Opinion
Case No. 97-19586-SSM, Adversary Proceeding No. 98-1221
May 24, 1999
John Edwards Harrison, Esquire, Harrison Hughes, P.C., Alexandria, VA, of Counsel for plaintiffs
Richard G. Hall, Esquire, Annandale, VA, of Counsel for debtors
David D. Hudgins, Esquire, Hudgins Law Firm, Alexandria, VA, of Counsel for defendants Gary D. Weinstein and Lainof, Cohen Weinstein, P.C.
Steven Ramsdell, Esquire, Tyler, Bartl, Burke Albert, P.L.L.C., Alexandria, VA, of Counsel for defendant Advanta Mortgage Corp. as servicing agent for Bankers Trust Co.
John P. Forest, II, Esquire, Haas Anderson, P.C., McLean, VA, of Counsel for defendants First Potomac Mortgage Corp. and Alexander Kakar
Alan Rosenblum, Esquire, Rosenblum Rosenblum, LLC, Alexandria, VA, of Counsel for defendant Deborah Frye
MEMORANDUM OPINION
A trial was held in open court on February 18 and 19, 1999, on (a) the debtors' complaint for damages for fraud and conspiracy in connection with the refinancing of their residence, and to set aside the resulting deed of trust; and (b) the debtors' objection to the claim of the mortgage company that now services that deed of trust. At the conclusion of the debtors' evidence, the court granted the defendants' motion for judgment as a matter of law as to the conspiracy claim. The remaining issues were taken under advisement at the close of all the evidence. Upon review of the evidence and the applicable law, the court concludes that the debtors have not carried their burden of proving that they were fraudulently induced to enter into the loan. Accordingly, the complaint will be dismissed and the objection to claim overruled.
Facts
The plaintiffs, Joseph E. Spence and Minnie J. Spence ("the debtors") filed a joint voluntary petition under chapter 13 of the Bankruptcy Code in this court on December 29, 1997. Among the assets listed on their schedules is their jointly-owned residence located in Fairfax County, Virginia, at 4511 Squiredale Square, Alexandria, Virginia. The property is valued on their schedules at $140,000 and is shown as subject to a $162,000 claim in favor of Advanta Mortgage Company ("Advanta"). Advanta filed a timely proof of claim (Claim No. 1) on January 12, 1998, as a secured creditor in the amount of $162,245.80, of which $19,775.04 was claimed as a prepetition arrearage. The debtors' modified plan, dated January 23, 1998, while proposing a 100% payment over 60 months to unsecured creditors, proposes to make no payment on account of Advanta's claim, on the ground that the claim is unenforceable. The plan has not yet been confirmed, since the proposed treatment of Advanta's claim is dependent upon a ruling favorable to the debtors in the present adversary proceeding.
The debtors filed an objection to the claim on February 19, 1998.
Both Advanta and the chapter 13 trustee have filed objections to confirmation. The debtors filed the complaint commencing the present adversary proceeding on June 9, 1998. Pending confirmation of the plan, the court required that interim payments to the chapter 13 trustee be made in the amount of $850.00 per month, rather than $199.90 per month as proposed in the plan.
Mr. Spence is a retired Army staff sergeant with a high school equivalency certificate (GED). He had previously filed a chapter 13 petition in this court on March 4, 1993. While that case was pending, he approached Deborah Frye, who was then affiliated with Market Street Mortgage Corporation, about obtaining a loan to pay off the remaining balance of the chapter 13 plan as well as certain other debts he had incurred subsequent to the chapter 13 filing. He had previously contacted approximately ten other potential lenders but had been turned down because of his bad credit history. At that time, Mr. Spence's house, which had been purchased in 1986, was jointly owned with Lawrence Walker, Jr., a former Army buddy, and was subject to a VA mortgage with an approximate balance of $98,000 and a monthly payment (principal, interest, tax, and insurance) of $978.99 per month. Mr. Walker had left the area, and Mr. Spence, having remarried, was living in the house with Mrs. Spence. One of Mr. Spence's goals in refinancing was to buy out Mr. Walker's interest and to place Mrs. Spence on the title. Ms. Frye referred Mr. and Mrs. Spence to Gary Weinstein and the law firm of Lainof, Cohen Weinstein ("Lainof, Cohen").
