FYI: Ill App Ct (1st Dist) Holds Equitable Owner Not Necessary Party in Mortgage Foreclosure

The Illinois Appellate Court, First District, recently held that an entity with only a purported equitable interest in a property was only a permissive party to a foreclosure and not a necessary party, and therefore the plaintiff mortgagee was not required to serve the entity with process.  Thus, the allegedly defective service did not provide a basis to vacate the judgments entered against it.  

 

Additionally, the Court held that because lack of proper service was not apparent from the face of the record, the foreclosure sale buyer's interest in the property was protected.

 

Accordingly, the First District affirmed the ruling of the trial court dismissing the petition to vacate all orders under 735 ILCS 5/2-1401. 

 

A copy of the opinion is available at:  Link to Opinion

 

In October 2005, a bank ("Bank") extended a mortgage loan ("Loan") to an individual ("Borrower"), which loan was secured by residential property ("Property").  The Borrower stopped making payments on the Loan in October 2008.

 

On November 22, 2008, the Borrower executed a "Memorandum and Affidavit of Equitable Interest" that purported to grant a limited liability company ("LLC") an equitable interest in the Property.  The Memorandum was filed with the recorder of deeds in December 2010.  However, the Memorandum did not identify the LLC's mailing address, registered agent, or where it was formed.  Records later filed in the trial court revealed that the LLC was formed in New Mexico, and the Borrower was its sole member.

 

In 2009, the Bank filed a complaint to foreclose mortgage naming the Borrower and the LLC as defendants.  The Bank filed an affidavit of service by publication on the Borrower and the LLC saying that, after diligent inquiry, it was unable to locate them.  Notice was subsequently published, filed in the circuit court, and mailed to the Borrower at four different addresses.

 

The Bank subsequently filed an affidavit of special process server, stating that an Illinois limited liability company with the same name as the defendant LLC was served by leaving a copy of the summons and complaint with its registered agent.

 

In October 2009, the Bank filed a motion for default order against the Borrower and the LLC.  In May 2010, after the Borrower and LLC failed to answer or otherwise plead, the trial court entered an order of default and judgment of foreclosure.  The Property was subsequently sold at a sheriff's sale, and the trial court entered an order approving sale.  The Property was then conveyed to the Bank by judicial sales deed. 

After several conveyances, in August 2011, the Property was conveyed to the current homeowner ("Homeowner").

 

More than five years later, in November 2016, the LLC filed an appearance and petition to quash service and vacate all orders under section 2-1401 of the Illinois Code of Civil Procedure ("Code") (735 ILCS 5/2-1401).  In its petition, the LLC argued that the Bank served the wrong entity, and therefore it was never properly served and the orders entered against it were void.

 

The Bank and Homeowner moved to dismiss, arguing (1) the LLC had been properly served by publication, (2) the LLC could not bring the petition having never registered to do business in Illinois, (3) the LLC lacked standing to challenge the judgment as it had no bona fide interest in the Property, (4) the LLC was on notice of the foreclosure because its sole member, the Borrower, appeared, and (5) section 2-1401(e) of the Code protects the interest of the Homeowner because he is a bona fide purchaser for value. 

 

In response, the LLC argued that (1) the Limited Liability Company Act ("LLC Act") does not permit service by publication, (2) it was not required to register under the LLC Act because merely owning property in Illinois does not constitute transacting business under the Act, (3) the special process server did not serve it, (4) its standing to challenge the foreclosure judgment arises from an equitable interest in the Property, (5) a void judgment may be attacked at any time, and (6) the Homeowner was not a bona fide purchaser and his interest was not protected under section 2-1401(e) because lack of jurisdiction was apparent from the record.

 

The trial court granted the motions, finding that the Code and the "catchall" provision of the LLC Act permitted service by publication.  The matter was appealed. 

 

On appeal, the Bank and Homeowner argued for the first time that the LLC was not a necessary party to the foreclosure, and therefore the trial court did not err in dismissing the LLC's petition.  The First District determined that because the factual basis for the appellee's argument - that the LLC had not valid interest in the Property - was before the trial court, it could consider the necessary party argument for the first time on appeal.

