Note: We are crunching Supreme Court of Wisconsin decisions down to size. The rule for this is that no justice gets more than 10 paragraphs as written in the actual decision. The "upshot" and "background" sections do not count as part of the 10 paragraphs because of their summary and very necessary nature. We've also removed citations from the opinion for ease of reading, but have linked to important cases cited or information about them. Italics indicate WJI insertions except for case names, which also are italicized.
The case: Marilyn Casanova v. Michael S. Polsky, Esq.
Majority: Justice Rebecca Grassl Bradley (26 pages), for a unanimous court.
After the Atrium, a senior-living facility, defaulted on debt service payments to a group of bondholders, the facility filed a petition for receivership. The court-appointed receiver sold the Atrium's assets, generating more than $4 million in proceeds. According to the receiver, the Atrium owed the bondholders more than $6 million, secured by a valid mortgage lien on the Atrium's estate. Many of the Atrium's residents claimed they were entitled to the proceeds of the sale because, under their residency agreements, they were owed reimbursement of the entrance fees they paid to the Atrium. The circuit court concluded the bondholders' mortgage lien was superior to the residents' entrance fee claims. The court of appeals reversed, applying M&I First National Bank v. Episcopal Homes Management, Inc. to deem the residents' claims superior to the bondholders' lien.
Before this court, the residents concede the bondholders possess a valid, perfected mortgage lien on the Atrium's estate, but the residents argue (1) the bondholders contracted away the superiority of their mortgage lien, and (2) Episcopal Homes grants entrance fee claims superiority. We disagree and hold: (1) Under Wis. Stat. § 128.17, the bondholders' mortgage lien is superior to the residents' contract claims; (2) the bondholders did not contract away the superiority of their lien; and (3) Episcopal Homes does not apply to the proceeds from the sale of real property with a properly perfected mortgage lien. We therefore reverse the decision of the court of appeals.
The Atrium of Racine, Inc. was a nonprofit corporation that owned and operated a 76-unit senior-living facility. In 2002, the Atrium sought to build an assisted-living home called Bay Pointe. To finance the project, the Atrium contracted with the Elderly Housing Authority of the City of Racine (the Authority) to issue bonds. ...
The bonds to finance construction eventually were held by Bank One Trust Company, a trustee for a group of about 800 investors. Various contracts were signed by different parties.
.... As required by securities regulations, the bond underwriter prepared an Official Statement summarizing the material terms and conditions of the bond issuance as well as the risks of investing. Because the Official Statement is not a contract, it was not signed by any party, nor was it incorporated by reference into any contract.
Bank One purchased $8,050,000 in Atrium bonds from the Authority under the Trust Indenture, which assigned to Bank One (as Bondholders' Trustee) the Authority's Mortgage lien on the Atrium's estate. ... No party disputes the bondholders possess a properly perfected mortgage lien on the Atrium's estate.
Before moving into the Atrium, each resident signed a residency agreement requiring the resident to pay an entrance fee ranging from $40,000 to $238,000. Collectively, Atrium residents had paid over $7.5 million in entrance fees at the time this suit started. Upon moving out of the Atrium, each resident's entrance fee would be partly refundable when a new resident moved into the Atrium and paid an entrance fee. ... Once a new fee was paid, the Atrium used that money to refund the entrance fee paid by the former resident. Entrance fees were deposited in the Atrium's general operating account – commingled with the funds for day-to-day expenses – rather than a segregated account.
This suit arose when the Atrium defaulted on its debt service payments to the bondholders. ...
The receiver notified the Atrium's creditors and other interested parties of his appointment and requested they file their verified claims with the circuit court. Residents individually filed proofs of claim for refund of entrance fees collectively totaling more than $7 million. ...