Mr. Walker had previously informed Mr. Spence that he would be willing to convey his interest to Mr. Spence for $5,000.
After two unsuccessful attempts to obtain financing elsewhere, Ms. Frye, who by March 1, 1996, had moved to First Potomac Mortgage Corporation ("First Potomac"), arranged for a loan to be made by First Potomac (through its "bad credit division") in the amount of $162,500, with a loan origination fee of 9 points, interest at a periodic rate of 15.75%, monthly installments (principal and interest only) of $2,152.51, a balloon payment of $150,541.90 at the end of 15 years, and a 2% prepayment penalty during the first 18 months. The loan was funded by Walsh Securities, Inc. ("Walsh"), variously referred to in the testimony as the "correspondent," "investor," and "wholesaler." Closing was held on March 28, 1996, at Mr. Weinstein's office. The testimony was unrebutted that the loan terms were not made known to Mr. and Mrs. Spence prior to the closing. The loan terms were, however, fully and correctly set forth on the note, truth-in-lending disclosure, mortgage loan disclosure, and balloon payment disclosure signed by Mr. and Mrs. Spence at the closing.
The Annual Percentage Rate (APR), as set forth in the Truth in Lending disclosure, was 17.504%.
Mr. and Mrs. Spence were both concerned at the closing about the large amount of the monthly mortgage payment, but Mr. Spence made the decision, in which Mrs. Spence reluctantly acquiesced, that they should go forward with the loan. Mr. and Mrs. Spence both testified that Mr. Weinstein assured them, in response to Mrs. Spence's concern over the amount of the mortgage payment, that they would later be able to refinance the loan as long as they made their payments on time.
Mrs. Spence testified, "I got highly upset and I touch my husband and I said no, no; there's no way we can afford this. . . .There was no way that I felt we could live like I like to live and pay a mortgage of over $2,100. . . . I just knew that that was too much money to be paying for a house like that."
Mr. Spence testified in person; Mrs. Spence testified by way of deposition.
On April 3, 1996, following expiration of the three-day rescission period required by the Truth in Lending Act, Mr. Weinstein disbursed the loan proceeds in accordance with the settlement statement signed by the debtors at the closing (with one post-closing adjustment to reflect a reduction in the approximate amount of $3,000 in one of the debts to be paid off and a corresponding increase in the cash paid directly to the debtors). The disbursements included $98,994.36 to pay off the existing VA mortgage, $5,000.00 to buy out the interest of Mr. Walker, $5,400.00 to the chapter 13 trustee to pay off the balance of the chapter 13 plan, $22,508.98 to pay off various consumer debts (including Mr. Spence's car loan and a second deed of trust against the house) that were not being paid through the chapter 13 plan, $3,500.00 to the law firm itself, and $10,948.58 to the debtors. The debtors banked the cash from the settlement and used the funds to make the monthly mortgage payments until approximately May 1997, when they stopped making payments on the advice of counsel. Thereafter, they filed the present chapter 13 case to prevent their house from being foreclosed upon. Their chapter 13 plan, as noted above, proposes to make no payment whatsoever on account of the mortgage, based on the debtors' assertion that the refinance was incurred through fraud, making the resulting repayment obligation void.
As part of the transaction, a deed was recorded from Mr. Walker and Mr. Spence as grantors to Mr. and Mrs. Spence as grantees.
The specific fraud alleged is the submission to the loan underwriter of a fictitious and grossly inflated appraisal of Mr. and Mrs. Spence's property reflecting a fair market value of $291,000. At the time the $162,500 loan was made, Mr. and Mrs. Spence believed the property (which Mr. Spence had purchased in 1986 for $99,000) to be worth $140,000 to $150,000. At settlement, Mr. Spence was surprised to learn that the loan amount was $162,500, but assumed that the property might have appraised at that amount. Shortly after settlement, Mr. Spence received a copy of an appraisal report that reflected a fair market value of $154,000. Neither he nor Mrs. Spence saw the $291,000 appraisal report, and who created that report is disputed. The debtors suggest that Ms. Frye — whose husband at one time had been an appraiser and who had a software program on their home computer to generate appraisal reports — was the culprit. Ms. Frye denies that she created the report and suggests that her loan processor did it. She does admit, however, that she knew at settlement that "something was done" to enable the loan to be made but said nothing in order to collect her commission — which she testified was approximately $6,000 — for placing the loan.
