NU WAY DRYWALL COMPANY INC APPELLANT v. FIRST PLACE BANK MARK WHEATLEY UNKNOWN SPOUSE OF MARK WHEATLEY SMI NEW HOME SOLUTIONS LLC VALERIE SUSAN WHEATLEY CITY OF FLORENCE BOONE READY MIX INC AND COUNTY OF BOONE KENTUCKY APPELLEES

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Court of Appeals of Kentucky.

NU–WAY DRYWALL COMPANY, INC. APPELLANT v. FIRST PLACE BANK;  MARK WHEATLEY;  UNKNOWN SPOUSE OF MARK WHEATLEY;  SMI NEW HOME SOLUTIONS, LLC;  VALERIE SUSAN WHEATLEY;  CITY OF FLORENCE;  BOONE READY–MIX, INC.;  AND COUNTY OF BOONE, KENTUCKY APPELLEES

NO. 2011–CA–000242–MR

-- June 15, 2012

BEFORE:  CAPERTON, KELLER, AND THOMPSON, JUDGES. BRIEF FOR APPELLANT:  John E. Lange, IV Newport, Kentucky BRIEF FOR APPELLEE FIRST PLACE BANK:  Christopher M. Hill Frankfort, Kentucky BRIEF FOR APPELLEE CITY OF FLORENCE Dale T. Wilson Florence, Kentucky

NOT TO BE PUBLISHED

OPINIONAFFIRMING

Nu–Way Drywall Company, Inc. appeals from an In Rem Judgment and Order of Sale entered by the Boone Circuit Court in a foreclosure action filed by First Place Bank. Nu–Way contends that the circuit court erroneously determined that mortgages held by First Place Bank had first priority in foreclosure over a judgment lien held by Nu–Way.   After careful review, we affirm.

Factual Background and Procedural History

On May 9, 2007, Mark Wheatley, acting in his individual capacity, executed two balloon notes in favor of First Place Bank, each of which was for the principal amount of $30,400 with interest thereon at the rate of 10.25%. The first note provided an address of “Lot 1 Hopeful Road,” and the second note provided an address of “Lot 25 Hunterallen Road.” Both lots were located in the Hopeful Trails Subdivision in Florence, Kentucky.   On the same day, Wheatley, both in his individual capacity and as a member of SMI New Home Solutions, LLC (“SMI”), executed two mortgages against the lots to secure the notes.   Title to both lots was vested solely in SMI.

In April 2008, First Place Bank began preparing to file foreclosure actions on the lots against Wheatley and SMI. Prior to filing for foreclosure, First Place Bank, an independent title examiner, searched the title on both lots and uncovered no other mortgages, liens, or encumbrances on the lots beyond the mortgages held by First Place Bank. On May 5, 2008, First Place Bank filed a foreclosure action on the Lot 1 property.

Around this time, Wheatley contacted First Place Bank and its counsel and asked that he be allowed to deed the lots to First Place Bank in exchange for dismissal of any foreclosure action.   Wheatley additionally requested $1,000 for each lot.   Thereafter, on May 13, 2008, First Place Bank and Wheatley, acting on behalf of SMI, executed two Deeds in Lieu of Foreclosure (“deeds in lieu”) conveying the lots to First Place Bank. Each deed recited that its execution would release the underlying indebtedness owed by Wheatley, that Wheatley would also be paid “consideration of $1,000.00,” that the title to the property conveyed was “clear, perfect and unencumbered,” and that SMI would “WARRANT GENERALLY” the title to the property.

Along with the deeds in lieu, Wheatley, again acting on behalf of SMI, executed an Estoppel Affidavit and Agreement for Conditional Delivery of Deed for each lot wherein he represented that SMI held good title to each lot free of liens and encumbrances.   Notably, this document provided that SMI would receive a full release of the note and mortgage “subject to the condition which is understood and agreed by [SMI] that the deed to [First Place Bank] referred to herein is intended to convey a marketable title free of liens or encumbrances[.]”  The affidavit also provided that although the deeds in lieu did not restrict First Place Bank's right to institute foreclosure proceedings, they were “intended and understood to be an absolute conveyance and an unconditional sale, with full extinguishment of [SMI's] equity of redemption and with full release of all [SMI's] right, title and interest of every character in and to said property.”   The affidavit further indicated that it had “been made for the protection and benefit of [First Place Bank] in said deed[.]”

Prior to recording the deeds in lieu, First Place Bank had the titles for Lots 1 and 25 examined a second time on May 28, 2008, and once again the search revealed no other mortgages or liens on the properties.   On June 6, 2008, First Place Bank recorded the deeds in lieu and subsequently paid Wheatley $1,000 for each lot.   First Place Bank subsequently stamped “Mortgage Cancelled by Multiple Satisfaction” on the mortgage for Lot 1 and recorded a Satisfaction of Mortgage for Lot 1 in the Boone County Clerk's Office.   However, the foreclosure action was not dismissed and remained on the active docket.