 

In analyzing the issue, the Court noted that the Illinois Mortgage Foreclosure Law provides that the necessary parties to a mortgage foreclosure action are "(i) the mortgagor and (ii) other persons (but not guarantors) who owe payment of indebtedness or the performance of other obligations secured by the mortgage and against whom personal liability is asserted."  735 ILCS 5/15-1501(a).  Moreover, "[o]ther person, such as other mortgagees or claimants, may be joined, although they are not necessary parties."  735 ILCS 5/15-1501(b).

 

In its complaint, the Bank sought a deficiency only against the Borrower, which meant that the LLC was not a party "against whom personal liability is asserted."  Moreover, the LLC's purported equitable interest in the Property did not transform it into a mortgagor.

 

Thus, the LLC "may have been a permissive party, not a necessary party," and therefore "the failure to make [the LLC] a party did not divest the trial court of authority to enter the foreclosure judgment and confirm the sale." 

 

Accordingly, "[the Bank] was not required to serve process on [the LLC] and the trial court did not err in dismissing the section 2-1401 petition to quash service and vacate the default judgment." 

 

Additionally, the First District determined that "a bona fide purchaser for value, like [the Homeowner], is protected by section 2-1401(e) of the Code." 

 

Section 2-1401(e) protects third-party purchasers of a property from the effects of an order setting aside a judgment affecting title to a property as long as the defect in service is not apparent from the face of the record. 

 

The Court determined that the Homeowner "could not tell from the record that the trial court did not have jurisdiction over [the LLC] due to improper service until [the LLC] filed its section 2-1401 petition, attaching as exhibits the Illinois Secretary of State documents and the New Mexico documents."

 

Accordingly, "[b]ecause [the Homeowner] was a bona fide purchaser, [the LLC] cannot collaterally attack the foreclosure judgment."

 

 

 

Ralph T. Wutscher
Maurice Wutscher LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct:  (312) 551-9320
Fax: (312) 284-4751

Mobile:  (312) 493-0874
Email: rwutscher@MauriceWutscher.com

 

Admitted to practice law in Illinois

 

 

 

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FYI: 7th Circuit Holds Creditor Liable for Its Counsel's Bankruptcy Discharge Violation

The U.S. Court of Appeals for the Seventh Circuit recently affirmed in part and reversed in part a trial court's judgment against a debtor who filed an adversary proceeding alleging that a creditor and its counsel violated the bankruptcy discharge by trying to collect a discharged debt, holding that the attorney could not be held in contempt because he lacked of knowledge of the discharge, but the creditor could be held liable for the actions of its counsel under agency law.

 

A copy of the opinion is available at:  Link to Opinion

 

The plaintiff failed to pay her membership fees to a health club, and in July of 2001, the law firm representing the club filed a collection action in state court. In February of 2002, a default judgment was entered against the plaintiff.

 

The law firm engaged in post-judgment collection efforts and the judgment debtor failed to show up at several hearings to show cause, resulting in the entry of a writ of bodily attachment or bench warrant against her in April of 2010. Almost a year later, she was arrested by a police officer who stopped to help her with a flat tire and discovered the outstanding warrant.

 

Unbeknownst to the law firm, the judgment debtor had filed for bankruptcy in 2009 and listed the health club as a creditor, receiving a discharge in January of 2010. The notice of discharge was mailed to the club, but its manager failed to notify the law firm. The debtor also failed to notify both the state court and the law firm that the debt had been discharged, despite a local bankruptcy court rule requiring her to do so.

 

The debtor sued the creditor and its law firm in state court, but that suit was dismissed for lack of subject matter jurisdiction.

 

The debtor then filed an adversary complaint in bankruptcy court seeking to hold the defendants in civil contempt for violating 11 U.S.C. § 524 by trying to collect a discharged debt.

