding tli~t payments m<<dc tc>

dePenclant linsecux-tci caedit~~r wc,re,proparly set ~siel~; as

preferences Uecause they ~-vece made whc;n the debtor's

~issets ~vcre not greater than its li~~bilities due to the

etif'oracablc interaf~liate agrcen~ezit it h~~d t~~ guaa~nnlee

its parent corporation's debts. Only a Gust~;e or tlic

deUcor had tl~c~ riglri to cha]le.nge the ttgreeme~nt as

ti•~tudulc;nC conveyance.

LexisNexisC~> Headnotes

L3ankruplcy I,a~a~~ > ... > 1'ref~rential

7'rarxsfers > I;leme~ntk > Debtor' Tnsoh~ency

k3~iiakl•upccy I.,a~ti > ... > Pa~~;petrtion

"('ransfers > f'reterential 1'rz~usf~z•s > Cicneral

Overview

B~in1cruptey La~v >~ Itcorganizat~ions > Debtors in

Possession > C?auer~l C)vezview

2 of 8 2/6/2019 12:11 PM

about:blank

817. ]~.2d 19R, *19R; 1983 U.S. App. 1,I~.XIS 3():35, **l

I3ankr~il~tcy L1~v ~ ... > R.c:organizations %Debtors 11 U.S.C.S. § 544(b) in effect allo~~s the trustee to i~se

ii1I'o~session> Powers &Rights Che nt~~~licable state's l~i~v ~~l fraudulent coiivey~nces Co

sel aside c~bli~ations incurrrcl by the bankrupt.IINI [' J EIe~Y~er~ts, Debto►• Insolvency

ll TT.S.C.S. ~ 547(b) makes tratas~ictioi~s voidable by the

trustee, but l i 1.7.S.C.S. § l 107(x) gi~~cs tl~~ debtor .iia Btiisuiess ~ Corpnr~te Compliance % ... > Conh~acts

possession the po~~~~Y•s of a trustee. Lnw > Standards of Performznee > Creditors &

Debtors

Bankniptcy La~~~ > ... > Avoidance > Prepetitioti

Transfers =~ Preferential Transfers

FI~~T2[ ] Prepetition Transfe►•s, Preferential

Transfers

It makes no itifference whether the debtor has a

contingent asset or a eantin~ent liability; the asset car

liability must be reduced to its present, or ex~?ected,

value before a determination c<~n be made whether the

debtor's assets exceed its liabilities.

Banking L~u~~~ > Int~znat~ional Rani iia~; > I3~~z~ds,

Guar~xrtees & I.e~tters of Cr~ait > G~;ntral Ov~ivic~v

IIN3~ ] Intcrt~~~tional }3f~nlcit►~, Bonds, Guarsintees& .Letters of` (.`rediY

F~ guax•antee of an af'filiate's debt is ~nl~orceuble,

pa~~vicle~l tt;~Y thG ~u~i~- ii~tor derives 4tnxzc benefit, even 1#~

inclircct, fi-otn the ~uaraiatcc. "T'lje benefit opertttcs 1s a

partial offset to the iinpaii7i~e~~T itt the prospects of the

guaraz~~t.~~x•'s creditors resulting Crony the debt~~r's

assuming a conkin~ent liability.

I~a.nlau~~toy Lativ > ... > A.voidaiice > Traudulvait~

Tr~nsfer~> General Overview

Real Propexcy L,3~v =' Purchase &Sale > Fraudulent

Gr insleis

[3:tnkruptcy I.,avv > ... > 1'repetitiou

Transfers =-~ Voidable Trinsfers > Unsecured

CrediCors

/f1~~4[ ]Avoidance, I~'rtiaduleut'Cr~~nsCers

Contracts La~l~ > Defenses %Failure of.

Consideration

Real Property Lativ > Purchase &Sale > Frauchilent

Transfers

Bankruptcy La`u > ... == Avoidance > Fraudulent

Trantifers ?General C)verview

Cout~acts Law > Contract

Formatioi7 ̀~ Conaidei•atroxi =~ General Overview

Busuiess 8c Co~por~te Ccmipli~nce > ... > Contract

Formatie7n> Consideration> Adequate.

Cousider<ition

Ht~~S[] Standards of Pe~r1'ormance, C`reclitons &

Debtors

A conveyance not supptirte~l by ~idequate consideration

is "fraudulent," that is, tiileiiforceable, as against

existing creditors of 1 debtor who gave up value in

exehan~e for the uiadequ~te consideration. And, even if

the consideration is adequate, the c<7n~reyaiice is

fraudulent if made ~~~idi intent ko defraud ereditoi:s.

I3an.krupecy I.,a~-v > ... > nvoiclance % I~'raudulent

"ir~tnsfers > ;[ntenk

~t~al Property La~r~ %Purchase &Sale > Fraudulent

"('xztnsfers

I'e~x I.:a~~ > ... ?Sales 8z 13xcl~aiages > [nstallmc:nt

Sales ~ l~uturi~ T'~~vments

I3~~nk~uptcy Law > ... > Av~~idance =~ rraudiileilt

1'rarist~rs > General Overview

FIA'6[~ 1+►•autlalent"I'r:titisf~rs,T~~tex~t

Page 2 of 7

3 o~f 8 2/6/2019 12:ll PM

about blank

$~11 F.2d 198,, *1.93; 19ki3 U.S. App, I'.,I.~XIS 305, *~l

Tf an obligation is incurred within one year before the

filing ~f the petition Por baril ruptey, and there is actu~il

intent to defi~tua either an existi~~g or a lirture creditor,

t~hc trustee c~~i avoid t}~a obl.i~ation_ 11 IJ.S_C.S.

548(x)(1). Alt~:rnntiv~~~y, if Che debior recEiti~es 1~ss than

a ~easanably ec~~liv~lezit valae in exch~~nge for such

o1~ligatian t~~ad is insolvent o~~ tl~e date Yla~ obligation

vas incurred, the tnistee again can. avoid the c~bligatiurr.

1.1 U.S.C.S. § 54~(a~)(2).

Bankruptcy La~~~ > ... > Yrepetition

Transfers => Voidable Transfers % Unseuure,d

Creditors

Busiciess & C:~~rpc~rate

Ccimpliuuce > ... =~ NegotiaUle

Instruments ~ Enforce~~nent -- pint ~ Seve~r~l

Instruments

P~e~I Property La~v =~ Purchase &Sale > Fraudii(ent

Transfers

B~nluuptcy Lew ~ ... => Avoidance J Fraudulent

Transfers =~ General Over~fiew

Bankruptcy Law > ... =} Keorganizations =Debtors

in Possession > Pcnvers ~~. Rights

H~\'7[.° ]Voidable Transfers, I?nsecured Creditors

Tl~e right to invoke 11 U,S.C.S. §§ 54~#(b) and 548(x)

beIangs not to a p~rticul~r unsecitr~d creditor, but to the

trustee, or debtor in possession, as the representative of

all C(~.e tinsact~red creditors.

Counsel: Attarney'for Pl~inliff: Thomas D. Goldberg,

Hughes HuUU~rcl & keecl, Wushirigton, District of

Colwnbii.

Attorney for• Defendant: Erick S. Rein, Scli~vartz,

Cooper, Kult~ &Gaynor, Clltd., C'liic~go, Illinois.

Judges: Y<~snei-, Coffey, end ElsterUrook, Circuit

Judges.

Opinion by: POSNER

O~~inion

[*l99] PCJSNI:;R,,Circi~itJudg~e.

This bankruptcy case presezzts interesting questions

coi~ceining C1ac: status in t.~ank:ntpfcy of ~antingent

liabilities aid vrterr~ffiliate obligations. Tor backgrotuid

see Comment, ~~~.{i~r~iclubilitr of Ir~tef'eorpar•crte

Gercrt~crrai~ee,s ~(incler• S"ectiofas 54b'{cr)(~j anc~ ~4~(b) gf'tlze

Bm~ikruptcy Cac~'e, ~~ N.C.L. Rev. 1099 (1986). XonicS,

Inc., ~io~~~ in Chapter 11 t~aukruptcy, has several ~a~liolly

o~~~nied subsiditu~ies that are engaged in inaki~~g medical

equipinenY. "I~he lar~cst is Xc~nics Medical Systems, Llc.;

one of the smallest is Y~nics T'l~~tochemic~l, Tug, the

d~btoc i~a the jn'oc~edingbefare u~. I:n. 19$2 ~ii~ci 1~)S~, a

time crf pr•o~perity for tl~~ Xonics faiz~ily, Xonics

Medical Sysfeins boiro«-ed so~r3e $ 15 to $ 20 itrillion

Icon a bank, ~~n a $ ~~*2~ ?S millio~~ czeclit li~~e.

?to7rics, Ii.~a, the pare~lt, closed Xonics Pl~otochcmiczil,

Ina (along 4~~itl~ the other subsidiaries) fo ~i~s~~ntee the

login; a~i the trine Xonics Pl~otoclien~ic~l hid gross assets

of sonac S 2.0 million auci net assets of ~ 1.7 tuillion,

Xauics, :(ne. a(ao caused Xonicti i'lt~tochemica] t~~

becoule 1 co-maker with Xc~nics ivledical Sysiexns of 1

note To secure an adclitionil loan oP$ 3 n~illi<m.