Mrs. Spence testified that she had been shown an appraisal early in the application process, prior to settlement, reflecting a value of $ 126,000 or $127,000, but that at settlement she saw either an appraisal or some other document reflecting a value in the $160,000 range.
The plaintiffs assert that they did not become aware of the fraudulent appraisal, and did not come to the realization that the entire loan transaction was, as they now view it, a "sham," the only purpose of which was to steal the equity in their home and to generate fees for Frye, First Potomac, and Weinstein, until they were contacted in January 1997 by an FBI agent who was investigating loans that Frye and First Potomac had originated.
The complaint commencing this adversary proceeding was filed on June 9, 1998. As originally pleaded, it sought relief under five counts: Count I (fraud); Count II (conspiracy to defraud); Count III (violations of the Truth in Lending Act and the Real Estate Settlement Procedures Act); Count IV (voidance of the deed of trust); and Count V (legal malpractice). The defendants were First Potomac; Frye; a First Potomac officer named Alexander Kakar; two actual appraisers; one fictitious appraiser; Weinstein; Lainof, Cohen; Advanta; and the noteholder for which Advanta functioned as servicing agent. Count III was dismissed by the court prior to trial. The claims against the two genuine appraisers were voluntarily dismissed. Immediately prior to the trial, the plaintiffs reached a settlement with Weinstein and Lainof, Cohen, which had the effect of dismissing them (as well as Count V, as to which they were the only defendants) as parties. Thus, by trial the only remaining claims were the fraud and conspiracy claims (Counts I and II) against Frye, First Potomac, and Kakar; and the claim against Advanta and Bankers Trust Company for equitable relief (Count IV).
Michael Oakes and David German.
"Samuel Snead."
Bankers Trust Company. The court was advised by Advanta's counsel at the hearing that the note was in the process of being transferred.
Conclusions of Law and Discussion I.
This court has subject matter 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. Counts I and II are non-core "related" causes of action with respect to which a bankruptcy judge may conduct the trial but may not enter a final judgment or order except with the consent of the parties. At the trial, however, all parties orally consented on the record to entry of a final judgment by this court, subject to the right of appeal under 28 U.S.C. § 158(a). Count IV, captioned "voidance of trust," is functionally an objection to the secured claim of Advanta Mortgage Corp., USA, as servicing agent for Banker's Trust Co., and, under 28 U.S.C. § 157(b)(2)(B) and (K), is a core proceeding in which final judgments or orders may be entered by a bankruptcy judge. The defendants (with the exception of the fictitious "Samuel Snead") have been properly served and have appeared generally.
II.
As an initial matter, First Potomac argued in a pre-trial motion for summary judgment that the fraud and conspiracy claims were time-barred. The court ruled at the start of the trial that the claims were not time-barred and denied the summary judgment motion. Some further discussion is appropriate, however, for the benefit of the parties as well as any reviewing court.
A.
The statute of limitations in Virginia for fraud is two years. Va. Code Ann. § 8.01-243(A). The period does not begin to run, however, until the fraud "is discovered or by the exercise of due diligence reasonably should have been discovered." Va. Code Ann. § 8.01-249(1). Under the plaintiffs' theory of the case, the fraud, if any, was complete no later than the date the three-day rescission period expired and the loan funds were disbursed, that is, April 3, 1996. The debtors' complaint was filed on June 9, 1998, which is more than two years later. Thus, under Virginia law, and without considering the effect of § 108(a), Bankruptcy Code, Count I is time-barred unless the fraud was neither actually discovered nor reasonably discoverable until on or after June 9, 1996.
