Opinion
NOT FOR PUBLICATION
ORDER ON DEFENDANT'S RENEWED MOTION FOR PARTIAL SUMMARY JUDGMENT
PETER W. BOWIE, Judge
Defendants' previous motion for partial summary judgment was denied with respect to Plaintiffs' § 523(a)(2)(A) and § 523(a)(2)(B) claims. The § 523(a)(2)(A) is based upon Plaintiffs' reconveyance of a second priority deed of trust. In this renewed motion, Defendants have added evidence of -the value of the subject property as of the date of the reconveyance in an effort to establish that the reconveyed deed of trust had no value. The Court afforded Plaintiffs an additional opportunity to obtain their own evidence of value. Plaintiffs submitted appraisal reports which had been prepared prepetition at the request of Defendants' prepetition lender. The Court held an evidentiary hearing at which both appraisers testified. Having considered all of the evidence the Court finds that the most reasonable and accurate appraisal report establishes that as of the date of the reconveyance the property was worth less than the amount of the debt secured by the first priority deed of trust and thus the second priority deed of trust reconveyed by the Plaintiffs was valueless. Defendants' motion is therefore granted on the § 523(a)(2)(A) claim.
BACKGROUND
As of the beginning of 2006, after a series of transactions, Christopher and Wendy Philcox (Plaintiffs) held a promissory note . in the amount of $1.5 million signed by Defendants' wholly owned corporation, Pacific Liberty, Inc., (PL Note). The PL Note was secured by a second priority deed of trust on Defendants' real property at Las Flores Drive in Carlsbad, California (Las Flores Property). The Las Flores Property was, at the time, under construction. It is now "an 11-unit luxury residential condominium complex." See Appraisal Report of Kenneth A. Keagy (Keagy Report) at page vi. The Las Flores Property was at all times relevant hereto subject to a first priority deed of trust held by construction lender Temecula Valley Bank (TVB). At the time of the reconveyance the amount owing TVB was between $5,549,613.08 (as of September 19, 2006) and $5,597,561.22 (as of September 28, 2006).
On September 27, 2006, at the request of Defendant Curtis Farber, Plaintiffs reconveyed their second priority deed of trust on the Las Flores Property, ostensibly in order to enable Defendants to negotiate an extension with TVB. Plaintiffs contend that they agreed to reconvey the deed of trust based upon Curtis' assurance that the deed of trust would be promptly re-recorded. Indeed, the copy of the Reconveyance provided by Plaintiffs includes a notation "we've signed the form to put it right back on." Plaintiffs allege other misrepresentations, but this is the only misrepresentation at issue in the present motion.
For reasons which are not relevant to this decision, Plaintiffs' deed of trust was not re-recorded. On April 22, 2008, TVB foreclosed on the Las Flores Property. TVB credit bid the full amount of its senior claim, and Plaintiffs have received nothing on the PL Note since Defendants stopped making payments in May, 2008.
Plaintiffs filed a complaint seeking to have their claims excepted from Defendants' discharge on several theories. Two of the theories were challenged in the prior motion for summary judgment - sections 523(a)(2)(A) and (B). in a prior order the Court denied summary judgment with respect to the § 523(a)(2)(B) claim, which was based upon a separate alleged misrepresentation.
In support of the current motion Defendants rely upon the appraisal report of Kenneth Keagy in which he opines that the Property was worth $4,500,000 as of the date the Plaintiffs reconveyed their deed of trust. Plaintiffs have now provided a copy of an appraisal report prepared by James P. Leahy, MAI, and his associate dated August 18, 2006 (the Leahy Report) in which he opined that the "as is" was $8,221,611 as of August 9, 2006, shortly before the reconveyance. On February 20, 2 014, the Court conducted an evidentiary hearing to determine the value of the Property as of September 27, 2006, the date of the reconveyance. Mr. Leahy appeared and testified at the evidentiary hearing as did Defendants' appraiser Mr. Keagy. The Court took the matter under submission.
DISCUSSION
As discussed above, Plaintiffs contend that Defendant Curtis Farber induced them to reconvey their deed of trust on the Las Flores Property by misrepresenting his intent to immediately re-record the deed of trust. Section 523(a)(2)(A) excepts from discharge "any debt" "(2) for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by-- (A) false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor's or an insider's financial condition."
Claims under § 523(a)(2)(A) typically stand or fall on whether the representation was false, whether it was material and/or whether the debtor justifiably relied thereon. However, before getting to those issues, the Court must determine whether there is a "debt" and whether debtor "obtained" any "money, property, services, or an extension, renewal, or refinancing of credit, " in the first place.
