Mortgage Loan Sales / Guarantees: Freedom of Contract And Double Counting

In re Kaid, 472 B.R. 1 (Bankr. E.D. Mich. 2012)

Can a mortgagee retain the right to collect on a guarantee after a sale of the guaranteed note and mortgage?  In Kaid, the answer was yes; but to avoid double counting, the guarantor was entitled to a credit for any reductions in the amount due under the sold note, including the amount bid at a mortgage foreclosure sale.

Kalid Kaid guaranteed an $807,500 mortgage loan made by Flagstar Bank, FSB to Michigan & Lonyo Ultimate Service Center, Inc.  Flagstar sold the loan to AFT Investments, LLC as part of a group of loans, but expressly excluded the Kaid guarantee from the sale.  The agreement with AFT allocated a portion of the purchase price to the Michigan & Lonyo loan and set a “maximum foreclosure amount” for the mortgage.

Flagstar sued the guarantor in state court and obtained a judgment on the guarantee for approximately $830,000, although the court cautioned that allowing Flagstar to separate the guarantee and note should not enable it to obtain more than was owed on the note.  Then the note purchaser foreclosed the mortgage and successfully bid approximately $750,000 at the foreclosure sale, acquiring a sheriff’s deed to the mortgaged property.

The guarantor subsequently filed bankruptcy.  Flagstar filed a proof of claim for approximately $520,000.  The debtor objected, arguing that Flagstar was not entitled to assert a claim under the guarantee since the guarantee necessarily followed the assignment of the note, or in the alternative, that the debtor was entitled to a credit equal to the foreclosure sale bid.

The guarantee was governed by Michigan law.  Although the bankruptcy court noted Michigan cases holding that a guarantee follows assignment of a note when the assignment is silent as to the status of the guarantee, it concluded that there was nothing that would preclude Flagstar and AFT from agreeing to exclude the guarantee from the sale and assignment.  Consequently Flagstar was able to retain the right to make a claim under the guarantee.

Besides, the debtor had already litigated the issue of whether Flagstar could separate the guarantee from the note, and a state court had entered a judgment in favor of Flagstar.  Under the Rooker-Feldman doctrinethe bankruptcy court was required to defer to the state court judgment.  However, even the state court noted that Flagstar was not entitled to a double recovery.

Payments credited against the note should reduce the obligations under the guarantee, and similarly under the judgment.  When AFT foreclosed the mortgage and bid $750,000 at the foreclosure sale, the bid was credited against the amount that was owed under the note.  It was clear that the guarantor would have been entitled to a credit for any payments made on the note, and the bankruptcy court saw no reason to distinguish between a cash payment and a foreclosure sale bid.  So, the guarantor was entitled to a credit for the amount bid at the foreclosure sale.

Flagstar also argued that any credit should be limited to the amount that was allocated to the sale of the note.  Approximately $270,000 was allocated to this loan.  Flagstar apparently gave the guarantor credit for this payment in preparing its proof of claim, which the court notes would explain why Flagstar filed a proof of claim for $520,000 instead of the full balance of the judgment.  However, the transactions between Flagstar and AFT had no bearing on liability under the note or the guarantee.  When AFT paid Flagstar, neither the borrower nor the guarantor was entitled to any credit.  Consequently, the court found that the note sale transaction was irrelevant.

Flagstar also argued that the AFT foreclosure bid exceeded the maximum amount provided for in the note sale agreement, and consequently the credit for the foreclosure sale bid should be limited to that maximum amount.  Again, the court found that compliance with the agreement was an issue that was between Flagstar and AFT, and did not affect the debtor’s right to receive a credit for the full amount that was actually bid at the foreclosure sale.

As this case illustrates, separating obligations so that payments are made to two different parties based on one primary obligation can get messy.  If that is what the parties intend, it will be important that they understand that they can only collect the total debt once between all of the creditors, and that the documentation adequately reflects their agreement as to allocation of the right to payment.

Vicki R. Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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