Wilson v. Moir (In re Wilson) United States Bankruptcy Court for the Eastern District of Virginia, Alexandria Division December 27, 2006, Decided Case No. 05-13928-SSM, Chapter 7, Adversary Proceeding No. 06-1063 Reporter: 359 B.R. 123; 2006 Bankr. LEXIS 3635 ″investment return″ to the ″M″ defendants was subordi- nated to the claims of general creditors. The court re- In re: EMELINE D. WILSON, Debtor; EMELINE D. jected plaintiffs’ request that it recharacterize the ″M″ de- WILSON et al., Plaintiffs vs. DAVID L. MOIR et al., fendants’ claim as an equity investment. Next, the court Defendants found no basis for reducing the ″M″ defendants’ claim by the amount of a third-party guarantee. Finally, the ″M’ Prior History: Wilson v. Moir (In re Wilson), 2006 Bankr. defendants would be entitled to payment of the ″invest- LEXIS 1001 (Bankr. E.D. Va., May 26, 2006) ment return″ after the timely-filed unsecured claims had been paid in full. Core Terms Outcome Overall, the court determined that the ″M″ defendants’ trust deed, subordination, deed, equitable, conveyance, deed of trust was subordinate to the bank’s and seller’s grantor, bona fide purchaser, recharacterization, notice, ″ mortgage, investment return, legal title, acres, deeds of trust, and that payment of a $ 250,000 invest- constructive notice, real estate, settlement, claimant, ment return″ owed to the ″M″ defendants should be equi- deposit, collateral, repayments, acquisition of title, tably subordinated to the claims of unsecured credi- investment agreement, actual knowledge, certificate, tors. strong-arm, doctrine, seller, buyer, feet, purchase-money LexisNexis® Headnotes Case Summary Bankruptcy Law > Procedural Matters > Jurisdiction > Core Pro- ceedings Procedural Posture Plaintiff debtor sued to avoid a deed of trust in favor of de- HN1 A determination of the validity, extent or priority fendant creditors under the trustee’s strong-arm pow- of liens is a core proceeding in which a final judgment ers, or, alternatively, to equitably subordinate the credi- may be entered by a bankruptcy judge. 28 U.S.C.S. § tors’ claim, to recharacterize it as an equity investment, to 157(b)(2)(K). limit it to funds advanced, and to reduce it by the amount for which the creditors had a third-party guaran- Real Property Law > Priorities & Recording > General Overview tee. Holders of two competing deeds of trust sought to HN2 establish their priority. Pending was judgment. See Va. Code Ann. § 55-105 (1950). Real Property Law > Priorities & Recording > General Overview Overview After discussing the effect of Va. Code Ann. § 55-105 HN3 In Virginia , the mere fact that a deed of trust is re- (1950), the court could not find that the mere recording corded before the mortgagor acquires title to the prop- ″ ″ of the deed of trust (referred to here as the M deed of erty does not affect its validity as between the parties: trust) prior to the time debtor acquired legal title of re- When a deed purports to convey property, real or per- cord would have provided either constructive or inquiry sonal, describing it with reasonable certainty, which the notice to the bank and seller of the existence of a com- grantor does not own at the time of the execution of the peting deed of trust. Thus, the priority of the note hold- deed, but subsequently acquires, such deed shall, as be- er’s and seller’s respective deeds of trust were unaf- tween the parties thereto, have the same effect as if the title ″ ″ fected by, and were superior to, the M deed of trust. which the grantor subsequently acquires were vested in Given this ruling, the trustee’s avoidance claim was moot. him at the time of the execution of such deed and thereby As to the principal and interest on the funds advanced conveyed. Va. Code Ann. § 55-52. by the ″M″ defendants, no basis had been shown to equi- tably subordinate their claims. However, the $ 250,000 Real Property Law > Priorities & Recording > Elements > Bona Page 2 of 14 359 B.R. 123, *123; 2006 Bankr. LEXIS 3635, **3635 Fide Purchasers lien securing such a subordinated claim be transferred to the estate. 11 U.S.C.S. § 510(c). HN4 In Virginia , a bona fide purchaser for value is re- quired to examine the land records and is chargeable Bankruptcy Law > ... > Types of Claims > Unsecured Priority with such knowledge as might be revealed by such exami- Claims > Subordination nation. HN9 Although Congress included no explicit criteria for Real Property Law > Priorities & Recording > General Overview equitable subordination when it enacted 11 U.S.C.S. § 510(c), the language of the statute clearly indicates con- HN5 Va. Code Ann. § 55-105 (1950) is simply a limita- gressional intent at least to start with existing doctrine. tion on the constructive notice that would otherwise That existing doctrine, as the U.S. Supreme Court ob- arise from recordation and does not allow a purchaser