Summary
holding that the transferee has the burden of proof under § 550(b) of the Bankruptcy Code
Summary of this case from In re PaschallOpinion
Case No. 97-14401-SSM, Chapter 7, Adversary Proceeding No. 98-1288
April 16, 2001
Tina M. McMillan, Esquire, McMillan Lang, P.C., Fairfax, VA, Counsel for Donald F. King, Trustee.
John T. Donelan, Esquire, Alexandria, VA, Counsel for Countrywide Home Loans, Inc.
Robert K. Coulter, Esquire, Assistant United States Attorney, Alexandria, VA.
MEMORANDUM OPINION
This avoidance action is before the court following a remand to the District Court from the United States Court of Appeals for the Fourth Circuit. The District Court in turn has remanded to this court to determine what effect the limitation in § 550(b), Bankruptcy Code, has on the trustee's claim to certain real property that Countrywide Home Loans, Inc. ("Countrywide") purchased at a foreclosure sale. Countrywide and the successor chapter 7 trustee, Donald F. King, have filed briefs, and the court heard oral argument on April 10, 2001. Neither party sought leave to supplement the existing evidentiary record, and the issues are therefore ripe for determination.
Background
The factual background of this action is fully set forth in this court's original decision, Mayer v. United States (In re Reasonover), 236 B.R. 219, 223-25 (Bankr.E.D.Va. 1999), and need not be repeated in detail. Suffice it to note that Wei Tu Reasonover ("Ms. Reasonover"), who was a 50% shareholder in a business known as Business Depot, Inc. ("Business Depot"), had taken title in May 1996 to a house located at 11114 Saffold Way, Reston, Virginia, and had financed the purchase with two deed of trust loans. The transaction, however, was actually for the benefit of her company, Business Depot, which was in the business of purchasing run-down houses, renovating them, and reselling them for a profit. When the time came in December 1996 to sell the property, Business Depot deeded it to Luis F. Delgadillo. Ms. Reasonover expected that a deed would be recorded from her to Business Depot as part of the sale, but either a deed was not prepared, or, if prepared, was never recorded, creating a break in the chain of title.
Mr. Delgadillo's purchase of the property was financed by a first-trust loan from First Equitable Mortgage Corporation, with the loan proceeds being used to pay off the two deeds of trust that Ms. Reasonover had placed on the property when she purchased it. First Equitable subsequently assigned its note and deed of trust to Countrywide. On June 12, 1997, Ms. Reasonover and her husband filed a chapter 7 petition, and Robert G. Mayer was appointed as trustee. Approximately five weeks later (July 23, 1997), the property was sold at foreclosure. Countrywide was the high bidder at the foreclosure sale but assigned its interest to Federal National Mortgage Association ("FNMA"), and a deed from the foreclosure trustee to FNMA was recorded on August 12, 1997. At some point, FNMA became aware of the break in the chain of title and in May 1998 brought a quiet title action in state court. That action was stayed when it was learned that Ms. Reasonover, one of the defendants, was in bankruptcy. FNMA then transferred its interest in the Saffold Way property back to Countrywide.
The present action was commenced by the bankruptcy trustee in July 1998, to avoid the transfers through which Countrywide claimed title, as well as a post-petition restitution judgment lien in favor of the United States of America and two other post-petition judgment liens. After the action was filed, the bankruptcy trustee, over Countrywide's objection, was allowed to sell the property free and clear of liens, with the liens attaching to the proceeds of sale. On cross-motions for summary judgment, this court ruled that the trustee's status under § 544(a)(3), Bankruptcy Code, as a hypothetical bona fide purchaser of real estate gave him an interest in the property that was superior under Virginia law to the equitable claim of Countrywide except to the extent of $31,500.00, the amount due under the paid but unreleased second deed of trust placed on the property by Ms. Reasonover. 236 B.R. 233. As to that amount, the court ruled that Countrywide was equitably subrogated to the second trust-holder's lien. Id. Finally, the court ruled that the trustee's rights to the property were unaffected by the restitution judgment in favor of the United States that had been docketed post-petition. 236 B.R. at 236-37.
The original trustee was subsequently appointed as a judge of this court. Donald F. King was appointed as successor trustee and has been substituted as plaintiff.