Shortly after these transactions, Mitsui & Co, (LJ.S.A.),

Ii~c., a supplier to ~Coiaics i?hc~iocl~emical, shipped it

s~~me chvanicals, and iitvt~iced it for the ptu•ch~se price

of (flpproxirna~ely) $ 124,000. Xonics Phc~tochetnical

paid tlae invoice ~-vi.tl~ ttvo ehe~ks k'l~at cleared 3u Tanuary

198 . L,css tl~au 90 days ]at r, tonics Plaot~ocheinic~l

~~~as in basil ni~tcy. Xonics Medical Systems had

defaulted on its bnnli lo1r~, h•iggcrin~ the guaranties ~f

ils af:tiliaYes. 7'he total assets cif tl~e Xorrics family -- all

of which were pledged to the creditors of each mtinber

thzougll guarnistees similar to khe one Xonics

I'hc~to~henaical haci signed -- 4ve~•c; sl~o~-t of ll~e total

liabilities liy many millions ~~f do11a~•s; so X11 the

si~Ybsidiaries, as well ns the parent, f~~imd t}lemselvzs in

C`.laa~~ter .I l .

Xoilics Photochemical, as debtor in possessic~zi [**3]

(nee trustee in binkruptcy 11~ci baen appointed), brou~l~t

au adversary proceeding againtil Ivlitsui to set 3sicic the

t~yo payments fls preferences voidable tinder I 1 T_I.S.C. §

547(b). H~'VI ( ] ("['leis provision ~ualces transacfions

voidable by tl~c hust~ee, but 1.1 IJ.S.C. § 1.107(x) E,ives

the debtor in possession the po4~-ers of a t~-uste~.) 'Pile

ctispc~siti~~e issue was ~=1~ether Xonicr; I'hotochcniic~l

lead been i.iasolvei~t wti~:ii llle paya~~enls to Mifsui were

Page 3 of 7

4 of 8 2/6/2019 12:11 PM

about:blank

aai r-~.za i~a, ~1~~; ~~~s4 tl.s. ~~,~. t.r;x~s 3o3s, *~~

made; th~rt is, did the fait value of its liafiilities exceed

the fair v<~lue of its assets (1 L U.S.C. ~ 101(31)(A))? If

sn, the pa}~menls were indeed voidable ~~refere~~ces, see

11 LJ.S.G. 5 547(b)(3), si~lcc tla~e other conditions iu

section 547(b) had been met. The bank~tiiptay judge and

the district jucl~e thought Xonics Pliotochemic~l lead

been insolvent tl~~n; Mitsui disagrees an.ci his appealed.

~T'he startlixtg ieatiire of the case is the Ptjrties' apparent

~issenl to t(~e Proposif.ion that if the login gu~u~a~atee and

Clie note that Xonics 1']iotocheiilical lead co-signed were

valid obli~~tio»s, Xouics Ph~tocheinical (**4~ was

insolvent as o.0 the elate tl~,e obli~ati<>~as were assuinecl,

on ti c theo~.y khat they created liabilit~i~s gre~iter than tl~e

company's net assets (much greater: $ 23 million in

liabilities versus less than $ 2 ~nilli.on .i.i~ ~~ek assets). The

proposition is abstn~d; it ~voutd tne~ix~ that every

individual or l~ii•rn that had contingent liabilities greater

than his or its net ~issets was insoh~ent -- soinetliing no

one be~lie~~es. Evc~y firm (~hal is being sttcd or that ivay~

be sued, every individull ~vho has sibned 1n

accoulai~~oclation note, every baiak tl~~t has issued a letter

of credit, l~tis ~ contingent liability. Such litibiliti~s sire

occasionally [*200] listed on the firm's bala~ice sheet,

f'or e~a~n~le by earmarking a portion vf' surplus for

c~zx~ti.zlge,nt liabilities. (They Gyre supposed to b~. listed "if

the f~rture event is likely to occter and if iCs ainouut cai2

be reasor~c~b/y estimated." Nikolai et al., Intermediate

Accowiiing 611 (3d ccL. 7985) (~nlphasis ~in original).)

More often they are- ]ist~cd in a foohiote, Maus leaving the

Turn's stated iiet ~voi•tli undisturbed. Often they are not

listed ~t all, r~~hen they fire remote or ~vl~en they are too

s.i~aall to effect net ~vo~~t~l~ substantially. Ora khe proper

accounting t~re~tme-nt [**5] of ooiltiugcnt liabilities see

rd. at 610-I4; Faris, Accowiting for La~~~ryers 362-fi4 (3d

eel. ] )75); Williams, St<i~~~;a & H<~lder, Intenvediate

Accounting fi09-17 (1984}; Mei~s, Mosich &Johnson,

Accounting: The B1sis for Business llecisions 288 (3d

ed. 1972); I~ivaiacial Accounting Slandard5 Rc~au~cl,

FASI3 Staterneut of Standards No, S (1975).

Tlicre is a compelling re~ison not to value contingent

liabilities c~❑ tl~e balance sleet al their free amounts,

even if thak would be possible tv do Uecause the

liability, despite being; contin~eut, is fi>r ~ specified

a~~alo~inf (fhat is, even if there is uo uncert~i~nty ab~uC

~vh1t the Erna will owe zf the c~~ntingency .materializes).

Fay definition, a contingent liability is not certain -- and

often is h~igla~ly ur.~la~kcly -- aver to becoane an actual

liability. 'T'n value the contingent liability it is necessary

to discount it by the prob~biliry that the coiitulgency

will occur ~~nd the liability become real. Suppose that on

tl~e d~Lte the obli_r~ations ~verc assua~cd there was ti ].

pe~cceiit chance Ni t Xonics Photochemical would ever

be called on to yield up its assets tip creditors ot'Xo~aics

Medical Syst~ins (oi• ofhca- ~ucmbers oi' tLi~ Xonics

f~~mily, since the systetu of guarantees [~*C>] hsid khe

effect of pe~oling their astieLs Por the benefit of creditors

of: any mc~nber). "l'heil clue true ~nc~istArc of the liability

created by these obligation~ on the d~ite they were

assumed would not be S 28 million; it ti~ould lie a paltry

$ 17,000. Fc>r ~t ~~orst ~ot~ics Photocl~eznical ~~~ould

have co yield uP all of ifs assets (net of other liabilities),

that is, $ 1.7 million and Yl1e probability of this outcome

is by ~isstiinption oxaly 1 perce.i~t (eve are i~nori~ig

iutei~ulediate possibilities -- e.g.,that Xanics

Phc~tochemicll ~t-ottld be forced to pay over $ 1 million

rather than $ 1.7 million). Discounted, the obli~~tions

~~-ould uot~ make Xanics iuso]veut, and s~ctii~n 547(b)

~~ould not come into play furless events occurrinb

betti~~een tl~~ ~ssttmption of the obfigatioias in 1982 and

1983 tiiact t1~e bankruptcy in1984 had tilPered Q~e piclur4.

We aid that 3~onics Photocheiz~ic~l did not in :fact list

these obligations as liabiliTies on its balance sheet.

1~he prinetplc ,just outlined has long beeai .recognized in

cases dealing wiCh the tluestion whether ~ tii7~~ is

insolvent will~in the meaning of tl~e }3ankruptcy Code

(and this is such a case). 1ItV2[ ] It~ makes no

difference whether the Erna has a contiligenC asset or a

contingent liability; [**7~ the asset or 1i<tbility nausf be

recl~iccd fo its present, or expected, value before a

dete~•mination can he made whether fhE tu~li's assets

exceed its liabilities. See, e.g., Syr•nc~~se ~'ngf~~eer~ir~g

Co. v. Haight, 97 ~~.2d 573, 57C (2d Car. 1.93$) (I,.

Band, .1.); In re 011ag Ca~stt~xctior~ 1>gztipn~ierzt Gorp.,

578 P.2d 904, 909 (2a Cir. 1978); In r•e Fatlgha~m

C~m,slr•arclion Co., 7 I3.R. 629, C32-33 (T~<i~akr. M.D.

"[~c;nn. 1980), afEd, 14 13.R. 293 (NI.D. "Tenn. 19R 1); In

re Hernphi!], 18 I3.R. 38, 48-49~ (Bankr. S.D. Iowa

1?82). T'he criticism of this position ix~ the skirdent

Coinn~eiat cited etwlier, 64 N.C.I,. Rcv. at 7115-19, is

perfunctory and unpersuasive.

Occasionally one f.zacls tlae f1aY st<it~eniei~t f1~.at

"contingent or incl~.oate claims of the bankru~Y are not.

included ~s part of the bankrupt's ptroperty." .<Illegaer•t ~-.

Chemical Bank, 4lR .I'. Supp. 690, C92 (l .D.N.Y. 1970).

Page 4 of 7

5 of 8 2/6/2019 12:11 PM

about:blank

841. F.2d 19R, *200; 198 1.1.5. App. L,I>XIS 303, **7

This is the equally untenable opposite extrei~ne from

valuing them at Cheir face amount. Taut the quoted

language appears to be loose; ~~~hat these cases actually

Mean is th~it it; but for fl contii~g~nt clsinl unGk~ly to

yield any cash in the ~**8] near future, the firm would

be cleeuied insc~l~enl, the exi3tenee of ti faint hype --

colcl comfort :for creditors ~vaitiug fo be paid -- ~vi11 i~ot

save it from bankniptcy. Sec Penn i~. Grant, 244 i'.2d

30~ (9th Gtr. 1 57) (hex ctiiriu~l); lip rc: 13ic1~el Qptica~

I;abor•atorzE~s, lric., 299 F. Supp. 545 (T~. Minn. 1969).

[*201] No more should tl~e existence of remote

contingencies, ti~~l~icli do i~ot seriously en,cl~zl~er the

f~rn~'s z~bility to pay its debts, be deemed to make an

otherwise solveiat fn~in bei~lcnipt. Sec Ira r~e F~'aters, 8

B.R. lE>3, if>6 (Bankr. N.D. Ga. 1981).

We have gone into this nou-issue at such length Duly [n

ovoid cresting the unsetkling impression that co~ltingent

liabilities roust for pui-pos~s of detei-~ni~iirig solve~icy be

treated as definite liabi]ities even though tl~c

continScncy has not occurred. Mitsui his chosan not Yo

inak~ an issue oi' the conti~ag~nt n~iturc: of the guarantee

<tind of the co-signahire o:C the note; tu~iybe tonics

Medical Systems vas A~eally insolvent by the time Mitsui

received tl~e payments in issue froi~i Xonies

Yh.<~kochemical, so that tl~e cc>~~tin~ezat liabi~liCy ~~~as no

longer contingent. 'I~l~c Duly ar~utnent Mitsui. tulkes

against t}ie [*~9~ finding th~f the payments Yu it were

voidable preterenc~s is tl~<rC Xonics Photochemical was

not insolvent tivhen they ~verc made because the

trnnsact~ioits liet~veen it and its affiliates were (1) void

u~~ider stlte la~v (ll~e parties agree tl~iat the applicable

state la~v as tl~tit oP Ill.ia~ois), or (2) voidable as fi-aucfiul~nt

eoi~veyances. If cifhcr conteutiou is eon~ect, the

transactions creaCed iio liabilities on the part i~f Xonics

Photoclietnical and tliezefi>re could nc~t ha~~e naadt it

insolvent, whatever fhe plight of X~nics Medical

Systems; Bence section 547(b) 4vould 1~ot be triggered.

1. When a parent causes one of its subsidiaries to

gu~rnntee anoYl~er's (ar the parent's o~~vn} debts, there is

~n obvious danger -- one: indeed that has materialized in

this case -- Q~at crcd.itors of the guaraiiYor, ~vho nor~~ially

are tuiarvare oP the contingent liability and may not even

he <Y~vare ~f' their debtoa~'s ~ffili~tion ~vitl~ other

ecrrpnratio~~s, will find tl~e.~aiselves, witlao~.il waci~irig,

dealing ~arith a suddenly less solvent (not, as eve have

been 1t pains tc~ stress, necessarily insolvent) debtor.

7`lx: ek'.(eci v~~ tl~t guarantee, especially where as here it

is a part of 1 nef«-ark oP suarantces that have tl~e effect

of making the [~*10] debts of each affiliate debts of all

the other afli(iat~s tis well, is similar to that oP a n~le o1'

laa= that treats the assets of af~Jiated corporations as a

coi~nmoii pool available. to the creditors of each affiliate.

Such rules have someti,cnes been tidvc>cated, but the law

J~~is ~-eFused t~o ~~dopt then, for just tl~e reaso~i stated;

t}iey m<jke it harder for creditors of an affiliated

corporation to assess tl~eiz• debtor's credit~~vorthin~ss. If

such rules ~~~cre in Col•ce, "a sign of weakness in tiny

member ol'a fEimily of cc~iporations ~~ould lc~d creditors

to descend on e~cl~i member, strong or week, to claim

their p<~~md of flesh." Irt re i12~10-rain Cor~z, Trrc., 8] 0

1~.2c1 270, 277 (D.G. Cir. 1987). Ilcnce there is no

automatic "piercing of Uie corporate ~~eil" in affiliatio~l

settings. The ztssets of affiliated coi~aratious are not

treated as a conaino~a pool av~iilable to the creditars of

each affiliate ~mless imtisual circuinst~nces are present

that would make zt inequitable to allow tie other

~fGliatcs to sit up the pcinciplc of limited ]i~bility, tl~c

clearest such circ~unstance Ueing that the creditors of alt

the affiliates had thought they were dealing with a

unitary entetprise. For a ll~orougl~ [**],1] discussion see

Cissel! r•. First Nat'l Bank of Cincinrinti, 476 1~. Supp.

474, 479-81 (S.D. Ohio 1979); sec also !L1ui~a Ban7c cif

Chicago r. I3crkei~, 8F Ill. 2d 1.88, 204-OG, 427 ivr.l?.2d

I4, 7.01-U2, 5(i Ill. ]:)e;c. 1.~4 (.1981); Van Dor•ri Co. i~.

I'r~tcu~e C,7Tenracn! cP~ Orl Corp., 753 I'.2d 565, 569-70

(7t1~ Cir. 1985) (applyiizg Illinois law); cf. Irz re Kniser,

791 1~.2d 73, 75 (7th Cie. 1986).

I3tirt here tlae pooling u✓as accomplished vohintarily, sotl~e focus ol~ Ginalysis switches t~o the c~ucsti.o~a whet~lacr

tl~e policy 'behind generally not piercing the corporate

>>eil precludes ever enforcing a guarantee by one

at'.tiliate of anothec's debts. Courts l~Give nc~t tlacxtgl~t so;

fIN3[~~] a gu~x•antee of an affiliate's deUt is enforcc~Ule

(see Telefest, li~c. i~. t'~r-TV, Inc., 5)1 1'. Supp, 1368,

1.377-8.L (D.N.J. 19&4), a~~d cases cited tla~a~e) provided

that the gu<u~a~ator derives some benc;Cif, even if indirect,

see id. at 1379, from the gulrantee. The benefit operates

as a pa~-tir~i offseC to the impli~nient in the p~~ospeets of

tllc ~uarzintor's or4ditors [** 12] -resulting :fr~n~ kl~e

debtor's assuming a contirzg~nt liability.

[*202] Whefl~ea Xo~~ics Photoclieinical derived a

l~~uetiY 1i~c~m its guaraaitecs vas a factual question, and

we cAunot say that the baiilcrliptcy judge's resolution of

ii vas clearly ~none<~us. Although llae primary benefit

Page 5 of 7

6 of 8 2/6/2019 12:11 PM

about:blank

Kai i~.za i~~, ~,n~; ~~~~ tJ.s. nP~,. i.r~.xts 3o3s, ~~~,

i~f [lie l0~~.1 aeciuca to tl~e t.~orrowcr, X~nies M~dic~l

Systems, t}~af coml>a~3y's fnrCunes were entwined with

those of Xonic~ I'hc~toclae~niefil bec~us~, the sn~allei

aatnp~ny ~tscd its larger t~f~li~ic's disll-ibuYion syste~7~ t~o

clisis•ibi~te its o~vi1 ~~r~~ducts. 'I'lie benefit may not have

bee~i greet l~tit z~eillier ~v~~~ the cost. ~oiiics

~'~iotocl~einical F~~~s taot p~zyixig ~i3y in.tcrest on the loc~ia:,

it just yeas s~ ~niar3nior, and all concerned asstln3e~l t}~t~t

lie loan ~~c~uld be duly repaid acid no gunraiit.or mould

be out oPpockGt. Thu co-~igaiecl i~otc Boras to scctn-c a liue

of credi~C can ~-vhich Xonics Pl~otocliemical as ~i~ell pis

Xonics Meeiical Systems could draw; so again there vas

benefit.

3. Mitsui's second ~eoutt~l 1''or invalidating the

a~t~rGikliliate taansackions is thjt they ~iz~e Gaudtilez~t

co~~veyances ~vitlain the a~~eaning of :l 1 t.J.S.C. ~,'ti 544(h)

«r 548(a). 1'h~se two provisions (tivell discussed ii1 the

shutei~k Conm~~nt cited fti~ fl~~ begi»ling ~**13~ cif 111is

c~~ji.i~ion) Must lac disti.a~guishcd, Seckiou 544~(b) HN4[ ]

iii e1Ye~t allows ttie tnistee to use flee ~r~~~licablc state`s

lati~~ ok frai~idulenr convey2nces to set aside obligations

i,ticurrec3 by ll~e b~~nkru~t. `l'he acCion of a p~reut

corp~i~a~Yion in causi~ig one of its wholly c~~~7ied

suUsidit~ri~s to gt~aranCee t]se deUts of aii+.~tl~er could in

aPp~•o~riate cia~cuxaxst~~lce~ he cte~n~ecJ ~ :fra~id oar ll~~

gu~rauii~r's ~~5~i ar•editors, ~vcu it fliers Was

consider~Yion for the guaranty -- that is, even if the

git~irantor obt<rined .sun~~ bear:#d from the trt~n~acticfu --

s« that il~ would not fail un.<1~r ardiliary cc>~~~ttnct la~~~~. CP.

Ri~hin 4~. !~lrrna~~crcture~•s I~~~rnvver~ Tr~trst Gv., GG1 F.2d

9"11, 993 (2cl Cir. 191). Nominal co~isid~r~ti~n is, in

~unei~l, z~ll t11at is a~c~ded t~~ sr~tis.Cy tfae z-ec~nia~ein~a~ta oP

tlt~: law i7f 4onti-aets (see 2 I3lackstoi~~, Ca~~in.eiitaries

n~i CYie LatiFs of England 440 (17 6) ("peppercorn");

I~anasw~rth, Contracis §y~' Z.-ll.-.14 (.1.98:2)) -~ a

riquuem~.nt of lciec~uate or aaiuiticnstiii~ate cor3siderafi~n

~~ould g~~a~~ely titidenniiie freedom of conu~~ck. -- bi t

[** 14] H.NS~ ~ a couveyanc~ not sa~~pt~ried b_y

1dec~'itatc considcr<iton is °fraudulc~if" (tl~4~t is,

utienfoi•ce7ble) as against existing creditc~is of a debtor

~vho gave up e~lue ui exch7nbe for the inldegci~te

considexati«i~. See Kind v. Zo~~izalinf~ Inlernatio~~erl, I~~c_,

825 F.2d ~11~~, i1f36 (7k1~ Cie. 1987). Anil, e~~i~ if the

consideration is aclec~iiate, the conveyance is fzandulenC

if inacie v~ri~.h intc;nf to defi~~nd creditors. See i~~.

Section 548(x) crates ail atternativE, Ee.deral ec~~~icept of

fi~udt~lent cnnve_ya»ces -- ar ctithez two 7lturnaPive

fe~erlt coi7cepts, IINfi[ ] if an obligaxioal w~is incurred

witl3itl ~n~ year before the Cling of the pekitioii £or

bt~nl;n~ptcy, ~tnd t}te~•~ was ac[util intent t~~z clefrand eithet-

an etisti~,~g or ~ future cr~diTor, the tnistc:e case. avoid tl~c

~bligakiott. 11 [J.S.C. ~ 54R(a)(1). AlYrrliatively, if tl~e

cl~btut "raceivecl less than ~ re~~soiia~bly ecj~tivalen(. v~iltie

in exchange foi si~c}~ ... obll~atioi~" and ~v~~s insolvent

on the date the ot~li~nt~ion was in~ui7•ed, the trustee ~g1in

can avoid t}te oblig~Tion. 11 U,S,C. § 54$ (a)(2).

We sh~11 rnxt l~avi ~ ** 1 ~] ko decide ~vli~tl~er the-

oblignCions that Xonics I'hotocheauical incu~7eci by

viz•tue of its guarantee of the Ic~t~i.a tc~ Xonies Medical

Systems ni~d ~~f its becoming a co-m~~~;er ~~-i~h CMS ~~f a

Vote are vuhlerable Euider either 54~(~) oi• S4$(ii). II`V7[

] "l~l~e rigllP to iny~~kc Lhesc~ ~r~~vi~;ions beloi~~s taot to ~t

particular unsecuccd creditor siicla as Mit~iii but to tlac

tnistee (or del~ior in possession) as the represenfafive of

all the iun4eciu~ed crcctitars; and in this case the. det~tor in

r<>~;scssion Iles uoY im~okud eitl.~cr provision. I~t is x~ot as

if' Mitsui itself had beeei a creditor han7~ied by the

allegedly fi•~udulPnt conveyances; they ~~reeeded the

payments iri istiue. Mitsui is seeking to stand in the

shoes c,f creditors ~vl~o may have been 1~~rmed, but only

the trustee ar cfebt~r in possession cfln da that.

Siitue tlicre is i~o tn~stee aid t7i~ d~btoi• u~ possessic~i~

rei5iains nn ef~fili~te of the turn t~~l~ose debt the ciel~tor

had guKtraz7te;ecl, M:itseri is en.ti.tlecl to Gv<~nder cvlaether the

nfiisal by t~lie debtor ~i~~ posse:ss.ioia to try to void tl~.e

guarantee (and perhaps the co-sibnzct note r~s well) was

really i~~ade in good f~ikl~. I3ut, if' sa, Mitsui

co~~ild [**'I6~ ~havc sought Ylaa appoint~nGnt of ~ irust~~;

in L~ankrupkcy, see 'il iJ.S.C. ~ 11~~4, suet it [~2Q3] liar

ne~~~;r done sc~. Mitsui says it doesn't have ~nougl~ at

stake iax ibis case to ~-van' uil beticin~ the ~x~jense cif

proving the nerd for t}~e ~ppc~intinent of a titiistec:, yet iY

see~n~ ~~;~illing Yo supply the very s~nie proof in order fo

pc.rsuacie ins t1z1t it should he allowed to stand .in tl~e

shoes of the: elebtor in pcassession and invoke fraud~ilent-

convey~nce law.

11n alkc~i~~ative route possibly c7pen tc~ Mitsui, see In ~~e

~~ratornc7r'ec~ I3ar,sine,ss S.ust~~~ras, Inc., 64~ F.2c~ 200 (<~kh

Cir. 1?31); Ir7 re ,Ione.s, 37 I3.R. 9C~ (F3an(:r. N.D. Tex.

19~A), vas to ask 1:(~e bt~nln uptcy co~~a t to allow .it to

bring a Po.rm of dci~ivative suit in kl~e dame of tl~~ detat:or.

13nt bef'c~re it could do any such thing it would hive to

co~i.~~~icze~; iha c<nut tliat~ the deb(~o~• was shizki~G~~ lvs

Page 6 of 7

7 of 8 2/6/2019 12:11 PM

about:blanl<

841. P.2a 19R, *203; 1988 li.S. /app. I..F;XIS 3035, **l.b

stahrtory responsibilities; and this Mitsui has never

done. Cf. I'ox i~aGlei~ .9A~IC/Jeep, Inc. v. AM Credit

Corgi., 83C> F.2d 3CE (7th Cir. 1988), and cases cited

there..

Iaz these circun~stan.ces a batter argnme.uf :for Mitsui

li~oin sectiolts 544(b) and 548(a), but one Chat Mitsui

does not make, is j ** 17~ that these Provisions supply

a~~otl~er reasoia far ~~~ritulg do~~~n the contingent

]iabi]ities upon which. the liuding cif Xouics

Photochemical's insolvency at the time of the

preferential payments was (in part anyway) based. Por if

by virtue ~f i~~audulent-conveyance 1G~i~v the liabilities

mi~hY not b~ enforceable ~in Yl~~~ evsi~C of ban.kniptcy

(depending of course on «~Iiat a trustee in l~ankrupt~y o~•

debto~~ i~~.~ k~ossessiou mi.~lat choose to do) -- and i~~deect

iuight be voided in an independent action Uefore

bankruptcy -- this ~~~ould be another reason for thinking

that these liabilities should l>e drastically discounted i~~

deciding wl~ethcr they hdd made Ll~e debtor iil~olvent,

acid l~~iicc ~vhcther the ~aymcnts to Mitsui are ~~oidablc

under section 547(b). 1~n unenforceable debt is not

nr~ich of ~ li~bilit}~.

Mitsui has pres~nt~d no grotiind on ~vhieh eve are

autli.oa~ired to set aside the voidii~~ o_f the payaite~ats

made Yo it..

A3~ PIRMI;D.

~~.ard~ oaf I~~st~r~a~er,39~

Page 7 of 7

8 of 8 2/6/2019 12:11 PM

CautionAs of: February 7, 2019 1:53 AM Z

~ ~~ k

Court of Appeal of California, Third Appellate District

October 10, 1996, Decided

No. CO21518, No. CO21956.

Reporter49 Cal. App. 4th 1576 "; 57 Cal. Rptr. 2d 435 "; 1996 Cal. App. LEXIS 966 '"'"; 96 Cal. Daily Op. Service 7594; 96 Daily JournalDAR 12463

LENNAR NORTHEAST PARTNERS, Plaintiff andRespondent, v. DeWAYNE A. BUICE as Trustee, etc.,et al., Defendants and Appellants. LENNARNORTHEAST PARTNERS, Plaintiff and Respondent, v.TAHOE VISTA INN AND MARINA, Defendant andAppellant.

Prior History: [***1] Appeal from the judgment of theSuperior Court of Placer County. Super. Ct. No.SCV2117. Hon. James Roeder, Judge.

Disposition: The judgment is reversed and the matterremanded to the trial court with directions to enterjudgment in favor of the Trust on its cross-complaint andto make a declaration of the priority of the liens, treatingthe modification to the Trust's lien separately, inaccordance with the views expressed in this opinion.Since the Trust and TVIM have substantially prevailedon appeal, they shall recover their costs. (Cal. Rules ofCourt, rule 26.)

Core Terms

modification, trust deed, seller, subordinating, senior,lender, junior lienholder, interest rate, contends, default,lien priority, foreclosure, percent, buyer, summaryadjudication, construction lender, junior lien, trial court,materially, advances, senior lien, receiver, lienors,rights, terms, lienholder, argues, lease, amount ofprincipal, real property

Case Summary

Procedural PostureDefendants, trust and borrower, appealed from thejudgement of the Superior Court of Placer County(California), which granted a motion for summaryadjudication in favor of plaintiff junior lienor in an actionbrought by plaintiff to establish lien priorities and

foreclose on defendant borrower's property. Defendantborrower had secured loans purchased by bothdefendant trust and plaintiff with deeds of trust on itsreal property.

