Opinion ID: 402238
Heading Depth: 3
Heading Rank: 1

Heading: Mortgage or Sale?

Text: 45 The subject property herein was also the subject property in a prior Chapter XII proceeding filed by Ellis, Bankruptcy No. 70-249, in which an Amended Real Property Arrangement was confirmed by the court on January 22, 1971. That arrangement provided, among other things, as follows: 46 The subject property shall be conveyed by the debtor (Ellis) to the purchaser (Bessie Hagopian) free and clear of liens, but subject to a lease to creditor SILVERSWORD CORPORATION and a repurchase option to the debtor (Ellis), as provided in aforesaid agreements filed in this proceeding. 47 Subsequently Ellis executed and delivered to Bessie Hagopian a Warranty Deed, subject to an existing lease to the Silversword Corporation and a repurchase option to Ellis. The bankruptcy court's conclusion that this transaction was a sale and not a mortgage was based on its reasoning that, under the principle of res judicata, it was bound by the court-confirmed arrangement in Bankruptcy No. 70-249, and that this arrangement called for a sale of the property from Ellis to Hagopian, and not for a mortgage. 48 The appellants do not dispute that the prior bankruptcy proceedings must be given res judicata effect. They argue, however, that what was confirmed was a mortgage. Their position is that, under Hawaii law, a warranty deed purporting to convey a fee simple, but subject to a repurchase option in the grantor, is a mortgage instrument, and that the original bankruptcy court (in 70-249) was aware of this.
49 The law of other jurisdictions varies as to the effect of a deed absolute on its face coupled with a repurchase option. See Swallow Ranches, Inc. v. Bidart, 525 F.2d 995, 997-98 (9th Cir. 1975) (collecting cases and authorities). The Hawaii cases, however, do not disclose any similar uncertainty on this question. All reported cases bearing on the issue either support or are consistent with the position that the 1971 transaction was a mortgage. 50 In Makuakane v. Tanigawa, 50 Haw. 493, 443 P.2d 153 (1968), the court was faced with an instrument which contained an absolute conveyance in one portion, and in the other portion the following proviso: 51 PROVIDED HOWEVER; if the sum of One Hundred Ten ($110.00) Dollars is paid in full within one (1) year ... then this conveyance shall be of no force and effect. 52 Id. at 494-95, 443 P.2d at 154. The court observed: 53 The instrument is basically in the same form as modern mortgages drafted in this jurisdiction. That is, a mortgage usually contains an outright or absolute conveyance to a mortgagee with a disfeasance clause whereby it is stated that upon the payment of a certain sum of money the deed shall become null and void. The law is clear that where an absolute conveyance contains a disfeasance clause, the instrument is a mortgage. 54 Id. at 495, 443 P.2d at 155 (emphasis added). 55 Under Hawaii law it does not matter whether the disfeasance clause appears on the face of the deed, on a separate writing, or even in a mere oral agreement. Kahau v. Booth, 10 Haw. 332, 333-34 (1896). Kahau involved a deed absolute on its face, and a simultaneously executed repurchase option on a separate page. The court held that the transaction was a mortgage. 10 See also Chave v. Dowsett, 6 Haw. 221 (1878). While Kahau is indeed an old case, appellees have cited no Hawaii case which overrules it or even questions its authority. It was cited as precedent in Makuakane, supra, 50 Haw. at 495, 443 P.2d at 155. It was also cited and explained in Kawauchi v. Tabata, 49 Haw. 160, 170, 413 P.2d 221, 227 (1966). Kawauchi itself also directly supports the conclusion that the transaction here was a mortgage. Kawauchi involved a deed absolute with a leaseback and an option for the lessee to purchase the property. The transaction was held to be a mortgage, not a sale. 49 Haw. at 180, 413 P.2d at 232. 56 Appellees cite several cases in support of their contention that there is a heavy presumption in favor of interpreting such transactions in accordance with their form. Brief of Louis at 37. None of those cases help appellees, although they do illustrate the fact that the law varies from one jurisdiction to another on this point. Swallow Ranches, Inc. v. Bidart, 525 F.2d 995 (9th Cir. 1975), actually holds that the substance of the transaction and the intent of the parties is controlling, not the form. 525 F.2d at 998. But more important, the case construes and applies Nevada law and has no bearing on the issue here. Rizo v. MacBeth, 398 P.2d 209 (Alaska 1965), was concerned with the direct reformation of a deed. There is no mention in the case of any repurchase option or agreement, and no discussion of what effect such an agreement might have. And the case deals with Alaska law. Blue River Sawmills, Ltd. v. Gates, 225 Or. 439, 358 P.2d 239 (1960), declined to find a mortgage, observing that the test is whether there is an unsatisfied indebtedness owing the grantee which is enforceable independent of the deed. Id. at 460, 358 P.2d at 249. But this test is explicitly rejected in Kawauchi, supra, 49 Haw. at 172-76, 413 P.2d at 228-30. Blue River Sawmills is thus not a reliable guide to Hawaii law. Glasgow v. Andrews, 129 Cal.App.2d 660, 277 P.2d 400 (1954), turned on a factual dispute regarding the intention of the parties; the affirmance by the California Court of Appeals of the trial court's finding that a sale was intended does not shed light on the legal issue presented here. 57 We note that many jurisdictions regard the intent of the parties to be the controlling factor in determining whether a transaction is a sale or a mortgage. See, e.g., Swallow Ranches, Inc. v. Bidart, supra, 525 F.2d at 997-98 (collecting cases). This is the rule in Hawaii as well. See Haw.Rev.Stat. § 506-1(a) (1976) (Every transfer of an interest in real property ... subject to disfeasance upon the payment of an obligation ... is to be deemed a mortgage ....); Hess v. Paulo, 38 Haw. 279, 285-86 (1949) (construing former Haw.Rev.Stat. § 8871 (1945), now codified at § 506-1) (purpose of rule is to ensure effectuation of the genuine purpose and intention of the parties by subordinating thereto the ostensible form in which the transaction is finally couched). See also Kawauchi, supra, 49 Haw. at 170-71, 413 P.2d at 227; Ah Chong v. Kaluahine, 9 Haw. 571, 574 (1894). In the instant case, however, there is no indication in the record that the bankruptcy court engaged in any analysis of the facts which would bear on the intent of the parties and the true substance of the transaction. Instead, the court seems to have based its determination on the form of the transaction alone.