Appeals were taken from this court's ruling both by the trustee and by Countrywide. On October 18, 1999, the District Court affirmed in an unpublished opinion. Mayer v. United States, No. 99-989-A and 99-990-A (E.D.Va., Oct. 18, 1999). Both the trustee and Countrywide then appealed to the United States Court of Appeals for the Fourth Circuit. That court, in an unpublished per curiam decision, remanded for consideration of an issue that had not been previously raised, namely the effect of § 550(b), Bankruptcy Code:
Under certain circumstances, section 550(b) limits the trustee's right to recover property or its value from subsequent transferees of the initial transferee of the debtor. The effect of section 550(b) on this case was apparently not briefed or considered in the courts below. Because this section may bar the trustee from recovering from Countrywide — even if section 544(a)(3) allows the trustee to avoid Countrywide's equitable claim to the property — we remand to the district court for full consideration of section 550(b) and its effect, if any, on this case.
Countryside Home Loans, Inc. v. King (In re Reasonover), No. 99-2534 and 99-2620, 238 F.3d 414 (4th Cir., Dec. 22, 2000) (table).
Discussion A.
The Bankruptcy Code contains a number of provisions that allow a bankruptcy trustee to "avoid," or set aside, certain transfers of property. See § 544 (transfers voidable under state law), § 545 (certain statutory liens), § 547 (preferences), § 548 (fraudulent transfers), and § 549 (unauthorized post-petition transfer). Where the bankruptcy trustee has possession of the property, no further action is required once avoidance is decreed. The trustee simply holds the property free and clear of the avoided interest. A example might be where there is an unrecorded mortgage or a preferential judgment lien against the debtor's residence. Where the trustee does not have possession, however, avoidance as a practical matter must be followed by recovery. Section 550, Bankruptcy Code, allows a bankruptcy trustee who has successfully avoided a transfer to recover either the property or, if the court so orders, its value, not only from the initial transferee or from the person for whose benefit the transfer was made, but also from subsequent transferees:
This is particularly true with respect to the exercise of the trustee's "strong arm" powers under § 544(a)(3) as a hypothetical bona fide purchaser of the debtor's real estate. As one court has recently explained,
The "majority rule" adopted by several Circuit Courts of Appeal, is that the statute confers the status of bona fide purchaser upon the trustee for all purposes, regardless of whether a transfer to or from the debtor has taken place. * * * Section 544(a)(3) allows the trustee to have a bona fide purchaser's rights or avoid a transfer, so a "transfer" by the debtor cannot be a necessary condition of the strong-arm power. The statute mentions "transfer" only in the sense of the hypothetical transfer that measures the trustee's rights: if a hypothetical bona fide transferee from the debtor would come ahead of the "true" owner's rights, then the trustee takes ahead of the true owner.
Mullins v. Burtch (In re Paul J. Paradise Assocs., Inc.), 249 B.R. 360, 368 (D.Del. 2000) (emphasis added; internal citations and quotation marks omitted).
(a) Except as otherwise provided in this section, to the extent that a transfer is avoided under section 544, 545, 547, 548, 549, 553(b), or 724(a) of this title, the trustee may recover, for the benefit of the estate, the property transferred, or, if the court so orders, the value of such property, from —
(1) the initial transferee of such transfer or the entity for whose benefit such transfer was made; or
(2) any immediate or mediate transferee of such initial transferee.
§ 550(a), Bankruptcy Code. There is, however, an important limitation on the trustee's right to recover from transferees subsequent to the initial transferee:
(b) The trustee may not recover under subsection (a)(2) of this section from —
(1) a transferee that takes for value, including satisfaction or securing of a present or antecedent debt in good faith, and without knowledge of the voidability of the transfer avoided; or
(2) any immediate or mediate good faith transferee of such transferee.
Sometimes the entity that is literally the first recipient is held to be a "mere conduit" if it does not exercise actual dominion and control over the transferred property, with the result that the next transferee will be deemed the "initial" transferee for the purpose of § 550. See, e.g., Bowers v. Atlanta Motor Speedway, Inc. (In re Southeast Hotel Properties L.P.) 99 F.3d 151 (4th Cir. 1996).
B.
The obvious threshold issue is whether § 550(b) even applies to this action. As noted above, recovery under § 550 is not necessary to give effect to avoidance where the trustee, as successor to the debtor, has actual possession of the property, and where a simple decree avoiding the particular lien or interest is sufficient to provide relief. On the other hand, where the debtor has actually parted with possession, some form of recovery action — either of the property itself or its value — is ordinarily required.
