Ohio Practical Business Law : Columbus Ohio Business Lawyer & Attorney : Teri Rasmussen : Plunkett Cooney Law Firm : Commercial Law, Creditors, Business Formation : Columbus, Central Ohio

This morning I went down to the weekly Franklin County Sheriff's Sale to bid on a property for a client.  I don't get down there for this sort of thing that much anymore - paralegals and clients themselves tend to take the duty - but it was interesting to see both what was the same and what had changed from when I was the designated attendee years ago.

In the "old days", i.e. more than 20 years ago, sheriff's sales in foreclosures really did happen on the courthouse steps in some places.  Here in Franklin County, Ohio, sheriff's sales in foreclosures were done in the lobby of the Common Pleas Courthouse by a burly looking guy standing behind an enormous wooden podium (which is actually still there) and wielding a gavel.  It was noisy and necessarily a tad uncomfortable because it was strictly a standing only event with no seats.  And there really was a bit of a sense of drama as folks milled around waiting for the sale to begin.  And the actual fall of the gavel was a nice touch too.

Today, Franklin County sheriff's sales in foreclosure cases take place in a large nice quiet carpeted auditorium/room on the first floor of the courthouse with plenty of seats for everyone.  Three women - substantially less intimidating than I remember the guy doing it years ago - run the sales from a podium on a stage raised about 6 feet at the front of the room.  Then there are about a dozen table desks, well spaced in 3 rows, for the "regulars" who attend the event every week and may be bidding on multiple properties.  And for the rest of us, a couple of rows of reasonably comfortable chairs set up behind the special desks.  It is obviously a far more sensible arrangement, but at least to me, it somehow just doesn't quite seem as "official"  -- although of course it is.

Promptly at 9 AM every Friday (the time and day for sheriff's sales vary from county to county), the foreclosure sales begin.  First, all of the properties being withdrawn from sale, mostly because of bankruptcy filings but also possibly because they have been brought current or for some other reason, are read in alphabetical order by debtor.  Then each property is called in turn, again alphabetically by the principal defendant owner.  (Other counties may use a different order.)  Since my case involved a debtor defendant whose name started with "W", I was there for quite a while... and began to really appreciate the progress represented by the provision of those chairs.

So what happens, exactly?  Each sale is announced in the same way:

• Big Bank v. Jones at 123 Columbus Street,
• [Case  No.] 08-XXXX,
• Attorney Rasmussen,
• Appraised $XXX,XXX,
• Deposit $XX,XXX [in Franklin County and many other  Ohio counties, this is at least 10% of the appraised value, although the plaintiff lender can require more], 
• Parcel No. XXX-XXX-XXXX

And then, a brief description mentioning the subdivision or other identifying information is mentioned, followed by the words: 

Commonly known as 123 Columbus Street.  I need an Opening Bid of $XXX,XXX [here in Ohio this would be two-thirds of the Appraised Amount]    

At this juncture, bidding is open to everyone in attendance.    Sheriff's sales are open to the public.  It is not necessary to be an attorney, or even a paralegal, to bid.  Nor do you even have to be a resident of Ohio.  You do not have to register in advance, or even on the day of the sale,  to attend or bid.  You do, however, have to be there in person.  Eventually, sheriff's sales may carch up with technology, but for now there's no bidding by telephone or on-line and no streaming video of the sales as they happen. 

For most properties, there's not much interest.  Sometimes even the foreclosing plaintiff lender doesn't bid.  In these cases, the words "No Bid, No Sale "are intoned and the property will be reappraised at a lower value and offered for sale some subsequent Friday.   If, as often happens, the plaintiff lender makes the opening bid at the required minimum amount (and ocasionally for a bit more) and everyone else sits on their hands, the representative of the Sheriff's office simply says "Sold to the Plaintiff for $XX".

In the relatively rare situation in which there actually is some interest in the property being offered at foreclosure sale, bidding begins at the minimum bid amount, frequently kicked of by the plaintiff lender, and it goes from there.  There is no "auctioneer" in the sense of someone rattling on trying to coax higher bids as you might see in an ordinary auction.  Rather interested bidders simply speak up and the Sheriff's representative repeats the amount and pauses to see if anyone else wishes to place a higher bid.    If bidding gets bogged down, certain minimum increments may be imposed, but for the most part, bidding increases in the amounts desired by those bidding.  When it appears that no one wishes to place a higher bid, the iconic words "Going once, going twice, sold to... " are spoken, bringing the sale to an end.

At this point , the successful bidder must bring his properly completed Real Estate Judicial Sale Purchaser information Form and a Cashier's Check (no personal or company checks permitted except for lienholders) in the amount of the required deposit to the front of the room and hand it to the Sheriff's representative.  THIS MUST HAPPEN IMMEDIATELY - there is no waiting for the successful bidder to "go out to their car"  or over to the nearest bank branch to get the check - IMMEDIATE means NOW and if the deposit check isn't forthcoming or the paperwork is otherwise not in order for some reason, the property will be immediately resold right then and there!  (That actually happened once today although I don't know exactly what was wrong.) 

And then it's over.  No gavel now...  they just move on to the next property.  It's then up to the plaintiff lender's attorney to prepare a Confirmation Order within 3O days naming the successful bidder and specifying how the proceeds of sale are to be distributed in accordance with the applicable priority of the various lienholders.  The sheriff's deed conveying the real estate to the successful bidder and new owner must be prepared within 7 days after entry of the Confirmation Order and submitted to the Sheriff's office.  Sometimes it can then take quite a while after that before the deed actually gets recorded.  Once the Confirmation Order is entered by the Common Pleas Court, there is NO EQUITY OF REDEMPTION allowing the defendant to regain possession of the real property and the sale is final.

For more information about how Sheriff's sales are conducted here in Franklin County, Ohio, visit  the Franklin County Sheriff's website and click the "Civil Real Estate Sales" button on the left hand side of the page.   You can also find lists of properties to be sold at upcoming foreclosure sales, as well as the results of recently completed sales here - the results from today's sale were up by lunchtime.  Because Ohio's foreclosure law has recently changed, it may also be worthwhile to review the informational WHAT YOU NEED TO KNOW AS A POTENTIAL THIRD PARTY PURCHASER material made available there.

All in all, a fairly interesting Friday morning.

For another person's account of the experience, visit A Trip to the Franklin County Sheriff's Weekly Real Estate Auction.

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Because getting a judgment and actually getting paid on the judgment are two very different things, it may be worthwhile to "think outside the box" when it comes to finding ways to collect.  If a judgment debtor has patents or other intellectual property, has money coming to them through a bequest under a will, or owns other intangible property, a creditor's bill  may just be the creative solution.

In Ohio, a creditor’s bill action may be used to reach assets of a judgment debtor that might not otherwise be difficult to subject to judgment liens, executions, or garnishment. In re Estate of Mason, 109 Ohio St.3d 532, 849 N.E.2d 998, 2005-Ohio-3256.  It is authorized by Ohio Rev. Code §2333.01 which states in its entirety: 

Equitable and certain other assets

When a judgment debtor does not have sufficient personal or real property subject to levy on execution to satisfy the judgment, any equitable interest which he has in real estate as mortgagor, mortgagee, or otherwise, or any interest he has in a banking, turnpike, bridge, or other joint-stock company, or in a money contract, claim, or chose in action, due or to become due to him, or in a judgment or order, or money, goods, or effects which he has in the possession of any person or body politic or corporate, shall be subject to the payment of the judgment by action.

 Essentially, a creditor’s bill allows a creditor to reach more intangible property interests of the debtor not amenable to garnishment or attachment. Among other sorts of interests, this includes:

• Interests of heirs and legatees. In re Estate of Mason, 109 Ohio St.3d 532, 849 N.E.2d 998, 2005-Ohio-3256.
• Patents in which creditor does not have a security interest. Olive Branch Holdings, L.L.C. v. Smith Technology Dev., L.L.C. , 181 Ohio App.3d 479, 909 N.E.2d 671 (10^th App. Dist. 2009)
• Fees to be received by attorney for legal services provided. Huntington Center Associates v. Schwartz, Warren & Ramirez, 2000 WL 1376524 (10^th App. Dist.).
• Breach of contract claim. Lakeshore Motor Freight Co. v. Glenway Ind., 2 Ohio App.3d 8, 440 N.E.2d 567 (1^st App. Dist. 1981).

So how does one put this sort of remedy in motion?  First, it is important to understand that judgment on the underlying claim must have been obtained.  Then the judgment creditor must file a new lawsuit against the judgment debtor and any third party holding the intagible property owned by the judgment debtor.

The creditor's bill complaint must state that the debtor does not have sufficient personal or real assets subject to execution and levy to satisfy the creditor's outstanding judgment.  This is more than a technicality.  To be successful, a creditor must in fact present evidence of the debtor's insufficient assets and this must be something more than counsel's recitation of facts such as the debtor no longer being in business and conclusory statements.   Graybar Electric Co., Inc. v. Keller Electric Co., Inc., 113 Ohio App.3d 172, 680 N.E.2d 687 (9^th App. Dist. 1996).  Thus, for best results, it may be wise to take a judgment debtor examination or attempt garnishment before filing this sort of action. 

Once the creditor's bill case is filed, the creditor then obtains a lien on the intangible property sought and will have priority over other judgment creditors who have not pursued collection of their judgment in this way.

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I'm finishing up my recent series of posts on cognovit notes and judgments with a summary of the key things to know about cognovit notes and judgments in Ohio.   

     1.  Shortcut to Judgment.  Cognovit notes provide a shortcut to judgment, allowing a creditor to take a judgment immediately (and I mean within MINUTES) of the filing of the Complaint.  No advance notice to the debtor required.  For more information on how this works, visit my Cognovit Promissory Notes Explained post.

     2.   Few States Allow.  Ohio is one of only a handful of states permitting cognovit judgmentsnat all. In fact, as far as I know, they are only enforceable in OHIO, Pennsylvaina, Maryland, Virginia and Delaware.  Visit An Examination of Confession of Judgment Statutes in the Mid-Atlantic States  for a very concise and specific summary of what is required in each of these states for a valid cognovit note.  In Indiana, it's even a Class B misdemeanor (punishable by a $1,000 fine or 180 days imprisonment)  to include cognovit language in a promissory note or to try to enforce a cog taken somewhere else like, say, Ohio. Indiana Code 34-54-4-1  

     3.  Commercial Deals ONLY.  Cognovit notes are valid ONLY in commercial transactions involving businesses and are not enforceable with respect to consumer obligations.   Ohio Rev. Code 2323(E).  

>>>>>>      The rest of these points pertain ONLY with respect to Ohio cogs.  

     4.   Follow the Statute.   DO NOT VARY IN ANY WAY WHATSOEVER THE LANGUAGE OF THE STATUTORY COGNOVIT WARNING.  The cognovit warning  should appear IMMEDIATELY (and I mean WITHOUT ANYTHING IN BETWEEN)  above(preferably) or below the signature line and should look EXACTLY like this for best results:

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 RGARDLESS 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.   

     5.  Confession of Judgment Must Also Be included.  Do not forget to include the enabling language authorizing confession of judgment within the body of the promissory note, guaranty or other instrument.  If the enabling language is not included, the instrument will still be enforceable but will not be any good for taking a cognovit judgment.  Klosterman v. Turnkey-Ohio, L.L.C., 2009-Ohio-2508 (10th App. Dist.).   The statute does not specify the exact language to be used, but over time certain language has customarily come to be used in virtually every Ohio commercial note or guaranty.

      6.  Enforceable Where Signed or Where Maker Located. Cognovit judgments must be taken in (A) the County in which the cognovit note was signed; OR (B) the County in which the individual resides or the business has its principal office.  Ohio Rev. Code 2323.13(A)

     7.   Not Required to Use Business Courts.  At least for now, the existence of commercial law dockets/business courts does not require cognovit judgments to be taken by a judge of that docket  GLIC Real Estate Holding, L.L.C. v. 2014 Baltimore-Reynoldsburg Road, L.L.C., 906 N.E.2d 517, 2009-Ohio-2129 (Common Pleas-Franklin Cty)

     8.  Signing Cog Doesn't Create Attorney-Client Relationship.  No attorney client relationship is established when an Ohio attorney signs a cognovit answer on behalf of a defendant.  It is simply a ministerial act and does not subject the attorney signing the answer to any claim of unethcialconduct..  Opinion 93-3 Ohio Supreme Court Board of Commisioners on Greivancxes and Discipline,  Dibenetto v. Miller, 180 Ohio App.3d 69, 2008-Ohio-6506 (1st App. Dist.).

     9. Copies May Do.  While many Ohio courts may require or at least expect the original promissory note containing the cognovit provision to be produced, the statute does permit use of a copy.  Ohio Rev. Code 2323.13(A).  Good luck with that one - call me when you're able to get the judgment without showing the original of the note to  the judge.

       10.    Getting a Do-Over.  It does not take as much to open up a cognovit judgment thorugh a Rule 60(B) motion as it does with rexpect to other judgments.  However, you have to at least show that a meritorious defense exists, at least in theory.  Visit my previous post What It Takes to Open Up a Cog Judgment to find out more details.

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When I hear the word "indulgences", my mind immediately goes to something "sinful" and well, probably fun.  In this case, however, I'm talking about  that ubiquitous provision found in loan documents designed to allow lenders to continue to hold borrowers and gurantors liabile notwithstanding the lender's failure or inability to abide by the letter of the loan documents or to exercise all or some subset of its rights upon default in a manner saitsfactory (usually with the benefit of 20-20 hindsight) to the borrower and/or gurantor.  Does this stuff really worK?   

Suppose you have this deliquent borrower -  let's call him "B"  -- on a promissory note (though it could be any obligation) and collateral not worth enough to pay you off in full.  But then you also have this guarantor -- let's call him "G".  Somewhere along the line one of your folks messed up in that "commercial reasonable sale" thing that's supposed to happen when you repossess and liquidate collateral.  Or maybe you let a financial covenant default here and there pass for the time being.  Or perhaps you just extended the maturity date or went interest only for B for a while.  Question is whether you're still OK because you can hold G - who does have assets - liable for the obligation.

Most, if not all, bankers and their counsel would say "yes" because both the UCC and our loan docs say we can.  Which is why  Huntington National Bank v. Wallace, 2009 WL 2023891 (N.D. Ohio 2009) -- now on appeal to the Sixth Circuit and the subject of my last post -- is an important case to watch. 

In a nutshell, the Bank had allowed advances to the Borrower to fund draws on letters of credit in excess of a  "maximum amount" specified in the loan documents and the Bank was pursuing one of the guarantors,  Bank took cognovit judgment and guarantor sought relief from judgment   Federal district court held that the indulgence clause was not sufficient to preclude relief from judgment.

Initially, as a lender-oriented attorney, the case concerned me. It seemed to suggest that lenders permitting any sort of modification -- other than the most vanilla extension of time sort --would now be accepting a substantially greater risk that such forbearance would relieve any guarantor not explicitly consenting from liability. In addition, the manner in which it brushed aside the waivers contained in the “indulgence” clause as inapplicable sent a cold shiver down my spine.   And the logic of the ruling would be applicable not just to cognovit notes, but really any sort of obligation.  So, taken as a whole, if upheld by the Sixth Circuit, the decision seemed likely to convince many lenders that it simply was not in their best interests to work with delinquent borrowers.

As I've thought about it more, however, I've begun to think this decision makes more sense and is less alarming than I had first surmised.  The decision in fact makes an important distinction between the nature and extent of the obligation intended by the parties to be guaranteed on the one hand and mistakes and errors made by the lender in enforcing the guaranty on the other.  In this particular case, the guaranty was never intended to be unlimited - there was a clearly stated unambiguous cap on the amount of credit to be extended to the borrower at particular times.  In continuing to permit advances to fund letter of credit draws, the Bank exceeded this previously agreed limitation on the amount for which the guarantor had accepted responsibility for seeing was paid.

