Case No. 01-12296-SSM, Adversary Proceeding No. 03-1283United States Bankruptcy Court, E.D. Virginia.
May 11, 2004
Brian F. Kenney, Esquire, Miles Stockbridge, P.C., McLean, VA, for Plaintiff
James R. Schroll, Esquire, Bean, Kinney Korman, P.C., Arlington, VA, for Defendants
MEMORANDUM OPINION
STEPHEN MITCHELL, Bankruptcy Judge
This matter is before the court on the chapter 7 trustee’s motion for summary judgment against defendant Allodean Allobaidy on Counts II, IV, and V of the complaint. For the reasons stated, the motion will be granted in part and denied in part.
Background
Richard A. Forde (also known as Euburn Richard A. Forde) and his wife Wendie M. Forde filed a joint voluntary chapter 11 petition in this court on May 25, 2001, and remained in possession of their estate as debtors in possession until November 26, 2002, when their case was converted to chapter 7. While the case was still a chapter 11 case, the debtors filed a
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motion on March 5, 2002, for authority to sell real property they owned at 1036 Leigh Road, Great Falls, Virginia, to Allodean Allobaidy for $5,495,000 free and clear of liens.
The Real Estate Sales Agreement attached to the motion was dated February 15, 2002, and called for a $450,000 down payment. The balance of the purchase price would be financed by a $3,846,500 first-trust conventional loan to be obtained by Mr. Allobaidy and by a second-trust note to be taken back by the debtors in the amount of $1,099,000, with interest at 4.5% per annum, and payments of interest only for 15 years, at which time the principal would become due. The contract specifically provided, “This contract is contingent upon approval of the United States Bankruptcy Court[.]” An addendum to the contract provided that the debtors would “set aside $704,490.63 for a move-in and fix-up allowance” for the buyer, with the money being held in escrow to pay for certain designated construction work to be performed by Mr. Allobaidy’s contractor (G F Construction).
A hearing on the sale motion was held on March 12, 2002. A number of objections had been filed. Oxford Construction Company, a general contractor, had a deed of trust against the property to secure amounts owed to its subcontractors, some of whom had independently filed mechanic’s liens. The debtors agreed that $475,000 of the sales proceeds would be escrowed to cover the Oxford deed of trust and the mechanic’s liens. The United States Trustee had objected to a 4 1/2% commission being paid to a real estate broker (identified as Money Tree, Inc.) whose employment had not been approved by the court. The debtor’s counsel represented that the commission “was incorrectly stated” in the contract as a seller’s commission, but that it was actually a buyer’s commission, with the result that “the
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commission will be coming really out of the buyer’s side[,] not the seller’s side, at closing.” That led to the following colloquy:
THE COURT: On the settlement statement, it will be in the buyer’s column and not in the seller’s column?
MR. LICKSTEIN: That’s correct. That’s correct. . . . That will go on the buyer’s side of the equation on the HUD One, not on the seller’s side.
The United States Trustee had also objected to the low interest rate (4.5%) on the take-back note. The debtors’ attorney argued that the low rate had to be viewed in the context of the purchase price, which counsel characterized as “a pretty good deal,” also noting that the take-back note offered “an extra-added attraction of money over a period of years” and was “the money that I’m going to try to utilize for a plan because a good chunk of that money is going to go to unsecured creditors.” There was a further discussion between the debtors’ counsel and the court as to what the net proceeds would be after all credits and payments, and debtors’ counsel represented that in rough numbers he expected “there will be, we’ll say, a couple hundred thousand dollars essentially to play with,” and that “that money will be — is going to be part of a plan.” Debtors’ counsel further assured the court that the net proceeds of sale would be held in escrow pending confirmation of a plan. Counsel for the United States Trustee then sought clarification, “based on what [debtors’ counsel] is saying, we’re only going to have less than $200,000 in cash and the rest of it is going to be a note.” Debtor’s counsel replied, “Right.” After further discussion, the court ruled that the motion to approve the sale would be granted and directed debtors’ counsel to submit a proposed order.
An order was subsequently entered on March 14, 2002, authorizing the sale to Mr. Allobaidy “pursuant to” the contract, free and clear of liens, with the liens attaching to the
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proceeds of sale. An exhibit was attached to the order specifying some $2,811,310.30 of liens to be paid at settlement or escrowed. The order further required that the debtor file a report of sale and HUD-1 form within ten days of settlement.