Here, Ms. Reasonover unquestionably parted with possession of the Saffold Way property in December 1996, approximately six months prior to the filing of the bankruptcy petition, when she arranged for Business Depot to sell it to Mr. Delgadillo. There is no suggestion that possession did not pass to Mr. Delgadillo at settlement or that Mr. Delgadillo was not living in the house and exercising dominion and control over it on the date Ms. Reasonover filed her bankruptcy petition. Certainly, Ms. Reasonover, who was unaware of the title defect, did not think of herself as owning the property and did not list it on her schedules. As noted above, the property then went to foreclosure approximately five weeks later. Although no evidence was presented on the issue, it seems reasonable to assume that FNMA, to whom the property was deeded following foreclosure, exercised control over the property by changing locks and offering the property for sale. Ms. Reasonover and the trustee did not become aware until some ten months after the foreclosure sale that Ms. Reasonover was still the owner of record.
It is true that, after this adversary proceeding was commenced, this court entered an order allowing the trustee to sell the property free and clear of liens for $113,500.00, with any liens being transferred to the proceeds of sale. Thus, as a practical matter the trustee has dominion and control over the cash, and it could be argued that the trustee therefore no longer requires a judgment against Countrywide for the recovery of the property or its value. However, the fact remains that on the date Ms. Reasonover filed her bankruptcy petition, she did not have possession of the Saffold Way property. This court's order allowing the trustee to sell the property while the litigation was pending was solely intended to facilitate the efficient administration of the bankruptcy estate, and was not intended to alter the rights of any party to the proceeds of sale. Because on the date the bankruptcy petition was filed, the relief the trustee is seeking against Countrywide could not be accomplished simply by a decree avoiding the unrecorded transfer from Ms. Reasonover (and the subsequent transfers to Countrywide) the court concludes that § 550(b) applies to this action and thus potentially limits the trustee's right to recover the property or its value.
The trustee had filed a motion on July 10, 1998, for authority to sell the Saffold Way property free and clear of liens. At that time, the trustee had not identified a purchaser. Countywide filed an objection to the trustee's motion, and an order was entered on August 25, 1998, to which Countrywide's counsel noted his objection, authorizing the trustee to market the property but requiring him to obtain separate approval of any specific contract offers. After a contract was obtained, the trustee filed a motion on April 19, 1999, to approve the sale to the contract purchasers free and clear of liens for $113,500. (The estimated net proceeds after closing costs were $102,285.00.) No objections were filed to this motion, and an order was entered on May 11, 1999, approving the sale. The court does not treat the lack of formal objection to the second motion as waiving Countrywide's objection to the trustee's sale of the property but only as not objecting to the sales price.
C.
The next issue is whether Countrywide is a "mediate or immediate" transferee, rather than an initial transferee. The analysis is complicated somewhat because Countrywide is actually the recipient of a number of "transfers," given the broad definition of that term by the Bankruptcy Code:
"transfer" means every mode, direct or indirect, absolute or conditional, voluntary or involuntary, of disposing of or parting with property or with an interest in property, including retention of title as a security interest and foreclosure of the debtor's equity of redemption[.]
§ 101(54), Bankruptcy Code. Countrywide's predecessor in interest, First Equitable, was thus the recipient of a transfer when it acquired a lien by virtue of its deed of trust. Countrywide itself was the recipient of a transfer when it bid the property in at foreclosure. Finally, Countrywide again became the recipient of a transfer when FNMA deeded the property back to it. Regardless of which transfer is seen as operative, however, Countrywide is not the initial transferee. The initial voidable transfer was from Ms. Reasonover to Business Depot. Business Depot cannot be deemed a "mere conduit" because it, not Ms. Reasonover, recognized the profit on the sale. 226 B.R. at 224. Business Depot then transferred the property to Mr. Delgadillo, who contemporaneously transferred a lien interest to First Equitable. Thus, whichever transfer defines Countrywide's present status, Countrywide is plainly not the initial transferee but is a mediate or immediate transferee of Business Depot, the initial transferee.
In its brief, Countrywide relies on its purchase of the property at foreclosure as establishing its entitlement to the § 550(b) protection. Reply Brief filed Mar. 30, 2001, at 6. As noted, that sale occurred five weeks after Ms. Reasonover filed her bankruptcy petition.
D.
The final question is whether Countrywide is protected under § 550(b) against the trustee's recovery action. To qualify for the protection, Countrywide must have (1) taken for value, including satisfaction or securing of a present or antecedent debt, (2) in good faith, and (3) without knowledge of the voidability of the transfer. Alternately, it must be a "good faith" transferee of a protected transferee.