Unknown to First Place Bank, SMI had filed a Chapter 11 bankruptcy petition on May 5, 2008, prior to the conveyance of the deeds in lieu.   First Place Bank had not been listed as a creditor in the bankruptcy filing and was not otherwise notified that the filing had occurred.   The Bank subsequently learned that on January 29, 2008, Nu–Way had filed a Notice of Judgment Lien encumbering all property owned by SMI.

Upon completion of SMI's bankruptcy proceeding, First Place Bank filed an amended complaint seeking to foreclose on the mortgages for Lots 1 and 25 and adding Nu–Way and others having an interest in the subject lots as defendants.   First Place Bank claimed that Mark Wheatley's failure to disclose SMI's bankruptcy filing effectively rendered the deeds in lieu void ab initio and negated its release of the mortgage on Lot 1. First Place Bank further argued that because of this, it maintained an equitable lien upon the lots and was entitled to have the deeds in lieu set aside and to be restored to its senior lien position.

Nu–Way responded to the amended complaint by filing an answer, counterclaim, and cross-claim asserting that its judgment lien had first priority over any mortgage held by First Place Bank. Nu–Way specifically claimed that First Place Bank had lost its senior lien position as a result of accepting payment from SMI in exchange for the deeds in lieu and by releasing its mortgage on Lot 1. Nu–Way subsequently argued that First Place Bank's mortgages were not valid against the lots they purported to encumber because Wheatley did not own the lots at the time he borrowed money from First Place Bank and because the mortgages had not been supported with consideration.   Eventually, both Nu–Way and First Place Bank moved for summary judgment, with each party claiming that its lien/mortgages had first priority and Nu–Way claiming that First Place Bank's mortgages were invalid.   The circuit court denied both motions and referred the matter to the Deputy Master Commissioner for a recommended judgment.

Following briefing, the Deputy Master Commissioner filed a report addressing the question of whether First Place Bank had effectively waived and released its senior lien position by accepting title to the subject lots via the deeds in lieu, i.e., by merger.   Relying upon London Bank & Trust Co. v. American Fidelity Bank & Trust Co., 697 S.W.2d 956 (Ky.App.1985), the Deputy Master Commissioner concluded that it had not.   He specifically noted:

Reviewing the relevant documents filed in the Court's record, namely, the Deeds in Lieu of Foreclosure and Estoppel Affidavit and Conditional Delivery of Deed evidences an intent by Bank to take title to Lot 1 and Lot 25 free and clear of any and all other claims or encumbrances.   SMI, through its member, Wheatley, and Wheatley, acting in his individual capacity, stated under oath that title to Lot 1 and Lot 25 was conveyed free and clear of all liens and encumbrances and that it would warrant the title against all claims by third parties.   There is no language in any instrument filed into the Court's record to allow any inference, let alone a reasonable one, that Bank intended to acquire Lot 1 and Lot 25 subject to interests and liens of third parties, including but not limited to Nu–Way's Judgment Lien. Rather, these instruments evidence a clear intent by Bank to avoid a foreclosure and recoup its losses.   In sum, Bank was attempting to protect its interests by taking advantage of every position it could․  Simply because Bank took positive, protective measures for its own self-interest by taking title from SMI, “does not mean that equity works mindlessly against it[.”]

The Deputy Master Commissioner also addressed Nu–Way's contention that since SMI had not executed a promissory note with First Place Bank, it was not liable for Wheatley's indebtedness and, therefore, did not have a valid mortgage encumbering either lot.   The Deputy Master Commissioner concluded that because SMI owned the lots, it was free to use them as collateral in a mortgage whether it was a party to the underlying indebtedness or not.

Consequently, the Deputy Master Commissioner recommended that First Place Bank be found to have retained valid mortgages against Lots 1 and 25 and that those mortgages be found to have first priority in foreclosure over Nu–Way's judgment lien.   The circuit court ultimately confirmed this report and adopted the findings of fact and conclusions of law set forth therein.   An In Rem Judgment and Order of Sale was entered on January 5, 2011, and Lots 1 and 25 were ordered sold to satisfy First Place Bank's mortgages.   This appeal followed.

Analysis

On appeal, Nu–Way again argues that its judgment lien is entitled to first priority over the mortgages held by First Place Bank on Lots 1 and 25.   In support of that position, Nu–Way contends that First Place Bank's mortgages are defective and unenforceable due to a lack of consideration.   Nu–Way's argument is based on a view that because SMI was not a co-signer in the underlying loan transaction between Mark Wheatley, who borrowed in his individual capacity, and First Place Bank, it was ultimately not responsible for repayment of the notes.   Therefore, Nu–Way contends insufficient consideration existed to support any mortgage against the lots owned by SMI. Nu–Way also argues that Wheatley could not have mortgaged the lots because he did not own them.

