In re Marohn

Full title: In re: MICHAEL R. MAROHN, MARY LYNN MAROHN, Chapter 11, Debtors

Court: United States Bankruptcy Court, E.D. Virginia

Date published: Sep 26, 1997

Case No. 96-10340-SSM (Bankr. E.D. Va. Sep. 26, 1997)

Opinion

Case No. 96-10340-SSM

September 26, 1997

Bennett A. Brown, Esquire, Fairfax, VA, Counsel for the debtors in possession

Bruce A. McKechnie, Esquire, Locust Grove, VA, Counsel for REO, L.C.

MEMORANDUM OPINION

STEPHEN MITCHELL, Bankruptcy Judge

This matter is before the court on the objection of the debtors in possession to Claim No. 9 in the amount of $50,471.76 filed by Samson Financial on March 8, 1996. As discussed below in more detail, this proof of claim was purportedly "amended" by Claim No. 19 filed by REO, L.C. on May 23, 1997, in the amount of $495,475.30. An evidentiary hearing was held on September 18, 1997, at which the court heard the contentions of the parties with respect to both claims.¹ At the conclusion of the hearing, the court took the matter under advisement and, having reviewed the evidence and the applicable law, is now prepared to rule. This memorandum opinion constitutes the court's findings of fact and conclusions of law as required by F.R.Bankr.P. 7052.

1 Following the hearing, the debtors filed a formal objection to Claim No. 19 on September 22, 1997. The sole ground of objection is that the proof of claim was not timely filed.

Findings of Fact

Michael R. Marohn and Mary Lynn Marohn, who are husband and wife ("the debtors"), filed a joint voluntary petition in this court under chapter 11 of the Bankruptcy Code on January 26, 1996. They have remained in possession of their estate as debtors in possession since that date. A plan of reorganization has not yet been proposed.

Both debtors are physicians. In the summer of 1993, they became involved in a business transaction with Richard and Susan Hallock involving the purchase of a parcel of real estate at 1106 Mill Ridge, McLean, Virginia² and the construction of a house, which was then intended to be sold at a profit. The debtors, who apparently had no experience in real estate development, gave Richard Hallock their powers of attorney to represent them in the purchase of the property and the construction of the house. All the negotiations for the loan to purchase the property and construct the house were negotiated by Richard Hallock, who described himself as "builder/developer" and as the debtor's agent with respect to the project.

2 The legal description of the property was Lot 13, Swinks Mill Woods, Fairfax County, Virginia.

The debtors purchased the property from Yudh Vir Gupta, Kamlesh Gupta, Ved P. Tayal, and Krishna Tayal for $400,000. The sellers agreed to take back a $250,000 note secured by a second deed of trust against the property. Samson Financial Group, Inc. ("Samson"), at Richard Hallock's request, agreed to make a $682,000.00 construction loan, to be secured by a first-lien deed of trust against the property. For reasons that are unexplained, separate settlements were held, albeit on the same day (September 23, 1993), with respect to the Samson loan and the purchase from the Guptas and the Tayals. Additionally, although the settlement statement reflects the construction loan as being made from Samson directly to the Marohns, the notes executed by the Marohns at settlement were actually made payable to Richard Hallock and Susan Hallock, who then endorsed them to Samson.³ The total loan amount was divided among five separate promissory notes — one (Note No. 1) in the amount of $223,768.00 and four (Notes No. 2 through 5) in the amount of $114,558.00 each — apparently to facilitate their placement into mortgage investment "pools." Note No. 1 was subsequently transferred to an entity called Instant Money, Inc., apparently under an agreement that gave it priority over the four remaining notes.⁴ Three of the notes were transferred to entities designated as SFG Mortgage Pass-Through Certificates Series 92-1, 93-1, and 94-1, while the fourth note was transferred to The Elm Company, as servicer for SFG Mortgage Pass-Through Certificates Series 93-1.

3 Kevin C. Samson, the president of Samson, testified that the reason this was done was to ensure that the Hallocks were also personally liable on the notes.

4 The deed of trust treats the notes as having equal priority. No issue has been raised by the debtors, however, with respect to the issue of priority, and for the purpose of this opinion the court treats the note held by Instant Money, Inc., as functionally the equivalent of a first lien against the property, the four notes held by REO, L.C. as the equivalent of a second lien, and the lien held by the Guptas and the Tayals as the equivalent of a third lien.