Consideration of this issue is complicated by the fact that Countrywide did not plead or otherwise rely on § 550(b) in its answer to the complaint or in the motion for summary judgment. Instead, Countrywide relied solely on the argument that § 541(d), Bankruptcy Code, trumped the trustee's avoidance powers. The record is therefore entirely devoid of any evidence, whether by affidavit or otherwise, as to what "knowledge" Countrywide (or First Equitable) possessed when the various transfers occurred. (Of course, as to the transfer under which Countrywide now holds and claims an interest in the property — the deed from FNMA — Countrywide could hardly claim to be without knowledge of the voidability of the transfer, since it accepted the deed from FNMA after FNMA had filed its quiet title action, and after FNMA learned that Ms. Reasonover was in bankruptcy.)
The opinion of the Fourth Circuit remanded for "full consideration" of the applicability and effect of § 550(b) but did not specifically state whether the record could be reopened to receive additional evidence or whether the trustee could object on the basis that the § 550(b) protection was in the nature of an affirmative defense that was waived if not pleaded. The order of remand from the District Court simply directed that "the parties are to brief the issues addressed by the Fourth Circuit and the bankruptcy court is to consider those issues." Although it was not clear that the District Court's order of remand would permit reopening of the evidentiary record, the court nevertheless offered the parties that opportunity. Countrywide did not request an opportunity to present additional evidence, and, indeed, argued that such evidence was unnecessary because, in Countrywide's view, the trustee had the burden of proving that Countrywide did not qualify for the § 550(b) protection. The trustee was not opposed to reopening the record but did not affirmatively request an opportunity to do so.
This court must determine, then, who has the burden of proof. Countrywide cites to In re Hickey, 168 B.R. 840, 850 (Bankr.W.D.N.Y. 1994) for the proposition that the trustee has the burden of proving that Countrywide does not qualify for the protections of § 550(b). Other courts, however, have reached the opposite conclusion. See Hooker Atlanta (7) Corp. v. Hocker (In re Hooker Investments, Inc.), 155 B.R. 332, 337 (Bankr.S.D.N.Y. 1993). A leading treatise notes the split of authority, but opines that "the better-reasoned position is that once the trustee has avoided a transfer and has established that the property has been transferred to an immediate or mediate transferee, the transferee has the burden to show that it (1) took for value, (2) in good faith, and (3) without knowledge of the voidability of the transfer." 5 Lawrence B. King, ed., Collier on Bankruptcy ¶ 550.03[5] at 550.20 (15th ed. rev. 1996).
I concur. The very structure of the statute suggests that the § 550(b) protection is in the nature of an avoidance or affirmative defense. Section 550(a) first sets forth the general rule that the trustee can recover from initial transferees, from the party benefitted by the transfer, and from immediate or mediate transferees of the initial transferee. As to those subsequent transferees, however, § 550(b) provides a limited exception: recovery is not permitted if certain prescribed conditions exist, namely value, good faith, and lack of knowledge of voidability. Those elements are matters with respect to which the transferee would ordinarily have the relevant records and thus would be in the best position to offer evidence. Accordingly, I decline to follow Hickey and hold that Countrywide, as the party claiming the benefit of the § 550(b) protection, has the burden of proving that it is entitled to it.
Rule 8(c), Fed.R.Civ.P., which is incorporated by F.R.Bankr.P. 7008(a), requires that affirmative defenses be "set forth affirmatively" in the answer. Ordinarily, the failure to plead an affirmative defense precludes reliance on it at trial. However, the Fourth Circuit remand directing "full consideration" of the § 550(b) issues seemingly removes this limitation. In any event, the trustee has not asserted that the § 550(b) defense has been waived but instead has met the issue head on by arguing that it does not apply.
E.
