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Provident Savings Bank v Pinnacle Mortgage Corp
Transcript of Provident Savings Bank v Pinnacle Mortgage Corp
Loislaw Federal District Court Opinions
Copyright © 2013 CCH Incorporated or its affiliates
IN RE PINNACLE MORTGAGE INVESTMENT CORPORATION, (D.N.J. 1998)
IN RE PINNACLE MORTGAGE INVESTMENT CORPORATION, Debtor
PROVIDENT SAVINGS BANK, a New Jersey Banking Corporation,
Plaintiff/Appellant, v. PINNACLE MORTGAGE INVESTMENT CORPORATION, a
Pennsylvania Corporation, et al., Defendants, SETTLERS ABSTRACT CO., L.P.,
LAWYERS TITLE INSURANCE CORP., LAND TRANSFER CO, INC., FIDELITY NATIONAL
TITLE INSURANCE CO. OF PENNSYLVANIA, GINO L. ANDREUZZI, PIONEER AGENCY II
CORP. t/a PIONEER AGENCY, MUSSER & MUSSER, WILLIAM E. WARD, QUAKER ABSTRACT
CO., and SEARCHTEC ABSTRACT, INC., Appellees.
CIVIL NO. 980489 (JBS), [Bankruptcy Case No. 9510608 (JHW)], [Adv.
Proc. No. 951091]
United States District Court, D. New Jersey.
Filed: December 9, 1998
Walter E. Thomas, Jr., Esq., Timothy J. Matteson, Esq., Mark A. Trudeau,
Esq., Stern, Lavinthal, Norgaard & Kapnick, Esqs., Englewood, New Jersey,
Attorneys for Appellant.
Edward J. Hayes, Esq., Andrea Dobin, Esq., Fox, Rothschild, O'Brien &
Frankel, Princeton Pike Corporate Center, Lawrenceville, New Jersey,
Attorneys for Appellees, Settlers Abstract Co., L.P., Land Transfer Co,
Inc., Fidelity National Title Insurance Co. of Pennsylvania, Gino L.
Andreuzzi, Pioneer Agency II Corp. t/a Pioneer Agency, Musser & Musser,
Quaker Abstract Co, and Searchtec Abstract, Inc.
OPINION
SIMANDLE, District Judge.
I. INTRODUCTION
Provident Savings Bank appeals from a Judgment entered on December 17,
1997, pursuant to a written opinion issued on November 19, 1997, by the
Honorable Judith H. Wizmur, United States Bankruptcy Judge, after trial
in an adversary proceeding. That Opinion ruled in favor of the
Appellees, Settlers Abstract Co., L.P., Land Transfer Co, Inc., Fidelity
National Title Insurance Co. of Pennsylvania, Gino L. Andreuzzi, Pioneer
Agency II Corp. t/a Pioneer Agency, Musser & Musser, Quaker Abstract Co,
and Searchtec Abstract, Inc. ("title agents"). Reviewing a longstanding
complex lending relationship between Provident and the debtor, Pinnacle
Mortgage Corporation, of which the ten real estate mortgage loans at
issue herein were a part, the Bankruptcy Court held that appellee title
agents (who had advanced their own funds to cover disbursements when
Provident dishonored Pinnacle's checks) had a more valid or higher
priority security interest in the promissory notes and mortgages executed
as part of ten separate residential real estate closing than did
appellant. Provident Savings Bank appeals this ruling and seeks this
Court's determination that it was the holder in due course of those
documents.
The principal issue to be decided is whether the Bankruptcy Court
correctly determined under the Uniform Commercial Code that Provident was
not a holder in due course of the promissory notes arising from these
loans, where it found that Provident so closely participated in the
funding and approval of the Pinnaclebrokered loans that the transaction
did not end at the closing with the title agents, such that Provident did
not attain holder in due course status because it did not fit the
requisite role of a "good faith purchaser for value." For the reasons
that will be stated herein, the judgment will be affirmed because the
Bankruptcy Court's finding that Provident never attained HDC status was
neither clearly erroneous nor contrary to law.
II. BACKGROUND
A. Procedural History
This case arises from a dispute over the various security interests in
mortgage documents from ten separate real estate transactions in late
October, 1994, conducted by the debtor, Pinnacle Mortgage Investment
Corporation (who brokered the transactions), the appellant (who financed
the transactions), and the appellees (who were title closing agents in
the transactions). On February 2, 1995, appellant Provident Savings Bank
("Provident") and other creditors filed an involuntary petition under
Chapter 7 of Title 11 of the Bankruptcy Code against Pinnacle Mortgage
Investment Corporation ("Pinnacle"). An order for relief under Chapter 7
was entered by the Bankruptcy Court on March 6, 1995.
On March 24, 1995, Provident commenced this adversary proceeding by
filing a three count complaint to determine the extent, validity, and
priority of the various security interests asserted by Pinnacle, Meridian
Bank, Lawyers Title Insurance Corporation, the appellees, and William E.
Ward with regard to the promissory notes and mortgages from ten real
estate transactions.[fn1] Appellees responded to the complaint by filingan answer, counterclaims, and crossclaims, seeking money judgments in
the amount of the contested notes and mortgages, interest, cost of suit,
and attorneys fees; imposition of a constructive trust in their favor
with regard to the notes, mortgages, and proceeds thereof; and to have
the subject notes and mortgages avoided and stricken in favor of
subsequently executed mortgages between the appellees and the
mortgagors. Provident twice amended its complaint, finally seeking a
declaratory judgment that it is the holder in due course of the subject
notes and mortgages under the Uniform Commercial Code; avoidance of the
preferential transfer by appellee Andreuzzi pursuant to 11 U.S.C. § 547and 550; avoidance of the fraudulent transfer by appellee Andreuzzipursuant to §§ 548 and 550; and avoidance of the preferential and
fraudulent transfers by appellees pursuant to 11 U.S.C. § 547, 548,and 550.
Trial in this matter was held on July 16, 17, and 18, 1996, and October
1, 3, and 4, 1996. At the close of Provident's case in chief, upon motion
by the appellees, all of those portions of the Second Amended Complaint
which did not pertain to Provident's status as a holder in due course
("HDC") were dismissed.
B. The Factual History
In its November 19, 1997 opinion, the Bankruptcy Court determined that
the facts of the case are as follows. Debtor Pinnacle Mortgage Investment
Corporation ("Pinnacle" or "debtor") was a mortgage banker which
primarily dealt in residential mortgage lending and refinance. In December
of 1992, Pinnacle and Provident Savings Bank ("Provident" or "appellant")
entered into a Mortgage Warehouse Loan and Security Agreement
("Agreement"), whereby Provident would fund Pinnacle, who in turn funded
retail customers who sought to purchase or refinance residential real
estate. The borrower in each transaction would give Pinnacle a note and
mortgage, both of which acted as collateral to protect Provident until
Pinnacle sold the mortgage to a third party investor, such as the Federal
Home Loan Mortgage Corporation ("Freddie Mac"), who satisfied Pinnacle's
debt to Provident. Warehouse Agreement § 3.4.
1. The Warehouse Agreement
Under these types of agreements, there would usually not be any contact
between the warehouse lender and the ultimate mortgagor. Typically,
Pinnacle would arrange with a prospective borrower for Pinnacle to
advance funds for the borrower to purchase or refinance a home and for
the borrower to assign a note and mortgage to Pinnacle as collateral. The
mortgage would be endorsed in blank in order to accommodate the final
third party investor (such as Freddie Mac), with whom Pinnacle would
arrange to purchase the mortgage, usually as a part of a pool of
mortgages; this was known as a "takeout" agreement. All of this
completed, Pinnacle would submit a "package" to Provident seeking funding
for the particular transaction under its $10 million line of credit.[fn2]This package included a description of the borrower and the funding, an
assignment of the mortgage endorsed in blank, a takeout commitment, and
an agency agreement that indicated the borrower's attorney's agreement
"to act as the agent of the Bank" to disburse the Advance and to obtain
due execution and delivery to the bank of the original note that
evidences the debt underlying the Mortgage Loan." Warehouse Agreement
§ 5.3(A)(iii). The Agreement required all of this to be submitted
along with the initial funding request. As a matter of course, however,
the agency agreement was usually executed by the title agent handling the
closing instead of by the borrower's attorney, and Provident customarily
accepted the mortgage assignment and agency agreement after the actual
closing.
After Provident received the package and checked to see that Pinnacle's
credit limit had not been exceeded (although, as stated above, often
prior to receipt of the mortgage assignment and agency agreement),
Provident credited Pinnacle's checking account with 98% of the requested
funds. Warehouse Agreement §§ 1.1, 2.1. Pinnacle would write a
regular, uncertified check to the closing agent, who would close the loan
directly with the borrower on Pinnacle's behalf. Pinnacle was supposed to
use specific funds credited to their account to fund specific closings,
but no controls were in place to make sure that Pinnacle actually did
so.
With Pinnacle's check in hand, the closing agent would use money from
its own bank account to disburse funds to the mortgagor, later
replenishing its bank account by depositing Pinnacle's check. Next, the
closing agent would routinely send the original note, a certified copy of
the recorded mortgage, and the other closing documents to Pinnacle, who
would send them on to Provident, who would receive this original note
approximately three to five days after closing. Provident and the
borrowers had no contact; indeed, Provident and the closing agents had no
contact, save the extremely limited contact by the closing agents who did
return the agency agreement included in the borrowing package. Not all
closing agents did return the agreement signed; most of those who did
sent everything through Pinnacle to go to Provident, in accordance with
Pinnacle's written instructions, rather than remitting the note and other
papers directly to Provident, as stated in the agency agreement.
Ultimately, Provident would send the note and accompanying documents to
the third party investor, who would pay Provident the funds which
Provident had originally placed in Pinnacle's checking account by wiring
monies to Provident in Pinnacle's name. Because the third party investor
would send multiple payments in each wire transfer, Pinnacle would tell
Provident to which loans to apply each of the funds.
2. Pinnacle's Declining Financial State
Among the twenty or so warehouse customers that Provident had during
19931994, Pinnacle was the most profitable for Provident, providing
hundreds of millions of dollars in loan transactions. However, when the
mortgage banking industry suffered a decline in business, Pinnacle began
to experience financial difficulties as well.
The Warehouse Agreement, § 6.11, required Pinnacle to submit
unaudited balance sheets and statements of income to Provident on a
quarterly basis, though Pinnacle customarily provided monthly
statements. The statements filed for June, July, and August of 1993
reflected an accrued pretax income for the first three months of the
fiscal year of $281,351. Statements for September, October, and November
of 1993 reflected pretax income of $923,923 for the first six months of
the fiscal year. However, after the November 30 report, Pinnacle began to
send its reports quarterly, which was in accordance with the Warehouse
Agreement but which was nonetheless unusual due to Pinnacle's custom of
submitting reports monthly. The next report, covering the ninemonth
period ending February 28, 1994, was due on April 15 but not received
until some time in May. It showed pretax income of $136,000 for the
first nine months, or an $800,000 loss in the previous three months. The
accompanying unaudited balance sheets showed a reduction of assets from
$40 million to $28 million in those three months. The final financial
statement was due on August 31, 1994, but Provident never received it.
At a holiday party in May 1994, Edmund R. Folsom, head of Provident's
Commercial Lending Department, had learned that Pinnacle had sustained
losses in the winter months. On August 19, 1994, Sharon Kinkead, of
Provident's Warehouse Lending Department, called Pinnacle's headquarters
and learned from Pinnacle's CFO, Joseph Mader, that there would be a
delay in the submission of the audited financial statements for the
fiscal year ending May 31, 1994 because of a change of comptroller, but
that the report would be provided by September 15, 1994. That report
never arrived, and no other financial statements were received up until
Provident's termination of its relationship with Pinnacle in early
November 1994.
3. Provident's Relationship with Pinnacle
Throughout its relationship with Pinnacle, Provident routinely honored
overdrafts on behalf of Pinnacle — about twenty times in 1993 and
fifteen times in 1994. These overdrafts ranged from $7,240.87 to
$5,255,812.
When a check was presented to the bank on Pinnacle's account for which
Pinnacle had insufficient funds, Sharon Kinkead would contact Pinnacle to
ask whether Pinnacle would honor that overdraft. Having been told that
the check would be covered (usually from an anticipated wire transfer),
Kinkead and her supervisor, Mr. Folsom, would honor it and allow the
overdraft. Until November 1994, Provident honored all of Pinnacle's
overdrafts, without reviewing Pinnacle's books and records or monitoring
its checking account.
As mentioned earlier, Pinnacle's CFO, Joseph Mader, had informed
Provident that its final fiscal year report would be forthcoming on
September 15, 1994. When Provident did not receive the audited reports by
that date, Mr. Folsom spoke with Mr. Mader, who reported that though
Pinnacle had sustained losses, it was expecting a substantial infusion of
capital. Pinnacle wanted to hold off publishing the report so that it
could add a footnote explaining that there would be a capital infusion.
Based on this, Folsom decided to extend Pinnacle's credit line through
the end of November.
Folsom called Mader some time in October to check on the status of the
report. When Mader returned the call on November 1, he informed Folsom
that the capital infusion had failed. Folsom demanded a meeting with
Pinnacle's officers.
On November 2, Folsom and Kinkead met with Mader and Al Miller,
President of Pinnacle. Mader and Miller presented internally generated
financial statements indicating a pretax loss of six million dollars for
the previous fiscal year, as well as a pretax loss of almost one million
dollars for the first quarter of the current fiscal year. Miller and
Mader admitted that they had misused their warehouse credit line with
G.E. Capital Mortgage Services, Inc., to whom they were indebted for
about six million dollars. They "admitted fraud" as to G.E., but
indicated that they had not misappropriated the Provident funds and asked
for an extension of funding of their loans while they financially
reorganized. Provident declined to do so.
At that time, Provident finally reviewed Pinnacle's books and
discovered that Pinnacle had been diverting substantial sums of money
from Pinnacle's Provident account to its operating account at Meridian
Bank. Kinkead and Folsom also learned that Pinnacle had been requesting
advances on loans earlier than was routinely requested, possibly using
the money that was supposed to be for specific loans for other purposes
instead. Indeed, Pinnacle was engaging in a "kiting" scheme,
misappropriating monies from third party investors that should have been
applied to previously funded loans. A Pinnacle employee told Kinkead that
the Provident line was not "whole," that as much as $500,000 may have
been taken from it, though no fraudulent loans had been made.
As of November 2, 1994, all checks presented to Provident on Pinnacle's
account had been processed, and the customer balance summary showed an
overdraft of $206,653.67. On November 3, $830,127.48 was deposited in
Pinnacle's account. Sixteen checks totaling $1,584,041.63 were presented
to Provident against Pinnacle's account on November 3. There were
insufficient funds to cover all sixteen, so Folsom sent a letter to
Miller, Pinnacle's president, to ask which checks should be paid. At the
time, Provident knew that all sixteen of those checks represented monies
that Pinnacle had delivered to borrowers and closing agents for
particular loans, as well as that each transaction was accompanied by a
takeout commitment by a third party investor, who would have paid for
the loan.
Miller indicated that six of the checks could be paid. Provident
debited $863,821 to pay off eight loans on November 4, and other checks
were paid at Mader's instruction. There was an overdraft on that date of
$178,303.73, and Provident honored no more checks. The remaining ten of
the sixteen checks presented on November 3 were dishonored, and those are
the subject of the instant litigation.
4. The Ten Transactions
Prior to the closings in each of the ten transactions in question,
Pinnacle had requested from Provident — and received — monies
to fund the transactions. As usual, Pinnacle presented the closing agent
with an uncertified check drawn on its account at Provident representing
payment for the note and mortgage to be executed by the borrower,
purchaser, or refinancer of the property. With Pinnacle's check in hand,
the closing agents closed each transaction, issuing checks from their own
accounts to the parties entitled to receive funds. The closing agents
then deposited Pinnacle's checks in their own accounts, and their banks
presented those checks to Provident for payment. In each case, Provident
dishonored the checks due to insufficient funds. After each closing, but
before the discovery of any problem, each closing agent returned the
original note to Pinnacle. Several closing agents recorded the mortgage
and sent Pinnacle certified copies. Despite the fact that Pinnacle's
checks were not honored, each closing agent honored their own checks when
they were presented.
At the time, uncertified funds were routinely accepted from mortgage
bankers, with a few exceptions for out of state lenders, ignoring the
Pennsylvania statute which required mortgage bankers and brokers to
certify funds. Most mortgage lenders such as Pinnacle insisted on
acceptance of regular checks; title insurers could not stay in business
if they did not follow the standard in the industry.
As was usual for these transactions, Provident had no contact with any
of the closing agents prior to settlement. Agency agreements were
included in most, but not all, of the instruction packages sent by
Pinnacle to the respective closing agents. The agreement provided that
Provident had a security interest in the note and mortgage; moreover, it
provided that the closing agent would act as Provident's agent in
connection with the loan transaction, agreeing to record the mortgage and
then to send both the original note and the original recorded mortgage to
Provident upon closing. The text of the agreement conflicted with the
closing instructions that Pinnacle gave to the closing agents, which
required the note to be returned to Pinnacle. In six of the ten
transactions, the agreement was executed, but its provisions were
basically ignored, as the closing documents were returned directly to
Pinnacle.
The closing agents learned of the dishonor from their own banks.
Provident did not attempt to contact the closing agents until November
10, 1994, when they sent a letter with instructions to deliver to
Provident all notes, mortgages, loan files, and other collateral, and any
monies received in connection with each mortgage loan.
Several of the agents sought judicial relief. Two of the closing agents
who are appellees in this matter, Gino L. Andreuzzi and the Pioneer
Agency L.P., hold state court judgments in their favor, for a total of
three judgments against Pinnacle, striking the mortgages and notes
executed by their respective buyers in favor of Pinnacle. Andreuzzi, the
closing agent in the Hopeck settlement, filed suit against Pinnacle in
the Court of Common Pleas of Luzerne County, Pennsylvania, seeking a TRO
to keep Pinnacle from selling, transferring, or assigning the note and
mortgage in question. Provident was not joined in Andreuzzi's case, but
it did have notice of the litigation. Andreuzzi filed a lis pendens with
the Prothonotary on November 14, 1994. About three hours after the lis
pendens was filed, Provident recorded the assignment from the Hopeck
note. Ultimately, a default judgment was entered against Pinnacle.
Pioneer also filed suits in connection with the Weaver and Fisher
transactions. In both cases, Pioneer sued Pinnacle and Provident in the
Court of Common Pleas of Berks County, Pennsylvania, on November 14,
1994. A preliminary injunction was entered on November 22, and a default
judgment was entered against both defendants on December 21, 1994. Two
days later, Pinnacle moved to open the default judgment. It was still
pending on February 1, 1995 when an involuntary petition was filed against
Pinnacle. Provident removed the action to the Bankruptcy Court on May 8,
1995.
Other closing agents entered into agreements with the borrowers to
execute new notes and mortgages. By the time this came before the
Bankruptcy Court, the mortgages had either been satisfied in full, with
proceeds held in escrow, or payments on the new mortgages and notes were
being made by the borrowers to the closing agents in escrow pending the
resolution of this matter.
C. The Bankruptcy Court's Findings and Judgment
On November 19, 1997, the Bankruptcy Court issued its Opinion in favor
of the appellees, ruling that:
(1) the appellant did not achieve the status of an HDC
with regard to the notes and mortgages in issue;
(2) the appellees would be entitled to indemnification
even if an agency relationship existed between the
appellant and appellees;
(3) the Uniform Fiduciaries Law is inapplicable to
validate the appellant's position with regard to the
subject notes and mortgages; and
(4) the appellant is precluded from relitigating the
transactions with appellees Pioneer Agency II Corp
t/a Pioneer Agency and Andreuzzi.
Judgment against Provident was entered on December 17, 1997. On December
22, 1997, appellant filed a notice of appeal from the Judgment. On
February 13, 1998, the record on appeal was transmitted to this Court. As
"nothing remains for the [lower] court to do," Universal Minerals, Inc.
v. C.A. Hughes & Co., 669 F.2d 98, 101 (3d Cir. 1981), the BankruptcyCourt's ruling is final, and thus this Court properly has appellate
jurisdiction over the December 17, 1997 Order pursuant to
28 U.S.C. § 158(a).
III. ISSUES PRESENTED
On appeal, Provident makes six arguments. First, Provident argues that
it is the holder in due course ("HDC") of the ten mortgage notes.
Second, Provident argues that the Bankruptcy Court's ruling that the
appellees were entitled to indemnification if they were Provident's agents
is clearly erroneous. Third, appellant contends that the bankruptcy court
erred in ruling that Provident was not protected by the Uniform
Fiduciaries Act ("UFA"), adopted by both New Jersey and Pennsylvania at
N.J.S.A. 3B:1454 and 7 Pa. Cons. Stat. Ann. § 6361, respectively.Fourth, Provident argues, for the first time upon appeal, that the
doctrine of avoidable consequences bars appellees from recovering any
damages from Provident. Fifth, Provident maintains that the doctrines of
lis pendens, res judicata, and collateral estoppel do not bar
relitigation of these issues as to the Andreuzzi transaction. Finally,
Provident argues that the Bankruptcy Court erred by giving preclusionary
effect to the Pioneer action default judgments.
This Opinion will not address Provident's "avoidable consequences"
argument, as it was raised, for the first time, upon appeal.[fn3]Moreover, the doctrine of res judicata precludes review of the two
transactions for which Pioneer was the closing agent, and I thus affirm
the Bankruptcy Court's judgment as to Pioneer on that ground.[fn4] I willaffirm the Bankruptcy Court's holding that Provident is not entitled to
the protections of the Uniform Fiduciaries Act , especially in light of
the fact that Provident has withdrawn its argument that Pinnacle was its
agent.[fn5] For reasons stated herein, I will affirm the BankruptcyCourt's holding that Provident is not the holder in due course of the
eight[fn6] transactions still in question. Accordingly, there is no needfor this Court to address the Bankruptcy Court's alternate finding that
the closing agents would be entitled to indemnification.[fn7]
IV. STANDARD OF REVIEW
On appeal, the weight accorded to the findings of fact by a bankruptcy
court are governed by Fed.R.Bank.P. 8013, which provides as follows:
On appeal the district court or bankruptcy appellate
panel may affirm, modify, or reverse a bankruptcy
judge's judgment, order, or decree or remand with
instructions for further proceedings. Findings of
fact, whether based on oral or documentary evidence,
shall not be set aside unless clearly erroneous, and
due regard shall be given to the opportunity of the
bankruptcy court to judge the credibility of
witnesses.
Fed.R.Bank.P. 8013. Under this Rule, a bankruptcy court's factualfindings may be disturbed only if clearly erroneous. See FGH Realty
Credit v. Newark Airport/Hotel Ltd., 155 B.R. 93 (D.N.J. 1993). Where a
mixed question of law and fact is presented, the appropriate standard
must be applied to each component. In re Sharon Steel Corp., 871 F.2d 1217,
1222 (3d Cir. 1989). Thus, a reviewing court "must accept the [lower]court's findings of historical or narrative facts unless they are clearly
erroneous, but . . . must exercise a plenary review and its application
of those precepts to the historical facts." Universal Minerals, Inc. v.
C.A. Hughes & Co., 669 F.2d at 103.
While standards for establishing that a party is a holder in due course
are wellsettled law, see, e.g., Triffin v. Dillabough, 448 Pa. Super. 72,
87, 670 A.2d 684, 691 (1996), the Court's application of these standardsto the facts does result in a mixed finding of fact and law that is
subject to a mixed standard of review. Mellon Bank, N.A. v. Metro
Communications, Inc., 945 F.2d 635, 64142 (3d Cir. 1991), cert. denied,
503 U.S. 937 (1992). The factual findings can only be reversed for clearerror, In re Graves, 33 F.3d 242, 251 (3d Cir. 1994), even if thereviewing court would have decided the matter differently. In re
PrincetonNew York Investors, Inc., 1998 WL 111674 (D.N.J. 1998). This
Court, thus, may not overturn a bankruptcy judge's factual findings if
the factual determinations bear any "rational relationship to the
supporting evidentiary data. . . ." Fellheimer, Eichen & Braverman, P.C.
v. Charter Technologies, Inc., 57 F.3d 1215, 1223 (3d Cir. 1995) (citingHoots v. Comm. of Pa., 703 F.2d 722, 725 (3d Cir. 1983). However, thisCourt reviews any legal conclusions de novo.
V. DISCUSSION
Appellant argues that the Bankruptcy Court's finding that appellant is
not an HDC of the promissory notes and mortgages from the eight remaining
real estate transactions closed by appellees is clearly erroneous. The
dispute here is not a dispute of law, as the parties agree on what the
law concerning HDCs is. As the Bankruptcy Court correctly found,[fn8]every holder of a negotiable instrument is presumed to be an HDC, Morgan
Guaranty Trust Company of New York v. Staats, 631 A.2d 631, 636(Pa.Super.Ct. 1993), but when a defense of fraud is meritorious as to the
payee, the holder has the burden of showing that it is an HDC in order to
be immune from that defense. Norman v. World Wide Distributors, Inc.,
195 A.2d 115, 117 (Pa.Super.Ct. 1963). A holder of a negotiableinstrument (such as the promissory notes in this case) is either the
person with possession of bearer paper or the person identified on the
instrument if that person is in possession. 13 Pa. Cons. Stat. Ann.
§ 1201; N.J.S.A. 12A:3201 (West Supp. 1998). The holder of adocument of title (such as the mortgages in this case) is the person in
possession if the document is made out to bearer or to the order of the
person in possession. Id. The holder becomes an HDC if:
(1) the instrument when issued or negotiated to the
holder does not bear such apparent evidence of forgery
or alteration or is not otherwise so irregular or
incomplete as to call into question its authenticity;
and
(2) the holder took the instrument:
(i) for value;
(ii) in good faith;
(iii) without notice that the instrument is
overdue or has been dishonored or that there is an
uncured default with respect to payment of another
instrument issued as part of the same series;
(iv) without notice that the instrument contains
an unauthorized signature or has been altered;
(v) without notice of any claim to the instrument
described in section 3306 (relating to claims to an
instrument); and
(vi) without notice that any party has a defense
or claim in recoupment described in section 3305(a)
(relating to defenses and claims in recoupment).
13 Pa. Cons. Stat. Ann. § 3302. See also N.J.S.A. 12A:3302. Inshort, an HDC is the holder of the instrument or document who took for
value and in good faith without notice of any claims or defects on the
instrument or document. If classified as an HDC, the holder holds without
regard to defenses, with certain statutory exemptions which do not apply
here. 13 Pa. Cons. Stat. Ann. § 3305; N.J.S.A. 12A:3305.
It was clear to the parties and to the Bankruptcy Court below that
Provident did not have actual possession of the notes and mortgages
before November 2, 1998, when it learned that there were insufficient
funds in Pinnacle's account at Provident to cover Pinnacle's checks to
the closing agents here. Provident nonetheless argued that it was the
holder of the notes and mortgages because, before gaining actual
knowledge of Pinnacle's fraud, Provident "constructively possessed" the
notes and mortgages from the moment that the closing agents, who were
allegedly Provident's agents, took possession of the notes at the
closings before November 2.
The Bankruptcy Court rejected Provident's argument, finding that none
of the appellees acted as Provident's agents, and thus Provident never
constructively or actually possessed the notes and mortgages. Thus, the
Bankruptcy Court found that Provident never became the holder of these
notes and mortgages in the first place. (Opinion at 53.) Alternatively,
the Bankruptcy Court found that while Provident did give value for the
notes and mortgages (Opinion at 54), it did not take those notes and
mortgages in good faith and without knowledge of defenses, and thus
Provident is not an HDC. (Opinion at 63.) The question before this Court
is whether the Bankruptcy Court's rulings in this regard were clearly
erroneous. I hold that it was neither clearly erroneous nor contrary to
established law for the Bankruptcy Court to find that Provident did not
fit the role of "good faith purchaser for value" necessary to claim HDC
status even though Provident's lack of good faith arose after the title
agents closed the real estate transactions. As the following discussion
will explain, in the context of a course of dealing between Provident and
Pinnacle extending over thousands of such transactions, Provident was
essentially a party to the mortgage lending transactions and thus, by
definition, cannot claim HDC status in the negotiable papers which
resulted from those transactions, especially because Provident gained
knowledge of defenses before its own role in the original mortgage
lending transaction was complete.
I affirm the Bankruptcy Court's ruling that Provident is not the HDC of
these notes and mortgages. In so holding, I need not, and thus do not,
reach the issue of whether Provident constructively possessed the notes
and mortgages,[fn9] for holder status is irrelevant if Provident did nottake in good faith and without knowledge of defenses. Because I find that
the Bankruptcy Court's ruling that Provident did not take in good faith
was not clearly erroneous, I affirm the ruling that Provident is not
entitled to the protections afforded to a holder in due course.
The Bankruptcy Court correctly stated the law on good faith in this
context: the test for good faith is "not one of negligence of duty to
inquire, but rather it is one of willful dishonesty or actual knowledge."
Valley Bank & Trust Co. v. American Utilities, Inc., 415 F. Supp. 298,
301 (E.D.Pa. 1976). See also Mellon Bank v. PasqualisPoliti,
800 F. Supp. 1297, 1302 (W.D.Pa. 1992), aff'd, 990 F.2d 780 (3d Cir.1993); Carnegie Bank v. Shalleck, 606 A.2d 389, 394 (N.J.Super.Ct.A.D. 1992); General Inv. Corp. v. Angelini, 278 A.2d 193 (N.J. 1971).Good faith may be defeated only by actual knowledge or a deliberate
attempt to evade knowledge. Rice v. Barrington, 70 A. 169, 170 (N.J. E. &
A 1908). "There is no affirmative duty of inquiry on the part of one
taking a negotiable instrument, and there is no constructive notice from
the circumstances of the transaction, unless the circumstances are so
strong that if ignored they will be deemed to establish bad faith on the
part of the transferee." Bankers Trust Co. v. Crawford, 781 F.2d 39, 45(3d Cir. 1986). Moreover, an HDC must take not only in good faith, but
also without notice of defenses to the instrument or document. One has
"notice" when
(1) he has actual knowledge of it;
(2) he has received a notice or notification of it; or
(3) from all the facts and circumstances known to him
at the time in question he has reason to know that it
exists.
Pa. Cons. Stat. Ann. § 1201.
The Bankruptcy Court here found that Provident did not in fact have
actual knowledge of the fraud or potential defense of failure of
consideration at the time of each separate closing. (Opinion at 58.) The
Bankruptcy Court also found that despite the fact that Provident failed
to review Pinnacle's books, records, and checking account ledger, failed
to notice the overdraft problem, failed to properly monitor withdrawals,
and failed to act after knowledge of financial deterioration in default
in providing timely audited financial statements, the appellees had not
proved that Provident acted with willful dishonesty (id.); Provident did
act with negligence or gross negligence, but gross negligence alone is
not enough to defeat an HDC's title. See Washington & Canonsburg Ry. Co.
v. Murray, 211 F. 440, 445 (3d Cir. 1914); General Inv. Corp.,
278 A.2d 193. Moreover, the Bankruptcy Court correctly noted that holderin due course status is generally created at the time that the claimant
becomes a holder — meaning at the time of negotiation. N.J.S.A.
12A:3302; Sisemore v. Kierlow Co., Inc. v. Nicholas, 27 A.2d 473, 478(Pa.Super.Ct. 1942). In transactions such as the ones at issue here which
involve blank endorsements, the instruments and documents are bearer
paper and are thus negotiated upon delivery alone. 13 Pa. Cons. Stat.
Ann. § 3201; N.J.S.A. 12A:3201.
Nonetheless, the Bankruptcy Court found that Provident failed to attain
the status of a holder in due course. It acknowledged that once a party
establishes its position as a holder in due course, no future action can
undermine that status; so in the usual transaction with negotiable bearer
paper, actual knowledge of defenses gained after possession do not defeat
HDC status. (Opinion at 63.) See Bricks Unlimited, Inc. v. Agee,
672 F.2d 1255, 1259 (5th Cir. 1982); Park Gasoline Co. v. Crusius,158 A. 334 (N.J. 1932). However, the Bankruptcy Court said, it was not
finding lack of good faith after gaining HDC status, but rather that
Provident did not gain HDC status in the first place, for these were not
the "usual" transactions. Taken in a "global sense," the Bankruptcy Court
said, these transactions did not end until after the settlements.
(Opinion at 58.)
Usually, one who takes a negotiable instrument for value has only the
underlying circumstances of that transaction by which to determine if
there is reason to give pause as to the veracity of that instrument. A
lender provides funds to a borrower who executes a promissory note. Once
that transaction is complete, the lender transfers the note to a second
lender in exchange for which the first lender receives funds replenishing
his account and enabling him to lend the same funds to another borrower.
HDC status is given to that second lender if it acts in good faith and
without knowledge of defenses, and there is no general duty for that
second lender to inquire unless the circumstances are so suspicious that
they cannot be ignored. See, e.g. Triffin, 670 A.2d at 692. In the usualHDC transaction, there are two discernible transactions, two exchanges of
funds and notes. As the Bankruptcy Court pointed out, the purpose of
giving that second lender HDC status is "to meet the contemporary needs
of fast moving commercial society . . . (citation omitted) and to enhance
the marketability of negotiable instruments [allowing] bankers, brokers
and the general public to trade in confidence." Triffin,
670 A.2d at 693. However, "the more the holder knows about the underlyingtransaction, and particularly the more he controls or participates or
becomes involved in it, the less he fits the role of a good faith
purchaser for value; the closer his relationship to the underlying
agreement which is the source of the note, the less need there is for
giving him the tensionfree rights necessary in a fastmoving,
creditextending commercial world." Unico v. Owen, 50 N.J. 101, 109110 (1967). See also Jones v. Approved Bancredit Corp., 256 A.2d 739, 742(Del. 1969) (in such a situation, "[the financer] should not be able to
hide behind `the fictional fence' of the . . . UCC and thereby achieve an
unfair advantage over the purchaser.").
Here, there were not two separate, discernible transactions.
Provident's funding of Pinnacle who funded the borrowers was one complex
transaction. The acts of a third party investor who would buy the notes
and mortgages from Provident would have been the second separate,
discernible transaction here. Provident did not replenish Pinnacle's
account in exchange for receiving the notes and mortgages, such that
Pinnacle would have more money to make more loans, as in the "usual"
transaction. Rather, in a complex and longstanding scheme encompassing
thousands of transactions over several years, Provident gave Pinnacle a
line of credit, and then, after Pinnacle gave Provident information about
individual proposed loans to borrowers, Provident transferred money to
Pinnacle's account, in order to later receive the note and mortgage from
each transaction and pass them on to a third party investor. The
Bankruptcy Court, as a factual matter, found that under this complex
scheme, no transactions between any of the parties were complete until
both of the transactions were concluded, particularly because the "second
lender" (Provident) had the ultimate control over the first transaction
(by ordering the dishonor of Pinnacle's checks).[fn10]
I cannot say that the Bankruptcy Court's factual finding was clearly
erroneous. The Bankruptcy Court's ruling accords with the evidence as
well as with the policy underlying the holder in due course doctrine. I
hold that where a warehouse lender so closely participates in the funding
and approval of mortgages which will ultimately lead to the warehouse
lender's rights in mortgages and promissory notes that the transactions
between mortgage banker and mortgagor and between warehouse lender and
mortgage banker are in fact one continuous transaction, rather than two
discernible transactions, a showing of the warehouse lender's lack of
good faith after the closing between title agent and mortgagor but before
the mortgage banker's check is presented to the warehouse lender may
destroy HDC status. Indeed, where the party who claims HDC status was in
essence a party to the original transaction, it cannot, by definition, be
a holder in due course.
Provident had a great deal of involvement in the ongoing series of
transactions and ample knowledge of Pinnacle's overall financial
wellbeing, developed through years of funding Pinnacle's credit line for
thousands of such transactions and receipt of Pinnacle's periodic
financial reports. It had particular information about the borrowers
before it funded these loans. It was, in fact, part of the loan
transactions, and not a separate party who became an HDC through the
giving of value at a second separate, discernible transaction. Provident
had too much control of, participation in, and knowledge of the
underlying transaction to claim that it was a good faith purchaser for
value. See, e.g., Fidelity Bank Nat'l Assoc., 740 F. Supp. at 239.
Because, under this complex transactional scheme, Provident functioned
essentially as a party which approved and funded the loans and gained
actual knowledge of a defense to the notes and mortgages (lack of
consideration) before the transactions were complete, it was not clearly
erroneous for the Bankruptcy Court to find that Provident lacked the good
faith necessary to claim HDC status. Accordingly, the Bankruptcy Court's
ruling is affirmed.
VI. CONCLUSION
For the foregoing reasons, I will affirm the Bankruptcy Court's ruling
that appellant Provident Savings Bank was not the holder in due course of
the notes and mortgages from the ten transactions closed by appellees.
The defense of failure of consideration thus is available against
Provident. I therefore affirm the Bankruptcy Court's judgment that
appellees, and not appellant, are entitled to the notes and mortgages. The
accompanying Order is entered.
ORDER
This matter having come upon the court upon the appeal of appellant,
Provident Savings Bank, from a Judgment entered on December 17, 1997, by
the Honorable Judith H. Wizmur, United States Bankruptcy Judge for the
District of New Jersey,; and the Court having considered the parties'
submissions; and for the reasons set forth in the Opinion of today's
date;
IT IS this day of December, 1998, hereby
ORDERED that the Judgment entered by the Honorable Judith H. Wizmur,
United States Bankruptcy Judge for the District of New Jersey, on
December 17, 1997, which granted the notes and mortgages from
transactions closed by the appellees in this matter to the appellees,
be, and hereby is, AFFIRMED.
[fn1] The appellant's cause of action against defendant William E. Ward
was removed to state court in Delaware upon motion on the basis of
abstention pursuant to 28 U.S.C. § 1334(c) where it is now pending.The appellant's cause of action against Meridian Bank was resolved prior
to trial pursuant to the Stipulation of Settlement with respect to Count
II of the Complaint, filed on July 16, 1996. All claims between the
appellant and Lawyers Title Insurance Corporation were mutually dismissed
at trial.
[fn2] The Agreement said $10 million, but at times up to $12.5 million
was advanced.
[fn3] It is a wellestablished law that appellate courts may not pass
upon an issue not presented in a lower court. Singleton v. Wulff,
428 U.S. 106, 120 (1976). The same holds true for a U.S. District Courtsitting in its appellate capacity over matters appealed from the
bankruptcy court. See Barrett v. Commonwealth Fed. Sav. and Loan Ass'n,
939 F.2d 20 (3d Cir. 1991); In re Middle Atlantic Stud Welding Co.,
503 F.2d 1133, 1134 n. 1 (3d Cir. 1974). Because Provident never raisedthis issue before the Bankruptcy Court, I will not consider it now.
[fn4] The res judicata doctrine prevents relitigation of claims that grow
out of a transaction or occurrence from which other claims have earlier
been raised and decided validly, finally, and on the merits. Federated
Department Stores v. Moitie, 452 U.S. 394, 298 (1981). Under Pennsylvanialaw, default judgments, absent fraud, are afforded res judicata effect.
In re Graves, 156 B.R. 949, 954 (E.D.Pa. 1993), aff'd, 33 F.3d 242 (3dCir. 1994). On December 21, 1994, the Court of Common Pleas of Berks
County, Pennsylvania, entered default judgments against Provident on both
the Weaver and Fisher transactions, those transactions for which Pioneer
was the closing agent. Due to these default judgments, the doctrine of
res judicata bars relitigation of the Pioneer causes of action. The
Bankruptcy Court also held that the Andreuzzi transaction was barred by
res judicata or collateral estoppel because of the lis pendens. That,
however, is a more difficult issue and one that I need not reach now, as
my affirmance of the Bankruptcy Court's judgment applies equally to the
Andreuzzi transaction on the merits.
[fn5] At trial and in its briefs to this Court, as an alternative to its
holder in due course argument, Provident argued that it was protected by
the Pennsylvania Uniform Fiduciaries Act, 7 Pa. Cons. Stat. § 6361,
and the New Jersey Uniform Fiduciaries Law, N.J.S.A. 3B:1454, theprovisions of which are substantially similar. The two laws protect a
person who transfers money to a fiduciary in good faith, by noting that
"any right or title acquired from the fiduciary in consideration of such
payment or transfer is not invalid in consequences of a misapplication by
the fiduciary." 7 Pa. Cons. Stat. § 6361; N.J.S.A. 3B:1454. TheBankruptcy Court held that Pinnacle was not Provident's agent or
fiduciary, and thus the UFA did not apply. (Opinion at 66.) In light of
the fact that Provident's counsel, at oral argument before this Court on
November 13, 1998, themselves argued that Pinnacle was not Provident's
fiduciary, I will affirm this aspect of the Bankruptcy Court's ruling
without need to examine the factual bases on which it relied.
[fn6] The rest of this Opinion is limited to the eight transactions not
handled by Pioneer, since only the Pioneer transactions are bound by res
judicata.
[fn7] As Part V of this Opinion explains, one of the several bases for
the Bankruptcy Court's decision that Provident is not the HDC of the
mortgages and notes is that the settlement agents were not Provident's
agents, and thus Provident did not constructively possess the mortgages
and notes prior to gaining knowledge of claims or defenses on those
notes. (Opinion at 3453.) In the alternative, in case appellate courts
determined that Provident was the HDC of those notes because an agency
relationship did exist, the Bankruptcy Court held that the closing
agents, and not Provident, would still be the ones entitled to the notes
and mortgages, for the agents would have had a right to indemnification
from Provident. (Id. at 6364.) Though, as I explain in Part V, I do not
reach the agency issue, I do affirm the Bankruptcy Court's HDC ruling on
other grounds. In doing so, I am affirming the decision that the
appellees, and not Provident, are entitled to the notes and mortgages. The
Bankruptcy Court's indemnification ruling is just an alternative reason
for finding that the appellees are entitled to the notes and mortgages.
Having already agreed that the closing agents are so entitled because
Provident is not an HDC, there is no need to address that alternative
ruling upon appeal.
[fn8] Seven of the eight remaining transactions here are governed by
Pennsylvania law. The eighth is under New Jersey law, but the two states'
laws on HDC status are largely consistent on the issues raised in these
proceedings.
[fn9] The Bankruptcy Court agreed that authority from other jurisdictions
suggest that a party may become a constructive holder when its agent
takes possession of a negotiable instrument on its behalf. (Opinion at
3637.) However, the Bankruptcy Court made the factual finding that
appellees were not Provident's agents. It determined that though six of
the ten transactions involved written agency agreements, those agreements
were not controlling in light of the course of dealing between the
parties (Opinion at 46), and that Provident did not otherwise meet its
burden of establishing that an agency relationship existed. Because I
find that the Bankruptcy Court's determination that Provident did not act
in good faith is not clearly erroneous, and because the lack of good
faith alone is enough of a basis to sustain a judgment that Provident is
not an HDC of these eight notes and mortgages, I need not address whether
the agency determination was clearly erroneous.
[fn10] Under the Bankruptcy Court's findings of fact, Provident was, in
reality, a party to the original transaction. The situation is somewhat
analogous to a consumer goods financer who has a substantial voice in the
underlying transaction; that financer is not entitled to HDC status.
Westfield Investment Co. v. Fellers, 181 A.2d 809 (N.J.Super.Ct. LawDiv.). Provident had a substantial voice in providing and carrying out
funding of the underlying borrowing transactions, and it thus cannot
claim that it was a good faith HDC when it learned of the defense of
failure of consideration prior to dishonoring the Pinnacle checks.
Loislaw Federal District Court Opinions
Copyright © 2013 CCH Incorporated or its affiliates
IN RE PINNACLE MORTGAGE INVESTMENT CORPORATION, (D.N.J. 1998)
IN RE PINNACLE MORTGAGE INVESTMENT CORPORATION, Debtor
PROVIDENT SAVINGS BANK, a New Jersey Banking Corporation,
Plaintiff/Appellant, v. PINNACLE MORTGAGE INVESTMENT CORPORATION, a
Pennsylvania Corporation, et al., Defendants, SETTLERS ABSTRACT CO., L.P.,
LAWYERS TITLE INSURANCE CORP., LAND TRANSFER CO, INC., FIDELITY NATIONAL
TITLE INSURANCE CO. OF PENNSYLVANIA, GINO L. ANDREUZZI, PIONEER AGENCY II
CORP. t/a PIONEER AGENCY, MUSSER & MUSSER, WILLIAM E. WARD, QUAKER ABSTRACT
CO., and SEARCHTEC ABSTRACT, INC., Appellees.
CIVIL NO. 980489 (JBS), [Bankruptcy Case No. 9510608 (JHW)], [Adv.
Proc. No. 951091]
United States District Court, D. New Jersey.
Filed: December 9, 1998
Walter E. Thomas, Jr., Esq., Timothy J. Matteson, Esq., Mark A. Trudeau,
Esq., Stern, Lavinthal, Norgaard & Kapnick, Esqs., Englewood, New Jersey,
Attorneys for Appellant.
Edward J. Hayes, Esq., Andrea Dobin, Esq., Fox, Rothschild, O'Brien &
Frankel, Princeton Pike Corporate Center, Lawrenceville, New Jersey,
Attorneys for Appellees, Settlers Abstract Co., L.P., Land Transfer Co,
Inc., Fidelity National Title Insurance Co. of Pennsylvania, Gino L.
Andreuzzi, Pioneer Agency II Corp. t/a Pioneer Agency, Musser & Musser,
Quaker Abstract Co, and Searchtec Abstract, Inc.
OPINION
SIMANDLE, District Judge.
I. INTRODUCTION
Provident Savings Bank appeals from a Judgment entered on December 17,
1997, pursuant to a written opinion issued on November 19, 1997, by the
Honorable Judith H. Wizmur, United States Bankruptcy Judge, after trial
in an adversary proceeding. That Opinion ruled in favor of the
Appellees, Settlers Abstract Co., L.P., Land Transfer Co, Inc., Fidelity
National Title Insurance Co. of Pennsylvania, Gino L. Andreuzzi, Pioneer
Agency II Corp. t/a Pioneer Agency, Musser & Musser, Quaker Abstract Co,
and Searchtec Abstract, Inc. ("title agents"). Reviewing a longstanding
complex lending relationship between Provident and the debtor, Pinnacle
Mortgage Corporation, of which the ten real estate mortgage loans at
issue herein were a part, the Bankruptcy Court held that appellee title
agents (who had advanced their own funds to cover disbursements when
Provident dishonored Pinnacle's checks) had a more valid or higher
priority security interest in the promissory notes and mortgages executed
as part of ten separate residential real estate closing than did
appellant. Provident Savings Bank appeals this ruling and seeks this
Court's determination that it was the holder in due course of those
documents.
The principal issue to be decided is whether the Bankruptcy Court
correctly determined under the Uniform Commercial Code that Provident was
not a holder in due course of the promissory notes arising from these
loans, where it found that Provident so closely participated in the
funding and approval of the Pinnaclebrokered loans that the transaction
did not end at the closing with the title agents, such that Provident did
not attain holder in due course status because it did not fit the
requisite role of a "good faith purchaser for value." For the reasons
that will be stated herein, the judgment will be affirmed because the
Bankruptcy Court's finding that Provident never attained HDC status was
neither clearly erroneous nor contrary to law.
II. BACKGROUND
A. Procedural History
This case arises from a dispute over the various security interests in
mortgage documents from ten separate real estate transactions in late
October, 1994, conducted by the debtor, Pinnacle Mortgage Investment
Corporation (who brokered the transactions), the appellant (who financed
the transactions), and the appellees (who were title closing agents in
the transactions). On February 2, 1995, appellant Provident Savings Bank
("Provident") and other creditors filed an involuntary petition under
Chapter 7 of Title 11 of the Bankruptcy Code against Pinnacle Mortgage
Investment Corporation ("Pinnacle"). An order for relief under Chapter 7
was entered by the Bankruptcy Court on March 6, 1995.
On March 24, 1995, Provident commenced this adversary proceeding by
filing a three count complaint to determine the extent, validity, and
priority of the various security interests asserted by Pinnacle, Meridian
Bank, Lawyers Title Insurance Corporation, the appellees, and William E.
Ward with regard to the promissory notes and mortgages from ten real
estate transactions.[fn1] Appellees responded to the complaint by filingan answer, counterclaims, and crossclaims, seeking money judgments in
the amount of the contested notes and mortgages, interest, cost of suit,
and attorneys fees; imposition of a constructive trust in their favor
with regard to the notes, mortgages, and proceeds thereof; and to have
the subject notes and mortgages avoided and stricken in favor of
subsequently executed mortgages between the appellees and the
mortgagors. Provident twice amended its complaint, finally seeking a
declaratory judgment that it is the holder in due course of the subject
notes and mortgages under the Uniform Commercial Code; avoidance of the
preferential transfer by appellee Andreuzzi pursuant to 11 U.S.C. § 547and 550; avoidance of the fraudulent transfer by appellee Andreuzzipursuant to §§ 548 and 550; and avoidance of the preferential and
fraudulent transfers by appellees pursuant to 11 U.S.C. § 547, 548,and 550.
Trial in this matter was held on July 16, 17, and 18, 1996, and October
1, 3, and 4, 1996. At the close of Provident's case in chief, upon motion
by the appellees, all of those portions of the Second Amended Complaint
which did not pertain to Provident's status as a holder in due course
("HDC") were dismissed.
B. The Factual History
In its November 19, 1997 opinion, the Bankruptcy Court determined that
the facts of the case are as follows. Debtor Pinnacle Mortgage Investment
Corporation ("Pinnacle" or "debtor") was a mortgage banker which
primarily dealt in residential mortgage lending and refinance. In December
of 1992, Pinnacle and Provident Savings Bank ("Provident" or "appellant")
entered into a Mortgage Warehouse Loan and Security Agreement
("Agreement"), whereby Provident would fund Pinnacle, who in turn funded
retail customers who sought to purchase or refinance residential real
estate. The borrower in each transaction would give Pinnacle a note and
mortgage, both of which acted as collateral to protect Provident until
Pinnacle sold the mortgage to a third party investor, such as the Federal
Home Loan Mortgage Corporation ("Freddie Mac"), who satisfied Pinnacle's
debt to Provident. Warehouse Agreement § 3.4.
1. The Warehouse Agreement
Under these types of agreements, there would usually not be any contact
between the warehouse lender and the ultimate mortgagor. Typically,
Pinnacle would arrange with a prospective borrower for Pinnacle to
advance funds for the borrower to purchase or refinance a home and for
the borrower to assign a note and mortgage to Pinnacle as collateral. The
mortgage would be endorsed in blank in order to accommodate the final
third party investor (such as Freddie Mac), with whom Pinnacle would
arrange to purchase the mortgage, usually as a part of a pool of
mortgages; this was known as a "takeout" agreement. All of this
completed, Pinnacle would submit a "package" to Provident seeking funding
for the particular transaction under its $10 million line of credit.[fn2]This package included a description of the borrower and the funding, an
assignment of the mortgage endorsed in blank, a takeout commitment, and
an agency agreement that indicated the borrower's attorney's agreement
"to act as the agent of the Bank" to disburse the Advance and to obtain
due execution and delivery to the bank of the original note that
evidences the debt underlying the Mortgage Loan." Warehouse Agreement
§ 5.3(A)(iii). The Agreement required all of this to be submitted
along with the initial funding request. As a matter of course, however,
the agency agreement was usually executed by the title agent handling the
closing instead of by the borrower's attorney, and Provident customarily
accepted the mortgage assignment and agency agreement after the actual
closing.
After Provident received the package and checked to see that Pinnacle's
credit limit had not been exceeded (although, as stated above, often
prior to receipt of the mortgage assignment and agency agreement),
Provident credited Pinnacle's checking account with 98% of the requested
funds. Warehouse Agreement §§ 1.1, 2.1. Pinnacle would write a
regular, uncertified check to the closing agent, who would close the loan
directly with the borrower on Pinnacle's behalf. Pinnacle was supposed to
use specific funds credited to their account to fund specific closings,
but no controls were in place to make sure that Pinnacle actually did
so.
With Pinnacle's check in hand, the closing agent would use money from
its own bank account to disburse funds to the mortgagor, later
replenishing its bank account by depositing Pinnacle's check. Next, the
closing agent would routinely send the original note, a certified copy of
the recorded mortgage, and the other closing documents to Pinnacle, who
would send them on to Provident, who would receive this original note
approximately three to five days after closing. Provident and the
borrowers had no contact; indeed, Provident and the closing agents had no
contact, save the extremely limited contact by the closing agents who did
return the agency agreement included in the borrowing package. Not all
closing agents did return the agreement signed; most of those who did
sent everything through Pinnacle to go to Provident, in accordance with
Pinnacle's written instructions, rather than remitting the note and other
papers directly to Provident, as stated in the agency agreement.
Ultimately, Provident would send the note and accompanying documents to
the third party investor, who would pay Provident the funds which
Provident had originally placed in Pinnacle's checking account by wiring
monies to Provident in Pinnacle's name. Because the third party investor
would send multiple payments in each wire transfer, Pinnacle would tell
Provident to which loans to apply each of the funds.
2. Pinnacle's Declining Financial State
Among the twenty or so warehouse customers that Provident had during
19931994, Pinnacle was the most profitable for Provident, providing
hundreds of millions of dollars in loan transactions. However, when the
mortgage banking industry suffered a decline in business, Pinnacle began
to experience financial difficulties as well.
The Warehouse Agreement, § 6.11, required Pinnacle to submit
unaudited balance sheets and statements of income to Provident on a
quarterly basis, though Pinnacle customarily provided monthly
statements. The statements filed for June, July, and August of 1993
reflected an accrued pretax income for the first three months of the
fiscal year of $281,351. Statements for September, October, and November
of 1993 reflected pretax income of $923,923 for the first six months of
the fiscal year. However, after the November 30 report, Pinnacle began to
send its reports quarterly, which was in accordance with the Warehouse
Agreement but which was nonetheless unusual due to Pinnacle's custom of
submitting reports monthly. The next report, covering the ninemonth
period ending February 28, 1994, was due on April 15 but not received
until some time in May. It showed pretax income of $136,000 for the
first nine months, or an $800,000 loss in the previous three months. The
accompanying unaudited balance sheets showed a reduction of assets from
$40 million to $28 million in those three months. The final financial
statement was due on August 31, 1994, but Provident never received it.
At a holiday party in May 1994, Edmund R. Folsom, head of Provident's
Commercial Lending Department, had learned that Pinnacle had sustained
losses in the winter months. On August 19, 1994, Sharon Kinkead, of
Provident's Warehouse Lending Department, called Pinnacle's headquarters
and learned from Pinnacle's CFO, Joseph Mader, that there would be a
delay in the submission of the audited financial statements for the
fiscal year ending May 31, 1994 because of a change of comptroller, but
that the report would be provided by September 15, 1994. That report
never arrived, and no other financial statements were received up until
Provident's termination of its relationship with Pinnacle in early
November 1994.
3. Provident's Relationship with Pinnacle
Throughout its relationship with Pinnacle, Provident routinely honored
overdrafts on behalf of Pinnacle — about twenty times in 1993 and
fifteen times in 1994. These overdrafts ranged from $7,240.87 to
$5,255,812.
When a check was presented to the bank on Pinnacle's account for which
Pinnacle had insufficient funds, Sharon Kinkead would contact Pinnacle to
ask whether Pinnacle would honor that overdraft. Having been told that
the check would be covered (usually from an anticipated wire transfer),
Kinkead and her supervisor, Mr. Folsom, would honor it and allow the
overdraft. Until November 1994, Provident honored all of Pinnacle's
overdrafts, without reviewing Pinnacle's books and records or monitoring
its checking account.
As mentioned earlier, Pinnacle's CFO, Joseph Mader, had informed
Provident that its final fiscal year report would be forthcoming on
September 15, 1994. When Provident did not receive the audited reports by
that date, Mr. Folsom spoke with Mr. Mader, who reported that though
Pinnacle had sustained losses, it was expecting a substantial infusion of
capital. Pinnacle wanted to hold off publishing the report so that it
could add a footnote explaining that there would be a capital infusion.
Based on this, Folsom decided to extend Pinnacle's credit line through
the end of November.
Folsom called Mader some time in October to check on the status of the
report. When Mader returned the call on November 1, he informed Folsom
that the capital infusion had failed. Folsom demanded a meeting with
Pinnacle's officers.
On November 2, Folsom and Kinkead met with Mader and Al Miller,
President of Pinnacle. Mader and Miller presented internally generated
financial statements indicating a pretax loss of six million dollars for
the previous fiscal year, as well as a pretax loss of almost one million
dollars for the first quarter of the current fiscal year. Miller and
Mader admitted that they had misused their warehouse credit line with
G.E. Capital Mortgage Services, Inc., to whom they were indebted for
about six million dollars. They "admitted fraud" as to G.E., but
indicated that they had not misappropriated the Provident funds and asked
for an extension of funding of their loans while they financially
reorganized. Provident declined to do so.
At that time, Provident finally reviewed Pinnacle's books and
discovered that Pinnacle had been diverting substantial sums of money
from Pinnacle's Provident account to its operating account at Meridian
Bank. Kinkead and Folsom also learned that Pinnacle had been requesting
advances on loans earlier than was routinely requested, possibly using
the money that was supposed to be for specific loans for other purposes
instead. Indeed, Pinnacle was engaging in a "kiting" scheme,
misappropriating monies from third party investors that should have been
applied to previously funded loans. A Pinnacle employee told Kinkead that
the Provident line was not "whole," that as much as $500,000 may have
been taken from it, though no fraudulent loans had been made.
As of November 2, 1994, all checks presented to Provident on Pinnacle's
account had been processed, and the customer balance summary showed an
overdraft of $206,653.67. On November 3, $830,127.48 was deposited in
Pinnacle's account. Sixteen checks totaling $1,584,041.63 were presented
to Provident against Pinnacle's account on November 3. There were
insufficient funds to cover all sixteen, so Folsom sent a letter to
Miller, Pinnacle's president, to ask which checks should be paid. At the
time, Provident knew that all sixteen of those checks represented monies
that Pinnacle had delivered to borrowers and closing agents for
particular loans, as well as that each transaction was accompanied by a
takeout commitment by a third party investor, who would have paid for
the loan.
Miller indicated that six of the checks could be paid. Provident
debited $863,821 to pay off eight loans on November 4, and other checks
were paid at Mader's instruction. There was an overdraft on that date of
$178,303.73, and Provident honored no more checks. The remaining ten of
the sixteen checks presented on November 3 were dishonored, and those are
the subject of the instant litigation.
4. The Ten Transactions
Prior to the closings in each of the ten transactions in question,
Pinnacle had requested from Provident — and received — monies
to fund the transactions. As usual, Pinnacle presented the closing agent
with an uncertified check drawn on its account at Provident representing
payment for the note and mortgage to be executed by the borrower,
purchaser, or refinancer of the property. With Pinnacle's check in hand,
the closing agents closed each transaction, issuing checks from their own
accounts to the parties entitled to receive funds. The closing agents
then deposited Pinnacle's checks in their own accounts, and their banks
presented those checks to Provident for payment. In each case, Provident
dishonored the checks due to insufficient funds. After each closing, but
before the discovery of any problem, each closing agent returned the
original note to Pinnacle. Several closing agents recorded the mortgage
and sent Pinnacle certified copies. Despite the fact that Pinnacle's
checks were not honored, each closing agent honored their own checks when
they were presented.
At the time, uncertified funds were routinely accepted from mortgage
bankers, with a few exceptions for out of state lenders, ignoring the
Pennsylvania statute which required mortgage bankers and brokers to
certify funds. Most mortgage lenders such as Pinnacle insisted on
acceptance of regular checks; title insurers could not stay in business
if they did not follow the standard in the industry.
As was usual for these transactions, Provident had no contact with any
of the closing agents prior to settlement. Agency agreements were
included in most, but not all, of the instruction packages sent by
Pinnacle to the respective closing agents. The agreement provided that
Provident had a security interest in the note and mortgage; moreover, it
provided that the closing agent would act as Provident's agent in
connection with the loan transaction, agreeing to record the mortgage and
then to send both the original note and the original recorded mortgage to
Provident upon closing. The text of the agreement conflicted with the
closing instructions that Pinnacle gave to the closing agents, which
required the note to be returned to Pinnacle. In six of the ten
transactions, the agreement was executed, but its provisions were
basically ignored, as the closing documents were returned directly to
Pinnacle.
The closing agents learned of the dishonor from their own banks.
Provident did not attempt to contact the closing agents until November
10, 1994, when they sent a letter with instructions to deliver to
Provident all notes, mortgages, loan files, and other collateral, and any
monies received in connection with each mortgage loan.
Several of the agents sought judicial relief. Two of the closing agents
who are appellees in this matter, Gino L. Andreuzzi and the Pioneer
Agency L.P., hold state court judgments in their favor, for a total of
three judgments against Pinnacle, striking the mortgages and notes
executed by their respective buyers in favor of Pinnacle. Andreuzzi, the
closing agent in the Hopeck settlement, filed suit against Pinnacle in
the Court of Common Pleas of Luzerne County, Pennsylvania, seeking a TRO
to keep Pinnacle from selling, transferring, or assigning the note and
mortgage in question. Provident was not joined in Andreuzzi's case, but
it did have notice of the litigation. Andreuzzi filed a lis pendens with
the Prothonotary on November 14, 1994. About three hours after the lis
pendens was filed, Provident recorded the assignment from the Hopeck
note. Ultimately, a default judgment was entered against Pinnacle.
Pioneer also filed suits in connection with the Weaver and Fisher
transactions. In both cases, Pioneer sued Pinnacle and Provident in the
Court of Common Pleas of Berks County, Pennsylvania, on November 14,
1994. A preliminary injunction was entered on November 22, and a default
judgment was entered against both defendants on December 21, 1994. Two
days later, Pinnacle moved to open the default judgment. It was still
pending on February 1, 1995 when an involuntary petition was filed against
Pinnacle. Provident removed the action to the Bankruptcy Court on May 8,
1995.
Other closing agents entered into agreements with the borrowers to
execute new notes and mortgages. By the time this came before the
Bankruptcy Court, the mortgages had either been satisfied in full, with
proceeds held in escrow, or payments on the new mortgages and notes were
being made by the borrowers to the closing agents in escrow pending the
resolution of this matter.
C. The Bankruptcy Court's Findings and Judgment
On November 19, 1997, the Bankruptcy Court issued its Opinion in favor
of the appellees, ruling that:
(1) the appellant did not achieve the status of an HDC
with regard to the notes and mortgages in issue;
(2) the appellees would be entitled to indemnification
even if an agency relationship existed between the
appellant and appellees;
(3) the Uniform Fiduciaries Law is inapplicable to
validate the appellant's position with regard to the
subject notes and mortgages; and
(4) the appellant is precluded from relitigating the
transactions with appellees Pioneer Agency II Corp
t/a Pioneer Agency and Andreuzzi.
Judgment against Provident was entered on December 17, 1997. On December
22, 1997, appellant filed a notice of appeal from the Judgment. On
February 13, 1998, the record on appeal was transmitted to this Court. As
"nothing remains for the [lower] court to do," Universal Minerals, Inc.
v. C.A. Hughes & Co., 669 F.2d 98, 101 (3d Cir. 1981), the BankruptcyCourt's ruling is final, and thus this Court properly has appellate
jurisdiction over the December 17, 1997 Order pursuant to
28 U.S.C. § 158(a).
III. ISSUES PRESENTED
On appeal, Provident makes six arguments. First, Provident argues that
it is the holder in due course ("HDC") of the ten mortgage notes.
Second, Provident argues that the Bankruptcy Court's ruling that the
appellees were entitled to indemnification if they were Provident's agents
is clearly erroneous. Third, appellant contends that the bankruptcy court
erred in ruling that Provident was not protected by the Uniform
Fiduciaries Act ("UFA"), adopted by both New Jersey and Pennsylvania at
N.J.S.A. 3B:1454 and 7 Pa. Cons. Stat. Ann. § 6361, respectively.Fourth, Provident argues, for the first time upon appeal, that the
doctrine of avoidable consequences bars appellees from recovering any
damages from Provident. Fifth, Provident maintains that the doctrines of
lis pendens, res judicata, and collateral estoppel do not bar
relitigation of these issues as to the Andreuzzi transaction. Finally,
Provident argues that the Bankruptcy Court erred by giving preclusionary
effect to the Pioneer action default judgments.
This Opinion will not address Provident's "avoidable consequences"
argument, as it was raised, for the first time, upon appeal.[fn3]Moreover, the doctrine of res judicata precludes review of the two
transactions for which Pioneer was the closing agent, and I thus affirm
the Bankruptcy Court's judgment as to Pioneer on that ground.[fn4] I willaffirm the Bankruptcy Court's holding that Provident is not entitled to
the protections of the Uniform Fiduciaries Act , especially in light of
the fact that Provident has withdrawn its argument that Pinnacle was its
agent.[fn5] For reasons stated herein, I will affirm the BankruptcyCourt's holding that Provident is not the holder in due course of the
eight[fn6] transactions still in question. Accordingly, there is no needfor this Court to address the Bankruptcy Court's alternate finding that
the closing agents would be entitled to indemnification.[fn7]
IV. STANDARD OF REVIEW
On appeal, the weight accorded to the findings of fact by a bankruptcy
court are governed by Fed.R.Bank.P. 8013, which provides as follows:
On appeal the district court or bankruptcy appellate
panel may affirm, modify, or reverse a bankruptcy
judge's judgment, order, or decree or remand with
instructions for further proceedings. Findings of
fact, whether based on oral or documentary evidence,
shall not be set aside unless clearly erroneous, and
due regard shall be given to the opportunity of the
bankruptcy court to judge the credibility of
witnesses.
Fed.R.Bank.P. 8013. Under this Rule, a bankruptcy court's factualfindings may be disturbed only if clearly erroneous. See FGH Realty
Credit v. Newark Airport/Hotel Ltd., 155 B.R. 93 (D.N.J. 1993). Where a
mixed question of law and fact is presented, the appropriate standard
must be applied to each component. In re Sharon Steel Corp., 871 F.2d 1217,
1222 (3d Cir. 1989). Thus, a reviewing court "must accept the [lower]court's findings of historical or narrative facts unless they are clearly
erroneous, but . . . must exercise a plenary review and its application
of those precepts to the historical facts." Universal Minerals, Inc. v.
C.A. Hughes & Co., 669 F.2d at 103.
While standards for establishing that a party is a holder in due course
are wellsettled law, see, e.g., Triffin v. Dillabough, 448 Pa. Super. 72,
87, 670 A.2d 684, 691 (1996), the Court's application of these standardsto the facts does result in a mixed finding of fact and law that is
subject to a mixed standard of review. Mellon Bank, N.A. v. Metro
Communications, Inc., 945 F.2d 635, 64142 (3d Cir. 1991), cert. denied,
503 U.S. 937 (1992). The factual findings can only be reversed for clearerror, In re Graves, 33 F.3d 242, 251 (3d Cir. 1994), even if thereviewing court would have decided the matter differently. In re
PrincetonNew York Investors, Inc., 1998 WL 111674 (D.N.J. 1998). This
Court, thus, may not overturn a bankruptcy judge's factual findings if
the factual determinations bear any "rational relationship to the
supporting evidentiary data. . . ." Fellheimer, Eichen & Braverman, P.C.
v. Charter Technologies, Inc., 57 F.3d 1215, 1223 (3d Cir. 1995) (citingHoots v. Comm. of Pa., 703 F.2d 722, 725 (3d Cir. 1983). However, thisCourt reviews any legal conclusions de novo.
V. DISCUSSION
Appellant argues that the Bankruptcy Court's finding that appellant is
not an HDC of the promissory notes and mortgages from the eight remaining
real estate transactions closed by appellees is clearly erroneous. The
dispute here is not a dispute of law, as the parties agree on what the
law concerning HDCs is. As the Bankruptcy Court correctly found,[fn8]every holder of a negotiable instrument is presumed to be an HDC, Morgan
Guaranty Trust Company of New York v. Staats, 631 A.2d 631, 636(Pa.Super.Ct. 1993), but when a defense of fraud is meritorious as to the
payee, the holder has the burden of showing that it is an HDC in order to
be immune from that defense. Norman v. World Wide Distributors, Inc.,
195 A.2d 115, 117 (Pa.Super.Ct. 1963). A holder of a negotiableinstrument (such as the promissory notes in this case) is either the
person with possession of bearer paper or the person identified on the
instrument if that person is in possession. 13 Pa. Cons. Stat. Ann.
§ 1201; N.J.S.A. 12A:3201 (West Supp. 1998). The holder of adocument of title (such as the mortgages in this case) is the person in
possession if the document is made out to bearer or to the order of the
person in possession. Id. The holder becomes an HDC if:
(1) the instrument when issued or negotiated to the
holder does not bear such apparent evidence of forgery
or alteration or is not otherwise so irregular or
incomplete as to call into question its authenticity;
and
(2) the holder took the instrument:
(i) for value;
(ii) in good faith;
(iii) without notice that the instrument is
overdue or has been dishonored or that there is an
uncured default with respect to payment of another
instrument issued as part of the same series;
(iv) without notice that the instrument contains
an unauthorized signature or has been altered;
(v) without notice of any claim to the instrument
described in section 3306 (relating to claims to an
instrument); and
(vi) without notice that any party has a defense
or claim in recoupment described in section 3305(a)
(relating to defenses and claims in recoupment).
13 Pa. Cons. Stat. Ann. § 3302. See also N.J.S.A. 12A:3302. Inshort, an HDC is the holder of the instrument or document who took for
value and in good faith without notice of any claims or defects on the
instrument or document. If classified as an HDC, the holder holds without
regard to defenses, with certain statutory exemptions which do not apply
here. 13 Pa. Cons. Stat. Ann. § 3305; N.J.S.A. 12A:3305.
It was clear to the parties and to the Bankruptcy Court below that
Provident did not have actual possession of the notes and mortgages
before November 2, 1998, when it learned that there were insufficient
funds in Pinnacle's account at Provident to cover Pinnacle's checks to
the closing agents here. Provident nonetheless argued that it was the
holder of the notes and mortgages because, before gaining actual
knowledge of Pinnacle's fraud, Provident "constructively possessed" the
notes and mortgages from the moment that the closing agents, who were
allegedly Provident's agents, took possession of the notes at the
closings before November 2.
