Judgment Creditor and Debtor’s Lawyers Duke It Out Over Equity in Home – ND IL

A law firm’s failure to look closer at its client’s suspiciously timed transfer of residential property to a land trust recently backfired in a pitched priority battle between competing creditors.
Earlier this month (June 2018), the Northern District of Illinois reversed an earlier priority ruling for the law firm (see Radiance v. Accurate Steel, 2018 WL 1394036) for not exhausting its inquiry notice obligations. (The Court’s order is found at ECF No. 82; Case No. 13 C 7481.)

The case centers around a dispute over real estate between the plaintiff – a judgment creditor of the debtor (who defaulted on some promissory notes) – and the aforementioned law firm, who defended the debtor in post-judgment enforcement proceedings.

The Relevant Chronology

August 2013 – Defendant debtor transferred the Property to an irrevocable trust;

March 2014 – Plaintiff’s predecessor recorded its money judgment against defendant;

June 2014 – The law firm agrees to represent defendant if she mortgaged her residence property (the Property) as an advanced payment retainer (retainer funds that immediately become property of the attorney)(see https://www.iardc.org/DowlingFAQs.html).

June 2015 – The law firm records a mortgage against the Property;

March 2018 – The court voids the 2013 transfer of the Property into a land trust as a fraudulent transfer.

The effect of this last order was the Property reverted back to the debtor and was no longer protected by the trust from the debtor’s creditors. The Court later ruled that the law firm lacked actual or constructive notice that the creditor’s prior judgment lien could wipe out the later mortgage. As a result, the Court found the law firm met the criteria for a bona fide purchaser – someone who gives value for something without notice of a competing claimant’s right to the same property.

Reversing itself on plaintiff’s motion to reconsider, the Court first noted that recording a judgment gives the creditor a lien on all real estate owned in a given county by a debtor. 735 ILCS 5/12-101. Illinois follows the venerable “first-in-time, first-in-right” rule which confers priority status on the party who first records its lien.  An exception to the first-in-time priority rule is where a competing claimant is a bona fide purchaser (BFP). A BFP is someone who provides value for something without notice of a prior lien on it.

Here, the law firm unquestionably provided value – legal services – and lacked notice of the bank’s judgment lien since at the time the firm recorded its mortgage, the title to the real estate was held in trust. Where a creditor records a judgment against property held in a land trust, the judgment is not a lien on the real estate. Instead, it only liens the debtor’s beneficial interest in the trust. (See here  and here.) These factors led the Court originally to find that the Firm met the BFP test under the law.

Granting the creditor plaintiff’s motion to reconsider, the Court found the law firm was apprised of enough facts to put it on inquiry notice that the mortgage was vulnerable to being trumped by the plaintiff’s judgment lien. A species of constructive notice, a party is on inquiry notice “when facts or circumstances are present that create doubt, raise suspicions, or engender uncertainty about the true state of title to real estate, the transferee can’t turn a blind eye….but is required to investigate further.” In re Thorpe, 546 B.R. 172, 185 (Bankr. C.D. Ill. 2016)(citing Illinois state court case authorities). A property mortgagee has a responsibility not only to check for prior liens and encumbrances in the chain-of-title, but also to consider “circumstances reasonably engendering suspicions as to title.” Id.

In its reconsideration order, the Court cited the Creditor recording its judgment lien 15 months before the law firm recorded its mortgage, the copious evidence of the debtor’s financial problems and transfer of the Property just as debtor’s creditors were closing in as likely badges of a fraud. The Court found the debtor’s Property transfer after she defaulted on numerous business loans she guaranteed should have put the law firm on notice that the Property was fair game for creditors like plaintiff. In short, the Court found that the law firm was apprised of facts – namely, debtor’s financial problems, aggressive creditors, and valueless transfer of the Property into a land trust – that obligated the law firm to dig deeper into the circumstances surrounding the transfer.

Afterwords:

Radiance and the various briefing that culminated in the Court’s reconsideration order provide an interesting discussion of creditor priority rules, law firm retainer agreements, trust law fundamentals and fraudulent transfer basics, all in a complex fact pattern.

The case reaffirms the proposition that where property is held in trust, a prior judgment lien against a beneficiary will not trump the later recorded judgment against the trust property.

However, where real estate is arguably fraudulently transferred – either intentionally or constructively (no value is received, transferor incurs debts beyond her ability to pay, e.g.) – a creditor of that transferee, like the Law Firm here, should at least think twice before transacting business with a debtor and  further into whether a given property transfer is legitimate.

 

 

Joint Mortgage Debt Means No Tenancy By Entirety Protection for Homeowners

The Illinois First District recently affirmed a mortgage foreclosure summary judgment for a plaintiff mortgage lender in a case involving the protection given to tenancy by the entirety (TBE) property.

In Marquette Bank v. Heartland Bank and Trust, 2015 IL App (1st) 142627, the main issue was whether a marital home was protected from foreclosure where it was owned by a land trust, the beneficiaries of which were a husband and wife; each owning beneficial interests TBE.

The defendants argued that since their home was owned by a land trust and they were the TBE beneficial owners of that land trust, the plaintiff could not foreclose its mortgage.

Affirming summary judgment, the appeals court examined the interplay between land trust law and how TBE property impacts judgment creditors’ rights.