Given the burden of proof, it is evident that Countrywide's invocation of the § 550(b) defense on remand is unavailing. Countrywide has provided no evidence, whether by affidavit, deposition, or otherwise, to show what First Equitable knew when it loaned Mr. Delgadillo the money to purchase the property, or what Countrywide knew when it acquired the note from First Equitable or what Countrywide knew when it bid the property in at foreclosure some five weeks after the bankruptcy was filed. (And, as noted above, it clearly had knowledge of the voidability of the transfer when it accepted a reconveyance of title from FNMA some ten months later.) Without quite saying so, Countrywide would seemingly have this court indulge a presumption that residential mortgage lenders acquire liens, or bid on property at foreclosure, in good faith and without knowledge of the voidability of the transactions. In particular, Countrywide urges that when First Equitable made the mortgage loan, it could not have anticipated that Ms. Reasonover would file for bankruptcy six months later, and it points to a footnote to Smith v. Mixon (In re Mixon), 788 F.2d 229, 232 n. 2 (4th Cir. 1986), which contains the following quotation from Collier on Bankruptcy: "With respect to prepetition transfers that are recoverable only if a petition seeking relief under the Bankruptcy Code is filed, the transferee should be held to have knowledge of the voidability of the transfer, if, inter alia, he has reasonable knowledge to believe that a petition may be filed." (Emphasis added). The quoted language does not say, however, (as Countrywide would recast it) that a person has knowledge of the voidability of a transfer only if he has reasonable knowledge to believe a petition may be filed. Rather, knowledge of an impending petition is only one of many reasons ("inter alia") why knowledge of voidability might be found to exist. Furthermore, the right of recovery the trustee is pursuing in this action is not one which is "only" dependent on a bankruptcy petition having been filed, but is predicated, rather, on well-settled Virginia law that allows a bona fide purchaser to take real property free from any latent equity against it. 236 B.R. 232. Put another way, while the trustee's standing as plaintiff arises under bankruptcy law, the cause of action he is pursuing is based on the state law rights that could be asserted by any good faith purchaser from Ms. Reasonover. Accordingly, Mixon cannot be read as establishing Countrywide's entitlement to the § 550(b) protection simply because First Equitable could not have predicted that Ms. Reasonover would later file for bankruptcy relief.
Of course, First Equitable and Countrywide both had constructive notice of the avoidability of the transfer, since a simple examination of the land records would have disclosed the break in the chain of title. However, the Fourth Circuit has ruled that "knowledge" for the purpose of § 550 does not include constructive notice. Smith v. Mixon (In re Mixon), 788 F.2d 229, 232 (4th Cir. 1986).
In this connection, it may readily be supposed that First Equitable, when making the loan to Mr. Delgadillo, had no way of anticipating that Ms. Reasonover would file a bankruptcy petition six months later. But that does not answer the question of what it knew concerning the break in the chain title, and, in particular, whether it was in possession of a title report that would have shown that Ms. Reasonover remained the holder of record title. It also does not answer the question of what Countrywide knew when it acquired the note and what it knew later when it bid on the property at the foreclosure sale. It is certainly not uncommon for lenders to require title reports when making loans and before instituting foreclosures, and it would also be surprising if an investor purchasing mortgage notes in the secondary market did not require and inspect the title work done at the time the loan was made. In short, there are simply a large number of unanswered factual questions bearing on good faith and knowledge of avoidability as to which Countrywide is in the best position to offer evidence but has failed to do so.
F.
One final point requires only brief discussion. On brief and at oral argument, Countrywide also asserted for the first time a defense under § 550(d), Bankruptcy Code, which limits the trustee to a "single satisfaction." First, the issue of § 550(d) is not properly before the court. When a case is remanded to a lower court by an appellate tribunal, the order of remand determines the issues that may be considered. Here, the Fourth Circuit and the District Court remanded solely to consider the applicability of § 550(b), not § 550(d). In any event, § 550(d) is simply not implicated. Section 550(a), as discussed, allows the trustee to obtain judgments, either for the property or its value, against a broad range of parties. Section 550(d) simply makes it clear that if the trustee obtains multiple judgments, the satisfaction of any one of them exhausts the trustee's right to recovery. Here the trustee does not have a judgment for recovery against any party other than Countrywide. At bottom, Countrywide's argument has nothing whatsoever to do with the "single satisfaction" rule and but is simply a recasting of its previous argument that Ms. Reasonover's creditors received a benefit when the two deed of trust notes encumbering the property were paid off by the proceeds of the First Equitable loan, and that to allow exercise of the trustee's avoidance powers would effectively give the creditors an unfair double benefit. 236 B.R. at 230. However, as previously noted, Virginia law would allow an actual bona fide purchaser from Ms. Reasonover to prevail over the equitable claims asserted by Countrywide. 236 B.R. at 232. Since under § 544(a)(3), Bankruptcy Code, the trustee is treated as a bona fide purchaser for value from the debtor, the trustee takes free of those same equities.
The trustee does have a judgment avoiding the post-petition judgment liens of the United States of America, Lee Landing Condominium Unit Owners Association, and Robert and Maggie Wang. However, no recovery against those parties is necessary to give effect to such avoidance.
G.
In conclusion, because Countrywide has the burden of proof on its entitlement to the § 550(b) protection and has presented absolutely no evidence to support that entitlement, the court concludes that its original judgment was correct and does not require amendment. A separate order will be entered consistent with this opinion.