In re David Scott LEE, Debtor. Chase Manhattan Mortgage Corporation, Plaintiff-Appellee, v. Mark H. Shapiro, Trustee, Defendant-Appellant.
No. 06-1538
United States Court of Appeals, Sixth Circuit
Decided and Filed: June 26, 2008
530 F.3d 458
Argued: Dec. 6, 2007.
We therefore conclude that the record clearly supports the finding by a preponderance of the evidence that plaintiff‘s failure to take advantage of FedEx‘s preventive and corrective measures was unreasonable. It follows that FedEx has established its Ellerth/Faragher affirmative defense to employer liability. The award of summary judgment to FedEx on plaintiff‘s hostile work environment claim is also properly affirmed, albeit on grounds other than those relied on by the district court.
III
Accordingly, for the reasons stated by the district court in its opinion, as augmented by this opinion, the district court‘s judgment in favor of FedEx is AFFIRMED.
Before: MERRITT, COLE, and GRIFFIN, Circuit Judges.
COLE, J., delivered the opinion of the court, in which GRIFFIN, J., joined. MERRITT, J. (p. 474), delivered a separate dissenting opinion.
OPINION
R. GUY COLE, JR., Circuit Judge.
Approximately six months before he filed a voluntary Chapter 7 bankruptcy petition, David Scott Lee (“Lee” or “Debtor“) refinanced a residential mortgage loan with Chase Manhattan Mortgage Corporation (“Chase“), which was both the holder of the original mortgage and the refinanced mortgage. Seventy-seven days before Lee filed his bankruptcy case, and seventy-two days after Chase had distributed the funds that were used to discharge the original mortgage, a new mortgage on
I. BACKGROUND
A. Facts
In early 2001, the Debtor purchased the premises located at 129 West New York Avenue, Pontiac, Michigan (“Property“) and obtained a thirty-year mortgage loan in the principal amount of $108,000 from Flagstar Bank, FSB (“Flagstar“). The Debtor executed and delivered to Flagstar a promissory note (“Promissory Note“) that was secured by a mortgage on the Property (“Original Mortgage“). The Original Mortgage was properly recorded by the Clerk/Register of Deeds of Oakland County, Michigan (“Register of Deeds“).
Later in 2001, Flagstar assigned the Promissory Note and the Original Mortgage to the Federal National Mortgage Association, in care of Chase Mortgage Company, an Ohio Corporation (“Chase Ohio“), pursuant to an Assignment of Mortgage that was recorded by the Register of Deeds in early 2002. By merger of Chase Ohio into Chase, Chase became the holder of both the Original Mortgage and the loan evidenced by the Promissory Note (“Original Loan“).
On October 6, 2003, the Debtor refinanced the Original Loan. The Debtor obtained another mortgage loan (“New Loan“) from Chase, and used the proceeds to pay off the Original Loan. The Debtor also granted Chase a new 30-year mortgage (“New Mortgage“). By a “Discharge of Mortgage” dated October 27, 2003 (“Discharge“), Chase discharged the Original Mortgage. The Discharge stated that the Original Mortgage was “fully paid, satisfied and discharged.” The Register of Deeds received the Discharge on November 12, 2003 and recorded it on January 16, 2004. On December 17, 2003—51 days after Chase discharged the Original Mortgage and 72 days after the closing of the New Loan—the Register of Deeds recorded the New Mortgage.
B. Procedural History
On March 4, 2004, 77 days after the New Mortgage was recorded, the Debtor commenced his bankruptcy case by filing a voluntary petition for relief under Chapter 7 of the Bankruptcy Code in the United States Bankruptcy Court, Eastern District of Michigan. On April 20, 2004, the Chapter 7 Trustee Mark H. Shapiro (“Trustee“) filed an adversary complaint in the bankruptcy court against Chase, seeking to avoid the New Mortgage as a preferential transfer under
1. Bankruptcy Court Decision
The bankruptcy court avoided the New Mortgage as a preferential transfer because it found that the Trustee had met his burden on all elements under
The court next rejected Chase‘s argument that there was no diminution of the Debtor-estate‘s assets, finding that because Chase delayed in perfecting its mortgage lien, the Court could not treat the October 6 refinancing as part of the same transaction as the transfer of the lien recorded on December 17. Because the two transactions were separate transactions, the diminution requirement was met because perfection of the New Mortgage elevated Chase from unsecured to secured status, resulting in fewer assets of the Debtor‘s estate for other unsecured creditors. The court granted the Trustee‘s motion for summary judgment, holding that the estate was diminished by the December 17 perfection of the New Mortgage, and that the secured interest was an avoidable preference.
