Loan Docs To Failed Condo Project Are Against Married Couple
Written by: Alan Nochumson
With every successful real estate development project, there are many more that do not go according to plan.
Most real estate development projects are financed by lending institutions through a construction loan. As a condition of lending the money, many lending institutions not only require that the property owner, which in many cases is a single-purpose entity, provide a promissory note and mortgage in connection with the construction financing, but, many times, the principals of this single-purpose entity and their spouses are obligated to personally guarantee the indebtedness.
In Beneficial Mutual Savings Bank v. Silverleaf Development LLC, 2014 Phila. Ct. Com. Pl. LEXIS 81 (March 11, 2014), a trial court judge in the Philadelphia Court of Common Pleas explained her rationale for finding in favor of a lending institution and against a married couple as to a non-conforming construction loan that led not only to the foreclosure of the investment property but also to their marital residence, as well as a personal judgment against them for the loan arrearage.
In Silverleaf Development, a corporate entity named Silverleaf Development LLC obtained a construction loan in a sum in excess of $1.6 million from Beneficial Mutual Savings Bank’s predecessor-in-interest, St. Edmond’s Federal Savings Bank, which was collateralized by a mortgage encumbering properties located in the city of Philadelphia at 1507-09 Moyamensing Ave. as well as 763 S. Ninth St., according to the opinion.
The purpose of the construction loan was for the development of a multi-unit condominium building at the Moyamensing Avenue property, the opinion said. At the time the construction loan was secured, the South Ninth Street property was owned solely by Louis Silverstein, Silverleaf Development’s sole shareholder, the opinion said. Silverstein resided at the South Ninth Street property with his wife, Thea Foglietta Silverstein—a licensed attorney who has practiced law in Pennsylvania and other jurisdictions, the opinion said.
In order to further secure the construction loan, Louis and Thea Silverstein separately agreed to personally guarantee the obligations of Silverleaf Development under the construction loan by way of the execution of written guaranty agreements, the opinion said.
After the loan documents related to the construction loan were executed but before any proceeds from the construction loan were disbursed, Louis Silverstein transferred ownership of the South Ninth Street property by way of deed to his wife for nominal consideration, even though the loan documents required the approval of Beneficial Mutual Savings Bank’s predecessor-in-interest before the marital residence could be so transferred, the opinion said.
When the construction loan matured and remained unpaid, Beneficial Mutual Savings Bank’s predecessor-in-interest filed a mortgage foreclosure action against Silverleaf Development as to the Moyamensing property, a mortgage foreclosure action against the Silversteins as to their marital residence, as well as against the Silversteins under the written personal guaranty agreements.
These separate actions were consolidated by the trial court and a trial took place as to all of these actions at the same time before Judge Idee Fox.
At the conclusion of the bench trial, a judgment was entered in favor of Beneficial Mutual Savings Bank, the then-holder in due course of the loan documents, and against the defendants as to all of the pending actions.
In a memorandum opinion, Fox explained her rationale for rejecting many of the legal arguments made by the defendants at trial.
Fox first flatly rejected the argument made by the Silversteins that she erred in foreclosing on the marital residence because title to the property had been transferred and, thus, the property could not serve as additional collateral for a construction loan to Louis Silverstein’s company.
At trial, according to the opinion, the Silversteins emphasized that, since Beneficial Mutual Savings Bank knew of the transfer of title solely to Thea Silverstein before any money was paid on the construction loan and it took no action to assert its interest in the marital residence, it could not foreclose on their marital residence, which was now solely in Thea Silverstein’s name.
In rejecting that legal argument, Fox relied upon Rule 1144 of the Pennsylvania Rules of Civil Procedure.
Under Rule 1144(a), Fox noted that “a plaintiff is required to name as defendants in a mortgage foreclosure action both the mortgagor and the real owner of the property if that is a separate entity.” According to Fox, “It follows therefore that the plaintiff may foreclose having named all the proper parties, even though the property has been transferred.”
Irrespective, Fox emphasized that the mortgage on the marital residence had been executed prior to the deed transferring the marital residence to Thea Silverstein and was not otherwise permitted under the mortgage.
In the mortgage, Louis Silverstein was prohibited from transferring the marital residence to any third party, including Thea Silverstein, without first obtaining the written permission of Beneficial Mutual Savings Bank’s predecessor-in-interest, the opinion said. Not only did Louis Silverstein fail to obtain such permission, but his wife testified at trial that they intended to invalidate the mortgage by transferring the marital residence to her, the opinion said.
Fox next addressed whether she erred in enforcing the written personal guaranty agreements against the Silversteins as Beneficial Mutual Savings Bank’s predecessor-in-interest violated the Equal Credit Opportunity Act (ECOA), 15 U.S.C. § 1691, by requiring Thea Silverstein to serve as a personal guarantor to the construction loan.
Under the federal regulations implementing the ECOA, Fox pointed out that “a creditor shall not require the signature of an applicant’s spouse or other person, other than a joint applicant, on any credit instrument if the applicant qualifies under the creditor’s standards of creditworthiness for the amount and terms of the credit requested.”
As indicated by Fox, “‘when determining whether a creditor has violated the ECOA by requiring a spousal signature, it is critical to determine whether the husband and wife were joint applicants on the loan,'” since “lenders are permitted to require spousal signatures where the spouses are joint applicants.”
Quoting the U.S. Court of Appeals for the Third Circuit in Midlantic National Bank v. Hansen, 48 F.3d 693 (3d Cir. 1995), Fox provided that a “‘joint applicant’ is ‘someone who applies contemporaneously with the applicant for shared or joint credit’ and not someone ‘whose signature is required by the creditor as a condition for granting the credit requested.'”
Because Fox believed that Thea Silverstein applied with her husband for the construction loan with Beneficial Mutual Savings Bank’s predecessor-in-interest, she held that the lending institution at the time was entitled to request a personal guaranty from her, a joint applicant, under the ECOA.
LESSON LEARNED
The factual circumstances in Silverleaf Development are sadly par for the course.
First of all, most mortgages, both commercial and residential, require the borrower to obtain the written permission from the mortgage lender before the encumbered property may be transferred to a third party and, if the borrower transfers the property without obtaining such permission, that failure is deemed a default under the mortgage and the mortgage lender is then allowed to foreclose on the property.
Furthermore, whether the mortgage lender explicitly states it or not, the other spouse typically serves as a personal guarantor on smaller business and real estate loans. Whether the mortgage lender complies with the ECOA depends upon whether that other spouse is a joint applicant for the credit being sought. As such, both the mortgage lender and the married couple should be very mindful of who applies for the credit, since that may very well affect the ability of the mortgage lender to obtain a judgment against the other spouse should a default occur under the loan documents.
Reprinted with permission from the May 20, 2014 edition of The Legal Intelligencer © 2014 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. For information, contact 877-257-3382, reprints@alm.com or visit www.almreprints.com.