When read closely, the language itself – and certainly the concept originally underlying inclusion of such a clause – is about the consequences of the Bank’s inaction or failure to take appropriate steps to ensure the obligation guaranteed could be satisfied from sources other than the guarantor. When viewed from this perspective, the decision leaves largely intact a lender’s ability to rely on indulgence clauses with respect to events and actions occurring during the course of a workout situation.  It is only a lender’s decision to continue extending credit to the borrower beyond an explicitly agreed–upon point that becomes a problem.

Granted, the ruling is still worrisome.  In asset-based lending, a lender may unknowingly extend credit beyond the “availability” permitted pursuant to a borrowing base calculation formula.  And in the Wallace case, the Bank was obligated to honor letters of credit previously issued and really did not have the ability to refuse to make further advances.

What also makes things a bit problematic for me in this case is that the “cap” in question was only for a very short, almost temporary, period of time and was substantially less than it was at other times.  Had the events occurred but a couple of months earlier or later, the cap would not have come into play.

For me, the take-away lessons for now from this case are:

•  If at all possible, obtain guarantor consent to any modifications or waivers at the time the modifications are made or waivers given.  I already do this anyway, but now it will be even more important.
•  If a lender wants the guaranty to truly be unlimited and/or cover over-advances, the guaranty should say so very explicitly.
• Problems arising due to lack of perfection, release of collateral or other obligors, or other events and circumstances connected with an aspect of the lending relationship that do not pertain to the amount advanced are probably still within the protection of indulgence clauses.   

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How would Peanuts’ Linus manage without his trusty security blanket? Depending on the result, the Sixth Circuit reaches in a recently appealed cognovit judgment case, financial institutions such as banks and others relying on cognovit notes, and perhaps ordinary promissory notes as well, may well have to face a similar question.

Every guaranty I’ve seen has some variation of what is sometimes called an “indulgence” clause. These provisions essentially say that a guaranty remains in effect even if the Bank waives a default by the primary obligor or errs in its collection efforts. Now a federal district court, applying Ohio law, has snatched this security blanket away, saying that such a clause does not allow the lender to ignore the credit terms of a loan with impunity. 

In Huntington National Bank v. Wallace, 2009 WL 2023891 (N.D. Ohio 2009) (Case No.09CV408, Carr, J.), decided August 19, 2009, the defendant guarantor alleged he had a meritorious defense justifying vacation of the cognovit judgment taken against him. His argument was that because the Bank made a “material alteration” to the terms of his guaranty by continuing to allow advances even though the amount outstanding exceeded the prescribed “maximum amount”, his guaranty obligation was rendered invalid. 

The Bank has now appealed the case to the Sixth Circuit (Case No. 09-4172).  If upheld, the decision may have far reaching consequences beyond cognovit notes.  The district court decision suggests that the ONLY modification to an obligation that a lender may comfortably do is an extension of time unless the guarantor agrees.  It could also be taken as meaning that even if the guarntor consents, such modifications would release the guarantor of all liability

Factual Background

The underlying fact scenario is a common one. In August 2007, a company known as Bellepointe entered into a First Amended and Restated Loan and Security Agreement “Loan Agreement”) with the Bank. The Loan Agreement governed three separate obligations – a term note, a line of credit, and a “Guidance Line” involving draws on letters of credit. Michael Wallace (“Wallace”), the father of the company’s owner, executed a guaranty of Bellepointe’s indebtedness to the Bank; the son also executed a guaranty, but the case pertains only to the father’s guaranty.

The guaranty excluded any liability for the term loan indebtedness and also capped the maximum amount of liability with respect to the Line of Credit. The crux of the case focused on the proper interpretation of certain language found in the Loan Agreement and the Guidance Line cognovit note, to wit: 

Notwithstanding anything to the contrary contained herein, the maximum amount available under the Guidance Line shall be as follows:

from the date hereof through and including 11/30/07 - $865,000

12/1/07 through and including 12/31/07 - $250,000

1/1/08 and thereafter - $550,000      

These provisions obviously required a substantial reduction in the amount outstanding as of December 1, 2007. It is not altogether uncommon for lines of credit to require a substantial reduction in the amount outstanding at least once a year. 

Procedural History

Procedurally, the case is a bit complicated. Apparently there was some discussion back and forth between Wallace and the Bank concerning his liability prior to any lawsuit being filed. When those talks broke down, Wallace filed a declaratory judgment action in the Southern District of Ohio federal district court against the Bank on February 11, 2009. Two days later, the Bank took a cognovit judgment against Wallace in Lucas County Common Pleas Court. The Bank said it had no knowledge of the declaratory judgment action when it took the cognovit judgment. 

Wallace promptly removed the state court cognovit judgment action to federal district court for the Northern District of Ohio, apparently on diversity grounds that he was a resident of Florida, and sought relief from judgment. After the Northern District federal court granted the motion to vacate the cognovit judgment, the Bank appealed to the Sixth Circuit where the case is now pending. It appears likely that the Southern District declaratory judgment action will be consolidated with the pending Northern District cognovit action.

The Decision 

Wallace alleged that the Bank continued to make advances on the Guidance Line in December 2007 even though Bellepointe had failed to reduce the amount outstanding as required.  Consequently, he contended that the Bank’s actions caused a “material alteration” in the nature of his guaranty obligation, thereby relieving him of liability under his guaranty. The Bank did not dispute that the advannces exceeded the "maximum amount."  However,it countered by pointing out that its loan documents had one of those “indulgence clauses” which stated:

Guarantor hereby promises that if one or more of the Obligations are not paid promptly when due, he will pay the Obligations to Bank, irrespective of any action or lack of action on the Bank's part in connection with the acquisition, perfection, possession, enforcement or disposition of any or all Obligations....   Guarantor agrees that no extension of time, whether one or more, nor any other indulgence granted to [sic] Bank by [sic] Debtor, or to any other gurantor, or any of them, and no omission or delay on Bank's part in exercising the right against, or in taking any action to collect from or pursue Bank's remedies against Debtor or any other guarantor, or any of them, will release, discharge or modify the duties of guarantor hereunder.

In addition, the Bank insisted that it was obligated to pay the draws on outstanding letters of credit in any event and that the definition of “advances” used in the line of credit differed from the definition of “maximum amount available” for precisely this reason. It also argued that the “indulgence” provisions in Wallace’s guaranty allowed it to ignore Bellepointe’s default in any event.  

So what happened? The federal district court agreed that the provisions of the loan documents did allow the Bank to continue making advances in December 2007. However, the court also noted that “Wallace’s burden is only to allege a meritorious defense, not to prove that he will prevail.” It went on to say:

Even if Wallace had initially failed to allege sufficient facts to support his defense, he has subsequently submitted an affidavit describing the above referenced facts, Wallace alleged sufficient facts for this court to evaluate whether his defense is meritorious.

And the reason? The Court cited Toland v. Key Bank of Wyoming, 847 P.2d 540 (1993) and Frost National Bank v. Burge, 29 S.W.3d 580 (Tex. App. 2000) for the proposition that “’indulgence’ is limited to extensions of time for payment and contract terms permitting indulgences do not waive suretyship defenses.” That’s it!  Really isn’t any further analysis or discussion. 

What IS interesting and informative are the briefs of the parties filed in the federal distriuct court case.  Leaving out exhibits, but including affidavits,here they are:

• Wallace's Motion to Vacate
• Bank's Responsive Memo in Opposition
• Wallace's Reply
• Bank's Sur-reply

Now I think the district court got this wrong and I’d really have appreciated a little further analysis of the pertinent provisions in the loan documents so I could fully understand the Court’s reasoning.  However, I also think the Sixth Circuit proceedings will be rather interesting to follow in the months ahead for lender attorneys everywhere. I’ll share my thoughts about the decision in more detail in my next post. 

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Creditors love cognovit notes because of the shortcut to judgment they offer upon the default of a borrower.  However, all is not entirely lost for unfortunate judgment debtors.  Recently, a case involving a cognovit note executed in connection with an asset purchase of a business discussed in more detail what a judgment debtor must demonstrate to obtain relief from a cognovit judgment.  See Baker Motors, Inc. v. Baker Motors Towing, Inc., 2009-Ohio-3294  (8th App. Dist.).  

Standard for Vacating a Cog

It is well accepted that the 60(B) standard for relief from judgment  is not as stringent with respect to opening up a cognovit judgment as it is for other judgments in that only a meritorious defense timely asserted need be shown.  Lykins Oil Company v.  Pritchard,169 Ohio App.3d 194 (2006).; it is not necessary to demonstrate that the defense would prevail. 

To successfully assert the existence of a meritorious defense to a cognovit judgment, the judgment debtor must demonstrate it "goes to the integrity  and validity of the creation of the debt or note, the state of the underlying debt at the time of confession of judgment; or the procedure utilized in the confession of judgment on the note"  First Nat'l Bank of Pandora v.Freed,  2004-Ohio-3554 (3rd App. Dist.); First Merit Bank N.A. v. NEBS Financial Servs., Inc., 2006-Ohio-5260  (8th App. Dist.)(emphasis supplied)   (For more on this standard, visit my previous post on American College of Cognovit Lawyers Ohio Case Roundup.)

While defenses available to a maker of a cognovit note are "extremely limited", there are some meritorious defenses which would justify granting relief from jugment according to the Court of Appeals in Baker:

 The "defense of 'non-default' is certainly one. Other asserted defenses found meritorious include improper conduct in obtaining the debtor's signature  on the note; deviation  from proper procedures in confessing judgment on the note  at the time of confession of judgment.

Standard Applied 

In the Baker case, successor liability was imposed on the purchaser for certain workers compensation obligations to the State of Ohio.  The purchaser consequently stopped making payments on the cognovit note given the seller for the balance of the purchase price.  Predictably the seller then took a cognovit judgment against the purchaser who immediately moved to have the judgment vacated.  The purchaser alleged the following defenses:

• its obligations under the note were excused by the seller's breach of its warranty that the assets were free and clear of liens and adverse claims.
• it had a right to set off the workers' compensation liabilities against its liabilities under the note
• its payment obligations were suspended when it notified the seller of the liability being asserted against it 

In analyzing the case before it , the Court of Appeals first noted that a "counterclaim or setoff is not a meritorious defense to a cognovit judgment."  Why? Because, according to the Court,  it "is, in effect, a claim that would reduce or satisfy the amount due on the note."  Now to me that sounds like a meritorious defense, but then I'm not on the Court of Appeals.  And from a lender's counsel perspective, I'm sure it was the correct interpretation; it is at least consistent with similar law in replevin actions.  With this perspective, the Court of Appeals held that neither the seller's breach of its warranty of title that the assets being sold were unencumbered  nor its alleged setoff claim would qualify as a meritorious defense permiting relief from judgment on the cognovit note. 

This, however, did not mean that the plaintiff seller won.  In what I would consider a victory for a lawyer's penchant for essentially dealing with the same issue in multiple places in a document, the Court of Appeals found a meritorious defense in other remedies given the purchaser in the event of the seller's default of its obligations under the asset purchase agreement.  Tucked within the Asset Purchase Agreement was a provision which allowed the purchaser to suspend payment on the cognovit note upon giving notice to the seller of assertion of workers compensation claim against the purchaser. 

The Asset Purchase Agreement apparently gave the seller one hundred eighty days to resolve the problem with the workers compensation claims and authorized the suspension of payments  on the cognovit note during that time.  What the decision doesn't explain is whether the Asset Purchase Agreement had any provision for what would happen if the seller failed to resolve the workers compensation liability.  Nevertheless this provision was sufficient for the Court of Appeals to overturn the cognovit judgment and send it back down to the lower court.

Practical Pointer

Perhaps the best take-away from this is that it is not always duplicative to address important issues in multiple sections of documentation of transaction.   The line between setoff, counterclaim, and defense, is often very thin. So providing multiple sorts of remedies for breach may well be a good idea.

>>> For more on the basics of cognovit notes, visit my Cognovit Promissory Notes Explained post. 

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Over the last few months, Ohio appellate courts have handed down several interesting decisions regarding cognovit notes and judgments -- including one currently on appeal in the Sixth Circuit, Huntington National Bank v. Wallace, on which I'll be doing a separate post.  So for the next few posts, I'll be focusing on some of these  

For those wanting just the practice pointers coming out of the cases discussed in this post:

• It's OK to continue to have your bank's logo on the front page of a cognovit note, at least in the Tenth Appellate District here in Central Ohio
• Best practice is to box and bold the cognovit warning in PRECISELY the same language as that found in the statute and NOT ADD ANYTHING!  If you feel compelled to include additional language, at least do it in addition to and in a smaller type face than the warning.
• Don't worry about having to take cogs in commercial dockets/business courts if available.
• Make sure you can show where a cognovit note is executed and get a good address at least at the time of execution.  

Of Logos and Extra Language.  If you've always wondered exactly how magic the look and language of the cogonovit wanring on promissory notes really is,  read Huntington National Bank v. Burda, 2009-Ohio-1752 (10th App. Dist April 14, 2009).    (Hat tip to a Creditor Rights and Bankruptpcy E-Alert sent out by another firm in town for biring the case to my attention)  As readers of my previous posts on cognovit notes know, valid cognovit notes require the appearance of certain language "in such type size or distinctive marking that it appears more clearly and conspicuously than anything else on the document"  Ohio Rev. Code 2323.13

Many banks like to put their logo at the top of the first page of their promissory notes. And because it's generally larger than any text, I suppose it's not especially surprising that someone would eventually try to allege that the presence of such a logo rendered a cognovit note unenforceable as a cognovit note.  That's exactly what happened in Huntington National Bank v. Burda.  In addition, the Court addressed the issue of whether the addition of additional language to the cognovit WARNING block rendered it invalid. 

The cognovit warning  in question looked something like this:

NOTICE: FOR THIS NOTICE “YOU” MEANS THE BORROWER AND “CREDITOR” AND “HIS” MEANS LENDER.

 

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 RGARDLESS 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.   

 In rejecting the borrower's claims that the warning was insufficient, the Court of Appeals noted that "[i]n creating a warning that appears more clearly and conspicuously than anything else, a drafter of a cognovit note may employ multiple methods - capitalization, italicayion, underlining, bolding, framing the warning with  borders or a distinctive type face" and that "a drafter need not go so far as to use 'flashing neon light.'"  In this particular case, the court determined that "in combination, the use of bolding, capitalization, type size, and a black box make the warning the most clear and conspicuous part of the promissory notes."

With respect to the argument that the prominence of the Sky Bank logo made the warning invalid, the court concluded "the warning is more clear and conspicuous, particularly because it  - unlike the words "Sky Banl" -- is enclosed in a box with thick black margins,"

As far as the additional sentence in the warning, because it was set off from the statutory warning, it did not vitiate the warning.  The Court of Appeals did note that courts of appeal in Ohio's Fifth and Seventh Appellate Districts had vacated cognovit judgments where note did not include a "verbatum recitation of the statutory warning", the Court held that this situation was more like that faced by Ohio's Eighth Appellate District in Olmsted Lumber Co. v. Palmetto Homes, Inc., Case No. 41802 (June 12, 1980) with the language being "mere surplusage"  As the Court of Appeals saw it:

Although included in the black box with the warning, the additional sentence is separated from the warning by a space and the use of smaller, regular (not bold) type.  Because the additional sentneceis not incorporated into the warning, it does not modify the warning,

Role of Commercial Dockets/Business Courts.  Whenever a new wrinkle is added, there's always a transition period in which the outside limits are tested.  In the recent case of GLIC Real Estate Holding, L.L.C. v. 2014 Baltimore-Reynoldsburg Road, L.L.C., 906 N.E.2d 517, 2009-Ohio-2129 (Common Pleas-Franklin Cty), the Court was asked to decide whether a cognovit judgment requires that the case be first assigned to the new commercial docket being tried in several parts of the State of Ohio and that judgment only be rendered by a commetical docket judge rather than than the usual duty judge procedure.