Nu–Way correctly asserts that Mark Wheatley did not own the subject lots.   We agree that it is questionable whether Wheatley could have mortgaged the lots to secure his loans because, even as a member of SMI, he did not own the property as an individual.   See KRS 275.240(1),”Property transferred to or otherwise acquired by a limited liability company shall be the property of the limited liability company and not of the members individually.”   However, the fact that Wheatley did not own the lots does not necessarily invalidate the mortgages with regard to SMI. Each of the mortgages in question contains the following language:

Borrower covenants and agrees that Borrower's obligations and liability shall be joint and several.   However, any Borrower who co-signs this Security Instrument but does not execute the Note (a “co-signer”):  (a) is co-signing this Security Instrument only to mortgage, grant and convey the co-signer's interest in the Property under the terms of this Security Instrument;  (b) is not personally obligated to pay the sums secured by this Security Instrument;  and (c) agrees that Lender and any other Borrower can agree to extend, modify, forbear or make any accommodations with regard to the terms of this Security Instrument or the Note without the co-signer's consent.

Thus, this language contemplates that SMI could pledge its property to secure Wheatley's promissory notes even though SMI was not a co-signer to those notes.

As to Nu–Way's argument regarding a lack of consideration, the parties have not directed this Court to a Kentucky case directly holding that a mortgage may or may not secure the obligation of another, but there is ample authority from other jurisdictions for the proposition.   Indeed, it appears to be a little debated principle of mortgage law.   We agree with, and adopt the position of, those numerous decisions holding “that consideration for a mortgage need not move directly from the mortgagee to the mortgagor but may consist of a loan to a third person, and that a benefit to a third person constitutes sufficient consideration for an agreement.”  First Nat. Bank and Trust Co. of Williston v. Brakken, 468 N.W.2d 633, 638 (N.D.1991);  see also, e.g., 54A Am.Jur.2d Mortgages § 59;  59 C.J.S. Mortgages § 128;  Restatement (Third) of Property (Mortgages) § 1.3 cmt. (a) (1997);  Double Arkansas Iron and Metal Co. v. First Nat. Bank of Rogers, 16 Ark.App. 245, 252, 701 S.W.2d 380, 384 (Ark.Ct.App.1985);  F.D.I.C. v. Diamond C Nurseries, Inc., 629 So.2d 157, 160 (Fla.Dist.Ct.App.1993);  Surety Life Ins. Co. v. Rose Chapel Mortuary, Inc., 95 Idaho 599, 603, 514 P.2d 594, 598 (1973);  Riddle v. La Salle Nat. Bank, 34 Ill.App.2d 116, 119, 180 N.E.2d 719, 721 (Ill.App.Ct.1962);  Huntingburg Production Credit Ass'n v. Griese, 456 N.E.2d 448, 451 (Ind.Ct.App.1983);  Opperman v. M. & I. Dehy, Inc., 644 N.W.2d 1, 5 (Iowa 2002);  Nebraska State Bank v. Pedersen, 234 Neb. 499, 508, 452 N.W.2d 12, 19 (1990);  Continental Bank of Pennsylvania v. Barclay Riding Academy, Inc., 93 N.J. 153, 171, 459 A.2d 1163, 1172 (1983);  Matter of Foreclosure of Deed of Trust of Enderle, 110 N.C.App. 773, 775, 431 S.E.2d 549, 550 (N.C.Ct.App.1993);  First Nat. Bank and Trust Co. of Williston v. Brakken, 468 N.W.2d 633, 638 (N.D.1991);  Tuller v. Nantahala Park Co., 276 S.C. 667, 676, 281 S.E.2d 474, 478 (1981);  Walker v. First State Bank, 849 S.W.2d 337, 342 (Tenn.Ct.App.1992);  Wilbanks v. Wilbanks, 160 Tex. 317, 319, 330 S.W.2d 607, 608 (1960);  Seattle–First Nat. Bank v. Hart, 19 Wash.App. 71, 73, 573 P.2d 827, 829 (Wash.Ct.App.1978).   Consequently, Nu–Way's argument that the mortgages executed by SMI lacked adequate consideration is rejected.

Nu–Way also suggests that the validity of the mortgages is questionable because First Place Bank did not produce any documentation indicating that SMI was an active limited liability company, that Wheatley was an actual member of SMI, or that Wheatley was authorized to bind the company in such a manner.   However, Nu–Way's argument amounts to speculation as it has not directed this Court to any evidence suggesting that SMI, and/or Wheatley as a member of SMI, was prohibited by SMI's organizing documents from signing the mortgages.   Therefore, we decline to consider this argument.

