posting for

Wednesday, August 4, 2004

 

by:  Bert Rush

brush@firstam.com

 

PAYOFF DEMANDS/RELEASE TO COME/ESCROW AND CLOSING

 

Some years ago in California we had problems with lenders giving payoff demands, and accepting payoffs, but then refusing to issue reconveyances (i.e., satisfactions) on grounds the demand had been miscalculated.

 

The legislature responded by enacting a statute requiring lenders to provide a written "payoff demand statement" when requested, and protecting those who rely on same in making payoffs.  Amounts that are erroneously omitted from a payoff demand now become an unsecured obligation of the borrower.  (See Civil Code section 2943[a][5], [c] and [d].)

 

In a case of first impression, a California Court of Appeal has held that an "ambiguous" payoff demand may be considered outside the statute, not reasonably relied upon, and not binding on the lender. 

 

The case is California National Bank v. Havis, ___ Cal.App.4th ___ (2004).  Here's what happened.

 

In 1998, a predecessor of California National Bank ("Bank") loaned $1.2 million to Keyshawn Johnson (now star wide receiver for the Dallas Cowboys) for purchase of property in the Los Angeles area where Johnson would operate a restaurant.

 

In June 2002 Johnson agreed to sell the property to Investor's Capital Management Group ("Investor's") for $2 million.  The new lender would be Gold Mountain Financial Institution.  Escrow was opened with Wilshire Escrow.  Gold Mountain gave escrow instructions that its new loan must be secured by a first deed of trust against the property.

 

On June 20, 2002, Bank prepared a payoff demand for Johnson's financial advisers showing $1,165,422 due and including a per diem interest calculation good for 30 days.  Wilshire Escrow received a copy.  Bank, however, did not receive funds to pay off the loan within the 30-day period.

 

Then, on July 24, 2002, purchaser Investor's delivered a check to one of Bank's branches in the amount of $1,175,247, which purported to pay off the Johnson loan.

 

Five days later, on July 29, Bank employee Cleo Douglas sent a fax letter to Wilshire Escrow saying in part:

 

"This letter is to verify that California National Bank

received payoff funds for the above referenced (Johnson)

loan on July 24, 2002, in the amount of $1,175,247.14.

 

It is our policy to issue the Full Reconveyance, 10

days after receipt of the pay off check.  Therefore, a

Full Reconveyance will be sent to the County Recorders

(sic) on or about August 5, 2002."

 

The Douglas letter raised eyebrows at Wilshire Escrow, since it was contemplated the purchase money would be coming from Gold Mountain and would pass through escrow, so a representative of Wilshire Escrow called Ms. Douglas to confirm the payoff.  Here's how Ms. Douglas later recalled the conversation:

 

"During that telephone conversation, I restated and

re-emphasized to him...that the underlying Note had not

been satisfied since the check tendered to California

National Bank had not been cleared and good funds had

not been collected.  Furthermore, I told him at that time

that (Bank) would not forward for recording a reconveyance

of its deed of trust...until such time as the Note was paid

in full with good funds--meaning, that the check tendered

to (Bank) was collected upon and monies deposited with

 (Bank)."

 

On the same day, July 29, counsel for Gold Mountain sent a fax letter to Wilshire Escrow saying in part:

 

"We have no way to verify that the borrower/buyer if (sic)

fact prepaid the (Bank) loan.  Normally, the title company

handles loan pay-offs.  I am writing to inform you of the

above information because my client expects to receive a

policy of title insurance from your firm insuring my client's

loan as a first deed of trust...."

 

What next occurred is not explained by the Court's opinion:  On July 31, Gold Mountain deposited $1.4 million into escrow.  On August 1, escrow closed without further confirmation from Bank that it had been paid with good funds.  A new deed of trust in favor of Gold Mountain was recorded, and the $1.4 million in escrow was disbursed (apparently to purchaser Investor's).

 

The Investor's check tendered to Bank on July 24 did not clear and, on August 5, Bank sent a letter to Johnson's financial advisers purporting to provide an "Updated Demand for Payoff."  Meanwhile, on September 4, Gold Mountain assigned its deed of trust to third party investors.   

 

On October 30, Bank filed suit seeking a receivership for the restaurant business, and seeking to enforce its still-unreleased deed of trust.  The trial court appointed a receiver, and enjoined the Gold Mountain assignees from "selling, transferring, disposing, encumbering, or concealing the property without a prior court order."

