Paul Ronald vs. Bank of America – Court Closes Door on Another Exotic Theory of Mortgage Liability

The trend in the courts has been to reduce the legal theories available to persons who suffered losses during the mortgage meltdown.  Traditional theories based on breach of contract, fraud, and promissory estoppel, remain viable causes of action.

Yet the more exotic theories seeking to impose liability have been narrowed and often eliminated.  Such is the case in Bank of America v. Superior Court (Paul Ronald) (August 25, 2011) 2011 DJDAR 12942.  In the Paul Ronald action, the plaintiff sought to hold Bank of America, as successor-in-interest to Countrywide Mortgage, liable for the general decline in property values triggered by Countrywide’s bad lending practices.  The court would have none of it.

According to the complaint, “Countrywide’s founder and CEO, Angelo Mozilo determined that Countrywide could not sustain its business ‘unless it used its size and large market share in California to systematically create false and inflated property appraisals throughout California.  Countrywide then used these false property valuations to induce Plaintiffs and other borrowers into ever-larger loans on increasingly risky terms.’

The complaint continued.  “Mozilo knew ‘these loans were unsustainable for Countrywide and the borrowers and to a certainty would result in a crash that would destroy the equity invested by Plaintiffs and other Countrywide borrowers.  Mozilo and others at Countrywide ‘hatched a plan to ‘pool’ the foregoing mortgages and sell the pools for inflated value.  Rapidly, these two intertwined schemes grew into a brazen plan to disregard underwriting standards and fraudulently inflate property values.’”

Unfortunately, those allegations describe the general problems that swept through the mortgage industry.  “This writ petition relates solely to plaintiffs’ cause of action for fraudulent concealment.”

The trial judge noted the scope of the issue presented to it.  On January 11, 2011, the matter came on for hearing.  At the outset, the trial court indicated, “the issues presented by the many plaintiffs in this case as against their current mortgage lender and/or loan servicer are part of a larger socioeconomic problem that confronts our society in California and all of the other states in this union, an issue of great concern to the U.S. Congress, state Legislature, and the bank regulators, given that in our banking system the banks are insured by the full faith and credit of the United States government for all intents and purposes, so the continued solvency of the banking industry as a whole is a matter of intense interest to the U.S. Congress as well as the central bank.”

That’s the real problem.  This is not a matter that should be dumped into a trail court.  Our entire justice system has shrugged its shoulders and refused to impose liability on anyone for the manipulations that developed into the mortgage crisis.  Shame on us.

Destin, Fla.

It seems there are some 20 cases rolling around in Los Angeles and Orange Counties based on the same charging allegations.  As explained by the court of appeal, “We conclude the plaintiffs/borrowers cannot state a cause of action against Countrywide for fraudulent concealment of an alleged scheme to bilk investors by selling them pooled mortgages at inflated values, the demise of which scheme led to devastated home values across California.”

Explained the court, “we conclude that while Countrywide had a duty to refrain from committing fraud, it had no independent duty to disclose to its borrowers its alleged intent to defraud its investors by selling them mortgage pools at inflated values.”

More specifically, “Due to the generalized decline in home values which affects all homeowners (borrowers of Countrywide, borrowers who dealt with other lenders, and homeowners who owned their homes free and clear), there is no nexus between Countrywide’s alleged fraudulent concealment of its scheme to bilk investors and the diminution in value of the instant borrowers’ properties.”

Further, the court noted that the complaint embraced a general decline in property values across the state.  “Irrespective of whether a homeowner obtained a loan from Countrywide, or obtained a loan through another lender, or whether a homeowner owned his or her home free and clear, all suffered a loss of home equity due to the generalized decline in home values.  That being the case, there is no nexus between the alleged fraudulent concealment by Countrywide and the economic harm which these plaintiffs/borrowers have suffered.”

The final holding – “We merely conclude plaintiffs failed to state a cause of action against Countrywide for fraudulent concealment of its alleged scheme to bilk investors by selling collateralized mortgage pools at an inflated value, the demise of which led to a generalized decline in California residential property values.”

This writer is as upset about the mortgage debacle, and the refusal of governmental authorities to take action, as anyone else.  But the right place for action is the Department of Justice, or the Securities and Exchange Commission, not a trial court.

Most commendable is the speed at which the court issued this decision.  The lawsuit was filed in March 2009.  The trial court issued its order dismissing the claim for fraudulent concealment on January 11, 2011.  This writ proceeding was resolved by decision entered on August 25, 2011.  Justice is not always delayed.

Bank of America v. Superior Court (Paul Ronald) (August 25, 2011) 2011 DJDAR 12942

Tracing the Origin of the English Trust to the Year 1350

Here is the clearest explanation I have found to date regarding the rise of trusts in English law.  Bear in mind that England was still a feudal system in the year 1350.  Also bear in mind that a court of law could not enforce a trust – such jurisdiction lay within the court of equity, which was still developing.

Profs. Maitland and Montague take the stage with the following concise statement of legal history.

