There was no DD for January 1, a holiday which the Editor celebrated at the Rose Parade

Daily Development for Friday, January 25, 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; DEBT; PARTNERSHIPS: Where mortgagee holds a deficiency judgment against a partnership and its individual partners, joint and several, and assigns that judgment to the partnership and some of the partners, the debt is merged away, and those who acquired it have no right to collect it against the partners who did not participate in the acquisition. The partners, however, may have a contribution right as a function of partnership law.

Great Western Bank v. Kong, 108 Cal. Rptr. 266 (Cal. App. 2001)

A general partnership borrowed money to acquire an apartment complex. Nine years later, the lender brought a judicial foreclosure action. (In California, that means trouble, since it indicates that the lender is not content with getting the building, and intends to pursue a deficiency, which is not available in a private foreclosure in California.) The foreclosure produced a deficiency of about $750,000, counting the fee award. The deficiency judgment, of course, was against the partnership and each of the partners, jointly and severally.

Some of the partners paid the bank $170,000 and took an assignment of the deficiency judgment. They were in the process of dissolving other partnerships in which they had been involved with the other partners in the apartment house. Disputes were seething, and they were seeking charging orders against some of the remaining partners in connection with the dissolution of those partnerships.

The partners holding the deficiency judgment attempt to invoke this judgment in support of obtaining a charging order against one of the partners in the apartment deal who did not participate paying the $170,000. The trial court granted the charging order, but the appeals court here reversed.

The court noted the established rule that where on co-obligor acquires a debt, the debt is extingished as to all co-obligors. It is "merged away." The court reminded the plaintiffs that they nevertheless had the option of seeking an action in contribution against the partners who did not participate in acquiring the obligation. But this is a far different action, and represents a claim based upon the partnership relationship, and not upon the debt itself.

Comment: This rule of merger of the debt upon acquisition by one co- debtor is pretty basic, and its curious that the trial court ruled against it. Nothing in the appeals court decision indicates why this happened. But although the rule is well established, the editor has seen it ignored in practice, and has seen horrendous consequences follow.

One area that is particularly troublesome here is the "alter ego" theory. Sometimes a co-debtor will acquire the debt through a controlled or related entity, and then try to pursue that debt through that entity against other co-debtors. This sometimes can work, but if the court concludes that the acquiring entity is to "alter ego" of a co- debtor, any claim on the debt is over. Whether a contribution action based upon a partnership relationship will help solve the problem is questionable, and the action may not be available, due to statute of limitations considerations, if you are down the road on the collection action before you get burned on the alter ego notion. I had a client go down for about $6 million that way a few years ago. Fortunately for me, I hadn't advised the original strategy to acquire the debt and did advise settlement when I found out about it.

Ignored. (Sigh).

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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