This DD was contributed by Jack Murray, and is replete with
Jack's characteristically exhaustive citations of authority that he provides on
issues of concern to him. Way down at
the bottom I manage a puny little response.
Ed.
Daily Development for Tuesday, April 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; DEED IN LIEU; MERGER: Debtor's grant of security
interest in its personal property (including "instruments") to
corporate parent did not result in
"transfer" of mortgage, which thereafter was extinguished when
mortgagor issued quitclaim deed in lieu of foreclosure notwithstanding
anti-merger language in deed.
United States Leather, Inc. v. Mitchell Mfg. Group, Inc.,
276 F.3d 782 (6th Cir. 2002)
Courts generally will not enforce a non-merger provision in
a deed in lieu of foreclosure where the rights of innocent third parties may be
affected - or even lost - because of fraud or inequitable conduct by the
parties to the deed. Here, the Sixth
Circuit held that under the facts of the case, allowing an exception to the
merger rule (based on the intention of the parties stated in the quitclaim deed
in lieu of foreclosure that no merger of the mortgage and fee would occur)
would not be enforced because to deny merger would inequitably permit the
mortgagor to void its obligations to an intervening judgment creditor to the
sole advantage of the mortgagor's corporate parent.
This decision involved a very complicated factual situation.
The case arose out of the efforts of the plaintiff, United States Leather, Inc.
("USL"), to enforce a judgment of approximately $1.5 million against
Mitchell Automotive, Inc. ("Mitchell Automotive"), which owned
personal property and a manufacturing facility in Clare, Michigan. Mitchell
Automotive was in the business of manufacturing and selling leather products
for use in automobile interiors.
Over time, Mitchell Automotive built up a substantial debt
to USL (as a supplier of finished leather), as well as to its parent
corporation, Mitchell Corporation of Owosso ("Mitchell Corp."). Mitchell Automotive eventually succeeded in
finding a buyer, Lamont Group, Inc., and Lamont Group Acquisition Corp.
(collectively, "Lamont Group") to purchase Mitchell Automotive's real
and personal property. Lamont Group paid $6.5 million in cash to Mitchell
Automotive and gave two promissory notes for the balance of the purchase price
of $27.5 million. To secure the indebtedness, Lamont Group granted Mitchell
Automotive a security interest in the purchased assets and a mortgage on the
real property. Shortly thereafter,
Mitchell Automotive granted its parent, Mitchell Corp., a security interest in
all its personal and intangible property (including all
"instruments") to secure any and all existing and future indebtedness
to Mitchell Corp. According to the court, "It is undisputed that Mitchell
Corp. obtained a security interest in the Lamont Group's mortgage and promissory
notes through their agreement."
The Lamont Group subsequently defaulted, and agreed to
surrender all the personal property collateral and deliver a deed in lieu of
foreclosure to the secured real property to Mitchell Automotive. The quitclaim deed to the real property
contained language stating that it was the intention of the parties that the
deed did not constitute "a merger with or extinguishment of the
indebtedness secured thereby."
(The deed also provided that the recourse obligation of Lamont under the
Asset Purchase Agreement for the purchase of Mitchell Automotive's assets would
be reduced by $6 million). As a result of the conveyance, Mitchell Automotive
held title to both the mortgage and the fee interest in the real property.
Shortly thereafter, USL obtained a consent judgment against
Mitchell Automotive and Lamont Group in the amount of approximately $1.5
million, and levied on the personal property of Mitchell Automotive at its
offices in Owosso, Michigan. The levy
officer did not take actual possession of the property, based on the agreement
of Mitchell Automotive's attorney that the property would not be moved, sold,
or disposed of and that Mitchell Automotive's remaining personal property was
not sufficient to satisfy the judgment.
