Legacy Bank v. John F. Holmes and Ruthann Holmes ( 2015 )

IN THE COURT OF APPEALS OF IOWA
No. 14-1591
Filed November 25, 2015
LEGACY BANK,
Plaintiff-Appellee,
vs.
JOHN F. HOLMES and
RUTHANN HOLMES,
Defendants-Appellants.
________________________________________________________________
Appeal from the Iowa District Court for Johnson County, Paul D. Miller,
Judge.
Mortgagors appeal the district court’s foreclosure ruling. AFFIRMED.
Thomas D. Hanson of Dickinson, Mackaman, Tyler & Hagen, P.C., Des
Moines, for appellants.
John D. Hunter, Alexander M. Johnson, and Haley R. Van Loon of Brown,
Winick, Graves, Gross, Baskerville & Schoenbaum, P.L.C., Des Moines, for
appellee.
Heard by Vogel, P.J., and Vaitheswaran and Bower, JJ.
2
BOWER, Judge.
John and Ruthann Holmes appeal the district court’s ruling foreclosing
mortgages in favor of Legacy Bank on their residence. The Holmes family claims
the Small Business Association (SBA) is an indispensable party to this consumer
foreclosure. SBA became a junior lienholder on the residence after it authorized
a commercial loan for John Holmes Publishing Company (“JHP Company”). The
Holmes family also claims the doctrine of equitable estoppel should preclude
Legacy Bank from an award of a deficiency judgment. We affirm.
I. Background Facts and Proceedings
John’s long-term accountant, David Merritt, started working for DeWaay
Financial Management. Merritt and a financial advisor, also from DeWaay, called
Brian Chittenden, executive vice president of Legacy Bank, and invited
Chittenden to a lunch meeting with John. Chittenden testified the “main points”
of discussion were John’s company, the company’s history, the company’s
business, and what John had done “for a number of years, that [John] was in a
couple of lending relationships and institutions that they were thinking about
changing, and that might include, at some point, in looking at some loans with the
company as well.”
Thereafter, the Holmes family asked Legacy Bank to consolidate and
refinance some of the family’s existing debt—a note secured by their personal
residence (an Iowa City condominium) and a note “against investment accounts.”
On August 6, 2008, the Holmes family refinanced those obligations by executing
a promissory note in favor of Legacy Bank for $1,109,935 at 6.5% interest. The
3
note was separately secured by an August 6, 2008 open-end mortgage on the
condominium and by an “assignment [of investment accounts] dated 8-6-2008.”
The 2008 mortgage also secured “[a]ll future advances from [Legacy Bank] to
Mortgagor (the Holmes family) or other future obligations of [the Homes family] to
[Legacy Bank] under any promissory note.” The 2008 mortgage became the first
lien on the family condominium, and the family regularly paid the note’s $7000
monthly payment.
John testified that in 2009, he hired an independent attorney to advise him
about the SBA loan process for JHP Company and about “some of these other
related issues about money we owed.” John approached Chittenden about the
possibility of Legacy Bank financing “the next phase” of JHP Company, i.e.,
consolidating its business debt and adding a “large amount” of additional debt for
implementation of technology upgrades. Legacy Bank contracted with a third
party to attempt to obtain a SBA loan for John’s company. John’s attorney
assisted him during the negotiations for and execution of the SBA loan.
John testified he retired from the day-to-day management of his company
in 2008. However, during the SBA loan process in November 2009, John and
Ruthann signed a personal financial statement listing their net worth at $864,446
and stating John’s yearly salary was $399,426. John and Ruthann assigned a
value of $800,000 to their condominium, while identifying the 2008 Legacy Bank
mortgage and a second mortgage for a Regions Bank home equity loan.1
1
During the foreclosure process, Legacy Bank valued the condominium in the $600,000
range.
