Memorandum of Decision Re: Disguised Security Transaction

FOR THE NORTHERN DISTRICT OF CALIFORNIA In re LENDVEST MORTGAGE, INC.,                                       No. 1-88-01058      Debtor. ___________________________/ CHARLES E. SIMS, Trustee,      Plaintiff,    v.                                                                                        A.P. No. 1-89-100 LENDVEST MORTGAGE FUND II, GARDNER and DOREEN LEIGHTON,      Defendants. ______________________________/
Memorandum and Order
     Plaintiff Charles E. Sims is the trustee of the estate of Lendvest Mortgage, Inc. (hereafter, "Lendvest"), a now-defunct mortgage company formerly known as Napa Valley Mortgage Co., Inc. Like many other mortgage brokers which have ended up in bankruptcy, Lendvest went beyond the mere brokering of loans. It made secured loans in its own name and then assigned the notes and their securing deeds of trust to investors, giving the investors a written guarantee that if the borrower failed to pay the note Lendvest would make the investor whole.      Lendvest was the general partner of a limited partnership known as Lendvest Mortgage Fund II (hereafter, "Fund"); its limited partners were investors. Lendvest used Fund to hold notes on a short-term basis, pending their transfer to investors.      Defendants Gardner and Doreen Leighton are investors who invested in two promissory notes, a $30,000.00 note made by Michael Pring and Pamela Bright (hereafter, the "Pring note") and a $21,000.00 note made by Ronald and Susan Bushby (hereafter, the "Bushby note"). There is one significant difference between the two notes. The original payee on the Pring note is Lendvest, which made the loan in its own name a few weeks before the note was assigned to the Leightons. However, the Leightons themselves are the payees on the Bushby note.      The originals of both notes were held by Lendvest when it filed its bankruptcy petition; the Leightons had given Lendvest their power of attorney to service the loans and execute any documents in their name.      Shortly before bankruptcy, the Leightons informed Lendvest that they wished to cash out their investment. In order to raise the cash, Lendvest used the powers of attorney to assign the Pring and Bushby notes to Fund, which paid $51,000.00 to Lendvest. The notes remained in the possession of Lendvest, which put the $51,000.00 into its general account. As of the filing date of the bankruptcy, the Leightons had received nothing.      The Trustee instituted this adversary proceeding to establish that it owned the Pring and Bushby notes by virtue of possession, and that any interest in them held by either Fund or the Leightons is avoidable. The Fund having reached a settlement with the Trustee, the only issue left for the court to decide is whether the Leightons have any remaining interest in the notes.      The Leightons clearly have no tenable claim to the Pring note.      Since they did not have possession of the note, their interest in it is avoidable under section 544(a) of the Bankruptcy Code as unperfected if its transfer from Lendvest to them is deemed to be a transfer for security purposes and not an outright sale. In re Staff Mortgage & Inv. Corp. (9th Cir.1980) 625 F.2d 281. Only if the transfer was a true sale would the Leightons have any rights in the note notwithstanding their lack of possession. In re Golden Plan of California, Inc. (9th Cir.1986) 829 F.2d 705, 708. The form of the documents is not controlling; it may be properly determined from all the facts and circumstances that the bargain was a security transaction and not a sale, even if all the documents recite that it is a sale. In re The Woodson Company (9th Cir.1987) 813 F.2d 266. The protests of the investor that no security transaction was intended cannot overcome the effect of the documents themselves. In re Executive Growth Investments, Inc. (Bkrtcy.C.D.Cal.1984) 40 B.R. 417, 420.      The dispositive test of whether the transfer was a sale or a security transaction is whether the investor received a contractual guarantee of repayment from the debtor, so that the risk of loss was shifted from the investor to the debtor. In re Golden Plan, at 709; In re The Woodson Company, at 271. In Golden Plan, the trustee lost because although the debtor had advanced funds to investors in bad loans, it was not contractually obligated to do so. In Woodson, the trustee won because the debtor had issued its written guarantee to the investors.      In this case, the documents signed by the Leightons are virtually identical to those before the court in Woodson, and this court accordingly has no trouble finding that the transfer of the Pring note to the Leightons was a security transaction notwithstanding the form of the documents. Accordingly, their lack of possession is fatal to their claim to ownership of the Pring note.      This case is not distinguishable from Woodson because the debtor here did not have an insurance policy to protect its investors. The court in Woodson did not base its holding on the fact that there was insurance. The holding there was based on documents, indistinguishable from those now at issue, which the court found created a debtor-creditor relationship between the mortgage company and the investors.      The Leightons have raised the indisputed wrongdoing and fraud of Lendvest as defenses to this action, but such defenses are not permitted. The Trustee has brought this action for the benefit of the creditors of Lendvest, not Lendvest itself. Accordingly, the wrongdoings of the debtor do not constitute defenses. In re Davis, 785 F.2d 926 (11th Cir.1986); Matter of Intern. Gold Bullion Exchange, Inc., 60 B.R. 261, 264 (Bkrtcy.S.D.Fla.1986).      The Leightons' interest in the Bushby note is not so easily resolved, as there is a key factual difference. The Pring note was at one time owned by Lendvest, and transferred by Lendvest to the Leightons. Accordingly, to resolve the dispute the court needed only to apply the Woodson and Golden Plan tests to decide if the transfer was in substance absolute or for purposes of security. However, there was no transfer of the Bushby note from Lendvest to the Leightons; the Leightons are the original payees. The Trustee can prevail as to the Bushby note only if the court finds that every note guaranteed by a mortgage broker is in substance owned by the broker if the broker retains possession for loan servicing purposes. Such a result is not mandated by Woodson. While it is possible that such a holding could be reached in a proper case, the court finds here that the documents alone, which are the only evidence offered by either side, do not support a finding that the Leightons were not the owners of the Bushby note.      However, a finding that the Leightons' interest in the Bushby note is not avoidable as an unperfected security interest does not mean that they have any rights left in the Bushby note. Using the power of attorney which they granted, Lendvest assigned the note to Fund and received full payment for it. If the assignment was valid and the cash received for it commingled with Lendvest's general funds, then the Leightons may still be nothing more than unsecured creditors.      Since the parties did not address the last issue, it is clear that further evidence must be taken and further argument heard before a judgment can be rendered. While the court would not ordinarily allow further evidence after taking a matter under submission, it appears in this case that the Leightons "sandbagged" the Trustee by representing that they would not appear in the matter and then filing their answer and appearing on the eve of trial. It therefore seems appropriate to reopen the case for further evidence and argument.      Further, the court recognizes that several of the facts recited in the first five paragraphs of this memorandum are derived from other trials the court has held, but are not substantiated by the record in this adversary proceeding. Fairness dictates that any disputed facts must be based on proper evidence.      Accordingly, the court orders as follows:
     1. A status conference shall be held in this matter on October 29, 1990, at 2:00 P.M. in Santa Rosa. At that time, a new trial date shall be set as to any issues remaining to be decided.
     2. On or before October 22, 1990, each side shall file a statement detailing all facts stated in the first five paragraphs of this memorandum which it contests. Any facts which are not included in such statements will be deemed admitted.
Dated: September 17, 1990                                                                          _______________________                                                                                                                      Alan Jaroslovsky                                                                                                                      U.S. Bankruptcy