Mitchell Corp. then advised USL that it claimed priority
against the assets of Mitchell Automotive by virtue of its prior security
agreement and that it had "peaceably repossessed" the personal
property of Mitchell Automotive in accordance with its rights under that
agreement. USL responded to this development by filing a formal Notice of Levy
against the manufacturing facility
owned by Mitchell Automotive (which was the property previously conveyed
by the deed-in-lieu from Lamont Group to Mitchell Automotive), and served a
garnishment on the tenant of the property - eventually collecting $46,000 in
lease payments before the lease was terminated.
USL then filed a "motion for determination of interests
in the property of Mitchell Automotive," arguing that "Mitchell
Corp.'s security interest was extinguished by merger, was not perfected, was
fraudulent, and that the corporate form should be disregarded." Id. at 786.
The district court adopted the findings of the magistrate judge, who
held that the mortgage was extinguished by merger notwithstanding the
non-merger language contained in the deed in lieu of foreclosure. The district
court further ruled that the question of whether Mitchell Corp. had to perfect
its security interest until after USL's garnishment and levy of Mitchell
Automotive's personal property was irrelevant.
In upholding the ruling of the district court, the Sixth
Circuit first stated the general rule in Michigan regarding the merger doctrine
"The general rule in Michigan is that when a holder of
a real estate mortgage becomes the owner of the fee, the mortgage and fee are
merged and the mortgage is extinguished. . . This rule is, however, subject to
the exception that when it is to the interest of the mortgagee and is his
intention to keep the mortgage alive, there is no merger, unless the rights of
the mortgagor or third persons are affected thereby.'" (citations omitted)
The Sixth Circuit rejected Mitchell Automotive' argument
that there was no merger because it did not hold both the title to the real
property and the mortgage. The court
reasoned that although Mitchell Automotive had granted a security interest in
the Lamont Group's mortgage and promissory notes to Mitchell Corp., it
"did not assign, transfer, or convey Lamont's mortgage to
anyone." Id. at 787.
The court then ruled that because of equitable
considerations involving the conflicting rights of USL as an intervening third
party, it would not enforce the express non-merger intent of the parties as set
forth in the deed in lieu of foreclosure from Lamont Group to Mitchell
Automotive. According to the court
"Allowing an exception to [the] merger rule in this
instance would do grave injustice. Such a finding would permit Defendant [Mitchell
Automotive] to avoid paying an uncontested $1.5 million debt to [USL] in favor
of its parent corporation, Defendant [Mitchell Corp.]. The fact that these two corporations share
the same office space, computers, employees, and are run by the same President
who originally incurred the debt to [USL] only highlights the inequity of
applying the exception."
The court found that this case was distinguishable from
other Michigan cases where non-merger language contained in a deed in lieu of
foreclosure had been enforced, as this was not a situation where the mortgagee
was trying to protect itself from the claims of junior lienholders of the
mortgagor. As the court stated
"[Mitchell Automotive] is not in the position of a mortgagee trying to
protect itself from junior lienholders of the Lamont Defendants; it is
attempting to protect itself from having to pay a debt it acknowledges owing to
Plaintiff. We agree that equitable considerations preclude Mitchell Automotive
from avoiding merger when the effect is not to protect its own interests from
the creditors of the Lamont Group (the mortgagor), but rather to prefer the
debt of its parent corporation over the debt owed to USL as a third
party."
The Sixth Circuit further noted that unlike the Michigan
cases cited by Mitchell Corp., USL did not expressly acknowledge the priority
of Mitchell Corp.'s mortgage and its judgment was not expressly made subject to
Mitchell Corp.'s mortgage. The court
also rejected Mitchell Corp.'s argument
that it was itself a third party whose rights were "most affected
by merger or non-merger." The
court held that USL was equally affected by the merger issue. The court further denied Mitchell Corp.'s
claim that it was unfair to "lump" Mitchell Corp. and Mitchell
Automotive together without first determining whether the corporate veil could
be pierced. The court was greatly
influenced by its finding (as stated earlier) that both corporations shared the
same office space, computers, employees, and officers.
The court reasoned that because USL had abandoned any claim
against Mitchell Corp. for the indebtedness owed to it by Mitchell Automotive,
it was not necessary to make a determination as to whether the facts of the
case justified piercing the corporate veil.