The Bankruptcy Court rejected Provident's argument, finding that none
of the appellees acted as Provident's agents, and thus Provident never
constructively or actually possessed the notes and mortgages. Thus, the
Bankruptcy Court found that Provident never became the holder of these
notes and mortgages in the first place. (Opinion at 53.) Alternatively,
the Bankruptcy Court found that while Provident did give value for the
notes and mortgages (Opinion at 54), it did not take those notes and
mortgages in good faith and without knowledge of defenses, and thus
Provident is not an HDC. (Opinion at 63.) The question before this Court
is whether the Bankruptcy Court's rulings in this regard were clearly
erroneous. I hold that it was neither clearly erroneous nor contrary to
established law for the Bankruptcy Court to find that Provident did not
fit the role of "good faith purchaser for value" necessary to claim HDC
status even though Provident's lack of good faith arose after the title
agents closed the real estate transactions. As the following discussion
will explain, in the context of a course of dealing between Provident and
Pinnacle extending over thousands of such transactions, Provident was
essentially a party to the mortgage lending transactions and thus, by
definition, cannot claim HDC status in the negotiable papers which
resulted from those transactions, especially because Provident gained
knowledge of defenses before its own role in the original mortgage
lending transaction was complete.
I affirm the Bankruptcy Court's ruling that Provident is not the HDC of
these notes and mortgages. In so holding, I need not, and thus do not,
reach the issue of whether Provident constructively possessed the notes
and mortgages,[fn9] for holder status is irrelevant if Provident did nottake in good faith and without knowledge of defenses. Because I find that
the Bankruptcy Court's ruling that Provident did not take in good faith
was not clearly erroneous, I affirm the ruling that Provident is not
entitled to the protections afforded to a holder in due course.
The Bankruptcy Court correctly stated the law on good faith in this
context: the test for good faith is "not one of negligence of duty to
inquire, but rather it is one of willful dishonesty or actual knowledge."
Valley Bank & Trust Co. v. American Utilities, Inc., 415 F. Supp. 298,
301 (E.D.Pa. 1976). See also Mellon Bank v. PasqualisPoliti,
800 F. Supp. 1297, 1302 (W.D.Pa. 1992), aff'd, 990 F.2d 780 (3d Cir.1993); Carnegie Bank v. Shalleck, 606 A.2d 389, 394 (N.J.Super.Ct.A.D. 1992); General Inv. Corp. v. Angelini, 278 A.2d 193 (N.J. 1971).Good faith may be defeated only by actual knowledge or a deliberate
attempt to evade knowledge. Rice v. Barrington, 70 A. 169, 170 (N.J. E. &
A 1908). "There is no affirmative duty of inquiry on the part of one
taking a negotiable instrument, and there is no constructive notice from
the circumstances of the transaction, unless the circumstances are so
strong that if ignored they will be deemed to establish bad faith on the
part of the transferee." Bankers Trust Co. v. Crawford, 781 F.2d 39, 45(3d Cir. 1986). Moreover, an HDC must take not only in good faith, but
also without notice of defenses to the instrument or document. One has
"notice" when
(1) he has actual knowledge of it;
(2) he has received a notice or notification of it; or
(3) from all the facts and circumstances known to him
at the time in question he has reason to know that it
exists.
Pa. Cons. Stat. Ann. § 1201.
The Bankruptcy Court here found that Provident did not in fact have
actual knowledge of the fraud or potential defense of failure of
consideration at the time of each separate closing. (Opinion at 58.) The
Bankruptcy Court also found that despite the fact that Provident failed
to review Pinnacle's books, records, and checking account ledger, failed
to notice the overdraft problem, failed to properly monitor withdrawals,
and failed to act after knowledge of financial deterioration in default
in providing timely audited financial statements, the appellees had not
proved that Provident acted with willful dishonesty (id.); Provident did
act with negligence or gross negligence, but gross negligence alone is
not enough to defeat an HDC's title. See Washington & Canonsburg Ry. Co.
v. Murray, 211 F. 440, 445 (3d Cir. 1914); General Inv. Corp.,
278 A.2d 193. Moreover, the Bankruptcy Court correctly noted that holderin due course status is generally created at the time that the claimant
becomes a holder — meaning at the time of negotiation. N.J.S.A.
12A:3302; Sisemore v. Kierlow Co., Inc. v. Nicholas, 27 A.2d 473, 478(Pa.Super.Ct. 1942). In transactions such as the ones at issue here which
involve blank endorsements, the instruments and documents are bearer
paper and are thus negotiated upon delivery alone. 13 Pa. Cons. Stat.
Ann. § 3201; N.J.S.A. 12A:3201.
Nonetheless, the Bankruptcy Court found that Provident failed to attain
the status of a holder in due course. It acknowledged that once a party
establishes its position as a holder in due course, no future action can
undermine that status; so in the usual transaction with negotiable bearer
paper, actual knowledge of defenses gained after possession do not defeat
HDC status. (Opinion at 63.) See Bricks Unlimited, Inc. v. Agee,
672 F.2d 1255, 1259 (5th Cir. 1982); Park Gasoline Co. v. Crusius,158 A. 334 (N.J. 1932). However, the Bankruptcy Court said, it was not
finding lack of good faith after gaining HDC status, but rather that
Provident did not gain HDC status in the first place, for these were not
the "usual" transactions. Taken in a "global sense," the Bankruptcy Court
said, these transactions did not end until after the settlements.
(Opinion at 58.)
Usually, one who takes a negotiable instrument for value has only the
underlying circumstances of that transaction by which to determine if
there is reason to give pause as to the veracity of that instrument. A
lender provides funds to a borrower who executes a promissory note. Once
that transaction is complete, the lender transfers the note to a second
lender in exchange for which the first lender receives funds replenishing
his account and enabling him to lend the same funds to another borrower.
HDC status is given to that second lender if it acts in good faith and
without knowledge of defenses, and there is no general duty for that
second lender to inquire unless the circumstances are so suspicious that
they cannot be ignored. See, e.g. Triffin, 670 A.2d at 692. In the usualHDC transaction, there are two discernible transactions, two exchanges of
funds and notes. As the Bankruptcy Court pointed out, the purpose of
giving that second lender HDC status is "to meet the contemporary needs
of fast moving commercial society . . . (citation omitted) and to enhance
the marketability of negotiable instruments [allowing] bankers, brokers
and the general public to trade in confidence." Triffin,
670 A.2d at 693. However, "the more the holder knows about the underlyingtransaction, and particularly the more he controls or participates or
becomes involved in it, the less he fits the role of a good faith
purchaser for value; the closer his relationship to the underlying
agreement which is the source of the note, the less need there is for
giving him the tensionfree rights necessary in a fastmoving,
creditextending commercial world." Unico v. Owen, 50 N.J. 101, 109110 (1967). See also Jones v. Approved Bancredit Corp., 256 A.2d 739, 742(Del. 1969) (in such a situation, "[the financer] should not be able to
hide behind `the fictional fence' of the . . . UCC and thereby achieve an
unfair advantage over the purchaser.").
Here, there were not two separate, discernible transactions.
Provident's funding of Pinnacle who funded the borrowers was one complex
transaction. The acts of a third party investor who would buy the notes
and mortgages from Provident would have been the second separate,
discernible transaction here. Provident did not replenish Pinnacle's
account in exchange for receiving the notes and mortgages, such that
Pinnacle would have more money to make more loans, as in the "usual"
transaction. Rather, in a complex and longstanding scheme encompassing
thousands of transactions over several years, Provident gave Pinnacle a
line of credit, and then, after Pinnacle gave Provident information about
individual proposed loans to borrowers, Provident transferred money to
Pinnacle's account, in order to later receive the note and mortgage from
each transaction and pass them on to a third party investor. The
Bankruptcy Court, as a factual matter, found that under this complex
scheme, no transactions between any of the parties were complete until
both of the transactions were concluded, particularly because the "second
lender" (Provident) had the ultimate control over the first transaction
(by ordering the dishonor of Pinnacle's checks).[fn10]
I cannot say that the Bankruptcy Court's factual finding was clearly
erroneous. The Bankruptcy Court's ruling accords with the evidence as
well as with the policy underlying the holder in due course doctrine. I
hold that where a warehouse lender so closely participates in the funding
and approval of mortgages which will ultimately lead to the warehouse
lender's rights in mortgages and promissory notes that the transactions
between mortgage banker and mortgagor and between warehouse lender and
mortgage banker are in fact one continuous transaction, rather than two
discernible transactions, a showing of the warehouse lender's lack of
good faith after the closing between title agent and mortgagor but before
the mortgage banker's check is presented to the warehouse lender may
destroy HDC status. Indeed, where the party who claims HDC status was in
essence a party to the original transaction, it cannot, by definition, be
a holder in due course.
Provident had a great deal of involvement in the ongoing series of
transactions and ample knowledge of Pinnacle's overall financial
wellbeing, developed through years of funding Pinnacle's credit line for
thousands of such transactions and receipt of Pinnacle's periodic
financial reports. It had particular information about the borrowers
before it funded these loans. It was, in fact, part of the loan
transactions, and not a separate party who became an HDC through the
giving of value at a second separate, discernible transaction. Provident
had too much control of, participation in, and knowledge of the
underlying transaction to claim that it was a good faith purchaser for
value. See, e.g., Fidelity Bank Nat'l Assoc., 740 F. Supp. at 239.
Because, under this complex transactional scheme, Provident functioned
essentially as a party which approved and funded the loans and gained
actual knowledge of a defense to the notes and mortgages (lack of
consideration) before the transactions were complete, it was not clearly
erroneous for the Bankruptcy Court to find that Provident lacked the good
faith necessary to claim HDC status. Accordingly, the Bankruptcy Court's
ruling is affirmed.
VI. CONCLUSION
For the foregoing reasons, I will affirm the Bankruptcy Court's ruling
that appellant Provident Savings Bank was not the holder in due course of
the notes and mortgages from the ten transactions closed by appellees.
The defense of failure of consideration thus is available against
Provident. I therefore affirm the Bankruptcy Court's judgment that
appellees, and not appellant, are entitled to the notes and mortgages. The
accompanying Order is entered.
ORDER
This matter having come upon the court upon the appeal of appellant,
Provident Savings Bank, from a Judgment entered on December 17, 1997, by
the Honorable Judith H. Wizmur, United States Bankruptcy Judge for the
District of New Jersey,; and the Court having considered the parties'
submissions; and for the reasons set forth in the Opinion of today's
date;
IT IS this day of December, 1998, hereby
ORDERED that the Judgment entered by the Honorable Judith H. Wizmur,
United States Bankruptcy Judge for the District of New Jersey, on
December 17, 1997, which granted the notes and mortgages from
transactions closed by the appellees in this matter to the appellees,
be, and hereby is, AFFIRMED.
[fn1] The appellant's cause of action against defendant William E. Ward
was removed to state court in Delaware upon motion on the basis of
abstention pursuant to 28 U.S.C. § 1334(c) where it is now pending.The appellant's cause of action against Meridian Bank was resolved prior
to trial pursuant to the Stipulation of Settlement with respect to Count
II of the Complaint, filed on July 16, 1996. All claims between the
appellant and Lawyers Title Insurance Corporation were mutually dismissed
at trial.
[fn2] The Agreement said $10 million, but at times up to $12.5 million
was advanced.
[fn3] It is a wellestablished law that appellate courts may not pass
upon an issue not presented in a lower court. Singleton v. Wulff,
428 U.S. 106, 120 (1976). The same holds true for a U.S. District Courtsitting in its appellate capacity over matters appealed from the
bankruptcy court. See Barrett v. Commonwealth Fed. Sav. and Loan Ass'n,
939 F.2d 20 (3d Cir. 1991); In re Middle Atlantic Stud Welding Co.,
503 F.2d 1133, 1134 n. 1 (3d Cir. 1974). Because Provident never raisedthis issue before the Bankruptcy Court, I will not consider it now.
[fn4] The res judicata doctrine prevents relitigation of claims that grow
out of a transaction or occurrence from which other claims have earlier
been raised and decided validly, finally, and on the merits. Federated
Department Stores v. Moitie, 452 U.S. 394, 298 (1981). Under Pennsylvanialaw, default judgments, absent fraud, are afforded res judicata effect.
In re Graves, 156 B.R. 949, 954 (E.D.Pa. 1993), aff'd, 33 F.3d 242 (3dCir. 1994). On December 21, 1994, the Court of Common Pleas of Berks
County, Pennsylvania, entered default judgments against Provident on both
the Weaver and Fisher transactions, those transactions for which Pioneer
was the closing agent. Due to these default judgments, the doctrine of
res judicata bars relitigation of the Pioneer causes of action. The
Bankruptcy Court also held that the Andreuzzi transaction was barred by
res judicata or collateral estoppel because of the lis pendens. That,
however, is a more difficult issue and one that I need not reach now, as
my affirmance of the Bankruptcy Court's judgment applies equally to the
Andreuzzi transaction on the merits.
[fn5] At trial and in its briefs to this Court, as an alternative to its
holder in due course argument, Provident argued that it was protected by
the Pennsylvania Uniform Fiduciaries Act, 7 Pa. Cons. Stat. § 6361,
and the New Jersey Uniform Fiduciaries Law, N.J.S.A. 3B:1454, theprovisions of which are substantially similar. The two laws protect a
person who transfers money to a fiduciary in good faith, by noting that
"any right or title acquired from the fiduciary in consideration of such
payment or transfer is not invalid in consequences of a misapplication by
the fiduciary." 7 Pa. Cons. Stat. § 6361; N.J.S.A. 3B:1454. TheBankruptcy Court held that Pinnacle was not Provident's agent or
fiduciary, and thus the UFA did not apply. (Opinion at 66.) In light of
the fact that Provident's counsel, at oral argument before this Court on
November 13, 1998, themselves argued that Pinnacle was not Provident's
fiduciary, I will affirm this aspect of the Bankruptcy Court's ruling
without need to examine the factual bases on which it relied.
[fn6] The rest of this Opinion is limited to the eight transactions not
handled by Pioneer, since only the Pioneer transactions are bound by res
judicata.
[fn7] As Part V of this Opinion explains, one of the several bases for
the Bankruptcy Court's decision that Provident is not the HDC of the
mortgages and notes is that the settlement agents were not Provident's
agents, and thus Provident did not constructively possess the mortgages
and notes prior to gaining knowledge of claims or defenses on those
notes. (Opinion at 3453.) In the alternative, in case appellate courts
determined that Provident was the HDC of those notes because an agency
relationship did exist, the Bankruptcy Court held that the closing
agents, and not Provident, would still be the ones entitled to the notes
and mortgages, for the agents would have had a right to indemnification
from Provident. (Id. at 6364.) Though, as I explain in Part V, I do not
reach the agency issue, I do affirm the Bankruptcy Court's HDC ruling on
other grounds. In doing so, I am affirming the decision that the
appellees, and not Provident, are entitled to the notes and mortgages. The
Bankruptcy Court's indemnification ruling is just an alternative reason
for finding that the appellees are entitled to the notes and mortgages.
Having already agreed that the closing agents are so entitled because
Provident is not an HDC, there is no need to address that alternative
ruling upon appeal.
[fn8] Seven of the eight remaining transactions here are governed by
Pennsylvania law. The eighth is under New Jersey law, but the two states'
laws on HDC status are largely consistent on the issues raised in these
proceedings.
[fn9] The Bankruptcy Court agreed that authority from other jurisdictions
suggest that a party may become a constructive holder when its agent
takes possession of a negotiable instrument on its behalf. (Opinion at
3637.) However, the Bankruptcy Court made the factual finding that
appellees were not Provident's agents. It determined that though six of
the ten transactions involved written agency agreements, those agreements
were not controlling in light of the course of dealing between the
parties (Opinion at 46), and that Provident did not otherwise meet its
burden of establishing that an agency relationship existed. Because I
find that the Bankruptcy Court's determination that Provident did not act
in good faith is not clearly erroneous, and because the lack of good
faith alone is enough of a basis to sustain a judgment that Provident is
not an HDC of these eight notes and mortgages, I need not address whether
the agency determination was clearly erroneous.
[fn10] Under the Bankruptcy Court's findings of fact, Provident was, in
reality, a party to the original transaction. The situation is somewhat
analogous to a consumer goods financer who has a substantial voice in the
underlying transaction; that financer is not entitled to HDC status.
Westfield Investment Co. v. Fellers, 181 A.2d 809 (N.J.Super.Ct. LawDiv.). Provident had a substantial voice in providing and carrying out
funding of the underlying borrowing transactions, and it thus cannot
claim that it was a good faith HDC when it learned of the defense of
failure of consideration prior to dishonoring the Pinnacle checks.
Loislaw Federal District Court Opinions
Copyright © 2013 CCH Incorporated or its affiliates
IN RE PINNACLE MORTGAGE INVESTMENT CORPORATION, (D.N.J. 1998)
IN RE PINNACLE MORTGAGE INVESTMENT CORPORATION, Debtor
PROVIDENT SAVINGS BANK, a New Jersey Banking Corporation,
Plaintiff/Appellant, v. PINNACLE MORTGAGE INVESTMENT CORPORATION, a
Pennsylvania Corporation, et al., Defendants, SETTLERS ABSTRACT CO., L.P.,
LAWYERS TITLE INSURANCE CORP., LAND TRANSFER CO, INC., FIDELITY NATIONAL
TITLE INSURANCE CO. OF PENNSYLVANIA, GINO L. ANDREUZZI, PIONEER AGENCY II
CORP. t/a PIONEER AGENCY, MUSSER & MUSSER, WILLIAM E. WARD, QUAKER ABSTRACT
CO., and SEARCHTEC ABSTRACT, INC., Appellees.
CIVIL NO. 980489 (JBS), [Bankruptcy Case No. 9510608 (JHW)], [Adv.
Proc. No. 951091]
United States District Court, D. New Jersey.
Filed: December 9, 1998
Walter E. Thomas, Jr., Esq., Timothy J. Matteson, Esq., Mark A. Trudeau,
Esq., Stern, Lavinthal, Norgaard & Kapnick, Esqs., Englewood, New Jersey,
Attorneys for Appellant.
Edward J. Hayes, Esq., Andrea Dobin, Esq., Fox, Rothschild, O'Brien &
Frankel, Princeton Pike Corporate Center, Lawrenceville, New Jersey,
Attorneys for Appellees, Settlers Abstract Co., L.P., Land Transfer Co,
Inc., Fidelity National Title Insurance Co. of Pennsylvania, Gino L.
Andreuzzi, Pioneer Agency II Corp. t/a Pioneer Agency, Musser & Musser,
Quaker Abstract Co, and Searchtec Abstract, Inc.
OPINION
SIMANDLE, District Judge.
I. INTRODUCTION
Provident Savings Bank appeals from a Judgment entered on December 17,
1997, pursuant to a written opinion issued on November 19, 1997, by the
Honorable Judith H. Wizmur, United States Bankruptcy Judge, after trial
in an adversary proceeding. That Opinion ruled in favor of the
Appellees, Settlers Abstract Co., L.P., Land Transfer Co, Inc., Fidelity
National Title Insurance Co. of Pennsylvania, Gino L. Andreuzzi, Pioneer
Agency II Corp. t/a Pioneer Agency, Musser & Musser, Quaker Abstract Co,
and Searchtec Abstract, Inc. ("title agents"). Reviewing a longstanding
complex lending relationship between Provident and the debtor, Pinnacle
Mortgage Corporation, of which the ten real estate mortgage loans at
issue herein were a part, the Bankruptcy Court held that appellee title
agents (who had advanced their own funds to cover disbursements when
Provident dishonored Pinnacle's checks) had a more valid or higher
priority security interest in the promissory notes and mortgages executed
as part of ten separate residential real estate closing than did
appellant. Provident Savings Bank appeals this ruling and seeks this
Court's determination that it was the holder in due course of those
documents.
The principal issue to be decided is whether the Bankruptcy Court
correctly determined under the Uniform Commercial Code that Provident was
not a holder in due course of the promissory notes arising from these
loans, where it found that Provident so closely participated in the
funding and approval of the Pinnaclebrokered loans that the transaction
did not end at the closing with the title agents, such that Provident did
not attain holder in due course status because it did not fit the
requisite role of a "good faith purchaser for value." For the reasons
that will be stated herein, the judgment will be affirmed because the
Bankruptcy Court's finding that Provident never attained HDC status was
neither clearly erroneous nor contrary to law.
II. BACKGROUND
A. Procedural History
This case arises from a dispute over the various security interests in
mortgage documents from ten separate real estate transactions in late
October, 1994, conducted by the debtor, Pinnacle Mortgage Investment
Corporation (who brokered the transactions), the appellant (who financed
the transactions), and the appellees (who were title closing agents in
the transactions). On February 2, 1995, appellant Provident Savings Bank
("Provident") and other creditors filed an involuntary petition under
Chapter 7 of Title 11 of the Bankruptcy Code against Pinnacle Mortgage
Investment Corporation ("Pinnacle"). An order for relief under Chapter 7
was entered by the Bankruptcy Court on March 6, 1995.
On March 24, 1995, Provident commenced this adversary proceeding by
filing a three count complaint to determine the extent, validity, and
priority of the various security interests asserted by Pinnacle, Meridian
Bank, Lawyers Title Insurance Corporation, the appellees, and William E.
Ward with regard to the promissory notes and mortgages from ten real
estate transactions.[fn1] Appellees responded to the complaint by filingan answer, counterclaims, and crossclaims, seeking money judgments in
the amount of the contested notes and mortgages, interest, cost of suit,
and attorneys fees; imposition of a constructive trust in their favor
with regard to the notes, mortgages, and proceeds thereof; and to have
the subject notes and mortgages avoided and stricken in favor of
subsequently executed mortgages between the appellees and the
mortgagors. Provident twice amended its complaint, finally seeking a
declaratory judgment that it is the holder in due course of the subject
notes and mortgages under the Uniform Commercial Code; avoidance of the
preferential transfer by appellee Andreuzzi pursuant to 11 U.S.C. § 547and 550; avoidance of the fraudulent transfer by appellee Andreuzzipursuant to §§ 548 and 550; and avoidance of the preferential and
fraudulent transfers by appellees pursuant to 11 U.S.C. § 547, 548,and 550.
Trial in this matter was held on July 16, 17, and 18, 1996, and October
1, 3, and 4, 1996. At the close of Provident's case in chief, upon motion
by the appellees, all of those portions of the Second Amended Complaint
which did not pertain to Provident's status as a holder in due course
("HDC") were dismissed.
B. The Factual History
In its November 19, 1997 opinion, the Bankruptcy Court determined that
the facts of the case are as follows. Debtor Pinnacle Mortgage Investment
Corporation ("Pinnacle" or "debtor") was a mortgage banker which
primarily dealt in residential mortgage lending and refinance. In December
of 1992, Pinnacle and Provident Savings Bank ("Provident" or "appellant")
entered into a Mortgage Warehouse Loan and Security Agreement
("Agreement"), whereby Provident would fund Pinnacle, who in turn funded
retail customers who sought to purchase or refinance residential real
estate. The borrower in each transaction would give Pinnacle a note and
mortgage, both of which acted as collateral to protect Provident until
Pinnacle sold the mortgage to a third party investor, such as the Federal
Home Loan Mortgage Corporation ("Freddie Mac"), who satisfied Pinnacle's
debt to Provident. Warehouse Agreement § 3.4.
1. The Warehouse Agreement
Under these types of agreements, there would usually not be any contact
between the warehouse lender and the ultimate mortgagor. Typically,
Pinnacle would arrange with a prospective borrower for Pinnacle to
advance funds for the borrower to purchase or refinance a home and for
the borrower to assign a note and mortgage to Pinnacle as collateral. The
mortgage would be endorsed in blank in order to accommodate the final
third party investor (such as Freddie Mac), with whom Pinnacle would
arrange to purchase the mortgage, usually as a part of a pool of
mortgages; this was known as a "takeout" agreement. All of this
completed, Pinnacle would submit a "package" to Provident seeking funding
for the particular transaction under its $10 million line of credit.[fn2]This package included a description of the borrower and the funding, an
assignment of the mortgage endorsed in blank, a takeout commitment, and
an agency agreement that indicated the borrower's attorney's agreement
"to act as the agent of the Bank" to disburse the Advance and to obtain
due execution and delivery to the bank of the original note that
evidences the debt underlying the Mortgage Loan." Warehouse Agreement
§ 5.3(A)(iii). The Agreement required all of this to be submitted
along with the initial funding request. As a matter of course, however,
the agency agreement was usually executed by the title agent handling the
closing instead of by the borrower's attorney, and Provident customarily
accepted the mortgage assignment and agency agreement after the actual
closing.
After Provident received the package and checked to see that Pinnacle's
credit limit had not been exceeded (although, as stated above, often
prior to receipt of the mortgage assignment and agency agreement),
Provident credited Pinnacle's checking account with 98% of the requested
funds. Warehouse Agreement §§ 1.1, 2.1. Pinnacle would write a
regular, uncertified check to the closing agent, who would close the loan
directly with the borrower on Pinnacle's behalf. Pinnacle was supposed to
use specific funds credited to their account to fund specific closings,
but no controls were in place to make sure that Pinnacle actually did
so.
With Pinnacle's check in hand, the closing agent would use money from
its own bank account to disburse funds to the mortgagor, later
replenishing its bank account by depositing Pinnacle's check. Next, the
closing agent would routinely send the original note, a certified copy of
the recorded mortgage, and the other closing documents to Pinnacle, who
would send them on to Provident, who would receive this original note
approximately three to five days after closing. Provident and the
borrowers had no contact; indeed, Provident and the closing agents had no
contact, save the extremely limited contact by the closing agents who did
return the agency agreement included in the borrowing package. Not all
closing agents did return the agreement signed; most of those who did
sent everything through Pinnacle to go to Provident, in accordance with
Pinnacle's written instructions, rather than remitting the note and other
papers directly to Provident, as stated in the agency agreement.
Ultimately, Provident would send the note and accompanying documents to
the third party investor, who would pay Provident the funds which
Provident had originally placed in Pinnacle's checking account by wiring
monies to Provident in Pinnacle's name. Because the third party investor
would send multiple payments in each wire transfer, Pinnacle would tell
Provident to which loans to apply each of the funds.
2. Pinnacle's Declining Financial State
Among the twenty or so warehouse customers that Provident had during
19931994, Pinnacle was the most profitable for Provident, providing
hundreds of millions of dollars in loan transactions. However, when the
mortgage banking industry suffered a decline in business, Pinnacle began
to experience financial difficulties as well.
The Warehouse Agreement, § 6.11, required Pinnacle to submit
unaudited balance sheets and statements of income to Provident on a
quarterly basis, though Pinnacle customarily provided monthly
statements. The statements filed for June, July, and August of 1993
reflected an accrued pretax income for the first three months of the
fiscal year of $281,351. Statements for September, October, and November
of 1993 reflected pretax income of $923,923 for the first six months of
the fiscal year. However, after the November 30 report, Pinnacle began to
send its reports quarterly, which was in accordance with the Warehouse
Agreement but which was nonetheless unusual due to Pinnacle's custom of
submitting reports monthly. The next report, covering the ninemonth
period ending February 28, 1994, was due on April 15 but not received
until some time in May. It showed pretax income of $136,000 for the
first nine months, or an $800,000 loss in the previous three months. The
accompanying unaudited balance sheets showed a reduction of assets from
$40 million to $28 million in those three months. The final financial
statement was due on August 31, 1994, but Provident never received it.
At a holiday party in May 1994, Edmund R. Folsom, head of Provident's
Commercial Lending Department, had learned that Pinnacle had sustained
losses in the winter months. On August 19, 1994, Sharon Kinkead, of
Provident's Warehouse Lending Department, called Pinnacle's headquarters
and learned from Pinnacle's CFO, Joseph Mader, that there would be a
delay in the submission of the audited financial statements for the
fiscal year ending May 31, 1994 because of a change of comptroller, but
that the report would be provided by September 15, 1994. That report
never arrived, and no other financial statements were received up until
Provident's termination of its relationship with Pinnacle in early
November 1994.
3. Provident's Relationship with Pinnacle
Throughout its relationship with Pinnacle, Provident routinely honored
overdrafts on behalf of Pinnacle — about twenty times in 1993 and
fifteen times in 1994. These overdrafts ranged from $7,240.87 to
$5,255,812.
When a check was presented to the bank on Pinnacle's account for which
Pinnacle had insufficient funds, Sharon Kinkead would contact Pinnacle to
ask whether Pinnacle would honor that overdraft. Having been told that
the check would be covered (usually from an anticipated wire transfer),
Kinkead and her supervisor, Mr. Folsom, would honor it and allow the
overdraft. Until November 1994, Provident honored all of Pinnacle's
overdrafts, without reviewing Pinnacle's books and records or monitoring
its checking account.
As mentioned earlier, Pinnacle's CFO, Joseph Mader, had informed
Provident that its final fiscal year report would be forthcoming on
September 15, 1994. When Provident did not receive the audited reports by
that date, Mr. Folsom spoke with Mr. Mader, who reported that though
Pinnacle had sustained losses, it was expecting a substantial infusion of
capital. Pinnacle wanted to hold off publishing the report so that it
could add a footnote explaining that there would be a capital infusion.
Based on this, Folsom decided to extend Pinnacle's credit line through
the end of November.
Folsom called Mader some time in October to check on the status of the
report. When Mader returned the call on November 1, he informed Folsom
that the capital infusion had failed. Folsom demanded a meeting with
Pinnacle's officers.
On November 2, Folsom and Kinkead met with Mader and Al Miller,
President of Pinnacle. Mader and Miller presented internally generated
financial statements indicating a pretax loss of six million dollars for
the previous fiscal year, as well as a pretax loss of almost one million
dollars for the first quarter of the current fiscal year. Miller and
Mader admitted that they had misused their warehouse credit line with
G.E. Capital Mortgage Services, Inc., to whom they were indebted for
about six million dollars. They "admitted fraud" as to G.E., but
indicated that they had not misappropriated the Provident funds and asked
for an extension of funding of their loans while they financially
reorganized. Provident declined to do so.
At that time, Provident finally reviewed Pinnacle's books and
discovered that Pinnacle had been diverting substantial sums of money
from Pinnacle's Provident account to its operating account at Meridian
Bank. Kinkead and Folsom also learned that Pinnacle had been requesting
advances on loans earlier than was routinely requested, possibly using
the money that was supposed to be for specific loans for other purposes
instead. Indeed, Pinnacle was engaging in a "kiting" scheme,
misappropriating monies from third party investors that should have been
applied to previously funded loans. A Pinnacle employee told Kinkead that
the Provident line was not "whole," that as much as $500,000 may have
been taken from it, though no fraudulent loans had been made.
As of November 2, 1994, all checks presented to Provident on Pinnacle's
account had been processed, and the customer balance summary showed an
overdraft of $206,653.67. On November 3, $830,127.48 was deposited in
Pinnacle's account. Sixteen checks totaling $1,584,041.63 were presented
to Provident against Pinnacle's account on November 3. There were
insufficient funds to cover all sixteen, so Folsom sent a letter to
Miller, Pinnacle's president, to ask which checks should be paid. At the
time, Provident knew that all sixteen of those checks represented monies
that Pinnacle had delivered to borrowers and closing agents for
particular loans, as well as that each transaction was accompanied by a
takeout commitment by a third party investor, who would have paid for
the loan.
Miller indicated that six of the checks could be paid. Provident
debited $863,821 to pay off eight loans on November 4, and other checks
were paid at Mader's instruction. There was an overdraft on that date of
$178,303.73, and Provident honored no more checks. The remaining ten of
the sixteen checks presented on November 3 were dishonored, and those are
the subject of the instant litigation.
4. The Ten Transactions
Prior to the closings in each of the ten transactions in question,
Pinnacle had requested from Provident — and received — monies
to fund the transactions. As usual, Pinnacle presented the closing agent
with an uncertified check drawn on its account at Provident representing
payment for the note and mortgage to be executed by the borrower,
purchaser, or refinancer of the property. With Pinnacle's check in hand,
the closing agents closed each transaction, issuing checks from their own
accounts to the parties entitled to receive funds. The closing agents
then deposited Pinnacle's checks in their own accounts, and their banks
presented those checks to Provident for payment. In each case, Provident
dishonored the checks due to insufficient funds. After each closing, but
before the discovery of any problem, each closing agent returned the
original note to Pinnacle. Several closing agents recorded the mortgage
and sent Pinnacle certified copies. Despite the fact that Pinnacle's
checks were not honored, each closing agent honored their own checks when
they were presented.
At the time, uncertified funds were routinely accepted from mortgage
bankers, with a few exceptions for out of state lenders, ignoring the
Pennsylvania statute which required mortgage bankers and brokers to
certify funds. Most mortgage lenders such as Pinnacle insisted on
acceptance of regular checks; title insurers could not stay in business
if they did not follow the standard in the industry.
As was usual for these transactions, Provident had no contact with any
of the closing agents prior to settlement. Agency agreements were
included in most, but not all, of the instruction packages sent by
Pinnacle to the respective closing agents. The agreement provided that
Provident had a security interest in the note and mortgage; moreover, it
provided that the closing agent would act as Provident's agent in
connection with the loan transaction, agreeing to record the mortgage and
then to send both the original note and the original recorded mortgage to
Provident upon closing. The text of the agreement conflicted with the
closing instructions that Pinnacle gave to the closing agents, which
required the note to be returned to Pinnacle. In six of the ten
transactions, the agreement was executed, but its provisions were
basically ignored, as the closing documents were returned directly to
Pinnacle.
The closing agents learned of the dishonor from their own banks.
Provident did not attempt to contact the closing agents until November
10, 1994, when they sent a letter with instructions to deliver to
Provident all notes, mortgages, loan files, and other collateral, and any
monies received in connection with each mortgage loan.
Several of the agents sought judicial relief. Two of the closing agents
who are appellees in this matter, Gino L. Andreuzzi and the Pioneer
Agency L.P., hold state court judgments in their favor, for a total of
three judgments against Pinnacle, striking the mortgages and notes
executed by their respective buyers in favor of Pinnacle. Andreuzzi, the
closing agent in the Hopeck settlement, filed suit against Pinnacle in
the Court of Common Pleas of Luzerne County, Pennsylvania, seeking a TRO
to keep Pinnacle from selling, transferring, or assigning the note and
mortgage in question. Provident was not joined in Andreuzzi's case, but
it did have notice of the litigation. Andreuzzi filed a lis pendens with
the Prothonotary on November 14, 1994. About three hours after the lis
pendens was filed, Provident recorded the assignment from the Hopeck
note. Ultimately, a default judgment was entered against Pinnacle.
Pioneer also filed suits in connection with the Weaver and Fisher
transactions. In both cases, Pioneer sued Pinnacle and Provident in the
Court of Common Pleas of Berks County, Pennsylvania, on November 14,
1994. A preliminary injunction was entered on November 22, and a default
judgment was entered against both defendants on December 21, 1994. Two
days later, Pinnacle moved to open the default judgment. It was still
pending on February 1, 1995 when an involuntary petition was filed against
Pinnacle. Provident removed the action to the Bankruptcy Court on May 8,
1995.
Other closing agents entered into agreements with the borrowers to
execute new notes and mortgages. By the time this came before the
Bankruptcy Court, the mortgages had either been satisfied in full, with
proceeds held in escrow, or payments on the new mortgages and notes were
being made by the borrowers to the closing agents in escrow pending the
resolution of this matter.
C. The Bankruptcy Court's Findings and Judgment
On November 19, 1997, the Bankruptcy Court issued its Opinion in favor
of the appellees, ruling that:
(1) the appellant did not achieve the status of an HDC
with regard to the notes and mortgages in issue;
(2) the appellees would be entitled to indemnification
even if an agency relationship existed between the
appellant and appellees;
(3) the Uniform Fiduciaries Law is inapplicable to
validate the appellant's position with regard to the
subject notes and mortgages; and
(4) the appellant is precluded from relitigating the
transactions with appellees Pioneer Agency II Corp
t/a Pioneer Agency and Andreuzzi.
Judgment against Provident was entered on December 17, 1997. On December
22, 1997, appellant filed a notice of appeal from the Judgment. On
February 13, 1998, the record on appeal was transmitted to this Court. As
"nothing remains for the [lower] court to do," Universal Minerals, Inc.
v. C.A. Hughes & Co., 669 F.2d 98, 101 (3d Cir. 1981), the BankruptcyCourt's ruling is final, and thus this Court properly has appellate
jurisdiction over the December 17, 1997 Order pursuant to
28 U.S.C. § 158(a).
III. ISSUES PRESENTED
On appeal, Provident makes six arguments. First, Provident argues that
it is the holder in due course ("HDC") of the ten mortgage notes.
Second, Provident argues that the Bankruptcy Court's ruling that the
appellees were entitled to indemnification if they were Provident's agents
is clearly erroneous. Third, appellant contends that the bankruptcy court
erred in ruling that Provident was not protected by the Uniform
Fiduciaries Act ("UFA"), adopted by both New Jersey and Pennsylvania at
N.J.S.A. 3B:1454 and 7 Pa. Cons. Stat. Ann. § 6361, respectively.Fourth, Provident argues, for the first time upon appeal, that the
doctrine of avoidable consequences bars appellees from recovering any
damages from Provident. Fifth, Provident maintains that the doctrines of
lis pendens, res judicata, and collateral estoppel do not bar
relitigation of these issues as to the Andreuzzi transaction. Finally,
Provident argues that the Bankruptcy Court erred by giving preclusionary
effect to the Pioneer action default judgments.
This Opinion will not address Provident's "avoidable consequences"
argument, as it was raised, for the first time, upon appeal.[fn3]Moreover, the doctrine of res judicata precludes review of the two
transactions for which Pioneer was the closing agent, and I thus affirm
the Bankruptcy Court's judgment as to Pioneer on that ground.[fn4] I willaffirm the Bankruptcy Court's holding that Provident is not entitled to
the protections of the Uniform Fiduciaries Act , especially in light of
the fact that Provident has withdrawn its argument that Pinnacle was its
agent.[fn5] For reasons stated herein, I will affirm the BankruptcyCourt's holding that Provident is not the holder in due course of the
eight[fn6] transactions still in question. Accordingly, there is no needfor this Court to address the Bankruptcy Court's alternate finding that
the closing agents would be entitled to indemnification.[fn7]
IV. STANDARD OF REVIEW
On appeal, the weight accorded to the findings of fact by a bankruptcy
court are governed by Fed.R.Bank.P. 8013, which provides as follows:
On appeal the district court or bankruptcy appellate
panel may affirm, modify, or reverse a bankruptcy
judge's judgment, order, or decree or remand with
instructions for further proceedings. Findings of
fact, whether based on oral or documentary evidence,
shall not be set aside unless clearly erroneous, and
due regard shall be given to the opportunity of the
bankruptcy court to judge the credibility of
witnesses.
Fed.R.Bank.P. 8013. Under this Rule, a bankruptcy court's factualfindings may be disturbed only if clearly erroneous. See FGH Realty
Credit v. Newark Airport/Hotel Ltd., 155 B.R. 93 (D.N.J. 1993). Where a
mixed question of law and fact is presented, the appropriate standard
must be applied to each component. In re Sharon Steel Corp., 871 F.2d 1217,
1222 (3d Cir. 1989). Thus, a reviewing court "must accept the [lower]court's findings of historical or narrative facts unless they are clearly
erroneous, but . . . must exercise a plenary review and its application
of those precepts to the historical facts." Universal Minerals, Inc. v.
C.A. Hughes & Co., 669 F.2d at 103.
While standards for establishing that a party is a holder in due course
are wellsettled law, see, e.g., Triffin v. Dillabough, 448 Pa. Super. 72,
87, 670 A.2d 684, 691 (1996), the Court's application of these standardsto the facts does result in a mixed finding of fact and law that is
subject to a mixed standard of review. Mellon Bank, N.A. v. Metro
Communications, Inc., 945 F.2d 635, 64142 (3d Cir. 1991), cert. denied,
503 U.S. 937 (1992). The factual findings can only be reversed for clearerror, In re Graves, 33 F.3d 242, 251 (3d Cir. 1994), even if thereviewing court would have decided the matter differently. In re
PrincetonNew York Investors, Inc., 1998 WL 111674 (D.N.J. 1998). This
Court, thus, may not overturn a bankruptcy judge's factual findings if
the factual determinations bear any "rational relationship to the
supporting evidentiary data. . . ." Fellheimer, Eichen & Braverman, P.C.
v. Charter Technologies, Inc., 57 F.3d 1215, 1223 (3d Cir. 1995) (citingHoots v. Comm. of Pa., 703 F.2d 722, 725 (3d Cir. 1983). However, thisCourt reviews any legal conclusions de novo.
V. DISCUSSION
Appellant argues that the Bankruptcy Court's finding that appellant is
not an HDC of the promissory notes and mortgages from the eight remaining
real estate transactions closed by appellees is clearly erroneous. The
dispute here is not a dispute of law, as the parties agree on what the
law concerning HDCs is. As the Bankruptcy Court correctly found,[fn8]every holder of a negotiable instrument is presumed to be an HDC, Morgan
Guaranty Trust Company of New York v. Staats, 631 A.2d 631, 636(Pa.Super.Ct. 1993), but when a defense of fraud is meritorious as to the
payee, the holder has the burden of showing that it is an HDC in order to
be immune from that defense. Norman v. World Wide Distributors, Inc.,
195 A.2d 115, 117 (Pa.Super.Ct. 1963). A holder of a negotiableinstrument (such as the promissory notes in this case) is either the
person with possession of bearer paper or the person identified on the
instrument if that person is in possession. 13 Pa. Cons. Stat. Ann.
§ 1201; N.J.S.A. 12A:3201 (West Supp. 1998). The holder of adocument of title (such as the mortgages in this case) is the person in
possession if the document is made out to bearer or to the order of the
person in possession. Id. The holder becomes an HDC if:
(1) the instrument when issued or negotiated to the
holder does not bear such apparent evidence of forgery
or alteration or is not otherwise so irregular or
incomplete as to call into question its authenticity;
and
(2) the holder took the instrument:
(i) for value;
(ii) in good faith;
(iii) without notice that the instrument is
overdue or has been dishonored or that there is an
uncured default with respect to payment of another
instrument issued as part of the same series;
(iv) without notice that the instrument contains
an unauthorized signature or has been altered;
(v) without notice of any claim to the instrument
described in section 3306 (relating to claims to an
instrument); and
(vi) without notice that any party has a defense
or claim in recoupment described in section 3305(a)
(relating to defenses and claims in recoupment).
13 Pa. Cons. Stat. Ann. § 3302. See also N.J.S.A. 12A:3302. Inshort, an HDC is the holder of the instrument or document who took for
value and in good faith without notice of any claims or defects on the
instrument or document. If classified as an HDC, the holder holds without
regard to defenses, with certain statutory exemptions which do not apply
here. 13 Pa. Cons. Stat. Ann. § 3305; N.J.S.A. 12A:3305.
It was clear to the parties and to the Bankruptcy Court below that
Provident did not have actual possession of the notes and mortgages
before November 2, 1998, when it learned that there were insufficient
funds in Pinnacle's account at Provident to cover Pinnacle's checks to
the closing agents here. Provident nonetheless argued that it was the
holder of the notes and mortgages because, before gaining actual
knowledge of Pinnacle's fraud, Provident "constructively possessed" the
notes and mortgages from the moment that the closing agents, who were
allegedly Provident's agents, took possession of the notes at the
closings before November 2.
The Bankruptcy Court rejected Provident's argument, finding that none
of the appellees acted as Provident's agents, and thus Provident never
constructively or actually possessed the notes and mortgages. Thus, the
Bankruptcy Court found that Provident never became the holder of these
notes and mortgages in the first place. (Opinion at 53.) Alternatively,
the Bankruptcy Court found that while Provident did give value for the
notes and mortgages (Opinion at 54), it did not take those notes and
mortgages in good faith and without knowledge of defenses, and thus
Provident is not an HDC. (Opinion at 63.) The question before this Court
is whether the Bankruptcy Court's rulings in this regard were clearly
erroneous. I hold that it was neither clearly erroneous nor contrary to
established law for the Bankruptcy Court to find that Provident did not
fit the role of "good faith purchaser for value" necessary to claim HDC
status even though Provident's lack of good faith arose after the title
agents closed the real estate transactions. As the following discussion
will explain, in the context of a course of dealing between Provident and
Pinnacle extending over thousands of such transactions, Provident was
essentially a party to the mortgage lending transactions and thus, by
definition, cannot claim HDC status in the negotiable papers which
resulted from those transactions, especially because Provident gained
knowledge of defenses before its own role in the original mortgage
lending transaction was complete.
I affirm the Bankruptcy Court's ruling that Provident is not the HDC of
these notes and mortgages. In so holding, I need not, and thus do not,
reach the issue of whether Provident constructively possessed the notes
and mortgages,[fn9] for holder status is irrelevant if Provident did nottake in good faith and without knowledge of defenses. Because I find that
the Bankruptcy Court's ruling that Provident did not take in good faith
was not clearly erroneous, I affirm the ruling that Provident is not
entitled to the protections afforded to a holder in due course.
The Bankruptcy Court correctly stated the law on good faith in this
context: the test for good faith is "not one of negligence of duty to
inquire, but rather it is one of willful dishonesty or actual knowledge."
Valley Bank & Trust Co. v. American Utilities, Inc., 415 F. Supp. 298,
301 (E.D.Pa. 1976). See also Mellon Bank v. PasqualisPoliti,
800 F. Supp. 1297, 1302 (W.D.Pa. 1992), aff'd, 990 F.2d 780 (3d Cir.1993); Carnegie Bank v. Shalleck, 606 A.2d 389, 394 (N.J.Super.Ct.A.D. 1992); General Inv. Corp. v. Angelini, 278 A.2d 193 (N.J. 1971).Good faith may be defeated only by actual knowledge or a deliberate
attempt to evade knowledge. Rice v. Barrington, 70 A. 169, 170 (N.J. E. &
A 1908). "There is no affirmative duty of inquiry on the part of one
taking a negotiable instrument, and there is no constructive notice from
the circumstances of the transaction, unless the circumstances are so
strong that if ignored they will be deemed to establish bad faith on the
part of the transferee." Bankers Trust Co. v. Crawford, 781 F.2d 39, 45(3d Cir. 1986). Moreover, an HDC must take not only in good faith, but
also without notice of defenses to the instrument or document. One has
"notice" when
(1) he has actual knowledge of it;
(2) he has received a notice or notification of it; or
(3) from all the facts and circumstances known to him
at the time in question he has reason to know that it
exists.
Pa. Cons. Stat. Ann. § 1201.
The Bankruptcy Court here found that Provident did not in fact have
actual knowledge of the fraud or potential defense of failure of
consideration at the time of each separate closing. (Opinion at 58.) The
Bankruptcy Court also found that despite the fact that Provident failed
to review Pinnacle's books, records, and checking account ledger, failed
to notice the overdraft problem, failed to properly monitor withdrawals,
and failed to act after knowledge of financial deterioration in default
in providing timely audited financial statements, the appellees had not
proved that Provident acted with willful dishonesty (id.); Provident did
act with negligence or gross negligence, but gross negligence alone is
not enough to defeat an HDC's title. See Washington & Canonsburg Ry. Co.
v. Murray, 211 F. 440, 445 (3d Cir. 1914); General Inv. Corp.,
278 A.2d 193. Moreover, the Bankruptcy Court correctly noted that holderin due course status is generally created at the time that the claimant
becomes a holder — meaning at the time of negotiation. N.J.S.A.
12A:3302; Sisemore v. Kierlow Co., Inc. v. Nicholas, 27 A.2d 473, 478(Pa.Super.Ct. 1942). In transactions such as the ones at issue here which
involve blank endorsements, the instruments and documents are bearer
paper and are thus negotiated upon delivery alone. 13 Pa. Cons. Stat.
Ann. § 3201; N.J.S.A. 12A:3201.
Nonetheless, the Bankruptcy Court found that Provident failed to attain
the status of a holder in due course. It acknowledged that once a party
establishes its position as a holder in due course, no future action can
undermine that status; so in the usual transaction with negotiable bearer
paper, actual knowledge of defenses gained after possession do not defeat
HDC status. (Opinion at 63.) See Bricks Unlimited, Inc. v. Agee,
672 F.2d 1255, 1259 (5th Cir. 1982); Park Gasoline Co. v. Crusius,158 A. 334 (N.J. 1932). However, the Bankruptcy Court said, it was not
finding lack of good faith after gaining HDC status, but rather that
Provident did not gain HDC status in the first place, for these were not
the "usual" transactions. Taken in a "global sense," the Bankruptcy Court
said, these transactions did not end until after the settlements.
(Opinion at 58.)
Usually, one who takes a negotiable instrument for value has only the
underlying circumstances of that transaction by which to determine if
there is reason to give pause as to the veracity of that instrument. A
lender provides funds to a borrower who executes a promissory note. Once
that transaction is complete, the lender transfers the note to a second
lender in exchange for which the first lender receives funds replenishing
his account and enabling him to lend the same funds to another borrower.
HDC status is given to that second lender if it acts in good faith and
without knowledge of defenses, and there is no general duty for that
second lender to inquire unless the circumstances are so suspicious that
they cannot be ignored. See, e.g. Triffin, 670 A.2d at 692. In the usualHDC transaction, there are two discernible transactions, two exchanges of
funds and notes. As the Bankruptcy Court pointed out, the purpose of
giving that second lender HDC status is "to meet the contemporary needs
of fast moving commercial society . . . (citation omitted) and to enhance
the marketability of negotiable instruments [allowing] bankers, brokers
and the general public to trade in confidence." Triffin,
670 A.2d at 693. However, "the more the holder knows about the underlyingtransaction, and particularly the more he controls or participates or
becomes involved in it, the less he fits the role of a good faith
purchaser for value; the closer his relationship to the underlying
agreement which is the source of the note, the less need there is for
giving him the tensionfree rights necessary in a fastmoving,
creditextending commercial world." Unico v. Owen, 50 N.J. 101, 109110 (1967). See also Jones v. Approved Bancredit Corp., 256 A.2d 739, 742(Del. 1969) (in such a situation, "[the financer] should not be able to
hide behind `the fictional fence' of the . . . UCC and thereby achieve an
unfair advantage over the purchaser.").
Here, there were not two separate, discernible transactions.
Provident's funding of Pinnacle who funded the borrowers was one complex
transaction. The acts of a third party investor who would buy the notes
and mortgages from Provident would have been the second separate,
discernible transaction here. Provident did not replenish Pinnacle's
account in exchange for receiving the notes and mortgages, such that
Pinnacle would have more money to make more loans, as in the "usual"
transaction. Rather, in a complex and longstanding scheme encompassing
thousands of transactions over several years, Provident gave Pinnacle a
line of credit, and then, after Pinnacle gave Provident information about
individual proposed loans to borrowers, Provident transferred money to
Pinnacle's account, in order to later receive the note and mortgage from
each transaction and pass them on to a third party investor. The
Bankruptcy Court, as a factual matter, found that under this complex
scheme, no transactions between any of the parties were complete until
both of the transactions were concluded, particularly because the "second
lender" (Provident) had the ultimate control over the first transaction
(by ordering the dishonor of Pinnacle's checks).[fn10]
I cannot say that the Bankruptcy Court's factual finding was clearly
erroneous. The Bankruptcy Court's ruling accords with the evidence as
well as with the policy underlying the holder in due course doctrine. I
hold that where a warehouse lender so closely participates in the funding
and approval of mortgages which will ultimately lead to the warehouse
lender's rights in mortgages and promissory notes that the transactions
between mortgage banker and mortgagor and between warehouse lender and
mortgage banker are in fact one continuous transaction, rather than two
discernible transactions, a showing of the warehouse lender's lack of
good faith after the closing between title agent and mortgagor but before
the mortgage banker's check is presented to the warehouse lender may
destroy HDC status. Indeed, where the party who claims HDC status was in
essence a party to the original transaction, it cannot, by definition, be
a holder in due course.
Provident had a great deal of involvement in the ongoing series of
transactions and ample knowledge of Pinnacle's overall financial
wellbeing, developed through years of funding Pinnacle's credit line for
thousands of such transactions and receipt of Pinnacle's periodic
financial reports. It had particular information about the borrowers
before it funded these loans. It was, in fact, part of the loan
transactions, and not a separate party who became an HDC through the
giving of value at a second separate, discernible transaction. Provident
had too much control of, participation in, and knowledge of the
underlying transaction to claim that it was a good faith purchaser for
value. See, e.g., Fidelity Bank Nat'l Assoc., 740 F. Supp. at 239.
Because, under this complex transactional scheme, Provident functioned
essentially as a party which approved and funded the loans and gained
actual knowledge of a defense to the notes and mortgages (lack of
consideration) before the transactions were complete, it was not clearly
erroneous for the Bankruptcy Court to find that Provident lacked the good
faith necessary to claim HDC status. Accordingly, the Bankruptcy Court's
ruling is affirmed.
VI. CONCLUSION
For the foregoing reasons, I will affirm the Bankruptcy Court's ruling
that appellant Provident Savings Bank was not the holder in due course of
the notes and mortgages from the ten transactions closed by appellees.
The defense of failure of consideration thus is available against
Provident. I therefore affirm the Bankruptcy Court's judgment that
appellees, and not appellant, are entitled to the notes and mortgages. The
accompanying Order is entered.
ORDER
This matter having come upon the court upon the appeal of appellant,
Provident Savings Bank, from a Judgment entered on December 17, 1997, by
the Honorable Judith H. Wizmur, United States Bankruptcy Judge for the
District of New Jersey,; and the Court having considered the parties'
submissions; and for the reasons set forth in the Opinion of today's
date;
IT IS this day of December, 1998, hereby
ORDERED that the Judgment entered by the Honorable Judith H. Wizmur,
United States Bankruptcy Judge for the District of New Jersey, on
December 17, 1997, which granted the notes and mortgages from
transactions closed by the appellees in this matter to the appellees,
be, and hereby is, AFFIRMED.
[fn1] The appellant's cause of action against defendant William E. Ward
was removed to state court in Delaware upon motion on the basis of
abstention pursuant to 28 U.S.C. § 1334(c) where it is now pending.The appellant's cause of action against Meridian Bank was resolved prior
to trial pursuant to the Stipulation of Settlement with respect to Count
II of the Complaint, filed on July 16, 1996. All claims between the
appellant and Lawyers Title Insurance Corporation were mutually dismissed
at trial.
[fn2] The Agreement said $10 million, but at times up to $12.5 million
was advanced.
[fn3] It is a wellestablished law that appellate courts may not pass
upon an issue not presented in a lower court. Singleton v. Wulff,
428 U.S. 106, 120 (1976). The same holds true for a U.S. District Courtsitting in its appellate capacity over matters appealed from the
bankruptcy court. See Barrett v. Commonwealth Fed. Sav. and Loan Ass'n,
939 F.2d 20 (3d Cir. 1991); In re Middle Atlantic Stud Welding Co.,
503 F.2d 1133, 1134 n. 1 (3d Cir. 1974). Because Provident never raisedthis issue before the Bankruptcy Court, I will not consider it now.
[fn4] The res judicata doctrine prevents relitigation of claims that grow
out of a transaction or occurrence from which other claims have earlier
been raised and decided validly, finally, and on the merits. Federated
Department Stores v. Moitie, 452 U.S. 394, 298 (1981). Under Pennsylvanialaw, default judgments, absent fraud, are afforded res judicata effect.
In re Graves, 156 B.R. 949, 954 (E.D.Pa. 1993), aff'd, 33 F.3d 242 (3dCir. 1994). On December 21, 1994, the Court of Common Pleas of Berks
County, Pennsylvania, entered default judgments against Provident on both
the Weaver and Fisher transactions, those transactions for which Pioneer
was the closing agent. Due to these default judgments, the doctrine of
res judicata bars relitigation of the Pioneer causes of action. The
Bankruptcy Court also held that the Andreuzzi transaction was barred by
res judicata or collateral estoppel because of the lis pendens. That,
however, is a more difficult issue and one that I need not reach now, as
my affirmance of the Bankruptcy Court's judgment applies equally to the
Andreuzzi transaction on the merits.
[fn5] At trial and in its briefs to this Court, as an alternative to its
holder in due course argument, Provident argued that it was protected by
the Pennsylvania Uniform Fiduciaries Act, 7 Pa. Cons. Stat. § 6361,
and the New Jersey Uniform Fiduciaries Law, N.J.S.A. 3B:1454, theprovisions of which are substantially similar. The two laws protect a
person who transfers money to a fiduciary in good faith, by noting that
"any right or title acquired from the fiduciary in consideration of such
payment or transfer is not invalid in consequences of a misapplication by
the fiduciary." 7 Pa. Cons. Stat. § 6361; N.J.S.A. 3B:1454. TheBankruptcy Court held that Pinnacle was not Provident's agent or
fiduciary, and thus the UFA did not apply. (Opinion at 66.) In light of
the fact that Provident's counsel, at oral argument before this Court on
November 13, 1998, themselves argued that Pinnacle was not Provident's
fiduciary, I will affirm this aspect of the Bankruptcy Court's ruling
without need to examine the factual bases on which it relied.
[fn6] The rest of this Opinion is limited to the eight transactions not
handled by Pioneer, since only the Pioneer transactions are bound by res
judicata.
[fn7] As Part V of this Opinion explains, one of the several bases for
the Bankruptcy Court's decision that Provident is not the HDC of the
mortgages and notes is that the settlement agents were not Provident's
agents, and thus Provident did not constructively possess the mortgages
and notes prior to gaining knowledge of claims or defenses on those
notes. (Opinion at 3453.) In the alternative, in case appellate courts
determined that Provident was the HDC of those notes because an agency
relationship did exist, the Bankruptcy Court held that the closing
agents, and not Provident, would still be the ones entitled to the notes
and mortgages, for the agents would have had a right to indemnification
from Provident. (Id. at 6364.) Though, as I explain in Part V, I do not
reach the agency issue, I do affirm the Bankruptcy Court's HDC ruling on
other grounds. In doing so, I am affirming the decision that the
appellees, and not Provident, are entitled to the notes and mortgages. The
Bankruptcy Court's indemnification ruling is just an alternative reason
for finding that the appellees are entitled to the notes and mortgages.
Having already agreed that the closing agents are so entitled because
Provident is not an HDC, there is no need to address that alternative
ruling upon appeal.
[fn8] Seven of the eight remaining transactions here are governed by
Pennsylvania law. The eighth is under New Jersey law, but the two states'
laws on HDC status are largely consistent on the issues raised in these
proceedings.
[fn9] The Bankruptcy Court agreed that authority from other jurisdictions
suggest that a party may become a constructive holder when its agent
takes possession of a negotiable instrument on its behalf. (Opinion at
3637.) However, the Bankruptcy Court made the factual finding that
appellees were not Provident's agents. It determined that though six of
the ten transactions involved written agency agreements, those agreements
were not controlling in light of the course of dealing between the
parties (Opinion at 46), and that Provident did not otherwise meet its
burden of establishing that an agency relationship existed. Because I
find that the Bankruptcy Court's determination that Provident did not act
in good faith is not clearly erroneous, and because the lack of good
faith alone is enough of a basis to sustain a judgment that Provident is
not an HDC of these eight notes and mortgages, I need not address whether
the agency determination was clearly erroneous.
[fn10] Under the Bankruptcy Court's findings of fact, Provident was, in
reality, a party to the original transaction. The situation is somewhat
analogous to a consumer goods financer who has a substantial voice in the
underlying transaction; that financer is not entitled to HDC status.
Westfield Investment Co. v. Fellers, 181 A.2d 809 (N.J.Super.Ct. LawDiv.). Provident had a substantial voice in providing and carrying out
funding of the underlying borrowing transactions, and it thus cannot
claim that it was a good faith HDC when it learned of the defense of
failure of consideration prior to dishonoring the Pinnacle checks.
Loislaw Federal District Court Opinions
Copyright © 2013 CCH Incorporated or its affiliates
IN RE PINNACLE MORTGAGE INVESTMENT CORPORATION, (D.N.J. 1998)
IN RE PINNACLE MORTGAGE INVESTMENT CORPORATION, Debtor
PROVIDENT SAVINGS BANK, a New Jersey Banking Corporation,
Plaintiff/Appellant, v. PINNACLE MORTGAGE INVESTMENT CORPORATION, a
Pennsylvania Corporation, et al., Defendants, SETTLERS ABSTRACT CO., L.P.,
LAWYERS TITLE INSURANCE CORP., LAND TRANSFER CO, INC., FIDELITY NATIONAL
TITLE INSURANCE CO. OF PENNSYLVANIA, GINO L. ANDREUZZI, PIONEER AGENCY II
CORP. t/a PIONEER AGENCY, MUSSER & MUSSER, WILLIAM E. WARD, QUAKER ABSTRACT
CO., and SEARCHTEC ABSTRACT, INC., Appellees.
CIVIL NO. 980489 (JBS), [Bankruptcy Case No. 9510608 (JHW)], [Adv.
Proc. No. 951091]
United States District Court, D. New Jersey.
Filed: December 9, 1998
Walter E. Thomas, Jr., Esq., Timothy J. Matteson, Esq., Mark A. Trudeau,
Esq., Stern, Lavinthal, Norgaard & Kapnick, Esqs., Englewood, New Jersey,
Attorneys for Appellant.
Edward J. Hayes, Esq., Andrea Dobin, Esq., Fox, Rothschild, O'Brien &
Frankel, Princeton Pike Corporate Center, Lawrenceville, New Jersey,
Attorneys for Appellees, Settlers Abstract Co., L.P., Land Transfer Co,
Inc., Fidelity National Title Insurance Co. of Pennsylvania, Gino L.
Andreuzzi, Pioneer Agency II Corp. t/a Pioneer Agency, Musser & Musser,
Quaker Abstract Co, and Searchtec Abstract, Inc.
OPINION
SIMANDLE, District Judge.
I. INTRODUCTION
Provident Savings Bank appeals from a Judgment entered on December 17,
1997, pursuant to a written opinion issued on November 19, 1997, by the
Honorable Judith H. Wizmur, United States Bankruptcy Judge, after trial
in an adversary proceeding. That Opinion ruled in favor of the
Appellees, Settlers Abstract Co., L.P., Land Transfer Co, Inc., Fidelity
National Title Insurance Co. of Pennsylvania, Gino L. Andreuzzi, Pioneer
Agency II Corp. t/a Pioneer Agency, Musser & Musser, Quaker Abstract Co,
and Searchtec Abstract, Inc. ("title agents"). Reviewing a longstanding
complex lending relationship between Provident and the debtor, Pinnacle
Mortgage Corporation, of which the ten real estate mortgage loans at
issue herein were a part, the Bankruptcy Court held that appellee title
agents (who had advanced their own funds to cover disbursements when
Provident dishonored Pinnacle's checks) had a more valid or higher
priority security interest in the promissory notes and mortgages executed
as part of ten separate residential real estate closing than did
appellant. Provident Savings Bank appeals this ruling and seeks this
Court's determination that it was the holder in due course of those
documents.
The principal issue to be decided is whether the Bankruptcy Court
correctly determined under the Uniform Commercial Code that Provident was
not a holder in due course of the promissory notes arising from these
loans, where it found that Provident so closely participated in the
funding and approval of the Pinnaclebrokered loans that the transaction
did not end at the closing with the title agents, such that Provident did
not attain holder in due course status because it did not fit the
requisite role of a "good faith purchaser for value." For the reasons
that will be stated herein, the judgment will be affirmed because the
Bankruptcy Court's finding that Provident never attained HDC status was
neither clearly erroneous nor contrary to law.
II. BACKGROUND
A. Procedural History
This case arises from a dispute over the various security interests in
mortgage documents from ten separate real estate transactions in late
October, 1994, conducted by the debtor, Pinnacle Mortgage Investment
Corporation (who brokered the transactions), the appellant (who financed
the transactions), and the appellees (who were title closing agents in
the transactions). On February 2, 1995, appellant Provident Savings Bank
("Provident") and other creditors filed an involuntary petition under
Chapter 7 of Title 11 of the Bankruptcy Code against Pinnacle Mortgage
Investment Corporation ("Pinnacle"). An order for relief under Chapter 7
was entered by the Bankruptcy Court on March 6, 1995.
On March 24, 1995, Provident commenced this adversary proceeding by
filing a three count complaint to determine the extent, validity, and
priority of the various security interests asserted by Pinnacle, Meridian
Bank, Lawyers Title Insurance Corporation, the appellees, and William E.
Ward with regard to the promissory notes and mortgages from ten real
estate transactions.[fn1] Appellees responded to the complaint by filingan answer, counterclaims, and crossclaims, seeking money judgments in
the amount of the contested notes and mortgages, interest, cost of suit,
and attorneys fees; imposition of a constructive trust in their favor
with regard to the notes, mortgages, and proceeds thereof; and to have
the subject notes and mortgages avoided and stricken in favor of
subsequently executed mortgages between the appellees and the
mortgagors. Provident twice amended its complaint, finally seeking a
declaratory judgment that it is the holder in due course of the subject
notes and mortgages under the Uniform Commercial Code; avoidance of the
preferential transfer by appellee Andreuzzi pursuant to 11 U.S.C. § 547and 550; avoidance of the fraudulent transfer by appellee Andreuzzipursuant to §§ 548 and 550; and avoidance of the preferential and
fraudulent transfers by appellees pursuant to 11 U.S.C. § 547, 548,and 550.
Trial in this matter was held on July 16, 17, and 18, 1996, and October
1, 3, and 4, 1996. At the close of Provident's case in chief, upon motion
by the appellees, all of those portions of the Second Amended Complaint
which did not pertain to Provident's status as a holder in due course
("HDC") were dismissed.
B. The Factual History
In its November 19, 1997 opinion, the Bankruptcy Court determined that
the facts of the case are as follows. Debtor Pinnacle Mortgage Investment
Corporation ("Pinnacle" or "debtor") was a mortgage banker which
primarily dealt in residential mortgage lending and refinance. In December
of 1992, Pinnacle and Provident Savings Bank ("Provident" or "appellant")
entered into a Mortgage Warehouse Loan and Security Agreement
("Agreement"), whereby Provident would fund Pinnacle, who in turn funded
retail customers who sought to purchase or refinance residential real
estate. The borrower in each transaction would give Pinnacle a note and
mortgage, both of which acted as collateral to protect Provident until
Pinnacle sold the mortgage to a third party investor, such as the Federal
Home Loan Mortgage Corporation ("Freddie Mac"), who satisfied Pinnacle's
debt to Provident. Warehouse Agreement § 3.4.
1. The Warehouse Agreement
Under these types of agreements, there would usually not be any contact
between the warehouse lender and the ultimate mortgagor. Typically,
Pinnacle would arrange with a prospective borrower for Pinnacle to
advance funds for the borrower to purchase or refinance a home and for
the borrower to assign a note and mortgage to Pinnacle as collateral. The
mortgage would be endorsed in blank in order to accommodate the final
third party investor (such as Freddie Mac), with whom Pinnacle would
arrange to purchase the mortgage, usually as a part of a pool of
mortgages; this was known as a "takeout" agreement. All of this
completed, Pinnacle would submit a "package" to Provident seeking funding
for the particular transaction under its $10 million line of credit.[fn2]This package included a description of the borrower and the funding, an
assignment of the mortgage endorsed in blank, a takeout commitment, and
an agency agreement that indicated the borrower's attorney's agreement
"to act as the agent of the Bank" to disburse the Advance and to obtain
due execution and delivery to the bank of the original note that
evidences the debt underlying the Mortgage Loan." Warehouse Agreement
§ 5.3(A)(iii). The Agreement required all of this to be submitted
along with the initial funding request. As a matter of course, however,
the agency agreement was usually executed by the title agent handling the
closing instead of by the borrower's attorney, and Provident customarily
accepted the mortgage assignment and agency agreement after the actual
closing.
After Provident received the package and checked to see that Pinnacle's
credit limit had not been exceeded (although, as stated above, often
prior to receipt of the mortgage assignment and agency agreement),
Provident credited Pinnacle's checking account with 98% of the requested
funds. Warehouse Agreement §§ 1.1, 2.1. Pinnacle would write a
regular, uncertified check to the closing agent, who would close the loan
directly with the borrower on Pinnacle's behalf. Pinnacle was supposed to
use specific funds credited to their account to fund specific closings,
but no controls were in place to make sure that Pinnacle actually did
so.
With Pinnacle's check in hand, the closing agent would use money from
its own bank account to disburse funds to the mortgagor, later
replenishing its bank account by depositing Pinnacle's check. Next, the
closing agent would routinely send the original note, a certified copy of
the recorded mortgage, and the other closing documents to Pinnacle, who
would send them on to Provident, who would receive this original note
approximately three to five days after closing. Provident and the
borrowers had no contact; indeed, Provident and the closing agents had no
contact, save the extremely limited contact by the closing agents who did
return the agency agreement included in the borrowing package. Not all
closing agents did return the agreement signed; most of those who did
sent everything through Pinnacle to go to Provident, in accordance with
Pinnacle's written instructions, rather than remitting the note and other
papers directly to Provident, as stated in the agency agreement.
Ultimately, Provident would send the note and accompanying documents to
the third party investor, who would pay Provident the funds which
Provident had originally placed in Pinnacle's checking account by wiring
monies to Provident in Pinnacle's name. Because the third party investor
would send multiple payments in each wire transfer, Pinnacle would tell
Provident to which loans to apply each of the funds.
2. Pinnacle's Declining Financial State
Among the twenty or so warehouse customers that Provident had during
19931994, Pinnacle was the most profitable for Provident, providing
hundreds of millions of dollars in loan transactions. However, when the
mortgage banking industry suffered a decline in business, Pinnacle began
to experience financial difficulties as well.
The Warehouse Agreement, § 6.11, required Pinnacle to submit
unaudited balance sheets and statements of income to Provident on a
quarterly basis, though Pinnacle customarily provided monthly
statements. The statements filed for June, July, and August of 1993
reflected an accrued pretax income for the first three months of the
fiscal year of $281,351. Statements for September, October, and November
of 1993 reflected pretax income of $923,923 for the first six months of
the fiscal year. However, after the November 30 report, Pinnacle began to
send its reports quarterly, which was in accordance with the Warehouse
Agreement but which was nonetheless unusual due to Pinnacle's custom of
submitting reports monthly. The next report, covering the ninemonth
period ending February 28, 1994, was due on April 15 but not received
until some time in May. It showed pretax income of $136,000 for the
first nine months, or an $800,000 loss in the previous three months. The
accompanying unaudited balance sheets showed a reduction of assets from
$40 million to $28 million in those three months. The final financial
statement was due on August 31, 1994, but Provident never received it.