4
John testified the whole process with the SBA took longer than he
expected, causing him to dip into his cash reserves “to float the company in the
meantime.” However, John also testified he was “pulling too much money out of
[his] company.” John agreed that at the time he entered into the SBA loan in
February 2010, he certified JHP Company was in good condition. Chittenden
explained it took a long time from John’s initial discussions with the bank to a
completed business loan:
The bulk of the issue . . . was kind of a vague . . . amount of
money that was brought up at different times. And it wasn’t really
ever the same amount. And there was a desire for us to have a . . .
very good accounting for what the money was going to be used for,
the strategic plan for the money, [along with] multiple different
documentation needs . . . to do a SBA financing package that
[Legacy Bank] had hired a third party to put together.
....
The SBA process is a very lengthy process, in which there
are a number of different application steps. There are a number of
different documentation requirements,[2] a number of background
checks, a lot of vetting of [the] history of the company, financial
performance, and the ongoing viability and projections of what the
company expects to achieve with the capital deployed.
On December 28, 2009, the SBA approved Legacy Bank’s application for
“SBA to guarantee 90% of a loan . . . in the amount of $1,300,000 to assist” JHP
Company. In the loan authorization, SBA instructed Legacy Bank to close the
loan and listed numerous SBA forms Legacy Bank, as the lender, was required
to use, including note, guarantee, and limited guarantee. SBA required Legacy
Bank to document that JHP Company “used the loan proceeds for the purposes
stated in this authorization.”
2
For example, the SBA required a real estate appraisal of JHP Company’s real property,
which valued that property at $225,000. The SBA required life insurance on John’s life
“satisfactory to lender.”
5
Chittenden testified that as a part of the SBA process, the Holmes family’s
2008 “note for the condo residence and the investment accounts had to be
redone because of the need for the SBA to have certain pieces of collateral,” i.e.,
the investment accounts. In the SBA authorization, SBA required Legacy Bank
to perfect liens on collateral, including (1) a first mortgage lien on the real
property of JHP Company; (2) a first perfected security interest in JHP Company
personal property (equipment, fixtures, inventory, accounts, etc.); (3) an
assignment to Legacy Bank by John F. Holmes (shareholder of JHP Company)
of all interest in DeWaay Capital Management brokerage account; (4) a
“guarantee on SBA form 148, by John F. Holmes” secured by a third mortgage
on the condominium that is subject only to two specific prior liens—Legacy Bank
($856,000) and Regions Bank ($76,150); and (5) a guarantee from Ruthann
Holmes, also secured by SBA’s third mortgage on the condominium.
On February 1, 2010, John sent a letter to the day-to-day manager of JHP
Company, Charis Lloyd, terminating her employment.3 Also on February 1,
2010, the Holmes family executed a personal note in favor of Legacy Bank in the
amount of $884,677.62 at 5.75% interest, listing the purpose as “refinance
personal residence.” This refinancing lowered the family’s monthly payments to
3
Interestingly, although John would certify to the SBA on February 5, 2010, that his
company’s financial position had not changed during the application process, John’s
February 1 letter to Lloyd stated:
You are well aware of [JHP Company’s] dire financial condition,
including the company’s substantial delinquency with Legacy Bank.
Holmes Publishing is insolvent. According to the bank, their willingness
to forbear has been exhausted. I anticipate that the bank will soon
acquire all of the pledged assets of the business, either by foreclosure or
by means of a forced turnover.
6
$5000 a month. Chittenden testified the family’s 2010 note essentially replaced
the family’s 2008 note.4 The 2010 consumer note stated it was “separately
secured by” a “real estate mortgage dated 8/8/2008 and an assignment of life
insurance and an assignment of investment accounts dated 2/1/2010.” Thus,
Legacy Bank retained its position as first mortgagee on the condominium.
Several documents were executed on February 5, 2010. Legacy Bank
signed the SBA loan authorization and accepted the SBA’s conditions. JHP
Company executed a SBA7(a) loan for $1,300,000. This was a 90/10 loan,
meaning the loan was 90% guaranteed by the SBA and Legacy Bank carried
10% of the loan. JHP Company executed a borrower’s certification, with John
initialing each paragraph, and stating in relevant part: “A(2) Borrower and [JHP
Company] (Operating Company) certify . . . [t]hat there has been no adverse
change in Borrower’s (and Operating Company) financial condition, organization,
operations or fixed assets” and “C(6) Borrower and Operating Company will
not . . . [a]llow total annual salaries . . . to officers or owners of borrower and
operating company, and their immediate family members, to exceed $135,000.”
