Daily Development for Friday, September 17, 1999

By: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri

Note two notes on the same case here:

FRAUDULENT CONVEYANCES; LEASES: Lease extensions in the face of an impending execution on a judgment against the lessor were not fraudulent conveyances where the extensions continued a longstanding business relationship between the lessor and the lessee and otherwise showed no indicia of fraud.

Ralfs v. Mowry, 586 N.W.2d 369 (Iowa 1998).

The defendant began leasing farmland from a landowner in the early 1980s. In 1990, the defendant loaned the landowner a sum of money, secured by a mortgage on the property and negotiated a twoyear lease. Shortly thereafter, a default judgment was entered against the landowner, which she fought unsuccessfully. The judgment was not properly registered in Iowa until February 1994. The property was sold at a sheriff's sale in February 1995 in execution on the judgment and conveyed to the plaintiff by sheriff's deed in April 1996. In the meantime, the defendant and the landowner had negotiated extensions of their lease agreement through 1994 and then, in 1994, renegotiated the agreement to extend that lease through February 1996, with three oneyear extension options in the tenant. Once he obtained title to the property, the plaintiff brought an action claiming superior possessory rights to the property based on allegations that the lease extensions were fraudulent conveyances made to keep the property out of the hands of the judgment holder and, therefore, himself.

The Court defined a fraudulent conveyance as a transaction by which the owner of real or personal property prejudices the legal or equitable rights of the owner's creditor by placing the property beyond the creditor's reach. The doctrine applies to leases as well as conveyances of fee title. To determine if a particular conveyance is fraudulent, a court must look for "badges or indicia of fraud" such as inadequacy of consideration, the insolvency of the transferor, pendency or threat of thirdparty litigation, secrecy or concealment, departure from usual business measures, reservation of benefits to the transferor, and retention of the property by the transferor. The plaintiff must prove that fraud exists by clear and convincing evidence.

In this instance, the Court held that the plaintiff fell far short of meeting this burden of proof. The lease extensions between the defendant and the landowner continued an existing business relationship of over ten years' duration. The rent paid by the defendant for the property was commensurate with rents paid for neighboring properties. The landowner was not insolvent, and the lease extensions were done openly and with notice to the plaintiff, who at the time had no possessory interest in the property. Because the lease extensions were not motivated by deceit, they did not rise to level of fraudulent conveyances.

Comment 1: Note that this is an application of a common law fraudulent transfer concept. Many states have statutes that define the requirements somewhat differently. Of course, the fraudulent advance concept in bankruptcy is different again, and requires no indicia of fraud (although it does require a showing that the transfer price was inadequate.)

Comment 2: The editor has set forth the "naked holding" above, but the case is more interesting in that is contains a subtext suitable for a "made for TV" movie (or perhaps just a "made for the law classroom." King, widowed and left with a farm, leased the farm to Mowry. Thereafter, King took up residence with Mitsui, apparently in California.  King and Mitsui then fell into a financial dispute which became the subject of litigation.  King's farm was subject to a mortgage. She refinanced the mortgage with Mowry, her tenant. At that time she negotiated a new two year lease with Mowry. In 1991, Mitsui obtained a $134,000 default judgment in California in 1991.

There ensued a lengthy battle over the farmland as Mitsui identified it and attempt to establish and execute a lien against it. Mowry and King renegotiated the mortgage, advancing an additional $15,000 in order to assist King in fighting Mitsui, and simultaneously entered into another extension of the lease for an additional two years, with three one year options in Mowry thereafter.

Ralfs, an owner of a neighboring, helped to finance King's battle with Mitsui to preserve King's title, apparently because Ralfs wished to buy the farm. Ralfs loaned money to a corporation related to King in order to try to set aside the California judgment. But when King's efforts to do this failed, Ralfs decided "if you can't lick em, join em," and moved to Matsui's side. He contracted bo buy Matsui's interest in the farm should Matsui prevail in his efforts to execute upon it.