“From the field of the common law the chancellor was slowly compelled to retreat … It seems possible that this nascent civil jurisdiction of the chancellor would have come to naught but for a curious episode in the history of our land law.

“In the second half of the fourteenth century many causes were conspiring to induce the landholders of England to convey their lands to friends, who, while becoming the legal owners of those lands, would, nevertheless, be bound by an honorable understanding as to the uses to which their ownership should be put. There were feudal burdens that could thus be evaded, ancient restrictions which could thus be loosened.”

There it is.  The wealthy landowners sought to avoid the feudal burdens owed to their lords.  The Chancellor, acting on behalf of the king, recognized these arrangements.

“The chancellor began to hold himself out as willing to enforce these honorable understandings, these ‘uses, trusts, or confidences,’ as they were called, to send to prison the trustee who would not keep faith.”

Normandy coast

Add Maitland and Montague, “It is an exceedingly curious episode.  The whole nation seems to enter into one large conspiracy to evade its own laws, to evade laws which it has not the courage to reform.  The Chancellor, the Judges, and the Parliament seem all to be in the conspiracy.”

“And yet there is really no conspiracy: men are but living from hand to mouth, arguing from one case to the next case, and they do not see what is going to happen. Too late the king, the one person who had steadily been losing by the process, saw what had happened. Henry VIII put into the mouth of a reluctant Parliament a statute [the Statute of Uses, enacted in 1535[ which did its best – a clumsy best it was – to undo the work.”

“But past history was too strong even for that high and mighty prince.  The statute was a miserable failure.  A little trickery with words would circumvent it.  The chancellor, with the active connivance of the judges, was enabled to do what he had been doing in the past, to enforce the obligations known as trusts.”

How fascinating is this history to our current law of trusts.  The “traditional” trust arose during a 50-year period, as the wealthy sought to avoid the obligations of feudal society.  They employ an exceedingly flexible device, which accomplishes its purpose, but only because many learned people look away during this period.

So also it is with our current law of “living trusts.”  These estate planning trusts came to prominence during the last 50 years.  They suffer from an intellectually deficient legal platform; it makes little sense to contend that one person can simultaneously serve as trustor, trustee, and beneficiary.

Such trusts exist solely to transfer property at death, and solely to avoid the jurisdiction of the probate court.  And yet, with a collective nod, we in the legal profession have said, “Yes, this quasi-will should be valid, and we should honor it, notwithstanding its failure to comply with centuries of law relating to wills.”

The old is new again.

Maitland and Montague, A Sketch of English Legal History (G. P. Putnam’s Sons 1915)

Bellows v. Bellows – Further Proof That Estate Planning Trusts Are Not Always a Good Idea

The fees in a probate case trigger a reaction that sometimes borders on panic.  Part of the reasoning behind the use of an estate planning trust (sometimes referred to as an inter vivos trust) is that the trust will save on attorney’s fees.

However, as I tell clients, it only works if the beneficiaries get along.  If not, the attorney’s fees in a trust dispute will greatly exceed the regular probate fees.  A case in point is the recent decision in Bellows v. Bellows (June 13, 2011) 2011 DJDAR 8530.  The estate was in the range of $65,000.  Under California law, the probate fees would have been around $2,600 (four percent of the estate).  Yet the trust litigation has triggered attorneys fees in excess of $20,000, which surely was not the intended result.

The case also stands for the proposition that a trustee cannot demand a release as a condition to making a distribution as required under the trust agreement.  (Again, such a release comes part and parcel with a probate, as the court approves all distributions by the executor.)

Here are the facts.  “In 2003, Beverly Bellows established the Beverly Bellows trust, naming her and Frederick as cotrustees. As restated in 2005, the trust provided that on her death, the trust assets would be divided equally between Frederick and Donald. Following Beverly’s death in 2008, Donald requested distribution of his share of the trust.”

Watch as the wheels start to slip – the two brothers did not get along. “In September 2009, when the distribution had not been made, Donald filed a petition in the probate court pursuant to section 17200 seeking an accounting and distribution of the trust assets. On November 13, the court ordered Frederick to provide an accounting of the trust assets and to distribute one-half of the assets to Donald within 10 days. The order awarded Donald attorney fees in the amount of $9,800.”

Ouch.  That fee award – long before the fees on appeal – was four times the total probate fees, had the estate been subject to probate.  But it only gets worse, as Donald also claimed that “Frederick had improperly deducted from the remaining corpus of the trust approximately $13,000 of his own attorney fees prior to dividing the trust assets in half.”

London

Never forget Molly Ivins’ first rule of holes – When you find yourself in one, stop digging.  These two brothers amassed more than $25,000 in collective attorney’s fees, before they ever took the matter up on appeal.

“On February 23, 2010, Donald filed a motion to compel compliance with the court’s November 2009 order.  Frederick opposed the motion and filed a cross-motion for abatement and for attorney fees and sanctions.”

