Opinion
CIVIL NO. 98-0489 (JBS), [Bankruptcy Case No. 95-10608 (JHW)], [Adv. Proc. No. 95-1091]
Filed: December 9, 1998
Walter E. Thomas, Jr., Esq., Timothy J. Matteson, Esq., Mark A. Trudeau, Esq., Stern, Lavinthal, Norgaard Kapnick, Esqs., Englewood, New Jersey, Attorneys for Appellant.
Edward J. Hayes, Esq., Andrea Dobin, Esq., Fox, Rothschild, O'Brien Frankel, Princeton Pike Corporate Center, Lawrenceville, New Jersey, Attorneys for Appellees, Settlers Abstract Co., L.P., Land Transfer Co, Inc., Fidelity National Title Insurance Co. of Pennsylvania, Gino L. Andreuzzi, Pioneer Agency II Corp. t/a Pioneer Agency, Musser Musser, Quaker Abstract Co, and Searchtec Abstract, Inc.
OPINION
I. INTRODUCTION
Provident Savings Bank appeals from a Judgment entered on December 17, 1997, pursuant to a written opinion issued on November 19, 1997, by the Honorable Judith H. Wizmur, United States Bankruptcy Judge, after trial in an adversary proceeding. That Opinion ruled in favor of the Appellees, Settlers Abstract Co., L.P., Land Transfer Co, Inc., Fidelity National Title Insurance Co. of Pennsylvania, Gino L. Andreuzzi, Pioneer Agency II Corp. t/a Pioneer Agency, Musser Musser, Quaker Abstract Co, and Searchtec Abstract, Inc. ("title agents"). Reviewing a longstanding complex lending relationship between Provident and the debtor, Pinnacle Mortgage Corporation, of which the ten real estate mortgage loans at issue herein were a part, the Bankruptcy Court held that appellee title agents (who had advanced their own funds to cover disbursements when Provident dishonored Pinnacle's checks) had a more valid or higher priority security interest in the promissory notes and mortgages executed as part of ten separate residential real estate closing than did appellant. Provident Savings Bank appeals this ruling and seeks this Court's determination that it was the holder in due course of those documents.
The principal issue to be decided is whether the Bankruptcy Court correctly determined under the Uniform Commercial Code that Provident was not a holder in due course of the promissory notes arising from these loans, where it found that Provident so closely participated in the funding and approval of the Pinnacle-brokered loans that the transaction did not end at the closing with the title agents, such that Provident did not attain holder in due course status because it did not fit the requisite role of a "good faith purchaser for value." For the reasons that will be stated herein, the judgment will be affirmed because the Bankruptcy Court's finding that Provident never attained HDC status was neither clearly erroneous nor contrary to law.
II. BACKGROUND
A. Procedural History
This case arises from a dispute over the various security interests in mortgage documents from ten separate real estate transactions in late October, 1994, conducted by the debtor, Pinnacle Mortgage Investment Corporation (who brokered the transactions), the appellant (who financed the transactions), and the appellees (who were title closing agents in the transactions). On February 2, 1995, appellant Provident Savings Bank ("Provident") and other creditors filed an involuntary petition under Chapter 7 of Title 11 of the Bankruptcy Code against Pinnacle Mortgage Investment Corporation ("Pinnacle"). An order for relief under Chapter 7 was entered by the Bankruptcy Court on March 6, 1995.
On March 24, 1995, Provident commenced this adversary proceeding by filing a three count complaint to determine the extent, validity, and priority of the various security interests asserted by Pinnacle, Meridian Bank, Lawyers Title Insurance Corporation, the appellees, and William E. Ward with regard to the promissory notes and mortgages from ten real estate transactions. Appellees responded to the complaint by filing an answer, counterclaims, and cross-claims, seeking money judgments in the amount of the contested notes and mortgages, interest, cost of suit, and attorneys fees; imposition of a constructive trust in their favor with regard to the notes, mortgages, and proceeds thereof; and to have the subject notes and mortgages avoided and stricken in favor of subsequently executed mortgages between the appellees and the mortgagors. Provident twice amended its complaint, finally seeking a declaratory judgment that it is the holder in due course of the subject notes and mortgages under the Uniform Commercial Code; avoidance of the preferential transfer by appellee Andreuzzi pursuant to 11 U.S.C. § 547 and 550; avoidance of the fraudulent transfer by appellee Andreuzzi pursuant to §§ 548 and 550; and avoidance of the preferential and fraudulent transfers by appellees pursuant to 11 U.S.C. § 547, 548, and 550.
The appellant's cause of action against defendant William E. Ward was removed to state court in Delaware upon motion on the basis of abstention pursuant to 28 U.S.C. § 1334(c) where it is now pending. The appellant's cause of action against Meridian Bank was resolved prior to trial pursuant to the Stipulation of Settlement with respect to Count II of the Complaint, filed on July 16, 1996. All claims between the appellant and Lawyers Title Insurance Corporation were mutually dismissed at trial.
Trial in this matter was held on July 16, 17, and 18, 1996, and October 1, 3, and 4, 1996. At the close of Provident's case in chief, upon motion by the appellees, all of those portions of the Second Amended Complaint which did not pertain to Provident's status as a holder in due course ("HDC") were dismissed.
