Friday, July 29, 2011

Voidable Or Void Ab Initio (Or "Void Unless & Until Later Ratified")?

In a 2010 court case, the U.S. Court of Appeals for the 5th Circuit was asked to determine, in an apparent ripoff where a 'rogue' member of a two member LLC deeded a 520-acre tract of land in Panola County, Mississippi owned by the LLC to a second LLC, 'wholly-owned' by the rogue member, without the knowledge of the other, unwitting member, whether the deed used in the conveyance was void ab initio, or merely voidable.

The reason this distinction was crucial was because, after illegally hijacking title to the property, the rogue member then went out an obtained a $300,000 mortgage loan in the name of his 'wholly-owned' LLC, secured by the ripped-off 520-acre tract, stuck substantially all of the loan proceeds in his pocket, and ultimately stiffed the bank out of its payments.

Consequently, the lender's interest in this deal hinged on whether the ripoff was merely voidable (in which case, it would hold a valid interest in the tract - provided, of course, that it otherwise qualified for protection as a bona fide purchaser/encumbrancer), or void ab initio (in which case the secured lender is really left unsecured and, regrettably for it, also left holding the bag).

In considering the question, the Federal appeals court made this analysis of the existing law of Mississippi:
  • Mississippi courts have held several types of deeds voidable rather than void ab initio. For example, when a corporation takes an ultra vires action not authorized by its charter, the result can usually be ratified and thus cannot have been void ab initio. See Home Owners' Loan Corp. v. Moore, 184 Miss. 283, 185 So. 253, 255 (1939) ("An act of a corporation relating to the subjects within its powers though it should exceed those powers is not void."); see also Haynes v. Covington, 21 Miss. (13 S. & M.) 408, 1850 WL 3405, at *2 (Miss.Err. & App.1850).[5]

    Similarly, a fraudulent conveyance is voidable rather than void ab initio—i.e., it is subject to the intervening rights of a bona fide purchaser for value without notice of the fraud. See Parker v. King, 235 Miss. 80, 108 So.2d 224, 226 (1959) (fraudulently induced execution of a mineral deed is voidable); see also Guice v. Burrage, 156 F.2d 304, 306 (5th Cir. 1946); Lee v. Boyd, 195 Miss. 794, 16 So.2d 30, 30 (1943); Sanders v. Sorrell, 65 Miss. 288, 3 So. 661, 663 (1888).

    A forged conveyance, on the other hand, is void ab initio and cannot pass title to a bona fide purchaser. See
    Securities Inv. Co. of St. Louis v. Williams, 193 So.2d 719, 722 (Miss.1967) ("The note and trust deed having been forgeries, even an innocent purchaser, for value and without notice that they were forgeries, could acquire no title.").

    Mississippi courts have held deeds void ab initio in homestead cases. A homestead occupied by husband and wife cannot be conveyed without the signature of both spouses, and any deed made without both signatures is absolutely void and passes no title. See
    Thornhill v. Caroline Hunt Trust Estate, 594 So.2d 1150, 1152 (Miss.1992).[6]

    Mississippi courts have also held unauthorized tax sales by the State to be void ab initio rather than voidable. See Pittman v. Currie, 391 So.2d 654, 655 (Miss.1980); see also In re Hardy, 910 So.2d 1052 (Miss.2005) (citing a tax sale case in support of its holding that certain deeds made by an agent who exceeded her power of attorney were void ab initio); Money v. Wood, 152 Miss. 17, 118 So. 357, 360 (1928); Hit-Tuk-Ho-Mi v. Watts, 15 Miss. (7 S. & M.) 363 (Miss.Err. & App. 1846).

In concluding that "[none] of these classes of cases answered the voidable/void ab initio question presented here" and that "[t]he issue has serious and potentially far-reaching public policy implications for Mississippi LLCs and those who do business with them[,]" the 5th Circuit appeals court did the only smart thing that any Federal appeals court could do when asked to address an issue of state substantive law where the state case law is not clear: it declined to rule on the case.

Rather than making what has been described as a "reasoned attempt to anticipate what the state's [highest] court[] would decide" (often referred to as making an "Erie guess"), it 'punted' the case over to the Mississippi Supreme Court (the court most qualified to interpret its own state law(1)), and respectfully requested that the state high court figure out the answer to the question.

The Mississippi high court graciously granted the request (a grant that is purely discretionary, not mandatory), and for the reasons set forth in its ruling, found that the deed used in the ripoff was neither void ab initio, nor voidable.

It approached the issue by applying the rules of agency and found the deed to be "void unless and until later ratified." It went further and concluded that, because the rogue member "had neither actual nor apparent authority to transfer [the LLC's] property, and because [the LLC] did not ratify the transaction, [the deed] was void and of no legal effect ([alterations] mine, not in the original text).(2)

Having answered the 5th Circuit's question on what the state law was, it kicked the case back over to them, at which point, the 5th Circuit affirmed a ruling by a U.S. District Court which, in turn, affirmed a U.S. Bankruptcy Court ruling finding that the deed was to be treated as a nullity and of no legal effect (consequently restoring the unwitting LLC member's interest in the 520-acre tract of land, and leaving the unwitting mortgage lender, BancPlus, with an unsecured position on the $300,000 loan made to the rogue LLC member).

For the rulings, see:

(1) The U.S. Supreme Court has stated that, in cases when the Federal courts have been asked to rule on issues involving the interpretation and application of substantive (as opposed to procedural) state law, "the State's highest court is the best authority on its own law." Commissioner v. Estate of Bosch, 387 U.S. 456 (1967).

(2) Specifically, and for the reasons it set forth in its ruling, the Mississippi high court said (see In re Northlake Development II, at paragraphs 15-16):

  • ¶ 15. So where no actual or apparent authority exists to transfer a principal's property, we decline to characterize the deed as voidable. Rather, it is void unless and until later ratified. Ratification is a principal's after-the-fact, conscious decision to be bound by an agent's unauthorized act, and it is that decision that can trigger the principal's liability to third parties. Where the agent has no actual or apparent authority, a principal has no need to repudiate an agent's unauthorized act in order to "put things back" the way they were. Absent ratification—and prior to ratification—nothing changes.

    ¶ 16. Earwood was without authority (actual or apparent) to convey the property to Northlake. The conveyance therefore had no effect on Kinwood's interest in the property. Once Kinwood learned of the purported conveyance, it could have ratified it—but didn't. Kinwood's rights in the property are therefore unaffected by the actions of Earwood, Northlake, or any other subsequent party. DeedVoidVoidable

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