Here’s the holding on appeal. “There is no dispute that under the terms of the trust as interpreted by the court in its November 2009 order, Frederick was required to distribute to Donald one-half of the trust assets. Under the plain language of [Probate Code] section 16004.5, subdivision (a), Frederick could not condition the payment on a release of liability . . .

“There was no dispute that Donald was entitled to receive from the trust at least $30,376.80, based on Frederick’s own accounting. Frederick, as trustee, was required to make this distribution to Donald without any strings attached. He was not entitled to condition the payment on the release of other claims or demands of the trust beneficiary.

Added the court, “[the statute] permits a trustee to seek a voluntary release or discharge.  A release obtained as a condition of accepting payment to which the beneficiary is entitled is in no sense voluntary . . . Frederick could not condition such an agreement on Donald releasing his right to an accounting or of other claims he might have against the trustee. Again, such an interpretation would render subdivision (a) nugatory.”

Finally, the court added that, “subdivision (b)(4) confirms the right of the trustee to withhold any distribution that is reasonably in dispute. In such a case, as subdivision (b)(5) confirms, the trustee may seek instructions from the court, the well-established method of resolving controversies that may arise between trustee and beneficiary . . . What the trustee may not do is extract from the beneficiary an agreement to accept a compromise concerning a disputed issue as a condition of receiving a distribution to which the beneficiary is unquestionably entitled. A trustee may not under any circumstances condition a required distribution on an involuntary release of liability.”

As it looks to this writer, the two brothers spent all of the money on attorney’s fees. That’s a bad result under any standard.

Bellows v. Bellows (June 13, 2011) 2011 DJDAR 8530

William Penn Partnership – There are No Winners

The Delaware Supreme Court recently decided William Penn Partnership v. Saliba, a case in which there are no winners.  In the case, one of the members breached his fiduciary obligations, but his conduct caused no damage.  Nonetheless, the court awarded attorneys’ fees as an “equitable remedy.”  In this author’s view, the award distorts the law of equitable remedies, creates uncertainty in the law, and rewards fruitless litigation.

The facts were as follows.  The parties were members of a limited liability company called Del Bay Associates, LLC.  Del Bay built the Beacon Motel in Lewes, Delaware in 1987, with 66 guest units.  Later, some of the members (the Lingos) wanted to “end their business relationship” with the other members.

The Lingos concocted a story about their need to dissolve the limited liability company and sell the motel to fulfill obligations under a section 1031 tax-deferred exchange.  Explained the court, “On June 10, 2003, the Lingos convinced Hoyt to sign the contract immediately so they could present it to the JGT board. The Lingos told Hoyt that if he did not sign the contract, JGT might back off.”

The court found that the representations were not true.  Instead, the Lingos controlled both sides of the transaction – seller and buyer.  For example, “The Lingos manipulated the sales process through misrepresentations and repeated material omissions such as (1) imposing an artificial deadline justified by ‘tax purposes;’ (2) failing to inform Saliba and Ksebe that they were matching their offer by assuming the existing mortgage; [and] (3) failing to inform Saliba and Ksebe that they had already committed to selling the property to JGT, an entity the Lingos controlled.”

So, we have a transaction in which one member abused his fiduciary duties to the other members.  More bluntly, “The Lingos here acted in their own self interest by orchestrating the sale of Del Bay’s sole asset, the Beacon Motel, on terms that were favorable to them.  By standing on both sides of the transaction – as the seller, through their interest in and status as managers of Del Bay, and the buyer, through their interest in JGT– they bear the burden of demonstrating the entire fairness of the transaction.”

Such proof of “entire fairness” was a burden the Lingos could not meet.  “The concept of entire fairness consists of two blended elements: fair dealing and fair price.  Fair dealing involves analyzing how the transaction was structured, the timing, disclosures, and approvals.  Fair price relates to the economic and financial considerations of the transaction.  We examine the transaction as a whole and both aspects of the test must be satisfied; a party does not meet the entire fairness standard simply by showing that the price fell within a reasonable range that would be considered fair.”

In fact, the price did fall with “a reasonable range.”  The buyer paid $6,625,000 for the Beacon Motel, while the trial court found that the “retained appraisal valued the property at $5,480,000.”  Thus, the price paid by the buyer was greater than the fair market value for the motel, meaning that the non-controlling members suffered no compensable injury.

The court found that this result was not satisfactory.  “Merely showing that the sale price was in the range of fairness, however, does not necessarily satisfy the entire fairness burden when fiduciaries stand on both sides of a transaction and manipulate the sales process.”

OK, but we have no basis on which to award damages.  “Saliba and Ksebe were left without a typical damage award because the Court’s appraisal of the property came in at a value lower than the sale price.”

What to do?  This court decided to award attorneys’ fees to the non-controlling members.  “The Chancellor concluded it would be unfair and inequitable for Saliba and Ksebe to shoulder the costs of litigation arising out of improper prelitigation conduct attributable to the Lingos that amounted to a violation of their fiduciary duties.”