B. The Factual History
In its November 19, 1997 opinion, the Bankruptcy Court determined that the facts of the case are as follows. Debtor Pinnacle Mortgage Investment Corporation ("Pinnacle" or "debtor") was a mortgage banker which primarily dealt in residential mortgage lending and refinance. In December of 1992, Pinnacle and Provident Savings Bank ("Provident" or "appellant") entered into a Mortgage Warehouse Loan and Security Agreement ("Agreement"), whereby Provident would fund Pinnacle, who in turn funded retail customers who sought to purchase or refinance residential real estate. The borrower in each transaction would give Pinnacle a note and mortgage, both of which acted as collateral to protect Provident until Pinnacle sold the mortgage to a third party investor, such as the Federal Home Loan Mortgage Corporation ("Freddie Mac"), who satisfied Pinnacle's debt to Provident. Warehouse Agreement § 3.4.
1. The Warehouse Agreement
Under these types of agreements, there would usually not be any contact between the warehouse lender and the ultimate mortgagor. Typically, Pinnacle would arrange with a prospective borrower for Pinnacle to advance funds for the borrower to purchase or refinance a home and for the borrower to assign a note and mortgage to Pinnacle as collateral. The mortgage would be endorsed in blank in order to accommodate the final third party investor (such as Freddie Mac), with whom Pinnacle would arrange to purchase the mortgage, usually as a part of a pool of mortgages; this was known as a "take-out" agreement. All of this completed, Pinnacle would submit a "package" to Provident seeking funding for the particular transaction under its $10 million line of credit. This package included a description of the borrower and the funding, an assignment of the mortgage endorsed in blank, a take-out commitment, and an agency agreement that indicated the borrower's attorney's agreement "to act as the agent of the Bank" to disburse the Advance and to obtain due execution and delivery to the bank of the original note that evidences the debt underlying the Mortgage Loan." Warehouse Agreement § 5.3(A)(iii). The Agreement required all of this to be submitted along with the initial funding request. As a matter of course, however, the agency agreement was usually executed by the title agent handling the closing instead of by the borrower's attorney, and Provident customarily accepted the mortgage assignment and agency agreement after the actual closing.
The Agreement said $10 million, but at times up to $12.5 million was advanced.
After Provident received the package and checked to see that Pinnacle's credit limit had not been exceeded (although, as stated above, often prior to receipt of the mortgage assignment and agency agreement), Provident credited Pinnacle's checking account with 98% of the requested funds. Warehouse Agreement §§ 1.1, 2.1. Pinnacle would write a regular, uncertified check to the closing agent, who would close the loan directly with the borrower on Pinnacle's behalf. Pinnacle was supposed to use specific funds credited to their account to fund specific closings, but no controls were in place to make sure that Pinnacle actually did so.
With Pinnacle's check in hand, the closing agent would use money from its own bank account to disburse funds to the mortgagor, later replenishing its bank account by depositing Pinnacle's check. Next, the closing agent would routinely send the original note, a certified copy of the recorded mortgage, and the other closing documents to Pinnacle, who would send them on to Provident, who would receive this original note approximately three to five days after closing. Provident and the borrowers had no contact; indeed, Provident and the closing agents had no contact, save the extremely limited contact by the closing agents who did return the agency agreement included in the borrowing package. Not all closing agents did return the agreement signed; most of those who did sent everything through Pinnacle to go to Provident, in accordance with Pinnacle's written instructions, rather than remitting the note and other papers directly to Provident, as stated in the agency agreement. Ultimately, Provident would send the note and accompanying documents to the third party investor, who would pay Provident the funds which Provident had originally placed in Pinnacle's checking account by wiring monies to Provident in Pinnacle's name. Because the third party investor would send multiple payments in each wire transfer, Pinnacle would tell Provident to which loans to apply each of the funds.
2. Pinnacle's Declining Financial State
Among the twenty or so warehouse customers that Provident had during 1993-1994, Pinnacle was the most profitable for Provident, providing hundreds of millions of dollars in loan transactions. However, when the mortgage banking industry suffered a decline in business, Pinnacle began to experience financial difficulties as well.
The Warehouse Agreement, § 6.11, required Pinnacle to submit unaudited balance sheets and statements of income to Provident on a quarterly basis, though Pinnacle customarily provided monthly statements. The statements filed for June, July, and August of 1993 reflected an accrued pre-tax income for the first three months of the fiscal year of $281,351. Statements for September, October, and November of 1993 reflected pre-tax income of $923,923 for the first six months of the fiscal year. However, after the November 30 report, Pinnacle began to send its reports quarterly, which was in accordance with the Warehouse Agreement but which was nonetheless unusual due to Pinnacle's custom of submitting reports monthly. The next report, covering the nine-month period ending February 28, 1994, was due on April 15 but not received until some time in May. It showed pre-tax income of $136,000 for the first nine months, or an $800,000 loss in the previous three months. The accompanying unaudited balance sheets showed a reduction of assets from $40 million to $28 million in those three months. The final financial statement was due on August 31, 1994, but Provident never received it.