OverviewDefendant trust purchased a bank note secured by asenior deed of trust on defendant borrower's property.Defendant trust advanced more money, and amendedthe note, changing the principal amount, interest rate,and maturity date. Plaintiff junior lienor brought anaction to establish priority of its lien and to foreclose onthe property. Defendant trust filed across-complaint.The trial court held that there was a substantialmodification to the senior debt that materially affectedthe security of plaintiff's lien, which caused the seniordeed of trust to lose its priority. The court reversed andremanded to the trial court. The court held that theamendments were material and substantial because theinterest rate increase from prime plus 3 percent to 12percent when coupled with the greater principal amountworsened plaintiff's position. The court ruled, however,that only the increase due to the modifications shouldhave been denied priority. The court found that as themodification had no effect on the value of the underlyingsecurity, by denying the modification priority, plaintiffwas restored to the same position it bargained for byagreeing to accept a second lien.

OutcomeThe court reversed the judgment and remanded to thetrial court with directions to enter judgment in favor ofdefendants and to make a declaration of the priority ofliens, treating the modifications to defendant trusts lienseparately. The court held that the amendments madeby defendant trust to the senior note were substantialand material, but that denying only the modificationspriority restored plaintiff to its bargained for position.

LexisNexisO Headnotes

Page 2 of 10

49 Cal. App. 4th 1576, *1576; 57 Cal. Rptr. 2d 435, x'`435; 1996 Cal. App. LEXIS 966, **"1

Civil Procedure > ... > Summary

Judgment > Entitlement as Matter of Law > General

Overview

Civil Procedure > Judgments > Summary

Judgment > General Overview

Civil Procedure > ... > Summary

Judgment > Motions for Summary

Judgment > General Overview

9~~1[] Summary Judgment, Entitlement as Matter

of Law

In reviewing the propriety of granting a motion for

summary judgment or summary adjudication, the first

step is to identify the issues framed by the pleadings

since it is these allegations to which the motion must

respond.

Real Property

Law > Financing > Foreclosures > Judicial

Foreclosures

Real Property

Law > Financing > Foreclosures > General

Overview

Real Property Law > ... > Liens > Nonmortgage

Liens > General Overview

Real Property Law > ... > Liens > Nonmortgage

Liens > Lien Priorities

Civil Procedure > ... > Pleadings > Time

Limitations > General Overview

Real Property Law > Financing > Secondary

Financing > Lien Priorities

11,3[] Time Limitations, Extension of Time

A senior lienholder may extend the time for payments of

the senior debt provided the extension does not impair

the junior lienholder's rights and security.

Real Property Law > ... > Liens > Nonmortgage

Liens > Lien Priorities

H~[] Nonmortgage Liens, Lien Priorities

An extension of a senior debt that merely alters the date

of payments generally does not adversely affect the

junior lienholders. However, when the obligation is

increased, by an increase in the principal amount or an

increase in the interest rate, the junior lienholder's

position is worsened.

Real Property Law > ... > Liens > Nonmortgage

Liens > Lien Priorities

h'~t['`] Nonmortgage Liens, Lien Priorities

A modification to the senior secured debt, such as an

increase in the interest rate, can affect the income

produced by the property. As the expenses increase,

the value of the property, as measured by its return,

decreases. The decrease in value has a material effect

on the value of any existing junior lien.

1-~~~[] Foreclosures, Judicial Foreclosures

An action for judicial foreclosure must establish the

relative priority of the lien claimants joined as parties so

that any surplus sales proceeds can be paid to junior

lienholders in order of priority.

Civil Procedure > Trials > Bench Trials

Civil Procedure > Trials > Judgment as Matter of

Law > General Overview

#-f~d6['`] Trials, Bench Trials

Civil Procedure > ... > Pleadings > Time

Limitations > Extension of Time

Real Property Law > ... > Liens > Nonmortgage

Liens > Lien Priorities

While a dispute over the effect of an unconsented to

modification often raises a question of fact, where

reasonable minds cannot differ, the question may be

resolved as one of law.

Page 3 of 1049 Cal. App. 4th 1576, ̀1576; 57 Cal. Rptr. 2d 435, '`*435; 1996 Cal. App. LEXIS 966, *`*1

Contracts Law > ... > Perfections &Priorities > Priorities > General Overview

Real Property Law > Financing > SecondaryFinancing > Lien Priorities

substantial modification that caused the senior deed of

trust to lose its priority, and the trial court entered ajudgment of foreclosure on the deed of trust held byplaintiff. (Superior Court of Placer County, No.SCV2117, James L. Roeder, Judge.)

Contracts Law > ... > SecuredTransactions > Perfections &Priorities > GeneralOverview

Real Property Law > Financing > Mortgages &Other Security Instruments > Mortgage Formalities

Real Property Law > ... > Liens > Nonmortgage

Liens > Lien Priorities

~fN7[] Perfections &Priorities, Priorities

It is well established that while a senior mortgagee can

enter into an agreement with the mortgagor modifying

the terms of the underlying note or mortgage without

first having to notify any junior lienors or to obtain their

consent, if the modification is such that it prejudices the

rights of the junior lienors or impairs the security, their

consent is required. Failure to obtain the consent in

these cases results in the modification being ineffective

as to the junior lienors and the senior lienor

relinquishing to the junior lienors its priority with respect

to the modified terms. While this sanction ordinarily

creates only the partial loss of priority noted above, in

situations where the senior lienor's actions in modifying

the note or mortgage have substantially impaired the

junior lienors' security interest or effectively destroyed

their equity, courts have indicated an inclination to

wholly divest the senior lien of its priority and to elevate

the junior liens to a position of superiority.

Headnotes/Summary

SummaryCALIFORNIA OFFICIAL REPORTS SUMMARY

A junior lienholder brought an action for judicial

foreclosure of the encumbered real property and for

appointment of a receiver, after amendments were

made to a note and the senior deed of trust held by the

senior lienholder. The senior lienholder brought a cross-

complaint for judicial foreclosure of its deed of trust, for

declaratory relief regarding the priority of the liens, and

injunctive relief to stop plaintiff's foreclosure action. The

trial court granted plaintiff's motion for summary

adjudication, finding that the amendments were a

The Court of Appeal reversed the judgment andremanded the matter to the trial court with directions to

enter judgment in favor of the senior lienholder on itscross-complaint and to make a declaration of the priorityof the liens, treating the modification to the senior

lienholder's lien separately. The court held that the trial

court did not err in finding that modifications to the note

and the deed of trust held by the senior lienholder were

substantial as a matter of law, thereby requiring an

adjustment of priorities. The effect of the modifications

taken together, which included amendments to the

interest rate and the principal amount of the note, was to

increase substantially the amount of secured debt that

was senior to plaintiffs lien, adversely affecting plaintiffs

rights as a junior lienholder and the value of its security.

However, the court held that the modifications did not

require subordination of the senior lienholder's entire

lien, but rather, only the modifications. By denying

priority only to the modifications, it was possible to

restore plaintiff to its original position: the position it

bargained for by agreeing to accept a second lien on the

property as security for its loan. At foreclosure, the

amount due under the senior lienholder's note,

calculated in accordance with the terms of the note

before it was modified, could be calculated and given

first priority. Any additional amount owing under the

amendment would then be junior to the liens existing as

of the date of the modification. (Opinion by Morrison, J.,

with Sparks, Acting P. J., and Nicholson, J., concurring.)

HeadnotesCALIFORNIA OFFICIAL REPORTS HEADNOTES

Classified to California Digest of Official Reports

~~ A ~l ~~)

Summary Judgment § 25—Appellate Review—Identification of Issues Framed by Pleadings.

--In reviewing the propriety of granting a motion for

summary judgment or summary adjudication, the first

step is to identify the issues framed by the pleadings,

since it is these allegations to which the motion must

respond.

Page 4 of 10

49 Cal. App. 4th 1576, "1576; 57 Cal. Rptr. 2d 435, "`435; 1996 Cal. App. LEXIS 966, *"1

~~ ~ ~l ~2)

Liens § 9—Priorities—As Determined by SummaryAdjudication: Deeds of Trust § 14—Priorities.

--In an action by a junior lienholder for judicial

foreclosure of the encumbered real property and

appointment of a receiver, the issue of the priority of

competing deeds of trust was properly before the trial

court in plaintiff's motion for summary adjudication,

notwithstanding that plaintiff's complaint included

causes of action solely for judicial foreclosure and

appointment of a receiver. In looking at the actual

allegations of the complaint and its answer, the

complaint alleged that defendant, another lienholder,

had a trust deed, and in its prayer asked for adjudication

of priorities of the liens. Defendants answer asserted a

senior lien as an affirmative defense. Thus, the issue of

the priority of the liens was within the general area of

the issues framed by the pleadings. Indeed, an action

for judicial foreclosure must establish the relative priority

of the lien claimants joined as parties so that any

surplus sales proceeds can be paid to junior lienholders

in order of priority.

Liens § 9—Priorities—Adjustment of Priorities Based

on Modification to Note and Senior Deed of Trust:Deeds of Trust § 14—Priorities.

--In an action by a junior lienholder for judicial

foreclosure of the encumbered real property and

appointment of a receiver, the trial court did not err in

finding that modifications to a note and the senior deed

of trust held by defendant on the same property were

substantial as a matter of law, thereby requiring an

adjustment of priorities. The amendment to defendant's

note, which extended its term until the following year,

with an option for a second one-year extension, did not,

by itself, result in a material modification. However, the

note's interest rate was changed from a variable rate of

prime plus 3 percent to a fixed rate of 12 percent,

resulting in a substantial increase from 9 to 12 percent.

The principal of the note was also increased, which

increased the amount of secured debt senior to

plaintiffs lien. The enlarged debt payment also

increased the expenses of the property, thus lessening

the return available to junior lienholders. Further, by

adding accrued interest and prepaid interest to the

principal, the note changed from simple interest to

compound interest. The effect of the modifications taken

together was to increase substantially the amount of

secured debt that was senior to plaintiff's lien, adversely

affecting plaintiff's rights as a junior lienholder and the

value of its security. While a dispute over the effect of

an unconsented-to modification often raises a question

of fact, the question may be resolved as one of law

where, as in this case, reasonable minds cannot differ.

Liens § 9—Priorities—Adjustment of Priorities Basedon Modification to Note and Senior Deed of Trust—Subordination of Modification Only: Deeds of Trust §14—Priorities.

--In an action by a junior lienholder for judicial

foreclosure of the encumbered real property and

appointment of a receiver, after substantial

modifications were made to a note and the senior deed

of trust held by defendant on the same property, the

modifications did not require subordination of

defendant's entire lien, but rather, only the

modifications. By denying priority only to the

modifications, it was possible to restore plaintiff to its

original position: the position it bargained for by

agreeing to accept a second lien on the property as

security for its loan. At foreclosure, the amount due

under defendants note, calculated in accordance with

the terms of the note before it was modified, could be

calculated and given first priority. Any additional amount

owing under the amendment would then be junior to the

liens existing as of the date of the modification.

[See 3 Witkin, Summary of Cal. Law (9th ed. 1987)

Secured Transactions in Real Property, § 38 et seq.]

~l ~5)

Liens § 9—Priorities—Adjustment of Priorities Basedon Modification to Note or Mortgage—Consent.

--While a senior mortgagee can enter into an

agreement with the mortgagor modifying the terms of

the underlying note or mortgage without first having to

notify any junior lienors or to obtain their consent, if the

modification is such that it prejudices the rights of the

junior lienors or impairs the security, their consent is

required. Failure to obtain the consent in such cases

results in the modification being ineffective as to the

junior lienors and the senior lienor relinquishing to the

Page 5 of 10

49 Cal. App. 4th 1576, '`1576; 57 Cal. Rptr. 2d 435, "'435; 1996 Cal. App. LEXIS 966, "*"1

junior lienors its priority with respect to the modified

terms. While this sanction ordinarily creates only thepartial loss of priority noted above, in situations where

the senior lienor's actions in modifying the note or

mortgage have substantially impaired the junior lienors'

security interest or effectively destroyed their equity,

courts have indicated an inclination to wholly divest the

senior lien of its priority and to elevate the junior liens to

a position of superiority.

Counsel: Miller, Starr &Regalia, Edmund L. Regalia,

Chamberlain, Chamberlain & Baldo, Russell Baldo and

Thomas C. Thompson for Defendants and Appellants.

Morrison & Foerster and Douglas Hendricks for Plaintiff

and Respondent.

Judges: Opinion by Morrison, J., with Sparks, Acting P.

J., and Nicholson, J., concurring.

Opinion by: MORRISON

Opinion

Trust asserts equitable subrogation should apply to

restore the priority of its lien. We agree that only themodification to the [***3] Trusts deed of trust should bea junior lien and so reverse the judgment.

FACTUAL AND PROCEDURAL BACKGROUND

The property in question consists of six rental

condominiums, with adjacent docks, parking area, and

related facilities, including a restaurant, in Tahoe Vista,

California.

In 1983, TVIM's predecessor in interest executed a

promissory note in favor of Bank of America. The note

provided that principal amounts advanced would not

exceed $ 600,000, and such amounts were payable on

demand or on December 21, 1984. The note bore

interest of prime plus 2 percent. The note was secured

by a deed of trust on the property.

In March 1984, TVIM gave aone-year promissory note

for $ 700,000 to Chesapeake Savings and Loan. This

note also was secured by a deed of trust on the

property. Both deeds of trust were recorded on April 2,

1984, at 9:35 a.m. The Chesapeake deed of trust stated

it was subordinate to the Bank of America deed of trust.[*1579] [**436] MORRISON, J.

Tahoe Vista Inn and Marina (TVIM) owns real property

located on the shore of Lake Tahoe; the property is

encumbered with several deeds of trust. The Buice

Revocable Living Trust (the Trust) purchased a

promissory note made by TVIM from Bank of America;

the note [***2] was secured by the senior deed of trust

on TVIM's real property. As part of the transaction, the

Trust made additional advances to TVIM and amended

the note and deed of trust, changing the principal

amount, the interest rate, and the maturity date. The trial

court found these amendments were a substantial

modification which caused the deed of trust to lose its

priority. The trial court granted a motion for summary

adjudication by Lennar Northeast Partners (Lennar), the

holder of what had been the second deed of trust on

TVIM's property. A judgment of foreclosure was entered

on the deed of trust held by Lennar.

The Trust appeals from this judgment, advancing

several arguments to restore the priority of all or most of

its lien. It contends the modifications [*1580] were not

so substantial as to require a change in priorities, or the

question of their materiality was a factual one that could

not be resolved by summary adjudication. Even if the

modifications were substantial, the Trust argues only the

modification ["*437] should be a junior lien. Finally, the

In 1988, TVIM entered into loan workout agreements

with Bank of America and Chase Bank of Maryland,

Chesapeake's successor. Both agreements extended

the due date for the loans until December 31, 1988,

changed the interest rate due on the note, and [*"*4]

required a second note for unpaid interest. The new

interest rate on the Bank of America note was prime

plus 3 percent. Bank of America's interest note was in

the amount of $ 126,000; Chase's was $ 157,802.46.

Both workout agreements also required subordination

agreements from junior lienholders to assure the same

priority of the liens. Chase executed a subordination

agreement in favor of the Bank of America deed of trust.

The Chase note and deed of trust were amended.

Junior lienholders executed subordination agreements.

In 1990, TVIM executed a second deed of trust in favor

of Bank of America. This deed of trust stated it was to

secure the $ 600,000 note dated December 21, 1983;

the $ 126,000 note dated March 30, 1988; and a $

72,250 note. This deed of trust was never recorded and

there is no evidence the $ 75,250 note was executed.

The Trust indicates this deed of trust was part of a

second, unsuccessful workout agreement.

[*1581] In 1993, the original Bank of America note for

$ 600,000, the second note for $ 126,000, and the deed

Page 6 of 10

49 Cal. App. 4th 1576, "1581; 57 Cal. Rptr, 2d 435, '`"`437; 1996 Cal. App. LEXIS 966, *"`4

of trust were assigned to the Trust. The amendment to

the note states the unpaid principal and interest under

the note is $ 934,513.16, and that [**'"5] the Trust has

advanced additional funds so the principal balance with

interest through May 15, 1994 is $ 1,075,000. Interest

from that date is 12 percent. The due date of the note is

December 15, 1994; upon payment of $ 10,000, the due

date can be extended to December 15, 1995.

In May 1994, Chase brought suit for judicial foreclosure

and appointment of a receiver, alleging its $ 700,000

note was in default. TVIM and the Trust were named as

defendants. ~ Under the heading "Senior Trust Deed

Lien," the complaint alleged the Trust is the holder of a

trust deed lien. In the prayer, the complaint asks for an

adjudication that the liens of defendants are subsequent

and subordinate to Chase's trust deed.

had priority because the amendment [***7] had

substantially changed its terms and materially affected

the security of Lennar's lien. The court authorized sale

of the property with a listing price of $ 2,400,000.

[*1582] The Trust moved for reconsideration. This

motion was denied.

Lennar moved for summary adjudication, contending its

note was in default and its deed of trust had priority over

the Trusts.

The Trust opposed this motion; it argued the undisputed

facts showed the Trust was entitled to summary

adjudication. The Trust brought across-complaint for

judicial foreclosure of its deed of trust, for declaratory

relief regarding the priority of the liens, and for injunctive

relief to stop Lennar's foreclosure action.

[***6] In its answer to the complaint, the Trust asserted

as an affirmative defense that it held a promissory note

secured by a deed of trust senior to Chase's deed of

trust.

Chase nominated Jon Eicholtz as receiver and he was

appointed by stipulation. The receiver petitioned for

instructions, raising a question as to the priority of the

liens. The receiver also requested authorization to

market the property at a listing price of $ 1,800,000. The

existing listing had a suggested sales price of $

2,950,000, and there had been no valid offers.

[**438] Lennar purchased the loan from Chase and

substituted into the action as plaintiff. Lennar responded

to the receiver's petition contending that the Trust's

deed of trust was entirely subordinate to its deed of

trust.

The Trust argued it had a valid first lien. It explained that

Bank of America's payoff demand was $ 980,654.27,

and $ 14,849.35 was disbursed to TVIM for

improvements and maintenance of the property. The

advances made to TVIM for prepaid interest,

improvements and maintenance totaled $ 90,000 and

were made according to the terms of the note.

The trial court ruled the Trust's deed of trust no longer

~ The complaint named several Doe defendants. The

complaint was later amended to show the true names of four

of these defendants; they were junior lienholders on the

property. Default judgments were entered against three of

these defendants. The fourth had to be served by publication,

and disposition of the matter as to him does not appear in the

record.

The trial court, with a different judge presiding, granted