 

Later, on cross motions for summary judgment, the trial court ruled in favor of the Gold Mountain assignees, holding the July 29 Douglas letter was a "payoff demand statement" upon which escrow and Gold Mountain justifiably relied under Civil Code section 2943.    Since it based its ruling on the statute, the trial court did not consider testimony about conversations taking place after the Douglas letter was delivered, nor did it consider circumstances of the closing.  Bank appealed.

 

The Court of Appeal reversed, holding that (a) the Douglas letter was not a "payoff demand statement" as defined by section 2943, (b) there is a triable question of fact as to whether the letter was reasonably relied upon to close escrow, and (c) there is likewise a triable question as to relative priorities of the competing deeds of trust.

 

In so holding, the Court first distinguished the Douglas letter from a statutory "payoff demand statement," which by definition gives amounts needed to pay off an encumbrance, because the letter did not give amounts but instead reported receipt of Investor's check outside of escrow.  Moreover, the letter said Bank expected to issue a reconveyance after the check cleared.  The Court concluded, "nothing in this letter could be relied upon to justify the closing of the escrow prior to August 5, 2002."

 

Next, since the Douglas letter was not a "payoff demand statement" per section 2943, the Court said questions remain as to whether Bank should be equitably estopped from asserting 'first lien' status because Wilshire Escrow and Gold Mountain detrimentally relied on the letter to close escrow.  Again the Court emphasized the letter's ambiguity, concluding there is a triable question of fact as to whether the letter was reasonably relied upon.  In deciding this question, the Court said the trier of fact should consider the testimony of Ms. Douglas and others about conversations between July 29 (when the letter was sent) and August 1 (when escrow closed).

 

Finally, the Court said evidence of how the Douglas letter was received by Wilshire Escrow and Gold Mountain (i.e., it surprised them), together with questions about why the closing took place when it did, raised a triable question as to whether Gold Mountain acted in good faith--entitled to status of "a bona fide encumbrancer for value."

 

With that, the summary judgment in favor of the Gold Mountain assignees was reversed, and the case was remanded for further proceedings.

 

Comment:  While I don't disagree with the outcome, several things about this case bothered me.

 

First, it bothered me that the Court seemed to say that a 'zero' payoff demand is not within the statutory definition of a "payoff demand statement"--entitled to be relied upon by escrow--simply for lack of payoff amounts.  I understand the statute contemplates the lender will supply amounts, but if nothing is due then that's the correct information and a demand that says so should be subject to the same rules as one that gives amounts.  Besides, section 2943(c) says that when requested the lender "shall" supply a written payoff demand statement.  In this case, let's suppose the lender was so requested.  It seems unfair that the lender can avoid its responsibilities by giving an ambiguous reply to a proper request.

 

On the other hand, the Douglas letter was not an unqualified 'zero' demand--and I'd agree it should not have been relied upon (without more) to close escrow.

 

Second, the Court's handling of the good faith/bona fide encumbrancer issue bothered me.  Forgetting for the moment this may be a red herring, it does not appear the issue was raised before the trial court and it may not have been briefed.  Remember, appellants in this case were assignees of Gold Mountain, who may be entitled to their own protected status as holders in due course as to the note, and good faith purchasers as to the deed of trust, if in fact they took the assignment from Gold Mountain without notice or knowledge of the brewing dispute with Bank.

 

So how does the Court suppose the assignees stand in the same position as Gold Mountain vis-a-vis the Bank?  According to the opinion, this is based entirely on a concession made by counsel for the assignees at oral argument.  Sounds like an ambush to me.  Hopefully the issue will get more thoughtful consideration when the case returns to the trial court.

 

There seems to be a lot we don't know about this case, but if I were laying odds at this juncture I'd say (a) the escrow should not have closed as it did on August 1, (b) Bank should not be subject to equitable estoppel because it did not give erroneous information justifying reliance by Wilshire Escrow and Gold Mountain, and (c) the Gold Mountain assignees may well be good faith/bona fide encumbrancers who nevertheless hold their deed of trust subject to the previously recorded deed of trust in favor of Bank.  In other words, Bank wins because there's no grounds to cancel their senior deed of trust.

 

How 'bout that Keyshawn Johnson?

 

Questions, comment, argument?  Just press the "reply" button....

 

 

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Following Wednesday's posting, Leonard Gray (Atlanta, GA) writes:

 

I agree that there seems to be more to this than reflected in the Court’s opinion. Aside from the statutory interpretation issues raised (i.e. whether the lender correspondence given constituted a demand statement under CA Civil Code section 2943), I think it is important to follow the money.

