Banking and Finance Law Report : Banking & Finance Lawyer & Attorney : Porter Wright Morris & Arthur Law Firm : Bankruptcy, Commercial Lending

Receiverships have gained in popularity in foreclosure cases and in other types of litigation in recent years. Orders appointing receivers and setting forth the receiver’s duties frequently include a provision allowing the receiver to market and sell real estate. However, the question of whether a receiver legally has the ability to convey title to real estate, free and clear of liens and encumbrances, appears to have been answered in the negative, at least by one appellate district in Ohio.

In 2008, the Eighth District Court of Appeals handed down its decision in the matter of Ohio Director of Transp. v. Eastlake Land Dev. Co., 177 Ohio App.3d 379, 2008-Ohio-3013, 894 N.E.2d 1255. In what appears to be a classic example of bad facts making bad law, the appellate court reversed the lower court’s approval of a receiver’s sale of real property free and clear of liens. In Eastlake, which was not a foreclosure, the court-appointed receiver sought authority to sell a parcel of real estate for the sum of $250,000, an amount which he stated he “believed” was a commercially reasonable price for the property. In connection with the motion, the receiver presented no evidence of his marketing and sale efforts, nor did he present any evidence regarding the value of the property. Notably, the receiver’s motion did not state that he intended to sell the property free and clear of AFF’s liens. The senior lienholder, American First Federal, Inc. (“AFF”) intervened in the case and filed an objection to the receiver’s motion to sell the property for less than what was owed to AFF. 

On January 20, 2007, the court issued two, inconsistent orders related to the receiver’s motion. In the first, the court set the receiver’s motion for hearing on February 13, 2007. In the second, the court “inexplicably” granted the receiver’s motion to sell, without vacating the order setting the hearing.   In its approval of the motion, the trial court specifically authorized the receiver’s sale free and clear of AFF’s liens. On February 2, 2007, (presumably unaware of the court’s 1/20/07 granting of the sale motion) AFF filed its objection to the receiver’s motion and in that objection (1) submitted a credit bid of $251,000 and (2) offered evidence to the court that the property in question was worth at least $600,000.

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The recent equitable subordination cases of In re Kreisler and Erenberg, 546 F.3d 863 (7^th Cir. 2008) and Credit Suisse v. Official Committee of Unsecured Creditors (In re Yellowstone Mountain Club, LLC), Bankr. D. Mont., No. 09-00014 show a possible deviation in the courts regarding the proper application of the doctrine of equitable subordination. Accordingly, secured lenders should stay abreast of these different interpretations and possibly consider adjusting their lending practices. Those who fail to do so could see their claims in bankruptcy move further down the chain of priority.

The doctrine of equitable subordination allows a bankruptcy court, using principles of equity, to subordinate all or part of one creditor’s claim to all or part of another creditor’s claim where the inequitable conduct of one creditor has caused injury to the interests of another creditor. Codified at 11 U.S.C. § 510(c), the doctrine is simple to state and yet, at least it would appear, is rather difficult to apply.

Courts have adopted the Mobile Steel Test as a method to decide when it is appropriate to invoke the doctrine of equitable subordination. The Mobile Steel Test, as its name suggests, originates in the case of In re Mobile Steel Co., 563 F.2d 692 (5^th Cir. 1977). The Mobile Steel Test lays out three conditions that must be satisfied before exercising the power of equitable subordination. They are as follows:

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In Wilborn v. Bank One Corporation (Slip Opinion No. 2009-Ohio-306), the Supreme Court of Ohio upheld a provision in a residential mortgage contract that required a defaulting borrower to pay a lender's reasonable attorney fees as a condition for reinstating a defaulted loan and terminating foreclosure proceedings.  Although this decision merely upholds a common practice among lenders, there should be little doubt now that Ohio lenders may require the payment of attorney fees to reinstate a mortgage in foreclosure, particularly if the mortgage was a standardized Fannie Mae or Freddie Mac document. 