Lennar's motion for summary adjudication. 2 The court

stated it had reviewed all the papers de novo, not

relying on the prior ruling, and found the substantial

modification of the Trust's deed of trust affected the

junior lienholders' security. The court found the secured

debt had increased $ 140,486.84.

[***8] The Trust moved for reconsideration, arguing

only $ 140,486.84 of the debt to the Trust should be

subordinated to Lennar's deed of trust, and requested

an evidentiary hearing.

The parties agreed the issues of the Trust's cross-

complaint had been adjudicated; a judgment of

foreclosure in favor of Lennar was entered.

The Trust and TVIM appeal. TVIM simply joins in the

Trust's arguments.

DISCUSSION

NT~~(] ~ ~ [] (1) In reviewing the propriety of

granting a motion for summary judgment or summary

adjudication, the first step is to "identify the issues

framed by the pleadings since it is these allegations to

which the motion must respond ." ( AARTS

Prc~cluctar~sIncT_v. „Cracker Natiar~al_~~nk._(~986~_.1.79

~~1.~._3d 1061106 ~22~ Cal. Rptr. 203.) C~ ~ []

(2)The Trust contends the summary adjudication was

ZThe trial judge who ruled on the receiver's petition

disqualified himself from the case.

Page 7 of 10

49 Cal. App. 4th 1576, *1582; 57 Cal. Rptr. 2d 435, **438; 1996 Cal. App. LEXIS 966, ̀'`*8

improper because the issue of the priority of the liens

was not framed by the pleadings. The Trust contends

Lennar's complaint sought only judicial foreclosure and

appointment of a receiver.

In focusing solely on the description of the two causes

of action in Lennar's complaint, the Trust ignores the

actual allegations of the complaint [*1583] and its

answer. The complaint alleges the [*'"*9] Trust has a

trust deed, and in its prayer asks for adjudication of

priorities of the liens. The Trusts answer asserts a

senior lien as an affirmative defense. The issue of the

priority of the liens was certainly "within the general area

of the issues framed by the pleadings." (Masan v.

Su erirlr~ Court 99F3~ 163 C~1. /~ ~d 989 J96 29CJ

Cal, R ir. 63.) Indeed, t-f2[] an action for judicial

foreclosure must establish the relative priority of the lien

claimants joined as parties so that any surplus sales

proceeds can be paid to junior lienholders in order of

priority. (4 Miller &Starr, Cal. Real Estate (2d ed. 1989)

§ 9:165, p. 558.) The issue of the priority of the

competing deeds of trust was properly before the court

in the motion for summary adjudication.

upon the junior lienholders. !-ft~~[] A senior lienholder

may extend the time for payments of the senior debt

provided the extension does not impair the junior

lienholder's rights and security. ( 1nl~stcrr~ F. G. v.

Security Title etc. Cn. X9937) 2Q CSI. gip. 2d 150 155-

15~ r~6 P.2ct 1"*'"~91] 74?I.) In Resolution gust Cora. v.~3V,S Develo n~er~t lnc. 9th Crt~. 1~JJ4 ~2 F.3c~ '(206,

the subordinated lienholder contended the subordination

agreement was nullified by a five-month extension of the

senior loan. The Ninth Circuit, applying California law,

found this extension [*1584] was not the type of

modification that materially increased the risk of default.

Rather, the extension gave the development a greater

chance of turning around and becoming successful,

which gave the subordinated lender a greater chance of

being paid. (lcl. ate. ?2_95.)

Here, too, the extension was made at a time when the

borrower was in difficulty; it could be reasonably argued

the extension gave the borrower a chance to turn itself

around and pay off its debts. By itself, the extension

cannot be said to be a material modification requiring an

adjustment of priorities as a matter of law. At most, it

raises a factual issue of whether it materially affected

the value of Lennar's junior lien.

A~3~[J (3) The Trust contends the modifications to

the Bank of America note and deed of [**439] trust in

1993 were not so substantial as to cause any change in

the priorities of the liens. The Trust argues that instead

of prejudicing Lennar, the modifications benefited the

junior lienholders by curing the default. While conceding

there were modifications to the term, interest rate, and

principal balance of the loan, the Trust disputes ['"**10]

the extent and the effect of each modification. The Trust

urges the modifications, whether taken individually or in

the aggregate, were minor. The Trust argues that since

the question of whether the modification was substantial

and prejudicial is essentially factual, it cannot be

resolved as a question of law.

The Trust does not contend that Lennar or Chase

consented to the modification. Indeed, in its motion for

summary adjudication, Lennar provided a letter from

Chase's counsel to the title company objecting to the

increase in debt secured by the first trust deed. Instead,

the Trust disputes the materiality of the changes

resulting from the modification.

The 1993 amendment to the Bank of America note

extended its term to December 15, 1994, and permitted

an additional one-year extension upon payment of $

10,000. The Trust argues that by extending the loan

rather than simply foreclosing, it bestowed a benefit

The more significant modifications were to the interest

rate and the principal amount of the note. The interest

rate was changed from a variable rate of prime plus 3

percent to a fixed rate of 12 percent. [***12] The Trust

argues this change is immaterial and was not much of

an increase, if at all. It notes the interest rate would be

about the same at the time of briefing, since the prime

rate was then 9 percent. This argument ignores the

effect the rate change had at the time it was made. The

Trusts own undisputed evidence indicated that at the

time of the modification the prime rate was 6 percent.

Thus, the modification increased the interest rate from 9

to 12 percent. This increase was substantial, particularly

when coupled with the increase in the principal amount

of the note.

The trial court found the principal of the note was

increased by over $ 140,000; this figure is taken from

the amendment to the note which states $ 934,513.16 is

the amount then due and additional advances have

increased the principal, with interest through May 15,

1994, to $ 1,075,000. The Trust disputes this finding. It

contends the only additional advance was $ 14,849.35,

which was disbursed to TVIM for repairs and

maintenance, and did not prejudice the junior

Page 8 of 10

49 Cal. App. 4th 1576, *1584; 57 Cal. Rptr. 2d 435, *'`439; 1996 Cal. App. LEXIS 966, *`*12

lienholders. 3 The Trust contends the remaining

difference between the stated amount due on the note

($ 934,513.16) and the ['""440] amount of the amended

note [***13] ($ 1,075,000) was the required payoff to

Bank of America ($ 980,654.27), prepaid interest ($

75,000), and closing costs.

Lennar contends that regardless of what the additional

amounts represent, they still increased the amount of

secured debt senior to its lien. The [*1585] enlarged

debt payment increased the expenses of the property,

thus lessening the return available to junior lienholders.

Lennar points [***14] out that since prepaid interest of

12 percent on $ 1,000,000 for five months would be only

$ 50,000, the additional $ 75,000 represents either

prejudicial usurious interest or an additional advance.

Further, by adding the accrued interest and prepaid

interest to the principal, the note changed from simple

interest to compound interest.

Lennar has the better argument on this point. N~4[]

An extension of a senior debt that merely alters the date

of payments generally does not adversely affect the

junior lienholders. However, when the obligation is

increased, by an increase in the principal amount or an

increase in the interest rate, the junior lienholder's

position is worsened. (3 Powell, Real Property (1996) P

458, pp. 37-258 to 37-259.) The effect of the

modifications taken together was to increase

substantially the amount of secured debt that was senior

to Lennar's lien. As Miller and Starr explain, t~5[] a

modification to the senior secured debt, such as an

increase in the interest rate, can affect the income

produced by the property. As the expenses increase,

the value of the property, as measured by its return,

decreases. The decrease in value has a material effect

on the value of any existing [***15] junior lien. (3 Miller

& Starr, Cal. Real Estate, supra, § 8:83, p. 426.)

Indisputably, this change adversely affected Lennar's

rights as a junior lienholder and the value of its security.

~J[] While a dispute over the effect of an

unconsented to modification often raises a question of

3 Where a deed of trust secures optional future advances,

priority of the security for such future advances is determined

by the circumstances when the advances are made; if at that

time the senior lender has notice of other liens, the other liens

have priority. (Pipe v. Tcrttfe (197? 1~ Cal.~p, ~d 746. 759

(;~i Cal. Rptr. X037.) Neither party proposes that this case

should be treated as a future advance case. Thus, we need

not determine whether the original deed of trust authorized

future advances or whether the Trust had actual notice of the

junior liens at the time it made the advances.

fact, where reasonable minds cannot differ, the question

may be resolved as one of law. (K~tz v. Chevrc~rr Cv~p.

f19J~]) 2~ C~1. A,~p. 4tf~ 1X52, 9;~fi~ fig. 92 (27 C<~al. f?ptr.

~d C381 ] ["...where reasonable minds could not differ

on the question, 'materiality' could be determined as a

matter of law."].) Here, there can be no reasonable

dispute as to the effect of the modifications. The trial

court did not err in finding the modifications were

substantial as a matter of law, We must now determine

the effect of the substantial modification on the priorities

of the liens; that is, whether the modifications require

the Trust's entire lien to lose its priority, or only the

modifications.

[] (4a) In finding the modifications resulted in

a loss of priority of the Trusts entire lien, the court relied

upon Glu~kin v. Atlantic ~~vin ~ &Loan Assn, 1973

3.7 Cpl. ,~ ~c~ 307 90 3 ~~1. R tr, 398. In [***16]

Gluskin, the plaintiff sold land to the buyer for $ 400,000

and took back a note for $ 175,000 secured by a deed

of trust on the property. The buyer secured two

construction loans to build houses on the property. The

plaintiff agreed to subordinate its deed of trust to those

of the construction lender. The two notes to the ["1586]

construction lender were payable in 30 years. (/d. ~f..~~~a.

311312.) Due to a poor market for housing sales, the

buyer and the construction lender restructured the loan.

The principal of the larger note was reduced from $

2,246,580 to $ 712,530; the interest increased from 61/4

to 10 percent; the monthly payments reduced; and the

maturity shortened to 10 months with a large balloon

payment at the end. The modification also contained the

buyer's representation that no one else had an interest

in the land. The buyer ultimately defaulted and the

construction lender bought the property at a foreclosure

sale. (lc~. at ~~. 392.)

The plaintiff seller objected the modifications were made

in utter disregard of its rights as the junior lienholder. It

sought declaratory relief that its lien was superior to the

deeds of trust held by the construction [***17] lender.

The trial court entered judgment adverse to the seller.

The appellate court reversed. Recognizing the

vulnerable position of the subordinating seller, it held

that public policy required protection of subordinating

sellers. "(A] lender and a borrower may not bilaterally

make a material modification in the loan to which the

seller has subordinated, [**441] without the knowledge

and consent of the seller to that modification, if the

modification materially affects the seller's rights."

Gi~.r~l<~`r7 v..~tC~rrtic Savin s &Lain ~I ~sn., sc~r~ 32 C~~l.

Page 9 of 10

49 Cal. App. 4th 1576, *1586; 57 Cal. Rptr. 2d 435, "*441; 1996 Cal. App. LEXIS 966, ""*17

Asap. 3d at___„~a. 394.) The court noted that if sound

business required the modification, the seller would

presumably agree. "If a dispute results from an

unconsented to modification it is of course a question of

fact whether the modification materially affected the

rights of the subordinated seller.” (Id. ~~. 39J.)

While there was no general obligation on a lender to

protect a subordinating seller from the risk of the buyer's

default, the requirement of fair dealing prohibits conduct

between a lender and a buyer that results in destruction

of the seller's interest. (Gluskin v. ~1tl~r7fic Scivinps &

l_aar~ ,~ssr~. su ra 3?. dal. **'"9 ,~ . 3d cat .395.)

"If, however innocently, their bilateral agreement or

conduct so modifies the terms of the senior loan that the

risk that it will become a subject of default is materially

increased, then the buyer and the lender may subject

themselves to liability to the seller if they proceed

without the tatter's consent, and if the seller's otherwise

junior loan is to be adversely affected." (Ibid.) The court

found the seller had not consented to the modification

and its drastic terms "clearly enhanced the likelihood of

a default by [buyer] and the consequent foreclosure."

Irl. ~t~317.)

While the Gluskin court did not specify the liability the

buyer and the lender face in making a modification

without consent of the subordinating seller, the case has

been interpreted to permit the loss of the lender's lien

[*1587] priority. (2 Cal. Real Property Financing

(Cont.Ed.Bar 1989) § 1.21, p. 23.) That is how the trial

court applied Gluskin in this case.

While the court in Glcrskin v. Atlantic S~vings &Loan

Assn„_ su~ar~. _32__C~/. A~_ ,~c~, 307 addressed the

particular situation of a subordinating seller, a leading

commentator has suggested that a material [***19]

modification to any senior lien should result in a loss of

priority. "It is submitted that in any case where the

senior lien is modified in any material manner which

produces an important impact on the value of the junior

lien, the modification should be junior to the second lien,

and if that is not practical, the entire senior lien should

become junior to the existing second lien." (3 Miller &

Starr, Cal. Real Estate, supra, § 8:83, p. 426.) Another

authority has stated that "since the junior lienholder had

no notice of the additional indebtedness when the junior

lien arose, only the amount of the original obligation

should enjoy the priority position held by the senior

mortgage." (3 Powell, Real Property, supra, P 458, p.

37-259. )

substantial, the proper remedy requires that only the

modifications lose priority, arguing a total loss of priority

is appropriate only in the case of a subordinating seller,

as in t~ltrs!<i~~ v. Att~ntic S~vings & L.a~an Assn., supra

32 Cpl. 1~~, ~d 3~J7. The Trust asserts that the public

policy need for protection of a subordinating seller does

not apply between two hard money lenders, [''**20] as

here. It cites several cases in which only the

modification was denied priority. For example, in tl~7i~(er

v. Gitizerts S~v. ~ Lc~~r7 Assr7.199~i7) 248 dal. At~z~. 2d

655 rah ~~1. R,~tr. f~4~Z, the seller subordinated its deed

of trust to those of the construction lender. The lender

then advanced sums that were not used for construction

purposes. The court held these amounts were subject to

the deed of trust of the seller. (id, ~i~,_665.)

A similar rule applies to a modification of a lease that is

senior to other encumbrances. A "lessor, by the

extension agreement with the lessee, could not, without

notice, knowledge or consent of the plaintiff, create a

greater burden on the property, or carve any estate

therefrom, other than that reserved to it under the

original lease, without making such extension

agreement and its additional burdens subject to the

superior rights of the plaintiff under the trust deed."

~i~st._N t._ ~a~7k v.__Co~st Consol. 4i/, Co. 1940 8~3 ~al_-

A . 2d 250 25x4256 19D P.2d 29~ .)

In R-Ranch Markets # 2, Inc~ve Otd Star~e_Ei~nk (9993

_1~„Cal. A~~. 4fh 7323121 C~1Rpfr: 2c1 21~j, the lessor

entered into a lease amendment with the lessee that

permitted [*"'*21] assignment or subletting without the

consent of the landlord. The original lease had [*'`442]

prohibited assignment or subletting. When ['"1588] the

secured lender, whose deed of trust was junior to this

lease, foreclosed on the property, the amendment to the

lease was extinguished. The court found the

amendment was made without the lender's consent and

it "substantially increased the burden on the property

and security without [the lender's] consent." (/cam. aim

1;28.)

Lennar urges the Trust has provided no authority for

treating hard money lenders differently than

subordinating sellers. Further, it contends the

modification cannot be easily segregated from the

remainder of the loan. It argues the Trust's suggestion

that only the change in principal lose priority ignores the

changes in the interest rate and the maturity date of the

note.

We need not determine whether a material modification

The Trust contends that if the modifications were to a senior lien may result in a total loss of priority of the

Page 10 of 10

49 Cal. App. 4th 1576, *1588; 57 Cal. Rptr. 2d 435, **442; 1996 Cal. App. LEXIS 966, '``*21

senior lien where the lienholders are hard money

lenders. The equities in this case do not require such a

result. Here, the impairment to Lennar's security and its

rights as a junior lienholder caused by the modification

can be [***22] fully eliminated by denying priority to the

modification. Unlike in C'k skin v. ,~t(~ntic ~avrrr~~~ ~

L.na~~ Assn., supra, 32 Coal. A,np. 3d ~U7, the

modification had no effect on the value of the underlying

security. Denying priority only to the modification

restores Lennar to the same position as before: the

position it bargained for by agreeing to accept a second

lien on the property as security for its loan. At

foreclosure the amount due under the Bank of America

note, calculated in accordance with the terms of the

note before fhe 1993 amendment, can be calculated

and given first priority. Any additional amount owing

under the amendment would then be junior to the liens

existing as of the date of the modification.

When the junior lienholder is a subordinating seller,

equity may require a different result. As the Gluskin

court noted, a subordinating seller is in a particularly

vulnerable position. By subordinating the purchase

money deed of trust to that of the construction lender,

the seller must rely that proceeds from the construction

loan will properly be used to enhance the value of the

property, for only then can the seller be assured the

property will be adequate [*''*23] security for both the

purchase loan and the construction loan. (Glus6crn v.

Atl~~r~~ic SG~av~s &,_L oar? As~sn..z.e supr~r32 C~l.__~_C?~~ 3

3t77. 313 ;314; see also N~t?dY v. ~vr~lcan (1967~6~ Cal.

2d _578,._ ~S1 ~~5 Cal__. R~fr._..rT69~.._422 P.2ct. 32~,, 26

A L.R.3d__ S4$~j.) In Gluskin, the modifications were

"substantial and drastic'; the principal was reduced, the

interest rate increased, and the maturity shortened from

30 years to 10 months. (32 ~aL Abp. 3c~ at~a. 312.) The

effect of these modifications, as the seller alleged, was

to allow the construction lender "to escape its obligation

to [*1589] disburse construction funds and to obtain

property for itself without having to pay [the seller] the

balance owing on the sales price." (Ibid.) The very short

term with a large balloon payment clearly enhanced the

likelihood of default. (Id. ~t,~a. 391.) Moreover, since the

default occurred before construction had enhanced the

value of the property, the seller was left with worthless

security. In the vernacular of the marketplace, the seller

was 'wiped out.' (Middlebrook-Anderson Co. v.

Sauthwcst S~ay. ~ L~a~~rr Assi7. ~~71 9~ Coal. ~f a. ;3c~

9Q~3 10:37 9fi Cal. R tr. 3,~~3 .) ["**24] In this

circumstance, subordinating the entire lien of the

construction lender to those of the existing juniors is fair

and reasonable.

.4 [] (5) The rationale for deciding when to

subordinate only the modification and when the entire

lien loses priority is explained by a New York court.

#~N7[~~] "It is well established that while a senior

mortgagee can enter into an agreement with the

mortgagor modifying the terms of the underlying note or

mortgage without first having to notify any junior lienors

or to obtain their consent, if the modification is such that

it prejudices the rights of the junior lienors or impairs the

security, their consent is required [citations]. Failure to

obtain the consent in these cases results in the

modification being ineffective as to the junior lienors

[citation] and the senior lienor relinquishing to the junior

lienors its priority with respect to the modified terms

[citations]. While this sanction ordinarily creates only the

partial loss of priority noted above, in situations where

the senior lienor's actions in modifying the note or

mortgage have substantially impaired the junior lienors'

security [**443] interest or effectively destroyed their

equity, courts have indicated [***25] an inclination to

wholly divest the senior lien of its priority and to elevate

the junior liens to a position of superiority [citation]."

5hultrs v. V~loc~dstnck L~rrd fJev. Assoc. 1993 ?8~

A ;U. ~d 234,_._236-237.1594 N__d__Y, S. 2cf $94x._89• )