At a holiday party in May 1994, Edmund R. Folsom, head of Provident's Commercial Lending Department, had learned that Pinnacle had sustained losses in the winter months. On August 19, 1994, Sharon Kinkead, of Provident's Warehouse Lending Department, called Pinnacle's headquarters and learned from Pinnacle's CFO, Joseph Mader, that there would be a delay in the submission of the audited financial statements for the fiscal year ending May 31, 1994 because of a change of comptroller, but that the report would be provided by September 15, 1994. That report never arrived, and no other financial statements were received up until Provident's termination of its relationship with Pinnacle in early November 1994.
3. Provident's Relationship with Pinnacle
Throughout its relationship with Pinnacle, Provident routinely honored overdrafts on behalf of Pinnacle — about twenty times in 1993 and fifteen times in 1994. These overdrafts ranged from $7,240.87 to $5,255,812.
When a check was presented to the bank on Pinnacle's account for which Pinnacle had insufficient funds, Sharon Kinkead would contact Pinnacle to ask whether Pinnacle would honor that overdraft. Having been told that the check would be covered (usually from an anticipated wire transfer), Kinkead and her supervisor, Mr. Folsom, would honor it and allow the overdraft. Until November 1994, Provident honored all of Pinnacle's overdrafts, without reviewing Pinnacle's books and records or monitoring its checking account.
As mentioned earlier, Pinnacle's CFO, Joseph Mader, had informed Provident that its final fiscal year report would be forthcoming on September 15, 1994. When Provident did not receive the audited reports by that date, Mr. Folsom spoke with Mr. Mader, who reported that though Pinnacle had sustained losses, it was expecting a substantial infusion of capital. Pinnacle wanted to hold off publishing the report so that it could add a footnote explaining that there would be a capital infusion. Based on this, Folsom decided to extend Pinnacle's credit line through the end of November.
Folsom called Mader some time in October to check on the status of the report. When Mader returned the call on November 1, he informed Folsom that the capital infusion had failed. Folsom demanded a meeting with Pinnacle's officers.
On November 2, Folsom and Kinkead met with Mader and Al Miller, President of Pinnacle. Mader and Miller presented internally generated financial statements indicating a pre-tax loss of six million dollars for the previous fiscal year, as well as a pre-tax loss of almost one million dollars for the first quarter of the current fiscal year. Miller and Mader admitted that they had misused their warehouse credit line with G.E. Capital Mortgage Services, Inc., to whom they were indebted for about six million dollars. They "admitted fraud" as to G.E., but indicated that they had not misappropriated the Provident funds and asked for an extension of funding of their loans while they financially reorganized. Provident declined to do so.
At that time, Provident finally reviewed Pinnacle's books and discovered that Pinnacle had been diverting substantial sums of money from Pinnacle's Provident account to its operating account at Meridian Bank. Kinkead and Folsom also learned that Pinnacle had been requesting advances on loans earlier than was routinely requested, possibly using the money that was supposed to be for specific loans for other purposes instead. Indeed, Pinnacle was engaging in a "kiting" scheme, misappropriating monies from third party investors that should have been applied to previously funded loans. A Pinnacle employee told Kinkead that the Provident line was not "whole," that as much as $500,000 may have been taken from it, though no fraudulent loans had been made.
As of November 2, 1994, all checks presented to Provident on Pinnacle's account had been processed, and the customer balance summary showed an overdraft of $206,653.67. On November 3, $830,127.48 was deposited in Pinnacle's account. Sixteen checks totaling $1,584,041.63 were presented to Provident against Pinnacle's account on November 3. There were insufficient funds to cover all sixteen, so Folsom sent a letter to Miller, Pinnacle's president, to ask which checks should be paid. At the time, Provident knew that all sixteen of those checks represented monies that Pinnacle had delivered to borrowers and closing agents for particular loans, as well as that each transaction was accompanied by a take-out commitment by a third party investor, who would have paid for the loan.
Miller indicated that six of the checks could be paid. Provident debited $863,821 to pay off eight loans on November 4, and other checks were paid at Mader's instruction. There was an overdraft on that date of $178,303.73, and Provident honored no more checks. The remaining ten of the sixteen checks presented on November 3 were dishonored, and those are the subject of the instant litigation.
4. The Ten Transactions
Prior to the closings in each of the ten transactions in question, Pinnacle had requested from Provident — and received — monies to fund the transactions. As usual, Pinnacle presented the closing agent with an uncertified check drawn on its account at Provident representing payment for the note and mortgage to be executed by the borrower, purchaser, or refinancer of the property. With Pinnacle's check in hand, the closing agents closed each transaction, issuing checks from their own accounts to the parties entitled to receive funds. The closing agents then deposited Pinnacle's checks in their own accounts, and their banks presented those checks to Provident for payment. In each case, Provident dishonored the checks due to insufficient funds. After each closing, but before the discovery of any problem, each closing agent returned the original note to Pinnacle. Several closing agents recorded the mortgage and sent Pinnacle certified copies. Despite the fact that Pinnacle's checks were not honored, each closing agent honored their own checks when they were presented.
At the time, uncertified funds were routinely accepted from mortgage bankers, with a few exceptions for out of state lenders, ignoring the Pennsylvania statute which required mortgage bankers and brokers to certify funds. Most mortgage lenders such as Pinnacle insisted on acceptance of regular checks; title insurers could not stay in business if they did not follow the standard in the industry.
