In re Taylor

• Decision Date: 28 August 1984
• Docket Number: Adv. No. 84-0054.,Bankruptcy No. 83-5027
• Citation: 43 BR 524
• Parties: In re James Floyd TAYLOR f/d/b/a Lance Sportswear, Debtor. J. William WHITE, Trustee, v. James Floyd TAYLOR, individually and fdba Lance Sportswear; William John Tolley; Jessie Heppinstall Tolley; Real Estate Financing, Inc., a corporation; Metropolitan Life Insurance Co., a corporation and Wayne Smith, Defendants.
• Court: U.S. Bankruptcy Court — Northern District of Alabama

43 B.R. 524 (1984)

In re James Floyd TAYLOR f/d/b/a Lance Sportswear, Debtor.

J. William WHITE, Trustee, v. James Floyd TAYLOR, individually and fdba Lance Sportswear; William John Tolley; Jessie Heppinstall Tolley; Real Estate Financing, Inc., a corporation; Metropolitan Life Insurance Co., a corporation and Wayne Smith, Defendants.

Bankruptcy No. 83-5027, Adv. No. 84-0054.

United States Bankruptcy Court, N.D. Alabama, W.D.

August 28, 1984.

J. William White, Scottsboro, Ala., trustee.

Walter P. Crownover, Tuscaloosa, Ala., for debtor.

GEORGE S. WRIGHT, Bankruptcy Judge.

MEMORANDUM OF DECISION

This matter came to trial before this Court on the Trustee's complaint to have an unrecorded transfer of real estate declared null and void pursuant to 11 U.S.C. Sect. 544(a). This case illustrates the often unforseen difficulties which may be encountered in "creative financing" schemes. The issue to be decided is whether the possession of the disputed property by the transferees is sufficient notice to defeat the claim of the Trustee who under 11 U.S.C. Sect. 544(a), has the rights of a hypothetical judicial lien creditor or bona fide purchaser as of the date of the petition. The resolution of this issue ultimately hinges upon whether the parties to the transaction in question intended the warranty deed or the contemporaneously executed lease with a purchase option to be the controlling document.

FINDINGS OF FACT

Prior to January 22, 1980, defendant Wayne A. Smith was the record owner of a house and lot described as Lot 42 of Northwood 11 in Tuscaloosa County, Alabama. Mr. Smith conveyed this property by warranty deed to debtor-defendant James F. Taylor on January 22, 1980. On the same day, Mr. Taylor executed a real estate mortgage in favor of defendant Real Estate Financing, Inc. This mortgage secured a note for $60,000 at an interest rate of approximately 10½% and contained a standard "due on sale" clause.¹ Both the warranty deed to James F. Taylor and the mortgage to Real Estate Financing were recorded.²

Soon after this transaction was completed, Mr. Taylor decided that he didn't want the Northwood property. He arranged instead to trade the Northwood property to Mr. Smith for a lot and house at Number 4 Academy Drive, Tuscaloosa, Alabama. Seeking to sell the Northwood property, Mr. Smith contacted Mr. and Mrs. Tolley in March of 1980. The Tolleys wanted to buy the Northwood property but could not afford to assume the mortgage since doing so would trigger the "due on sale" clause, and interest rates had risen from 10½% in January, 1980 to nearly 18% in March, 1980.

In order to circumvent the "due on sale" clause no deed from Mr. Taylor conveying the Northwood property back to Mr. Smith was ever executed. Also to avoid triggering the "due on sale" clause and to permit the Tolleys to buy the Northwood property at an interest rate of 10½%, Mr. Smith arranged for Mr. Taylor to execute a warranty deed conveying the Northwood property to the Tolleys; and the parties agreed to not record this deed until the interest rates had come back down. This deed was dated April 8, 1980; and the parties contemporaneously executed a lease with an option to purchase for a term of three years. The rental agreement was supposed to have been recorded to protect the Tolley's interest in this house until the mortgage could be assumed, but this was never done.

Because the Tolleys were advised in a letter from Mr. Smith to record the rental agreement immediately and warned not to record the deed until the interest rates permitted the mortgage to be assumed, the Trustee argues that the rental agreement with the option to purchase was intended by the parties to be the controlling document. The Trustee contends that the delivery of the deed was a conditional delivery to be effective only upon the actual assumption of the mortgage. Since the Tolleys have not exercised the option in the rental agreement, the Trustee asserts that the Tolleys now have no interest in the Northwood property.

This Court, however, is not persuaded by the Trustee's arguments and rejects the contention that the rental agreement was intended by the parties to be the controlling instrument. Viewing the evidence in its totality, the Court finds that the parties intended the April 8, 1980 transaction to be a sale of the Northwood property and not a lease with a conditional delivery of a warranty deed. The Court, therefore, finds that the parties intended the warranty deed to be the controlling instrument.