~~~ b [ ] (4b) We need not address the Trust's

contention that equitable subordination should apply.

"The whole theory of equitable subrogation in such

situations is that the junior encumbrancer .. , is left in

exactly the same junior position he had before.

[Citations.]" ( Smifh v. Sf~t~ Sevin s &, Lean Assn.

~~i9&51 17~_ C~(~A~~•_ 3d _1092,_..1097 X223 Cal f~otr.

298~j.) That is accomplished by making only the 1993

modification to the Bank of America note a junior lien.

DISPOSITION

The judgment is reversed and the matter remanded to

the trial court with directions to enter judgment in favor

of the Trust on its cross-complaint and to make a

declaration of the priority of the liens, treating the

modification to [*1590] the Trust's lien separately, in

accordance with the views expressed in this opinion.

Since the Trust and TVIM have substantially prevailed

on appeal, they shall recover their costs. (Cal. Rules of

Court, rule 26.)

Sparks, Acting P. [*"'*26] J., and Nicholson, J.,

concurred.

1satl <si~ ~3ticsarr~en£

CautionAs of: February 7, 2019 1:54 AM Z

t~ ,~ f .

Court of Appeal of California, First Appellate District, Division Four

January 23, 2001, Decided ;January 23, 2001

Nos. A084401, A086021.

Reporter86 Cal. App. 4th 486 *; 103 Cal. Rptr. 2d 421 "'; 2001 Cal. App. LEXIS 33 ""; 2001 Daily Journal DAR 849; 2001 Cal. Daily Op.

Service 692

THE NIPPON CREDIT BANK, LTD., LOS ANGELES

AGENCY, Plaintiff and Appellant, v. 1333 NORTH

CALIFORNIA BOULEVARD et al., Defendants and

Appellants.

Notice: [***1] Opinion certified for partial publication.

Subsequent History: Review Denied May 16, 2001,

Reported at: 2Q01 t. L~XfS ~32~37.

Prior History: Superior Court of Contra Costa County.

Super. Ct. No. C96-02075. Mark B. Simons, Judge.

Disposition: The order denying the motion for judgment

notwithstanding the verdict, and the order for a new trial

on the amount of punitive damages only, are affirmed.

The parties shall bear their own costs on appeal.

Core Terms

Borrowers, Partnership, taxes, bad faith, property taxes,

real property tax, failure to pay, lender, foreclosure, trust

deed, nonrecourse, impairment, damages, default,

installment, mortgage, punitive damages, pay tax,

malice, tenant, unpaid, non payment of taxes, tax

payment, faxed, substantial impairment, credit bid, new

trial, negotiations, fail to pay, contractual

Case Summary

Procedural Posture

Defendants challenged the order of the Contra Costa

County Superior Court (California) denying their

motions for judgment notwithstanding the verdict and

new trial. Plaintiff also challenged the new trial order,

based on refusal to accept remittitur.

Overview

Defendants borrowed money from plaintiff to refinance

an initial construction loan. A large chunk of the

difference between the amounts of the original

construction loan and bank loan was earmarked to

repay the project owner for his investment. Plaintiff sued

for bad faith waste upon defendants' failure to pay

property taxes. They alleged that such failure was not

caused solely or primarily by an economic downturn, but

was intended to harm, and did substantially impair, their

security interest. The trial court denied defendants'

motion for judgment notwithstanding the verdict, but

ordered a new trial, based upon plaintiff's failure to

agree to remittitur. On appeal, the court affirmed the

orders, reasoning that defendants did not have a reason

to commit waste, but a continued obligation to pay

taxes. The project had not reached such dire straits to

merit nonpayment of taxes. Evidence showed that the

project was earning enough money to meet its other

obligations, and failure to pay the taxes amounted to

waste that legitimately caused plaintiff's security to

become substantially impaired.

Outcome

Orders affirmed. Jury could have determined that

defendants' sole aim in defaulting on the taxes was to

extract as much money from the subjected project as

possible, thus punitive damages, denial of judgment

notwithstanding the verdict, and a new trial were

appropriate.

LexisNexisO Headnotes

`Pursuant to California Rules of Court, rules 976(b) and

976.1, this opinion is certified for publication with the exception

of parts II.A., II.C.1. and II.C.2. Real Property Law > Torts > Waste > Elements

Page 2 of 13

86 Cal. App. 4th 486, *486; 103 Cal. Rptr. 2d 421, ""'421; 2001 Cal. App. LEXIS 33, """1

Real Property Law > Financing > Mortgages & An action for waste could be predicated on the failure of

Other Security Instruments > Mortgagor's Interests a trustor of a deed of trust or a mortgagor to pay real

property taxes.

Real Property Law > Torts > General Overview

Real Property Law > Torts > Waste > General

OverviewReal Property Law > Torts > General Overview

tlfV~['"] Waste, Elements

The bad faith waste cause of action, established in

Cornelison and extended in Osuna, exists in situations

where a defendant has failed to pay real property taxes.

Real Property Law > Financing > Mortgages &

Other Security Instruments > General Overview

Real Property Law > Torts > Waste > General

Overview

~B~l2[ '] Financing, Mortgages & Other Security

Instruments

See. ~~l. Civ. Cacfc~ ~ 292.

Tax Law > State &Local Taxes > Administration &

Procedure > Tax Liens

Real Property Law > Financing > Mortgages &

Other Security Instruments > Mortgagor's Interests

Real Property Law > Torts > Waste > General

Overview

t~5[] Real Property Law, Torts

Waste encompasses default on senior tax liens because

the mortgagee has a reasonable and legitimate

expectation that the mortgagor will not place a

governmental entity in a position to destroy the

mortgage. While there may be disagreement as to the

scope of the borrower's obligation to maintain the

property physically, particularly if the documents are

imprecise, there can be little question that the borrower,

as owner, is expected to pay all real estate taxes.

Real Property Law > Torts > Waste > General

Overview

1~,3[] Torts, Waste

Prohibitions against deficiency judgments on purchase

money obligations, under dal. Civ. Proc. Cnde § 580h,

or following trustee's sales under ~l. Civ. f~rac. Cade .~

~~Od would bar an action for impairment of security

where failure to maintain the property was caused by a

general decline of real property values. However, bad

faith waste resulting from reckless, intentional or

malicious conduct would be actionable despite those

prohibitions.

Real Property Law > Torts > General Overview

Tax Law > State &Local Taxes > Real Property

Taxes > General Overview

Real Property Law > Financing > Mortgages &

Other Security Instruments > Mortgagee's Interests

Real Property Law > Financing > Mortgages &

Other Security Instruments > Mortgagor's Interests

Real Property Law > Torts > Waste > General

Overview

Real Property Law > Torts > Waste > General

Overview

Real Property Law > Financing > Mortgages &

Other Security Instruments > Mortgagor's Interests

Real Property Law > Torts > General Overview

~-9~4['°`] Torts, Waste

h'6[" '] Real Property Law, Torts

The tax payment is just another check that a borrower

must write, resembling the obligation to pay principal

and interest for which the nonrecourse borrower is not

personally liable. Moreover, the lender's failure to

require that the borrower expressly assume personal

responsibility for the obligation to pay taxes could be

interpreted to mean that no such liability was intended.

On the other hand, nonpayment of taxes may be just as

Page 3 of 13

86 Cal. App. 4th 486, *486; 103 Cal. Rptr. 2d 421, "*421; 2001 Cal. App. LEXIS 33, '`*'`1

damaging to the security as intentional destruction of

the property, an act which the lender could not have

intended to permit. Moreover, nonrecourse borrowers

have a special responsibility to protect an asset of theirs

that they have pledged to another as the sole security

for repayment of a debt. Thus, there are circumstances

where a nonrecourse borrower should be liable for

waste, including failure to pay real property taxes.

A legal argument may be raised for the first time in a

new trial motion or on appeal only so long as the new

theory presents a question of law to be applied to

undisputed facts in the record.

Real Property Law > Torts > Waste > General

Overview

Real Property Law > Estates > Present

Estates > Life Estates

Real Property Law > Torts > Waste > General

Overview

Real Property Law > Torts > Waste > Remedies

9~N7[] Present Estates, Life Estates

The waste doctrine was developed to mediate between

the competing interests of life tenants and

remaindermen.

Real Property Law > Financing > Mortgages &

Other Security Instruments > General Overview

Real Property Law > Torts > Waste > General

Overview

Torts > Business Torts > Bad Faith Breach of

Contract > General Overview

Real PropertyLaw > Financing > Foreclosures > Private Power of

Sale Foreclosure

#~i~'7!3[] Torts, Waste

A tort action for bad faith waste may be made following

a nonjudicial foreclosure unless the foreclosure results,

by full credit bid or otherwise, in full satisfaction of the

secured debt.

Real Property

Law > Financing > Foreclosures > General

Overview

Real Property Law > Torts > Waste > General

Overview

I~dB[] Financing, Mortgages & Other Security 199[] Financing, Foreclosures

Instruments

The ultimate test for waste liability in connection with a

nonrecourse loan is whether the lender has suffered

losses caused by actions the borrower would not have

taken had it been fully liable.

Where the creditor bids less than the full amount of the

obligation and thereby acquires the property valued at

less than the full amount, his security has been impaired

and he may recover damages for waste in an amount

not exceeding the difference between the amount of his

bid and the full amount of the outstanding indebtedness

immediately prior to the foreclosure sale.

Civil Procedure > Judgments > Relief From

Judgments > Motions for New Trials

Civil Procedure > Judgments > Relief From

Judgments > General Overview

Real Property

Law > Financing > Foreclosures > General

Overview

Civil Procedure > Appeals > Reviewability of Lower

Court Decisions > Preservation for Review

f~9[`] Relief From Judgments, Motions for New

Trials

Tax Law > State &Local Taxes > Administration &

Procedure > Tax Liens

Real Property Law > ... > Liens > Nonmortgage

Liens > General Overview

Page 4 of 13

86 Cal. App. 4th 486, *486; 103 Cal. Rptr. 2d 421, ~*421; 2001 Cal. App. LEXIS 33, '"'`1

Real Property Law > ... > Liens > Nonmortgage

Liens > Tax Liens

~iPJ1[] Financing, Foreclosures

~fl~~4[] Damages, Punitive Damages

Exposure to punitive damages may be as much a

deterrent to bad faith waste as to any other tort.

A requirement that the security impairment be

considerable may put a lender in an untenable position

where the impairment stems from a failure to pay real

property taxes. Given the duty to mitigate damages, a

lender should not be made to wait for the tax lien to

mushroom with multiple unpaid installments, and should

not be penalized for promptly curing a tax default.

Business &Corporate Compliance > ... > Sales of

Goods > Remedies > General Overview

Civil Procedure > Remedies > Damages > Punitive

Damages

Torts > ... > Punitive Damages > Measurement of

Damages > Judicial Review

Civil Procedure > Trials > Jury Trials > Province of

Court &Jury

Civil Procedure > Remedies > Damages > General

Overview

Civil Procedure > ... > Standards of

Review > Substantial Evidence > Sufficiency of

Evidence

Torts > ... > Types of Damages > Punitive

Damages > General Overview

~-d- ~f9[°'"] Sales of Goods, Remedies

Entitlement to punitive damages is generally an issue

for the trier of fact.

Civil Procedure > Remedies > Damages > Punitive

Damages

Real Property Law > Torts > Waste > General

Overview

Torts > Business Torts > Bad Faith Breach of

Contract > General Overview

Torts > ... > Types of Damages > Punitive

Damages > General Overview

Headnotes/Summary

SummaryCALIFORNIA OFFICIAL REPORTS SUMMARY

A partnership borrowed money from a bank to refinance

a construction project. The partnership was required

under the deed of trust securing the loan to timely pay

all property taxes for the project. The partnership did not

pay a $ 358,000 property tax installment, and defaulted

on two loan payments to the bank. In the ensuing tort

action for bad faith waste brought by the bank against

the partnership and the partners, the jury found

defendants liable. The jury also found by clear and

convincing evidence that the failure to pay the taxes

was done with malice, and awarded $ 8,333,333.33 in

punitive damages. The trial court denied defendants'

motion for judgment notwithstanding the verdict, but

granted their new trial motion unless plaintiff agreed to

remit all but $ 1.6 million of the punitive damage award.

Plaintiff declined the remittitur and the trial court ordered

a new trial. (Superior Court of Contra Costa County, No.

C96-02075, Mark B. Simons, Judge.)

The Court of Appeal affirmed the trial court's order

denying the motion for judgment notwithstanding the

verdict and the order for a new trial on the amount of

punitive damages only. The court held that the jury

properly found defendants liable to plaintiff for bad faith

waste. An action for waste can be predicated on the

failure of a trustor of a deed of trust or a mortgagor to

pay real property taxes. Nonpayment of taxes may be

just as damaging to the security as intentional

destruction of the property. Further, the evidence

showed that the partnership had accumulated sufficient

earnings to make the tax payment and meet its other

immediate obligations when it was decided that the

taxes would not be paid. The court held that the trial

court did not err in instructing the jury that substantial

impairment of the bank's security would be impairment

that was more than a slight, trivial, negligible, or

theoretical factor. The court held that the jury, which

could have inferred from testimony that defendants

withheld the tax payment to punish the bank for failing

to agree to their demand for an interest rate concession,

properly found defendants liable for punitive damages.

Page 5 of 13

86 Cal. App. 4th 486, "486; 103 Cal. Rptr. 2d 421,'`*421; 2001 Cal. App. LEXIS 33, '""`1

(Opinion by Hanlon, J., ~ with Reardon, Acting P. J., and

Sepulveda, J., concurring.)

HeadnotesCALIFORNIA OFFICIAL REPORTS HEADNOTES

Classified to California Digest of Official Reports

security. The prohibitions against deficiency judgments

on purchase money obligations ( G~de Giv. Prot.

~~3(7b) or following trustees' sales ( ~'oca'~ GfV. ~'1"DG„ G

580d) bar an action for impairment of security where

failure to maintain the property was caused by a general

decline of real property values. However, bad faith

waste resulting from reckless, intentional, or malicious

conduct is actionable despite those prohibitions.

Waste § 2—Actions: Deeds of Trust § 11—Obligations

of Trustors—To Pay Property Taxes.

--In a bad faith waste action brought by a bank against

a partnership that had obtained a loan from the bank,

secured by a deed of trust, to refinance a construction

project, the jury properly found the partnership and the

partners liable to plaintiff based on defendants' bad faith

failure to pay a $ 358,000 property tax installment. An

action for waste can be predicated on the failure of a

trustor of a deed of trust or a mortgagor to pay real

property taxes. Nonpayment of taxes may be just as

damaging to the security as intentional destruction of

the property. Further, the evidence showed that the

partnership had accumulated sufficient earnings to

make the tax payment and meet its other immediate

obligations when it was decided that the taxes would not

be paid. That decision was apparently made only

because the controlling partner believed that he would

not have to pay for its consequences. In addition, even

though this action followed a nonjudicial foreclosure,

there was no double recovery, since the bank was still

owed millions of dollars after application of the credit

bid at the foreclosure.

[See 3 Witkin, Summary of Cal. Law (9th ed. 1987)

Security Transactions in Real Property, § 74.]

.~[l C2)

Waste § 2—Actions: Deeds of Trust § 11—Obligations

of Trustors—Impairment of Trustee's Security.

~f~L l (3)

Appellate Review § 32—Presenting and Preserving

Questions in Trial Court: New Trial § 1—Raising

Argument for First Time.

--A legal argument may be raised for the first time in a

new trial motion or on appeal only so long as the new

theory presents a question of law to be applied to

undisputed facts in the record.

4~~~4)

Waste § 2—Actions—Jury Instructions: Deeds of Trust

§ 11—Obligations of Trustors—To Pay Property

Taxes—Effect of Failure to Pay on Security Interest.

--In a bad faith waste action brought by a bank against

a partnership that had obtained a loan from the bank,

secured by a deed of trust, to refinance a construction

project, and against the partners the trial court did not

err in instructing the jury that substantial impairment of

the bank's security would be impairment that was more

than a slight, trivial, negligible, or theoretical factor.

Since the alleged waste at issue was defendants' failure

to pay real property taxes, to require a showing of a

more considerable impairment would place the lender in

an untenable position, given the duty to mitigate

damages. In any event, there was no reasonable

probability that a more expansive definition would have

produced a different verdict, since the jury's large

punitive damages award in favor of plaintiff showed that

it regarded defendants' malfeasance to be considerable.

--The common law action for waste is partially codified

in Civ. Code, § 2929, which provides that no person

whose interest is subject to the lien of a mortgage may

do any act that will substantially impair the mortgagee's

Retired Presiding Justice of the Court of Appeal, First

Appellate District, assigned by the Chief Justice pursuant to

r~f"fICIC V( section fi Uf the C~Irforni~ Constitution.

~t Ll (5)

Waste § 2—Actions—Availability of Punitive Damages:

Deeds of Trust § 11—Obligations of Trustors—To Pay

Property Taxes.