The loan made by Samson carried a 15% discount fee and a periodic interest rate of 12.5% and was due in full on September 23, 1998. Of the $682,000 loan amount, $223,768.00 was disbursed at settlement. After deduction of the 15 points to Samson, $187,682.76 was paid to the Marohns. Of that amount, $152,609.94 was shown on the separate settlement statement prepared for the Guptas and the Tayals — who were unaware that the "down payment" consisted of borrowed money — as "cash from" the Marohns. The remaining $35,072.82 was apparently turned over to Richard Hallock to pay various fees that had been incurred for plans, permits, and the like.

The original estimate of construction costs was $619,695. Not surprisingly, the $458,232 remaining for draws on the Samson loan did not prove adequate to finish construction, and construction eventually ceased with the house only about 65% complete. The Hallocks had been making the monthly payments on the notes, but apparently stopped doing so at approximately the same time as construction ceased. It was in late 1995 or early 1996 that the debtors discovered that the Hallocks had opened a number of charge accounts in the debtors' name without their knowledge or permission. Michael Marohn contacted Kevin C. ("K.C.") Samson, the president of Samson Financial Group, to reach some sort of settlement. The efforts were unsuccessful because the Hallocks would not agree to the proposal, and no agreement was ever signed.

The debtors, as noted above, filed their chapter 11 petition on January 26, 1996. They filed schedules listing Instant Money, Inc. as a secured creditor in the amount of $225,000.00 and Samson Financial Group as a secured creditor in the amount of $457,000.00. Neither claim was scheduled as contingent, unliquidated, or disputed. The bar date for filing proofs of claim was June 3, 1996. On March 8, 1996, a proof of claim was filed in the name of "Samson Financial" in the amount of $50,471.76.⁵ No supporting documents, as expressly required by the instructions, were attached. The proof of claim was further deficient in failing to state the "Basis for Claim" and the "Date Debt Was Incurred." At the hearing, counsel who signed the proof of claim — and who is the same attorney now representing REO, L.C. — explained that the amount shown consisted of the accrued unpaid interest on Notes No. 2 through 5 and did not include the principal balance because the notes had not matured.

5 Counsel explained that he had filed the proof of claim in the wrong name because he had not had time to research who was actually the owner of the notes and he was anxious to get the claim filed by the bar date. However, on the same day as he filed the proof of claim, he filed — as counsel for Instant Money, Inc., and REO, L.C. — a motion for relief from the automatic stay that correctly set forth the ownership of the five notes. The court can only conclude that counsel signed the proof of claim with little if any concern for its accuracy or completeness.

It was stipulated at the hearing that Notes No. 2 through 5 had been transferred "without recourse" to REO, L.C. in the latter half of 1995, and that Samson Financial Group, Inc., had no interest, whether as holder or as servicing agent, in the notes, either at the time the debtors filed their chapter 11 petition or at the time the proof of claim was filed.

On the same date that the proof of claim was filed, Instant Money, Inc. and REO, L.C. filed a motion for relief from the automatic stay seeking leave to foreclose. Attached to the motion were copies of Notes No. 1 through 5 and the deed of trust. The motion alleged that Notes No. 2 through 5 were held by REO, L.C., and that the balance then due on those notes, including interest and late fees, was $508,703.00. Counsel for the debtors subsequently endorsed a consent order which was entered on March 29, 1996, terminating the automatic stay.⁶

6 That order was subsequently vacated on motion of the Tayals as holders of two of the subordinate notes. The Tayals and the Guptas then filed a response opposing relief from stay on the ground that they had been fraudulently induced to execute the deed of subordination that subordinated the lien of their deed of trust to the deed of trust securing Instant Money, Inc. and REO, L.C. They also filed an adversary complaint seeking to void the deed of subordination on the same ground. Following an evidentiary hearing on June 20, 1996, an order was signed on July 10, 1996, granting relief from the automatic stay. While it was clear to the court that the Guptas and the Tayals had probably been defrauded by Richard Hallock, the court was unable to find from the evidence that Instant Money, Inc. or REO, L.C. had, or were chargeable with, knowledge of the fraud.

On April 7, 1997, the debtors filed the objection that is presently before the court. In response, REO, L.C., filed on May 23, 1997, a proof of claim in its own name — which it characterizes as an "amendment" of the Samson Financial claim — in the amount of $495,475.30.

The testimony by REO, L.C.'s "president" (apparently the title given to her as managing member) was that REO, L.C. acquires, for the purpose of workout or foreclosure, notes that are in default held by the mortgage pools organized by Samson. The pools in exchange receive a membership interest in the company proportional to the amount of the note and subsequently receive distributions based on whatever the company recovers by way of workout or foreclosure. In the present case, the substitute trustee under the deed of trust securing Notes No. 1 through 5 conducted a foreclosure sale on July 10, 1996. REO, L.C. purchased the property at the foreclosure sale for $430,000.00. The foreclosure proceeds paid Note No. 1 in full and resulted in a credit of $109,278.51 against the four notes (Notes No. 2 through 5) held by REO, L.C.⁷ REO, L.C. subsequently resold the property in January 1997 for $540,000. REO, L.C.'s witness testified that the principal balance on the four notes, as of the filing date of the chapter 11 petition, was $445,249.08; that accrued but unpaid interest, calculated at the note rate, was due in the amount of $31,546.08; and that late charges and fees were due in the amount of $1,123.38.