Settlement reportedly occurred on June 28, 2002, but a report of sale was not filed until a month later, and it was another two weeks before the HUD-1 form was filed. The report of sale reflected, not “a couple hundred thousand dollars” of net proceeds as represented at the hearing, but only $1,500. Additionally, the report of sale failed to account for $500,842.60. That is, it reported “gross proceeds” of $5,995,000, while the items shown on the report as paid (including the $1,500 in net proceeds to the sellers) total only $3,897,907.40. Contrary to the assurance given at the hearing that the broker’s commission would be paid from the buyer’s funds and would appear on the buyer’s side of the settlement statement, that commission (in the amount of $359,700) is shown instead on the sellers’ side of the HUD-1 form as a reduction in the amount due the sellers. Additionally, the broker is identified as National Home Buyers Realty Co., Inc.,[1] rather than Money Tree, Inc., and the amount of the commission is 6% rather than 4 1/2%. Furthermore (although the fact is obscured by the way the HUD-1 form was prepared)[2] no deposit was actually paid by Mr. Allobaidy.
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Finally, the debtors, rather than taking back a $1,099,000 note as provided in the contract, instead took back a $1,498,750 note at 9% interest.[3] The note provided for annual payments of interest only in the amount of $134,887.50, with the entire outstanding balance due in full on May 31, 2007. The note contained an acceleration clause allowing the holder to demand payment of the entire principal amount outstanding and accrued interest in the event the maker failed “to make any payments of interest or principal . . . within seven (7) days of when such payment shall become due and payable.” At the closing, Mr. Allobaidy inserted a handwritten provision into the note stating, “This note is not assignable by the Noteholders unless Borrower agrees in writing.” Pltf Ex. D. Additionally, Mr. Allobaidy and Mr. Forde executed a document — dated two days prior to the settlement — entitled “Addendum to Second Deed of Trust Negotiable Promissory Note.”[4] This Addendum sets forth a number of “changes” to the non-yet executed promissory note. Specifically, Mr. Allobaidy agreed that Mr. Forde and his family could reside at the property for the five-year period from July 1, 2002 until July 1, 2007. Mr. Forde would pay no rent during that period and would be “responsible for paying all utilities, coordinating and managing all additional construction work on the property as described in the Escrow Agreement, and maintenance of the house.” Mr. Allobaidy for his part would not pay any interest on the $1,498,750 note during the period that
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the debtor was living in the house. In fact, Mr. Allobaidy would never make any payment on the note:
The second Deed of Trust ($1,4798,750) [sic] dated June 28th 2002 will be self-liquidating for [Mr. Forde] staying the house [sic] from July 1st, 2002 to July 1st, 2007. No balloon payments will be due at the end of the five (5) years period. There will be no demand for any payments toward the Second Deed of Trust during the life of the Second Trust.
Pltf Ex. G (emphasis added).
Mr. Forde remained in the property following settlement. Mr. Allobaidy did not make the annual interest payment due on June 28, 2003, even after the Trustee made a demand for the payment on August 5, 2003. The present action was filed by the chapter 7 trustee on September 16, 2003, against Mr. Allobaidy and National Home Buyer Realty, Inc. The complaint, as most recently amended, is pleaded in six counts:
Recovery is sought against Mr. Allobaidy on all counts and against National Home Buyer Really, Inc., on Counts I and III.
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Discussion I.
The trustee’s motion for summary judgment is addressed solely to Counts II, IV and V. These counts seek, respectively, judgment for the unpaid $450,000 deposit; judgment for the amount due on the promissory note; and reformation of the note to eliminate the anti-assignment language.