--In a bad faith waste action brought by a bank against

a partnership that had obtained a loan from the bank,

Page 6 of 13

86 Cal. App. 4th 486, *486; 103 Cal. Rptr. 2d 421,'"`421; 2001 Cal. App. LEXIS 33, "*"1

secured by a deed of trust, to refinance a construction

project and against the partners, based on defendants'

failure to pay property taxes, the jury properly found

defendants liable for punitive damages. Entitlement to

punitive damages is generally an issue for the trier of

fact (~iv. Cc~d~, ~S X294). Defendants had a legal duty

under tort law, as well as a contractual obligation, to pay

the property taxes. They indisputably breached that

legal duty and contractual obligation in deciding that the

taxes would not be paid. Furthermore, a partner testified

that the taxes would have been paid if the bank had

granted an interest rate concession sought by the

partnership. The jury could have inferred from that

testimony that the defendants withheld the tax payment

to punish the bank for failing to agree to their demand,

and that inference was sufficient to support the finding

of malice. Exposure to punitive damages may be as

much a deterrent to bad faith waste as to any other tort.

It was up to a jury to decide whether those damages

were justified in this case.

Counsel: Senn, Palumbo & Meulemans, Kevin J. Senn,

Catherine S. Meulemans and Michael J. Kerins for

Plaintiff and Appellant.

Miller, Starr &Regalia, Edmund L. Regalia and Lewis J.

Soffer for Defendants and Appellants.

Judges: Hanlon, J., 'with Reardon, Acting P. J., and

Sepulveda, J., concurring.

Opinion by: Hanlon, J.

Opinion

Agency (Bank) for bad faith waste. Bank appeals from

the order granting a new trial, and Borrowers appeal

from a subsequent order involving the order for new

trial.

The principal issues are whether a lender can recover

for waste when the lender's security is substantially

impaired by the borrower's bad faith failure to pay real

property taxes, and whether that failure in this case

supports an award of punitive damages. We answer

both of those questions in the [*"*3] affirmative in the

published portion of this opinion.

(.BACKGROUND

Sunset and Diller were the general and managing

partners, respectively, of the Partnership, which

developed, owned and operated atwo-building office

complex in Walnut Creek (the Project). Diller owned

Sunset and, through [*490] Sunset and the DNS Trust

(DNS), a family trust, he owned over 80 percent of the

Partnership. Diller was the "last word" on all important

financial decisions for the Partnership.

The Partnership borrowed $ 73 million from Bank in

1989 to refinance an initial construction loan of

approximately $ 55 million from another lender and

complete construction of the Project. Bank's loan

officer, [**423] Greg Gillam, testified that a "large

chunk" of the difference between the amounts of the

original construction loan and Bank's loan was

earmarked to repay Diller for his investment in the

Project. Diller acknowledged that the Partnership

received $ 10 million of the proceeds of Bank's loan.

Cal Prom Inc., a construction company wholly owned by

Diller, received $ 5.1 million of the loan proceeds.

[*489] [*'"422] HANLON, J. ~ --Defendants [***2]

1333 North California Boulevard, a limited partnership

(the Partnership), Sunset Ridge, Co., Inc. (Sunset) and

Sanford Diller (Diller; the Partnership, Sunset and Diller

are referred to collectively as Borrowers) appeal from

the order denying their motion for judgment

notwithstanding the verdict after a jury found them liable

to plaintiff The Nippon Credit Bank, Ltd., Los Angeles

Retired Presiding Justice of the Court of Appeai, First

Appellate District, assigned by the Chief Justice pursuant to

article VI, section 6 of the California Constitution.

Retired Presiding Justice of the Court of Appeal, First

Appellate District, assigned by the Chief Justice pursuant to

article Vl s~cfinn 6 of fh~ ~alifawnia Ccanstitution.

Bank's loan was structured as a nonrecourse obligation.

The Partnership paid interest on the [*'"*4] loan at a

variable rate tied to the London Inter-Bank Offer Rate

(LIBOR), and could elect to "lock in" specified rates for

one to six-month periods. The Partnership was required

under the deed of trust securing the loan to timely pay

all property taxes for the Project, and Bank had the right

under the loan documents to pay the taxes if the

Partnership did not. The Partnership was authorized

under the deed of trust to collect and retain rents from

the Project until written revocation of that right from

Bank after an event of default.

The Partnership made all loan and property tax

payments until December 1994, when Diller directed

that the $ 358,000 property tax installment due on the

12th of that month not be paid. Before that decision was

Page 7 of 13

86 Cal. App. 4th 486, *490; 103 Cal. Rptr. 2d 421, ~"423; 2001 Cal. App. LEXIS 33, **'`4

made, the Partnership had asked Bank for a

concession on the rate of interest payable on the loan,

and the request had been denied.

Vicki Mullins, who was the chief financial officer of the

Project's property manager, another Diller-owned entity

called Maxim Property Management, and another

Partnership representative met with Gillam and another

Bank representative on November 15, 1994. Mullins

presented projections showing that, because of

rising [***5] interest rates and other factors, the Project

would have a cash flow shortfall of over $ 1 million in

1995. A number of leases were coming due the next

year, rental rates were decreasing, and tenants were

demanding shorter leases with more tenant

improvements. Mullins and Diller testified that there was

a severe real estate recession at the time. "[T]he state

of the economy was an absolute disaster," Diller said,

and "[d]evelopers were dropping like flies." Appraisals

submitted by the Partnership to Bank showed that the

Project's value had dropped from $ 103 [*491] million

in September of 1989 to $ 52 million in November-

December of 1994.

In his memo of the November 1994 meeting, Gillam said

he thought that the Partnership could pay more interest

than Mullins projected if it paid all tenant improvement

costs, and requested that Diller "use his own cash to

cover deficits of the [P]roject because he has already

earned a large amount of money through the [P]roject."

On December 2, Mullins faxed Gillam a letter stating

that the Project would have a negative cash flow "prior

to any increase in the LIBOR rate" if it paid Bank's loan,

the property tax installment, the operating [*'"*6]

expenses, and the tenant improvements due that

month. The letter requested a "six-month lock" at the

current LIBOR rate. Diller conceded at trial that this

request was for a "below market' interest rate--a

concession Bank was not legally obligated to make.

Gillam called Mullins about five minutes after receiving

the fax and rejected the request.

Diller testified that he would have paid the December

1994 tax installment if Bank had "worked with us," but

he was "convinced that they were not dealing fairly ...."

He said that his decision not to pay the taxes was "very

difficult' and taken with "a lot" of thought. Diller admitted

that the Project had sufficient cash flow that month to

make the payment. There was no dispute that the

Partnership had the means to pay the taxes. On the

date the $ 358,000 tax payment was due, the

Partnership paid Diller's entity DNS over $ 683,000.

Diller said that this payment was made to reduce DNS's

investment in the Partnership.

Diller acknowledged at trial that the unpaid taxes would

be a charge against the [**424] Project, and that Bank

would eventually have to pay the taxes or accept a

reduced sale price for the Project. He also agreed

that [***7] the missed $ 358,000 payment was a

substantial sum of money. However, he thought that the

amount of the unpaid taxes was insignificant compared

to the value of the Project and that the missed payment

did not substantially impair Bank's security. He denied

using nonpayment of the taxes to try to gain leverage to

force Bank to make concessions. However, Diller did

say that he wanted Bank to "share the pain."

In addition to directing that the December 1994 taxes

not be paid, Diller caused the Partnership to default on

the January and February 1995 loan payments to Bank.

He explained: "The reason it was decided [not to make

the January loan payment] was that it was determined

at that time Bank] in negotiations and restructuring this

loan was acting in bad faith, Bank was not dealing

fairly, Bank had no intention of restructuring the loan.

[P] What [*492] Bank intended to do was to bleed the

[P]artnership dry, to have the [P]artnership come up with

outside funds and to convert this loan from a

nonrecourse loan to a recourse loan, and then as soon

as Bank has bled the [P]artnership dry and got all the

money it could out of it through outside sources

so [***8] that the loan would be kept current, then it

would go ahead on its previously-determined course of

action and take the property away from the

[P]artnership. [P] And that's why we felt it was hopeless

to allow this bank to extract all of this money from us

and also throw us off the property. [P] They were not

negotiating in good faith, although negotiations did

continue to try and save the ship after that ...."

The Partnership sent Bank a series of proposals in

January and February of 1995. On January 5, Mullins

faxed Gillam a proposal to purchase the Project at fair

market value. On January 6, Mullins faxed Gillam a

letter stating: "Rather than a deed in lieu, we would like

to propose a cash flow mortgage." On February 3,

Mullins faxed Gillam a term sheet for restructuring

Bank's loan. On February 16, Mullins faxed Gillam a

letter asking for "your thoughts on an outright sale for

cash." On February 28, Mullins faxed Gillam a letter

proposing a deed in lieu of foreclosure.

No agreement was ever reached, other than a "pre-

workouY' agreement which stated that no agreement on

preliminary issues would be binding in the absence of a

Page 8 of 13

86 Cal. App, 4th 486, '`492; 103 Cal. Rptr. 2d 421, '"424; 2001 Cal. App. LEXIS 33, *`*8

global settlement. Gillam testified that Bank [***9]

agreed at one point to take a deed in lieu of foreclosure,

but that arrangement fell through when the Partnership

proposed additional conditions. Gillam said that Bank

would sometimes make concessions if the customer

kept the loan current and generally lived up to its

obligations. Here, Gillam said, "there were so many

proposals and the borrower was still unwilling to pay any

amount of the past due interest, we didn't know whether

he was serious or not." Gillam said he told Diller that he

thought Diller was negotiating in bad faith and trying by

his tactics to hold Bank "hostage." Gillam said Bank

eventually came to believe that "they were not serious

about any kind of negotiation, that they were just intent

on withholding the rent or not paying the interest and on

taking as much cash out of [the] building as they could

before eventually they would--they were going to lose

it."

On February 14, 1995, Bank sent the Partnership an

effective demand to turn over rents from the Project,

and the Partnership thereafter complied with the

demand. Diller testified that, before receipt of that

demand, he regarded the Project's revenue as "our

money." Diller acknowledged that his family trust,

[***10] DNS, received a net amount of $ 1.7 million

from the Partnership from December 5, 1994, to April 1,

1995. He said that he still lost $ 5.2 million in the

Project.

[*493] The Partnership remitted approximately $

300,000 from Project revenues to Bank in March 1995,

and approximately [**425] $ 440,000 in April 1995.

Gillam testified that when these funds were delivered

the outstanding balance of the loan was about $ 1

million. Bank used these funds in April 1995 to pay the

$ 394,713.56 then due for the delinquent December

1994 property tax installment.

The jury awarded this $ 394,713.56 sum to Bank as

compensatory damages for bad faith waste, based on

findings that Borrowers' failure to pay the December

1994 taxes was not "caused solely or primarily by an

economic downturn," and that the failure to make this

payment was intended to harm, and did substantially

impair, Bank's security interest. The jury found by clear

and convincing evidence that the failure to pay the taxes

was done with malice, and awarded $ 8,333,333.33 in

punitive damages. Borrowers' motion for judgment

notwithstanding the verdict was denied, but their new

trial motion was granted unless Bank agreed to ["**11]

remit all but $ 1.6 million of the punitive damage award.

Bank declined the remittitur and a new trial was

ordered.

II. DISCUSSION

A. Motion for Summary Disposition of Appeals "

B. Judgment Notwithstanding the Verdict

1. Liability for Bad Faith Waste

C 9 [] (1 a) Borrowers contend that they were

entitled to judgment notwithstanding the verdict on the

ground that their failure to pay the property tax

installment cannot be deemed to have been an act of

bad faith waste. ~f~fi[] The "bad faith waste" cause of

action was established in Corrtelisor~ v. Kc~rnblufh

197 15 ~9, 3d 59Q 925 ~~C. R tr. 557 512 1~.2d

9~, and extended in C~s~u~~ v. Alk~er#sr~n (1932) 134

mod, ~ ,~. ~d 71 9~3~ ~'~l. R tr. 33 3 , to situations where

the defendant has failed to pay real property taxes.

Borrowers contend that Osuna misconstrued Cornelison

and that ["'"*12] Osuna was incorrectly decided.

The plaintiff in Cornelison sold a residence and took

back a note and deed of trust. The home was

subsequently conveyed by buyers to the defendant

[*494] and eventually condemned as unfit for human

habitation. The plaintiff caused the property to be sold at

a trustee's sale, and bought it for a full credit bid. She

then sued the defendant for breach of contract and

waste. Summary judgment was entered for the

defendant on the contract claim on the ground that he

had not assumed the secured debt and thus was not

liable for breaching covenants in the deed of trust, and

on the waste claim on the ground that plaintiff's full

credit bid precluded any claim that her security had

been impaired. The Supreme Court affirmed, but

concluded that the plaintiff might have had a claim for

bad faith waste had she not made a full credit bid for

the property.

[] (2) The court noted that the common law

action for waste was partially codified in l~€~12[''] Civil

Cc~c~e section 2923, which provides that "[n]o person

whose interest is subject to the lien of a [***13]

mortgage may do any act which will substantially impair

the mortgagee's security." (Corn~tisor,_v~Krarr7biuth

supr~a~ 1_~,_al. 3d _~t~~ 59I.) The court reasoned that

the ~f~[] prohibitions against deficiency judgments

on purchase money obligations (Corse CivW Proc.,__~

'See footnote, ante, page 486.

Page 9 of 13

86 Cal. App. 4th 486, *494; 103 Cal. Rptr, 2d 421,'`*425; 2001 Cal. App. LEXIS 33, *""13

~~Ot.~) or following trustee's sales (id., § 580d) would bar

an action for impairment of security where failure to

maintain the property was caused by a "general decline

of real property values." (Cornelisan, at p~. 6~~-6Q5.)

However, the court concluded that "bad faith" waste

resulting from "reckless," "intentional" or "malicious"

conduct would be actionable despite those prohibitions.

( !d. at pp. ~iO4-605.)

Leipziger, The Mortgagee's Remedies for Waste (1976)

64 Cal. L.Rev. 1086, 1109 [describing Krone as a

"muddled opinion"].) Osuna also observed that cases in

other [*""*16] jurisdictions were split on whether failure

to pay property taxes could constitute waste. (Osuna ~°.

6~Ibertson, scr~ra 134 dal, ~ln,~. 3d ~~. 78.) However,

Osuna correctly anticipated the direction of the law on

this point.

~~4 ~~r [] (1 b) The Osuna case held that tif~[~'] an

action for waste could be predicated on the failure of a

trustor of a deed of trust or a mortgagor (*"426] to pay

real property taxes, finding that this conclusion was

supported by "a fair reading of the holding in

[Cornelison [**'"14] ], in relation to the facts alleged."

C)sun~ ~. ~1lberfson s, u~ 134 Cd,_~~7,~~..._~.~._ ~?~77•)The cause of action for waste in Cornelison "alleged in

substance that defendant owed a duty to properly and

adequately care for the property and that defendant

negligently failed to fulfill this duty, thereby causing

plaintiff to be damaged in specified particulars and

amounts by reason of the loss of improvements to the

real property as well as by reason of the loss of its use."

Cornelison ~. Karr7bluthy_su ram_ 15__Caf.,3d ~t_~:._594.)

While these allegations did not refer to failure to pay

property taxes, the waste claim in Cornelison also

incorporated by reference the material allegations of the

breach of contract cause of action, where the breaches

included failure to pay property taxes as well as failure

to properly maintain the property. (Ibid.) It also appeared

from the trial court ruling quoted in the opinion that the

plaintiff in Cornelison alleged that the defendant had

duties apart from the contract to pay taxes on the

property as well as maintain it. (id, ~~~5~~ fn~9.)

Thus, while Cornelison did ['"'""15] not mention failure to

pay [*495] property taxes in its analysis of the waste

claim, Cornelison's discussion of that claim could

plausibly be construed as it was in Osuna to encompass

that dereliction. Accordingly, we are not persuaded that

Osuna misconstrued Cornelison.

Nor are we persuaded that Osuna was wrongly decided.

Osuna acknowledged that the court in Krar~~ V. C9~~

(997 } 5~ C~1. A,ap. 3d 991. 19~dw195 j92% dal. F~ptr.

3~, a case decided before Cornelison, had found no

authority for the proposition that failure to pay real

property taxes constituted waste. However, that lack of

authority was remedied by the discussion in Cr~rneli~on.

C.3sun~ v. Al~a~rtso~~ su rG~~ 13~ Cal. A . 3c~ ~t . 77

[noting timing of the decisions]; see also 4 Miller &Starr,

Cal. Real Estate (3d ed. 2000) Deeds of Trust, § 10.53,

p. 159, fn. 10 [characterizing Krone's references to

waste liability for nonpayment of taxes as dicta]; cf.

"Relatively few courts have had occasion to consider

whether waste includes nonpayment of real estate taxes

by the mortgagor," but "[t]his broad conception of waste

appears to be part of an emerging legal trend with roots

dating to the 19th Century." (1V. ~r~~errc~r7 Sec. Life v.

Harris Trust & S~v. ~r~lc ~.p.11/. `IJ94 S59 F. Si!

1163 .91. 5.) For example, willful failure to pay property

taxes has been recognized as actionable waste under

New York law on facts much like those presented here,

where the partnership borrower owned an office building

and distributed $ 17 million to its partners shortly after

defaulting on a tax payment. (Travelers lr7s. Co. v. 633

7"l~ird...~lssvcr~tes._.~2d Cir;~99J4~ 14 ~~3d_ 914. 917-91f3.)

The Second Circuit's opinion in the Travelers case

noted that a number of other courts had likewise held

that failure to pay property taxes could constitute waste.

( Id._~t_~a;_~123 [***17] [collecting cases].) Commentators

have recognized the split of authority among the states

Rest.3d Property, Mortgages, § 4.6, reporter's notes, p.

279 [collecting cases]; see also An~7otWf~at

Constitutes Waste Jusfifvinc~ Appninfrnent of Receiver of

Mort~~~~cd_ Prca~e~~j1974~ ~5 A L.R.~r1 1fJ41,._1046~

~(06~~1075 [nonpayment of taxes is generally regarded

as waste justifying appointment of a receiver]), but have

observed that courts are becoming more willing to hold

borrowers who fail to pay real property taxes liable for

waste notwithstanding nonrecourse provisions of their

loans (Stein, The Scope of the Borrower's ["'`527]

Liability in a Nonrecourse Real Estate Loan (1998) 55

V1/ashry & L~~ L.~~v. 92D~921C1 (hereafter Stein)).