Also on February 5, 2010, the Holmes family executed an open-end mortgage on
their condominium for $1,300,000 in favor of Legacy Bank.
In March 2010, Legacy Bank sold the SBA-guaranteed portion of the loan,
much like the sale of a mortgage, for a premium of over $88,000. After the sale,
the bank still had its 10% of the loan on its books.
4
We observe the 2008 note in our record is marked: “Note Paid in Full 2-1-10 Legacy
Bank.”
7
According to Chittenden, JHP Company started missing its loan payments
“within the first twelve months, and the company was, basically, bleeding cash for
quite a lengthy period of time.” John and his attorney met with Legacy Bank
several times, trying to figure out a solution. The bank was told the new products
“were implemented but had not taken off yet.” The bank “petitioned the SBA to
change the payments to an interest-only payment structure . . . to try to give time
for some of the new products that they were developing to take hold.”
In 2011, John and Ruthann failed to make the payments on the February
2010 consumer note. Legacy Bank worked with the Holmes family on options to
keep them in the property.
John’s attempt to sell the business was unsuccessful, and at some point
the cash flow for JHP Company ran out. John and his attorney worked with the
bank to reach a resolution on the business debt. Legacy Bank had to decide
whether to foreclose the business or to request John turn over the business for
the bank “to salvage what was left.” Chittenden explained why the bank was
willing to try a turnover of assets:
[W]e hired a couple of experts to go out and look at the
business to try to see what the problems were because of the
speed at which it had faltered. And [the opinions from several
sources were] that they believed it was a large management
problem and a pay problem with some of the senior staff. And our
intention was to come up with a solution where, hopefully, we could
save the business, show value, and . . . obviously pay our notes off
and get John and Ruthann out of the issue.
On February 1, 2012, Legacy Bank entered into a Master Agreement with
the company and its guarantors, the Holmes family, in which Legacy Bank took
over JHP Company. The bank hoped to put the company in a better position to
8
sell, and John had no further role in the business. Legacy Bank hired a bank
subsidiary to run JHP Publishing. John testified he thought the company would
become profitable after the turnover because he “believed in” the subsidiary
group hired to run the company. Specifically, John thought company profits
would ensue because he had given up his salary, “which I admitted was too high;
Charis’s was way out of bounds, her daughter. And we had twice the employees
we needed.” Therefore, “we lowered our employee compensation over a million
dollars a year from what it was about a year before that. The big parts of that
was John Holmes’ [salary,] Charis Lloyd’s salary, and Wendy Lloyd’s.” John
believed the company had pretty good sales and also thought the salary
reductions “gave [the subsidiary], say, a million dollars profit in addition to what
they were going to make.” But any possible sale of the company by Legacy
Bank was delayed when Charis Lloyd sued the company and Legacy Bank. JHP
Company filed a counterclaim against Lloyd alleging breach of fiduciary duty.
The company did not assert a third-party claim against Legacy Bank. At the
subsequent trial on the consumer notes, John admitted Lloyd’s lawsuit would
make the bank’s sale of the business virtually impossible.5
Seven months after the Master Agreement, in September 2012, Legacy
Bank sent the Holmes family a notice to cure the consumer default. In November
2012, Legacy Bank filed a petition to foreclose and request for lis pendens index,
alleging the Holmes family entered into the 2008 and 2010 notes and mortgages,
with the February 5, 2010 mortgage entered into “in order to secure the payment
5
The employment dispute was settled shortly before the trial commenced on the
consumer-loan foreclosure.
9
of [the 2010 note] and other obligations.” The bank sought a personal judgment
against the Holmes family for the principal sum of $873,285.88 plus interest
through October 18, 2012 ($137.57 per day). The bank also sought judgment in
rem against the real estate, attorney fees, and a post-sale deficiency judgment.
