Mick Mulvaney's South Carolina Land Shenanigans All Under Seal

Last year the Washington Post covered Mick Mulvaney's South Carolina land deal gone sour. It was a pretty amazing case that is fantastic for teaching purposes. Mick's moves would have made some of the most sophisticated distressed debt funds (not to mention a real estate developer president) blush with shame (or green with envy).

I've got an update on the case that appears quite troubling: it seems that the South Carolina court has put everything except the docket entry list under seal, including previously public available documents. If I am correct, this is really disturbing because would indicate a willingness by the South Carolina court system to accommodate Mick's desire to shield keep his business dealings from any public scrutiny, even though there is no legitimate reason that I can see for the court to turn seal all the documents in a public judicial proceeding about a commercial real estate foreclosure action. 

Here's the brief recap. Mick formed a company to develop a strip mall. The company borrowed money from a bank with a first lien and from a wealthy local individual, secured by a second lien. The mall never got developed and faced with a default on the bank loan, Mick formed a new company, which bought the first lien loan from the bank. Mick's new company, as holder of the first lien loan on the old company moved to foreclose on the lien. If Mick's new company were merely to credit bid its debt, it could probably win the foreclosure sale and own the property free and clear, as the effect of the foreclosure would be to discharge the lien on the second lien debt, which would render the second lien creditor an unsecured creditor of Mick's old company--a corporate shell with no assets. It's a nice illustration of how a foreclosure sale discharges junior liens. 

Mick's move is allowed by the rules, but also totally in bad faith. Not surprisingly the second lien holder raised this bad faith as a defense. (I wonder if there's also a doctrine of merger issue here--there certainly would be if the corporate entities were disregarded as shams. To the extent Mick personally guarantied the first lien debt, there might be such an argument.) 

After teaching Mick's bad faith move to my financial restructuring class this year, I decided to see if there were any updates on the story. Since the Post's coverage, it's been radio silence in the press. Moreover the URLs in the old coverage that linked to case documents are all dead now. I'm not entirely sure why, but it seems that everything in the case is now under seal. It's possible that I just don't know how to navigate the state court's docketing system, but if I'm right and it's all sealed, then that's pretty outrageous--documents that have been publicly available shouldn't become sealed and there's really no good reason for anything in this case be sealed. Indeed, even the motion for sealing is sealed so it cannot be evaluated.

But the and somethings can be gleaned. I'm not 100% confident in my reading of the docket, but it seems as if there were a summary judgment motion filed by Mick's outfit (Indian Land Ventures, LLC) in August 2019, with an order on it in November.

Incredibly, even the court's order is under seal. I've never seen an order deciding a foreclosure action that is under seal. It's frankly ridiculous. This is a dodgy land deal, not a state secret.

There was then a motion to reconsider that appears to have been filed by the defendant (which suggests that the defendant lost), but then on December 30, a notice of appeal that appears. It looks to have been filed by Mick's company, which would suggest that Mick lost in the end, but the disposition date given in the docket is the November summary judgment order date, which would indicate otherwise. Perhaps the docket is showing that Mick receive a notice that an appeal had been filed?  

Hopefully some enterprising journalist can either figure out a way to get the records unsealed or find someone in South Carolina who is willing to talk about the status of the case because Mulvaney's business dealings seem to confirm his modus operandi as chief of staff. I think there's likely a good story here... 

Update:  An intrepid reader decided to check out the South Carolina Appellate Court docket for the case. The Appellate Court docket hasn't been sealed, and it's possible to download the Summary Judgment Order plus the Denial of Rehearing Order. 

The Summary Judgment Order has some interesting things in it. First, it indicates that Mulvaney was deposed (no surprise) and that his deposition transcript was submitted to the court. While it's common for excerpts of deposition transcripts to be filed as exhibits to motions, a complete deposition transcript is less common, and would potentially be quite illuminating about Mick's business dealings. Whatever's there, however, is under seal.  

Second, there's some mystery to the case--the only mention of Mulvaney in the opinion is about his deposition transcript (he's referred to as "John M. Mulvaney"--you'd never realize that it's Mick from the reference...). Curiously, Mick is never identified as having any ownership interest in either land development company. Instead, the owner of the land development companies (LLCs) is just identified as "Member A". This seems to be in part a function of the defendants' pleadings, but it's hard to tell for sure. 