As I've explained the process before, the Court of Appeals noted:

As is customary with cognovit note cases, the judgment [in this case] was entered by another judge of this court serving that week as the court's duty judge.  The duty-judge responsibility rotates week-by-week through all judges in the court.  For many years, cognovit note cases have routinely been routed to the duty judge serving when the case is filed.

Apparently, challenging a cognovit judgment on the basis it should have been entered by a commerical docket judge has caught the fancy of other defendants as well:  

Since it was created in January 2009, arguments have been raised in several cases that the assignment of cases to the commercial docket is a jurisdictional requirement.  This, it is argued, rulings may only be made in cases otherwise meeting the criteria for the commercial docket by one of the two judges in Franklin County specifically assigned to the docket by nthe Chief Justice of the Supreme Court of Ohio. 

No doubt gladdening the hearts of creditors' attorneys such as myself throughout the state, the Court rejected this argument, saying

While the judgment challenged in the case was not rendered by a commercial docket judge, that fact has no jurisdictional significance.  The temporary rules of superintendence do not demand that commercial cases only be decided by a commercial judge, failing which they are void or voidable.  Instead, those rules are concerned with case-assignment and case-management procedures.  They do not -- indeed could not -- alter the jurisdiction of the court.

Location, Location, Location - Jursdiction for a Cog Judgment.  We all know that cognovits are disfavored so it should really not come as not too much of a surprise that it really does matter where the promissory note was executed and where the makers reside/have their principal office when the judgment is taken. 

In Pheils v. Glass City Sales, LLC, 2009-Ohio-4623 (3rd App. Dist.). the plaintiff attempted to take a cognovit judgment against the defendant company in Seneca County, alleging that the company's ownership of real property in that county was sufficient to give the court jurisdiction.  The Court of Appeals disagreed, saying "The fact that Glass City Sales purchased the property [in Seneca County] and its name was placed on the deed using the property's address does not, without more, prove that it conducted business from the site."  Apparenlty, there was also an affidavit by one of the individual defendants to the effect that the defendant company never did business in Seenca County.

There are several things I don't like about this case. The defendant company's  Articles of Organization were apparently incomplete in that they did not include an address for the LLC.  While i suppose the creditor should have done a better job of getting an address at the time the note was executed, it doesn't seem unreasonable to me that the ownership of property in the county suggests some level of business being conducted.  It also seems like it would have been a whole lot easier just to depose the individual defendants as to where the defendant company's place of business was.

Instead what we wind up with is a case underscoring the importance of having a cognovit note at least stating the county in which it is being executed to eliminate this sort of problem.

Copies or Originals?  Finally, while these are not exactly recent decisions, I did discover a couple of decisions indicating that, contrary to what I've always taken as an article of faith, at least some courts in Ohio may be willing to allow a cognovit judgment to be taken without the necessity of producing the original promissory note.  Ohio Courts of Appeal for the Sixth and Seventh District Courts of Appeal have ruled that producing merely a copy of the note containing the cognovit provisions is enough.  Masters Tuxedo-Charleston, Inc. v. Krainock, 2002-Ohio-5235 (7th App. Dist.); Fogg v. Frieser, 562 N.E.2d 937, 55 Ohio App.3d 139 (6th App. Dist. 1988).

It's true that Ohio Rev. Code section 2323.13 states "[t]he original or a copy of the warrant shall be filed with the clerk."  So, technically I suppose these courts are correct.  However, practical custom still seems to be that most judges most places still like to see the originals.

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If you have an ownership interest in an LLC or partnership and are having financial difficulties or if someone owes you money and you are concerned about getting paid back, then you want to know about "charging orders".  A charging order is a way for creditors to get to dividends, distributions, or other payments that would otherwise be paid to a person owing the creditor money.

The first thing to know about charging orders is that they don't come into play until AFTER the creditor has obtained a judgment.  In essence, a  charging order “charges” .the judgment debtor’s membership or partnership interest with the payment of the unsatisfied judgment previously obtained by the creditor.  It allows judgment creditors of a partner or LLC member that permits the creditor to receive the profits and distributions otherwise due to the judgment debtor partner or LLC member.  

Because Ohio has recently adopted the Revised Uniform Partnership Act, Ohio Rev. Code §1775.27 which governed charging orders with respect to partnerships has been replaced by Ohio Rev. Code §1776.50 .   Charging orders may also be obtained against members of a limited liability company organized in Ohio and are governed by Ohio Rev. Code §1705.19 which is much less detailed:

To obtain a charging order, the creditor need only file a motion in the case where the judgment was obtained and obtain the appropriate Order.  It is also advisable to include an Affidavit along with the Motion setting forth the amount of the judgment and the equity interest to be charged. Larson v. Larson, 2000 WL 1566522 (11^th App. Dist. 2000).  Ohio, unlike many states, does not make a charging order an exclusive remedy so the creditor may still pursue other remedies against the judgment debtor.

Once the charging order has been obtained, the creditor should specifically notify in writing the partnership and partners or the LLC and its members, as applicable.  The notice should inform them that no further payments should be made to the judgment debtor. The creditor may also proceed with a foreclosure sale of the equity interest and the charging order itself should contain language authorizing the creditor to do so.    

Charging orders are powerful weapons for creditors because if the creditor does foreclose on the partnership or membership interest, the purchaser will be entitled to the judgment debtor’s share of profits and distributions indefinitely, thus potentially resulting in a windfall to such a purchaser.

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In recent years we have all become far more conscious of the importance of our personal identification information and the undesirable consequences that can result if the information falls into the wrong hands.  Now Ohio courts will join many other judicial and other governmental agencies in taking steps to protect this sort of information. 

Effective July 1, 2009, the Ohi Supreme Court issued Public Access Rules in the form of new Rules of Superintendance 44-47 requiring the redaction of "personal identifiers" in pleadings, orders, and judicial administrative records.  The new rules are applicable to any court filing in any court, including even Small Claims Court.     

"Personal identifiers" are defined in Sup, R. 44 as

social security numbers, except tor the last four digits, financial account numbers, including but not limited to debit card, charge card, and credit card numbers, employer and employee identification numbers, and a juvenile's initials or a generic abbreviation such as "CV" for "child victim"  

The Ohio Supreme Court has a link on the right hand side of its home page to a subpage on its website with a great deal of information about the new rules.  In addition to the text of the rules, there is:

• Summary of Rules
• Frequently Asked Questions - this is very helpful
• a very short executive summary type Important Points to Understand About the New Access Rules 
• a very nice PowerPoint presentation explaining the new Public Access Rules
• Comments by the Chief Justice
• Sample Confidential Personal Identifiers forms which must be completed separately when this sort of information is important to the disposition of the case (Sup. R. 45(D))

The various Common Pleas Courts, Municipal Courts, and Courts of Appeal are left to their own devices as far as developing implementation procedures for these rules.  The Rules of Superintendence also contain some procedures those wishing to obtain access to redacted infromation can follow.  No specific penalties for violation are included in the rules. 

While the intent of the rule was probably primarily focused on protecting the privacy of individuals, the language of the new Public Access Rules also encompass businesses and other commercial ventures.  In this respect, they are more restrictive than those that have already been in force in Bankruptcy Court  which pertain only to personal information of individuals. 

In addition, it is important to remember that the rule applies not only to the text in pleadings and order, but also to EXHIBITS that might be attached.  So, for example, if a promissory note being sued on has a "note number" or "obligor number", or a purchase order has an "account number", that information should be redacted to be safe. 

>>>>>>>

And on a personal note, today was a glorious day to be a University of Michigan graduate in Columbus, Ohio: Michigan beats Notre Dame in a tight football game in the Big House while Ohio State loses at home to USC.  It'll be a long football season this year for UM, but at leasr for a few days I can be happy. 

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So the latest brilliant (?) idea about what to do about the financial predicament GM finds itself in  - notice nobody is even talking in any meaningful way any more about resuscitating Chrysler - is to do what is known as a "363 sale" (so called because of the section of the Bankruptcy Code allowing it) in a quick two week "surgical" bankruptcy. 

How would that work?  And could it really be done in less than a fortnight?  Perhaps if you still believe in Santa Claus and the Tooth Fairy and think all those stores about Paul Bunyon are true.  But otherwise, it's one tall tale to swallow.  As Jonathon Glater recently wrote in his NYT news analysis "A Quick Bankruptcy for G.M.?  Not So Fast":

Any hope of a high-speed bankruptcy by General Motors faces a serious obstacle:   a judge -- not the Obama administration, not G.M. management and not the company's creditors -- would reign in court.  

Overview of 363 Sale Process

Leaving aside considerations of "how things actually work in the real world", what are the mechanics involved in making a 363 sale happen?  Well, reduced to the bare essentials, the debtor files a motion (or motions) seeking authorization to sell certain, or all, of its assets.  Sometimes there is a written purchase offer from a prospective purchaser (who is known in bankruptcy circles as a "stalking horse" and will often seek payment of a "break-up fee" or topping fee" to protect against other would-be purchasers) that may be described in, or attached to the Motion.  Other times the Motion seeks authorization of some sort of auction procedure or submission of sealed bids.  Depending upon the complexity and size of the case, these procedures can often be -- and most certainly would be in a GM bankruptcy -- incredibly complicated.  Then the Bankruptcy Court may or may not hear testimony and ultimately issues an order approving the sale as proposed or as modified.     

There are of course rules that govern how all of this is supposed to take place.  Section 363(b)(1) states that a debtor "after notice and a hearing, may use, sell or lease, other than in the course of ordinary business, property of the estate..."  For purposes of a 363 sale, "property of the estate" is essentially the debtor's assets, i.e. equipment, real estate, etc. 

After Notice and a Hearing,,, or Not

And it is true that "after notice and a hearing" has a rather elastic meaning and may not really require an actual hearing in all cases.  According to section 102 of the Bankruptcy Code, it

(A)  means after such notice as is appropriate in the particular circumstances, and such opportunity for a hearing as is appropriate in the particular circumstances; but

(B) authorizes an act without an actual hearing if such notice is given properly and if --

(i)  such a hearing is not requested timely by a party in interest; or

(ii)  there is insufficient time for a hearing to be commenced before such act must be done, and the court authorizes such act.

SO, at least theoretically, a 363 sale could be authorized by the Bankruptcy Court in a matter of days in a GM bankruptcy.  

Section 363(f) - When Sale Can Occur

There are, however, some other requirements which might slow things down, even theoretically speaking.  Section 363(f) of the Bankruptcy Code will only permit the sale of the debtor's property "free and clear of any interest ,,," (which is of course the whole reason for doing a 363 sale in the first place) if and only if:

• Applicable non-bankruptcy law permits sale of such property free and clear of such interest;
• The lienholder or other party with an interest in the property consents;
• With respect to lienholders, the price at which such property is to be sold is greater than the aggregate value of all liens on the property being sold;  
• The interest is in bona fide dispute; OR
• The lienholder or other party with an interest in the property could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest.

Now it used to be that bankruptcy courts routinely reasoned that state foreclosure law -- and similar laws with respect to personal property going by such names as replevin or "claim and delivery") -- provided all the rationale they needed to approve a 363 sale.  After all, the end result of a foreclosure IS that lienholders get however much money is paid at the sheriff's sale in the order of their priority. If you're the third lienholder and the sale proceeds only pay 10% of your debt after the folks ahead of you get paid, that's just too bad; you can still chase the debtor of course, but the successful purchaser at the sheriff's sale now owns the property free and clear of your lien.  The Uniform Commercial Code provides for a similar result when personal property is sold by the secured creditor in a "commercially reasonable" way.

Section 363(m) - What Appeal?

And, thanks to section 363(m) of the Bankruptcy Code, once the Bankruptcy Court had "done the deed"  of authorizing a 363 sale, the reversal or modification of that Order on appeal "does not affect the validity of the sale... under such authorization to an entity that purchased... such property in good faith, whether or not such entity know of the pendency of the appeal, unless such authorization and such sale... were stayed pending appeal."  Because 363 sales were often consummated moments after the Order authorizing them was signed by the Bankruptcy Judge, disgruntled lienholders and other parties in interest often never had a chance to even seek a stay, let alone obtain one.

You may have noticed that I've been using the past tense in the last couple of paragraphs.  That's because the Ninth Circuit U. S. Circuit Court of Appeals Bankruptcy Appellate  Panel recently raised some questions about the supposed invulnerability of an order authorizing a 363 sale.  In Clear Channel Outdoor, Inc. v. Knupfer (In re PW, LLC), 391 B.R. 25 (B.A.P. 9th Cir. 2008), the Bankruptcy Court had authorized a 383 sale in which the ultimately successful purchaser was the bank which held the first priority lien over the objection of the junior lienholder.  The bank "credit bid" the amount that was owed to it so it did not come out of pocket and no dollars flowed into the bankruptcy estate to pay the junior lienholder which a a $2.5 million claim.  The BAP overuled the bankruptcy court with a rather intricate interpretation of section 363(m).  In addition, the case was remanded to the Bankruptcy Court for a more specific demonstration that the provisions of subsection 363(f) were being met.   

For more detail on this case and what the BAP holding may mean  in general, visit "Clear Channel Raises Troubling Issues in Section 363 Sales But Case Doesn't Spell the End of Free-and-Clear Sales" , an article by Christopher Combest and Faye B. Feinstein in the Turnaround Management Journal.

Also check out "Will Section 363 'free and Clear' Sale Orders Survive an Appeal?  A recent Appellate Decision Raises New Doubts" by Robert Eisenbach III of the In the (Red) blog.

Although technically this only affects bankruptcies in the Ninth Circuit on the West Coast  - one place we can be certain GM will not file -- bankruptcy law has long been a procduct of trends starting in one particular jurisdiction.  Thus it's entirely possible that whatever Bankruptcy Court GM winds up facing would adopt this viewpoint.  So the net result of this is that a purchaser at any 363 sale might need to wait out the 10 day appeal period (and any subsequent appeal) before consummating the sale authorized by the Bankruptcy Court.  And some sort of real record will need to be made demonstrating the satisfaction of section 363(f) - there will need to be at least a modicum of due process allowing some preparation time before the hearing.

Other Important Requirements 363 Sales Must Meet 

There's also other substantive requirements that must be met before a 363 sale can be approved.  In the United States Sixth Circuit  -- which is certainly one place a GM bankruptcy might well unfold given its headquarters in Michigan -- a sale of all of the debtor's assets (and possibly by extension, the most important assets) can only be approved "when a sound business purpose dictates such action."  Stephens Indus., Inc. v. McClung,  789 F.2d 386 (6th Cir. 1986).  To determine whether that standard has been met in a particular case, the Bankruptcy Court must look at the following factors:

• whether the terms of the proposed sale reflect the highest and best offer for the assets
• whether the negotiations were conducted at arm's length
• whether the sale is in the best interest of the estate and its creditors

There must also be a finding that the the purchaser has acted in "good faith" and that the sale itself is in "good faith".  The words of a slightly earlier case in the Sixth Circuit, Comm. of Equity Sec. Holders v. Lionel Corp. (In re Lionel), 722 F.2d 1063 (6th Cir. 1983) seem particular pertinent today:

In fashioning its findings, a bankruptcy judge must not blindly follow the hue and cry of the most vocal special interest groups; rather he should consider all salient factors pertaining to the proceeding and, accordingly, act to further the diverse interests of the debtor, creditors and equity holders, alike.  he might, for example, look to such relevant factors as the proportionate value of the asset to the estate as a whole, the amount of elapsed time since the filing, the liklihood that a plan of reorganization will be proposed and confirmed in the near future, the effect of the proposed disposition on future plans of reorganization, the proceeds to be obtained from the disposition vis-a-vis any appraisals of the property, which of the alternatives of use, sale or lease the proposal envisions and most importantly perhaps, whether the asset is increasing or decreasing in value.  This list is not exhaustivee, but merely to provide guidance to the bankruptcy judge. 

