The Equitable Mortgage: How “Bad Faith” Dealing Can Unwind Your Transaction

Since about 2014, real estate investing and ‘flipping’ has been a hot and profitable industry. Lots of money can certainly be made; but while there are great deals out there to be had, Michigan law will not tolerate abusive investment tactics at the expense of the Michigan homeowner. Below is Michigan case law which should be instructive to real estate investors and ‘home flippers’ on what essentially can be challenged as an absolute conveyance.   

THE EQUITABLE MORTGAGE

Michigan courts have long upheld the Doctrine of Equitable Mortgage that looks past the formal sale or reconveyance documents and, when considering the totality of the circumstances surrounding a specific real estate sales transaction, will instead characterize an entire purchase transaction as a mortgage refinance.  Michigan Courts also follow the Restatement (Third) of Property §3.3 (1997) which sets forth several factors for consideration in determining whether a foreclosure reconveyance transaction or any other real estate transaction is indeed an equitable mortgage.

According to the Restatement of Property, foreclosure reconveyance transactions frequently contain the following facts that can help establish an equitable mortgage: (1) the investor’s statements that the purpose of the deal is to help the homeowner save or stay in the home; (2) a substantial difference between the price of the conveyance to the investors and the property’s fair market value and a difference between the repurchase price and market value; (3) retention by the foreclosed homeowner not only of possession but also of the obligations and prerogatives of ownership, such as paying taxes and insurance and being responsible for repairs; (4) the complexity of the transaction coupled with a substantial disparity in the sophistication of the parties; and, (5) a prior relationship between the homeowner and the investors or associated people regarding promises or attempts at a more traditional refinance.  

So even when there is a purchase agreement and warranty deed between Parties, courts, can and will, determine whether a transaction was meant to really be a real estate conveyance or an equitable mortgage, and as result, whether the seller retains an equitable interest or right in a property as as a mortgagor. 

Michigan Case Law

In Emerson v. Atwater, 12 Mich 314, 317 (1864), the Michigan Supreme Court held that when deciding whether a deed absolute on its face is an equitable mortgage, the courts should also determine if there exists  “[1] the pecuniary embarrassment of the grantor, [2] his indebtedness to the grantee, and [3] inadequacy of consideration.” 

In Grant v. Van Reken, 71 Mich. App. 121, 246 N.W.2d 348 (1976) the plaintiff was attempting to keep his family home that was in foreclosure when he came into contact with the defendant, who allegedly told him, “You don’t have to lose your house, I save a lot of houses. Let me help you.” Id. The plaintiff executed a warranty deed, a lease with an option to repurchase, and an agreement. Id. The exchange of value in the Grant deal was inadequate as the plaintiff’s mortgage companies received cash of approximately $2,300 while the defendant obtained a deed to property worth $25,000, encumbered by approximately $9,000.  The Grant court reasoned,  “we have given great weight to this inadequacy of consideration and the fact that plaintiffs were financially embarrassed”. Id. See also London v. Gregory, 2001 Mich. App. LEXIS 1700, *7 (finding the transaction was an equitable mortgage and not an outright conveyance after facts demonstrated inadequate consideration, the transaction was executed two days before foreclosure without the assistance of counsel, the defendant remained in possession of the property after granting plaintiff the deed, and defendant did not intend to sell the home). 

Likewise, in Koenig v. Van Reken, 89 Mich. App. 102, 279 N.W.2d 590 (1979), the Michigan Court of Appeals reversed a Circuit Court order granting summary judgment in favor of the defendant on an equitable mortgage count. In Koenig, the plaintiff was in the foreclosure process when approached by the defendant, who offered to pay the delinquent taxes and service the mortgage for a 10% fee. In return, the plaintiff executed three documents consisting of an agreement, a warranty deed, and a lease with an exclusive option to repurchase. There, the plaintiff stated that the warranty deed was silent to consideration when she signed it and she never received any consideration. In the Koenig court’s analysis it stated, “Under Michigan law, it is well settled that the adverse financial condition of the grantor, coupled with the inadequacy of the purchase price for the property, is sufficient to establish a deed absolute on its face to be a mortgage.” Id. (citing Ellis v Wayne Real Estate Co, 357 Mich 115; 97 NW2d 758 (1959), McLaughlen v Majestic Development Corp, 247 Mich 498; 226 NW 256 (1929).

Furthermore, the Koenig court determined that the plaintiff had conveyed her equity worth over $30,000.00 for less than $4,000.00. The Appeals court held that the inadequacy of consideration indicated the parties did not intend for the deed to be an absolute conveyance of the property and “that the lease-back arrangement entered into by the parties effectively circumvented the right to redeem, which is designed to protect purchasers such as plaintiff in times of financial crisis.” 

Another case with similar facts is Ellis v Wayne Real Estate Co, 357 Mich 115; 97 NW2d 758 (1959). In this matter, the plaintiff sought a loan from the defendant in an attempt to save their home from foreclosure. The plaintiff hurriedly executed a quitclaim deed and land contract to repurchase the property while the defendant paid the default and delinquent taxes. The Ellis court noted that there was an inadequate consideration given for the property by the defendant compared to the actual value of the property. Id. Furthermore, it stated, “that affirmance of the circuit court’s decree would do violence to the principles by which this and other courts determine the true effect of conveyances executed in like circumstances”. Id. Therefore, the Ellis court held the quitclaim deed and land contract to repurchase constituted a loan secured by a mortgage. Id.

It is well settled that the intent of the parties to the deed, as evidenced by all of the surrounding circumstances, controls the question of whether the deed represents security for the repayment of a loan. Sheets v. Huben, 354 Mich 536, 540; 93 NW2d 168 (1958);  Koenig v. VanReken, 89 Mich App 102, 106; 279 NW2d 590 (1979).  

Circumstances that persuasively signify the parties’ intention that a deed constitutes security for a loan include the inadequacy of consideration given in exchange for the deed, the grantor’s existing indebtedness to the grantee, and the parties’ unequal bargaining positions. Sheets, supra at 540-541; Wilson, supra at 251; Koenig, supra at 106-107.  But of all these circumstances,  Michigan courts have held that the “‘inadequacy of consideration is the most important.’” Ellis v Wayne Real Estate Co, 357 Mich 115, 119; 97 NW2d 758 (1959), quoting Emerson v Atwater, 12 Mich 314, 317 (1864).

There is a lot of opportunity in real estate investing, but if the cases above demonstrate anything, they illustrate that deal -making can be costly to the real estate buyer / investor who acts in bad faith.

About David Soble:  Since 1990, attorney David Soble has represented lenders, loan servicers, consumers and business owners in real estate, finance and compliance matters. For over 30 years, he has been involved in thousands of real estate transactions and has successfully negotiated and saved millions for his business and consumer clients.

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