Carmel Financing, LLC v. Schoenmann

Background

Carmel Financing, LLC loaned Mayacamas Holdings LLC $2 million to refinance the purchase of Sonoma County property. The loan was secured by a deed of trust. The promissory note provided for six percent annual interest, an automatic $75,000 exit fee at maturity, and an 18 percent interest rate after default and after the maturity date. The note and deed of trust selected Colorado law.

The deed of trust gave Carmel an interest in insurance-related rights and proceeds. Carmel did not provide the insurer, Philadelphia Indemnity Insurance Company, with the deed of trust or promissory note and did not ask to be identified as a mortgagee or loss payee when the original policy was issued. In January 2015, Mayacamas changed an insurance renewal form by crossing out another person’s name and writing in Carmel’s name under an “Additional Insured” schedule, but the later policies did not identify Carmel as a loss payee or mortgagee. After the Tubbs Fire destroyed the property in October 2017, the insurer replaced the prior mortgagee with Carmel and identified Carmel as mortgagee and loss payee. The trustee later received $2,107,438.76 in insurance proceeds.

The bankruptcy court granted the trustee summary judgment on her claim that she could avoid Carmel’s interest in the insurance proceeds. It dismissed the trustee’s claim that the default interest rate, exit fee, and late charges were unlawful, based on its conclusion that Colorado law governed. It also denied the trustee’s request for attorney’s fees. The parties appealed those rulings.

Insurance proceeds and perfection

The district court affirmed the bankruptcy court’s summary judgment for the trustee. Under the bankruptcy trustee’s “strong-arm” powers, the trustee generally has the rights of a judgment lien creditor and may avoid an unperfected security interest. California law provides that a security interest in an insurance policy or insurance proceeds may be perfected only by giving written notice of the interest to the insurer.

The court rejected Carmel’s argument that no notice to the insurer was required because such notice would not alert other creditors. The statute’s wording was clear, and the court held that written notice to the insurer was the required method of perfection. The January 2015 communication was insufficient because it did not notify the insurer that Carmel had a security interest in the insurance proceeds. It appeared, at most, to request that Carmel be named as an additional insured. Recording the deed of trust also did not perfect Carmel’s interest in the insurance proceeds.

The court likewise affirmed the result rejecting Carmel’s request for an equitable lien. An equitable lien is a court-imposed remedy that can give a claimant an interest in property. The court held that, on these facts, an equitable lien would remain subordinate to the trustee’s strong-arm powers because it had not been imposed, reduced to judgment, or perfected before the bankruptcy case. The court therefore affirmed the bankruptcy court’s summary judgment for the trustee on the insurance-proceeds issue.

Choice of law for default provisions

The trustee challenged the increased interest rate, exit fee, and monthly late charges as unlawful penalties under California law. The bankruptcy court dismissed that claim because it treated the promissory note’s Colorado choice-of-law provision as controlling without applying the relevant exceptions.

The district court held that the bankruptcy court used the wrong part of the choice-of-law framework. In bankruptcy cases, federal choice-of-law rules apply. Under the approach used here, the parties’ chosen law is generally honored, but the court must consider whether an exception applies when the disputed issue is one the parties could not resolve simply by inserting a contractual choice.

Because the trustee’s claim asked whether the provisions were unlawful, the district court held that the bankruptcy court should have started with Colorado law and then examined whether the exceptions applied. Those exceptions include whether Colorado had no substantial relationship to the parties or transaction and whether applying Colorado law would violate a fundamental policy of a state with a materially greater interest. The district court did not decide whether the provisions were lawful under either state’s law. It reversed the dismissal and remanded the issue for the bankruptcy court to address the proper tests in the first instance.

Attorney’s fees

The trustee also appealed the denial of attorney’s fees under California Civil Code section 1717. That statute can allow reasonable fees in an action on a contract when the contract contains an applicable attorney’s-fee provision.

The district court held that the trustee’s claim was an action “on a contract” because it sought to avoid a security interest created by the deed of trust. The claim depended on the contract and involved the contractual priority of interests in property. The court rejected the view that the trustee’s use of bankruptcy strong-arm powers made the action unrelated to the contract.

The district court did not decide whether the trustee was a prevailing party or what amount of fees, if any, should be awarded. It reversed the bankruptcy court’s denial of attorney’s fees and remanded for that court to decide whether fees should be awarded and, if so, in what amount.

Disposition

The bankruptcy court’s judgment was affirmed in part, reversed in part, and remanded for further proceedings. The summary judgment allowing the trustee to avoid Carmel’s interest in the insurance proceeds was affirmed. The dismissal of the trustee’s challenge to the default provisions and the denial of the trustee’s attorney’s-fee motion were reversed, with both matters remanded.