Ohio Practical Business Lawyer & Attorney : Teri Rasmussen : Lane Alton & Horst Law Firm : Commercial Law, Creditors, Business Formation : Columbus, Central Ohio

If you've been paying any attention at all to the national news of late, you know that Detroit's Big Three automakers are in deep trouble and that a substantial number of folks seem to think that forcing them into a "prepackaged " bankruptcy is the ANSWER.  When I first heard this, I thought this seemed like a pretty good idea ....  until I started really thinking about both what can and can't be accomplished  with this sort of Chapter 11 bankruptcy proceeding. 

So in a two-part post, I want to first explore the nature of the beast  those of us in the "biz" call a "prepack" and then focus more specifically on how it might actually operate in the context of the problems being faced by America's automakers.  While superfically appealing, a prepack is far from the panacea some seem to think it could be.  To understand why, you first have to understand how prepacks work in general.

Prepack Coming of Age.  Chapter 11 (and they always are Chapter 11 reorganizations) prepackaged bankruptcies came to the fore about twenty years ago.  Many say that  Dallas based hospital owner Republic Health Corp. was the first successful prepack with a plan confirmed less than five months later.  Prepacks became somewhat more popular during the 1990's in the context of failed LBO's, to implement mass-tort settlements, or as a vehicle to consummate sales or mergers of companies.   In the August issue of the Turnaround Management Association's Journal of Corporate Renewal, an article by Douglas Foley and James Van Horn entitled "Prepacks on the Rise in Chapter 11 Bankruptcies Prenegotiated Plans Can Accelerate Reorganization", asserts that there has recently been renewed interest in this variation of Chapter 11 with four filed in 2007 and more than a dozen filed in the first half of 2008. 

Companies utilizing the prepackaged option have included Donald Trump's Taj Mahal Casino in Atlantic City, Zenith Electronics, Aurora Foods-Pinnacle Foods merger, and TWA.  More recent participants have included Davis Petroleum (Case No. 06-20152, Bankr. S.D. Tex.) (whose plan was confirmed less than a week after filing), Blue Bird Body Co. (Case No. 06-50026, Bankr. D. Nev.), Bally Total Fitness (Case No.07-12395, Bankr. S.D.N. Y.), and Mrs. Fields' Original Cookies (Case No. 08 - 11953 , Bankr. D. Del.) (plan confirmed in less than sixty days after bankruptcy filed).

To promote organization and judicial economy, some jurisdictions such as the Northern District of California Bankruptcy Court and the Southern District of New York Bankrptcy Court have even adopted local rules governing prepackaged bankruptcies.   

Prepack Advantages.  The hallmark and principal advantage of a successful prepack is a substantial savings in time and disruption as compared with the ordinary Chapter 11 bankruptcy case.  The average Chapter 11 case, even a relatively small one, is rarely likely to be completed in less than a year and it can often take two or three years, or even longer, for a company to emerge from Chapter 11.  By contrast, prepackaged cases typically take less than six months, thus saving both time and money typically spent on case administration.  Conventional wisdom also holds that deterioration of the intrinsic value of a business which is often a consequence of a Chapter 11 filing and the attendant uncertainty is lessened through use of the prepackaged option.  (For a general discussion of the general effect of a Chapter 11 bankruptcy on a public company's shareholders, visit the discusssion of "What Every investor Should Know ... Corporate Bankruptcy" on the SEC's website.)

Technically, a prepackaged bankruptcy differs from a prenegotiated bankruptcy in that votes for a plan of reorganization have already been solicited and agreed upon prior to the filing, thereby leaving nothing to chance when it comes to achieving a successful confirmation of the Plan of Reorganization.  In a prenegotiated bankruptcy, actual votes or agreements to vote have not yet been reached with the critical mass of creditors, although resolution has typically been reached with those creditors deemed most crucial to success. 

The most important characteristic of a prepack  (or a prenegotiated bankruptcy) is that the major players in the bankruptcy have come to an agreement among themselves about the most important issues of subsequent financing, lien priority, and the extent to which the debt owing will be discounted or terms of repayment extended.  This reduces the potential for the debtor to lose control of the proceeding and allows it to proceed directly to its contemplted reorganized operations.  By minimizing the time spent subject to the restrictions and various oversight provisions embodied in the Bankruptcy Code and reaching important agreement before  even filing, the liklihood of full blown creditor second-guessing and need to balance the influence of various interests is thought to be significantly and productively decreased. 

Nuts and Bolts.  Section 1126(b) of the Bankruptcy Code and Bankruptcy Rule 3018(b) explicitly allow prepetiton solicitation of votes for approval of a Plan of Reorganization as long as certain procedures are observed.  The key elements to a successful prepetiton solicitation crtical to making a prepack a "go" are:

• The proposed plan must have been transmitted to substantially all creditors or equity security holders entitled  to vote in a class;
• Sufficient time  must have been allowed for voting (or in the words of the statute, the time allowed must not be "unreasonably short" which is of courae a case by case judgment call)
• Those solicited must have been provided with "adequate information" in connection with the solicitation of their vote.
• The provisions of any applicable nonbankruptcy law  such as federal securities law governing communication with shareholders of public companies must be complied with.

In essence, a prepack allows the debtor to bypass the lengthy time (starting with a 25 day notice period  for a hearing on the Disclosure Statement) involved in getting a disclosure statement approved by the Bankruptcy Court, distributed to creditors, and gathering/tabulating ballots approving or rejecting the proposed Plan of Reorganization.  There is of course the risk that the Court will determine after the fact that the prepetition solicitation process did not meet the requirements set forth above; this can happen either as a result of a motion by a party in interest on the Court can make such a finding on its own initiative.

What a prepack does not do, however, is change the requirements concerning creditor approval of a Plan of Reorganization.  Pursuant to section 1126(c), a class of "impaired" creditors (i.e. those not being paid in full) will be deemed to have accepted the plan if and only if the creditors in that class voting hold two-thirds in amount and at least a majority in number of claims voted do in fact vote to accept the plan.  In addition, pursuant to section 1129(a)(10), the plan cannot be confirmed unless at least one class of impaired creditors vote to accept the plan.  there are also the other usual requirements of feasibility and the like. 

Prepack Risks and Obstacles.  Prepackaged bankruptcies tend to work best where there are a limited number of sophisticated secured creditors involved with whom productive negotiations can actually be had.  They tend to work less well when a debtor has a large number of creditors, especially if unsecured, with a variety of different claims ( e.g. trade creditors, employees, landlords, equipment lessors,etc.) entitled to varying treatment under the Bankruptcy Code and which may fluctuate considerably during the period immediately preceding a filing.  Large numbers of contingent claims can also be an obstacle for the obvious reason that time must be spent determining how to estimate the amount of such claims.

In addition, by immediately proceeding to the plan confirmation phase, a debtor does lose the benefit of the "breathing spell" provided by the automatic stay which arises immediately upon the filing of the petition.  And, of course, it does tip the debtor's hand as to its financial distress (which may often be obvious anyway).

Drawing Conclusions.  While there are certainly some useful rights and remedies available to Detroit's Big Three should they decide to file Chapter 11 - being able to shed burdensome labor and/or dealer contracts springs to mind - there are also substantial risks - will consumers continue to spend thousands of dollars to buy vehicles from a car company in bankruptcy.   Prepackaged bankruptcy seems to be advanced by many of its advocates as a way to maximize the advantages of being a Chapter 11 debtor while eliiminating the "down side" of a bankruptcy filing.  I just don't think it's that simple.

So next time I will focus more specifically on how well suited the prepack option really is for Detroit's Big Three and what it might and might not be able to do for them.,

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If you've been in business long at all, somewhere along the line there may well have been some sort of dispute about the amount a customer owes.  And if you've had any contact at all with an attorney, you have undoubtedly been told to watch out for "payment in full"  situations in which you receive checks purporting to be "in full satisfaction" or containing some similar endorsement indicating that the customer intends this payment to be it.  In fact, if you're in Ohio, you have probably been admonished (and maybe even established as policy) that any check accompanied by a such a restrictive endorsement, or any cover correspondence using this language, MUST be returned to the customer. 

