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In Re: Roger C. Schaefer and Eva K. Schaefer v. Official Committee of Unsecured Creditors

March 28, 2011

IN RE: ROGER C. SCHAEFER AND EVA K. SCHAEFER, DEBTORS. FIRST STATE BANK OF RED BUD, APPELLANT,
v.
OFFICIAL COMMITTEE OF UNSECURED CREDITORS, APPELLEE.



The opinion of the court was delivered by: Murphy, District Judge:

MEMORANDUM AND ORDER

This bankruptcy appeal came before the Court for oral argument on August 9, 2010. Having fully considered all the papers on file and the arguments presented, the Court rules as follows.

FACTUAL BACKGROUND

On February 15, 2008, Roger C. Schaefer and Eva K. Schaefer (the Debtors) filed a petition for relief under Chapter 11 of Title 11 of the United States Code. The Debtors were in the farming and pork production business and conducted business under the names "Roger and Eva Schaefer" and "Schaefer Stock Farm." The Debtors also were shareholders in a pork production corporation named "Premium Pork, Inc." First State Bank of Red Bud (the Bank) made loans to the Debtors and to Premium Pork, Inc., which the Debtors personally guaranteed.

The Debtors owned certain real property and improvements commonly known as 9442 Taake Road, Columbia, Illinois, 62236-3926 (the Property). On August 27, 2007, the Debtors executed and delivered to the Bank a real estate mortgage (the Mortgage) against the Property to secure a principal amount of indebtedness not to exceed $4 million. The Mortgage defines "Borrower" as Premium Pork, Inc., including all co-signers and co-makers of the Note and all their successors and assigns; "Grantor" as Roger C. Schaefer and Eva K. Schaefer; and "Lender" as First State Bank of Red Bud, its successors and assigns. By its terms, the Mortgage provides for cross-collateralization and future advances.

CROSS-COLLATERALIZATION. In addition to the Note, this Mortgage secures all obligations, debts and liabilities, plus interest thereon, of either Grantor or Borrower to Lender, or any one or more of them, as well as all claims by Lender against Borrower and Grantor or any one or more of them, whether now existing or hereafter arising, whether related or unrelated to the purpose of the Note, whether voluntary or otherwise, whether due or not due, direct or indirect, determined or undetermined, absolute or contingent, liquidated or unliquidated, whether Borrower or Grantor may be liable individually or jointly with others, whether obligated as guarantor, surety, accommodation party or otherwise, and whether recovery upon such amounts may be or hereafter may become barred by any statute of limitations, and whether the obligation to repay such amounts may be or hereafter may become otherwise unenforceable.

Grantor presently assigns to Lender all of Grantor's right, title, and interest in and to all present and future leases of the Property and all Rents from the Property. In addition, Grantor grants to Lender a Uniform Commercial Code security interest in the Personal Property and Rents.

FUTURE ADVANCES. In addition to the Note, this Mortgage secures all future advances made by Lender to Grantor whether or not the advances are made pursuant to a commitment. Specifically, without limitation, this Mortgage secures, in addition to the amounts specified in the Note, all future amounts Lender in its discretion may loan to Borrower, together with all interest thereon; however, in no event shall such future advances (excluding interest) exceed in the aggregate $4,000,000.00. THIS MORTGAGE, INCLUDING THE ASSIGNMENT OF RENTS AND THE SECURITY INTEREST IN THE RENTS AND PERSONAL PROPERTY, IS GIVEN TO SECURE (A) PAYMENT OF THE INDEBTEDNESS AND (B) PERFORMANCE OF ANY AND ALL OBLIGATIONS UNDER THE NOTE, THE RELATED DOCUMENTS, AND THIS MORTGAGE. THIS MORTGAGE IS INTENDED TO AND SHALL BE VALID AND HAVE PRIORITY OVER ALL SUBSEQUENT LIENS AND ENCUMBRANCES, INCLUDING STATUTORY LIENS, EXCEPTING SOLELY TAXES AND ASSESSMENTS LEVIED ON THE REAL PROPERTY, TO THE EXTENT OF THE MAXIMUM AMOUNT SECURED HEREBY. ..

The Mortgage further provides that if "Borrower or Grantor fails to comply with or to perform any other term, obligation, covenant or condition contained in this Mortgage or in any of the Related Documents or to comply with or to perform any term, obligation, covenant or condition contained in any other agreement between Lender and Borrower or Grantor," then such may constitute, at Lender's option, an Event of Default under the Mortgage. Upon the occurrence of an Event of Default and at any time thereafter, Lender, at its option, may, among other things, declare the entire indebtedness immediately due and payable. The word "Indebtedness" is defined as: all principal, interest, and other amounts, costs and expenses payable under the Note or Related Documents, together with all renewals of, extensions of, modifications of, consolidations of and substitutions for the Note or Related Documents and any amounts expended or advanced by the Lender to discharge Grantor's obligations or expenses incurred by Lender to enforce Grantor's obligations under this Mortgage, together with interest on such amounts as provided in this Mortgage. Specifically, without limitation, Indebtedness includes the future advances set forth in the Future Advances provision, together with all interest thereon and all amounts that may be indirectly secured by the Cross-Collateralization provision of this Mortgage.