The Illinois Joint Tenancy Act (765 ILCS 1005/1c) allows land trust beneficiaries to own their interests TBE and Code Section 12-112 (735 ILCS 5/12-112) provides that a TBE land trust beneficial interest “shall not be liable to be sold upon judgment entered….against only one of the tenants, except if the property was transferred into [TBE] with the sole intent to avoid the payment of debts existing at the time of the transfer beyond the transferor’s ability to pay those debts as they become due.”

TBE ownership protects marital residence property from a foreclosing creditor of only one spouse.  In TBE ownership, a husband and wife are considered a single unit – they each own 100% of the home – and the judgment creditors of one spouse normally can’t enforce a money judgment against the other spouse by forcing the home’s sale.

An exception to this rule is where property is conveyed into TBE solely to evade one spouse’s debt.  Another limitation on TBE protection is where both spouses are jointly liable on a debt.  In the joint debt setting, a judgment against one spouse will attach to the marital home and can be foreclosed on by the judgment creditor.

Code Section 12-112 provides that where property is held in a land trust and the trust’s beneficial owners are husband and wife, a creditor of only one of them can’t sell the other spouse’s beneficial land trust interest. 735 ILCS 5/12-112.

The Court rejected the defendants argument that as TBE land trust beneficiaries of the marital home, the spouse defendants were immune from foreclosure.  It noted that both spouses signed letters of direction authorizing the land trustee (owner) to mortgage the property, the mortgage documents allowed the plaintiff to foreclose in the event of default and empowered the lender to sell all or any part of the property. (¶¶ 16-18)

Summary Quick-Hits:

  • TBE property ownership protects an innocent spouse by saving the marital home from a judgment creditor’s foreclosure suit where only one spouse is liable on a debt;
  • A land trust beneficial interest is considered personal property and can be jointly owned in tenancy by the entirety;
  • Where spouses are jointly (both) liable on an underlying debt, TBE property can be sold to satisfy the joint debt.

 

Land Trust Beneficial Interest is Personal Property; Related Realty Can’t Be Liened by Creditor (IL Law)

It’s easy to robotically parrot the “beneficial interest in a land trust is personal property” rule but First Clover Leaf Bank v. Bank of Edwarsville, 2014 WL 6612947 (5th Dist. 2014) actually examines the rule’s impact against the factual backdrop of a judgment creditor trying to lien a debtor’s residence.

The creditor plaintiff obtained a $400,000-plus judgment against a husband and wife (the “Shareholders”) on various commercial guaranties they signed.  A corporation that the Shareholders each held a 50% stake in was the beneficiary of a land trust that held title to the Shareholders’ home (the “Property”).

When plaintiff learned that the Shareholders were trying to sell the Property for over $700,000, it recorded a lis pendens based on its earlier breach of guaranty judgment.  The lis pendens filing dissuaded the Property’s contract purchaser from closing and a lender later sued to foreclose on the Property.

The plaintiff then filed suit against the land trust, the corporate beneficiary (the Shareholders’ company) and the Shareholders to impose a constructive trust over the foreclosure sale proceeds.  The trial court granted plaintiff’s summary judgment motion and imposed a constructive trust on the proceeds.  The court also held that the corporate beneficiary was the alter ego of the Shareholders and so plaintiff was entitled to a constructive trust on each Shareholder’s equitable interest in the foreclosure sale proceeds.  The land trust appealed.

Held: reversed.  Land trust beneficial interest is personal property; not real property.  As a result, the lis pendens recording didn’t affect the corporate beneficiary’s interest in the Property.

Rules/reasoning:

A beneficiary’s interest in a land trust is personal property and is not considered real estate;

– To create a security interest in personal property, a creditor must look to Article 9 of the UCC;

– Assignment of a beneficial interest in an Illinois land trust transfers an interest in personal property and does not give the assignee a direct interest in the real estate subject to the trust;

– A lien on a beneficial interest is not a lien on the real estate itself;

– A corporation will be deemed an alter ego of a controlling shareholder where the corporation is inadequately capitalized, doesn’t issue stock or observe corporate formalities, fails to pay dividends, is insolvent, has no records and nonfunctioning officers;

– Illinois has a general reluctance to pierce the corporate veil and a party seeking to pierce must make a substantial showing on all these factors;

– A lis pendens notice can only be filed when real estate is involved (735 ILCS 5/2-1901); it is not proper to file in connection with a personal judgment against someone

(¶¶ 15-18)

Here, the Shareholders had no legal interest in the Property.  They were shareholders in a corporation that was a beneficiary of the land trust that held title to the Property.  The corporate beneficiary’s interest in the land trust was personal property.  Because of this, the Shareholders interest in that corporate beneficiary was also personal property.

The net effect: plaintiff could not impress a lien against the Property in efforts to enforce its guaranty judgments against the Shareholders. Instead, Plaintiff should have filed a UCC financing statement (in the Secretary of State’s office) to lien the beneficial interest in the land trust.  Since the shareholders had no definable legal interest in the Property (it was owned by the land trust), plaintiff couldn’t assert a constructive trust against the Property foreclosure sale proceeds.

Take-away:  A factually convoluted and tortured case that illustrates the challenges creditors face trying to untangle complex webs of corporate protection to reach a controlling individual’s assets.  If in the creditor’s position, in addition to filing a UCC statement, I think I would issue third-party citations on the land trust entity and the corporate beneficiary.  Then, I would try to impress a lien or seek a turnover order as to any of the Shareholders interests in either the land trust or the corporate beneficiary.