Opinion
Civ. No. 04-3061 (JNE).
March 30, 2005
Michael L. Brutlag, Esq., and Ryan J. Trucke, Esq., Brutlag, Hartmann Okoneski, P.A., appeared on brief for Wells Fargo Home Mortgage, Inc.
Michael S. Dietz, Esq., and Phong M. Luong, Esq., Dunlap Seeger, P.A., appeared on brief for Michael S. Dietz, Trustee of the Bankruptcy Estate of Edward L. Gross and Nellie Daune Roberts.
ORDER
This matter is before the Court pursuant to Wells Fargo Home Mortgage, Inc.'s (WFHM) and Michael S. Dietz's, Trustee of the Bankruptcy Estate of Edward L. Gross and Nellie Daune Roberts (Trustee), cross-appeals from the United States Bankruptcy Court for the District of Minnesota's May 13, 2004 Order. For the reasons set forth below, the Court affirms the decision of the bankruptcy court.
This Court has jurisdiction to hear appeals from final judgments, orders, and decrees entered by the United States Bankruptcy Court pursuant to 28 U.S.C. §§ 158(a)(1), 158(c)(1)(A)(2000).
The Honorable Gregory F. Kishel, Chief United States Bankruptcy Judge, presiding.
I. BACKGROUND
In 2001, Gross and Roberts, husband and wife, moved to Rochester, Minnesota, after Gross accepted a job as a physician at the Mayo Clinic. On or about June 1, 2001, Gross and Roberts entered into a Purchase Agreement to buy a home located at 2345 Transit Court (Property) for $1.15 million. WFHM financed $862,500 toward the purchase of the Property.Gross closed on the WFHM loan to be secured by a mortgage on the Property (Mortgage) on August 20, 2001. Neither Gross nor Roberts attended the closing; instead, an attorney-in-fact represented Gross. Gross' attorney-in-fact executed the Mortgage on the Property in favor of WFHM. Only Gross' signature, made through his attorney-in-fact, appears on the Mortgage. Also on August 20, 2001, the Warranty Deed was executed, wherein the previous owners of the Property conveyed and warranted to Gross and Roberts, as joint tenants, the Property.
On December 20, 2002, Gross and Roberts filed a Chapter 7 bankruptcy petition. On April 14, 2003, the Trustee commenced an adversary proceeding in bankruptcy court against WFHM. In its Complaint, the Trustee sought to avoid the Mortgage held by WFHM that encumbered the homestead of Gross and Roberts pursuant to 11 U.S.C. § 544(a)(2000). In addition, the Trustee alleged that the Mortgage should be equitably subordinated to the unsecured creditors' claims represented by the bankruptcy estate pursuant to 11 U.S.C. § 510(c).
While the adversary proceeding was pending, the Trustee sold the Property free and clear, and the WFHM Mortgage attached to the proceeds, subject to a final determination of the bankruptcy court concerning the validity and extent of the WFHM Mortgage. After discovery, both parties moved for summary judgment. The bankruptcy court held that the Mortgage did not attach to Roberts' ownership interest in the Property and that any claimed mortgage lien against Roberts' interest was unenforceable and therefore avoided. In addition, the bankruptcy court dismissed the Trustee's equitable subordination claim.
II. DISCUSSION
1. Standard of Review
This Court reviews de novo the bankruptcy court's decision to grant summary judgment. In re Cochrane, 124 F.3d 978, 981 (8th Cir. 1997). Summary judgment is proper "if the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law." Fed.R.Civ.P. 56(c). In determining whether summary judgment is appropriate, a court must look at the record and any inferences to be drawn from it in the light most favorable to the party opposing the motion. Anderson, 477 U.S. at 255. The moving party "bears the initial responsibility of informing the district court of the basis for its motion," and must identify "those portions of [the record] which it believes demonstrate the absence of a genuine issue of material fact." Celotex Corp. v. Catrett, 477 U.S. 317, 323 (1986). If the moving party satisfies its burden, Rule 56(e) requires the party opposing the motion to respond by submitting evidentiary materials that designate "specific facts showing that there is a genuine issue for trial." Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. 574, 587 (1986).
2. Lien Avoidance
The first issue before the Court is whether the WFHM Mortgage is valid and enforceable against Roberts' interest in the Property and whether any Mortgage lien may be avoided as against Roberts' interest. In the underlying adversary proceeding, the Trustee sought to avoid the WFHM Mortgage pursuant to 11 U.S.C. § 544. The bankruptcy court ruled that, as a matter of law, any mortgage lien claimed by WFHM against the undivided one-half interest in the Property that was formerly held by Roberts was "null, void and unenforceable under Minnesota law." Thus, to the extent of Roberts' ownership interest, the mortgage was effectively avoided as a lien. WFHM contends that the bankruptcy court's decision to grant summary judgment in favor of the Trustee with respect to Roberts' interest was in error.