The crux of the Wilbon matter centered on the apparent conflict between the mortgage document (which required payment of attorney fees as a condition of loan reinstatement after default) and Ohio public policy and common law dating back to 1893 (prohibiting the recovery of attorney fees resulting from a default upon a consumer or residential debt obligation). 

The Court walked a twisting and very narrow path to arrive at its conclusion, first finding that the current statutory scheme under R.C. 1301.21 authorizing the payment of attorney fees was merely illustrative and did not prohibit recovery in all other circumstances.  Next, the Court distinguished between the borrower's contractual right to reinstatement of the loan from its legal right to redeem the property.  Holding that while attorney fees may not be recovered as a condition to redemption, the payment of such fees was a reasonable bargin for the lender to agree to terminate foreclosure proceedings and voluntarily re-enter the loan arrangement with the consumer.  Finally, the Court found that the Fannie Mae/Freddie Mac documents were not contracts of adhesion because industry groups and consumer advocate groups were heavily involved in the negotiation and implementation of these form documents.  So while the individual borrower may have little power to alter the terms and conditions of the mortgage, the process by which the template for these forms came about was sufficient to protect the borrower's interests in this regard.

The takeaway from this case is that borrowers can likely be required to pay their lenders' attorney fees as a condition to loan reinstatement, and lenders can erase any doubt as to the enforcibility of these provisions by using Fannie/Freddie standardized loan documents rather than their own customized loan documents. 

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House Bill 138, effective September 11, 2008, makes sweeping and widespread changes to the substantive and procedural aspects of foreclosures in Ohio.  Although the actual implementation of these new standards may vary and each county's procedures must be verified for all current and future foreclosure cases, those currently in progress as of September 11, 2008 should be subject to the former statutes as to substantive matters but will be subject to the procedural changes in the new legislation.  Highlights are as follows:

• The court may require mediation of any foreclosure at any point during the proceeding and may require the personal attendance of both the mortgagor and mortgagee.
• The lis pendens date is changed from the date service is perfected on the principal defendant(s) to the date the complaint is actually filed.  Although this change doesn't eliminate the requirement that service be obtained on the defendant at some point in the case, it does create some certainty about the point at which subsequent liens are barred.
• In residential foreclosures a Preliminary Judicial Report (PJR) obtained from a title company must be filed within 14 days of the complaint and updated by a Final Judicial Report prior to the court issuing an order of sale.  Commercial foreclosures have the option of using a PJR or a standard title commitment. 
• The officer making the sale is required to collect certain purchaser information, such as contact information, the name of the purchaser and the name to which title should be conveyed, and other information.  This requirement applies to the foreclosing lender as well, should that lender be the successful bidder at the sale. 
• An obligation is placed on the parties to have the sale confirmed within thirty days of the sale, and the purchaser must pay the balance due within that time.  Failure to do so may be treated as a contempt of court and may result in forfeiture of the deposit.  The court is also granted broad authority to stay confirmation to give the defaulting borrower time to redeem the property or "for any other reason the court deems appropriate."
• The deed must now be prepared by the lender's attorney and submitted to the sheriff, who now handles recording.  Because taxes, conveyance fees and other charges must be paid prior to recording, lenders are being asked to submit a certain amount of money (varying by county) to cover these costs. 

Some of the foregoing changes, such as the revised lis pendens date, will speed the foreclosure process along and make title examination much easier.  Other changes will benefit consumers and title agents, such as the residential PJR requirements.  Lenders should note, however, that there are a number of pitfalls in this legislation that have the potential to extent foreclosure proceedings.  First, the possibility of mediation could result in delay, particularly when the borrower gives at least the appearance of being able to bring the loan current.  In addition, the court now has the discretion to stay a sale confirmation to give the defaulting borrower additional time to redeem the property or for any other reason the court deems appropriate.  How courts will use this apparently unfettered discretion remains to be seen.  In all events lenders will be saddled with additional costs and delays in what is already a time-consuming process. 

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