Simple enough.  But suppose you receive a cover letter enclosing a check for less than the amount owed which doesn't use these "magic" terms of art?  What if the letter specifically states that it is not placing any restrictive endorsement on the check to you, but hastens to add something to the effect that this is all the money we believe is owed to you?

In Ohio, the answer has changed over the years.   Prior to the 1989 Ohio Supreme Court case of AFC Interiors v. DiCello, 46 Ohio St.3d 1, 544 N.E.2d 869 (1989), creditors faced the dilemma of having to choose between  accepting the lesser amount offered and writing off the balance or rejecting the partial payment being offered in favor of pursuing the debtor for the entire amount due.  If a check offered "in full payment" or "in full satisfaction" was cashed by the creditor, the remaining amount owed simply could not be recovered.

From 1989 through 1994, there followed a glorious period for creditors in which they could rely upon Ohio Rev. Code 1301.13 to take the partial payment AND still pursue the debtor for the balance if they did so while make a "reservation of rights".  Thus if the creditor endorsed the check by writing words such as "under protest" or "without prejudice" just above their endorsement before cashing the check, the creditor had managed to have its cake and eat it too.  In this way, creditors accepted the partial payment, applied it against the balance owing and then were permittred to continue further collection efforts.  

All this changed in 1994 when Ohio adopted the revised version of Uniform Commercial Code Articles 3 and 4.  As a result of the change in the law, making a reservation of rights was no longer possible.  In addition, if the partical payment was accompanied by correspondence indicating that the payment was ended to satisfy the obligation in full. cashing the check meant that the creditor could not pursue the trmaining ballance.  New Ohio Rev. Code 1303.40 (A), which remains in effect today, provided that

the claim is discharged if the person against whom the claim is asserted proves that the instrument or an accompanying written communication contained a conspicuous statement to the effect that the instrument was tendered as full satisfaction of the claim.

 This had the effect of returning Ohio to the pre-1989 common law era.

So, today, do not be fooled if receiving a partial payment check.  In addition to the obvious situation in which it is clearly marked as "payment in full", you must also pay attention to the correspondence accompanying the payment.  If that correspondence indicates that the sender does not intend to pay the balance, then you are cashing the check at your own risk, even if there is no restrictive endorsement placed  on the check.  

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Whether you're a lender making a loan secured by a mortgage on real estate, a prospective buyer, or an unpaid tradesman making improvements to real estate, understanding Ohio mechanics' lien law is very important.  Guernsey Bank v. Milano Sports Enterprises, LLC, 2008-Ohio 2420 (May 20, 2008), a decision recently handed down by the Franklin County Tenth Appellate District Ohio Court of Appeals, while not really that interesting as far as making new law, underscores this importance and should be seen as a warning of what could happen if proper procedures are not followed.  Francisco Luttecke of Bricker & Eckler LLP provides a useful and complete summary of the facts and holding of this case in an e-alert to whose mailing list I seem to have been added (not that I'm complaining).

Facts of Guernsey Bank Case.  At the most basic level, the Guernsey Bank case illustrates some of the problems that can arise in more complicated transactions.  The defendant Milano Sports Enterprises, LLC ("Milano Sports") had entered into a purchase contract to buy an indoor tennis facility that it intended to convert into an ice rink.  Because Milano Sports wanted to get started on renovations immediately rather than waiting to close on the purchase, it entered into a lease agreement with the seller.  About two months later, the purchase was consumated and financed by a loan from Guernsey Bank secured by a mortgage on the subject real estate. 

Meanwhile, in the intervening two months, an electrical contractor and other tradesmen performed some of the work necessary for the conversion, but were not paid.  After the purchase transaction went through and the Guernsey Bank mortgage had been recorded, the electrical contractor and other unpaid contractors filed mechanic's lien affidavits.  It should also not come as too much of a surprise that a few months after this, Guernsey Bank started foreclosure proceedings regarding the real estate. 

Eventually the property was sold at foreclosure sale for $525,000, leaving Guernsey Bank with a deficiency of approximately $75,000.  A priority fight broke out over who was entitled to the foreclosure sale proceeds with Guernsey Bank challenging the priority and validity of the mechanics' liens.  Ultimately, Guernsey Bank received only about $137,000 of the foreclosure sale proceeds because the Court found the mechanics' lien holders had priority.  Thus Guernsey Bank wound up with a deficiency of more than $475,000 instead of only $75,000. 

What to Know About Mechanics' Liens.  Which brings us to the lessons to be learned from this rather ordinary case:

1. Mechanics' liens CAN trump and have priority over previously recorded mortgages in certain circumstances.  If no notice of commencement is filed, the relative priority of a mortgage and a mechanics' lien depends upon when the first of the labor or material was performed or furnished.  If the mortgage is recorded prior to any labor, work or furnishing, then the mortgage lien will have priority.  Ohio Rev. Code §§1311.13(A); 5301.23.  If, however, the labor, work or furnishing begin before the mortgage is filed for record, then the mechanics' lien will have priority over the entire mortgage for the entire amount of the mechanics' lienholder's claim even if (A) some of the goods or services were provided after the mortgage was recorded or (B) the lien affidavit perfecting the mechanics' lien is filed after the mortgage is recorded.  Ohio Rev. Code §§1311.13(A); 5301.23.
2. Determining when the first of the labor or materials were performed or furnished means establishing the date the "first visible" work or material being performed or furnished.  Ohio Rev. Code §1311.13(A)(1).  This test was set forth in the case of Huntington National Bank v. Treasurer of Franklin County, 13 Ohio App.3d 408, 469 N.E.2d 535 (10^th App. Dist. 1983) as

    whether the work performed had produced visible results which were sufficient to make it reasonably apparent to a person examining the site that the construction, excavation, or improvement had actually commenced.... In order for the work to be deemed the commencement of construction, it must form a part of the work necessary for the construction and be of a nature that can afterward be considered a component part of the structure.

   See also Schalmo Builders, Inc. v. Malz, 90 Ohio App.3d 321, 629 N.E.2d 52 (1993).
3. Make sure you get a title insurance policy and don't just rely on a title insurance commitment.  One of the things Guernsey Bank did right was buy a title insurance policy pursuant to which the title company promised to indemnify Guernsey Bank against any loss or damage incurred because of the "[l]ack of priority of the lien of the insured mortgage over any statutory lien for services, labor or material [ ] arising from an improvement or work related to the land which is contracted for or commenced prior to the Date of Policy * * *."  As a result, at least Guernsey Bank didn't have to pay the mechanics' lienholders out of its own pocket.
4. If you are the lender and/or purchaser in a real estate transaction, make sure you get an affidavit from the seller about off-record matters such as whether any labor or materials have been supplied to the property, just in case the title policy is not as generous as the one here.   
5. If you're going to rely on the construction mortgage exception (set forth in Ohio Rev. Code 1311.14) to the special priority given mechanics' liens, make sure you have more evidentiary support than a settlement statement (which the Court ruled was inadmissible in Guernsey Bank).
6. When preparing and filing a mechanics' lien, take care to follow the form of affidavit set forth by statute.  Ohio Rev. Code 1311.06.  Guernsey Bank challenged the validity of one mechanics' lien because it incorrectly stated the amount due.  While in this case, the Court upheld the validity of the mechanics' lien,  the law in this area is often very strictly interpreted.  Crock Constr. Co. v. Stanley Miller Constr. Co., 66 Ohio St. 3d 588, 613 N.E.2d 1027 (1993).  Pursuant to Ohio Rev. Code §1311.06 - which helpfully contains an acceptable form -- the lien affidavit must contain the following information: 
   • Amount due over and above all legal set offs
   • Description of the property sufficient to identify the premises with reasonable certainty, i.e as though for purposes of conveyance or by inclusion of the legal description contained in the deed conveying title to the owner (Ohio Rev. Code §§1311.06(D); 1311.04(B)
   • Name and address of the person to or for whom labor or work was performed or material furnished
   • Name of the owner, part owner, or lessee
   • Name and address of lien claimant
   • First and last days that the lien claimant performed any labor or work or furnished any material to the improvement giving rise to the lien
7. Another thing to remember is that an Affidavit of Lien must be filed with the county recorder for the county in which the property is located within seventy-five (75) days of the last day work was performed or furnished.  Ohio Rev. Code §1311.06(B)(3).  In addition, to perfect a mechanics' lien, it is also necessary to serve the lien affidavit in accordance with the provisions of Ohio Rev. Code §§1311.07 and 1311.19 upon the owner of the subject property within thirty (30) days after it has been recorded by the appropriate county recorder; if service cannot be accomplished, then the lien affidavit must be conspicuously posted at the subject property within ten (10) days after the thirty (30) day service period.  Even if the contracting party has actual knowledge of the lien, it must still be served (or posted) to be valid.  Brown v. Pearson, 1995 Ohio App. LEXIS 2788 (2^nd App. Dist).