7 The accounting prepared by the substitute trustee incorrectly shows The Elm Company as the holder of Notes No. 2 through 5. The evidence offered at the hearing does not reflect that the accounting has been submitted to, or approved by, the commissioner of accounts, as required by Va. Code Ann. § 26-15. The debtors have not challenged the accounting, however, and for the purpose of the present objection the court accepts it as otherwise correct.

Conclusions of Law and Discussion

A challenge to a proof of claim is a "core" proceeding over which this court has jurisdiction under 28 U.S.C. § 1334 and 157(a), and the general order of reference from the United States District Court for the Eastern District of Virginia dated August 15, 1984.

Procedurally, the present objection is a mess. The proof of claim to which the objection relates is conceded to have been filed by an entity that had no interest in the claim. The sole ground of objection set forth in the pleadings is that the debtors' signatures on the notes were procured by the fraud of the Hallocks participated in by Samson. At the hearing, counsel appeared for an entirely different entity, REO, L.C., which was the actual owner of the notes in question at the time the debtors filed their petition, and which, long after the bar date for filing claims, had filed in its own name an "amendment" to the Samson Financial proof of claim for an amount nearly ten times that set forth on the original proof of claim. The debtors at the hearing orally raised as a ground of objection the untimeliness of the REO, L.C., proof of claim.⁸ The questions before the court, therefore, are these: (1) must REO, L.C.'s proof of claim be disallowed as untimely? (2) must the claim be disallowed on the grounds of fraud? and (3) what is the correct amount of the claim, assuming it is allowed? The court will address these questions in order.

8 As noted above, the debtors have now filed a formal objection on that basis. At the hearing, without formally raising it as a ground of objection, the debtors also presented testimony that, after they had filed their chapter 11 petition, Kevin C. Samson contacted Michael R. Marohn and told him that if the debtors would consent to relief from stay, there would be no deficiency claim asserted. Michael Marohn further testified that, in reliance on those assurances, he instructed his attorney to consent to the relief from the stay. This defense to the deficiency claim was never set forth in the pleadings. While the court was willing to consider the legal argument made by the debtors at the hearing without formal amendment of the objection, the court is not willing to consider a new factual basis of objection that was, literally, sprung upon the creditor at the hearing.

I.

The debtor's argument with respect to the timeliness of the proof of claim is straightforward. A timely proof of claim was filed by an entity, Samson Financial, that had no standing to file a proof of claim because it had transferred all ownership and servicing rights to the four notes long before the debtors filed their chapter 11 petition. See, F.R.Bankr.P. 3001(e)(1) (where claim has been transferred other than for security before the proof of claim is filed, only the transferee may file a proof of claim). As noted above, the debtors were apparently unaware of the transfer, because they listed the claim on their schedules as being held by "Samson Financial Group c/o The Elm Company." The notes had originally been payable to Richard and Susan Hallock and were endorsed by them to Samson Financial Group, Inc., which in turn endorsed them to three different mortgage pools. The Elm Company was the servicing agent for the mortgage pools. After the notes went into default, but long before the chapter 11 filing, they were transferred to REO, L.C. in exchange for a membership interest in that limited liability company. The debtors argue that, inasmuch as Samson Financial Group, Inc., had no legal or equitable interest in the four promissory notes, it could not file a proof of claim, and that the claim filed by "Samson Financial" should be disallowed on that basis. As for the later claim filed by REO, L.C., the debtors argue that there is no basis upon which that claim can piggy-back on the invalid claim filed by Samson, and that it should therefore be disallowed as untimely.