The bankruptcy court explained that the situation did not involve an "avoidance per se because the interest never really attached." (Tr. of May 4, 2004 Hr'g on Mot. for Summ. J. at 7.)
The facts relevant to this issue are few and uncontested. Gross and Roberts each held a one-half interest in the Property as joint tenants. Despite the fact that Roberts did not sign the Mortgage, WFHM contends that the Mortgage was valid on the entire interest, including that of Roberts, and that it is entitled to the funds from the sale of the Property. The parties agree that the WFHM Mortgage is a purchase-money mortgage, but dispute the proper application of Minnesota law to a purchase-money mortgage that was executed by only one of two married persons who own a homestead as joint tenants.
WFHM devotes a considerable portion of its appellate brief to the history of the doctrine of favoring purchase-money mortgages. The Court acknowledges that the nature and purpose of the purchase-money mortgage is to secure the repayment of funds provided by a lender to enable the acquisition of the property pledged as a security. See Wells Fargo Home Mortgage, Inc. v. Newton, 646 N.W.2d 888, 893 (Minn.Ct.App. 2002). The Court also recognizes that the Minnesota Court of Appeals has explained that in Minnesota, the purchase-money mortgage is superior to any other party's interest in the property. See id. (citing Stewart v. Smith, 30 N.W. 430, 431 (1886) (noting that a purchase-money mortgage takes precedence over any other claim or lien arising through the mortgagor)). The parties, however, do not cite to, and the Court is not aware of, any decision based on a factual scenario identical to this one, i.e., where only one joint-tenant spouse executes a purchase-money mortgage on a jointly-owned property.
WFHM relies heavily on Minn. Stat. § 507.02 (2000), and Newton to support its argument. In reaching its conclusion that the WFHM Mortgage did not attach to Roberts' ownership interest in the Property, the bankruptcy court analyzed § 507.02 and § 507.03. The same statutes guide this Court's analysis.
First, § 507.02 reads in relevant part:
Conveyances by spouses; powers of attorney
If the owner is married, no conveyance of the homestead, except a mortgage for purchase money unpaid thereon, . . . shall be valid without the signatures of both spouses. A spouse's signature may be made by the spouse's duly appointed attorney-in-fact.
Minn. Stat. § 507.02 (emphasis in original).
The basic policy objective of § 507.02 is "protecting the alienation of the homestead without the willing signatures of both spouses." Newton, 646 N.W.2d at 895 (quoting Dvorak v. Maring, 285 N.W.2d 675, 678 (Minn. 1979)).
Second, § 507.03 reads in relevant part:
Purchase-money mortgage; nonjoinder of spouse
When a married individual purchases real property during marriage and mortgages the real property to secure the purchase price or any portion of it, the other spouse shall not be entitled to any inchoate, contingent, or marital property right or interest in the real property as against the mortgagee . . . even though the other spouse did not join the mortgage.
Minn. Stat. § 507.03 (emphasis in original). WFHM contends that under § 507.02, both spouses' homestead rights are deemed subordinate to those of a purchase-money lender, regardless of whether both spouses execute the mortgage. The Trustee, on the other hand, asserts that both § 507.02 and § 507.03 concern only inchoate marital rights and are, therefore, inapplicable to the present situation because Roberts' interest in the Property is that of a fee title holder. The bankruptcy court adopted the Trustee's argument and explained that there is no reasonable way to construe the facial language of those two statutes so as to hold for WFHM. The Court agrees.
Reading § 507.02 and § 507.03 together, the Court concludes that both provisions relate to a disclaimer of inchoate, contingent, or marital rights of a spouse who is not a titled owner to the property. Specifically, § 507.03 indicates that there are no inchoate marital rights superior to the rights of a purchase-money mortgage holder on real property. Because a titled owner would not need to rely on inchoate rights, this section necessarily addresses a situation in which one spouse is the sole owner of property. In particular, § 507.03 provides that a purchase-money mortgage is not invalidated by the failure of a non-titled spouse to sign a mortgage by way of the non-signing spouse's inchoate, contingent, or marital property rights. Thus, on its face, § 507.03 does not apply to a spouse who owns property as a joint tenant.
Moreover, § 507.02 creates an exception to the general rule of § 507.03, providing that in the case of homestead real property, "[i]f the owner is married, no conveyance of the homestead . . . shall be valid without the signature of both spouses." Section 507.02 does not, however, extend so far so as to subordinate the rights of a purchase-money lender to the inchoate right created for homestead property. The Court, therefore, agrees with the bankruptcy court's conclusion that the purchase-money mortgage exception to the requirement of both spouses' signatures found in § 507.02 relates only to the inchoate marital rights of the non-signing spouse. Thus, neither statute is implicated here because Roberts' interest in the Property is that of a joint tenant, or a fee title holder, and is not based on inchoate marital rights.