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Your business supplies a service or product to a customer and then bills the customer.  One month goes by, then two, and you hear nothing from the customer - no payment, no complaint, no explanation.  By the third month, you are probably becoming rather irritated at the very least and depending on how things are going financially, may be getting a bit concerned.  Or perhaps you've called the customer only to receive a series of excuses and promises that payment will soon be forthcoming.  What do you do?

Chris Moander of the Wisconsin Business Law and Litigation blog has been making a series of posts about how and when to make the decision to go to court to collect these sort of delinquent accounts.  My favorite, with the attention-getting title of "Would lower legal bills motivate you to organize your files?", explains what sort of information and records are helpful to your attorney when you turn the account over ro him or her for collection.  

What to Give Your Attorney.  I agree with everything on Chris' list and with his general point that the more organized information you can give your attorney about a delinquent account, the more quickly -- and inexpensively -- things can move forward.  While all of the items mentioned by Chris are certainly helpful, here's my list of what I find especially useful when I am asked to file a lawsuit against a customer who hasn't paid as agreed:

• Basic contact information (i.e.name, address, phone) of customer
• Credit application, purchase order, or contract documenting the purchase
• Invoice
• Ledger or account history for at least the last 3-4 months
• Copy of any checks previously sent by the customer (or information about the bank used by the customer)
• Any correspondence (including e-mails) exchanged (i.e. sent to, or received from) the customer relevant to the outstanding debt
• Any pertinent information about general nature or length of the relationship with the customer, i.e. was it generally good before this or has this customer always been difficult, is this a huge part of your revenues

With this information, I can get a fairly good idea of what the best approach might be and have what I need to file a lawsuit.  Getting it on the front end saves both time and money.

Why Collect?  Chris also addresses the question "Why collect?", and in another post entitled "Time to call Mr. Wolf", provides some guidelines concerning when it might be time to turn the matter over to your lawyer.  Again I agree wholeheartedly with Chris, but let me add some additional thoughts.  As far as the "why", that much seems rather self-evident.  Unfortunately, the world is not a perfect place and not everyone voluntarily does what they should.  If you're not willing to force the issue of payment when appropriate from time to time, it won't be long before you find you're not making any money and may have to go out of business altogether.

Deciding When to Pursue Legal Action.  Knowing "when" to pursue payment through legal channels and "when" it might be helpful to turn the matter over to your attorney is more complicated.  As Chris suggests, if any of the following are true, it probably is time to "go legal":

• The account is 90 days past due, and in some cases, even sooner.  If you wait too long to pursue legal action, events and circumstances may have occurred in the interim which make the legal option less effective
• Suddenly there's a "problem" with the product or service sold or the customer now has some other dispute with you and the customer wants some or all of their money back.  Of course in many cases, it makes good business sense to just go along with the customer and give a discount.  However, make sure you are doing that in appropriate cases.
• You've endured a series of excuses and broken promises that payment is right around the corner.

There are also times when it probably doesn't make sense to play the "legal" card:

• If there really was a problem or defect in the service or product, even if it wasn't near as big a deal as the customer is now making it
• The amount at stake is relatively small (or relatively small in comparison to the complexity of the situation resulting in nonpayment - read, lots of legal fees to sort through the facts and counter-allegations)  
• You have very important noneconomic reasons for wanting to avoid a dispute - perhaps it's your wife's brother's business
• Someone in your company engaged in some sort of objectionable behavior or made what could be characterized as misleading statements to the customer about any aspect of the business relationship between you (e.g. one of your sales people said somethingto the customer about waiting for the customer to get back on their feet before pressing for payment)
• There's virtually no chance the customer has any money or assets available to pay any judgment obtained

Thus knowing "when" it's time to pursue legal action is a case by case decision.  Often the choice will not be clear-cut. 

Once you've made the decision to pursue legal action, if the debt is small, you may still be able to handle it without the intervention of a lawyer if you really want to do so.  In Columbus where I live and practice law, and elsewhere throughout Ohio (and probably in other states as well), there are "Small Claims Courts".  In Ohio, these courts only have jurisdiction to hear matters involving $3,000 or less.  In addition, while it is possible for an officer or employee of the company to handle the case on behalf of the company without an attorney, he or she may only present documents such as invoices and testify only about facts of his or her own personal knowledge; no questioning or cross-examination of the customer's witnesses is permitted.  The Small Claims Division of the Franklin County, Ohio Municipal Court has prepared a very useful synopsis of how this court works.

If you decide to consult an attorney, that does not necessarily mean there has to be a lawsuit.  Often a letter from your attorney can prompt a response from the customer and it will be possible to work out a payment plan or other resolution of the matter.  An attorney can also help you make the determination whether pursuing collection makes sense in a particular case.

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Although I've practiced bankruptcy law for more than twenty years, when I first heard about Chapter 15, I thought it must be shorthand for another serial bankruptcy filing combination.  After all, I'd quickly adapted to Chapter 20 in which a Chapter 13 proceeding is followed by a Chapter 7 and I'm certainly familar with Chapter 22 consisting of successive Chapter 11 reorganization proceedings. 

But Chapter 15?  For the uninitiated, Chapter 15 was added to the Bankruptcy Code as part of the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act which is perhaps better known for its credit card industry inspired "means testing" provisions restricting consumer use of Chapter 7.  Chapter 15 addresses cross-border insolvencies and offers a way for debtors involved in foreign insolvency proceedings to administer assets found in the U.S.  In plain English, it deals with situations in which assets, creditors, or affiliates of the debtor exist in more than one country.  According to 11 U.S.C. 1501, Chapter 15 of the Bankruptcy Code is designed to

• promote cooperation between the United States courts and parties in interest and the courts and other competent authorities of foreign countries involved in cross-border insolvency cases; 
• establish greater legal certainty for trade and investment;
• provide for the fair and efficient administration of cross-border insolvencies that protects the interests of all creditors and other interested entities, including the debtor;
• afford protection and maximization of the value of the debtor's assets; and
• facilitate the rescue of financially troubled businesses, thereby protecting investment and preserving employment.

>>>>>>>>>   Chapter 15 of the Bankruptcy Code is still not well known, but there are some useful resources available to anyone wanting to know more.

There is a good overview of the statutory provisions making up Chapter 15 on the U.S. Courts website.

The Canadian law firm of Cassels offers a Canadian view of the important provisions of Chapter 15 and how it addresses issues of particular concern to domestic creditors.

Bob Eisenbach of the In the (Red) business bankruptcy blog provides a terrific summary of the major substantive aspects of Chapter 15 and how it works on a practical level.  Among other useful information, Bob explains that if a U.S. Bankruptcy Court "recognizes' a "main" insolvency proceeding pending outside the United States, the foreign debtor receives important protections such as the application of the automatic stay to U.S. creditors and assets without the necessity of a separate U.S. filing.  There are also other provisions giving U.S. bankruptcy courts discretion to grant other appropriate relief. 

