Opinion
Civil Action No. CCB-07-2971.
August 20, 2008
MEMORANDUM
Capital City Mortgage Corporation ("Capital City") appeals the bankruptcy court's determination that it failed to prove it was entitled to a defense under 11 U.S.C. § 550(b). More specifically, Capital City argues that the bankruptcy court erred in finding that it did not acquire an interest in the property in question in good faith and without knowledge of avoidability of prior transfers of the property. The issues in this case have been fully briefed and a hearing was held on August 7, 2008. Because the bankruptcy court properly applied the law to a thoroughly developed factual record, Capital City's appeal will be denied and the bankruptcy court's Order entered October 4, 2007 will be affirmed.
Capital City also has filed a motion to strike factual assertions made by the debtor Trustee in its opposition brief on the grounds that the evidence is not contained in the existing record. Many of the assertions made by the Trustee either appear in the record or are not material to the determination of this appeal. Therefore, the motion to strike will be denied.
BACKGROUND
The bankruptcy court's October 3, 2007 Memorandum of Decision provides a comprehensive and thorough discussion of the factual findings made by Chief Judge Duncan Keir following a one-day trial. In Re Walter Nieves, No. 03-8292 (Bankr. D. Md. Oct. 3, 2007). For the sake of completeness, the most relevant facts are recounted here.
Prior to August 8, 2002, Debtor Walter Nieves and his son Michael Nieves owned an 11.8 acre parcel of real property (the "Property") in Chester, Maryland. On that date, the Property was transferred to Walter Nieves's brother, Edgardo, for zero consideration (hereinafter the "Initial Transfer"). Walter Nieves filed for Chapter 13 bankruptcy soon thereafter. This Chapter 7 case was commenced by Walter Nieves on October 14, 2003, following dismissal of the Chapter 13 proceedings.
Meanwhile, on April 24, 2003, Edgardo sold the Property to 1st Financial Mortgage Services, LLC ("1st Financial"), which was owned and operated by Michael R. Nastasi, a friend of both Walter Nieves and Edgardo, for $18,000 (hereinafter the "Second Transfer"). The deed involved in the transfer was not properly notarized. Additionally, 1st Financial was not a legal entity at the time of the transaction, as its charter had been forfeited by the State of Maryland on October 5, 2001.
On May 29, 2003, 1st Financial secured a loan for $155,000 from Capital City using the Property as collateral (hereinafter the "Third Transfer"). The deed of trust involved in the transaction appears to have been defective, in part because it failed to identify who signed the deed on behalf of 1st Financial. Nevertheless, the repayment terms on the loan required 1st Financial to make monthly interest payments over a one-year period. The entire balance of the loan and any unpaid interest would be due at the end of that year. Capital City's only recourse against 1st Financial in the event of default was by way of executing a foreclosure on the Property.
Relevant to this appeal, Judge Keir found that there was no prior relationship between Capital City and 1st Financial or Edgardo and Walter Nieves. Capital City did not request any financial information about 1st Financial before granting the loan, nor did it request a credit report for the company or Nastasi. Capital City did, however, receive a certificate of good standing for 1st Financial on April 30, 2003, but made no effort to secure a more current certificate when the loan was made on May 29, 2003. As of that date, 1st Financial had once again lost its legal status with the State of Maryland. Counsel for Capital City conceded at the August 7, 2008 hearing before this court that Capital City had at least been aware before closing on the Property that 1st Financial's legal status was uncertain, but had nonetheless relied on the April 30 certificate of good standing. During the bankruptcy trial, however, expert testimony suggested that under normal circumstances, a lender would require a second up-to-date certificate of good standing at the time of closing. This would seemingly be even more prudent where the lender has knowledge of negative information about the borrower.
It thus appears that 1st Financial was already in discussions with Capital City to secure a loan against the Property either before or around the same time it purchased the Property from Edgardo. Capital City maintains that these facts are irrelevant to a good faith inquiry.
It appears that Articles of Reinstatement were filed April 30, 2003, but voided May 7, 2003 for nonpayment of required fees.
Capital City obtained from Paramount Title and Escrow LLC ("Paramount") a title insurance commitment for the Property. The commitment identifies the parties to the deed of trust, contains the Property description, and commits Paramount to insure fee simple title. Critically, however, the commitment does not indicate that Paramount performed a title or records search on the Property. Indeed, Judge Keir found that neither Capital City nor Paramount appears to have conducted a title search, which would have revealed negative information about the title and several grounds for avoidance of the previous fraudulent conveyances.
Capital City stated that it never reviewed a title report on the Property.
Ultimately, 1st Financial failed to make any payments under the Capital City loan, and the entire balance became due at the end of the year. Meanwhile, on June 8, 2005, because of the previous voidable transfers, the bankruptcy court in this matter entered an order authorizing the bankruptcy Trustee to sell the Property free and clear of the interests of Capital City, provided that $300,000 of any proceeds from the sale be held in escrow subject to further orders of the court. The Property sold in May of 2006 for a net amount of $442,973. Capital City argued that it was entitled to $304,969.43, equaling the amount necessary to pay off the principal, interest at the default rate, and late fees that resulted from 1st Financial's default.