The bondholders filed their own proof of claim for $6,264,620.65. The receiver noted the bonds were "secured by first position properly perfected security interests and mortgages" and determined the Atrium owed the bondholders' trust more than $6,097,000. As for cash in the Atrium's estate, the receiver found only two accounts, neither holding funds sufficient to continue operating the Atrium – or to pay the debt owed to the bondholders. The first account was a "general operating account" containing $80,795.11; the second was a "Resident Trust Account" containing less than $3,000. According to counsel for the receiver, the Resident Trust Account "did not have entrance fees deposited" into it. Instead, it held "some minimal amount of funds that [were] paid by the residents for various services at the debtor's facilities[.]"
The receiver eventually sold the Atrium for $5.5 million, with the money to go to the bondholders.
The residents lost in circuit court, appealed, and the appeals panel reversed the circuit court. The bondholders and the receiver then turned to the Supreme Court.
Relying on provisions of the Financing Documents and the Official Statement, the residents assert the bondholders contracted away the superiority of their Mortgage lien. Certain provisions, they argue, subordinated the bondholders' Mortgage lien to the contractually required repayment of the residents' entrance fees. We disagree.
Section 706.11(1) provides that when "[a]ny mortgage executed to a state or national bank" "has been duly recorded, it shall have priority over all liens upon the mortgaged premises and the buildings and improvements thereon . . . filed after the recording of such mortgage" with exceptions only for certain categories of liens under which the residents' entrance fee claims undisputedly do not fall.
The residents argue the bondholders consented in the Financing Documents and the Official Statement to the subordination of their Mortgage. Although "[i]t is true that a subordination can be incorporated" into any contract the Official Statement is not a contract and the Financing Documents do not contain any provision subordinating the bondholders' Mortgage.
The residents contended that the bondholders waived primacy in financing documents, including the Official Statement.
Because the Official Statement is not a contract, it is incapable of containing a subordination agreement. It is not an agreement at all, in whole or in part. The residents contend the Official Statement must be "controlling" because there is no other explanation for why it exists. To the contrary, it exists because the government says it must. The residents accurately argue the Official Statement serves as a notice to investors of investment risks and "what claims might be superior to theirs," but nothing in the Official Statement actually subordinates the bondholders' Mortgage.
Other provisions on which the residents rely likewise merely acknowledge superior claims might exist. ... The key word in these provisions is "may." Like "subject to," this word does not subordinate the Mortgage. It most naturally conveys only "a possibility." In effect, these provisions merely convey there is a possibility Permitted Liens could be superior to the Mortgage lien. Possibilities are not realities; the residents never attempted to create liens on the Atrium's real property, and these provisions do not subordinate the bondholders' secured lien to the residents' unsecured claims for entrance fees.
The residents next rely on Episcopal Homes – a court of appeals decision not binding on this court. ...
In Episcopal Homes, the circuit court granted summary judgment in favor of the DeKoven development residents and imposed a constructive trust against the entrance fee account. The court of appeals affirmed, concluding DeKoven had contracted with each resident as landlord and tenant; accordingly, the court deemed the rental agreements leases. Based on the language of the rental agreements, the court concluded the entrance fees were effectively security deposits under Wisconsin Administrative Code governed by the public policy espoused in the administrative code. Because Wisconsin Administrative Code prohibits using standard forms to place additional conditions on the return of security deposits, the court determined any subordinating provisions in the rental agreements were unenforceable.
The appeals court agreed.
Episcopal Homes is inapplicable to the facts of this case. In Episcopal Homes, the court of appeals exercised equitable powers against a segregated account containing funds traceable to the residents' payment of entrance fees. In contrast, the residents of the Atrium seek to usurp a first priority lien on the proceeds from the sale of real property. Whatever equitable powers courts may possess, nothing in law or equity authorizes courts to disrupt the statutorily prescribed priority of secured lenders.
The residents' argument for extending Episcopal Homes beyond a segregated account of entrance fees not in receivership to reach the materially distinct proceeds from the sale of real property subject to a perfected mortgage lien asks this court to disregard the plain language of chapter 128. We have no legal authority to do so.
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