As was usual for these transactions, Provident had no contact with any of the closing agents prior to settlement. Agency agreements were included in most, but not all, of the instruction packages sent by Pinnacle to the respective closing agents. The agreement provided that Provident had a security interest in the note and mortgage; moreover, it provided that the closing agent would act as Provident's agent in connection with the loan transaction, agreeing to record the mortgage and then to send both the original note and the original recorded mortgage to Provident upon closing. The text of the agreement conflicted with the closing instructions that Pinnacle gave to the closing agents, which required the note to be returned to Pinnacle. In six of the ten transactions, the agreement was executed, but its provisions were basically ignored, as the closing documents were returned directly to Pinnacle.
The closing agents learned of the dishonor from their own banks. Provident did not attempt to contact the closing agents until November 10, 1994, when they sent a letter with instructions to deliver to Provident all notes, mortgages, loan files, and other collateral, and any monies received in connection with each mortgage loan.
Several of the agents sought judicial relief. Two of the closing agents who are appellees in this matter, Gino L. Andreuzzi and the Pioneer Agency L.P., hold state court judgments in their favor, for a total of three judgments against Pinnacle, striking the mortgages and notes executed by their respective buyers in favor of Pinnacle. Andreuzzi, the closing agent in the Hopeck settlement, filed suit against Pinnacle in the Court of Common Pleas of Luzerne County, Pennsylvania, seeking a TRO to keep Pinnacle from selling, transferring, or assigning the note and mortgage in question. Provident was not joined in Andreuzzi's case, but it did have notice of the litigation. Andreuzzi filed a lis pendens with the Prothonotary on November 14, 1994. About three hours after the lis pendens was filed, Provident recorded the assignment from the Hopeck note. Ultimately, a default judgment was entered against Pinnacle.
Pioneer also filed suits in connection with the Weaver and Fisher transactions. In both cases, Pioneer sued Pinnacle and Provident in the Court of Common Pleas of Berks County, Pennsylvania, on November 14, 1994. A preliminary injunction was entered on November 22, and a default judgment was entered against both defendants on December 21, 1994. Two days later, Pinnacle moved to open the default judgment. It was still pending on February 1, 1995 when an involuntary petition was filed against Pinnacle. Provident removed the action to the Bankruptcy Court on May 8, 1995.
Other closing agents entered into agreements with the borrowers to execute new notes and mortgages. By the time this came before the Bankruptcy Court, the mortgages had either been satisfied in full, with proceeds held in escrow, or payments on the new mortgages and notes were being made by the borrowers to the closing agents in escrow pending the resolution of this matter.
C. The Bankruptcy Court's Findings and Judgment
On November 19, 1997, the Bankruptcy Court issued its Opinion in favor of the appellees, ruling that:
(1) the appellant did not achieve the status of an HDC with regard to the notes and mortgages in issue;
(2) the appellees would be entitled to indemnification even if an agency relationship existed between the appellant and appellees;
(3) the Uniform Fiduciaries Law is inapplicable to validate the appellant's position with regard to the subject notes and mortgages; and
(4) the appellant is precluded from relitigating the transactions with appellees Pioneer Agency II Corp t/a Pioneer Agency and Andreuzzi.
Judgment against Provident was entered on December 17, 1997. On December 22, 1997, appellant filed a notice of appeal from the Judgment. On February 13, 1998, the record on appeal was transmitted to this Court. As "nothing remains for the [lower] court to do," Universal Minerals, Inc. v. C.A. Hughes Co., 669 F.2d 98, 101 (3d Cir. 1981), the Bankruptcy Court's ruling is final, and thus this Court properly has appellate jurisdiction over the December 17, 1997 Order pursuant to 28 U.S.C. § 158(a).
III. ISSUES PRESENTED
On appeal, Provident makes six arguments. First, Provident argues that it is the holder in due course ("HDC") of the ten mortgage notes. Second, Provident argues that the Bankruptcy Court's ruling that the appellees were entitled to indemnification if they were Provident's agents is clearly erroneous. Third, appellant contends that the bankruptcy court erred in ruling that Provident was not protected by the Uniform Fiduciaries Act ("UFA"), adopted by both New Jersey and Pennsylvania at N.J.S.A. 3B:14-54 and 7 Pa. Cons. Stat. Ann. § 6361, respectively. Fourth, Provident argues, for the first time upon appeal, that the doctrine of avoidable consequences bars appellees from recovering any damages from Provident. Fifth, Provident maintains that the doctrines of lis pendens, res judicata, and collateral estoppel do not bar relitigation of these issues as to the Andreuzzi transaction. Finally, Provident argues that the Bankruptcy Court erred by giving preclusionary effect to the Pioneer action default judgments.
This Opinion will not address Provident's "avoidable consequences" argument, as it was raised, for the first time, upon appeal. Moreover, the doctrine of res judicata precludes review of the two transactions for which Pioneer was the closing agent, and I thus affirm the Bankruptcy Court's judgment as to Pioneer on that ground. I will affirm the Bankruptcy Court's holding that Provident is not entitled to the protections of the Uniform Fiduciaries Act , especially in light of the fact that Provident has withdrawn its argument that Pinnacle was its agent. For reasons stated herein, I will affirm the Bankruptcy Court's holding that Provident is not the holder in due course of the eight transactions still in question. Accordingly, there is no need for this Court to address the Bankruptcy Court's alternate finding that the closing agents would be entitled to indemnification.