Under Rule 56(c), Federal Rules of Civil Procedure, as incorporated by Federal Rule of Bankruptcy Procedure 7056, summary judgment is appropriate “if the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law.” In ruling on a motion for summary judgment, a court should believe the evidence of the non-movant, and all justifiable inferences must be drawn in his favor SeeAnderson v. Liberty Lobby, Inc., 477 U.S. 242, 255, 106 S.Ct. 2505, 2513, 91 L.Ed.2d 202 (1986); Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. 574, 106 S.Ct. 1348, 89 L.Ed.2d 530
(1986). At the same time, the Supreme Court has instructed that summary judgment “is properly regarded not as a disfavored procedural shortcut, but rather as an integral part of the Federal Rules as a whole, which are designed `to secure the just, speedy and inexpensive determination of every action.'” Celotex Corp. v. Catrett, 477 U.S. 317, 327, 106 S.Ct. 2548, 2555, 91 L.Ed.2d 265 (1986). “Once the moving party meets its initial burden, the non-moving party may not rely upon mere allegations or denials contained in its pleadings, but must come forward with some form of evidentiary material allowed by Rule 56 demonstrating the existence of a genuine issue of material fact requiring a trial.”Anderson v.
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Liberty Lobby, Inc., 477 U.S. at 248, 106 S.Ct. at 2510. Additionally, not every dispute as to the facts will preclude the entry of summary judgment, but only those disputes over facts that might affect the outcome of the suit under the governing law.
II.
The first issue is whether the trustee is entitled to summary judgment on his claim for the $450,000 deposit that the contract of sale required Mr. Allobaidy to pay. There is no dispute that the deposit was not paid. According to Mr. Allobaidy, however, the deposit was waived by Mr. Forde, who agreed to a corresponding increase in purchase price and the amount of the take-back note.[5] Although the contract of sale specifically states that it is contingent upon approval by this court, Agreement ¶ 8, Mr. Allobaidy asserts that he was not aware of that provision in the contract and had no actual notice that Mr. Forde was in bankruptcy or that court approval was required. Allobaidy Affidavit ¶¶ 7, 8
10. Mr. Forde denies that the deposit requirement was waived. Forde Dep. at 153.10-16. As noted, the fact that the deposit was not actually paid was obscured by the manner in which it was reported on the settlement statement as offsetting credits to both the buyer and the seller.
Were Mr. Forde an ordinary seller, there is little doubt that the sales contract could be modified at or prior to settlement to reflect mutually-agreed changes to the purchase price, deposit, and take-back amounts. The problem here is that Mr. Forde was not an ordinary seller but a debtor in possession in a bankruptcy case. He had no authority to sell the real estate except after notice and a hearing. § 363(b)(1), Bankruptcy Code. Indeed, the sales contract
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specifically acknowledged this requirement. Regardless of whether Mr. Allobaidy bothered to read the contract, he signed it and is charged with constructive notice of its contents. For that reason, his assertion that he had no actual knowledge of the bankruptcy filing or the order approving the sale “pursuant to” the contract terms is insufficient to create a material issue of fact. The fact that the purchase price and the take-back note were increased in amounts roughly commensurate to the unpaid deposit does not cure the problem, particularly in view of the arguments Mr. Allobaidy has raised with respect to enforcement of the note. Those arguments, if accepted, would deprive the bankruptcy estate of any benefit from the take-back note, while the $450,000 deposit, had it been paid at settlement, would have provided actual cash for funding a repayment plan to Mr. Forde’s creditors. Mr. Allobaidy certainly cannot have it both ways: he cannot avoid paying both the deposit and the note (which, he argues, makes up for the deposit).
Nevertheless, there is a grain of truth in the argument Mr. Allobaidy puts forth. If the trustee could recover both the unpaid deposit and the full amount of the note, the trustee would receive, if not quite a double, nearly a double, recovery. The trustee is entitled to what the estate would have received under the approved contract, but no more. As noted, the promissory note actually given back at settlement was in an amount $399,750 higher than required by the contract. Accordingly, while the court will grant summary judgment to the trustee for the amount of the unpaid deposit, any recovery will be a credit (up to $399,750) against amounts due the trustee under the promissory note.
III.