Although there was no statutory or contractual basis for an award of attorneys’ fees, the Delaware Supreme Court held that “The Chancellor’s decision to award attorneys’ fees and costs was well within his discretion and is supported by Delaware law in order to discourage outright acts of disloyalty by fiduciaries.  Absent this award, Saliba and Ksebe would have been penalized for bringing a successful claim against the Lingos for breach of their fiduciary duty of loyalty.”

Which perhaps would have been the better result.  This litigation was surely driven by the attorneys, not by the injured parties, with substantial attorneys’ fees.  The court’s award of attorneys’ fees on equitable grounds will only foster litigation in the future, which is hardly an optimal result.

William Penn Partnership v. Saliba (Del. Supreme Court Feb. 9, 2011) 2011 Del. LEXIS 91

Trust Does Not Create Contractual Rights in Favor of Beneficiary

The courts are increasingly faced with the cases involving the interpretation and enforcement of estate planning trusts.  In Diaz v. Bukey (May 10, 2011) 2011 DJDAR 6650, the court concisely framed the dispute:

“The beneficiary of a trust petitions to remove her sister as trustee of their parents’ trust.  The trustee responds by seeking to compel arbitration of their dispute as provided by the trust documents.

“Though the sisters are beneficiaries of the trust, neither was party to any agreement that such disputes would be resolved by arbitration.

“Here we hold that the beneficiary of a trust who did not agree to arbitrate disputes arising under the trust may not be compelled to do so.”

It seems that the trust was a standardized form.  It included the following provision:

“Any dispute arising in connection with this Trust, including disputes between Trustee and any beneficiary or among Co–Trustees, shall be settled by the negotiation, mediation and arbitration provisions of that certain LawForms Integrity Agreement (Uniform Agreement Establishing Procedures for Settling Disputes ) entered into by the parties prior to, concurrently with or subsequent to the execution of this Trust.   In the event that the parties have not entered into a LawForms Integrity Agreement (Uniform Agreement Establishing Procedures for Settling Disputes ), then disputes in connection with this Trust shall be settled by arbitration in accordance with the rules of the American Arbitration Association.”

(Of course, someone needs to produce the “integrity agreement.”)

BogotaOn appeal, “Bukey contends that Diaz is a third party beneficiary of the Trust and she is equitably estopped from denying her obligation to arbitrate.”  Further, “Bukey relies on a trio of cases in which appellate courts have characterized a trust as a contract between a trustor and trustee.”

Explained the court of appeal, “We do not find these cases persuasive for several reasons.  First, they are factually inapposite.  The controversy here involves a dispute between the trustee and a beneficiary over the internal affairs of the Trust.”

Also,  “In Saks v. Damon Raike & Co. (1992) 7 Cal.App.4th 419, the court rejected the argument that a trust was a third party beneficiary contract. The court said: ‘The rules governing the respective rights of action of trustees and beneficiaries of express trusts are not the same as those generally applicable to promisees and third party beneficiaries’ . . .

“The general right of a third party beneficiary to sue on a contract made expressly for his or her benefit has no application where a trust has been created in favor of that party, and the contract in question is between the trustee and an agent of the trustee.”

The court concluded that the arbitration provision was not enforceable because the trust was a relationship, not a contract (which is the correct result).  “As a matter of law, the trusts at issue here were not contracts.”

“A beneficiary of a trust receives a beneficial interest in trust property while the beneficiary of a contract gains a personal claim against the promissor. Moreover, a fiduciary relationship exists between a trustee and a trust beneficiary while no such relationship generally exists between parties to a contract.”

“The legal distinctions between a trust and a contract are at the heart of why the beneficiaries cannot be required to arbitrate their claims against the defendants. Arbitration rests on an exchange of promises.  Parties to a contract may decide to exchange promises to substitute an arbitral for a judicial forum. Their agreement to do so may end up binding (or benefitting) nonsignatories.

“In contrast, a trust does not rest on an exchange of promises.  A trust merely requires a trustor to transfer a beneficial interest in property to a trustee who, under the trust instrument, relevant statutes and common law, holds that interest for the beneficiary.”

So, we have the correct result for the correct reasons.

Diaz v. Bukey (May 10, 2011) 2011 DJDAR 6650, 2011 WL 1759798

McMackin v. Ehrheart – The Canary Swallows the Cat

In McMackin v. Ehrheart (April 8, 2011) 2011 DJDAR 5122, the court of appeal held that a Marvin-based palimony claim under California law could be asserted against an estate more than three years after the decedent’s death.  We remark on the extent to which the law is willing to allow a person to make a claim to real property when that claim is not evidenced by a writing, and, even when title was held 100% in the decedent’s name, as in McMackin.

Before reviewing the decision, let’s cut to the chase.  Hugh McCrackin lived with Patricia McGinness for 17 years, from 1987 until 2004.  He helped her in her declining health.  Patricia told people that she wanted Hugh to live in her house for the rest of her life.  The couple never married.

Let’s accept all of the foregoing as true.  On the other hand, Patricia did not make a will manifesting her intentions.  Nor did she undertake the simple expediency of executing a deed with a life estate in favor of Hugh.  Now, after Patricia’s death, Hugh petitions the court to enforce Patricia’s oral intentions.