58 Even though Hawaii law is settled that a deed absolute coupled with a repurchase option creates a mortgage when the parties so intend, the possibility exists that the bankruptcy court that approved the transaction understood it to be a sale and based its approval on that understanding. If that were the case, the principle of res judicata would provide sufficient basis to affirm the judgment below. Examination of the record, however, reveals no such understanding by the bankruptcy court and, in fact, suggests that the transaction was understood from the outset to be a mortgage. 59 Of particular interest is Ellis's application filed with the bankruptcy court seeking confirmation of the proposed arrangement. That application included the following recitations: 60 7.... 61 a. That the debtor convey the subject property to Bessie Hagopian upon the payment into the registry of this Court the balance of the purchase price of $85,500. 62 b. That said sale be subject to the existing lease to SILVERSWORD CORPORATION, ... yielding to the purchaser a net return of 10 percent per annum, after gross income taxes, on her investment of $85,500. 63 c. That said sale be subject to an assignable repurchase option to the debtor, to be exercised within two years after conveyance, providing for an additional increment of 5 percent per annum to Bessie Hagopian upon repurchase by the debtor. 64 10. That the creditors affected thereby have unanimously accepted the Amended Arrangement by filing Acceptances in this proceeding .... 65 12. That ... lessee SILVERSWORD CORPORATION is obligated to pay a percentage rental ...; and that ... any rental in excess of the fixed rental payable to Bessie Hagopian shall be payable to the debtor or his assigns. 66 13. That, upon execution of the Amended Arrangement, 67 c. The aggregate principal sum of $36,647.57 plus interest from 1959-1962 so consolidated and assigned to creditor SMITH shall be compromised to $28,500.00 plus a 5 percent fee for ... a total of $29,925.00, 68 d. The compromised sum of $29,925.00 shall be secured by a pledge to creditor SMITH of the debtor's option to repurchase the subject property, and 69 e. Said compromised sum shall be paid without interest from the debtor's assignment of percentage rentals from lessee SILVERSWORD CORPORATION in excess of the fixed rental due Bessie Hagopian ... 70 14. That, upon the execution of the Amended Arrangement, the following claims of creditor SILVERSWORD CORPORATION shall be deferred and applied contra future rental payments due the debtor or his assigns ... after payment of fixed rentals due Bessie Hagopian and percentage rentals in excess thereof assigned to creditor SMITH: 71 Claims now assigned to creditor SMITH and secured by a second mortgage ... $8,261.58 72 19. That, therefore, the effect of the Amended Arrangement is a down payment by your applicant (Ellis) of $8,114.41 on a purchase price of $187,000.00, the assumption of $85,127.01 in claims against the grantor, and the payment of $85,500.00 on account. 73 Notice that paragraph 7(b) sets the income to Hagopian from the preexisting lease to Silversword Corporation, which was operating a restaurant on the premises, as a percentage of her purchase price, and in an amount that was less than Silversword was obligated to pay under the preexisting lease. While perhaps consistent with the theory that the transaction is a sale, this feature supports more readily the conclusion that Hagopian was merely a lender of money. Ordinarily, the purchaser of real estate expects future income from the property to bear a relation to the future value of the property, and at best hopes that future income will relate favorably to the original purchase price. Here, however, Hagopian stood to gain nothing from future appreciation of the property, or increased profitability of the lessee Silversword Corporation. Instead, she would get a regular, fixed income set by reference to her initial investment-the usual expectation of a lender of money. Of course she did run the risk that the property would become worthless or that the lessee business would fail. This risk, however, is typical of the mortgagor-mortgagee transaction. 74 Secondly, the remainder was to be applied to satisfy Ellis's other debts. (paragraphs 12, 13, 14). This fact, too, suggests that Ellis was to remain the owner of the property, since beneficial ownership of property typically includes the right to enjoy the income generated by it. Satisfaction of Ellis's debts is a benefit to Ellis, not to Hagopian. Of course, this feature of the transaction is not conclusive either, since the owner of property is free to assign the rents to another. The suggestion is strengthened, however, by the recitation of paragraph 19 that Ellis was making a downpayment on the purchase price of the property. 75 Thirdly, Ellis stood to benefit, under the terms of the arrangement, from any appreciation in the value of the property since in the event of such appreciation, he was free to exercise the repurchase option and recover title to the property. Hagopian would then get only the return of her original investment plus a percentage increase. In this respect, Ellis again appears to have enjoyed the advantage of ownership, and Hagopian appears once again in the role of a mortgagee. 