2. District Court Decision
On appeal, the district court found that the Trustee did not establish diminution as required by
The district court‘s rationale for treating the entirety of the refinancing as one transaction was that even though the recorded interest occurred outside the 10-day period of
The Trustee filed a timely Notice of Appeal on April 4, 2006.
II. LEGAL ANALYSIS
When reviewing an order of a bankruptcy court on appeal from a decision of a district court, we review the bankruptcy court‘s order directly and give no deference to the district court‘s decision. See Rogan v. Bank One, Nat‘l Ass‘n (In re Cook), 457 F.3d 561, 565 (6th Cir. 2006). We review the bankruptcy court‘s findings of fact under the clearly erroneous standard, asking only whether we are left with a definite and firm conviction that a mistake has been committed. We review conclusions of law made by the bankruptcy court de novo. See id.
A. Preferential Transfers—General Principles
Under
1. Section 547(b)
The elements of a preferential transfer are set forth in
(b) Except as provided in subsection (c) of this section, the trustee may avoid any transfer of an interest of the debtor in property—
(1) to or for the benefit of a creditor;
(2) for or on account of an antecedent debt owed by the debtor before such transfer was made;
(3) made while the debtor was insolvent;
(4) made—
(A) on or within 90 days before the filing of the petition; or
(B) between ninety days and one year before the date of the filing of the petition, if such creditor at the time of such transfer was an insider; and
(5) that enables such creditor to receive more than such creditor would receive if—
(A) the case were a case under chapter 7 of this title;
(B) the transfer had not been made; and (C) such creditor received payment of such debt to the extent provided by the provisions of this title.
Two elements of
2. Section 547(e)
The other provision of the Bankruptcy Code before us is
(e)(1) For the purposes of this section—
(A) a transfer of real property other than fixtures . . . is perfected when a bona fide purchaser of such property from the debtor against whom applicable law permits such transfer to be perfected cannot acquire an interest that is superior to the interest of the transferee. . . .
(2) For the purposes of this section, except as provided in paragraph (3) of this subsection, a transfer is made—
(A) at the time such transfer takes effect between the transferor and the transferee, if such transfer is perfected at, or within 10 days after, such time, except as provided in subsection (c)(3)(B);
(B) at the time such transfer is perfected, if such transfer is perfected after such 10 days; or
(C) immediately before the date of the filing of the petition, if such transfer is not perfected at the later of—
(i) the commencement of the case; or
(ii) 10 days after such transfer takes effect between the transferor and the transferee.
(3) For the purposes of this section, a transfer is not made until the debtor has acquired rights in the property transferred.
In examining the rationale behind
Under this scenario, a borrower who later becomes a debtor incurs an antecedent and, at the time the mortgage is recorded, a transfer occurs for or on account of the debt that could be challenged as preferential by a trustee. Section 547(e) addresses this potential problem for lenders by providing a grace period for perfecting a security interest. As long as the mortgage is recorded within the 10-day time period,2 the associated mortgage debt will not be deemed antecedent. See In re Arnett, 731 F.2d at 364. On the other hand, if perfection occurs more than ten days after the transfer takes effect, the transfer occurs at the time of the perfection, and the debt thus will be an antecedent one. Id.