The debtors argue that, to the extent their complaint seeks equitable relief rather than money damages, the statute of limitations is inapplicable, and that their action can be barred, if at all, only under the doctrine of laches. This may well be true where the evidence establishes fraud in the facrum. However, the Virginia Supreme Court, in holding that an unjust enrichment suit in equity is governed by the statute of limitations for contract actions, has explained:
It is a well-established principle uniformly acted upon by courts of equity, that in respect to the statute of limitations equity follows the law, and if a legal demand be asserted in equity which at law is barred by statute, it is equally barred in equity.
Belcher v. Kirkwood, 238 Va. 430, 433, 383 S.E.2d 729, 731 (1989) (emphasis added; internal citations omitted.) Thus, where the fraud goes only to the inducement and would support a claim for damages, the equitable remedy of rescission is subject to the statute of limitations for fraud and deceit.
In this connection, there can be little doubt that the debtors were aware of the high interest rate and onerous terms of the First Potomac loan at the time they signed the loan documents and settlement statement on May 28, 1996. The heart of the fraud, as pleaded in the complaint, is the use of an inflated and fictitious appraisal to support the loan application in order to permit the collection by First Potomac, Weinstein, and Lainof, Cohen of exorbitant unearned fees. The debtors say that they were unaware of such fraud until after they were contacted in January 1997 by an FBI agent investigating this and other loans that Ms. Frye was involved with. They were both surprised at the closing, however, by the amount of the loan, which was more than what they thought the house was worth, and Mr. Spence, at least, assumed that a loan would not be made for more than the value of the house. Additionally, Mr. Spence received a copy of an appraisal shortly after the closing which reflected a valuation of $154,000. Although that value differed only slightly from what Mr. Spence believed the property to be worth ($140,000 to $150,000), it was nevertheless many thousands of dollars less than the amount of the loan. Thus, the debtors knew, shortly after the closing, that the loan had been made for more than the appraised value of the property. The debtors argue, however, that the extent of the fraud — and in particular, the existence of the fictitious $291,000 appraisal — would not have become apparent until the visit by the FBI agents. Moreover, the debtors testified they were assured by Mr. Weinstein that, assuming they maintained a good payment record, the loan could be refinanced for a lower payment, possibly eight or nine months down the road. In the nature of things, it is argued, the falsity of such a representation would only become apparent after the period had passed and the Spences had begun making applications to refinance.
Ms. Frye was eventually indicted for wire fraud in connection with seven mortgage loans — including the loan made to the Spences — and pleaded guilty to two counts, neither of which, however, involved the Spences.
The record readily shows that the Spences were not sophisticated in financial matters. Nevertheless, the "reasonably should have been discovered" standard of Va. Code Ann. § 8.01-249(1) is an objective one. Simply put, the Spences knew within days of the closing that the loan had been made for more than the appraised value of their house, and they were aware that home mortgage loans were ordinarily not made for more than the value of the house. That they did not know the full details of how their loan had been accomplished does not detract from the fact that they had knowledge of facts that would give a person of ordinary intelligence reason to suspect that refinancing would not be available on conventional terms, at least in the near term. Accordingly, unless § 108(a), Bankruptcy Code, dictates a different result, their fraud claim is time-barred.
There was testimony at trial that some lenders now make second trust loans up to 125% of appraised value; however, it would appear that the Spences, based on their income and credit history, would not qualify for such a loan.
B.
Section 108(a), Bankruptcy Code, protects the bankruptcy estate by providing the trustee at least two years in which to bring any cause of action belonging to the debtor as to which the statute of limitations had not already run on the date the bankruptcy petition was filed. The debtors' chapter 13 petition was filed on December 29, 1997, well within two years of the settlement. Thus, had the present action been brought by the trustee, there can be no question that it would be timely. The more difficult question is whether the debtors, as distinguished from the trustee, are entitled to the benefit of the extension.
The relevant language of Section 108 is as follows:
(a) If applicable nonbankruptcy law, an order entered in a nonbankruptcy proceeding, or an agreement fixes a period within which the debtor may commence an action, and such period has not expired before the date of the filing of the petition, the trustee may commence such action only before the later of —
(1) the end of such period, including any suspension of such period occurring on or after the commencement of the case; or
(2) two years after the order for relief.