Third, there's actually a cool legal issue--whether equitable subordination applies outside of bankruptcy. The court assumes that it can, but holds that the elements aren't met because "this is simply a case of a party properly using legal mechanisms to protect its own financial interests." The court sees the case as no harm, no foul because the second lien holder had junior priority to begin with and wasn't affected by the sale of the first lien--it remained the junior mortgagee.

That finding is correct if and only if there is an arm's length relationship between the buyer and the seller of the first lien mortgage. If they are affiliated, then the junior mortgagee has been harmed. Here's how. If a third-party lender had foreclosed on the first lien, both the first lien and the second lien would have been wiped out. But if the foreclosure was brought by the same party that held the first lien then it isn't really a foreclosure because you can't foreclose on yourself. That's the doctrine of merger. If you own a property and have a mortgage on it you are going to be treated just as an owner, not a mortgagor. That means that it's not a foreclosure sale, but just an ordinary sale of the collateral property from one entity to another, and the second lien should travel with the collateral if it isn't paid off.

So this comes down to a factual question--was the foreclosure brought by an arm's length third-party? The court found that "No Member of [the second land company] is also a Member [of the first land company]." That seemed sufficient for the court. Yet, the defendant had argued that the mysterious Member A was a Member of one entity and acted as agent for the other, as there seem to be some family members of Member A involved. Given the lack of clarity about who Member A is and the relationships involved, it's understandable that the defendant didn't going to prevail here. But if Member A in one entity was a relative of the parties who control the other entity, I think it gets much harder to say that this is an arm's length deal. Whether it is sufficient to trigger the doctrine of merger, I don't know, but given the equitable nature of foreclosure, the strong whiff of bad faith here should have made the court hesitate.  

Comments

[Howard Spector]

Since (presuming the foreclosure sale is a public sale) the second lien holder can always pay off the first at the sale, thus protecting its second lien. That was always the risk the second lien holder bore. Not sure I understand the bad faith in equity making the second put up or shut up.

[Adam Levitin]

In a perfect world, yes, a second lienholder can pay off the first at the sale. But parties often have liquidity constraints. (That was the back story to the RadLAX and Philly Newspaper litigations about limiting credit bidding--the debt was held by CLOs--close-ended funds which couldn't go and borrow to fund a cash bid.)

The alleged bad faith here is an entity affiliated with the debtor buying the first lien in order to foreclose and wipe out the second, which would be left with recourse to just an empty corporate shell. There's a factual question, however, about the affiliation of the entities.

[Adam Levitin]

Query--would an involuntary bankruptcy petition help the second lien holder? Perhaps the second lien holder would face a friendlier audience for its equitable subordination argument.

[Laird Minor]

Banks regularly sell distressed loans, for a variety of reasons. In this case it might have wanted to avoid the reputational risk of foreclosing on an important public figure. On its face there is nothing "dodgy" or in "bad faith" about it. Even if Mulvaney went through all these machinations purely to screw the 2nd lienholder that's not "bad faith" in any legal sense. The foreclosure sale was public and anyone could have bid in the property (including, as Mr. Spector points out, the 2nd lienholder; issues about his liquidity are irrelevant). And the bank could have sold the loan to some third party, with the same result. The second lienholder is not harmed by this.

Indeed, the fact that the second lienholder didn't bid in the property suggests that its value is less than the first lien and there was nothing left for him. If that's the case he's merely trying to use the courts to bail him out of a bad loan.

The really interesting part of all this, which I think you're missing, is the terms of the loan sale. Distressed loans are always sold at a discount to face amount; that's a given. But did the bank sell the note to Mulvaney's new company (#2) at an unusually steep discount? Did they solicit bids and sell it to #2 because it offered the best price, or did they sell it to #2 at an especially favorable price in order to curry favor with Mulvaney? If the latter were the case it could amount to an illegal campaign contribution. Unfortunately, there's probably no way for us to find out the sale price. But in any event that would create no legitimate claim on the part of the second lienholder.

I do agree with your point about sealing the case, though. That makes no sense.

[Adam Levitin]

Laird--You raise a really interesting point about the sale price, although it's a separate issue, as you note.

I simply disagree with you that going through these machinations to screw over the 2nd is not "bad faith" in any legal sense. The debtor allegedly set up a company that it used to buy the first lien for no purpose other than to deprive the second lienholder of its lien. If that's not bad faith by the debtor, I don't know what is. If this were in bankruptcy, I think there would be a very strong case for equitable subordination if there were a substantial identity between the debtor and the purchaser. Indeed, if you want to see a recent case with some parallels, look at the Marblegate case in the 2nd Circuit. It wasn't argued on good faith/equitable subordination, but on the Trust Indenture Act. The TIA argument lost in the 2nd Circuit, but the District Court bought it because the facts were so ugly.