[*496] The commentaries persuasively endorse this

liability. The Restatement Third of Property, Mortgages,

section 4.6, subdivision (a), page 262, lists as a form of

waste, along with physical alteration or neglect of

mortgaged property, a mortgagor's failure to pay

property taxes secured by a lien with priority over the

mortgage. (See also id., § 4.6, subd. (b)(3), p. 262

[damages may be recovered to the extent [**'"18] of the

security's impairment].) NnJ[] Waste encompasses

default on senior tax liens because the mortgagee "has

a reasonable and legitimate expectation that the

mortgagor will not place a governmental entity in a

position to destroy the mortgage." (Id., § 4.6, com. b, p.

Page 10 of 13

86 Cal. App. 4th 486, '`496; 103 Cal. Rptr. 2d 421, **527; 2001 Cal. App, LEXIS 33, **`18

265.) "While there may be disagreement as to the scope

of the borrower's obligation to maintain the property

physically, particularly if the documents are imprecise,

there can be little question that the borrower, as owner,

is expected to pay all real estate taxes." (Stein, supra,

55 Wash. &Lee L.Rev. at p. 1275.) As Diller conceded

at trial, amounts secured by a tax lien will either have to

be paid by the lender (Rest.3d Property, Mortgages, §

2.2, com. a, pp. 70-71 [authorizing advances for this

purpose]) or they will reduce the price paid for the

property at foreclosure (Stein, at p. 1269, fn. 169).

Unpaid real property taxes thus reduce the chances of

full recovery of the debt (id. at p. 1270, fn. 171), and

"from the secured creditor's vantage point ...may be as

costly as a leaky [***19] roof' (Travelers lns. ~o, v.

6~3 Tl~~ird ,~ssc~ci~tes ~u ~r~, 14 ~. ~cl of . 1 ? 1).

The Stein article discusses at length why borrowers

should be subject to personal liability for failing to pay

property taxes and other forms of waste even if their

loans are nonrecourse. On the one hand, "f~6[ the

tax payment is just another check that the borrower

must write, resembling the obligation to pay principal

and interest for which the nonrecourse borrower is not

personally liable." (Stein, supra, 55 Wash. &Lee L.Rev.

at p. 1277, fn. 196.) Moreover, the lender's failure to

require that the borrower expressly assume personal

responsibility for the obligation to pay taxes could be

interpreted to mean that no such liability was intended.

Id. at p. 1277.) On the other hand, nonpayment of taxes

may be just as damaging to the security as intentional

destruction of the property, an act which the lender

could not have intended to permit. (See id. at pp. 1275,

fn. 192 & 1277, fn. 196.) Moreover, "nonrecourse

borrowers have a special responsibility [""*20] to

protect an asset of theirs that they have pledged to

another as the sole security for repayment of a debt."

Id. at p. 1245.) Thus, there are circumstances where a

nonrecourse borrower should be liable for waste,

including failure to pay real property taxes. (Id. at p.

1272.)

Such liability redresses the kind of harm the tort of

waste was originally designed to remedy. (See

7~r~v~iers lns. Ca. ~. 63:3 ~~'hird Associates su r~

*97 14 ~'.:3d afi ~. 920 fn. 7.) ff7'[] The waste

doctrine was developed to mediate between the

competing interests of life tenants and remaindermen.

(Stein, supra, 55 Wash. &Lee L.Rev. at p. 1241, fn. 87,

quoting Posner, Economic Analysis of Law (5th ed.

1998) p. 83.) If the income-producing property were a

forest, the life tenant would want to cut down the trees

before their maturity even if the present value of the

timber would be greater if the logging were postponed

beyond the tenant's expected lifetime. (Stein, at p. 1241,

fn. 87.) Similarly, the owner of a distressed property will

be tempted to [***21] "scavenge whatever it can for its

own benefit" and "squeeze as much money out as

possible" before the property is lost, with no regard to

the property's resulting condition. (Id. at pp. 1243 &

1247, fn. 103; see also p. 1243, fn. 92 [likening this

situation to the return of a rental car with an empty gas

tank].) The prospect of tort liability may deter the

borrower from thus behaving "like a life tenant with very

little time left to live." (Id. at p. 1241, fn. 87.)

[**428] Such "milking" of the security has been

recognized as a form of bad faith waste within the

meaning of Cornelison (see in re Mills 9th Cir. 99813)

841 F,2d 9D2, 905}, and a trier of fact could find that the

missed tax payment qualified as "milking" in this

instance. There may be exigent circumstances which

would justify a failure to pay real property taxes; for

example, where a choice must be made between paying

the taxes and making loan payments or necessary

repairs, a tax default might merely rearrange the

lender's loss without increasing it. (Stein, supra, 55

Wash. &Lee L.Rev. at pp. 1273-1274.) In this case,

however, the Project had [***22] not reached such dire

straits when Diller directed that the taxes not be paid.

The evidence shows that Diller caused the Partnership

to pay DNS, his own trust, nearly twice the amount of

the $ 358,000 tax installment on the day the taxes were

due, and that DNS received a total of $ 1.7 million from

the Partnership while the taxes remained delinquent. It

is clear that the Partnership had accumulated sufficient

earnings to make the tax payment and meet its other

immediate obligations when it was decided that the

taxes would not be paid. Thus, the situation here cannot

be distinguished from the one in Travelers, where the

partnership borrower was found subject to waste liability

for neglecting to make a tax payment and then

distributing millions of dollars to its partners.

This case is distinguishable, however, from Ire re NJitls,

s~r~~, ~~1 F.2d 902, where a borrower was found not to

have "milked" the security. The borrower in Mills had

operated the property for only a few months and "lost

the bulk of his investment." (1~(. ~t p. 905.) Here, Bank

officer Gillam's belief that Diller had reaped profits from

the Project was supported by evidence [**"`23] that the

Partnership received $ 10 million of Bank's loan as a

[*498] repayment of Diller's investment in the Project,

that various Diller entities were paid for construction and

management of the Project, and that the Project was

operated successfully fora number of years. Thus,

Page 11 of 13

86 Cal. App. 4th 486, *498; 103 Cal. Rptr. 2d 421, ̀'`428; 2001 Cal. App. LEXIS 33, ""'`23

there were reasons to doubt Diller's claim that he had

lost money on the Project. Viewed in the light most

favorable to the verdict, the record does not establish a

loss of the bulk of Borrowers' investment.

t~~[~~~ The ultimate test proposed in the Stein article

for waste liability in connection with a nonrecourse loan

is whether the lender has "suffered losses caused by

actions the borrower would not have taken had it been

fully liable." (Stein, supra, 55 Wash. &Lee L.Rev. at p.

1244.) Assuming that this test correctly reflects the "bad

faith" standard for liability under Cornelison, it was

satisfied here. Borrowers cannot plausibly claim that the

Partnership would not have paid the property taxes

even if Diller and his partners had been personally liable

on Bank's loan. Taxes on the Project [*"*24] were paid

for years when it appeared that the Partnership had

something of value to lose; only when the Project was

threatened was DNS paid in lieu of the tax authorities.

(Stein, supra, 55 Wash. &Lee L.Rev. at p. 1258, fn. 136

[noting that the nonrecourse borrower is likely to

perform like one who is personally liable as long as the

project is successful].) Diller's decision not to pay the

taxes was apparently made "only because [he] believed

that [he] would not have to pay for [its] consequences."

Id. at p. 1283.)

Borrowers argue that bad faith waste liability under

Osuna for failing to pay real property taxes improperly

"converts" conduct which is only a breach of contract

into a tort. (See ~~ed Egtri meat _Carte_ ~~LittanWSaudi

Arabia Ltd. 1994 7 ~1. 4tf~ 503. 595 2S ~~f. R tr. 2cl

~7~~569 P.2d_,_454~j.) That result, Borrowers submit, is

confined to insurance bad faith cases. Borrowers cite

authorities indicating that there is no personal liability for

real property taxes and that sale of the land is the

state's sole remedy for nonpayment of those taxes.

(E.g., ll~c~'ikc~ v, ti~aton 1900 9~1 ~~f. 909 991 63 ~.

1~; [***25] Marcia v. Count of Santa ~~ara 1975) S7

~~1. A 3c! 319 323324 151 ~ 1. Fr' fr. S0.)

Borrowers ['"*429] reason that in the absence of

personal liability to the state for the taxes, or a statute

which in so many words makes nonpayment of the

taxes a tort, the only possible source of liability for this

neglect must be a contract (in this case the deed of

trust).

This line of argument is unconvincing. Tax policy and

tort law are separate fields. That the state has chosen

not to impose personal liability on property owners for

real property taxes says nothing about owners' liability

to other persons for the tort of waste. The tort codified in

Civil Cac(e s~ctrvn 29?_9 ( Corrre(isc~rr sr. Kornblcrtl~

s~?r~a, 15 ~1, ~3d at Via. 597) has long protected [*499]

lenders from "any act which will substantially impair"

their real property security. That prohibition can properly

be extended to nonpayment of real property taxes

regardless of whether the omission also creates tax or

contract liability. (See ,~cl~roed~r ~. Auto C~riveaw~a,~Gn.

~97~d 11 C~1. 3d 9t18 929 11~ GAL f; fr. C~22 52~

P.2c9 6621 [tort ["**26] damages may be awarded for

conduct which "incidentally involves a breach of

contract"].)

Borrowers contend that Osuna is distinguishable

because the nonpayment of taxes in that case resulted

in tax sales of the properties securing the debt.

However, total loss of the lender's security is not

required; mere impairment of the security constitutes

waste if the impairment is "substantial." (Civ. Crade,~

2929.)

Borrowers argue that the impairment of security in this

case was insubstantial as a matter of law. On the one

hand, as Diller admitted, the unpaid $ 358,000 tax

installment was a "substantial" sum of money. On the

other hand, as Diller also noted at trial, the unpaid taxes

were a small fraction of the value of Bank's security. In

these circumstances, where reasonable minds might

differ as to the substantiality of the impairment, the

question was properly left to the trier of fact.

Borrowers contend finally that, because Bank added the

amount it advanced to pay the real property taxes to the

indebtedness secured by the deed of trust and

conducted a trustee's sale of the property to satisfy that

debt, liability for waste is precluded in this case [***27]

by the one form of action (,Code. Civ. Pr~ac., X726) and

antideficiency (id., § 580d) rules. Borrowers submit that

Bank effectively elected its remedy by pursuing its

contract rights to recover the tax advance, and thus

could not pursue its tort claim for nonpayment of the

taxes.

This argument was raised for the first time in Borrowers'

motion for judgment notwithstanding the verdict; no

evidence concerning the foreclosure was presented at

trial. In connection with the posttrial motion, Borrowers

requested judicial notice of: allegations in Bank's April

1995 verified complaint for judicial foreclosure listing the

$ 394,713.56 tax advance as part of the $ 2,543,797.37

amount then delinquent on the loan; Bank's April 1995

notice of default under the deed of trust listing $

2,543,328.37 as the amount to reinstate as of April 20,

1995; and Bank's January 1996 notice of sale under the

deed of trust. Borrowers renew their request for judicial

Page 12 of 13

86 Cal. App. 4th 486, '`499; 103 Cal. Rptr. 2d 421, **429; 2001 Cal. App. LEXIS 33, "'"*27

notice on appeal, and also refer to Bank's accounting in

its complaint herein of amounts due under the loan after

the foreclosure, which listed the tax advance as part of

the unpaid balance of $ 28,551,390.59

remaining [***28] after [*500] application of the $

52,000,000 credit bid entered by Bank's subsidiary to

purchase the Project at the trustee's sale.

factor test in negligence law. (See com. to k~AJI Nc~.

3.76 (8th ed. 1994) p. 99.) Borrowers submit that the

court should instead have defined "substantial" as "[o]f

real worth and importance; of considerable value; .. .

[s]omething worthwhile as distinguished from something

without value or merely nominal." (Black's Law Dict.

(Abridged 5th ed. 1983) p. 744, col. 2.)

~(3)[ `] (3) 9[ ] A legal argument may be raised

for the first time in a new trial motion or on appeal only

"so long as the new theory presents a question of law to

be applied to undisputed facts in the record." (Noffirr~n-

HC~a ~. Trai~s~merrc~ lips. ~o. ~J91) 1 1. A~l~. 4tf~

9C7 15 9 dal. F~' tr, 2d f305 ;see ice. 96.) ~~ 9c [ ]

(1c) Since evidence for the election of remedies

argument was not brought forth until the motion for new

trial, the argument can be [**430] rejected here, as it

was in the trial court, as unsupported by the record.

This belated argument is contrary to the Cornelison

case in any event. Cornelison provides for #~1V9Q[] a

tort action for bad faith waste following a nonjudicial

foreclosure unless the foreclosure results, by full credit

bid or otherwise, in full satisfaction of the secured debt.

[***29] ~1h119[ Where as here the creditor "bids less

than the full amount of the obligation and thereby

acquires the property valued at less than the full

amount, his security has been impaired and he may

recover damages for waste in an amount not exceeding

the difference between the amount of his bid and the full

amount of the outstanding indebtedness immediately

prior to the foreclosure sale." (~orr~elisar~ ~a~Krarr~l~luth~,.

supra, 15 dal. 3cI at p. ~C?I.) Nothing in this passage

suggests that the "full amount' of the outstanding debt

cannot include money the creditor has advanced for the

unpaid taxes. If the foreclosure results in payment of all

or a portion of that advance, Cornelison's cap on

compensatory damages will preclude any double

recovery in a subsequent waste action. There was no

double recovery in this instance; the figures Borrowers

cite show that Bank was still owed millions of dollars

after application of the credit bid at the foreclosure.

Bank could therefore "recover any provable damages

for waste." (td. ~t p. 608.)

2. Jury Instructions

C~ 4 [] (4) Borrowers contend that the court erred in

its instructions ['`**30] on the issue of substantial

impairment of Bank's security by defining "substantial"

as "more than a slight, trivial, negligible, or theoretical

factor." The court borrowed this language from the

comment to the standard instruction on the substantial

As Bank observes, ~1~l9[ ~] a requirement that the

security impairment be "considerable" may put a lender

in an untenable position where the impairment [*501]

stems from a failure to pay real property taxes. Given

the duty to mitigate damages (Valve Ike Ora dank v.

G~r~7bc~a 1994 26 1. A nth 1~8G 7691 32 fat.

R_~___str,_2d_~~), the lender should not be made to wait for

the tax lien to mushroom with multiple unpaid

installments, and should not be penalized for ["**31]

promptly curing a tax default. We therefore conclude

that in this case the court's instruction was better than

the one Borrowers proposed.

We note further that even if Borrowers' definition would

have been preferable, there is no reasonable probability

that its use would have produced a different verdict.

Soule v. General Motors Car . 7994 8 dad. 4th 515,,

57~_(34,'ltle Ryatr. 2d 607, S&2 P.~c1 29t~1.) The court's

instruction was consistent with the not "merely nominal"

language of Borrowers' definition, and the large punitive

damage award shows that the jury regarded Borrowers'

malfeasance as very "real" and "considerable."

3. Liability for Punitive Damages

~~()~ (5) Borrowers assert that there is no

precedent for an award of punitive damages for waste,

and contend that there was no substantial evidence to

support the jury's finding that the waste in this instance

was malicious. However, 1~1~9~[ °] entitlement to

punitive damages is generally an issue for the trier of

fact (Giv~_Code, ~32~~ subc~:_... a ; B~cksfi v._Cifi~of

p~ri~ ter Goads Co. 9939 94 aJ. 2d 633 &39 96

P.2d 1221; [***32] Stevens v. Owens-Cornin Finer las

C~r.~. 1 ~)9G 4J ~l. A .nth 96~d5 96 a8 57 Cpl. R fr~.

2r1 52~ ), and this case is no exception.

[**431] Borrowers argue that they cannot be held liable

for punitive damages because, in failing to pay the

taxes, they did no more than exercise their contractual

right to retain the rents and profits from the Project. As

has been indicated, Bank did not effectively revoke that

right until two months after the taxes were due.

However, as has also been explained, Borrowers had a

legal duty under tort law, as well as a contractual

Page 13 of 13

86 Cal. App. 4th 486, *501; 103 Cal. Rptr. 2d 421, "*431; 2001 Cal. App, LEXIS 33, *'`*32

obligation, to pay the taxes. They indisputably breached

that legal duty and contractual obligation when Diller

decided that the taxes would not be paid. Borrowers'

right to retain funds from the Project rather than turning

that money over to Bank did not give them a license to

commit waste.

Borrowers argue that "[t]o look back at [their] decision

not to pay the December 1994 installment of property

taxes, and say that it was malicious, and intended to

harm Bank rather than to further the interests of

[Borrowers], is not a permissible inference from the

evidence." There are multiple problems [***33] with this

argument. First, it is not apparent why the aim of

Borrowers' conduct had to be either furthering their own

interest or harming [*502] Bank. Those aims are not

mutually exclusive. Second, no authority supports the

suggestion that a party can escape liability for malicious

conduct merely because it hopes to benefit from its

actions. Third, Diller admitted that the taxes would have

been paid if Bank had granted the interest rate

concession the Partnership sought. The jury could infer

from this testimony that Borrowers withheld the tax

payment to "punish" Bank for failing to accede to their

demand, and that inference was sufficient to support the

finding of malice. (Civ. Code,~,~ 3294 subd. (cam~...~._,...~.~e_r

[malice includes conduct which is intended to injure the

defendant].) ~

[**'"34] Borrowers maintain that "the mere breach of a

contractual obligation, even if committed in order to gain

an advantage in negotiations with the other party to the

contract," cannot support a finding of malice. They

derive this proposition from deck ~. State Farm Ir~i.~f.

/~utn. /t~~. Cc~. X976 a4 ~ 1. ~ ~c~ 347 926 ~/.

Rptr. 6021. This contention also fails for multiple

reasons. First, to reiterate, Borrowers did not merely

breach a contractual obligation; they committed a tort.

Second, the Beck case is inapposite. The court in Beck

found that the defendants bad faith failure to settle an

insurance claim did not support a finding of malice. (lcl,_

~t ~, 356.) The court did not purport to apply any rule

like the one Borrowers' postulate, and instead grounded

its conclusion on the particular circumstances presented

(ibid.), which were not analogous to those here. The

evidence in Beck showed, among other things, that the

defendant had a reasonable doubt as to the extent of its

liability when it asserted a defense it knew to be invalid.

Here, as Bank notes, Borrowers could not claim any

doubt about their obligation to pay the real

property [**''35] taxes, or the amount of that obligation,

when they decided not to pay it.

