Huffman v. Gollersrud (In re Westby), 2017 Bankr. LEXIS 423 (Bankr. D. Ore. 2017).
Tyler Westby (“Westby”), a real estate investor and speculator, sold a certain Oregon property (the “Property”) to Tony and Rosalinda Swanson (the “Swansons”) and took back a note (the “Swanson Note”) and trust deed (the “Swanson Trust Deed”). Subsequently, a creditor (the “Creditor”) loaned Westby $100,000, and in return, Westby executed a promissory note in favor of the Creditor (the “Westby Note #1”). Additionally, Westby assigned his interest in the Swanson Note and the Swanson Trust Deed to himself and the Creditor (“Assignment #1”) as security for the Westby Note #1.
Due to his inability to pay the Westby Note #1, Westby executed another note (the “Westby Note #2”), which superseded the Westby Note #1 and had identical terms but a later maturity date. The parties had also intended that Assignment #1 secure the Westby Note #2. Following the execution of the Westby Note #2, the Swansons defaulted on the Swanson Note and Westby obtained the Property back in his name. Westby then sold the Property to Cheryl Guenther (“Guenther”). As consideration for the sale, Westby received $10,000 cash and a $257,000 note (the “Guenther Note”). He also received a trust deed (“Guenther Trust Deed”), which gave him a lien on the Property to secure the sums due under the Guenther Note. After releasing his interest in the Swanson Trust Deed, Westby then assigned to himself and the Creditor the Guenther Note and the beneficial interest in the Guenther Trust Deed (“Assignment #2”) as replacement security. Guenther ultimately failed to timely pay Westby the amount owed under the Guenther Note. In satisfaction of her obligation, Guenther then transferred the Property back to Westby and executed a quitclaim deed (the “Quitclaim Deed”) of the Property to Westby.
Ultimately, Westby failed to pay the amount owed under the Westby Note #2 and filed a Chapter 7 petition, which resulted in the Property becoming an asset of the Chapter 7 estate. Thereafter, the Creditor filed a proof of claim, asserting that he was owed $103,749.99 by Westby and that such debt was secured by the Property. While the Creditor claimed that his right to repayment of the loan was secured by the Property itself, the court held that the actual security was the Guenther Note, which was in turn secured by the Guenther Trust Deed. Since the Guenther Note is a “promissory note”, which is an “instrument” and in turn a form of personal property, the court held that UCC Article 9 applied. The court explained that while Article 9 does not apply to liens on real property, its application to a security interest in a secured obligation is not affected by the fact that the obligation is itself secured by a transaction or interest to which Article 9 does not apply.
The court also held that Assignment #2 was not a “sale” of the Guenther Note and beneficial interest in the Guenther Trust Deed, but rather only a transfer of a security interest in rights thereunder. Since Westby and the Creditor both testified that Assignment #2 did not pass title to either the Guenther Note or Guenther Trust Deed, and since the parties’ intent was to secure Westby Note #2, those intentions were found by the court to control. The court also rejected the Chapter 7 Trustee’s (the “Trustee”) “statute of frauds” defense, explaining that Assignment #2 constituted an enforceable security agreement and therefore attached to the collateral.
The Creditor conceded that the Quitclaim Deed “satisfied” the Guenther Note. However, he argued that despite such satisfaction, there remained an “in rem” claim against the Property. Under the precept that non-merger will be presumed if appropriate to protect the intervening rights of a third party with a superior interest, as in this case, the Guenther Note and Guenther Trust Deed did not merge into the fee, and Creditor’s security interest therein survived as it pertained to ultimate recovery from the Property.
The Creditor’s interest was thus not “avoided or satisfied” by delivery of the Quitclaim Deed. However, since, the Creditor did not file a financing statement and did not take possession of the Guenther Note, the court determined that the Creditor’s security interest in the Guenther Note and the Guenther Trust Deed was unperfected. Furthermore, it was avoidable under the Bankruptcy Code and Article 9, because the Trustee’s “judicial lien” rights were superior to the rights of the Creditor’s unperfected interest. Finally, due to his failure to timely make the argument, the court denied Creditor’s request for an equitable lien in the Property.