Nat'l Union Fire Ins. Co. of Pittsburgh v. Krause (In re Krause)

• Decision Date: 30 April 2014
• Docket Number: Adversary No. 13 A 00901.,Bankruptcy No. 13 B 15811.
• Parties: In re Timothy D. and Cecilia S. KRAUSE, Debtors. National Union Fire Insurance Company of Pittsburgh, Plaintiff, v. Timothy D. and Cecilia S. Krause, Defendants.
• Court: U.S. Bankruptcy Court — Northern District of Illinois

510 B.R. 172

In re Timothy D. and Cecilia S. KRAUSE, Debtors.National Union Fire Insurance Company of Pittsburgh, Plaintiff,

v.Timothy D. and Cecilia S. Krause, Defendants.

Bankruptcy No. 13 B 15811.

Adversary No. 13 A 00901.

United States Bankruptcy Court,

N.D. Illinois,

Eastern Division.

Signed April 30, 2014.

James J. Bigoness, Clausen Miller PC, Chicago, IL, for Plaintiff.

John K. Kneafsey, Nisen & Elliott LLC, Chicago, IL, for Defendants.

MEMORANDUM OPINION

DONALD R. CASSLING, Bankruptcy Judge.

The Debtors are husband and wife and also co-owners of a general contracting business. They refinanced a short-term half-million dollar loan they had used for the purchase of raw land and the construction of a house thereon. Telling the refinancing lender that the newly-constructed house was to be their primary residence, they were able to obtain a thirty-year mortgage (the “Mortgage”) to secure repayment of a new promissory note (the “Note”). At the closing of the refinancing (the “Refi Closing”), the title insurance company failed to record the Mortgage.

Three months later, never having lived in the home themselves, the Debtors sold the property to another couple for almost $800,000. At the closing of that transaction (the “Sale Closing”), the unrecorded Mortgage did not appear on the title insurance commitment, and the settlement statement listed no amounts due and owing from the sellers to any lender. The only parties to or participants in the Sale Closing who were aware of the existence of the Note and unrecorded Mortgage were the Debtors themselves. As a result, they not only walked away from the Sale Closing with a sellers' proceeds check for almost $800,000, they kept walking. For more than three years, they failed to inform their lender that its collateral had been sold to a bona fide purchaser without notice of the Mortgage. Indeed, they actively concealed that fact from the lender by continuing to make monthly payments on a Note secured by a Mortgage on property they no longer owned. These facts only came to light when the Debtors suffered severe financial setbacks and defaulted on the Note and Mortgage.

In this adversary proceeding, the Plaintiff—the lender's assignee ¹—correctly points out that the bankruptcy discharge is reserved for honest but unfortunate debtors. It argues that the Debtors are not honest and that their misfortune is entirely of their own making. The Plaintiff therefore seeks to have the debt owed to it held nondischargeable on grounds of false representation or false pretenses ( 11 U.S.C. § 523(a)(2)(A)) and willful and malicious conversion ( 11 U.S.C. § 523(a)(6)).

In response, the Debtors point the finger at everyone but themselves, arguing that: (1) the title insurance company's failure to record the Mortgage rendered it utterly invalid; (2) only their wholly-owned company, Nevelco, Inc., should be bound by the Note and Mortgage that the Debtors both signed individually; (3) the Debtors are immune from liability for their actions because they were only following the alleged advice of their attorney that the sale proceeds were theirs to keep because the Mortgage was unrecorded; (4) they never bothered to read any of the loan documents they signed, because that is what attorneys are for; and (5) as a result, they should not be bound by all the legal mumbo jumbo contained in those documents, such as the “due-on-sale” clause requiring repayment of the loan upon sale or transfer of the collateral.

At trial, the Court had the opportunity to hear the testimony of both Debtors, as well as that of the attorney who represented them at the Sale Closing. The Court finds the Debtors' explanations and excuses implausible and their testimony belied by the contemporaneous documents they executed and by their actions prior to, during, and after the Sale Closing. The Court also concludes that their legal arguments are unconvincing and contrary to settled Illinois law. For the reasons set forth below, the Court concludes that the Plaintiff has met its burden and that the debt owed to the Plaintiff is nondischargeable under both § 523(a)(2)(A) and (a)(6).

FACTS AND BACKGROUND

Operating through their wholly-owned company, Nevelco, Inc. (“Nevelco”), the Debtors conducted a general contracting business.² The Debtor Timothy D. Krause (“Mr. Krause”) was president of Nevelco, and the Debtor Cecilia S. Krause (“Mrs. Krause”) was its secretary. Husband and wife each owned a 50% interest in Nevelco. Mrs. Krause testified that she was responsible for Nevelco's bookkeeping, which included paying bills and balancing the books.