For those wanting to follow Chapter 15 cases in detail, Chapter15.com is an invaluable resource.  In addition to various commentary on the pertinent law, Chapter15.com provides summary information about cases and related foreign proceedings, as well links to the dockets and pleadings for Chapter 15 cases filed throughout the U.S.  The website's database is searchable in a variety of ways, including by court, debtor, filing date, and industry.

While many cases are filed in New York as one might expect, at least one case has been filed in every circuit according to Chapter15.com.  In Ohio, the following cases involving Canadian insolvencies have been filed, including a recent filing here in the Southern District of Ohio:

• In the Northern  District of Ohio >>>  Kirshan K. Sudan, Case No. 07-11166, Judge Harris 
• In the Southern District of Ohio >>>  ROL Manufacturing (Canada) Ltd., Case No. 08-31022, Judge Walter presiding
  • Marwil, Inc., Case No. 08-31029, Judge Walter presiding
  • ROL Holdings USA, Inc., Case No. 08-31025, Judge Walter presiding
  • ROL Holdings (Canada) Inc., Case No. 08-31024, Judge Walter presiding
  • ROL Manufacturing of America, Inc. Case No. 08-31027, Judge Walter presiding

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The ongoing C.V. Perry receivership case reflects an interesting choice of state law insolvency procedures over federal bankruptcy proceedings. And yet, no doubt in part due to the sparseness of developed case law and statutory authority when it comes to Ohio receivership law, much has been borrowed from federal bankruptcy law.

As a Columbus bankruptcy attorney who often represents creditors, I find the C.V. Perry case quite interesting because the procedures and law that will be established during the course of this case are likely to have an impact for some years to come. If nothing else, Franklin County at least will have a roadmap for others contemplating receivership to follow.

A few months ago I wrote about how the C.V. Perry receivership was representative on what I saw as a mini-trend in choosing state court receivership over federal bankruptcy and some reasons that might be happening. In my last post, I provided more detailed information about the C.V. Perry receivership itself. In this post, I want to discuss some more of the events in the case and how the influence of federal bankruptcy law can be seen.

Proof of Claim Procedure. Although Ohio Rev. Code 1701.89(A) does refer to the "presentation and proof of all claims and demands against the corporation", the actual process to be followed is left rather vague. Moreover, there is no analogous provision in Chapter 1705 of the Ohio Revised Code applicable to limited liability companies. Under federal bankruptcy law, requiring creditors to make a written "proof of claim" is a key component to the administration of any bankruptcy case and Bankruptcy Rule 3002 and Bankruptcy Rule 3003 sets out exactly how and when this should be done.

Injunctive Relief in Form of a "Stay". Count VII of the Complaint seeks unspecified injunctive relief. However, the Amended Order goes further and in language very similar to section 362 of the Bankruptcy Code, provides:

IT IS FURTHER ORDERED that all creditors, claimants, bodies politic, parties in interest, and all sheriffs, marshalls, and other officers, and their respective attorneys, servants, agents, and employees, and all other persons, firms and corporations be, and they hereby are, jointly and severally, enjoined and stayed from commencing or continuing any action at law or suit or proceeding in equity to foreclose any lien or enforce any claim against any of the Movants or their respective property, or against Martin Management, as receiver and liquidating trustee, in any court. All such entities are further stayed from executing or issuing or causing the execution or issuance out of any Court of any writ, process, summons, attachment, subpoena, replevin, execution, or other process for the purpose of impounding or taking possession of or interfering with, or enforcing any claim or lien upon any property owned by or in possession of Martin Management, as receiver and liquidating trustee, and from doing any act or thing whatsoever to interfere with Martin Management, as receiver and liquidating trustee, in the discharge of its duties in this proceeding with the exclusive jurisdiction of this Court over Movants' properties and said receiver and liquidating trustee. This Order shall be in full force and effect as of the date of its journalization with the Clerk of Court.

Creditors have also responded in a fashion similar to what they would do in a bankruptcy proceeding. One even entitled its pleading "Motion for Relief from Stay".

My point here is that ordinarily in cases in which injunctive relief is granted outside bankruptcy, the procedure is somewhat different than what seems to be happening in this case. Typically an interim temporary restraining order is first imposed for a limited period of time followed, generally after some kind of hearing or by agreement of the parties, by a preliminary injunction. Parties wanting the injunction removed usually ask that it be dissolved, not that the "stay" be lifted. Here, there is no indication that any hearing was ever held prior to the issuance of this Order.

What makes the issuance and continuance of that portion of the order appointing the receiver/liquidating trustee particularly interesting is that, as some creditors have pointed out, statutory authority doesn't really support such a blanket imposition of a stay. While Ohio Rev. Code 1701.89(A)(2) does allow the imposition of a "stay of the prosecution of any proceeding against the corporation or involving any of its property", Ohio Rev. Code 1705.45(B)(2) specifically states that "dissolution of a limited liability company does not... prevent the commencement of a proceeding by or against the company in its name..."

"Administrative Priority". One especially interesting concept borrowed from bankruptcy practice is the recognition of "administrative priorty" for certain claims. An intial Borrowing Order entered in late December authorizes the Receiver/Liquidating Trustee to borrow funds or purchase materials up to an aggregate amount of $5 million. It also provides that those extending credit in this way "shall be entitled to administrative priority distribution" for those amounts.

More recently in February, the Receiver/Liquidating Trustee filed a Motion for Authorization to Establish Fund for Administrative Fees, Costs and Operating Expenses which essentially seeks to surcharge creditors with liens on real estate to pay fees for the Receiver/Liquidating Trustee and his counsel, as well as other administrative expenses. Creditors have opposed this latest motion and some have pointed out that in a Chapter 7 bankruptcy proceeding, attorneys' fees and other administrative priority claims are only paid out of the disposition of unencumbered assets.

The concept of "administrative priority" is a bankruptcy one spelled out in section 503 of the Bankruptcy Code. There is no comparable provision in the Ohio Revised Code. Here again, the sparseness of statutory authority and relative staleness of caselaw (most cases cited by any party are more than 50 years old and some date back before 1900) has led to importation of bankruptcy concepts into a state law insolvency proceeding.

The paucity of recent or extensive authority concerning receiverships in Ohio law has been both the advantage and drawback of choosing receivership over the more clearly delineated Chapter 7 bankruptcy proceeding. At the conclusion of the C.V. Perry case, that will no longer be true. As the case proceeds, it will be interesting to see the extent to which bankruptcy concepts and procedures are imported.

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In connection with the downfall of the C.V. Perry homebuilder entities, I have previously posted on the increasing use of receivership in place of bankruptcy. It's been a few months since then and perhaps time for an update, as well as some commentary.

This is the first of a two-part series concerning events in the case itself and some reflections on what it all means. In this post, I want to provide some more detailed information about the case, some of its players, and the context in which it is happening. In Part II, I will explore the influence of federal bankruptcy law in the case.

Parties. First, more info on the basics. The C.V. Perry receivership actually involves multiple related entities, consisting of limited liability companies in which C.V. Perry & Co. was the sole member. In addition to C.V. Perry & Co., the receivership case also includes the judicial administration and winding up of the following entities (collectively, along with C.V. Perry & Co., I'll refer to as "Perry Entities"):

• C.V. Perry Builders, LLC
• C.V. Builders II, LLC
• Manors at Homestead, LLC
• Pointe at Blacklick, LLC
• Manors at CrossCreeks, LLC
• C.V. Land II, LLC
• Arlington Remodeling, LLC

Martin Management Services, Inc., through its principal Reg Martin is the court appointed "Receiver and Liquidating Trustee" (more on what this means below) and is represented by the law firm of Strip, Hoppers, Leithart, McGrath & Terlecky Co., LPA. Judge John F. Bender is presiding.

Following Case Progress. Anyone wanting to follow this case closely can visit the Franklin County Clerk of Court's website and enter Case No. 07MS-11-454 (you don't actually have to enter the "11" as that is simply a notation indicating the case was filed in November) to see the docket showing the pleadings which have been filed. To see copies of pleadings, you can make a personal visit to the Franklin County Clerk of Courts and view them on computer terminals provided there.