By now you're probably starting to understand how unlikely -- even in the theoretical vacuum-- it would be for GM or any other debtor to get in and out of a "surgical" aka "prenegotiated" or "prepackaged" or "controlled" (as if any bankruptcy could really be controlled once filed !). bankruptcy in two weeks, even using a 363 sale.

There's one more thing.  Section 363(b)(2) applies in situations in which antitrust law might apply to the proposed sale.  It REQUIRES a FIFTEEN DAY waiting period, which may be extended, but CANNOT be shortened.  While that might not be relevant in many situtions, it surely could become relevant in a GM bankruptcy.

So there you have it.  Whether it's a Chapter 11 case of a small business or a mega case like GM would be, this is what you have to do in order to sell assets once in bankruptcy.  The procedures also apply in a Chapter 7 liquidation bankruptcy with a bankruptcy trustee.  The emphasis is on transparency and what is "fair" and "equitable".  And that is not something that can be achieved in a "shotgun" bankruptcy, even if there really was such a beast outside of legend. 

UPDATE (6/1/09): So now it's official - GM is now in bankruptcy.  Filed in NYC, Case No. 09-50026, Judge Gerber presiding.  Check out my post GM Follows Dealership Affiliate to Obtain NYC Venue for Its Bankruptcy for all the basic filing info and press releases.

Looks like I might be wrong about the speed of approval for a sale, but in my defense (A) GM HAS actually been working pretty hard lately before filing to clean up loose ends and (B) I was naive enough to think we would actually go by real bankruptcy rules as opposed to distoring them beyond all recognition.  Nonetheless since GM doesn't actually have a third party seller like Chrysler did, it may still take longer than GM and the obama Administration are planning... even they gave up on the idea of a TWO WEEK surgical bankruptcy.

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Years ago, back in the day (my grandfather used to talk this way and since I'll be hitting the BIG 5-0 in a few weeks, I figure I might as well too), when I was a young associate at another large firm, we used to joke about being members of the prestigious and elite American College of Cognovit Lawyers.  Its primary membership qualification was/is that you take cognovit judgments on a regular basis.   Of course, there is no such organization in real life, but there should be.  If there was, it would certainly issue case updates for its members from time to time, so here we go.....

>>>>>  Onda, LaBuhn, Rankin & Boggs Co., LPA, 2008-Ohio-7017 (4th App. Dist.): When a creditor takes a cognovit judgment in combination with other claims such as a foreclosure count, can the debtor appeal or seek relief from the cognovit judgment?  ANSWER:: No, becuase unless it has the magic word "no just cause for delay", it's not a final order.

Appeal by debtor dismissed because cognovit judgment deemed not a "final order".

Because Appellants'  [sic] complaint contains multiple claims, Civ. R. 54(B) applies.  Because the trial court's judgment entry only addresses the first claim regarding the cognovit note and not the foreclosure claim, it does not completely dispose of Appellants' [sic] claims against Appellees. [sic]  Under Civ. R. 54(B), a trial court can only enter a final judgment as to fewer than all of a party's claims only upon an express determination that there is no just reason for delay.

>>>>> Export-Import Bank v. Advanced Polymer Sciences, 2009 WL 688921 (N.D. Ohio): What does it take to get relief from a cognovit  judgment under Ohio law?  It must be a meritorious defense that goes to the very basis of the bargain

 The United States District Court for the Northern District of Ohio begins with a fairly extensive discussion of the nature and purpose of requiring the demonstration of a "meritorious defense" to obtain relief from cognovit judgments"

The meritorious defense requirement exists because "a litigant, as a precondition to relief under Rule 60(b), must give the trial court reason to believe that vacating the judgment will not be an empty exercise....  If after vacation of the judgment the court would rule against a defendant on the legal merits of his defenses, even though all his factual allegations were proven true, then vacation of the judgment would still be an empty exercise....

[In the context of relief from judgment on a cognovit instrument, quoting First Natl. Bank of Pandora v. Freed, 2004-Ohio-3554 (3d App. Dist) with approval] a meritorious defense is one that goes to the integrity and validity of the creation of the debt or note, the state of the underlying debt at the time of confession of judgment, or the procedure utlized in the confession of judgment on the note.   A judgment on a conovit note will generally not be vacated for reasons which do not encompass such matters of integrity and validity....

Examples of meritorious defenses to a cognovit judgment are "improper conduct in obtaining the debtor's signature on the note; deviation from proper procedures in confessing judgment on the note; and miscalculation of the amount remaining due on the note at the time of judgment.

The defenses of res judicata and laches... do not fit into any of these categories of meritorious defenses.  Neither defense involves the integrity or validity of the Guarantees they signed, whether the debt had already been satisfied, or whether the procedure utilized in confession of judgment comported with the statutory procedures set forth in Ohio Revised Code 2323.13. 

PREVIOUS POSTS ON COGNOVIT JUDGMENTS:

Cognovit Promissory Notes Explained

Cognovit Promissory Notes - Still Enforceable, But...? 

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I'm not sure how good I feel about the fact that far too many people now actually understand what I do as a bankruptcy creditors' attorney here in Central Ohio.  If I was unsure before about the truly distressing condition of the economy, the car ad I saw on TV the other day - which sought to induce viewers to purchase a car by telling them that  if they lost their source of income over the next year, they would be able to bring the car back - removed all doubt.  Then I heard this morning that the unemployment rate is the highest it has been in TWENTY-FIVE YEARS, which is to say AS LONG AS I'VE BEEN WORKING!!   Which certainily puts things in perspective and leads to the further disturbing conclusion that for lawyers like me working for creditors in the bankruptcy law area, job security is probably somewhat better than for the rest of America.

Unfortunately, for the country as a whole, the number of businesses becoming familar with the mechanics of Chapter 11 of the Bankruptcy Code is likely to increase in the year ahead.  Either one of their customers or vendors will be going through this or they themselves will become a Chapter 11 debtor-in-possession or DIP, for short.   

In addition, there has been a great deal of discussion recently about prepackaged bankruptcy for Detroit's Big Three automakers as being a possible antidote to the problems associated with the lengthy time frames associated with the the usual Chapter 11 bankruptcy,  To understand that, it's useful to consider the timelines generally associated with a Chapter 11 bankruptcy proceeding.

OVERVIEW OF EFFECT OF CHAPTER 11 FILING

So what actually happens when a business "goes Chapter 11"?  In many cases, those not in the know about the particular financial condition of a business may not even know that the business has sought the protection of the federal bankruptcy laws.  Companies in Chapter 11 bankruptcy are allowed to continue operating their business as before and from the customer perspective, the filing of the bankruptcy does not necessarily change the customer experience.  However, it is the bankrupt company's vendors and suppliers  that will notice an immediate difference in their relationships as various restrictions imposed by the Bankruptcy Code on the activities of the debtor company come into play. 

Technically, everything grinds to a halt when a bankruptcy petiton is filed and the world - for that company (who has now become a Debtor-in-Possession or DIP), its employees, customers, and vendors - was now become divided into

• "prepetition" involving claims arising and events occurring BEFORE the bankruptcy petition was filed AND
•  "post-petition" involving claims arising and events occurring AFTER the bankruptcy petiton was filed

Prepetition claims cannot be paid  - and collection cannot be pursued against the DIP company - absent specific authorization by the Bankruptcy Court.  Post petition claims can be paid in many instances if they arise in the ordinary course of the company's business and even if further authorization by the Bankruptcy Court is required,  generally go to the head of the line of unsecured creditors as administrative claims.

OVERVIEW OF TYPICAL CHAPTER 11 TIMELINE

The U.S. Courts' website provides a great summary of the typical Chapter 11 process, as well as the Offical Forms to be used by the company filing bankruptcy.  While there is no set timeline in a Chapter 11 (for an excellent visual representation of precisly how complicated things can get, look at the well known LoPucki's Bankruptcy Procedure Charts designed by UCLA law professior Lynn M. LoPucki) , some of the usual benchmarks might include the following:

ONE YEAR BEFORE PETITION IS FILED  - "Preference" period for "insiders" begins

NINETY DAYS BEFORE PETITION IS FILED - "Preference" period for noninsiders begins

PETITION DATE ("P") -   Day that Chapter 11 VOLUNTARY Bankruptcy Petition is filed   (Assume this is January 1, 2009)

• Bankruptcy Petition is only a few pages and easy to complete
• Must also include Creditor Matrix - list of names and addresses of all creditors
• List of Credtiors Holding 20 Largest Unsecured Claims must also be filed.
• Numerous "first day" motions filed (different ones in different cases), including motions for
  • Appointment of Debtor's Counsel
  • Appointment of other professionals being retained by Debtor (CPA, etc.)
  • Payment of prepetiton employee wages and benefits
  • Interim financing
  • Interim use of "cash collateral", i,e. proceeds generated from collateral on which a creditor has a lien
  • Authorizing honoring of Prepetiton Obligations to Customers in the form of warranties or gift certificates
  • Ensuring uninterrupted use of utlities
  • Extension of time to file bnakruptcy schedules

>>>> Meet with U.S. Trustee, open DIP (debtor-in-possession) bank accounts  

>>>> Resolve use of cash collateral issues, if not (hopefully) already done 

 P+15 days: (January 16, 2009)  Statement of Financial Affairs  and Schedules of Assets and Liabilities  must be filed unless deadline extended by Bankruptcy Court,  (In large cases, deadline often extended several times.)   Schedules include  a Summary, as well as the following  (Schedule I-Current Income and Schedule J-Current Expenditures relate only to individuals).

• Schedule A      Real Property
• Schedule B      Personal Property
• Schedule C      Property Claimed as Exempt (not relevant for non individual debtors)
• Schedule D      Creditors Holding Secured Claims (includes both fully secured and only partially secured creditors)
• Schedule E      Creditors Holding Unsecured Priority Claims (continuation sheet)
• Schedule F      Creditors Holding Unsecured Nonpriority Claims
• Schedule G      Executory Contracts and Unexpired Leases
• Schedule H      Codebtors

Completing the Statement of Financial Affairs which relates to debtor's prepetition behavior with respect to its assets, liabilities, and revenues, and especially all of the above bankruptcy Schedules relating to the debtor's assets and liabilities, is extremely time consuming.  The larger the business, the more complicated the process becomes.  in addition, companies needing to file bankruptcy often may not have had the best recordkeeping to begin with.  

>>>> UNSECURED CREDITORS' COMMITTEE FORMED (usually within the first couple of weeks following the Petition Date) based on the identity of the Twenty Largest Creditors as listed by the Debtor.  Generally selected by U.S. Trustee.  Motion for Appointment of Counsel for Creditors' Committee filed.  In smaller Chapter 11 cases, often no Unsecured Credtiors Committee is ever formed.  Purpose of Creditors' Committee is to represent the interest of creditors with smaller unsecured claims .

P+30 Days (February 1, 2009) - first Monthly Operating Report due showing results of postpetition activities.

>>>>>FIRST MEETING OF CREDITORS (aka 341 Meeting because it is mandated by 11 U.S.C. 341) conducted by U.S. Trustee at which debtor's representative answers questions under oath from creditors about the factors triggering the filing, status of assets (including those pledged as collateral), and plans for restructuring.

>>> continued filing of Monthly Operating Reports

>>>>Miscellaneous stay relief, adequate protection, lease and executory contract assumption/rejection issues arise; adversary proceedings filed

>>>>Revisit or further establish cash collateral arrangements and post-petition financing arrangements

>>>Establishment of a BAR DATE for when proof of claims must be filed by creditors

>>>>Begin formulation and negotiation with pertinent creditors regarding terms of Plan of Reorganzation, including proposed classification and treatment of claims

>>>Begin analysis of potential preference recoveries.

P+120 DAYS (May 2009) - Expiration of "exclusive period" during which only DIP is permitted to file plan of reorganization.  Exclusive period often extended at request of DIP by Bankruptcy Court. 

>>>> PROOF OF CLAIM BAR DATE - all creditors not agreeing to amount of claim shown in bankruptcy schedules must have filed proof of claim form to participate in any distributions

>>>>> Continued formulation and negotiation of Plan of Reorganization.  Proposed PLAN OF REORGANIZATION and proposed DISCLOSURE STATEMENT filed.  Disclosure Statement must summarize contents of proposed Plan and provide "adequate information" concerning the Plan and its implementation.

• At least a 25 day notice period is required for hearing on Disclosure Statement
• Once Disclosure Statement approved,  proposed Plan of Reorganization, approved Disclosure Statement, and Ballot for voting on Plan must be distributed to all creditors and parties in interest.
• Revision and extensive negotiation of Plan often required

>>>>> CONFIRMATION HEARING on proposed Plan of Reorganization

• At least a 25 day notice period is required for confirmation hearing  
• Ballots must be tabulated - at least a majority in number and two-thirds in amount of claims voted in at least one class of impaired claims required for confirmation
• Other confirmation requirements (including provisions governing contents of plan) set forth in sections 1126 and 1129  of the Bankruptcy Code such as feasibility must be satisfied

 >>>>PREFERENCE ACTIONS and other adversary proceedings intiiated.

>>>> Claims determination and allowance proceedings

That, somewhat oversimplified, is the timeline of a typical Chapter 11 case.  Because there is often no way to know how long it may take to reach agreement or determination of such crucial issues as the valuation of particular property securing creditor claims, it is rarely easy to predict how long any particular case may take to resolve sufficient issues for the company to emerge from bankruptcy.  Along the way, questions as to whether the company has the ability to service even a debt burden as permitted to be modified under the Bankruptcy Code may arise.  

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With the economy definitely on the downturn, more and more businesses are facing financial distress and looking for a way out.  One of the ironies of the current commercial landscape is that Chapter 11 bankruptcy may just be TOO EXPENSIVE for many privately held companies.  Even a relatively small Chapter 11 proceeding in Central Ohio will likely require the upfront payment of a retainer of  $25,000 or more to the attorney filing the petition on behalf of the would-be debtor.  So are there any alternatives to just throwing in the towel?

One alternative growing in popularity in many states is the Assignment for Benefit of Creditors, known as an ABC for short.  For an excellent overview of how ABCs generally work, read Bob Eisenbach"s post "Assignments for the Benefit of Creditors:Simple as ABC?" on his In the (Red) blog on business bankruptcy.  In general, an assignment for the benefit of creditors is often an out of court process by which a financially distressed compnay can distribute its available assets to creditors.

However, ABCs are a pure creature of state law and so will work differently in each state which recognizes them.  Here are some links to how they work in some particular states:

• Illinois
• Georgia
• Delaware

In Ohio, however, ABCs are not really a viable option in most cases.  Why?  In a nutshell, they involve the Probate Court which is not likely to be viewed by either debtor or creditor as well versed in dealing with financially distressed businesses and offer little if anything which could not be more easily accomplished through use of a receivership.

Unlike Ohio receiverships, Ohio ABCs are governed by a relatively detailed statutory scheme found in Ohio Revised Code Chapter 1313.  A company wishing to take advantage of the process must file a written assignment of its assets to a bondable assignee in the PROBATE COURT in the county in which the company's physical assets are located.  If there are no physical assets, then the filing must be  made in Franklin County, Ohio.

Once the chosen assignee has filed its bond (required to be accomplished within 10 days of the initial filing), the Probate Court appoints three individuals to act as appraisers to determine the value of the company's assets.  The assignee is required to file an inventory of all of the real and personal property of the company (including the values determined by the appraisers) within 30 days of his appointment.