In response, the bankruptcy Trustee argued that the transfer of the Property from 1st Financial to Capital City is avoidable under section 550(a) of the bankruptcy code. Judge Keir agreed, finding that Capital City had failed to prove a § 550(b) affirmative defense. Section 550(b) provides that Capital City can prevent avoidance of its transaction with 1st Financial if it can prove by a preponderance of the evidence that it received the transfer conveyed by the deed of trust: (1) for value; (2) in good faith; and (3) without knowledge of the voidability of a prior transfer that has been avoided. See Smith v. Mixon, 788 F.2d 229, 231 (4th Cir. 1986); In re Smoot, 265 B.R. 128, 140 (Bankr. E.D. Va. 1999).
In reaching his decision, Judge Keir found that Capital City, as a mediate transferee, received the transfer from 1st Financial for value. As to the second element, however, Judge Keir determined that Capital City had failed to meet its burden of demonstrating good faith in entering the transaction, because it did not conduct a title search despite negative indicators surrounding the transaction with 1st Financial. More specifically, Judge Keir found that Capital City knew or should have known of the potential avoidability of the transaction. He further added that willful ignorance does not support a finding of good faith. Under the unique facts of this case, Judge Keir did not find Capital City's reliance on Paramount's title insurance to be compelling, but rather concluded that a good faith lender would have searched the public records and discovered the title defects.
ANALYSIS
In considering an appeal of a bankruptcy court's ruling, a district court reviews findings of fact for clear error and conclusions of law under a de novo standard. In re Tudor Assoc., Ltd., 20 F.3d 115, 119 (4th Cir. 1994). Neither in its papers nor at the hearing did Capital City identify a specific fact in dispute; rather it disagreed with whether the inferences Judge Keir drew from the facts satisfied the applicable legal standards.
As previously noted, Capital City can prevent avoidance of its transaction with 1st Financial under § 550(b) if it can prove by a preponderance of the evidence that it received the transfer conveyed by the deed of trust: (1) for value; (2) in good faith; and (3) without knowledge of the voidability of the prior transfer. See Mixon, 788 F.2d at 231; In re Smoot, 265 B.R. at 140. Capital City argues that a "should have known" good faith standard under prong two eviscerates the Fourth Circuit's requirement in Mixon that the third prong be interpreted as requiring actual knowledge. See Mixon, 788 F.2d at 232.
The Fourth Circuit in Mixon, however, interpreted only the "knowledge" prong of § 550(b), and not good faith. The court quoted Collier on Bankruptcy ¶ 550.03 at 550-10 (15th ed. 1985), which observes that the knowledge prong of § 550(b)(1) "was included as surplusage to illustrate a transferee that could not be in good faith." Id. at 232 n. 2. In other words, a transferee with actual knowledge of voidability is merely a subset of those unable to demonstrate good faith. Mixon does not establish, however, that a transferee who lacks actual knowledge of voidability necessarily has demonstrated good faith. Rather, in determining good faith courts apply an objective standard in determining what the transferee "`knew or should have known' instead of examining the transferee's actual knowledge from a subjective standpoint." In re Laines, 352 B.R. 397, 406 (Bankr. E.D. Va. 2005) (quoting In re Agric. Research Tech. Group, Inc., 916 F.2d 528, 535-36 (9th Cir. 1990)); see also In re Smoot, 265 B.R. at 140 ("Good faith is not limited to lack of actual knowledge of actual fraud but also encompasses a lack of knowledge of circumstances requiring further investigation."). Therefore, the bankruptcy court properly recognized that the good faith prong in § 550(b) is distinct from the knowledge prong.
Even if Mixon requires the actual knowledge standard of prong three to be imputed to the good faith prong, however, Judge Keir correctly noted that under Fourth Circuit law, "wilful ignorance in the face of facts which [cry] out for investigation may not support a finding of good faith." In re Harbour, 845 F.2d 1254, 1258 (4th Cir. 1988). Therefore, a party may not invoke § 550(b) where it willfully fails to practice due diligence in light of the surrounding circumstances.
In summary, Judge Keir's analysis and his application of the law to the facts is thorough, comprehensive, and reasonable. First, Judge Keir noted that the burden of proving good faith is on Capital City. Second, Judge Keir noted the unusual circumstances surrounding the transaction with 1st Financial, including 1st Financial's questionable legal status, the proximity in time of transactions concerning the Property, and Capital City's failure to require an updated certificate of good standing. Finally, under the unique facts of this case, Judge Keir found significant Capital City's failure to perform or inquire into a title search on the Property. From these facts, the bankruptcy court concluded Capital City had failed to demonstrate good faith as required by the affirmative § 550(b) defense. Essentially, the bankruptcy court found that Capital City could not satisfy its burden when it had willfully turned a blind eye to a suspicious transaction. No clear error of fact or incorrect application of law has been shown.
A separate order follows.
ORDER
For the reasons stated in the accompanying Memorandum, it is hereby ORDERED that:1. the defendant's motion to strike (docket entry no. 13) is DENIED;
2. the bankruptcy court's Order entered October 4, 2007 is AFFIRMED; and
3. copies of this Order and the accompanying Memorandum shall be sent to Chief Bankruptcy Judge Duncan W. Keir and counsel of record.