Section 547(e) also supplements the Bankruptcy Code‘s general definition of “transfer,” which is codified at
Applying
Arguing against this result, Chase relies on the undisputed fact that the Discharge was recorded after the New Mortgage was recorded. According to Chase, at all relevant times third parties were on notice of Chase‘s secured interest in the Property. But the fact that third parties may have been on notice of Chase‘s Original Mortgage is beside the point. A transfer of an interest in real estate is not necessarily perfected for purposes of
“When” and “cannot acquire” are ostensibly straightforward references to time and action in the real world . . . A creditor “can” acquire such a lien at any time until the secured party performs the acts sufficient to perfect its interest. . . . Not until the secured party actually performs the final act that will perfect its interest can other creditors be foreclosed conclusively from obtaining a superior lien. It is only then that they “cannot” acquire such a lien. Thus, the terms of § 547(e)(1)(B) apparently imply that a transfer is “perfected” only when the secured party has done all the acts required to perfect its interest. . . .
Fidelity Fin. Servs., Inc. v. Fink, 522 U.S. 211, 216 (1998).6
Under
3. The Other Elements of Preference Liability
Chase does not dispute that the Trustee has established the elements of an avoidable preference set forth in subsections (b)(1), (b)(3) and (b)(4) of
B. The Earmarking Doctrine—Transfer of an “Interest of the Debtor in Property”
1. Development and Elements of the Earmarking Defense
When the other elements of a preferential transfer are established,
[T]here is an important exception to the general rule that the use of borrowed funds to discharge the debt constitutes a transfer of property of the debtor: where the borrowed funds have been specifically earmarked by the lender for payment to a designated creditor, there is held to be no transfer of property of the debtor even if the funds pass through the debtor‘s hands in getting to the selected creditor. See In re Hartley, 825 F.2d at 1070; In re Smith, 966 F.2d 1527, 1533 (7th Cir. 1992); In re Bohlen Enters., Ltd., 859 F.2d 561, 564-66 (8th Cir. 1988). “The courts have said that even when the lender‘s new earmarked funds are placed in the debtor‘s possession before payment to the old creditor, they are not within the debtor‘s
‘control.‘” Bohlen, 859 F.2d at 565 (citing cases).
McLemore v. Third Nat‘l Bank in Nashville (In re Montgomery), 983 F.2d 1389, 1395 (6th Cir. 1993).
The earmarking doctrine applies whenever a third party transfers property to a designated creditor of the debtor for the agreed-upon purpose of paying that creditor. See In re Hartley, 825 F.2d at 1070. Under such circumstances, the property is said to be “earmarked” for the designated creditor. As a result, there is deemed to have been no transfer of an interest of the debtor in property, even if the property passes through the hands of the debtor on its way to the creditor. In re Montgomery, 983 F.2d at 1395. The earmarking doctrine, then, is a judicially-created defense that may be invoked by a defendant to a preference action in an attempt to negate
2. The Earmarking Defense Applied to Refinancing Transactions
When applying the earmarking doctrine in the context of a refinancing transaction, courts have split over whether to characterize the refinancing as a single unitary transaction or as a number of parts.7 Although Chase suggests that the multiple-transfer approach adopted by the First Circuit in In re Lazarus has been followed only by a small minority of bankruptcy courts, it is in fact the prevailing view. See Encore Credit Corp. v. Lim, 373 B.R. 7, 17 (E.D. Mich. 2007); George v. Argent Mortgage Co. (In re Radbil), 364 B.R. 355, 358 (Bankr. E.D. Wis. 2007); Baker v. Mortgage Elec. Registration Sys., Inc. (In re King), 372 B.R. 337, 341 (Bankr. E.D. Ky. 2007); Peters v. Wray State Bank (In re Kerst), 347 B.R. 418, 422 (Bankr. D. Colo. 2006); Gold v. Interstate Fin. Corp. (In re Schmiel), 319 B.R. 520, 528 (Bankr. E.D. Mich. 2005); Scaffidi v. Kenosha City Credit Union (In re Moeri), 300 B.R. 326, 329-30 (Bankr. E.D. Wis. 2003); Strauss v. Chrysler Fin. Co. (In re Prindle), 270 B.R. 743, 746-47 (Bankr. W.D. Mo. 2001); Sheehan v. Valley Nat‘l Bank (In re Shreves), 272 B.R. 614, 625 (Bankr. N.D.W. Va. 2001); Vieira v. Anna Nat‘l Bank (In re Messamore), 250 B.R. 913, 916 (Bankr. S.D. Ill. 2000). See also Goodman v. S. Horizon Bank (In re Norsworthy), 373 B.R. 194, 200 n. 3 (Bankr. N.D. Ga. 2007) (“Many courts have held that the ‘earmarking doctrine’ is not properly applied in the case of the transfer of a security interest.