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Provident Savings Bank v. Pinnacle Mortgage Investment Corp.

December 9, 1998


The opinion of the court was delivered by: Jerome B. Simandle U.S. District Judge


SIMANDLE, District Judge


Provident Savings Bank appeals from a Judgment entered on December 17, 1997, pursuant to a written opinion issued on November 19, 1997, by the Honorable Judith H. Wizmur, United States Bankruptcy Judge, after trial in an adversary proceeding. That Opinion ruled in favor of the Appellees, Settlers Abstract Co., L.P., Land Transfer Co, Inc., Fidelity National Title Insurance Co. of Pennsylvania, Gino L. Andreuzzi, Pioneer Agency II Corp. t/a Pioneer Agency, Musser & Musser, Quaker Abstract Co, and Searchtec Abstract, Inc. ("title agents"). Reviewing a longstanding complex lending relationship between Provident and the debtor, Pinnacle Mortgage Corporation, of which the ten real estate mortgage loans at issue herein were a part, the Bankruptcy Court held that appellee title agents (who had advanced their own funds to cover disbursements when Provident dishonored Pinnacle's checks) had a more valid or higher priority security interest in the promissory notes and mortgages executed as part of ten separate residential real estate closing than did appellant. Provident Savings Bank appeals this ruling and seeks this Court's determination that it was the holder in due course of those documents.

The principal issue to be decided is whether the Bankruptcy Court correctly determined under the Uniform Commercial Code that Provident was not a holder in due course of the promissory notes arising from these loans, where it found that Provident so closely participated in the funding and approval of the Pinnacle-brokered loans that the transaction did not end at the closing with the title agents, such that Provident did not attain holder in due course status because it did not fit the requisite role of a "good faith purchaser for value." For the reasons that will be stated herein, the judgment will be affirmed because the Bankruptcy Court's finding that Provident never attained HDC status was neither clearly erroneous nor contrary to law.


A. Procedural History

This case arises from a dispute over the various security interests in mortgage documents from ten separate real estate transactions in late October, 1994, conducted by the debtor, Pinnacle Mortgage Investment Corporation (who brokered the transactions), the appellant (who financed the transactions), and the appellees (who were title closing agents in the transactions). On February 2, 1995, appellant Provident Savings Bank ("Provident") and other creditors filed an involuntary petition under Chapter 7 of Title 11 of the Bankruptcy Code against Pinnacle Mortgage Investment Corporation ("Pinnacle"). An order for relief under Chapter 7 was entered by the Bankruptcy Court on March 6, 1995.

On March 24, 1995, Provident commenced this adversary proceeding by filing a three count complaint to determine the extent, validity, and priority of the various security interests asserted by Pinnacle, Meridian Bank, Lawyers Title Insurance Corporation, the appellees, and William E. Ward with regard to the promissory notes and mortgages from ten real estate transactions. *fn1 Appellees responded to the complaint by filing an answer, counterclaims, and cross-claims, seeking money judgments in the amount of the contested notes and mortgages, interest, cost of suit, and attorneys fees; imposition of a constructive trust in their favor with regard to the notes, mortgages, and proceeds thereof; and to have the subject notes and mortgages avoided and stricken in favor of subsequently executed mortgages between the appellees and the mortgagors. Provident twice amended its complaint, finally seeking a declaratory judgment that it is the holder in due course of the subject notes and mortgages under the Uniform Commercial Code; avoidance of the preferential transfer by appellee Andreuzzi pursuant to 11 U.S.C. §§ 547 and 550; avoidance of the fraudulent transfer by appellee Andreuzzi pursuant to §§ 548 and 550; and avoidance of the preferential and fraudulent transfers by appellees pursuant to 11 U.S.C. §§ 547, 548, and 550.

Trial in this matter was held on July 16, 17, and 18, 1996, and October 1, 3, and 4, 1996. At the close of Provident's case in chief, upon motion by the appellees, all of those portions of the Second Amended Complaint which did not pertain to Provident's status as a holder in due course ("HDC") were dismissed.

B. The Factual History

In its November 19, 1997 opinion, the Bankruptcy Court determined that the facts of the case are as follows. Debtor Pinnacle Mortgage Investment Corporation ("Pinnacle" or "debtor") was a mortgage banker which primarily dealt in residential mortgage lending and refinance. In December of 1992, Pinnacle and Provident Savings Bank ("Provident" or "appellant") entered into a Mortgage Warehouse Loan and Security Agreement ("Agreement"), whereby Provident would fund Pinnacle, who in turn funded retail customers who sought to purchase or refinance residential real estate. The borrower in each transaction would give Pinnacle a note and mortgage, both of which acted as collateral to protect Provident until Pinnacle sold the mortgage to a third party investor, such as the Federal Home Loan Mortgage Corporation ("Freddie Mac"), who satisfied Pinnacle's debt to Provident. Warehouse Agreement § 3.4.