In a chapter 11 case where no trustee has been appointed, it seems clear that a debtor, as debtor in possession, is entitled to the extension, since a chapter 11 debtor in possession has (except for the right of compensation) all of the rights and powers of a trustee. § 1107(b), Bankruptcy Code; 2 Collier on Bankruptcy, ¶ 108.02[3], p. 108-6 (Lawrence P. King, ed; 15th ed. rev. 1998). It seems equally clear that in a chapter 7 case (or in a chapter 11 case in which a trustee has been appointed) only the trustee and not the debtor may take advantage of the extension. Craig v. Barclay American Finance, Inc. (In re Craig), 7 B.R. 864 (Bankr. E.D. Tenn. 1980).
In chapter 13, a somewhat different situation is presented. Even though a trustee is appointed, he or she functions primarily, although not exclusively, as a paying agent, and the debtor retains many of the powers that a trustee would have in chapter 7. In particular, § 1303, Bankruptcy Code, gives the debtor, "exclusive of the trustee, the rights and powers of a trustee under sections 363(b), 363(d), 363(e), 363(f), and 363(1) [.]" Section 363(b) in turn gives a trustee the power to " use, sell or lease . . . property of the estate." Property of the estate includes causes of action owned by the debtor on the filing date. Tignor v. Parkinson, 729 F.2d 977, 981 (4th Cir. 1984). The only way to "use" a cause of action is to bring suit on it (or to settle it). Since under § 1303 a chapter 13 debtor has the "rights and powers" of a trustee to bring suit on prepetition causes of action, it follows that a chapter 13 debtor is entitled to the extension granted a trustee by § 108. In re Gaskins, 98 B.R. 328 (Bankr. E.D. Tenn. 1989); 2 Collier on Bankruptcy, ¶ 108.02[3], p. 108-6.
In the present case, the Virginia two-year statute of limitations for fraud had not run at the time the debtors filed their chapter 13 petition. The present action was commenced within two years of the filing of the petition. Accordingly, the court concludes that the complaint is timely.
III. A.
The elements of a cause of action for fraudulent misrepresentation under Virginia law are: (1) a false representation, (2) of a material fact, (3) made intentionally and knowingly, (4) with an intent to mislead, and (5) reliance by the party misled, (6) resulting in damage to that party. Thompson v. Bacon, 245 Va. 107, 111, 425 S.E.2d 512, 514 (1993). Although a promise of future performance is not actionable in a claim for fraudulent misrepresentation, such a promise can support a claim for fraud if there is no intention to perform at the time the promise is made. Colonial Ford Truck Sales v. Schneider, 228 Va. 671, 676, 325 S.E.2d 91, 94 (1985).
B.
At trial, the debtors urged that the misrepresentations made to them constituted fraud in the factum rather than fraud in the inducement. The distinction is potentially important, because fraud in the factum renders a transaction absolutely void, while a contract induced by fraud is not void, but only voidable. Martin v. South Salem Land Co., 94 Va. 28, 26 S.E. 591 (1897). As explained by the then-Supreme Court of Appeals of Virginia,
"`Fraud in the factum' exists where one, by fraud or artifice, as in the case of substitution of one instrument for another, or artifice in concealment of an instrument, is induced to sign an instrument other and different from that presented for his signature. . . .In contrast, fraud in inducing a person to sign a contract or deed is simply fraud in the procurement." Michie's Juris., Fraud and Deceit, § 4. Fraud in the factum is also sometimes called "real" or "essential" fraud or "fraud in the essence." Official Comment, Va. Code Ann. § 8.03A-305.
See, e.g., Va. Code Ann. § 8.3A-305(a)(iii) (obligation of party to pay a negotiable instrument is subject to a defense, even against a holder in due course, of "fraud that has induced the obligor to sign the instrument with neither knowledge nor reasonable opportunity to learn of its essential character and terms").