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The next issue is whether the trustee is entitled to judgment on the promissory note. There is no dispute that Mr. Allobaidy failed to pay the annual interest payment due on June 28, 2003, within the following seven-day period. There is also no dispute that the trustee has made demand for payment of the entire principal amount and accrued interest. The trustee argues that the failure to make the payment, coupled with his status as successor to the debtors in possession, entitles him to judgment against Mr. Allobaidy for the $1,498,750 principal amount of the note, together with interest, legal fees, and costs. Mr. Allobaidy, for his part, asserts that he was not required to make the interest payment because the addenda signed at settlement allowed him to credit the rent owed by the debtors under the rent-back arrangement against the note payments. He also argues that the trustee cannot enforce the note because of the language that was added at settlement making the note non-assignable, and that the trustee, not being a holder in due course, is subject to all defenses Mr. Allobaidy would have against Mr. Forde. Finally, he argues that under the relevant Virginia statutes, the trustee cannot enforce the note because he does not have possession of it and cannot prove that it was lost, destroyed or stolen.
A.
Although the trustee has questioned the authenticity of the rent-back addendum, the court assumes for the purpose of the present motion that it is authentic and that Mr. Forde agreed to its terms. Nevertheless, for the same reason that Mr. Forde was not entitled to waive the deposit requirement, the court must conclude that he had no authority, as debtor in possession, to enter into the rent-back agreement without court approval, since it contradicted the very premise upon which the court had approved the sale, namely, that the proceeds would
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be available to fund a plan of reorganization to pay the creditors of Mr. and Mrs. Forde and amounted to an unauthorized expenditure of estate funds.
Mr. Allobaidy correctly notes that a debtor in possession may use estate property (which would include estate funds, so long as they did not constitute cash collateral) in the ordinary course of business without court approval and suggests that there is a disputed issue of fact as to whether the rent-back agreement was made in the ordinary course of business. The court disagrees. The sale of real estate is never in the ordinary course of business except, possibly, where the debtor is a real estate developer selling off lots or completed houses in a subdivision. Mr. Forde was not a real estate developer. He owned a single piece of property of substantial value. The transaction, moreover, was far from a straight-forward sale, and, indeed, has many of the indicia of a sham. No cash deposit was paid, the seller remained in possession, the “rent” payable by the seller exactly matched the payments under the note, the note was made non-assignable, and a “commission” was paid to the purchaser’s own company for “bringing himself to the transaction. In short, nearly every aspect of the transaction was irregular or out of the ordinary in one way or the other. For that reason, the court concludes that the rent-back agreement was not in the ordinary course of business and cannot bind the bankruptcy estate in the absence of court approval.
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B.
The trustee’s right to recover the sums due under the note is similarly not defeated by the added language making the note non-assignable. To reach this conclusion, the court need not even consider whether the non-assignment language can be stricken from the note, since the trustee does not hold the note by assignment but in the same capacity as Mr. Forde did, namely as fiduciary for the bankruptcy estate. At the time of the transaction, Mr. Forde was a debtor in possession, having the powers, duties and rights of a trustee, and it was in that capacity that he was authorized to sell the property to Mr. Allobaidy. When Mr. and Mrs. Forde’s case was converted to chapter 7, Mr. Peyton, as trustee, simply succeeded to Mr. Forde’s interests as debtor in possession. Additionally, the right of a bankruptcy trustee to enforce a debtor’s contract rights cannot, except in certain limited circumstances, be defeated by language purporting to make the agreement non-assignable. § 541(c)(1), Bankruptcy Code (“an interest of the debtor in property becomes property of the estate . . . notwithstanding any provision in an agreement, transfer instrument, or applicable nonbankruptcy law . . . that restricts or conditions transfer of such interest by the debtor”). Thus, the court concludes that the trustee’s right to enforce the note cannot be defeated by the non-assignment language.
C.
Finally, Mr. Allobaidy contends that the trustee’s enforcement of the note is precluded because he does not have physical possession of it and cannot satisfy the requirements of § 8.3A-309, Code of Virginia. That statute, which is captioned “Enforcement of lost, destroyed, or stolen instrument,” provides in relevant part as follows:
A person not in possession of an instrument is entitled to enforce the instrument if (i) the person was in possession of the
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instrument and entitled to enforce it when loss occurred, (ii) the loss of possession was not the result of a transfer by the person or a lawful seizure, and (iii) the person cannot reasonably obtain possession of the instrument because the instrument was destroyed, its whereabouts cannot be determined, or it is in the wrongful possession of an unknown person or a person that cannot be found or is not amenable to service of process.