The parties have not cited the court to any reported cases. As a general proposition, however, courts have consistently held that amendment, after the bar date has passed, of a timely-filed proof of claim to cure a defect in the claim as filed or to describe the claim with greater particularity should be freely allowed so long as the amendment will not cause undue prejudice to the debtor or to other creditors. Sambo's Restaurants, Inc. v. Wheeler (In re Sambo's Restaurants, Inc.), 754 F.2d 811 (9th Cir. 1985); Unioil v. Elledge (In re Unioil, Inc.), 962 F.2d 988 (10th Cir. 1992) (amendment allowed of defective claim filed by individual to show trust as true creditor); Newcomb v. United States (In re Newcomb), 60 B.R. 520 (Bankr. W.D. Va. 1986) (amendment of IRS claim allowed to add omitted quarter where chapter 13 plan had sufficient funds to pay amended claim); United States v. Vlavianos (In re Vlavianos), 71 B.R. 789, 793-94 (Bankr. W.D. Va. 1986) (disallowing amendment of IRS proof of claim after debtor completed payments under chapter 13 plan in reliance on filed claim). However, a new and different claim may not, in the guise of an "amendment" to an existing claim, be asserted after the bar date has passed. United States v. Int'l Horizons, Inc. (In re Int'I Horizons, Inc.), 751 F.2d 1212 (11th Cir. 1985); Matter of Stavriotis, 977 F.2d 1202 (7th Cir. 1992). Amendment of a proof of claim after the bar date to substitute the real party in interest is permitted where there is no unfair prejudice to creditors and the need to amend is not the product of bad fath or dilatory tactics on the part of the creditor. Gens v. Resolution Trust Corp., 112 F.3d 569 (1st Cir. 1997) (claim filed by RTC contractor in its own name could be amended to name RTC as holder of note). Gens and Unioil are similar on their facts to the present case and compel the conclusion that amendment of a timely-filed but defective claim should be freely permitted, even after the bar date has passed, to correctly name the creditor, so long as there is no unfair prejudice to creditors or to the debtor, and the original proof of claim provides adequate notice of the existence, nature and amount of the claim.

To be sure, the original proof of claim was, at the very least, highly confusing in setting forth a claim amount that consisted only of the accrued but unpaid interest and not the principal balance due. Such sloppiness is obviously not to be encouraged. However, the underlying claim was already listed on the schedules and was not scheduled as disputed, unliquidated, or contingent. In chapter 11, such scheduled claims are "deemed filed" and "constitute prima facie evidence of the validity and amount of the claims," so that it is not necessary for the creditor to file a proof of claim. § 1111(a), Bankruptcy Code; F.R.Bankr.P. 3003(b)(1). Thus, even had no proof of claim been filed, the claim would have been allowed (unless successfully objected to on some other ground) in the amount scheduled, that being $457,000. No party in interest has yet proposed a plan of reorganization or can otherwise be said to have relied on the defective proof of claim, and there is no suggestion that the claim was filed in bad faith or as a dilatory tactic. Additionally, bankruptcy courts have long allowed creditors who have filed some other pleading in the case within the claims bar date which clearly sets forth the creditor's claim, to have such pleading treated as an "informal" proof of claim that could be "amended," after the bar date, by filing a formal proof of claim. Fyne v. Atlas Supply Co., 245 F.2d 107 (4th Cir. 1957); Dabney v. Addison, 65 B.R. 348 (E.D. Va. 1985); see also, Davis v. Columbia Constr. Co. (In re Davis), 936 F.2d 771 (4th Cir. 1991) (amended proof of claim may be allowed, even in the absence of a prior written "informal" document, if the creditor has undertaken some other "affirmative action" in the case sufficient to constitute notice of a claim against the estate). In this case, as noted above, REO, L.C., filed, within the claims bar date, a motion for relief from the automatic stay that set forth with particularity its claim against the estate. Accordingly, the court concludes that the $495,457.30 claim filed by REO, L.C. on March 8, 1997, should be treated as a permissible amendment either of the timely-filed but defective $50,471.76 claim of "Samson Financial" or of the timely "informal" claim represented by the motion for relief from the automatic stay.

II.

The second issue that must be addressed is the debtors' objection that their underlying obligation on the four notes formerly held by Samson Financial Group, Inc., and now held by REO, L.C., is voidable on the ground of fraud.

Once a proper proof of claim is filed in a bankruptcy case, the claim "is deemed allowed" unless a party in interest objects. § 502(a), Bankruptcy Code. A proof of claim executed and filed in accordance with the Federal Rules of Bankruptcy Procedure constitutes "prima facie evidence of the validity and amount of the claim." F.R.Bankr.P. 3002(f). As a result, the party objecting to a properly-filed proof of claim has the initial burden of presenting sufficient probative evidence to overcome such prima facie effect. In re C-4 Media Cable South, L.P., 150 B.R. 374, 377 (Bankr. E.D. Va. 1992). Once the debtor has done so, the burden of proof then shifts to the creditor to establish the validity and amount of its claim. In re Shabazz, 206 B.R. 116, 120 (Bankr. E.D. Va. 1996). Where the debtor's defense to the claim, however, is one with respect to which the debtor would have the burden of proof in a non-bankruptcy forum, the debtor must carry that same burden of proof in connection with an objection to claim. See IRS v. Levy (In re Landbank Equity Corp.), 973 F.2d 265 (4th Cir. 1992) (debtor-taxpayer has burden of proof on disallowed deductions); In re White, 168 B.R. 825, 829 (Bankr. D. Conn. 1994) (debtor has burden of proof where affirmative defense filed to proof of claim).