Nu–Way finally argues that by accepting the deeds in lieu and otherwise acting in a manner evidencing the intent to release its mortgages, First Place Bank intentionally and voluntarily extinguished its liens on Lots 1 and 25 and released Wheatley/SMI from liability.   Nu–Way contends that as a result of these actions, First Place Bank lost priority over any subsequent liens because its mortgages were “merged” with the acquired title;  therefore, Nu–Way's judgment lien moved into the position of first priority. Double The question, then, is whether First Place Bank lost its lien priority status by accepting a conveyance of the lots.

The prevailing rule “is that the question of merger is always one of intention and, unless an intention to merge clearly appears, no merger results from the acquirement by the holder of the senior mortgage of the interest of the mortgagor[.]”  Purdom v. Broach, 210 Ky. 161, 275 S.W. 365, 366 (1925).   Where the intent to merge is not found, “the senior mortgage retains its priority as against all junior or intervening liens upon the mortgaged property;  and this is true, whether the interest of the mortgage is the legal title to the land or the mere equity of redemption.”  Id. As a general rule, “[i]t is only when the fee and the lien center in the same person without any intervening claims, liens, or equities that a merger of the title and the lien will take place.”  Id.;  see also London Bank, 697 S.W.2d at 957, “[T]he merger of the title and the lien occurs under two qualifications:  (1) there is intent to merge;  (2) there are no intervening liens and equities.”   Thus, “if there is an outstanding, intervening lien or title, the foundation for the merger does not exist, and none will be declared.”  Purdom, 210 Ky. 161, 275 S.W. at 366.

The rule set forth in Purdom, “is based upon the presumption, as a matter of law, that the prior lienholder must have intended to keep his lien alive when it is essential to his security against an intervening lien or title [.]”  Id.;   see also London Bank, 697 S.W.2d at 957–58.  “The existence of junior liens, usually impel[s] the courts to assume in construction that the mortgagee did not intend a merger which would be against his own self interest.   In the absence of affirmative intent, it is generally held that such junior liens remain subordinate, and no merger affects them.”  Id. at 957, quoting R. Powell, The Law of Real Property ¶ 469.1[3] (1984).   Indeed, at least one commentator has noted a “strong presumption against merger” in such cases because of the desire to allow “the mortgagee-grantee to protect himself against junior liens.”   Practicing Law Institute, Friedman on Contracts and Conveyances of Real Property § 3:6.2.

It is clear from the record that although First Place Bank accepted the deeds in lieu from SMI in exchange for $1,000 and a release of at least one of the mortgages, it intended to keep its first priority in foreclosure against any subordinate lien.   The most notable proof of this is in the documents executed by the parties as part of the conveyance of the lots.   They indicate that First Place Bank's ultimate acceptance of the deeds (and SMI's release from its obligations) was plainly conditioned on the lots being unencumbered by any other liens or mortgages.

Each deed anticipated that the title to the property conveyed was “clear, perfect and unencumbered,” and that SMI would “WARRANT GENERALLY” the title to said property.   Moreover, the Estoppel Affidavit and Agreement for Conditional Delivery of Deed executed by Wheatley/SMI for each lot again represented that SMI held good title to each lot free of liens and encumbrances.   Notably, this document provided that SMI would receive a full release of the note and mortgage “subject to the condition which is understood and agreed by [SMI] that the deed to [First Place Bank] referred to herein is intended to convey a marketable title free of liens or encumbrances[.]”  The affidavit also provided that the deeds in lieu did not restrict First Place Bank's right to institute foreclosure proceedings if desired and that it had “been made for the protection and benefit of [First Place Bank] in said deed[.]”

Consequently, it is apparent that First Place Bank did not intend for a merger to occur in this case in the absence of a conveyance of clear title.   Therefore, the obligations underlying First Place Bank's mortgages were not released, and the mortgages retained their priority against all junior or intervening liens upon the subject lots, including that of Nu–Way.   Nu–Way's arguments to the contrary are not persuasive in light of the authorities cited.   As was the case in London Bank, supra, it was not demonstrated that First Place Bank, by having the lots deeded to it, “intended to have such transfer work against its own self-interest.”  London Bank, 697 S.W.2d at 957–58.   Simply because First Place Bank “took positive, protective measures for its own self-interest by taking the title ․ does not mean that equity works mindlessly against it.”  Id. at 958.

Conclusion

For the foregoing reasons, the In Rem Judgment and Order of Sale entered by the Boone Circuit Court is affirmed.

ALL CONCUR.

THOMPSON, JUDGE:

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