Forester, Matter of

• Decision Date: 12 January 1976
• Docket Number: No. 74--2132,74--2132
• Citation: 529 F.2d 310
• Parties: In the Matter of George Francis FORESTER, doing business as Forester's Flying Realty, Bankrupt. A. E. MILLER, Trustee-Appellant, v. Bide STEWARD et al., Creditors-Appellees.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 310

529 F.2d 310

In the Matter of George Francis FORESTER, doing business as

Forester's Flying Realty, Bankrupt.

A. E. MILLER, Trustee-Appellant, v. Bide STEWARD et al., Creditors-Appellees.

No. 74--2132.

United States Court of Appeals, Ninth Circuit.

Jan. 12, 1976.

Harold A. Block (argued) of Dinkelspiel & Dinkelspiel, San Francisco, Cal., for trustee-appellant.

Dennis K. Cowan (argued), Redding, Cal., for creditors-appellees.

OPINION

Before HUFSTEDLER and TRASK, Circuit Judges, and HILL, ^* District Judge.

TRASK, Circuit Judge:

The trustee in bankruptcy appeals from the district court's order granting the Stewards' petition for reclamation, which sought rights to $7,000 in proceeds from certain collateral security.

In July 1968, Bide Steward, Winnie Steward, Fern S. Wescott, Gilbert Faulstich and Winola Faulstich (Stewards) sold George Forester land in California and Nevada called the Z--Bar Ranch. Forester borrowed $140,000 from the Federal Land Bank of Berkeley to finance the purchase, giving the bank in return a first deed of trust on the ranch property. Forester gave the Stewards the $140,000 and two notes totaling $125,000 in payment for the land. These notes were secured by a second deed of trust on the ranch in favor of the Stewards.

At the same time and as part of the borrowing transaction, Forester gave additional security to the bank to secure his obligation to it. As was required by 12 U.S.C. §§ 721, 733 (since repealed but in force on the date of this transaction), Forester upon his own credit caused $7,000 in Federal Land Bank stock to be pledged to the bank to secure the loan. ¹

In early 1970 he deeded his ranch to Great Western Ranches, Inc. (Great Western) as part of a tax free reorganization but retained his interest in the stock of the Federal Land Bank Association of Alturas, since no arrangement was made to convey it to Great Western. On April 16, 1970, the bank threatened foreclosure because no payments had been made on its loan to Forester. ² On July 1, 1970, Great Western filed a Chapter X petition in bankruptcy. The reorganization court subsequently restrained all creditors from foreclosing on any properties owned by Great Western. On June 25, 1971, Forester was adjudicated a bankrupt.

On July 6, 1971, the Stewards obtained a modification of the reorganization court's order protecting Great Western's property. Under the modified order the Stewards were permitted to sell the property under their power of sale in their second deed of trust and to bid it in. They were required by the court, however, to sell the property thereafter and to pay one-half the net proceeds, but in any event not less than $5,000, to the reorganization court trustee. On January 20, 1972, the Stewards completed the bidding-in process, but the debt owed them by Forester was not satisfied.

In late 1971 the bank was given authority by the reorganization court to foreclose its first deed of trust, pursuant to notices of default thereunder filed on May 18, 1970. The foreclosure sale could not be held until April 30, 1972.

The Stewards, meanwhile, having acquired the property subject to the bank's first deed of trust, proceeded to finalize arrangements to sell the property. They duly made demands upon the bank that it apply the $7,000 in stock to reduce Forester's obligation under the first deed of trust in order to ensure a greater return to the Stewards on the Forester-Steward debt under the second deed of trust. Acting upon the request of the trustee of Forester's estate, the bank declined to do so and also declined to pay the proceeds of the stock to the Stewards upon retirement of the stock after the Stewards paid off the Forester bank debt.

In order to prevent their private sale from failing the Stewards did not wait for a resolution of their dispute with the trustee and the bank over the $7,000 stock collateral. Stewards finally agreed to pay the gross amount of the debt to the bank undiminished by the application of the $7,000 credit. Stewards thus completed their sale in April 1972, protesting that the bank should have reduced the Forester balance by $7,000 or should have paid that amount to Stewards if Stewards were required to discharge the bank obligation without such reduction. The Stewards also paid $5,000 to the reorganization court trustee, the minimum they could pay under the court's order, since there were no net proceeds on the transaction. They retained the rest in cash or notes from the buyers to reduce their loss on the overall affair.

