Daily Development for Friday, March 2, 2001

The Reporter for this item is Howard Lax of the Michigan Bar.

Howard's comment 2 covers issues, not always thought about in connection with the equitable mortgage problem, which deserve some attention.

MORTGAGES; EQUITABLE MORTGAGES: Mortgagor's transfer of statutory redemption rights followed by transferee's redemption and subsequent lease/option arrangement with mortgagor constitutes an equitable mortgage. London v. Gregory,

 http://www.michbar.org/opinions/home.html?/opinions/appeals/2001/022301/9475.pdf

Gregory deeded her home to London two days prior to the end of a foreclosure redemption period. London redeemed the property from foreclosure for $38,000. Then London gave Gregory an 18 month lease and option to repurchase the home for $48,000. The lease payments were $400 per month, presumably fair market value, and the option was exercisable only at the end of the lease term, with closing to occur on December 17, 1997. The purchase option was exercisable only if all the rent payments were made on time.

Gregory only made one of fourteen scheduled lease payments, and that one was late. Apparently London tolerated all the missed payments, and finally, on December 16, 1997, served 30 day notice to quit in an eviction action.

The district court, in the eviction proceeding, found that the deed was really an equitable mortgage as a matter of law. It refused to accept any evidence of the actual intent of the parties.

The court of appeals upheld the decision, citing two similar cases where a property owner, under financial stress, deeds a property to an investor and receives a lease and/or option to repurchase the home. In both cases, the conveyance was held to be an equitable mortgage securing a loan and not a true conveyance. The court also held that the trial court properly excluded evidence of the parties' conscious intent.

Reporter's Comment 1: The court reached the correct result. Under Michigan law, a deed can be a form of mortgage, given the circumstances of the conveyance. A transaction may constitute a "loan"

even though it is in the form of a sale. Michigan Law & Practice, Usury, Section 3, citing Abeloff v. Ohio Finance Co., 313 Mich. 568 (1946).

See also Meyer and Perrone, "Usury and Interest," Real Property Law Section Homeward Bound Seminar, October 1988, written materials pages 3334, in which the authors cite five factors that help identify a sale and leaseback as a disguised loan(a) repurchase required; (b) rental geared to amortization of sales price with agreed upon rate of return; (c) Option (or repurchase) price not tied to fair market value at date of exercise; (d) affiliated parties; and (e) sale price significantly lower than the value of the property.

Reporter's Comment 2: A mortgage lending license is needed pursuant to MCL 445.1651, et. seq., to originate residential mortgage loans. All too often, persons who are not qualified to obtain a mortgage lending license will offer sale and lease back arrangements to distressed homeowners to skirt the law. A mortgage loan is a mortgage loan, regardless of the form it may take. The court and the parties miss the point that the Plaintiff should have been licensed (if he arranged more than ten such transactions in a fiscal year) and subject to Michigan's Mortgage Lending Practices Act (Michigan's AntiRedlining Act). The Defendant should also be arguing that Plaintiff should comply with TILA (five or more transactions in a year is the threshold), ECOA and RESPA.

Of course, we do not know from the court of appeals decision if this was an isolated transaction for Plaintiff or a course of business. If it was discovered that Plaintiff engages in these transactions regularly, Defendant could have sent a letter to Plaintiff rescinding the transaction, and arguing that TILA and ECOA penalties accrue (the statute of limitations may preclude the penalty, but at least the attorney could argue for his or her fees).

Editor's Comment 1: For a more accessible discussion of the standards for flipping a lease option or other "disguised security" arrangement into an equitable mortgage, see Nelson & Whitman, Real Estate Finance Law (3d. Ed. West 1994) pp. 4868. This excellent treatise will come out in a new edition later this year, so just read this one at the library.

Note that the factors set forth in Comment 1 need not all be present. The fundamental question is whether there was some form of "built in"

economic compulsion that would require the party to exercise an otherwise discretionary right to reclaim title to a property transferred earlier. The rest of the considerations tend to suggest that a court ought to be suspicious in evaluating this fundamental question.

Editor's Comment 2: Intent to created a land security interest simply does not matter. Here, the court commented: "Although it was not the plaintiff's intent to make a loan, it was not the defendant's intent to sell her home." But even where the documents state the parties intent, or where testimony would establish that the purported borrower had such an intent, courts will intervene.

Editor's Comment 3: Note that this situation does not arise only in the consumer context. One finds it frequently in informal commercial transactions, often for "bad reasons:" to dodge usury issues, to flip regular income in the form of interest into a capital gain income in the form of exercise of an option, or to disguise true ownership interest in the property from the equitable mortgagor's spouse or creditors (where the option back is unwritten or unrecorded). Some of the licensing issues Howard raises in his comments might also apply to parties who regularly engage in these activities at the commercial level.

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