The court noted that the district court had instead been "called
upon to weigh the equities between USL and Mitchell Corp. as secured creditors
competing for the sole asset of the debtor," and in this regard "it
was proper to consider the relationship between Mitchell Automotive and its
respective creditors." Id. The court found that the equities of the
case prevented Mitchell Automotive from relying on the exception to the merger
rule "to favor the debt owed to the parent company over USL's judgment
lien." Id. at 789.
Reporter's Comment 1:
The Sixth Circuit's ruling effectively employed the "balancing of
the equities" doctrine to thwart what appeared to be an attempted
preferential transfer or fraudulent conveyance of mortgaged property by a deed
in lieu of foreclosure (although the court never decided this precise issue) to
avoid an obligation to an innocent third-party judgment creditor. This case has
complicated and unusual facts, and the Sixth Circuit was careful in its opinion
to limit its holding to the facts presented.
The court expressly acknowledged and confirmed that the generally
permitted exception to the merger rule - i.e., that the mortgage would not be
extinguished if the parties expressed their intention in the deed not to
terminate the mortgage- would be valid and enforceable in those situations
where the mortgagee's reason for keeping the mortgage alive was for the purpose
of preserving its rights (including foreclosure) against subordinate
lienholders of the mortgagor.
As evidenced by
other cases and applicable state statutes (see below), the unique facts
of this case should not prevent the parties to a more conventional deed-in-lieu
transaction from entering into a deed containing specific non-merger language,
or prevent the owner-mortgagee from subsequently enforcing its rights under the
preserved mortgage.
Reporter's Comment 2:.
Many states rely (at least in part) on the intention of the parties,
either express or implied, to determine whether a merger occurred as the result
of a deed-in-lieu transaction. In Tidwell v.
Dasher, 152 Mich. App. 379, 393 N.W.2d 644 (1986), the court
dealt with the issue of whether a deed in lieu of foreclosure created a merger
that would affect the priority of an intervening lien. The court stated that
"[t]he question of intention of a mortgagee or vendor is a question of
fact which must be developed from evidence produced to show what the intention
was at the time the acts were done."
Id., 152 Mich. App. at
385, 393 N.W.2d at 647. In Weitzki v.Weitzki, 437 N.W.2d 449 (Neb. 1989), the court noted that the intention of the mortgagee is controlling as to whether the mortgage is kept alive. The court held that when the mortgagee becomes the owner of the fee, and there is no expression of intention as to whether the mortgagee wished to keep the mortgage alive, it will be presumed that the mortgagee intended to do what would prove most advantageous to himself in the absence of circumstances indicating a contrary purpose.
The court then found that in this case no merger of title
and lien occurred in light of the mortgagee's intent to retain the priority of
his lien against the subordinate lien.
See also FDIC v. Lee, 988 F.2d 838, 843 (8th Cir. 1993) ("[t]he
doctrine of merger is not favored and will not be applied in the absence of an
intent on the part of the mortgagee, or unless the application of the doctrine
is require by equities of a particular case" [quoting Construction
Machinery v. Roberts, 307 Ark. 252, 819 S.W.2d 268, 270 (1991)] ); Sylvania
Savings Bank v. Turner, 27 Mich. App. 640, 645, 183 N.W.2d 894, 896-97 (1970)
("whether [merger] occurs depends fundamentally on the mortgagee's
intention. If it is in his interest to preserve his lien separately from the
fee, it will ordinarily be concluded that he did not intend to merge the lien
into the fee"); Long Island Lighting Co. v. Commissioner of Taxation and
Finance, 652 N.Y.S.2d 640, 641, 235 A.D.2d 637, 638 (N.Y.A.D., 3rd Dept. 1997),
leave to appeal denied, 90 N.Y.2d 801, 660 N.Y.S.2d 554, 683 N.E.2d 19 (1997)
(noting that "the doctrine of merger is disfavored," the court stated
that "the determinative issue is whether the owner intended there be a
merger, which must be discerned from all the circumstances"); Nancy J.