76 Finally, if this transaction is nevertheless regarded as a sale to Hagopian, it is striking how little she got in comparison with the usual bundle of rights comprising fee simple title. The value of her interest is substantially unrelated to possible future appreciation of the property. It is subject to a lease of the whole parcel. It is defeasible. In reality, at least during the term of the lease and option, she got nothing but a flow of income calculated as a percentage of her investment. 77 In holding that the bankruptcy court confirmed a sale rather than a mortgage, Judge King nowhere discussed or even mentioned any of these recitations. His conclusion appears to have been based only on the form of the deed itself, and on language in the bankruptcy No. 70-249 order calling for a transaction memorialized in that form. In view of our survey of relevant Hawaii law, and in view of the absence of any findings as to the actual intent of the parties, we must conclude that the characterization of this transaction as a sale rather than a mortgage was error. We prefer not to speculate as to whether, in a full hearing, the evidence would support a finding that the parties intended a sale, or a finding that the bankruptcy judge in bankruptcy No. 70-249 understood the transaction to be a sale and based his order of confirmation on that understanding. Accordingly, we do not reach the question whether either such possible finding would support a judgment in favor of the Louis. 78
79 When the Louis sued Lillian in state court for specific performance of the agreement of sale between them, one of the defenses was that Lillian did not even own the property. This defense was based on the mortgage theory discussed above. The Louis now argue that the judgment in their favor in the state trial court, now affirmed in relevant part on appeal, 11 requires this court to reject the mortgage theory on principles of collateral estoppel and stare decisis. 80 Ellis, of course, and many of the other parties to these consolidated appeals, were not named parties to the state court action. Whether they could be bound by any collateral estoppel effect of that action would depend on the extent to which they had an interest in, and exercised control over, the litigation in the state courts. Montana v. United States, 440 U.S. 147, 154, 99 S.Ct. 970, 974, 59 L.Ed.2d 210 (1979). It is not necessary, however, to undertake that analysis here because the state trial court, as we read its decision, did not hold that the March, 1971 transaction was a sale. 81 We note at the outset that Judge Lum, in the state action, made a number of findings of fact relating to the March 1971 transaction and the mortgage theory. He found that circumstances of the kind surrounding the transaction in Kawauchi, supra, did not exist here. However, he stopped short of making an explicit finding that the transaction was a sale and not a mortgage. 12 At the same time, he made findings which would support the judgment rendered even if the transaction had been a mortgage. For instance, he found that Lillian Corey was estopped to now deny ownership of the property because of her own representations before and during the litigation. He also noted that (d) efendant could have achieved a conveyance of the property free and clear from all encumbrances even if she had in fact only the interest of a mortgagee therein, because of an outstanding offer by Ellis to convey the property to the Louis under a formula by which she would have received $282,500-more than she claimed to be entitled to under the mortgage theory. In view of these observations by Judge Lum, we do not see in his opinion an unequivocal finding that the 1971 transaction was a sale rather than a mortgage. 82 Even if there were an unequivocal finding that the transaction was a sale, we would not be able to apply it as a bar under principles of collateral estoppel or stare decisis. It is hornbook law that both of these principles give effect only to matters that have formed an essential basis for the earlier decision. But the prior action here was for enforcement of a contract between the Louis and Lillian. Lillian agreed to sell the Silversword Inn to the Louis. She failed to perform her agreement by delivering possession. Ordinarily, a person is not relieved of liability for breach of a promise to sell property simply because he or she turns out not to have marketable title. Of course, specific performance of such an agreement will not be decreed if the defendant does not have and cannot obtain title. 5A Corbin on Contracts P 1170 at 255 (West 1964). But that rule does not apply where, as Judge Lum found here, there is a contract between the vendor and the true owner under which the vendor can obtain title. See id. at 256. We conclude that it was unnecessary for the court to decide whether the 1971 transaction was a sale or a mortgage, and that therefore no such decision stands as a holding of the case. 13