1. The Warehouse Agreement

Under these types of agreements, there would usually not be any contact between the warehouse lender and the ultimate mortgagor. Typically, Pinnacle would arrange with a prospective borrower for Pinnacle to advance funds for the borrower to purchase or refinance a home and for the borrower to assign a note and mortgage to Pinnacle as collateral. The mortgage would be endorsed in blank in order to accommodate the final third party investor (such as Freddie Mac), with whom Pinnacle would arrange to purchase the mortgage, usually as a part of a pool of mortgages; this was known as a "take-out" agreement. All of this completed, Pinnacle would submit a "package" to Provident seeking funding for the particular transaction under its $10 million line of credit. *fn2 This package included a description of the borrower and the funding, an assignment of the mortgage endorsed in blank, a take-out commitment, and an agency agreement that indicated the borrower's attorney's agreement "to act as the agent of the Bank" to disburse the Advance and to obtain due execution and delivery to the bank of the original note that evidences the debt underlying the Mortgage Loan." Warehouse Agreement § 5.3(A)(iii). The Agreement required all of this to be submitted along with the initial funding request. As a matter of course, however, the agency agreement was usually executed by the title agent handling the closing instead of by the borrower's attorney, and Provident customarily accepted the mortgage assignment and agency agreement after the actual closing.

After Provident received the package and checked to see that Pinnacle's credit limit had not been exceeded (although, as stated above, often prior to receipt of the mortgage assignment and agency agreement), Provident credited Pinnacle's checking account with 98% of the requested funds. Warehouse Agreement §§ 1.1, 2.1. Pinnacle would write a regular, uncertified check to the closing agent, who would close the loan directly with the borrower on Pinnacle's behalf. Pinnacle was supposed to use specific funds credited to their account to fund specific closings, but no controls were in place to make sure that Pinnacle actually did so.

With Pinnacle's check in hand, the closing agent would use money from its own bank account to disburse funds to the mortgagor, later replenishing its bank account by depositing Pinnacle's check. Next, the closing agent would routinely send the original note, a certified copy of the recorded mortgage, and the other closing documents to Pinnacle, who would send them on to Provident, who would receive this original note approximately three to five days after closing. Provident and the borrowers had no contact; indeed, Provident and the closing agents had no contact, save the extremely limited contact by the closing agents who did return the agency agreement included in the borrowing package. Not all closing agents did return the agreement signed; most of those who did sent everything through Pinnacle to go to Provident, in accordance with Pinnacle's written instructions, rather than remitting the note and other papers directly to Provident, as stated in the agency agreement. Ultimately, Provident would send the note and accompanying documents to the third party investor, who would pay Provident the funds which Provident had originally placed in Pinnacle's checking account by wiring monies to Provident in Pinnacle's name. Because the third party investor would send multiple payments in each wire transfer, Pinnacle would tell Provident to which loans to apply each of the funds.

2. Pinnacle's Declining Financial State

Among the twenty or so warehouse customers that Provident had during 1993-1994, Pinnacle was the most profitable for Provident, providing hundreds of millions of dollars in loan transactions. However, when the mortgage banking industry suffered a decline in business, Pinnacle began to experience financial difficulties as well.

The Warehouse Agreement, § 6.11, required Pinnacle to submit unaudited balance sheets and statements of income to Provident on a quarterly basis, though Pinnacle customarily provided monthly statements. The statements filed for June, July, and August of 1993 reflected an accrued pre-tax income for the first three months of the fiscal year of $281,351. Statements for September, October, and November of 1993 reflected pre-tax income of $923,923 for the first six months of the fiscal year. However, after the November 30 report, Pinnacle began to send its reports quarterly, which was in accordance with the Warehouse Agreement but which was nonetheless unusual due to Pinnacle's custom of submitting reports monthly. The next report, covering the nine-month period ending February 28, 1994, was due on April 15 but not received until some time in May. It showed pre-tax income of $136,000 for the first nine months, or an $800,000 loss in the previous three months. The accompanying unaudited balance sheets showed a reduction of assets from $40 million to $28 million in those three months. The final financial statement was due on August 31, 1994, but Provident never received it.

At a holiday party in May 1994, Edmund R. Folsom, head of Provident's Commercial Lending Department, had learned that Pinnacle had sustained losses in the winter months. On August 19, 1994, Sharon Kinkead, of Provident's Warehouse Lending Department, called Pinnacle's headquarters and learned from Pinnacle's CFO, Joseph Mader, that there would be a delay in the submission of the audited financial statements for the fiscal year ending May 31, 1994 because of a change of comptroller, but that the report would be provided by September 15, 1994. That report never arrived, and no other financial statements were received up until Provident's termination of its relationship with Pinnacle in early November 1994.

3. Provident's Relationship with Pinnacle

Throughout its relationship with Pinnacle, Provident routinely honored overdrafts on behalf of Pinnacle--about twenty times in 1993 and fifteen times in 1994. These overdrafts ranged from $7,240.87 to $5,255,812.

When a check was presented to the bank on Pinnacle's account for which Pinnacle had insufficient funds, Sharon Kinkead would contact Pinnacle to ask whether Pinnacle would honor that overdraft. Having been told that the check would be covered (usually from an anticipated wire transfer), Kinkead and her supervisor, Mr. Folsom, would honor it and allow the overdraft. Until November 1994, Provident honored all of Pinnacle's overdrafts, without reviewing Pinnacle's books and records or monitoring its checking account.

As mentioned earlier, Pinnacle's CFO, Joseph Mader, had informed Provident that its final fiscal year report would be forthcoming on September 15, 1994. When Provident did not receive the audited reports by that date, Mr. Folsom spoke with Mr. Mader, who reported that though Pinnacle had sustained losses, it was expecting a substantial infusion of capital. Pinnacle wanted to hold off publishing the report so that it could add a footnote explaining that there would be a capital infusion. Based on this, Folsom decided to extend Pinnacle's credit line through the end of November.

Folsom called Mader some time in October to check on the status of the report. When Mader returned the call on November 1, he informed Folsom that the capital infusion had failed. ...

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