Once the inventory has been prepared and filed with the Probate Court, the assignee may begin selling assets after publishing notice in a newspaper of general circulation in the county.  However, the assignee cannot sell any item for less than two-thirds of its appraised value.  Any sale made must then be confirmed by the Probate Court.  The assignee is compensated for its efforts pursuant to Ohio Rev Code 1313.50 as follows:

• 6% of the first $1,000 of assets sold
• 4% of $1,000 to $5,000 of assets sold
• 2% of all proceeds above $5,000 

Creditors have six months from the time notice of the ABC has been published in a newspaper of general circulation in the county to file their claims with the Probate Court.

Overall, the ABC process in Ohio offers relatively few benefits to either debtor or creditors.  Unlike a bankruptcy or receivership, an ABC is solely a liquidation vehicle.  In addition, because of statutory requirements, it offers less flexibility in how any liquidation will be allowed to proceeed.  Finally, it is unlikely that either the distressed company or any creditor will feel especially comfortable about having to submit to the jursidiction of the local Probate Court.

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Last week, in a relatively unheralded decision (which didn't even rate an "official" summary by the Court's Public Information Office), the Ohio Supreme Court served notice that there's more than one way to look at certain aspects of the deepening foreclosure crisis.  In Wilborn v. Bank One Corp., 2009-Ohio-306 (hat tip to Justin Ristau for his summary in a Bricker & Eckler Creditor Rights & Bankruptcy E-Alert which called my attention to the case), the Court arguably departed a bit from established precedent to uphold an attorney fee shifting provision in the context of a residential mortgage reinstatement following the commencement of foreclosure proceedings.  Why?  Because the stability of the market demanded it.  But I'm getting ahead of myself here.

In my last post, I explained that generally speaking, everyone pays their own attorney fees in the United States, regardless of whether they wind up on the winning or losing side.  I also mentioned that one exception to this general rule was when the parties agreed between themselves that a particular party or parties was entitled to recover their attorney fees from the other side in the event they ultimately prevailed.  But that this sort of provision only really worked where both sides had relatively equal bargaining power.

Nearly all commercial loan documentation contain provisions obligating the borrower to pay the lender's attorney fees incurred in connection with the lender's enforcement of its rights under those documents.  Many consumer mortgage documents also contain such a provision.  However, in Ohio, up to now there have been several cases involving the enforceability of such provisions in the context of the enforcement of a debt -- and in foreclosure proceedings in particular -- which have generally found them to be against public policy and thus not enforceable.

What Wilborn Held.  What make Wilborn interesting is that, particularly in the current foreclosure crisis and overall difficult financial situation, it would have been VERY EASY for the Court to strike down the attorney fee shifting provisions.  While addressing a fairly unique fact pattern, the Court's naked capitalist reasoning and what it may portend for subsequent attorney fee shifting cases are worth examining. 

In Wilborn, the Ohio Supreme Court's syllabus states:

A provision in a residential mortgage contract requiring a defaulting borrower to pay a lender's reasonable attorney fees as a condition of terminating pending lender-initiated foreclosure proceedings on a defaulted loan and reinstating the loan is not contrary to Ohio statutory or decisonal law or against Ohio public policy 

Wilborn  Facts and Procedural History.  The case involved an appeal by 11 different plaintiffs in a class action (apparently a declaratory judgment action) challenging the enforceability of an attorney fee provision in a standarized residential mortgage.  After the lender had initiated foreclosure proceedings (but prior to the entry of a foreclosure judgment decrees), the plaintiffs had all entered into some sort of reinstatement of their defaulted mortgage.  In addition to bringing the defaulted mortgage current, the lender required the plaintiff borrowers to reimburse the lender for its attorneys fees and other collection costs.  The trial court dismissed the case on the grounds that payment of attorney fees as a condition for reinstatement was permissible.  The Court of Appeals affirmed.

The Reasoning.  The Ohio Supreme Court acknowleged that two very ancient cases - namely Leavans v. Ohio Natl. Bank, 50 Ohio St. 591 (1893) and Miller v. Kyle, 85 Ohio St. 186 (1911) - had long stood for the proposition that attorney fee provisions in connection with the enforcement of a debt obligation, particularly in foreclosure situations, were not enforceable.  It also recognized the holdings of Nottingdale Homeowners' Assn v. Darby, 33 Ohio St3d 32 (1987) and Worth v. Aetna Cas. & Sur. Co., 32 Ohio St3d 238 (1987)  to the effect that such provisons had to be the product of bargaining between parties of equal strength.

Now in the current economic climate, the plaintiffs-borrowers probably expected - and I certainly would not have been surprised  - the Ohio Supreme Court to apply these precedents easily and strike down the attorney fee provisons forcing poor defenseless folks on the verge of losing their homes to pay big bad banks for their legal costs in enforcing a mortgage that might even have been unfairly foisted upon the homeowner in the first place.  But that's not what happened. 

Not Against Public Policy

Instead, the Ohio Supreme Court first drew a distinction between foreclosure proceedings to enforce a mortgage and reinstatement.  It held that "reinstatement is not the enforcement of a debt obligation" and that consequently the public policy considerations of the ancient cases concenring "imposition of a penalty' were simply not relevant.  The Court explained:

A defaulting borrower is not entitled by law to have a mortgage loan reinstated.  Upon a borrower's default, a lender is entitled to initiate  foreclosure proceedings, to be paid in full, and to sever its relationship with the defaulting borrower.  A defaulting borrrower's right to reinstate the mortgage loan arises solely from the terms of the residential mortgage agreement between the parties.  Reinstatement occurs only when the defaulting borrower chooses reinstatement and consequently, chooses in the existing foreclosure proceeding to forgo those statutory protections arising from the foreclosure process.  The defaulting borrower's agreement to pay the lender's attorney fees incurred in connection with the foreclosure proceedings is a reasonable exchange for the right to require the lender to reinstate the defaulted mortgage loan and to forbear the lender's legal rights to foreclose, be presently paid in full, and sever the relationship with the defaulted borrower.

Thus, a mortgage reinstatement provison in a residential mortgage agreement creates no obligation on a defaulting borrower to pay a lender's attorney fees until the borrower exercises his or her choice to reinstate.  Thus the borrower's obligations to pay such fees does not arise solely as a consequence of the lender-initated foreclosure action.  instead, the obligation arises only upon the defaulting borrower's voluntary exercise of the contractual right to reinstate the mortgage loan, a right gained in exchange for the lender's surrender of the present right to foreclose.  

No Negative Implication of ORC 1301.21

The Ohio Supreme Court also found unpersuasive the borrowers' argument that the negative implication of Ohio Rev. Code 1301.21 - which is relatvely recent  (in the sense that it has become law during the course of my legal careeer)  and DOES allow attorney fee shifting provisons in larger commercial loans - was that the General Assembly did not intend to all such provisons in the consumer mortgage context.  Frankly, I thought this was a pretty good argument. but the Court simply put blinders on and said, well that's not what is says. 

No Contract of Adhesion - Equal Bargaining Power Exists

Perhaps even more surprising was the Ohio Supreme Court's choice to go "big picture" when considering the relative bargaining strength of the parties to a residential mortgage.  Instead of focusing on the obvious vast chasm in bargaining power between the individual homeowner and the lender, the Ohio Supreme Court instead chose to consider the entire business and commercial context in which the terms of the standarized mortgages were determined, launching into an extensive recitial of how Fannie Mae and Freddie Mac came to have standardized forms at all.  Thus, according to the Ohio Supreme Court:

although none of the Borrowers or Lenders in this case were involved, those who did participate in the process that created the uniform mortgage forms were virtual proxies for the consumers and lenders who would eventually use the product.  That process brought together many sophisticated parties with competing interests and significant bargaining power.  The reinstatement provison, including the payment of attorney fees incurred by the lender as a condition of reinstatement, was thus agreed to in a representative process of free and understanding negotiation between parties with equal bargaining power. 

Public Policy In Fact Demands Upholding Attorney Fee Shifting Provisions

In what must have seemed to the borrower-plaintiffs like adding insult to injury, the Ohio Supreme Court went on to conclude that not only did public policy not preclude enforcement of the attorney fee provisions- it in fact DEMANDED enforcement of such provisions.  As the Ohio Supreme Court saw it, weighing in the balance was nothing less than the stability of Ohio's mortgage business itself:

public policy strongly favors the use of these uniform mortgage forms to further Congress's stated purpose and to permit the trading of Ohio's conventional mortgages on the secondary market.  To declare some part of these forms unenforceable would make Ohio less competitive in the secondary mortgage market, thwarting the objectives of the Fannie Mae and Freddie Mac enabling legislation, denying lenders liquidity for their investment portfolios, and decreasing the capital available to borrowers for mortgages.  in light of the economic difficulties afflicting the national economy as of late, and particularly in the housing sector, our decision today also serves the public policy of this state by avoiding further destabilization,  

Bone to the Borrower

Almost as an afterthought, the Ohio Supreme Court threw borrowers a bone in a footnote to the effect that of course the amount of attorneys fees must still be "fair, just and reasonable as determined by the trial court upon full consideration of all the circumstances of the case." 

Some Thoughts and Implications.  While the gulf in bargaining power between consumer advocates and lenders is not nearly so wide as that between lender and consumer borrower, I'm not altogether convinced that characterizing the parties involved in hammering out the standardized mortgage forms as being of equal bargaining strength is all that accurate. 

In addition, while I "get" the distinction between foreclosure as a debt enforcement procedure and the "privilege" of reinstatement, I'm not convinced that such a distinction necessarily matters when it comes to public policy.  Personally, I've always felt that with consumer obligations such as auto loans or home mortgages, a slight presumption towards the consumer was not necessarily a bad thing.  My rationale is that, unlike business and commercial loans, in which someone has voluntarily decided to enter the business world in the hopes of making considerable money (and therefore needs to be willing to accept the risks of failure), home and auto loans are part of the fabric of everyday existence in America and are essentially unavoidable obligations.  As such, it is more appropriate for there to be protections for the borrower. 

Perhaps one of the ironic outcomes of this decision is that small commercial enterprises involved in commercial transactions with larger more powerful business partners may now actually have greater protection against an attorneys fee provision than the average consumer mortgage borrower.

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One of the immediate effects of a bankruptcy petition (of any type, whether Chapter 7, 11, or 13) is the imposition of the "automatic stay" pursuant to section 362 of the Bankruptcy Code which stops creditors cold in their tracks.  My law school professor used to say that all the creditor could do at this point was "smile at the debtor".  So what's a creditor to do?  Seek relief from stay, that's what.

Creditors wanting to go on about their business of enforcing their remedies for a debtor's default must apply to the Bankruptcy Court for permission to continue by filing a Motion for Relief from Stay.  In my part of the world here in Central Ohio, creditors seeking relief from stay in the Southern District of Ohio Bankruptcy Court must also comply with the procedures set out in Local Bankruptcy Rule 4001-1.  Among other things, that means completion of a worksheet summarizing important information about the debt nvolved and the value of the property  

Generally, two sorts of creditors seek stay relief  - secured creditors with liens on personal or real property and parties immursed in underlying litigation in another forum better suited to determine liability of the debtor.  To be successful, a party seeking relief from stay must satisfy one of the subsections of section 362(d) of the Bankruptcy Code which provides:

 (d) On request of a party in interest and after notice and a hearing, the court shall grant relief from the stay provided under subsection (a) of this section, such as by terminating, annulling, modifying, or conditioning such stay—

(1) for cause, including the lack of adequate protection of an interest in property of such party in interest;

 

(2) with respect to a stay of an act against property under subsection (a) of this section, if—

 

(A) the debtor does not have an equity in such property; and

(B) such property is not necessary to an effective reorganization;

(3) with respect to a stay of an act against single asset real estate under subsection (a), by a creditor whose claim is secured by an interest in such real estate, unless, not later than the date that is 90 days after the entry of the order for relief (or such later date as the court may determine for cause by order entered within that 90-day period) or 30 days after the court determines that the debtor is subject to this paragraph, whichever is later—

 

(A) the debtor has filed a plan of reorganization that has a reasonable possibility of being confirmed within a reasonable time; or

(B) the debtor has commenced monthly payments that—

(i) may, in the debtor’s sole discretion, notwithstanding section 363 (c)(2), be made from rents or other income generated before, on, or after the date of the commencement of the case by or from the property to each creditor whose claim is secured by such real estate (other than a claim secured by a judgment lien or by an unmatured statutory lien); and

(ii) are in an amount equal to interest at the then applicable nondefault contract rate of interest on the value of the creditor’s interest in the real estate; or

(4) with respect to a stay of an act against real property under subsection (a), by a creditor whose claim is secured by an interest in such real property, if the court finds that the filing of the petition was part of a scheme to delay, hinder, and defraud creditors that involved either—

 

(A) transfer of all or part ownership of, or other interest in, such real property without the consent of the secured creditor or court approval; or

(B) multiple bankruptcy filings affecting such real property.

If recorded in compliance with applicable State laws governing notices of interests or liens in real property, an order entered under paragraph (4) shall be binding in any other case under this title purporting to affect such real property filed not later than 2 years after the date of the entry of such order by the court, except that a debtor in a subsequent case under this title may move for relief from such order based upon changed circumstances or for good cause shown, after notice and a hearing. Any Federal, State, or local governmental unit that accepts notices of interests or liens in real property shall accept any certified copy of an order described in this subsection for indexing and recording.

Subsection (d)(2) - No Equity.   When I started practicing bankruptcy in Columbus almost 25 years ago, stay relief was fairly straightforward.  Mostly we went under subsection (d)(2) - no equity in the property and not necessary for an effective reorganization.  In Chapter 7 cases, that was pretty much a "slam dunk" from the "get-go",  In Chapter 11  or 13 cases, you might have to wait a few months just to make it easier to demonstrate that no reorganization was over the next hill, but it was still fairly cut and dried.  This tried and true option is still the the preferred route for creditors if they qualify. 

Subsection (d)(1) - Lack of Adequate Protection.  Another established option avbilable to creditors seeking relief from stay is subsection (d)(1) "for cause, including the lack of adequate protection".  Section 361 of the Bankruptcy Code defines "adequate protection" in some detail, but basically "adequate protection" is about compensating a creditor in such a way, usually with monetary payments, as to preserve the status quo existing at the time the bankruptcy petition was filed.  Generally, this grounds for relief from stay lends itself to situations in which the property pledged as collateral is deteriorating in value and/or any "equity cushion" representing the amount the value of the collateral exceeds the debt secured by it is small, nonexistent, or decreasing.  From the secured creditor's perspective, this ground is often used in tandem with subsection (d)(1) on the theory that at worst, the creditor will wind up receiving periodic (probably monthly) payments in most cases representing accrued interest.      

Subsection (d)(1) - "For Cause".  The more general "for cause" stay relief ground of subsection 362(d)(1) is a little more interesting.  It is the ground relied upon in insurance and other cases in which another court is in the process of, or is better suited, to determine what, if any, liability the debtor has with respect to a contingent or otherwise unliquidated claim asserted by a creditor.  It's also a catch-all provision allowing the Bankruptcy Court to exercise its powers of equity in appropriate cases,

"As used in §362(d)(1), the term ‘cause’ is a broad and flexible concept which permits a bankruptcy court, as a court of equity, to respond to inherently fact-sensitive situations.”   In re Indian River Estates, Inc., 293 B.R. 429, 433 (Bankr. N.D. Ohio 2003).   As the Bankruptcy Court explained:

Where relief from stay is being sought in order to continue the enforcement of a prior judgment, this Court in determining the existence of “cause”, has applied a balancing test, whereby the interests of the estate are weighed against the hardships that will be incurred by the creditor-plaintiff. For example, if lifting the stay would be unfairly detrimental to a debtor’s other creditors, relief will generally not be granted. On the other hand, if the debtor will unlikely be able to propose a plan of reorganization, “cause” for lifting the stay will usually be found.