“). In actuality, the case upon which Chase relies, In re Heitkamp, 137 F.3d 1087, represents the minority view. As far as we are aware, the only courts that have followed it
(a) Refinancing Viewed as Multiple Transfers
In In re Lazarus, the court recognized that a financing transaction involves several distinct transfers. See In re Lazarus, 478 F.3d at 15-16. There, the debtor refinanced her residential mortgage loan which had been held by Washington Mutual Bank with Greater Atlantic Mortgage Corporation (“GAMC“) within 90 days prior to filing her Chapter 7 petition. Id. at 13. The new mortgage was not recorded until 14 days after GAMC disbursed funds to Washington Mutual Bank. And, as in the case before us, the mortgage discharge was not recorded until even later. Id. The Chapter 7 trustee sought to avoid the new mortgage as a preferential transfer due to the delayed perfection. Id. In response, GAMC argued that under the earmarking doctrine, the new mortgage did not result in a transfer of an interest of the debtor in property. The bankruptcy court and district court held in favor of GAMC.9 Id. at 14. The In re Lazarus court, however, sided with the trustee, holding that “because the [filing of the mortgage] occurred 14 days after the initial transfer of funds, section 547(e) requires that the transfer be deemed to have occurred on the date of perfection. The mortgage, therefore, secured a debt antecedent to the transfer rather than simultaneous with it.” Id. at 15. The First Circuit reasoned: “[I]n refinancing there are multiple transactions, including a new loan to the debtor, a mortgage back from the debtor to the new lender, a pre-arranged use of the proceeds of the loan to pay off the old loan and the release of the old mortgage.” Id. at 15-16. The court then rejected GAMC‘s contention that the transferred property interest was not that of the debtor, holding that the earmarking doctrine did not shield the transfer challenged by the trustee—the recording of the mortgage—from avoidance. Id.
(b) Refinancing Viewed as a Unitary Transaction
Chase primarily relies upon In re Heitkamp in support of its earmarking argument. In In re Heitkamp, the debtors were in the business of constructing and selling houses. 137 F.3d at 1088. In connection with their business, the debtors maintained lines of credit with several subcontractors and took out a loan with a bank secured by a mortgage on one of the houses built by the debtors. While the loan remained outstanding, the bank agreed to loan additional funds to the debtor secured by a second mortgage. Id. But instead of paying the funds directly to the debtors, the bank agreed with the debtors that it would issue cashier‘s checks to specified subcontractors who had already performed work for, or provided goods to, the debtors. In exchange for the checks, the subcontractors waived their mechanic‘s liens on the property against which the bank held the mortgages. The bank‘s second mortgage remained unrecorded for over three months and ultimately was recorded three days before the debtors commenced their Chapter 7 case.
3. Analysis
As an initial matter, we note that Chase is not a “new creditor,” and that this alone precludes it from successfully invoking the earmarking doctrine. Because Chase refinanced its own loan with the Debtor, it cannot establish this preliminary element of the earmarking defense. See, e.g., In re Lazarus, 334 B.R. at 549 (“The earmarking doctrine requires three specific parties: the ‘debtor,’ an ‘old creditor,’ and a ‘new creditor’ who pays the debtor‘s obligation to the old creditor.“); In re Bohlen Enters., 859 F.2d at 565 (same).
