Through the economic turmoil of the late 2000s, borrowers came up with creative (and at times, inequitable) ways to protect their investments. One such method—the borrower’s indirectly purchasing and foreclosing a senior lien to rid the investment of junior liens—was recently rejected by Florida’s Third District Court of Appeal.
In CDC Builders v. Biltmore-Sevilla Debt Investors, LLC, 151 So. 3d 479 (Fla. 3d DCA 2014), a real estate investor, McBride, owned a large development through a group of companies he formed and controlled. The development was financed through a mortgage with SunTrust, and McBride’s companies hired a contractor to construct homes on the development. When McBride’s companies could not pay the contractor for the last eight homes constructed, the contractor recorded statutory construction liens against the development.
While the contractor’s sought to enforce its construction liens, McBride formed a new company, BSDI, which purchased SunTrust’s first mortgage. BDSI (the new company formed by McBride) then filed a foreclosure action against McBride’s companies that owned the property and the contractor. The trial court entered summary final judgment of foreclosure against the contractor, and the contractor subsequently appealed to the Third DCA.
On appeal, the Third DCA reversed the summary judgment ruling, explaining that a borrower cannot obtain and foreclose a senior mortgage to rid his investment of junior liens. Additionally, the Third DCA explained that a borrower cannot do indirectly (i.e., through a company he forms and controls) what he cannot do directly. Thus, a borrower may not create a company for the purpose of purchasing the first mortgage on his investment and foreclosing out junior liens.
Based on this principle, the Third DCA remanded to the trial court to determine whether McBride had formed BDSI for the purpose of foreclosing out the contractor’s liens. The Third DCA noted several facts as particularly relevant to McBride’s intent, including:
- There was evidence that McBride controlled both the developers and BDSI;
- It appeared that McBride may have personally guaranteed the loan used to purchase the SunTrust loan;
- BDSI was not formed until the contractor sought to foreclose its liens;
- SunTrust’s file stated the loan was “repaid by the borrower buying our documents,” despite SunTrust’s willingness to refinance; and
- McBride could not provide any legitimate reason for forming BDSI.
In short, lenders need to be keenly aware of the types of creative ways borrowers may attempt to protect their investments as real estate values continue to increase. As shown in CDC Lenders, in certain cases, a lender may have a remedy to avoid what it perceives as an inequitable result.