A lack of good faith may constitute “cause” for lifting the automatic stay. In re Trident Associates Limited Partnership, 52 F.3d 127 (6^th Cir. 1994). “Cause” can certainly include improper pre-petition conduct by Debtor, In re Charfoos, 979 F.2d 390, 394 (6^th Cir. 1992).  In evaluating whether a lack of good faith such as would justify a lifting of the stay, the Sixth Circuit enumerated the following factors in In re Trident Associates Limited Partnership, namely:

• Debtor has one asset
• Pre-petition conduct of debtor has been improper
• Debtor has only a few unsecured creditors
• Debtor’s property has been posted for foreclosure and debtor has been unsuccessful in defending against foreclosure in state court
• Debtor and creditor have proceeded to a standstill in state court and debtor has lost
• Filing of the petition effectively allows the debtor to evade court order
• Debtor has no ongoing business or employees
• Lack of possibility of reorganization

In the last few years, additional subsections have been added to section 362(d) that address situations in which a secured creditor previously might have had to rely on the general "for cause" grounds of subsection (d)(1). 

Subsection (d)(3) - "Single Asset Real Estate".  Subsection (d)(3) applies to cases involving "single asset real estate" and starts a clock ticking in these cases.  Section 101(51B) of the  Bankruptcy Code defines "single asset real estate" as:

real property constituting a single property or project, other than residential real property with fewer than 4 residential units, which generates substantially all of the gross income of a debtor who is not a family farmer and on which no substantial business is being conducted by a debtor other than the business of operating the real property and activities incidental.  

Under subsection (d)93), when a bankruptcy (usually a Chapter 11) involves "single asset real estate", the debtor has 90 days to either file  a feasible plan of reorganization OR essentially start making adequate protection payments in an amount equal to the accruing interest - calculated at a nondefault rate - on the VALUE of the property securing the creditor's claim.

Subsection (d)(4) - Multiple Bankruptcy Filings Affecting Real Property Parcel.  Finally, subsection 362(d)(4) relates to the situation in which a debtor has abused the bankruptcy system with serial filings affecting real property.  This might apply in situations in which there have been multiple filings by the same debtor or tag-team filings by a husband and wife. 

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In my last post, I highlighted a post by Mark Edwards at the Concurring Opinions blog focused on the plight of perhaps "blameless" tenants being evicted from property being foreclosed upon.  Although I think Mark has overstated the problem somewhat, I also believe he raises an excellent point of general application reminding us that there is a "human" consequence entailed in foreclosure that shouldn't just be ignored.

Keith Mullen of the Tough Times for Lenders blog who brought my attention to Mark's post has followed up with a post entitled "Foreclosure and the Residential Tenant: Some Helpful Hints".  In this post, Keith explains that commercial lenders should be more concerned about this topic because"the time will come when evicting a small business owner, or evicting families who occupy abandoned property (or a model home), or evicting laid-off workers occupying an abandoned warehouse ofr factory will gain the attention of the local media."  His suggestions, aimed at getting the property back "while managing media coverage":

• Realize that a broader spectrum of people and entities may need to be notified, i.e get the lender's community/governmental relations group involved so that they can "rach out to local community organizations and governmental agencies".
• As soon as you have the legal right to do so COMMUNICATE directly with the occupant(s) about the process and options available to them (e.g. local community and governmental resources)
• Consider entering into short-term leases both as a bridge to finding a replacement tenant and to allow occupants to find other housing
• Examine title records to determine any restrictions burdening the property.

Commercial lenders DO need to be concerned about the likely increasing complications involved in regaining possession of real property, but Keith's list seems to me to miss the point, both from the lender perspective of wanting the shortest least complicated route to clean possession and resale of the property and from the perspective of addressing the true underlying problem.  The challenge presented by the presence of perhaps unwanted occupants in foreclosed property is not as simple as just shoving the problem off to another division of the lender, but neither does it have to be a circus.   

Foreclosure, at least in Ohio, is not an especially swift process (click here and here for previous posts describing the procedures in Ohio). The best way to deal with the problem of squatters and/or other potentially unwanted occupants is to obtain the appointment of a receiver to manage the operation of the property and to sort out the occupancy issues during the pendency of the case.  Properly handled, any "media' issues should be able to be dealt with incrementally.  In addition, Keith's idea of utilizing short term leases to ameliorate any harshness entailed as a result of the forclosure process also seems like a useful approach.

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As a footnote to my last couple (click here and here) of posts about the Ohio foreclosure process, I thought it would be worthwhile to link to this recent post on "Evicting the Blameless Tenant"  by Mark Edwards of the Concurring Opinions blog which, especially for a legal blog post, has drawn substantial vociferous comments.  (Hat tip to the Tough Times for Lenders blog for their aptly titled "The Very Dark Side: Evicting tenants from foreclosed apartments" for drawing my attention to this post and pointing up the dichotomy between the lender/servicer view of apartment investment real estate as "project collateral" and the owner/investor (and certainly the tenant) perspective of an "apartment community").

This extremely well written post  poses the question of who as between a lender and a tenant should bear the risk of foreclosure.  It begins:

One of the most pernicious effects of the mortgage crisis has been the eviction of blameless tenants. Leases are usually terminated by foreclosure. Tenants who have never missed a rent payment, and who have no idea that their landlord has not been applying rent payments to their mortgage obligations, suddenly face eviction -- often with no notice.

 

It is difficult to overstate the trauma of the eviction. Tenants are not only turned out into the streets. Often their personal property is put on the curb or thrown into dumpsters. They don't just lose their homes -- they can lose everything they own. Passing rainstorms or scavengers can turn a lifetime's worth of work into nothing. Children in particular can be traumitized by seeing parents rendered powerless, by losing their possessions, and by the fear of the unknown. Violence is a constant threat.

While it is hard not to be moved by these words, it remains difficult for me to be believe that lenders routinely make the effort to boot out truly "blameless" tenants.   Although I can certainly conceive of situations in which tenants have dutifully paid their rent to an unscrupulous landlord who has filed to make mortgage payments, thus resulting in a foreclosure. it remains difficult for me to believe that the truly "blameless" tenant, whether residential or commercial, is all that frequently in danger of being thrown out on the street without warning.  For one thing, at least in Ohio, they would need to be named as defendants in the foreclosure for their rights to be definitively cut off.  

If the tenant is willing and able to continue paying rent at something close to a market rate, I just can't imagine that any purchaser in their right mind would want to disturb such a scenario.  In my experience, low vacancy properties with paying tenants are precisely the sort of commercial real estate valued most highly.  Why?  Because it's a turnkey operation and all the new owner has to do is notify the tenant(s) of a new address to which rent checks should be sent.  Why would any rational purchaser want to dump perfectly good tenants in favor of having to expend resources of time and money to go out and find others?

What I suspect is more likely the case is a situation in which the tenant has perhaps been a bit lax in consistently making timely rent payments - perhaps not so much deliquent that the property owner would be inclined to go to the trouble to get the tenant out, but enough to adversely affect the value of the property as a commercial investment.  In this scenario, it is not the "pure as the driven snow"  tenant we all feel for that we are really talking about.  

And now we are really back to the central issue in the larger foreclosure crisis - what to do about people who can no longer afford to remain in their homes and whether it matters whether we think they are at fault for allowing themselves to be in this situation.  Edwards (correctly in my view) recognizes that '[f]or the bank, the risk is that it is saddled with the responsibility of property management, and that it might be more difficult to sell the property".  He goes on to contend that the relative harm to the tenant of possible eviction and loss of personal property is higher and that

the absolute harm to society in general is greater [than the harm to the lender] when blameless tenants are evicted because of foreclosure, because eviction of blameless tenants has significant negative externalities for neighborhoods and cities. 

A number of the comments to the post (which are themselves interesting to read) seem to elicit an unusual amount of passion. and appear preccupied with allocating the moral supeiority high ground between the lender and tenant.  One more cogent comment by Nate Oman made the most sense to me and reflects my own questions as I read the post:

I am curious as to the underlying economics of these foreclosures. I can understand why the banks don't want to go into the property management business, but I don't see why avoiding that business requires evicting the tenants. Why can't the banks simply sell the properties along with the leases, which if the tenants really are blameless are a valuable income stream after all?

 

It seems to me that there are two possible issues. First, banks can't sell occupied property. Second, the leases lock in rental rates that no longer pay for the landlord. Niether of these seem intuitively plausible to me. The first possiblity is certainly belied by the routine sale of occupied commercial real estate. The second seems odd to me as well. If rent was somehow tied to the land lord's costs, then we would expect leases written at the height of the bubble to actually have very attractive terms given the current real estate market.

 

In short, I am confused as to exactly why this is happening. I suspect that there is some important part of the story that we are missing, and I'd like to understand what it is before signing off on any particular policy response.

While I certainly agree that commercial foreclosures could result in "collateral damage" to those actually living in the foreclosed property and that the"human element" of displaced residents raises issues that need to be addressed, I see these as social issues to be dealt with in a larger context.   Simply saying that because the lender has deeper pockets, it should have to deal with the problem (and in essence maintain the status quo of allowing continued occupancy of an apartment complex without regard to whether market rate rate is being paid by the third-party tenant)  seems too superficial (and frankly unfair) a solution to the issue. 

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In my last post, I made some overall observations about Ohio's required judicial foreclosure procedures and explained the initial steps necessary to begin the foreclosure process.  In this post, I will explain what is involved, once the Complaint has been properly filed, in getting the property being foreclosed upon to sheriff's sale

One other caveat about this explanation is that it relates to foreclosures filed in STATE court as opposed to FEDERAL court.  While foreclosures are generally filed in state court, especially when receivership is involved, if diversity jursidiction can be met, foreclosures are now being filed somewhat more often in federal court.  in Ohio, this seems to happen most often in Cuyahoga County where the federal court route is perceived as a faster track option.

STEP THREE - Receivership Detour.  (Less than one day to several weeks after Complaint is filed.)  When commercial investment property is involved such as an office building, apartment complex, or multi-family property, the real property is generating revenues in the form of rental payments from tenants.  Lenders wanting to protect that stream of income and apply it to the defaulted loan will often seek appointment of a receiver to manage the property.  In addition, property securing defaulted loans has often been the subject of deferred maintenance and lenders are frequently concerned about deteriorating value of the property as a result.

Virtually all commercial loan mortgages securing a loan of any size have explicit provisions in them pursuant to which the mortgagor consents in advance to the appointment of a receiver in advance.  The following is a very typical such provision:

If an Event of Default has occurred and is continuing, regardless of the adequacy of Lender’s security, without regard to Borrower’s solvency and without the necessity of giving prior notice (oral or written) to Borrower, Lender may apply to any court having jurisdiction for the appointment of receiver for the Mortgaged Property to take any or all the actions set forth in the preceding sentence. If Lender elects to seek the appointment of a receiver for the Mortgaged Property at any time after an Event of Default has occurred and is continuing, Borrower, by its execution of this instrument, expressly consents to the appointment of such receiver, including the appointment of a receiver ex parte if permitted by applicable law.

Thus, commercial borrowers have by contract usually agreed to the appointment of a receiver in the event of a default. 

If for some reason, the mortgage lacks the requisite language consenting to appointment of a receiver,  Ohio Rev. Code 2735.01 permits appointment of a receiver when:

 A receiver may be appointed by ... the court of common pleas or a judge thereof in his county … in the following cases:            …

(B) In an action by a mortgagee, for the foreclosure of his mortgage and sale of the mortgaged property, when it appears that the mortgaged property is in danger of being lost, removed, or materially injured, or that the condition of the mortgage has not been performed, and the property is probably insufficient to discharge the mortgage debt;

…

(F) In all other cases in which receivers have been appointed by the usages of equity.

Appointment of a receiver is also permissible under common law whenever it will prevent a wasting of assets. 

To expedite appointment of a receiver, a motion seeking appointment of a receiver is usually filed at the same time as the Complaint.  Technically, the identity of a receiver and the terms of his/her appointment are up to the Court, but generally (although this varies considerably from county to county and from judge to judge) the Court will follow the suggestion of the foreclosing creditor.  Once appointed, the party appointed as receiver will have to post a bond in an amount set by the Court.

While appointment of a receiver often makes sense with respect to income producing property, lenders must weigh those benefits against the additional costs associated with receivership such as the premium for a receiver's bond, fees and expenses of the receiver, and additional attorneys' fees.  

STEP FOUR - Obtaining Decree in Foreclosure.  (No less than 6 weeks, generally 16-24 weeks, sometimes much longer.)  Once the Complaint, and any applicable motion for a receiver, is filed, service of process must be obtained upon the defendants just as in any other lawsuit.  Generally, service is first sought by way of certified mail, then by regular ordinary first class U.S. mail, and then, if necessary, by appointment of a special process server or by advertising.  Obtaining good service on all defendants may take as little as a week or several months; generally this process only takes about a week or two.

Twenty-eight (28) days after being served, a defendant must file an answer to the Complaint.  If no answer ot other responsive pleading is filed, a default judgment will be entered against the defendant.  If a senior lienholder fails to answer, their lien can be eliminated without. any payment to the lienholder so it is important not to ignore a foreclosure initiated by another creditor.  If the foreclosure has been commenced by another creditor, a creditor has the option of  either (A) "crossclaiming" by setting forth its own foreclosure claims which can continue even if the first creditor resolves its differences with the delinquent borrower; or (B) simply filing an answer setting forth its interest in the property being foreclosed.

If one or more defendants answer, then a motion for summary judgment must be filed before a decree in  foreclosure can be obtained.  If factual issues exist, a full-blown trial may even be necessary. 

Unless and until a receiver has been appointed, the delinquent mortgagor may remain in possession of the real property throught the pendency of the foreclosure proceeding.

STEP FIVE - Setting a Date for Sheriff's Sale.  (No less than 6 weeks and often much longer.)  After the Court has entered the Decree in Foreclosure, whether by default judgment, grant of a summary judgment motion, or following trial on the merits, a separate Order of Sale must be entered directing the Sheriff to sell the subject property at auction,  Once the Decree in Foreclosure has been obtained, the Order of Sale is a formality and serves as the operational document to put the mechanics of the foreclosure sale procedure in motion.

Pursuant to Ohio Rev. Code 2329.17 and Ohio Rev, Code 2329.18, the Sheriff must obtain an appraisal of the property from three (3) appraisers and file a copy of the appraisals with the Court.  The Sheriff handles the appraisal process on his own without intervention, consultation, or assistance from the foreclosing creditor.  The average of the appraisals establishes a floor below which the property cannot be sold; pursuant to Ohio Rev. Code 2329.20, the required MINIMUM BID is TWO-THIRDS of the APPRAISED VALUE based on the appraisal filed with the Court. 

Before the real property can be sold, Ohio Rev. Code 2329.26  requires that a notice of sale, showing time and place of sale, address of the property,and certain other required information,  must be published in a newspaper of general circulation within the county beginning at least thrity (30) days before the date of sale.  The notice must be published at least once a week, on the same day of the week, for at least three weeks.  All defendants (other than those who failed to respond to the Complaint) must be served with the notice of sale at least seven days before the sale. 

