Lynn Schoenmann, Chapter 7 Trustee v. Carmel Financing, LLC (In re Mayacamas Holdings LLC), 608 B.R. 522 (Bankr. N.D. Cal. 2019)
Granting in part and denying in part a motion to dismiss an adversary proceeding brought by a chapter 7 trustee, the United States Bankruptcy Court for the Northern District of California held that a lender’s claims for default interest, late charges and an exit fee under a promissory note were enforceable under Colorado law, the chosen governing law of the note, where the total interest, fees and costs did not exceed Colorado’s 45% per annum cap. However, the lender did not have a security interest in the insurance proceeds received by the chapter 7 trustee after a fire severely damaged the real property that secured the debtor’s obligations under the note because the lender failed to notify the insurer in writing that it should be added as a loss payee on the insurance policy.
In April 2014, Mayacamas Holdings LLC (the “Debtor”) executed a promissory note, governed by Colorado law, in the principal amount of $2,000,000 (the “Note”), governed by Colorado law, and bearing interest at a non-default rate of 6%, to the order of Carmel Financing LLC (“Carmel”). The Note was secured by a first priority deed of trust (the “DOT”) encumbering property located in eastern Sonoma County, California (the “Ranch Parcel”). The Debtor filed for chapter 11 relief on April 7, 2017, listing the Ranch Property as its principal asset. On October 4, 2017, the plaintiff was appointed as the chapter 11 trustee. The case was converted to chapter 7 on December 5, 2017 and the plaintiff was appointed chapter 7 trustee (in such capacity, the “Trustee”). On October 8, 2017, four days after the appointment of the Trustee, a fire caused significant damage to the Ranch Parcel. The Trustee has received over $2 million from the Debtor’s insurance carrier for claims arising out of the fire (the “Insurance Proceeds”). Carmel was not named as loss payee on the insurance policy.
Carmel asserted that under the Note and the DOT, it was entitled to the remaining Insurance Proceeds. The Trustee commenced an adversary proceeding seeking a determination that (i) Carmel had no security interest in the insurance policy and the Insurance Proceeds and (ii) certain provisions of the Note were unenforceable, including those imposing an 18% default interest rate, monthly late charges of 4% and a $75,000 “exit fee” (the “Disputed Note Provisions”). Carmel filed a motion to dismiss, asserting that the Trustee had failed to state a claim under Rule 12(b)(6) of the Federal Rules of Civil Procedure.
The bankruptcy court granted Carmel’s motion to dismiss as to the Trustee’s claims that the Disputed Note Provisions were unenforceable, but denied Carmel’s motion to dismiss as to the Trustee’s claims relating to the Insurance Proceeds.
As to the Disputed Note Provisions, the bankruptcy court first determined that Colorado law applied to the Note. The court held that bankruptcy courts apply federal common law choice-of-law rules to determine the enforceability of a contractual choice of law provision, even when resolution of the underlying dispute turns on state law. Applying such choice of law rules, the court held that the choice of Colorado law to govern the Note was enforceable.
Under Colorado law, miscellaneous charges such as default charges and exist fees are allowed if the total amount of the interest and fees and charges to be paid is less than Colorado’s usury rate of 45%. Assuming the factual accuracy of Carmel’s representation about the terms of the non-default interest rate of 6% and the Disputed Note Provisions, the total fees, interest and charges were below Colorado’s usury law cap. Thus, Carmel prevailed on its motion to dismiss these elements of the plaintiff’s claim.
As to the Insurance Proceeds, Carmel’s claim was not secured. Carmel argued that its claim was secured by the Insurance Proceeds because one paragraph of the DOT granted it a security interest in both real and personal property pursuant to the Uniform Commercial Code (the “UCC”). Carmel contended that the security interest extended to all insurance policies and proceeds (whether or not Carmel was named loss payee). The court rejected those arguments. First, the UCC defines a “security interest” as “an interest in personal property or fixtures that secures payment or performance of an obligation.” Carmel had not shown that it had perfected any security interest in personal property or fixtures by filing a financing statement. Second, the UCC, in any case, does not apply to the creation or transfer of an interest in or lien on real property. Third, Carmel did not notify the insurer in writing that it should be added as a loss payee to the policy even though California’s version of the UCC allows a creditor to acquire a security interest in an insurance policy that the debtor has obtained for its own benefit only if written notification is provided to the insurer.
Article courtesy of David P. Simonds (Hogan Lovells US LLP) and Edward McNeilly (Hogan Lovells US LLP).
Link to the full decision: In re Mayacamas Holdings LLC