At a holiday party in May 1994, Edmund R. Folsom, head of Provident's
Commercial Lending Department, had learned that Pinnacle had sustained
losses in the winter months. On August 19, 1994, Sharon Kinkead, of
Provident's Warehouse Lending Department, called Pinnacle's headquarters
and learned from Pinnacle's CFO, Joseph Mader, that there would be a
delay in the submission of the audited financial statements for the
fiscal year ending May 31, 1994 because of a change of comptroller, but
that the report would be provided by September 15, 1994. That report
never arrived, and no other financial statements were received up until
Provident's termination of its relationship with Pinnacle in early
November 1994.
3. Provident's Relationship with Pinnacle
Throughout its relationship with Pinnacle, Provident routinely honored
overdrafts on behalf of Pinnacle — about twenty times in 1993 and
fifteen times in 1994. These overdrafts ranged from $7,240.87 to
$5,255,812.
When a check was presented to the bank on Pinnacle's account for which
Pinnacle had insufficient funds, Sharon Kinkead would contact Pinnacle to
ask whether Pinnacle would honor that overdraft. Having been told that
the check would be covered (usually from an anticipated wire transfer),
Kinkead and her supervisor, Mr. Folsom, would honor it and allow the
overdraft. Until November 1994, Provident honored all of Pinnacle's
overdrafts, without reviewing Pinnacle's books and records or monitoring
its checking account.
As mentioned earlier, Pinnacle's CFO, Joseph Mader, had informed
Provident that its final fiscal year report would be forthcoming on
September 15, 1994. When Provident did not receive the audited reports by
that date, Mr. Folsom spoke with Mr. Mader, who reported that though
Pinnacle had sustained losses, it was expecting a substantial infusion of
capital. Pinnacle wanted to hold off publishing the report so that it
could add a footnote explaining that there would be a capital infusion.
Based on this, Folsom decided to extend Pinnacle's credit line through
the end of November.
Folsom called Mader some time in October to check on the status of the
report. When Mader returned the call on November 1, he informed Folsom
that the capital infusion had failed. Folsom demanded a meeting with
Pinnacle's officers.
On November 2, Folsom and Kinkead met with Mader and Al Miller,
President of Pinnacle. Mader and Miller presented internally generated
financial statements indicating a pretax loss of six million dollars for
the previous fiscal year, as well as a pretax loss of almost one million
dollars for the first quarter of the current fiscal year. Miller and
Mader admitted that they had misused their warehouse credit line with
G.E. Capital Mortgage Services, Inc., to whom they were indebted for
about six million dollars. They "admitted fraud" as to G.E., but
indicated that they had not misappropriated the Provident funds and asked
for an extension of funding of their loans while they financially
reorganized. Provident declined to do so.
At that time, Provident finally reviewed Pinnacle's books and
discovered that Pinnacle had been diverting substantial sums of money
from Pinnacle's Provident account to its operating account at Meridian
Bank. Kinkead and Folsom also learned that Pinnacle had been requesting
advances on loans earlier than was routinely requested, possibly using
the money that was supposed to be for specific loans for other purposes
instead. Indeed, Pinnacle was engaging in a "kiting" scheme,
misappropriating monies from third party investors that should have been
applied to previously funded loans. A Pinnacle employee told Kinkead that
the Provident line was not "whole," that as much as $500,000 may have
been taken from it, though no fraudulent loans had been made.
As of November 2, 1994, all checks presented to Provident on Pinnacle's
account had been processed, and the customer balance summary showed an
overdraft of $206,653.67. On November 3, $830,127.48 was deposited in
Pinnacle's account. Sixteen checks totaling $1,584,041.63 were presented
to Provident against Pinnacle's account on November 3. There were
insufficient funds to cover all sixteen, so Folsom sent a letter to
Miller, Pinnacle's president, to ask which checks should be paid. At the
time, Provident knew that all sixteen of those checks represented monies
that Pinnacle had delivered to borrowers and closing agents for
particular loans, as well as that each transaction was accompanied by a
takeout commitment by a third party investor, who would have paid for
the loan.
Miller indicated that six of the checks could be paid. Provident
debited $863,821 to pay off eight loans on November 4, and other checks
were paid at Mader's instruction. There was an overdraft on that date of
$178,303.73, and Provident honored no more checks. The remaining ten of
the sixteen checks presented on November 3 were dishonored, and those are
the subject of the instant litigation.
4. The Ten Transactions
Prior to the closings in each of the ten transactions in question,
Pinnacle had requested from Provident — and received — monies
to fund the transactions. As usual, Pinnacle presented the closing agent
with an uncertified check drawn on its account at Provident representing
payment for the note and mortgage to be executed by the borrower,
purchaser, or refinancer of the property. With Pinnacle's check in hand,
the closing agents closed each transaction, issuing checks from their own
accounts to the parties entitled to receive funds. The closing agents
then deposited Pinnacle's checks in their own accounts, and their banks
presented those checks to Provident for payment. In each case, Provident
dishonored the checks due to insufficient funds. After each closing, but
before the discovery of any problem, each closing agent returned the
original note to Pinnacle. Several closing agents recorded the mortgage
and sent Pinnacle certified copies. Despite the fact that Pinnacle's
checks were not honored, each closing agent honored their own checks when
they were presented.
At the time, uncertified funds were routinely accepted from mortgage
bankers, with a few exceptions for out of state lenders, ignoring the
Pennsylvania statute which required mortgage bankers and brokers to
certify funds. Most mortgage lenders such as Pinnacle insisted on
acceptance of regular checks; title insurers could not stay in business
if they did not follow the standard in the industry.
As was usual for these transactions, Provident had no contact with any
of the closing agents prior to settlement. Agency agreements were
included in most, but not all, of the instruction packages sent by
Pinnacle to the respective closing agents. The agreement provided that
Provident had a security interest in the note and mortgage; moreover, it
provided that the closing agent would act as Provident's agent in
connection with the loan transaction, agreeing to record the mortgage and
then to send both the original note and the original recorded mortgage to
Provident upon closing. The text of the agreement conflicted with the
closing instructions that Pinnacle gave to the closing agents, which
required the note to be returned to Pinnacle. In six of the ten
transactions, the agreement was executed, but its provisions were
basically ignored, as the closing documents were returned directly to
Pinnacle.
The closing agents learned of the dishonor from their own banks.
Provident did not attempt to contact the closing agents until November
10, 1994, when they sent a letter with instructions to deliver to
Provident all notes, mortgages, loan files, and other collateral, and any
monies received in connection with each mortgage loan.
Several of the agents sought judicial relief. Two of the closing agents
who are appellees in this matter, Gino L. Andreuzzi and the Pioneer
Agency L.P., hold state court judgments in their favor, for a total of
three judgments against Pinnacle, striking the mortgages and notes
executed by their respective buyers in favor of Pinnacle. Andreuzzi, the
closing agent in the Hopeck settlement, filed suit against Pinnacle in
the Court of Common Pleas of Luzerne County, Pennsylvania, seeking a TRO
to keep Pinnacle from selling, transferring, or assigning the note and
mortgage in question. Provident was not joined in Andreuzzi's case, but
it did have notice of the litigation. Andreuzzi filed a lis pendens with
the Prothonotary on November 14, 1994. About three hours after the lis
pendens was filed, Provident recorded the assignment from the Hopeck
note. Ultimately, a default judgment was entered against Pinnacle.
Pioneer also filed suits in connection with the Weaver and Fisher
transactions. In both cases, Pioneer sued Pinnacle and Provident in the
Court of Common Pleas of Berks County, Pennsylvania, on November 14,
1994. A preliminary injunction was entered on November 22, and a default
judgment was entered against both defendants on December 21, 1994. Two
days later, Pinnacle moved to open the default judgment. It was still
pending on February 1, 1995 when an involuntary petition was filed against
Pinnacle. Provident removed the action to the Bankruptcy Court on May 8,
1995.
Other closing agents entered into agreements with the borrowers to
execute new notes and mortgages. By the time this came before the
Bankruptcy Court, the mortgages had either been satisfied in full, with
proceeds held in escrow, or payments on the new mortgages and notes were
being made by the borrowers to the closing agents in escrow pending the
resolution of this matter.
C. The Bankruptcy Court's Findings and Judgment
On November 19, 1997, the Bankruptcy Court issued its Opinion in favor
of the appellees, ruling that:
(1) the appellant did not achieve the status of an HDC
with regard to the notes and mortgages in issue;
(2) the appellees would be entitled to indemnification
even if an agency relationship existed between the
appellant and appellees;
(3) the Uniform Fiduciaries Law is inapplicable to
validate the appellant's position with regard to the
subject notes and mortgages; and
(4) the appellant is precluded from relitigating the
transactions with appellees Pioneer Agency II Corp
t/a Pioneer Agency and Andreuzzi.
Judgment against Provident was entered on December 17, 1997. On December
22, 1997, appellant filed a notice of appeal from the Judgment. On
February 13, 1998, the record on appeal was transmitted to this Court. As
"nothing remains for the [lower] court to do," Universal Minerals, Inc.
v. C.A. Hughes & Co., 669 F.2d 98, 101 (3d Cir. 1981), the BankruptcyCourt's ruling is final, and thus this Court properly has appellate
jurisdiction over the December 17, 1997 Order pursuant to
28 U.S.C. § 158(a).
III. ISSUES PRESENTED
On appeal, Provident makes six arguments. First, Provident argues that
it is the holder in due course ("HDC") of the ten mortgage notes.
Second, Provident argues that the Bankruptcy Court's ruling that the
appellees were entitled to indemnification if they were Provident's agents
is clearly erroneous. Third, appellant contends that the bankruptcy court
erred in ruling that Provident was not protected by the Uniform
Fiduciaries Act ("UFA"), adopted by both New Jersey and Pennsylvania at
N.J.S.A. 3B:1454 and 7 Pa. Cons. Stat. Ann. § 6361, respectively.Fourth, Provident argues, for the first time upon appeal, that the
doctrine of avoidable consequences bars appellees from recovering any
damages from Provident. Fifth, Provident maintains that the doctrines of
lis pendens, res judicata, and collateral estoppel do not bar
relitigation of these issues as to the Andreuzzi transaction. Finally,
Provident argues that the Bankruptcy Court erred by giving preclusionary
effect to the Pioneer action default judgments.
This Opinion will not address Provident's "avoidable consequences"
argument, as it was raised, for the first time, upon appeal.[fn3]Moreover, the doctrine of res judicata precludes review of the two
transactions for which Pioneer was the closing agent, and I thus affirm
the Bankruptcy Court's judgment as to Pioneer on that ground.[fn4] I willaffirm the Bankruptcy Court's holding that Provident is not entitled to
the protections of the Uniform Fiduciaries Act , especially in light of
the fact that Provident has withdrawn its argument that Pinnacle was its
agent.[fn5] For reasons stated herein, I will affirm the BankruptcyCourt's holding that Provident is not the holder in due course of the
eight[fn6] transactions still in question. Accordingly, there is no needfor this Court to address the Bankruptcy Court's alternate finding that
the closing agents would be entitled to indemnification.[fn7]
IV. STANDARD OF REVIEW
On appeal, the weight accorded to the findings of fact by a bankruptcy
court are governed by Fed.R.Bank.P. 8013, which provides as follows:
On appeal the district court or bankruptcy appellate
panel may affirm, modify, or reverse a bankruptcy
judge's judgment, order, or decree or remand with
instructions for further proceedings. Findings of
fact, whether based on oral or documentary evidence,
shall not be set aside unless clearly erroneous, and
due regard shall be given to the opportunity of the
bankruptcy court to judge the credibility of
witnesses.
Fed.R.Bank.P. 8013. Under this Rule, a bankruptcy court's factualfindings may be disturbed only if clearly erroneous. See FGH Realty
Credit v. Newark Airport/Hotel Ltd., 155 B.R. 93 (D.N.J. 1993). Where a
mixed question of law and fact is presented, the appropriate standard
must be applied to each component. In re Sharon Steel Corp., 871 F.2d 1217,
1222 (3d Cir. 1989). Thus, a reviewing court "must accept the [lower]court's findings of historical or narrative facts unless they are clearly
erroneous, but . . . must exercise a plenary review and its application
of those precepts to the historical facts." Universal Minerals, Inc. v.
C.A. Hughes & Co., 669 F.2d at 103.
While standards for establishing that a party is a holder in due course
are wellsettled law, see, e.g., Triffin v. Dillabough, 448 Pa. Super. 72,
87, 670 A.2d 684, 691 (1996), the Court's application of these standardsto the facts does result in a mixed finding of fact and law that is
subject to a mixed standard of review. Mellon Bank, N.A. v. Metro
Communications, Inc., 945 F.2d 635, 64142 (3d Cir. 1991), cert. denied,
503 U.S. 937 (1992). The factual findings can only be reversed for clearerror, In re Graves, 33 F.3d 242, 251 (3d Cir. 1994), even if thereviewing court would have decided the matter differently. In re
PrincetonNew York Investors, Inc., 1998 WL 111674 (D.N.J. 1998). This
Court, thus, may not overturn a bankruptcy judge's factual findings if
the factual determinations bear any "rational relationship to the
supporting evidentiary data. . . ." Fellheimer, Eichen & Braverman, P.C.
v. Charter Technologies, Inc., 57 F.3d 1215, 1223 (3d Cir. 1995) (citingHoots v. Comm. of Pa., 703 F.2d 722, 725 (3d Cir. 1983). However, thisCourt reviews any legal conclusions de novo.
V. DISCUSSION
Appellant argues that the Bankruptcy Court's finding that appellant is
not an HDC of the promissory notes and mortgages from the eight remaining
real estate transactions closed by appellees is clearly erroneous. The
dispute here is not a dispute of law, as the parties agree on what the
law concerning HDCs is. As the Bankruptcy Court correctly found,[fn8]every holder of a negotiable instrument is presumed to be an HDC, Morgan
Guaranty Trust Company of New York v. Staats, 631 A.2d 631, 636(Pa.Super.Ct. 1993), but when a defense of fraud is meritorious as to the
payee, the holder has the burden of showing that it is an HDC in order to
be immune from that defense. Norman v. World Wide Distributors, Inc.,
195 A.2d 115, 117 (Pa.Super.Ct. 1963). A holder of a negotiableinstrument (such as the promissory notes in this case) is either the
person with possession of bearer paper or the person identified on the
instrument if that person is in possession. 13 Pa. Cons. Stat. Ann.
§ 1201; N.J.S.A. 12A:3201 (West Supp. 1998). The holder of adocument of title (such as the mortgages in this case) is the person in
possession if the document is made out to bearer or to the order of the
person in possession. Id. The holder becomes an HDC if:
(1) the instrument when issued or negotiated to the
holder does not bear such apparent evidence of forgery
or alteration or is not otherwise so irregular or
incomplete as to call into question its authenticity;
and
(2) the holder took the instrument:
(i) for value;
(ii) in good faith;
(iii) without notice that the instrument is
overdue or has been dishonored or that there is an
uncured default with respect to payment of another
instrument issued as part of the same series;
(iv) without notice that the instrument contains
an unauthorized signature or has been altered;
(v) without notice of any claim to the instrument
described in section 3306 (relating to claims to an
instrument); and
(vi) without notice that any party has a defense
or claim in recoupment described in section 3305(a)
(relating to defenses and claims in recoupment).
13 Pa. Cons. Stat. Ann. § 3302. See also N.J.S.A. 12A:3302. Inshort, an HDC is the holder of the instrument or document who took for
value and in good faith without notice of any claims or defects on the
instrument or document. If classified as an HDC, the holder holds without
regard to defenses, with certain statutory exemptions which do not apply
here. 13 Pa. Cons. Stat. Ann. § 3305; N.J.S.A. 12A:3305.
It was clear to the parties and to the Bankruptcy Court below that
Provident did not have actual possession of the notes and mortgages
before November 2, 1998, when it learned that there were insufficient
funds in Pinnacle's account at Provident to cover Pinnacle's checks to
the closing agents here. Provident nonetheless argued that it was the
holder of the notes and mortgages because, before gaining actual
knowledge of Pinnacle's fraud, Provident "constructively possessed" the
notes and mortgages from the moment that the closing agents, who were
allegedly Provident's agents, took possession of the notes at the
closings before November 2.
The Bankruptcy Court rejected Provident's argument, finding that none
of the appellees acted as Provident's agents, and thus Provident never
constructively or actually possessed the notes and mortgages. Thus, the
Bankruptcy Court found that Provident never became the holder of these
notes and mortgages in the first place. (Opinion at 53.) Alternatively,
the Bankruptcy Court found that while Provident did give value for the
notes and mortgages (Opinion at 54), it did not take those notes and
mortgages in good faith and without knowledge of defenses, and thus
Provident is not an HDC. (Opinion at 63.) The question before this Court
is whether the Bankruptcy Court's rulings in this regard were clearly
erroneous. I hold that it was neither clearly erroneous nor contrary to
established law for the Bankruptcy Court to find that Provident did not
fit the role of "good faith purchaser for value" necessary to claim HDC
status even though Provident's lack of good faith arose after the title
agents closed the real estate transactions. As the following discussion
will explain, in the context of a course of dealing between Provident and
Pinnacle extending over thousands of such transactions, Provident was
essentially a party to the mortgage lending transactions and thus, by
definition, cannot claim HDC status in the negotiable papers which
resulted from those transactions, especially because Provident gained
knowledge of defenses before its own role in the original mortgage
lending transaction was complete.
I affirm the Bankruptcy Court's ruling that Provident is not the HDC of
these notes and mortgages. In so holding, I need not, and thus do not,
reach the issue of whether Provident constructively possessed the notes
and mortgages,[fn9] for holder status is irrelevant if Provident did nottake in good faith and without knowledge of defenses. Because I find that
the Bankruptcy Court's ruling that Provident did not take in good faith
was not clearly erroneous, I affirm the ruling that Provident is not
entitled to the protections afforded to a holder in due course.
The Bankruptcy Court correctly stated the law on good faith in this
context: the test for good faith is "not one of negligence of duty to
inquire, but rather it is one of willful dishonesty or actual knowledge."
Valley Bank & Trust Co. v. American Utilities, Inc., 415 F. Supp. 298,
301 (E.D.Pa. 1976). See also Mellon Bank v. PasqualisPoliti,
800 F. Supp. 1297, 1302 (W.D.Pa. 1992), aff'd, 990 F.2d 780 (3d Cir.1993); Carnegie Bank v. Shalleck, 606 A.2d 389, 394 (N.J.Super.Ct.A.D. 1992); General Inv. Corp. v. Angelini, 278 A.2d 193 (N.J. 1971).Good faith may be defeated only by actual knowledge or a deliberate
attempt to evade knowledge. Rice v. Barrington, 70 A. 169, 170 (N.J. E. &
A 1908). "There is no affirmative duty of inquiry on the part of one
taking a negotiable instrument, and there is no constructive notice from
the circumstances of the transaction, unless the circumstances are so
strong that if ignored they will be deemed to establish bad faith on the
part of the transferee." Bankers Trust Co. v. Crawford, 781 F.2d 39, 45(3d Cir. 1986). Moreover, an HDC must take not only in good faith, but
also without notice of defenses to the instrument or document. One has
"notice" when
(1) he has actual knowledge of it;
(2) he has received a notice or notification of it; or
(3) from all the facts and circumstances known to him
at the time in question he has reason to know that it
exists.
Pa. Cons. Stat. Ann. § 1201.
The Bankruptcy Court here found that Provident did not in fact have
actual knowledge of the fraud or potential defense of failure of
consideration at the time of each separate closing. (Opinion at 58.) The
Bankruptcy Court also found that despite the fact that Provident failed
to review Pinnacle's books, records, and checking account ledger, failed
to notice the overdraft problem, failed to properly monitor withdrawals,
and failed to act after knowledge of financial deterioration in default
in providing timely audited financial statements, the appellees had not
proved that Provident acted with willful dishonesty (id.); Provident did
act with negligence or gross negligence, but gross negligence alone is
not enough to defeat an HDC's title. See Washington & Canonsburg Ry. Co.
v. Murray, 211 F. 440, 445 (3d Cir. 1914); General Inv. Corp.,
278 A.2d 193. Moreover, the Bankruptcy Court correctly noted that holderin due course status is generally created at the time that the claimant
becomes a holder — meaning at the time of negotiation. N.J.S.A.
12A:3302; Sisemore v. Kierlow Co., Inc. v. Nicholas, 27 A.2d 473, 478(Pa.Super.Ct. 1942). In transactions such as the ones at issue here which
involve blank endorsements, the instruments and documents are bearer
paper and are thus negotiated upon delivery alone. 13 Pa. Cons. Stat.
Ann. § 3201; N.J.S.A. 12A:3201.
Nonetheless, the Bankruptcy Court found that Provident failed to attain
the status of a holder in due course. It acknowledged that once a party
establishes its position as a holder in due course, no future action can
undermine that status; so in the usual transaction with negotiable bearer
paper, actual knowledge of defenses gained after possession do not defeat
HDC status. (Opinion at 63.) See Bricks Unlimited, Inc. v. Agee,
672 F.2d 1255, 1259 (5th Cir. 1982); Park Gasoline Co. v. Crusius,158 A. 334 (N.J. 1932). However, the Bankruptcy Court said, it was not
finding lack of good faith after gaining HDC status, but rather that
Provident did not gain HDC status in the first place, for these were not
the "usual" transactions. Taken in a "global sense," the Bankruptcy Court
said, these transactions did not end until after the settlements.
(Opinion at 58.)
Usually, one who takes a negotiable instrument for value has only the
underlying circumstances of that transaction by which to determine if
there is reason to give pause as to the veracity of that instrument. A
lender provides funds to a borrower who executes a promissory note. Once
that transaction is complete, the lender transfers the note to a second
lender in exchange for which the first lender receives funds replenishing
his account and enabling him to lend the same funds to another borrower.
HDC status is given to that second lender if it acts in good faith and
without knowledge of defenses, and there is no general duty for that
second lender to inquire unless the circumstances are so suspicious that
they cannot be ignored. See, e.g. Triffin, 670 A.2d at 692. In the usualHDC transaction, there are two discernible transactions, two exchanges of
funds and notes. As the Bankruptcy Court pointed out, the purpose of
giving that second lender HDC status is "to meet the contemporary needs
of fast moving commercial society . . . (citation omitted) and to enhance
the marketability of negotiable instruments [allowing] bankers, brokers
and the general public to trade in confidence." Triffin,
670 A.2d at 693. However, "the more the holder knows about the underlyingtransaction, and particularly the more he controls or participates or
becomes involved in it, the less he fits the role of a good faith
purchaser for value; the closer his relationship to the underlying
agreement which is the source of the note, the less need there is for
giving him the tensionfree rights necessary in a fastmoving,
creditextending commercial world." Unico v. Owen, 50 N.J. 101, 109110 (1967). See also Jones v. Approved Bancredit Corp., 256 A.2d 739, 742(Del. 1969) (in such a situation, "[the financer] should not be able to
hide behind `the fictional fence' of the . . . UCC and thereby achieve an
unfair advantage over the purchaser.").
Here, there were not two separate, discernible transactions.
Provident's funding of Pinnacle who funded the borrowers was one complex
transaction. The acts of a third party investor who would buy the notes
and mortgages from Provident would have been the second separate,
discernible transaction here. Provident did not replenish Pinnacle's
account in exchange for receiving the notes and mortgages, such that
Pinnacle would have more money to make more loans, as in the "usual"
transaction. Rather, in a complex and longstanding scheme encompassing
thousands of transactions over several years, Provident gave Pinnacle a
line of credit, and then, after Pinnacle gave Provident information about
individual proposed loans to borrowers, Provident transferred money to
Pinnacle's account, in order to later receive the note and mortgage from
each transaction and pass them on to a third party investor. The
Bankruptcy Court, as a factual matter, found that under this complex
scheme, no transactions between any of the parties were complete until
both of the transactions were concluded, particularly because the "second
lender" (Provident) had the ultimate control over the first transaction
(by ordering the dishonor of Pinnacle's checks).[fn10]
I cannot say that the Bankruptcy Court's factual finding was clearly
erroneous. The Bankruptcy Court's ruling accords with the evidence as
well as with the policy underlying the holder in due course doctrine. I
hold that where a warehouse lender so closely participates in the funding
and approval of mortgages which will ultimately lead to the warehouse
lender's rights in mortgages and promissory notes that the transactions
between mortgage banker and mortgagor and between warehouse lender and
mortgage banker are in fact one continuous transaction, rather than two
discernible transactions, a showing of the warehouse lender's lack of
good faith after the closing between title agent and mortgagor but before
the mortgage banker's check is presented to the warehouse lender may
destroy HDC status. Indeed, where the party who claims HDC status was in
essence a party to the original transaction, it cannot, by definition, be
a holder in due course.
Provident had a great deal of involvement in the ongoing series of
transactions and ample knowledge of Pinnacle's overall financial
wellbeing, developed through years of funding Pinnacle's credit line for
thousands of such transactions and receipt of Pinnacle's periodic
financial reports. It had particular information about the borrowers
before it funded these loans. It was, in fact, part of the loan
transactions, and not a separate party who became an HDC through the
giving of value at a second separate, discernible transaction. Provident
had too much control of, participation in, and knowledge of the
underlying transaction to claim that it was a good faith purchaser for
value. See, e.g., Fidelity Bank Nat'l Assoc., 740 F. Supp. at 239.
Because, under this complex transactional scheme, Provident functioned
essentially as a party which approved and funded the loans and gained
actual knowledge of a defense to the notes and mortgages (lack of
consideration) before the transactions were complete, it was not clearly
erroneous for the Bankruptcy Court to find that Provident lacked the good
faith necessary to claim HDC status. Accordingly, the Bankruptcy Court's
ruling is affirmed.
VI. CONCLUSION
For the foregoing reasons, I will affirm the Bankruptcy Court's ruling
that appellant Provident Savings Bank was not the holder in due course of
the notes and mortgages from the ten transactions closed by appellees.
The defense of failure of consideration thus is available against
Provident. I therefore affirm the Bankruptcy Court's judgment that
appellees, and not appellant, are entitled to the notes and mortgages. The
accompanying Order is entered.
ORDER
This matter having come upon the court upon the appeal of appellant,
Provident Savings Bank, from a Judgment entered on December 17, 1997, by
the Honorable Judith H. Wizmur, United States Bankruptcy Judge for the
District of New Jersey,; and the Court having considered the parties'
submissions; and for the reasons set forth in the Opinion of today's
date;
IT IS this day of December, 1998, hereby
ORDERED that the Judgment entered by the Honorable Judith H. Wizmur,
United States Bankruptcy Judge for the District of New Jersey, on
December 17, 1997, which granted the notes and mortgages from
transactions closed by the appellees in this matter to the appellees,
be, and hereby is, AFFIRMED.
[fn1] The appellant's cause of action against defendant William E. Ward
was removed to state court in Delaware upon motion on the basis of
abstention pursuant to 28 U.S.C. § 1334(c) where it is now pending.The appellant's cause of action against Meridian Bank was resolved prior
to trial pursuant to the Stipulation of Settlement with respect to Count
II of the Complaint, filed on July 16, 1996. All claims between the
appellant and Lawyers Title Insurance Corporation were mutually dismissed
at trial.
[fn2] The Agreement said $10 million, but at times up to $12.5 million
was advanced.
[fn3] It is a wellestablished law that appellate courts may not pass
upon an issue not presented in a lower court. Singleton v. Wulff,
428 U.S. 106, 120 (1976). The same holds true for a U.S. District Courtsitting in its appellate capacity over matters appealed from the
bankruptcy court. See Barrett v. Commonwealth Fed. Sav. and Loan Ass'n,
939 F.2d 20 (3d Cir. 1991); In re Middle Atlantic Stud Welding Co.,
503 F.2d 1133, 1134 n. 1 (3d Cir. 1974). Because Provident never raisedthis issue before the Bankruptcy Court, I will not consider it now.
[fn4] The res judicata doctrine prevents relitigation of claims that grow
out of a transaction or occurrence from which other claims have earlier
been raised and decided validly, finally, and on the merits. Federated
Department Stores v. Moitie, 452 U.S. 394, 298 (1981). Under Pennsylvanialaw, default judgments, absent fraud, are afforded res judicata effect.
In re Graves, 156 B.R. 949, 954 (E.D.Pa. 1993), aff'd, 33 F.3d 242 (3dCir. 1994). On December 21, 1994, the Court of Common Pleas of Berks
County, Pennsylvania, entered default judgments against Provident on both
the Weaver and Fisher transactions, those transactions for which Pioneer
was the closing agent. Due to these default judgments, the doctrine of
res judicata bars relitigation of the Pioneer causes of action. The
Bankruptcy Court also held that the Andreuzzi transaction was barred by
res judicata or collateral estoppel because of the lis pendens. That,
however, is a more difficult issue and one that I need not reach now, as
my affirmance of the Bankruptcy Court's judgment applies equally to the
Andreuzzi transaction on the merits.
[fn5] At trial and in its briefs to this Court, as an alternative to its
holder in due course argument, Provident argued that it was protected by
the Pennsylvania Uniform Fiduciaries Act, 7 Pa. Cons. Stat. § 6361,
and the New Jersey Uniform Fiduciaries Law, N.J.S.A. 3B:1454, theprovisions of which are substantially similar. The two laws protect a
person who transfers money to a fiduciary in good faith, by noting that
"any right or title acquired from the fiduciary in consideration of such
payment or transfer is not invalid in consequences of a misapplication by
the fiduciary." 7 Pa. Cons. Stat. § 6361; N.J.S.A. 3B:1454. TheBankruptcy Court held that Pinnacle was not Provident's agent or
fiduciary, and thus the UFA did not apply. (Opinion at 66.) In light of
the fact that Provident's counsel, at oral argument before this Court on
November 13, 1998, themselves argued that Pinnacle was not Provident's
fiduciary, I will affirm this aspect of the Bankruptcy Court's ruling
without need to examine the factual bases on which it relied.
[fn6] The rest of this Opinion is limited to the eight transactions not
handled by Pioneer, since only the Pioneer transactions are bound by res
judicata.
[fn7] As Part V of this Opinion explains, one of the several bases for
the Bankruptcy Court's decision that Provident is not the HDC of the
mortgages and notes is that the settlement agents were not Provident's
agents, and thus Provident did not constructively possess the mortgages
and notes prior to gaining knowledge of claims or defenses on those
notes. (Opinion at 3453.) In the alternative, in case appellate courts
determined that Provident was the HDC of those notes because an agency
relationship did exist, the Bankruptcy Court held that the closing
agents, and not Provident, would still be the ones entitled to the notes
and mortgages, for the agents would have had a right to indemnification
from Provident. (Id. at 6364.) Though, as I explain in Part V, I do not
reach the agency issue, I do affirm the Bankruptcy Court's HDC ruling on
other grounds. In doing so, I am affirming the decision that the
appellees, and not Provident, are entitled to the notes and mortgages. The
Bankruptcy Court's indemnification ruling is just an alternative reason
for finding that the appellees are entitled to the notes and mortgages.
Having already agreed that the closing agents are so entitled because
Provident is not an HDC, there is no need to address that alternative
ruling upon appeal.
[fn8] Seven of the eight remaining transactions here are governed by
Pennsylvania law. The eighth is under New Jersey law, but the two states'
laws on HDC status are largely consistent on the issues raised in these
proceedings.
[fn9] The Bankruptcy Court agreed that authority from other jurisdictions
suggest that a party may become a constructive holder when its agent
takes possession of a negotiable instrument on its behalf. (Opinion at
3637.) However, the Bankruptcy Court made the factual finding that
appellees were not Provident's agents. It determined that though six of
the ten transactions involved written agency agreements, those agreements
were not controlling in light of the course of dealing between the
parties (Opinion at 46), and that Provident did not otherwise meet its
burden of establishing that an agency relationship existed. Because I
find that the Bankruptcy Court's determination that Provident did not act
in good faith is not clearly erroneous, and because the lack of good
faith alone is enough of a basis to sustain a judgment that Provident is
not an HDC of these eight notes and mortgages, I need not address whether
the agency determination was clearly erroneous.
[fn10] Under the Bankruptcy Court's findings of fact, Provident was, in
reality, a party to the original transaction. The situation is somewhat
analogous to a consumer goods financer who has a substantial voice in the
underlying transaction; that financer is not entitled to HDC status.
Westfield Investment Co. v. Fellers, 181 A.2d 809 (N.J.Super.Ct. LawDiv.). Provident had a substantial voice in providing and carrying out
funding of the underlying borrowing transactions, and it thus cannot
claim that it was a good faith HDC when it learned of the defense of
failure of consideration prior to dishonoring the Pinnacle checks.
Loislaw Federal District Court Opinions
Copyright © 2013 CCH Incorporated or its affiliates
IN RE PINNACLE MORTGAGE INVESTMENT CORPORATION, (D.N.J. 1998)
IN RE PINNACLE MORTGAGE INVESTMENT CORPORATION, Debtor
PROVIDENT SAVINGS BANK, a New Jersey Banking Corporation,
Plaintiff/Appellant, v. PINNACLE MORTGAGE INVESTMENT CORPORATION, a
Pennsylvania Corporation, et al., Defendants, SETTLERS ABSTRACT CO., L.P.,
LAWYERS TITLE INSURANCE CORP., LAND TRANSFER CO, INC., FIDELITY NATIONAL
TITLE INSURANCE CO. OF PENNSYLVANIA, GINO L. ANDREUZZI, PIONEER AGENCY II
CORP. t/a PIONEER AGENCY, MUSSER & MUSSER, WILLIAM E. WARD, QUAKER ABSTRACT
CO., and SEARCHTEC ABSTRACT, INC., Appellees.
CIVIL NO. 980489 (JBS), [Bankruptcy Case No. 9510608 (JHW)], [Adv.
Proc. No. 951091]
United States District Court, D. New Jersey.
Filed: December 9, 1998
Walter E. Thomas, Jr., Esq., Timothy J. Matteson, Esq., Mark A. Trudeau,
Esq., Stern, Lavinthal, Norgaard & Kapnick, Esqs., Englewood, New Jersey,
Attorneys for Appellant.
Edward J. Hayes, Esq., Andrea Dobin, Esq., Fox, Rothschild, O'Brien &
Frankel, Princeton Pike Corporate Center, Lawrenceville, New Jersey,
Attorneys for Appellees, Settlers Abstract Co., L.P., Land Transfer Co,
Inc., Fidelity National Title Insurance Co. of Pennsylvania, Gino L.
Andreuzzi, Pioneer Agency II Corp. t/a Pioneer Agency, Musser & Musser,
Quaker Abstract Co, and Searchtec Abstract, Inc.
OPINION
SIMANDLE, District Judge.
I. INTRODUCTION
Provident Savings Bank appeals from a Judgment entered on December 17,
1997, pursuant to a written opinion issued on November 19, 1997, by the
Honorable Judith H. Wizmur, United States Bankruptcy Judge, after trial
in an adversary proceeding. That Opinion ruled in favor of the
Appellees, Settlers Abstract Co., L.P., Land Transfer Co, Inc., Fidelity
National Title Insurance Co. of Pennsylvania, Gino L. Andreuzzi, Pioneer
Agency II Corp. t/a Pioneer Agency, Musser & Musser, Quaker Abstract Co,
and Searchtec Abstract, Inc. ("title agents"). Reviewing a longstanding
complex lending relationship between Provident and the debtor, Pinnacle
Mortgage Corporation, of which the ten real estate mortgage loans at
issue herein were a part, the Bankruptcy Court held that appellee title
agents (who had advanced their own funds to cover disbursements when
Provident dishonored Pinnacle's checks) had a more valid or higher
priority security interest in the promissory notes and mortgages executed
as part of ten separate residential real estate closing than did
appellant. Provident Savings Bank appeals this ruling and seeks this
Court's determination that it was the holder in due course of those
documents.
The principal issue to be decided is whether the Bankruptcy Court
correctly determined under the Uniform Commercial Code that Provident was
not a holder in due course of the promissory notes arising from these
loans, where it found that Provident so closely participated in the
funding and approval of the Pinnaclebrokered loans that the transaction
did not end at the closing with the title agents, such that Provident did
not attain holder in due course status because it did not fit the
requisite role of a "good faith purchaser for value." For the reasons
that will be stated herein, the judgment will be affirmed because the
Bankruptcy Court's finding that Provident never attained HDC status was
neither clearly erroneous nor contrary to law.
II. BACKGROUND
A. Procedural History
This case arises from a dispute over the various security interests in
mortgage documents from ten separate real estate transactions in late
October, 1994, conducted by the debtor, Pinnacle Mortgage Investment
Corporation (who brokered the transactions), the appellant (who financed
the transactions), and the appellees (who were title closing agents in
the transactions). On February 2, 1995, appellant Provident Savings Bank
("Provident") and other creditors filed an involuntary petition under
Chapter 7 of Title 11 of the Bankruptcy Code against Pinnacle Mortgage
Investment Corporation ("Pinnacle"). An order for relief under Chapter 7
was entered by the Bankruptcy Court on March 6, 1995.
On March 24, 1995, Provident commenced this adversary proceeding by
filing a three count complaint to determine the extent, validity, and
priority of the various security interests asserted by Pinnacle, Meridian
Bank, Lawyers Title Insurance Corporation, the appellees, and William E.
Ward with regard to the promissory notes and mortgages from ten real
estate transactions.[fn1] Appellees responded to the complaint by filingan answer, counterclaims, and crossclaims, seeking money judgments in
the amount of the contested notes and mortgages, interest, cost of suit,
and attorneys fees; imposition of a constructive trust in their favor
with regard to the notes, mortgages, and proceeds thereof; and to have
the subject notes and mortgages avoided and stricken in favor of
subsequently executed mortgages between the appellees and the
mortgagors. Provident twice amended its complaint, finally seeking a
declaratory judgment that it is the holder in due course of the subject
notes and mortgages under the Uniform Commercial Code; avoidance of the
preferential transfer by appellee Andreuzzi pursuant to 11 U.S.C. § 547and 550; avoidance of the fraudulent transfer by appellee Andreuzzipursuant to §§ 548 and 550; and avoidance of the preferential and
fraudulent transfers by appellees pursuant to 11 U.S.C. § 547, 548,and 550.
Trial in this matter was held on July 16, 17, and 18, 1996, and October
1, 3, and 4, 1996. At the close of Provident's case in chief, upon motion
by the appellees, all of those portions of the Second Amended Complaint
which did not pertain to Provident's status as a holder in due course
("HDC") were dismissed.
B. The Factual History
In its November 19, 1997 opinion, the Bankruptcy Court determined that
the facts of the case are as follows. Debtor Pinnacle Mortgage Investment
Corporation ("Pinnacle" or "debtor") was a mortgage banker which
primarily dealt in residential mortgage lending and refinance. In December
of 1992, Pinnacle and Provident Savings Bank ("Provident" or "appellant")
entered into a Mortgage Warehouse Loan and Security Agreement
("Agreement"), whereby Provident would fund Pinnacle, who in turn funded
retail customers who sought to purchase or refinance residential real
estate. The borrower in each transaction would give Pinnacle a note and
mortgage, both of which acted as collateral to protect Provident until
Pinnacle sold the mortgage to a third party investor, such as the Federal
Home Loan Mortgage Corporation ("Freddie Mac"), who satisfied Pinnacle's
debt to Provident. Warehouse Agreement § 3.4.
1. The Warehouse Agreement
Under these types of agreements, there would usually not be any contact
between the warehouse lender and the ultimate mortgagor. Typically,
Pinnacle would arrange with a prospective borrower for Pinnacle to
advance funds for the borrower to purchase or refinance a home and for
the borrower to assign a note and mortgage to Pinnacle as collateral. The
mortgage would be endorsed in blank in order to accommodate the final
third party investor (such as Freddie Mac), with whom Pinnacle would
arrange to purchase the mortgage, usually as a part of a pool of
mortgages; this was known as a "takeout" agreement. All of this
completed, Pinnacle would submit a "package" to Provident seeking funding
for the particular transaction under its $10 million line of credit.[fn2]This package included a description of the borrower and the funding, an
assignment of the mortgage endorsed in blank, a takeout commitment, and
an agency agreement that indicated the borrower's attorney's agreement
"to act as the agent of the Bank" to disburse the Advance and to obtain
due execution and delivery to the bank of the original note that
evidences the debt underlying the Mortgage Loan." Warehouse Agreement
§ 5.3(A)(iii). The Agreement required all of this to be submitted
along with the initial funding request. As a matter of course, however,
the agency agreement was usually executed by the title agent handling the
closing instead of by the borrower's attorney, and Provident customarily
accepted the mortgage assignment and agency agreement after the actual
closing.
After Provident received the package and checked to see that Pinnacle's
credit limit had not been exceeded (although, as stated above, often
prior to receipt of the mortgage assignment and agency agreement),
Provident credited Pinnacle's checking account with 98% of the requested
funds. Warehouse Agreement §§ 1.1, 2.1. Pinnacle would write a
regular, uncertified check to the closing agent, who would close the loan
directly with the borrower on Pinnacle's behalf. Pinnacle was supposed to
use specific funds credited to their account to fund specific closings,
but no controls were in place to make sure that Pinnacle actually did
so.
With Pinnacle's check in hand, the closing agent would use money from
its own bank account to disburse funds to the mortgagor, later
replenishing its bank account by depositing Pinnacle's check. Next, the
closing agent would routinely send the original note, a certified copy of
the recorded mortgage, and the other closing documents to Pinnacle, who
would send them on to Provident, who would receive this original note
approximately three to five days after closing. Provident and the
borrowers had no contact; indeed, Provident and the closing agents had no
contact, save the extremely limited contact by the closing agents who did
return the agency agreement included in the borrowing package. Not all
closing agents did return the agreement signed; most of those who did
sent everything through Pinnacle to go to Provident, in accordance with
Pinnacle's written instructions, rather than remitting the note and other
papers directly to Provident, as stated in the agency agreement.
Ultimately, Provident would send the note and accompanying documents to
the third party investor, who would pay Provident the funds which
Provident had originally placed in Pinnacle's checking account by wiring
monies to Provident in Pinnacle's name. Because the third party investor
would send multiple payments in each wire transfer, Pinnacle would tell
Provident to which loans to apply each of the funds.
2. Pinnacle's Declining Financial State
Among the twenty or so warehouse customers that Provident had during
19931994, Pinnacle was the most profitable for Provident, providing
hundreds of millions of dollars in loan transactions. However, when the
mortgage banking industry suffered a decline in business, Pinnacle began
to experience financial difficulties as well.
The Warehouse Agreement, § 6.11, required Pinnacle to submit
unaudited balance sheets and statements of income to Provident on a
quarterly basis, though Pinnacle customarily provided monthly
statements. The statements filed for June, July, and August of 1993
reflected an accrued pretax income for the first three months of the
fiscal year of $281,351. Statements for September, October, and November
of 1993 reflected pretax income of $923,923 for the first six months of
the fiscal year. However, after the November 30 report, Pinnacle began to
send its reports quarterly, which was in accordance with the Warehouse
Agreement but which was nonetheless unusual due to Pinnacle's custom of
submitting reports monthly. The next report, covering the ninemonth
period ending February 28, 1994, was due on April 15 but not received
until some time in May. It showed pretax income of $136,000 for the
first nine months, or an $800,000 loss in the previous three months. The
accompanying unaudited balance sheets showed a reduction of assets from
$40 million to $28 million in those three months. The final financial
statement was due on August 31, 1994, but Provident never received it.
At a holiday party in May 1994, Edmund R. Folsom, head of Provident's
Commercial Lending Department, had learned that Pinnacle had sustained
losses in the winter months. On August 19, 1994, Sharon Kinkead, of
Provident's Warehouse Lending Department, called Pinnacle's headquarters
and learned from Pinnacle's CFO, Joseph Mader, that there would be a
delay in the submission of the audited financial statements for the
fiscal year ending May 31, 1994 because of a change of comptroller, but
that the report would be provided by September 15, 1994. That report
never arrived, and no other financial statements were received up until
Provident's termination of its relationship with Pinnacle in early
November 1994.
3. Provident's Relationship with Pinnacle
Throughout its relationship with Pinnacle, Provident routinely honored
overdrafts on behalf of Pinnacle — about twenty times in 1993 and
fifteen times in 1994. These overdrafts ranged from $7,240.87 to
$5,255,812.
When a check was presented to the bank on Pinnacle's account for which
Pinnacle had insufficient funds, Sharon Kinkead would contact Pinnacle to
ask whether Pinnacle would honor that overdraft. Having been told that
the check would be covered (usually from an anticipated wire transfer),
Kinkead and her supervisor, Mr. Folsom, would honor it and allow the
overdraft. Until November 1994, Provident honored all of Pinnacle's
overdrafts, without reviewing Pinnacle's books and records or monitoring
its checking account.
As mentioned earlier, Pinnacle's CFO, Joseph Mader, had informed
Provident that its final fiscal year report would be forthcoming on
September 15, 1994. When Provident did not receive the audited reports by
that date, Mr. Folsom spoke with Mr. Mader, who reported that though
Pinnacle had sustained losses, it was expecting a substantial infusion of
capital. Pinnacle wanted to hold off publishing the report so that it
could add a footnote explaining that there would be a capital infusion.
Based on this, Folsom decided to extend Pinnacle's credit line through
the end of November.
Folsom called Mader some time in October to check on the status of the
report. When Mader returned the call on November 1, he informed Folsom
that the capital infusion had failed. Folsom demanded a meeting with
Pinnacle's officers.
On November 2, Folsom and Kinkead met with Mader and Al Miller,
President of Pinnacle. Mader and Miller presented internally generated
financial statements indicating a pretax loss of six million dollars for
the previous fiscal year, as well as a pretax loss of almost one million
dollars for the first quarter of the current fiscal year. Miller and
Mader admitted that they had misused their warehouse credit line with
G.E. Capital Mortgage Services, Inc., to whom they were indebted for
about six million dollars. They "admitted fraud" as to G.E., but
indicated that they had not misappropriated the Provident funds and asked
for an extension of funding of their loans while they financially
reorganized. Provident declined to do so.
At that time, Provident finally reviewed Pinnacle's books and
discovered that Pinnacle had been diverting substantial sums of money
from Pinnacle's Provident account to its operating account at Meridian
Bank. Kinkead and Folsom also learned that Pinnacle had been requesting
advances on loans earlier than was routinely requested, possibly using
the money that was supposed to be for specific loans for other purposes
instead. Indeed, Pinnacle was engaging in a "kiting" scheme,
misappropriating monies from third party investors that should have been
applied to previously funded loans. A Pinnacle employee told Kinkead that
the Provident line was not "whole," that as much as $500,000 may have
been taken from it, though no fraudulent loans had been made.
As of November 2, 1994, all checks presented to Provident on Pinnacle's
account had been processed, and the customer balance summary showed an
overdraft of $206,653.67. On November 3, $830,127.48 was deposited in
Pinnacle's account. Sixteen checks totaling $1,584,041.63 were presented
to Provident against Pinnacle's account on November 3. There were
insufficient funds to cover all sixteen, so Folsom sent a letter to
Miller, Pinnacle's president, to ask which checks should be paid. At the
time, Provident knew that all sixteen of those checks represented monies
that Pinnacle had delivered to borrowers and closing agents for
particular loans, as well as that each transaction was accompanied by a
takeout commitment by a third party investor, who would have paid for
the loan.
Miller indicated that six of the checks could be paid. Provident
debited $863,821 to pay off eight loans on November 4, and other checks
were paid at Mader's instruction. There was an overdraft on that date of
$178,303.73, and Provident honored no more checks. The remaining ten of
the sixteen checks presented on November 3 were dishonored, and those are
the subject of the instant litigation.
4. The Ten Transactions
Prior to the closings in each of the ten transactions in question,
Pinnacle had requested from Provident — and received — monies
to fund the transactions. As usual, Pinnacle presented the closing agent
with an uncertified check drawn on its account at Provident representing
payment for the note and mortgage to be executed by the borrower,
purchaser, or refinancer of the property. With Pinnacle's check in hand,
the closing agents closed each transaction, issuing checks from their own
accounts to the parties entitled to receive funds. The closing agents
then deposited Pinnacle's checks in their own accounts, and their banks
presented those checks to Provident for payment. In each case, Provident
dishonored the checks due to insufficient funds. After each closing, but
before the discovery of any problem, each closing agent returned the
original note to Pinnacle. Several closing agents recorded the mortgage
and sent Pinnacle certified copies. Despite the fact that Pinnacle's
checks were not honored, each closing agent honored their own checks when
they were presented.
At the time, uncertified funds were routinely accepted from mortgage
bankers, with a few exceptions for out of state lenders, ignoring the
Pennsylvania statute which required mortgage bankers and brokers to
certify funds. Most mortgage lenders such as Pinnacle insisted on
acceptance of regular checks; title insurers could not stay in business
if they did not follow the standard in the industry.
As was usual for these transactions, Provident had no contact with any
of the closing agents prior to settlement. Agency agreements were
included in most, but not all, of the instruction packages sent by
Pinnacle to the respective closing agents. The agreement provided that
Provident had a security interest in the note and mortgage; moreover, it
provided that the closing agent would act as Provident's agent in
connection with the loan transaction, agreeing to record the mortgage and
then to send both the original note and the original recorded mortgage to
Provident upon closing. The text of the agreement conflicted with the
closing instructions that Pinnacle gave to the closing agents, which
required the note to be returned to Pinnacle. In six of the ten
transactions, the agreement was executed, but its provisions were
basically ignored, as the closing documents were returned directly to
Pinnacle.
The closing agents learned of the dishonor from their own banks.
Provident did not attempt to contact the closing agents until November
10, 1994, when they sent a letter with instructions to deliver to
Provident all notes, mortgages, loan files, and other collateral, and any
monies received in connection with each mortgage loan.
Several of the agents sought judicial relief. Two of the closing agents
who are appellees in this matter, Gino L. Andreuzzi and the Pioneer
Agency L.P., hold state court judgments in their favor, for a total of
three judgments against Pinnacle, striking the mortgages and notes
executed by their respective buyers in favor of Pinnacle. Andreuzzi, the
closing agent in the Hopeck settlement, filed suit against Pinnacle in
the Court of Common Pleas of Luzerne County, Pennsylvania, seeking a TRO
to keep Pinnacle from selling, transferring, or assigning the note and
mortgage in question. Provident was not joined in Andreuzzi's case, but
it did have notice of the litigation. Andreuzzi filed a lis pendens with
the Prothonotary on November 14, 1994. About three hours after the lis
pendens was filed, Provident recorded the assignment from the Hopeck
note. Ultimately, a default judgment was entered against Pinnacle.
Pioneer also filed suits in connection with the Weaver and Fisher
transactions. In both cases, Pioneer sued Pinnacle and Provident in the
Court of Common Pleas of Berks County, Pennsylvania, on November 14,
1994. A preliminary injunction was entered on November 22, and a default
judgment was entered against both defendants on December 21, 1994. Two
days later, Pinnacle moved to open the default judgment. It was still
pending on February 1, 1995 when an involuntary petition was filed against
Pinnacle. Provident removed the action to the Bankruptcy Court on May 8,
1995.
Other closing agents entered into agreements with the borrowers to
execute new notes and mortgages. By the time this came before the
Bankruptcy Court, the mortgages had either been satisfied in full, with
proceeds held in escrow, or payments on the new mortgages and notes were
being made by the borrowers to the closing agents in escrow pending the
resolution of this matter.
C. The Bankruptcy Court's Findings and Judgment
On November 19, 1997, the Bankruptcy Court issued its Opinion in favor
of the appellees, ruling that:
(1) the appellant did not achieve the status of an HDC
with regard to the notes and mortgages in issue;
(2) the appellees would be entitled to indemnification
even if an agency relationship existed between the
appellant and appellees;
(3) the Uniform Fiduciaries Law is inapplicable to
validate the appellant's position with regard to the
subject notes and mortgages; and
(4) the appellant is precluded from relitigating the
transactions with appellees Pioneer Agency II Corp
t/a Pioneer Agency and Andreuzzi.
Judgment against Provident was entered on December 17, 1997. On December
22, 1997, appellant filed a notice of appeal from the Judgment. On
February 13, 1998, the record on appeal was transmitted to this Court. As
"nothing remains for the [lower] court to do," Universal Minerals, Inc.
v. C.A. Hughes & Co., 669 F.2d 98, 101 (3d Cir. 1981), the BankruptcyCourt's ruling is final, and thus this Court properly has appellate
jurisdiction over the December 17, 1997 Order pursuant to
28 U.S.C. § 158(a).
III. ISSUES PRESENTED
On appeal, Provident makes six arguments. First, Provident argues that
it is the holder in due course ("HDC") of the ten mortgage notes.
Second, Provident argues that the Bankruptcy Court's ruling that the
appellees were entitled to indemnification if they were Provident's agents
is clearly erroneous. Third, appellant contends that the bankruptcy court
erred in ruling that Provident was not protected by the Uniform
Fiduciaries Act ("UFA"), adopted by both New Jersey and Pennsylvania at
N.J.S.A. 3B:1454 and 7 Pa. Cons. Stat. Ann. § 6361, respectively.Fourth, Provident argues, for the first time upon appeal, that the
doctrine of avoidable consequences bars appellees from recovering any
damages from Provident. Fifth, Provident maintains that the doctrines of
lis pendens, res judicata, and collateral estoppel do not bar
relitigation of these issues as to the Andreuzzi transaction. Finally,
Provident argues that the Bankruptcy Court erred by giving preclusionary
effect to the Pioneer action default judgments.
This Opinion will not address Provident's "avoidable consequences"
argument, as it was raised, for the first time, upon appeal.[fn3]Moreover, the doctrine of res judicata precludes review of the two
transactions for which Pioneer was the closing agent, and I thus affirm
the Bankruptcy Court's judgment as to Pioneer on that ground.[fn4] I willaffirm the Bankruptcy Court's holding that Provident is not entitled to
the protections of the Uniform Fiduciaries Act , especially in light of
the fact that Provident has withdrawn its argument that Pinnacle was its
agent.[fn5] For reasons stated herein, I will affirm the BankruptcyCourt's holding that Provident is not the holder in due course of the
eight[fn6] transactions still in question. Accordingly, there is no needfor this Court to address the Bankruptcy Court's alternate finding that
the closing agents would be entitled to indemnification.[fn7]
IV. STANDARD OF REVIEW
On appeal, the weight accorded to the findings of fact by a bankruptcy
court are governed by Fed.R.Bank.P. 8013, which provides as follows:
On appeal the district court or bankruptcy appellate
panel may affirm, modify, or reverse a bankruptcy
judge's judgment, order, or decree or remand with
instructions for further proceedings. Findings of
fact, whether based on oral or documentary evidence,
shall not be set aside unless clearly erroneous, and
due regard shall be given to the opportunity of the
bankruptcy court to judge the credibility of
witnesses.
Fed.R.Bank.P. 8013. Under this Rule, a bankruptcy court's factualfindings may be disturbed only if clearly erroneous. See FGH Realty
Credit v. Newark Airport/Hotel Ltd., 155 B.R. 93 (D.N.J. 1993). Where a
mixed question of law and fact is presented, the appropriate standard
must be applied to each component. In re Sharon Steel Corp., 871 F.2d 1217,
1222 (3d Cir. 1989). Thus, a reviewing court "must accept the [lower]court's findings of historical or narrative facts unless they are clearly
erroneous, but . . . must exercise a plenary review and its application
of those precepts to the historical facts." Universal Minerals, Inc. v.
C.A. Hughes & Co., 669 F.2d at 103.
While standards for establishing that a party is a holder in due course
are wellsettled law, see, e.g., Triffin v. Dillabough, 448 Pa. Super. 72,
87, 670 A.2d 684, 691 (1996), the Court's application of these standardsto the facts does result in a mixed finding of fact and law that is
subject to a mixed standard of review. Mellon Bank, N.A. v. Metro
Communications, Inc., 945 F.2d 635, 64142 (3d Cir. 1991), cert. denied,
503 U.S. 937 (1992). The factual findings can only be reversed for clearerror, In re Graves, 33 F.3d 242, 251 (3d Cir. 1994), even if thereviewing court would have decided the matter differently. In re
PrincetonNew York Investors, Inc., 1998 WL 111674 (D.N.J. 1998). This
Court, thus, may not overturn a bankruptcy judge's factual findings if
the factual determinations bear any "rational relationship to the
supporting evidentiary data. . . ." Fellheimer, Eichen & Braverman, P.C.
v. Charter Technologies, Inc., 57 F.3d 1215, 1223 (3d Cir. 1995) (citingHoots v. Comm. of Pa., 703 F.2d 722, 725 (3d Cir. 1983). However, thisCourt reviews any legal conclusions de novo.
V. DISCUSSION
Appellant argues that the Bankruptcy Court's finding that appellant is
not an HDC of the promissory notes and mortgages from the eight remaining
real estate transactions closed by appellees is clearly erroneous. The
dispute here is not a dispute of law, as the parties agree on what the
law concerning HDCs is. As the Bankruptcy Court correctly found,[fn8]every holder of a negotiable instrument is presumed to be an HDC, Morgan
Guaranty Trust Company of New York v. Staats, 631 A.2d 631, 636(Pa.Super.Ct. 1993), but when a defense of fraud is meritorious as to the
payee, the holder has the burden of showing that it is an HDC in order to
be immune from that defense. Norman v. World Wide Distributors, Inc.,
195 A.2d 115, 117 (Pa.Super.Ct. 1963). A holder of a negotiableinstrument (such as the promissory notes in this case) is either the
person with possession of bearer paper or the person identified on the
instrument if that person is in possession. 13 Pa. Cons. Stat. Ann.
§ 1201; N.J.S.A. 12A:3201 (West Supp. 1998). The holder of adocument of title (such as the mortgages in this case) is the person in
possession if the document is made out to bearer or to the order of the
person in possession. Id. The holder becomes an HDC if:
(1) the instrument when issued or negotiated to the
holder does not bear such apparent evidence of forgery
or alteration or is not otherwise so irregular or
incomplete as to call into question its authenticity;
and
(2) the holder took the instrument:
(i) for value;
(ii) in good faith;
(iii) without notice that the instrument is
overdue or has been dishonored or that there is an
uncured default with respect to payment of another
instrument issued as part of the same series;
(iv) without notice that the instrument contains
an unauthorized signature or has been altered;
(v) without notice of any claim to the instrument
described in section 3306 (relating to claims to an
instrument); and
(vi) without notice that any party has a defense
or claim in recoupment described in section 3305(a)
(relating to defenses and claims in recoupment).
13 Pa. Cons. Stat. Ann. § 3302. See also N.J.S.A. 12A:3302. Inshort, an HDC is the holder of the instrument or document who took for
value and in good faith without notice of any claims or defects on the
instrument or document. If classified as an HDC, the holder holds without
regard to defenses, with certain statutory exemptions which do not apply
here. 13 Pa. Cons. Stat. Ann. § 3305; N.J.S.A. 12A:3305.
It was clear to the parties and to the Bankruptcy Court below that
Provident did not have actual possession of the notes and mortgages
before November 2, 1998, when it learned that there were insufficient
funds in Pinnacle's account at Provident to cover Pinnacle's checks to
the closing agents here. Provident nonetheless argued that it was the
holder of the notes and mortgages because, before gaining actual
knowledge of Pinnacle's fraud, Provident "constructively possessed" the
notes and mortgages from the moment that the closing agents, who were
allegedly Provident's agents, took possession of the notes at the
closings before November 2.
The Bankruptcy Court rejected Provident's argument, finding that none
of the appellees acted as Provident's agents, and thus Provident never
constructively or actually possessed the notes and mortgages. Thus, the
Bankruptcy Court found that Provident never became the holder of these
notes and mortgages in the first place. (Opinion at 53.) Alternatively,
the Bankruptcy Court found that while Provident did give value for the
notes and mortgages (Opinion at 54), it did not take those notes and
mortgages in good faith and without knowledge of defenses, and thus
Provident is not an HDC. (Opinion at 63.) The question before this Court
is whether the Bankruptcy Court's rulings in this regard were clearly
erroneous. I hold that it was neither clearly erroneous nor contrary to
established law for the Bankruptcy Court to find that Provident did not
fit the role of "good faith purchaser for value" necessary to claim HDC
status even though Provident's lack of good faith arose after the title
agents closed the real estate transactions. As the following discussion
will explain, in the context of a course of dealing between Provident and
Pinnacle extending over thousands of such transactions, Provident was
essentially a party to the mortgage lending transactions and thus, by
definition, cannot claim HDC status in the negotiable papers which
resulted from those transactions, especially because Provident gained
knowledge of defenses before its own role in the original mortgage
lending transaction was complete.
I affirm the Bankruptcy Court's ruling that Provident is not the HDC of
these notes and mortgages. In so holding, I need not, and thus do not,
reach the issue of whether Provident constructively possessed the notes
and mortgages,[fn9] for holder status is irrelevant if Provident did nottake in good faith and without knowledge of defenses. Because I find that
the Bankruptcy Court's ruling that Provident did not take in good faith
was not clearly erroneous, I affirm the ruling that Provident is not
entitled to the protections afforded to a holder in due course.
The Bankruptcy Court correctly stated the law on good faith in this
context: the test for good faith is "not one of negligence of duty to
inquire, but rather it is one of willful dishonesty or actual knowledge."
Valley Bank & Trust Co. v. American Utilities, Inc., 415 F. Supp. 298,
301 (E.D.Pa. 1976). See also Mellon Bank v. PasqualisPoliti,
800 F. Supp. 1297, 1302 (W.D.Pa. 1992), aff'd, 990 F.2d 780 (3d Cir.1993); Carnegie Bank v. Shalleck, 606 A.2d 389, 394 (N.J.Super.Ct.A.D. 1992); General Inv. Corp. v. Angelini, 278 A.2d 193 (N.J. 1971).Good faith may be defeated only by actual knowledge or a deliberate
attempt to evade knowledge. Rice v. Barrington, 70 A. 169, 170 (N.J. E. &
A 1908). "There is no affirmative duty of inquiry on the part of one
taking a negotiable instrument, and there is no constructive notice from
the circumstances of the transaction, unless the circumstances are so
strong that if ignored they will be deemed to establish bad faith on the
part of the transferee." Bankers Trust Co. v. Crawford, 781 F.2d 39, 45(3d Cir. 1986). Moreover, an HDC must take not only in good faith, but
also without notice of defenses to the instrument or document. One has
"notice" when
(1) he has actual knowledge of it;
(2) he has received a notice or notification of it; or
(3) from all the facts and circumstances known to him
at the time in question he has reason to know that it
exists.
Pa. Cons. Stat. Ann. § 1201.
The Bankruptcy Court here found that Provident did not in fact have
actual knowledge of the fraud or potential defense of failure of
consideration at the time of each separate closing. (Opinion at 58.) The
Bankruptcy Court also found that despite the fact that Provident failed
to review Pinnacle's books, records, and checking account ledger, failed
to notice the overdraft problem, failed to properly monitor withdrawals,
and failed to act after knowledge of financial deterioration in default
in providing timely audited financial statements, the appellees had not
proved that Provident acted with willful dishonesty (id.); Provident did
act with negligence or gross negligence, but gross negligence alone is
not enough to defeat an HDC's title. See Washington & Canonsburg Ry. Co.
v. Murray, 211 F. 440, 445 (3d Cir. 1914); General Inv. Corp.,
278 A.2d 193. Moreover, the Bankruptcy Court correctly noted that holderin due course status is generally created at the time that the claimant
becomes a holder — meaning at the time of negotiation. N.J.S.A.
12A:3302; Sisemore v. Kierlow Co., Inc. v. Nicholas, 27 A.2d 473, 478(Pa.Super.Ct. 1942). In transactions such as the ones at issue here which
involve blank endorsements, the instruments and documents are bearer
paper and are thus negotiated upon delivery alone. 13 Pa. Cons. Stat.
Ann. § 3201; N.J.S.A. 12A:3201.
Nonetheless, the Bankruptcy Court found that Provident failed to attain
the status of a holder in due course. It acknowledged that once a party
establishes its position as a holder in due course, no future action can
undermine that status; so in the usual transaction with negotiable bearer
paper, actual knowledge of defenses gained after possession do not defeat
HDC status. (Opinion at 63.) See Bricks Unlimited, Inc. v. Agee,
672 F.2d 1255, 1259 (5th Cir. 1982); Park Gasoline Co. v. Crusius,158 A. 334 (N.J. 1932). However, the Bankruptcy Court said, it was not
finding lack of good faith after gaining HDC status, but rather that
Provident did not gain HDC status in the first place, for these were not
the "usual" transactions. Taken in a "global sense," the Bankruptcy Court
said, these transactions did not end until after the settlements.
(Opinion at 58.)
Usually, one who takes a negotiable instrument for value has only the
underlying circumstances of that transaction by which to determine if
there is reason to give pause as to the veracity of that instrument. A
lender provides funds to a borrower who executes a promissory note. Once
that transaction is complete, the lender transfers the note to a second
lender in exchange for which the first lender receives funds replenishing
his account and enabling him to lend the same funds to another borrower.
HDC status is given to that second lender if it acts in good faith and
without knowledge of defenses, and there is no general duty for that
second lender to inquire unless the circumstances are so suspicious that
they cannot be ignored. See, e.g. Triffin, 670 A.2d at 692. In the usualHDC transaction, there are two discernible transactions, two exchanges of
funds and notes. As the Bankruptcy Court pointed out, the purpose of
giving that second lender HDC status is "to meet the contemporary needs
of fast moving commercial society . . . (citation omitted) and to enhance
the marketability of negotiable instruments [allowing] bankers, brokers
and the general public to trade in confidence." Triffin,
670 A.2d at 693. However, "the more the holder knows about the underlyingtransaction, and particularly the more he controls or participates or
becomes involved in it, the less he fits the role of a good faith
purchaser for value; the closer his relationship to the underlying
agreement which is the source of the note, the less need there is for
giving him the tensionfree rights necessary in a fastmoving,
creditextending commercial world." Unico v. Owen, 50 N.J. 101, 109110 (1967). See also Jones v. Approved Bancredit Corp., 256 A.2d 739, 742(Del. 1969) (in such a situation, "[the financer] should not be able to
hide behind `the fictional fence' of the . . . UCC and thereby achieve an
unfair advantage over the purchaser.").
Here, there were not two separate, discernible transactions.
Provident's funding of Pinnacle who funded the borrowers was one complex
transaction. The acts of a third party investor who would buy the notes
and mortgages from Provident would have been the second separate,
discernible transaction here. Provident did not replenish Pinnacle's
account in exchange for receiving the notes and mortgages, such that
Pinnacle would have more money to make more loans, as in the "usual"
transaction. Rather, in a complex and longstanding scheme encompassing
thousands of transactions over several years, Provident gave Pinnacle a
line of credit, and then, after Pinnacle gave Provident information about
individual proposed loans to borrowers, Provident transferred money to
Pinnacle's account, in order to later receive the note and mortgage from
each transaction and pass them on to a third party investor. The
Bankruptcy Court, as a factual matter, found that under this complex
scheme, no transactions between any of the parties were complete until
both of the transactions were concluded, particularly because the "second
lender" (Provident) had the ultimate control over the first transaction
(by ordering the dishonor of Pinnacle's checks).[fn10]
I cannot say that the Bankruptcy Court's factual finding was clearly
erroneous. The Bankruptcy Court's ruling accords with the evidence as
well as with the policy underlying the holder in due course doctrine. I
hold that where a warehouse lender so closely participates in the funding
and approval of mortgages which will ultimately lead to the warehouse
lender's rights in mortgages and promissory notes that the transactions
between mortgage banker and mortgagor and between warehouse lender and
mortgage banker are in fact one continuous transaction, rather than two
discernible transactions, a showing of the warehouse lender's lack of
good faith after the closing between title agent and mortgagor but before
the mortgage banker's check is presented to the warehouse lender may
destroy HDC status. Indeed, where the party who claims HDC status was in
essence a party to the original transaction, it cannot, by definition, be
a holder in due course.
Provident had a great deal of involvement in the ongoing series of
transactions and ample knowledge of Pinnacle's overall financial
wellbeing, developed through years of funding Pinnacle's credit line for
thousands of such transactions and receipt of Pinnacle's periodic
financial reports. It had particular information about the borrowers
before it funded these loans. It was, in fact, part of the loan
transactions, and not a separate party who became an HDC through the
giving of value at a second separate, discernible transaction. Provident
had too much control of, participation in, and knowledge of the
underlying transaction to claim that it was a good faith purchaser for
value. See, e.g., Fidelity Bank Nat'l Assoc., 740 F. Supp. at 239.
Because, under this complex transactional scheme, Provident functioned
essentially as a party which approved and funded the loans and gained
actual knowledge of a defense to the notes and mortgages (lack of
consideration) before the transactions were complete, it was not clearly
erroneous for the Bankruptcy Court to find that Provident lacked the good
faith necessary to claim HDC status. Accordingly, the Bankruptcy Court's
ruling is affirmed.
VI. CONCLUSION
For the foregoing reasons, I will affirm the Bankruptcy Court's ruling
that appellant Provident Savings Bank was not the holder in due course of
the notes and mortgages from the ten transactions closed by appellees.
The defense of failure of consideration thus is available against
Provident. I therefore affirm the Bankruptcy Court's judgment that
appellees, and not appellant, are entitled to the notes and mortgages. The
accompanying Order is entered.
ORDER
This matter having come upon the court upon the appeal of appellant,
Provident Savings Bank, from a Judgment entered on December 17, 1997, by
the Honorable Judith H. Wizmur, United States Bankruptcy Judge for the
District of New Jersey,; and the Court having considered the parties'
submissions; and for the reasons set forth in the Opinion of today's
date;
IT IS this day of December, 1998, hereby
ORDERED that the Judgment entered by the Honorable Judith H. Wizmur,
United States Bankruptcy Judge for the District of New Jersey, on
December 17, 1997, which granted the notes and mortgages from
transactions closed by the appellees in this matter to the appellees,
be, and hereby is, AFFIRMED.
[fn1] The appellant's cause of action against defendant William E. Ward
was removed to state court in Delaware upon motion on the basis of
abstention pursuant to 28 U.S.C. § 1334(c) where it is now pending.The appellant's cause of action against Meridian Bank was resolved prior
to trial pursuant to the Stipulation of Settlement with respect to Count
II of the Complaint, filed on July 16, 1996. All claims between the
appellant and Lawyers Title Insurance Corporation were mutually dismissed
at trial.