Yet even if we were to deem Chase to be a new creditor, the earmarking doctrine would not shield it from preference liability under the circumstances of this case. As did the First Circuit in In re Lazarus and the clear majority of courts that have decided the issue, we conclude that the earmarking doctrine does not protect the late-perfecting refinancer from preference exposure. We reach this conclusion because we find the analysis in In re Lazarus persuasive, and because we find In re Heitkamp‘s unitary-transaction approach to be fundamentally flawed in several respects.
First, In re Heitkamp‘s unitary-transaction theory ignores the plain meaning of the Bankruptcy Code. The common theme in the Supreme Court‘s bankruptcy jurisprudence over the past two decades is that courts must apply the plain meaning of the Code unless its literal application would produce a result demonstrably at odds with the intent of Congress. See, e.g., Hartford Underwriters Ins. Co. v. Union Planters Bank, Nat‘l Ass‘n, 530 U.S. 1, 6 (2000) (“[W]hen the statute‘s language is plain, the sole function of the courts—at least where the disposition required by the text is not absurd—is to enforce it according to its terms.“) (quotations omitted); Connecticut Nat‘l Bank v. Germain, 503 U.S. 249, 253-54 (1992) (“[I]n interpreting a statute a court should always turn first to one, cardinal canon before all others. We have stated time and again that courts must presume that a legislature says in a statute what it means and means in a statute what it says there. When the words of a statute are unambiguous, then, this first canon is also the last: judicial inquiry is complete.“) (citations and quotations omitted); United States v. Ron Pair Enters., Inc., 489 U.S. 235, 241 (1989) (“[W]here, as here, the statute‘s language is plain, the sole function of the courts is to enforce it according to its terms.“) (citations and quotations omitted).10 In re Heitkamp‘s extension of the
Chase urges us to follow In re Heitkamp and turn a blind eye to the plain meaning of the term “transfer” contained in
Second, applying earmarking to the transfer of a lien interest—as opposed to a transfer of funds—extends the doctrine beyond its logical limits. A debtor‘s grant of a mortgage lien in a refinancing transaction does not involve a transfer of “earmarked” property. Here, Lee did not serve as a conduit for the transfer of property from a third party to Chase. Rather, the transfer challenged by the Trustee—Lee‘s grant of a mortgage to Chase—was most assuredly that of a property interest owned and controlled by the Debtor. See In re Lazarus, 478 F.3d at 15 (“[U]se of the earmarking doctrine in this case is not
Third, to successfully invoke the earmarking defense, a preference defendant must demonstrate that the transfer in question did not result in a diminution of the debtor‘s bankruptcy estate. Although Chase claims no diminution, it arrives at this conclusion by pointing to its status at the inception of the refinancing transaction, a time when it indisputably had a perfected mortgage on the Property, and its status at the conclusion of the transaction—when it again had a perfected mortgage—and ignoring everything that happened in between. But focusing on the actual transfer at issue, Chase‘s perfection of the New Mortgage, clearly reveals that Lee‘s bankruptcy estate was in fact diminished. From the point that the New Loan was made and the Original Mortgage discharged up until such time as the New Mortgage was recorded, Chase did not hold a perfected lien interest. Thus, Chase‘s subsequent perfection of the New Mortgage diminished Lee‘s estate because the non-exempt equity in the Property that otherwise would have been available for distribution to Lee‘s unsecured creditors became encumbered, and unavailable to unsecured creditors, by the New Mortgage that Chase received.
Finally, applying the earmarking doctrine to insulate Chase from preference liability would essentially write
For all these reasons, we conclude that the earmarking doctrine does not protect Chase from preference liability.