 

Someone here appears to have benefited to the tune of $1,175,247, which is the amount of the dishonored check given to “payoff” the first lender. Also, who received the extra funds “disbursed” by escrow from the Gold Mountain loan proceeds? The seller may have extra funds and the buyer as well. Someone left the table with more than they should have. Perhaps this could also be considered upon remand.

 

Comment by Bert Rush:  To finance the $2 million purchase price buyer deposited $600,000 and Gold Mountain deposited $1,400,000 into escrow.  Here's what the Court of Appeal said:

 

"Though the record indicates the funds were deposited

into escrow, it does not indicate who received the $1.4

million at the close of escrow.  Incredibly, at oral argument,

none of the counsel present were able to state with any

certainty just what happened to these funds, other than to

confirm that they were not delivered to Bank."

 

Mike Fromhold (King of Prussia/Philadelphia, PA) writes:

 

Recognize that I’m coming from an area where “wet” or “round table” closings are the norm, but wasn’t the concern which necessitated the Bank’s letter, to confirm that the amount as tendered was the total due (since it appears that the amount tendered was not readily calculable under the original payoff letter - i.e.  it was beyond the payoff time period in the original payoff letter). In hindsight, if Douglas’ letter at the second paragraph had added something like “ Subject to the check clearing”  (or words of similar import) then any third party would have immediately recognized that the amount tendered was ok - but subject to “collection”.  It sounds to me like the court got it right, and appears to imply “collection” to the Douglas letter, which isn’t off the wall to me, especially in the context of a commercial transaction. The issue that the CA legislature was addressing is a concern we all have, and that is the numbers seem to change after the fact where there has been good faith reliance by third parties in the payoff letter from a financial institution. I'd like to see legislation like CA on this subject, in our area, too.

 

 

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Following up on last Wednesday's posting, and replies, Alan Rubin (Manhattan) writes:

 

While on the subject of accepting payoffs, how about this one?

 

On July 30, 1998, John Tecklenburg, who was already in title to the premises, made a mortgage in favor of Champion Mortgage Co. ("Champion") in the amount of $71,000.00. First American issued a loan policy to Champion. The title report indicates that there were several prior mortgages raised, including: (1) $25,000 mortgage in favor of Inter-County dated 11/14/77; (2) $67,539.00 mortgage in favor of Inter-County dated 9/24/91 and (3) $24,788 mortgage in favor of Mid-Hudson dated 8/11/93. Mortgages #1 & 2 were consolidated to form a single lien of $80,000 by Agreement dated 9/24/91, and mortgages #1, 2 and 3 were consolidated to form a single lien of $100,000 by Agreement dated 8/30/93.

 

The mortgages, as consolidated, foreclosed, naming Champion as a junior lienor, and the claim submitted to us was based on the question of lien priority as raised in a motion and cross-motion for summary judgment.

 

After Tecklenburg's application for a loan by Champion had been tentatively approved, Champion became aware of the fact that there were prior mortgages encumbering the premises held by Mid-Hudson Savings Bank (which subsequently merged into First Union National Bank). Since the program under which Tecklenburg was to borrow from Champion required the loan to be secured by a first mortgage, it was essential that the prior mortgages either be satisfied or subordinated to any new first mortgage taken back by Champion.

 

Tecklenburg advised Champion that the prior consolidated mortgage held by Mid-Hudson had been satisfied. As evidence of the satisfaction, Tecklenburg produced a letter from First Union dated 4/17/98 indicating that the mortgage held by First Union had been paid in full on 2/20/98. Tecklenburg also produced a letter that he had received from Nationwide Title Clearing, an apparent agent of First Union, that their records indicated that the loan had been paid in full to First Union Mortgage Corporation.

 

In addition to the foregoing, prior to the disbursement of the loan proceeds the closing attorney for Champion and the title agent checked by telephone with Nationwide Title Clearing, which confirmed that its records indicated that the Tecklenburg mortgage held by First Union-as successor interest to Mid-Hudson-had been paid in full.

 

The affidavit of First Union's attorney (in support of the plaintiff's motion for summary judgment) indicates that: First Union mistakenly applied payoff funds received by First Union in connection with another loan to Tecklenburg's account, and by letter dated March 4, 1998, Tecklenburg was advised by First Union that his loan and been paid in full. The affidavit further indicated that the error was not discovered by First Union until six (6) weeks after the Tecklenburg/Champion closing.