Similarly, WFHM's reliance on Newton is misplaced. In Newton, the Minnesota Court of Appeals held that the spousal-signature requirement of § 507.02 did not apply to the portion of a mortgage that secured the unpaid purchase price of a homestead. 646 N.W.2d at 897. However, in that case, the spouse who did not sign the mortgage did not own the house, was not on the deed, id. at 891, and therefore had only inchoate rights to the property arising from his marital status. Here, on the other hand, Roberts has an actual fee simple title interest in the Property. WFHM submits that the distinction between Newton, which involved a sole title holder to the subject property, and this case involving joint tenants, is of no consequence and that the purchase-money mortgage should trump all other interests, including that of a non-signing joint tenant. The Court, however, finds the distinction significant and refuses to extend the ruling in Newton to allow a joint tenant to unilaterally convey away the interest of another fee simple owner of a homestead property.
This conclusion is consistent with what appears to be an intended purpose of the homestead purchase-money mortgage exception of § 507.02 — protecting a lender from invisible rights against which it cannot protect itself. Here, Roberts' rights in the Property as a joint tenant were not invisible to WFHM. Indeed, the Warranty Deed, which was executed on the same day as the Mortgage, clearly conveyed the Property to both Roberts and Gross as joint tenants. WFHM could have required all of the grantees on the deed (including Roberts) to sign the Mortgage. It did not and, therefore, the Mortgage cannot be valid as to Roberts' interest in the Property. To hold otherwise would allow a joint-tenant spouse to grant a lien on property owned by another joint-tenant spouse without his/her consent or even over his/her objection.
After reviewing the relevant statutes and case law, and for the reasons discussed above, the Court affirms the bankruptcy court's conclusion that any mortgage lien claimed by WFHM against the undivided one-half interest of Roberts was null, void, unenforceable and therefore avoided. 3. Equitable subordination
The second issue before the Court is whether the WFHM Mortgage could be equitably subordinated. Specifically, the bankruptcy court held that the Trustee's equitable subordination claim fails for lack of evidence of a specific intention on the part of WFHM to injure Gross and Roberts, other creditors, or to gain an unfair advantage over other creditors. The Trustee argues that the bankruptcy court erred in granting summary judgment because genuine issues of fact exist as to whether WFHM engaged in misconduct throughout the loan application process so as to merit the subordination of WFHM's claim to those of the unsecured creditors.
Specifically, the Trustee alleges that Jill Savage, a Senior Mortgage Consultant for WFHM, included false, material information on Gross' loan application so that it would be approved by WFHM. For example, the Trustee contends that Gross completed a handwritten application in Savage's presence and that Savage directed him to list under the category of "Cash Value, Stocks, Bonds, Securities," a judgment of $960,000 which had been awarded to Gross in a lawsuit in Canada but which was on appeal. In addition, the Trustee claims that when Savage prepared subsequent versions of Gross' loan application, she omitted and inaccurately transferred certain pieces of information. For example, despite the fact that Savage knew Gross was a party in a case pending in Canada, Savage denied that Gross was a party to a lawsuit. In addition, Savage noted that Gross owned $1 million in "MISC STOCK PORTFOLIO" when, indeed, Gross did not own any stocks.
The parties give two very different accounts of the facts underlying the Trustee's equitable subordination claim. For example, Savage denies ever meeting with Gross or assisting him with any paperwork. For purposes of this appeal, wherein the Trustee claims that summary judgment was improperly granted, the disputed facts as stated here, unless otherwise indicated, are construed in the light most favorable to the Trustee. See Anderson, 477 U.S. at 255.
Finally, the Trustee suggests that WFHM concocted a fake Rental Agreement to facilitate approval of the loan. Specifically, the Trustee asserts that Gross' loan was finally approved after initially being suspended only after it received evidence of a Rental Agreement purporting to indicate rental income in the amount of $14,000 per month that Gross would earn by leasing his home in Canada. The Trustee questions the legitimacy of the Rental Agreement, claiming Gross never entered into such an agreement, never heard of the purported renter, and had never seen the Rental Agreement prior to his deposition in this case. The Trustee also disputes whether Gross' apparent signature on the Rental Agreement is legitimate.