Original Complaint. According to the Perry Entities' receivership Complaint, filed November 7, 2007, the impetus for seeking appointment of a receiver/liquidating trustee resulted from such problems as (1) numerous cognovit judgments having been taken against the Perry Entities by The Home Savings and Loan Company of Youngstown; (2) dozens of mechanics' liens filed against Perry Entities; and (3) numerous other lawsuits filed against the Perry Entities. The Complaint for Judicial Administration of Winding Up of Affairs of Voluntarily Dissolved Corporation and Limited Liability Companies has eight counts which are:

• Appointment of Receiver for C.V. Perry; R.C. 1701.89(A)(8)
• Appointment of Liquidating Trustee for the Limited Liability Companies; R.C. 1705.44
• Establishment of Proof of Claims Procedure; R.C. 1701.89(A)(1), 1705.45 and 1705.46
• Settlement or Determination of Claims; R.C. 1701.89(A)(3), 1705.45 and 1705.46
• Determination of Rights of Holders of Shares; 1701.89(A)(4), 1705.45 and 1705.46
• Presentation and Filing of Receiver's and Liquidations Trustee's Account; R.C. 1701.89(A)(5) and 1705.44
• Injuctive Relief; R.C. 1701.89(A)(9) and 1705.44
• Allowance and Payment of Compensation to Receiver, Liquidating Trustee, Attorneys, Accountants, and other Persons; R.C. 1701.89(A)(10) and 1705.44

Order Appointing Receiver and Liquidating Trustee. An initial Order appointing the receiver/liquidating trustee was entered the same day as the Complaint was filed, but an Amended Order Appointing Receiver and Liquidating Trustee was entered on December 5, 2007. The Amended Order granted the relief sought in the Complaint and required the newly appointed Receiver and Liquidating Trustee to post a bond of $100.00 with the Franklin County Clerk of Court.

So why the appointment as Receiver and Liquidating Trustee? Simply put, what statutory authority Ohio has concerning the liquidation and winding up of the affairs of business entities are slightly different with respect to corporations and limited liability companies. Ohio Rev. Code 1701.89, applying to corporations, references appointment of a receiver. Ohio Rev. Code 1705.44, the analogous statute for LLCs, refers to a "liquidating trustee".

Local Rule 93. In addition to these statutes, Franklin County Court of Pleas Common Pleas Court Local Rule 93 (courts elsewhere in Ohio will have their own rules which may differ in important respects from this rule) will govern procedures and events in this case. Among other provisions, Local Rule 93 requires the filing of an initial inventory and appraisal of the assets of the entity placed in receivership by the court appointed receiver within two months of his or her appointment, together with receipts and disbursements received and made to that point. It also restricts a receiver's fees to no more than $75 an hour and caps fees for counsel for a receiver at $150,000 (which may seem like a lot, but in this case may pose a problem for the receiver's counsel).

Events. What's happened so far has mainly been authorization to sell certain properties, establishment of a "proof of claim" procedure, and a fair amount of sparring about "administrative priority". I'll talk about the latter two of these in my next post.

So that's the lay of the land. In Part II, I will focus on the influence of federal bankruptcy law on these receivership proceedings.

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As a bankruptcy attorney who mostly represents creditors, I am not infrequently asked to assist companies who have recently received correspondence demanding that they repay thousands of dollars of payments received from a now bankrupt customer because it's a "preference". Often this happens well into the bankruptcy proceeding and long after the creditor has closed its books on the account, perhaps even writing off a remaining balance as uncollectible. If you have been unfortunate enough to be tagged for a "preference", the most important thing to remember is that you still have options and it is not always necessary to just write a check for the amount demanded.

Bizpointer>>> As a practical matter, it is NEVER wrong for a creditor to accept a payment even if the creditor thinks it might be a "preference". For one thing, the failing company may last longer than you think and may not file until after the payment to you is outside the ninety day preference period. In addition, to recover, it is the debtor which must demonstrate its "insolvency" at the time the payment was made. Furthermore, there are a number of defenses which can be asserted which can wind up justifying the creditor's receipt of the payment. Finally, preference actions are typically matters especially susceptible to neogtiation and settlement which may allow creditors to keep a portion of the prefernce payment.

Bankruptcy Preference Defined. So what, exactly, is a "preference" and what should you do if you get one of these letters, or worse, actually get sued? Basically, a "preference" is a payment that allows the recipient to receive more than their fair share of the now bankrupt customer's available cash and assets. The Bankruptcy Code says that a "preference" must be repaid because it frustrates the underlying policy of federal bankruptcy law that similar creditors should be treated in a similar fashion. This policy is intended to discourage a mad grab by creditors that might accelerate a financially ailing company's slide into bankruptcy.

On a more technical level, section 547 of the Bankruptcy Code defines a "preference" as a payment

• On an antecedent (i.e. past due) debt owed to a creditor;
• Made while the now bankrupt customer was "insolvent";
• Within 90 days (or a year, if the creditor is an "insider" such as a shareholder, officer, or director of the bankrupt debtor, or another affiliated company) before the date the bankruptcy proceeding was filed; AND
• That allowed the creditor to receive more on its claim than it would have had the payment not been made and the claim paid through the bankruptcy proceeding.

Banks and other creditors holding collateral for a debt can wind up receiving a preference payment if they are owed more than the collateral is worth. However, it is unsecured creditors such as the ordinary trade creditor in the form of suppliers, product inventors, and service providers that are the most vulnerable. In addition, it is important to understand that a preference claim can be asserted against a creditor even if the debtor still owes money to the creditor after the payment.

How to Respond. The records of a company in bankruptcy are, not surprisingly, often disorganized and sometimes incomplete. As a result, the net for possible preference payments is usually cast far wider than the true universe of actual preference payments. Thus, once fingered as a possible preference payment defendant, it is crucial to do a thorough "preference analysis" to determine whether there is really any actual liability.

A bankruptcy and creditors' rights attorney has the skills and experience to assist with this crucial task of evaluating what the likely liability exposure is. Martindale-Hubbell's Counsel to Counsel magazine offers this helpful, but very brief, overview of action steps and conceptual considerations that should be undertaken by any company being confronted with preference allegations.

• The CMA Daily News offers several suggestions about how to avoid being in a preference payment situation by taking certain preventive action such as requiring payment in advance of supplying goods or services.

• Thomas Onder of the New Jersey Law Blog recommends that, before contacting your attorney, you should try to gather a full payment history for the period of at least the year before the payment was made. A copy of all invoices showing both sales and payments received during this period is essential to a good defense. In addition, copies of any correspondence (including e-mail), contracts, checks, or other evidence of payments received can be extremely helpful. If you can determine the number of days which generally elapsed between presentation of the invoices and receipt of payment and detect any patterns, that can also be useful.

• Why is this information useful? Well, the two leading defenses to a preference action rely upon what this information can show. The "contemporaneous exchange" defense found in section 547(c)(1) excepts payments where the debtor receives something of value at the same time the payment is made. A related defense depends upon the amount of "subsequent new value" extended to the debtor by the creditor. Alternatively, the "ordinary course" argument based on section 547(c)(2) rests upon a demonstration that a payment comported with a reasonable course of dealing between the creditor and the debtor.

How This Helps in the Defense of a Preference Action. A preference analysis can utilize this information and preventive action to determine whether there is in fact a defense to the demand for repayment of the alleged preference payment. Three of the most common defenses are:

Contemporaneous Exchange. In many cases, as the now bankrupt customer begins to have more and more severe financial problems, there will be times in which the need for a particular shipment of goods or services is so great, that there will be payment for that particular shipment. When the shipment of goods or services and receipt of payment for those goods and services happen more or less at the same time, there is said to be a "contemporaneous exchange", constituting an exception within the meaning of section 547(c)(1) of the Bankruptcy Code.