The word "Note" means, in pertinent part: the promissory note dated August 27, 2007, in the original principal amount of $4,000,000.00 from Borrower to Lender, together with all renewals of, extensions of, modifications of, refinancings of, consolidations of, and substitutions for the promissory note or agreement. The interest rate on the Note is a variable interest rate based upon an index. The index currently is 8.250% per annum. Payments on the Note are to be made in accordance with the following payment schedule: in one payment of all outstanding principal plus all accrued unpaid interest on September 27, 2007. ..

It is clear from the terms of the Mortgage that the Bank intended for Premium Pork, Inc., to execute a promissory note in the principal amount of $4 million on August 27, 2007. There is no Note dated August 27, 2007. Rather, three promissory notes were executed on September 21, 2007:

(1) the Debtors executed a promissory note in favor of the Bank in the principal amount of $753,824.30; (2) Premium Pork, Inc., executed a promissory note in favor of the Bank in the principal amount of $3,563,080.09; and (3) Premium Pork, Inc., executed another promissory note in favor of the Bank in the principal amount of $315,673.93. Only the Debtors' note is included in the record; there is no dispute regarding Premium Pork, Inc.'s, notes. The Debtors' note provides payment on demand or, alternatively, on September 21, 2008. It seems clear that the Debtors were obligated to the Bank before they executed the Mortgage, but the amount of the debt is unclear. Debtor Roger Schaefer testified during his debtor examination that the Debtors had smaller notes that were consolidated under one, but these exhibits were not filed in the Bankruptcy Court nor in this Court.

In the Bankruptcy Court, the Debtors filed an adversary proceeding against their creditors to determine the validity and priority of liens against and security interest in the Property. There is no dispute among the parties that First National Bank of Waterloo holds the first and second priority mortgage liens against the Property. The Debtors and the Bank contend that the Mortgage creates a third priority lien for the remaining amounts due on the principal sum of $4 million. The Office of the United States Trustee created and appointed members to the Official Committee of Unsecured Creditors (the Committee), and the Bankruptcy Court granted the Committee's motion for derivative standing to pursue certain claims. Thereafter, the Committee filed a cross claim against the Bank, seeking to avoid the Mortgage as a fraudulent transfer pursuant to 11 U.S.C. § 548; specifically, the Committee claimed that the Bank did not provide the Debtors with reasonably equivalent value in exchange for the Mortgage. The cross claim states: "Upon information and belief, the [Mortgage to the Bank] was done in connection with an out of court work out or forbearance, where the [Bank] agreed not to foreclose on its various security interests in exchange for certain promises by the Debtors and the [Mortgage]" (Cross-Claim at ¶ 9). The Bank admitted this allegation in its original answer to the cross claim and seemingly attempted to clear up some of the uncertainties regarding the Debtors' obligations described above by stating: "The [Bank] also extended the terms of the Debtor's notes and lowered the Debtor's interest charges as further consideration for the granting of the third mortgage to secure prior Debtor debts of $5,074,906.09" (Answer at ¶ 9). The Bank later filed an amended answer, stating: "Bank admits that the [Mortgage] was in connection with the collateralization of antecedent obligations of the Debtors to Bank, and Bank further admits that as part of the consideration for the [Mortgage] it forbore from enforcing the Debtors' obligations to Bank. Bank further admits that it made other concessions to the Debtors in connection with the [Mortgage]. Bank denies each and every allegation in paragraph 9 of the Cross-Claim not specifically admitted." (Amended Answer at ¶ 9). While the amount of the Debtors' antecedent debt is uncertain, it is clear to this Court -- and not seriously disputed by the parties -- that Debtors had antecedent debt obligations at the time they executed the Mortgage.

The Bankruptcy Court, relying on the case of In re Solomon, 299 B.R. 626 (BAP 10th Cir. 2003), found that there was no reasonably equivalent value given for the Mortgage. Consequently, the Bankruptcy Court found that the Mortgage was constructively fraudulent pursuant to ยง 548(a)(1)(B) and that the lien created by the Mortgage should be avoided. The Bank appeals these findings and argues, primarily, that the Bankruptcy Court erred as a matter of law by engrafting a "new value" requirement into the determination of reasonably equivalent value. Alternatively, the Bank argues that the Bankruptcy Court failed to consider the Debtors' direct ...


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