Despite several fals starts, Matsui was unable to get his California judgment filed unti 1994 and he executed in February, 1995. Matsui and Ralfs then fell into a dispute over their agreement, triggering more litigation, which was settled with Ralf's obtaining Matsui's sherriff's deed (presumably following a statutory redemption period) in April of 1996.

At this time, the farm was in the first of the three one year option periods under the Mowry lease and subject to the senior Mowry mortgage. Ralfs argued that the Mowry lease was a fraudulent conveyance designed to keep Matsui off the property. The court, reviewing the matter de novo, found, as set forth above, that the lease was a continuation of an existing business relationship that predated the Matsui problems and that the lease was for fair value.

The court did not really discuss the fact that the Mowry mortgage, which was negotiated at the time of the dispute with Mitsui, did appear to be tied to that litigation. Perhaps this is because the original mortage was nothing more than a refinancing of preexisting indebtedness to a third party. But it permitted Ralfs to dodge the $15,000 advance another way, discussed here under the heading "Mortgages; Future Advances. "

 MORTGAGES; FUTURE ADVANCES; VALIDITY: Judgment lien creditor can attack validity of future advance claims in mortgage that is senior to the creditor's lien on grounds that original mortgage debtor did not anticipate that advances were related to the mortgage.

Ralfs v. Mowry, 586 N.W.2d 369 (Iowa 1998).

The "soap opera" like tale giving rise to this litigation is set forth in the report of the case under "Fraudulent Conveyances; Leases."

In a nutshell, Mowry refinanced an earlier debt on King's farm in 1991. In 1993, Mowry and King agreed to enlarge the amount secured by the mortgage by $15,000 to permit King to fight an impending judgment from a California lawsuit. The extension agreement was not recorded. In 1994, that judgment was validly recorded. In 1996, following an execution on the judgment, the execution purchaser desired to clear the title of the Mowry mortgage, but claimed that he should not have to pay the additional $15,000 amount.

The court's discussion of the issue of the $15,000 advance is quite sketchy, but it appears to view the $15,000 as a future advance. If this is the case, then the original mortgage would have provided for future advances, and thus the fact that the renegotiation of the mortgage was not recorded would not have made Ralfs a BFP, permitting him to avoid the mortgage on those grounds.

But Iowa has a strong policy requiring a close relationship between future advances and a original loan purpose. The court seems to be suggesting that the necessary relationship did not exist here, so the property was not encumbered by the mortgage.

Comment 1: It is interesting to note that the party benefitting from the application of the future advance doctrine is not the mortgage debtor, but a judgment lien creditor. Presumably King, the mortgage debtor, remains liable on the $15,000 note, although it now is unsecured.

The court's discussion of this issue is so abbreviated that perhaps it is best to ignore it entirely. The court points out that the parties did not argue the point. But it is a holding on a legal issue by a state supreme court, and therefore we are bound to at least consider whether it makes precedent. If it does, the precedent is a questionable one.

The fundamental purpose of the Iowa rule on future advances is to protect a mortgage debtor from unwittingly incurring additional mortgage debt under a vaguely worded future advance clause.  But this case does not involve that concern, since the mortgage willingly entered into an (unrecorded) modification that stating the mortgage stood as serurity for the new advance. So the mortgage debtor was not fooled.

If the original mortgage contained language permitting such advances, the subsequent execution sale purchaser had inquiry knowledge of the possibility of advances , and should have ascertained what the mortgage balance was.

If the original mortgage did not contain a future advance clause, then, of course, the execution sale creditor may have a stronger argument. But if that is the case, then the Iowa's court's referring to the Iowa law on future advance mortgages is out of place here.

For a more standard application of the future advance doctrine, see Gardner v. Guldi, 724 So.2d 186 (Fla. 5th DCA 1999), reported under this heading. (Florida court denies application of mortgage future advance clause to subsequent loan that was separately secured and lacked any documentation linking it to the original clause. )

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