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Eighth Circuit BAP Rules Third Party Contractually Entitled to Funds From Rent to Debtor - Potts v. Guilford

May 9, 2012

Vincent Howard and our Riverside personal bankruptcy attorneys were interested to see an appeals court decision allowing a third party to collect part of a bankruptcy debtor's rental income. In Potts v. Guilford, the Bankruptcy Appellate Panel for the Eighth U.S. Circuit Court of Appeals determined that Gary Guilford is entitled to part of the funds from a check made out to both him and the debtor, Steven Potts of Missouri. After Potts was already in bankruptcy, Guilford and some business entities owned by Guilford purchased some of Potts's secured debts. Their contract had a requirement that if Potts leased his real estate, the rent payments should be issued jointly to Potts and Guilford, and Guilford would be entitled to the proceeds if Potts was not current in his loan payments. Because of that provision, the BAP found that Guilford was entitled to the money.

Potts went into bankruptcy in 2008. In 2010, he was unable to make certain payments to creditors, and Guilford agreed to buy some of Potts's secured debt. Potts agreed to repay nearly $112,000 in four installments, with the last due in 2014. However, Potts never signed a promissory note, security agreement or deed of trust, as the contract required. He did sign the contract itself, which required rent payments to be made jointly to the two men, and provided that if Potts was not current in his payments, Guilford could retain enough money from the rent funds to cure the default. In 2010, Potts leased some real estate to Strcue, Inc., which made out its January 2011 rent check to "Steve Potts and Gary Guilford, Manager." By May of 2011, Potts had defaulted on his debt to Guilford; however, he did sell the real estate and pay off the debt purchased by Guilford and his companies. The next month, Potts asked the bankruptcy court to compel Guilford to endorse the rent check. Instead, the court ordered Guilford to endorse the check and take out the amount owed by Potts, leaving Potts with a bit more than a third of the money.

Potts appealed, but had no better luck with the Eighth Circuit's BAP. That court ruled that the plain language of the two men's agreement permitted Guilford to retain the money. There is no dispute that Guilford is a joint payee on the check, the court said, and therefore clearly has an interest in the funds. Furthermore, the court said, Potts didn't make the payment for 2011 on the debt he owed to Guilford. Therefore, he was in default on that debt -- at least at the time of the hearing -- and under the contract, the BAP said, Guilford had every right to retain the funds. Potts argued that Guilford became an unsecured creditor when his attorney gave the check to the attorney for Potts. As an unsecured creditor, Potts argued, Guilford should only receive a pro-rated share of the money under the bankruptcy plan. The court rejected this argument, saying whether Guilford has a secured interest is irrelevant when he is a payee under their contract.

Vincent Howard and our Irvine consumer bankruptcy lawyers are not surprised to see the court enforcing a contract so strictly. While courts may be sympathetic to arguments that parties have waived their contractual rights through trickery or wrongdoing, they generally give a lot of deference to contracts that parties entered into freely. In this case, despite the lack of paperwork from Potts, the court declined to deviate from an apparently otherwise valid contract. In our work with people fighting foreclosure, our San Diego County bankruptcy attorneys frequently run across this attitude as to mortgage contracts. Those contracts can be challenged, but plaintiffs have the most success when they argue that the lender can't prove ownership ("show me the note" cases) or broke the law when making the contract in the first place (predatory lending).

If you're considering bankruptcy because you're out of ideas to handle your overwhelming debt, don't wait to call Vincent Howard and the team at Howard Law, P.C. For a consultation or to learn more, call us toll-free at 1-800-872-5925 or send us an email.

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