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
Items reported here and in the ABA
publications are for general information purposes only and should not be relied
upon in the course of representation or in the forming of decisions in legal
matters. The same is true of all commentary provided by contributors to the DIRT
list. Accuracy of data and opinions expressed are the sole responsibility of
the DIRT editor and are in no sense the publication of the ABA.
Parties posting messages to DIRT are posting
to a source that is readily accessible by members of the general public, and
should take that fact into account in evaluating confidentiality issues.
ABOUT DIRT:
DIRT is an Internet discussion group for
serious real estate professionals. Message volume varies, but commonly runs 5 ‑
10 messages per workday.
Daily Developments are posted every workday.
To subscribe to Dirt, send an e-mail to:
To: |
ListServ@listserv.umkc.edu |
Subject: |
[Does not matter] |
Text in body of message |
Subscribe Dirt [your name] |
To cancel your subscription to Dirt, send an e-mail
to:
To: |
ListServ@listserv.umkc.edu |
Subject: |
[Does not matter] |
Text in body of message |
Signoff Dirt |
For information on other commands, send the
message Help to the listserv address.
DIRT has an alternate, more extensive
coverage that includes not only commercial and general real estate matters but
also focuses specifically upon residential real estate matters. Because real
estate brokers generally find this service more valuable, it is named
"Brokerdirt." But residential specialist attorneys, title insurers,
lenders and others interested in the residential market will want to subscribe
to this alternative list. If you subscribe to Brokerdirt, it is not necessary
also to subscribe to DIRT, as Brokerdirt carries all DIRT traffic in addition
to the residential discussions.
To subscribe to Brokerdirt, send an e-mail
to:
To: |
ListServ@listserv.umkc.edu |
Subject: |
[Does not matter] |
Text in body of message |
Subscribe Brokerdirt [your name] |
To cancel your subscription to Brokerdirt,
send an e-mail to:
To: |
ListServ@listserv.umkc.edu |
Subject: |
[Does not matter] |
Text in body of message |
Signoff Brokerdirt |
DIRT is a service of the American Bar Association
Section on Real Property, Probate & Trust Law and the University of
Missouri, Kansas City, School of Law. Daily Developments are copyrighted by
Patrick A. Randolph, Jr., Professor of Law, UMKC School of Law, but Professor
Randolph grants permission for copying or distribution of Daily Developments
for educational purposes, including professional continuing education, provided
that no charge is imposed for such distribution and that appropriate credit is
given to Professor Randolph, DIRT, and its sponsors.
DIRT has a WebPage at: http://www.umkc.edu/dirt/