[fn2] The Agreement said $10 million, but at times up to $12.5 million
was advanced.
[fn3] It is a wellestablished law that appellate courts may not pass
upon an issue not presented in a lower court. Singleton v. Wulff,
428 U.S. 106, 120 (1976). The same holds true for a U.S. District Courtsitting in its appellate capacity over matters appealed from the
bankruptcy court. See Barrett v. Commonwealth Fed. Sav. and Loan Ass'n,
939 F.2d 20 (3d Cir. 1991); In re Middle Atlantic Stud Welding Co.,
503 F.2d 1133, 1134 n. 1 (3d Cir. 1974). Because Provident never raisedthis issue before the Bankruptcy Court, I will not consider it now.
[fn4] The res judicata doctrine prevents relitigation of claims that grow
out of a transaction or occurrence from which other claims have earlier
been raised and decided validly, finally, and on the merits. Federated
Department Stores v. Moitie, 452 U.S. 394, 298 (1981). Under Pennsylvanialaw, default judgments, absent fraud, are afforded res judicata effect.
In re Graves, 156 B.R. 949, 954 (E.D.Pa. 1993), aff'd, 33 F.3d 242 (3dCir. 1994). On December 21, 1994, the Court of Common Pleas of Berks
County, Pennsylvania, entered default judgments against Provident on both
the Weaver and Fisher transactions, those transactions for which Pioneer
was the closing agent. Due to these default judgments, the doctrine of
res judicata bars relitigation of the Pioneer causes of action. The
Bankruptcy Court also held that the Andreuzzi transaction was barred by
res judicata or collateral estoppel because of the lis pendens. That,
however, is a more difficult issue and one that I need not reach now, as
my affirmance of the Bankruptcy Court's judgment applies equally to the
Andreuzzi transaction on the merits.
[fn5] At trial and in its briefs to this Court, as an alternative to its
holder in due course argument, Provident argued that it was protected by
the Pennsylvania Uniform Fiduciaries Act, 7 Pa. Cons. Stat. § 6361,
and the New Jersey Uniform Fiduciaries Law, N.J.S.A. 3B:1454, theprovisions of which are substantially similar. The two laws protect a
person who transfers money to a fiduciary in good faith, by noting that
"any right or title acquired from the fiduciary in consideration of such
payment or transfer is not invalid in consequences of a misapplication by
the fiduciary." 7 Pa. Cons. Stat. § 6361; N.J.S.A. 3B:1454. TheBankruptcy Court held that Pinnacle was not Provident's agent or
fiduciary, and thus the UFA did not apply. (Opinion at 66.) In light of
the fact that Provident's counsel, at oral argument before this Court on
November 13, 1998, themselves argued that Pinnacle was not Provident's
fiduciary, I will affirm this aspect of the Bankruptcy Court's ruling
without need to examine the factual bases on which it relied.
[fn6] The rest of this Opinion is limited to the eight transactions not
handled by Pioneer, since only the Pioneer transactions are bound by res
judicata.
[fn7] As Part V of this Opinion explains, one of the several bases for
the Bankruptcy Court's decision that Provident is not the HDC of the
mortgages and notes is that the settlement agents were not Provident's
agents, and thus Provident did not constructively possess the mortgages
and notes prior to gaining knowledge of claims or defenses on those
notes. (Opinion at 3453.) In the alternative, in case appellate courts
determined that Provident was the HDC of those notes because an agency
relationship did exist, the Bankruptcy Court held that the closing
agents, and not Provident, would still be the ones entitled to the notes
and mortgages, for the agents would have had a right to indemnification
from Provident. (Id. at 6364.) Though, as I explain in Part V, I do not
reach the agency issue, I do affirm the Bankruptcy Court's HDC ruling on
other grounds. In doing so, I am affirming the decision that the
appellees, and not Provident, are entitled to the notes and mortgages. The
Bankruptcy Court's indemnification ruling is just an alternative reason
for finding that the appellees are entitled to the notes and mortgages.
Having already agreed that the closing agents are so entitled because
Provident is not an HDC, there is no need to address that alternative
ruling upon appeal.
[fn8] Seven of the eight remaining transactions here are governed by
Pennsylvania law. The eighth is under New Jersey law, but the two states'
laws on HDC status are largely consistent on the issues raised in these
proceedings.
[fn9] The Bankruptcy Court agreed that authority from other jurisdictions
suggest that a party may become a constructive holder when its agent
takes possession of a negotiable instrument on its behalf. (Opinion at
3637.) However, the Bankruptcy Court made the factual finding that
appellees were not Provident's agents. It determined that though six of
the ten transactions involved written agency agreements, those agreements
were not controlling in light of the course of dealing between the
parties (Opinion at 46), and that Provident did not otherwise meet its
burden of establishing that an agency relationship existed. Because I
find that the Bankruptcy Court's determination that Provident did not act
in good faith is not clearly erroneous, and because the lack of good
faith alone is enough of a basis to sustain a judgment that Provident is
not an HDC of these eight notes and mortgages, I need not address whether
the agency determination was clearly erroneous.
[fn10] Under the Bankruptcy Court's findings of fact, Provident was, in
reality, a party to the original transaction. The situation is somewhat
analogous to a consumer goods financer who has a substantial voice in the
underlying transaction; that financer is not entitled to HDC status.
Westfield Investment Co. v. Fellers, 181 A.2d 809 (N.J.Super.Ct. LawDiv.). Provident had a substantial voice in providing and carrying out
funding of the underlying borrowing transactions, and it thus cannot
claim that it was a good faith HDC when it learned of the defense of
failure of consideration prior to dishonoring the Pinnacle checks.
Loislaw Federal District Court Opinions
Copyright © 2013 CCH Incorporated or its affiliates
IN RE PINNACLE MORTGAGE INVESTMENT CORPORATION, (D.N.J. 1998)
IN RE PINNACLE MORTGAGE INVESTMENT CORPORATION, Debtor
PROVIDENT SAVINGS BANK, a New Jersey Banking Corporation,
Plaintiff/Appellant, v. PINNACLE MORTGAGE INVESTMENT CORPORATION, a
Pennsylvania Corporation, et al., Defendants, SETTLERS ABSTRACT CO., L.P.,
LAWYERS TITLE INSURANCE CORP., LAND TRANSFER CO, INC., FIDELITY NATIONAL
TITLE INSURANCE CO. OF PENNSYLVANIA, GINO L. ANDREUZZI, PIONEER AGENCY II
CORP. t/a PIONEER AGENCY, MUSSER & MUSSER, WILLIAM E. WARD, QUAKER ABSTRACT
CO., and SEARCHTEC ABSTRACT, INC., Appellees.
CIVIL NO. 980489 (JBS), [Bankruptcy Case No. 9510608 (JHW)], [Adv.
Proc. No. 951091]
United States District Court, D. New Jersey.
Filed: December 9, 1998
Walter E. Thomas, Jr., Esq., Timothy J. Matteson, Esq., Mark A. Trudeau,
Esq., Stern, Lavinthal, Norgaard & Kapnick, Esqs., Englewood, New Jersey,
Attorneys for Appellant.
Edward J. Hayes, Esq., Andrea Dobin, Esq., Fox, Rothschild, O'Brien &
Frankel, Princeton Pike Corporate Center, Lawrenceville, New Jersey,
Attorneys for Appellees, Settlers Abstract Co., L.P., Land Transfer Co,
Inc., Fidelity National Title Insurance Co. of Pennsylvania, Gino L.
Andreuzzi, Pioneer Agency II Corp. t/a Pioneer Agency, Musser & Musser,
Quaker Abstract Co, and Searchtec Abstract, Inc.
OPINION
SIMANDLE, District Judge.
I. INTRODUCTION
Provident Savings Bank appeals from a Judgment entered on December 17,
1997, pursuant to a written opinion issued on November 19, 1997, by the
Honorable Judith H. Wizmur, United States Bankruptcy Judge, after trial
in an adversary proceeding. That Opinion ruled in favor of the
Appellees, Settlers Abstract Co., L.P., Land Transfer Co, Inc., Fidelity
National Title Insurance Co. of Pennsylvania, Gino L. Andreuzzi, Pioneer
Agency II Corp. t/a Pioneer Agency, Musser & Musser, Quaker Abstract Co,
and Searchtec Abstract, Inc. ("title agents"). Reviewing a longstanding
complex lending relationship between Provident and the debtor, Pinnacle
Mortgage Corporation, of which the ten real estate mortgage loans at
issue herein were a part, the Bankruptcy Court held that appellee title
agents (who had advanced their own funds to cover disbursements when
Provident dishonored Pinnacle's checks) had a more valid or higher
priority security interest in the promissory notes and mortgages executed
as part of ten separate residential real estate closing than did
appellant. Provident Savings Bank appeals this ruling and seeks this
Court's determination that it was the holder in due course of those
documents.
The principal issue to be decided is whether the Bankruptcy Court
correctly determined under the Uniform Commercial Code that Provident was
not a holder in due course of the promissory notes arising from these
loans, where it found that Provident so closely participated in the
funding and approval of the Pinnaclebrokered loans that the transaction
did not end at the closing with the title agents, such that Provident did
not attain holder in due course status because it did not fit the
requisite role of a "good faith purchaser for value." For the reasons
that will be stated herein, the judgment will be affirmed because the
Bankruptcy Court's finding that Provident never attained HDC status was
neither clearly erroneous nor contrary to law.
II. BACKGROUND
A. Procedural History
This case arises from a dispute over the various security interests in
mortgage documents from ten separate real estate transactions in late
October, 1994, conducted by the debtor, Pinnacle Mortgage Investment
Corporation (who brokered the transactions), the appellant (who financed
the transactions), and the appellees (who were title closing agents in
the transactions). On February 2, 1995, appellant Provident Savings Bank
("Provident") and other creditors filed an involuntary petition under
Chapter 7 of Title 11 of the Bankruptcy Code against Pinnacle Mortgage
Investment Corporation ("Pinnacle"). An order for relief under Chapter 7
was entered by the Bankruptcy Court on March 6, 1995.
On March 24, 1995, Provident commenced this adversary proceeding by
filing a three count complaint to determine the extent, validity, and
priority of the various security interests asserted by Pinnacle, Meridian
Bank, Lawyers Title Insurance Corporation, the appellees, and William E.
Ward with regard to the promissory notes and mortgages from ten real
estate transactions.[fn1] Appellees responded to the complaint by filingan answer, counterclaims, and crossclaims, seeking money judgments in
the amount of the contested notes and mortgages, interest, cost of suit,
and attorneys fees; imposition of a constructive trust in their favor
with regard to the notes, mortgages, and proceeds thereof; and to have
the subject notes and mortgages avoided and stricken in favor of
subsequently executed mortgages between the appellees and the
mortgagors. Provident twice amended its complaint, finally seeking a
declaratory judgment that it is the holder in due course of the subject
notes and mortgages under the Uniform Commercial Code; avoidance of the
preferential transfer by appellee Andreuzzi pursuant to 11 U.S.C. § 547and 550; avoidance of the fraudulent transfer by appellee Andreuzzipursuant to §§ 548 and 550; and avoidance of the preferential and
fraudulent transfers by appellees pursuant to 11 U.S.C. § 547, 548,and 550.
Trial in this matter was held on July 16, 17, and 18, 1996, and October
1, 3, and 4, 1996. At the close of Provident's case in chief, upon motion
by the appellees, all of those portions of the Second Amended Complaint
which did not pertain to Provident's status as a holder in due course
("HDC") were dismissed.
B. The Factual History
In its November 19, 1997 opinion, the Bankruptcy Court determined that
the facts of the case are as follows. Debtor Pinnacle Mortgage Investment
Corporation ("Pinnacle" or "debtor") was a mortgage banker which
primarily dealt in residential mortgage lending and refinance. In December
of 1992, Pinnacle and Provident Savings Bank ("Provident" or "appellant")
entered into a Mortgage Warehouse Loan and Security Agreement
("Agreement"), whereby Provident would fund Pinnacle, who in turn funded
retail customers who sought to purchase or refinance residential real
estate. The borrower in each transaction would give Pinnacle a note and
mortgage, both of which acted as collateral to protect Provident until
Pinnacle sold the mortgage to a third party investor, such as the Federal
Home Loan Mortgage Corporation ("Freddie Mac"), who satisfied Pinnacle's
debt to Provident. Warehouse Agreement § 3.4.
1. The Warehouse Agreement
Under these types of agreements, there would usually not be any contact
between the warehouse lender and the ultimate mortgagor. Typically,
Pinnacle would arrange with a prospective borrower for Pinnacle to
advance funds for the borrower to purchase or refinance a home and for
the borrower to assign a note and mortgage to Pinnacle as collateral. The
mortgage would be endorsed in blank in order to accommodate the final
third party investor (such as Freddie Mac), with whom Pinnacle would
arrange to purchase the mortgage, usually as a part of a pool of
mortgages; this was known as a "takeout" agreement. All of this
completed, Pinnacle would submit a "package" to Provident seeking funding
for the particular transaction under its $10 million line of credit.[fn2]This package included a description of the borrower and the funding, an
assignment of the mortgage endorsed in blank, a takeout commitment, and
an agency agreement that indicated the borrower's attorney's agreement
"to act as the agent of the Bank" to disburse the Advance and to obtain
due execution and delivery to the bank of the original note that
evidences the debt underlying the Mortgage Loan." Warehouse Agreement
§ 5.3(A)(iii). The Agreement required all of this to be submitted
along with the initial funding request. As a matter of course, however,
the agency agreement was usually executed by the title agent handling the
closing instead of by the borrower's attorney, and Provident customarily
accepted the mortgage assignment and agency agreement after the actual
closing.
After Provident received the package and checked to see that Pinnacle's
credit limit had not been exceeded (although, as stated above, often
prior to receipt of the mortgage assignment and agency agreement),
Provident credited Pinnacle's checking account with 98% of the requested
funds. Warehouse Agreement §§ 1.1, 2.1. Pinnacle would write a
regular, uncertified check to the closing agent, who would close the loan
directly with the borrower on Pinnacle's behalf. Pinnacle was supposed to
use specific funds credited to their account to fund specific closings,
but no controls were in place to make sure that Pinnacle actually did
so.
With Pinnacle's check in hand, the closing agent would use money from
its own bank account to disburse funds to the mortgagor, later
replenishing its bank account by depositing Pinnacle's check. Next, the
closing agent would routinely send the original note, a certified copy of
the recorded mortgage, and the other closing documents to Pinnacle, who
would send them on to Provident, who would receive this original note
approximately three to five days after closing. Provident and the
borrowers had no contact; indeed, Provident and the closing agents had no
contact, save the extremely limited contact by the closing agents who did
return the agency agreement included in the borrowing package. Not all
closing agents did return the agreement signed; most of those who did
sent everything through Pinnacle to go to Provident, in accordance with
Pinnacle's written instructions, rather than remitting the note and other
papers directly to Provident, as stated in the agency agreement.
Ultimately, Provident would send the note and accompanying documents to
the third party investor, who would pay Provident the funds which
Provident had originally placed in Pinnacle's checking account by wiring
monies to Provident in Pinnacle's name. Because the third party investor
would send multiple payments in each wire transfer, Pinnacle would tell
Provident to which loans to apply each of the funds.
2. Pinnacle's Declining Financial State
Among the twenty or so warehouse customers that Provident had during
19931994, Pinnacle was the most profitable for Provident, providing
hundreds of millions of dollars in loan transactions. However, when the
mortgage banking industry suffered a decline in business, Pinnacle began
to experience financial difficulties as well.
The Warehouse Agreement, § 6.11, required Pinnacle to submit
unaudited balance sheets and statements of income to Provident on a
quarterly basis, though Pinnacle customarily provided monthly
statements. The statements filed for June, July, and August of 1993
reflected an accrued pretax income for the first three months of the
fiscal year of $281,351. Statements for September, October, and November
of 1993 reflected pretax income of $923,923 for the first six months of
the fiscal year. However, after the November 30 report, Pinnacle began to
send its reports quarterly, which was in accordance with the Warehouse
Agreement but which was nonetheless unusual due to Pinnacle's custom of
submitting reports monthly. The next report, covering the ninemonth
period ending February 28, 1994, was due on April 15 but not received
until some time in May. It showed pretax income of $136,000 for the
first nine months, or an $800,000 loss in the previous three months. The
accompanying unaudited balance sheets showed a reduction of assets from
$40 million to $28 million in those three months. The final financial
statement was due on August 31, 1994, but Provident never received it.
At a holiday party in May 1994, Edmund R. Folsom, head of Provident's
Commercial Lending Department, had learned that Pinnacle had sustained
losses in the winter months. On August 19, 1994, Sharon Kinkead, of
Provident's Warehouse Lending Department, called Pinnacle's headquarters
and learned from Pinnacle's CFO, Joseph Mader, that there would be a
delay in the submission of the audited financial statements for the
fiscal year ending May 31, 1994 because of a change of comptroller, but
that the report would be provided by September 15, 1994. That report
never arrived, and no other financial statements were received up until
Provident's termination of its relationship with Pinnacle in early
November 1994.
3. Provident's Relationship with Pinnacle
Throughout its relationship with Pinnacle, Provident routinely honored
overdrafts on behalf of Pinnacle — about twenty times in 1993 and
fifteen times in 1994. These overdrafts ranged from $7,240.87 to
$5,255,812.
When a check was presented to the bank on Pinnacle's account for which
Pinnacle had insufficient funds, Sharon Kinkead would contact Pinnacle to
ask whether Pinnacle would honor that overdraft. Having been told that
the check would be covered (usually from an anticipated wire transfer),
Kinkead and her supervisor, Mr. Folsom, would honor it and allow the
overdraft. Until November 1994, Provident honored all of Pinnacle's
overdrafts, without reviewing Pinnacle's books and records or monitoring
its checking account.
As mentioned earlier, Pinnacle's CFO, Joseph Mader, had informed
Provident that its final fiscal year report would be forthcoming on
September 15, 1994. When Provident did not receive the audited reports by
that date, Mr. Folsom spoke with Mr. Mader, who reported that though
Pinnacle had sustained losses, it was expecting a substantial infusion of
capital. Pinnacle wanted to hold off publishing the report so that it
could add a footnote explaining that there would be a capital infusion.
Based on this, Folsom decided to extend Pinnacle's credit line through
the end of November.
Folsom called Mader some time in October to check on the status of the
report. When Mader returned the call on November 1, he informed Folsom
that the capital infusion had failed. Folsom demanded a meeting with
Pinnacle's officers.
On November 2, Folsom and Kinkead met with Mader and Al Miller,
President of Pinnacle. Mader and Miller presented internally generated
financial statements indicating a pretax loss of six million dollars for
the previous fiscal year, as well as a pretax loss of almost one million
dollars for the first quarter of the current fiscal year. Miller and
Mader admitted that they had misused their warehouse credit line with
G.E. Capital Mortgage Services, Inc., to whom they were indebted for
about six million dollars. They "admitted fraud" as to G.E., but
indicated that they had not misappropriated the Provident funds and asked
for an extension of funding of their loans while they financially
reorganized. Provident declined to do so.
At that time, Provident finally reviewed Pinnacle's books and
discovered that Pinnacle had been diverting substantial sums of money
from Pinnacle's Provident account to its operating account at Meridian
Bank. Kinkead and Folsom also learned that Pinnacle had been requesting
advances on loans earlier than was routinely requested, possibly using
the money that was supposed to be for specific loans for other purposes
instead. Indeed, Pinnacle was engaging in a "kiting" scheme,
misappropriating monies from third party investors that should have been
applied to previously funded loans. A Pinnacle employee told Kinkead that
the Provident line was not "whole," that as much as $500,000 may have
been taken from it, though no fraudulent loans had been made.
As of November 2, 1994, all checks presented to Provident on Pinnacle's
account had been processed, and the customer balance summary showed an
overdraft of $206,653.67. On November 3, $830,127.48 was deposited in
Pinnacle's account. Sixteen checks totaling $1,584,041.63 were presented
to Provident against Pinnacle's account on November 3. There were
insufficient funds to cover all sixteen, so Folsom sent a letter to
Miller, Pinnacle's president, to ask which checks should be paid. At the
time, Provident knew that all sixteen of those checks represented monies
that Pinnacle had delivered to borrowers and closing agents for
particular loans, as well as that each transaction was accompanied by a
takeout commitment by a third party investor, who would have paid for
the loan.
Miller indicated that six of the checks could be paid. Provident
debited $863,821 to pay off eight loans on November 4, and other checks
were paid at Mader's instruction. There was an overdraft on that date of
$178,303.73, and Provident honored no more checks. The remaining ten of
the sixteen checks presented on November 3 were dishonored, and those are
the subject of the instant litigation.
4. The Ten Transactions
Prior to the closings in each of the ten transactions in question,
Pinnacle had requested from Provident — and received — monies
to fund the transactions. As usual, Pinnacle presented the closing agent
with an uncertified check drawn on its account at Provident representing
payment for the note and mortgage to be executed by the borrower,
purchaser, or refinancer of the property. With Pinnacle's check in hand,
the closing agents closed each transaction, issuing checks from their own
accounts to the parties entitled to receive funds. The closing agents
then deposited Pinnacle's checks in their own accounts, and their banks
presented those checks to Provident for payment. In each case, Provident
dishonored the checks due to insufficient funds. After each closing, but
before the discovery of any problem, each closing agent returned the
original note to Pinnacle. Several closing agents recorded the mortgage
and sent Pinnacle certified copies. Despite the fact that Pinnacle's
checks were not honored, each closing agent honored their own checks when
they were presented.
At the time, uncertified funds were routinely accepted from mortgage
bankers, with a few exceptions for out of state lenders, ignoring the
Pennsylvania statute which required mortgage bankers and brokers to
certify funds. Most mortgage lenders such as Pinnacle insisted on
acceptance of regular checks; title insurers could not stay in business
if they did not follow the standard in the industry.
As was usual for these transactions, Provident had no contact with any
of the closing agents prior to settlement. Agency agreements were
included in most, but not all, of the instruction packages sent by
Pinnacle to the respective closing agents. The agreement provided that
Provident had a security interest in the note and mortgage; moreover, it
provided that the closing agent would act as Provident's agent in
connection with the loan transaction, agreeing to record the mortgage and
then to send both the original note and the original recorded mortgage to
Provident upon closing. The text of the agreement conflicted with the
closing instructions that Pinnacle gave to the closing agents, which
required the note to be returned to Pinnacle. In six of the ten
transactions, the agreement was executed, but its provisions were
basically ignored, as the closing documents were returned directly to
Pinnacle.
The closing agents learned of the dishonor from their own banks.
Provident did not attempt to contact the closing agents until November
10, 1994, when they sent a letter with instructions to deliver to
Provident all notes, mortgages, loan files, and other collateral, and any
monies received in connection with each mortgage loan.
Several of the agents sought judicial relief. Two of the closing agents
who are appellees in this matter, Gino L. Andreuzzi and the Pioneer
Agency L.P., hold state court judgments in their favor, for a total of
three judgments against Pinnacle, striking the mortgages and notes
executed by their respective buyers in favor of Pinnacle. Andreuzzi, the
closing agent in the Hopeck settlement, filed suit against Pinnacle in
the Court of Common Pleas of Luzerne County, Pennsylvania, seeking a TRO
to keep Pinnacle from selling, transferring, or assigning the note and
mortgage in question. Provident was not joined in Andreuzzi's case, but
it did have notice of the litigation. Andreuzzi filed a lis pendens with
the Prothonotary on November 14, 1994. About three hours after the lis
pendens was filed, Provident recorded the assignment from the Hopeck
note. Ultimately, a default judgment was entered against Pinnacle.
Pioneer also filed suits in connection with the Weaver and Fisher
transactions. In both cases, Pioneer sued Pinnacle and Provident in the
Court of Common Pleas of Berks County, Pennsylvania, on November 14,
1994. A preliminary injunction was entered on November 22, and a default
judgment was entered against both defendants on December 21, 1994. Two
days later, Pinnacle moved to open the default judgment. It was still
pending on February 1, 1995 when an involuntary petition was filed against
Pinnacle. Provident removed the action to the Bankruptcy Court on May 8,
1995.
Other closing agents entered into agreements with the borrowers to
execute new notes and mortgages. By the time this came before the
Bankruptcy Court, the mortgages had either been satisfied in full, with
proceeds held in escrow, or payments on the new mortgages and notes were
being made by the borrowers to the closing agents in escrow pending the
resolution of this matter.
C. The Bankruptcy Court's Findings and Judgment
On November 19, 1997, the Bankruptcy Court issued its Opinion in favor
of the appellees, ruling that:
(1) the appellant did not achieve the status of an HDC
with regard to the notes and mortgages in issue;
(2) the appellees would be entitled to indemnification
even if an agency relationship existed between the
appellant and appellees;
(3) the Uniform Fiduciaries Law is inapplicable to
validate the appellant's position with regard to the
subject notes and mortgages; and
(4) the appellant is precluded from relitigating the
transactions with appellees Pioneer Agency II Corp
t/a Pioneer Agency and Andreuzzi.
Judgment against Provident was entered on December 17, 1997. On December
22, 1997, appellant filed a notice of appeal from the Judgment. On
February 13, 1998, the record on appeal was transmitted to this Court. As
"nothing remains for the [lower] court to do," Universal Minerals, Inc.
v. C.A. Hughes & Co., 669 F.2d 98, 101 (3d Cir. 1981), the BankruptcyCourt's ruling is final, and thus this Court properly has appellate
jurisdiction over the December 17, 1997 Order pursuant to
28 U.S.C. § 158(a).
III. ISSUES PRESENTED
On appeal, Provident makes six arguments. First, Provident argues that
it is the holder in due course ("HDC") of the ten mortgage notes.
Second, Provident argues that the Bankruptcy Court's ruling that the
appellees were entitled to indemnification if they were Provident's agents
is clearly erroneous. Third, appellant contends that the bankruptcy court
erred in ruling that Provident was not protected by the Uniform
Fiduciaries Act ("UFA"), adopted by both New Jersey and Pennsylvania at
N.J.S.A. 3B:1454 and 7 Pa. Cons. Stat. Ann. § 6361, respectively.Fourth, Provident argues, for the first time upon appeal, that the
doctrine of avoidable consequences bars appellees from recovering any
damages from Provident. Fifth, Provident maintains that the doctrines of
lis pendens, res judicata, and collateral estoppel do not bar
relitigation of these issues as to the Andreuzzi transaction. Finally,
Provident argues that the Bankruptcy Court erred by giving preclusionary
effect to the Pioneer action default judgments.
This Opinion will not address Provident's "avoidable consequences"
argument, as it was raised, for the first time, upon appeal.[fn3]Moreover, the doctrine of res judicata precludes review of the two
transactions for which Pioneer was the closing agent, and I thus affirm
the Bankruptcy Court's judgment as to Pioneer on that ground.[fn4] I willaffirm the Bankruptcy Court's holding that Provident is not entitled to
the protections of the Uniform Fiduciaries Act , especially in light of
the fact that Provident has withdrawn its argument that Pinnacle was its
agent.[fn5] For reasons stated herein, I will affirm the BankruptcyCourt's holding that Provident is not the holder in due course of the
eight[fn6] transactions still in question. Accordingly, there is no needfor this Court to address the Bankruptcy Court's alternate finding that
the closing agents would be entitled to indemnification.[fn7]
IV. STANDARD OF REVIEW
On appeal, the weight accorded to the findings of fact by a bankruptcy
court are governed by Fed.R.Bank.P. 8013, which provides as follows:
On appeal the district court or bankruptcy appellate
panel may affirm, modify, or reverse a bankruptcy
judge's judgment, order, or decree or remand with
instructions for further proceedings. Findings of
fact, whether based on oral or documentary evidence,
shall not be set aside unless clearly erroneous, and
due regard shall be given to the opportunity of the
bankruptcy court to judge the credibility of
witnesses.
Fed.R.Bank.P. 8013. Under this Rule, a bankruptcy court's factualfindings may be disturbed only if clearly erroneous. See FGH Realty
Credit v. Newark Airport/Hotel Ltd., 155 B.R. 93 (D.N.J. 1993). Where a
mixed question of law and fact is presented, the appropriate standard
must be applied to each component. In re Sharon Steel Corp., 871 F.2d 1217,
1222 (3d Cir. 1989). Thus, a reviewing court "must accept the [lower]court's findings of historical or narrative facts unless they are clearly
erroneous, but . . . must exercise a plenary review and its application
of those precepts to the historical facts." Universal Minerals, Inc. v.
C.A. Hughes & Co., 669 F.2d at 103.
While standards for establishing that a party is a holder in due course
are wellsettled law, see, e.g., Triffin v. Dillabough, 448 Pa. Super. 72,
87, 670 A.2d 684, 691 (1996), the Court's application of these standardsto the facts does result in a mixed finding of fact and law that is
subject to a mixed standard of review. Mellon Bank, N.A. v. Metro
Communications, Inc., 945 F.2d 635, 64142 (3d Cir. 1991), cert. denied,
503 U.S. 937 (1992). The factual findings can only be reversed for clearerror, In re Graves, 33 F.3d 242, 251 (3d Cir. 1994), even if thereviewing court would have decided the matter differently. In re
PrincetonNew York Investors, Inc., 1998 WL 111674 (D.N.J. 1998). This
Court, thus, may not overturn a bankruptcy judge's factual findings if
the factual determinations bear any "rational relationship to the
supporting evidentiary data. . . ." Fellheimer, Eichen & Braverman, P.C.
v. Charter Technologies, Inc., 57 F.3d 1215, 1223 (3d Cir. 1995) (citingHoots v. Comm. of Pa., 703 F.2d 722, 725 (3d Cir. 1983). However, thisCourt reviews any legal conclusions de novo.
V. DISCUSSION
Appellant argues that the Bankruptcy Court's finding that appellant is
not an HDC of the promissory notes and mortgages from the eight remaining
real estate transactions closed by appellees is clearly erroneous. The
dispute here is not a dispute of law, as the parties agree on what the
law concerning HDCs is. As the Bankruptcy Court correctly found,[fn8]every holder of a negotiable instrument is presumed to be an HDC, Morgan
Guaranty Trust Company of New York v. Staats, 631 A.2d 631, 636(Pa.Super.Ct. 1993), but when a defense of fraud is meritorious as to the
payee, the holder has the burden of showing that it is an HDC in order to
be immune from that defense. Norman v. World Wide Distributors, Inc.,
195 A.2d 115, 117 (Pa.Super.Ct. 1963). A holder of a negotiableinstrument (such as the promissory notes in this case) is either the
person with possession of bearer paper or the person identified on the
instrument if that person is in possession. 13 Pa. Cons. Stat. Ann.
§ 1201; N.J.S.A. 12A:3201 (West Supp. 1998). The holder of adocument of title (such as the mortgages in this case) is the person in
possession if the document is made out to bearer or to the order of the
person in possession. Id. The holder becomes an HDC if:
(1) the instrument when issued or negotiated to the
holder does not bear such apparent evidence of forgery
or alteration or is not otherwise so irregular or
incomplete as to call into question its authenticity;
and
(2) the holder took the instrument:
(i) for value;
(ii) in good faith;
(iii) without notice that the instrument is
overdue or has been dishonored or that there is an
uncured default with respect to payment of another
instrument issued as part of the same series;
(iv) without notice that the instrument contains
an unauthorized signature or has been altered;
(v) without notice of any claim to the instrument
described in section 3306 (relating to claims to an
instrument); and
(vi) without notice that any party has a defense
or claim in recoupment described in section 3305(a)
(relating to defenses and claims in recoupment).
13 Pa. Cons. Stat. Ann. § 3302. See also N.J.S.A. 12A:3302. Inshort, an HDC is the holder of the instrument or document who took for
value and in good faith without notice of any claims or defects on the
instrument or document. If classified as an HDC, the holder holds without
regard to defenses, with certain statutory exemptions which do not apply
here. 13 Pa. Cons. Stat. Ann. § 3305; N.J.S.A. 12A:3305.
It was clear to the parties and to the Bankruptcy Court below that
Provident did not have actual possession of the notes and mortgages
before November 2, 1998, when it learned that there were insufficient
funds in Pinnacle's account at Provident to cover Pinnacle's checks to
the closing agents here. Provident nonetheless argued that it was the
holder of the notes and mortgages because, before gaining actual
knowledge of Pinnacle's fraud, Provident "constructively possessed" the
notes and mortgages from the moment that the closing agents, who were
allegedly Provident's agents, took possession of the notes at the
closings before November 2.
The Bankruptcy Court rejected Provident's argument, finding that none
of the appellees acted as Provident's agents, and thus Provident never
constructively or actually possessed the notes and mortgages. Thus, the
Bankruptcy Court found that Provident never became the holder of these
notes and mortgages in the first place. (Opinion at 53.) Alternatively,
the Bankruptcy Court found that while Provident did give value for the
notes and mortgages (Opinion at 54), it did not take those notes and
mortgages in good faith and without knowledge of defenses, and thus
Provident is not an HDC. (Opinion at 63.) The question before this Court
is whether the Bankruptcy Court's rulings in this regard were clearly
erroneous. I hold that it was neither clearly erroneous nor contrary to
established law for the Bankruptcy Court to find that Provident did not
fit the role of "good faith purchaser for value" necessary to claim HDC
status even though Provident's lack of good faith arose after the title
agents closed the real estate transactions. As the following discussion
will explain, in the context of a course of dealing between Provident and
Pinnacle extending over thousands of such transactions, Provident was
essentially a party to the mortgage lending transactions and thus, by
definition, cannot claim HDC status in the negotiable papers which
resulted from those transactions, especially because Provident gained
knowledge of defenses before its own role in the original mortgage
lending transaction was complete.
I affirm the Bankruptcy Court's ruling that Provident is not the HDC of
these notes and mortgages. In so holding, I need not, and thus do not,
reach the issue of whether Provident constructively possessed the notes
and mortgages,[fn9] for holder status is irrelevant if Provident did nottake in good faith and without knowledge of defenses. Because I find that
the Bankruptcy Court's ruling that Provident did not take in good faith
was not clearly erroneous, I affirm the ruling that Provident is not
entitled to the protections afforded to a holder in due course.
The Bankruptcy Court correctly stated the law on good faith in this
context: the test for good faith is "not one of negligence of duty to
inquire, but rather it is one of willful dishonesty or actual knowledge."
Valley Bank & Trust Co. v. American Utilities, Inc., 415 F. Supp. 298,
301 (E.D.Pa. 1976). See also Mellon Bank v. PasqualisPoliti,
800 F. Supp. 1297, 1302 (W.D.Pa. 1992), aff'd, 990 F.2d 780 (3d Cir.1993); Carnegie Bank v. Shalleck, 606 A.2d 389, 394 (N.J.Super.Ct.A.D. 1992); General Inv. Corp. v. Angelini, 278 A.2d 193 (N.J. 1971).Good faith may be defeated only by actual knowledge or a deliberate
attempt to evade knowledge. Rice v. Barrington, 70 A. 169, 170 (N.J. E. &
A 1908). "There is no affirmative duty of inquiry on the part of one
taking a negotiable instrument, and there is no constructive notice from
the circumstances of the transaction, unless the circumstances are so
strong that if ignored they will be deemed to establish bad faith on the
part of the transferee." Bankers Trust Co. v. Crawford, 781 F.2d 39, 45(3d Cir. 1986). Moreover, an HDC must take not only in good faith, but
also without notice of defenses to the instrument or document. One has
"notice" when
(1) he has actual knowledge of it;
(2) he has received a notice or notification of it; or
(3) from all the facts and circumstances known to him
at the time in question he has reason to know that it
exists.
Pa. Cons. Stat. Ann. § 1201.
The Bankruptcy Court here found that Provident did not in fact have
actual knowledge of the fraud or potential defense of failure of
consideration at the time of each separate closing. (Opinion at 58.) The
Bankruptcy Court also found that despite the fact that Provident failed
to review Pinnacle's books, records, and checking account ledger, failed
to notice the overdraft problem, failed to properly monitor withdrawals,
and failed to act after knowledge of financial deterioration in default
in providing timely audited financial statements, the appellees had not
proved that Provident acted with willful dishonesty (id.); Provident did
act with negligence or gross negligence, but gross negligence alone is
not enough to defeat an HDC's title. See Washington & Canonsburg Ry. Co.
v. Murray, 211 F. 440, 445 (3d Cir. 1914); General Inv. Corp.,
278 A.2d 193. Moreover, the Bankruptcy Court correctly noted that holderin due course status is generally created at the time that the claimant
becomes a holder — meaning at the time of negotiation. N.J.S.A.
12A:3302; Sisemore v. Kierlow Co., Inc. v. Nicholas, 27 A.2d 473, 478(Pa.Super.Ct. 1942). In transactions such as the ones at issue here which
involve blank endorsements, the instruments and documents are bearer
paper and are thus negotiated upon delivery alone. 13 Pa. Cons. Stat.
Ann. § 3201; N.J.S.A. 12A:3201.
Nonetheless, the Bankruptcy Court found that Provident failed to attain
the status of a holder in due course. It acknowledged that once a party
establishes its position as a holder in due course, no future action can
undermine that status; so in the usual transaction with negotiable bearer
paper, actual knowledge of defenses gained after possession do not defeat
HDC status. (Opinion at 63.) See Bricks Unlimited, Inc. v. Agee,
672 F.2d 1255, 1259 (5th Cir. 1982); Park Gasoline Co. v. Crusius,158 A. 334 (N.J. 1932). However, the Bankruptcy Court said, it was not
finding lack of good faith after gaining HDC status, but rather that
Provident did not gain HDC status in the first place, for these were not
the "usual" transactions. Taken in a "global sense," the Bankruptcy Court
said, these transactions did not end until after the settlements.
(Opinion at 58.)
Usually, one who takes a negotiable instrument for value has only the
underlying circumstances of that transaction by which to determine if
there is reason to give pause as to the veracity of that instrument. A
lender provides funds to a borrower who executes a promissory note. Once
that transaction is complete, the lender transfers the note to a second
lender in exchange for which the first lender receives funds replenishing
his account and enabling him to lend the same funds to another borrower.
HDC status is given to that second lender if it acts in good faith and
without knowledge of defenses, and there is no general duty for that
second lender to inquire unless the circumstances are so suspicious that
they cannot be ignored. See, e.g. Triffin, 670 A.2d at 692. In the usualHDC transaction, there are two discernible transactions, two exchanges of
funds and notes. As the Bankruptcy Court pointed out, the purpose of
giving that second lender HDC status is "to meet the contemporary needs
of fast moving commercial society . . . (citation omitted) and to enhance
the marketability of negotiable instruments [allowing] bankers, brokers
and the general public to trade in confidence." Triffin,
670 A.2d at 693. However, "the more the holder knows about the underlyingtransaction, and particularly the more he controls or participates or
becomes involved in it, the less he fits the role of a good faith
purchaser for value; the closer his relationship to the underlying
agreement which is the source of the note, the less need there is for
giving him the tensionfree rights necessary in a fastmoving,
creditextending commercial world." Unico v. Owen, 50 N.J. 101, 109110 (1967). See also Jones v. Approved Bancredit Corp., 256 A.2d 739, 742(Del. 1969) (in such a situation, "[the financer] should not be able to
hide behind `the fictional fence' of the . . . UCC and thereby achieve an
unfair advantage over the purchaser.").
Here, there were not two separate, discernible transactions.
Provident's funding of Pinnacle who funded the borrowers was one complex
transaction. The acts of a third party investor who would buy the notes
and mortgages from Provident would have been the second separate,
discernible transaction here. Provident did not replenish Pinnacle's
account in exchange for receiving the notes and mortgages, such that
Pinnacle would have more money to make more loans, as in the "usual"
transaction. Rather, in a complex and longstanding scheme encompassing
thousands of transactions over several years, Provident gave Pinnacle a
line of credit, and then, after Pinnacle gave Provident information about
individual proposed loans to borrowers, Provident transferred money to
Pinnacle's account, in order to later receive the note and mortgage from
each transaction and pass them on to a third party investor. The
Bankruptcy Court, as a factual matter, found that under this complex
scheme, no transactions between any of the parties were complete until
both of the transactions were concluded, particularly because the "second
lender" (Provident) had the ultimate control over the first transaction
(by ordering the dishonor of Pinnacle's checks).[fn10]
I cannot say that the Bankruptcy Court's factual finding was clearly
erroneous. The Bankruptcy Court's ruling accords with the evidence as
well as with the policy underlying the holder in due course doctrine. I
hold that where a warehouse lender so closely participates in the funding
and approval of mortgages which will ultimately lead to the warehouse
lender's rights in mortgages and promissory notes that the transactions
between mortgage banker and mortgagor and between warehouse lender and
mortgage banker are in fact one continuous transaction, rather than two
discernible transactions, a showing of the warehouse lender's lack of
good faith after the closing between title agent and mortgagor but before
the mortgage banker's check is presented to the warehouse lender may
destroy HDC status. Indeed, where the party who claims HDC status was in
essence a party to the original transaction, it cannot, by definition, be
a holder in due course.
Provident had a great deal of involvement in the ongoing series of
transactions and ample knowledge of Pinnacle's overall financial
wellbeing, developed through years of funding Pinnacle's credit line for
thousands of such transactions and receipt of Pinnacle's periodic
financial reports. It had particular information about the borrowers
before it funded these loans. It was, in fact, part of the loan
transactions, and not a separate party who became an HDC through the
giving of value at a second separate, discernible transaction. Provident
had too much control of, participation in, and knowledge of the
underlying transaction to claim that it was a good faith purchaser for
value. See, e.g., Fidelity Bank Nat'l Assoc., 740 F. Supp. at 239.
Because, under this complex transactional scheme, Provident functioned
essentially as a party which approved and funded the loans and gained
actual knowledge of a defense to the notes and mortgages (lack of
consideration) before the transactions were complete, it was not clearly
erroneous for the Bankruptcy Court to find that Provident lacked the good
faith necessary to claim HDC status. Accordingly, the Bankruptcy Court's
ruling is affirmed.
VI. CONCLUSION
For the foregoing reasons, I will affirm the Bankruptcy Court's ruling
that appellant Provident Savings Bank was not the holder in due course of
the notes and mortgages from the ten transactions closed by appellees.
The defense of failure of consideration thus is available against
Provident. I therefore affirm the Bankruptcy Court's judgment that
appellees, and not appellant, are entitled to the notes and mortgages. The
accompanying Order is entered.
ORDER
This matter having come upon the court upon the appeal of appellant,
Provident Savings Bank, from a Judgment entered on December 17, 1997, by
the Honorable Judith H. Wizmur, United States Bankruptcy Judge for the
District of New Jersey,; and the Court having considered the parties'
submissions; and for the reasons set forth in the Opinion of today's
date;
IT IS this day of December, 1998, hereby
ORDERED that the Judgment entered by the Honorable Judith H. Wizmur,
United States Bankruptcy Judge for the District of New Jersey, on
December 17, 1997, which granted the notes and mortgages from
transactions closed by the appellees in this matter to the appellees,
be, and hereby is, AFFIRMED.
[fn1] The appellant's cause of action against defendant William E. Ward
was removed to state court in Delaware upon motion on the basis of
abstention pursuant to 28 U.S.C. § 1334(c) where it is now pending.The appellant's cause of action against Meridian Bank was resolved prior
to trial pursuant to the Stipulation of Settlement with respect to Count
II of the Complaint, filed on July 16, 1996. All claims between the
appellant and Lawyers Title Insurance Corporation were mutually dismissed
at trial.
[fn2] The Agreement said $10 million, but at times up to $12.5 million
was advanced.
[fn3] It is a wellestablished law that appellate courts may not pass
upon an issue not presented in a lower court. Singleton v. Wulff,
428 U.S. 106, 120 (1976). The same holds true for a U.S. District Courtsitting in its appellate capacity over matters appealed from the
bankruptcy court. See Barrett v. Commonwealth Fed. Sav. and Loan Ass'n,
939 F.2d 20 (3d Cir. 1991); In re Middle Atlantic Stud Welding Co.,
503 F.2d 1133, 1134 n. 1 (3d Cir. 1974). Because Provident never raisedthis issue before the Bankruptcy Court, I will not consider it now.
[fn4] The res judicata doctrine prevents relitigation of claims that grow
out of a transaction or occurrence from which other claims have earlier
been raised and decided validly, finally, and on the merits. Federated
Department Stores v. Moitie, 452 U.S. 394, 298 (1981). Under Pennsylvanialaw, default judgments, absent fraud, are afforded res judicata effect.
In re Graves, 156 B.R. 949, 954 (E.D.Pa. 1993), aff'd, 33 F.3d 242 (3dCir. 1994). On December 21, 1994, the Court of Common Pleas of Berks
County, Pennsylvania, entered default judgments against Provident on both
the Weaver and Fisher transactions, those transactions for which Pioneer
was the closing agent. Due to these default judgments, the doctrine of
res judicata bars relitigation of the Pioneer causes of action. The
Bankruptcy Court also held that the Andreuzzi transaction was barred by
res judicata or collateral estoppel because of the lis pendens. That,
however, is a more difficult issue and one that I need not reach now, as
my affirmance of the Bankruptcy Court's judgment applies equally to the
Andreuzzi transaction on the merits.
[fn5] At trial and in its briefs to this Court, as an alternative to its
holder in due course argument, Provident argued that it was protected by
the Pennsylvania Uniform Fiduciaries Act, 7 Pa. Cons. Stat. § 6361,
and the New Jersey Uniform Fiduciaries Law, N.J.S.A. 3B:1454, theprovisions of which are substantially similar. The two laws protect a
person who transfers money to a fiduciary in good faith, by noting that
"any right or title acquired from the fiduciary in consideration of such
payment or transfer is not invalid in consequences of a misapplication by
the fiduciary." 7 Pa. Cons. Stat. § 6361; N.J.S.A. 3B:1454. TheBankruptcy Court held that Pinnacle was not Provident's agent or
fiduciary, and thus the UFA did not apply. (Opinion at 66.) In light of
the fact that Provident's counsel, at oral argument before this Court on
November 13, 1998, themselves argued that Pinnacle was not Provident's
fiduciary, I will affirm this aspect of the Bankruptcy Court's ruling
without need to examine the factual bases on which it relied.
[fn6] The rest of this Opinion is limited to the eight transactions not
handled by Pioneer, since only the Pioneer transactions are bound by res
judicata.
[fn7] As Part V of this Opinion explains, one of the several bases for
the Bankruptcy Court's decision that Provident is not the HDC of the
mortgages and notes is that the settlement agents were not Provident's
agents, and thus Provident did not constructively possess the mortgages
and notes prior to gaining knowledge of claims or defenses on those
notes. (Opinion at 3453.) In the alternative, in case appellate courts
determined that Provident was the HDC of those notes because an agency
relationship did exist, the Bankruptcy Court held that the closing
agents, and not Provident, would still be the ones entitled to the notes
and mortgages, for the agents would have had a right to indemnification
from Provident. (Id. at 6364.) Though, as I explain in Part V, I do not
reach the agency issue, I do affirm the Bankruptcy Court's HDC ruling on
other grounds. In doing so, I am affirming the decision that the
appellees, and not Provident, are entitled to the notes and mortgages. The
Bankruptcy Court's indemnification ruling is just an alternative reason
for finding that the appellees are entitled to the notes and mortgages.
Having already agreed that the closing agents are so entitled because
Provident is not an HDC, there is no need to address that alternative
ruling upon appeal.
[fn8] Seven of the eight remaining transactions here are governed by
Pennsylvania law. The eighth is under New Jersey law, but the two states'
laws on HDC status are largely consistent on the issues raised in these
proceedings.
[fn9] The Bankruptcy Court agreed that authority from other jurisdictions
suggest that a party may become a constructive holder when its agent
takes possession of a negotiable instrument on its behalf. (Opinion at
3637.) However, the Bankruptcy Court made the factual finding that
appellees were not Provident's agents. It determined that though six of
the ten transactions involved written agency agreements, those agreements
were not controlling in light of the course of dealing between the
parties (Opinion at 46), and that Provident did not otherwise meet its
burden of establishing that an agency relationship existed. Because I
find that the Bankruptcy Court's determination that Provident did not act
in good faith is not clearly erroneous, and because the lack of good
faith alone is enough of a basis to sustain a judgment that Provident is
not an HDC of these eight notes and mortgages, I need not address whether
the agency determination was clearly erroneous.
[fn10] Under the Bankruptcy Court's findings of fact, Provident was, in
reality, a party to the original transaction. The situation is somewhat
analogous to a consumer goods financer who has a substantial voice in the
underlying transaction; that financer is not entitled to HDC status.
Westfield Investment Co. v. Fellers, 181 A.2d 809 (N.J.Super.Ct. LawDiv.). Provident had a substantial voice in providing and carrying out
funding of the underlying borrowing transactions, and it thus cannot
claim that it was a good faith HDC when it learned of the defense of
failure of consideration prior to dishonoring the Pinnacle checks.
Loislaw Federal District Court Opinions
Copyright © 2013 CCH Incorporated or its affiliates
IN RE PINNACLE MORTGAGE INVESTMENT CORPORATION, (D.N.J. 1998)
IN RE PINNACLE MORTGAGE INVESTMENT CORPORATION, Debtor
PROVIDENT SAVINGS BANK, a New Jersey Banking Corporation,
Plaintiff/Appellant, v. PINNACLE MORTGAGE INVESTMENT CORPORATION, a
Pennsylvania Corporation, et al., Defendants, SETTLERS ABSTRACT CO., L.P.,
LAWYERS TITLE INSURANCE CORP., LAND TRANSFER CO, INC., FIDELITY NATIONAL
TITLE INSURANCE CO. OF PENNSYLVANIA, GINO L. ANDREUZZI, PIONEER AGENCY II
CORP. t/a PIONEER AGENCY, MUSSER & MUSSER, WILLIAM E. WARD, QUAKER ABSTRACT
CO., and SEARCHTEC ABSTRACT, INC., Appellees.
CIVIL NO. 980489 (JBS), [Bankruptcy Case No. 9510608 (JHW)], [Adv.
Proc. No. 951091]
United States District Court, D. New Jersey.
Filed: December 9, 1998
Walter E. Thomas, Jr., Esq., Timothy J. Matteson, Esq., Mark A. Trudeau,
Esq., Stern, Lavinthal, Norgaard & Kapnick, Esqs., Englewood, New Jersey,
Attorneys for Appellant.
Edward J. Hayes, Esq., Andrea Dobin, Esq., Fox, Rothschild, O'Brien &
Frankel, Princeton Pike Corporate Center, Lawrenceville, New Jersey,
Attorneys for Appellees, Settlers Abstract Co., L.P., Land Transfer Co,
Inc., Fidelity National Title Insurance Co. of Pennsylvania, Gino L.
Andreuzzi, Pioneer Agency II Corp. t/a Pioneer Agency, Musser & Musser,
Quaker Abstract Co, and Searchtec Abstract, Inc.
OPINION
SIMANDLE, District Judge.
I. INTRODUCTION
Provident Savings Bank appeals from a Judgment entered on December 17,
1997, pursuant to a written opinion issued on November 19, 1997, by the
Honorable Judith H. Wizmur, United States Bankruptcy Judge, after trial
in an adversary proceeding. That Opinion ruled in favor of the
Appellees, Settlers Abstract Co., L.P., Land Transfer Co, Inc., Fidelity
National Title Insurance Co. of Pennsylvania, Gino L. Andreuzzi, Pioneer
Agency II Corp. t/a Pioneer Agency, Musser & Musser, Quaker Abstract Co,
and Searchtec Abstract, Inc. ("title agents"). Reviewing a longstanding
complex lending relationship between Provident and the debtor, Pinnacle
Mortgage Corporation, of which the ten real estate mortgage loans at
issue herein were a part, the Bankruptcy Court held that appellee title
agents (who had advanced their own funds to cover disbursements when
Provident dishonored Pinnacle's checks) had a more valid or higher
priority security interest in the promissory notes and mortgages executed
as part of ten separate residential real estate closing than did
appellant. Provident Savings Bank appeals this ruling and seeks this
Court's determination that it was the holder in due course of those
documents.
The principal issue to be decided is whether the Bankruptcy Court
correctly determined under the Uniform Commercial Code that Provident was
not a holder in due course of the promissory notes arising from these
loans, where it found that Provident so closely participated in the
funding and approval of the Pinnaclebrokered loans that the transaction
did not end at the closing with the title agents, such that Provident did
not attain holder in due course status because it did not fit the
requisite role of a "good faith purchaser for value." For the reasons
that will be stated herein, the judgment will be affirmed because the
Bankruptcy Court's finding that Provident never attained HDC status was
neither clearly erroneous nor contrary to law.
II. BACKGROUND
A. Procedural History
This case arises from a dispute over the various security interests in
mortgage documents from ten separate real estate transactions in late
October, 1994, conducted by the debtor, Pinnacle Mortgage Investment
Corporation (who brokered the transactions), the appellant (who financed
the transactions), and the appellees (who were title closing agents in
the transactions). On February 2, 1995, appellant Provident Savings Bank
("Provident") and other creditors filed an involuntary petition under
Chapter 7 of Title 11 of the Bankruptcy Code against Pinnacle Mortgage
Investment Corporation ("Pinnacle"). An order for relief under Chapter 7
was entered by the Bankruptcy Court on March 6, 1995.
On March 24, 1995, Provident commenced this adversary proceeding by
filing a three count complaint to determine the extent, validity, and
priority of the various security interests asserted by Pinnacle, Meridian
Bank, Lawyers Title Insurance Corporation, the appellees, and William E.
Ward with regard to the promissory notes and mortgages from ten real
estate transactions.[fn1] Appellees responded to the complaint by filingan answer, counterclaims, and crossclaims, seeking money judgments in
the amount of the contested notes and mortgages, interest, cost of suit,
and attorneys fees; imposition of a constructive trust in their favor
with regard to the notes, mortgages, and proceeds thereof; and to have
the subject notes and mortgages avoided and stricken in favor of
subsequently executed mortgages between the appellees and the
mortgagors. Provident twice amended its complaint, finally seeking a
declaratory judgment that it is the holder in due course of the subject
notes and mortgages under the Uniform Commercial Code; avoidance of the
preferential transfer by appellee Andreuzzi pursuant to 11 U.S.C. § 547and 550; avoidance of the fraudulent transfer by appellee Andreuzzipursuant to §§ 548 and 550; and avoidance of the preferential and
fraudulent transfers by appellees pursuant to 11 U.S.C. § 547, 548,and 550.
Trial in this matter was held on July 16, 17, and 18, 1996, and October
1, 3, and 4, 1996. At the close of Provident's case in chief, upon motion
by the appellees, all of those portions of the Second Amended Complaint
which did not pertain to Provident's status as a holder in due course
("HDC") were dismissed.
B. The Factual History
In its November 19, 1997 opinion, the Bankruptcy Court determined that
the facts of the case are as follows. Debtor Pinnacle Mortgage Investment
Corporation ("Pinnacle" or "debtor") was a mortgage banker which
primarily dealt in residential mortgage lending and refinance. In December
of 1992, Pinnacle and Provident Savings Bank ("Provident" or "appellant")
entered into a Mortgage Warehouse Loan and Security Agreement
("Agreement"), whereby Provident would fund Pinnacle, who in turn funded
retail customers who sought to purchase or refinance residential real
estate. The borrower in each transaction would give Pinnacle a note and
mortgage, both of which acted as collateral to protect Provident until
Pinnacle sold the mortgage to a third party investor, such as the Federal
Home Loan Mortgage Corporation ("Freddie Mac"), who satisfied Pinnacle's
debt to Provident. Warehouse Agreement § 3.4.
1. The Warehouse Agreement
Under these types of agreements, there would usually not be any contact
between the warehouse lender and the ultimate mortgagor. Typically,
Pinnacle would arrange with a prospective borrower for Pinnacle to
advance funds for the borrower to purchase or refinance a home and for
the borrower to assign a note and mortgage to Pinnacle as collateral. The
mortgage would be endorsed in blank in order to accommodate the final
third party investor (such as Freddie Mac), with whom Pinnacle would
arrange to purchase the mortgage, usually as a part of a pool of
mortgages; this was known as a "takeout" agreement. All of this
completed, Pinnacle would submit a "package" to Provident seeking funding
for the particular transaction under its $10 million line of credit.[fn2]This package included a description of the borrower and the funding, an
assignment of the mortgage endorsed in blank, a takeout commitment, and
an agency agreement that indicated the borrower's attorney's agreement
"to act as the agent of the Bank" to disburse the Advance and to obtain
due execution and delivery to the bank of the original note that
evidences the debt underlying the Mortgage Loan." Warehouse Agreement
§ 5.3(A)(iii). The Agreement required all of this to be submitted
along with the initial funding request. As a matter of course, however,
the agency agreement was usually executed by the title agent handling the
closing instead of by the borrower's attorney, and Provident customarily
accepted the mortgage assignment and agency agreement after the actual
closing.
After Provident received the package and checked to see that Pinnacle's
credit limit had not been exceeded (although, as stated above, often
prior to receipt of the mortgage assignment and agency agreement),
Provident credited Pinnacle's checking account with 98% of the requested
funds. Warehouse Agreement §§ 1.1, 2.1. Pinnacle would write a
regular, uncertified check to the closing agent, who would close the loan
directly with the borrower on Pinnacle's behalf. Pinnacle was supposed to
use specific funds credited to their account to fund specific closings,
but no controls were in place to make sure that Pinnacle actually did
so.
With Pinnacle's check in hand, the closing agent would use money from
its own bank account to disburse funds to the mortgagor, later
replenishing its bank account by depositing Pinnacle's check. Next, the
closing agent would routinely send the original note, a certified copy of
the recorded mortgage, and the other closing documents to Pinnacle, who
would send them on to Provident, who would receive this original note
approximately three to five days after closing. Provident and the
borrowers had no contact; indeed, Provident and the closing agents had no
contact, save the extremely limited contact by the closing agents who did
return the agency agreement included in the borrowing package. Not all
closing agents did return the agreement signed; most of those who did
sent everything through Pinnacle to go to Provident, in accordance with
Pinnacle's written instructions, rather than remitting the note and other
papers directly to Provident, as stated in the agency agreement.
Ultimately, Provident would send the note and accompanying documents to
the third party investor, who would pay Provident the funds which
Provident had originally placed in Pinnacle's checking account by wiring
monies to Provident in Pinnacle's name. Because the third party investor
would send multiple payments in each wire transfer, Pinnacle would tell
Provident to which loans to apply each of the funds.
2. Pinnacle's Declining Financial State
Among the twenty or so warehouse customers that Provident had during
19931994, Pinnacle was the most profitable for Provident, providing
hundreds of millions of dollars in loan transactions. However, when the
mortgage banking industry suffered a decline in business, Pinnacle began
to experience financial difficulties as well.
The Warehouse Agreement, § 6.11, required Pinnacle to submit
unaudited balance sheets and statements of income to Provident on a
quarterly basis, though Pinnacle customarily provided monthly
statements. The statements filed for June, July, and August of 1993
reflected an accrued pretax income for the first three months of the
fiscal year of $281,351. Statements for September, October, and November
of 1993 reflected pretax income of $923,923 for the first six months of
the fiscal year. However, after the November 30 report, Pinnacle began to
send its reports quarterly, which was in accordance with the Warehouse
Agreement but which was nonetheless unusual due to Pinnacle's custom of
submitting reports monthly. The next report, covering the ninemonth
period ending February 28, 1994, was due on April 15 but not received
until some time in May. It showed pretax income of $136,000 for the
first nine months, or an $800,000 loss in the previous three months. The
accompanying unaudited balance sheets showed a reduction of assets from
$40 million to $28 million in those three months. The final financial
statement was due on August 31, 1994, but Provident never received it.
At a holiday party in May 1994, Edmund R. Folsom, head of Provident's
Commercial Lending Department, had learned that Pinnacle had sustained
losses in the winter months. On August 19, 1994, Sharon Kinkead, of
Provident's Warehouse Lending Department, called Pinnacle's headquarters
and learned from Pinnacle's CFO, Joseph Mader, that there would be a
delay in the submission of the audited financial statements for the
fiscal year ending May 31, 1994 because of a change of comptroller, but
that the report would be provided by September 15, 1994. That report
never arrived, and no other financial statements were received up until
Provident's termination of its relationship with Pinnacle in early
November 1994.
3. Provident's Relationship with Pinnacle
Throughout its relationship with Pinnacle, Provident routinely honored
overdrafts on behalf of Pinnacle — about twenty times in 1993 and
fifteen times in 1994. These overdrafts ranged from $7,240.87 to
$5,255,812.
When a check was presented to the bank on Pinnacle's account for which
Pinnacle had insufficient funds, Sharon Kinkead would contact Pinnacle to
ask whether Pinnacle would honor that overdraft. Having been told that
the check would be covered (usually from an anticipated wire transfer),
Kinkead and her supervisor, Mr. Folsom, would honor it and allow the
overdraft. Until November 1994, Provident honored all of Pinnacle's
overdrafts, without reviewing Pinnacle's books and records or monitoring
its checking account.
As mentioned earlier, Pinnacle's CFO, Joseph Mader, had informed
Provident that its final fiscal year report would be forthcoming on
September 15, 1994. When Provident did not receive the audited reports by
that date, Mr. Folsom spoke with Mr. Mader, who reported that though
Pinnacle had sustained losses, it was expecting a substantial infusion of
capital. Pinnacle wanted to hold off publishing the report so that it
could add a footnote explaining that there would be a capital infusion.
Based on this, Folsom decided to extend Pinnacle's credit line through
the end of November.
Folsom called Mader some time in October to check on the status of the
report. When Mader returned the call on November 1, he informed Folsom
that the capital infusion had failed. Folsom demanded a meeting with
Pinnacle's officers.
On November 2, Folsom and Kinkead met with Mader and Al Miller,
President of Pinnacle. Mader and Miller presented internally generated
financial statements indicating a pretax loss of six million dollars for
the previous fiscal year, as well as a pretax loss of almost one million
dollars for the first quarter of the current fiscal year. Miller and
Mader admitted that they had misused their warehouse credit line with
G.E. Capital Mortgage Services, Inc., to whom they were indebted for
about six million dollars. They "admitted fraud" as to G.E., but
indicated that they had not misappropriated the Provident funds and asked
for an extension of funding of their loans while they financially
reorganized. Provident declined to do so.
At that time, Provident finally reviewed Pinnacle's books and
discovered that Pinnacle had been diverting substantial sums of money
from Pinnacle's Provident account to its operating account at Meridian
Bank. Kinkead and Folsom also learned that Pinnacle had been requesting
advances on loans earlier than was routinely requested, possibly using
the money that was supposed to be for specific loans for other purposes
instead. Indeed, Pinnacle was engaging in a "kiting" scheme,
misappropriating monies from third party investors that should have been
applied to previously funded loans. A Pinnacle employee told Kinkead that
the Provident line was not "whole," that as much as $500,000 may have
been taken from it, though no fraudulent loans had been made.
As of November 2, 1994, all checks presented to Provident on Pinnacle's
account had been processed, and the customer balance summary showed an
overdraft of $206,653.67. On November 3, $830,127.48 was deposited in
Pinnacle's account. Sixteen checks totaling $1,584,041.63 were presented
to Provident against Pinnacle's account on November 3. There were
insufficient funds to cover all sixteen, so Folsom sent a letter to
Miller, Pinnacle's president, to ask which checks should be paid. At the
time, Provident knew that all sixteen of those checks represented monies
that Pinnacle had delivered to borrowers and closing agents for
particular loans, as well as that each transaction was accompanied by a
takeout commitment by a third party investor, who would have paid for
the loan.
Miller indicated that six of the checks could be paid. Provident
debited $863,821 to pay off eight loans on November 4, and other checks
were paid at Mader's instruction. There was an overdraft on that date of
$178,303.73, and Provident honored no more checks. The remaining ten of
the sixteen checks presented on November 3 were dishonored, and those are
the subject of the instant litigation.
4. The Ten Transactions
Prior to the closings in each of the ten transactions in question,
Pinnacle had requested from Provident — and received — monies
to fund the transactions. As usual, Pinnacle presented the closing agent
with an uncertified check drawn on its account at Provident representing
payment for the note and mortgage to be executed by the borrower,
purchaser, or refinancer of the property. With Pinnacle's check in hand,
the closing agents closed each transaction, issuing checks from their own
accounts to the parties entitled to receive funds. The closing agents
then deposited Pinnacle's checks in their own accounts, and their banks
presented those checks to Provident for payment. In each case, Provident
dishonored the checks due to insufficient funds. After each closing, but
before the discovery of any problem, each closing agent returned the
original note to Pinnacle. Several closing agents recorded the mortgage
and sent Pinnacle certified copies. Despite the fact that Pinnacle's
checks were not honored, each closing agent honored their own checks when
they were presented.
At the time, uncertified funds were routinely accepted from mortgage
bankers, with a few exceptions for out of state lenders, ignoring the
Pennsylvania statute which required mortgage bankers and brokers to
certify funds. Most mortgage lenders such as Pinnacle insisted on
acceptance of regular checks; title insurers could not stay in business
if they did not follow the standard in the industry.
As was usual for these transactions, Provident had no contact with any
of the closing agents prior to settlement. Agency agreements were
included in most, but not all, of the instruction packages sent by
Pinnacle to the respective closing agents. The agreement provided that
Provident had a security interest in the note and mortgage; moreover, it
provided that the closing agent would act as Provident's agent in
connection with the loan transaction, agreeing to record the mortgage and
then to send both the original note and the original recorded mortgage to
Provident upon closing. The text of the agreement conflicted with the
closing instructions that Pinnacle gave to the closing agents, which
required the note to be returned to Pinnacle. In six of the ten
transactions, the agreement was executed, but its provisions were
basically ignored, as the closing documents were returned directly to
Pinnacle.
The closing agents learned of the dishonor from their own banks.
Provident did not attempt to contact the closing agents until November
10, 1994, when they sent a letter with instructions to deliver to
Provident all notes, mortgages, loan files, and other collateral, and any
monies received in connection with each mortgage loan.
Several of the agents sought judicial relief. Two of the closing agents
who are appellees in this matter, Gino L. Andreuzzi and the Pioneer
Agency L.P., hold state court judgments in their favor, for a total of
three judgments against Pinnacle, striking the mortgages and notes
executed by their respective buyers in favor of Pinnacle. Andreuzzi, the
closing agent in the Hopeck settlement, filed suit against Pinnacle in
the Court of Common Pleas of Luzerne County, Pennsylvania, seeking a TRO
to keep Pinnacle from selling, transferring, or assigning the note and
mortgage in question. Provident was not joined in Andreuzzi's case, but
it did have notice of the litigation. Andreuzzi filed a lis pendens with
the Prothonotary on November 14, 1994. About three hours after the lis
pendens was filed, Provident recorded the assignment from the Hopeck
note. Ultimately, a default judgment was entered against Pinnacle.
Pioneer also filed suits in connection with the Weaver and Fisher
transactions. In both cases, Pioneer sued Pinnacle and Provident in the
Court of Common Pleas of Berks County, Pennsylvania, on November 14,
1994. A preliminary injunction was entered on November 22, and a default
judgment was entered against both defendants on December 21, 1994. Two
days later, Pinnacle moved to open the default judgment. It was still
pending on February 1, 1995 when an involuntary petition was filed against
Pinnacle. Provident removed the action to the Bankruptcy Court on May 8,
1995.
Other closing agents entered into agreements with the borrowers to
execute new notes and mortgages. By the time this came before the
Bankruptcy Court, the mortgages had either been satisfied in full, with
proceeds held in escrow, or payments on the new mortgages and notes were
being made by the borrowers to the closing agents in escrow pending the
resolution of this matter.
C. The Bankruptcy Court's Findings and Judgment
On November 19, 1997, the Bankruptcy Court issued its Opinion in favor
of the appellees, ruling that:
(1) the appellant did not achieve the status of an HDC
with regard to the notes and mortgages in issue;
(2) the appellees would be entitled to indemnification
even if an agency relationship existed between the
appellant and appellees;
(3) the Uniform Fiduciaries Law is inapplicable to
validate the appellant's position with regard to the
subject notes and mortgages; and
(4) the appellant is precluded from relitigating the
transactions with appellees Pioneer Agency II Corp
t/a Pioneer Agency and Andreuzzi.
Judgment against Provident was entered on December 17, 1997. On December
22, 1997, appellant filed a notice of appeal from the Judgment. On
February 13, 1998, the record on appeal was transmitted to this Court. As
"nothing remains for the [lower] court to do," Universal Minerals, Inc.
v. C.A. Hughes & Co., 669 F.2d 98, 101 (3d Cir. 1981), the BankruptcyCourt's ruling is final, and thus this Court properly has appellate
jurisdiction over the December 17, 1997 Order pursuant to
28 U.S.C. § 158(a).
III. ISSUES PRESENTED
On appeal, Provident makes six arguments. First, Provident argues that
it is the holder in due course ("HDC") of the ten mortgage notes.
Second, Provident argues that the Bankruptcy Court's ruling that the
appellees were entitled to indemnification if they were Provident's agents
is clearly erroneous. Third, appellant contends that the bankruptcy court
erred in ruling that Provident was not protected by the Uniform
Fiduciaries Act ("UFA"), adopted by both New Jersey and Pennsylvania at
N.J.S.A. 3B:1454 and 7 Pa. Cons. Stat. Ann. § 6361, respectively.Fourth, Provident argues, for the first time upon appeal, that the
doctrine of avoidable consequences bars appellees from recovering any
damages from Provident. Fifth, Provident maintains that the doctrines of
lis pendens, res judicata, and collateral estoppel do not bar
relitigation of these issues as to the Andreuzzi transaction. Finally,
Provident argues that the Bankruptcy Court erred by giving preclusionary
effect to the Pioneer action default judgments.
This Opinion will not address Provident's "avoidable consequences"
argument, as it was raised, for the first time, upon appeal.[fn3]Moreover, the doctrine of res judicata precludes review of the two
transactions for which Pioneer was the closing agent, and I thus affirm
the Bankruptcy Court's judgment as to Pioneer on that ground.[fn4] I willaffirm the Bankruptcy Court's holding that Provident is not entitled to
the protections of the Uniform Fiduciaries Act , especially in light of
the fact that Provident has withdrawn its argument that Pinnacle was its
agent.[fn5] For reasons stated herein, I will affirm the BankruptcyCourt's holding that Provident is not the holder in due course of the
eight[fn6] transactions still in question. Accordingly, there is no needfor this Court to address the Bankruptcy Court's alternate finding that
the closing agents would be entitled to indemnification.[fn7]
IV. STANDARD OF REVIEW
On appeal, the weight accorded to the findings of fact by a bankruptcy
court are governed by Fed.R.Bank.P. 8013, which provides as follows:
On appeal the district court or bankruptcy appellate
panel may affirm, modify, or reverse a bankruptcy
judge's judgment, order, or decree or remand with
instructions for further proceedings. Findings of
fact, whether based on oral or documentary evidence,
shall not be set aside unless clearly erroneous, and
due regard shall be given to the opportunity of the
bankruptcy court to judge the credibility of
witnesses.