There can be no question that under Virginia law, fraud in the inducement constitutes grounds for cancellation of an obligation incurred as a result of such fraud. Gray v. Atlantic SL Assn. (In re Gray), 49 B.R. 540, 544 (Bankr. E.D. Va. 1985), citing Pate v. Southern Bank Tr. Co., 214 Va. 596, 203 S.E.2d 126 (1974). Fraud, however, is an affirmative defense, and the burden of proving it is on the debtor. Sands v. Banker's Fire Ins. Co., 168 Va. 645, 192 S.E. 617 (1937). In this case there was essentially no evidence presented at the hearing tending to show — as asserted in the objection to claim — that the debtors' signatures on the notes were obtained as a result of fraud participated in by Samson.⁹ No evidence was presented as to what representations, if any, were made to the debtors by Richard Hallock. There was at best some generalized testimony that Hallock misrepresented to Samson (as well as, apparently, to the Guptas and the Tayals) that the debtors had a large amount of savings and would be making a $150,000 down-payment on the property. There was also some testimony that, after the loan documents were signed, Hallock had opened various unauthorized charge accounts in the debtors' names. Samson's president testified that he was unaware that the purported financial statement of the debtors that Hallock submitted to him was a forgery. He testified further that he believed, at the time the construction loan was made, that it made economic sense based on the information provided by Hallock. To be sure, in hindsight any close review of the settlement statements from the separate settlements that were held with respect to the purchase from the Guptas and the Tayals and the loan from Samson should have alerted Samson that the debtors had not in fact put up any money in connection with the purchase, and that, as a result of construction loan funds having been used to purchase the property, the remaining loan funds would be insufficient to complete construction. But there is a difference between a lender being inattentive and a lender participating in fraud. In this case, the evidence is simply insufficient to demonstrate that the debtors agreed to sign the notes based on false representations by the Hallocks or that Samson participated in the fraud.

9 Since there was not even a sufficient threshold showing of fraud, the court need not reach the issue of whether REO, L.C. is a holder in due course.

III.

Although not raised as an issue by the parties, the court, in reviewing the proof of claim, notes that it improperly includes $126,813.38 in post-petition interest. Under § 502(b)(2), Bankruptcy Code, the amount of a claim is determined "as of the date of the filing of the petition" and is not allowed "to the extent that . . . such claim is for unmatured interest." There is an exception under § 506(b), Bankruptcy Code, for an over-secured secured creditor, that is, a creditor whose claim "is secured by property the value of which . . . is greater than the amount of such claim." Id. (emphasis added). Such creditor, and only such creditor, is entitled "to interest on such claim, and any reasonable fees, costs, or charges provided for under the agreement under which such claim arose." Id. The claim of an undersecured creditor, by contrast, is fixed as of the filing date.¹⁰ See, United Sav. Ass'n of Texas v. Timbers of Inwood Forest Assocs., Ltd., 484 U.S. 365, 108 S.Ct. 626, 98 L.Ed.2d 740 (1988) (undersecured creditor not entitled to post-petition interest payments as "adequate protection"). Here, there is no question that REO, L.C. was undersecured. The property was sold at foreclosure and did not bring enough to satisfy the claim, leaving an unsecured deficiency. § 506(a), Bankruptcy Code. An undersecured creditor is not permitted — as REO, L.C., has attempted to do here — to apply the proceeds from a foreclosure sale against post-petition interest and then assert an unsecured claim in the bankruptcy for the principal and the pre-petition interest. Sexton v. Dreyfus, 219 U.S. 339, 31 S.Ct. 256, 55 L.Ed. 244 (1911). The testimony in this case established that the amount due on the four notes as of the filing date was $477,918.54 and that the credit to the four notes from the foreclosure sale was $109,278.51. Accordingly, the claim will be allowed in the amount of $368,640.03, and the balance of the claim will be disallowed.

10 Of course, to the extent that the claim is secured, the claim, if paid out under a plan over time, is entitled to interest on the secured portion from the "the effective date of the plan" — ordinarily, the date of confirmation. § 1129(b)(2)(A)(i)(II), Bankruptcy Code. But that is a different issue. Here, the only remaining claim of REO, L.C. is unsecured.

A separate order will be entered consistent with this opinion.