This bizarre little case simply sticks in the craw. Not much law, and certainly not earthshaking precedent, but the editor just couldn't put it aside. The editor is hopeful that someone else sees more in the court's analysis of the problem than he did. Maybe an Alabama DIRTer knows more about it.

Daily Development for Wednesday, January 23, 2002

By: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
prandolph@cctr.umkc.edu

MORTGAGES; EQUITABLE MORTGAGES; DEED/OPTIONS: Alabama Supreme Court refuses to find implied reconveyance obligation in disguised mortgage transaction.

Cassels v. Pal, 791 So. 2d 947 (Ala. 2001).

Pals owned a home worth $30,000 free and clear (apparently). They needed money. Apparently Pals' money problems prevented them from borrowing against the property under their own credit, or perhaps the problem was that Pals were foreign nationals and couldn't establish credit for small housing loans.

Cassels owned a real estate company (the opinion does not indicate whether they were licensed brokers - but it appears likely that they were, since they were engaged in property management). Cassels entered into a deal that the court styles as an attempt to "help" the Pals.

Cassels agreed in a written contract (which they drafted) to buy the property from Pals for $20,000 but to borrow $25,000 on it immediately, paying $20,000 to Pals and pocketing the rest, after expenses. Cassels walked away with the property and an economic benefit of about $4350.

The contract provided that Pals could buy back the property for $20,000 and that Cassels would rent the property. But the contract gets somewhat bizarre after that. We'll print the relevant language here as a further evidence, if some is needed, that lawyers should draft contracts:

[The property] Uplands will be transferred to the Pals upon the payment of $20,000 cash plus costs of sale closed on September 18, 1987, plus all maintenance charges accrued to the house during the time title is held by the Cassels plus all charges of the transfer. Maintenance charges are defined as follows: "This house will be managed by the rental division of Cassels Real estate [sic] in the same manner as if title was still held by the Pals. Monthly accounting will be done. A 10% management fee will be charged. Rents collected will be credited and expenses of repair and maintenance will be debited. All negative cash flow will be paid by the Cassels. But at the time of transfer, this negative must be paid in full to the Cassels.

"If the $20,000 plus the maintenance charges plus costs of two title transfers are insufficient to pay off the mortgage to Central Bank, the Cassels agree to pay up to, but not more than $2,000 (two thousand dollars) to complete the pay off of the mortgage." (Emphasis added)

The court dances around the language providing that "maintenance charges" are to be applied to the mortgage, calling it an "anomaly" but doesn't really resolve what was meant.

The Pals' construction of the agreement was that the Cassels were to collect the rents and that when rents had been collected sufficient to pay the $20,000, the costs of the transfers, and any maintenance paid by Cassels, the Cassels were to reconvey to them. Over the two years since the deal had closed, Cassels in fact had collected gross $38,000 in rentals, and had paid repairs in the amount of $5000. The parties apparently agreed that Cassels had a "negative cash flow" of $3500, but no one tells us what that term meant in the context of this case.

Cassels' reading of the agreement was that they had an obligation to reconvey to Pals either when the mortgage loan had been fully amortized from net rents or when Pals paid the balance (less the $2000 that Cassels' had agreed to pay.)

The Pals claimed that if this was the meaning of the deal, they had been defrauded. The question was whether the Pals were entitled to show fraud, since the statute of limitations had run since the closing, when allegedly the fraud occurred. The question, then, was whether the Pals knew or should have known of the fraud at that time.

At closing, apparently, the Cassels executed a $25,900 note and mortgage. The bank representative discussed the terms of the note with Cassels, apparently in Pals' presence. The court concludes that Pals should have been paying attention, since the mortgage was referred to in the agreement. Had they paid attention, the court says, they would have discovered that more than $22,000 would be necessary to pay off the note. The court appears to assume that they then would have understood that Cassels would be amortizing the note and that only the net remaining after payment of interest on the note would be available to return the mortgage.

The court notes that if Cassels indeed had conveyed the property back when the Pals demanded, the mortgage would still be on the property and the bank would have accelerated under the due on sale clause and foreclosed for the remaining principle balance. The court appears to assume that this debt would somehow have been chargeable to Pals, even though Cassels signed the note.

Since the Pals, therefore, should have known, at closing that the deal couldn't possibly be what they thought it was, they became aware of circumstances sufficient to make them aware that fraud was being committed. Therefore, they were barred by the statute of limitations on fraud.

They were left to argue the meaning of the contract as written. The court then bought the Cassels' argument that, as written, the Cassels' could continue to manage the property to generate funds to amortize the note, collect their 10% management fee, and reconvey to Pals only if and when the mortgage had been paid and all costs had been collected (which of course could be never), unless the Pals paid them cash.

Comment 1: Although obviously this is a fact intensive case, which makes it difficult to generalize about the law, it is the opinion of a state supreme court, and strikes the editor as a bit off beat.

One of the most well established equitable principles in mortgage law is that parties who use absolute deeds as substitutes for mortgages are going to get their deals undone, no matter what the deals say. One of the primary indicia of mortgage substitute arrangements is transfers of property for less than fair market value with "buy backs" that create an economic compulsion on the part of the holder of the buy back right to exercise it. On its face, that is what appears to be going on here.

Although the court styles the Cassels' as "good actors" who made very little return on the deal, the facts as set forth by the court indicate that they acquired control over a property from which they took 10% of the gross each month and in addition pulled out over $3500 in cash at the front end. Of course, they also managed the cash, determined who would rent the property and for how much, and reported income and expenses to the Pals, who were out of the country a great deal and witnessed very little. One with a suspicious mind might conclude that the Cassels found other ways to profit from this relationship as well.

Comment 2: Application of classic doctrine here would say that the Pals' deed was not a deed at all, but a mortgage to Cassels for $20,000 (plus closing expenses). The Pals could buy back the property for the $20,000 plus interest at an equitable amount determined by the court, and the Cassels would have to account for their possession and management as mortgagees in possession, crediting any balances to reduce the mortgage debt. As to the $25,900 note and mortgage that the Cassels signed - well, that's their problem.

Comment 3: The court didn't do any of the above. The editor is somewhat nonplussed to understand why, but perhaps the insistence of the Pals themselves that some other deal was intended threw the court (or counsel) off the track. Of course, the court had the whole transcript and was in a position to make judgments about the transaction that we can't make from this distance. But the court's discussion of the mortgage strikes the editor as way off base. How the court could conclude that the Pals, and not the Cassels, were obligated to pay the mortgage is somewhat of a mystery.

Readers are urged to respond, comment, and argue with the daily development or the editor's comments about it.

Items in the Daily Development section generally are extracted from the Quarterly Report on Developments in Real Estate Law, published by the ABA Section on Real Property, Probate & Trust Law. Subscriptions to the Quarterly Report are available to Section members only. The cost is nominal. For the last six years, these Reports have been collated, updated, indexed and bound into an Annual Survey of Developments in Real Estate Law, volumes 1‑6, published by the ABA Press. The Annual Survey volumes are available for sale to the public. For the Report or the Survey, contact Maria Tabor at the ABA. (312) 988 5590 or mtabor@staff.abanet.org

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