In re Columbia Pacific Mortg., Inc.

• Decision Date: 03 September 1981
• Docket Number: Bankruptcy No. 80-01590.
• Citation: 20 BR 259
• Parties: In re COLUMBIA PACIFIC MORTGAGE, INC., Debtor.
• Court: U.S. Bankruptcy Court — Western District of Washington

20 B.R. 259 (1981)

In re COLUMBIA PACIFIC MORTGAGE, INC., Debtor.

Bankruptcy No. 80-01590.

United States Bankruptcy Court, W.D. Washington.

September 3, 1981.

Arthur H. McKean of Aiken, St. Louis & Siljeg, Seattle, Wash., for Bohemian Savings & Loan Assoc.

Kimberly Osenbaugh and Susan Boyle of Bogle & Gates, Seattle, Wash., for Community Sav. & Loan Ass'n.

Daniel M. Caine and D. Gordon Willhite of Sax & MacIver, Seattle, Wash., for trustee.

MEMORANDUM AND ORDER

KENNETH S. TREADWELL, Bankruptcy Judge.

This is an action by the Bohemian Savings and Loan Association of Cedar Rapids, Iowa, to recover from the Trustee proceeds of sales of real estate to which it claims it is entitled under its Loan Participation and Service Agreement with the debtor, Columbia Pacific Mortgage, Inc.

Community Federal Savings and Loan Association intervened in this action in support of Bohemian's position. Community on January 24, 1980, purchased a 90% participation ownership interest in 41 single family residential loans from Columbia Pacific Mortgage, Inc. for the sum of $1,672,963.50.

The Debtor is a mortgage company engaged in the business of financing the construction and purchase of single family residences in the States of Washington, Oregon, Idaho and Montana. On July 10, 1980, it filed its voluntary petition under Chapter 11 of the Bankruptcy Code and since said date its business has been continued by a Trustee appointed under Sec. 1104 of that Code.

In the regular course of its business the debtor packaged and sold undivided participation interest in loans it negotiated to a number of savings and loan associations, a majority of which are located in the Midwest. Bohemian Savings and Loan Association, on August 31, 1979, purchased from Debtor an 80% interest in a package of 49 loans for the sum of $1,960.078.00. Prior to the order of relief, three of the loans fell into default and the debtor obtained title to the properties. These three properties were liquidated by the Debtor-in-Possession for the net sum of $200,700.00. It is 80% of this fund that Bohemian Savings and Loan Association seeks to recover from the Trustee. In response, the Trustee, has launched an attack on the validity of Bohemian's ownership interest, asserting that since Bohemian did not obtain possession of the promissory notes and/or record partial assignments of the deeds of trust which secure the notes, the interest of Bohemian is void under Sec. 544(a)(3) of the Code.

The Trustee's attack must fail for three substantial reasons.

1. Participation ownership interests in property acquired in the secondary mortgage market are fully protected by Sec. 541(d) of the Bankruptcy Code.

2. The holders of participation certificates are beneficial owners of an undivided interest in the loans and Columbia Pacific Mortgage, Inc. (seller) holds the notes and deeds of trust in trust for the purchasers.

3. A participation ownership interest in a note secured by a deed of trust is not a real property interest subject to attack by a Trustee as a bona fide purchaser under Sec. 544(a)(3) of the Bankruptcy Code.

Mortgage participations have been enforced by the courts in this country in a wide variety of situations for well over 100 years. Batesville Institute v. Kauffman, 85 U.S. 151, 154, 21 L.Ed. 775 (1873). The courts have uniformly held that the purchaser of a mortgage participation certificate was entitled to his proportionate share of the mortgage proceeds. Prudence Realization Corp. v. Geist, 316 U.S. 89, 62 S.Ct. 978, 86 L.Ed. 1293 (1942); Delatour v. Prudence Realization Corp., 167 F.2d 621 (2nd Cir. 1947); Coffey v. Lawman, 99 F.2d 245 (6th Cir. 1938); In re The Westover, Inc., 82 F.2d 177 (2nd Cir. 1936); Title Guarantee & Trust Co. v. Mortgage Comm'n, 273 N.Y. 415, 7 N.E.2d 841 (1937); Domeyer v. O'Connell, 364 Ill. 467, 4 N.E.2d 830 (1936); Northern Bond & Mortgage v. Cowell, 172 Wash. 217, 20 P.2d 11 (1933); Price v. Northern Bond & Mortgage Co., 161 Wash. 690, 297 P. 786 (1931).