STEP SIX - Selling the Property at Sheriff's Sale.  Once the date of sale has been obtained and proper notice has been sent out, there is little for anyone to do but wait.   While Ohio Rev. Code 2339.272 permits the Sheriff to hold an "open house" at which prospective purchasers may view the property being foreclosed upon, in my experience, that rarely, if ever, happens.  Commercial investment property has typically remained open to the public thoroughout  the foreclosure proceedings so in these cases, perhaps the need for an "open house" is relatively small.  However, in residential foreclosures, the borrower may have moved out and the actual condition of the property may not be readily apparent.   In both cases, the doctrine of caveat emptor, i.e."buyer beware" has never been more applicable.  There are NO warranties about the condition of the property being sold at foreclosure sale, the successful purchaser is buying "AS IS, with all faults". 

And, no, the foreclosing lender will not make arrangements for prospective bidders to get inside to see the property so don't bother even asking!

On the appointed date of sale, the Sheriff holds an auction sale of the property, often quite literally on the steps of the County Courthouse, with bidding beginning at two-thirds of the appraised value as determined by the Sheriff. Thus, if the real property has been appraised at $150,000, it cannot be sold at sheriff's sale for less than $100,000.   If no one is willing to purchase at the required minimum bid, the property will be re-appraised and re-noticed for sale. 

The highest bidder becomes the succcessful purchaser of the property and is awarded ownership of the property free and clear of all liens belonging to defendants named in the forecosure action.   Typically, the successful bidder is required to make an immediate down payment to the Sheriff of at least ten percent of the winning bid with the balance due within a specified time thereafter, usually 15-30 days.  The foreclosing creditor is permitted to bid at the sale and if it is the successful high bidder, it need only pay the amount, if any, by which its successful "credit bid" exceeds the amount owed to te foreclosing creditor.  In addition the successful bidder is permitted to assign its bid to another party on whatever terms are agreeable between it and its assignee upon the filing of approriate pleading to the effect with the Court.

For the sake of comparison, it may be helpful to visit a post on the Calculated Risk blog entitled "Foreclosure Sales and REO for UberNerds" (which contains a further useful link to a website purporting to contain summaries of foreclosure procedures in all 50 states) to see how the Ohio foreclosure sale process differs in several significant ways from that in several other states.

STEP SEVEN - Completing the Foreclosure Sale Process.  (Approximately 4-6 weeks).  Following completion of the foreclosure sale and payment in full of the purchase price by the successful bidder (or bid assignee), a Confirmation Order approving the sale and ordering delivery of the deed to the successful bidder must then be entered by the Court of Common Pleas.

Once the Confirmation Order is entered by the Court, the delinquent mortgagor has no further right of redemption.   Ohio Rev. Code 2923.31 and Ohio Rev. Code 2329.33.  This differs from many other states.  Prior to entry of the Confirmation Order, the mortgagor can redeem the property and in  essence undo the foreclosure sale by paying the amount of the judgment, plus interest on the purchase price at the rate of 8% per annum from the date of deposit.

Again, every foreclosure is different and has its own timetable.  Local procedures vary considerably from county to county in Ohio and from judge to judge.  In addition, unique issues may arise which complicate the process.  However, in general, this is how a typical Ohio foreclosure unfolds when filed in state court.

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Now that the calender has rolled over to 2009, everyone should also be aware that the permissible rate of interest on judgments obtained in Ohio has changed as well.  For new judgments obtained in Ohio courts in 2009 for tort claims or with respect to contracts (including promissory notes and trade accounts) that do not otherwise specify an interest rate, the new rate of interest is ONLY 5%.  This is the lowest it's been since 2005 and quite a drop from the 8% applicable in 2007 and 2008.  For a more detailed explanation of how this number is determined and calculated, visit my previous post "Determining Interest on Ohio Judgments".

Judgments obtained prior to 2009 can continue to accrue interest at the rate specified in the applicable judgment entry.  However, new judgments obtained in 2009 will only accrue interest at 5% even if the permissible rate goes back up in subsequent years.      

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When you're part of the Ohio outpost of a Michigan-based law firm, you get asked questions about Ohio law that you're so used to knowing, it sorta surprises you initially... until you stop and realize there's a whole heckuva lot about Michigan law that you don't know.  Anyway, recently I was asked about foreclosure procedure in Ohio and it occurred to me that in the current economic climate, this might be useful information for lots of folks. 

So, here's a two part post laying out a roadmap for a typical Ohio foreclosure.  Part One covers getting from declaring default to bringing foreclosure proceedings into full swing.  Part Two deals with obtaining the judgment decree in foreclosure once the case is filed, selling the property at sheriff's sale, and the adminstrative details involved in completing the process.  

And of course, my disclaimer: Every foreclosure is unique and presents its own problems and challenges so the following description of the process should be seen only as the most general outline and not relied upon as a detailed explanation of how every forclosure will proceed.  

Whether involved in a foreclosure from the creditor side or as the delinquent mortgagor, everyone always wants to know how long it will take.  And the short answer is longer than you might think.  The length of foreclosure proceedings in Ohio varies considerably from one county to the next and of course every case has its own pace,  However, in my experience, Ohio foreclosures rarely, if ever, take any less than at least six months and often take much longer, not infrequently more than a year.

Initial Observations.  In Ohio, foreclosure proceedings work much the same way regardless of whether the property involved is residential, i.e. someone's home, or commercial/investment.  The most significant difference is that a receiver is often appointed in cases involving commercial investment property to protect the value of the property and the flow of income from occupants in the property.  Because my law practice here in Central Ohio primarily involves representation of creditors with liens on commercial or investment properties, this post will focus primarily on how the process works in those situations.  However, most of what is said is equally applicable to the resdential side as well.  

Ohio, unlike many other states, does not offer creditors the option of a nonjudicial foreclosure, strict foreclosure or deed of sale.  (Click here for a very brief explanation of the difference between judicial and nonjudicial foreclosure.)  If a creditor has a mortgage or judgment lien on real property in Ohio and wishes to convert that lien to cash to pay off the borrower's debt, a lawsuit MUST be filed; there is NO summary procedure or shortcut.  The only out of court alternative available is a "deed-in'lieu" situation in which the borrower voluntarily conveys the real property to the creditor in full or partial satisfaction of the outstanding obligation.  (This could and probably will be the subject of a separate post.)

Because Ohio does enforce cognovit promissory notes evidencing commercial obligations which permit creditors to obtain money judgment immediately upon filing a Complaint, creditors are allowed to pursue post-judgment collection actions with respect to a debtor and its personal property assets during the pendency of the foreclosure proceeding if they have taken a cognovit judgment on the underlying monetary obligation.  Perhaps the most important point here is that a creditor can both take a cognovit judgment and pursue foreclosure simultaneously.

The fact that the titled owner of the real property may be a guarantor rather than a borrower does not affect foreclosure proceedings in any meaningful way.  Nor does the fact that the loan agreement, note, or mortgage is a "hypothecated" obligation or contains "exculpatory" provisions, both of which relieve the signatory of liability in excess of the value of the property pledged, change any aspect of the foreclosure proceedings other than eliminate any attempt to obtain money judgment.

While statutes and court rules governing foreclosure are uniform throughout Ohio, several counties have additional supplementary local rules, many of which fall in the "unwritten" variety, that must be followed by the foreclosing creditor.  Several counties, including Cuyahoga (think Cleveland) and Hamilton (think Cincinnati), use magistrates for foreclosure proceedings.  This can add time to the process because Magistrate Decisions must be adopted by Common Pleas judges before becoming effective.

STEP ONE - Establishing the Event of Default.    (Generally 1 -3 weeks, occasionally 4-5 weeks.) Obviously, an event of default, whether monetary or nonmonetary, must first occur before the foreclosure remedy is appropriate.  Typically, upon default, a demand letter of some sort will be sent to the borrower and any guarantors setting out the amount owed and referencing the occurrence of the default.  Nonmonetary default can include many things, a number of which will likely be spelled out in the applicable loan documents, and can include such things as default on obligations to other creditors, decrease or deterioration in the value of the real property, failure to maintain insurance, or filing of a mechanics' lien upon the real property. 

Before commencing a foreclosure action, lenders must take care to comply with any applicable cure period which allows the borrower to bring the obligation current or otherwise correct the default.  Loans guaranteed by the Small Business Administration, or in which the Veterans' Administration or the Federal Housing Administration is involved may have specific notice periods and guidelines that must be observed before foreclosure should be initiated.   

STEP TWO - Preparing and Filing Foreclosure Complaint.  (Typically 1- 3 weeks, depending on the complexity of the title work required; process can occur contemporaneously with STEP ONE.)  To ensure that all creditors with liens on the real property --  including junior or senior mortgageholders, judgment lien holders, mechanics' lien holders, and taxing authorities -- are properly included as defendants in the foreclosure action, a title report must be ordered from a title company.  It is important to include all such lienholders because if omitted, the lien will remain an encumbrance on the real property even following foreclosure sale, and depending on its priority, might even be entitled to recover proceeds from the foreclsoure sale from other recipients. 

Purusant to Ohio Rev Code 2329.191, the title report or preliminary judicial report (sometimes called PJR, for short), must be filed with the Complaint in the Common Pleas Court in the Ohio county in which the real property is located.  The key is WHERE the property is located; it does not matter if the debtor is a  foreign corporation headquartered in, say Delaware, or if the loan documents were all signed in Michigan, or even if the principal place of business of the debtor is in another county or state. 

Defendants named in the complaint MUST include the follwing:

• Original mortgagor (i.e. party granting the mortgage) - note that this may or may not be the principal borrower and that if not, the principal borrower is not required to be named a defendant
• Current owner of the property, if different from the original mortgagor
• Junior or senior lienholders, including mortgage holders, judgment lien holders, statutory lien holders such as mechanics' liens and others
• Spouse of individual debtor (to eliminate dower rights)
• Current tenants and other occupants, whether there pursuant to written lease or not
• Holders of other interests such as easements, if wish to eliminate them

The Complaint may seek only foreclosure or may also include other counts for such causes of action as money judgments against the borrower(s) and guarantor(s), replevin (i.e.personal property foreclosure - yes, this too will likely eventually be the subject of a separate post), or other related claim.  If a lender has determined appointment of a receiver is warranted, the Complaint will also include a count seeking appointment of a receiver and the lender should have selected a preferred receiver appointee before filing the Complaint.

So this is how a typical Ohio foreclosure generally begins.  In my next post, I'll explain what happens once the foreclosure action is filed and how the process culminates in a sheriff's sale conveying good title to the real estate being foreclosed to another party and providing the source of funds to payall or part of the delinquent debt.

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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.,

UPDATE:  In the first quarter of 2009, prepackaged bankruptcies hit an 8 year high with more than in all of 2008.

Also thanks to Scott Jagow of American Public Media's Scratch Pad for putting a practical spin on how this would apply in a Chrysler bankruptcy.

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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.

UPDATE: David Lerner, an attorney in the Bloomfield Hills office of my Plunkett Conney law firm, has made this excellent half hour presentation (webinar with streaming audio and video lasting about a half hour) covering the basics anyone needs to know about bankruptcy preference law. 

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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.

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If your business receives a "bad check" from a customer, there may be a solution you haven't considered.  Under Ohio law, in certain circumstances you may be entitled to "treble damages" equal to three times the amount of the check, plus your attorneys' fees.

Here is the way it works.  Under Ohio Rev. Code §2913.01 and §2913.11, if someone gives you a check and there is not enough money in the account to pay the check, a criminal theft offense has been committed.  Ohio Rev. Code §2307.60 allows a person injured by a criminal act such as a theft offense to bring a civil action to recover damages, plus attorneys' fees.  Ohio Rev. Code §2307.61 speaks to the amount of those damages.

Pursuant to Ohio Rev. Code §2307.61, the recipient of a bad check is entitled to receive, at its choice, either compensatory or liquidated damages.  Compensatory damages are awarded as follows:

•     $50 if the loss was $50 or less

•     $100 if the loss was more than $50 but no more than $100

•     $150 if the loss was more than $100

Liquidated damages is the greater of either $200 or three (3) times the amount of the check, plus any charges imposed by the recipient's financial institution as a result of there being insufficient funds in the issuer's account, "irrespective of whether the property is recovered by way of replevin or otherwise, is destroyed or otherwise damaged, is modified or otherwise altered, or is resalable at its full market price."  In plain English this means that you can get treble damages (i.e. three times the amount of the check) even if you get the goods back that the "bad check" was used to purchase.  

If the original amount involved is less than $5000, the recipient of the bad check can also recover "reasonable administrative expenses" if a written demand for payment of the treble damages is made by certified mail, receipt requested, in accordance with the requirements set out in the statute.  Ohio Rev. Code §2307.61(A)(2).  "Administrative expenses" includes "the costs of written demands for payment and associated postage."  Ohio Rev. Code §2307.61(H)(1).  The notice must be sent at least thirty days prior to filing any lawsuit.

While the statute does not seem to require it, caselaw has imposed the same notice requirement on parties seeking treble damages because not requiring it "would defeat the public policy of encouraging parties to settle their disputes outside the judicial system."  Buckeye Check Cashing Inc. v. Proctor, 199 Ohio App. LEXIS 2678 (Franklin County)

Thus, the key thing to remember is that a notice must be given the perpetrator who issued the check at least thrity days before initiating a lawsuit.  To be efective, that notice must contain certain specific information pursuant to §2307.61(C):

• The specific property damage or theft offense committed

• The amount of damages for which recovery is sought

• Notice that if payment of the specified demand amount is made within thirty days thereafter or an agreement for payment is made within that time and kept, no lawsuit will be filed

• Notice that if either payment of the damages demand is not made within thirty days or there is a default on any agreement made within that thirty days, a lawsuit may be filed

• The fact that any recovery in the lawsuit may also include attorneys' fees, reasonable administrative costs, court costs, and any compensatory damages provable

To be sure you have sent an effective notice, be sure to read the satute carefully or consult an attorney before sending it out.  In addition, sending the notice by both regular and certified mail is a good idea.

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Over the last couple of weeks, Judge Boyko and Judge O'Malley in Cleveland, as well as Judge Rose in Dayton, have dismissed numerous residential foreclosures brought by the trustees of mortgage-backed securitizations on the grounds that the financial institutions have failed to demonstrate adequately their ownership of the mortgages being foreclosed. Because of all the hype these federal court dismissals without prejudice seem to be getting, especially in the blogosphere (visit Iamfacingforeclosure.com if you don't know what I'm talking about), I thought it would be helpful to post some basic source documents in one place so that everyone could see what this is all about.

1. Judges' Opinions - there are three so far that I know about:

• Judge Boyko's decision, handed down October 31, 2007, dismissed 14 cases and has the most colorful language and juicy footnotes - click JudgeBoykoOrder to read.

• Judge O'Malley's decision, handed down November 14, 2007, dismissed 32 cases and is the most matter-of-fact decision - click Judge O'Malley Order to read.

• Judge Rose's decision, handed down November 15, 2007, dismissed 20 cases and chooses to focus on a perception that mortgage lenders are generally scofflaws by referencing a study by University of Iowa Associate Professor Katherine Porter (more about this below) - click JudgeRoseOrder to read.

2. Misbehavior and Mistake in Bankruptcy Mortgage Claims, a recently released study by University of Iowa Associate Professor Katherine Porter of 1700 Chapter 13 bankruptcy cases filed in April 2006 across 24 states which was quoted by Judge Rose as follows:

("[H]ome mortgage lenders often disobey the law and overreach in calculating the mortgage obligations of consumers.... Many of the overcharges and unreliable calculations... raise the spector of poor recordkeeping, failure to comply with consumer protection laws, and massive, consistent overcharging.")

I have not yet read this study with any thoroughness so I can't comment on it other than to say its conclusion certainly is that mortgage lenders have been permitted to be rather lax in providing appropriate documentation in at least consumer bankruptcy proceedings. From the limited vantage point of my own legal practice, I will say that I disagree with the conclusion as a sweeping generalization.

3. The Affidavits - Just so everyone understands what these Judges were looking at, I thought I would post examples from each Judge of an Affidavit being put forth. In most state courts in Ohio, no such affidavit is needed at the inception of the case. Yes, they are fairly conclusory.