 

In their cross-motions for summary judgment, Tecklenburg and Champion contended that the foreclosing plaintiff should be equitably estopped from bringing the action. The Supreme Court, Orange County, in dismissing the foreclosure action, stated that "Champion should not lose its priority due to plaintiff's negligence and its affirmative representations that the mortgage had been paid. Under these circumstances, the loss should be borne by the party who made the mistake, plaintiff". The court held, however, that as to Tecklenburg, an essential element of estoppel, detrimental reliance, was missing.

 

The Appellate Division, Second Department reversed in favor of Tecklenburg, finding that "all the requirements of an estoppel have been met". Contrary to the lower court's determination, the appellate Division found that Tecklenburg demonstrated that he underwent "a detrimental change in his position" (i.e., he would have been required to pay two mortgages). See, First Union National Bank v. Tecklenburg, 769 N.Y.S.2d 573 (2d Dept. 2003).

 

 

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Following up on our posting for 8/4/04 and, in particular, Alan Rubin's reply, Jack Murray (Chicago, IL) writes:

 

Below is my description and analysis (posted to the DIRT listserv on July 15) of the infamous N.Y. Tecklenberg case that Alan Rubin described. This was in response to Prof. Randolph's discussion of the recent Martin v. Cadle Co. case (Tex.) (also described below), which held that a mortgagee has no power to rescind a release once it has provided it, even if the borrower supports the rescission.

 

From the DIRT listserv--Comment by Jack Murray:

 

I generally sympathize with the court's belief (as stated by Prof. Randolph) that greater regularity is a worthy goal in the legal arena (and also in personal matters -- which is why laxatives are sold).

 

Also, I tend to agree with Pat that this was something of an odd decision, and that if Johnstone in fact paid off the mortgage debt, Martin's attorneys were probably guilty of malpractice for not at least raising equitable subrogation as a defense and doing some significant due diligence in this area. (For a summary of recent case law involving equitable and "conventional" subrogation, see the article on my website, in the Mortgages and Financing section, entitled "Equitable and Conventional Subrogation in Illinois (An Update).")

 

In another surprising recent decision involving a mortgage release, First Union Bank v. Tecklenburg, 769 N.Y.S.2d 573 (N.Y. App. Div. 2003), the borrower had regularly paid the amounts due on his mortgage for more than 20 years. The bank lender (successor to the original lender) apparently received payoff funds that were erroneously applied to the borrower's account, and sent him a letter stating that his loan was now paid in full. The borrower "directed numerous inquiries to the [bank] seeking an explanation of this unexpected transaction and was repeatedly told that the mortgage had been paid off and a satisfaction would be forthcoming." Id. at 576.

 

Four months later, the borrower obtained a new mortgage from a new lender, which also confirmed with the bank, before closing, that the prior mortgage had been paid in full. Finally coming to its senses (or arising from its stupor) and realizing its error, the bank advised the borrower -- one month after he had closed on his new loan -- that it had mistakenly credited his account with the payoff funds ant that the bank's mortgage had in fact not been paid in full. But the bank -- obviously not the most stellar lending institution in the banking universe -- proceeded, for unknown reasons, to subsequently record a mortgage satisfaction and return the original mortgage documents to the borrower! The bank then filed a foreclosure action, alleging that the original loan was in default. The borrower, of course, immediately moved to dismiss the action based on the doctrine of equitable estoppel.

 

The appellate court agreed with the borrower and reversed the trial court, which had ruled in favor of the bank. The appellate court ruled that all the elements of equitable estoppel in New York had been met, and stated that, "[a] mortgage lender may be estopped from asserting rights under a mortgage to prevent a fraud or injustice to the person against whom enforcement is sought, or who in justifiable reliance upon the lender's words or conduct has been misled to his detriment (citations omitted)." Id at 576-77. The court also stated that, contrary to the determination by the trial court, "by securing a mortgage from [the new mortgage lender] after the [bank] mistakenly informed him that the mortgage had been satisfied, the [borrower] demonstrated that he underwent a detrimental change in his position." Id. at 577.

 

Mirabile dictu! The moral: If you act like a doormat, expect to get stepped on. The bank's actions are inexplicable, and undercut its argument (normally persuasive) that a borrower should not profit from a mistaken release of its mortgage.

 

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Daily Development for Friday, July 9, 2004

by: Patrick A. Randolph, Jr.