Ordinary Course of Business. Section 547(c)(2) of the Bankruptcy Code offers another defense if the payment was made in the "ordinary course of business or financial affairs" of the creditor and bankrupt customer in payment of a debt "incurred in the ordinary course of business or financial affairs" of the parties. Payment made "according to ordinary business terms" are also excepted. Thus, both the course of dealing between the parties as well as customs in the relevant industry can be important. Changes in the Bamkruptcy Code in the last few years has made it somewhat easier to rely upon this defense.

Subsequent New Value. Sometimes, even as a financially distressed company struggles for survival, it is able to induce creditors to continue doing business with it, perhaps on the strength of a promise to get everything caught up in the near future or a partial payment of the past due amount. If there are both payments and supplying of goods and/or services within the ninety day "preference period", it is likely that the "subsequent new value" defense found in section 547(c)(4) will be applicable at least to some extent. If applicable, the amount of "subsequent new value" extended will be subtracted from the amount of payments received.

All of these defenses depend greatly on the timing of invoices and payments and require a careful legal analysis of the creditor's documentation. Once a preference analysis has been completed by a bankruptcy attorney, you will have a much better idea of the strength of your case. This will then allow you to make a legally informed decision whether to fight or negotiate your best settlement quickly, thus minimizing the cost both in the amount paid back and attorneys' fees.

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The other day, one of my attorney friends called to see if I could "sign a cog" for him, by which he meant confess judgment for the defendants by signing an Answer to the Complaint on their behalf.  Since this function is considered merely a ministerial act in Ohio and gives rise to no actual attorney-client relationship with the unfortunate defendants, I said sure and we made a date for lunch when I'll sign the pleadings. 

I've previously posted on the enforceability of cognovit promisory notes, but I thought it might be useful to step back for a moment and explain in more detail what they really are.  Ohio is one of only a handful of states that still allow the enforcement of cognovits in commercial transactions.  To the best of my knowledge, it has been decades since any jursidiction permitted cognovit provisions to be enforced in consumer transactions.  While cognovit provisions are most commonly used in promissory notes, they can also be used in guaranties, litigation settlement agreements and even contracts involving the payment of money.   

As long as the debtor does not default, there is really no practical difference between a cognovit promissory note and any other promissory note.  However, when  things go bad, they head south much faster for the borrower who signed a cognovit note.   

Language.  Cognovit notes are simply a special kind of promissory note -- with the addition of certain statutorily required language.  That extra verbage gives creditors an unusually rapid path to judgment and collection activities in the event of a default by the borrower.  In Ohio, cognovit provisions are effective ONLY if they have the language required by Ohio Rev. Code 2323.13.  Thus, the following warning - IN EXACTLY THIS LANGUAGE - must appear "in such type size or distinctive marking that it appears more clearly and conspicuously than anything else in the document" immediately above or below (customarily it will be just above) the signature of the debtor:

WARNING

BY SIGNING THIS PAPER, YOU GIVE UP YOUR RIGHT TO NOTICE AND COURT TRIAL.  IF YOU DO NOT PAY ON TIME, A COURT JUDGMENT MAY BE TAKEN AGAINST YOU WITHOUT YOUR PRIOR KNOWLEDGE, AND THE POWERS OF A COURT CAN BE USED TO COLLECT FROM YOU REGARDLESS OF ANY CLAIMS YOU MAY HAVE AGAINST THE CREDITOR WHETHER FOR RETURNED GOODS, FAULTY GOODS, FAILURE ON HIS PART TO COMPLY WITH THE AGREEMENT, OR ANY OTHER CAUSE.

To ensure compliance with the statute, this language is typically in a larger boldfaced typeface and often boxed.

In addition, an authorization to take a cognovit judgment must be contained somewhere in the body of the promissory note or other instrument of indebtedness,   Thus, generally near the end of the document, the following language (or something fairly similar) must appear:

WARRANT OF ATTORNEY

Each of the undersigned authorize any attorney at law to appear in any Court of Record in the State of Ohio or in any other state or territory of the United States after the above indebtedness becomes due, whether by acceleration or otherwise, to waive the issuing and service of process, and to confess judgment against any one or more of the undersigned in favor of the Bank for the amount then appearing due together with costs of suit, and thereupon to waive all errors and all rights of appeal and stays of execution.  No such judgment or judgments against less than all of the undersigned shall be a bar to a subsequent judgment or judgments against any one or more of the undersigned against whom judgment has not been obtained hereon; this being a joint and several warrant of attorney to confess judgment.

Execution.  To be valid, a cognovit promissory note must either be signed in Ohio or the borrower executing the cognovit must reside in Ohio at the time judgment is taken.  To ensure enforceability, virtually all creditors will require execution in Ohio, even if that means the borrower must make a plane trip.

Enforcement.  The primary value of cognovit provisions is that they provide a shortcut to judgment for the creditor.  If the debtor defaults, the creditor can file a complaint, as well as an answer on behalf of the delinquent debtor, and obtain judgment within minutes of filing the action rather than having to wait a month or more to obtain a default judgment.  Within minutes after that, bank account or wage garnishments or other post judgment action can be instituted against the now judgment debtor.  Thus it is entirely possible that the defaulting borrower's bank account will be cleaned out by the creditor before the debtor even knows judgment has been taken.  The only requirement is that the ORIGINAL of the note or other document with cognovit provisions must be produced and shown to the judge before judgment is entered. 

Traditionally, the job of taking cognovit judgments falls to the youngest lawyer in the office.  In urban populated areas like Columbus and Franklin County where I practice, taking a cog is really no big deal from the standpoint of difficulty.  You simply call one of your attorney friends and take them to lunch in exchange for their signature on the purported answer of the debtor and then head down to court with the pleadings and the original note.  Once there, you file the Complaint and then find your way to the "Duty Judge" who checks to make sure you have the original promissory note or other instrument with the cognovit provision, signs the judgment entry, and gives it back to you to be filed downstairs with the Clerk.  If you want to hit some bank accounts belonging to the defendant, you can then do that too, although I usually let the court runner take care of that in his next run because there's lots of copies involved and it takes too long.  The whole thing takes maybe an hour at most, but it does have to be a real lawyer who does the deed - no paralegals or laypeople allowed.

In more rural counties, taking a cog can sometimes be an adventure.  Often there is only one judge for the county and if he or she is in trial, well then you just have to wait for a break in the action.  In addition, I have strong and not so pleasant  memories of one judge in particular cross-examing me at length about whether our "Warning" was distinctive enough.  For a while, I was seriously concerned that he would refuse to sign my judgment entry and began wondering just how I was going to be able to spin this one and explain coming home without the judgment.  Fortunately for me, the judge did eventually sign the entry and my membership in the mythical American College of Cognovit Lawyers remained secure.         

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Today, Ohio Attorney General Marc Dann -- along with the Attorney Generals of ten other states as part of a group calling itself the State Foreclosure Prevention Working Group -- issued a report on the "foreclosure crisis" and the perceived shortcomings in the response of "subprime mortage loan servicers". The report is titled Analysis of Subprime Mortgage Servicing Performance -Data Report No. 1, thus implying that additional "reports" will be forthcoming. Click here to read the press release issued by the Office of Ohio Attorney General Marc Dann about the report. (Click here to learn about the other foreclosure prevention assistance resources the Office of Attorney General Marc Dann has assembled.) As things have been going on this topic, this is one of the more sedate and traditional governmental responses to arise.

I've previously posted on the initial set of foreclosure dismissals by federal judges in Cleveland and Dayton which, at least in the Cleveland cases, might have had as much to do with federal judges wanting to send a message to lenders to stop bothering federal courts with ordinary foreclosure cases that belonged in regular state court. And in another previous post, I rounded up pertinent pleadings from those cases. Then, as things began to take a truly novel turn with the Cleveland "public nuisance" lawsuit against the Wall Street securitization lenders and the Baltimore "predatory lending" case, I posted again to the effect that while I wasn't convinced any of attacks on pending foreclosures had much basis in legal rationality, I recognized that things were about to get a whole lot more interesting.