Fed.R.Bank.P. 8013. Under this Rule, a bankruptcy court's factualfindings may be disturbed only if clearly erroneous. See FGH Realty
Credit v. Newark Airport/Hotel Ltd., 155 B.R. 93 (D.N.J. 1993). Where a
mixed question of law and fact is presented, the appropriate standard
must be applied to each component. In re Sharon Steel Corp., 871 F.2d 1217,
1222 (3d Cir. 1989). Thus, a reviewing court "must accept the [lower]court's findings of historical or narrative facts unless they are clearly
erroneous, but . . . must exercise a plenary review and its application
of those precepts to the historical facts." Universal Minerals, Inc. v.
C.A. Hughes & Co., 669 F.2d at 103.
While standards for establishing that a party is a holder in due course
are wellsettled law, see, e.g., Triffin v. Dillabough, 448 Pa. Super. 72,
87, 670 A.2d 684, 691 (1996), the Court's application of these standardsto the facts does result in a mixed finding of fact and law that is
subject to a mixed standard of review. Mellon Bank, N.A. v. Metro
Communications, Inc., 945 F.2d 635, 64142 (3d Cir. 1991), cert. denied,
503 U.S. 937 (1992). The factual findings can only be reversed for clearerror, In re Graves, 33 F.3d 242, 251 (3d Cir. 1994), even if thereviewing court would have decided the matter differently. In re
PrincetonNew York Investors, Inc., 1998 WL 111674 (D.N.J. 1998). This
Court, thus, may not overturn a bankruptcy judge's factual findings if
the factual determinations bear any "rational relationship to the
supporting evidentiary data. . . ." Fellheimer, Eichen & Braverman, P.C.
v. Charter Technologies, Inc., 57 F.3d 1215, 1223 (3d Cir. 1995) (citingHoots v. Comm. of Pa., 703 F.2d 722, 725 (3d Cir. 1983). However, thisCourt reviews any legal conclusions de novo.
V. DISCUSSION
Appellant argues that the Bankruptcy Court's finding that appellant is
not an HDC of the promissory notes and mortgages from the eight remaining
real estate transactions closed by appellees is clearly erroneous. The
dispute here is not a dispute of law, as the parties agree on what the
law concerning HDCs is. As the Bankruptcy Court correctly found,[fn8]every holder of a negotiable instrument is presumed to be an HDC, Morgan
Guaranty Trust Company of New York v. Staats, 631 A.2d 631, 636(Pa.Super.Ct. 1993), but when a defense of fraud is meritorious as to the
payee, the holder has the burden of showing that it is an HDC in order to
be immune from that defense. Norman v. World Wide Distributors, Inc.,
195 A.2d 115, 117 (Pa.Super.Ct. 1963). A holder of a negotiableinstrument (such as the promissory notes in this case) is either the
person with possession of bearer paper or the person identified on the
instrument if that person is in possession. 13 Pa. Cons. Stat. Ann.
§ 1201; N.J.S.A. 12A:3201 (West Supp. 1998). The holder of adocument of title (such as the mortgages in this case) is the person in
possession if the document is made out to bearer or to the order of the
person in possession. Id. The holder becomes an HDC if:
(1) the instrument when issued or negotiated to the
holder does not bear such apparent evidence of forgery
or alteration or is not otherwise so irregular or
incomplete as to call into question its authenticity;
and
(2) the holder took the instrument:
(i) for value;
(ii) in good faith;
(iii) without notice that the instrument is
overdue or has been dishonored or that there is an
uncured default with respect to payment of another
instrument issued as part of the same series;
(iv) without notice that the instrument contains
an unauthorized signature or has been altered;
(v) without notice of any claim to the instrument
described in section 3306 (relating to claims to an
instrument); and
(vi) without notice that any party has a defense
or claim in recoupment described in section 3305(a)
(relating to defenses and claims in recoupment).
13 Pa. Cons. Stat. Ann. § 3302. See also N.J.S.A. 12A:3302. Inshort, an HDC is the holder of the instrument or document who took for
value and in good faith without notice of any claims or defects on the
instrument or document. If classified as an HDC, the holder holds without
regard to defenses, with certain statutory exemptions which do not apply
here. 13 Pa. Cons. Stat. Ann. § 3305; N.J.S.A. 12A:3305.
It was clear to the parties and to the Bankruptcy Court below that
Provident did not have actual possession of the notes and mortgages
before November 2, 1998, when it learned that there were insufficient
funds in Pinnacle's account at Provident to cover Pinnacle's checks to
the closing agents here. Provident nonetheless argued that it was the
holder of the notes and mortgages because, before gaining actual
knowledge of Pinnacle's fraud, Provident "constructively possessed" the
notes and mortgages from the moment that the closing agents, who were
allegedly Provident's agents, took possession of the notes at the
closings before November 2.
The Bankruptcy Court rejected Provident's argument, finding that none
of the appellees acted as Provident's agents, and thus Provident never
constructively or actually possessed the notes and mortgages. Thus, the
Bankruptcy Court found that Provident never became the holder of these
notes and mortgages in the first place. (Opinion at 53.) Alternatively,
the Bankruptcy Court found that while Provident did give value for the
notes and mortgages (Opinion at 54), it did not take those notes and
mortgages in good faith and without knowledge of defenses, and thus
Provident is not an HDC. (Opinion at 63.) The question before this Court
is whether the Bankruptcy Court's rulings in this regard were clearly
erroneous. I hold that it was neither clearly erroneous nor contrary to
established law for the Bankruptcy Court to find that Provident did not
fit the role of "good faith purchaser for value" necessary to claim HDC
status even though Provident's lack of good faith arose after the title
agents closed the real estate transactions. As the following discussion
will explain, in the context of a course of dealing between Provident and
Pinnacle extending over thousands of such transactions, Provident was
essentially a party to the mortgage lending transactions and thus, by
definition, cannot claim HDC status in the negotiable papers which
resulted from those transactions, especially because Provident gained
knowledge of defenses before its own role in the original mortgage
lending transaction was complete.
I affirm the Bankruptcy Court's ruling that Provident is not the HDC of
these notes and mortgages. In so holding, I need not, and thus do not,
reach the issue of whether Provident constructively possessed the notes
and mortgages,[fn9] for holder status is irrelevant if Provident did nottake in good faith and without knowledge of defenses. Because I find that
the Bankruptcy Court's ruling that Provident did not take in good faith
was not clearly erroneous, I affirm the ruling that Provident is not
entitled to the protections afforded to a holder in due course.
The Bankruptcy Court correctly stated the law on good faith in this
context: the test for good faith is "not one of negligence of duty to
inquire, but rather it is one of willful dishonesty or actual knowledge."
Valley Bank & Trust Co. v. American Utilities, Inc., 415 F. Supp. 298,
301 (E.D.Pa. 1976). See also Mellon Bank v. PasqualisPoliti,
800 F. Supp. 1297, 1302 (W.D.Pa. 1992), aff'd, 990 F.2d 780 (3d Cir.1993); Carnegie Bank v. Shalleck, 606 A.2d 389, 394 (N.J.Super.Ct.A.D. 1992); General Inv. Corp. v. Angelini, 278 A.2d 193 (N.J. 1971).Good faith may be defeated only by actual knowledge or a deliberate
attempt to evade knowledge. Rice v. Barrington, 70 A. 169, 170 (N.J. E. &
A 1908). "There is no affirmative duty of inquiry on the part of one
taking a negotiable instrument, and there is no constructive notice from
the circumstances of the transaction, unless the circumstances are so
strong that if ignored they will be deemed to establish bad faith on the
part of the transferee." Bankers Trust Co. v. Crawford, 781 F.2d 39, 45(3d Cir. 1986). Moreover, an HDC must take not only in good faith, but
also without notice of defenses to the instrument or document. One has
"notice" when
(1) he has actual knowledge of it;
(2) he has received a notice or notification of it; or
(3) from all the facts and circumstances known to him
at the time in question he has reason to know that it
exists.
Pa. Cons. Stat. Ann. § 1201.
The Bankruptcy Court here found that Provident did not in fact have
actual knowledge of the fraud or potential defense of failure of
consideration at the time of each separate closing. (Opinion at 58.) The
Bankruptcy Court also found that despite the fact that Provident failed
to review Pinnacle's books, records, and checking account ledger, failed
to notice the overdraft problem, failed to properly monitor withdrawals,
and failed to act after knowledge of financial deterioration in default
in providing timely audited financial statements, the appellees had not
proved that Provident acted with willful dishonesty (id.); Provident did
act with negligence or gross negligence, but gross negligence alone is
not enough to defeat an HDC's title. See Washington & Canonsburg Ry. Co.
v. Murray, 211 F. 440, 445 (3d Cir. 1914); General Inv. Corp.,
278 A.2d 193. Moreover, the Bankruptcy Court correctly noted that holderin due course status is generally created at the time that the claimant
becomes a holder — meaning at the time of negotiation. N.J.S.A.
12A:3302; Sisemore v. Kierlow Co., Inc. v. Nicholas, 27 A.2d 473, 478(Pa.Super.Ct. 1942). In transactions such as the ones at issue here which
involve blank endorsements, the instruments and documents are bearer
paper and are thus negotiated upon delivery alone. 13 Pa. Cons. Stat.
Ann. § 3201; N.J.S.A. 12A:3201.
Nonetheless, the Bankruptcy Court found that Provident failed to attain
the status of a holder in due course. It acknowledged that once a party
establishes its position as a holder in due course, no future action can
undermine that status; so in the usual transaction with negotiable bearer
paper, actual knowledge of defenses gained after possession do not defeat
HDC status. (Opinion at 63.) See Bricks Unlimited, Inc. v. Agee,
672 F.2d 1255, 1259 (5th Cir. 1982); Park Gasoline Co. v. Crusius,158 A. 334 (N.J. 1932). However, the Bankruptcy Court said, it was not
finding lack of good faith after gaining HDC status, but rather that
Provident did not gain HDC status in the first place, for these were not
the "usual" transactions. Taken in a "global sense," the Bankruptcy Court
said, these transactions did not end until after the settlements.
(Opinion at 58.)
Usually, one who takes a negotiable instrument for value has only the
underlying circumstances of that transaction by which to determine if
there is reason to give pause as to the veracity of that instrument. A
lender provides funds to a borrower who executes a promissory note. Once
that transaction is complete, the lender transfers the note to a second
lender in exchange for which the first lender receives funds replenishing
his account and enabling him to lend the same funds to another borrower.
HDC status is given to that second lender if it acts in good faith and
without knowledge of defenses, and there is no general duty for that
second lender to inquire unless the circumstances are so suspicious that
they cannot be ignored. See, e.g. Triffin, 670 A.2d at 692. In the usualHDC transaction, there are two discernible transactions, two exchanges of
funds and notes. As the Bankruptcy Court pointed out, the purpose of
giving that second lender HDC status is "to meet the contemporary needs
of fast moving commercial society . . . (citation omitted) and to enhance
the marketability of negotiable instruments [allowing] bankers, brokers
and the general public to trade in confidence." Triffin,
670 A.2d at 693. However, "the more the holder knows about the underlyingtransaction, and particularly the more he controls or participates or
becomes involved in it, the less he fits the role of a good faith
purchaser for value; the closer his relationship to the underlying
agreement which is the source of the note, the less need there is for
giving him the tensionfree rights necessary in a fastmoving,
creditextending commercial world." Unico v. Owen, 50 N.J. 101, 109110 (1967). See also Jones v. Approved Bancredit Corp., 256 A.2d 739, 742(Del. 1969) (in such a situation, "[the financer] should not be able to
hide behind `the fictional fence' of the . . . UCC and thereby achieve an
unfair advantage over the purchaser.").
Here, there were not two separate, discernible transactions.
Provident's funding of Pinnacle who funded the borrowers was one complex
transaction. The acts of a third party investor who would buy the notes
and mortgages from Provident would have been the second separate,
discernible transaction here. Provident did not replenish Pinnacle's
account in exchange for receiving the notes and mortgages, such that
Pinnacle would have more money to make more loans, as in the "usual"
transaction. Rather, in a complex and longstanding scheme encompassing
thousands of transactions over several years, Provident gave Pinnacle a
line of credit, and then, after Pinnacle gave Provident information about
individual proposed loans to borrowers, Provident transferred money to
Pinnacle's account, in order to later receive the note and mortgage from
each transaction and pass them on to a third party investor. The
Bankruptcy Court, as a factual matter, found that under this complex
scheme, no transactions between any of the parties were complete until
both of the transactions were concluded, particularly because the "second
lender" (Provident) had the ultimate control over the first transaction
(by ordering the dishonor of Pinnacle's checks).[fn10]
I cannot say that the Bankruptcy Court's factual finding was clearly
erroneous. The Bankruptcy Court's ruling accords with the evidence as
well as with the policy underlying the holder in due course doctrine. I
hold that where a warehouse lender so closely participates in the funding
and approval of mortgages which will ultimately lead to the warehouse
lender's rights in mortgages and promissory notes that the transactions
between mortgage banker and mortgagor and between warehouse lender and
mortgage banker are in fact one continuous transaction, rather than two
discernible transactions, a showing of the warehouse lender's lack of
good faith after the closing between title agent and mortgagor but before
the mortgage banker's check is presented to the warehouse lender may
destroy HDC status. Indeed, where the party who claims HDC status was in
essence a party to the original transaction, it cannot, by definition, be
a holder in due course.
Provident had a great deal of involvement in the ongoing series of
transactions and ample knowledge of Pinnacle's overall financial
wellbeing, developed through years of funding Pinnacle's credit line for
thousands of such transactions and receipt of Pinnacle's periodic
financial reports. It had particular information about the borrowers
before it funded these loans. It was, in fact, part of the loan
transactions, and not a separate party who became an HDC through the
giving of value at a second separate, discernible transaction. Provident
had too much control of, participation in, and knowledge of the
underlying transaction to claim that it was a good faith purchaser for
value. See, e.g., Fidelity Bank Nat'l Assoc., 740 F. Supp. at 239.
Because, under this complex transactional scheme, Provident functioned
essentially as a party which approved and funded the loans and gained
actual knowledge of a defense to the notes and mortgages (lack of
consideration) before the transactions were complete, it was not clearly
erroneous for the Bankruptcy Court to find that Provident lacked the good
faith necessary to claim HDC status. Accordingly, the Bankruptcy Court's
ruling is affirmed.
VI. CONCLUSION
For the foregoing reasons, I will affirm the Bankruptcy Court's ruling
that appellant Provident Savings Bank was not the holder in due course of
the notes and mortgages from the ten transactions closed by appellees.
The defense of failure of consideration thus is available against
Provident. I therefore affirm the Bankruptcy Court's judgment that
appellees, and not appellant, are entitled to the notes and mortgages. The
accompanying Order is entered.
ORDER
This matter having come upon the court upon the appeal of appellant,
Provident Savings Bank, from a Judgment entered on December 17, 1997, by
the Honorable Judith H. Wizmur, United States Bankruptcy Judge for the
District of New Jersey,; and the Court having considered the parties'
submissions; and for the reasons set forth in the Opinion of today's
date;
IT IS this day of December, 1998, hereby
ORDERED that the Judgment entered by the Honorable Judith H. Wizmur,
United States Bankruptcy Judge for the District of New Jersey, on
December 17, 1997, which granted the notes and mortgages from
transactions closed by the appellees in this matter to the appellees,
be, and hereby is, AFFIRMED.
[fn1] The appellant's cause of action against defendant William E. Ward
was removed to state court in Delaware upon motion on the basis of
abstention pursuant to 28 U.S.C. § 1334(c) where it is now pending.The appellant's cause of action against Meridian Bank was resolved prior
to trial pursuant to the Stipulation of Settlement with respect to Count
II of the Complaint, filed on July 16, 1996. All claims between the
appellant and Lawyers Title Insurance Corporation were mutually dismissed
at trial.
[fn2] The Agreement said $10 million, but at times up to $12.5 million
was advanced.
[fn3] It is a wellestablished law that appellate courts may not pass
upon an issue not presented in a lower court. Singleton v. Wulff,
428 U.S. 106, 120 (1976). The same holds true for a U.S. District Courtsitting in its appellate capacity over matters appealed from the
bankruptcy court. See Barrett v. Commonwealth Fed. Sav. and Loan Ass'n,
939 F.2d 20 (3d Cir. 1991); In re Middle Atlantic Stud Welding Co.,
503 F.2d 1133, 1134 n. 1 (3d Cir. 1974). Because Provident never raisedthis issue before the Bankruptcy Court, I will not consider it now.
[fn4] The res judicata doctrine prevents relitigation of claims that grow
out of a transaction or occurrence from which other claims have earlier
been raised and decided validly, finally, and on the merits. Federated
Department Stores v. Moitie, 452 U.S. 394, 298 (1981). Under Pennsylvanialaw, default judgments, absent fraud, are afforded res judicata effect.
In re Graves, 156 B.R. 949, 954 (E.D.Pa. 1993), aff'd, 33 F.3d 242 (3dCir. 1994). On December 21, 1994, the Court of Common Pleas of Berks
County, Pennsylvania, entered default judgments against Provident on both
the Weaver and Fisher transactions, those transactions for which Pioneer
was the closing agent. Due to these default judgments, the doctrine of
res judicata bars relitigation of the Pioneer causes of action. The
Bankruptcy Court also held that the Andreuzzi transaction was barred by
res judicata or collateral estoppel because of the lis pendens. That,
however, is a more difficult issue and one that I need not reach now, as
my affirmance of the Bankruptcy Court's judgment applies equally to the
Andreuzzi transaction on the merits.
[fn5] At trial and in its briefs to this Court, as an alternative to its
holder in due course argument, Provident argued that it was protected by
the Pennsylvania Uniform Fiduciaries Act, 7 Pa. Cons. Stat. § 6361,
and the New Jersey Uniform Fiduciaries Law, N.J.S.A. 3B:1454, theprovisions of which are substantially similar. The two laws protect a
person who transfers money to a fiduciary in good faith, by noting that
"any right or title acquired from the fiduciary in consideration of such
payment or transfer is not invalid in consequences of a misapplication by
the fiduciary." 7 Pa. Cons. Stat. § 6361; N.J.S.A. 3B:1454. TheBankruptcy Court held that Pinnacle was not Provident's agent or
fiduciary, and thus the UFA did not apply. (Opinion at 66.) In light of
the fact that Provident's counsel, at oral argument before this Court on
November 13, 1998, themselves argued that Pinnacle was not Provident's
fiduciary, I will affirm this aspect of the Bankruptcy Court's ruling
without need to examine the factual bases on which it relied.
[fn6] The rest of this Opinion is limited to the eight transactions not
handled by Pioneer, since only the Pioneer transactions are bound by res
judicata.
[fn7] As Part V of this Opinion explains, one of the several bases for
the Bankruptcy Court's decision that Provident is not the HDC of the
mortgages and notes is that the settlement agents were not Provident's
agents, and thus Provident did not constructively possess the mortgages
and notes prior to gaining knowledge of claims or defenses on those
notes. (Opinion at 3453.) In the alternative, in case appellate courts
determined that Provident was the HDC of those notes because an agency
relationship did exist, the Bankruptcy Court held that the closing
agents, and not Provident, would still be the ones entitled to the notes
and mortgages, for the agents would have had a right to indemnification
from Provident. (Id. at 6364.) Though, as I explain in Part V, I do not
reach the agency issue, I do affirm the Bankruptcy Court's HDC ruling on
other grounds. In doing so, I am affirming the decision that the
appellees, and not Provident, are entitled to the notes and mortgages. The
Bankruptcy Court's indemnification ruling is just an alternative reason
for finding that the appellees are entitled to the notes and mortgages.
Having already agreed that the closing agents are so entitled because
Provident is not an HDC, there is no need to address that alternative
ruling upon appeal.
[fn8] Seven of the eight remaining transactions here are governed by
Pennsylvania law. The eighth is under New Jersey law, but the two states'
laws on HDC status are largely consistent on the issues raised in these
proceedings.
[fn9] The Bankruptcy Court agreed that authority from other jurisdictions
suggest that a party may become a constructive holder when its agent
takes possession of a negotiable instrument on its behalf. (Opinion at
3637.) However, the Bankruptcy Court made the factual finding that
appellees were not Provident's agents. It determined that though six of
the ten transactions involved written agency agreements, those agreements
were not controlling in light of the course of dealing between the
parties (Opinion at 46), and that Provident did not otherwise meet its
burden of establishing that an agency relationship existed. Because I
find that the Bankruptcy Court's determination that Provident did not act
in good faith is not clearly erroneous, and because the lack of good
faith alone is enough of a basis to sustain a judgment that Provident is
not an HDC of these eight notes and mortgages, I need not address whether
the agency determination was clearly erroneous.
[fn10] Under the Bankruptcy Court's findings of fact, Provident was, in
reality, a party to the original transaction. The situation is somewhat
analogous to a consumer goods financer who has a substantial voice in the
underlying transaction; that financer is not entitled to HDC status.
Westfield Investment Co. v. Fellers, 181 A.2d 809 (N.J.Super.Ct. LawDiv.). Provident had a substantial voice in providing and carrying out
funding of the underlying borrowing transactions, and it thus cannot
claim that it was a good faith HDC when it learned of the defense of
failure of consideration prior to dishonoring the Pinnacle checks.
Loislaw Federal District Court Opinions
Copyright © 2013 CCH Incorporated or its affiliates
IN RE PINNACLE MORTGAGE INVESTMENT CORPORATION, (D.N.J. 1998)
IN RE PINNACLE MORTGAGE INVESTMENT CORPORATION, Debtor
PROVIDENT SAVINGS BANK, a New Jersey Banking Corporation,
Plaintiff/Appellant, v. PINNACLE MORTGAGE INVESTMENT CORPORATION, a
Pennsylvania Corporation, et al., Defendants, SETTLERS ABSTRACT CO., L.P.,
LAWYERS TITLE INSURANCE CORP., LAND TRANSFER CO, INC., FIDELITY NATIONAL
TITLE INSURANCE CO. OF PENNSYLVANIA, GINO L. ANDREUZZI, PIONEER AGENCY II
CORP. t/a PIONEER AGENCY, MUSSER & MUSSER, WILLIAM E. WARD, QUAKER ABSTRACT
CO., and SEARCHTEC ABSTRACT, INC., Appellees.
CIVIL NO. 980489 (JBS), [Bankruptcy Case No. 9510608 (JHW)], [Adv.
Proc. No. 951091]
United States District Court, D. New Jersey.
Filed: December 9, 1998
Walter E. Thomas, Jr., Esq., Timothy J. Matteson, Esq., Mark A. Trudeau,
Esq., Stern, Lavinthal, Norgaard & Kapnick, Esqs., Englewood, New Jersey,
Attorneys for Appellant.
Edward J. Hayes, Esq., Andrea Dobin, Esq., Fox, Rothschild, O'Brien &
Frankel, Princeton Pike Corporate Center, Lawrenceville, New Jersey,
Attorneys for Appellees, Settlers Abstract Co., L.P., Land Transfer Co,
Inc., Fidelity National Title Insurance Co. of Pennsylvania, Gino L.
Andreuzzi, Pioneer Agency II Corp. t/a Pioneer Agency, Musser & Musser,
Quaker Abstract Co, and Searchtec Abstract, Inc.
OPINION
SIMANDLE, District Judge.
I. INTRODUCTION
Provident Savings Bank appeals from a Judgment entered on December 17,
1997, pursuant to a written opinion issued on November 19, 1997, by the
Honorable Judith H. Wizmur, United States Bankruptcy Judge, after trial
in an adversary proceeding. That Opinion ruled in favor of the
Appellees, Settlers Abstract Co., L.P., Land Transfer Co, Inc., Fidelity
National Title Insurance Co. of Pennsylvania, Gino L. Andreuzzi, Pioneer
Agency II Corp. t/a Pioneer Agency, Musser & Musser, Quaker Abstract Co,
and Searchtec Abstract, Inc. ("title agents"). Reviewing a longstanding
complex lending relationship between Provident and the debtor, Pinnacle
Mortgage Corporation, of which the ten real estate mortgage loans at
issue herein were a part, the Bankruptcy Court held that appellee title
agents (who had advanced their own funds to cover disbursements when
Provident dishonored Pinnacle's checks) had a more valid or higher
priority security interest in the promissory notes and mortgages executed
as part of ten separate residential real estate closing than did
appellant. Provident Savings Bank appeals this ruling and seeks this
Court's determination that it was the holder in due course of those
documents.
The principal issue to be decided is whether the Bankruptcy Court
correctly determined under the Uniform Commercial Code that Provident was
not a holder in due course of the promissory notes arising from these
loans, where it found that Provident so closely participated in the
funding and approval of the Pinnaclebrokered loans that the transaction
did not end at the closing with the title agents, such that Provident did
not attain holder in due course status because it did not fit the
requisite role of a "good faith purchaser for value." For the reasons
that will be stated herein, the judgment will be affirmed because the
Bankruptcy Court's finding that Provident never attained HDC status was
neither clearly erroneous nor contrary to law.
II. BACKGROUND
A. Procedural History
This case arises from a dispute over the various security interests in
mortgage documents from ten separate real estate transactions in late
October, 1994, conducted by the debtor, Pinnacle Mortgage Investment
Corporation (who brokered the transactions), the appellant (who financed
the transactions), and the appellees (who were title closing agents in
the transactions). On February 2, 1995, appellant Provident Savings Bank
("Provident") and other creditors filed an involuntary petition under
Chapter 7 of Title 11 of the Bankruptcy Code against Pinnacle Mortgage
Investment Corporation ("Pinnacle"). An order for relief under Chapter 7
was entered by the Bankruptcy Court on March 6, 1995.
On March 24, 1995, Provident commenced this adversary proceeding by
filing a three count complaint to determine the extent, validity, and
priority of the various security interests asserted by Pinnacle, Meridian
Bank, Lawyers Title Insurance Corporation, the appellees, and William E.
Ward with regard to the promissory notes and mortgages from ten real
estate transactions.[fn1] Appellees responded to the complaint by filingan answer, counterclaims, and crossclaims, seeking money judgments in
the amount of the contested notes and mortgages, interest, cost of suit,
and attorneys fees; imposition of a constructive trust in their favor
with regard to the notes, mortgages, and proceeds thereof; and to have
the subject notes and mortgages avoided and stricken in favor of
subsequently executed mortgages between the appellees and the
mortgagors. Provident twice amended its complaint, finally seeking a
declaratory judgment that it is the holder in due course of the subject
notes and mortgages under the Uniform Commercial Code; avoidance of the
preferential transfer by appellee Andreuzzi pursuant to 11 U.S.C. § 547and 550; avoidance of the fraudulent transfer by appellee Andreuzzipursuant to §§ 548 and 550; and avoidance of the preferential and
fraudulent transfers by appellees pursuant to 11 U.S.C. § 547, 548,and 550.
Trial in this matter was held on July 16, 17, and 18, 1996, and October
1, 3, and 4, 1996. At the close of Provident's case in chief, upon motion
by the appellees, all of those portions of the Second Amended Complaint
which did not pertain to Provident's status as a holder in due course
("HDC") were dismissed.
B. The Factual History
In its November 19, 1997 opinion, the Bankruptcy Court determined that
the facts of the case are as follows. Debtor Pinnacle Mortgage Investment
Corporation ("Pinnacle" or "debtor") was a mortgage banker which
primarily dealt in residential mortgage lending and refinance. In December
of 1992, Pinnacle and Provident Savings Bank ("Provident" or "appellant")
entered into a Mortgage Warehouse Loan and Security Agreement
("Agreement"), whereby Provident would fund Pinnacle, who in turn funded
retail customers who sought to purchase or refinance residential real
estate. The borrower in each transaction would give Pinnacle a note and
mortgage, both of which acted as collateral to protect Provident until
Pinnacle sold the mortgage to a third party investor, such as the Federal
Home Loan Mortgage Corporation ("Freddie Mac"), who satisfied Pinnacle's
debt to Provident. Warehouse Agreement § 3.4.
1. The Warehouse Agreement
Under these types of agreements, there would usually not be any contact
between the warehouse lender and the ultimate mortgagor. Typically,
Pinnacle would arrange with a prospective borrower for Pinnacle to
advance funds for the borrower to purchase or refinance a home and for
the borrower to assign a note and mortgage to Pinnacle as collateral. The
mortgage would be endorsed in blank in order to accommodate the final
third party investor (such as Freddie Mac), with whom Pinnacle would
arrange to purchase the mortgage, usually as a part of a pool of
mortgages; this was known as a "takeout" agreement. All of this
completed, Pinnacle would submit a "package" to Provident seeking funding
for the particular transaction under its $10 million line of credit.[fn2]This package included a description of the borrower and the funding, an
assignment of the mortgage endorsed in blank, a takeout commitment, and
an agency agreement that indicated the borrower's attorney's agreement
"to act as the agent of the Bank" to disburse the Advance and to obtain
due execution and delivery to the bank of the original note that
evidences the debt underlying the Mortgage Loan." Warehouse Agreement
§ 5.3(A)(iii). The Agreement required all of this to be submitted
along with the initial funding request. As a matter of course, however,
the agency agreement was usually executed by the title agent handling the
closing instead of by the borrower's attorney, and Provident customarily
accepted the mortgage assignment and agency agreement after the actual
closing.
After Provident received the package and checked to see that Pinnacle's
credit limit had not been exceeded (although, as stated above, often
prior to receipt of the mortgage assignment and agency agreement),
Provident credited Pinnacle's checking account with 98% of the requested
funds. Warehouse Agreement §§ 1.1, 2.1. Pinnacle would write a
regular, uncertified check to the closing agent, who would close the loan
directly with the borrower on Pinnacle's behalf. Pinnacle was supposed to
use specific funds credited to their account to fund specific closings,
but no controls were in place to make sure that Pinnacle actually did
so.
With Pinnacle's check in hand, the closing agent would use money from
its own bank account to disburse funds to the mortgagor, later
replenishing its bank account by depositing Pinnacle's check. Next, the
closing agent would routinely send the original note, a certified copy of
the recorded mortgage, and the other closing documents to Pinnacle, who
would send them on to Provident, who would receive this original note
approximately three to five days after closing. Provident and the
borrowers had no contact; indeed, Provident and the closing agents had no
contact, save the extremely limited contact by the closing agents who did
return the agency agreement included in the borrowing package. Not all
closing agents did return the agreement signed; most of those who did
sent everything through Pinnacle to go to Provident, in accordance with
Pinnacle's written instructions, rather than remitting the note and other
papers directly to Provident, as stated in the agency agreement.
Ultimately, Provident would send the note and accompanying documents to
the third party investor, who would pay Provident the funds which
Provident had originally placed in Pinnacle's checking account by wiring
monies to Provident in Pinnacle's name. Because the third party investor
would send multiple payments in each wire transfer, Pinnacle would tell
Provident to which loans to apply each of the funds.
2. Pinnacle's Declining Financial State
Among the twenty or so warehouse customers that Provident had during
19931994, Pinnacle was the most profitable for Provident, providing
hundreds of millions of dollars in loan transactions. However, when the
mortgage banking industry suffered a decline in business, Pinnacle began
to experience financial difficulties as well.
The Warehouse Agreement, § 6.11, required Pinnacle to submit
unaudited balance sheets and statements of income to Provident on a
quarterly basis, though Pinnacle customarily provided monthly
statements. The statements filed for June, July, and August of 1993
reflected an accrued pretax income for the first three months of the
fiscal year of $281,351. Statements for September, October, and November
of 1993 reflected pretax income of $923,923 for the first six months of
the fiscal year. However, after the November 30 report, Pinnacle began to
send its reports quarterly, which was in accordance with the Warehouse
Agreement but which was nonetheless unusual due to Pinnacle's custom of
submitting reports monthly. The next report, covering the ninemonth
period ending February 28, 1994, was due on April 15 but not received
until some time in May. It showed pretax income of $136,000 for the
first nine months, or an $800,000 loss in the previous three months. The
accompanying unaudited balance sheets showed a reduction of assets from
$40 million to $28 million in those three months. The final financial
statement was due on August 31, 1994, but Provident never received it.
At a holiday party in May 1994, Edmund R. Folsom, head of Provident's
Commercial Lending Department, had learned that Pinnacle had sustained
losses in the winter months. On August 19, 1994, Sharon Kinkead, of
Provident's Warehouse Lending Department, called Pinnacle's headquarters
and learned from Pinnacle's CFO, Joseph Mader, that there would be a
delay in the submission of the audited financial statements for the
fiscal year ending May 31, 1994 because of a change of comptroller, but
that the report would be provided by September 15, 1994. That report
never arrived, and no other financial statements were received up until
Provident's termination of its relationship with Pinnacle in early
November 1994.
3. Provident's Relationship with Pinnacle
Throughout its relationship with Pinnacle, Provident routinely honored
overdrafts on behalf of Pinnacle — about twenty times in 1993 and
fifteen times in 1994. These overdrafts ranged from $7,240.87 to
$5,255,812.
When a check was presented to the bank on Pinnacle's account for which
Pinnacle had insufficient funds, Sharon Kinkead would contact Pinnacle to
ask whether Pinnacle would honor that overdraft. Having been told that
the check would be covered (usually from an anticipated wire transfer),
Kinkead and her supervisor, Mr. Folsom, would honor it and allow the
overdraft. Until November 1994, Provident honored all of Pinnacle's
overdrafts, without reviewing Pinnacle's books and records or monitoring
its checking account.
As mentioned earlier, Pinnacle's CFO, Joseph Mader, had informed
Provident that its final fiscal year report would be forthcoming on
September 15, 1994. When Provident did not receive the audited reports by
that date, Mr. Folsom spoke with Mr. Mader, who reported that though
Pinnacle had sustained losses, it was expecting a substantial infusion of
capital. Pinnacle wanted to hold off publishing the report so that it
could add a footnote explaining that there would be a capital infusion.
Based on this, Folsom decided to extend Pinnacle's credit line through
the end of November.
Folsom called Mader some time in October to check on the status of the
report. When Mader returned the call on November 1, he informed Folsom
that the capital infusion had failed. Folsom demanded a meeting with
Pinnacle's officers.
On November 2, Folsom and Kinkead met with Mader and Al Miller,
President of Pinnacle. Mader and Miller presented internally generated
financial statements indicating a pretax loss of six million dollars for
the previous fiscal year, as well as a pretax loss of almost one million
dollars for the first quarter of the current fiscal year. Miller and
Mader admitted that they had misused their warehouse credit line with
G.E. Capital Mortgage Services, Inc., to whom they were indebted for
about six million dollars. They "admitted fraud" as to G.E., but
indicated that they had not misappropriated the Provident funds and asked
for an extension of funding of their loans while they financially
reorganized. Provident declined to do so.
At that time, Provident finally reviewed Pinnacle's books and
discovered that Pinnacle had been diverting substantial sums of money
from Pinnacle's Provident account to its operating account at Meridian
Bank. Kinkead and Folsom also learned that Pinnacle had been requesting
advances on loans earlier than was routinely requested, possibly using
the money that was supposed to be for specific loans for other purposes
instead. Indeed, Pinnacle was engaging in a "kiting" scheme,
misappropriating monies from third party investors that should have been
applied to previously funded loans. A Pinnacle employee told Kinkead that
the Provident line was not "whole," that as much as $500,000 may have
been taken from it, though no fraudulent loans had been made.
As of November 2, 1994, all checks presented to Provident on Pinnacle's
account had been processed, and the customer balance summary showed an
overdraft of $206,653.67. On November 3, $830,127.48 was deposited in
Pinnacle's account. Sixteen checks totaling $1,584,041.63 were presented
to Provident against Pinnacle's account on November 3. There were
insufficient funds to cover all sixteen, so Folsom sent a letter to
Miller, Pinnacle's president, to ask which checks should be paid. At the
time, Provident knew that all sixteen of those checks represented monies
that Pinnacle had delivered to borrowers and closing agents for
particular loans, as well as that each transaction was accompanied by a
takeout commitment by a third party investor, who would have paid for
the loan.
Miller indicated that six of the checks could be paid. Provident
debited $863,821 to pay off eight loans on November 4, and other checks
were paid at Mader's instruction. There was an overdraft on that date of
$178,303.73, and Provident honored no more checks. The remaining ten of
the sixteen checks presented on November 3 were dishonored, and those are
the subject of the instant litigation.
4. The Ten Transactions
Prior to the closings in each of the ten transactions in question,
Pinnacle had requested from Provident — and received — monies
to fund the transactions. As usual, Pinnacle presented the closing agent
with an uncertified check drawn on its account at Provident representing
payment for the note and mortgage to be executed by the borrower,
purchaser, or refinancer of the property. With Pinnacle's check in hand,
the closing agents closed each transaction, issuing checks from their own
accounts to the parties entitled to receive funds. The closing agents
then deposited Pinnacle's checks in their own accounts, and their banks
presented those checks to Provident for payment. In each case, Provident
dishonored the checks due to insufficient funds. After each closing, but
before the discovery of any problem, each closing agent returned the
original note to Pinnacle. Several closing agents recorded the mortgage
and sent Pinnacle certified copies. Despite the fact that Pinnacle's
checks were not honored, each closing agent honored their own checks when
they were presented.
At the time, uncertified funds were routinely accepted from mortgage
bankers, with a few exceptions for out of state lenders, ignoring the
Pennsylvania statute which required mortgage bankers and brokers to
certify funds. Most mortgage lenders such as Pinnacle insisted on
acceptance of regular checks; title insurers could not stay in business
if they did not follow the standard in the industry.
As was usual for these transactions, Provident had no contact with any
of the closing agents prior to settlement. Agency agreements were
included in most, but not all, of the instruction packages sent by
Pinnacle to the respective closing agents. The agreement provided that
Provident had a security interest in the note and mortgage; moreover, it
provided that the closing agent would act as Provident's agent in
connection with the loan transaction, agreeing to record the mortgage and
then to send both the original note and the original recorded mortgage to
Provident upon closing. The text of the agreement conflicted with the
closing instructions that Pinnacle gave to the closing agents, which
required the note to be returned to Pinnacle. In six of the ten
transactions, the agreement was executed, but its provisions were
basically ignored, as the closing documents were returned directly to
Pinnacle.
The closing agents learned of the dishonor from their own banks.
Provident did not attempt to contact the closing agents until November
10, 1994, when they sent a letter with instructions to deliver to
Provident all notes, mortgages, loan files, and other collateral, and any
monies received in connection with each mortgage loan.
Several of the agents sought judicial relief. Two of the closing agents
who are appellees in this matter, Gino L. Andreuzzi and the Pioneer
Agency L.P., hold state court judgments in their favor, for a total of
three judgments against Pinnacle, striking the mortgages and notes
executed by their respective buyers in favor of Pinnacle. Andreuzzi, the
closing agent in the Hopeck settlement, filed suit against Pinnacle in
the Court of Common Pleas of Luzerne County, Pennsylvania, seeking a TRO
to keep Pinnacle from selling, transferring, or assigning the note and
mortgage in question. Provident was not joined in Andreuzzi's case, but
it did have notice of the litigation. Andreuzzi filed a lis pendens with
the Prothonotary on November 14, 1994. About three hours after the lis
pendens was filed, Provident recorded the assignment from the Hopeck
note. Ultimately, a default judgment was entered against Pinnacle.
Pioneer also filed suits in connection with the Weaver and Fisher
transactions. In both cases, Pioneer sued Pinnacle and Provident in the
Court of Common Pleas of Berks County, Pennsylvania, on November 14,
1994. A preliminary injunction was entered on November 22, and a default
judgment was entered against both defendants on December 21, 1994. Two
days later, Pinnacle moved to open the default judgment. It was still
pending on February 1, 1995 when an involuntary petition was filed against
Pinnacle. Provident removed the action to the Bankruptcy Court on May 8,
1995.
Other closing agents entered into agreements with the borrowers to
execute new notes and mortgages. By the time this came before the
Bankruptcy Court, the mortgages had either been satisfied in full, with
proceeds held in escrow, or payments on the new mortgages and notes were
being made by the borrowers to the closing agents in escrow pending the
resolution of this matter.
C. The Bankruptcy Court's Findings and Judgment
On November 19, 1997, the Bankruptcy Court issued its Opinion in favor
of the appellees, ruling that:
(1) the appellant did not achieve the status of an HDC
with regard to the notes and mortgages in issue;
(2) the appellees would be entitled to indemnification
even if an agency relationship existed between the
appellant and appellees;
(3) the Uniform Fiduciaries Law is inapplicable to
validate the appellant's position with regard to the
subject notes and mortgages; and
(4) the appellant is precluded from relitigating the
transactions with appellees Pioneer Agency II Corp
t/a Pioneer Agency and Andreuzzi.
Judgment against Provident was entered on December 17, 1997. On December
22, 1997, appellant filed a notice of appeal from the Judgment. On
February 13, 1998, the record on appeal was transmitted to this Court. As
"nothing remains for the [lower] court to do," Universal Minerals, Inc.
v. C.A. Hughes & Co., 669 F.2d 98, 101 (3d Cir. 1981), the BankruptcyCourt's ruling is final, and thus this Court properly has appellate
jurisdiction over the December 17, 1997 Order pursuant to
28 U.S.C. § 158(a).
III. ISSUES PRESENTED
On appeal, Provident makes six arguments. First, Provident argues that
it is the holder in due course ("HDC") of the ten mortgage notes.
Second, Provident argues that the Bankruptcy Court's ruling that the
appellees were entitled to indemnification if they were Provident's agents
is clearly erroneous. Third, appellant contends that the bankruptcy court
erred in ruling that Provident was not protected by the Uniform
Fiduciaries Act ("UFA"), adopted by both New Jersey and Pennsylvania at
N.J.S.A. 3B:1454 and 7 Pa. Cons. Stat. Ann. § 6361, respectively.Fourth, Provident argues, for the first time upon appeal, that the
doctrine of avoidable consequences bars appellees from recovering any
damages from Provident. Fifth, Provident maintains that the doctrines of
lis pendens, res judicata, and collateral estoppel do not bar
relitigation of these issues as to the Andreuzzi transaction. Finally,
Provident argues that the Bankruptcy Court erred by giving preclusionary
effect to the Pioneer action default judgments.
This Opinion will not address Provident's "avoidable consequences"
argument, as it was raised, for the first time, upon appeal.[fn3]Moreover, the doctrine of res judicata precludes review of the two
transactions for which Pioneer was the closing agent, and I thus affirm
the Bankruptcy Court's judgment as to Pioneer on that ground.[fn4] I willaffirm the Bankruptcy Court's holding that Provident is not entitled to
the protections of the Uniform Fiduciaries Act , especially in light of
the fact that Provident has withdrawn its argument that Pinnacle was its
agent.[fn5] For reasons stated herein, I will affirm the BankruptcyCourt's holding that Provident is not the holder in due course of the
eight[fn6] transactions still in question. Accordingly, there is no needfor this Court to address the Bankruptcy Court's alternate finding that
the closing agents would be entitled to indemnification.[fn7]
IV. STANDARD OF REVIEW
On appeal, the weight accorded to the findings of fact by a bankruptcy
court are governed by Fed.R.Bank.P. 8013, which provides as follows:
On appeal the district court or bankruptcy appellate
panel may affirm, modify, or reverse a bankruptcy
judge's judgment, order, or decree or remand with
instructions for further proceedings. Findings of
fact, whether based on oral or documentary evidence,
shall not be set aside unless clearly erroneous, and
due regard shall be given to the opportunity of the
bankruptcy court to judge the credibility of
witnesses.
Fed.R.Bank.P. 8013. Under this Rule, a bankruptcy court's factualfindings may be disturbed only if clearly erroneous. See FGH Realty
Credit v. Newark Airport/Hotel Ltd., 155 B.R. 93 (D.N.J. 1993). Where a
mixed question of law and fact is presented, the appropriate standard
must be applied to each component. In re Sharon Steel Corp., 871 F.2d 1217,
1222 (3d Cir. 1989). Thus, a reviewing court "must accept the [lower]court's findings of historical or narrative facts unless they are clearly
erroneous, but . . . must exercise a plenary review and its application
of those precepts to the historical facts." Universal Minerals, Inc. v.
C.A. Hughes & Co., 669 F.2d at 103.
While standards for establishing that a party is a holder in due course
are wellsettled law, see, e.g., Triffin v. Dillabough, 448 Pa. Super. 72,
87, 670 A.2d 684, 691 (1996), the Court's application of these standardsto the facts does result in a mixed finding of fact and law that is
subject to a mixed standard of review. Mellon Bank, N.A. v. Metro
Communications, Inc., 945 F.2d 635, 64142 (3d Cir. 1991), cert. denied,
503 U.S. 937 (1992). The factual findings can only be reversed for clearerror, In re Graves, 33 F.3d 242, 251 (3d Cir. 1994), even if thereviewing court would have decided the matter differently. In re
PrincetonNew York Investors, Inc., 1998 WL 111674 (D.N.J. 1998). This
Court, thus, may not overturn a bankruptcy judge's factual findings if
the factual determinations bear any "rational relationship to the
supporting evidentiary data. . . ." Fellheimer, Eichen & Braverman, P.C.
v. Charter Technologies, Inc., 57 F.3d 1215, 1223 (3d Cir. 1995) (citingHoots v. Comm. of Pa., 703 F.2d 722, 725 (3d Cir. 1983). However, thisCourt reviews any legal conclusions de novo.
V. DISCUSSION
Appellant argues that the Bankruptcy Court's finding that appellant is
not an HDC of the promissory notes and mortgages from the eight remaining
real estate transactions closed by appellees is clearly erroneous. The
dispute here is not a dispute of law, as the parties agree on what the
law concerning HDCs is. As the Bankruptcy Court correctly found,[fn8]every holder of a negotiable instrument is presumed to be an HDC, Morgan
Guaranty Trust Company of New York v. Staats, 631 A.2d 631, 636(Pa.Super.Ct. 1993), but when a defense of fraud is meritorious as to the
payee, the holder has the burden of showing that it is an HDC in order to
be immune from that defense. Norman v. World Wide Distributors, Inc.,
195 A.2d 115, 117 (Pa.Super.Ct. 1963). A holder of a negotiableinstrument (such as the promissory notes in this case) is either the
person with possession of bearer paper or the person identified on the
instrument if that person is in possession. 13 Pa. Cons. Stat. Ann.
§ 1201; N.J.S.A. 12A:3201 (West Supp. 1998). The holder of adocument of title (such as the mortgages in this case) is the person in
possession if the document is made out to bearer or to the order of the
person in possession. Id. The holder becomes an HDC if:
(1) the instrument when issued or negotiated to the
holder does not bear such apparent evidence of forgery
or alteration or is not otherwise so irregular or
incomplete as to call into question its authenticity;
and
(2) the holder took the instrument:
(i) for value;
(ii) in good faith;
(iii) without notice that the instrument is
overdue or has been dishonored or that there is an
uncured default with respect to payment of another
instrument issued as part of the same series;
(iv) without notice that the instrument contains
an unauthorized signature or has been altered;
(v) without notice of any claim to the instrument
described in section 3306 (relating to claims to an
instrument); and
(vi) without notice that any party has a defense
or claim in recoupment described in section 3305(a)
(relating to defenses and claims in recoupment).
13 Pa. Cons. Stat. Ann. § 3302. See also N.J.S.A. 12A:3302. Inshort, an HDC is the holder of the instrument or document who took for
value and in good faith without notice of any claims or defects on the
instrument or document. If classified as an HDC, the holder holds without
regard to defenses, with certain statutory exemptions which do not apply
here. 13 Pa. Cons. Stat. Ann. § 3305; N.J.S.A. 12A:3305.
It was clear to the parties and to the Bankruptcy Court below that
Provident did not have actual possession of the notes and mortgages
before November 2, 1998, when it learned that there were insufficient
funds in Pinnacle's account at Provident to cover Pinnacle's checks to
the closing agents here. Provident nonetheless argued that it was the
holder of the notes and mortgages because, before gaining actual
knowledge of Pinnacle's fraud, Provident "constructively possessed" the
notes and mortgages from the moment that the closing agents, who were
allegedly Provident's agents, took possession of the notes at the
closings before November 2.
The Bankruptcy Court rejected Provident's argument, finding that none
of the appellees acted as Provident's agents, and thus Provident never
constructively or actually possessed the notes and mortgages. Thus, the
Bankruptcy Court found that Provident never became the holder of these
notes and mortgages in the first place. (Opinion at 53.) Alternatively,
the Bankruptcy Court found that while Provident did give value for the
notes and mortgages (Opinion at 54), it did not take those notes and
mortgages in good faith and without knowledge of defenses, and thus
Provident is not an HDC. (Opinion at 63.) The question before this Court
is whether the Bankruptcy Court's rulings in this regard were clearly
erroneous. I hold that it was neither clearly erroneous nor contrary to
established law for the Bankruptcy Court to find that Provident did not
fit the role of "good faith purchaser for value" necessary to claim HDC
status even though Provident's lack of good faith arose after the title
agents closed the real estate transactions. As the following discussion
will explain, in the context of a course of dealing between Provident and
Pinnacle extending over thousands of such transactions, Provident was
essentially a party to the mortgage lending transactions and thus, by
definition, cannot claim HDC status in the negotiable papers which
resulted from those transactions, especially because Provident gained
knowledge of defenses before its own role in the original mortgage
lending transaction was complete.
I affirm the Bankruptcy Court's ruling that Provident is not the HDC of
these notes and mortgages. In so holding, I need not, and thus do not,
reach the issue of whether Provident constructively possessed the notes
and mortgages,[fn9] for holder status is irrelevant if Provident did nottake in good faith and without knowledge of defenses. Because I find that
the Bankruptcy Court's ruling that Provident did not take in good faith
was not clearly erroneous, I affirm the ruling that Provident is not
entitled to the protections afforded to a holder in due course.
The Bankruptcy Court correctly stated the law on good faith in this
context: the test for good faith is "not one of negligence of duty to
inquire, but rather it is one of willful dishonesty or actual knowledge."
Valley Bank & Trust Co. v. American Utilities, Inc., 415 F. Supp. 298,
301 (E.D.Pa. 1976). See also Mellon Bank v. PasqualisPoliti,
800 F. Supp. 1297, 1302 (W.D.Pa. 1992), aff'd, 990 F.2d 780 (3d Cir.1993); Carnegie Bank v. Shalleck, 606 A.2d 389, 394 (N.J.Super.Ct.A.D. 1992); General Inv. Corp. v. Angelini, 278 A.2d 193 (N.J. 1971).Good faith may be defeated only by actual knowledge or a deliberate
attempt to evade knowledge. Rice v. Barrington, 70 A. 169, 170 (N.J. E. &
A 1908). "There is no affirmative duty of inquiry on the part of one
taking a negotiable instrument, and there is no constructive notice from
the circumstances of the transaction, unless the circumstances are so
strong that if ignored they will be deemed to establish bad faith on the
part of the transferee." Bankers Trust Co. v. Crawford, 781 F.2d 39, 45(3d Cir. 1986). Moreover, an HDC must take not only in good faith, but
also without notice of defenses to the instrument or document. One has
"notice" when
(1) he has actual knowledge of it;
(2) he has received a notice or notification of it; or
(3) from all the facts and circumstances known to him
at the time in question he has reason to know that it
exists.
Pa. Cons. Stat. Ann. § 1201.
The Bankruptcy Court here found that Provident did not in fact have
actual knowledge of the fraud or potential defense of failure of
consideration at the time of each separate closing. (Opinion at 58.) The
Bankruptcy Court also found that despite the fact that Provident failed
to review Pinnacle's books, records, and checking account ledger, failed
to notice the overdraft problem, failed to properly monitor withdrawals,
and failed to act after knowledge of financial deterioration in default
in providing timely audited financial statements, the appellees had not
proved that Provident acted with willful dishonesty (id.); Provident did
act with negligence or gross negligence, but gross negligence alone is
not enough to defeat an HDC's title. See Washington & Canonsburg Ry. Co.
v. Murray, 211 F. 440, 445 (3d Cir. 1914); General Inv. Corp.,
278 A.2d 193. Moreover, the Bankruptcy Court correctly noted that holderin due course status is generally created at the time that the claimant
becomes a holder — meaning at the time of negotiation. N.J.S.A.
12A:3302; Sisemore v. Kierlow Co., Inc. v. Nicholas, 27 A.2d 473, 478(Pa.Super.Ct. 1942). In transactions such as the ones at issue here which
involve blank endorsements, the instruments and documents are bearer
paper and are thus negotiated upon delivery alone. 13 Pa. Cons. Stat.
Ann. § 3201; N.J.S.A. 12A:3201.
Nonetheless, the Bankruptcy Court found that Provident failed to attain
the status of a holder in due course. It acknowledged that once a party
establishes its position as a holder in due course, no future action can
undermine that status; so in the usual transaction with negotiable bearer
paper, actual knowledge of defenses gained after possession do not defeat
HDC status. (Opinion at 63.) See Bricks Unlimited, Inc. v. Agee,
672 F.2d 1255, 1259 (5th Cir. 1982); Park Gasoline Co. v. Crusius,158 A. 334 (N.J. 1932). However, the Bankruptcy Court said, it was not
finding lack of good faith after gaining HDC status, but rather that
Provident did not gain HDC status in the first place, for these were not
the "usual" transactions. Taken in a "global sense," the Bankruptcy Court
said, these transactions did not end until after the settlements.
(Opinion at 58.)
Usually, one who takes a negotiable instrument for value has only the
underlying circumstances of that transaction by which to determine if
there is reason to give pause as to the veracity of that instrument. A
lender provides funds to a borrower who executes a promissory note. Once
that transaction is complete, the lender transfers the note to a second
lender in exchange for which the first lender receives funds replenishing
his account and enabling him to lend the same funds to another borrower.
HDC status is given to that second lender if it acts in good faith and
without knowledge of defenses, and there is no general duty for that
second lender to inquire unless the circumstances are so suspicious that
they cannot be ignored. See, e.g. Triffin, 670 A.2d at 692. In the usualHDC transaction, there are two discernible transactions, two exchanges of
funds and notes. As the Bankruptcy Court pointed out, the purpose of
giving that second lender HDC status is "to meet the contemporary needs
of fast moving commercial society . . . (citation omitted) and to enhance
the marketability of negotiable instruments [allowing] bankers, brokers
and the general public to trade in confidence." Triffin,
670 A.2d at 693. However, "the more the holder knows about the underlyingtransaction, and particularly the more he controls or participates or
becomes involved in it, the less he fits the role of a good faith
purchaser for value; the closer his relationship to the underlying
agreement which is the source of the note, the less need there is for
giving him the tensionfree rights necessary in a fastmoving,
creditextending commercial world." Unico v. Owen, 50 N.J. 101, 109110 (1967). See also Jones v. Approved Bancredit Corp., 256 A.2d 739, 742(Del. 1969) (in such a situation, "[the financer] should not be able to
hide behind `the fictional fence' of the . . . UCC and thereby achieve an
unfair advantage over the purchaser.").
Here, there were not two separate, discernible transactions.
Provident's funding of Pinnacle who funded the borrowers was one complex
transaction. The acts of a third party investor who would buy the notes
and mortgages from Provident would have been the second separate,
discernible transaction here. Provident did not replenish Pinnacle's
account in exchange for receiving the notes and mortgages, such that
Pinnacle would have more money to make more loans, as in the "usual"
transaction. Rather, in a complex and longstanding scheme encompassing
thousands of transactions over several years, Provident gave Pinnacle a
line of credit, and then, after Pinnacle gave Provident information about
individual proposed loans to borrowers, Provident transferred money to
Pinnacle's account, in order to later receive the note and mortgage from
each transaction and pass them on to a third party investor. The
Bankruptcy Court, as a factual matter, found that under this complex
scheme, no transactions between any of the parties were complete until
both of the transactions were concluded, particularly because the "second
lender" (Provident) had the ultimate control over the first transaction
(by ordering the dishonor of Pinnacle's checks).[fn10]
I cannot say that the Bankruptcy Court's factual finding was clearly
erroneous. The Bankruptcy Court's ruling accords with the evidence as
well as with the policy underlying the holder in due course doctrine. I
hold that where a warehouse lender so closely participates in the funding
and approval of mortgages which will ultimately lead to the warehouse
lender's rights in mortgages and promissory notes that the transactions
between mortgage banker and mortgagor and between warehouse lender and
mortgage banker are in fact one continuous transaction, rather than two
discernible transactions, a showing of the warehouse lender's lack of
good faith after the closing between title agent and mortgagor but before
the mortgage banker's check is presented to the warehouse lender may
destroy HDC status. Indeed, where the party who claims HDC status was in
essence a party to the original transaction, it cannot, by definition, be
a holder in due course.
Provident had a great deal of involvement in the ongoing series of
transactions and ample knowledge of Pinnacle's overall financial
wellbeing, developed through years of funding Pinnacle's credit line for
thousands of such transactions and receipt of Pinnacle's periodic
financial reports. It had particular information about the borrowers
before it funded these loans. It was, in fact, part of the loan
transactions, and not a separate party who became an HDC through the
giving of value at a second separate, discernible transaction. Provident
had too much control of, participation in, and knowledge of the
underlying transaction to claim that it was a good faith purchaser for
value. See, e.g., Fidelity Bank Nat'l Assoc., 740 F. Supp. at 239.
Because, under this complex transactional scheme, Provident functioned
essentially as a party which approved and funded the loans and gained
actual knowledge of a defense to the notes and mortgages (lack of
consideration) before the transactions were complete, it was not clearly
erroneous for the Bankruptcy Court to find that Provident lacked the good
faith necessary to claim HDC status. Accordingly, the Bankruptcy Court's
ruling is affirmed.
VI. CONCLUSION
For the foregoing reasons, I will affirm the Bankruptcy Court's ruling
that appellant Provident Savings Bank was not the holder in due course of
the notes and mortgages from the ten transactions closed by appellees.
The defense of failure of consideration thus is available against
Provident. I therefore affirm the Bankruptcy Court's judgment that
appellees, and not appellant, are entitled to the notes and mortgages. The
accompanying Order is entered.
ORDER
This matter having come upon the court upon the appeal of appellant,
Provident Savings Bank, from a Judgment entered on December 17, 1997, by
the Honorable Judith H. Wizmur, United States Bankruptcy Judge for the
District of New Jersey,; and the Court having considered the parties'
submissions; and for the reasons set forth in the Opinion of today's
date;
IT IS this day of December, 1998, hereby
ORDERED that the Judgment entered by the Honorable Judith H. Wizmur,
United States Bankruptcy Judge for the District of New Jersey, on
December 17, 1997, which granted the notes and mortgages from
transactions closed by the appellees in this matter to the appellees,
be, and hereby is, AFFIRMED.
[fn1] The appellant's cause of action against defendant William E. Ward
was removed to state court in Delaware upon motion on the basis of
abstention pursuant to 28 U.S.C. § 1334(c) where it is now pending.The appellant's cause of action against Meridian Bank was resolved prior
to trial pursuant to the Stipulation of Settlement with respect to Count
II of the Complaint, filed on July 16, 1996. All claims between the
appellant and Lawyers Title Insurance Corporation were mutually dismissed
at trial.
[fn2] The Agreement said $10 million, but at times up to $12.5 million
was advanced.
[fn3] It is a wellestablished law that appellate courts may not pass
upon an issue not presented in a lower court. Singleton v. Wulff,
428 U.S. 106, 120 (1976). The same holds true for a U.S. District Courtsitting in its appellate capacity over matters appealed from the
bankruptcy court. See Barrett v. Commonwealth Fed. Sav. and Loan Ass'n,
939 F.2d 20 (3d Cir. 1991); In re Middle Atlantic Stud Welding Co.,
503 F.2d 1133, 1134 n. 1 (3d Cir. 1974). Because Provident never raisedthis issue before the Bankruptcy Court, I will not consider it now.
[fn4] The res judicata doctrine prevents relitigation of claims that grow
out of a transaction or occurrence from which other claims have earlier
been raised and decided validly, finally, and on the merits. Federated
Department Stores v. Moitie, 452 U.S. 394, 298 (1981). Under Pennsylvanialaw, default judgments, absent fraud, are afforded res judicata effect.
In re Graves, 156 B.R. 949, 954 (E.D.Pa. 1993), aff'd, 33 F.3d 242 (3dCir. 1994). On December 21, 1994, the Court of Common Pleas of Berks
County, Pennsylvania, entered default judgments against Provident on both
the Weaver and Fisher transactions, those transactions for which Pioneer
was the closing agent. Due to these default judgments, the doctrine of
res judicata bars relitigation of the Pioneer causes of action. The
Bankruptcy Court also held that the Andreuzzi transaction was barred by
res judicata or collateral estoppel because of the lis pendens. That,
however, is a more difficult issue and one that I need not reach now, as
my affirmance of the Bankruptcy Court's judgment applies equally to the
Andreuzzi transaction on the merits.
[fn5] At trial and in its briefs to this Court, as an alternative to its
holder in due course argument, Provident argued that it was protected by
the Pennsylvania Uniform Fiduciaries Act, 7 Pa. Cons. Stat. § 6361,
and the New Jersey Uniform Fiduciaries Law, N.J.S.A. 3B:1454, theprovisions of which are substantially similar. The two laws protect a
person who transfers money to a fiduciary in good faith, by noting that
"any right or title acquired from the fiduciary in consideration of such
payment or transfer is not invalid in consequences of a misapplication by
the fiduciary." 7 Pa. Cons. Stat. § 6361; N.J.S.A. 3B:1454. TheBankruptcy Court held that Pinnacle was not Provident's agent or
fiduciary, and thus the UFA did not apply. (Opinion at 66.) In light of
the fact that Provident's counsel, at oral argument before this Court on
November 13, 1998, themselves argued that Pinnacle was not Provident's
fiduciary, I will affirm this aspect of the Bankruptcy Court's ruling
without need to examine the factual bases on which it relied.
[fn6] The rest of this Opinion is limited to the eight transactions not
handled by Pioneer, since only the Pioneer transactions are bound by res
judicata.
[fn7] As Part V of this Opinion explains, one of the several bases for
the Bankruptcy Court's decision that Provident is not the HDC of the
mortgages and notes is that the settlement agents were not Provident's
agents, and thus Provident did not constructively possess the mortgages
and notes prior to gaining knowledge of claims or defenses on those
notes. (Opinion at 3453.) In the alternative, in case appellate courts
determined that Provident was the HDC of those notes because an agency
relationship did exist, the Bankruptcy Court held that the closing
agents, and not Provident, would still be the ones entitled to the notes
and mortgages, for the agents would have had a right to indemnification
from Provident. (Id. at 6364.) Though, as I explain in Part V, I do not
reach the agency issue, I do affirm the Bankruptcy Court's HDC ruling on
other grounds. In doing so, I am affirming the decision that the
appellees, and not Provident, are entitled to the notes and mortgages. The
Bankruptcy Court's indemnification ruling is just an alternative reason
for finding that the appellees are entitled to the notes and mortgages.
Having already agreed that the closing agents are so entitled because
Provident is not an HDC, there is no need to address that alternative
ruling upon appeal.
[fn8] Seven of the eight remaining transactions here are governed by
Pennsylvania law. The eighth is under New Jersey law, but the two states'
laws on HDC status are largely consistent on the issues raised in these
proceedings.
[fn9] The Bankruptcy Court agreed that authority from other jurisdictions
suggest that a party may become a constructive holder when its agent
takes possession of a negotiable instrument on its behalf. (Opinion at
3637.) However, the Bankruptcy Court made the factual finding that
appellees were not Provident's agents. It determined that though six of
the ten transactions involved written agency agreements, those agreements
were not controlling in light of the course of dealing between the
parties (Opinion at 46), and that Provident did not otherwise meet its
burden of establishing that an agency relationship existed. Because I
find that the Bankruptcy Court's determination that Provident did not act
in good faith is not clearly erroneous, and because the lack of good
faith alone is enough of a basis to sustain a judgment that Provident is
not an HDC of these eight notes and mortgages, I need not address whether
the agency determination was clearly erroneous.
[fn10] Under the Bankruptcy Court's findings of fact, Provident was, in
reality, a party to the original transaction. The situation is somewhat
analogous to a consumer goods financer who has a substantial voice in the
underlying transaction; that financer is not entitled to HDC status.
Westfield Investment Co. v. Fellers, 181 A.2d 809 (N.J.Super.Ct. LawDiv.). Provident had a substantial voice in providing and carrying out
funding of the underlying borrowing transactions, and it thus cannot
claim that it was a good faith HDC when it learned of the defense of
failure of consideration prior to dishonoring the Pinnacle checks.
Loislaw Federal District Court Opinions
Copyright © 2013 CCH Incorporated or its affiliates
IN RE PINNACLE MORTGAGE INVESTMENT CORPORATION, (D.N.J. 1998)
IN RE PINNACLE MORTGAGE INVESTMENT CORPORATION, Debtor
PROVIDENT SAVINGS BANK, a New Jersey Banking Corporation,
Plaintiff/Appellant, v. PINNACLE MORTGAGE INVESTMENT CORPORATION, a
Pennsylvania Corporation, et al., Defendants, SETTLERS ABSTRACT CO., L.P.,
LAWYERS TITLE INSURANCE CORP., LAND TRANSFER CO, INC., FIDELITY NATIONAL
TITLE INSURANCE CO. OF PENNSYLVANIA, GINO L. ANDREUZZI, PIONEER AGENCY II
CORP. t/a PIONEER AGENCY, MUSSER & MUSSER, WILLIAM E. WARD, QUAKER ABSTRACT
CO., and SEARCHTEC ABSTRACT, INC., Appellees.
CIVIL NO. 980489 (JBS), [Bankruptcy Case No. 9510608 (JHW)], [Adv.
Proc. No. 951091]
United States District Court, D. New Jersey.
Filed: December 9, 1998
Walter E. Thomas, Jr., Esq., Timothy J. Matteson, Esq., Mark A. Trudeau,
Esq., Stern, Lavinthal, Norgaard & Kapnick, Esqs., Englewood, New Jersey,
Attorneys for Appellant.
Edward J. Hayes, Esq., Andrea Dobin, Esq., Fox, Rothschild, O'Brien &
Frankel, Princeton Pike Corporate Center, Lawrenceville, New Jersey,
Attorneys for Appellees, Settlers Abstract Co., L.P., Land Transfer Co,
Inc., Fidelity National Title Insurance Co. of Pennsylvania, Gino L.
Andreuzzi, Pioneer Agency II Corp. t/a Pioneer Agency, Musser & Musser,
Quaker Abstract Co, and Searchtec Abstract, Inc.
OPINION
SIMANDLE, District Judge.
I. INTRODUCTION
Provident Savings Bank appeals from a Judgment entered on December 17,
1997, pursuant to a written opinion issued on November 19, 1997, by the
Honorable Judith H. Wizmur, United States Bankruptcy Judge, after trial
in an adversary proceeding. That Opinion ruled in favor of the
Appellees, Settlers Abstract Co., L.P., Land Transfer Co, Inc., Fidelity
National Title Insurance Co. of Pennsylvania, Gino L. Andreuzzi, Pioneer
Agency II Corp. t/a Pioneer Agency, Musser & Musser, Quaker Abstract Co,
and Searchtec Abstract, Inc. ("title agents"). Reviewing a longstanding
complex lending relationship between Provident and the debtor, Pinnacle
Mortgage Corporation, of which the ten real estate mortgage loans at
issue herein were a part, the Bankruptcy Court held that appellee title
agents (who had advanced their own funds to cover disbursements when
Provident dishonored Pinnacle's checks) had a more valid or higher
priority security interest in the promissory notes and mortgages executed
as part of ten separate residential real estate closing than did
appellant. Provident Savings Bank appeals this ruling and seeks this
Court's determination that it was the holder in due course of those
documents.
The principal issue to be decided is whether the Bankruptcy Court
correctly determined under the Uniform Commercial Code that Provident was
not a holder in due course of the promissory notes arising from these
loans, where it found that Provident so closely participated in the
funding and approval of the Pinnaclebrokered loans that the transaction
did not end at the closing with the title agents, such that Provident did
not attain holder in due course status because it did not fit the
requisite role of a "good faith purchaser for value." For the reasons
that will be stated herein, the judgment will be affirmed because the
Bankruptcy Court's finding that Provident never attained HDC status was
neither clearly erroneous nor contrary to law.
II. BACKGROUND
A. Procedural History
This case arises from a dispute over the various security interests in
mortgage documents from ten separate real estate transactions in late
October, 1994, conducted by the debtor, Pinnacle Mortgage Investment
Corporation (who brokered the transactions), the appellant (who financed
the transactions), and the appellees (who were title closing agents in
the transactions). On February 2, 1995, appellant Provident Savings Bank
("Provident") and other creditors filed an involuntary petition under
Chapter 7 of Title 11 of the Bankruptcy Code against Pinnacle Mortgage
Investment Corporation ("Pinnacle"). An order for relief under Chapter 7
was entered by the Bankruptcy Court on March 6, 1995.
On March 24, 1995, Provident commenced this adversary proceeding by
filing a three count complaint to determine the extent, validity, and
priority of the various security interests asserted by Pinnacle, Meridian
Bank, Lawyers Title Insurance Corporation, the appellees, and William E.
Ward with regard to the promissory notes and mortgages from ten real
estate transactions.[fn1] Appellees responded to the complaint by filingan answer, counterclaims, and crossclaims, seeking money judgments in
the amount of the contested notes and mortgages, interest, cost of suit,
and attorneys fees; imposition of a constructive trust in their favor
with regard to the notes, mortgages, and proceeds thereof; and to have
the subject notes and mortgages avoided and stricken in favor of
subsequently executed mortgages between the appellees and the
mortgagors. Provident twice amended its complaint, finally seeking a
declaratory judgment that it is the holder in due course of the subject
notes and mortgages under the Uniform Commercial Code; avoidance of the
preferential transfer by appellee Andreuzzi pursuant to 11 U.S.C. § 547and 550; avoidance of the fraudulent transfer by appellee Andreuzzipursuant to §§ 548 and 550; and avoidance of the preferential and
fraudulent transfers by appellees pursuant to 11 U.S.C. § 547, 548,and 550.