In this case what Defendants "obtained" was a reconveyance of Plaintiffs' deed of trust. The reconveyed deed of trust is clearly not money, services, nor an extension, renewal or refinancing of credit. The only other option is that it is property. Property is not defined in § 523 or anywhere else in the Code. In a Supreme Court case applying the predecessor to § 523 under the Act, the court concluded that legal services were not property, describing the limitations of the concept of property:
At most [property] denotes something subject to ownership, transfer, or exclusive possession and enjoyment, which may be brought within the dominion and control of a court through some recognized process. This is certainly the full extent of the word's meaning as employed in ordinary speech and business, and the same significance attaches to it in many carefully prepared writings.
Gleason v. Thaw, 236 U.S. 558, 561 (1915).
The Court finds that in general, the reconveyance of a deed of trust would fit within this parameter and would amount to obtaining property. It is generally accepted that granting a security interest in property is a transfer of property. It stands to reason then that return of such an interest is a transfer of property.
The issue raised by Defendants' renewed motion is whether the security interest reconveyed had any value. If it did not, Defendants' theory is that no "debt" would have resulted based upon the reconveyance. Another way to state the same argument, is that the alleged fraud and reconveyance would have resulted in no damages. See In re Siriani, 967 F.2d 302, 304 (9th Cir. 1992), in which the court set out the elements of § 523(a)(2)(A), which included "(7) that damage proximately resulted from the misrepresentation."
In support of the prior motion Defendants had submitted the declaration of appraiser Kenneth Keagy, in which he opined on the value of the Las Flores Property as of April 22, 2008, the date TVB foreclosed. In support of the renewed motion Defendants submitted the Supplemental Appraisal Report of appraiser Keagy, in which he opines that as of September 27, 2006, the date the Las Flores deed of trust was reconveyed, the Las Flores Property was worth $4,500, 00, which is less than what was owed to TVB at that time - $5,549,613.80 as of September 19, 2006. Based upon these numbers, the reconveyed deed of trust would have had no value, and thus no debt would have arisen based thereon. Further, Defendants would have received no property.
At the prior hearing, Plaintiffs requested a continuance in order to obtain a competing appraisal, showing that the reconveyed deed of trust had some value. The Court had misgivings, because, as counsel for the Defendants explained at the hearing, Plaintiffs had notice of the hearing and ample opportunity to obtain a competing appraisal. Nevertheless, upon reflection the Court decided to allow the Plaintiffs such an opportunity.
Plaintiffs did not obtain a new appraisal. Rather, they rely upon two appraisal reports previously prepared by James P. Leahy at the request of TVB. The Leahy Reports were dated August 18, 2006 and February 8, 2008 and provided an "As Is" value as of August 9, 2006 and February 4, 2008 respectively.
The parties have stipulated that as of the September 27, 2006 reconveyance date, the amount owing to TVB secured by its first priority deed of trust was approximately $5,549,613.80. Thus, the issue of fact before the Court is whether the Property was worth more or less than $5,549,613.80 on September 27, 2006.
Keagy Report
In his Supplemental Appraisal Report Mr. Keagy noted that as of September 2006 "construction was still less than half complete, " and opined that the market value of the Property as of September 27, 2006 was $4,500,000. Mr. Keagy explained the methodology used to arrive at this number:
Discounted Cash Flow analysis was used to value the Subject Property. The Discounted Cash Flow analysis first required the appraiser to estimate the prospective market value of each individual Subject condominium-units as if completed. For the September 2006 date of value, a 6-month constructions period was assumed with a completion date of about April 1, 2007.... Then a cash flow model was created by projecting remaining construction costs, sales absorption rate, sales costs, holding costs and selecting a discount rate to be applied to the periodic cash flows. Because no remaining construction cost estimate was available for the two dates of value, the actual subsequent amounts of Temecula Valley Bank construction loan disbursements from October 1, 2006 and October 1, 2007 were applied as a reasonable approximations of remaining construction costs (see loan disbursement schedule page 38).
He also explained that "cost to complete construction was assumed to be $3,070,631 based upon TVB loan disbursements from October 1, 2006 through January 30, 2008." He also warned that to the extent the developer contributed additional equity funds not included on the TVB loan disbursement schedule to complete construction, or if construction was not 100% complete as of January 30, 2008, the assumed cost to complete construction in this report would be understated and, as a result, the market value estimates herein would be overstated." On cross-examination counsel for the Plaintiffs raised no real errors or omissions in the methodology used in or creation of the Keagy Report.