I had thought this would be the end of it for a while and had every intention of quietly returning to my usual array of topics more immediately related to the legal concerns and issues facing businesses. I had no idea. As events in what the swirling maelstorm generally becoming known as the subprime problem/foreclosure mess continue to unfold every day and every week, I find myself inextricably drawn to discovering each new revelation. And I'm rapidly coming to the conclusion that this is only the beginning of a very long, very tortuous, odyssey in the annuals of foreclosure law. Because part of the purpose behind this blog is to help business people make sense of legal concepts intruding into their lives, I've chosen to revisit this topic once again.

Ohio AG Efforts to Halt Foreclosures. Thanks to the Wall Street Journal Law Blog for reporting on another intriguing chapter in the whole bizarre Ohio foreclosure scene. Earlier this week, Magistrate Michael L. Bachman of the Hamilton County Common Pleas Court issued a Magistrate's Decision in Deustche Bank Nat. Trust Co. v. Barnes, Case No. Ao705631, Judge Ruehlman presiding, arguably interjecting something of a voice of reason to the debate, but also igniting its own controversy.

The 11-page decision rebuked Attorney General Marc Dann for filing a Motion to Dismiss piggybacking on prior federal decisions dismissing foreclosures in Cleveland and Dayton and even went so far as to question the Attorney General's legal ethics. (Interestingly, in contrast to other actions being undertaken by the Office of Ohio Attorney General Marc Dann, this and similar legal actions are being pursued without publicity or press release by the AG's Office.) However, to me, the more important part of the decision points out that the whole "where's the assignment piece of paper" ignores well settled law that as between the debtor and the holder of the note and mortgage, recording is not a necessary element for recovery. As Magistrate Bachman explains:

under the Uniform Commercial Code as codified in Ohio, parties to a Note, subsequent holders of the note, nonholders in possession of the note who have the rights of holders and persons not in possession of the note who are entitled to enforce the Note pursuant to other statutory requirements, may enforce the terms of the Note as to each other. parties falling within these legal categories may enforce the terms of the note even if the note is lost, stoledn, or destroyed.

 

Ohio law does not require parties to the note to record the note with the county. Rather, controlling case law states that the current holder of a note, despite having no part in the original transaction, is the real party in interest....

 

Ohio case law and statutory authority do not require the recording of a mortgage as a condition precedent to enforcement as between the parties.

Magistrate Bachman makes the additional point that requiring "plaintiffs to attach all relevant assignments at the pleading stage seems overly burdensome, given the notice pleading requirements contemplated in Civil Rule 8."

The Disconnect. Don't get me wrong - I recognize that this country is facing a crisis of substantial proportions as a result of many people having become unable to pay their home mortgages in accordance with the terms of the loans they signed for. And I'm even willing to accept that in at least some cases, unsophisticated borrowers may have been taken advantage of by unscrupulous mortgage brokers more interested in their bonus commission than explaining exactly how the "too good to be true" mortgage was really likely to unfold. Nor do I care to dispute that some governmental intervention may well be appropriate at some point.

It's just that I'm having more and more difficulty understanding how the governmental response reflected by various recent convoluted actions and events makes much sense even by itself or is really going to be very productive in the long run. For example, the Barnes case presents a rather unusual procedural situation in which the State of Ohio's Motion to Dismiss was apparently not filed until after the State of Ohio had already filed an untimely Answer, a Judgment Entry had already been entered, AND the property in question had ALREADY BEEN SOLD AT SHERIFF'S SALE and only the Entry Confirming the Sale remained to be entered. Now call me picky, but this does seem to be the proverbial situation where the horse has already left the barn.

Apparently Barnes was only one of seven foreclosure cases in which the Attorney General sought to have the case dismissed on the grounds that the lender had failed to demonstrate it was the proper owner of the note and mortgage in default. I don't know what the procedural status of the others were, but I would hope that at least some of them were not quite so far down the track. Otherwise, it's difficult for me to even seriously consider the argument being made.

The bottom line for me is yes, lenders should have to demonstrate they are the proper holder of a promissory note and mortgage involved in a foreclosure. However, once a lender has asserted that, regardless of whether an actual assignment is produced, it ought to be up to the borrower/homeowner to demonstrate that's not the case. Unless there's really any serious doubt that the foreclosing lender is the proper "holder in due course" entitled to enforce the mortgage -- and up to now I've not heard of any cases in which multiple lenders are claiming they are BOTH entitled to foreclose a particular mortgage -- borrowers should not be allowed to escape the consequences of having freely borrowed money and not paying it back.

No one disputes that real money was lent to real people who used it to buy actual homes. Whether these borrowers fully understood what they were getting into -- and regardless where one comes out on whether these people need to take some responsibility for their actions in accepting these loans -- is a separate issue. The point is that no one disputes that these borrowers do in fact have some obligation to repay these amounts, or at least a substantial portion of the funds received. Addressing the unfortunate consequences of this legal conclusion IS a valid concern, but it is one that ought to be addressed somewhere other than in the standard foreclosure case.

Others will undoubtedly note that the Barnes Magistrate's Decision has no force until it is adopted by Judge Ruehlman and that objections to it will almost certainly be filed, all of which is true. However, I find myself in agreement with Magistrate Bachman's conclusion:

The Attorney General acknowledges he directed his staff to file the seven motions to dismiss in Hamilton County in order to "raise a public policy issue". The court acknowledges courts in Ohio and throughout the nation have sometimes created new public policy based upon tenuous linkages to existing law or procedure. Certainly, the Attorney General is free to use his office to "lobby" for changes in the law and civil procedure he feels are in the public interest.

 

The Constitutions of both the United States of America and the State of Ohio guarantee the people the right to petition their respective governments for a redress of their grievances. However, the proper venue for such petitions lies in the branches of government vested with the authority to change the law or procedure at issue. In Ohio, the people and the State Assembly have the express authority to enact legislation in the State of Ohio. Similarly, the Supreme Court of Ohio is vested with the authority to "prescribe rules governing practice and procedure in all courts of the state." Comity suggests the judiciary defer its exercise of jurisdiction over these questions to those governmental institutions constitutionally vested with such authroity. If, as the Attorney General asserts, he directed his subordiantes to file these motions seeking to change the way courts adjudicate foreclosure actions in the State of Ohio, then the Attorney General should address his efforts to the General Assembly or Supreme Court of Ohio.

I haven't yet read the AG's foreclosure crisis report, but I for one would like to see more of this sort of governmental response and political proposals based on this sort of analysis and less mettling with legitimate judicial proceedings.

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OK, so I thought the dismissals of foreclosures without prejudice by three federal judges a couple of months back were not that big a deal by themselves. Click here and here for my earlier postings on the decisions by Judge Boyko, Judge O'Malley, and Judge Rose. However, the recent "public nuisance" and "predatory lending" lawsuits by the City of Cleveland and the City of Baltimore, respectively - coupled with a number of other events I'll describe below - HAS gotten my attention.

I stand by my earlier postings about the importance of those particular decisions on their own, but the march of events since then clearly indicates that foreclosures - regardless of whether they are connected to the subprime mortgage business - and mortgage lending in general are destined for the national stage. For a quick round-up on what's been happening here in Ohio click here. For those wanting the most succinct description of recent legal filings in Cleveland and Baltimore, click here for the Wall Street Journal Law Blog's posting.

As might be expected, according to the Cleveland Plain Dealer, the rulings did affect the actual number of filings in federal court in Cleveland, resulting in drastically fewer filings. Click here for the Christmas Day story in the Cleveland Plain Dealer. However, the impact has been far more widespread. Like a lit match dropped on dry wood, these rulings have ignited a veritable forest fire not easily extinguished.

Summary of Recent Events. A brief review of some recent events is in order. This is by no means complete, even with respect to Ohio, but should give an idea of the burgeoning issue.