It is a well-established law that appellate courts may not pass upon an issue not presented in a lower court. Singleton v. Wulff , 428 U.S. 106, 120 (1976). The same holds true for a U.S. District Court sitting in its appellate capacity over matters appealed from the bankruptcy court. See Barrett v. Commonwealth Fed. Sav. and Loan Ass'n , 939 F.2d 20 (3d Cir. 1991); In re Middle Atlantic Stud Welding Co . , 503 F.2d 1133, 1134 n. 1 (3d Cir. 1974). Because Provident never raised this issue before the Bankruptcy Court, I will not consider it now.
The res judicata doctrine prevents relitigation of claims that grow out of a transaction or occurrence from which other claims have earlier been raised and decided validly, finally, and on the merits. Federated Department Stores v. Moitie , 452 U.S. 394, 298 (1981). Under Pennsylvania law, default judgments, absent fraud, are afforded res judicata effect. In re Graves , 156 B.R. 949, 954 (E.D.Pa. 1993), aff'd , 33 F.3d 242 (3d Cir. 1994). On December 21, 1994, the Court of Common Pleas of Berks County, Pennsylvania, entered default judgments against Provident on both the Weaver and Fisher transactions, those transactions for which Pioneer was the closing agent. Due to these default judgments, the doctrine of res judicata bars relitigation of the Pioneer causes of action. The Bankruptcy Court also held that the Andreuzzi transaction was barred by res judicata or collateral estoppel because of the lis pendens. That, however, is a more difficult issue and one that I need not reach now, as my affirmance of the Bankruptcy Court's judgment applies equally to the Andreuzzi transaction on the merits.
At trial and in its briefs to this Court, as an alternative to its holder in due course argument, Provident argued that it was protected by the Pennsylvania Uniform Fiduciaries Act, 7 Pa. Cons. Stat. § 6361, and the New Jersey Uniform Fiduciaries Law, N.J.S.A. 3B:14-54, the provisions of which are substantially similar. The two laws protect a person who transfers money to a fiduciary in good faith, by noting that "any right or title acquired from the fiduciary in consideration of such payment or transfer is not invalid in consequences of a misapplication by the fiduciary." 7 Pa. Cons. Stat. § 6361; N.J.S.A. 3B:14-54. The Bankruptcy Court held that Pinnacle was not Provident's agent or fiduciary, and thus the UFA did not apply. (Opinion at 66.) In light of the fact that Provident's counsel, at oral argument before this Court on November 13, 1998, themselves argued that Pinnacle was not Provident's fiduciary, I will affirm this aspect of the Bankruptcy Court's ruling without need to examine the factual bases on which it relied.
The rest of this Opinion is limited to the eight transactions not handled by Pioneer, since only the Pioneer transactions are bound by res judicata.
As Part V of this Opinion explains, one of the several bases for the Bankruptcy Court's decision that Provident is not the HDC of the mortgages and notes is that the settlement agents were not Provident's agents, and thus Provident did not constructively possess the mortgages and notes prior to gaining knowledge of claims or defenses on those notes. (Opinion at 34-53.) In the alternative, in case appellate courts determined that Provident was the HDC of those notes because an agency relationship did exist, the Bankruptcy Court held that the closing agents, and not Provident, would still be the ones entitled to the notes and mortgages, for the agents would have had a right to indemnification from Provident. ( Id . at 63-64.) Though, as I explain in Part V, I do not reach the agency issue, I do affirm the Bankruptcy Court's HDC ruling on other grounds. In doing so, I am affirming the decision that the appellees, and not Provident, are entitled to the notes and mortgages. The Bankruptcy Court's indemnification ruling is just an alternative reason for finding that the appellees are entitled to the notes and mortgages. Having already agreed that the closing agents are so entitled because Provident is not an HDC, there is no need to address that alternative ruling upon appeal.
IV. STANDARD OF REVIEW
On appeal, the weight accorded to the findings of fact by a bankruptcy court are governed by Fed.R.Bank.P. 8013, which provides as follows:
On appeal the district court or bankruptcy appellate panel may affirm, modify, or reverse a bankruptcy judge's judgment, order, or decree or remand with instructions for further proceedings. Findings of fact, whether based on oral or documentary evidence, shall not be set aside unless clearly erroneous, and due regard shall be given to the opportunity of the bankruptcy court to judge the credibility of witnesses.
Fed.R.Bank.P. 8013. Under this Rule, a bankruptcy court's factual findings may be disturbed only if clearly erroneous. See FGH Realty Credit v. Newark Airport/Hotel Ltd., 155 B.R. 93 (D.N.J. 1993). Where a mixed question of law and fact is presented, the appropriate standard must be applied to each component. In re Sharon Steel Corp., 871 F.2d 1217, 1222 (3d Cir. 1989). Thus, a reviewing court "must accept the [lower] court's findings of historical or narrative facts unless they are clearly erroneous, but . . . must exercise a plenary review and its application of those precepts to the historical facts." Universal Minerals, Inc. v. C.A. Hughes Co., 669 F.2d at 103.
