Court Dismisses Bank From NJ Sale Leaseback Equity Stripping Victim's Lawsuit Based On Pleading Defect; Gives Homeowner Chance To Amend Complaint

In a lawsuit filed by by a homeowner of a foreclosure rescue, equity stripping ripoff, a U.S. District Court in New Jersey dismissed, on procedural grounds and without prejudice, the claims made against Cornerstone Bank, the financial institution who (apparently unwitting) funded the alleged ripoff orchestrated by a sale leaseback peddler.

The underlying basis for the homeowner's claims was that sale-leaseback was a disguised financing transaction that should be recharacterized as an equitable mortgage.(1) According to the court:

• Although, applying the Johnson v. Novastar Mortgage, Inc. test, it appears Plaintiff has pled sufficient facts to assert the sale-leaseback arrangement was an equitable mortgage, the Complaint is void of any facts alleging the role and involvement of Defendant Cornerstone in the transaction.

  As noted by Defendant Cornerstone, Plaintiff's Complaint makes "vague references to a `loan'", but never avers the parties to the loan or who financed the loan. (Doc. 19, Def. Br. 9). Plaintiff's sole allegation concerning why the Court should impose an equitable mortgage is that Defendant Cornerstone "was on notice by its own HUD1 and other documents accompanying the transaction" that it funded a foreclosure rescue transaction. (Doc. 1, Compl. ¶ 63).
  

  This sole allegation for Defendant Cornerstone's liability fails to meet the Twombly/Iqbal threshold standard for pleading. It is a bald legal conclusion unsupported by averments in the Complaint. [...] The Court will grant Plaintiff leave to, within thirty days of entry of the Order accompanying this Opinion, file an Amended Complaint to cure the pleading defects relating to Defendant Cornerstone.

An important reminder to those looking to undo sale-leaseback, equity stripping scams in New Jersey, is that, no matter how unwitting the lender may have been when funding this ripoff, the the general rule in New Jersey is that possession of real estate by the occupant thereof which is actual, open and visible, inconsistent with the title of the apparent owner [ie. the sale-leaseback peddler] by the record is constructive notice to all the world of the rights of the party in possession, and that this rule applies, not only to would-be buyers, but also applies to a person proposing to take a mortgage on the property.(2)

When looking to attack the mortgagee's interest held by a lender who funds these deals (unwittingly or otherwise), it is important to assert that, in addition to any other evidence that the bank was on notice, it was placed on constructive notice of the ripoff by reason of the victimized homeowner's continued occupancy of the premises where such occupany is actual, open and visible, and allow the judge to decide whether or not this principle applies to the facts of the case.

For the court ruling, see Davidson v. Cornerstone Bank, No. 10-2825 (D.N.J. February 16, 2011).

(1) The court briefly described what is meant by an 'equitable mortgage' in the following excerpt (bold text is my emphasis):

• An equitable mortgage is a judicially created doctrine that arises when "a deed or contract, lacking the characteristics of a common law mortgage, is used for the purpose of pledging real property, or some interest therein, as security for a debt or obligation, and with the intention that it shall have effect as a mortgage, equity will give effect to the intention of the parties." Bank of New York v. Patel, No. F-3482-05, 2006 WL 337074, at * 2 (N.J. Super. Ct. Ch. Div. 2006) (quoting J.W. Pierson Co. v. Freeman, 113 N.J. Eq. 268, 271 (E & A 1933)).

  Among other circumstances, courts have imposed an equitable mortgage when the plaintiff, to avoid foreclosure, enters into a sale-leaseback agreement with a defendant. Johnson v. Novastar Mortg., Inc., 698 F. Supp.2d 463, 469-470 (D.N.J. 2010); see In re PCH Assocs., 949 F.2d 585, 600 (2nd Cir. 1991) (treating a sale-leaseback as an equitable mortgage). To determine whether a transaction constitutes a sale-leaseback arrangement, and consequently an equitable mortgage, Courts in this district apply a multi-factor test.[10] Johnson, 698 F. Supp.2d at 469-470. The determination of whether the parties' interactions created an equitable mortgage is not limited to the existence of an express contract. Id. at 470-71. An equitable mortgage may arise between parties that did not have any direct interactions. Id.

(2) See generally, Clawans v. Ordway Bldg. & Loan Ass'n, 112 N.J. Eq. 280; 164 A. 267 (E & A 1933) (bold text is my emphasis):

• In Wood v. Price, 79 N.J. Eq. 620, 81 A. 983, Mr. Justice Voorhees said (at p. 624): "All authorities are agreed that the general rule is that possession of real estate which is actual, open and visible occupation, inconsistent with the title of the apparent owner by the record and not equivocal, occasional or for a temporary or special purpose, is constructive notice to all the world of the rights of the party in possession."

  The testimony relating to the complainant's possession, accepted by the trial court as true, was, we think, sufficient to bring that possession within the application of the rule thus stated. It was held by this court in La Combe v. Headley, 91 N.J. Eq. 63, 108 A. 185, opinion by the chief-justice, that: "It is the duty of an intending purchaser of land which is in the possession of a person other than the intending grantor to inquire of the occupant and ascertain the rights under which he holds; and if he does not make such inquiry, he is chargeable with notice of such facts as the inquiry, if it had been in fact made, would have revealed."

  The efficacy of notice by actual possession applies to a person proposing to take a mortgage on the property. Phelan v. Brady, 119 N.Y. 587, 23 N.E. 1109; Chicago and A. R. Co. v. Kelly, 182 Ill. 267; 54 N.E. 979. The inquiry required to be made of the occupant must, of course, be made with due diligence; and it was not so made in the instant case. Indeed the visitation of the defendant's representatives at the premises seems to have been directed towards the physical condition of the property and not at all towards the character or significance of the occupancy.

For more on this point, see New Jersey Bona Fide Purchaser, Possession, Duty To Inquire.

See also, Faulty Service Of Process In Tax Foreclosure, Failure To Investigate Rights Of Persons In Possession Leaves Unwitting Buyer Empty Handed.

For other states, see Bona Fide Purchaser Doctrine, Possession Of Property By Occupants Other Than The Vendor & The Duty To Inquire.

For two recent cases from other states in which the scam-funding lender of the sale leaseback deal was found to have constructive notice of the ripoff as a result of the homeowner's continued open possession of the subject home, see:

• Illinois: Davis v. Elite Mortg. Servs., 592 F. Supp. 2d 1052 (USDC N.D.Ill., East. Div. 2009) (see also Lender's Failure To Inquire Into Possession Disqualifies It For Bona Fide Purchaser Protection In Suit To Undo Foreclosure Rescue Sale Leaseback Scam),
• Pennsylvania: In re Fowler (go here for Google Scholar version with embedded links), 425 B.R. 157 (Bankr. E.D. Pa. 2010) (see also Pennsylvania B'kruptcy Court Voids Sale Leaseback Scam; Victimized Homeowners' Continued Possession Leads To Invalidation Of Subsequent Deed, Mortgage).