These facts do not strike this writer as commanding judicial intervention.  The ability to execute a will or a deed with a life estate is known to all.  The notion that courts should be quick to enforce oral agreements in derogation of the statute of frauds is discomforting, and bears greater scrutiny.

To return to the case.  “Plaintiff Hugh J. McMackin lived with Patricia Lyn McGinness in her home from approximately 1987 until [Patricia] died intestate on October 1, 2004. [Hugh] was never on title to the home but continued to occupy it after [Patricia]’s death.

“Defendants Kimberly Frost and Kellian Ehrheart are [Patricia]’s daughters and are the heirs of [Patricia]’s estate. On February 25, 2008, more than three years after [Patricia]’s death, [her daughter] opened a probate . . .

“On November 23, 2009, Ehrheart served [Hugh] with a 60-day notice to quit. On January 13, 2010, [Hugh] filed a complaint, the gravamen of which was that [Patricia] promised him a life estate in the home upon her death in consideration for 17 years of his ‘love, affection, care and companionship.’”

That’s the stage for this action.  “On January 21, 2010, [Hugh] filed an ex parte application for a temporary restraining order and for an order to show cause why an injunction should not issue to enjoin [the daughters] from evicting him from the home.”

The injunction was entered in favor of Hugh, and was affirmed on appeal.  According to Hugh, Patricia “agreed that he could live in the home for the rest of his life after her death and that she made this promise in consideration of the love, affection, care and companionship we shared over those 17 years.”  The housekeeper “declared that on approximately twenty (20) different occasions [Patricia] told her that she wanted [Hugh] to live in the home for the rest of his life.”

Cala resort in Panama

This is a classic case of an promise that lies outside the statute of frauds, and would normally be unenforceable.  Even more, California Probate Code section 366.3 provides that an action to enforce a claim arising from an agreement with a decedent for distribution from an estate must be filed within one year after the decedent’s death.  This statute applies to “a promise to transfer property upon death [that] could be performed only after death, by the decedent’s personal representative, by conveying property that otherwise belonged to the estate.”

The court of appeal noted that “The limitations period provided in this section for commencement of an action shall not be tolled or extended for any reason except as provided in Sections 12, 12a, and 12b of this code, and [certain provisions] of the Probate Code [not applicable to this action].”

Hugh would appear to be out of luck.  However, the court of appeal rescued Hugh by allowing him to apply the doctrine of “equitable estoppel.”  “The court held that there is a distinction between the doctrine of equitable estoppel, on the one hand, and the tolling or extension of the statute of limitations, on the other hand.”

In other words, “there is a distinction between tolling and equitable estoppel. Tolling concerns the suspension of the statute of limitations. The doctrine of equitable estoppel applies only after the limitations period has run to preclude a party from asserting the statute of limitations as a defense to an untimely action where the party’s conduct has induced another into forbearing to file suit.”

The court of appeal ruled that “depending on the circumstances of each case, the doctrine of equitable estoppel may preclude a party from asserting section 366.3 as a defense to an untimely action where the party’s wrongdoing has induced another to forbear filing suit.”

Unfortunately, the opinion does not address whether there was any factual basis for Hugh’s assertion of equitable estoppel against the daughters.  We do not know that the daughters did after the death of their mother that stopped the statute of limitations from running.

Stated the court, “We are not asked, nor do we decide, whether this implied ruling was supported by substantial evidence because [the daughters] made it clear at oral argument on appeal that they challenge the application of equitable estoppel as a matter of law, not whether the evidence supported its application for the purposes of the issuance of a preliminary injunction.“

That’s the easy way out.  The court does not tell us what the daughters said or did that gave Hugh the right claim they were estopped (i.e., prevented by their conduct) from asserting the one-year statute of limitations as a defense.  For the time being, Hugh has deftly stepped over both the statute of frauds and the statute of limitations.

McMackin v. Ehrheart (April 8, 2011) 2011 DJDAR 5122

Historic Roots of the English Legal System

Scholars trace the creation of the English common law to the second half of the 12th century, at the time of Henry II.  Explains Belgian scholar Raoul Van Caenegem in The Birth of the English Common Law (Cambridge Univ. Press 1973), “the Common Law of England – so different from the jus commune or common learned law of the European universities – is the oldest national law in Europe.  It is the oldest body of law that was common to a whole kingdom and administered by central court with the nation-wide competence in first instance.  In the rest of Europe, law was either European or local, not national.”

Prof. Van Caenegem continues.  “The breakthrough of a centralized and modernized legal system took place exceptionally early in England (and Normandy), before Roman law was in a position to exert any profound influence . . .

“If the modernization of law came exceptionally early in England, it was also remarkably systematic.  The activity of the justices at Westminster and in eyre and the various actions with which they dealt formed a coherent whole and were grasped and described as such.  This new law and its judicial apparatus were national and royal.  Not local magnates, but the king and his central justices were the bearers of the whole system and application was nation-wide.  This was very unlike the Continent, were local and regional custom reigned supreme . . .

