A recent court ruling by a U.S. Bankruptcy Court in Rockford, Illinois (In re Primes
, 9/26/14) illustrates how the doctrine of equitable mortgage applies in the context of a transaction involving a financially distressed homeowner facing the loss of her home, and the lender currently holding the mortgage and threatening foreclosure.
More specifically, and given the particular facts of this case, it illustrates how a bank requiring the defaulting homeowner to sign over a deed to be held in escrow in connection with obtaining a forbearance agreement will be prevented from taking possession of the premises upon a subsequent default by the homeowner without first bringing a foreclosure action. In such a case, the bank is prohibited from obtaining possession of the premises by simply recording the escrowed deed and booting the homeowner through a forcible detainer
(eviction) action. Such a scheme was looked at by the court as nothing more than the bank's attempt to improperly extinguish the homeowner's equitable right of redemption to evade judicial foreclosure.
An oversimplified summary of the fact follows (the reader is referred to the court's opinion for a full recitation of all the minutiae):
- After the homeowner defaulted on her payments on her home mortgage, the bank commenced a foreclosure proceeding.
- The homeowner filed for Chapter 13 bankruptcy to halt the foreclosure action, and subsequent thereto, reached a forbearance agreement with the bank that called for regular monthly payments and a balloon payment.
- In addition, the bank required the homeowner to sign over a quit claim deed (which purported on its face to be in lieu of foreclosure) to the bank as security for homeowner's performance of her obligations pursuant to the forbearance agreement.
- The bank agreed to hold the deed in escrow, but that in the event of homeowner's default, the bank was authorized to record the deed and take possession of the home.
- As part of the agreement, the bank dismissed the ongoing foreclosure action.
- After approximately two years of monthly payments on the forbearance agreement (and shortly after the bankruptcy case was closed and the Chapter 13 trustee was discharged), the homeowner defaulted again.
- The bank sent notice to the homeowner that if the payment default was not timely cured, it would record the deed held in escrow.The homeowner failed to cure; the bank then recorded the deed.
- The homeowner then filed a second Chapter 13 case, (a) proposing to make up the back payments to reinstate the forbearance agreement, and (b) claiming that she was still the owner of the home, despite the deed she signed over to the bank a couple of years earlier.
The court described the legal issue to be addressed as follows ("Alpine" is Alpine Bank & Trust Co., the mortgage lender, Mrs. Primes is the Debtor/homeowner):
- Alpine argues that the pre-petition recording of the quit claim deed transferred ownership in the Mila Ave. property to the bank. Alpine thus contends that as of the petition date the Debtor had no interest in her residence and no right to redeem the property, and, therefore, the property is not necessary for her reorganization. See, e.g., Colon v. Option One Mortgage Corp., 319 F.3d 912 (7th Cir. 2003) (automatic stay may be lifted because at the time debtor filed her plan under Chapter 13 she "had no right to redeem").
Ms. Primes argues in response that under Illinois law the quit claim deed given in connection with the Forbearance Agreement must be treated as an equitable mortgage, that the bank's recording of the deed without judicial foreclosure is ineffective to transfer her ownership interest, and that she is entitled to cure her default and satisfy the bank's secured claim through her Chapter 13 plan.
Under the facts presented, the court finds the Debtor's argument to be correct under Illinois law.
As the basis for its conclusion, the court goes through an extensive analysis of the Illinois law (refer to the court's opinion for its full analysis of the law), and its application of the law to the facts of the case. Interesting to note that, while the underlying principles are the same, the case law reviewed by the court was a different line of cases than the line of cases often cited when the equitable mortgage doctrine is invoked in Illinois in the context of a sale leaseback foreclosure rescue scheme (compare the line of cases cited in In re Primes
with the line of cases cited in Hatchett v. W2X, Inc
., 993 NE 2d 944 (Ill. App., 1st Dist., 1st Div. 2013), a sale leaseback foreclosure rescue case).
After its analysis of the applicable Illinois law, the court reached its conclusion, making these findings and observations:
- The doctrine of equitable mortgage applies not only to purported transfers executed at the time money is lent, but also to deeds executed after the time the debt is created such as in the context of an amendment, a refinancing, a forbearance agreement or other work-out situation.
Applying the principles discussed above to the facts in this case, it is clear that the execution, delivery and recording of the Debtor's quit claim deed was ineffective to transfer title in her Rockford, Illinois property from Ms. Primes to Alpine Bank. Instead, the Debtor still owned the Mila Ave. property as of the petition date. Alpine Bank holds only a secured claim which could be modified through a plan pursuant to and in accordance with Chapter 13 of the Bankruptcy Code.
The evidence establishes that the parties did not intend for the quit claim deed to immediately transfer title to the Mila Ave. property from the Debtor to Alpine Bank on July 13, 2011. The Forbearance Agreement provided that the deed would be held in escrow and not recorded until after a future default in the Debtor's payment obligations. Additionally, at least for some period after July 13, 2011, the Debtor continued to make and Alpine Bank continued to accept payments. Alpine instead simply held the deed for the contingency of a later default. The bank's officer admitted at trial that it was not his bank's understanding that it was receiving the property at the time the Debtor deliver the deed; rather the instrument was security to secure the loan. Therefore, the deed here is not a deed in lieu of foreclosure as contemplated by 735 ILCS 5/15-1401.
Further, it is clear from the language of the Forbearance Agreement and the bank's actions that Alpine Bank did not intend that the recording of the quit claim deed would extinguish or satisfy the debt owed by the Debtor to the bank. The Agreement expressly states that the "recording of the Deed will not extinguish the debt of Borrower to Bank." The Agreement also provides that the debt would not be reduced until the further step of a sale of the property to a third party. The Agreement states that "[u]pon the sale of the Property, Bank shall provide a credit to Borrower against the indebtedness which is due at that time" and that any "deficiency which remains after the sale of the Property shall be due and payable in full to Bank from Borrower." Again, as the bank's officer admitted, the quit claim deed was security for its loan that it only recorded after the Debtor missed several payment installments.
Alpine cannot have it both ways. As stated in Sutphen v. Cushman, the bank cannot argue that it holds the property absolutely and at the same time retain the right to enforce payment of the full debt. 35 Ill. 186 (Ill. 1864). At most, the parties intended to agree upon a mechanism that they believed would allow Alpine Bank to obtain title to the property upon a future default without the need for judicial foreclosure and without requiring future cooperation of the Debtor. But as stated by the Illinois Supreme Court in Bearss, parties cannot "by mere agreement . . . even by express stipulation" agree in advance to "cut off the right of redemption" in such a manner. 108 Ill.16.
Even were this court able — which it is not — to set aside Bearss and the well-established law of Illinois and, as Alpine now proposes, adopt the approach taken by the courts in Ringling Joint Venture II and Guam Hakubotan, Inc., it does not appear that result here would change. In marked contrast with those decisions, the instant case involves an individual debtor's residential property in a consumer transaction with an unsophisticated borrower. There is no evidence that the Forbearance Agreement was drafted at the insistence of the Debtor or that she signed it in bad faith. Indeed the Debtor testified without dispute that she intended to make payments under the agreement at the time she signed it, that she did initially make payments and only fell behind after she broke her wrist and was out of work for several months.
Accordingly, the Debtor held title to the property as of the date of the petition.
For the court ruling, see In re Primes
, Bankr. No. 13-B-83310 (Bankr. N.D. Ill., Western Div. September 26, 2014).