Trial in this matter was held on July 16, 17, and 18, 1996, and October
1, 3, and 4, 1996. At the close of Provident's case in chief, upon motion
by the appellees, all of those portions of the Second Amended Complaint
which did not pertain to Provident's status as a holder in due course
("HDC") were dismissed.
B. The Factual History
In its November 19, 1997 opinion, the Bankruptcy Court determined that
the facts of the case are as follows. Debtor Pinnacle Mortgage Investment
Corporation ("Pinnacle" or "debtor") was a mortgage banker which
primarily dealt in residential mortgage lending and refinance. In December
of 1992, Pinnacle and Provident Savings Bank ("Provident" or "appellant")
entered into a Mortgage Warehouse Loan and Security Agreement
("Agreement"), whereby Provident would fund Pinnacle, who in turn funded
retail customers who sought to purchase or refinance residential real
estate. The borrower in each transaction would give Pinnacle a note and
mortgage, both of which acted as collateral to protect Provident until
Pinnacle sold the mortgage to a third party investor, such as the Federal
Home Loan Mortgage Corporation ("Freddie Mac"), who satisfied Pinnacle's
debt to Provident. Warehouse Agreement § 3.4.
1. The Warehouse Agreement
Under these types of agreements, there would usually not be any contact
between the warehouse lender and the ultimate mortgagor. Typically,
Pinnacle would arrange with a prospective borrower for Pinnacle to
advance funds for the borrower to purchase or refinance a home and for
the borrower to assign a note and mortgage to Pinnacle as collateral. The
mortgage would be endorsed in blank in order to accommodate the final
third party investor (such as Freddie Mac), with whom Pinnacle would
arrange to purchase the mortgage, usually as a part of a pool of
mortgages; this was known as a "takeout" agreement. All of this
completed, Pinnacle would submit a "package" to Provident seeking funding
for the particular transaction under its $10 million line of credit.[fn2]This package included a description of the borrower and the funding, an
assignment of the mortgage endorsed in blank, a takeout commitment, and
an agency agreement that indicated the borrower's attorney's agreement
"to act as the agent of the Bank" to disburse the Advance and to obtain
due execution and delivery to the bank of the original note that
evidences the debt underlying the Mortgage Loan." Warehouse Agreement
§ 5.3(A)(iii). The Agreement required all of this to be submitted
along with the initial funding request. As a matter of course, however,
the agency agreement was usually executed by the title agent handling the
closing instead of by the borrower's attorney, and Provident customarily
accepted the mortgage assignment and agency agreement after the actual
closing.
After Provident received the package and checked to see that Pinnacle's
credit limit had not been exceeded (although, as stated above, often
prior to receipt of the mortgage assignment and agency agreement),
Provident credited Pinnacle's checking account with 98% of the requested
funds. Warehouse Agreement §§ 1.1, 2.1. Pinnacle would write a
regular, uncertified check to the closing agent, who would close the loan
directly with the borrower on Pinnacle's behalf. Pinnacle was supposed to
use specific funds credited to their account to fund specific closings,
but no controls were in place to make sure that Pinnacle actually did
so.
With Pinnacle's check in hand, the closing agent would use money from
its own bank account to disburse funds to the mortgagor, later
replenishing its bank account by depositing Pinnacle's check. Next, the
closing agent would routinely send the original note, a certified copy of
the recorded mortgage, and the other closing documents to Pinnacle, who
would send them on to Provident, who would receive this original note
approximately three to five days after closing. Provident and the
borrowers had no contact; indeed, Provident and the closing agents had no
contact, save the extremely limited contact by the closing agents who did
return the agency agreement included in the borrowing package. Not all
closing agents did return the agreement signed; most of those who did
sent everything through Pinnacle to go to Provident, in accordance with
Pinnacle's written instructions, rather than remitting the note and other
papers directly to Provident, as stated in the agency agreement.
Ultimately, Provident would send the note and accompanying documents to
the third party investor, who would pay Provident the funds which
Provident had originally placed in Pinnacle's checking account by wiring
monies to Provident in Pinnacle's name. Because the third party investor
would send multiple payments in each wire transfer, Pinnacle would tell
Provident to which loans to apply each of the funds.
2. Pinnacle's Declining Financial State
Among the twenty or so warehouse customers that Provident had during
19931994, Pinnacle was the most profitable for Provident, providing
hundreds of millions of dollars in loan transactions. However, when the
mortgage banking industry suffered a decline in business, Pinnacle began
to experience financial difficulties as well.
The Warehouse Agreement, § 6.11, required Pinnacle to submit
unaudited balance sheets and statements of income to Provident on a
quarterly basis, though Pinnacle customarily provided monthly
statements. The statements filed for June, July, and August of 1993
reflected an accrued pretax income for the first three months of the
fiscal year of $281,351. Statements for September, October, and November
of 1993 reflected pretax income of $923,923 for the first six months of
the fiscal year. However, after the November 30 report, Pinnacle began to
send its reports quarterly, which was in accordance with the Warehouse
Agreement but which was nonetheless unusual due to Pinnacle's custom of
submitting reports monthly. The next report, covering the ninemonth
period ending February 28, 1994, was due on April 15 but not received
until some time in May. It showed pretax income of $136,000 for the
first nine months, or an $800,000 loss in the previous three months. The
accompanying unaudited balance sheets showed a reduction of assets from
$40 million to $28 million in those three months. The final financial
statement was due on August 31, 1994, but Provident never received it.
At a holiday party in May 1994, Edmund R. Folsom, head of Provident's
Commercial Lending Department, had learned that Pinnacle had sustained
losses in the winter months. On August 19, 1994, Sharon Kinkead, of
Provident's Warehouse Lending Department, called Pinnacle's headquarters
and learned from Pinnacle's CFO, Joseph Mader, that there would be a
delay in the submission of the audited financial statements for the
fiscal year ending May 31, 1994 because of a change of comptroller, but
that the report would be provided by September 15, 1994. That report
never arrived, and no other financial statements were received up until
Provident's termination of its relationship with Pinnacle in early
November 1994.
3. Provident's Relationship with Pinnacle
Throughout its relationship with Pinnacle, Provident routinely honored
overdrafts on behalf of Pinnacle — about twenty times in 1993 and
fifteen times in 1994. These overdrafts ranged from $7,240.87 to
$5,255,812.
When a check was presented to the bank on Pinnacle's account for which
Pinnacle had insufficient funds, Sharon Kinkead would contact Pinnacle to
ask whether Pinnacle would honor that overdraft. Having been told that
the check would be covered (usually from an anticipated wire transfer),
Kinkead and her supervisor, Mr. Folsom, would honor it and allow the
overdraft. Until November 1994, Provident honored all of Pinnacle's
overdrafts, without reviewing Pinnacle's books and records or monitoring
its checking account.
As mentioned earlier, Pinnacle's CFO, Joseph Mader, had informed
Provident that its final fiscal year report would be forthcoming on
September 15, 1994. When Provident did not receive the audited reports by
that date, Mr. Folsom spoke with Mr. Mader, who reported that though
Pinnacle had sustained losses, it was expecting a substantial infusion of
capital. Pinnacle wanted to hold off publishing the report so that it
could add a footnote explaining that there would be a capital infusion.
Based on this, Folsom decided to extend Pinnacle's credit line through
the end of November.
Folsom called Mader some time in October to check on the status of the
report. When Mader returned the call on November 1, he informed Folsom
that the capital infusion had failed. Folsom demanded a meeting with
Pinnacle's officers.
On November 2, Folsom and Kinkead met with Mader and Al Miller,
President of Pinnacle. Mader and Miller presented internally generated
financial statements indicating a pretax loss of six million dollars for
the previous fiscal year, as well as a pretax loss of almost one million
dollars for the first quarter of the current fiscal year. Miller and
Mader admitted that they had misused their warehouse credit line with
G.E. Capital Mortgage Services, Inc., to whom they were indebted for
about six million dollars. They "admitted fraud" as to G.E., but
indicated that they had not misappropriated the Provident funds and asked
for an extension of funding of their loans while they financially
reorganized. Provident declined to do so.
At that time, Provident finally reviewed Pinnacle's books and
discovered that Pinnacle had been diverting substantial sums of money
from Pinnacle's Provident account to its operating account at Meridian
Bank. Kinkead and Folsom also learned that Pinnacle had been requesting
advances on loans earlier than was routinely requested, possibly using
the money that was supposed to be for specific loans for other purposes
instead. Indeed, Pinnacle was engaging in a "kiting" scheme,
misappropriating monies from third party investors that should have been
applied to previously funded loans. A Pinnacle employee told Kinkead that
the Provident line was not "whole," that as much as $500,000 may have
been taken from it, though no fraudulent loans had been made.
As of November 2, 1994, all checks presented to Provident on Pinnacle's
account had been processed, and the customer balance summary showed an
overdraft of $206,653.67. On November 3, $830,127.48 was deposited in
Pinnacle's account. Sixteen checks totaling $1,584,041.63 were presented
to Provident against Pinnacle's account on November 3. There were
insufficient funds to cover all sixteen, so Folsom sent a letter to
Miller, Pinnacle's president, to ask which checks should be paid. At the
time, Provident knew that all sixteen of those checks represented monies
that Pinnacle had delivered to borrowers and closing agents for
particular loans, as well as that each transaction was accompanied by a
takeout commitment by a third party investor, who would have paid for
the loan.
Miller indicated that six of the checks could be paid. Provident
debited $863,821 to pay off eight loans on November 4, and other checks
were paid at Mader's instruction. There was an overdraft on that date of
$178,303.73, and Provident honored no more checks. The remaining ten of
the sixteen checks presented on November 3 were dishonored, and those are
the subject of the instant litigation.
4. The Ten Transactions
Prior to the closings in each of the ten transactions in question,
Pinnacle had requested from Provident — and received — monies
to fund the transactions. As usual, Pinnacle presented the closing agent
with an uncertified check drawn on its account at Provident representing
payment for the note and mortgage to be executed by the borrower,
purchaser, or refinancer of the property. With Pinnacle's check in hand,
the closing agents closed each transaction, issuing checks from their own
accounts to the parties entitled to receive funds. The closing agents
then deposited Pinnacle's checks in their own accounts, and their banks
presented those checks to Provident for payment. In each case, Provident
dishonored the checks due to insufficient funds. After each closing, but
before the discovery of any problem, each closing agent returned the
original note to Pinnacle. Several closing agents recorded the mortgage
and sent Pinnacle certified copies. Despite the fact that Pinnacle's
checks were not honored, each closing agent honored their own checks when
they were presented.
At the time, uncertified funds were routinely accepted from mortgage
bankers, with a few exceptions for out of state lenders, ignoring the
Pennsylvania statute which required mortgage bankers and brokers to
certify funds. Most mortgage lenders such as Pinnacle insisted on
acceptance of regular checks; title insurers could not stay in business
if they did not follow the standard in the industry.
As was usual for these transactions, Provident had no contact with any
of the closing agents prior to settlement. Agency agreements were
included in most, but not all, of the instruction packages sent by
Pinnacle to the respective closing agents. The agreement provided that
Provident had a security interest in the note and mortgage; moreover, it
provided that the closing agent would act as Provident's agent in
connection with the loan transaction, agreeing to record the mortgage and
then to send both the original note and the original recorded mortgage to
Provident upon closing. The text of the agreement conflicted with the
closing instructions that Pinnacle gave to the closing agents, which
required the note to be returned to Pinnacle. In six of the ten
transactions, the agreement was executed, but its provisions were
basically ignored, as the closing documents were returned directly to
Pinnacle.
The closing agents learned of the dishonor from their own banks.
Provident did not attempt to contact the closing agents until November
10, 1994, when they sent a letter with instructions to deliver to
Provident all notes, mortgages, loan files, and other collateral, and any
monies received in connection with each mortgage loan.
Several of the agents sought judicial relief. Two of the closing agents
who are appellees in this matter, Gino L. Andreuzzi and the Pioneer
Agency L.P., hold state court judgments in their favor, for a total of
three judgments against Pinnacle, striking the mortgages and notes
executed by their respective buyers in favor of Pinnacle. Andreuzzi, the
closing agent in the Hopeck settlement, filed suit against Pinnacle in
the Court of Common Pleas of Luzerne County, Pennsylvania, seeking a TRO
to keep Pinnacle from selling, transferring, or assigning the note and
mortgage in question. Provident was not joined in Andreuzzi's case, but
it did have notice of the litigation. Andreuzzi filed a lis pendens with
the Prothonotary on November 14, 1994. About three hours after the lis
pendens was filed, Provident recorded the assignment from the Hopeck
note. Ultimately, a default judgment was entered against Pinnacle.
Pioneer also filed suits in connection with the Weaver and Fisher
transactions. In both cases, Pioneer sued Pinnacle and Provident in the
Court of Common Pleas of Berks County, Pennsylvania, on November 14,
1994. A preliminary injunction was entered on November 22, and a default
judgment was entered against both defendants on December 21, 1994. Two
days later, Pinnacle moved to open the default judgment. It was still
pending on February 1, 1995 when an involuntary petition was filed against
Pinnacle. Provident removed the action to the Bankruptcy Court on May 8,
1995.
Other closing agents entered into agreements with the borrowers to
execute new notes and mortgages. By the time this came before the
Bankruptcy Court, the mortgages had either been satisfied in full, with
proceeds held in escrow, or payments on the new mortgages and notes were
being made by the borrowers to the closing agents in escrow pending the
resolution of this matter.
C. The Bankruptcy Court's Findings and Judgment
On November 19, 1997, the Bankruptcy Court issued its Opinion in favor
of the appellees, ruling that:
(1) the appellant did not achieve the status of an HDC
with regard to the notes and mortgages in issue;
(2) the appellees would be entitled to indemnification
even if an agency relationship existed between the
appellant and appellees;
(3) the Uniform Fiduciaries Law is inapplicable to
validate the appellant's position with regard to the
subject notes and mortgages; and
(4) the appellant is precluded from relitigating the
transactions with appellees Pioneer Agency II Corp
t/a Pioneer Agency and Andreuzzi.
Judgment against Provident was entered on December 17, 1997. On December
22, 1997, appellant filed a notice of appeal from the Judgment. On
February 13, 1998, the record on appeal was transmitted to this Court. As
"nothing remains for the [lower] court to do," Universal Minerals, Inc.
v. C.A. Hughes & Co., 669 F.2d 98, 101 (3d Cir. 1981), the BankruptcyCourt's ruling is final, and thus this Court properly has appellate
jurisdiction over the December 17, 1997 Order pursuant to
28 U.S.C. § 158(a).
III. ISSUES PRESENTED
On appeal, Provident makes six arguments. First, Provident argues that
it is the holder in due course ("HDC") of the ten mortgage notes.
Second, Provident argues that the Bankruptcy Court's ruling that the
appellees were entitled to indemnification if they were Provident's agents
is clearly erroneous. Third, appellant contends that the bankruptcy court
erred in ruling that Provident was not protected by the Uniform
Fiduciaries Act ("UFA"), adopted by both New Jersey and Pennsylvania at
N.J.S.A. 3B:1454 and 7 Pa. Cons. Stat. Ann. § 6361, respectively.Fourth, Provident argues, for the first time upon appeal, that the
doctrine of avoidable consequences bars appellees from recovering any
damages from Provident. Fifth, Provident maintains that the doctrines of
lis pendens, res judicata, and collateral estoppel do not bar
relitigation of these issues as to the Andreuzzi transaction. Finally,
Provident argues that the Bankruptcy Court erred by giving preclusionary
effect to the Pioneer action default judgments.
This Opinion will not address Provident's "avoidable consequences"
argument, as it was raised, for the first time, upon appeal.[fn3]Moreover, the doctrine of res judicata precludes review of the two
transactions for which Pioneer was the closing agent, and I thus affirm
the Bankruptcy Court's judgment as to Pioneer on that ground.[fn4] I willaffirm the Bankruptcy Court's holding that Provident is not entitled to
the protections of the Uniform Fiduciaries Act , especially in light of
the fact that Provident has withdrawn its argument that Pinnacle was its
agent.[fn5] For reasons stated herein, I will affirm the BankruptcyCourt's holding that Provident is not the holder in due course of the
eight[fn6] transactions still in question. Accordingly, there is no needfor this Court to address the Bankruptcy Court's alternate finding that
the closing agents would be entitled to indemnification.[fn7]
IV. STANDARD OF REVIEW
On appeal, the weight accorded to the findings of fact by a bankruptcy
court are governed by Fed.R.Bank.P. 8013, which provides as follows:
On appeal the district court or bankruptcy appellate
panel may affirm, modify, or reverse a bankruptcy
judge's judgment, order, or decree or remand with
instructions for further proceedings. Findings of
fact, whether based on oral or documentary evidence,
shall not be set aside unless clearly erroneous, and
due regard shall be given to the opportunity of the
bankruptcy court to judge the credibility of
witnesses.
Fed.R.Bank.P. 8013. Under this Rule, a bankruptcy court's factualfindings may be disturbed only if clearly erroneous. See FGH Realty
Credit v. Newark Airport/Hotel Ltd., 155 B.R. 93 (D.N.J. 1993). Where a
mixed question of law and fact is presented, the appropriate standard
must be applied to each component. In re Sharon Steel Corp., 871 F.2d 1217,
1222 (3d Cir. 1989). Thus, a reviewing court "must accept the [lower]court's findings of historical or narrative facts unless they are clearly
erroneous, but . . . must exercise a plenary review and its application
of those precepts to the historical facts." Universal Minerals, Inc. v.
C.A. Hughes & Co., 669 F.2d at 103.
While standards for establishing that a party is a holder in due course
are wellsettled law, see, e.g., Triffin v. Dillabough, 448 Pa. Super. 72,
87, 670 A.2d 684, 691 (1996), the Court's application of these standardsto the facts does result in a mixed finding of fact and law that is
subject to a mixed standard of review. Mellon Bank, N.A. v. Metro
Communications, Inc., 945 F.2d 635, 64142 (3d Cir. 1991), cert. denied,
503 U.S. 937 (1992). The factual findings can only be reversed for clearerror, In re Graves, 33 F.3d 242, 251 (3d Cir. 1994), even if thereviewing court would have decided the matter differently. In re
PrincetonNew York Investors, Inc., 1998 WL 111674 (D.N.J. 1998). This
Court, thus, may not overturn a bankruptcy judge's factual findings if
the factual determinations bear any "rational relationship to the
supporting evidentiary data. . . ." Fellheimer, Eichen & Braverman, P.C.
v. Charter Technologies, Inc., 57 F.3d 1215, 1223 (3d Cir. 1995) (citingHoots v. Comm. of Pa., 703 F.2d 722, 725 (3d Cir. 1983). However, thisCourt reviews any legal conclusions de novo.
V. DISCUSSION
Appellant argues that the Bankruptcy Court's finding that appellant is
not an HDC of the promissory notes and mortgages from the eight remaining
real estate transactions closed by appellees is clearly erroneous. The
dispute here is not a dispute of law, as the parties agree on what the
law concerning HDCs is. As the Bankruptcy Court correctly found,[fn8]every holder of a negotiable instrument is presumed to be an HDC, Morgan
Guaranty Trust Company of New York v. Staats, 631 A.2d 631, 636(Pa.Super.Ct. 1993), but when a defense of fraud is meritorious as to the
payee, the holder has the burden of showing that it is an HDC in order to
be immune from that defense. Norman v. World Wide Distributors, Inc.,
195 A.2d 115, 117 (Pa.Super.Ct. 1963). A holder of a negotiableinstrument (such as the promissory notes in this case) is either the
person with possession of bearer paper or the person identified on the
instrument if that person is in possession. 13 Pa. Cons. Stat. Ann.
§ 1201; N.J.S.A. 12A:3201 (West Supp. 1998). The holder of adocument of title (such as the mortgages in this case) is the person in
possession if the document is made out to bearer or to the order of the
person in possession. Id. The holder becomes an HDC if:
(1) the instrument when issued or negotiated to the
holder does not bear such apparent evidence of forgery
or alteration or is not otherwise so irregular or
incomplete as to call into question its authenticity;
and
(2) the holder took the instrument:
(i) for value;
(ii) in good faith;
(iii) without notice that the instrument is
overdue or has been dishonored or that there is an
uncured default with respect to payment of another
instrument issued as part of the same series;
(iv) without notice that the instrument contains
an unauthorized signature or has been altered;
(v) without notice of any claim to the instrument
described in section 3306 (relating to claims to an
instrument); and
(vi) without notice that any party has a defense
or claim in recoupment described in section 3305(a)
(relating to defenses and claims in recoupment).
13 Pa. Cons. Stat. Ann. § 3302. See also N.J.S.A. 12A:3302. Inshort, an HDC is the holder of the instrument or document who took for
value and in good faith without notice of any claims or defects on the
instrument or document. If classified as an HDC, the holder holds without
regard to defenses, with certain statutory exemptions which do not apply
here. 13 Pa. Cons. Stat. Ann. § 3305; N.J.S.A. 12A:3305.
It was clear to the parties and to the Bankruptcy Court below that
Provident did not have actual possession of the notes and mortgages
before November 2, 1998, when it learned that there were insufficient
funds in Pinnacle's account at Provident to cover Pinnacle's checks to
the closing agents here. Provident nonetheless argued that it was the
holder of the notes and mortgages because, before gaining actual
knowledge of Pinnacle's fraud, Provident "constructively possessed" the
notes and mortgages from the moment that the closing agents, who were
allegedly Provident's agents, took possession of the notes at the
closings before November 2.
The Bankruptcy Court rejected Provident's argument, finding that none
of the appellees acted as Provident's agents, and thus Provident never
constructively or actually possessed the notes and mortgages. Thus, the
Bankruptcy Court found that Provident never became the holder of these
notes and mortgages in the first place. (Opinion at 53.) Alternatively,
the Bankruptcy Court found that while Provident did give value for the
notes and mortgages (Opinion at 54), it did not take those notes and
mortgages in good faith and without knowledge of defenses, and thus
Provident is not an HDC. (Opinion at 63.) The question before this Court
is whether the Bankruptcy Court's rulings in this regard were clearly
erroneous. I hold that it was neither clearly erroneous nor contrary to
established law for the Bankruptcy Court to find that Provident did not
fit the role of "good faith purchaser for value" necessary to claim HDC
status even though Provident's lack of good faith arose after the title
agents closed the real estate transactions. As the following discussion
will explain, in the context of a course of dealing between Provident and
Pinnacle extending over thousands of such transactions, Provident was
essentially a party to the mortgage lending transactions and thus, by
definition, cannot claim HDC status in the negotiable papers which
resulted from those transactions, especially because Provident gained
knowledge of defenses before its own role in the original mortgage
lending transaction was complete.
I affirm the Bankruptcy Court's ruling that Provident is not the HDC of
these notes and mortgages. In so holding, I need not, and thus do not,
reach the issue of whether Provident constructively possessed the notes
and mortgages,[fn9] for holder status is irrelevant if Provident did nottake in good faith and without knowledge of defenses. Because I find that
the Bankruptcy Court's ruling that Provident did not take in good faith
was not clearly erroneous, I affirm the ruling that Provident is not
entitled to the protections afforded to a holder in due course.
The Bankruptcy Court correctly stated the law on good faith in this
context: the test for good faith is "not one of negligence of duty to
inquire, but rather it is one of willful dishonesty or actual knowledge."
Valley Bank & Trust Co. v. American Utilities, Inc., 415 F. Supp. 298,
301 (E.D.Pa. 1976). See also Mellon Bank v. PasqualisPoliti,
800 F. Supp. 1297, 1302 (W.D.Pa. 1992), aff'd, 990 F.2d 780 (3d Cir.1993); Carnegie Bank v. Shalleck, 606 A.2d 389, 394 (N.J.Super.Ct.A.D. 1992); General Inv. Corp. v. Angelini, 278 A.2d 193 (N.J. 1971).Good faith may be defeated only by actual knowledge or a deliberate
attempt to evade knowledge. Rice v. Barrington, 70 A. 169, 170 (N.J. E. &
A 1908). "There is no affirmative duty of inquiry on the part of one
taking a negotiable instrument, and there is no constructive notice from
the circumstances of the transaction, unless the circumstances are so
strong that if ignored they will be deemed to establish bad faith on the
part of the transferee." Bankers Trust Co. v. Crawford, 781 F.2d 39, 45(3d Cir. 1986). Moreover, an HDC must take not only in good faith, but
also without notice of defenses to the instrument or document. One has
"notice" when
(1) he has actual knowledge of it;
(2) he has received a notice or notification of it; or
(3) from all the facts and circumstances known to him
at the time in question he has reason to know that it
exists.
Pa. Cons. Stat. Ann. § 1201.
The Bankruptcy Court here found that Provident did not in fact have
actual knowledge of the fraud or potential defense of failure of
consideration at the time of each separate closing. (Opinion at 58.) The
Bankruptcy Court also found that despite the fact that Provident failed
to review Pinnacle's books, records, and checking account ledger, failed
to notice the overdraft problem, failed to properly monitor withdrawals,
and failed to act after knowledge of financial deterioration in default
in providing timely audited financial statements, the appellees had not
proved that Provident acted with willful dishonesty (id.); Provident did
act with negligence or gross negligence, but gross negligence alone is
not enough to defeat an HDC's title. See Washington & Canonsburg Ry. Co.
v. Murray, 211 F. 440, 445 (3d Cir. 1914); General Inv. Corp.,
278 A.2d 193. Moreover, the Bankruptcy Court correctly noted that holderin due course status is generally created at the time that the claimant
becomes a holder — meaning at the time of negotiation. N.J.S.A.
12A:3302; Sisemore v. Kierlow Co., Inc. v. Nicholas, 27 A.2d 473, 478(Pa.Super.Ct. 1942). In transactions such as the ones at issue here which
involve blank endorsements, the instruments and documents are bearer
paper and are thus negotiated upon delivery alone. 13 Pa. Cons. Stat.
Ann. § 3201; N.J.S.A. 12A:3201.
Nonetheless, the Bankruptcy Court found that Provident failed to attain
the status of a holder in due course. It acknowledged that once a party
establishes its position as a holder in due course, no future action can
undermine that status; so in the usual transaction with negotiable bearer
paper, actual knowledge of defenses gained after possession do not defeat
HDC status. (Opinion at 63.) See Bricks Unlimited, Inc. v. Agee,
672 F.2d 1255, 1259 (5th Cir. 1982); Park Gasoline Co. v. Crusius,158 A. 334 (N.J. 1932). However, the Bankruptcy Court said, it was not
finding lack of good faith after gaining HDC status, but rather that
Provident did not gain HDC status in the first place, for these were not
the "usual" transactions. Taken in a "global sense," the Bankruptcy Court
said, these transactions did not end until after the settlements.
(Opinion at 58.)
Usually, one who takes a negotiable instrument for value has only the
underlying circumstances of that transaction by which to determine if
there is reason to give pause as to the veracity of that instrument. A
lender provides funds to a borrower who executes a promissory note. Once
that transaction is complete, the lender transfers the note to a second
lender in exchange for which the first lender receives funds replenishing
his account and enabling him to lend the same funds to another borrower.
HDC status is given to that second lender if it acts in good faith and
without knowledge of defenses, and there is no general duty for that
second lender to inquire unless the circumstances are so suspicious that
they cannot be ignored. See, e.g. Triffin, 670 A.2d at 692. In the usualHDC transaction, there are two discernible transactions, two exchanges of
funds and notes. As the Bankruptcy Court pointed out, the purpose of
giving that second lender HDC status is "to meet the contemporary needs
of fast moving commercial society . . . (citation omitted) and to enhance
the marketability of negotiable instruments [allowing] bankers, brokers
and the general public to trade in confidence." Triffin,
670 A.2d at 693. However, "the more the holder knows about the underlyingtransaction, and particularly the more he controls or participates or
becomes involved in it, the less he fits the role of a good faith
purchaser for value; the closer his relationship to the underlying
agreement which is the source of the note, the less need there is for
giving him the tensionfree rights necessary in a fastmoving,
creditextending commercial world." Unico v. Owen, 50 N.J. 101, 109110 (1967). See also Jones v. Approved Bancredit Corp., 256 A.2d 739, 742(Del. 1969) (in such a situation, "[the financer] should not be able to
hide behind `the fictional fence' of the . . . UCC and thereby achieve an
unfair advantage over the purchaser.").
Here, there were not two separate, discernible transactions.
Provident's funding of Pinnacle who funded the borrowers was one complex
transaction. The acts of a third party investor who would buy the notes
and mortgages from Provident would have been the second separate,
discernible transaction here. Provident did not replenish Pinnacle's
account in exchange for receiving the notes and mortgages, such that
Pinnacle would have more money to make more loans, as in the "usual"
transaction. Rather, in a complex and longstanding scheme encompassing
thousands of transactions over several years, Provident gave Pinnacle a
line of credit, and then, after Pinnacle gave Provident information about
individual proposed loans to borrowers, Provident transferred money to
Pinnacle's account, in order to later receive the note and mortgage from
each transaction and pass them on to a third party investor. The
Bankruptcy Court, as a factual matter, found that under this complex
scheme, no transactions between any of the parties were complete until
both of the transactions were concluded, particularly because the "second
lender" (Provident) had the ultimate control over the first transaction
(by ordering the dishonor of Pinnacle's checks).[fn10]
I cannot say that the Bankruptcy Court's factual finding was clearly
erroneous. The Bankruptcy Court's ruling accords with the evidence as
well as with the policy underlying the holder in due course doctrine. I
hold that where a warehouse lender so closely participates in the funding
and approval of mortgages which will ultimately lead to the warehouse
lender's rights in mortgages and promissory notes that the transactions
between mortgage banker and mortgagor and between warehouse lender and
mortgage banker are in fact one continuous transaction, rather than two
discernible transactions, a showing of the warehouse lender's lack of
good faith after the closing between title agent and mortgagor but before
the mortgage banker's check is presented to the warehouse lender may
destroy HDC status. Indeed, where the party who claims HDC status was in
essence a party to the original transaction, it cannot, by definition, be
a holder in due course.
Provident had a great deal of involvement in the ongoing series of
transactions and ample knowledge of Pinnacle's overall financial
wellbeing, developed through years of funding Pinnacle's credit line for
thousands of such transactions and receipt of Pinnacle's periodic
financial reports. It had particular information about the borrowers
before it funded these loans. It was, in fact, part of the loan
transactions, and not a separate party who became an HDC through the
giving of value at a second separate, discernible transaction. Provident
had too much control of, participation in, and knowledge of the
underlying transaction to claim that it was a good faith purchaser for
value. See, e.g., Fidelity Bank Nat'l Assoc., 740 F. Supp. at 239.
Because, under this complex transactional scheme, Provident functioned
essentially as a party which approved and funded the loans and gained
actual knowledge of a defense to the notes and mortgages (lack of
consideration) before the transactions were complete, it was not clearly
erroneous for the Bankruptcy Court to find that Provident lacked the good
faith necessary to claim HDC status. Accordingly, the Bankruptcy Court's
ruling is affirmed.
VI. CONCLUSION
For the foregoing reasons, I will affirm the Bankruptcy Court's ruling
that appellant Provident Savings Bank was not the holder in due course of
the notes and mortgages from the ten transactions closed by appellees.
The defense of failure of consideration thus is available against
Provident. I therefore affirm the Bankruptcy Court's judgment that
appellees, and not appellant, are entitled to the notes and mortgages. The
accompanying Order is entered.
ORDER
This matter having come upon the court upon the appeal of appellant,
Provident Savings Bank, from a Judgment entered on December 17, 1997, by
the Honorable Judith H. Wizmur, United States Bankruptcy Judge for the
District of New Jersey,; and the Court having considered the parties'
submissions; and for the reasons set forth in the Opinion of today's
date;
IT IS this day of December, 1998, hereby
ORDERED that the Judgment entered by the Honorable Judith H. Wizmur,
United States Bankruptcy Judge for the District of New Jersey, on
December 17, 1997, which granted the notes and mortgages from
transactions closed by the appellees in this matter to the appellees,
be, and hereby is, AFFIRMED.
[fn1] The appellant's cause of action against defendant William E. Ward
was removed to state court in Delaware upon motion on the basis of
abstention pursuant to 28 U.S.C. § 1334(c) where it is now pending.The appellant's cause of action against Meridian Bank was resolved prior
to trial pursuant to the Stipulation of Settlement with respect to Count
II of the Complaint, filed on July 16, 1996. All claims between the
appellant and Lawyers Title Insurance Corporation were mutually dismissed
at trial.
[fn2] The Agreement said $10 million, but at times up to $12.5 million
was advanced.
[fn3] It is a wellestablished law that appellate courts may not pass
upon an issue not presented in a lower court. Singleton v. Wulff,
428 U.S. 106, 120 (1976). The same holds true for a U.S. District Courtsitting in its appellate capacity over matters appealed from the
bankruptcy court. See Barrett v. Commonwealth Fed. Sav. and Loan Ass'n,
939 F.2d 20 (3d Cir. 1991); In re Middle Atlantic Stud Welding Co.,
503 F.2d 1133, 1134 n. 1 (3d Cir. 1974). Because Provident never raisedthis issue before the Bankruptcy Court, I will not consider it now.
[fn4] The res judicata doctrine prevents relitigation of claims that grow
out of a transaction or occurrence from which other claims have earlier
been raised and decided validly, finally, and on the merits. Federated
Department Stores v. Moitie, 452 U.S. 394, 298 (1981). Under Pennsylvanialaw, default judgments, absent fraud, are afforded res judicata effect.
In re Graves, 156 B.R. 949, 954 (E.D.Pa. 1993), aff'd, 33 F.3d 242 (3dCir. 1994). On December 21, 1994, the Court of Common Pleas of Berks
County, Pennsylvania, entered default judgments against Provident on both
the Weaver and Fisher transactions, those transactions for which Pioneer
was the closing agent. Due to these default judgments, the doctrine of
res judicata bars relitigation of the Pioneer causes of action. The
Bankruptcy Court also held that the Andreuzzi transaction was barred by
res judicata or collateral estoppel because of the lis pendens. That,
however, is a more difficult issue and one that I need not reach now, as
my affirmance of the Bankruptcy Court's judgment applies equally to the
Andreuzzi transaction on the merits.
[fn5] At trial and in its briefs to this Court, as an alternative to its
holder in due course argument, Provident argued that it was protected by
the Pennsylvania Uniform Fiduciaries Act, 7 Pa. Cons. Stat. § 6361,
and the New Jersey Uniform Fiduciaries Law, N.J.S.A. 3B:1454, theprovisions of which are substantially similar. The two laws protect a
person who transfers money to a fiduciary in good faith, by noting that
"any right or title acquired from the fiduciary in consideration of such
payment or transfer is not invalid in consequences of a misapplication by
the fiduciary." 7 Pa. Cons. Stat. § 6361; N.J.S.A. 3B:1454. TheBankruptcy Court held that Pinnacle was not Provident's agent or
fiduciary, and thus the UFA did not apply. (Opinion at 66.) In light of
the fact that Provident's counsel, at oral argument before this Court on
November 13, 1998, themselves argued that Pinnacle was not Provident's
fiduciary, I will affirm this aspect of the Bankruptcy Court's ruling
without need to examine the factual bases on which it relied.
[fn6] The rest of this Opinion is limited to the eight transactions not
handled by Pioneer, since only the Pioneer transactions are bound by res
judicata.
[fn7] As Part V of this Opinion explains, one of the several bases for
the Bankruptcy Court's decision that Provident is not the HDC of the
mortgages and notes is that the settlement agents were not Provident's
agents, and thus Provident did not constructively possess the mortgages
and notes prior to gaining knowledge of claims or defenses on those
notes. (Opinion at 3453.) In the alternative, in case appellate courts
determined that Provident was the HDC of those notes because an agency
relationship did exist, the Bankruptcy Court held that the closing
agents, and not Provident, would still be the ones entitled to the notes
and mortgages, for the agents would have had a right to indemnification
from Provident. (Id. at 6364.) Though, as I explain in Part V, I do not
reach the agency issue, I do affirm the Bankruptcy Court's HDC ruling on
other grounds. In doing so, I am affirming the decision that the
appellees, and not Provident, are entitled to the notes and mortgages. The
Bankruptcy Court's indemnification ruling is just an alternative reason
for finding that the appellees are entitled to the notes and mortgages.
Having already agreed that the closing agents are so entitled because
Provident is not an HDC, there is no need to address that alternative
ruling upon appeal.
[fn8] Seven of the eight remaining transactions here are governed by
Pennsylvania law. The eighth is under New Jersey law, but the two states'
laws on HDC status are largely consistent on the issues raised in these
proceedings.
[fn9] The Bankruptcy Court agreed that authority from other jurisdictions
suggest that a party may become a constructive holder when its agent
takes possession of a negotiable instrument on its behalf. (Opinion at
3637.) However, the Bankruptcy Court made the factual finding that
appellees were not Provident's agents. It determined that though six of
the ten transactions involved written agency agreements, those agreements
were not controlling in light of the course of dealing between the
parties (Opinion at 46), and that Provident did not otherwise meet its
burden of establishing that an agency relationship existed. Because I
find that the Bankruptcy Court's determination that Provident did not act
in good faith is not clearly erroneous, and because the lack of good
faith alone is enough of a basis to sustain a judgment that Provident is
not an HDC of these eight notes and mortgages, I need not address whether
the agency determination was clearly erroneous.
[fn10] Under the Bankruptcy Court's findings of fact, Provident was, in
reality, a party to the original transaction. The situation is somewhat
analogous to a consumer goods financer who has a substantial voice in the
underlying transaction; that financer is not entitled to HDC status.
Westfield Investment Co. v. Fellers, 181 A.2d 809 (N.J.Super.Ct. LawDiv.). Provident had a substantial voice in providing and carrying out
funding of the underlying borrowing transactions, and it thus cannot
claim that it was a good faith HDC when it learned of the defense of
failure of consideration prior to dishonoring the Pinnacle checks.
Loislaw Federal District Court Opinions
Copyright © 2013 CCH Incorporated or its affiliates
IN RE PINNACLE MORTGAGE INVESTMENT CORPORATION, (D.N.J. 1998)
IN RE PINNACLE MORTGAGE INVESTMENT CORPORATION, Debtor
PROVIDENT SAVINGS BANK, a New Jersey Banking Corporation,
Plaintiff/Appellant, v. PINNACLE MORTGAGE INVESTMENT CORPORATION, a
Pennsylvania Corporation, et al., Defendants, SETTLERS ABSTRACT CO., L.P.,
LAWYERS TITLE INSURANCE CORP., LAND TRANSFER CO, INC., FIDELITY NATIONAL
TITLE INSURANCE CO. OF PENNSYLVANIA, GINO L. ANDREUZZI, PIONEER AGENCY II
CORP. t/a PIONEER AGENCY, MUSSER & MUSSER, WILLIAM E. WARD, QUAKER ABSTRACT
CO., and SEARCHTEC ABSTRACT, INC., Appellees.
CIVIL NO. 980489 (JBS), [Bankruptcy Case No. 9510608 (JHW)], [Adv.
Proc. No. 951091]
United States District Court, D. New Jersey.
Filed: December 9, 1998
Walter E. Thomas, Jr., Esq., Timothy J. Matteson, Esq., Mark A. Trudeau,
Esq., Stern, Lavinthal, Norgaard & Kapnick, Esqs., Englewood, New Jersey,
Attorneys for Appellant.
Edward J. Hayes, Esq., Andrea Dobin, Esq., Fox, Rothschild, O'Brien &
Frankel, Princeton Pike Corporate Center, Lawrenceville, New Jersey,
Attorneys for Appellees, Settlers Abstract Co., L.P., Land Transfer Co,
Inc., Fidelity National Title Insurance Co. of Pennsylvania, Gino L.
Andreuzzi, Pioneer Agency II Corp. t/a Pioneer Agency, Musser & Musser,
Quaker Abstract Co, and Searchtec Abstract, Inc.
OPINION
SIMANDLE, District Judge.
I. INTRODUCTION
Provident Savings Bank appeals from a Judgment entered on December 17,
1997, pursuant to a written opinion issued on November 19, 1997, by the
Honorable Judith H. Wizmur, United States Bankruptcy Judge, after trial
in an adversary proceeding. That Opinion ruled in favor of the
Appellees, Settlers Abstract Co., L.P., Land Transfer Co, Inc., Fidelity
National Title Insurance Co. of Pennsylvania, Gino L. Andreuzzi, Pioneer
Agency II Corp. t/a Pioneer Agency, Musser & Musser, Quaker Abstract Co,
and Searchtec Abstract, Inc. ("title agents"). Reviewing a longstanding
complex lending relationship between Provident and the debtor, Pinnacle
Mortgage Corporation, of which the ten real estate mortgage loans at
issue herein were a part, the Bankruptcy Court held that appellee title
agents (who had advanced their own funds to cover disbursements when
Provident dishonored Pinnacle's checks) had a more valid or higher
priority security interest in the promissory notes and mortgages executed
as part of ten separate residential real estate closing than did
appellant. Provident Savings Bank appeals this ruling and seeks this
Court's determination that it was the holder in due course of those
documents.
The principal issue to be decided is whether the Bankruptcy Court
correctly determined under the Uniform Commercial Code that Provident was
not a holder in due course of the promissory notes arising from these
loans, where it found that Provident so closely participated in the
funding and approval of the Pinnaclebrokered loans that the transaction
did not end at the closing with the title agents, such that Provident did
not attain holder in due course status because it did not fit the
requisite role of a "good faith purchaser for value." For the reasons
that will be stated herein, the judgment will be affirmed because the
Bankruptcy Court's finding that Provident never attained HDC status was
neither clearly erroneous nor contrary to law.
II. BACKGROUND
A. Procedural History
This case arises from a dispute over the various security interests in
mortgage documents from ten separate real estate transactions in late
October, 1994, conducted by the debtor, Pinnacle Mortgage Investment
Corporation (who brokered the transactions), the appellant (who financed
the transactions), and the appellees (who were title closing agents in
the transactions). On February 2, 1995, appellant Provident Savings Bank
("Provident") and other creditors filed an involuntary petition under
Chapter 7 of Title 11 of the Bankruptcy Code against Pinnacle Mortgage
Investment Corporation ("Pinnacle"). An order for relief under Chapter 7
was entered by the Bankruptcy Court on March 6, 1995.
On March 24, 1995, Provident commenced this adversary proceeding by
filing a three count complaint to determine the extent, validity, and
priority of the various security interests asserted by Pinnacle, Meridian
Bank, Lawyers Title Insurance Corporation, the appellees, and William E.
Ward with regard to the promissory notes and mortgages from ten real
estate transactions.[fn1] Appellees responded to the complaint by filingan answer, counterclaims, and crossclaims, seeking money judgments in
the amount of the contested notes and mortgages, interest, cost of suit,
and attorneys fees; imposition of a constructive trust in their favor
with regard to the notes, mortgages, and proceeds thereof; and to have
the subject notes and mortgages avoided and stricken in favor of
subsequently executed mortgages between the appellees and the
mortgagors. Provident twice amended its complaint, finally seeking a
declaratory judgment that it is the holder in due course of the subject
notes and mortgages under the Uniform Commercial Code; avoidance of the
preferential transfer by appellee Andreuzzi pursuant to 11 U.S.C. § 547and 550; avoidance of the fraudulent transfer by appellee Andreuzzipursuant to §§ 548 and 550; and avoidance of the preferential and
fraudulent transfers by appellees pursuant to 11 U.S.C. § 547, 548,and 550.
Trial in this matter was held on July 16, 17, and 18, 1996, and October
1, 3, and 4, 1996. At the close of Provident's case in chief, upon motion
by the appellees, all of those portions of the Second Amended Complaint
which did not pertain to Provident's status as a holder in due course
("HDC") were dismissed.
B. The Factual History
In its November 19, 1997 opinion, the Bankruptcy Court determined that
the facts of the case are as follows. Debtor Pinnacle Mortgage Investment
Corporation ("Pinnacle" or "debtor") was a mortgage banker which
primarily dealt in residential mortgage lending and refinance. In December
of 1992, Pinnacle and Provident Savings Bank ("Provident" or "appellant")
entered into a Mortgage Warehouse Loan and Security Agreement
("Agreement"), whereby Provident would fund Pinnacle, who in turn funded
retail customers who sought to purchase or refinance residential real
estate. The borrower in each transaction would give Pinnacle a note and
mortgage, both of which acted as collateral to protect Provident until
Pinnacle sold the mortgage to a third party investor, such as the Federal
Home Loan Mortgage Corporation ("Freddie Mac"), who satisfied Pinnacle's
debt to Provident. Warehouse Agreement § 3.4.
1. The Warehouse Agreement
Under these types of agreements, there would usually not be any contact
between the warehouse lender and the ultimate mortgagor. Typically,
Pinnacle would arrange with a prospective borrower for Pinnacle to
advance funds for the borrower to purchase or refinance a home and for
the borrower to assign a note and mortgage to Pinnacle as collateral. The
mortgage would be endorsed in blank in order to accommodate the final
third party investor (such as Freddie Mac), with whom Pinnacle would
arrange to purchase the mortgage, usually as a part of a pool of
mortgages; this was known as a "takeout" agreement. All of this
completed, Pinnacle would submit a "package" to Provident seeking funding
for the particular transaction under its $10 million line of credit.[fn2]This package included a description of the borrower and the funding, an
assignment of the mortgage endorsed in blank, a takeout commitment, and
an agency agreement that indicated the borrower's attorney's agreement
"to act as the agent of the Bank" to disburse the Advance and to obtain
due execution and delivery to the bank of the original note that
evidences the debt underlying the Mortgage Loan." Warehouse Agreement
§ 5.3(A)(iii). The Agreement required all of this to be submitted
along with the initial funding request. As a matter of course, however,
the agency agreement was usually executed by the title agent handling the
closing instead of by the borrower's attorney, and Provident customarily
accepted the mortgage assignment and agency agreement after the actual
closing.
After Provident received the package and checked to see that Pinnacle's
credit limit had not been exceeded (although, as stated above, often
prior to receipt of the mortgage assignment and agency agreement),
Provident credited Pinnacle's checking account with 98% of the requested
funds. Warehouse Agreement §§ 1.1, 2.1. Pinnacle would write a
regular, uncertified check to the closing agent, who would close the loan
directly with the borrower on Pinnacle's behalf. Pinnacle was supposed to
use specific funds credited to their account to fund specific closings,
but no controls were in place to make sure that Pinnacle actually did
so.
With Pinnacle's check in hand, the closing agent would use money from
its own bank account to disburse funds to the mortgagor, later
replenishing its bank account by depositing Pinnacle's check. Next, the
closing agent would routinely send the original note, a certified copy of
the recorded mortgage, and the other closing documents to Pinnacle, who
would send them on to Provident, who would receive this original note
approximately three to five days after closing. Provident and the
borrowers had no contact; indeed, Provident and the closing agents had no
contact, save the extremely limited contact by the closing agents who did
return the agency agreement included in the borrowing package. Not all
closing agents did return the agreement signed; most of those who did
sent everything through Pinnacle to go to Provident, in accordance with
Pinnacle's written instructions, rather than remitting the note and other
papers directly to Provident, as stated in the agency agreement.
Ultimately, Provident would send the note and accompanying documents to
the third party investor, who would pay Provident the funds which
Provident had originally placed in Pinnacle's checking account by wiring
monies to Provident in Pinnacle's name. Because the third party investor
would send multiple payments in each wire transfer, Pinnacle would tell
Provident to which loans to apply each of the funds.
2. Pinnacle's Declining Financial State
Among the twenty or so warehouse customers that Provident had during
19931994, Pinnacle was the most profitable for Provident, providing
hundreds of millions of dollars in loan transactions. However, when the
mortgage banking industry suffered a decline in business, Pinnacle began
to experience financial difficulties as well.
The Warehouse Agreement, § 6.11, required Pinnacle to submit
unaudited balance sheets and statements of income to Provident on a
quarterly basis, though Pinnacle customarily provided monthly
statements. The statements filed for June, July, and August of 1993
reflected an accrued pretax income for the first three months of the
fiscal year of $281,351. Statements for September, October, and November
of 1993 reflected pretax income of $923,923 for the first six months of
the fiscal year. However, after the November 30 report, Pinnacle began to
send its reports quarterly, which was in accordance with the Warehouse
Agreement but which was nonetheless unusual due to Pinnacle's custom of
submitting reports monthly. The next report, covering the ninemonth
period ending February 28, 1994, was due on April 15 but not received
until some time in May. It showed pretax income of $136,000 for the
first nine months, or an $800,000 loss in the previous three months. The
accompanying unaudited balance sheets showed a reduction of assets from
$40 million to $28 million in those three months. The final financial
statement was due on August 31, 1994, but Provident never received it.
At a holiday party in May 1994, Edmund R. Folsom, head of Provident's
Commercial Lending Department, had learned that Pinnacle had sustained
losses in the winter months. On August 19, 1994, Sharon Kinkead, of
Provident's Warehouse Lending Department, called Pinnacle's headquarters
and learned from Pinnacle's CFO, Joseph Mader, that there would be a
delay in the submission of the audited financial statements for the
fiscal year ending May 31, 1994 because of a change of comptroller, but
that the report would be provided by September 15, 1994. That report
never arrived, and no other financial statements were received up until
Provident's termination of its relationship with Pinnacle in early
November 1994.
3. Provident's Relationship with Pinnacle
Throughout its relationship with Pinnacle, Provident routinely honored
overdrafts on behalf of Pinnacle — about twenty times in 1993 and
fifteen times in 1994. These overdrafts ranged from $7,240.87 to
$5,255,812.
When a check was presented to the bank on Pinnacle's account for which
Pinnacle had insufficient funds, Sharon Kinkead would contact Pinnacle to
ask whether Pinnacle would honor that overdraft. Having been told that
the check would be covered (usually from an anticipated wire transfer),
Kinkead and her supervisor, Mr. Folsom, would honor it and allow the
overdraft. Until November 1994, Provident honored all of Pinnacle's
overdrafts, without reviewing Pinnacle's books and records or monitoring
its checking account.
As mentioned earlier, Pinnacle's CFO, Joseph Mader, had informed
Provident that its final fiscal year report would be forthcoming on
September 15, 1994. When Provident did not receive the audited reports by
that date, Mr. Folsom spoke with Mr. Mader, who reported that though
Pinnacle had sustained losses, it was expecting a substantial infusion of
capital. Pinnacle wanted to hold off publishing the report so that it
could add a footnote explaining that there would be a capital infusion.
Based on this, Folsom decided to extend Pinnacle's credit line through
the end of November.
Folsom called Mader some time in October to check on the status of the
report. When Mader returned the call on November 1, he informed Folsom
that the capital infusion had failed. Folsom demanded a meeting with
Pinnacle's officers.
On November 2, Folsom and Kinkead met with Mader and Al Miller,
President of Pinnacle. Mader and Miller presented internally generated
financial statements indicating a pretax loss of six million dollars for
the previous fiscal year, as well as a pretax loss of almost one million
dollars for the first quarter of the current fiscal year. Miller and
Mader admitted that they had misused their warehouse credit line with
G.E. Capital Mortgage Services, Inc., to whom they were indebted for
about six million dollars. They "admitted fraud" as to G.E., but
indicated that they had not misappropriated the Provident funds and asked
for an extension of funding of their loans while they financially
reorganized. Provident declined to do so.
At that time, Provident finally reviewed Pinnacle's books and
discovered that Pinnacle had been diverting substantial sums of money
from Pinnacle's Provident account to its operating account at Meridian
Bank. Kinkead and Folsom also learned that Pinnacle had been requesting
advances on loans earlier than was routinely requested, possibly using
the money that was supposed to be for specific loans for other purposes
instead. Indeed, Pinnacle was engaging in a "kiting" scheme,
misappropriating monies from third party investors that should have been
applied to previously funded loans. A Pinnacle employee told Kinkead that
the Provident line was not "whole," that as much as $500,000 may have
been taken from it, though no fraudulent loans had been made.
As of November 2, 1994, all checks presented to Provident on Pinnacle's
account had been processed, and the customer balance summary showed an
overdraft of $206,653.67. On November 3, $830,127.48 was deposited in
Pinnacle's account. Sixteen checks totaling $1,584,041.63 were presented
to Provident against Pinnacle's account on November 3. There were
insufficient funds to cover all sixteen, so Folsom sent a letter to
Miller, Pinnacle's president, to ask which checks should be paid. At the
time, Provident knew that all sixteen of those checks represented monies
that Pinnacle had delivered to borrowers and closing agents for
particular loans, as well as that each transaction was accompanied by a
takeout commitment by a third party investor, who would have paid for
the loan.
Miller indicated that six of the checks could be paid. Provident
debited $863,821 to pay off eight loans on November 4, and other checks
were paid at Mader's instruction. There was an overdraft on that date of
$178,303.73, and Provident honored no more checks. The remaining ten of
the sixteen checks presented on November 3 were dishonored, and those are
the subject of the instant litigation.
4. The Ten Transactions
Prior to the closings in each of the ten transactions in question,
Pinnacle had requested from Provident — and received — monies
to fund the transactions. As usual, Pinnacle presented the closing agent
with an uncertified check drawn on its account at Provident representing
payment for the note and mortgage to be executed by the borrower,
purchaser, or refinancer of the property. With Pinnacle's check in hand,
the closing agents closed each transaction, issuing checks from their own
accounts to the parties entitled to receive funds. The closing agents
then deposited Pinnacle's checks in their own accounts, and their banks
presented those checks to Provident for payment. In each case, Provident
dishonored the checks due to insufficient funds. After each closing, but
before the discovery of any problem, each closing agent returned the
original note to Pinnacle. Several closing agents recorded the mortgage
and sent Pinnacle certified copies. Despite the fact that Pinnacle's
checks were not honored, each closing agent honored their own checks when
they were presented.
At the time, uncertified funds were routinely accepted from mortgage
bankers, with a few exceptions for out of state lenders, ignoring the
Pennsylvania statute which required mortgage bankers and brokers to
certify funds. Most mortgage lenders such as Pinnacle insisted on
acceptance of regular checks; title insurers could not stay in business
if they did not follow the standard in the industry.
As was usual for these transactions, Provident had no contact with any
of the closing agents prior to settlement. Agency agreements were
included in most, but not all, of the instruction packages sent by
Pinnacle to the respective closing agents. The agreement provided that
Provident had a security interest in the note and mortgage; moreover, it
provided that the closing agent would act as Provident's agent in
connection with the loan transaction, agreeing to record the mortgage and
then to send both the original note and the original recorded mortgage to
Provident upon closing. The text of the agreement conflicted with the
closing instructions that Pinnacle gave to the closing agents, which
required the note to be returned to Pinnacle. In six of the ten
transactions, the agreement was executed, but its provisions were
basically ignored, as the closing documents were returned directly to
Pinnacle.
The closing agents learned of the dishonor from their own banks.
Provident did not attempt to contact the closing agents until November
10, 1994, when they sent a letter with instructions to deliver to
Provident all notes, mortgages, loan files, and other collateral, and any
monies received in connection with each mortgage loan.
Several of the agents sought judicial relief. Two of the closing agents
who are appellees in this matter, Gino L. Andreuzzi and the Pioneer
Agency L.P., hold state court judgments in their favor, for a total of
three judgments against Pinnacle, striking the mortgages and notes
executed by their respective buyers in favor of Pinnacle. Andreuzzi, the
closing agent in the Hopeck settlement, filed suit against Pinnacle in
the Court of Common Pleas of Luzerne County, Pennsylvania, seeking a TRO
to keep Pinnacle from selling, transferring, or assigning the note and
mortgage in question. Provident was not joined in Andreuzzi's case, but
it did have notice of the litigation. Andreuzzi filed a lis pendens with
the Prothonotary on November 14, 1994. About three hours after the lis
pendens was filed, Provident recorded the assignment from the Hopeck
note. Ultimately, a default judgment was entered against Pinnacle.
Pioneer also filed suits in connection with the Weaver and Fisher
transactions. In both cases, Pioneer sued Pinnacle and Provident in the
Court of Common Pleas of Berks County, Pennsylvania, on November 14,
1994. A preliminary injunction was entered on November 22, and a default
judgment was entered against both defendants on December 21, 1994. Two
days later, Pinnacle moved to open the default judgment. It was still
pending on February 1, 1995 when an involuntary petition was filed against
Pinnacle. Provident removed the action to the Bankruptcy Court on May 8,
1995.
Other closing agents entered into agreements with the borrowers to
execute new notes and mortgages. By the time this came before the
Bankruptcy Court, the mortgages had either been satisfied in full, with
proceeds held in escrow, or payments on the new mortgages and notes were
being made by the borrowers to the closing agents in escrow pending the
resolution of this matter.
C. The Bankruptcy Court's Findings and Judgment
On November 19, 1997, the Bankruptcy Court issued its Opinion in favor
of the appellees, ruling that:
(1) the appellant did not achieve the status of an HDC
with regard to the notes and mortgages in issue;
(2) the appellees would be entitled to indemnification
even if an agency relationship existed between the
appellant and appellees;
(3) the Uniform Fiduciaries Law is inapplicable to
validate the appellant's position with regard to the
subject notes and mortgages; and
(4) the appellant is precluded from relitigating the
transactions with appellees Pioneer Agency II Corp
t/a Pioneer Agency and Andreuzzi.
Judgment against Provident was entered on December 17, 1997. On December
22, 1997, appellant filed a notice of appeal from the Judgment. On
February 13, 1998, the record on appeal was transmitted to this Court. As
"nothing remains for the [lower] court to do," Universal Minerals, Inc.
v. C.A. Hughes & Co., 669 F.2d 98, 101 (3d Cir. 1981), the BankruptcyCourt's ruling is final, and thus this Court properly has appellate
jurisdiction over the December 17, 1997 Order pursuant to
28 U.S.C. § 158(a).
III. ISSUES PRESENTED
On appeal, Provident makes six arguments. First, Provident argues that
it is the holder in due course ("HDC") of the ten mortgage notes.
Second, Provident argues that the Bankruptcy Court's ruling that the
appellees were entitled to indemnification if they were Provident's agents
is clearly erroneous. Third, appellant contends that the bankruptcy court
erred in ruling that Provident was not protected by the Uniform
Fiduciaries Act ("UFA"), adopted by both New Jersey and Pennsylvania at
N.J.S.A. 3B:1454 and 7 Pa. Cons. Stat. Ann. § 6361, respectively.Fourth, Provident argues, for the first time upon appeal, that the
doctrine of avoidable consequences bars appellees from recovering any
damages from Provident. Fifth, Provident maintains that the doctrines of
lis pendens, res judicata, and collateral estoppel do not bar
relitigation of these issues as to the Andreuzzi transaction. Finally,
Provident argues that the Bankruptcy Court erred by giving preclusionary
effect to the Pioneer action default judgments.
This Opinion will not address Provident's "avoidable consequences"
argument, as it was raised, for the first time, upon appeal.[fn3]Moreover, the doctrine of res judicata precludes review of the two
transactions for which Pioneer was the closing agent, and I thus affirm
the Bankruptcy Court's judgment as to Pioneer on that ground.[fn4] I willaffirm the Bankruptcy Court's holding that Provident is not entitled to
the protections of the Uniform Fiduciaries Act , especially in light of
the fact that Provident has withdrawn its argument that Pinnacle was its
agent.[fn5] For reasons stated herein, I will affirm the BankruptcyCourt's holding that Provident is not the holder in due course of the
eight[fn6] transactions still in question. Accordingly, there is no needfor this Court to address the Bankruptcy Court's alternate finding that
the closing agents would be entitled to indemnification.[fn7]
IV. STANDARD OF REVIEW
On appeal, the weight accorded to the findings of fact by a bankruptcy
court are governed by Fed.R.Bank.P. 8013, which provides as follows:
On appeal the district court or bankruptcy appellate
panel may affirm, modify, or reverse a bankruptcy
judge's judgment, order, or decree or remand with
instructions for further proceedings. Findings of
fact, whether based on oral or documentary evidence,
shall not be set aside unless clearly erroneous, and
due regard shall be given to the opportunity of the
bankruptcy court to judge the credibility of
witnesses.
Fed.R.Bank.P. 8013. Under this Rule, a bankruptcy court's factualfindings may be disturbed only if clearly erroneous. See FGH Realty
Credit v. Newark Airport/Hotel Ltd., 155 B.R. 93 (D.N.J. 1993). Where a
mixed question of law and fact is presented, the appropriate standard
must be applied to each component. In re Sharon Steel Corp., 871 F.2d 1217,
1222 (3d Cir. 1989). Thus, a reviewing court "must accept the [lower]court's findings of historical or narrative facts unless they are clearly
erroneous, but . . . must exercise a plenary review and its application
of those precepts to the historical facts." Universal Minerals, Inc. v.
C.A. Hughes & Co., 669 F.2d at 103.
While standards for establishing that a party is a holder in due course
are wellsettled law, see, e.g., Triffin v. Dillabough, 448 Pa. Super. 72,
87, 670 A.2d 684, 691 (1996), the Court's application of these standardsto the facts does result in a mixed finding of fact and law that is
subject to a mixed standard of review. Mellon Bank, N.A. v. Metro
Communications, Inc., 945 F.2d 635, 64142 (3d Cir. 1991), cert. denied,
503 U.S. 937 (1992). The factual findings can only be reversed for clearerror, In re Graves, 33 F.3d 242, 251 (3d Cir. 1994), even if thereviewing court would have decided the matter differently. In re
PrincetonNew York Investors, Inc., 1998 WL 111674 (D.N.J. 1998). This
Court, thus, may not overturn a bankruptcy judge's factual findings if
the factual determinations bear any "rational relationship to the
supporting evidentiary data. . . ." Fellheimer, Eichen & Braverman, P.C.
v. Charter Technologies, Inc., 57 F.3d 1215, 1223 (3d Cir. 1995) (citingHoots v. Comm. of Pa., 703 F.2d 722, 725 (3d Cir. 1983). However, thisCourt reviews any legal conclusions de novo.
V. DISCUSSION
Appellant argues that the Bankruptcy Court's finding that appellant is
not an HDC of the promissory notes and mortgages from the eight remaining
real estate transactions closed by appellees is clearly erroneous. The
dispute here is not a dispute of law, as the parties agree on what the
law concerning HDCs is. As the Bankruptcy Court correctly found,[fn8]every holder of a negotiable instrument is presumed to be an HDC, Morgan
Guaranty Trust Company of New York v. Staats, 631 A.2d 631, 636(Pa.Super.Ct. 1993), but when a defense of fraud is meritorious as to the
payee, the holder has the burden of showing that it is an HDC in order to
be immune from that defense. Norman v. World Wide Distributors, Inc.,
195 A.2d 115, 117 (Pa.Super.Ct. 1963). A holder of a negotiableinstrument (such as the promissory notes in this case) is either the
person with possession of bearer paper or the person identified on the
instrument if that person is in possession. 13 Pa. Cons. Stat. Ann.
§ 1201; N.J.S.A. 12A:3201 (West Supp. 1998). The holder of adocument of title (such as the mortgages in this case) is the person in
possession if the document is made out to bearer or to the order of the
person in possession. Id. The holder becomes an HDC if:
(1) the instrument when issued or negotiated to the
holder does not bear such apparent evidence of forgery
or alteration or is not otherwise so irregular or
incomplete as to call into question its authenticity;
and
(2) the holder took the instrument:
(i) for value;
(ii) in good faith;
(iii) without notice that the instrument is
overdue or has been dishonored or that there is an
uncured default with respect to payment of another
instrument issued as part of the same series;
(iv) without notice that the instrument contains
an unauthorized signature or has been altered;
(v) without notice of any claim to the instrument
described in section 3306 (relating to claims to an
instrument); and
(vi) without notice that any party has a defense
or claim in recoupment described in section 3305(a)
(relating to defenses and claims in recoupment).
13 Pa. Cons. Stat. Ann. § 3302. See also N.J.S.A. 12A:3302. Inshort, an HDC is the holder of the instrument or document who took for
value and in good faith without notice of any claims or defects on the
instrument or document. If classified as an HDC, the holder holds without
regard to defenses, with certain statutory exemptions which do not apply
here. 13 Pa. Cons. Stat. Ann. § 3305; N.J.S.A. 12A:3305.
It was clear to the parties and to the Bankruptcy Court below that
Provident did not have actual possession of the notes and mortgages
before November 2, 1998, when it learned that there were insufficient
funds in Pinnacle's account at Provident to cover Pinnacle's checks to
the closing agents here. Provident nonetheless argued that it was the
holder of the notes and mortgages because, before gaining actual
knowledge of Pinnacle's fraud, Provident "constructively possessed" the
notes and mortgages from the moment that the closing agents, who were
allegedly Provident's agents, took possession of the notes at the
closings before November 2.
The Bankruptcy Court rejected Provident's argument, finding that none
of the appellees acted as Provident's agents, and thus Provident never
constructively or actually possessed the notes and mortgages. Thus, the
Bankruptcy Court found that Provident never became the holder of these
notes and mortgages in the first place. (Opinion at 53.) Alternatively,
the Bankruptcy Court found that while Provident did give value for the
notes and mortgages (Opinion at 54), it did not take those notes and
mortgages in good faith and without knowledge of defenses, and thus
Provident is not an HDC. (Opinion at 63.) The question before this Court
is whether the Bankruptcy Court's rulings in this regard were clearly
erroneous. I hold that it was neither clearly erroneous nor contrary to
established law for the Bankruptcy Court to find that Provident did not
fit the role of "good faith purchaser for value" necessary to claim HDC
status even though Provident's lack of good faith arose after the title
agents closed the real estate transactions. As the following discussion
will explain, in the context of a course of dealing between Provident and
Pinnacle extending over thousands of such transactions, Provident was
essentially a party to the mortgage lending transactions and thus, by
definition, cannot claim HDC status in the negotiable papers which
resulted from those transactions, especially because Provident gained
knowledge of defenses before its own role in the original mortgage
lending transaction was complete.
I affirm the Bankruptcy Court's ruling that Provident is not the HDC of
these notes and mortgages. In so holding, I need not, and thus do not,
reach the issue of whether Provident constructively possessed the notes
and mortgages,[fn9] for holder status is irrelevant if Provident did nottake in good faith and without knowledge of defenses. Because I find that
the Bankruptcy Court's ruling that Provident did not take in good faith
was not clearly erroneous, I affirm the ruling that Provident is not
entitled to the protections afforded to a holder in due course.
The Bankruptcy Court correctly stated the law on good faith in this
context: the test for good faith is "not one of negligence of duty to
inquire, but rather it is one of willful dishonesty or actual knowledge."
Valley Bank & Trust Co. v. American Utilities, Inc., 415 F. Supp. 298,
301 (E.D.Pa. 1976). See also Mellon Bank v. PasqualisPoliti,
800 F. Supp. 1297, 1302 (W.D.Pa. 1992), aff'd, 990 F.2d 780 (3d Cir.1993); Carnegie Bank v. Shalleck, 606 A.2d 389, 394 (N.J.Super.Ct.A.D. 1992); General Inv. Corp. v. Angelini, 278 A.2d 193 (N.J. 1971).Good faith may be defeated only by actual knowledge or a deliberate
attempt to evade knowledge. Rice v. Barrington, 70 A. 169, 170 (N.J. E. &
A 1908). "There is no affirmative duty of inquiry on the part of one
taking a negotiable instrument, and there is no constructive notice from
the circumstances of the transaction, unless the circumstances are so
strong that if ignored they will be deemed to establish bad faith on the
part of the transferee." Bankers Trust Co. v. Crawford, 781 F.2d 39, 45(3d Cir. 1986). Moreover, an HDC must take not only in good faith, but
also without notice of defenses to the instrument or document. One has
"notice" when
(1) he has actual knowledge of it;
(2) he has received a notice or notification of it; or
(3) from all the facts and circumstances known to him
at the time in question he has reason to know that it
exists.
Pa. Cons. Stat. Ann. § 1201.
The Bankruptcy Court here found that Provident did not in fact have
actual knowledge of the fraud or potential defense of failure of
consideration at the time of each separate closing. (Opinion at 58.) The
Bankruptcy Court also found that despite the fact that Provident failed
to review Pinnacle's books, records, and checking account ledger, failed
to notice the overdraft problem, failed to properly monitor withdrawals,
and failed to act after knowledge of financial deterioration in default
in providing timely audited financial statements, the appellees had not
proved that Provident acted with willful dishonesty (id.); Provident did
act with negligence or gross negligence, but gross negligence alone is
not enough to defeat an HDC's title. See Washington & Canonsburg Ry. Co.
v. Murray, 211 F. 440, 445 (3d Cir. 1914); General Inv. Corp.,
278 A.2d 193. Moreover, the Bankruptcy Court correctly noted that holderin due course status is generally created at the time that the claimant
becomes a holder — meaning at the time of negotiation. N.J.S.A.
12A:3302; Sisemore v. Kierlow Co., Inc. v. Nicholas, 27 A.2d 473, 478(Pa.Super.Ct. 1942). In transactions such as the ones at issue here which
involve blank endorsements, the instruments and documents are bearer
paper and are thus negotiated upon delivery alone. 13 Pa. Cons. Stat.
Ann. § 3201; N.J.S.A. 12A:3201.
Nonetheless, the Bankruptcy Court found that Provident failed to attain
the status of a holder in due course. It acknowledged that once a party
establishes its position as a holder in due course, no future action can
undermine that status; so in the usual transaction with negotiable bearer
paper, actual knowledge of defenses gained after possession do not defeat
HDC status. (Opinion at 63.) See Bricks Unlimited, Inc. v. Agee,
672 F.2d 1255, 1259 (5th Cir. 1982); Park Gasoline Co. v. Crusius,158 A. 334 (N.J. 1932). However, the Bankruptcy Court said, it was not
finding lack of good faith after gaining HDC status, but rather that
Provident did not gain HDC status in the first place, for these were not
the "usual" transactions. Taken in a "global sense," the Bankruptcy Court
said, these transactions did not end until after the settlements.
(Opinion at 58.)
Usually, one who takes a negotiable instrument for value has only the
underlying circumstances of that transaction by which to determine if
there is reason to give pause as to the veracity of that instrument. A
lender provides funds to a borrower who executes a promissory note. Once
that transaction is complete, the lender transfers the note to a second
lender in exchange for which the first lender receives funds replenishing
his account and enabling him to lend the same funds to another borrower.
