ROBERT J. FARIS, Bankruptcy Judge.
HSBC
In 2003, IndyMac Bank, F.S.B. ("IndyMac"), agreed to make a construction loan to Lawrence and Kathy Abatie in the amount of $524,000. The Abaties signed a promissory note and a mortgage that encumbered the Abaties' property in Lahaina.
The note provided an initial interest rate of six percent per annum, subject to annual change based on an index. The interest rate could not exceed twelve percent and would never change by more than two percentage points at any one time. The
The note gives HSBC "the right to be paid back by [the obligor] for all of its costs and expenses in enforcing this Note to the extent not prohibited by applicable law. Those expenses include, for example, reasonable attorneys' fees."
In 2006, The Mortgage Store lent the Abaties $220,000, secured by a second mortgage on the Lahaina property.
In 2007, IndyMac and the Abaties entered into a Modification Agreement.
At some point, through a series of intermediate transfers, HSBC succeeded to the interest of IndyMac in the Abaties' loan. HSBC has possession of the original promissory note, which is endorsed in blank.
Mrs. Abatie filed a chapter 13 bankruptcy case in 2008 that was dismissed in 2009. She filed another chapter 13 case in 2009 that was dismissed in 2010.
In 2010, TMS filed this chapter 7 case.
In 2011, Mrs. Abatie filed her third bankruptcy case, this time under chapter 7. Both HSBC and the TMS trustee obtained relief from the stay to foreclose their respective mortgages. The TMS trustee commenced a judicial foreclosure proceeding. HSBC could have sought foreclosure of its mortgage in that proceeding but inexplicably did not. The TMS trustee obtained a decree of foreclosure and was the successful bidder at the foreclosure sale. Thus, the TMS trustee became the owner of the property, subject to the HSBC mortgage.
In 2013, I authorized the TMS trustee to sell the property for $840,000, to pay the costs of sale, to pay HSBC the then undisputed part of the HSBC debt ($524,000), and to retain the remaining proceeds until the HSBC debt could be determined.
The parties exchanged information about HSBC's claim. Both parties are dissatisfied with the other's performance
In December 2013, HSBC filed the motion that is before me now. The TMS trustee objects to the motion on numerous grounds and argues, not only that HSBC should receive none of the additional sale proceeds, but that it should also refund the $524,000 it received at closing.
The TMS trustee argues that HSBC has not established that it is entitled to enforce the loan and mortgage. I disagree.
The TMS trustee acknowledges that the promissory note is a negotiable instrument and that it was endorsed in blank. HSBC has established that its counsel has possession of it. Thus, HSBC is a person entitled to enforce the note.
The TMS trustee argues that the recorded assignment of the mortgage does not also transfer the note. This is correct but irrelevant. Under Hawaii law (and the law of most other states), the collateral follows the obligation.
The TMS trustee argues that "[t]he assignment of a security interest, without a concomitant assignment of the underlying obligation, severs the security from the obligation it secured."
The trustee's argues that "[t]he 2007 Modification Agreement was essentially a new note," and that the 2003 mortgage does not secure the "new note" or any additional principal or other charges arising from that modification. I disagree.
There is only one obligation of the Abaties to HSBC and its predecessors. HSBC's predecessor lent money to the Abaties and the Abaties promised to pay it back. The modification agreement changed the interest rate and repayment terms of that existing debt. This change
The 2003 mortgage secures the debt under the note as modified by the 2007 modification agreement. The mortgage says that it secures modifications of the original note. TMS had constructive notice of this provision of the recorded mortgage when it made its second mortgage loan. The lender was not required to record a new mortgage or an amendment to the existing mortgage due to the modification agreement.
The trustee argues that the 2007 amendment cannot be enforced against him because the negative amortization feature of the modification materially jeopardized his second lien position. He cites only one court decision in support of his argument, Remodeling & Const. Corp. v. Melker.
Neither the trustee nor HSBC cites any Hawaii law on point. I predict that a Hawaii court would hold that, in the absence of an agreement between the senior and junior lienholder, the junior lienholder cannot challenge a change of the interest rate or payment schedule for the debt secured by the senior mortgage, where the first mortgage expressly states that it secures "modifications" of the original note. This is consistent with the Restatement (Third) of Property.
The TMS trustee argues that Hawaii law disfavors negative amortization. I disagree. Nothing in Hawaii law precludes "negative amortization," "interest on interest," or the capitalization of accrued but unpaid interest. Prior to 1986, Hawaii law forbade compound interest in most circumstances.
The trustee says that the negative amortization feature of the modified note was unconscionable. But the Hawaii legislature legalized compound interest (in most circumstances) nearly thirty years ago. I will not employ the unconscionability doctrine to invalidate a term that the legislature has approved.
Therefore, HSBC correctly used the 2007 modification agreement to compute the interest, late fees, and other amounts due to it and secured by its first mortgage.
HSBC argues that the TMS trustee is a non-party to the loan and therefore lacks standing to object to the amount of HSBC's claim. HSBC is wrong under both federal and state law.
First, under bankruptcy law, the trustee has the right, and "if a purpose would be served" the statutory duty, to object to claims against the estate.
Second, under Hawaii state law, "[t]he mortgagor, or any subsequent mortgagee, may defend the action for foreclosure, and may show any matter in legal or equitable avoidance of the mortgage."