A contract procured by fraud is not void, but voidable only, at the option of the party defrauded. It is binding upon him until rescinded, and if, before he exercises the option to rescind, innocent third parties have, in reliance on the fraudulent contract, acquired rights which would be prejudiced by its rescission, they may generally have it enforced for their benefit, although the party by whose fraud it was procured could not do so.
Id. at 597 (emphasis added).
In the present case, even accepting all of the debtors' evidence, the misrepresentations constituted at most fraud in the inducement and not fraud in the factum. Simply put, this is not a case in which the debtors signed a note and deed of trust on the misrepresentation that those instruments were something other than what they were stated to be. The debtors fully understood that they were signing a note and deed of trust, and they were aware of all the essential terms, including, most importantly, the amount of the loan and the amount of the monthly payment. Their testimony is rather that, because of the magnitude of the monthly payment, they would not have gone through with the transaction absent an assurance that the loan could be refinanced after some relatively short period and the payments reduced to a level they could more easily afford. In short, the debtors' evidence shows, not that they were deceived about the essential nature of the transaction, but that they were falsely told they would not have to live with it. Though this may well be fraud, it is fraud in the inducement, not fraud in the factum.
C.
In their complaint, the Spences alleged four misrepresentations by Fry, Kakar, First Potomac, and Weinstein as constituting the basis for their fraud action: first, that the loan was a "real" loan rather than a sham to generate fees (¶¶ 47-48); second, that after one year the Spences could refinance (¶ 49); third, that the loan was a "normal residential refinance transaction" (¶ 50); and fourth, that the charges and fees set forth on the settlement statement "were normal and regular charges for work actually performed" (¶ 51). The court observes first that no evidence was presented as to any representations having been made to the debtors by Mr. Kakar, and, accordingly, the claims against him will be dismissed. There was also no evidence of any express statements that the loan was a "real" loan or a "normal residential refinance transaction." However, in order to be actionable, false representations need not be express but may be implied. Even so, the evidence does not show that the loan was, as alleged by the Spences, a "sham" to generate unearned fees and to "steal" the equity in their home. The evidence shows, rather, that an actual loan was made to the Spences which accomplished their goals of paying off the chapter 13, getting Mr. Walker off the title, and placing Mrs. Spence on the title. As a result of the refinance, they derived $142,851.92 of direct benefit in the form of cash disbursed to them at settlement, existing debts paid off, and a co-owner's interest bought out. Although the monthly payment was much higher than Mr. Spence had been paying ($2,152 compared with $979), the refinance eliminated the requirement for $800 per month in monthly payments that Mr. Spence had been making on his car loan ($363 per month) and chapter 13 bankruptcy ($437 per month), as well as payments on credit card accounts. That the terms of the loan were onerous, and that First Potomac and Ms. Frye were handsomely compensated for placing it, does not suffice to transform the loan into a sham. There was no evidence, moreover, that mortgage loans were available in the market place on any more advantageous terms, given Mr. Spence's credit history. Mr. Spence, after all, was in chapter 13 at the time he applied for the loan and had already been turned down by ten different lenders. Ms. Frye had unsuccessfully tried two other lenders before turning the application over to First Potomac's "bad credit" division. Michael Roché, First Potomac's chief executive officer at the time the loan was made, testified without rebuttal that the loan was classified by Walsh, the underwriter, as a "D"-rated credit, which is the lowest recognized credit classification, and that the interest rate charged the Spences was "in the middle" of the range for borrowers in that category. In sum, the evidence simply does not support the assertion that the loan was not really a loan but just a device to milk the equity from the Spence's residence.
The actual difference is somewhat greater than these figures would suggest, since the old loan payment included tax and insurance escrows, while the new payment was for principal and interest only.
Indeed, shortly after the settlement, Mr. Spence bought a new automobile for which the payments were $539 per month.
There remains the contention that the Spences were falsely told, to induce them to go through with the transaction, that the loan could be refinanced and the payments could be reduced after some relatively brief period of time, provided they made their payments on time and otherwise kept their credit history clean. It is painfully clear that refinance would not actually be possible any time in the near future regardless of the debtors' payment history, since neither First Potomac in particular nor the market place in general offers first mortgage loans exceeding the appraised value of the property.