The bank filed a motion for summary judgment. The Holmes family’s April 2013
answer included numerous affirmative defenses and asked for dismissal. The
Holmes family resisted summary judgment and in October 2013, filed a demand
for delay of sale. Also in October 2013, the court denied Legacy Bank’s first
motion for summary judgment, stating the affirmative defenses raised fact issues.
Trial commenced on November 7, 2013, with Chittenden and John
testifying. John testified the consumer notes tied to the 2008 mortgage on their
condominium were separate loan transactions and separate obligations from
John’s company’s loan obligations. At the close of the evidence, the Holmes
family moved for a directed verdict, claiming the foreclosure proceedings should
be stayed or dismissed because the SBA was not served with notice of the
proceedings and also claiming the bank’s conduct was so inequitable that the
court should decline to enter a deficiency judgment.
While the court’s resolution of the consumer foreclosure was pending,
Legacy Bank accessed the Holmes family’s investment accounts. Their attorney
e-mailed the bank’s attorney and protested. On February 28, 2014, the bank’s
attorney replied, explaining Legacy Bank, as the bank making the loan subject to
a SBA guaranty, “is in charge of servicing and collecting on the loan.” Also:
1. Legacy Bank has a security interest in the Holmes’
accounts as acknowledged in your e-mail. In connection with that
10
security interest the Bank, the Holmes, and [the brokerage]
executed a control agreement. The control agreement allows the
Bank to offset the accounts in the event of a default. A judgment
isn’t required.
2. The amounts acquired . . . will be applied to the SBA
note.
3. The Bank has not “defrauded” the Holmes. These
accounts are security for the SBA note, and the Bank is acting in
accordance with the agreements.
In March 2014, the Holmes family filed an application to reopen the
evidence, stating the seized “accounts were those that had been pledged by
Ruthann Holmes to the [SBA] to support the SBA guarantee. These were the
same accounts that the [Bank] claimed it had a right to seize to reduce the
deficiency it expected to have after foreclosure.” Also, “the Bank has shown
nothing to indicate that the ‘SBA Note’ is in default,” and there “is no reason to
believe the Bank’s claims the ‘proceeds will be used to pay down the SBA
loan’ . . . . The Bank is simply using self-help in violation of its agreement [in
order] to get its hoped-for deficiency judgment.”
The bank resisted: “Defendants continue their attempt to confuse the court
that the SBA is somehow improperly missing from the proceeding before the
court. This is not the case. In fact, the loans before the court in this foreclosure
proceeding are not subject to an SBA guaranty.” The bank’s resistance also
stated that the only relationship between the consumer notes and the SBA note
“is that the [2010] mortgage backing [the 2010 consumer loan] served as
additional security for the SBA loan. The SBA loan is a completely separate
note, not involved or a part of [this] action.”
11
The court granted the Holmes family’s motion and conducted additional
proceedings in late May 2014. Ruthann testified the consumer notes tied to the
2008 mortgage on their condominium were separate loan transactions and
separate obligations from JHP Company’s loan obligations. Ruthann also
testified Legacy Bank had removed significant funds from the family’s investment
accounts in 2014 without notice. She admitted, however, the investment
accounts had been pledged as collateral for the business loan. Ruthann was
unable to produce a document setting forth a notice requirement. Chittenden
testified similarly, the investment accounts were pledged as collateral for the SBA
loan. Chittenden testified the accounts the bank accessed are not collateral for
the consumer loan and none of the bank’s agreements with JHP Company
required the bank to give notice to the Holmes family of its actions with JHP
Company.
The court entered judgment in favor of Legacy Bank in August 2014, and
this appeal followed.
II. Standard of Review
The parties disagree on the standard of review. It is undisputed the bank
filed its foreclosure action in equity. However, the bank contends the matter was
tried at law because the court ruled on evidentiary objections and kept out
allegedly objectionable testimony.
In determining whether a case was tried at law or in equity, one important
test is whether the court ruled on evidentiary objections. Master Builders of Iowa,
Inc. v. Polk Co., 653 N.W.2d 382, (Iowa 2002). The record shows the district
12
court ruled on all the evidentiary objections raised by the parties, in some
instances allowing the testimony and in other instances disallowing the
testimony. We conclude our review is for errors at law.6 See Citizens Sav. Bank
v. Sac City State Bank, 315 N.W.2d 20, 24 (Iowa 1982) (“[W]e will consider and
review a case on appeal in the manner it was treated below.”).