HDC status is given to that second lender if it acts in good faith and
without knowledge of defenses, and there is no general duty for that
second lender to inquire unless the circumstances are so suspicious that
they cannot be ignored. See, e.g. Triffin, 670 A.2d at 692. In the usualHDC transaction, there are two discernible transactions, two exchanges of
funds and notes. As the Bankruptcy Court pointed out, the purpose of
giving that second lender HDC status is "to meet the contemporary needs
of fast moving commercial society . . . (citation omitted) and to enhance
the marketability of negotiable instruments [allowing] bankers, brokers
and the general public to trade in confidence." Triffin,
670 A.2d at 693. However, "the more the holder knows about the underlyingtransaction, and particularly the more he controls or participates or
becomes involved in it, the less he fits the role of a good faith
purchaser for value; the closer his relationship to the underlying
agreement which is the source of the note, the less need there is for
giving him the tensionfree rights necessary in a fastmoving,
creditextending commercial world." Unico v. Owen, 50 N.J. 101, 109110 (1967). See also Jones v. Approved Bancredit Corp., 256 A.2d 739, 742(Del. 1969) (in such a situation, "[the financer] should not be able to
hide behind `the fictional fence' of the . . . UCC and thereby achieve an
unfair advantage over the purchaser.").
Here, there were not two separate, discernible transactions.
Provident's funding of Pinnacle who funded the borrowers was one complex
transaction. The acts of a third party investor who would buy the notes
and mortgages from Provident would have been the second separate,
discernible transaction here. Provident did not replenish Pinnacle's
account in exchange for receiving the notes and mortgages, such that
Pinnacle would have more money to make more loans, as in the "usual"
transaction. Rather, in a complex and longstanding scheme encompassing
thousands of transactions over several years, Provident gave Pinnacle a
line of credit, and then, after Pinnacle gave Provident information about
individual proposed loans to borrowers, Provident transferred money to
Pinnacle's account, in order to later receive the note and mortgage from
each transaction and pass them on to a third party investor. The
Bankruptcy Court, as a factual matter, found that under this complex
scheme, no transactions between any of the parties were complete until
both of the transactions were concluded, particularly because the "second
lender" (Provident) had the ultimate control over the first transaction
(by ordering the dishonor of Pinnacle's checks).[fn10]
I cannot say that the Bankruptcy Court's factual finding was clearly
erroneous. The Bankruptcy Court's ruling accords with the evidence as
well as with the policy underlying the holder in due course doctrine. I
hold that where a warehouse lender so closely participates in the funding
and approval of mortgages which will ultimately lead to the warehouse
lender's rights in mortgages and promissory notes that the transactions
between mortgage banker and mortgagor and between warehouse lender and
mortgage banker are in fact one continuous transaction, rather than two
discernible transactions, a showing of the warehouse lender's lack of
good faith after the closing between title agent and mortgagor but before
the mortgage banker's check is presented to the warehouse lender may
destroy HDC status. Indeed, where the party who claims HDC status was in
essence a party to the original transaction, it cannot, by definition, be
a holder in due course.
Provident had a great deal of involvement in the ongoing series of
transactions and ample knowledge of Pinnacle's overall financial
wellbeing, developed through years of funding Pinnacle's credit line for
thousands of such transactions and receipt of Pinnacle's periodic
financial reports. It had particular information about the borrowers
before it funded these loans. It was, in fact, part of the loan
transactions, and not a separate party who became an HDC through the
giving of value at a second separate, discernible transaction. Provident
had too much control of, participation in, and knowledge of the
underlying transaction to claim that it was a good faith purchaser for
value. See, e.g., Fidelity Bank Nat'l Assoc., 740 F. Supp. at 239.
Because, under this complex transactional scheme, Provident functioned
essentially as a party which approved and funded the loans and gained
actual knowledge of a defense to the notes and mortgages (lack of
consideration) before the transactions were complete, it was not clearly
erroneous for the Bankruptcy Court to find that Provident lacked the good
faith necessary to claim HDC status. Accordingly, the Bankruptcy Court's
ruling is affirmed.
VI. CONCLUSION
For the foregoing reasons, I will affirm the Bankruptcy Court's ruling
that appellant Provident Savings Bank was not the holder in due course of
the notes and mortgages from the ten transactions closed by appellees.
The defense of failure of consideration thus is available against
Provident. I therefore affirm the Bankruptcy Court's judgment that
appellees, and not appellant, are entitled to the notes and mortgages. The
accompanying Order is entered.
ORDER
This matter having come upon the court upon the appeal of appellant,
Provident Savings Bank, from a Judgment entered on December 17, 1997, by
the Honorable Judith H. Wizmur, United States Bankruptcy Judge for the
District of New Jersey,; and the Court having considered the parties'
submissions; and for the reasons set forth in the Opinion of today's
date;
IT IS this day of December, 1998, hereby
ORDERED that the Judgment entered by the Honorable Judith H. Wizmur,
United States Bankruptcy Judge for the District of New Jersey, on
December 17, 1997, which granted the notes and mortgages from
transactions closed by the appellees in this matter to the appellees,
be, and hereby is, AFFIRMED.
[fn1] The appellant's cause of action against defendant William E. Ward
was removed to state court in Delaware upon motion on the basis of
abstention pursuant to 28 U.S.C. § 1334(c) where it is now pending.The appellant's cause of action against Meridian Bank was resolved prior
to trial pursuant to the Stipulation of Settlement with respect to Count
II of the Complaint, filed on July 16, 1996. All claims between the
appellant and Lawyers Title Insurance Corporation were mutually dismissed
at trial.
[fn2] The Agreement said $10 million, but at times up to $12.5 million
was advanced.
[fn3] It is a wellestablished law that appellate courts may not pass
upon an issue not presented in a lower court. Singleton v. Wulff,
428 U.S. 106, 120 (1976). The same holds true for a U.S. District Courtsitting in its appellate capacity over matters appealed from the
bankruptcy court. See Barrett v. Commonwealth Fed. Sav. and Loan Ass'n,
939 F.2d 20 (3d Cir. 1991); In re Middle Atlantic Stud Welding Co.,
503 F.2d 1133, 1134 n. 1 (3d Cir. 1974). Because Provident never raisedthis issue before the Bankruptcy Court, I will not consider it now.
[fn4] The res judicata doctrine prevents relitigation of claims that grow
out of a transaction or occurrence from which other claims have earlier
been raised and decided validly, finally, and on the merits. Federated
Department Stores v. Moitie, 452 U.S. 394, 298 (1981). Under Pennsylvanialaw, default judgments, absent fraud, are afforded res judicata effect.
In re Graves, 156 B.R. 949, 954 (E.D.Pa. 1993), aff'd, 33 F.3d 242 (3dCir. 1994). On December 21, 1994, the Court of Common Pleas of Berks
County, Pennsylvania, entered default judgments against Provident on both
the Weaver and Fisher transactions, those transactions for which Pioneer
was the closing agent. Due to these default judgments, the doctrine of
res judicata bars relitigation of the Pioneer causes of action. The
Bankruptcy Court also held that the Andreuzzi transaction was barred by
res judicata or collateral estoppel because of the lis pendens. That,
however, is a more difficult issue and one that I need not reach now, as
my affirmance of the Bankruptcy Court's judgment applies equally to the
Andreuzzi transaction on the merits.
[fn5] At trial and in its briefs to this Court, as an alternative to its
holder in due course argument, Provident argued that it was protected by
the Pennsylvania Uniform Fiduciaries Act, 7 Pa. Cons. Stat. § 6361,
and the New Jersey Uniform Fiduciaries Law, N.J.S.A. 3B:1454, theprovisions of which are substantially similar. The two laws protect a
person who transfers money to a fiduciary in good faith, by noting that
"any right or title acquired from the fiduciary in consideration of such
payment or transfer is not invalid in consequences of a misapplication by
the fiduciary." 7 Pa. Cons. Stat. § 6361; N.J.S.A. 3B:1454. TheBankruptcy Court held that Pinnacle was not Provident's agent or
fiduciary, and thus the UFA did not apply. (Opinion at 66.) In light of
the fact that Provident's counsel, at oral argument before this Court on
November 13, 1998, themselves argued that Pinnacle was not Provident's
fiduciary, I will affirm this aspect of the Bankruptcy Court's ruling
without need to examine the factual bases on which it relied.
[fn6] The rest of this Opinion is limited to the eight transactions not
handled by Pioneer, since only the Pioneer transactions are bound by res
judicata.
[fn7] As Part V of this Opinion explains, one of the several bases for
the Bankruptcy Court's decision that Provident is not the HDC of the
mortgages and notes is that the settlement agents were not Provident's
agents, and thus Provident did not constructively possess the mortgages
and notes prior to gaining knowledge of claims or defenses on those
notes. (Opinion at 3453.) In the alternative, in case appellate courts
determined that Provident was the HDC of those notes because an agency
relationship did exist, the Bankruptcy Court held that the closing
agents, and not Provident, would still be the ones entitled to the notes
and mortgages, for the agents would have had a right to indemnification
from Provident. (Id. at 6364.) Though, as I explain in Part V, I do not
reach the agency issue, I do affirm the Bankruptcy Court's HDC ruling on
other grounds. In doing so, I am affirming the decision that the
appellees, and not Provident, are entitled to the notes and mortgages. The
Bankruptcy Court's indemnification ruling is just an alternative reason
for finding that the appellees are entitled to the notes and mortgages.
Having already agreed that the closing agents are so entitled because
Provident is not an HDC, there is no need to address that alternative
ruling upon appeal.
[fn8] Seven of the eight remaining transactions here are governed by
Pennsylvania law. The eighth is under New Jersey law, but the two states'
laws on HDC status are largely consistent on the issues raised in these
proceedings.
[fn9] The Bankruptcy Court agreed that authority from other jurisdictions
suggest that a party may become a constructive holder when its agent
takes possession of a negotiable instrument on its behalf. (Opinion at
3637.) However, the Bankruptcy Court made the factual finding that
appellees were not Provident's agents. It determined that though six of
the ten transactions involved written agency agreements, those agreements
were not controlling in light of the course of dealing between the
parties (Opinion at 46), and that Provident did not otherwise meet its
burden of establishing that an agency relationship existed. Because I
find that the Bankruptcy Court's determination that Provident did not act
in good faith is not clearly erroneous, and because the lack of good
faith alone is enough of a basis to sustain a judgment that Provident is
not an HDC of these eight notes and mortgages, I need not address whether
the agency determination was clearly erroneous.
[fn10] Under the Bankruptcy Court's findings of fact, Provident was, in
reality, a party to the original transaction. The situation is somewhat
analogous to a consumer goods financer who has a substantial voice in the
underlying transaction; that financer is not entitled to HDC status.
Westfield Investment Co. v. Fellers, 181 A.2d 809 (N.J.Super.Ct. LawDiv.). Provident had a substantial voice in providing and carrying out
funding of the underlying borrowing transactions, and it thus cannot
claim that it was a good faith HDC when it learned of the defense of
failure of consideration prior to dishonoring the Pinnacle checks.
Loislaw Federal District Court Opinions
Copyright © 2013 CCH Incorporated or its affiliates
IN RE PINNACLE MORTGAGE INVESTMENT CORPORATION, (D.N.J. 1998)
IN RE PINNACLE MORTGAGE INVESTMENT CORPORATION, Debtor
PROVIDENT SAVINGS BANK, a New Jersey Banking Corporation,
Plaintiff/Appellant, v. PINNACLE MORTGAGE INVESTMENT CORPORATION, a
Pennsylvania Corporation, et al., Defendants, SETTLERS ABSTRACT CO., L.P.,
LAWYERS TITLE INSURANCE CORP., LAND TRANSFER CO, INC., FIDELITY NATIONAL
TITLE INSURANCE CO. OF PENNSYLVANIA, GINO L. ANDREUZZI, PIONEER AGENCY II
CORP. t/a PIONEER AGENCY, MUSSER & MUSSER, WILLIAM E. WARD, QUAKER ABSTRACT
CO., and SEARCHTEC ABSTRACT, INC., Appellees.
CIVIL NO. 980489 (JBS), [Bankruptcy Case No. 9510608 (JHW)], [Adv.
Proc. No. 951091]
United States District Court, D. New Jersey.
Filed: December 9, 1998
Walter E. Thomas, Jr., Esq., Timothy J. Matteson, Esq., Mark A. Trudeau,
Esq., Stern, Lavinthal, Norgaard & Kapnick, Esqs., Englewood, New Jersey,
Attorneys for Appellant.
Edward J. Hayes, Esq., Andrea Dobin, Esq., Fox, Rothschild, O'Brien &
Frankel, Princeton Pike Corporate Center, Lawrenceville, New Jersey,
Attorneys for Appellees, Settlers Abstract Co., L.P., Land Transfer Co,
Inc., Fidelity National Title Insurance Co. of Pennsylvania, Gino L.
Andreuzzi, Pioneer Agency II Corp. t/a Pioneer Agency, Musser & Musser,
Quaker Abstract Co, and Searchtec Abstract, Inc.
OPINION
SIMANDLE, District Judge.
I. INTRODUCTION
Provident Savings Bank appeals from a Judgment entered on December 17,
1997, pursuant to a written opinion issued on November 19, 1997, by the
Honorable Judith H. Wizmur, United States Bankruptcy Judge, after trial
in an adversary proceeding. That Opinion ruled in favor of the
Appellees, Settlers Abstract Co., L.P., Land Transfer Co, Inc., Fidelity
National Title Insurance Co. of Pennsylvania, Gino L. Andreuzzi, Pioneer
Agency II Corp. t/a Pioneer Agency, Musser & Musser, Quaker Abstract Co,
and Searchtec Abstract, Inc. ("title agents"). Reviewing a longstanding
complex lending relationship between Provident and the debtor, Pinnacle
Mortgage Corporation, of which the ten real estate mortgage loans at
issue herein were a part, the Bankruptcy Court held that appellee title
agents (who had advanced their own funds to cover disbursements when
Provident dishonored Pinnacle's checks) had a more valid or higher
priority security interest in the promissory notes and mortgages executed
as part of ten separate residential real estate closing than did
appellant. Provident Savings Bank appeals this ruling and seeks this
Court's determination that it was the holder in due course of those
documents.
The principal issue to be decided is whether the Bankruptcy Court
correctly determined under the Uniform Commercial Code that Provident was
not a holder in due course of the promissory notes arising from these
loans, where it found that Provident so closely participated in the
funding and approval of the Pinnaclebrokered loans that the transaction
did not end at the closing with the title agents, such that Provident did
not attain holder in due course status because it did not fit the
requisite role of a "good faith purchaser for value." For the reasons
that will be stated herein, the judgment will be affirmed because the
Bankruptcy Court's finding that Provident never attained HDC status was
neither clearly erroneous nor contrary to law.
II. BACKGROUND
A. Procedural History
This case arises from a dispute over the various security interests in
mortgage documents from ten separate real estate transactions in late
October, 1994, conducted by the debtor, Pinnacle Mortgage Investment
Corporation (who brokered the transactions), the appellant (who financed
the transactions), and the appellees (who were title closing agents in
the transactions). On February 2, 1995, appellant Provident Savings Bank
("Provident") and other creditors filed an involuntary petition under
Chapter 7 of Title 11 of the Bankruptcy Code against Pinnacle Mortgage
Investment Corporation ("Pinnacle"). An order for relief under Chapter 7
was entered by the Bankruptcy Court on March 6, 1995.
On March 24, 1995, Provident commenced this adversary proceeding by
filing a three count complaint to determine the extent, validity, and
priority of the various security interests asserted by Pinnacle, Meridian
Bank, Lawyers Title Insurance Corporation, the appellees, and William E.
Ward with regard to the promissory notes and mortgages from ten real
estate transactions.[fn1] Appellees responded to the complaint by filingan answer, counterclaims, and crossclaims, seeking money judgments in
the amount of the contested notes and mortgages, interest, cost of suit,
and attorneys fees; imposition of a constructive trust in their favor
with regard to the notes, mortgages, and proceeds thereof; and to have
the subject notes and mortgages avoided and stricken in favor of
subsequently executed mortgages between the appellees and the
mortgagors. Provident twice amended its complaint, finally seeking a
declaratory judgment that it is the holder in due course of the subject
notes and mortgages under the Uniform Commercial Code; avoidance of the
preferential transfer by appellee Andreuzzi pursuant to 11 U.S.C. § 547and 550; avoidance of the fraudulent transfer by appellee Andreuzzipursuant to §§ 548 and 550; and avoidance of the preferential and
fraudulent transfers by appellees pursuant to 11 U.S.C. § 547, 548,and 550.
Trial in this matter was held on July 16, 17, and 18, 1996, and October
1, 3, and 4, 1996. At the close of Provident's case in chief, upon motion
by the appellees, all of those portions of the Second Amended Complaint
which did not pertain to Provident's status as a holder in due course
("HDC") were dismissed.
B. The Factual History
In its November 19, 1997 opinion, the Bankruptcy Court determined that
the facts of the case are as follows. Debtor Pinnacle Mortgage Investment
Corporation ("Pinnacle" or "debtor") was a mortgage banker which
primarily dealt in residential mortgage lending and refinance. In December
of 1992, Pinnacle and Provident Savings Bank ("Provident" or "appellant")
entered into a Mortgage Warehouse Loan and Security Agreement
("Agreement"), whereby Provident would fund Pinnacle, who in turn funded
retail customers who sought to purchase or refinance residential real
estate. The borrower in each transaction would give Pinnacle a note and
mortgage, both of which acted as collateral to protect Provident until
Pinnacle sold the mortgage to a third party investor, such as the Federal
Home Loan Mortgage Corporation ("Freddie Mac"), who satisfied Pinnacle's
debt to Provident. Warehouse Agreement § 3.4.
1. The Warehouse Agreement
Under these types of agreements, there would usually not be any contact
between the warehouse lender and the ultimate mortgagor. Typically,
Pinnacle would arrange with a prospective borrower for Pinnacle to
advance funds for the borrower to purchase or refinance a home and for
the borrower to assign a note and mortgage to Pinnacle as collateral. The
mortgage would be endorsed in blank in order to accommodate the final
third party investor (such as Freddie Mac), with whom Pinnacle would
arrange to purchase the mortgage, usually as a part of a pool of
mortgages; this was known as a "takeout" agreement. All of this
completed, Pinnacle would submit a "package" to Provident seeking funding
for the particular transaction under its $10 million line of credit.[fn2]This package included a description of the borrower and the funding, an
assignment of the mortgage endorsed in blank, a takeout commitment, and
an agency agreement that indicated the borrower's attorney's agreement
"to act as the agent of the Bank" to disburse the Advance and to obtain
due execution and delivery to the bank of the original note that
evidences the debt underlying the Mortgage Loan." Warehouse Agreement
§ 5.3(A)(iii). The Agreement required all of this to be submitted
along with the initial funding request. As a matter of course, however,
the agency agreement was usually executed by the title agent handling the
closing instead of by the borrower's attorney, and Provident customarily
accepted the mortgage assignment and agency agreement after the actual
closing.
After Provident received the package and checked to see that Pinnacle's
credit limit had not been exceeded (although, as stated above, often
prior to receipt of the mortgage assignment and agency agreement),
Provident credited Pinnacle's checking account with 98% of the requested
funds. Warehouse Agreement §§ 1.1, 2.1. Pinnacle would write a
regular, uncertified check to the closing agent, who would close the loan
directly with the borrower on Pinnacle's behalf. Pinnacle was supposed to
use specific funds credited to their account to fund specific closings,
but no controls were in place to make sure that Pinnacle actually did
so.
With Pinnacle's check in hand, the closing agent would use money from
its own bank account to disburse funds to the mortgagor, later
replenishing its bank account by depositing Pinnacle's check. Next, the
closing agent would routinely send the original note, a certified copy of
the recorded mortgage, and the other closing documents to Pinnacle, who
would send them on to Provident, who would receive this original note
approximately three to five days after closing. Provident and the
borrowers had no contact; indeed, Provident and the closing agents had no
contact, save the extremely limited contact by the closing agents who did
return the agency agreement included in the borrowing package. Not all
closing agents did return the agreement signed; most of those who did
sent everything through Pinnacle to go to Provident, in accordance with
Pinnacle's written instructions, rather than remitting the note and other
papers directly to Provident, as stated in the agency agreement.
Ultimately, Provident would send the note and accompanying documents to
the third party investor, who would pay Provident the funds which
Provident had originally placed in Pinnacle's checking account by wiring
monies to Provident in Pinnacle's name. Because the third party investor
would send multiple payments in each wire transfer, Pinnacle would tell
Provident to which loans to apply each of the funds.
2. Pinnacle's Declining Financial State
Among the twenty or so warehouse customers that Provident had during
19931994, Pinnacle was the most profitable for Provident, providing
hundreds of millions of dollars in loan transactions. However, when the
mortgage banking industry suffered a decline in business, Pinnacle began
to experience financial difficulties as well.
The Warehouse Agreement, § 6.11, required Pinnacle to submit
unaudited balance sheets and statements of income to Provident on a
quarterly basis, though Pinnacle customarily provided monthly
statements. The statements filed for June, July, and August of 1993
reflected an accrued pretax income for the first three months of the
fiscal year of $281,351. Statements for September, October, and November
of 1993 reflected pretax income of $923,923 for the first six months of
the fiscal year. However, after the November 30 report, Pinnacle began to
send its reports quarterly, which was in accordance with the Warehouse
Agreement but which was nonetheless unusual due to Pinnacle's custom of
submitting reports monthly. The next report, covering the ninemonth
period ending February 28, 1994, was due on April 15 but not received
until some time in May. It showed pretax income of $136,000 for the
first nine months, or an $800,000 loss in the previous three months. The
accompanying unaudited balance sheets showed a reduction of assets from
$40 million to $28 million in those three months. The final financial
statement was due on August 31, 1994, but Provident never received it.
At a holiday party in May 1994, Edmund R. Folsom, head of Provident's
Commercial Lending Department, had learned that Pinnacle had sustained
losses in the winter months. On August 19, 1994, Sharon Kinkead, of
Provident's Warehouse Lending Department, called Pinnacle's headquarters
and learned from Pinnacle's CFO, Joseph Mader, that there would be a
delay in the submission of the audited financial statements for the
fiscal year ending May 31, 1994 because of a change of comptroller, but
that the report would be provided by September 15, 1994. That report
never arrived, and no other financial statements were received up until
Provident's termination of its relationship with Pinnacle in early
November 1994.
3. Provident's Relationship with Pinnacle
Throughout its relationship with Pinnacle, Provident routinely honored
overdrafts on behalf of Pinnacle — about twenty times in 1993 and
fifteen times in 1994. These overdrafts ranged from $7,240.87 to
$5,255,812.
When a check was presented to the bank on Pinnacle's account for which
Pinnacle had insufficient funds, Sharon Kinkead would contact Pinnacle to
ask whether Pinnacle would honor that overdraft. Having been told that
the check would be covered (usually from an anticipated wire transfer),
Kinkead and her supervisor, Mr. Folsom, would honor it and allow the
overdraft. Until November 1994, Provident honored all of Pinnacle's
overdrafts, without reviewing Pinnacle's books and records or monitoring
its checking account.
As mentioned earlier, Pinnacle's CFO, Joseph Mader, had informed
Provident that its final fiscal year report would be forthcoming on
September 15, 1994. When Provident did not receive the audited reports by
that date, Mr. Folsom spoke with Mr. Mader, who reported that though
Pinnacle had sustained losses, it was expecting a substantial infusion of
capital. Pinnacle wanted to hold off publishing the report so that it
could add a footnote explaining that there would be a capital infusion.
Based on this, Folsom decided to extend Pinnacle's credit line through
the end of November.
Folsom called Mader some time in October to check on the status of the
report. When Mader returned the call on November 1, he informed Folsom
that the capital infusion had failed. Folsom demanded a meeting with
Pinnacle's officers.
On November 2, Folsom and Kinkead met with Mader and Al Miller,
President of Pinnacle. Mader and Miller presented internally generated
financial statements indicating a pretax loss of six million dollars for
the previous fiscal year, as well as a pretax loss of almost one million
dollars for the first quarter of the current fiscal year. Miller and
Mader admitted that they had misused their warehouse credit line with
G.E. Capital Mortgage Services, Inc., to whom they were indebted for
about six million dollars. They "admitted fraud" as to G.E., but
indicated that they had not misappropriated the Provident funds and asked
for an extension of funding of their loans while they financially
reorganized. Provident declined to do so.
At that time, Provident finally reviewed Pinnacle's books and
discovered that Pinnacle had been diverting substantial sums of money
from Pinnacle's Provident account to its operating account at Meridian
Bank. Kinkead and Folsom also learned that Pinnacle had been requesting
advances on loans earlier than was routinely requested, possibly using
the money that was supposed to be for specific loans for other purposes
instead. Indeed, Pinnacle was engaging in a "kiting" scheme,
misappropriating monies from third party investors that should have been
applied to previously funded loans. A Pinnacle employee told Kinkead that
the Provident line was not "whole," that as much as $500,000 may have
been taken from it, though no fraudulent loans had been made.
As of November 2, 1994, all checks presented to Provident on Pinnacle's
account had been processed, and the customer balance summary showed an
overdraft of $206,653.67. On November 3, $830,127.48 was deposited in
Pinnacle's account. Sixteen checks totaling $1,584,041.63 were presented
to Provident against Pinnacle's account on November 3. There were
insufficient funds to cover all sixteen, so Folsom sent a letter to
Miller, Pinnacle's president, to ask which checks should be paid. At the
time, Provident knew that all sixteen of those checks represented monies
that Pinnacle had delivered to borrowers and closing agents for
particular loans, as well as that each transaction was accompanied by a
takeout commitment by a third party investor, who would have paid for
the loan.
Miller indicated that six of the checks could be paid. Provident
debited $863,821 to pay off eight loans on November 4, and other checks
were paid at Mader's instruction. There was an overdraft on that date of
$178,303.73, and Provident honored no more checks. The remaining ten of
the sixteen checks presented on November 3 were dishonored, and those are
the subject of the instant litigation.
4. The Ten Transactions
Prior to the closings in each of the ten transactions in question,
Pinnacle had requested from Provident — and received — monies
to fund the transactions. As usual, Pinnacle presented the closing agent
with an uncertified check drawn on its account at Provident representing
payment for the note and mortgage to be executed by the borrower,
purchaser, or refinancer of the property. With Pinnacle's check in hand,
the closing agents closed each transaction, issuing checks from their own
accounts to the parties entitled to receive funds. The closing agents
then deposited Pinnacle's checks in their own accounts, and their banks
presented those checks to Provident for payment. In each case, Provident
dishonored the checks due to insufficient funds. After each closing, but
before the discovery of any problem, each closing agent returned the
original note to Pinnacle. Several closing agents recorded the mortgage
and sent Pinnacle certified copies. Despite the fact that Pinnacle's
checks were not honored, each closing agent honored their own checks when
they were presented.
At the time, uncertified funds were routinely accepted from mortgage
bankers, with a few exceptions for out of state lenders, ignoring the
Pennsylvania statute which required mortgage bankers and brokers to
certify funds. Most mortgage lenders such as Pinnacle insisted on
acceptance of regular checks; title insurers could not stay in business
if they did not follow the standard in the industry.
As was usual for these transactions, Provident had no contact with any
of the closing agents prior to settlement. Agency agreements were
included in most, but not all, of the instruction packages sent by
Pinnacle to the respective closing agents. The agreement provided that
Provident had a security interest in the note and mortgage; moreover, it
provided that the closing agent would act as Provident's agent in
connection with the loan transaction, agreeing to record the mortgage and
then to send both the original note and the original recorded mortgage to
Provident upon closing. The text of the agreement conflicted with the
closing instructions that Pinnacle gave to the closing agents, which
required the note to be returned to Pinnacle. In six of the ten
transactions, the agreement was executed, but its provisions were
basically ignored, as the closing documents were returned directly to
Pinnacle.
The closing agents learned of the dishonor from their own banks.
Provident did not attempt to contact the closing agents until November
10, 1994, when they sent a letter with instructions to deliver to
Provident all notes, mortgages, loan files, and other collateral, and any
monies received in connection with each mortgage loan.
Several of the agents sought judicial relief. Two of the closing agents
who are appellees in this matter, Gino L. Andreuzzi and the Pioneer
Agency L.P., hold state court judgments in their favor, for a total of
three judgments against Pinnacle, striking the mortgages and notes
executed by their respective buyers in favor of Pinnacle. Andreuzzi, the
closing agent in the Hopeck settlement, filed suit against Pinnacle in
the Court of Common Pleas of Luzerne County, Pennsylvania, seeking a TRO
to keep Pinnacle from selling, transferring, or assigning the note and
mortgage in question. Provident was not joined in Andreuzzi's case, but
it did have notice of the litigation. Andreuzzi filed a lis pendens with
the Prothonotary on November 14, 1994. About three hours after the lis
pendens was filed, Provident recorded the assignment from the Hopeck
note. Ultimately, a default judgment was entered against Pinnacle.
Pioneer also filed suits in connection with the Weaver and Fisher
transactions. In both cases, Pioneer sued Pinnacle and Provident in the
Court of Common Pleas of Berks County, Pennsylvania, on November 14,
1994. A preliminary injunction was entered on November 22, and a default
judgment was entered against both defendants on December 21, 1994. Two
days later, Pinnacle moved to open the default judgment. It was still
pending on February 1, 1995 when an involuntary petition was filed against
Pinnacle. Provident removed the action to the Bankruptcy Court on May 8,
1995.
Other closing agents entered into agreements with the borrowers to
execute new notes and mortgages. By the time this came before the
Bankruptcy Court, the mortgages had either been satisfied in full, with
proceeds held in escrow, or payments on the new mortgages and notes were
being made by the borrowers to the closing agents in escrow pending the
resolution of this matter.
C. The Bankruptcy Court's Findings and Judgment
On November 19, 1997, the Bankruptcy Court issued its Opinion in favor
of the appellees, ruling that:
(1) the appellant did not achieve the status of an HDC
with regard to the notes and mortgages in issue;
(2) the appellees would be entitled to indemnification
even if an agency relationship existed between the
appellant and appellees;
(3) the Uniform Fiduciaries Law is inapplicable to
validate the appellant's position with regard to the
subject notes and mortgages; and
(4) the appellant is precluded from relitigating the
transactions with appellees Pioneer Agency II Corp
t/a Pioneer Agency and Andreuzzi.
Judgment against Provident was entered on December 17, 1997. On December
22, 1997, appellant filed a notice of appeal from the Judgment. On
February 13, 1998, the record on appeal was transmitted to this Court. As
"nothing remains for the [lower] court to do," Universal Minerals, Inc.
v. C.A. Hughes & Co., 669 F.2d 98, 101 (3d Cir. 1981), the BankruptcyCourt's ruling is final, and thus this Court properly has appellate
jurisdiction over the December 17, 1997 Order pursuant to
28 U.S.C. § 158(a).
III. ISSUES PRESENTED
On appeal, Provident makes six arguments. First, Provident argues that
it is the holder in due course ("HDC") of the ten mortgage notes.
Second, Provident argues that the Bankruptcy Court's ruling that the
appellees were entitled to indemnification if they were Provident's agents
is clearly erroneous. Third, appellant contends that the bankruptcy court
erred in ruling that Provident was not protected by the Uniform
Fiduciaries Act ("UFA"), adopted by both New Jersey and Pennsylvania at
N.J.S.A. 3B:1454 and 7 Pa. Cons. Stat. Ann. § 6361, respectively.Fourth, Provident argues, for the first time upon appeal, that the
doctrine of avoidable consequences bars appellees from recovering any
damages from Provident. Fifth, Provident maintains that the doctrines of
lis pendens, res judicata, and collateral estoppel do not bar
relitigation of these issues as to the Andreuzzi transaction. Finally,
Provident argues that the Bankruptcy Court erred by giving preclusionary
effect to the Pioneer action default judgments.
This Opinion will not address Provident's "avoidable consequences"
argument, as it was raised, for the first time, upon appeal.[fn3]Moreover, the doctrine of res judicata precludes review of the two
transactions for which Pioneer was the closing agent, and I thus affirm
the Bankruptcy Court's judgment as to Pioneer on that ground.[fn4] I willaffirm the Bankruptcy Court's holding that Provident is not entitled to
the protections of the Uniform Fiduciaries Act , especially in light of
the fact that Provident has withdrawn its argument that Pinnacle was its
agent.[fn5] For reasons stated herein, I will affirm the BankruptcyCourt's holding that Provident is not the holder in due course of the
eight[fn6] transactions still in question. Accordingly, there is no needfor this Court to address the Bankruptcy Court's alternate finding that
the closing agents would be entitled to indemnification.[fn7]
IV. STANDARD OF REVIEW
On appeal, the weight accorded to the findings of fact by a bankruptcy
court are governed by Fed.R.Bank.P. 8013, which provides as follows:
On appeal the district court or bankruptcy appellate
panel may affirm, modify, or reverse a bankruptcy
judge's judgment, order, or decree or remand with
instructions for further proceedings. Findings of
fact, whether based on oral or documentary evidence,
shall not be set aside unless clearly erroneous, and
due regard shall be given to the opportunity of the
bankruptcy court to judge the credibility of
witnesses.
Fed.R.Bank.P. 8013. Under this Rule, a bankruptcy court's factualfindings may be disturbed only if clearly erroneous. See FGH Realty
Credit v. Newark Airport/Hotel Ltd., 155 B.R. 93 (D.N.J. 1993). Where a
mixed question of law and fact is presented, the appropriate standard
must be applied to each component. In re Sharon Steel Corp., 871 F.2d 1217,
1222 (3d Cir. 1989). Thus, a reviewing court "must accept the [lower]court's findings of historical or narrative facts unless they are clearly
erroneous, but . . . must exercise a plenary review and its application
of those precepts to the historical facts." Universal Minerals, Inc. v.
C.A. Hughes & Co., 669 F.2d at 103.
While standards for establishing that a party is a holder in due course
are wellsettled law, see, e.g., Triffin v. Dillabough, 448 Pa. Super. 72,
87, 670 A.2d 684, 691 (1996), the Court's application of these standardsto the facts does result in a mixed finding of fact and law that is
subject to a mixed standard of review. Mellon Bank, N.A. v. Metro
Communications, Inc., 945 F.2d 635, 64142 (3d Cir. 1991), cert. denied,
503 U.S. 937 (1992). The factual findings can only be reversed for clearerror, In re Graves, 33 F.3d 242, 251 (3d Cir. 1994), even if thereviewing court would have decided the matter differently. In re
PrincetonNew York Investors, Inc., 1998 WL 111674 (D.N.J. 1998). This
Court, thus, may not overturn a bankruptcy judge's factual findings if
the factual determinations bear any "rational relationship to the
supporting evidentiary data. . . ." Fellheimer, Eichen & Braverman, P.C.
v. Charter Technologies, Inc., 57 F.3d 1215, 1223 (3d Cir. 1995) (citingHoots v. Comm. of Pa., 703 F.2d 722, 725 (3d Cir. 1983). However, thisCourt reviews any legal conclusions de novo.
V. DISCUSSION
Appellant argues that the Bankruptcy Court's finding that appellant is
not an HDC of the promissory notes and mortgages from the eight remaining
real estate transactions closed by appellees is clearly erroneous. The
dispute here is not a dispute of law, as the parties agree on what the
law concerning HDCs is. As the Bankruptcy Court correctly found,[fn8]every holder of a negotiable instrument is presumed to be an HDC, Morgan
Guaranty Trust Company of New York v. Staats, 631 A.2d 631, 636(Pa.Super.Ct. 1993), but when a defense of fraud is meritorious as to the
payee, the holder has the burden of showing that it is an HDC in order to
be immune from that defense. Norman v. World Wide Distributors, Inc.,
195 A.2d 115, 117 (Pa.Super.Ct. 1963). A holder of a negotiableinstrument (such as the promissory notes in this case) is either the
person with possession of bearer paper or the person identified on the
instrument if that person is in possession. 13 Pa. Cons. Stat. Ann.
§ 1201; N.J.S.A. 12A:3201 (West Supp. 1998). The holder of adocument of title (such as the mortgages in this case) is the person in
possession if the document is made out to bearer or to the order of the
person in possession. Id. The holder becomes an HDC if:
(1) the instrument when issued or negotiated to the
holder does not bear such apparent evidence of forgery
or alteration or is not otherwise so irregular or
incomplete as to call into question its authenticity;
and
(2) the holder took the instrument:
(i) for value;
(ii) in good faith;
(iii) without notice that the instrument is
overdue or has been dishonored or that there is an
uncured default with respect to payment of another
instrument issued as part of the same series;
(iv) without notice that the instrument contains
an unauthorized signature or has been altered;
(v) without notice of any claim to the instrument
described in section 3306 (relating to claims to an
instrument); and
(vi) without notice that any party has a defense
or claim in recoupment described in section 3305(a)
(relating to defenses and claims in recoupment).
13 Pa. Cons. Stat. Ann. § 3302. See also N.J.S.A. 12A:3302. Inshort, an HDC is the holder of the instrument or document who took for
value and in good faith without notice of any claims or defects on the
instrument or document. If classified as an HDC, the holder holds without
regard to defenses, with certain statutory exemptions which do not apply
here. 13 Pa. Cons. Stat. Ann. § 3305; N.J.S.A. 12A:3305.
It was clear to the parties and to the Bankruptcy Court below that
Provident did not have actual possession of the notes and mortgages
before November 2, 1998, when it learned that there were insufficient
funds in Pinnacle's account at Provident to cover Pinnacle's checks to
the closing agents here. Provident nonetheless argued that it was the
holder of the notes and mortgages because, before gaining actual
knowledge of Pinnacle's fraud, Provident "constructively possessed" the
notes and mortgages from the moment that the closing agents, who were
allegedly Provident's agents, took possession of the notes at the
closings before November 2.
The Bankruptcy Court rejected Provident's argument, finding that none
of the appellees acted as Provident's agents, and thus Provident never
constructively or actually possessed the notes and mortgages. Thus, the
Bankruptcy Court found that Provident never became the holder of these
notes and mortgages in the first place. (Opinion at 53.) Alternatively,
the Bankruptcy Court found that while Provident did give value for the
notes and mortgages (Opinion at 54), it did not take those notes and
mortgages in good faith and without knowledge of defenses, and thus
Provident is not an HDC. (Opinion at 63.) The question before this Court
is whether the Bankruptcy Court's rulings in this regard were clearly
erroneous. I hold that it was neither clearly erroneous nor contrary to
established law for the Bankruptcy Court to find that Provident did not
fit the role of "good faith purchaser for value" necessary to claim HDC
status even though Provident's lack of good faith arose after the title
agents closed the real estate transactions. As the following discussion
will explain, in the context of a course of dealing between Provident and
Pinnacle extending over thousands of such transactions, Provident was
essentially a party to the mortgage lending transactions and thus, by
definition, cannot claim HDC status in the negotiable papers which
resulted from those transactions, especially because Provident gained
knowledge of defenses before its own role in the original mortgage
lending transaction was complete.
I affirm the Bankruptcy Court's ruling that Provident is not the HDC of
these notes and mortgages. In so holding, I need not, and thus do not,
reach the issue of whether Provident constructively possessed the notes
and mortgages,[fn9] for holder status is irrelevant if Provident did nottake in good faith and without knowledge of defenses. Because I find that
the Bankruptcy Court's ruling that Provident did not take in good faith
was not clearly erroneous, I affirm the ruling that Provident is not
entitled to the protections afforded to a holder in due course.
The Bankruptcy Court correctly stated the law on good faith in this
context: the test for good faith is "not one of negligence of duty to
inquire, but rather it is one of willful dishonesty or actual knowledge."
Valley Bank & Trust Co. v. American Utilities, Inc., 415 F. Supp. 298,
301 (E.D.Pa. 1976). See also Mellon Bank v. PasqualisPoliti,
800 F. Supp. 1297, 1302 (W.D.Pa. 1992), aff'd, 990 F.2d 780 (3d Cir.1993); Carnegie Bank v. Shalleck, 606 A.2d 389, 394 (N.J.Super.Ct.A.D. 1992); General Inv. Corp. v. Angelini, 278 A.2d 193 (N.J. 1971).Good faith may be defeated only by actual knowledge or a deliberate
attempt to evade knowledge. Rice v. Barrington, 70 A. 169, 170 (N.J. E. &
A 1908). "There is no affirmative duty of inquiry on the part of one
taking a negotiable instrument, and there is no constructive notice from
the circumstances of the transaction, unless the circumstances are so
strong that if ignored they will be deemed to establish bad faith on the
part of the transferee." Bankers Trust Co. v. Crawford, 781 F.2d 39, 45(3d Cir. 1986). Moreover, an HDC must take not only in good faith, but
also without notice of defenses to the instrument or document. One has
"notice" when
(1) he has actual knowledge of it;
(2) he has received a notice or notification of it; or
(3) from all the facts and circumstances known to him
at the time in question he has reason to know that it
exists.
Pa. Cons. Stat. Ann. § 1201.
The Bankruptcy Court here found that Provident did not in fact have
actual knowledge of the fraud or potential defense of failure of
consideration at the time of each separate closing. (Opinion at 58.) The
Bankruptcy Court also found that despite the fact that Provident failed
to review Pinnacle's books, records, and checking account ledger, failed
to notice the overdraft problem, failed to properly monitor withdrawals,
and failed to act after knowledge of financial deterioration in default
in providing timely audited financial statements, the appellees had not
proved that Provident acted with willful dishonesty (id.); Provident did
act with negligence or gross negligence, but gross negligence alone is
not enough to defeat an HDC's title. See Washington & Canonsburg Ry. Co.
v. Murray, 211 F. 440, 445 (3d Cir. 1914); General Inv. Corp.,
278 A.2d 193. Moreover, the Bankruptcy Court correctly noted that holderin due course status is generally created at the time that the claimant
becomes a holder — meaning at the time of negotiation. N.J.S.A.
12A:3302; Sisemore v. Kierlow Co., Inc. v. Nicholas, 27 A.2d 473, 478(Pa.Super.Ct. 1942). In transactions such as the ones at issue here which
involve blank endorsements, the instruments and documents are bearer
paper and are thus negotiated upon delivery alone. 13 Pa. Cons. Stat.
Ann. § 3201; N.J.S.A. 12A:3201.
Nonetheless, the Bankruptcy Court found that Provident failed to attain
the status of a holder in due course. It acknowledged that once a party
establishes its position as a holder in due course, no future action can
undermine that status; so in the usual transaction with negotiable bearer
paper, actual knowledge of defenses gained after possession do not defeat
HDC status. (Opinion at 63.) See Bricks Unlimited, Inc. v. Agee,
672 F.2d 1255, 1259 (5th Cir. 1982); Park Gasoline Co. v. Crusius,158 A. 334 (N.J. 1932). However, the Bankruptcy Court said, it was not
finding lack of good faith after gaining HDC status, but rather that
Provident did not gain HDC status in the first place, for these were not
the "usual" transactions. Taken in a "global sense," the Bankruptcy Court
said, these transactions did not end until after the settlements.
(Opinion at 58.)
Usually, one who takes a negotiable instrument for value has only the
underlying circumstances of that transaction by which to determine if
there is reason to give pause as to the veracity of that instrument. A
lender provides funds to a borrower who executes a promissory note. Once
that transaction is complete, the lender transfers the note to a second
lender in exchange for which the first lender receives funds replenishing
his account and enabling him to lend the same funds to another borrower.
HDC status is given to that second lender if it acts in good faith and
without knowledge of defenses, and there is no general duty for that
second lender to inquire unless the circumstances are so suspicious that
they cannot be ignored. See, e.g. Triffin, 670 A.2d at 692. In the usualHDC transaction, there are two discernible transactions, two exchanges of
funds and notes. As the Bankruptcy Court pointed out, the purpose of
giving that second lender HDC status is "to meet the contemporary needs
of fast moving commercial society . . . (citation omitted) and to enhance
the marketability of negotiable instruments [allowing] bankers, brokers
and the general public to trade in confidence." Triffin,
670 A.2d at 693. However, "the more the holder knows about the underlyingtransaction, and particularly the more he controls or participates or
becomes involved in it, the less he fits the role of a good faith
purchaser for value; the closer his relationship to the underlying
agreement which is the source of the note, the less need there is for
giving him the tensionfree rights necessary in a fastmoving,
creditextending commercial world." Unico v. Owen, 50 N.J. 101, 109110 (1967). See also Jones v. Approved Bancredit Corp., 256 A.2d 739, 742(Del. 1969) (in such a situation, "[the financer] should not be able to
hide behind `the fictional fence' of the . . . UCC and thereby achieve an
unfair advantage over the purchaser.").
Here, there were not two separate, discernible transactions.
Provident's funding of Pinnacle who funded the borrowers was one complex
transaction. The acts of a third party investor who would buy the notes
and mortgages from Provident would have been the second separate,
discernible transaction here. Provident did not replenish Pinnacle's
account in exchange for receiving the notes and mortgages, such that
Pinnacle would have more money to make more loans, as in the "usual"
transaction. Rather, in a complex and longstanding scheme encompassing
thousands of transactions over several years, Provident gave Pinnacle a
line of credit, and then, after Pinnacle gave Provident information about
individual proposed loans to borrowers, Provident transferred money to
Pinnacle's account, in order to later receive the note and mortgage from
each transaction and pass them on to a third party investor. The
Bankruptcy Court, as a factual matter, found that under this complex
scheme, no transactions between any of the parties were complete until
both of the transactions were concluded, particularly because the "second
lender" (Provident) had the ultimate control over the first transaction
(by ordering the dishonor of Pinnacle's checks).[fn10]
I cannot say that the Bankruptcy Court's factual finding was clearly
erroneous. The Bankruptcy Court's ruling accords with the evidence as
well as with the policy underlying the holder in due course doctrine. I
hold that where a warehouse lender so closely participates in the funding
and approval of mortgages which will ultimately lead to the warehouse
lender's rights in mortgages and promissory notes that the transactions
between mortgage banker and mortgagor and between warehouse lender and
mortgage banker are in fact one continuous transaction, rather than two
discernible transactions, a showing of the warehouse lender's lack of
good faith after the closing between title agent and mortgagor but before
the mortgage banker's check is presented to the warehouse lender may
destroy HDC status. Indeed, where the party who claims HDC status was in
essence a party to the original transaction, it cannot, by definition, be
a holder in due course.
Provident had a great deal of involvement in the ongoing series of
transactions and ample knowledge of Pinnacle's overall financial
wellbeing, developed through years of funding Pinnacle's credit line for
thousands of such transactions and receipt of Pinnacle's periodic
financial reports. It had particular information about the borrowers
before it funded these loans. It was, in fact, part of the loan
transactions, and not a separate party who became an HDC through the
giving of value at a second separate, discernible transaction. Provident
had too much control of, participation in, and knowledge of the
underlying transaction to claim that it was a good faith purchaser for
value. See, e.g., Fidelity Bank Nat'l Assoc., 740 F. Supp. at 239.
Because, under this complex transactional scheme, Provident functioned
essentially as a party which approved and funded the loans and gained
actual knowledge of a defense to the notes and mortgages (lack of
consideration) before the transactions were complete, it was not clearly
erroneous for the Bankruptcy Court to find that Provident lacked the good
faith necessary to claim HDC status. Accordingly, the Bankruptcy Court's
ruling is affirmed.
VI. CONCLUSION
For the foregoing reasons, I will affirm the Bankruptcy Court's ruling
that appellant Provident Savings Bank was not the holder in due course of
the notes and mortgages from the ten transactions closed by appellees.
The defense of failure of consideration thus is available against
Provident. I therefore affirm the Bankruptcy Court's judgment that
appellees, and not appellant, are entitled to the notes and mortgages. The
accompanying Order is entered.
ORDER
This matter having come upon the court upon the appeal of appellant,
Provident Savings Bank, from a Judgment entered on December 17, 1997, by
the Honorable Judith H. Wizmur, United States Bankruptcy Judge for the
District of New Jersey,; and the Court having considered the parties'
submissions; and for the reasons set forth in the Opinion of today's
date;
IT IS this day of December, 1998, hereby
ORDERED that the Judgment entered by the Honorable Judith H. Wizmur,
United States Bankruptcy Judge for the District of New Jersey, on
December 17, 1997, which granted the notes and mortgages from
transactions closed by the appellees in this matter to the appellees,
be, and hereby is, AFFIRMED.
[fn1] The appellant's cause of action against defendant William E. Ward
was removed to state court in Delaware upon motion on the basis of
abstention pursuant to 28 U.S.C. § 1334(c) where it is now pending.The appellant's cause of action against Meridian Bank was resolved prior
to trial pursuant to the Stipulation of Settlement with respect to Count
II of the Complaint, filed on July 16, 1996. All claims between the
appellant and Lawyers Title Insurance Corporation were mutually dismissed
at trial.
[fn2] The Agreement said $10 million, but at times up to $12.5 million
was advanced.
[fn3] It is a wellestablished law that appellate courts may not pass
upon an issue not presented in a lower court. Singleton v. Wulff,
428 U.S. 106, 120 (1976). The same holds true for a U.S. District Courtsitting in its appellate capacity over matters appealed from the
bankruptcy court. See Barrett v. Commonwealth Fed. Sav. and Loan Ass'n,
939 F.2d 20 (3d Cir. 1991); In re Middle Atlantic Stud Welding Co.,
503 F.2d 1133, 1134 n. 1 (3d Cir. 1974). Because Provident never raisedthis issue before the Bankruptcy Court, I will not consider it now.
[fn4] The res judicata doctrine prevents relitigation of claims that grow
out of a transaction or occurrence from which other claims have earlier
been raised and decided validly, finally, and on the merits. Federated
Department Stores v. Moitie, 452 U.S. 394, 298 (1981). Under Pennsylvanialaw, default judgments, absent fraud, are afforded res judicata effect.
In re Graves, 156 B.R. 949, 954 (E.D.Pa. 1993), aff'd, 33 F.3d 242 (3dCir. 1994). On December 21, 1994, the Court of Common Pleas of Berks
County, Pennsylvania, entered default judgments against Provident on both
the Weaver and Fisher transactions, those transactions for which Pioneer
was the closing agent. Due to these default judgments, the doctrine of
res judicata bars relitigation of the Pioneer causes of action. The
Bankruptcy Court also held that the Andreuzzi transaction was barred by
res judicata or collateral estoppel because of the lis pendens. That,
however, is a more difficult issue and one that I need not reach now, as
my affirmance of the Bankruptcy Court's judgment applies equally to the
Andreuzzi transaction on the merits.
[fn5] At trial and in its briefs to this Court, as an alternative to its
holder in due course argument, Provident argued that it was protected by
the Pennsylvania Uniform Fiduciaries Act, 7 Pa. Cons. Stat. § 6361,
and the New Jersey Uniform Fiduciaries Law, N.J.S.A. 3B:1454, theprovisions of which are substantially similar. The two laws protect a
person who transfers money to a fiduciary in good faith, by noting that
"any right or title acquired from the fiduciary in consideration of such
payment or transfer is not invalid in consequences of a misapplication by
the fiduciary." 7 Pa. Cons. Stat. § 6361; N.J.S.A. 3B:1454. TheBankruptcy Court held that Pinnacle was not Provident's agent or
fiduciary, and thus the UFA did not apply. (Opinion at 66.) In light of
the fact that Provident's counsel, at oral argument before this Court on
November 13, 1998, themselves argued that Pinnacle was not Provident's
fiduciary, I will affirm this aspect of the Bankruptcy Court's ruling
without need to examine the factual bases on which it relied.
[fn6] The rest of this Opinion is limited to the eight transactions not
handled by Pioneer, since only the Pioneer transactions are bound by res
judicata.
[fn7] As Part V of this Opinion explains, one of the several bases for
the Bankruptcy Court's decision that Provident is not the HDC of the
mortgages and notes is that the settlement agents were not Provident's
agents, and thus Provident did not constructively possess the mortgages
and notes prior to gaining knowledge of claims or defenses on those
notes. (Opinion at 3453.) In the alternative, in case appellate courts
determined that Provident was the HDC of those notes because an agency
relationship did exist, the Bankruptcy Court held that the closing
agents, and not Provident, would still be the ones entitled to the notes
and mortgages, for the agents would have had a right to indemnification
from Provident. (Id. at 6364.) Though, as I explain in Part V, I do not
reach the agency issue, I do affirm the Bankruptcy Court's HDC ruling on
other grounds. In doing so, I am affirming the decision that the
appellees, and not Provident, are entitled to the notes and mortgages. The
Bankruptcy Court's indemnification ruling is just an alternative reason
for finding that the appellees are entitled to the notes and mortgages.
Having already agreed that the closing agents are so entitled because
Provident is not an HDC, there is no need to address that alternative
ruling upon appeal.
[fn8] Seven of the eight remaining transactions here are governed by
Pennsylvania law. The eighth is under New Jersey law, but the two states'
laws on HDC status are largely consistent on the issues raised in these
proceedings.
[fn9] The Bankruptcy Court agreed that authority from other jurisdictions
suggest that a party may become a constructive holder when its agent
takes possession of a negotiable instrument on its behalf. (Opinion at
3637.) However, the Bankruptcy Court made the factual finding that
appellees were not Provident's agents. It determined that though six of
the ten transactions involved written agency agreements, those agreements
were not controlling in light of the course of dealing between the
parties (Opinion at 46), and that Provident did not otherwise meet its
burden of establishing that an agency relationship existed. Because I
find that the Bankruptcy Court's determination that Provident did not act
in good faith is not clearly erroneous, and because the lack of good
faith alone is enough of a basis to sustain a judgment that Provident is
not an HDC of these eight notes and mortgages, I need not address whether
the agency determination was clearly erroneous.
[fn10] Under the Bankruptcy Court's findings of fact, Provident was, in
reality, a party to the original transaction. The situation is somewhat
analogous to a consumer goods financer who has a substantial voice in the
underlying transaction; that financer is not entitled to HDC status.
Westfield Investment Co. v. Fellers, 181 A.2d 809 (N.J.Super.Ct. LawDiv.). Provident had a substantial voice in providing and carrying out
funding of the underlying borrowing transactions, and it thus cannot
claim that it was a good faith HDC when it learned of the defense of
failure of consideration prior to dishonoring the Pinnacle checks.
Loislaw Federal District Court Opinions
Copyright © 2013 CCH Incorporated or its affiliates
IN RE PINNACLE MORTGAGE INVESTMENT CORPORATION, (D.N.J. 1998)
IN RE PINNACLE MORTGAGE INVESTMENT CORPORATION, Debtor
PROVIDENT SAVINGS BANK, a New Jersey Banking Corporation,
Plaintiff/Appellant, v. PINNACLE MORTGAGE INVESTMENT CORPORATION, a
Pennsylvania Corporation, et al., Defendants, SETTLERS ABSTRACT CO., L.P.,
LAWYERS TITLE INSURANCE CORP., LAND TRANSFER CO, INC., FIDELITY NATIONAL
TITLE INSURANCE CO. OF PENNSYLVANIA, GINO L. ANDREUZZI, PIONEER AGENCY II
CORP. t/a PIONEER AGENCY, MUSSER & MUSSER, WILLIAM E. WARD, QUAKER ABSTRACT
CO., and SEARCHTEC ABSTRACT, INC., Appellees.
CIVIL NO. 980489 (JBS), [Bankruptcy Case No. 9510608 (JHW)], [Adv.
Proc. No. 951091]
United States District Court, D. New Jersey.
Filed: December 9, 1998
Walter E. Thomas, Jr., Esq., Timothy J. Matteson, Esq., Mark A. Trudeau,
Esq., Stern, Lavinthal, Norgaard & Kapnick, Esqs., Englewood, New Jersey,
Attorneys for Appellant.
Edward J. Hayes, Esq., Andrea Dobin, Esq., Fox, Rothschild, O'Brien &
Frankel, Princeton Pike Corporate Center, Lawrenceville, New Jersey,
Attorneys for Appellees, Settlers Abstract Co., L.P., Land Transfer Co,
Inc., Fidelity National Title Insurance Co. of Pennsylvania, Gino L.
Andreuzzi, Pioneer Agency II Corp. t/a Pioneer Agency, Musser & Musser,
Quaker Abstract Co, and Searchtec Abstract, Inc.
OPINION
SIMANDLE, District Judge.
I. INTRODUCTION
Provident Savings Bank appeals from a Judgment entered on December 17,
1997, pursuant to a written opinion issued on November 19, 1997, by the
Honorable Judith H. Wizmur, United States Bankruptcy Judge, after trial
in an adversary proceeding. That Opinion ruled in favor of the
Appellees, Settlers Abstract Co., L.P., Land Transfer Co, Inc., Fidelity
National Title Insurance Co. of Pennsylvania, Gino L. Andreuzzi, Pioneer
Agency II Corp. t/a Pioneer Agency, Musser & Musser, Quaker Abstract Co,
and Searchtec Abstract, Inc. ("title agents"). Reviewing a longstanding
complex lending relationship between Provident and the debtor, Pinnacle
Mortgage Corporation, of which the ten real estate mortgage loans at
issue herein were a part, the Bankruptcy Court held that appellee title
agents (who had advanced their own funds to cover disbursements when
Provident dishonored Pinnacle's checks) had a more valid or higher
priority security interest in the promissory notes and mortgages executed
as part of ten separate residential real estate closing than did
appellant. Provident Savings Bank appeals this ruling and seeks this
Court's determination that it was the holder in due course of those
documents.
The principal issue to be decided is whether the Bankruptcy Court
correctly determined under the Uniform Commercial Code that Provident was
not a holder in due course of the promissory notes arising from these
loans, where it found that Provident so closely participated in the
funding and approval of the Pinnaclebrokered loans that the transaction
did not end at the closing with the title agents, such that Provident did
not attain holder in due course status because it did not fit the
requisite role of a "good faith purchaser for value." For the reasons
that will be stated herein, the judgment will be affirmed because the
Bankruptcy Court's finding that Provident never attained HDC status was
neither clearly erroneous nor contrary to law.
II. BACKGROUND
A. Procedural History
This case arises from a dispute over the various security interests in
mortgage documents from ten separate real estate transactions in late
October, 1994, conducted by the debtor, Pinnacle Mortgage Investment
Corporation (who brokered the transactions), the appellant (who financed
the transactions), and the appellees (who were title closing agents in
the transactions). On February 2, 1995, appellant Provident Savings Bank
("Provident") and other creditors filed an involuntary petition under
Chapter 7 of Title 11 of the Bankruptcy Code against Pinnacle Mortgage
Investment Corporation ("Pinnacle"). An order for relief under Chapter 7
was entered by the Bankruptcy Court on March 6, 1995.
On March 24, 1995, Provident commenced this adversary proceeding by
filing a three count complaint to determine the extent, validity, and
priority of the various security interests asserted by Pinnacle, Meridian
Bank, Lawyers Title Insurance Corporation, the appellees, and William E.
Ward with regard to the promissory notes and mortgages from ten real
estate transactions.[fn1] Appellees responded to the complaint by filingan answer, counterclaims, and crossclaims, seeking money judgments in
the amount of the contested notes and mortgages, interest, cost of suit,
and attorneys fees; imposition of a constructive trust in their favor
with regard to the notes, mortgages, and proceeds thereof; and to have
the subject notes and mortgages avoided and stricken in favor of
subsequently executed mortgages between the appellees and the
mortgagors. Provident twice amended its complaint, finally seeking a
declaratory judgment that it is the holder in due course of the subject
notes and mortgages under the Uniform Commercial Code; avoidance of the
preferential transfer by appellee Andreuzzi pursuant to 11 U.S.C. § 547and 550; avoidance of the fraudulent transfer by appellee Andreuzzipursuant to §§ 548 and 550; and avoidance of the preferential and
fraudulent transfers by appellees pursuant to 11 U.S.C. § 547, 548,and 550.
Trial in this matter was held on July 16, 17, and 18, 1996, and October
1, 3, and 4, 1996. At the close of Provident's case in chief, upon motion
by the appellees, all of those portions of the Second Amended Complaint
which did not pertain to Provident's status as a holder in due course
("HDC") were dismissed.
B. The Factual History
In its November 19, 1997 opinion, the Bankruptcy Court determined that
the facts of the case are as follows. Debtor Pinnacle Mortgage Investment
Corporation ("Pinnacle" or "debtor") was a mortgage banker which
primarily dealt in residential mortgage lending and refinance. In December
of 1992, Pinnacle and Provident Savings Bank ("Provident" or "appellant")
entered into a Mortgage Warehouse Loan and Security Agreement
("Agreement"), whereby Provident would fund Pinnacle, who in turn funded
retail customers who sought to purchase or refinance residential real
estate. The borrower in each transaction would give Pinnacle a note and
mortgage, both of which acted as collateral to protect Provident until
Pinnacle sold the mortgage to a third party investor, such as the Federal
Home Loan Mortgage Corporation ("Freddie Mac"), who satisfied Pinnacle's
debt to Provident. Warehouse Agreement § 3.4.
1. The Warehouse Agreement
Under these types of agreements, there would usually not be any contact
between the warehouse lender and the ultimate mortgagor. Typically,
Pinnacle would arrange with a prospective borrower for Pinnacle to
advance funds for the borrower to purchase or refinance a home and for
the borrower to assign a note and mortgage to Pinnacle as collateral. The
mortgage would be endorsed in blank in order to accommodate the final
third party investor (such as Freddie Mac), with whom Pinnacle would
arrange to purchase the mortgage, usually as a part of a pool of
mortgages; this was known as a "takeout" agreement. All of this
completed, Pinnacle would submit a "package" to Provident seeking funding
for the particular transaction under its $10 million line of credit.[fn2]This package included a description of the borrower and the funding, an
assignment of the mortgage endorsed in blank, a takeout commitment, and
an agency agreement that indicated the borrower's attorney's agreement
"to act as the agent of the Bank" to disburse the Advance and to obtain
due execution and delivery to the bank of the original note that
evidences the debt underlying the Mortgage Loan." Warehouse Agreement
§ 5.3(A)(iii). The Agreement required all of this to be submitted
along with the initial funding request. As a matter of course, however,
the agency agreement was usually executed by the title agent handling the
closing instead of by the borrower's attorney, and Provident customarily
accepted the mortgage assignment and agency agreement after the actual
closing.
After Provident received the package and checked to see that Pinnacle's
credit limit had not been exceeded (although, as stated above, often
prior to receipt of the mortgage assignment and agency agreement),
Provident credited Pinnacle's checking account with 98% of the requested
funds. Warehouse Agreement §§ 1.1, 2.1. Pinnacle would write a
regular, uncertified check to the closing agent, who would close the loan
directly with the borrower on Pinnacle's behalf. Pinnacle was supposed to
use specific funds credited to their account to fund specific closings,
but no controls were in place to make sure that Pinnacle actually did
so.
With Pinnacle's check in hand, the closing agent would use money from
its own bank account to disburse funds to the mortgagor, later
replenishing its bank account by depositing Pinnacle's check. Next, the
closing agent would routinely send the original note, a certified copy of
the recorded mortgage, and the other closing documents to Pinnacle, who
would send them on to Provident, who would receive this original note
approximately three to five days after closing. Provident and the
borrowers had no contact; indeed, Provident and the closing agents had no
contact, save the extremely limited contact by the closing agents who did
return the agency agreement included in the borrowing package. Not all
closing agents did return the agreement signed; most of those who did
sent everything through Pinnacle to go to Provident, in accordance with
Pinnacle's written instructions, rather than remitting the note and other
papers directly to Provident, as stated in the agency agreement.
Ultimately, Provident would send the note and accompanying documents to
the third party investor, who would pay Provident the funds which
Provident had originally placed in Pinnacle's checking account by wiring
monies to Provident in Pinnacle's name. Because the third party investor
would send multiple payments in each wire transfer, Pinnacle would tell
Provident to which loans to apply each of the funds.
2. Pinnacle's Declining Financial State
Among the twenty or so warehouse customers that Provident had during
19931994, Pinnacle was the most profitable for Provident, providing
hundreds of millions of dollars in loan transactions. However, when the
mortgage banking industry suffered a decline in business, Pinnacle began
to experience financial difficulties as well.
The Warehouse Agreement, § 6.11, required Pinnacle to submit
unaudited balance sheets and statements of income to Provident on a
quarterly basis, though Pinnacle customarily provided monthly
statements. The statements filed for June, July, and August of 1993
reflected an accrued pretax income for the first three months of the
fiscal year of $281,351. Statements for September, October, and November
of 1993 reflected pretax income of $923,923 for the first six months of
the fiscal year. However, after the November 30 report, Pinnacle began to
send its reports quarterly, which was in accordance with the Warehouse
Agreement but which was nonetheless unusual due to Pinnacle's custom of
submitting reports monthly. The next report, covering the ninemonth
period ending February 28, 1994, was due on April 15 but not received
until some time in May. It showed pretax income of $136,000 for the
first nine months, or an $800,000 loss in the previous three months. The
accompanying unaudited balance sheets showed a reduction of assets from
$40 million to $28 million in those three months. The final financial
statement was due on August 31, 1994, but Provident never received it.
At a holiday party in May 1994, Edmund R. Folsom, head of Provident's
Commercial Lending Department, had learned that Pinnacle had sustained
losses in the winter months. On August 19, 1994, Sharon Kinkead, of
Provident's Warehouse Lending Department, called Pinnacle's headquarters
and learned from Pinnacle's CFO, Joseph Mader, that there would be a
delay in the submission of the audited financial statements for the
fiscal year ending May 31, 1994 because of a change of comptroller, but
that the report would be provided by September 15, 1994. That report
never arrived, and no other financial statements were received up until
Provident's termination of its relationship with Pinnacle in early
November 1994.
3. Provident's Relationship with Pinnacle
Throughout its relationship with Pinnacle, Provident routinely honored
overdrafts on behalf of Pinnacle — about twenty times in 1993 and
fifteen times in 1994. These overdrafts ranged from $7,240.87 to
$5,255,812.
When a check was presented to the bank on Pinnacle's account for which
Pinnacle had insufficient funds, Sharon Kinkead would contact Pinnacle to
ask whether Pinnacle would honor that overdraft. Having been told that
the check would be covered (usually from an anticipated wire transfer),
Kinkead and her supervisor, Mr. Folsom, would honor it and allow the
overdraft. Until November 1994, Provident honored all of Pinnacle's
overdrafts, without reviewing Pinnacle's books and records or monitoring
its checking account.
As mentioned earlier, Pinnacle's CFO, Joseph Mader, had informed
Provident that its final fiscal year report would be forthcoming on
September 15, 1994. When Provident did not receive the audited reports by
that date, Mr. Folsom spoke with Mr. Mader, who reported that though
Pinnacle had sustained losses, it was expecting a substantial infusion of
capital. Pinnacle wanted to hold off publishing the report so that it
could add a footnote explaining that there would be a capital infusion.
Based on this, Folsom decided to extend Pinnacle's credit line through
the end of November.
Folsom called Mader some time in October to check on the status of the
report. When Mader returned the call on November 1, he informed Folsom
that the capital infusion had failed. Folsom demanded a meeting with
Pinnacle's officers.
On November 2, Folsom and Kinkead met with Mader and Al Miller,
President of Pinnacle. Mader and Miller presented internally generated
financial statements indicating a pretax loss of six million dollars for
the previous fiscal year, as well as a pretax loss of almost one million
dollars for the first quarter of the current fiscal year. Miller and
Mader admitted that they had misused their warehouse credit line with
G.E. Capital Mortgage Services, Inc., to whom they were indebted for
about six million dollars. They "admitted fraud" as to G.E., but
indicated that they had not misappropriated the Provident funds and asked
for an extension of funding of their loans while they financially
reorganized. Provident declined to do so.
At that time, Provident finally reviewed Pinnacle's books and
discovered that Pinnacle had been diverting substantial sums of money
from Pinnacle's Provident account to its operating account at Meridian
Bank. Kinkead and Folsom also learned that Pinnacle had been requesting
advances on loans earlier than was routinely requested, possibly using
the money that was supposed to be for specific loans for other purposes
instead. Indeed, Pinnacle was engaging in a "kiting" scheme,
misappropriating monies from third party investors that should have been
applied to previously funded loans. A Pinnacle employee told Kinkead that
the Provident line was not "whole," that as much as $500,000 may have
been taken from it, though no fraudulent loans had been made.
As of November 2, 1994, all checks presented to Provident on Pinnacle's
account had been processed, and the customer balance summary showed an
overdraft of $206,653.67. On November 3, $830,127.48 was deposited in
Pinnacle's account. Sixteen checks totaling $1,584,041.63 were presented
to Provident against Pinnacle's account on November 3. There were
insufficient funds to cover all sixteen, so Folsom sent a letter to
Miller, Pinnacle's president, to ask which checks should be paid. At the
time, Provident knew that all sixteen of those checks represented monies
that Pinnacle had delivered to borrowers and closing agents for
particular loans, as well as that each transaction was accompanied by a
takeout commitment by a third party investor, who would have paid for
the loan.
Miller indicated that six of the checks could be paid. Provident
debited $863,821 to pay off eight loans on November 4, and other checks
were paid at Mader's instruction. There was an overdraft on that date of
$178,303.73, and Provident honored no more checks. The remaining ten of
the sixteen checks presented on November 3 were dishonored, and those are
the subject of the instant litigation.
4. The Ten Transactions
Prior to the closings in each of the ten transactions in question,
Pinnacle had requested from Provident — and received — monies
to fund the transactions. As usual, Pinnacle presented the closing agent
with an uncertified check drawn on its account at Provident representing
payment for the note and mortgage to be executed by the borrower,
purchaser, or refinancer of the property. With Pinnacle's check in hand,
the closing agents closed each transaction, issuing checks from their own
accounts to the parties entitled to receive funds. The closing agents
then deposited Pinnacle's checks in their own accounts, and their banks
presented those checks to Provident for payment. In each case, Provident
dishonored the checks due to insufficient funds. After each closing, but
before the discovery of any problem, each closing agent returned the
original note to Pinnacle. Several closing agents recorded the mortgage
and sent Pinnacle certified copies. Despite the fact that Pinnacle's
checks were not honored, each closing agent honored their own checks when
they were presented.
At the time, uncertified funds were routinely accepted from mortgage
bankers, with a few exceptions for out of state lenders, ignoring the
Pennsylvania statute which required mortgage bankers and brokers to
certify funds. Most mortgage lenders such as Pinnacle insisted on
acceptance of regular checks; title insurers could not stay in business
if they did not follow the standard in the industry.