Elmer F. Pierson Professor of Law

UMKC School of Law

Of Counsel: Blackwell Sanders Peper Martin Kansas City, Missouri dirt@umkc.edu

 

MORTGAGES; RELEASE: A mortgagee has no power to rescind a release once it has provided it, even if the borrower supports the rescission.

 

Martin v. Cadle Co., 133 S.W. 2d 897 (Tex. App. 5/19/04)

 

Pratt was a judgment debtor on certain recorded judgment liens, including several owned by Cadle.  Pratt acquired a cotenancy interest in certain property, giving a purchase money deed of trust to the predecessor of Compass Bank.  The effect of this event was to create a purchase money lien in Compass Bank with priority over the Cadle judgment liens, the but judgment liens attached to the property in junior position.

 

Three years later, Compass Bank executed and recorded a release of lien of its note and deed of trust, stating in the release that it had received "full payment."  Two weeks later, however, Johnstone, a party apparently having some relationship to Pratt or Pratt's cotenant, filed a notice of foreclosure by substitute trustee of the Compass Bank deed of trust (yes, the one that had been released of record.)  This notice stated that Johnstone was the owner of the note and deed of trust.  The foreclosure sale occurred, and Pratt's cotenant bought at the sale.

 

One week after the foreclosure sale, Compass Bank executed and recorded a transfer of its note and deed of trust to Johnstone.  Thereafter, the successful foreclosure purchaser sold the property to Martins, parties apparently unrelated to the rest of the group.

 

Some years later, Cadle argued that his judgment lien remained valid against Martins' title, and brought declaratory relief.  The trial court awarded summary judgment to Cadle.

 

On appeal: Held: Affirmed. As there was nothing in the record to suggest that Compass Bank had erroneously executed and recorded the original release, Cadle's judgment lien rose to a first priority position against the property as of that release.   Therefore, subsequent actions by the bank in attempting to undo its release and transfer its interest to Johnstone were of no avail.

 

As to Martins, they had record notice of the fact that Johnstone did not own the deed of trust when she foreclosed.  Further, Johnstone's trustees deed to the foreclosure sale purchaser references the prior release by Compass Bank.  So the Martins had inquiry notice of the whole problem.

 

Comment 1:  Note that the affidavits provided to the court in the summary motion proceeding did not allege that Johnstone had herself paid off the debt secured by the Compass note.  If she had, she might have been able to mount a subrogation claim.  If, indeed, she did cause payment to be made, it was a critical error of Martins not to allege this.  Unfortunately, Martins were in a very weak position because the challenge to their title came five years after the Johnstone foreclosure and acquisition of the note, and Martins may have had very little information about the circumstances surrounding those events.

 

Comment 2: What the editor finds interesting about this case is the court's emphasis on regularity.  There is no claim that Cadle or anyone else relied to their detriment on the filing of the release.  The court simply concludes that once the bank entered the release, it could not withdraw from it.

 

Note that in many cases lender have arranged for release of claims that they have refinanced (either claims held by themselves or others) with the clear intention of relying upon a recorded refinancing mortgage as security.  But the majority rule, supported by the Restatement, appears to be that the bank nevertheless will be entitled to equitable subrogation to the released lien where necessary to preserve its priority.   It may be that in this case there simply were inadequate allegations concerning the relationship between Johnstone and the debtor to reach the conclusion that the transfer to Johnstone was related to a payment of the debt.  But why else would the bank have transferred to Johnstone?  Thus, the regularity requirements imposed here seem inconsistent with the typical equitable subrogation decisions.

 

Note that the author is a thin voice crying in the wilderness as to the propriety of requiring greater regularity on the part of banks in these subrogation cases.  Most authorities seem to be of the view that the refinancing bank gets subrogation even where the prior lien had been fully released with the bank's knowledge and even where the refinancing bank recorded its new mortgage with knowledge of existing unpaid liens junior to the old mortgage but senior to the refinancing lien.

 

Items reported here and in the ABA publications are for general information purposes only and should not be relied upon in the course of representation or in the forming of decisions in legal matters.  The same is true of all commentary provided by contributors to the DIRT list.  Accuracy of data and opinions expressed are the sole responsibility of the DIRT editor and are in no sense the publication of the ABA.

 

Parties posting messages to DIRT are posting to a source that is readily accessible by members of the general public, and should take that fact into account in evaluating confidentiality issues.

 

 

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