The Court's finding is supported by several facts which have been brought out in the pleadings and at trial. In the first place, the Tolleys took possession of the Northwood property on April 12, 1980 and have remained there continuously since then. Under the rental agreement, the Tolleys were obligated to make payments of $630.43 per month. Mr. Smith testified that this amount was exactly equal to the payments under the Taylor mortgage. Except for two or three payments made through Mr. Smith, the Tolleys have made all of their payments directly to Real Estate Financing, Inc.

The Tolleys have at all times since April 8, 1980 considered themselves to be the owners of the Northwood property and have acted in accordance with that belief by making valuable improvements on the property which include clearing the back yard, moving trees and shrubs, and installing ceiling fans and dead-bolt locks. All of these improvements were made without the consent or over the objection of anyone.

Also, when the Tolleys entered into this transaction, they traded to Mr. Smith their $8,000 equity in their previous home. The Court finds this fact very persuasive since it is highly unlikely that one would trade the equity in his home for a lease with an option to buy. Lastly, Mr. Smith testified that he considered the Northwood property to have been sold on April 8, 1980.

Based upon these facts, the parties clearly intended the warranty deed executed on April 8, 1980 conveying the Northwood property to the Tolleys to be the controlling document. The rental agreement was ancillary to the sale and was merely a device intended to circumvent the effects of the "due on sale" clause in the Taylor mortgage. The Court so finds.

CONCLUSIONS OF LAW

Section 544(a) of the Bankruptcy Code, also known as the "strong arm clause", gives the trustee the rights of and the power to avoid any transfer avoidable by a hypothetical judicial lien creditor or a hypothetical bona fide purchaser of real property of the debtor as of the date of the petition. 11 U.S.C. Sect. 544(a); see generally 2 Collier Bankruptcy Manual 544.01 (3rd Ed.1984); 4 Collier on Bankruptcy 544.01-.02 (15th Ed.1984). That section provides:

Section 544 Trustee as lien creditor and as successor to certain creditors and purchasers.

(a) The trustee shall have, as of the commencement of the case, and without regard to any knowledge of the trustee or of any creditor, the rights and powers of, or may avoid any transfer of the property of the debtor or any obligation incurred by the debtor that is voidable by—

(1) a creditor that extends credit to the debtor at the time of the commencement of the case, and that obtains, at such time and with respect to such credit, a judicial lien on all property on which a creditor on a simple contract could have obtained a judicial lien, whether or not such a creditor exists;

(2) a creditor that extends credit to the debtor at the time of the commencement of the case, and obtains, at such time and with respect to such credit, an execution against the debtor that is returned unsatisfied at such time, whether or not such a creditor exists; and

(3) a bona fide purchaser of real property from the debtor, against whom applicable law permits such transfer to be perfected, that obtains the status of a bona fide purchaser at the time of the commencement of the case, whether or not such a purchaser exists.

11 U.S.C. Section 544(a).

Although Section 544 vests the trustee with the broad powers listed above, the extent of those rights is determined by substantive state law. See Matter of Clifford, 566 F.2d 1023, 1025 (5th Cir.1978) (Construing Section 70(c) of the Bankruptcy Act); In re Rosenberg Iron & Metal Co., 343 F.2d 527, 529 (7th Cir.1965); Matter of Steele, 27 B.R. 474, 476 (Bkrtcy.W.D. Wis.1983) (citing 4 Collier on Bankruptcy 544.02 (15th Ed.1982)); In re Sanford, 8 B.R. 761, 764, 7 B.C.D. 929, 931 (Bkrtcy.N. D.Cal.1981) (state law limits under either Code or Act). The applicable Alabama statute is Section 35-4-90(a) of the Alabama Code which provides:

Section 35-4-90. Conveyances of real property generally.

(a) All conveyances of real property, deeds, mortgages, deeds of trust or instruments in the nature of mortgages to secure any debts are inoperative and void as to purchasers for a valuable consideration, mortgages and judgment creditors without notice, unless the same have been recorded before the accrual of the right of such purchasers, mortgagees or judgment creditors.

Ala. Code Sect. 35-4-90(a)(1975). Under this section, if a subsequent purchaser for valuable consideration or judgment creditor is without notice of a prior unrecorded conveyance or mortgage, that subsequent purchaser or creditor is given priority over the first party. Since this case concerns a purchaser in possession, of real property under an unrecorded deed, the issue then becomes whether such possession constitutes notice which would defeat the Trustee's assertion of the status of a bona fide purchaser or a judicial lien creditor without notice.³

The Alabama Supreme Court has consistently held that possession of land even under an unrecorded deed puts subsequent purchasers and judgment creditors on notice of the possessor's claim or title. See Gulf Oil Corp. v. Beck, 293 Ala. 158, 300 So.2d 822 (1974) (notice to creditor); Alexander v. Fountain, 195 Ala. 3, 70 So. 669 (1916) (notice to purchaser). In the Alexander case...