The bank retired the bank stock in its possession and returned $7,000 to the association. The association then paid the $7,000 to Forester's trustee and retired the $7,000 in association stock it retained.

The Stewards filed an application to reclaim the $7,000 in bank stock proceeds with the bankruptcy court. The referee in bankruptcy found for the trustee, holding that the Stewards were volunteers when they paid off the bank loan and had no subrogation rights and that the bankrupt's estate was not unjustly enriched by an award of the proceeds.

Upon review, the district court reversed and ordered the trustee to turn the $7,000 over to the Stewards. The court found that the Stewards were subrogated to the bank's rights to apply the collateral security to reduce the amount they had to pay to pay off the Forester bank loan. ³ The court further found that a constructive trust should be implied so that the bankrupt estate was not unjustly enriched at the expense of the Stewards.

We affirm the district court's judgment. The Stewards were entitled to subrogation to the bank's security position and to marshaling of the bank's collateral security interest in the stock.

I. Subrogation

Section 2904 of the California Civil Code provides:

'Rights of Inferior Lienor. One who has a lien inferior to another, upon the same property, has a right:

'1. To redeem the property in the same manner as its owner might, from the superior lien; and,

'2. To be subrogated to all the benefits of the superior lien, when necessary for the protection of his interest, upon satisfying the claim secured thereby.'

The series of steps that the Stewards took with respect to the ranch were, in effect, a redemption by a junior lienor of a superior lien. In April 1970, prior to any action by the Stewards in this case, the bank threatened to foreclose its first deed of trust. A few months later the Great Western reorganization court restrained the bank, the Stewards, and all other creditors from foreclosing on any Great Western property. The Stewards eventually received approval to foreclose on their second deed of trust on the condition that they then sell the property at the highest price possible and pay one-half the net proceeds to the Great Western trustee, but in any event no less than $5,000. The bank also received permission to foreclose on its first deed of trust after April 29, 1972. The Stewards bid on and acquired ownership of the ranch in January 1972. The sale to third parties was completed in April of the same year; as part of the sale transaction the Stewards paid off the bank loan to Forester.

All of these steps by the Stewards were taken to protect their second trust deed interest and to effect their private sale. The ownership of the ranch by foreclosure of the second lien was but a contemporaneous step toward the payment of the bank loan and sale of the property.

At the time that Stewards were attempting to clear the title to the land so that a sale could be effected by them, the bank was the holder of the first deed of trust and the security interest in the stock. It had declared the debt which was secured by the lien, in default, and announced that it would foreclose. The reorganization court had given to the bank its authority to foreclose the first deed of trust although directing that the actual sale be deferred. This meant that Stewards in order to effect their private sale had to pay the bank's debt, refinance it or otherwise dispose of it in order to be able to sell the property and provide title free and clear of the first deed of trust. They first attempted to get the bank to apply the stock interest to the debt to reduce the amount of cash Stewards would have to supply. The bank was adamant in its refusal. Stewards then paid to the bank the entire debt principal and interest. ⁴ When they did so they became legally entitled to be subrogated to the bank's position. They could continue the foreclosure proceedings against Forester or dismiss them and release the first deed of trust. In any event, it was the Stewards and not the bank who had the right to determine whether to apply the stock to the debt. The Stewards were then the creditor in the bank's position with all the bank's lien rights and all of the bank's security rights including the right to apply the $7,000 stock collateral. The bank at that time had no right to release and turn over its security interest in the land and hold back its security interest in the shares of stock (which were part of the same security transaction) and deliver it to the debtor's trustee. When the bank was paid it lost its control over either the lien of the first deed of trust or the security right to the stock or its proceeds.

Sections 2903, defining subrogation rights generally, ⁵ and 2904 of the California Civil Code would apply to give the Stewards subrogation rights to the collateral security in the stock since they paid off the senior lien to protect their junior lien interest. The fact that the Stewards acquired a temporary ownership interest for the purpose of effecting the sale does not deprive them of the protection of sections 2903 and 2904.

This approach is supported by general equitable notions. It appears that subrogation is a doctrine broader in its reach than that prescribed in the Civil Code. As the court in Employers Mutual Liability Ins. Co. v. Pacific Ind. Co., 167 Cal.App.2d 369, 334 P.2d...