III. SBA—Necessary Party
On appeal, the Holmes family claims the district court erred in failing to
find the SBA was a necessary party to this consumer foreclosure. See Iowa R.
Civ. P. 1.234(2) (“A party is indispensable . . . if notwithstanding the party’s
absence the party’s interest would necessarily be inequitably affected by a
judgment rendered between those before the court.”). The Holmes family admits
“there is law to the effect that a junior lienholder may not be a necessary party to
a foreclosure action” but contends “the status of the SBA is unclear in these
proceedings,” due to Legacy Bank’s accessing the investment accounts after the
trial. The family claims there is “nothing left for the SBA—to say nothing for the
[Holmes family]. Clearly, the SBA’s interest was inequitably affected.”
We find nothing unclear about the SBA’s status. The SBA loan
authorization showed the SBA’s knowledge it was the third lienholder on the
condominium property—subject to the prior liens of Legacy Bank and Regions
Bank. The SBA-required pledge of the investment accounts as collateral for the
business loan is undisputed. The SBA also required Legacy Bank to service the
business loan. Whether Legacy Bank failed to appropriately apply the business
6
Even under a de novo review and based on the issues presented on appeal, our ruling
would be the same.
13
collateral (investment accounts) it accessed in 2014 to the business loan is a
separate matter from this consumer foreclosure, and does not make the SBA a
necessary party to this consumer foreclosure. In fact, one court has ruled the
SBA is not even a necessary party in a dispute concerning a SBA business loan.
See Landes v. Capital City Bank, 795 P.2d 1127, 1131 (Utah 1990) (stating “that
because the SBA authorized [the bank] to sue on the [business] note and
guaranties, the absence of the SBA does not prevent the guarantors from
obtaining complete relief”).
We find additional support for our conclusion the SBA is not a necessary
party in long-standing Iowa case law. In the mid-1800’s our supreme court
established that junior lienholders-mortgagees, such as the SBA, are not
necessary parties in a senior lienholder-mortgagee’s foreclosure action: “Nor is
the making of subsequent mortgagees parties indispensable, for the reason that
the law of foreclosure . . . not only does not require it, but . . . seems to
contemplate that a mortgage may be foreclosed without making them parties.”
Heimstreet v. Winnie, 10 Iowa 430, 431 (1860). The Heimstreet court stated a
foreclosing plaintiff could elect to make a subsequent mortgagee a party but also
recognized: “It is one thing to allow a subsequent mortgagee to be made party
and quite another to insist that he must be.” Id. (ruling debtor-mortgagor “has no
right to speak for” a junior creditor-mortgagee and rejecting debtor-mortgagor’s
claim the foreclosing mortgagee had to perfect service on the junior mortgagee).
As in Heimstreet, the objection here comes from the debtor-mortgagor (the
Holmes family) and not from the junior mortgagee (the SBA). Accordingly, the
14
SBA is not a necessary party. See id.; see also Donnelly v. Rusch, 15 Iowa 99,
100 (1863) (“Though a proper, [the junior incumbrancer] was not a necessary,
party.”).
IV. Equitable Estoppel and Unclean Hands
Urging us to apply the doctrine of equitable estoppel, the Holmes family
seeks to avoid a post-sale deficiency judgment on their consumer notes. Both
parties agree the district court correctly set out the elements the Holmes family
had to prove to be successful: “(1) a false representation or concealment of
material facts [by Legacy Bank], (2) lack of knowledge of the true facts on the
part of the [Holmes family], (3) intention to be relied upon, and (4) reliance
thereon by [the Holmes family to their] prejudice and injury.” The district court
also correctly noted an “estoppel may arise under certain circumstances from
silence or inaction.” The Holmes family asks us to “review the documentary
evidence relating to the SBA loan,” claiming Legacy Bank made
misrepresentations or material omissions in its (1) preparation of the SBA loan
application, (2) its administration of the SBA loan, and (3) its takeover of all the
business assets of JHP Company.