A public foreclosure sale doesn't change anything. (I'm not actually sure if the sale would be public, but let's assume so.) BFP v. RTC aside, foreclosure sales are not arm's length sale conditions. They are often not well marketed, and the possibility of a credit bid chills outside bidders, particularly when the first lien holder had an informational advantage about the property by virtue of its connection with the debtor. I don't know if the 2nd was liquidity constrained, but I am not going to assume a world of perfect markets when dealing with foreclosure sale bidding.

I cannot disprove your holdup litigation argument--perhaps the 2nd is being a squeaky wheel to get some payment. Given that there has not yet been a sale, however, we don't know if the 2nd will in fact pay off the 1st lien. But if I were representing Mick, I might want some discovery about this.

I think your strongest argument is that the bank could have sold the loan to a third party with the same result. That's true, but that's not the situation here. The nature of the good faith/equitable subordination argument is that the activity while perhaps generically lawful was undertaken for nefarious reasons. It dovetails with your question about price--would any third party have purchased the loan from the bank?

[David Shemano]

Adam -- let's assume the 1st foreclosed and Mulvaney showed up at the foreclosure sale and purchased the property for the amount of the 1st debt, thereby purchasing the property free of the 2nd. Bad faith? How any different conceptually than buying the 1st position before the foreclosure sale?

[Adam Levitin]

David, it's a nice question. I don't think that would be bad faith. It's different because Mulvaney wouldn't be assured of winning the auction just by paying off the first lien. He'd have to bid more than that to defeat a credit bid, and he'd have no assurance that the first lienholder or someone else wouldn't outbid him. All of that would mean that he would have to pay the 2nd lienholder something to get rid of the 2nd lien. In other words, there'd be market process that would check his behavior. He'd also be on equal footing with the 2nd lienholder in the auction. Those checks goes away when Mick buys the lien in a private sale from the bank and brings the foreclosure himself.

Additionally, the bad faith here is in part the bringing of the foreclosure--if the bank still held the first lien, Mick and the 2nd would likely have to jointly come to the table for a workout; here there's no opportunity for the 2nd.

[Mo]

Is Student Loan a Negotiable Instrument?
Does Non Negotiable Instrument assign to Trust via Assignments Only (not by Endorsements am I right?0

[Howard Spector]

1. If the junior creditor wanted recourse against more than the land, it should have contracted for a personal guaranty or other collateral.

2. With the deal upside down, even assuming Mick orchestrated a purchase of the senior debt, the junior creditor presumably had the same ability to buy the 1st lien note (or could have, had it negotiated an intercreditor agreement with the senior lienholder at the time of financing, which is also pretty standard). The fact that Mick might be more liquid than the second lender does not engender any sympathy from me.

3. Assuming the junior lienholder failed to protect itself in either of the 2 ways described above, purchase of the senior debt merely gives the purchaser (assuming it’s Mulvaney) the right to sue on the debt and send the property to a public auction (since SC is a judicial foreclosure state). At that point, again, the junior can pay off the senior debt, credit bid its position, and own the property. Again, if they don't want to do this or can't fund it, maybe they should not be in the business of lending money in subordinate positions.

The junior lender has received exactly what it bargained (or failed to bargain) for. I do a fair bit of debtor work, and we often engage in similar tactics to make (mostly junior) lenders “put up or shut up” when they are alleging their position is secured. This is also the basis for lien stripping unsecured claims in bankruptcy cases under 506.

[Howard Spector]

Your premise that the "checks" against misconduct go away when Mick buys the lien in a private sale from the bank and brings the foreclosure himself is, I think, wrong. Mick's foreclosure mechanism (as opposed to his note purchase which only gets him the right to foreclose) is a public auction just like the bank's would be.

The doctrine of equitable subordination is founded on me principle that creditor misconduct disadvantages other creditors. If the second lien was out of the money, Mick's conduct did not "disadvantage" the junior lender. If the second lien had value, Mick will be required to pay something to the second lender because the sale of the property at a public foreclosure will establish a market price for the collateral. Either way, the second lender is not harmed even if it is unable or unwilling to protect itself at the foreclosure sale.