or served, was judge-made and was generally triggered mortgagee to simply ignore a conveyance or mortgage by a showing that the creditor had engaged in ″some type recorded prior to the time the grantor acquired record title of inequitable conduct″ that ″resulted in injury to the where the purchaser has actual knowledge or inquiry creditors of the bankrupt or conferred an unfair advan- knowledge of its existence. tage on the claimant. Under the test adopted by the U.S. Court of Appeals for the Fourth Circuit, equitable sub- Real Property Law > Priorities & Recording > General Overview ordination generally requires an inquiry into (1) whether HN6 the claimant engaged in fraudulent conduct, (2) Under Va. Code Ann. § 55-105 (1950), the record- whether the conduct resulted in injury to creditors, and ing of a deed or contract before a party acquires legal (3) whether subordination would be consistent with the title of record does not constitute constructive notice to bankruptcy law. As the U.S. Court of Appeals for the subsequent purchasers or mortgagors. Additionally, in Vir- ″ ″ ″ ″ Tenth Circuit recently explained, inequitable conduct ginia , the doctrine of transitory seisin would prevent for subordination purposes encompasses three categories any interest that is perfected simultaneously with the ac- of misconduct: (1) fraud, illegality, and breach of fidu- quisition of title from achieving priority over a deed of ciary duties; (2) undercapitalization; or (3) claimant’s use trust to secure the purchase price of the property. As ex- of the debtor as a mere instrumentality or alter ego. plained in an early decision: When, therefore, land is conveyed and the purchaser at the same time gives back Bankruptcy Law > ... > Types of Claims > Unsecured Priority a mortgage or other incumbrance to secure the purchase Claims > Subordination -money, he does not thereby acquire any such seizen or in- terest as will entitle his wife to dower, or his creditor HN10 It has been said that equitable subordination is an to subject the land to his debts discharged of the mort- extraordinary remedy which is applied sparingly. For gage. In such cases the deed and mortgage are regarded as this reason, where the claimant is not an insider or a fi- parts of the same contract, and constitute but a single duciary, the party seeking equitable subordination transaction, investing the purchaser with seizen for a tran- must demonstrate egregious conduct such as gross mis- sitory instant only. conduct tantamount to fraud, misrepresentation, over- reaching, or spoliation. Bankruptcy Law > ... > Prepetition Transfers > Voidable Trans- fers > Lien Creditors & Purchasers Bankruptcy Law > ... > Types of Claims > Unsecured Priority Claims > Subordination HN7 A bankruptcy trustee has the rights and powers of, or may avoid any transfer of property of the debtor HN11 It is true that there is nothing inherently inequi- that is voidable by a bona fide purchaser of real prop- table when parties dealing at arm’s length with each other erty, other than fixtures, from the debtor that obtains the agree to structure a financial transaction in a way that status of a bona fide purchaser at the time of the com- is more favorable to the party putting up the money. Put mencement of the case. 11 U.S.C.S. § 544(a)(3). Simply another way, equitable subordination is not appropriate stated, the bankruptcy trustee is in the same position, simply because a claim is larger than it would have been with respect to real estate, as if he were a bona fide pur- had the parties structured the transaction some other chaser who bought the property from the debtor on the way. filing date and simultaneously perfected the transfer by re- cording a deed. Bankruptcy Law > Claims > General Overview Bankruptcy Law > ... > Types of Claims > Unsecured Priority Claims > Subordination Bankruptcy Law > ... > Types of Claims > Unsecured Priority Claims > Subordination HN12 As a practical matter, recharacterization of a debt HN8 A bankruptcy court may (1) under principles of eq- as equity achieves essentially the same result as equi- uitable subordination, subordinate for purposes of distri- table subordination, since equity receives distributions in bution all or part of an allowed claim to all or part of an- bankruptcy only after creditors have been paid in full. other allowed claim or all or part of an interest to all or However, recharacterization proceeds from a different part of another allowed interest; or (2) order that any premise. Equitable subordination focuses on the credi- Page 3 of 14 359 B.R. 123, *123; 2006 Bankr. LEXIS 3635, **3635 tor’s conduct vis-a-vis the debtor or other creditors. By contrast, when a putative loan to a corporation is rechar- For Brett Anthony Amendola, ROGER AMENDOLA, De- acterized, the courts effectively ignore the label at- fendant (06-01063-SSM): Geoffrey J.