Appleby, Negotiating and Structuring a Friendly Foreclosure or Deed in Lieu of
ForeclosureA Lender's Perspective," Negotiating and Structuring a Friendly
Foreclosure or Deed in Lieu of Foreclosure, American Bar Association Section of
Real Property, Probate and Trust Law, New York, NY (August 10, 1993), Tab 8.
The section of the Illinois mortgage foreclosure statute
that deals specifically with deeds in lieu of foreclosure, 735 ILCS 5/15-1401,
states (with respect to the issue of merger) that "A deed in lieu of
foreclosure, whether to the mortgagee or mortgagee's nominee, shall not effect
a merger of the mortgagee's interest as mortgagee and the mortgagee's interest
derived from the deed in lieu of foreclosure."
Reporter's Comment 3:
A deed in lieu of foreclosure does not "wipe out" any
subordinate liens, and the grantee takes subject to all existing liens, whether
known or unknown. To attempt to
eliminate these liens, the lender still must foreclose the mortgage or
otherwise deal with each of the existing encumbrances. (The lender actually may have an incentive
to pay something on lien claims to avoid a contested foreclosure proceeding;
after all, the primary purpose of a deed-in-lieu transaction usually is to
avoid foreclosure).
Recent case law (Professor Randolph's protestations to the
contrary) generally supports the ability of a mortgagee to foreclose its
mortgage after acceptance of a deed in lieu of foreclosure. See, e.g., PNC
Bank, Delaware v. Philben, Inc., 1997 Del. Super. LEXIS 467 (Del.Super.Ct. 1997)
(not reported in A.2d) (holding that where the deed-in-lieu documents contained
an anti-merger provision, the owner-mortgagee could subsequently commence
foreclosure proceedings; the court noted that "where the mortgage includes
an anti-merger provision to protect an existing mortgage balance, the deed is
merely additional security for the mortgage debt" and that "[the
mortgagee] preserved its right to foreclose"); GBJ, Inc. v. FirstAvenue
Investment Corp., 520 N.W.2d 508, 511 (Minn. App. 1994) (ruling that "[the
mortgagee] did not forfeit its rights as mortgagee when it took the deed in
lieu of foreclosure. To the contrary,
the doctrine of merger presumes that the mortgagee retains all rights";
the court further stated that "[the mortgagee] therefore retained the
right to foreclose"); Runge v. Runge, 1999 Minn. App. LEXIS 1187 (Ct. of
Appeals of Minnesota) (unpublished)(stating that "[the mortgagee] did not
forfeit his rights as mortgagee when he took the deed in lieu of
foreclosure"; and noting that deed
contained "an unambiguous anti-merger clause evidencing
[mortgagee's] intent not to merge his interests"); Olney Trust Bank
v.Pitts, 200 Ill. App.3d 917, 926-27, 558 N.E.2d 398, 403-04 (5th Dist. 1990)
(holding that "because there is no merger, the mortgage debt is not
satisfied or extinguished"; the court permitted the lender, who had
obtained a deed-in-lieu, to foreclose but prohibited it from pursuing an action
for a deficiency judgment) In re Estate
of Ozier, 225 Ill. App.3d 33, 36, 587 N.E.2d 77, 80 (4th Dist. 1992) ("In
the absence of evidence to the contrary, the law presumes that a mortgagee
intended to keep his mortgage alive, when such course was essential to his
protection against an intervening title or for other purposes of
security"); Zubrys v. Harbor Country Banking Co., Docket No. 192822
(unpublished opinion per curiam of the Michigan Court of Appeals, December 19,
1997) (holding that where the first mortgagee took a deed in lieu of
foreclosure and subsequently foreclosed its mortgage after discovering the
existence of a second mortgage, there was sufficient language in the
deed-in-lieu documents to prevent a merger of the security interest and
ownership interest; the court also held that the second mortgagee did not have
standing to challenge the adequacy of the consideration given to the mortgagor
for the deed in lieu); Union Bank & Trust Co. v. Farmwald Development
Corp., 181 Mich. App. 538, 547, 450 N.W.2d 274, 278 (1989) (ruling that junior
mortgagee's objection to entry of foreclosure of mortgages of first mortgagee
was unfounded, because first mortgagee's interest was not extinguished and
discharged by mortgagor's conveyance of the secured property to the first
mortgagee); Clark v. Federal Land Bank, 167 Mich.App. 439, 444-45, 423 N.W.2d
220, 222 (1988) (refusing to permit a subordinate judgment
lienholder to have bank's foreclosure on property subject to lien declared
invalid; and stating that "the quitclaim deed executed by the [mortgagors]
to the bank manifested unequivocally an intention that the mortgage not merge
with the fee. Additionally, plaintiff's
rights were not affected by the intention to keep the mortgage alive, for she
knew her judgment lien was subject to a first mortgage pursuant to the judgment
of divorce"); 55 Am.Jur.2d Mortgages,
1345, Intervening or Junior Claims or Liens.
