Court Gives Nod to 1932 Florida Supreme Court Case, Blocking Developers’ Ability to Avoid Additional Payments

We are often asked when representing a client in defense of a claim whether the client could avoid the liability asserted by the claimant by potentially buying the cause of action out from under the claimant. The most common circumstance is when the plaintiff has an adverse uncollected judgment or, perhaps, owes money under a promissory note in default or construction lien.
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Michael Kreitzer and Helene Brown

By Michael Kreitzer and Helene Brown, Bilzin Sumberg

We are often asked when representing a client in defense of a claim whether the client could avoid the liability asserted by the claimant by potentially buying the cause of action out from under the claimant. The most common circumstance is when the plaintiff has an adverse uncollected judgment or, perhaps, owes money under a promissory note in default or construction lien.

Until quite recently, case law on this issue was scant. In fact, the only Florida case that spoke to this issue was handed down by the Florida Supreme Court over 80 years ago. In the case, Clermont-Minneola Country Club, Inc. v. Joblaw, 106 Fla. 122 (Fla. 1932), the Florida Supreme Court affirmed a ruling that prohibited an individual property owner, through a newly created corporation, from defrauding a junior lienholder in order to evade payment due under that lien. In that case, a mortgagor/property owner hired a contractor to pave a portion of her property, which resulted in a lien.

In order to evade payment to the contractor, the individual created a corporation wherein she and her immediate family were the only shareholders. This newly created corporation paid off the mortgage on the property and rather than having the mortgagee record a satisfaction of mortgage in the public records (thereby extinguishing that lien on the property), the corporation directed the mortgagee to assign the mortgage to it.

Thereafter, the newly created corporation initiated a foreclosure proceeding to wipe out that very mortgage and the contractor’s junior lien, thereby obviating the need to pay the contractor. The Florida Supreme Court affirmed the lower court’s ruling and held that the construction lien was not wiped out by virtue of the foreclosure sale; the Court concluding that a person will not be permitted to do indirectly what he cannot do directly.  In other words, the Court was unwilling to allow the property (and the landowner) to escape the construction lien through the guise of an assignment of the mortgage to a corporation owned by the very landowner who owed the paving company the debt.

Last month, the Florida Third District Court of Appeal was given an opportunity to speak on the issue. In CDC Builders, Inc. v. Biltmore-Sevilla Debt Investors, LLC, et al. No. 3D13-603, 2014 WL 4628515 (Fla. 3d DCA 2014), the Court reversed a lower court’s ruling which had permitted a developers’ related entity to purchase the developers’ own construction loan from the construction lender, and thereafter foreclose the loan (essentially foreclosing upon itself) for the central purpose of wiping out a contractor’s construction lien on the property.

This artful legal saga began when developers, Riviera Biltmore, LLC and Riviera Sevilla, LLC, both of which are managed by the same person, hired a general contractor to build 25 luxury homes in Coral Gables.  When the developers failed to pay the contractor for the last 8 homes constructed, the contractor recorded two construction liens for the unpaid work.  At the same time, the developers were also in default of their construction loan.

In order to avoid its obligation to satisfy the construction liens, the developers schemed to create a related company to purchase the defaulted construction loan and thereafter assign the loan to the related entity.  The loan assignment allowed the developers’ related entity to step into the Bank’s superior lien position.  The related entity thereafter foreclosed against the developers and the contractor so as to wipe out the contractor’s construction liens which were inferior in time to the construction loan.  This tactic worked at the trial court level, causing a judgment of foreclosure in favor of the related entity.

But on appeal, the Third District Court of Appeal reversed and held that what investors cannot do indirectly through a single company, investors cannot do indirectly through a network of companies.  In fact, the Court specifically noted that:

“The law does not permit a person to borrow money from a bank, give the bank a mortgage, incur additional liens and junior mortgages on the property, purchase the mortgage back from the bank, and then foreclose on the mortgage for the primary purpose of eliminating the additional liens and junior mortgages.

Investors cannot grant mortgages, contract for the improvement of the property mortgaged, and then use a network of companies to purchase and foreclose the mortgage for the primary purpose of extinguishing the construction liens that increased the value of the property.”

The CDC Builders case makes clear that Florida courts will not permit individuals or corporations to circumvent their payment obligations due to junior lienors through a series of legal subterfuge to obtain control of a senior obligation that could otherwise wipe out junior interests. But this holding can easily be expanded to address a more common scenario: when a defendant facing claims by a plaintiff might try to acquire the plaintiff’s claims through some form of forced sale and once owing the claim, would thereafter dismiss it as against itself.

In other words, suppose a creditor is owed money from its customer and files suit to recover the indebtedness. If the indebtedness was large enough, a clever debtor might look to determine if the creditor had any outstanding judgments against it. If so, the debtor might consider buying the judgment, foreclosing on the creditor and acquiring the debtor’s debt by a sheriff’s levy. For the first time in 80 years, the CDC Builders case sheds light on the likely outcome:  that a person will not be permitted to do indirectly what he cannot do directly.

Michael Kreitzer is Partner and Litigation Co-Chair in Bilzin Sumberg’s Litigation Group; Helene Brown is a Staff Associate in the firm’s Litigation Group