Daily Development for Friday, January 9, 2004 
by: Patrick A. Randolph, Jr. 
Elmer F. Pierson Professor of Law 
UMKC School of Law 
Of Counsel: Blackwell Sanders Peper Martin 
Kansas City, Missouri 
dirt@umkc.edu 
MORTGAGES; CHARACTERIZATON; EQUITABLE 
MORTGAGES: Illinois court finds that intent of the parties is a central 
factor in determining whether a sale/leasback with option to purchase is 
an equitable mortgage, and when party seeking recharacterization cannot 
satisfy burden of proof of showing that the parties intended a security 
arrangement, court will not recharacterize the transaction. 
185 North Wabash, LLC, v. Lake Wabash LLC, No. 1-03-0751 (Ill. 
App. (1st Dist. 12/24/2003) 
Property owner, in financial extremis with a pending obligation to buy 
back property from a property tax foreclosure purchaser, negotiated with 
the owner of neighboring property (and, ultimately, some financial 
partners) to sell the property to that owner and to lease the property back 
for $10 per year. The property apparently was an operating office 
building of historic character which the owner wished to convert to a 
Holiday Inn franchise, a goal toward which the owner had made some 
progress. 
Apparently the seller/lessee agreed to provide some maintenance to the 
building during its tenure there (the court is vague on this point.) 
The parties agreed that, at closing, the purchaser would give to the owner 
an option to purchase the property back during the next two years for a 
price based upon the original $6.5 million purchase price plus an 
additional amount scaled to the time passing since the option was 
created. The option required that the optionee give notice prior to 
exercise and provide a $50,000 earnest money payment. The option was 
replete with language providing that failure to exercise in a timely 
manner resulted in forfeiture of all option rights. 
Of course, the reader can guess the rest of the story. The deal closed and 
the optionee later timely provided notice of intent to exercise the option, 
but the earnest money check bounced. The purchaser/optionor then 
declared the option void and a few months later obtained possession of 
the property when the lease ran out. 
There was some disagreement in the testimony as to the value of the 
property. The best reading (and one accepted by the court) was that the 
value of the property was approximately what the buyer paid for it, no 
more or less. The owner tried to factor in the potential value of the hotel 
deal, but the court refused. The seller also contracted to resell the 
property for almost double the sale price shortly after the transaction, but 
that deal fell through and the court didn't credit that either. 
Apparently the original owner/tenant/optionee was content to lick its 
wounds until it got a bill from the new owner/landlor/optionor for repairs 
it allegedly was supposed to make during the period of its occupancy. It 
then sued to recharacterize the deal as an equitable mortgage. The court 
doesn't tell us where the plaintiff wanted to go with this suit if obtained 
such a recharacterization, but if it could establish that in fact the value of 
the property in the hands of the "equitable mortgagee" exceeded the 
amount of the "loan," then there would be no claim for the failure to 
repair. 
The trial court held that there was no evidence that the parties agreed at 
the time of the transaction that this deal was a loan, that there was no 
preexisting relationship, that the parties were advised by counsel and 
knew what they were doing, and that the value of the property at the time 
of the deal appeared to be $6.5 million - the agreed purchase price. In 
evaluating the evidence of the appraiser that so concluded, the trial court 
stated that the appraiser took into account " "the condition of the 
property, the leaseback and the ground lease, as well as comparable 
sales," and concluded that this methodology was appropriate. The trial 
court concluded that no recharacterization was appropriate. 
On appeal: Held: Affirmed (yes - affirmed) 
The court cited well established Illinois law that recharacterization is 
possible in these cases. Here are all the factors listed in one case: 
"[T]he existence of an indebtedness, the close relationship of the 
parties, prior unsuccessful attempts for loans, the circumstances 
surrounding the transaction, the disparity of the situation of the 
parties, the lack of legal assistance, the unusual type of sale, the 
inadequacy of consideration, the way the consideration was paid, 
the retention of written evidence of the debt, the belief that the 
debt remains unpaid, an agreement to repurchase, and the 
continued exercise of ownership privileges and responsibilities by 
the seller." 
The court stressed that it deferred on factual issues to the judgment of the 
trial court, and therefore it would not quibble with the fact that it 
disregarded the evidence of two appraisers who opined that the property 
was worth from $9 million to $11.5 million at time of transaction. 
Although this salient factor indeed might have been sufficient, in light of 
the lack of preexisting indebtedness, to confirm the trial court, the 
appeals court proceeded to expound at length about the evidence 
demonstrating that the parties in fact had no intent to make an equitable 
mortgage at the time of the transaction. In fact, it noted that the buyer 
paid a transfer tax of $48,500 which, the court maintained, the seller 
might have contested if it really believed that it was an equitable 
mortgagor. 
Comment 1: The lawyer who sent this case to the editor warned to be 
ready for a surprise ending. The editor was surprised. In fact, we're 
talking about almost a standard "cookie cutter" recharacterization case, 
where any reasonable lawyer would raise the issue with the 
purchaser/landlord/optionor before closing. For that reason alone, the 
editor finds it difficult to credit the court's conclusion that no one 
thought about the risk of an equitable mortgage prior to closing. Was 
there no title insurer? Were the lawyers involved at all experienced in 
the transactions on which they were working? If so, this issue would 
have been addressed. If not, it is difficult to conclude that the parties 
were represented by competent counsel and use that as a factor in the 
recharacterization analysis. 
Comment 2: Of course, the issue of value could make or break the case. 
If, indeed the property was worth no more than the amount paid for it, 
there was no "economic compulsion" for the optionee to exercise the 
option and consequently an important element of the traditional analysis 
is lost. But note that the appraiser credited by the court took into account 
the existence of the leaseback and the option in reaching its conclusion as 
to value. The court characterized this methodology as "appropriate." 
Surely, in context, this was wholly inappropriate. Of course the market 
will not value property subject to a $6.5 million option price as worth 
much more than $6.5 million. The question should be what the market 
value of the property would be disregarding the presence of the leaseback 
and the option. The question is whether the seller/lessee/optionee would 
forfeit something of value to it if it did not "repay its debt" by exercising 
the option. 
The other factors that may exist in some cases and are described by the 
court here - the preexisting indebtedness, etc., are more relevant when 
there is no fixed option to repurchase and less important in a case like 
this one. 
Comment 3: The most problematic part of this case, however, is the 
court's harping on the evidence of what the parties intended. As 
indicated above, it is difficult to credit the conclusion that parties who 
really did a standard deal with competent lawyers would not have been 
aware that there was a possibility they'd be viewed as having an 
equitable mortgage. 
But even if there were ironclad evidence that the parties sincerely 
believed that there were not doing a loan, in most cases historically this 
was beside the point. The purpose of the doctrine resulting in 
recharacterization of a transaction into an equitable mortgage was 
precisely to protect the mortgagor against itself - to insert into the deal 
the *non waiveable* equity of redemption that is inherent in any land 
security agreement at common law (civil law countries often recognize it 
as well in one form or another.) There are many cases where the 
documents state on their face that the parties intend that the transaction 
will be a sale and leaseback and not a mortgage loan or land security 
agreement. Usually such language is disregarded by courts who look to 
other factors demonstrating the fact that the economics of the transaction 
are more consistent with a loan. 
As indicated above, if indeed the court properly construed the economics 
of the transaction, then maybe we didn't have a loan. If we did, however, 
the parties' belief that they didn't make a loan transaction really is beside 
the point, and the court does a disservice to the precedent in concluding 
otherwise here. 
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