• Affidavit in Boyko Case
• Affidavit in O'Malley Case
• Affidavit in Rose Case

4. The Complaints - again so we are all starting from the same information, here are examples of the Complaints that were filed in these cases, together with a notation of the named plaintiff and the named mortgagee in the document in each case:

• Complaint in Boyko case - Plaintiff is Deutsche Bank National Trust Company, as Trustee of Argent Mortgage Securties, Inc. Asset-Backed Pass-Through Certificates, Series 2006-W4 under the Pooling and Servicing Agreement dated April 1, 2006, assignee of Argent Mortgage Company, LLC. Mortgagee is Argent Mortgage Company, LLC
• Complaint in O'Malley case - Plaintiff is Deutsche Bank National Trust Company, as Trustee of Argent Mortgage Securties, Inc. Asset Backed Pass-Through Certificates, Series 2005-W5 under the Pooling and Servicing Agreement dated as of November 1, 2005 Without Recourse. Mortgagee is Argent Mortgage Company, LLC
• Complaint in Rose case - Plaintiff is Citibank, N.A., as trustee for First Franklin Mortgage Loan Trust, Mortgage Loan Asset-backed Certificates, Series 2005-FF12 c/o Home Loan Services, Inc. Mortgagee is First Franklin, a division on Nat. City Bank of In.

Rather than explaining the chain of title or alleging that the named plaintiff is an assignee of the original mortgagee, the Complaints simply allege that the named plaintiff is the "holder" of the mortgage, or perhaps the "owner and holder" of the mortgage. Had either the Complaint, or the Affidavit, in these cases added an extra sentence or two explaining the assignment, it would not have been nearly as easy a decision for the courts to dismiss these cases.

5. Securitization - What's it All About? - And finally for those who really are trying to understand the underlying factual and legal context in which these dismissals occurred, I offer the following links to resources explaining how securitization works. At some point soon, I hope to post on this as well [UPDATE-click here for post on this] , but for now visit either:

Chicago Federal Reserve November 2007 newsletter

Wikipedia's Securitization posting

In Ohio, foreclosures are most often brought in state, rather than federal, court. One reason these cases may have been filed in federal court was for the convenience of being able to assign a number of cases to a single attorney who would not have to travel from county to county. It will be interesting to see if Ohio state court judges (who are elected) follow the lead of the federal courts or this becomes a friendlier forum for financial institutions.

I continue to think that the most likely outcome in the long run will simply be more detailed form Complaints explaining the securitization process and alleging the plaintiff is an assignee. New securitizations may also involve a few more pieces of paper as individual assignments are executed for the notes and mortgages, or more likely there will simply be a schedule attached to a blanket assignment.

What is not going to happen is that securitization ceases to be a viable financing tool. Instead, those involved in these transactions will merely adapt. There may be some delays, or additional costs, in the short run, but ultimately securitization will continue.

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The Cleveland foreclosure cases recently dismissed by Judge Boyko and Judge O'Malley have been incorrectly heralded by some as a severe blow to lenders wishing to foreclose on delinquent loans. At most, the decisions are merely a warning to a certain class of lenders involved in "securitization" transactions that they will need to pay more attention to certain details in those transactions, particularly if they wish to avail themselves of the federal courts in Northern Ohio.

It may have started with this post from I am Facing Foreclosure.com, but it was the New York Times story by Gretchen Morgensen which increased the level of interest in the dismissals of more than thirty foreclosure cases by two federal judges in Cleveland, Ohio. This then produced a bevy of activity in the blogosphere as others rushed in to express how exciting this was for borrowers. Click here and here for a sample of the reaction.

Now that Judge Rose, another federal judge in Dayton, Ohio has dismissed fourteen other similar cases and this has now also been reported by Gretchen Morgensen in the New York Times, some pundits will undoubtedly become even more effusive about this "victory" for homeowners facing foreclosure. For a copy of Judge Rose's Order, click JudgeRoseOrder.

However, those believing that these federal trial court dismissals without prejudice have somehow signaled disaster for lenders everywhere and a debt holiday for borrowers are sadly mistaken. To be sure, there have been some responsible bloggers who have tried to stem the tide against premature celebration. For example Calculated Risk has made at least two reasoned and exceptionally well explained posts about what this is all really about. Click here and here to read these - and if you read nothing else about these cases, read this! In addition, John Waller of the Indiana Commercial Foreclosure Blog has rather succinctly summed up what these cases mean in reality for lenders:

The moral of the story is that the institution filing the foreclosure suit, if pressed by the Court or the defendant borrower, must have proof that it owned the note and held the mortgage on the date of the filing of the foreclosure complaint. As demonstrated by the Ohio ruling, with respect to mortgage security pools this seemingly simple requirement may be burdensome or perhaps even impossible under certain structuring.

Corrective action probably can be taken during the proceedings in most cases to ensure that the named plaintiff actually holds the mortgage and owns the note. For example, depending upon the circumstances, the pleadings can be amended to name the proper party or, on the other hand, assignments can be executed to place the note/mortgage into the hands of the plaintiff. Lenders/investors and their counsel should be advised of the Ohio ruling and prepare themselves accordingly.

At the outset, it is important to understand how limited the dismissal ruling really is. All of the cases were dismissed "without prejudice" which means that once the deficiencies noted by the Judges are corrected (which they probably can be), the lenders can, and almost certainly will, refile the foreclosure successfully. In addition, unlike most foreclosures that are typically filed in state court, these dismissals occurred in cases filed in federal courts and there is no way to know whether state courts would require the same proof of the ownership of notes and mortgages. Finally, these were decisions made by trial courts which leaves other trial courts free to make other decisions.

So why were the cases dismissed? Simply put, the lenders failed to take sufficient care in establishing the chain of ownership through the various assignments of the mortgage and promissory note from one financial institution to another. The nature of the "securitization" process as applied to the mortgages in question certainly contributed to this shortcoming by making it more cumbersome to obtain all of the proper assignments throught the chain of title.

However, as explained in the Calculated Risk postings, with some expenditure of time and money, the problem can be remedied in these cases and relatively minor changes in procedures can totally eliminate the issue. Moreover, in those cases where the promissory note and mortgage have only been assigned once or twice and are not part of a mortgage-backed securitization, the problem of demostrating ownership is unlikely to arise anyway.

Thus, while these developments certainly underscore the importance of attention to detail, they in no way indicate any collapse of the securitization market or an insurmouintable problem for lenders. For another bank attorney's similar conclusion focusing on the practical realities of the situation, read Kevin Funnell's "Tale of Two Judges" posting on his Bank Lawyer's Blog.

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Obtaining a judgment is rarely the end of a matter when it comes to actually getting paid for a delinquent debt.  However, it is important to ensure that the judgment entry memorializing a creditor's entitlement to payment properly reflect the interest owed. 

Ohio Revised Code §1343.01 establishes a maximum rate of interest of 8% for contracts, promissory notes, and other writings, as well as a number of permissible exceptions to that maximum, including situations involving loans over $100,000.

If, however, the contract, promissory note, or other writing does not specify an interest rate, or judgment has been obtained on a tort claim or verbal agreement, the applicable interest rate on the judgment is established pursuant to Ohio Revised Code §1343.03.  According to this statute, the applicable rate of interest in this instance is determined by application of Ohio Revised Code §5703.47 which requires the Ohio Tax Commissioner to establish the applicable interest rate for the next year by October 15 of each year.

After performing the necessary calculations, the Ohio Tax Commissioner has determined that the applicable statutory interest rate on judgments obtained in 2008 will be 8%, the same as in 2007.  For a list of the applicable statutory interest rate for judgments obtained in prior years, click here.  Over the last twenty years, the applicable statutory interest rate has been as low as 4% in 2004 and as high as 11% from 1989-1991.  The rate is based upon the "federal short-term rate". 

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About a week ago, established Central Ohio custom home builder C.V. Perry & Co. was placed in state court receivership to liquidate its assets.  (Case No.07-MS-454 in Franklin County Common Pleas Court, Judge Bender presiding - click here to visit the court's website and see the latest docket.)  C.V. Perry & Co. had been in business for sixty years and had faced increasing financial difficulties following the death of its founder and founder's son in 2004.  Click here to read more about what led up to the company's decision to shut down operations. 

What is most interesting about this development is the choice to utilize relatively vague state court receivership law rather than a more well-defined federal bankruptcy proceeding.  While it's not so prevalent that one could call it a trend yet, more and more often, litigants seem to be choosing state court receivership remedies in Ohio over federal bankruptcy court.  In part, the increasing popularity of receivership may be the result of a perception that it will be less costly and complex than federal bankruptcy -- which I'm not convinced is correct.  However, I think parties are also attracted to the concept that they can define how the receivership will operate in a way not possible in the more structured federal bankruptcy proceeding.

In Ohio, receiverships are governed primarily by the provisions of Ohio Revised Code Chapter 2735 and the local rules of the trial court in which the action is commenced.  In recent years, the primary use of receiverships in Ohio has been in conjunction with a foreclosure of income-producing commercial property by a mortgagee during the pendency of the lawsuit prior to the foreclosure sale.  However, Ohio Revised Code  §2735.01 also permits appointment of a receiver to carry out the terms of a judgment, in cases of corporate insolvency or "in all other cases in which receivers have been appointed by the usages of equity."  In addition, Ohio Revised Code §1701.90 specifically authorizes appointment of a receiver for the winding up of the affairs of a corporation and Ohio Revised Code §1701.91 regarding judicial dissolution of a corporation also contemplates use of a receiver.

Under Ohio law, both the circumstances justifying appointment of a receiver and the powers a receiver will have once appointed remain highly flexible.  While Ohio courts routinely note that appointment of a receiver is an "extraordinary remedy", there also seems to be substantial deference given to a trial court's determination that it is appropriate in particular circumstances.  Aside from relatively sparse case law, the only guidance regarding the scope of an Ohio receiver is found in Ohio Revised Code §2735.04 which states that a receiver "may bring and defend actions in his own name as receiver, take and keep possession of property, receive rents, collect, compound for, and compromise demands, make transfers, and generally do such acts respecting the property as the court authorizes."  Thus, unlike federal bankruptcy court where the rights and obligations of debtor and creditor are fairly clear, in an Ohio receivership action, the outer limits of permissible action by receivers has not yet been established.

Since I began practicing law more than twenty years ago, Ohio receivership law has always been a somewhat uncertain body of law.  In past years, however, that uncertainty seemed to encourage use of federal bankruptcy courts in insolvency situations.  Now, however, that very uncertainty and lack of established rules seems to be attracting both creditors and debtors as if they see receiverships as a "design your own" solution. 

At the same time, however, one can see some influence of bankruptcy law.  Orders appointing receivers now regularly contain "automatic stay" type provisions.  Frequently, a claims determination process similar to the proof of claim requirements in bankruptcy is mandated.  Asset sales are often modeled after the procedures used in bankruptcy court. 

Whether receivership is the answer in any particular case depends upon your role in the situation and what you hope to achieve in an insovency proceeding.  While the relative informality of the state court receivership is alluring, I believe  that in general both debtors, and especially creditors, are better served by participating in federal bankruptcy proceedings. 

For creditors, while I understand the attraction of perhaps being able to get orders from state court judges allowing the creditor all sorts of latitude in dealing with the assets of a debtor, I remain unconvinced that receivership will ultimately be less expensive.  The fact that there ARE established priocedures and responsibilities in a bankruptcy proceeding seem to me more likely to expedite resolution than the situation in state court receivership in which every issue is one in which almost anything could happen.  Moreover, aggreesive collection action seems more likely than receivership to result in available cash flow and assets being directed specifically in the direction of my client.

For debtors wishing to continue in business, state court receivership may actually offer a viable alternative to Chapter 11 proceedings which are indeed quite expensive.  Because Ohio receivership law is so undeveloped, there is an opportunity to choose which aspects of federal bankruptcy law are most beneficial while perhaps avoiding those considered less desirable.  Depending upon how the receiver is selected and the relationship which develops between the receiver and the principals of the debtor, state court may offer real opportunities for resurgence.  However, control over the company's business affairs may just as easily be irretrievably lost due to the sweeping scope of a receiver's powers. 

For debtors intending to liquidate, the advantage of a federal bankruptcy proceeding is that there is established law about what the effect of such a proceeding is. 

If the current trend towards utilizing state court receivership rather than federal bankruptcy court continues, it will be interesting to see how the case law develops concerning the grounds justifying appointment of a receiver and the scope of a receiver's powers once appointed.  

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Several recent Ohio Court of Appeals decisions have confirmed that while Ohio will remain among the minority of states that recognize and enforce cognovit provisions in promissory notes (see Ohio Rev. Code section 2323.13), getting back into court on a motion for relief from judgment may be becomining easier.  Over time, Ohio courts have been gradually lowering the threshold for obtaining relief from judgment when it comes to opening up a cognovit judgment.  However, the individual  facts of the case and the specificity of the judgment debtor's factual allegations supporting the purported meritorious defense remain important. 

 When a promissory note contains a cognovit provision, also known as "confession of judgment" provisions, a creditor can obtain judgment immediately following the filing of the Complaint without any notice to the erstwhile debtor or opportunity to be heard.  All that is necessary is that the creditor file a ministerial answer on behalf of the debtor and present the court with the original of the promissory note containing the appropriate "warrant of attorney" cognovit language and "clear and conspicuous" warning.  Creditors obviously appreciate this feature as it can give them a head start on such post-judgment collection activities as bank account garnishment.

 For many years, cognovit judgment debtors were required to demonstrate they in fact did have a "meritorious defense" just as any other party seeking relief form judgment was required to prove.  In addition, many courts held the view that the mere existence of cognovit provisions in a promissory note precluded any defense other than payment.  (see, e.g. Fifth Third Bank v. Jarrell,  2005 Ohio 1260 (Franklin Cty- 10th App. Dist.). 

While no less an authority than the United States Supreme Court has upheld the constitutionality of cognovit notes and specifically as used in Ohio (D. H. Overmyer Co., Inc. v. Frick Co., 405 U.S. 174 (1972)), Ohio courts have gradually become more uncomfortable about the lack of due process inherent in the enforcement of cognovit provisions in promissory notes.  Some courts have become more willing to entertain potential defenses to cognovit judgments beyond simply payment.  In addition, the threshold for obtaining relief from judgment on a cognivit judgment has been modifed so that the judgment debtor need only show that a meritorious defense can be asserted, and need not prove that he or she would prevail upon that defense.

However, while Ohio courts are becoming somewhat more receptive to relief from cognovit judgment, it is not entirely clear what that will mean in practice.  Just last week, in Gerold v. Bush,  2007 Ohio 5885, 2007 Ohio App. LEXIS 5171, the Erie County Court of Appeals for the Sixth Appellate District upheld a trial court's grant of relief from judgment where the debtor alleged accord and satisfaction and a failure of consideration without requiring much more from the judgment debtor.  Meanwhile, a little more than a month ago, the Knox County Fifth Appellate District Court of Appeals upheld the denial of relief from a cognovit judgment in World Tire Corp. v. Webb, 2007 Ohio 5135, 2007 Ohio App. LEXIS 4517 in which the debtor alleged fraudulent inducement to execute the note because the judgment debtor failed to provide sufficient "operative facts" in its affidavit.  Other Ohio Courts of Appeal also upheld denial of relief from cognovit judgments on the grounds that insufficient "operative facts" had been alleged.

Thus from the creditor's perspective, cognovit promissory notes will remain an important tool.  From the judgment debtor's perspective, taking care to be specific about the facts giving rise to a perceived defense seems likely to be particualry important.

UPDATE: To learn more about cognovit notes in Ohio, click here for my post on the basics.

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