There is an issue, though, as to which representations may fairly be laid to First Potomac's charge. Even if the court credits the Spences' testimony that Mr. Weinstein assured them at closing that they would be able to refinance and reduce the payment, the evidence does not show that Mr. Weinstein was the agent of, or was otherwise acting on behalf of, or in collusion with, First Potomac. Thus, his statements cannot establish fraud on the part of First Potomac.
Of course, as a settlement agent, he was a fiduciary for both First Potomac and the Spences, but that is a different issue. While Mr. Weinstein was recommended to Mr. Spence by Ms. Frye (before she joined First Potomac), First Potomac did not require that the Spences use Mr. Weinstein as the settlement agent for the loan.
The court accepts Mr. Weinstein's testimony that he did not see or review the appraisal at or prior to the closing and was unaware that the loan was being made for more than the appraised value of the property. Whether he should have made further inquiry, and what advice he should have given the Spences, is now moot in light of the settlement and dismissal of the malpractice claim. In any event, the court is satisfied that he made no knowing misrepresentations to the Spences. Of course, were he found to be First Potomac's agent for the purpose of the loan transaction, even an innocent but negligent misrepresentation on his part could constitute constructive fraud provided all the other elements were present. Hitachi Credit America Corp. v. Signet Bank, 166 F.3d 614, 628 (4th Cir. 1999). However, the court need not reach that issue on the present record.
Ms. Frye, by contrast, unquestionably was the agent of First Potomac. However, there is no clear evidence of any representations made by her to the Spences concerning refinance of the $162,500 loan. She did testify that she had a conversation in which she told Mr. Spence he would be able to refinance after two years (two years being the period mortgage lenders typically require a borrower to have been out of bankruptcy before making a loan); but when that discussion took place is far from clear. Although Ms. Frye testified that she was at the settlement, both Mr. and Mrs. Spence testified that she was not. Mrs. Spence testified that she had only one discussion with Ms. Frye, and that was early in the loan process before Ms. Frye had found a lender. On the first day of trial, Mr. Spence testified he had been told by Ms. Frye that he could refinance the loan after eight or nine months. On further examination during the second day of trial, however, he unequivocally stated that Ms. Frye was not at the settlement and that his discussion with her about refinancing had occurred while she was still at Market Street Mortgage, which was well prior to the loan application being submitted to Walsh for the $162,500 loan. Thus, the evidence simply does not show that any representations — false or otherwise — were made by Ms. Frye to the Spences to induce them to go through with the settlement after they learned of the loan terms and Mrs. Spence became alarmed at the loan and monthly payment amount. Absent such representations, there is simply nothing upon which to base a finding of fraud.
During oral argument, the court raised the issue of whether, under the holding of Massie v. Firmstone, 134 Va. 450, 114 S.E. 652 (1922) the debtors were precluded from arguing that they were induced to enter into the transaction based on Ms. Frye's representations that the loan could be refinanced. Massie held that where a party testifies as to facts within his own knowledge, he is bound by that testimony and cannot rely on the more favorable testimony of other witnesses. As the Fourth Circuit has explained, however, Massie is a state rule of evidence and is not binding in a Federal trial even where Virginia substantive law applies. Utility Control Corp. v. Prince William Constr. Co., Inc., 558 F.2d 716, 719-720 (4th Cir. 1977) (defendant was entitled to cross-examine its former president, called by the plaintiff as an adverse witness, and to present other evidence that his testimony did not accurately depict the true facts).
Of course, there can be little question that whoever prepared or knowingly made use of the fictitious $291,000 appraisal to secure loan approval from Walsh is guilty of fraud. That fraud, however, was against Walsh and any down-stream transferees of the mortgage, not against the Spences. The Spences never saw that appraisal, nor were they even told of its existence until long after the loan had closed. Since they were unaware of it, they could not have relied on it, and accordingly they cannot sustain a fraud cause of action based on it.
IV.