The trustee challenges HSBC's computation of its claim on various grounds.
The trustee argues that HSBC has not established that it advanced the full amount of the construction loan, and that HSBC must establish the date of each advance in order to substantiate its calculation of interest. I disagree. In the 2007 modification agreement, the Abaties agreed that the principal amount of the debt was $524,000.
The trustee argues that HSBC has not adequately documented its calculation of the escrow balance. Although HSBC's documentation is confusing and hard to read, I find that the claim is adequately substantiated.
The trustee objects to HSBC's claim for attorneys' fees on several grounds.
The TMS trustee objects to the heavy redaction of the billing information supporting the attorneys' fees request. At the hearing on HSBC's motion, I agreed with HSBC's suggestion that I review the unredacted billing statements in camera. I also encouraged HSBC's counsel to review the redactions because I found it hard to believe that so much material in the bills was truly privileged.
HSBC has now submitted unredacted statements for in camera review and revised redacted statements. The dramatic change in the amount of redaction confirms that the original redaction was grossly excessive. Particularly egregious is the redaction of the hourly rates charged by the Alston Hunt firm, a fact which could not conceivably be privileged.
The remaining redaction is still excessive. Most of the redacted information describes the general subject matter of a communication. This is not privileged and must usually be revealed in a privilege log.
I will not waste further time on this collateral issue, however. The TMS trustee has had a fair opportunity to object to HSBC's claim and I can independently review the redacted entries.
The TMS trustee objects to all of the fees and costs charged before HSBC acquired the note and mortgage. I do not accept this contention. The holder of a note is entitled to collect all amounts owed under the note. It does not matter that a prior holder actually incurred and paid the collection costs that are included in the claim, just as it does not matter that a prior holder actually made the loan evidenced by the note.
HSBC seeks reimbursement for $57,183.02 of attorneys' fees incurred by six law firms. One would expect higher than normal fees because the lender had to deal with four bankruptcy proceedings spanning a six year period. But a significant portion of the fees are unsubstantiated, unreasonable, or both.
Rush Moore, LLP, $9,481.88. In support of this claim, HSBC has submitted documents
Barrett, Daffin, et al., $950.00. Although the documentation for this claim is scanty,
Law Office of David Rosen, $24,758.27. I do not doubt that HSBC should pay this firm the amounts billed, but HSBC is not entitled to charge its borrower for three categories of work done by this firm.
First, the Rosen firm spent time getting information from RCO Legal and learning about the case, and then transferring the case to Alston Hunt. This work was only necessary because HSBC chose to replace the RCO firm and then chose to replace the Rosen firm. HSBC's debtor and the junior lienholder should not have to pay extra because the senior lender decided to change lawyers. (The relevant time entries are underlined in black on exhibit "A" to this decision.)
Second, the Rosen firm spent substantial time preparing pleadings and motions which were never filed. HSBC has never explained why it did not seek foreclosure of its own mortgage. I do not intend to be critical of the Rosen firm, because I do not doubt that the firm did the work at the request and for the benefit of its client, but HSBC is not entitled to add these charges to the debt. (The relevant time entries are underlined in red on exhibit "A.")
Third, the Rosen firm spent substantial time identifying the holder of the mortgage and preparing mortgage assignment instruments for recording. Nothing in the loan documents permits HSBC to shift these costs to its borrower. (The relevant time entries are underlined in blue on exhibit "A.")
I will reduce this portion of the claim by $14,997.60.
Alston Hunt Floyd & Ing, $4,518.85. For the reasons given above, HSBC is not entitled to reimbursement for transition work caused by HSBC's decision to hire new counsel. The Alston firm had to do this work and its client should pay it, but the debtor and the junior lienor should not bear this burden. (The relevant time entries are underlined in black on exhibit "A.")
I will reduce this portion of the claim by $1,574.00.
Allen Matkins Leck Gamble Mallory & Natsis, LLP, $14,499.38. The timesheets indicate that this firm's sole role was to act as an intermediary between the loan servicer and the attorneys who actually did the work. Evidently the servicer has chosen to outsource work which could be done by the servicer's employees. This may or may not be a rational business decision, but the borrower and junior lender's burden should not be increased as a result. This case was not so large or complex as to justify the lender's retention of both mainland and local counsel. Therefore, all of the Allen Matkins bills are disallowed.
HSBC's reasonable attorneys' fees and costs are $14,988.16.
The TMS trustee argues that the attorneys' fees he incurred in challenging HSBC's claim should be deducted from HSBC's distribution.
The first is the Hawaii statute which permits the prevailing party "in all actions on a promissory note or other contract in writing" to recover a reasonable attorneys' fee.
Second, in my view, a lender who demands payment of a debt, including foreclosure of a lien, has an implied duty to respond promptly to reasonable requests about the validity and amount of that debt.
Considering that both parties are responsible, to some extent, for the delay, the fair remedy is to deny the trustee's claim for attorneys' fees and HSBC's claim for attorneys' fees incurred after the closing of the sale. It is worth noting that HSBC is not claiming interest after April 29, 2013.
HSBC is entitled to disbursement of $172,819.48 of the sale proceeds. Counsel for HSBC shall prepare an appropriate separate order.
SO ORDERED.