“The breach came during the momentous modernization of European society in general, and the law in particular, that took place in the 12th and 13th centuries, a watershed of the greatest importance . . .

The professor traces these developments to William the Conqueror’s invasion of England in 1066.  After losing control over Normandy at the beginning of the 12th century, the English rulers (of Norman descent) began to centralize the legal system in England.

“English law prefers precedent as a basis for judgments, and moves empirically from case to case, from one reality to another.  Continental law tends to move more theoretically by deductive reasoning, basing judgments on abstract principles; it is more conceptual, more scholastic and works with more definitions and distinctions.”

Holyrood Palace in Edinburgh

Twenty years of chaos during the first half of the 12th century gave Henry II a footing on which to establish binding legal precedent in a society that had been sorely lacking therein.  “It was a coincidence again that Henry II ruled after Stephen and Matilda had created such chaos that the country was ripe for the stern, nation-wide clean-up of the Assizes and the liquidation of judicial contradictions and uncertainties through centralization in the royal courts.”

“This Anglo-Norman law only became English after the loss of Normandy, nurtured (while it withered away in Normandy) by a state that had turned from the Anglo-Norman into an English state, with English instead of French kings, justices of English descent on the benches, and with an aristocracy that had in the end become so English that the conquest was viewed with distaste by men who were French in speech and habits, and who owned their whole family fortune to William I and his successors.  It was in the 13th century the diffusion of Norman and English into one nation took place in that, and Common Law, which bound together for freemen of every descent, became truly English.”

Who created the English Common Law?  Not surprisingly, it was initially established to protect the upper class.  “The Common Law took no interest in the unfree peasants who were harshly excluded and amerced if they tried to use its benefits.  The man who created it were members of a small aristocracy and it was accessible to them and the free minority of the natives [ ] and they created it in order to preserve harmony among the free, landowning top class.”

(The professor notes that French was the language of the English legal system from the late 13th century until 1731, when English was established as the official language of the law in England by an act of Parliament of George II.)

The Historical Roots of Eviction Law

The law of eviction, or unlawful detainer, has roots that extend back hundreds of years.  Here in California, where everyone has the opportunity to make a fresh start, we sometimes forget the past and how it affects our laws.

Yet in eviction, which is properly referred to as “unlawful detainer,” the historical underpinnings are quite plain.  Unlawful detainer is concerned with the possession of real property and is described as a “summary remedy.”  In contrast, an action to determine title to real estate is known as a “quiet title” proceeding, and involves the full trial process.

This distinction between an action for possession and an action for title existed in feudal England.  Legal historian R.C. Van Caenegem, in a series of lectures compiled in The Birth of the English Common Law (Cambridge Univ. Press 1973), explained how these two legal actions were established under King Henry II (1133–89), who reigned from 1154.

It is astonishing to note how closely the forms of action that existed almost 900 years ago parallel those that we use today in California.  Prof. Van Caenegem begins by noting that, “The assize and the action based on it offered protection of tenure, i.e. the peaceful possession and exploitation of free land, at a time when land was the essential form of wealth, the basis of almost everyone’s livelihood and the great source of power and prestige.”

Let’s pause.  It was important for the King to maintain peace in his kingdom.  Acts of self-help to regain possession of real property were likely to lead to violent responses.  The use of the courts, and a ban on self-help, helped preserve peace.  We continue to follow this rule to this day.

Prof. Van Caenegem continues.  “The classic action of novel disseisin, a fruit of Henry II’s reign, was the culmination of a very long royal preoccupation with seisin, witnessed by numerous orders to restore possession, with or without certain forms of judicial enquiry.”

“It was not the preoccupation with seisin that was new, but its systematic judicial form in the hands of the royal justices and the fact that it was now at the disposal of all free men.  Seisin and the protection of seisin – as opposed to right and the lawsuits connected with it – were very old notions, with roots in Germanic gewere, feudal vestitura and ecclesiastical ideas . . . of the early Middle Ages.”

Clear Lake

Listen carefully to the following words, for they remain valid today.  “People had known for centuries that seisin and right – possessio and proprietas being the corresponding Roman notions – were two different things and that measures concerning seisin could be followed by litigation on right, but could just as well be taken for their own sake and without further litigation.  So it had been in the past and so it remained after novel disseisin had taken shape.”

Here he is explaining that distinct legal procedures existed for actions based on possession, as opposed to actions based on title, during the time of Henry II.  Were we to meet a lawyer from that time, we would speak the same language when it came to a lawsuit for eviction, in which the sole legal issue is the right to possession of the property.  That is a remarkable notion.

Prof. Van Caenegem continues. “Of course, people who lost their case on seisin could try an action on right, but this was an exceedingly rare phenomenon and the reason is not far to seek.  Seisin was not merely a question of material but of lawful detention: ‘seisin must include some modicum of right, and it is hardly possible to say where seisin ends and right begins.’”