Va. Code Ann. § 8.3A-309(a). The party seeking enforcement of a lost, destroyed, or stolen instrument must “prove the terms of the instrument” and the party’s right to enforce it. Va. Code Ann. § 8.3A-309(b). But if such proof is made, the party has the same rights as a person in physical possession, so long as the court finds that the person required to pay the instrument “is adequately protected against loss that might occur by reason of a claim by another person to enforce the instrument.” Id. Such adequate protection “may be provided by any reasonable means.”
There is no dispute that the trustee does not have physical possession of the note. The debtors’ attorney, who acted as the settlement agent for the transaction, testified that he does not know what happened to the original note. However, there is no dispute as to the terms of the note, and Mr. Allobaidy does not deny that the copy produced by the trustee is a true copy of the original. The trustee, as previously discussed, is a successor to the debtors in possession and is entitled to enforce any rights the debtors had. There is no evidence, or even suggestion, that the debtors transferred the note or that the note was the subject of a lawful seizure. The only real issue, therefore, is whether there is any likelihood of a future claim against Mr. Allobaidy by someone other than the trustee.
Mr. Allobaidy argues that the note, notwithstanding the prohibition on assignment, is nevertheless a negotiable instrument and that the non-assignment language would not actually
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prevent enforcement of the note against Mr. Allobaidy by a subsequent holder but would merely give Mr. Allobaidy an action against the debtors for beach of contract. It is true that, except for the non-assignment clause, the note otherwise qualifies as a negotiable instrument. However, as a practical matter the presence of the non-assignment clause would undoubtedly tend to spook a potential transferee for value by creating a cloud as to the enforceability of the obligation by other than the original holder. Thus, the court would have to conclude that there is little actual likelihood that the note has been transferred to someone who would be in a position to enforce it against Mr. Allobaidy. At the same time, the court is unable on the present record to find that there is no possibility the original note has (or may be) transferred. As noted, the statute requires the court, as a condition of entering judgment on a lost instrument, to find that the obligor is “adequately protected” against competing claims. Adequate protection, according to the official comment, is intended to be “a flexible concept” that depends “on the degree of certainly about the facts in the case.” UCC rev. § 3-309 Official Comment. See Fails v. Norine, 644 N.W.2d 512 (Neb. 2002) (adequate protection provided by withholding entry of judgment until statute of limitations had passed on competing claims). Even so, the court has been unable to locate a reported case holding that the low likelihood of a competing claim by itself constitutes “adequate protection” such that an indemnifying bond or other form of security is not necessary as a condition of granting judgment to the trustee on the note. Accordingly, while summary judgment will be granted determining that the trustee is entitled to judgment for the principal and unpaid interest due on the promissory note, final judgment will be withheld pending further briefing by the parties, or presentation of evidence at the scheduled trial of this action, as to what form of adequate
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protection must be provided. Additionally, as discussed above in connection with the unpaid deposit, however, any recovery on the note, up to the amount of $399,750, will be a credit against the judgment for the unpaid deposit, and vice versa.
IV.
Count V of the complaint seeks reformation of the note to remove the anti-assignment clause on the ground that it was not authorized by the order approving the sale or, alternatively, was the result of a mutual mistake of fact as to the debtors’ authority to agree to the provision.
The court need not decide whether there was a mutual mistake in fact because in any event the anti-assignment clause was not authorized by the order approving the sale. That approval of the sale was predicated on the representation that the proceeds would be used to fund a plan of reorganization. A non-negotiable promissory note (even absent the Addendum that effectively relieved Mr. Allobaidy from making any
payments and transformed the note itself into a sham) would have been of limited utility for the purpose of funding a plan since it could not have been sold at a discount for present cash and would have tied the estate to at least a five-year payout of claims. In any event, a non-negotiable promissory note is well outside the norm for real estate transactions. For that reason, court approval of a sales contract requiring the debtors to finance a portion of the purchase price by taking back “a Second Deed of Trust or Mortgage loan secured by the property” cannot reasonably be read as implying approval for the loan to take the form of a non-assignable note. Since the addition of the non-assignment language fell outside the terms of the court order approving the sale, the note will be reformed by deleting the restriction.
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V.
A separate order will be entered consistent with this opinion granting the trustee summary judgment for the unpaid deposit and the amount due on the promissory note (subject to a further determination of what form of adequate protection must be provided) and reforming the note to eliminate the non-assignment language.