Problem.Summary

     In 1989 Telegraph Partnership purchased a building for $3.5 million from NevLife Insurance (NLI) Company. Telegraph paid $500,000 down and gave NLI a note for 3 million. This note was secured by a deed of trust on the building. Telegraph's general partner, Greg, signed the note and deed of trust. The deed of trust was immediately recorded.

     In 1991, Telegraph entered into an agreement with HVAC Corporation to have HVAC install new heating and air conditioning in the building. Telegraph signed a note for $90,000 and gave HVAC a security instrument in the equipment which was properly filed.

     In 1994, Telegraph found itself in financial difficulty and defaulted on both the HVAC and NLI notes. NLI is concerned (obviously) about its security and seeks advice on the following matters:

     a. HVAC has accelerated the balance due on its note which is $65,000. NLI wants to know if it should pay off that note. What advice would you give?

     b. NLI paid off the HVAC note prior to seeking your advice. Telegraph is unable to bring the NLI loan current. NLI begins both a judicial and nonjudicial foreclosure. Telegraph files a complaint requesting that the court enjoin the foreclosure, alleging that it is entitled to set-off from the amount due on its note, amounts it was required to pay to remove asbestos which it found on the property after it purchased. NLI believes that it had no responsibility under the contract for the asbestos removal. The judge agrees to enjoin the sale on the condition that Telegraph deposit enough money on a monthly basis to keep payments current. (In other words, Telegraph did not have to cure the past default but only had to keep further defaults from occurring, pending the outcome of the lawsuit.) The money was to be deposited into an account which could be accessed only upon the agreement of both NLI and Telegraph.

     In order to keep the payments current, Telegraph borrowed $200,000 (payable interest only) from one of Telegraph's limited partners, Tom. Telegraph signed a note and gave Tom a second deed of trust on the building. This deed of trust was promptly recorded.

     Thereafter, Telegraph filed a Chapter 11 bankruptcy proceeding. The lawsuit regarding the asbestos was removed to bankruptcy court, and eventually NLI got an order entering judgment in its favor. Telegraph did not have the judge sign a final judgment. (Do you know why?)

     Prior to the foreclosure sale, Telegraph offered to give NLI a Grant Deed to the building, in exchange for a release of all personal liability on the debt. NLI would also assume the leases and numerous other debts on the building. The Settlement Agreement would expressly state that the deed was not intended to merge NLI's security interest with its title and that the deed of trust remains in full force and effect. In fact, NLI would have you form a subsidiary (NevLife Properties or NLP) to take title to the property. Should NLI enter into the Settlement Agreement? What if Tom, who holds the second, refuses to sign the Agreement?

     c. Assume NLI enters into the Settlement Agreement and NLP takes title to the building. NLI still retains a first deed of trust on the property, assuming no merger occurred. If NLI's note is not paid, should it foreclose? How? What amounts can it include in its Notice of Default or Complaint? Can it include the $65,000 it paid on the HVAC note? The attorney's fees incurred in the prior lawsuit and bankruptcy regarding the asbestos? The ten past-due payments on the note that accrued prior to the Settlement Agreement and that were never brought current?

     d. Assume NLI nonjudicially forecloses its first deed of trust and enters a credit bid which does not cover all of the above defaults but which does include the $65,000 payment to HVAC and a large portion of the attorney's fees listed in (c). Does Tom, the holder of the second, have any basis upon which to complain?