• In early December, Hamilton County Common Pleas Judge Steven E. Martin dismissed a Wells Fargo foreclosure with facts very similar to those in the federal cases. Although the bank was ultimately able after the case had been filed to demonstrate that it was the owner of the mortgage, Judge Martin nevertheless dismissed the action. In addition, the law firm handling the foreclosure was told that it could not file any more foreclosures unless it provided proof of the client's ownership of the mortgage at the time of the initial filing. Click here for news coverage on this by Cincinnati Enquirer.

• According to several news reports (including various ones I've linked to elsewhere in this post), the Consumer Protection Section of the Office of Ohio Attorney General Marc Dann is apparently waging a stealth campaign by filing motions in Hamilton County and elsewhere challenging whether the named plaintiff is the proper "party in interest". Interestingly, while some reports state that as many as 30 such motions have been filed, there is no press release on the Attorney General's website concerning these actions.

• On the Friday before Christmas, Ohio State Bar Association President Rob Ware sent an e-mail to OSBA members seeking volunteers to help assist people facing foreclosure and according to this story in the Cincinnati Enquirer, by the day after Christmas more than 200 attorneys had volunteered.

• In Clermont County, Common Pleas Judge Robert P. Ringland has sent a letter to local law firms asking that they participate in mediation in foreclosure cases. Click here for coverage by the Cincinnati Enquirer.

• Following on the heels of the recently released University of Iowa study Misbehavior and Mistake in Bankruptcy Mortgage Claims detailing widespread "shortcuts" and other less than stellar loan collection practices in Chapter 13 bankruptcies, came a New York Times article about how Countrywide Home Loan, Inc. was forced to admit it "recreated" certain letters used as evidence in a bankruptcy proceeding. Read the Countrywide Transcipt of the Status Conference in which this came out.

Enter City of Baltimore and City of Cleveland. Then, last week came the attention-commanding lawsuits by the City of Baltimore and the City of Cleveland:

• Last Tuesday, the City of Baltimore filed a Complaint infederal district court, Case No. L 08 CV 062,against Wells Fargo Bank, NA alleging that the bank engaged in a"reverse redlining"predatory lendingpractice by charging higher fees and interest rates in Baltimore's poorest neigborhoods, resulting in foreclosure rates twice the citywide average. Click here for the press release issued by the City of Baltimore about the lawsuit. Click here for news coverage by the New York Times. Click here and here for news coverage by the Baltimore Sun-Times and here for Baltimore Sun-Times coverage of reaction.

• A couple of days later on January 10, 2008, the City of Cleveland filed a "public nuisance" action in state court against Deutsche Bank Trust Company and twenty other lenders (including Wells Fargo & Company, but not including any Ohio home grown institutions such as National City Bank, KeyBank, Fifth Third Bank or the Huntington National Bank) in a suit on the docket of Cuyahoga Common Pleas Court captioned City of Cleveland v. Deutsche Bank Trust Company, Case No. CV 08 646970, Judge Corrigan presiding, Here is a copy of the filed Cleveland Complaint and a graphic showing the named defendants and their foreclosure activity in the Cleveland area. Click here for the City of Cleveland press release on the case.
  • For news coverage from Cleveland including a video of Cleveland Law Director Robert Triozzi discussing the lawsuit, click here and here. In the "notable quote" department, Cleveland Mayor Jackson told the Cleveland Plain Dealer reporters, "To me, this is no different than organized crime or drugs."
  • For Cleveland Plain Dealer coverage of reaction to the suit, click here
  • For the Cleveland Plain Dealer's Sunday editorial praising the filing of the lawsuit click here.
  • UPDATE: On January 16, 2008, defendant Lehman Brothers Holdings, Inc. got the case removed to federal court in the U.S. District Court for the Northern District of Ohio, Case No. 08-CV-00139-DCN, Judge Donald C. Nugent presiding. As might be expected, the City of Cleveland has responded by filing a Motion to Remand.

What the Boyko, O'Malley, and Rose decisions did was legitimize lingering questions and uncork pent-up forces long looking for an angle of attack. To some extent, an old problem has simply gotten new visibility. Click here for an ABC News story on a New Hampshire man engaged in a six year "predatory lending" battle and click here for a Wall Street Journal Law Blog posting about a Cleveland man ahead of the curve who made the "not the owner" argument years ago and is now appealing on that basis to the United States Sixth Circuit. Read his arguments in Davet Motion.

So, basically there's a lot to take in at this point. For one academic perspective on whether municipalities even have standing to file actions like the City of Baltimore action, see Cleveland State University Assistant Professor Kathleen Engel's 2005 paper, "Do Cities Have Standing? Redressing the Externalites of Predatory Lending", which discusses "public nuisance" as a possible basis for city claims against predatory lenders.

What's It All Mean? Anyone who reading the papers over the last month or so can see that the politicians from the federal government on down have recognized that foreclosures have started to be a enough of a real risk for a substantial enough Americans that they need to take notice. And there will undoubtedly be various plans offering "assistance" of one kind or another to "deserving" homeowners. It's still too early to know the form these will take or whether they will really help any significant number of people.

From a legal standpoint, residential foreclosures in Ohio may become more costly for lenders (and less easy for lenders' counsel to do on a "flat rate" per case basis as is often done) in the short run. Logically, the stricter standards may also carry over into commericial foreclosures although probably with less impact since commericial mortgages are less often commoditized into securitization vehicles.

Documenting Ownership. In the end, however, the "not the real owner" argument will merely force lenders to take more care in documenting transfers of mortgage loans. While this is certainly not a bad thing from an objective standpoint - although it may add to transaction costs ( which may ultimately be passed on to consumers), especially in the beginning as lenders retool - it is also not some sort of fatal blow to the mortgage lending industry or even to securitization. In addition, not every mortgage loan has been assigned away. This theory may buy some borrowers some time (and sometimes that IS very important), but with some exceptions, it's probably not going to change the outcome for most borrowers in default.

Public Nuisance. Although the "public nuisance" theory advanced by the City of Cleveland is certainly innovative and I'd be remiss if I didn't give kudos to a superfically appealing argument, I just don't see it as a winning argument ultimately. I haven't fully digested the lengthy Complaint yet and perhaps once I do, I'll have a better understanding. It strikes me as just another reincarnation of the "lender liability" arguments in vogue when I began practicing law - "you shouldn't have lent me the money because you knew I couldn't pay it back". At some point, there has to be some assumption of responsibility by borrowers for taking the loans in the first place. From my cursory review of the City of Cleveland Complaint, it seems to contend that lenders "should have known" about all sorts of trends and economic factors more easily understood by everyone in hindsight. While "lender liability" lawsuits did get some borrowers out of some loans and did complicate lenders' lives for a while, eventually the novelty wore off. I think the same thing may happen here.

Predatory Lending. Now this one MIGHT amount to something. If lenders did mislead borrowers about the terms of their loan, then they should have to reap the consequences. Perhaps due to all my years as bank counsel, however, I'm a bit skeptical here too. The truth of the matter is that NONE of us really listen to all of the terms of the loan; we just want the house and are happy we found a bank willing to give us the money we need to make it happen. So who's job is it to police the terms offered? Again I haven't fully analyzed the allegations of the City of Baltimore Complaint either so I'm not sure how strong that case is. So I will be interested to see how this one develops, both in Baltimore and elsewhere.

Why It Matters. Aside from the obvious reasons why we should all care about this issue both personally in terms of our own ability to access mortgage loans and more generally in terms of the plight of our fellow citizen, its effect on the credit markets is likely to extend beyond residential mortgages. Business owners may find that their ability and cost to obtain credit have changed.

It's hard to know for sure how the foreclosure "crisis" will play out over the next few months in Ohio and elsewhere. In the short run, however, "business as usual" for the foreclosing lender is over for a while.

UPDATE: What Might Be Next. For an interesting peek at what might be next in Cleveland and Baltimore, click here for the recent cover story in Business Week about "Bank Day" in a Buffalo courtroom in which lenders are being held accountable for various housing code violations on properties being foreclosed upon.

This post was accidentally deleted for a time, but fortunately I had kept a copy and was able to put the original post back up once I realized the problem.