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Lake Wabash argued that the trial court erred as a matter of law when it held th
at all 13 factors enunciated in the Robinson Case (as set forth above) were requ
ired elements of proof and that Lake Wabash was required to establish all the el
ements by clear and convincing evidence. But the Appellate Court found that the
trial court's Order actually contradicted that contention and that the trial cou
rt merely considered -- correctly -- the Robinson Case factors as an aid in asce
rtaining the true intent of the parties when they entered into the transaction.
The Appellate Court noted that a deed absolute on its face may, under certain ci
rcumstances, be found to constitute an equitable mortgage. In fact, Section 5 of
the Illinois Mortgage Act codifies this concept and provides that, "every deed
conveying real estate, which shall appear to have been intended only as a securi
ty in the nature of a mortgage, though it be an absolute conveyance in terms, sh
all be considered a mortgage." 765 ILCS 905/5. The Court also noted that the Rob
inson Case held that courts routinely consider the adequacy of the consideration
to determine intent and, hence, this was why the appraisal testimony was so imp
ortant in the trial court's decision.
The Appellate Court determined that proof of the existence of an equitable mortg
age must be "clear, satisfactory, and convincing." The Court noted the parties'
sophistication in real estate matters and found that the documents negotiated an
d executed by the parties reflected the parties' intention to treat the transact
ion as a sale. The Court also noted that the documents specifically stated that
failure to exercise the option would result in Lake Wabash having "no legal or e
quitable" interest in the Property, and reasoned that the fact that Lake Wabash
attempted to exercise the option on the last day it could do so indicated that i
t treated the transaction as a sale and not a mortgage. The Court also noted (as
mentioned earlier) that Lake Wabash had filed transfer tax declarations that re
quired the payment of transfer taxes at the closing, and that the transfer tax d
eclarations indicated that the transaction was a sale, and noted further that if
the parties had intended the transaction to be a loan, the RESL Agreement would
have indicated the terms of repayment if Lake Wabash chose not to timely exerci
se its repurchase option.
Lake Wabash also argued that the trial court should not have relied upon the app
raisal testimony by 185 North's appraiser that $6.5 million constituted the fair
market value of the Property. But the court found that the valuation establishe
d by 185 North's appraiser -- who had more than 30 years of appraisal experience
-- was "not against the manifest weight of the evidence." The Court also found
that the trial court's exclusion of the appraisal prepared by North Wabash's app
raiser (and the court's striking of the testimony in connection therewith) did n
ot constitute reversible error in any event, because sufficient independent evid
ence existed to support the trial court's ruling in favor of 185 North Wabash.
Lake Wabash further argued that it received nothing from the sale because the $6
million in proceeds went to the tax buyers and there was no reason for it to do
the transaction if it was not a loan, because otherwise it could have just allo
wed the Property to be transferred to the tax buyers. But the Court noted that L
ake Wabash, by virtue of the repurchase option, obtained a one-year reprieve fro
m certain loss of the Property and gained the opportunity to obtain financing on
the Property or secure a development partner.
Finally, the Appellate Court rejected Lake Wabash's argument that a news story i
t found on the Internet (three years after the execution of the RESL Agreement),
regarding the planned $45 million conversion of the Property into a multi-famil
y rental project, was relevant with respect to the value of the Property at the
time the parties entered into the RESL Agreement.
Conclusion
So what lessons and morals can be gleaned from the Appellate Court's decision in
185 N. Wabash? The authors have the following observations on the Court's rulin
g:
This case involved sophisticated and experienced real estate investors and sophi
sticated legal counsel, as pointed out by both the trial court and the Appellate
Court. The documents negotiated and drafted by these parties (and their actions
and conversations in connection therewith) specifically referred to the transac
tion as a sale-leaseback and made no mention, express or implied, of any other c
haracterization. Also, Lake Wabash signed transfer tax declarations stating that
the transaction was in fact a sale. Clearly the facts, and the burden of proof,
were in 185 North's favor and Lake Wabash faced an uphill battle in attempting
to prove the existence of a sufficient number of the Robinson Case factors (beyo
nd its argument that it had previously unsuccessfully attempted to obtain a loan
and the documents contained a repurchase right and provided for a lease at a no
minal rental amount) to establish that the intention of the parties was other th
an as stated in their documents.