Leahy Report
In his Report dated August 18, 2006 (the Leahy Report) Mr. Leahy provided four separate valuations. Three of those are irrelevant to the current dispute as they are as of January 1, 2007 - the estimated date of completion of the condominium project. The fourth, dated as of August 9, 2006, is the one of -interest to the Court:
Our opinion of the Market Value 'As is' of the fee simple interest for the subject property, based upon information contained in this report, as of August 9, 2006 is [$8,221,611].
Leahy Report at page 3. In the report, and at the hearing, Mr. Leahy explained that he arrived at this value using the "cost approach, " which was defined twice in the report:
Cost Approach: A value approach through which an appraiser derives a value indication of the fee simple interest in a property by estimating the current cost to construct a reproduction of or a replacement for the existing structure, deducting for all evidence of accrued depreciation from the cost new of the reproduction or replacement structure, and adding the estimated land value plus an entrepreneurial profit.
Leahy Report at 15. A more succinct definition was provided further on:
The Cost Approach to value consists of adding the land value to the estimated reproduction (or replacement) cost new of all improvements less accrued depreciation from all causes.
Leahy Report at 53.
At the hearing Mr. Leahy confirmed that the $8,221,611 figure was arrived at by adding the estimated land value of $3,300,000 at page 58 of the report to the "direct cost (incremental value) [which was] reported by Temecula Valley Bank to be $4,921,611, " at page 16. These figures do indeed total the $8,221,611 figure found at page 3.
At the hearing several problems with the Leahy Report were raised. First, when discussing the costs, the report also provides the "Construction at the subject property commenced 12 months ago.... The subject property has experienced numerous delays and cost overruns." Leahy Report at 16. At the hearing Mr. Leahy admitted that he did not know the extent to which the $4, 92.1, 611 direct cost expense number provided by TVB included expenses due to the delay and cost overruns, such as interest carry. The report provided "The developer of the subject property has provided an itemized cost breakdown for the subject property along with a component cost detail. Further, a complete specification list was provided for review. All are contained in the addendum to the report." Leahy Report at 53. However, no such addendum was attached, and Mr. Leahy had no specific recollection of such a report. At the hearing Mr. Leahy conceded that interest carry and such costs should not properly be included in the cost approach since they would not have enhanced the value of the project. Thus, the appropriateness of the $4,921,611 figure is suspect.
That figure for direct costs to date is also called into question by the fact that the estimated "Total Direct Costs" for the completed project are only $4,433,474 - which is less than the "direct costs" as of the date of the report for the incomplete project. See Leahy Report at 55 and 59. This might simply be an error in the report using the term "direct costs" at page 16 to include what are referred to as "direct" and "indirect" costs at page 59. Or perhaps it is an indication that the $4,921,611 "direct cost" used in the "as is" value includes a great deal of interest carry and other non-improving expenses.
Finally there is the question of what to do with the figure in the footnote to the "as is" value which provides:
Land Value plus the contributory value of the
improvements completed as of the effective date of valuation. Contributory value (% disbursed) as reported by the Temecula Valley Bank amounts to $2,238,613 .
Leahy Report at 3, Fn. (**). Counsel for the Defendants raised the possibility that this was the real figure for direct costs with interest and the like backed out. Mr. Leahy could not recall.
There was at least one factual error in the Leahy Report that was raised at the hearing. It incorrectly stated that "the subterranean parking garage was in place and the primary structures have been framed. Subflooring is also in place at the subject property." As pointed out in the Keagy Report, this description is inconsistent with the photograph at page 6 of the Leahy Report which clearly shows incomplete framing. The Court agrees that the projected completion schedule of 4 months August 2 006 to January 2 007) in the Leahy Report was aggressive. Keagy Report's six month projection is more reasonable. However, since Mr. Leahy's "as is" value was based upon disbursements to date, not projected, the error would not have impacted Mr. Leahy's conclusions.
Analysis
The Leahy Report simply contains insufficient support for the $8,221,611 "as is" valuation. Based upon the language of the report, the direct costs used appear to include at least some costs such as interest carry which should not be included for a valuation. On the other hand, the Court finds no serious objection to the Keagy -Report.