“The question put to the jury was not only whether A had been disseised without judgment, but whether he had been disseised unjustly and without judgment: the jury had to go into the legal situation and if a jury of twelve lawful freemen had found that a man had not been disseised unjustly the chances that a subsequent jury of twelve knights in a process on right would find that he had, after all, the greater right were very small.  It is not because a negative judgment on seisin leaves the loser the theoretical liberty to start a plea on right that his real chances are good.”

So remains the law today.  Which is remarkable to this author; an everyday lawsuit in California is the same lawsuit that would have been filed in feudal England in 1150.

R.C. Van Caenegem, The Birth of the English Common Law (Cambridge Univ. Press 1973)

Trustee Can be Held Liable for Debts As Alter Ego of Limited Liability Company

Another in a recent wave of California cases has hit the nail on the head, holding that the trustee can be held liable for debts, but not the trust itself.  The reason is elementary – a trust is a relationship, not an entity.  This rule has roots that run back hundreds of years.  It explains a number of the seeming paradoxes in trust law.

The second published appellate decision in Greenspan v. LADT, LLC (Dec. 30, 2010) 191 Cal.App.4th 486 concerned efforts to enforce an $8.45 million judgment.  It seems that $47 million in assets that should have been available to satisfy a judgment had dwindled to $13,000.  The judgment creditor looked to other assets to satisfy the judgment.

This is one of the inflection points at which our legal system buckles.  It can be inordinately difficult to enforce a judgment.  Here, the court held that it was proper to amend the judgment to add the trustee as a judgment debtor.  With a twist, because the trustee was the manager of the limited liability companies against which the judgment was entered, such that the liability was based on an alter ego theory.

Let’s consider the court’s analysis.  The court held that Barry Shy could be added as judgment debtor based on “his control of the Shy Trust and its companies to such an extent that his failure to satisfy the judgment would promote injustice.”

The court employed a well-known procedure, stating that “Amendment of a judgment to add an alter ego is an equitable procedure based on the theory that the court is not amending the judgment to add a new defendant but is merely inserting the correct name of the real defendant.”

Now, I have trouble understanding why equity should intervene, because the claim seeks substantive legal relief.  The cavalier use of this procedure does not promote justice, especially when the defendants were known to the plaintiff during the trial on the merits.  Still, court held that “such a procedure is an appropriate and complete method by which to bind new defendants where it can be demonstrated that in their capacity as alter ego of the corporation they in fact had control of the previous litigation, and thus were virtually represented in the lawsuit.”

The trustee was the manager of the limited liability companies against which judgment was entered.  His liability arose, as a factual matter, from his management of the limited liability companies, not from his acts as trustee (manager) of the trusts.  This then is a leap, albeit a small one.  With our modern statutory schemes for limited liability companies, we have made it difficult to enforce judgments placed against an LLC.

Austria

Stated the court, “we conclude the alter ego doctrine may apply to a trustee but not a trust . . . Courts often speak of the alter ego doctrine as if it applied to a trust as an entity.  But a distinction must be made between a trust and a trustee. The general rule that a trust is a relationship is universally recognized by U.S. cases and statutes, and is consistent with the prevailing norms of the entire common-law world. The fundamental nature of this relationship is that one person holds legal title for the benefit of another person.  Thus, in actuality, a trust is not a legal person which can own property or enter into contracts.”

That is a rock-solid statement of the law, correct on all points.  “Because a trust is not an entity, it’s impossible for a trust to be anybody’s alter ego. That’s because alter ego theory, which is simply one of the grounds to ‘pierce the corporate veil,’ is inescapably linked to the notion that one person or entity exercises undue control over another person or entity.  However, a trust’s status as a non-entity logically precludes a trust from being an alter ego.”

The court is still right on the money.  “Unlike a corporation, a trust is not a legal entity. Legal title to property owned by a trust is held by the trustee.  A trust is simply a collection of assets and liabilities. As such, it has no capacity to sue or be sued, or to defend an action.”

But now we enter a hazy area.  Generally, a claim against the trustee must be connected to a claim connected with the management and operation of trust assets.  Stated differently, the personal liability of a trustee for his wrongdoing does not enable a judgment creditor to reach trust assets.  Such protection of trust assets is tied to the fundamental notion that a trust is a relationship, whereby the trustee holds title to the trust assets for benefit of the cestui que trust.

The court’s next step is not on such firm grounding.  “The proper procedure for one who wishes to ensure that trust property will be available to satisfy a judgment is to sue the trustee in his or her representative capacity.”  True, but the court seeks to hold the trustee liable for debts owed by a trust asset.  How do we cross this bridge?

In a single leap.  “In the present case, Greenspan properly sought to add Moti Shai, the trustee of the Shy Trust, as a judgment debtor.  If Moti Shai is the alter ego of Barry Shy, then Barry may be considered the owner of the Shy Trust’s assets for purposes of satisfying the judgment.”