Although the Holmes family asks us to interweave the business
transaction into this case premised on consumer notes, in the Master Agreement
between Legacy Bank and JHP Company (borrower) and the Holmes family
(guarantors), the Holmes family specifically acknowledged the distinction
between their consumer debt and the company’s business debt:
[JHP Company] and Guarantors acknowledge that the
Guarantors borrowed money from [Legacy Bank] and delivered to
15
[Legacy Bank] a note, dated February 1, 2010, in the original
principal amount of [$884,677.62] (“the Consumer Promissory
Note”). The Consumer Promissory Note was for personal
purposes. As security for repayment of the Consumer Promissory
Note, each of the Guarantors executed and delivered in favor of
[Legacy Bank] a certain Real Estate Mortgage dated August 6,
2008, Assignment of Life Insurance and Assignment of Investment
Accounts and related documents (together with the Consumer
Promissory Note, the “Consumer Transaction”). [JHP Company]
and Guarantors agree that [the Master Agreement] does not apply
to the Consumer Transaction and that [Legacy Bank] retains the
right to exercise all of its legal and equitable rights under the
Consumer Promissory Note and related consumer documents.
We reject the Holmes family’s request that we should consider, in this
consumer-foreclosure action, the bank’s alleged misrepresentations and
omissions regarding the separate and distinct business note. We conclude any
such alleged representations or omissions “relating to the SBA loan,” a loan that
was executed after the consumer notes at issue herein, are extraneous matters.
Equitable estoppel is inapplicable.
The Holmes family also claims Legacy Bank comes to the consumer
foreclosure with “unclean hands” because the bank “orchestrated this situation.
Legacy Bank sought and received a SBA guarantee of a $1.3 million loan
ostensibly to provide working capital to a company that John Holmes owned. In
fact, a substantially larger portion of that loan was used to pay off Legacy debt.”
The record does not support this claim. John testified he received the
loan proceeds, or working capital, that he expected to receive from the SBA loan.
A February 16, 2010 memo detailed the “use of proceeds”: $495,746.76 for
working capital; $524,444.40 “to pay notes payable to Bank Iowa”; $255,393.84
to pay notes payable to Legacy Bank; and $14,415 to pay closing costs. Thus,
16
the amount of working capital that John expected and the company received
exceeded the amount “used to pay off Legacy debt.” Further, John was the party
approaching Legacy Bank, and John was the party seeking to consolidate his
company’s debt and obtain additional working capital to upgrade company
technology. The bank did not “orchestrate” but rather acted to facilitate John’s
goals for his company. Finally, the SBA loan accomplished John’s goals by
refinancing his company’s existing business debt and by providing additional
working capital; the term “ostensibly” is totally inapplicable. We cannot improve
on the well-reasoned analysis of the district court, which we adopt.
The [district] court finds no evidence of a misrepresentation
on the part of [Legacy Bank] in the parties’ entry into the written
agreements. The agreements set forth the parties obligations
thereunder, and Mr. Holmes was aware of the state of affairs of his
business and his and Mrs. Holmes’ personal financial situation. Mr.
Holmes had legal representation during the process that led up to
the Master Agreement being executed. The court finds no
motivation on the part of [Legacy Bank] to conceal facts from [the
Holmes family] to convince the [Holmes family] to enter into the
agreements. If the business had performed successfully, as all
parties anticipated and hoped, there would have been no prejudice
and injury on the part of [the Holmes family], but the business failed
to perform up to expectations. Equitable estoppel does not apply to
these facts.
Nor has [Legacy Bank] come to this action with unclean
hands . . . . There is simply no evidence in the record that [Legacy
Bank] engaged in inequitable, unfair, dishonest, fraudulent, or
deceitful conduct that has harmed [the Holmes family]. Rather, [the
record] is clear that [Legacy Bank] made an extensive effort to
provide all the assistance it could to [the Holmes family] to ensure
that [the Holmes family] were able to meet their obligations, which
would have been beneficial to all parties.
AFFIRMED.