While standards for establishing that a party is a holder in due course are well-settled law, see, e.g., Triffin v. Dillabough, 448 Pa. Super. 72, 87, 670 A.2d 684, 691 (1996), the Court's application of these standards to the facts does result in a mixed finding of fact and law that is subject to a mixed standard of review. Mellon Bank, N.A. v. Metro Communications, Inc., 945 F.2d 635, 641-42 (3d Cir. 1991), cert. denied, 503 U.S. 937 (1992). The factual findings can only be reversed for clear error, In re Graves, 33 F.3d 242, 251 (3d Cir. 1994), even if the reviewing court would have decided the matter differently. In re Princeton-New York Investors, Inc., 1998 WL 111674 (D.N.J. 1998). This Court, thus, may not overturn a bankruptcy judge's factual findings if the factual determinations bear any "rational relationship to the supporting evidentiary data. . . ." Fellheimer, Eichen Braverman, P.C. v. Charter Technologies, Inc., 57 F.3d 1215, 1223 (3d Cir. 1995) (citingHoots v. Comm. of Pa., 703 F.2d 722, 725 (3d Cir. 1983). However, this Court reviews any legal conclusions de novo.
V. DISCUSSION
Appellant argues that the Bankruptcy Court's finding that appellant is not an HDC of the promissory notes and mortgages from the eight remaining real estate transactions closed by appellees is clearly erroneous. The dispute here is not a dispute of law, as the parties agree on what the law concerning HDCs is. As the Bankruptcy Court correctly found, every holder of a negotiable instrument is presumed to be an HDC, Morgan Guaranty Trust Company of New York v. Staats, 631 A.2d 631, 636 (Pa.Super.Ct. 1993), but when a defense of fraud is meritorious as to the payee, the holder has the burden of showing that it is an HDC in order to be immune from that defense. Norman v. World Wide Distributors, Inc., 195 A.2d 115, 117 (Pa.Super.Ct. 1963). A holder of a negotiable instrument (such as the promissory notes in this case) is either the person with possession of bearer paper or the person identified on the instrument if that person is in possession. 13 Pa. Cons. Stat. Ann. § 1201; N.J.S.A. 12A:3-201 (West Supp. 1998) . The holder of a document of title (such as the mortgages in this case) is the person in possession if the document is made out to bearer or to the order of the person in possession. Id. The holder becomes an HDC if:
Seven of the eight remaining transactions here are governed by Pennsylvania law. The eighth is under New Jersey law, but the two states' laws on HDC status are largely consistent on the issues raised in these proceedings.
(1) the instrument when issued or negotiated to the holder does not bear such apparent evidence of forgery or alteration or is not otherwise so irregular or incomplete as to call into question its authenticity; and
(2) the holder took the instrument:
(i) for value;
(ii) in good faith;
(iii) without notice that the instrument is overdue or has been dishonored or that there is an uncured default with respect to payment of another instrument issued as part of the same series;
(iv) without notice that the instrument contains an unauthorized signature or has been altered;
(v) without notice of any claim to the instrument described in section 3306 (relating to claims to an instrument); and
(vi) without notice that any party has a defense or claim in recoupment described in section 3305(a) (relating to defenses and claims in recoupment).
13 Pa. Cons. Stat. Ann. § 3302. See also N.J.S.A. 12A:3-302. In short, an HDC is the holder of the instrument or document who took for value and in good faith without notice of any claims or defects on the instrument or document. If classified as an HDC, the holder holds without regard to defenses, with certain statutory exemptions which do not apply here. 13 Pa. Cons. Stat. Ann. § 3305; N.J.S.A. 12A:3-305.
It was clear to the parties and to the Bankruptcy Court below that Provident did not have actual possession of the notes and mortgages before November 2, 1998, when it learned that there were insufficient funds in Pinnacle's account at Provident to cover Pinnacle's checks to the closing agents here. Provident nonetheless argued that it was the holder of the notes and mortgages because, before gaining actual knowledge of Pinnacle's fraud, Provident "constructively possessed" the notes and mortgages from the moment that the closing agents, who were allegedly Provident's agents, took possession of the notes at the closings before November 2.
The Bankruptcy Court rejected Provident's argument, finding that none of the appellees acted as Provident's agents, and thus Provident never constructively or actually possessed the notes and mortgages. Thus, the Bankruptcy Court found that Provident never became the holder of these notes and mortgages in the first place. (Opinion at 53.) Alternatively, the Bankruptcy Court found that while Provident did give value for the notes and mortgages (Opinion at 54), it did not take those notes and mortgages in good faith and without knowledge of defenses, and thus Provident is not an HDC. (Opinion at 63.) The question before this Court is whether the Bankruptcy Court's rulings in this regard were clearly erroneous. I hold that it was neither clearly erroneous nor contrary to established law for the Bankruptcy Court to find that Provident did not fit the role of "good faith purchaser for value" necessary to claim HDC status even though Provident's lack of good faith arose after the title agents closed the real estate transactions. As the following discussion will explain, in the context of a course of dealing between Provident and Pinnacle extending over thousands of such transactions, Provident was essentially a party to the mortgage lending transactions and thus, by definition, cannot claim HDC status in the negotiable papers which resulted from those transactions, especially because Provident gained knowledge of defenses before its own role in the original mortgage lending transaction was complete.