Editor's Comment: Because Jack Murray was generous enough to
donate this DD, and because anything he writes is worth reading, I've gone
ahead and printed his entire piece, including his voluminous citations.
Jack indicates that he has a disagreement with me on this
issue. Our disagreement is somewhat
narrow. It relates to situations in
which a mortgagee takes a deed in lieu of foreclosure with actual knowledge of the
existence of other interests junior to the mortgage. These interests are not foreclosed away, of course, and are still
binding on the property. Jack has argued that courts should preserve the
mortgagee's rights against these parties, notwithstanding the probable merger
that results from the transfer of the fee to the mortgagee. I have argued that although this result may
be appropriate where a mortgagee was
unaware of the competing interest, even though it was recorded, it is not
appropriate where a mortgagee deliberately seeks the advantage of a deed in
lieu with actual knowledge of the existence of other interests.
I have not before seen Jack emphasize the argument that the
result is affected by "anti merger" language in the deed in
lieu. I have understood him to argue
that, even absent such language, the court should set aside the merger.
I have acknowledged the authority supporting Jack's result
in the past. For instance, the DD of 8/11/00 reported the case of Miller v. Martineau, 983 P.2d 1107 (Utah
App. 1999), where merger was not found when there was an intervening leasehold
interest.
I don't know how many of the cases that Jack cites indeed
deal with the situation of the known intervening interest, nor how many also
involve the feature of an express reservation denying merger. If they all directly support Jack's position
on the point, that indeed is persuasive.
My view in the past has been based upon the notion that
parties ought to live with the consequences of their actions. They have the device of foreclosure to clear
the title. If they choose not to use
it, then they should abide by the consequences of that choice, which is that
title is not cleared.
Jack's position here has driven me to rethink the
issue. What harm results by denying
merger? The best scenario that I can
think of that raises a question would be where the mortgagor believes that the
mortgagee is taking title subject to the other interests, and thus does not
appreciate that it has much of a bargaining position in the deed in lieu
negotiations. Courts are careful in
reviewing such deals, since they do involve a waiver of the equity of
redemption. If the mortgagor believes
that the mortgagee is taking title subject to other interests, and this is not
the case, the mortgagor may be giving up more than it should. This is particularly true if the mortgagor
thinks that the mortgagee would have no right of recourse if liens attached to
the property foreclosed.
This problem is avoided to a certain extent if the parties
stipulate in the deed in lieu that the mortgagee continues to assert its
priority position as against the existing liens. Since that's the only scenario I have been able to come up with
so far, I will withdraw my general view in favor of merger where the parties
have so stipulated. I'm not sure that
general boiler plate "anti merger" language is such a stipulation.
The Reporter for this case is Jack Murray of First American Title in Chicago.
Readers are urged to respond, comment, and
argue with the daily development or the editor's comments about it.
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