This result means that the court is disregarding two layers – the limited liability company (on alter ego grounds) and the trust.  I propose that the trust should be disregarded on a more fundamental basis – an estate planning trust has no legal effect until the death of the settlor.  If the trust is revocable by the trustor, it should always be ignored by the court.  If the trust is irrevocable, then we enter the familiar area of the fraudulent transfer.  In other words, the court reached the right result, but there’s an easier way to connect the dots.

Greenspan v. LADT, LLC (Dec. 30, 2010) 191 Cal.App.4th 486

In re Honkanen – Bankruptcy Court Holds that Real Estate Broker’s Breach of Fiduciary Obligation is Dischargeable

A new decision has made an important change concerning he liability of real estate brokers in the context of a bankruptcy.  Specifically, the decision in In re Honkanen, 2011 DJDAR 3358 (9th Cir. Bankruptcy Appellate Panel March 4, 2011) holds that a real estate broker can obtain a discharge from a state court finding of breach of fiduciary duties if the finding was based on the debtor’s status as a broker.

In other words, state law holds that a broker owes fiduciary duties to his client.  Bankruptcy law holds that certain debts arising out of a breach of fiduciary duties are not dischargeable in bankruptcy.  The Honkanen court stepped into the intersection of these rules and held that the broker’s breach of fiduciary duties is a dischargeable debt because the broker was not acting as a trustee.  This represents a change in existing precedent.

Here are the facts.  “Honkanen had acted as Archer’s real estate broker[.]  After the transaction was not consummated, Archer sued Honkanen in state court accusing Honkanen of performing her real estate licensee duties negligently and of intentionally breaching her fiduciary duty to Archer.”

According to the lawsuit, “The alleged breach consisted of Honkanen making intentional misrepresentations to Archer concerning the real estate purchase agreement and the insufficiency of Archer’s performance, in addition to failing to disclose the deficiency in Archer’s performance . . . Archer also accused Honkanen of breaching her fiduciary duty of loyalty to Archer, the buyer, by acting in the interest of the seller rather than in Archer’s, interest.”

The result was in favor of the client.  “The jury awarded Archer damages in the amount of $356,000 for negligent and intentional breach of Honkanen’s fiduciary duty to Archer.”

Ms. Honkanen later filed for bankruptcy.  The client filed an adversary complaint seeking to hold that the debt was not dischargeable.  Based on prior case law (which was favorable to the creditor), “the only evidence admitted at trial was the original state court complaint, the state court judgment, and the state court jury instructions.”

Under prior law, this would have been sufficient to support a finding of non-dischargeability.  However, the appellate court made a break with published precedent, explaining that, “The broad definition of fiduciary under nonbankruptcy law – a relationship involving trust, confidence, and good faith – is inapplicable the dischargeability context.”

Asian Garden Mall

Instead, the Honkanen court stated that in the bankruptcy context, “the Ninth Circuit has adopted a narrow definition of ‘fiduciary.’ To fit within § 523 (a) (4), the fiduciary relationship must be one arising from an express or technical trust that was imposed before, and without reference to, the wrongdoing that caused the debt as opposed to a trust ex maleficio, constructively imposed because of the act of wrongdoing from which the debt arose.”

In other words, for the debt to be non-dischargeable, “the applicable state law must clearly define fiduciary duties and identify trust property . . . The mere fact that state law puts two parties in a fiduciary-like relationship does not necessarily mean it is a fiduciary relationship within 11 U.S.C. § 523 (a)(4).”

The Honkanen court then found a change in the law.  “In Cantrell, 329 F.3d 1119 (2003), the Ninth Circuit decided an issue of first impression and interpreted California corporate law to conclude that while officers and directors of a corporation are imbued with the fiduciary duties of an agent and certain duties of a trustee, they are not trustees with respect to corporate assets and, therefore, are not fiduciaries within the meaning of § 523(a)(4).”

To this end, non-dischargeability for breach of fiduciary obligations requires an express finding of a trust.  “In Cantrell, Cal-Micro, the plaintiff, contended that under California law a corporate officer is a statutory trustee with respect to corporate assets but the court rejected that contention because the cases relied upon by Cal-Micro merely held that officers owe fiduciary duties in their capacity as agents of a corporation – but failed to hold the officers are trustees of an express, technical, or statutory trust with respect to corporate assets.”

Here is an important point of law.  “A director of a corporation acts in a fiduciary capacity and the law does not allow him to secure any personal advantage as against the corporation or its stockholders.  However, speaking, the relationship is not one of trust, but of agency.”

Therefore, the law did not support a holding of non-dischargeability.  “Based on the requirements set forth in Cantrell, a California real estate licensee does not meet the fiduciary capacity requirement of § 523(a) (4) solely based on his or her status as a real estate licensee.  General fiduciary obligations are not sufficient to fulfill the fiduciary capacity requirement in the absence of a statutory, express, or technical trust.”

The decision affirms that fiduciary obligations – and the results arising from such a relationship – are often case-specific.

In re Honkanen, 2011 DJDAR 3358 (9th Cir. Bankruptcy Appellate Panel March 4, 2011)