If you know you are dealing with extremely litigious parties (apparently the cas
e in this matter), think long and hard before you drag them into court and give
them an opportunity to make a claim of an equitable mortgage -- especially when
you have already obtained title to and possession of the property and the proper
ty is worth at least the amount of the original sale price (which apparently, wa
s the case in 185 North Wabash based on the appraisal testimony accepted by the
Appellate Court).
Appraisal testimony can be crucial in determining the value of the property in t
hese types of cases, which in turn is crucial to the issue of whether the consid
eration for the transaction is fair and sufficient to prevent recharacterization
. The credibility of the appraisers certainly was critical to the Appellate Cour
t's decision in 185 North Wabash, and it appears that 185 North was shrewd in re
taining a highly reputable, experienced, and believable appraiser who stood up w
ell under direct- and cross-examination in court. (Query: Would it not be the ca
se that whenever commercial property is encumbered with a lease containing a rep
urchase option, the value of the property will be negatively impacted?)
The language in the option provision of the RESL Agreement, stating that failure
to timely exercise the purchase option and deliver the earnest money would term
inate the option right and nullify it ab initio -- and that Lake Wabash would th
ereafter have no legal or equitable interest in the Property -- certainly was he
lpful to 185 North. But it likely would have been even more helpful if the RESL
Agreement had contained specific language (perhaps bolded and in caps) negating
and disclaiming any construction of the transaction as a security arrangement or
equitable mortgage, or any intention to create any relationship between the par
ties, either express or implied, other than as expressly stated in the RESL Agre
ement.
Recharacterization is always an uphill battle -- you are trying to argue that so
mething is not what the parties said it is. Courts are not particularly fond of
these cases; they are equitable proceedings and courts generally will hold the p
arty seeking to recharacterize a document or transaction to a high standard of p
roof. As demonstrated by the Appellate Court's holding in 185 North Wabash, the
question of valuation is often crucial. Sale/leaseback transactions may be recha
racterized as either equitable mortgages or joint ventures (although to date no
final court decision has ever recharacterized a sale/leaseback transaction as a
joint venture). See Thomas C. Homburger and Brian P. Gallagher, To Pay or Not to
Pay: Claiming Damages for Recharacterization of Sale Leaseback Transactions Und
er Owner's Title Insurance Policies, 30 Real Prop. Prob. and Tr. J. 443, 488-489
(Fall 1995); Thomas C. Homburger and Gregory Andre, Real Estate Sale and Leaseb
ack Transactions and the Risk of Recharacterization in Bankruptcy Proceedings, 2
4 Real Prop. Prob. and Tr. J. 95 (Spring 1995). In a sale/leaseback transaction,
the seller/lessee may attempt to have the sale and leaseback recharacterized as
an equitable mortgage in order, among other things, to provide it with an oppor
tunity to "redeem" the property at a foreclosure sale. The recharacterization te
sts applied by bankruptcy courts often serve as a useful guideline when analyzin
g the risks of the transaction. See, e.g., Barneys, Inc. v. Isetan Co. (In re Ba
rney's, Inc.), 206 B.R. 328, 332-33 (Bankr. S.D.N.Y. 1997) (stating that the "[t
]he appropriate inquiry is whether the parties intended to impose obligations an
d confer rights significantly different from those arising from the ordinary lan
dlord/tenant relationship;" the court also noted that where the purported "lease
" involves rental payments that are actually payments of principal and interest
on a real estate loan, there is no "true" or "bona fide" lease). The courts have
applied a fact-based analysis to determine whether the substance of the transac
tion is in accord with its form and the expressed intent of the parties. Althoug
h the issue of whether a transaction is characterized as a sale or a mortgage de
pends to a great extent on the expressed intention of the parties, the economic
substance of the transaction -- and not its label -- will ultimately determine w
hether it is a true sale/leaseback or a financing transaction.