 

After a bench trial, the bankruptcy court ruled in favor of the defendants, reasoning that the individual lawyer for the creditor involved in the case lacked knowledge of the discharge, had no duty to inquire, and the debtor failed to notify him of the discharge. As to the creditor, the bankruptcy court found that although the creditor received notice of the discharge, it did not willfully violate the discharge order because after referring the case for collection in 2001, "there was no evidence that [the creditor] was aware of the status of its case against [the debtor] or that it directed [the lawyer] to take any particular action in the case."

 

The trial court affirmed the bankruptcy court's judgment and the debtor appealed.

 

On appeal, the Seventh Circuit explained that "[w]hen a party violates a bankruptcy court's order by pursuing a discharged debt, the debtor can ask that the court hold that party in contempt. … But the debtor can do so only for willful violations. … A willful violation … require[s] that the offending party both violated the court's order and had 'actual knowledge that a bankruptcy is under way or has ended in a discharge." The debtor has "the burden of proving the defendants' contempt by clear and convincing evidence."

 

The Court first addressed whether the creditor had actual knowledge of the discharge, agreeing with the bankruptcy court's finding that the creditor knew the debt had been discharged because the notice as mailed by the bankruptcy court, and the creditor offered no evidence that the notice had not been received, entitling the plaintiff to the presumption that it was received.

 

Turning to the second prong of the test -- "violative action" -- the Court disagreed with the bankruptcy and trial courts because while the creditor "had itself taken no action that violated the discharge order", the lower courts' finding reflected "an error in legal reasoning", namely that the creditor was "responsible for only its own actions and not those of [its counsel]."

 

The Court explained that it has "repeatedly stated that clients are bound by their counsel's conduct[,][which] … makes perfect sense when viewed through the lens of agency law:  the clients are principals, the attorney is an agent, and under the law of agency the principal is bound by his chose agent's deeds.'"

 

Applying agency law, the Seventh Circuit concluded that the creditor's counsel was acting within the scope of his authority when he continued the state court collection case against the debtor in violation of the discharge order and that the attorney's "actions, imputed to [the creditor], were taken despite [the creditor's] knowledge of the discharge order, meeting the requirements for civil contempt. The bankruptcy court erred as a legal matter by concluding otherwise. … Our conclusion here is not only consistent with our circuit precedent, it is sensible. Holding otherwise would create a loophole in the law through which creditors could avoid liability simply by remaining ignorant of their agents' actions or by failing to notify their agents of debtors' bankruptcy proceedings. We decline to incentivize such careless behavior."

 

Turning to the attorney's knowledge, the Appellate Court found that "[t]he bankruptcy court's finding that [the attorney] did not have the requisite knowledge was reasonable and was supported by the evidence. We see no clear error in it."

 

Thus, the attorney/agent was "in the inverse position" of its client/principal. However, "[u]nlike with the [creditor/principal], we do not impute the principal's knowledge to the agent."

 

Because the attorney did not have knowledge of the discharge order and the principal's knowledge is not imputed to the agent, the attorney "cannot have willfully violated the discharge order and cannot be held in contempt. Both the district court and the bankruptcy court correctly concluded as much, and we affirm their rulings."

 

Finally, the Court gave a "final word of caution[,]" explaining that although it concluded that the creditor "acted in contempt, we not that this regrettable event could have been avoided had" the debtor complied with the local bankruptcy rule requiring her to give notice of the discharge and left "to the bankruptcy court's discretion whether to factor this into the damages calculation."

  

Accordingly, the Seventh Circuit affirmed in part and reversed in part the trial court's judgment and remanded the case to the bankruptcy court for further proceedings.

 

 

 

 

Ralph T. Wutscher
Maurice Wutscher LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct:  (312) 551-9320
Fax: (312) 284-4751

Mobile:  (312) 493-0874
Email: rwutscher@MauriceWutscher.com

 

Admitted to practice law in Illinois

 

 

 

Alabama   |   California   |   Florida   |   Georgia  |   Illinois   |   Massachusetts   |   New Jersey   |   New York   |   Ohio   |   Pennsylvania   |   Texas   |   Washington, DC

 

 

NOTICE: We do not send unsolicited emails. If you received this email in error, or if you wish to be removed from our update distribution list, please simply reply to this email and state your intention. Thank you.

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