More importantly, of the two valuation approaches, the Court finds the market value approach used by Mr. Keagy to be more likely to arrive at accurate valuation than the cost approach used by Mr. Leahy. In the view of the Court, the cost approach has at least two shortcomings. First, as a matter of application, it can only be accurately applied if the true costs are known. As discussed above, Mr. Leahy admitted that he did not know what, if any, portion of the funds dispersed by TVB and used as the "direct costs" was attributable to interest carry or late fees and the like. To the extent the cost were due to costs not attributable to the improvements, they should not have been included.
Second, as a matter of common sense, what someone is likely to spend on a partially completed project (the market value approach used by Mr. Keagy), is a much better indicator of value than what had been spent to date. As Mr. Keagy explained at the hearing, the aggregate cost approach used by Mr. Leahy (adding land value and costs) was not reliable because it does not account for overruns, delay and market turndown. The Court agrees with Mr. Keagy that it is best used, if at all, as a secondary check of value. Having considered the opinions of the two experts the Court concludes that the best approach is the one used by Mr. Keagy.
The Court's conclusion is buttressed by Mr. Leahy's own report (Ex. 1), in which he arrives at his "Market Value 'As is.'" At p. 13 of the same report, he tells us the then "current economic definition of market value" was:
"The most profitable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as a specified date and the passing of title from seller to buyer under conditions whereby:
(1) Buyer and seller are typically motivated;
(2) Both parties are well-informed or well-advised, and acting in what they consider their own best interests;
(3) A reasonable time is allowed for exposure in the open market;
(4) Payment is made in terms of cash in U.S. dollars or in terms of financial arrangements comparable thereto; and
(5) The price represents the normal consideration for the property sold unaffected by special or creative financing or sales concessions granted by anyone associated with the sale."
In contrast, on the next page, Mr. Leahy provides his definition of "Market Value 'As is.'" It provides:
The current value estimate of the subject property in its present physical and economic state without hypothetical conditions, assumptions or qualifications are of the date of value. In purposes of this appraised analysis, the Market Value "As is" estimate consists of the Aggregate Retail Proceeds less any and all costs associated with the marketing and sales of the subject property as individual "for sale" condominiums.
Based on the testimony taken at the hearing, it appears there are inconsistencies between the foregoing definition of "Market Value 'As is'", and the assumptions made to arrive at any sort of value. Most troubling to the Court is the idea that one arrive at any sort of value by adding land costs and lender disbursements (whatever they might include, such as cost overruns and prolonged interest carry because of delays), without regard to what the defined Market Value might be.
To be fair to Mr. Leahy, he was not hired by either of the parties to opine on market value. Rather, he was hired by the construction lender back in 2006 for mortgage finance purposes. He was subpoenaed to testify about an appraisal he made 7-1/2 years before, and made for different purposes. Nevertheless, the Court concludes that it is of significantly less usefulness for present purposes than the appraisal of Mr. Keagy.
For the foregoing reasons, the Court adopts the valuation provided in the Keagy Report, and rejects that of the Leahy Report. With a value of $4,500,000 as of September 27, 2006, compared to the stipulated senior lien of TVB of $5,549,613.80, the Court concludes that the deed of trust reconveyed on September 27, 2006, was of no value. Regardless of whether the market value of the property is determined as of September 27, 2006, when the reconveyance was made, or September 2007, when Mr. Philcox learned the junior trust deed had not been re-recorded, or April 22, 2008 when foreclosure by TVB occurred, it is clear that the senior debt owed to TVB always significantly exceeded the market value of the property on each corresponding date. Hence, there was no property obtained by Defendants by virtue of the alleged fraud and no damages flowing from the alleged misrepresentations.
Finally, the Philcoxes also assert that they were damaged by the loss to foreclosure of rights they would have had as junior lien creditors (if the trust deed had been re-recorded). However, it is established in this Court that an otherwise secured creditor who claims such rights must prove that at the time of, for example, forbearance "it had valuable collection remedies." Cho-Hung Bank v. Kim, 163 B.R. 157, 161 (9th Cir. BAP 1994), aff'd and adopted 62 F.3d 1511 (9th Cir. 1995); see also In re Sirian, 967 F.2d 302, 305 (9th Cir. 1992). In short, so far as the record in this case reflects, at no relevant point in time would the Philcoxes have had any equity value to which their junior lien would have attached assuming the trust deed purporting to secure the debt had been re-recorded.
CONCLUSION
For the foregoing reasons, the Court grants Defendants' motion for summary judgment on the § 523(a)(2)(A) claim at this time. The Court has already denied the motion with respect to the § 523(a)(2)(B) claim.
IT IS SO ORDERED.