I affirm the Bankruptcy Court's ruling that Provident is not the HDC of these notes and mortgages. In so holding, I need not, and thus do not, reach the issue of whether Provident constructively possessed the notes and mortgages, for holder status is irrelevant if Provident did not take in good faith and without knowledge of defenses. Because I find that the Bankruptcy Court's ruling that Provident did not take in good faith was not clearly erroneous, I affirm the ruling that Provident is not entitled to the protections afforded to a holder in due course.
The Bankruptcy Court agreed that authority from other jurisdictions suggest that a party may become a constructive holder when its agent takes possession of a negotiable instrument on its behalf. (Opinion at 36-37.) However, the Bankruptcy Court made the factual finding that appellees were not Provident's agents. It determined that though six of the ten transactions involved written agency agreements, those agreements were not controlling in light of the course of dealing between the parties (Opinion at 46), and that Provident did not otherwise meet its burden of establishing that an agency relationship existed. Because I find that the Bankruptcy Court's determination that Provident did not act in good faith is not clearly erroneous, and because the lack of good faith alone is enough of a basis to sustain a judgment that Provident is not an HDC of these eight notes and mortgages, I need not address whether the agency determination was clearly erroneous.
The Bankruptcy Court correctly stated the law on good faith in this context: the test for good faith is "not one of negligence of duty to inquire, but rather it is one of willful dishonesty or actual knowledge."Valley Bank Trust Co. v. American Utilities, Inc., 415 F. Supp. 298, 301 (E.D.Pa. 1976). See also Mellon Bank v. Pasqualis-Politi, 800 F. Supp. 1297, 1302 (W.D.Pa. 1992), aff'd, 990 F.2d 780 (3d Cir. 1993); Carnegie Bank v. Shalleck, 606 A.2d 389, 394 (N.J.Super.Ct. A.D. 1992); General Inv. Corp. v. Angelini, 278 A.2d 193 (N.J. 1971). Good faith may be defeated only by actual knowledge or a deliberate attempt to evade knowledge. Rice v. Barrington, 70 A. 169, 170 (N.J. E. A 1908). "There is no affirmative duty of inquiry on the part of one taking a negotiable instrument, and there is no constructive notice from the circumstances of the transaction, unless the circumstances are so strong that if ignored they will be deemed to establish bad faith on the part of the transferee." Bankers Trust Co. v. Crawford, 781 F.2d 39, 45 (3d Cir. 1986). Moreover, an HDC must take not only in good faith, but also without notice of defenses to the instrument or document. One has "notice" when
(1) he has actual knowledge of it;
(2) he has received a notice or notification of it; or
(3) from all the facts and circumstances known to him at the time in question he has reason to know that it exists.
Pa. Cons. Stat. Ann. § 1201.
The Bankruptcy Court here found that Provident did not in fact have actual knowledge of the fraud or potential defense of failure of consideration at the time of each separate closing. (Opinion at 58.) The Bankruptcy Court also found that despite the fact that Provident failed to review Pinnacle's books, records, and checking account ledger, failed to notice the overdraft problem, failed to properly monitor withdrawals, and failed to act after knowledge of financial deterioration in default in providing timely audited financial statements, the appellees had not proved that Provident acted with willful dishonesty (id.); Provident did act with negligence or gross negligence, but gross negligence alone is not enough to defeat an HDC's title. See Washington Canonsburg Ry. Co. v. Murray, 211 F. 440, 445 (3d Cir. 1914); General Inv. Corp., 278 A.2d 193. Moreover, the Bankruptcy Court correctly noted that holder in due course status is generally created at the time that the claimant becomes a holder — meaning at the time of negotiation. N.J.S.A. 12A:3-302; Sisemore v. Kierlow Co., Inc. v. Nicholas, 27 A.2d 473, 478 (Pa.Super.Ct. 1942). In transactions such as the ones at issue here which involve blank endorsements, the instruments and documents are bearer paper and are thus negotiated upon delivery alone. 13 Pa. Cons. Stat. Ann. § 3201; N.J.S.A. 12A:3-201.
Nonetheless, the Bankruptcy Court found that Provident failed to attain the status of a holder in due course. It acknowledged that once a party establishes its position as a holder in due course, no future action can undermine that status; so in the usual transaction with negotiable bearer paper, actual knowledge of defenses gained after possession do not defeat HDC status. (Opinion at 63.) See Bricks Unlimited, Inc. v. Agee, 672 F.2d 1255, 1259 (5th Cir. 1982); Park Gasoline Co. v. Crusius, 158 A. 334 (N.J. 1932). However, the Bankruptcy Court said, it was not finding lack of good faith after gaining HDC status, but rather that Provident did not gain HDC status in the first place, for these were not the "usual" transactions. Taken in a "global sense," the Bankruptcy Court said, these transactions did not end until after the settlements. (Opinion at 58.)