On September 10, 2004, Nevelco purchased a vacant lot at 205 S. Maple, Itasca, Illinois (Pl.Ex. No. 6) (the “Property”) for $205,000, using financing from Itasca Bank & Trust. In 2004, Nevelco conveyed title to the Property into Land Trust No. 12022. Although there was no testimony at trial that there was additional financing from Itasca Bank & Trust,³ Plaintiff's Exhibit No. 9 is a November 5, 2009, HUD Settlement Statement listing additional sums lent to the Debtors, presumably for the construction of a house on the Property. That settlement statement indicates that the Debtors used the proceeds of a refinancing loan from Washington Mutual (described below) to pay off a balance of $570,506.28 owed to Itasca Bank & Trust.

The Debtors testified that, because the loan from Itasca Bank & Trust was a “construction” loan, it had a short term and needed to be refinanced. To that end, on November 9, 2005, the Debtors submitted a “Uniform Residential Loan Application” to Washington Mutual. (Pl.Ex. No. 8.) In that application, the Debtors sought a thirty-year “conventional loan” in the amount of $662,500 to be secured by a new mortgage on the Property. ( Id.) Although the Debtors checked the box declaring the purpose of the loan to be a “Refinance,” they never identified the borrower as Nevelco. ( Id.) Instead, they signed the application only in their individual capacities, checking a box on the first page indicating the Property would be an “Investment” and checking a box on the second page representing that they “intend[ed] to occupy the property as [their] primary residence.” ( Id.) At trial, both Debtors testified that they listed both personal and business assets in the statement of assets and liabilities required by the application.

On November 8, 2005, the Debtors closed on the refinancing loan with Washington Mutual in the amount of $562,500 (the “Refi Loan”). (Pl.Ex. Nos. 9–14.) At the Refi Closing, the Debtors each executed the Note both individually and as “trustee,” even though neither Debtor was a trustee of Trust No. 12022 (Pl.Ex. No. 10.) Nevelco did not execute the Note, which, in fact, makes no reference at all to Nevelco. ( Id.) The Debtors also executed the Mortgage both individually and “as trustee of a trust agreement date 7/16/03 known as Trust # 12022.” (Pl.Ex. No. 11.) As was the case with the Note, Nevelco did not execute the Mortgage, which also makes no reference at all to Nevelco. ( Id.)

Also at the Refi Closing on November 8, 2005, the Debtors each executed two riders to the Mortgage, once again executing them both individually and “as trustee of a trust agreement known as Trust No. 12022.” (Pl.Ex. Nos. 12 & 13.) And once again, Nevelco did not execute either rider and neither rider made any reference to Nevelco. ( Id.) In addition, on November 9, 2005, the Debtors each individually signed a Truth–In–Lending disclosure statement. (Pl.Ex. No. 14.) Finally, on November 15, 2005, the Debtors each individually signed off on a payoff letter for Itasca Bank and Trust, loan no. 106313851, the construction loan which was being paid off from the proceeds of the Refi Loan. (Pl.Ex. No. 15.)

It is both significant to this case and undisputed that neither Washington Mutual nor Stewart Title recorded the Mortgage after the Refi Closing.

On February 14, 2006, just three months after the Refi Closing, and despite the Debtors' representations to Washington Mutual that they intended to reside permanently on the Property, Mr. Krause executed a Real Estate Sales Contract for the sale of the Property to Scott and Colleen Becker (the “Beckers”). (Pl.Ex. No. 16.) He executed the contract in his capacity as president of Nevelco, thereby representing it to be the owner and seller of the Property. The Sale Closing took place on March 13, 2006. Mr. Krause attended with his attorney, Christopher Galloway (“Mr. Galloway”). Mrs. Krause did not attend.

From the date of the execution of the sale contract with the Beckers and continuing for over three years, the Debtors clammed up. The Debtors neither requested nor obtained Washington Mutual's prior consent to the sale, as required by the Note and Mortgage. (Pl.Ex. Nos. 10 & 11.) Indeed, they neglected even to notify Washington Mutual of their intent to sell the Property. Nor did the Debtors inform the title insurance company of the existence of the Mortgage on the property or of the underlying Note. Prior to the Sale Closing, the Debtors did not even inform their attorney, Mr. Galloway, of the existence of the Note and Mortgage held by Washington Mutual.

Mr. Krause did testify that, immediately after the closing, he told Mr. Galloway about the outstanding Note and Mortgage held by Washington Mutual and that Mr. Galloway advised him that because the Mortgage was unrecorded, it was okay for the Debtors to retain all the proceeds of the sale and use them to pay other loans. By contrast, Mr. Galloway testified that he could not recall ever having such a conversation with Mr. Krause and, moreover, that it would have been contrary to his normal practice and custom to give a client such advice under these circumstances because it could lead to charges of fraud and other liabilities for the client.

In any event, on March 14, 2006, the day after the Sale Closing, Mr. Krause deposited the title insurance company's check for the entire...