Participation certificates have been enforced in a number of bankruptcy cases and receivership proceedings. FDIC v. Mademoiselle of California, 379 F.2d 660 (9th Cir. 1967); Stratford Financial Corp. v. Finex, 367 F.2d 569 (2nd Cir. 1966); Mayfield v. First National Bank of Chattanooga, 137 F.2d 1013 (6th Cir. 1943).

However, in none of the reported cases had the validity of participations been challenged by bankruptcy trustees or equity receivers. It wasn't until 1976 in the Hamilton Mortgage case (In re Hamilton Mortgage Corporation, No. BK-1-76-264 (DC, E.D.Tenn., So.Div. unreported) that a bankruptcy trustee challenged the validity of participation interests in loans sold by the Hamilton Mortgage Corporation to a number of savings and loan associations. This attack and its resolution by settlement raised the specter of future challenges to mortgage participations by bankruptcy trustees.¹

In an obvious effort to eliminate the uncertainties developing in the national secondary mortgage market and to promote that market by protecting participation interests in loans from challenge in bankruptcy, Congress enacted Sec. 541(d) of the Bankruptcy Code (11 U.S.C. § 541(d)) which provides:

"(d) Property in which the debtor holds, as of the commencement of the case, only legal title and not an equitable interest, such as a mortgage secured by real property, or an interest in such a mortgage, sold by the debtor but as to which the debtor retains legal title to service or supervise the servicing of such mortgage or interest, becomes property of the estate under subsection (a) of this section only to the extent of the debtor\'s legal title to such property, but not to the extent of any equitable interest in such property that the debtor does not hold."

Congress by enacting Sec. 541(d) confirmed the status of bona fide secondary mortgage transactions as the purchase and sale of assets. Congress specifically noted that the seller's retention of original loan documents and the purchaser's decision not to record under state recording statutes would not in any way impair the asset sale character or validity of the secondary mortgage market transaction.

The express purpose of Congress inserting into Sec. 541(d) the following words

"such as a mortgage secured by real property, or an interest in such a mortgage, sold by the debtor but as to which the debtor retains legal title to service or supervise the servicing of such mortgage or interest."

was to exempt secondary mortgage market transactions from compliance with state recording statutes and Article 9 of the Uniform Commercial Code and to make certain that secondary mortgage market sales as they are currently structured would not be subject to challenge by bankruptcy trustees. This is clearly disclosed by the legislative history of this section:

"The seller of mortgages in the secondary mortgage market will often retain the original mortgage notes and related documents and the seller will not endorse the notes to reflect the sale to the purchaser. Similarly, the purchaser will often not record the purchaser\'s ownership of the mortgages or interests in mortgages under State recording statutes. These facts are irrelevant and the seller\'s retention of the mortgage documents and the purchaser\'s decision not to record do not change the trustee\'s obligation to turn the mortgages or interests in mortgages over to the purchaser. The application of section 541(d) to secondary mortgage market transactions will not be affected by the terms of the servicing agreement between the mortgage servicer and the purchaser of the mortgages. Under section 541(d), the trustee is required to recognize the purchaser\'s title to the mortgages or interests in mortgages and to turn this property over to the purchaser. It makes no difference whether the servicer and the purchaser characterize their relationship as one of trust, agency, or independent contractor.

The purpose of section 541(d) as applied to the secondary mortgage market is therefore to make certain that secondary mortgage market sales as they are currently structured are not subject to challenge by bankruptcy trustees and that purchasers of mortgages will be able to obtain the mortgages or interests in mortgages which they have purchased from trustees without the trustee\'s asserting that a sale of mortgages is a loan from the purchaser to the seller.

Thus, as section 541(a)(1) clearly states, the estate is comprised of all legal or equitable interests of the debtor in property as of the commencement of the case. To the extent such an interest is limited in the hands of the debtor, it is equally limited in the hands of the estate except to the extent that defenses which are person against the debtor are not effective against the estate. 124 Cong.Rec. H. 11, 114 (Sept. 28, 1978); S. 17, 430-1 (Oct. 6, 1978)."

The provisions of this section do more than validate participation interest. The principle purpose of Sec. 541(d) is to recognize and exempt from estates all property held in trust by the debtor. For Sec. 541(a)(1) provides that the commencement of a case creates an estate comprised of "all legal and equitable interest of the debtor in property". Sec. 541(d) limits and clarifies Sec. 541(a)(1)...