Usually, one who takes a negotiable instrument for value has only the underlying circumstances of that transaction by which to determine if there is reason to give pause as to the veracity of that instrument. A lender provides funds to a borrower who executes a promissory note. Once that transaction is complete, the lender transfers the note to a second lender in exchange for which the first lender receives funds replenishing his account and enabling him to lend the same funds to another borrower. HDC status is given to that second lender if it acts in good faith and without knowledge of defenses, and there is no general duty for that second lender to inquire unless the circumstances are so suspicious that they cannot be ignored. See, e.g. Triffin, 670 A.2d at 692. In the usual HDC transaction, there are two discernible transactions, two exchanges of funds and notes. As the Bankruptcy Court pointed out, the purpose of giving that second lender HDC status is "to meet the contemporary needs of fast moving commercial society . . . (citation omitted) and to enhance the marketability of negotiable instruments [allowing] bankers, brokers and the general public to trade in confidence." Triffin, 670 A.2d at 693. However, "the more the holder knows about the underlying transaction, and particularly the more he controls or participates or becomes involved in it, the less he fits the role of a good faith purchaser for value; the closer his relationship to the underlying agreement which is the source of the note, the less need there is for giving him the tension-free rights necessary in a fast-moving, credit-extending commercial world." Unico v. Owen, 50 N.J. 101, 109-110 (1967). See also Jones v. Approved Bancredit Corp., 256 A.2d 739, 742 (Del. 1969) (in such a situation, "[the financer] should not be able to hide behind `the fictional fence' of the . . . UCC and thereby achieve an unfair advantage over the purchaser.").
Here, there were not two separate, discernible transactions. Provident's funding of Pinnacle who funded the borrowers was one complex transaction. The acts of a third party investor who would buy the notes and mortgages from Provident would have been the second separate, discernible transaction here. Provident did not replenish Pinnacle's account in exchange for receiving the notes and mortgages, such that Pinnacle would have more money to make more loans, as in the "usual" transaction. Rather, in a complex and longstanding scheme encompassing thousands of transactions over several years, Provident gave Pinnacle a line of credit, and then, after Pinnacle gave Provident information about individual proposed loans to borrowers, Provident transferred money to Pinnacle's account, in order to later receive the note and mortgage from each transaction and pass them on to a third party investor. The Bankruptcy Court, as a factual matter, found that under this complex scheme, no transactions between any of the parties were complete untilboth of the transactions were concluded, particularly because the "second lender" (Provident) had the ultimate control over the first transaction (by ordering the dishonor of Pinnacle's checks).
Under the Bankruptcy Court's findings of fact, Provident was, in reality, a party to the original transaction. The situation is somewhat analogous to a consumer goods financer who has a substantial voice in the underlying transaction; that financer is not entitled to HDC status. Westfield Investment Co. v. Fellers , 181 A.2d 809 (N.J.Super.Ct. Law Div.). Provident had a substantial voice in providing and carrying out funding of the underlying borrowing transactions, and it thus cannot claim that it was a good faith HDC when it learned of the defense of failure of consideration prior to dishonoring the Pinnacle checks.
I cannot say that the Bankruptcy Court's factual finding was clearly erroneous. The Bankruptcy Court's ruling accords with the evidence as well as with the policy underlying the holder in due course doctrine. I hold that where a warehouse lender so closely participates in the funding and approval of mortgages which will ultimately lead to the warehouse lender's rights in mortgages and promissory notes that the transactions between mortgage banker and mortgagor and between warehouse lender and mortgage banker are in fact one continuous transaction, rather than two discernible transactions, a showing of the warehouse lender's lack of good faith after the closing between title agent and mortgagor but before the mortgage banker's check is presented to the warehouse lender may destroy HDC status. Indeed, where the party who claims HDC status was in essence a party to the original transaction, it cannot, by definition, be a holder in due course.
Provident had a great deal of involvement in the ongoing series of transactions and ample knowledge of Pinnacle's overall financial well-being, developed through years of funding Pinnacle's credit line for thousands of such transactions and receipt of Pinnacle's periodic financial reports. It had particular information about the borrowers before it funded these loans. It was, in fact, part of the loan transactions, and not a separate party who became an HDC through the giving of value at a second separate, discernible transaction. Provident had too much control of, participation in, and knowledge of the underlying transaction to claim that it was a good faith purchaser for value. See, e.g., Fidelity Bank Nat'l Assoc., 740 F. Supp. at 239.
Because, under this complex transactional scheme, Provident functioned essentially as a party which approved and funded the loans and gained actual knowledge of a defense to the notes and mortgages (lack of consideration) before the transactions were complete, it was not clearly erroneous for the Bankruptcy Court to find that Provident lacked the good faith necessary to claim HDC status. Accordingly, the Bankruptcy Court's ruling is affirmed.
VI. CONCLUSION
For the foregoing reasons, I will affirm the Bankruptcy Court's ruling that appellant Provident Savings Bank was not the holder in due course of the notes and mortgages from the ten transactions closed by appellees. The defense of failure of consideration thus is available against Provident. I therefore affirm the Bankruptcy Court's judgment that appellees, and not appellant, are entitled to the notes and mortgages. The accompanying Order is entered.
ORDER
This matter having come upon the court upon the appeal of appellant, Provident Savings Bank, from a Judgment entered on December 17, 1997, by the Honorable Judith H. Wizmur, United States Bankruptcy Judge for the District of New Jersey,; and the Court having considered the parties' submissions; and for the reasons set forth in the Opinion of today's date;
IT IS this day of December, 1998, hereby
ORDERED that the Judgment entered by the Honorable Judith H. Wizmur, United States Bankruptcy Judge for the District of New Jersey, on December 17, 1997, which granted the notes and mortgages from transactions closed by the appellees in this matter to the appellees, be, and hereby is, AFFIRMED.