Third, the evidence does not necessarily justify

Borrowers' assertion that they intended to try to reach

some agreement with Bank after they defaulted on the

tax payment. While conflicting inferences could be

drawn from the evidence, the jury could have

determined that Borrowers' sole aim in defaulting on the

taxes and thereafter was to extract as much money from

the Project as possible before walking away from it. The

jury could have accepted Bank's argument that the

Partnership's flurry of proposals after the tax default was

meant only to delay Bank's demand for the Projects

revenues. We observe that Diller had already

determined by the time he decided not to pay [**432]

the taxes that Bank had no intention of making any fair

[*503] accommodation--that was his professed reason

for withholding the tax payment.

#314[ Exposure to punitive damages may be as

much a deterrent to bad faith waste as to any other tort.

(See Stein, supra, 55 Wash. &Lee L.Rev. at p. 1245, fn.

97.) It was up to a jury [***36] to decide whether those

damages were justified in this case.

C. Motion for New Trial

1., 2. "

III. DISPOSITION

The order denying the motion for judgment

notwithstanding the verdict, and the order for a new trial

on the amount of punitive damages only, are affirmed.

The parties shall bear their own costs on appeal.

Reardon, Acting P. J., and Sepulveda, J., concurred.

The petition of defendants and appellants for review by

the Supreme Court was denied May 16, 2001.

~ Malice also includes despicable conduct taken with a willful

and conscious disregard of the rights of others (Civ. Cc~d~a,

x,294 subd. tc?(~)), and Bank cites authority on this

"conscious disregard" form of malice. However, since the jury

here was not instructed on this form of malice, it will not be

considered.

~s~~ci ~a3' I~r~ca~tt~e~~t

'See footnote, ante, page 486.

See footnote, ante, page 486.

Order No.

I:NDORS~M~NTAttached to Policy No.

Issued byChicago Title Insurance Company

Policy No.

On the representation of the Insured that the Insured has extended the due date of the indebtedness secured by the InsuredMortgage:

The Company insures the Insured that the priority of the Insured Mortgage has not changed by reason of said extension.

This endorsement does not insure against loss or damage based on any statute of limitations.

No coverage is provided hereby in the event the Agreement modifies the Insured Mortgage to any greater extent or in anydifferent way from those ways represented above.

This endorsement is issued as part of the policy. Except as it expressly states, it does not (i) modify any of the terms andprovisions of the policy, (ii) modify any prior• endorsements, (iii) extend the Date of Policy, or (iv) increase the Amount ofInsurance. To the extent a provision of the policy or a previous endorsement is inconsistent with an express provision of thisendorsement, this endorsement controls. Otherwise, this endorsement is subject to all of the terms and provisions of thepolicy and of any prior endorsements to it.

Dated:

Chicago Title Insurance Company

Countersigned:

By.

Authorized Signature

~#

~..,~,....,.,~.._..,~,..,,,,,.,.

Rifi t .v....._-_-.__

Aii65~Y

,..:-~ ~ r

~̀~`j~✓

~.", ~ + ~}

~~~is~y.~~.

5E-251-06 Extension of Due Date of Promissory Note Endorsement (11-17-11) Page 1 of 1

Order No.

ENDOI2S~MENTAttached to Policy No.

Issued byChicago Title Insurance Company

The Company insures against loss or damage sustained by the Insured by reason of:

Policy No.

The invalidity or unenforceability of the lien of the Insured Mortgage upon the Title at Date of Endorsement as a

result of the agreement dated ,recorded ,Instrument No. ,Book ,Page of Official Records

("Modification"); and

2. The lack of priority of the lien of the Insured Mortgage, at Date of Endorsement, over defects in or liens or

encumbrances on the Title, except for those shown in the policy or any prior endorsement and except:

This endorsement does not insure against loss or damage, and the Company will not pay costs, attorneys' fees, or expenses,

by reason of any claim that arises out of the transaction creating the Modification by reason of the operation of federal

bankruptcy, state insolvency, or similar creditors' rights laws that is based on:

the Modification being deemed a fraudulent conveyance or fraudulent transfer; or

2. the Modification being deemed a preferential transfer except where the preferential transfer results from the failure

a. to timely record the instrument of transfer; or

b. of such recordation to irnpart notice to a purchaser for value or to a judgment or lien creditor.

This endorsement is issued as part of the policy. Except as it expressly states, it does not (i) modify any of the terms and

provisions of the policy, (ii) modify any prior endorsements, (iii) extend the Date of Policy, or (iv) increase the Amount of

Insurance. To the extent a provision of the policy or a previous endorsement is inconsistent with an express provision of this

endorsement, this endorsement controls. Otherwise, this endorsement is subject to all of the terms and provisions of the

policy and of any prior endorsements.

Dated:

Chicago Title Insurance Company

Countersigned: ~Y:~..

,r...~,nr~.... ~ ,= ~T4.. t', ~

.~.....~,..._Raai~y C3~sir= a ...~,~,...,.....,n,.

By: ~ ' ,1 l A 1 ~ ~ ~ A9t~s!

Authorized Signature '~~ ,,~..___

72E114 ALTA 11-06 Mortgaqe Modification (06-17-06) Page 1

Copyright American Land Title Association. All rights reserved. The use of this Form is restricted to ALTA licensees and ALTA ,~.,<«~~aN..

members in good standing as of the date of use. All other uses are prohibited. Reprinted under license from the American Land ~""° T'T`F

Title Association. -.0

Order No.

ENDORSEMENTAttached to Policy No.

Issued ByChicago Title Insurance Company

Policy No.

For purposes of this endorsement only:

a. "Modification" means the agreement between and dated and recorded as document number

"Date of Endorsement' means

2. The Amount of Insurance is increased to $

3. Subject to the exclusions in Sections 4 and 5 of this endorsement, the Exclusions from Coverage, the Exceptions

contained in Schedule B, and the Conditions contained in the policy, and any exclusion or exception in any prior

endorsement, the Company insures as of Date of Endorsement against loss or damage sustained by the Insured by

reason of any of the following:

a. The invalidity or unenforceability of the lien of the Insured Mortgage upon the Title as a result of the

Modification;

The lack of priority of the lien of the Insured Mortgage over defects in or liens or encumbrances on the

Title, except:

c. The failure of the following matters to be subordinate to the lien of the Insured Mortgage:

4. This endorsement does not insure against loss or damage, and the Company will not pay costs, attorneys' fees, or

expenses, by reason of any claim that arises out of the transaction creating the Modification by reason of the

operation of federal bankruptcy, state insolvency, or similar creditors' rights laws that is based on:

a. the Modification being deemed a fraudulent conveyance or fraudulent transfer; or

the Modification being deemed a preferential transfer except where the preferential transfer results from the

failure

to timely record the instrument of transfer; or

of such recordation to impart notice to a purchaser for value or to a judgment or lien creditor.

5. This endorsement does not insure against loss or damage, and the Company will not pay costs, attorneys' fees, or

expenses, by reason of the invalidity, unenforceability or lack of priority of the lien of the Insured Mortgage because

all applicable mortgage recording or similar intangible taxes were not paid at time of recording of the Modification.

72E778 ALTA 11.2-06 Mortgaqe Modification with Additional Amount of Insurance (12-2-13) Page 1

Copyright American Land Title Association. All rights reserved. The use of this Form is restricted to ALTA licensees and ALTA n,t~_L«iC.AN

members in good standing as of the date of use. All other uses are prohibited. Reprinted under license from the American Land AND TITLF

~51)f:lAilUN

Title Association. ~.

Order No. Policy No.

This endorsement is issued as part of the policy. Except as it expressly states, it does not (i) modify any of the terms and

provisions of the policy, (ii) modify any prior endorsements, (iii) extend the Date of Policy, or (iv) increase the Amount of

Insurance. To the extent a provision of the policy or a previous endorsement is inconsistent with an express provision of this

endorsement, this endorsement controls. Otherwise, this endorsement is subject to all of the terms and provisions of the

policy and of any prior endorsements.

Dated:

Chicago Title Insurance Company

Countersigned:

.....~.

By:Authorized Signature

:~ ~~`,,, ~~ ~~ ~r , n~ ~:~r~ ~~~ t _._.M.....~. ._._~ _ _.._..........~ _.4

aj A~.. ~ .~ I.~ A. ~ F,.,.,:iavit

~ i1 '.>L 11

A~t~~e

__ .. d : ,,.,.

72E778 ALTA 11 2 06 Mortgaqe Modification with Additional Amount of Insurance (12-2-13) Page 2

Copyright American Land Title Association. All rights reserved. The use of this Form is restricted to ALTA licensees and ALTA .,,.,~a~~,~N

members in good standing as of the date of use. All other uses are prohibited. Reprinted under license from the American Land ~"";°;;i,`

Title Association.x

American Land Title Association Endorsement 32-06 (Construction Loan —Loss of Priority)Adopted 2-3-11

ENDORSEMENT

Attached to Policy No.

Issued by

CHICAGO TITLE INSURANCE COMPANY

1. Covered Risk 11(a) of this policy is deleted.

2. The insurance [for Construction Loan Advances] added by Section 3 of this endorsement is subject to

the exclusions in Section 4 of this endorsement and the Exclusions from Coverage in the Policy, the

provisions of the Conditions, and the exceptions contained in Schedule B. For the purposes of this

endorsement and each subsequent Disbursement Endorsement:

a. "Date of Coverage", is f 1 [Date of Policy] unless the Company sets

a different Date of Coverage by an ALTA 33-06 Disbursement Endorsement issued at the

discretion of the Company.

b. "Construction Loan Advance," shall mean an advance that constitutes Indebtedness made on or

before Date of Coverage for the purpose of financing in whole or in part the construction of

improvements on the Land.

c. "Mechanic's Lien," shall mean any statutory lien or claim of lien, affecting the Title, that arises

from services provided, labor performed, or materials or equipment furnished.

3. The Company insures against loss or damage sustained by the insured by reason of:

a. The invalidity or unenforceability of the lien of the Insured Mortgage as security for each

Construction Loan Advance made on or before the Date of Coverage;

b. The lack of priority of the lien of the Insured Mortgage as security for each Construction Loan

Advance made on or before the Date of Coverage, over any lien or encumbrance on the Title

recorded in the Public Records and not shown in Schedule B; and

c, The lack of priority of the lien of the Insured Mortgage, as security for each Construction Loan

Advance made on or before the Date of Coverage over any Mechanic's Lien, if notice of the

Mechanic's Lien is not filed or recorded in the Public Records, but only to the event that the

charges for the services, labor, materials or equipment for which the Mechanic's Lien is claimed

were designated for payment in the documents supporting a Construction Loan Advance

disbursed by or on behalf of the Insured on or before Date of Coverage.

~~A ht lilU (:~N

I.ANI1 '1'I"I I.I.

\1S(1 (:I,\I Il1N

~" ,

Copyright 2011 American Land Title Association. All rights reserved. r ay

The use of this Form is restricted to ALTA licensees and ALTA members

in good standing as of the date of use. All other uses are prohibited.

Reprinted under license from the American Land Title Association.

American Land Title Association Endorsement 32-06 (Construction Loan —Loss of Priority)Adopted 2-3-11

4. This policy does not insure against loss or damage (and the Company will not pay costs, attorneys'fees or expenses) by reason of any Mechanic's Lien arising from services, labor, material orequipment:

a. furnished after Date of Coverage; or

b. not designated for payment in the documents supporting a Construction Loan Advance disbursed

by or on behalf of the Insured on or before Dafe of Coverage.

This endorsement is issued as part of the policy. Except as it expressly states, it does not (i) modify any

of the terms and provisions of the policy, (ii) modify any prior endorsements, (iii) extend the Date of

Policy, or (iv) increase the Amount of Insurance. To the extent a provision of the policy or a previous

endorsement is inconsistent with an express provision of this endorsement, this endorsement controls.

Otherwise, this endorsement is subject to all of the terms and provisions of the policy and of any prior

endorsements.

CHICAGO TITLE INSURANCE COMPANY

By:

Authorized Signatory

Copyright 2011 American Land Title Association. All rights reserved.

The use of this Form is restricted to ALTA licensees and AI.TA members

In good standing as of the date of use. All other uses are prohibited.

Reprinted under license (ram the American Land Title Association.

~~AMfJU CANLAND "f ff l.I..u~ocinriou

-~

American Land Title Association Endorsement 33-06 (Disbursement)Adopted 2-3-11

ENDORSEMENT

Attached to Policy No.

Issued by

CHICAGO TITLE INSURANCE COMPANY

1. The Date of Coverage is amended to

[a. The current disbursement is: $

[b. The aggregate amount, including the current disbursement, recognized by the Company as

disbursed by the Insured is: $ 1

2. Schedule A is amended as follows:

3. Schedule B is amended as follows:

[Part I]

[Part II]

This endorsement is issued as part of the policy. Except as it expressly states, it does not (i) modify any

of the terms and provisions of the policy, (ii) modify any prior endorsements, (iii) extend the Date of

Policy, or (iv) increase the Amount of Insurance. To the extent a provision of the policy or a previous

endorsement is inconsistent with an express provision of this endorsement, this endorsement controls.

Otherwise, this endorsement is subject to all of the terms and provisions of the policy and of any prior

endorsements.

[Witness clause optional]

CHICAGO TITLE INSURANCE COMPANY

By:

~~A A11:IU (:AN

I.ANC7'fl'ILI-nf~Uc:ldll<lU

Copyright 2011 American Land Title Association. All rights reserved. f "~`

The use of this Form is resiricted to AL.TA licensees and ALTA members

in good standing as of the date of use. All other uses are prohibited.Reprinted under license from the American Land Title Association.

CHICAGO TITLE INSURANCE COMPANYSWORN OWNER'S STATEMENT TO CHICAGO TITLE INSURANCE COMPANY

STATE OF

COUNTY OF

The affiant

} SSGuarantee No.

Escrow No.

being first duly sworn, on oath deposes

held by

_County, Illinois, to wit:

and says that he is the "owner/beneficiary of Trust No _

which is the owner' of the following described premises in

1. That he is thoroughly familiar wish all the facts and circumstances concerning the premises described above;2. That with respect to improvements on the premises the only work done or materials furnished to date are as listed below;

3. That the only contracts let for the furnishing of future work or materials relative to the contemplated improvements are as listed below;A. That this statement is a true and complete statement of all such conVacfs, previous payments and balances due, if any.

ADJUSTED TOTAL PREVIOUSLY AMOUNT OF ggLANCE TO

NAME AND ADDRESS KIND OF WORK CONTRACT INC. PAID THIS g~COME DUE

EXTRAS & CREDITS PAYMENT

ARCHITECT

SURVEYOR

ENGINEER

SOIL TESTS

GENERALCONTRACTOR

OFF SITEIMPROVEMENTS

OTHERS

TOTAL:

"STRIKE ONE` THE UNDER51GNE0 HEREBY APPROVES THE ABOVE AMOUNTS FOR PAYMENT.

SIGNED _

ADDRESS

Subscribed and sworn before me this day of _, 20

ry Public

WO

SWORN STATEMENT OFCONTRACTOR AND SUBCONTRACTOR

TO OWNER AND TO CHICAGO TITLE INSURANCE COMPANY

State of

} ss.County of

The affiantthat he isofcontract with _

Page _ o(_ Pages

being first duly sworn, on oath deposes and says

that hasowner (or

on the following described premises in said County, to wit.

That, for the purposes of saltl contract, the following persons have been contracted with, and have furnished, or are furnishing and preparing

materials tor, and have done or are doing labor on said improvement. That there is due and to become due them, respectively, the amounts set

opposite their names for materials or labor as stated. That this statement is a full, true and complete statement of all such persons, the amounts

paid and the amounts due or to become due to each.

~ y J 4 5 6 7

Amount of Retention NelotPrevious Net Amount Balance to

Name and Address Kind of Work Contract ~inc.cunent) Payrnenis This Payment Become Due

Inc. Rententions

TOTALAMOUNT OF ORIGINAL CONTRACT 5 WORK COMPLETED TO DATE $

EXTRAS TO CONTRACT 8 LESS %RETAINED "5

TOTAL CONTRACT AND EXTRAS $ NET AMOUNT EARNED $

CREDITS TO CONTRACT S NET PREVIOUSLY PAIp 5

ADJUSTED TOTAL CONTRACT S NET AMOUNT OF THIS PAYMENT SBALANCE TO BECOME DUE Inc. Retention ~

i[ is unaers~ooa mai ine wiai a~uo~m Na~u w ~p~o N~~~ ~~ ~~ a~ ~~,,,.~ ~~ ~~y,.~~,,,,, ~~~ ,,,,,, ,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,, ,,,,,,,,,,,, —,~ _....- ---- - -- -completed to date.

agree to furnish Waivers of Lien for all materials under my contract when demanded.

Signed

(Position)

Subscribed and sworn to before me this day of , ~~

Notary Public

The above sworn statement should be obtained by the owner before each and every payment.Provided by Chicago Title Insurance Company

sscTscr

S ~ '"

Date:

LENDER'S DRAW REQUESTPENDING DISBURSEMENT ENDORSEMENTS

{CLTA 122.06 / ALTA 32.2-06 & ALTA 33.0-06 combination)

TO: Chicago Title CompanyAttn:725 S. Figueroa, Ste200, Los Angeles, Ca90017

Reference: Title Policy #for pc•operiy known as:Lender's Loan Number:

Loan Advance/Disbursement Information:

Lo1n Advance Number:

Anticipated Date ofAdvance/Endorsement:

The amount of this loan advance:

Aggregate loan advances (including this advance)

Un-disbursed Loan Amount Prior to this Advance:

Amount of this Advance:

Interest Reserve $ (date)Title End. Fee $ (date)Inspection Fee $ (date)

Other: $ (date)Construction Draw $

Remaining L1n-disbursed (after this advance):

Request is hereby made for one of the following applicable disbursement endorsements - CLTA 122.06/ ALTA 33.0-06 to the above

reference Title Policy bringing current the coverage provided by the applicable interim mechanic's lien coverage endorsement made a part

of the Policy on its original Policy Date.

PLEASE CONTACT THE UNDERSIGNED AS SOON AS PASSIBLE TO COORDINATE FUNDING WITH TfIE ISSUANCE OF

THE applicable ENDORSEN~NT.

The undersigned lender certifies that this ADVANCE is made under the above in accordance with provisions calling for installment

disbursements set forth in the loan agreement between borrower and lender. The undersigned lender is not aware of any existing event

that would result in u default u~:def~ any of the terms of the loan agreement/documents.

Bank;

Executed by: _____

Title:

Address: Telephone: Fax Email address: