Union Security Mortgage Corporation agreed to loan Philip Walker $72,687 to buy a piece of residential real estate from Erica Collins. Union arranged to have East Tennessee Title Insurance Agency (ETT) simultaneously close the loan transaction and the sale of Collins' home to Walker. The closing did not take place as planned, however, because Union had not yet provided ETT with a check for $72,687 to fund the sale. Instead, ETT had Walker make both a note in this amount payable to the order of Union Security, and a deed of trust securing that note. ETT held these documents in anticipation of its receipt of the funding check from Union Security.

On January 3, Union Security delivered to ETT a check for $72,867 payable to the order of ETT. This check was uncertified and was drawn on Union's bank account. ETT deposited the check in its account and used its own funds to pay Collins the purchase price of her home. ETT also delivered the warranty deed to Walker, and the note and deed of trust to Union Security.

Six days later, ETT found out that Union's bank had dishonored the check. Two days after that, ETT sued Union, seeking a writ of possession for the note and deed of trust. ETT's action was terminated later that day, however, when Union assigned the note and deed of trust to ETT. Since that time, ETT has held the note and received monthly payments from Walker.

One monthly later, Union was the subject of an involuntary petition filed under Chapter 11. A trustee commenced an action against ETT in which he sought to avoid the assignment as a preference under 11 U.S.C. Sec. 547.

ETT argued that when Union's check was dishonored, ETT's right of recourse on the underlying obligation included a right to rescind the "agreement" pursuant to which the check was presented. ETT argued that this right of rescission gave it equitable title to the note and deed of trust, and that the assignment accordingly did not cause it to receive more than it otherwise would have received in a Chapter 7 liquidation of debtor's assets.

The Court's Ruling

The court disagreed. It ruled that Union plainly did not agree to give ETT $72,867 as consideration for ETT's "transfer" of the note and deed of trust. That Union did not so agree is revealed by the fact that ETT never had ownership rights in those documents, which were made out to Union and held by ETT merely as an escrow agent. Instead, the arrangement between Union and ETT appears to have been a more "pedestrian one," according to the court. That is, in exchange for a relatively small fee, ETT agreed to make appropriate dispersals of funds and documents upon the satisfaction of certain conditions. Union's delivery of the check was one of the conditions, just as Collins' delivery of the warranty deed to ETT was another.

The court found that Union's delivery of the check no more discharged an obligation owed by Union to ETT than Collins' delivery of the warranty deed discharged an obligation owed by her to ETT. These deliveries were merely incident to the performance of ETT's escrow agent function. Since no obligation owed by Union to ETT underly Union's delivery of the check to ETT, there was no "underlying obligation" upon which ETT could maintain an action when the check was dishonored. In the absence of such an obligation, there could be neither a "failure of consideration" nor an agreement that could be rescinded.

Because the remedy of rescission accordingly was unavailable to it, ETT had no right to return to the status quo as it was before the documents-for-check exchange. The court concluded that ETT's argument that a right of rescission gave it equitable title to the note and deed of trust was without merit.

In re Union Security Mortgage Co., 93-5755 (MD Tenn 1994)

Editor's Note: The above article originally appeared in the Credit & Collection Manager's Letter, a newsletter purchased by Credit Today in 2006. This article originally appeared prior to 2000.