Pursuant to § 510(c), a court may, under principles of equitable subordination, subordinate all or part of an allowed claim or interest to another allowed claim or interest, or order that any lien securing such a subordinated claim be transferred to the estate. 11 U.S.C. § 510(c). The Trustee must demonstrate the existence of three conditions to merit equitable subordination: (1) WFHM engaged in some type of inequitable conduct; (2) WFHM's misconduct resulted in injury to the creditors of the bankrupt or conferred an unfair advantage on the claimant; and (3) the result of equitable subordination of the claim is not inconsistent with the provisions of the Bankruptcy Code. United States v. Noland, 517 U.S. 535, 538-39 (1996) (citing In re Mobile Steel Co., 563 F.2d 692, 700 (5th Cir. 1977) and noting that district courts and courts of appeals have generally followed the Mobile Steel formulation). See also In re Bellanca Aircraft Corp., 850 F.2d 1275, 1283 (8th Cir. 1998); In re Northgate Computer Sys., Inc., 240 B.R. 328, 367 (D. Minn. 1999). In addition, because the Trustee does not allege, and there is no evidence to support, the existence of an insider relationship between Gross and WFHM, the Trustee must demonstrate "gross misconduct," or something equivalent to it, on the part of WFHM to establish the existence of inequitable conduct. See Baker Getty Fin. Servs., Inc. v. Rafoth, 974 F.2d 712, 718 (6th Cir. 1992); In re Northgate, 240 B.R. at 368.
The Supreme Court noted that the third requirement "has been read as a reminder to the bankruptcy court that although it is a court of equity, it is not free to adjust the legally valid claim of an innocent party who asserts the claim in good faith merely because the court perceives that the result is inequitable." Noland, 517 U.S. at 539 (quotation omitted).
Courts have explained that the prior relationships of the parties is relevant when determining the character and extent of misconduct that will merit equitable subordination. In re Northgate Computer Sys., 240 B.R. at 368.
The bankruptcy court noted correctly that to prevail on an inequitable subordination claim, one must demonstrate that the misconduct occurred in relation to, or was directed at, the bankruptcy estate or the creditors. See Baker Getty, 974 F.2d at 719 (holding that bank's actions fail to meet first part of the Mobile Steel test where bank's conduct not specifically directed toward the injury of the debtor or other creditors). Here, WFHM's actions, while perhaps neither prudent nor sound, do not rise to the level of "gross misconduct" to merit equitable subordination. Specifically, even when viewing the facts in the light most favorable to the Trustee, there simply is no evidence that WFHM directed any questionable conduct to the bankruptcy estate or creditors. First, WFHM's approval of Gross's Mortgage occurred before bankruptcy proceedings were initiated. Second, there is no evidence in the record that WFHM coerced Gross into signing the loan. To the contrary, the evidence reveals that Gross voluntarily applied for and signed the loan. Third, there is no evidence that WFHM attempted to tie-up value to prevent other creditors from laying claim to it in the future. Indeed, to the extent that WFHM recovers anything on the loan, it is simply collecting funds that it advanced to Gross to purchase the Property. Cf. Toledo Trust Co. v. Peoples Banking Co., 52 B.R. 679, 691 (N.D. Ohio 1985) (rejecting the argument that refusal to equitably subordinate claim by bank would harm unsecured creditors despite the fact that bank's policies were lax and ill advised). Accordingly, the Court concludes that WFHM's actions do not meet the first prong of the Mobile Steel test.
In addition, WFHM argues that the Trustee has failed to demonstrate any actual harm to creditors or unfair advantage conferred to WFHM as required by the second prong of the Mobile Steel test. The Trustee's claim that creditors have been harmed is premised on the argument that wrongful approval of the loan caused harm to unidentified creditors. In particular, the Trustee asserts that if WFHM had properly rejected Gross' loan application, Gross would not have had financing to purchase the Property and, instead, would have purchased a modestly priced home, thereby allowing Gross to pay off other creditors without having to resort to bankruptcy protection. This argument, however, is not supported by any proof of injury to creditors, let alone any injury caused by WFHM. Therefore, the Trustee has failed to meet his burden with respect to the second prong of the Mobile Steel test. See In re Bellanca, 850 F.2d at 1282; Diazo Serv. Co., v. Redmond, 144 B.R. 771, 777 (M.D. Tenn. 1992) (noting that the failure to link inequitable conduct to injury is fatal to claim of inequitable subordination).
Because the Trustee has failed to demonstrate that WFHM engaged in inequitable conduct or that any injury to creditors was caused by any of WFHM's actions, the Trustee's equitable subordination claim fails as a matter of law. The bankruptcy court's order granting summary judgment to WFHM on the Trustee's equitable subordination claim is, therefore, affirmed.
III. CONCLUSION
Based on the foregoing, and all the files, records and proceedings herein, IT IS HEREBY ORDERED that the bankruptcy court's Order is AFFIRMED.