Thursday, May 30, 2024


             Starting in 2010, Jerome Cohen and Shaun Cohen, through their entities EquityBuild, Inc. and EquityBuild Finance, LLC, sold promissory notes to investors. Each note represented a fractional interest in a specific real estate property. Investors were assured returns ranging from 12% to 20%. 

            Separate mortgages on underdeveloped areas of Chicagoland secured the notes. 

            The Cohens had each investor sign a contract granting to EquityBuild the right to service the loans. Consequently, the mortgages were structured so that EquityBuild was the borrower and individual investors were the lenders, “in care of” EquityBuild. 

            The contracts authorized EquityBuild to issue monthly statements and payoff demands, and collect loan payments. The contracts also limited EquityBuild’s power, by requiring written instructions from investors before foreclosure, amendment, or termination of the mortgage debt. 

            However, separately and in addition to the contract, many investors also signed a document providing EquityBuild with the authority to receive payments and issue mortgage releases. 

            In 2017, BC57 loaned $5.3 million to EquityBuild, in exchange for a first mortgage on five properties located on the south side of Chicago. Those five properties were already owned by EquityBuild, and were already subject to preexisting mortgage liens securing individual investors. 

            To deal with the problem of competing first-lien security interests, EquityBuild provided payoff letters and Releases to BC57 and the escrow agent at closing, purporting to pay and discharge the existing loans. The Releases were executed by EquityBuild, with Shaun Cohen signing as the manager of EquityBuild. 

            Individual investors did not sign the Releases. Neither did individual investors receive any monies from BD57’s payment. 

            All of this collapsed in 2018, when the Cohens admitted to the US Securities and Exchange Commission that EquityBuild had funded investor interest payments with later investments. The SEC filed a lawsuit, obtained a temporary restraining order, and the district court authorized the appointment of a Receiver to liquidate the assets of EquityBuild. 

            With approval from the district court, the Receiver sold the five Chicagoland properties and recovered $3 million. The individual investors asserted a claim to those proceeds, arguing that they never received payment or released their mortgages. 

            BC57 disagreed and asserted it had priority. 

            The district court ultimately awarded the funds to the individual investors, concluding that the mortgage releases were defective and that EquityBuild lacked the authority to execute them. 

            BC57 appealed, claiming that its $5.3 million payment was made in exchange for first-lien mortgages. And that the lien positions of the individual investors had been discharged through full payment of their mortgages. 

            The baseline rule, as determined by the Appellate Court, is that payment of a debt secured by a mortgage automatically extinguishes the security interest. BC57 contends that this rule yields the inescapable conclusion that BC57 is entitled to all net funds recovered by the court’s Receiver. 

            In reviewing other appellate decisions, the Court found that there can be circumstances when payment alone does not extinguish a debt. To cause a mortgage debt to be fully discharged, a properly executed, valid Release instrument, is also required. 

            The Releases that were tendered contained fundamental errors. As the most glaring example, the Releases list EquityBuild as the party issuing the releases, even though EquityBuild was the borrower – not the lender or the lender’s agent. 

            BC57’s response is that discrepancies do not invalidate the Releases, because they fall under the legal doctrine of mutual mistake. In reviewing that position, the Appellate Court approved the district court’s decision concluding the opposite. There was no mutual mistake here, rather all of this pertains directly to the Cohens’ business model operated to purposefully obscure legal responsibility and asset ownership. 

            The Releases were facially invalid. Mortgage payment alone does not extinguish a preexisting security interest without a valid Release. Individual investors win; BC57 loses. See SEC v. EquityBuild; US Court of Appeals 7th Circuit, Case No. 23-1870, May 6, 2024: 

            Questions / Issues / Comments: 

1.      Title insurance for the individual investors and BC57 is not mentioned in this case. My conclusion is that all of this occurred without such coverage. I could be wrong – perhaps there are separate claims against escrow agents and title underwriters – but if so then presumably it all would have been consolidated here, for judicial economy. 

2.      Even if lender title insurance policies had been issued, the same claims and defenses would still have been asserted. But at least one or more “deep-pocket” insurance companies could possibly have been induced to pay claims. 

3.      Putting aside title insurance, the underlying issue is the legal effect of Lien Release documents. It is my impression that not enough real estate lawyers, title agents, underwriters, and escrow officers review these documents other than possibly to verify that the Property description and recording data are correct. The assumption is that mortgage payment equals mortgage release. That will now (should!) change, based on this case. 

                                                                       Stuart A. Lautin, Esq.*

 Board Certified, Commercial (1989) and Residential (1988) Real Estate Law, Texas Board of Legal Specialization

Licensed in the States of Texas and New York


Reprinted with the permission of North Texas Commercial Association of REALTORS®, Inc.

No comments:

Post a Comment