As was usual for these transactions, Provident had no contact with any
of the closing agents prior to settlement. Agency agreements were
included in most, but not all, of the instruction packages sent by
Pinnacle to the respective closing agents. The agreement provided that
Provident had a security interest in the note and mortgage; moreover, it
provided that the closing agent would act as Provident's agent in
connection with the loan transaction, agreeing to record the mortgage and
then to send both the original note and the original recorded mortgage to
Provident upon closing. The text of the agreement conflicted with the
closing instructions that Pinnacle gave to the closing agents, which
required the note to be returned to Pinnacle. In six of the ten
transactions, the agreement was executed, but its provisions were
basically ignored, as the closing documents were returned directly to
Pinnacle.
The closing agents learned of the dishonor from their own banks.
Provident did not attempt to contact the closing agents until November
10, 1994, when they sent a letter with instructions to deliver to
Provident all notes, mortgages, loan files, and other collateral, and any
monies received in connection with each mortgage loan.
Several of the agents sought judicial relief. Two of the closing agents
who are appellees in this matter, Gino L. Andreuzzi and the Pioneer
Agency L.P., hold state court judgments in their favor, for a total of
three judgments against Pinnacle, striking the mortgages and notes
executed by their respective buyers in favor of Pinnacle. Andreuzzi, the
closing agent in the Hopeck settlement, filed suit against Pinnacle in
the Court of Common Pleas of Luzerne County, Pennsylvania, seeking a TRO
to keep Pinnacle from selling, transferring, or assigning the note and
mortgage in question. Provident was not joined in Andreuzzi's case, but
it did have notice of the litigation. Andreuzzi filed a lis pendens with
the Prothonotary on November 14, 1994. About three hours after the lis
pendens was filed, Provident recorded the assignment from the Hopeck
note. Ultimately, a default judgment was entered against Pinnacle.
Pioneer also filed suits in connection with the Weaver and Fisher
transactions. In both cases, Pioneer sued Pinnacle and Provident in the
Court of Common Pleas of Berks County, Pennsylvania, on November 14,
1994. A preliminary injunction was entered on November 22, and a default
judgment was entered against both defendants on December 21, 1994. Two
days later, Pinnacle moved to open the default judgment. It was still
pending on February 1, 1995 when an involuntary petition was filed against
Pinnacle. Provident removed the action to the Bankruptcy Court on May 8,
1995.
Other closing agents entered into agreements with the borrowers to
execute new notes and mortgages. By the time this came before the
Bankruptcy Court, the mortgages had either been satisfied in full, with
proceeds held in escrow, or payments on the new mortgages and notes were
being made by the borrowers to the closing agents in escrow pending the
resolution of this matter.
C. The Bankruptcy Court's Findings and Judgment
On November 19, 1997, the Bankruptcy Court issued its Opinion in favor
of the appellees, ruling that:
(1) the appellant did not achieve the status of an HDC
with regard to the notes and mortgages in issue;
(2) the appellees would be entitled to indemnification
even if an agency relationship existed between the
appellant and appellees;
(3) the Uniform Fiduciaries Law is inapplicable to
validate the appellant's position with regard to the
subject notes and mortgages; and
(4) the appellant is precluded from relitigating the
transactions with appellees Pioneer Agency II Corp
t/a Pioneer Agency and Andreuzzi.
Judgment against Provident was entered on December 17, 1997. On December
22, 1997, appellant filed a notice of appeal from the Judgment. On
February 13, 1998, the record on appeal was transmitted to this Court. As
"nothing remains for the [lower] court to do," Universal Minerals, Inc.
v. C.A. Hughes & Co., 669 F.2d 98, 101 (3d Cir. 1981), the BankruptcyCourt's ruling is final, and thus this Court properly has appellate
jurisdiction over the December 17, 1997 Order pursuant to
28 U.S.C. § 158(a).
III. ISSUES PRESENTED
On appeal, Provident makes six arguments. First, Provident argues that
it is the holder in due course ("HDC") of the ten mortgage notes.
Second, Provident argues that the Bankruptcy Court's ruling that the
appellees were entitled to indemnification if they were Provident's agents
is clearly erroneous. Third, appellant contends that the bankruptcy court
erred in ruling that Provident was not protected by the Uniform
Fiduciaries Act ("UFA"), adopted by both New Jersey and Pennsylvania at
N.J.S.A. 3B:1454 and 7 Pa. Cons. Stat. Ann. § 6361, respectively.Fourth, Provident argues, for the first time upon appeal, that the
doctrine of avoidable consequences bars appellees from recovering any
damages from Provident. Fifth, Provident maintains that the doctrines of
lis pendens, res judicata, and collateral estoppel do not bar
relitigation of these issues as to the Andreuzzi transaction. Finally,
Provident argues that the Bankruptcy Court erred by giving preclusionary
effect to the Pioneer action default judgments.
This Opinion will not address Provident's "avoidable consequences"
argument, as it was raised, for the first time, upon appeal.[fn3]Moreover, the doctrine of res judicata precludes review of the two
transactions for which Pioneer was the closing agent, and I thus affirm
the Bankruptcy Court's judgment as to Pioneer on that ground.[fn4] I willaffirm the Bankruptcy Court's holding that Provident is not entitled to
the protections of the Uniform Fiduciaries Act , especially in light of
the fact that Provident has withdrawn its argument that Pinnacle was its
agent.[fn5] For reasons stated herein, I will affirm the BankruptcyCourt's holding that Provident is not the holder in due course of the
eight[fn6] transactions still in question. Accordingly, there is no needfor this Court to address the Bankruptcy Court's alternate finding that
the closing agents would be entitled to indemnification.[fn7]
IV. STANDARD OF REVIEW
On appeal, the weight accorded to the findings of fact by a bankruptcy
court are governed by Fed.R.Bank.P. 8013, which provides as follows:
On appeal the district court or bankruptcy appellate
panel may affirm, modify, or reverse a bankruptcy
judge's judgment, order, or decree or remand with
instructions for further proceedings. Findings of
fact, whether based on oral or documentary evidence,
shall not be set aside unless clearly erroneous, and
due regard shall be given to the opportunity of the
bankruptcy court to judge the credibility of
witnesses.
Fed.R.Bank.P. 8013. Under this Rule, a bankruptcy court's factualfindings may be disturbed only if clearly erroneous. See FGH Realty
Credit v. Newark Airport/Hotel Ltd., 155 B.R. 93 (D.N.J. 1993). Where a
mixed question of law and fact is presented, the appropriate standard
must be applied to each component. In re Sharon Steel Corp., 871 F.2d 1217,
1222 (3d Cir. 1989). Thus, a reviewing court "must accept the [lower]court's findings of historical or narrative facts unless they are clearly
erroneous, but . . . must exercise a plenary review and its application
of those precepts to the historical facts." Universal Minerals, Inc. v.
C.A. Hughes & Co., 669 F.2d at 103.
While standards for establishing that a party is a holder in due course
are wellsettled law, see, e.g., Triffin v. Dillabough, 448 Pa. Super. 72,
87, 670 A.2d 684, 691 (1996), the Court's application of these standardsto the facts does result in a mixed finding of fact and law that is
subject to a mixed standard of review. Mellon Bank, N.A. v. Metro
Communications, Inc., 945 F.2d 635, 64142 (3d Cir. 1991), cert. denied,
503 U.S. 937 (1992). The factual findings can only be reversed for clearerror, In re Graves, 33 F.3d 242, 251 (3d Cir. 1994), even if thereviewing court would have decided the matter differently. In re
PrincetonNew York Investors, Inc., 1998 WL 111674 (D.N.J. 1998). This
Court, thus, may not overturn a bankruptcy judge's factual findings if
the factual determinations bear any "rational relationship to the
supporting evidentiary data. . . ." Fellheimer, Eichen & Braverman, P.C.
v. Charter Technologies, Inc., 57 F.3d 1215, 1223 (3d Cir. 1995) (citingHoots v. Comm. of Pa., 703 F.2d 722, 725 (3d Cir. 1983). However, thisCourt reviews any legal conclusions de novo.
V. DISCUSSION
Appellant argues that the Bankruptcy Court's finding that appellant is
not an HDC of the promissory notes and mortgages from the eight remaining
real estate transactions closed by appellees is clearly erroneous. The
dispute here is not a dispute of law, as the parties agree on what the
law concerning HDCs is. As the Bankruptcy Court correctly found,[fn8]every holder of a negotiable instrument is presumed to be an HDC, Morgan
Guaranty Trust Company of New York v. Staats, 631 A.2d 631, 636(Pa.Super.Ct. 1993), but when a defense of fraud is meritorious as to the
payee, the holder has the burden of showing that it is an HDC in order to
be immune from that defense. Norman v. World Wide Distributors, Inc.,
195 A.2d 115, 117 (Pa.Super.Ct. 1963). A holder of a negotiableinstrument (such as the promissory notes in this case) is either the
person with possession of bearer paper or the person identified on the
instrument if that person is in possession. 13 Pa. Cons. Stat. Ann.
§ 1201; N.J.S.A. 12A:3201 (West Supp. 1998). The holder of adocument of title (such as the mortgages in this case) is the person in
possession if the document is made out to bearer or to the order of the
person in possession. Id. The holder becomes an HDC if:
(1) the instrument when issued or negotiated to the
holder does not bear such apparent evidence of forgery
or alteration or is not otherwise so irregular or
incomplete as to call into question its authenticity;
and
(2) the holder took the instrument:
(i) for value;
(ii) in good faith;
(iii) without notice that the instrument is
overdue or has been dishonored or that there is an
uncured default with respect to payment of another
instrument issued as part of the same series;
(iv) without notice that the instrument contains
an unauthorized signature or has been altered;
(v) without notice of any claim to the instrument
described in section 3306 (relating to claims to an
instrument); and
(vi) without notice that any party has a defense
or claim in recoupment described in section 3305(a)
(relating to defenses and claims in recoupment).
13 Pa. Cons. Stat. Ann. § 3302. See also N.J.S.A. 12A:3302. Inshort, an HDC is the holder of the instrument or document who took for
value and in good faith without notice of any claims or defects on the
instrument or document. If classified as an HDC, the holder holds without
regard to defenses, with certain statutory exemptions which do not apply
here. 13 Pa. Cons. Stat. Ann. § 3305; N.J.S.A. 12A:3305.
It was clear to the parties and to the Bankruptcy Court below that
Provident did not have actual possession of the notes and mortgages
before November 2, 1998, when it learned that there were insufficient
funds in Pinnacle's account at Provident to cover Pinnacle's checks to
the closing agents here. Provident nonetheless argued that it was the
holder of the notes and mortgages because, before gaining actual
knowledge of Pinnacle's fraud, Provident "constructively possessed" the
notes and mortgages from the moment that the closing agents, who were
allegedly Provident's agents, took possession of the notes at the
closings before November 2.
The Bankruptcy Court rejected Provident's argument, finding that none
of the appellees acted as Provident's agents, and thus Provident never
constructively or actually possessed the notes and mortgages. Thus, the
Bankruptcy Court found that Provident never became the holder of these
notes and mortgages in the first place. (Opinion at 53.) Alternatively,
the Bankruptcy Court found that while Provident did give value for the
notes and mortgages (Opinion at 54), it did not take those notes and
mortgages in good faith and without knowledge of defenses, and thus
Provident is not an HDC. (Opinion at 63.) The question before this Court
is whether the Bankruptcy Court's rulings in this regard were clearly
erroneous. I hold that it was neither clearly erroneous nor contrary to
established law for the Bankruptcy Court to find that Provident did not
fit the role of "good faith purchaser for value" necessary to claim HDC
status even though Provident's lack of good faith arose after the title
agents closed the real estate transactions. As the following discussion
will explain, in the context of a course of dealing between Provident and
Pinnacle extending over thousands of such transactions, Provident was
essentially a party to the mortgage lending transactions and thus, by
definition, cannot claim HDC status in the negotiable papers which
resulted from those transactions, especially because Provident gained
knowledge of defenses before its own role in the original mortgage
lending transaction was complete.
I affirm the Bankruptcy Court's ruling that Provident is not the HDC of
these notes and mortgages. In so holding, I need not, and thus do not,
reach the issue of whether Provident constructively possessed the notes
and mortgages,[fn9] for holder status is irrelevant if Provident did nottake in good faith and without knowledge of defenses. Because I find that
the Bankruptcy Court's ruling that Provident did not take in good faith
was not clearly erroneous, I affirm the ruling that Provident is not
entitled to the protections afforded to a holder in due course.
The Bankruptcy Court correctly stated the law on good faith in this
context: the test for good faith is "not one of negligence of duty to
inquire, but rather it is one of willful dishonesty or actual knowledge."
Valley Bank & Trust Co. v. American Utilities, Inc., 415 F. Supp. 298,
301 (E.D.Pa. 1976). See also Mellon Bank v. PasqualisPoliti,
800 F. Supp. 1297, 1302 (W.D.Pa. 1992), aff'd, 990 F.2d 780 (3d Cir.1993); Carnegie Bank v. Shalleck, 606 A.2d 389, 394 (N.J.Super.Ct.A.D. 1992); General Inv. Corp. v. Angelini, 278 A.2d 193 (N.J. 1971).Good faith may be defeated only by actual knowledge or a deliberate
attempt to evade knowledge. Rice v. Barrington, 70 A. 169, 170 (N.J. E. &
A 1908). "There is no affirmative duty of inquiry on the part of one
taking a negotiable instrument, and there is no constructive notice from
the circumstances of the transaction, unless the circumstances are so
strong that if ignored they will be deemed to establish bad faith on the
part of the transferee." Bankers Trust Co. v. Crawford, 781 F.2d 39, 45(3d Cir. 1986). Moreover, an HDC must take not only in good faith, but
also without notice of defenses to the instrument or document. One has
"notice" when
(1) he has actual knowledge of it;
(2) he has received a notice or notification of it; or
(3) from all the facts and circumstances known to him
at the time in question he has reason to know that it
exists.
Pa. Cons. Stat. Ann. § 1201.
The Bankruptcy Court here found that Provident did not in fact have
actual knowledge of the fraud or potential defense of failure of
consideration at the time of each separate closing. (Opinion at 58.) The
Bankruptcy Court also found that despite the fact that Provident failed
to review Pinnacle's books, records, and checking account ledger, failed
to notice the overdraft problem, failed to properly monitor withdrawals,
and failed to act after knowledge of financial deterioration in default
in providing timely audited financial statements, the appellees had not
proved that Provident acted with willful dishonesty (id.); Provident did
act with negligence or gross negligence, but gross negligence alone is
not enough to defeat an HDC's title. See Washington & Canonsburg Ry. Co.
v. Murray, 211 F. 440, 445 (3d Cir. 1914); General Inv. Corp.,
278 A.2d 193. Moreover, the Bankruptcy Court correctly noted that holderin due course status is generally created at the time that the claimant
becomes a holder — meaning at the time of negotiation. N.J.S.A.
12A:3302; Sisemore v. Kierlow Co., Inc. v. Nicholas, 27 A.2d 473, 478(Pa.Super.Ct. 1942). In transactions such as the ones at issue here which
involve blank endorsements, the instruments and documents are bearer
paper and are thus negotiated upon delivery alone. 13 Pa. Cons. Stat.
Ann. § 3201; N.J.S.A. 12A:3201.
Nonetheless, the Bankruptcy Court found that Provident failed to attain
the status of a holder in due course. It acknowledged that once a party
establishes its position as a holder in due course, no future action can
undermine that status; so in the usual transaction with negotiable bearer
paper, actual knowledge of defenses gained after possession do not defeat
HDC status. (Opinion at 63.) See Bricks Unlimited, Inc. v. Agee,
672 F.2d 1255, 1259 (5th Cir. 1982); Park Gasoline Co. v. Crusius,158 A. 334 (N.J. 1932). However, the Bankruptcy Court said, it was not
finding lack of good faith after gaining HDC status, but rather that
Provident did not gain HDC status in the first place, for these were not
the "usual" transactions. Taken in a "global sense," the Bankruptcy Court
said, these transactions did not end until after the settlements.
(Opinion at 58.)
Usually, one who takes a negotiable instrument for value has only the
underlying circumstances of that transaction by which to determine if
there is reason to give pause as to the veracity of that instrument. A
lender provides funds to a borrower who executes a promissory note. Once
that transaction is complete, the lender transfers the note to a second
lender in exchange for which the first lender receives funds replenishing
his account and enabling him to lend the same funds to another borrower.
HDC status is given to that second lender if it acts in good faith and
without knowledge of defenses, and there is no general duty for that
second lender to inquire unless the circumstances are so suspicious that
they cannot be ignored. See, e.g. Triffin, 670 A.2d at 692. In the usualHDC transaction, there are two discernible transactions, two exchanges of
funds and notes. As the Bankruptcy Court pointed out, the purpose of
giving that second lender HDC status is "to meet the contemporary needs
of fast moving commercial society . . . (citation omitted) and to enhance
the marketability of negotiable instruments [allowing] bankers, brokers
and the general public to trade in confidence." Triffin,
670 A.2d at 693. However, "the more the holder knows about the underlyingtransaction, and particularly the more he controls or participates or
becomes involved in it, the less he fits the role of a good faith
purchaser for value; the closer his relationship to the underlying
agreement which is the source of the note, the less need there is for
giving him the tensionfree rights necessary in a fastmoving,
creditextending commercial world." Unico v. Owen, 50 N.J. 101, 109110 (1967). See also Jones v. Approved Bancredit Corp., 256 A.2d 739, 742(Del. 1969) (in such a situation, "[the financer] should not be able to
hide behind `the fictional fence' of the . . . UCC and thereby achieve an
unfair advantage over the purchaser.").
Here, there were not two separate, discernible transactions.
Provident's funding of Pinnacle who funded the borrowers was one complex
transaction. The acts of a third party investor who would buy the notes
and mortgages from Provident would have been the second separate,
discernible transaction here. Provident did not replenish Pinnacle's
account in exchange for receiving the notes and mortgages, such that
Pinnacle would have more money to make more loans, as in the "usual"
transaction. Rather, in a complex and longstanding scheme encompassing
thousands of transactions over several years, Provident gave Pinnacle a
line of credit, and then, after Pinnacle gave Provident information about
individual proposed loans to borrowers, Provident transferred money to
Pinnacle's account, in order to later receive the note and mortgage from
each transaction and pass them on to a third party investor. The
Bankruptcy Court, as a factual matter, found that under this complex
scheme, no transactions between any of the parties were complete until
both of the transactions were concluded, particularly because the "second
lender" (Provident) had the ultimate control over the first transaction
(by ordering the dishonor of Pinnacle's checks).[fn10]
I cannot say that the Bankruptcy Court's factual finding was clearly
erroneous. The Bankruptcy Court's ruling accords with the evidence as
well as with the policy underlying the holder in due course doctrine. I
hold that where a warehouse lender so closely participates in the funding
and approval of mortgages which will ultimately lead to the warehouse
lender's rights in mortgages and promissory notes that the transactions
between mortgage banker and mortgagor and between warehouse lender and
mortgage banker are in fact one continuous transaction, rather than two
discernible transactions, a showing of the warehouse lender's lack of
good faith after the closing between title agent and mortgagor but before
the mortgage banker's check is presented to the warehouse lender may
destroy HDC status. Indeed, where the party who claims HDC status was in
essence a party to the original transaction, it cannot, by definition, be
a holder in due course.
Provident had a great deal of involvement in the ongoing series of
transactions and ample knowledge of Pinnacle's overall financial
wellbeing, developed through years of funding Pinnacle's credit line for
thousands of such transactions and receipt of Pinnacle's periodic
financial reports. It had particular information about the borrowers
before it funded these loans. It was, in fact, part of the loan
transactions, and not a separate party who became an HDC through the
giving of value at a second separate, discernible transaction. Provident
had too much control of, participation in, and knowledge of the
underlying transaction to claim that it was a good faith purchaser for
value. See, e.g., Fidelity Bank Nat'l Assoc., 740 F. Supp. at 239.
Because, under this complex transactional scheme, Provident functioned
essentially as a party which approved and funded the loans and gained
actual knowledge of a defense to the notes and mortgages (lack of
consideration) before the transactions were complete, it was not clearly
erroneous for the Bankruptcy Court to find that Provident lacked the good
faith necessary to claim HDC status. Accordingly, the Bankruptcy Court's
ruling is affirmed.
VI. CONCLUSION
For the foregoing reasons, I will affirm the Bankruptcy Court's ruling
that appellant Provident Savings Bank was not the holder in due course of
the notes and mortgages from the ten transactions closed by appellees.
The defense of failure of consideration thus is available against
Provident. I therefore affirm the Bankruptcy Court's judgment that
appellees, and not appellant, are entitled to the notes and mortgages. The
accompanying Order is entered.
ORDER
This matter having come upon the court upon the appeal of appellant,
Provident Savings Bank, from a Judgment entered on December 17, 1997, by
the Honorable Judith H. Wizmur, United States Bankruptcy Judge for the
District of New Jersey,; and the Court having considered the parties'
submissions; and for the reasons set forth in the Opinion of today's
date;
IT IS this day of December, 1998, hereby
ORDERED that the Judgment entered by the Honorable Judith H. Wizmur,
United States Bankruptcy Judge for the District of New Jersey, on
December 17, 1997, which granted the notes and mortgages from
transactions closed by the appellees in this matter to the appellees,
be, and hereby is, AFFIRMED.
[fn1] The appellant's cause of action against defendant William E. Ward
was removed to state court in Delaware upon motion on the basis of
abstention pursuant to 28 U.S.C. § 1334(c) where it is now pending.The appellant's cause of action against Meridian Bank was resolved prior
to trial pursuant to the Stipulation of Settlement with respect to Count
II of the Complaint, filed on July 16, 1996. All claims between the
appellant and Lawyers Title Insurance Corporation were mutually dismissed
at trial.
[fn2] The Agreement said $10 million, but at times up to $12.5 million
was advanced.
[fn3] It is a wellestablished law that appellate courts may not pass
upon an issue not presented in a lower court. Singleton v. Wulff,
428 U.S. 106, 120 (1976). The same holds true for a U.S. District Courtsitting in its appellate capacity over matters appealed from the
bankruptcy court. See Barrett v. Commonwealth Fed. Sav. and Loan Ass'n,
939 F.2d 20 (3d Cir. 1991); In re Middle Atlantic Stud Welding Co.,
503 F.2d 1133, 1134 n. 1 (3d Cir. 1974). Because Provident never raisedthis issue before the Bankruptcy Court, I will not consider it now.
[fn4] The res judicata doctrine prevents relitigation of claims that grow
out of a transaction or occurrence from which other claims have earlier
been raised and decided validly, finally, and on the merits. Federated
Department Stores v. Moitie, 452 U.S. 394, 298 (1981). Under Pennsylvanialaw, default judgments, absent fraud, are afforded res judicata effect.
In re Graves, 156 B.R. 949, 954 (E.D.Pa. 1993), aff'd, 33 F.3d 242 (3dCir. 1994). On December 21, 1994, the Court of Common Pleas of Berks
County, Pennsylvania, entered default judgments against Provident on both
the Weaver and Fisher transactions, those transactions for which Pioneer
was the closing agent. Due to these default judgments, the doctrine of
res judicata bars relitigation of the Pioneer causes of action. The
Bankruptcy Court also held that the Andreuzzi transaction was barred by
res judicata or collateral estoppel because of the lis pendens. That,
however, is a more difficult issue and one that I need not reach now, as
my affirmance of the Bankruptcy Court's judgment applies equally to the
Andreuzzi transaction on the merits.
[fn5] At trial and in its briefs to this Court, as an alternative to its
holder in due course argument, Provident argued that it was protected by
the Pennsylvania Uniform Fiduciaries Act, 7 Pa. Cons. Stat. § 6361,
and the New Jersey Uniform Fiduciaries Law, N.J.S.A. 3B:1454, theprovisions of which are substantially similar. The two laws protect a
person who transfers money to a fiduciary in good faith, by noting that
"any right or title acquired from the fiduciary in consideration of such
payment or transfer is not invalid in consequences of a misapplication by
the fiduciary." 7 Pa. Cons. Stat. § 6361; N.J.S.A. 3B:1454. TheBankruptcy Court held that Pinnacle was not Provident's agent or
fiduciary, and thus the UFA did not apply. (Opinion at 66.) In light of
the fact that Provident's counsel, at oral argument before this Court on
November 13, 1998, themselves argued that Pinnacle was not Provident's
fiduciary, I will affirm this aspect of the Bankruptcy Court's ruling
without need to examine the factual bases on which it relied.
[fn6] The rest of this Opinion is limited to the eight transactions not
handled by Pioneer, since only the Pioneer transactions are bound by res
judicata.
[fn7] As Part V of this Opinion explains, one of the several bases for
the Bankruptcy Court's decision that Provident is not the HDC of the
mortgages and notes is that the settlement agents were not Provident's
agents, and thus Provident did not constructively possess the mortgages
and notes prior to gaining knowledge of claims or defenses on those
notes. (Opinion at 3453.) In the alternative, in case appellate courts
determined that Provident was the HDC of those notes because an agency
relationship did exist, the Bankruptcy Court held that the closing
agents, and not Provident, would still be the ones entitled to the notes
and mortgages, for the agents would have had a right to indemnification
from Provident. (Id. at 6364.) Though, as I explain in Part V, I do not
reach the agency issue, I do affirm the Bankruptcy Court's HDC ruling on
other grounds. In doing so, I am affirming the decision that the
appellees, and not Provident, are entitled to the notes and mortgages. The
Bankruptcy Court's indemnification ruling is just an alternative reason
for finding that the appellees are entitled to the notes and mortgages.
Having already agreed that the closing agents are so entitled because
Provident is not an HDC, there is no need to address that alternative
ruling upon appeal.
[fn8] Seven of the eight remaining transactions here are governed by
Pennsylvania law. The eighth is under New Jersey law, but the two states'
laws on HDC status are largely consistent on the issues raised in these
proceedings.
[fn9] The Bankruptcy Court agreed that authority from other jurisdictions
suggest that a party may become a constructive holder when its agent
takes possession of a negotiable instrument on its behalf. (Opinion at
3637.) However, the Bankruptcy Court made the factual finding that
appellees were not Provident's agents. It determined that though six of
the ten transactions involved written agency agreements, those agreements
were not controlling in light of the course of dealing between the
parties (Opinion at 46), and that Provident did not otherwise meet its
burden of establishing that an agency relationship existed. Because I
find that the Bankruptcy Court's determination that Provident did not act
in good faith is not clearly erroneous, and because the lack of good
faith alone is enough of a basis to sustain a judgment that Provident is
not an HDC of these eight notes and mortgages, I need not address whether
the agency determination was clearly erroneous.
[fn10] Under the Bankruptcy Court's findings of fact, Provident was, in
reality, a party to the original transaction. The situation is somewhat
analogous to a consumer goods financer who has a substantial voice in the
underlying transaction; that financer is not entitled to HDC status.
Westfield Investment Co. v. Fellers, 181 A.2d 809 (N.J.Super.Ct. LawDiv.). Provident had a substantial voice in providing and carrying out
funding of the underlying borrowing transactions, and it thus cannot
claim that it was a good faith HDC when it learned of the defense of
failure of consideration prior to dishonoring the Pinnacle checks.
Loislaw Federal District Court Opinions
Copyright © 2013 CCH Incorporated or its affiliates
IN RE PINNACLE MORTGAGE INVESTMENT CORPORATION, (D.N.J. 1998)
IN RE PINNACLE MORTGAGE INVESTMENT CORPORATION, Debtor
PROVIDENT SAVINGS BANK, a New Jersey Banking Corporation,
Plaintiff/Appellant, v. PINNACLE MORTGAGE INVESTMENT CORPORATION, a
Pennsylvania Corporation, et al., Defendants, SETTLERS ABSTRACT CO., L.P.,
LAWYERS TITLE INSURANCE CORP., LAND TRANSFER CO, INC., FIDELITY NATIONAL
TITLE INSURANCE CO. OF PENNSYLVANIA, GINO L. ANDREUZZI, PIONEER AGENCY II
CORP. t/a PIONEER AGENCY, MUSSER & MUSSER, WILLIAM E. WARD, QUAKER ABSTRACT
CO., and SEARCHTEC ABSTRACT, INC., Appellees.
CIVIL NO. 980489 (JBS), [Bankruptcy Case No. 9510608 (JHW)], [Adv.
Proc. No. 951091]
United States District Court, D. New Jersey.
Filed: December 9, 1998
Walter E. Thomas, Jr., Esq., Timothy J. Matteson, Esq., Mark A. Trudeau,
Esq., Stern, Lavinthal, Norgaard & Kapnick, Esqs., Englewood, New Jersey,
Attorneys for Appellant.
Edward J. Hayes, Esq., Andrea Dobin, Esq., Fox, Rothschild, O'Brien &
Frankel, Princeton Pike Corporate Center, Lawrenceville, New Jersey,
Attorneys for Appellees, Settlers Abstract Co., L.P., Land Transfer Co,
Inc., Fidelity National Title Insurance Co. of Pennsylvania, Gino L.
Andreuzzi, Pioneer Agency II Corp. t/a Pioneer Agency, Musser & Musser,
Quaker Abstract Co, and Searchtec Abstract, Inc.
OPINION
SIMANDLE, District Judge.
I. INTRODUCTION
Provident Savings Bank appeals from a Judgment entered on December 17,
1997, pursuant to a written opinion issued on November 19, 1997, by the
Honorable Judith H. Wizmur, United States Bankruptcy Judge, after trial
in an adversary proceeding. That Opinion ruled in favor of the
Appellees, Settlers Abstract Co., L.P., Land Transfer Co, Inc., Fidelity
National Title Insurance Co. of Pennsylvania, Gino L. Andreuzzi, Pioneer
Agency II Corp. t/a Pioneer Agency, Musser & Musser, Quaker Abstract Co,
and Searchtec Abstract, Inc. ("title agents"). Reviewing a longstanding
complex lending relationship between Provident and the debtor, Pinnacle
Mortgage Corporation, of which the ten real estate mortgage loans at
issue herein were a part, the Bankruptcy Court held that appellee title
agents (who had advanced their own funds to cover disbursements when
Provident dishonored Pinnacle's checks) had a more valid or higher
priority security interest in the promissory notes and mortgages executed
as part of ten separate residential real estate closing than did
appellant. Provident Savings Bank appeals this ruling and seeks this
Court's determination that it was the holder in due course of those
documents.
The principal issue to be decided is whether the Bankruptcy Court
correctly determined under the Uniform Commercial Code that Provident was
not a holder in due course of the promissory notes arising from these
loans, where it found that Provident so closely participated in the
funding and approval of the Pinnaclebrokered loans that the transaction
did not end at the closing with the title agents, such that Provident did
not attain holder in due course status because it did not fit the
requisite role of a "good faith purchaser for value." For the reasons
that will be stated herein, the judgment will be affirmed because the
Bankruptcy Court's finding that Provident never attained HDC status was
neither clearly erroneous nor contrary to law.
II. BACKGROUND
A. Procedural History
This case arises from a dispute over the various security interests in
mortgage documents from ten separate real estate transactions in late
October, 1994, conducted by the debtor, Pinnacle Mortgage Investment
Corporation (who brokered the transactions), the appellant (who financed
the transactions), and the appellees (who were title closing agents in
the transactions). On February 2, 1995, appellant Provident Savings Bank
("Provident") and other creditors filed an involuntary petition under
Chapter 7 of Title 11 of the Bankruptcy Code against Pinnacle Mortgage
Investment Corporation ("Pinnacle"). An order for relief under Chapter 7
was entered by the Bankruptcy Court on March 6, 1995.
On March 24, 1995, Provident commenced this adversary proceeding by
filing a three count complaint to determine the extent, validity, and
priority of the various security interests asserted by Pinnacle, Meridian
Bank, Lawyers Title Insurance Corporation, the appellees, and William E.
Ward with regard to the promissory notes and mortgages from ten real
estate transactions.[fn1] Appellees responded to the complaint by filingan answer, counterclaims, and crossclaims, seeking money judgments in
the amount of the contested notes and mortgages, interest, cost of suit,
and attorneys fees; imposition of a constructive trust in their favor
with regard to the notes, mortgages, and proceeds thereof; and to have
the subject notes and mortgages avoided and stricken in favor of
subsequently executed mortgages between the appellees and the
mortgagors. Provident twice amended its complaint, finally seeking a
declaratory judgment that it is the holder in due course of the subject
notes and mortgages under the Uniform Commercial Code; avoidance of the
preferential transfer by appellee Andreuzzi pursuant to 11 U.S.C. § 547and 550; avoidance of the fraudulent transfer by appellee Andreuzzipursuant to §§ 548 and 550; and avoidance of the preferential and
fraudulent transfers by appellees pursuant to 11 U.S.C. § 547, 548,and 550.
Trial in this matter was held on July 16, 17, and 18, 1996, and October
1, 3, and 4, 1996. At the close of Provident's case in chief, upon motion
by the appellees, all of those portions of the Second Amended Complaint
which did not pertain to Provident's status as a holder in due course
("HDC") were dismissed.
B. The Factual History
In its November 19, 1997 opinion, the Bankruptcy Court determined that
the facts of the case are as follows. Debtor Pinnacle Mortgage Investment
Corporation ("Pinnacle" or "debtor") was a mortgage banker which
primarily dealt in residential mortgage lending and refinance. In December
of 1992, Pinnacle and Provident Savings Bank ("Provident" or "appellant")
entered into a Mortgage Warehouse Loan and Security Agreement
("Agreement"), whereby Provident would fund Pinnacle, who in turn funded
retail customers who sought to purchase or refinance residential real
estate. The borrower in each transaction would give Pinnacle a note and
mortgage, both of which acted as collateral to protect Provident until
Pinnacle sold the mortgage to a third party investor, such as the Federal
Home Loan Mortgage Corporation ("Freddie Mac"), who satisfied Pinnacle's
debt to Provident. Warehouse Agreement § 3.4.
1. The Warehouse Agreement
Under these types of agreements, there would usually not be any contact
between the warehouse lender and the ultimate mortgagor. Typically,
Pinnacle would arrange with a prospective borrower for Pinnacle to
advance funds for the borrower to purchase or refinance a home and for
the borrower to assign a note and mortgage to Pinnacle as collateral. The
mortgage would be endorsed in blank in order to accommodate the final
third party investor (such as Freddie Mac), with whom Pinnacle would
arrange to purchase the mortgage, usually as a part of a pool of
mortgages; this was known as a "takeout" agreement. All of this
completed, Pinnacle would submit a "package" to Provident seeking funding
for the particular transaction under its $10 million line of credit.[fn2]This package included a description of the borrower and the funding, an
assignment of the mortgage endorsed in blank, a takeout commitment, and
an agency agreement that indicated the borrower's attorney's agreement
"to act as the agent of the Bank" to disburse the Advance and to obtain
due execution and delivery to the bank of the original note that
evidences the debt underlying the Mortgage Loan." Warehouse Agreement
§ 5.3(A)(iii). The Agreement required all of this to be submitted
along with the initial funding request. As a matter of course, however,
the agency agreement was usually executed by the title agent handling the
closing instead of by the borrower's attorney, and Provident customarily
accepted the mortgage assignment and agency agreement after the actual
closing.
After Provident received the package and checked to see that Pinnacle's
credit limit had not been exceeded (although, as stated above, often
prior to receipt of the mortgage assignment and agency agreement),
Provident credited Pinnacle's checking account with 98% of the requested
funds. Warehouse Agreement §§ 1.1, 2.1. Pinnacle would write a
regular, uncertified check to the closing agent, who would close the loan
directly with the borrower on Pinnacle's behalf. Pinnacle was supposed to
use specific funds credited to their account to fund specific closings,
but no controls were in place to make sure that Pinnacle actually did
so.
With Pinnacle's check in hand, the closing agent would use money from
its own bank account to disburse funds to the mortgagor, later
replenishing its bank account by depositing Pinnacle's check. Next, the
closing agent would routinely send the original note, a certified copy of
the recorded mortgage, and the other closing documents to Pinnacle, who
would send them on to Provident, who would receive this original note
approximately three to five days after closing. Provident and the
borrowers had no contact; indeed, Provident and the closing agents had no
contact, save the extremely limited contact by the closing agents who did
return the agency agreement included in the borrowing package. Not all
closing agents did return the agreement signed; most of those who did
sent everything through Pinnacle to go to Provident, in accordance with
Pinnacle's written instructions, rather than remitting the note and other
papers directly to Provident, as stated in the agency agreement.
Ultimately, Provident would send the note and accompanying documents to
the third party investor, who would pay Provident the funds which
Provident had originally placed in Pinnacle's checking account by wiring
monies to Provident in Pinnacle's name. Because the third party investor
would send multiple payments in each wire transfer, Pinnacle would tell
Provident to which loans to apply each of the funds.
2. Pinnacle's Declining Financial State
Among the twenty or so warehouse customers that Provident had during
19931994, Pinnacle was the most profitable for Provident, providing
hundreds of millions of dollars in loan transactions. However, when the
mortgage banking industry suffered a decline in business, Pinnacle began
to experience financial difficulties as well.
The Warehouse Agreement, § 6.11, required Pinnacle to submit
unaudited balance sheets and statements of income to Provident on a
quarterly basis, though Pinnacle customarily provided monthly
statements. The statements filed for June, July, and August of 1993
reflected an accrued pretax income for the first three months of the
fiscal year of $281,351. Statements for September, October, and November
of 1993 reflected pretax income of $923,923 for the first six months of
the fiscal year. However, after the November 30 report, Pinnacle began to
send its reports quarterly, which was in accordance with the Warehouse
Agreement but which was nonetheless unusual due to Pinnacle's custom of
submitting reports monthly. The next report, covering the ninemonth
period ending February 28, 1994, was due on April 15 but not received
until some time in May. It showed pretax income of $136,000 for the
first nine months, or an $800,000 loss in the previous three months. The
accompanying unaudited balance sheets showed a reduction of assets from
$40 million to $28 million in those three months. The final financial
statement was due on August 31, 1994, but Provident never received it.
At a holiday party in May 1994, Edmund R. Folsom, head of Provident's
Commercial Lending Department, had learned that Pinnacle had sustained
losses in the winter months. On August 19, 1994, Sharon Kinkead, of
Provident's Warehouse Lending Department, called Pinnacle's headquarters
and learned from Pinnacle's CFO, Joseph Mader, that there would be a
delay in the submission of the audited financial statements for the
fiscal year ending May 31, 1994 because of a change of comptroller, but
that the report would be provided by September 15, 1994. That report
never arrived, and no other financial statements were received up until
Provident's termination of its relationship with Pinnacle in early
November 1994.
3. Provident's Relationship with Pinnacle
Throughout its relationship with Pinnacle, Provident routinely honored
overdrafts on behalf of Pinnacle — about twenty times in 1993 and
fifteen times in 1994. These overdrafts ranged from $7,240.87 to
$5,255,812.
When a check was presented to the bank on Pinnacle's account for which
Pinnacle had insufficient funds, Sharon Kinkead would contact Pinnacle to
ask whether Pinnacle would honor that overdraft. Having been told that
the check would be covered (usually from an anticipated wire transfer),
Kinkead and her supervisor, Mr. Folsom, would honor it and allow the
overdraft. Until November 1994, Provident honored all of Pinnacle's
overdrafts, without reviewing Pinnacle's books and records or monitoring
its checking account.
As mentioned earlier, Pinnacle's CFO, Joseph Mader, had informed
Provident that its final fiscal year report would be forthcoming on
September 15, 1994. When Provident did not receive the audited reports by
that date, Mr. Folsom spoke with Mr. Mader, who reported that though
Pinnacle had sustained losses, it was expecting a substantial infusion of
capital. Pinnacle wanted to hold off publishing the report so that it
could add a footnote explaining that there would be a capital infusion.
Based on this, Folsom decided to extend Pinnacle's credit line through
the end of November.
Folsom called Mader some time in October to check on the status of the
report. When Mader returned the call on November 1, he informed Folsom
that the capital infusion had failed. Folsom demanded a meeting with
Pinnacle's officers.
On November 2, Folsom and Kinkead met with Mader and Al Miller,
President of Pinnacle. Mader and Miller presented internally generated
financial statements indicating a pretax loss of six million dollars for
the previous fiscal year, as well as a pretax loss of almost one million
dollars for the first quarter of the current fiscal year. Miller and
Mader admitted that they had misused their warehouse credit line with
G.E. Capital Mortgage Services, Inc., to whom they were indebted for
about six million dollars. They "admitted fraud" as to G.E., but
indicated that they had not misappropriated the Provident funds and asked
for an extension of funding of their loans while they financially
reorganized. Provident declined to do so.
At that time, Provident finally reviewed Pinnacle's books and
discovered that Pinnacle had been diverting substantial sums of money
from Pinnacle's Provident account to its operating account at Meridian
Bank. Kinkead and Folsom also learned that Pinnacle had been requesting
advances on loans earlier than was routinely requested, possibly using
the money that was supposed to be for specific loans for other purposes
instead. Indeed, Pinnacle was engaging in a "kiting" scheme,
misappropriating monies from third party investors that should have been
applied to previously funded loans. A Pinnacle employee told Kinkead that
the Provident line was not "whole," that as much as $500,000 may have
been taken from it, though no fraudulent loans had been made.
As of November 2, 1994, all checks presented to Provident on Pinnacle's
account had been processed, and the customer balance summary showed an
overdraft of $206,653.67. On November 3, $830,127.48 was deposited in
Pinnacle's account. Sixteen checks totaling $1,584,041.63 were presented
to Provident against Pinnacle's account on November 3. There were
insufficient funds to cover all sixteen, so Folsom sent a letter to
Miller, Pinnacle's president, to ask which checks should be paid. At the
time, Provident knew that all sixteen of those checks represented monies
that Pinnacle had delivered to borrowers and closing agents for
particular loans, as well as that each transaction was accompanied by a
takeout commitment by a third party investor, who would have paid for
the loan.
Miller indicated that six of the checks could be paid. Provident
debited $863,821 to pay off eight loans on November 4, and other checks
were paid at Mader's instruction. There was an overdraft on that date of
$178,303.73, and Provident honored no more checks. The remaining ten of
the sixteen checks presented on November 3 were dishonored, and those are
the subject of the instant litigation.
4. The Ten Transactions
Prior to the closings in each of the ten transactions in question,
Pinnacle had requested from Provident — and received — monies
to fund the transactions. As usual, Pinnacle presented the closing agent
with an uncertified check drawn on its account at Provident representing
payment for the note and mortgage to be executed by the borrower,
purchaser, or refinancer of the property. With Pinnacle's check in hand,
the closing agents closed each transaction, issuing checks from their own
accounts to the parties entitled to receive funds. The closing agents
then deposited Pinnacle's checks in their own accounts, and their banks
presented those checks to Provident for payment. In each case, Provident
dishonored the checks due to insufficient funds. After each closing, but
before the discovery of any problem, each closing agent returned the
original note to Pinnacle. Several closing agents recorded the mortgage
and sent Pinnacle certified copies. Despite the fact that Pinnacle's
checks were not honored, each closing agent honored their own checks when
they were presented.
At the time, uncertified funds were routinely accepted from mortgage
bankers, with a few exceptions for out of state lenders, ignoring the
Pennsylvania statute which required mortgage bankers and brokers to
certify funds. Most mortgage lenders such as Pinnacle insisted on
acceptance of regular checks; title insurers could not stay in business
if they did not follow the standard in the industry.
As was usual for these transactions, Provident had no contact with any
of the closing agents prior to settlement. Agency agreements were
included in most, but not all, of the instruction packages sent by
Pinnacle to the respective closing agents. The agreement provided that
Provident had a security interest in the note and mortgage; moreover, it
provided that the closing agent would act as Provident's agent in
connection with the loan transaction, agreeing to record the mortgage and
then to send both the original note and the original recorded mortgage to
Provident upon closing. The text of the agreement conflicted with the
closing instructions that Pinnacle gave to the closing agents, which
required the note to be returned to Pinnacle. In six of the ten
transactions, the agreement was executed, but its provisions were
basically ignored, as the closing documents were returned directly to
Pinnacle.
The closing agents learned of the dishonor from their own banks.
Provident did not attempt to contact the closing agents until November
10, 1994, when they sent a letter with instructions to deliver to
Provident all notes, mortgages, loan files, and other collateral, and any
monies received in connection with each mortgage loan.
Several of the agents sought judicial relief. Two of the closing agents
who are appellees in this matter, Gino L. Andreuzzi and the Pioneer
Agency L.P., hold state court judgments in their favor, for a total of
three judgments against Pinnacle, striking the mortgages and notes
executed by their respective buyers in favor of Pinnacle. Andreuzzi, the
closing agent in the Hopeck settlement, filed suit against Pinnacle in
the Court of Common Pleas of Luzerne County, Pennsylvania, seeking a TRO
to keep Pinnacle from selling, transferring, or assigning the note and
mortgage in question. Provident was not joined in Andreuzzi's case, but
it did have notice of the litigation. Andreuzzi filed a lis pendens with
the Prothonotary on November 14, 1994. About three hours after the lis
pendens was filed, Provident recorded the assignment from the Hopeck
note. Ultimately, a default judgment was entered against Pinnacle.
Pioneer also filed suits in connection with the Weaver and Fisher
transactions. In both cases, Pioneer sued Pinnacle and Provident in the
Court of Common Pleas of Berks County, Pennsylvania, on November 14,
1994. A preliminary injunction was entered on November 22, and a default
judgment was entered against both defendants on December 21, 1994. Two
days later, Pinnacle moved to open the default judgment. It was still
pending on February 1, 1995 when an involuntary petition was filed against
Pinnacle. Provident removed the action to the Bankruptcy Court on May 8,
1995.
Other closing agents entered into agreements with the borrowers to
execute new notes and mortgages. By the time this came before the
Bankruptcy Court, the mortgages had either been satisfied in full, with
proceeds held in escrow, or payments on the new mortgages and notes were
being made by the borrowers to the closing agents in escrow pending the
resolution of this matter.
C. The Bankruptcy Court's Findings and Judgment
On November 19, 1997, the Bankruptcy Court issued its Opinion in favor
of the appellees, ruling that:
(1) the appellant did not achieve the status of an HDC
with regard to the notes and mortgages in issue;
(2) the appellees would be entitled to indemnification
even if an agency relationship existed between the
appellant and appellees;
(3) the Uniform Fiduciaries Law is inapplicable to
validate the appellant's position with regard to the
subject notes and mortgages; and
(4) the appellant is precluded from relitigating the
transactions with appellees Pioneer Agency II Corp
t/a Pioneer Agency and Andreuzzi.
Judgment against Provident was entered on December 17, 1997. On December
22, 1997, appellant filed a notice of appeal from the Judgment. On
February 13, 1998, the record on appeal was transmitted to this Court. As
"nothing remains for the [lower] court to do," Universal Minerals, Inc.
v. C.A. Hughes & Co., 669 F.2d 98, 101 (3d Cir. 1981), the BankruptcyCourt's ruling is final, and thus this Court properly has appellate
jurisdiction over the December 17, 1997 Order pursuant to
28 U.S.C. § 158(a).
III. ISSUES PRESENTED
On appeal, Provident makes six arguments. First, Provident argues that
it is the holder in due course ("HDC") of the ten mortgage notes.
Second, Provident argues that the Bankruptcy Court's ruling that the
appellees were entitled to indemnification if they were Provident's agents
is clearly erroneous. Third, appellant contends that the bankruptcy court
erred in ruling that Provident was not protected by the Uniform
Fiduciaries Act ("UFA"), adopted by both New Jersey and Pennsylvania at
N.J.S.A. 3B:1454 and 7 Pa. Cons. Stat. Ann. § 6361, respectively.Fourth, Provident argues, for the first time upon appeal, that the
doctrine of avoidable consequences bars appellees from recovering any
damages from Provident. Fifth, Provident maintains that the doctrines of
lis pendens, res judicata, and collateral estoppel do not bar
relitigation of these issues as to the Andreuzzi transaction. Finally,
Provident argues that the Bankruptcy Court erred by giving preclusionary
effect to the Pioneer action default judgments.
This Opinion will not address Provident's "avoidable consequences"
argument, as it was raised, for the first time, upon appeal.[fn3]Moreover, the doctrine of res judicata precludes review of the two
transactions for which Pioneer was the closing agent, and I thus affirm
the Bankruptcy Court's judgment as to Pioneer on that ground.[fn4] I willaffirm the Bankruptcy Court's holding that Provident is not entitled to
the protections of the Uniform Fiduciaries Act , especially in light of
the fact that Provident has withdrawn its argument that Pinnacle was its
agent.[fn5] For reasons stated herein, I will affirm the BankruptcyCourt's holding that Provident is not the holder in due course of the
eight[fn6] transactions still in question. Accordingly, there is no needfor this Court to address the Bankruptcy Court's alternate finding that
the closing agents would be entitled to indemnification.[fn7]
IV. STANDARD OF REVIEW
On appeal, the weight accorded to the findings of fact by a bankruptcy
court are governed by Fed.R.Bank.P. 8013, which provides as follows:
On appeal the district court or bankruptcy appellate
panel may affirm, modify, or reverse a bankruptcy
judge's judgment, order, or decree or remand with
instructions for further proceedings. Findings of
fact, whether based on oral or documentary evidence,
shall not be set aside unless clearly erroneous, and
due regard shall be given to the opportunity of the
bankruptcy court to judge the credibility of
witnesses.
Fed.R.Bank.P. 8013. Under this Rule, a bankruptcy court's factualfindings may be disturbed only if clearly erroneous. See FGH Realty
Credit v. Newark Airport/Hotel Ltd., 155 B.R. 93 (D.N.J. 1993). Where a
mixed question of law and fact is presented, the appropriate standard
must be applied to each component. In re Sharon Steel Corp., 871 F.2d 1217,
1222 (3d Cir. 1989). Thus, a reviewing court "must accept the [lower]court's findings of historical or narrative facts unless they are clearly
erroneous, but . . . must exercise a plenary review and its application
of those precepts to the historical facts." Universal Minerals, Inc. v.
C.A. Hughes & Co., 669 F.2d at 103.
While standards for establishing that a party is a holder in due course
are wellsettled law, see, e.g., Triffin v. Dillabough, 448 Pa. Super. 72,
87, 670 A.2d 684, 691 (1996), the Court's application of these standardsto the facts does result in a mixed finding of fact and law that is
subject to a mixed standard of review. Mellon Bank, N.A. v. Metro
Communications, Inc., 945 F.2d 635, 64142 (3d Cir. 1991), cert. denied,
503 U.S. 937 (1992). The factual findings can only be reversed for clearerror, In re Graves, 33 F.3d 242, 251 (3d Cir. 1994), even if thereviewing court would have decided the matter differently. In re
PrincetonNew York Investors, Inc., 1998 WL 111674 (D.N.J. 1998). This
Court, thus, may not overturn a bankruptcy judge's factual findings if
the factual determinations bear any "rational relationship to the
supporting evidentiary data. . . ." Fellheimer, Eichen & Braverman, P.C.
v. Charter Technologies, Inc., 57 F.3d 1215, 1223 (3d Cir. 1995) (citingHoots v. Comm. of Pa., 703 F.2d 722, 725 (3d Cir. 1983). However, thisCourt reviews any legal conclusions de novo.
V. DISCUSSION
Appellant argues that the Bankruptcy Court's finding that appellant is
not an HDC of the promissory notes and mortgages from the eight remaining
real estate transactions closed by appellees is clearly erroneous. The
dispute here is not a dispute of law, as the parties agree on what the
law concerning HDCs is. As the Bankruptcy Court correctly found,[fn8]every holder of a negotiable instrument is presumed to be an HDC, Morgan
Guaranty Trust Company of New York v. Staats, 631 A.2d 631, 636(Pa.Super.Ct. 1993), but when a defense of fraud is meritorious as to the
payee, the holder has the burden of showing that it is an HDC in order to
be immune from that defense. Norman v. World Wide Distributors, Inc.,
195 A.2d 115, 117 (Pa.Super.Ct. 1963). A holder of a negotiableinstrument (such as the promissory notes in this case) is either the
person with possession of bearer paper or the person identified on the
instrument if that person is in possession. 13 Pa. Cons. Stat. Ann.
§ 1201; N.J.S.A. 12A:3201 (West Supp. 1998). The holder of adocument of title (such as the mortgages in this case) is the person in
possession if the document is made out to bearer or to the order of the
person in possession. Id. The holder becomes an HDC if:
(1) the instrument when issued or negotiated to the
holder does not bear such apparent evidence of forgery
or alteration or is not otherwise so irregular or
incomplete as to call into question its authenticity;
and
(2) the holder took the instrument:
(i) for value;
(ii) in good faith;
(iii) without notice that the instrument is
overdue or has been dishonored or that there is an
uncured default with respect to payment of another
instrument issued as part of the same series;
(iv) without notice that the instrument contains
an unauthorized signature or has been altered;
(v) without notice of any claim to the instrument
described in section 3306 (relating to claims to an
instrument); and
(vi) without notice that any party has a defense
or claim in recoupment described in section 3305(a)
(relating to defenses and claims in recoupment).
13 Pa. Cons. Stat. Ann. § 3302. See also N.J.S.A. 12A:3302. Inshort, an HDC is the holder of the instrument or document who took for
value and in good faith without notice of any claims or defects on the
instrument or document. If classified as an HDC, the holder holds without
regard to defenses, with certain statutory exemptions which do not apply
here. 13 Pa. Cons. Stat. Ann. § 3305; N.J.S.A. 12A:3305.
It was clear to the parties and to the Bankruptcy Court below that
Provident did not have actual possession of the notes and mortgages
before November 2, 1998, when it learned that there were insufficient
funds in Pinnacle's account at Provident to cover Pinnacle's checks to
the closing agents here. Provident nonetheless argued that it was the
holder of the notes and mortgages because, before gaining actual
knowledge of Pinnacle's fraud, Provident "constructively possessed" the
notes and mortgages from the moment that the closing agents, who were
allegedly Provident's agents, took possession of the notes at the
closings before November 2.
The Bankruptcy Court rejected Provident's argument, finding that none
of the appellees acted as Provident's agents, and thus Provident never
constructively or actually possessed the notes and mortgages. Thus, the
Bankruptcy Court found that Provident never became the holder of these
notes and mortgages in the first place. (Opinion at 53.) Alternatively,
the Bankruptcy Court found that while Provident did give value for the
notes and mortgages (Opinion at 54), it did not take those notes and
mortgages in good faith and without knowledge of defenses, and thus
Provident is not an HDC. (Opinion at 63.) The question before this Court
is whether the Bankruptcy Court's rulings in this regard were clearly
erroneous. I hold that it was neither clearly erroneous nor contrary to
established law for the Bankruptcy Court to find that Provident did not
fit the role of "good faith purchaser for value" necessary to claim HDC
status even though Provident's lack of good faith arose after the title
agents closed the real estate transactions. As the following discussion
will explain, in the context of a course of dealing between Provident and
Pinnacle extending over thousands of such transactions, Provident was
essentially a party to the mortgage lending transactions and thus, by
definition, cannot claim HDC status in the negotiable papers which
resulted from those transactions, especially because Provident gained
knowledge of defenses before its own role in the original mortgage
lending transaction was complete.
I affirm the Bankruptcy Court's ruling that Provident is not the HDC of
these notes and mortgages. In so holding, I need not, and thus do not,
reach the issue of whether Provident constructively possessed the notes
and mortgages,[fn9] for holder status is irrelevant if Provident did nottake in good faith and without knowledge of defenses. Because I find that
the Bankruptcy Court's ruling that Provident did not take in good faith
was not clearly erroneous, I affirm the ruling that Provident is not
entitled to the protections afforded to a holder in due course.
The Bankruptcy Court correctly stated the law on good faith in this
context: the test for good faith is "not one of negligence of duty to
inquire, but rather it is one of willful dishonesty or actual knowledge."
Valley Bank & Trust Co. v. American Utilities, Inc., 415 F. Supp. 298,
301 (E.D.Pa. 1976). See also Mellon Bank v. PasqualisPoliti,
800 F. Supp. 1297, 1302 (W.D.Pa. 1992), aff'd, 990 F.2d 780 (3d Cir.1993); Carnegie Bank v. Shalleck, 606 A.2d 389, 394 (N.J.Super.Ct.A.D. 1992); General Inv. Corp. v. Angelini, 278 A.2d 193 (N.J. 1971).Good faith may be defeated only by actual knowledge or a deliberate
attempt to evade knowledge. Rice v. Barrington, 70 A. 169, 170 (N.J. E. &
A 1908). "There is no affirmative duty of inquiry on the part of one
taking a negotiable instrument, and there is no constructive notice from
the circumstances of the transaction, unless the circumstances are so
strong that if ignored they will be deemed to establish bad faith on the
part of the transferee." Bankers Trust Co. v. Crawford, 781 F.2d 39, 45(3d Cir. 1986). Moreover, an HDC must take not only in good faith, but
also without notice of defenses to the instrument or document. One has
"notice" when
(1) he has actual knowledge of it;
(2) he has received a notice or notification of it; or
(3) from all the facts and circumstances known to him
at the time in question he has reason to know that it
exists.
Pa. Cons. Stat. Ann. § 1201.
The Bankruptcy Court here found that Provident did not in fact have
actual knowledge of the fraud or potential defense of failure of
consideration at the time of each separate closing. (Opinion at 58.) The
Bankruptcy Court also found that despite the fact that Provident failed
to review Pinnacle's books, records, and checking account ledger, failed
to notice the overdraft problem, failed to properly monitor withdrawals,
and failed to act after knowledge of financial deterioration in default
in providing timely audited financial statements, the appellees had not
proved that Provident acted with willful dishonesty (id.); Provident did
act with negligence or gross negligence, but gross negligence alone is
not enough to defeat an HDC's title. See Washington & Canonsburg Ry. Co.
v. Murray, 211 F. 440, 445 (3d Cir. 1914); General Inv. Corp.,
278 A.2d 193. Moreover, the Bankruptcy Court correctly noted that holderin due course status is generally created at the time that the claimant
becomes a holder — meaning at the time of negotiation. N.J.S.A.
12A:3302; Sisemore v. Kierlow Co., Inc. v. Nicholas, 27 A.2d 473, 478(Pa.Super.Ct. 1942). In transactions such as the ones at issue here which
involve blank endorsements, the instruments and documents are bearer
paper and are thus negotiated upon delivery alone. 13 Pa. Cons. Stat.
Ann. § 3201; N.J.S.A. 12A:3201.
Nonetheless, the Bankruptcy Court found that Provident failed to attain
the status of a holder in due course. It acknowledged that once a party
establishes its position as a holder in due course, no future action can
undermine that status; so in the usual transaction with negotiable bearer
paper, actual knowledge of defenses gained after possession do not defeat
HDC status. (Opinion at 63.) See Bricks Unlimited, Inc. v. Agee,
672 F.2d 1255, 1259 (5th Cir. 1982); Park Gasoline Co. v. Crusius,158 A. 334 (N.J. 1932). However, the Bankruptcy Court said, it was not
finding lack of good faith after gaining HDC status, but rather that
Provident did not gain HDC status in the first place, for these were not
the "usual" transactions. Taken in a "global sense," the Bankruptcy Court
said, these transactions did not end until after the settlements.
(Opinion at 58.)
Usually, one who takes a negotiable instrument for value has only the
underlying circumstances of that transaction by which to determine if
there is reason to give pause as to the veracity of that instrument. A
lender provides funds to a borrower who executes a promissory note. Once
that transaction is complete, the lender transfers the note to a second
lender in exchange for which the first lender receives funds replenishing
his account and enabling him to lend the same funds to another borrower.
HDC status is given to that second lender if it acts in good faith and
without knowledge of defenses, and there is no general duty for that
second lender to inquire unless the circumstances are so suspicious that
they cannot be ignored. See, e.g. Triffin, 670 A.2d at 692. In the usualHDC transaction, there are two discernible transactions, two exchanges of
funds and notes. As the Bankruptcy Court pointed out, the purpose of
giving that second lender HDC status is "to meet the contemporary needs
of fast moving commercial society . . . (citation omitted) and to enhance
the marketability of negotiable instruments [allowing] bankers, brokers
and the general public to trade in confidence." Triffin,
670 A.2d at 693. However, "the more the holder knows about the underlyingtransaction, and particularly the more he controls or participates or
becomes involved in it, the less he fits the role of a good faith
purchaser for value; the closer his relationship to the underlying
agreement which is the source of the note, the less need there is for
giving him the tensionfree rights necessary in a fastmoving,
creditextending commercial world." Unico v. Owen, 50 N.J. 101, 109110 (1967). See also Jones v. Approved Bancredit Corp., 256 A.2d 739, 742(Del. 1969) (in such a situation, "[the financer] should not be able to
hide behind `the fictional fence' of the . . . UCC and thereby achieve an
unfair advantage over the purchaser.").
Here, there were not two separate, discernible transactions.
Provident's funding of Pinnacle who funded the borrowers was one complex
transaction. The acts of a third party investor who would buy the notes
and mortgages from Provident would have been the second separate,
discernible transaction here. Provident did not replenish Pinnacle's
account in exchange for receiving the notes and mortgages, such that
Pinnacle would have more money to make more loans, as in the "usual"
transaction. Rather, in a complex and longstanding scheme encompassing
thousands of transactions over several years, Provident gave Pinnacle a
line of credit, and then, after Pinnacle gave Provident information about
individual proposed loans to borrowers, Provident transferred money to
Pinnacle's account, in order to later receive the note and mortgage from
each transaction and pass them on to a third party investor. The
Bankruptcy Court, as a factual matter, found that under this complex
scheme, no transactions between any of the parties were complete until
both of the transactions were concluded, particularly because the "second
lender" (Provident) had the ultimate control over the first transaction
(by ordering the dishonor of Pinnacle's checks).[fn10]
I cannot say that the Bankruptcy Court's factual finding was clearly
erroneous. The Bankruptcy Court's ruling accords with the evidence as
well as with the policy underlying the holder in due course doctrine. I
hold that where a warehouse lender so closely participates in the funding
and approval of mortgages which will ultimately lead to the warehouse
lender's rights in mortgages and promissory notes that the transactions
between mortgage banker and mortgagor and between warehouse lender and
mortgage banker are in fact one continuous transaction, rather than two
discernible transactions, a showing of the warehouse lender's lack of
good faith after the closing between title agent and mortgagor but before
the mortgage banker's check is presented to the warehouse lender may
destroy HDC status. Indeed, where the party who claims HDC status was in
essence a party to the original transaction, it cannot, by definition, be
a holder in due course.
Provident had a great deal of involvement in the ongoing series of
transactions and ample knowledge of Pinnacle's overall financial
wellbeing, developed through years of funding Pinnacle's credit line for
thousands of such transactions and receipt of Pinnacle's periodic
financial reports. It had particular information about the borrowers
before it funded these loans. It was, in fact, part of the loan
transactions, and not a separate party who became an HDC through the
giving of value at a second separate, discernible transaction. Provident
had too much control of, participation in, and knowledge of the
underlying transaction to claim that it was a good faith purchaser for
value. See, e.g., Fidelity Bank Nat'l Assoc., 740 F. Supp. at 239.
Because, under this complex transactional scheme, Provident functioned
essentially as a party which approved and funded the loans and gained
actual knowledge of a defense to the notes and mortgages (lack of
consideration) before the transactions were complete, it was not clearly
erroneous for the Bankruptcy Court to find that Provident lacked the good
faith necessary to claim HDC status. Accordingly, the Bankruptcy Court's
ruling is affirmed.
VI. CONCLUSION
For the foregoing reasons, I will affirm the Bankruptcy Court's ruling
that appellant Provident Savings Bank was not the holder in due course of
the notes and mortgages from the ten transactions closed by appellees.
The defense of failure of consideration thus is available against
Provident. I therefore affirm the Bankruptcy Court's judgment that
appellees, and not appellant, are entitled to the notes and mortgages. The
accompanying Order is entered.
ORDER
This matter having come upon the court upon the appeal of appellant,
Provident Savings Bank, from a Judgment entered on December 17, 1997, by
the Honorable Judith H. Wizmur, United States Bankruptcy Judge for the
District of New Jersey,; and the Court having considered the parties'
submissions; and for the reasons set forth in the Opinion of today's
date;
IT IS this day of December, 1998, hereby
ORDERED that the Judgment entered by the Honorable Judith H. Wizmur,
United States Bankruptcy Judge for the District of New Jersey, on
December 17, 1997, which granted the notes and mortgages from
transactions closed by the appellees in this matter to the appellees,
be, and hereby is, AFFIRMED.
[fn1] The appellant's cause of action against defendant William E. Ward
was removed to state court in Delaware upon motion on the basis of
abstention pursuant to 28 U.S.C. § 1334(c) where it is now pending.The appellant's cause of action against Meridian Bank was resolved prior
to trial pursuant to the Stipulation of Settlement with respect to Count
II of the Complaint, filed on July 16, 1996. All claims between the
appellant and Lawyers Title Insurance Corporation were mutually dismissed
at trial.
[fn2] The Agreement said $10 million, but at times up to $12.5 million
was advanced.
[fn3] It is a wellestablished law that appellate courts may not pass
upon an issue not presented in a lower court. Singleton v. Wulff,
428 U.S. 106, 120 (1976). The same holds true for a U.S. District Courtsitting in its appellate capacity over matters appealed from the
bankruptcy court. See Barrett v. Commonwealth Fed. Sav. and Loan Ass'n,
939 F.2d 20 (3d Cir. 1991); In re Middle Atlantic Stud Welding Co.,
503 F.2d 1133, 1134 n. 1 (3d Cir. 1974). Because Provident never raisedthis issue before the Bankruptcy Court, I will not consider it now.
[fn4] The res judicata doctrine prevents relitigation of claims that grow
out of a transaction or occurrence from which other claims have earlier
been raised and decided validly, finally, and on the merits. Federated
Department Stores v. Moitie, 452 U.S. 394, 298 (1981). Under Pennsylvanialaw, default judgments, absent fraud, are afforded res judicata effect.
In re Graves, 156 B.R. 949, 954 (E.D.Pa. 1993), aff'd, 33 F.3d 242 (3dCir. 1994). On December 21, 1994, the Court of Common Pleas of Berks
County, Pennsylvania, entered default judgments against Provident on both
the Weaver and Fisher transactions, those transactions for which Pioneer
was the closing agent. Due to these default judgments, the doctrine of
res judicata bars relitigation of the Pioneer causes of action. The
Bankruptcy Court also held that the Andreuzzi transaction was barred by
res judicata or collateral estoppel because of the lis pendens. That,
however, is a more difficult issue and one that I need not reach now, as
my affirmance of the Bankruptcy Court's judgment applies equally to the
Andreuzzi transaction on the merits.
[fn5] At trial and in its briefs to this Court, as an alternative to its
holder in due course argument, Provident argued that it was protected by
the Pennsylvania Uniform Fiduciaries Act, 7 Pa. Cons. Stat. § 6361,
and the New Jersey Uniform Fiduciaries Law, N.J.S.A. 3B:1454, theprovisions of which are substantially similar. The two laws protect a
person who transfers money to a fiduciary in good faith, by noting that
"any right or title acquired from the fiduciary in consideration of such
payment or transfer is not invalid in consequences of a misapplication by
the fiduciary." 7 Pa. Cons. Stat. § 6361; N.J.S.A. 3B:1454. TheBankruptcy Court held that Pinnacle was not Provident's agent or
fiduciary, and thus the UFA did not apply. (Opinion at 66.) In light of
the fact that Provident's counsel, at oral argument before this Court on
November 13, 1998, themselves argued that Pinnacle was not Provident's
fiduciary, I will affirm this aspect of the Bankruptcy Court's ruling
without need to examine the factual bases on which it relied.
[fn6] The rest of this Opinion is limited to the eight transactions not
handled by Pioneer, since only the Pioneer transactions are bound by res
judicata.
[fn7] As Part V of this Opinion explains, one of the several bases for
the Bankruptcy Court's decision that Provident is not the HDC of the
mortgages and notes is that the settlement agents were not Provident's
agents, and thus Provident did not constructively possess the mortgages
and notes prior to gaining knowledge of claims or defenses on those
notes. (Opinion at 3453.) In the alternative, in case appellate courts
determined that Provident was the HDC of those notes because an agency
relationship did exist, the Bankruptcy Court held that the closing
agents, and not Provident, would still be the ones entitled to the notes
and mortgages, for the agents would have had a right to indemnification
from Provident. (Id. at 6364.) Though, as I explain in Part V, I do not
reach the agency issue, I do affirm the Bankruptcy Court's HDC ruling on
other grounds. In doing so, I am affirming the decision that the
appellees, and not Provident, are entitled to the notes and mortgages. The
Bankruptcy Court's indemnification ruling is just an alternative reason
for finding that the appellees are entitled to the notes and mortgages.
Having already agreed that the closing agents are so entitled because
Provident is not an HDC, there is no need to address that alternative
ruling upon appeal.
[fn8] Seven of the eight remaining transactions here are governed by
Pennsylvania law. The eighth is under New Jersey law, but the two states'
laws on HDC status are largely consistent on the issues raised in these
proceedings.
[fn9] The Bankruptcy Court agreed that authority from other jurisdictions
suggest that a party may become a constructive holder when its agent
takes possession of a negotiable instrument on its behalf. (Opinion at
3637.) However, the Bankruptcy Court made the factual finding that
appellees were not Provident's agents. It determined that though six of
the ten transactions involved written agency agreements, those agreements
were not controlling in light of the course of dealing between the
parties (Opinion at 46), and that Provident did not otherwise meet its
burden of establishing that an agency relationship existed. Because I
find that the Bankruptcy Court's determination that Provident did not act
in good faith is not clearly erroneous, and because the lack of good
faith alone is enough of a basis to sustain a judgment that Provident is
not an HDC of these eight notes and mortgages, I need not address whether
the agency determination was clearly erroneous.
[fn10] Under the Bankruptcy Court's findings of fact, Provident was, in
reality, a party to the original transaction. The situation is somewhat
analogous to a consumer goods financer who has a substantial voice in the
underlying transaction; that financer is not entitled to HDC status.
Westfield Investment Co. v. Fellers, 181 A.2d 809 (N.J.Super.Ct. LawDiv.). Provident had a substantial voice in providing and carrying out
funding of the underlying borrowing transactions, and it thus cannot
claim that it was a good faith HDC when it learned of the defense of
failure of consideration prior to dishonoring the Pinnacle checks.