C. Diminution—§ 547(b)(5)
Chase contends, and the Trustee concedes, that
Chase argues that imposing preference liability on it would be unfair and against public policy because the refinancing transaction involved a mere substitution of its New Mortgage for the Original Mortgage and ultimately benefitted the Debtor‘s other creditors, not Chase. According to Chase, the refinancing reduced the amount of the Debtor‘s monthly mortgage payments, causing more funds to be available for other creditors. Moreover, Chase argues, it derived no benefit from the refinancing transaction and should not be penalized for assisting the Debtor in his attempt to avoid bankruptcy. However, “whatever equitable powers remain in the bankruptcy courts must and can only be exercised within the confines of the Bankruptcy Code.” Norwest Bank Worthington v. Ahlers, 485 U.S. 197, 206 (1988). See also Southmark Corp. v. Grosz (In re Southmark Corp.), 49 F.3d 1111, 1116 (5th Cir. 1995) (“Although
The problems that arise when courts effectively rewrite bankruptcy statutes in order to reach a result deemed “equitable” are illustrated by the bankruptcy court‘s decision that was reversed by In re Lazarus. Apparently recognizing the potentially open-ended effect of its ruling, the bankruptcy court there stated that it was not holding “that the earmarking doctrine necessarily applies to a refinancing transaction where the length of time between the transfer of value to the old creditor and the perfection of the new security interest is so extensive that a material issue of fact has arisen relative to the parties’ intention.” In re Lazarus, 334 B.R. at 553. But that begs the question: What length of time period would be too extensive—six months, one year, longer? The approach taken by that court, overturned by the First Circuit in In re Lazarus, and the approach advocated by Chase here substitutes the judgment of the courts for that of Congress. Congress, by enacting
Moreover, the result in this case, although arguably harsh, could have readily been prevented by Chase. On this point, our prior decision in In re Lewis is instructive. There, a late-perfecting mortgagee argued that we should apply the doctrine of equitable subrogation to insulate it from preference liability. In re Lewis, 398 F.3d at 746-47. In declining to apply the equi-
[The late-perfecting mortgagee] is a sophisticated creditor who had complete control over the recording of the signed mortgage. It offers no explanation for the more than seven-month delay between the signing and recording of the mortgage. Its own negligence led to the dilemma created by the debtor‘s filing for bankruptcy.
Id. at 747. See also In re Lazarus, 478 F.3d at 16 (“[T]he penalty [of lien avoidance] is not without a general benefit—pour encourager les autres—and is easily avoided by recording within 10 days as the statute directed.“).
Chase is a sophisticated lender well aware of the consequences of failing to perfect its security interest within the grace period afforded by
III. CONCLUSION
For the foregoing reasons, we hold that the recording of the New Mortgage is a preferential transfer under
MERRITT, Circuit Judge, dissenting.
Our court‘s opinion in this case, in my judgment, is wrong and further establishes a split in the circuits on the preference issue in mortgage refinancing transactions. I agree with the District Court and the Eighth Circuit in In re: Heitkamp, 137 F.3d 1087 (8th Cir. 1998), that we should look to the purpose, consequences, details, and common sense of the complete financing transaction at issue here and not just one little part of the transaction, i.e., the recording of the second mortgage more than 10 days after the execution of the second note and mortgage. We should look to see whether anyone was misled or whether the bankruptcy estate was diminished for reasons prohibited by Congress.
What happened here is that a lender (Chase) received a new promissory note and mortgage deed from the debtor on October 6, 2003, arising from the refinancing of an old mortgage. But the lender did not get the old mortgage “discharge” document formally recorded on the books of the Register of Deeds for over three months. And it did not get the new mortgage recorded for over two months. If one does not want to look at the reality of the situation but only at bankruptcy legalisms, then the lender should be viewed as retaining an old, non-discharged, 2-1/2 year-old mortgage on the books of the Register of Deeds office for a month after the new mortgage was recorded. No one doing even a cursory title search could have failed to see that the lender had a mortgage on the property from long before the debtor‘s bankruptcy. No creditor, secured or unsecured, could have possibly been misled into believing that the lender did not have a mortgage on the debtor‘s property or into believing that the debtor owned his house free and clear. From early 2001 until January 16, 2004, the records at the public mortgage office showed an original, non-discharged mortgage and from December 17, 2003, to January 16, 2004, the title search would have shown simultaneously both the old and the new mortgage on the property. Based on the public record, unsecured creditors would have known that the house was mortgaged
R. GUY COLE, JR.
UNITED STATES CIRCUIT JUDGE