Because the evidence does not establish that any misrepresentation was made to the Spences by First Potomac or its agents to induce them to go through with the $162,500 loan, the court need not reach the thorny issue of what remedy they would be entitled to had the fraud been proven. The court observes, however, that $142,851.92 of direct financial benefit was given to the debtors as a result of the refinance. Since the debtors have no ability to return those funds, the cancellation of the note and deed of trust, as requested by the debtors in their complaint, would appear inconsistent with normal equitable principles. A more appropriate remedy, had the fraud been proven, would likely have been an award against First Potomac and Frye of compensatory damages equal to the difference between the benefit received and the loan amount, plus some amount of punitive damages. Although Advanta pleaded in its answer that it was a holder in due course and therefore entitled to enforce the note under Va. Code Ann. § 8.3A-305 notwithstanding any defense of fraud in the inducement, it offered no evidence to support that position. The language of Va. Code Ann § 8.3A-308(b) makes it clear that once a party sued on an instrument "proves a defense," the burden then shifts to the party seeking to enforce the instrument to prove that such party "has rights of a holder in due course." See Duncan v. Carson, 127 Va. 306, 103 S.E. 665, 670 (1920) (where defendant sued on note showed fraud in the procurement, this "threw upon [the plaintiff] the burden of showing that `he or some person under whom he claims acquired the title as a holder in due course.'"). In the present case, Advanta presented no evidence to show that it was a holder in due course, and such status is not presumed. Accordingly, had the court found fraud in the inducement, the court would have disallowed Advanta's proof of claim to the extent it exceeded $142,851.92, the consideration actually received by the Spences.
As explained by the then-Supreme Court of Appeals of Virginia:
Upon discovery of the fraud, [the party injured] has, as a general rule, the choice of two remedies: He may elect to rescind the contract, if he can restore what he has received in the same state or condition in which he received it, and sue for and recover back the consideration he has paid or given, or, if he has not paid or given anything, repudiate the contract and rely, when sued, upon the fraud as a complete defense; or he may elect to retain what he has received under the contract, and bring an action to recover damages for the injury he has sustained from the deceit.Wilson v. Hundley, 96 Va. 96, 30 S.E. 492, 494 (1898) (emphasis added).
A "holder in due course" is defined in Va. Code Ann. § 8.3A-302(a)(2) as a holder who
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 § 8.3A-306, and (vi) without notice that any party has a defense or claim in recoupment described in § 8.3A-305(a).
Advanta urged in closing argument that, as a "transferee" of the note, it acquired any rights Walsh had as a holder in due course. See Va. Code Ann. 8.3A-203(b). However, no representative of Walsh testified at trial to establish Walsh's status as a holder in due course, and the testimony of Brian Roche, First Potomac's CEO at the time the loan was made, established only that the transfer of the note from First Potomac to Walsh — which took place approximately two weeks after closing — was for full value and that the note was not then in default. Since there was no direct evidence of the remaining elements necessary to make Walsh a holder in due course, the court is precluded from making such a finding, and Advanta, as a consequence, cannot simply piggy-back on Walsh.
The court is not without a great deal of sympathy for the position the Spences now find themselves in. The decision to pay off Mr. Spence's chapter 13 plan and the debts he had accumulated since the chapter 13 filing by borrowing against the equity in the house was, in retrospect, clearly not a good idea. With Mr. Spence then in chapter 13, any loan was bound to be at a significantly higher interest rate than the existing VA mortgage. While the refinance satisfied the Spences' immediate goals, it laid the seeds for financial disaster in the long run. It is truly unfortunate that they did not, before taking this step, consult with Mr. Spence's bankruptcy counsel, who might have talked them out of it. It is also unfortunate that Mr. Weinstein did not take a larger view of his role and advise the Spences against going through with the refinance. The Spences now find themselves in danger of losing their house because someone at First Potomac, greedy for fees, pushed through a loan that no responsible lender would have made. Unfortunate as that may be, there is simply no legal duty on the part of a lender to lend only to those who can repay.
The issue in the present case is fraud. While the fictitious appraisal certainly represented a fraud on Walsh and subsequent noteholders, it was not, in the legal sense, a fraud against the Spences. Accordingly, a separate judgment will be entered dismissing the remaining counts of the complaint and overruling the objection to Advanta's proof of claim.