Vera T. Welte Testamentary Trust

IN THE UNITED STATES BANKRUPTCY COURT

FOR THE NORTHERN DISTRICT OF IOWA

IN RE: )

) Chapter 12

VERA T. WELTE )

TESTAMENTARY TRUST, )

) Bankruptcy No. 19-00808

Debtor )

RULING ON MOTION TO DISMISS AND OBJECTION TO CLAIM

This matter came before the Court by evidentiary hearing in Sioux City,

Iowa on November 17, 2020. Jessica A. Board appeared for the Debtor Vera T.

Welte Testamentary Trust (“Trust”). Daniel L. Hartnett and Jeremy B. Saint

appeared for Creditor The Security National Bank of Sioux City, Iowa as personal

representative of The Estate of Roger Rand (“Rand Estate”). Carol F. Dunbar

appeared as the Chapter 12 Trustee. The Court received exhibits, heard argument,

and allowed post-trial briefing. All papers have been submitted and the case is

ready for decision. This is a core proceeding under 28 U.S.C. § 157(b)(2)(B).

STATEMENT OF THE CASE

The Trust filed its Chapter 12 petition on June 17, 2019. (ECF Doc. 1). On

August 23, 2019, the Rand Estate filed a Proof of Claim for $3,429,500.69.

(“Claim No. 2”). The Rand Estate based its claim on property pledged to secure

money the Estate loaned to Frank Welte, the only current beneficiary of the Trust.

On August 27, 2019, the Rand Estate filed a Motion to Dismiss. It argued that the

Trust is an ordinary testamentary trust and therefore not an eligible debtor under

the Bankruptcy Code. (ECF Doc. 16). The Trust filed a resistance to the Motion

to Dismiss and an Objection to Proof of Claim No. 2. The Trust argued that (1) the

mortgages underlying the claim are invalid because they were entered fraudulently

or under duress and because the Trustee was not permitted to enter into the

mortgages; and (2) that the Rand Estate lacks standing to assert the claim because

the debt has already been paid. (ECF Doc. 29). The Trust also argued it qualifies

as a debtor, and the Rand Estate also lacks standing to raise the issue. For the

following reasons, the Court grants the Trust’s Objection to Proof of Claim and

denies the Rand Estate’s Motion to Dismiss.

FINDINGS OF FACT

The Trust was created by the Last Will and Testament of Vera T. Welte

dated December 30, 2002 and the Codicil to the Last Will and Testament of Vera

T. Welte, dated October 7, 2008. The Trust appointed Vera’s son, Claire Welte to

serve as trustee (“Trustee”). Frank Welte (“Frank”) is the Trustee’s brother and the

only current beneficiary of the Trust. Under the Trust, Frank enjoys the right to

receive income from the Trust during his lifetime, with the remaining corpus, if

any, to be distributed to his descendants upon Frank’s death. The Trust’s primary

asset is 160 acres of land (“Trust Land”) which is farmed through a rental

agreement. (Ex. 8; see also ECF Doc. 1). The Trust derives additional income

from interest on investment in an LLC.

The Trustee is vested with broad powers under the Trust. Such powers

include the power: “[t]o borrow money and mortgage or pledge trust property”; to

borrow money to acquire additional real estate; to invest in stocks, bonds, real

estate, trusts, or any other investment company; to pay expenses and collect

insurance proceeds; and “[t]o do all other acts to accomplish the proper

management, investment and distribution of the trust.” (Ex. 1).

The Rand Estate came into being when Roger E. Rand (“Roger”) died in

August of 2016. Before his passing, Roger was a farmer in Salix, Iowa. In

addition to farming, Roger operated a seed, chemical, and fertilizer business selling

crop inputs to area farmers. Throughout the years, Roger would extend credit to

farmers purchasing crop inputs from his business. At times, Roger expanded this

practice to include advancing funds to farmers for other expenses, such as cash rent

payments.

In 2009, Frank approached Roger for crop inputs and financing. Because

Roger and Frank were unfamiliar with one another, Roger initially sold Frank crop

inputs on a cash-and-carry basis. As their business relationship progressed, Roger

began extending credit to Frank for additional crop expenses. In exchange, the

Trustee executed mortgages pledging trust property as additional security. This

practice continued annually until Roger’s death in 2016. The amount for each of

the relevant mortgages and related promissory notes were as follows:

Loan Note Mortgage Mortgage

Date Amount Date Amount

03/01/2013 $2,000,000.00 03/28/2013 $1,000,000.00

03/26/2014 $848,412.00 07/17/2014 $1,636,000.00

07/17/2014 $1,151,588.00 07/17/2014 $1,636,000.00

07/17/2015 $1,106,810.15 07/17/2015 $1,106,810.15

In each instance, the Trustee and Frank would visit Roger’s attorney’s office

to sign the paperwork. Both the notes and the mortgages contained disclosures

directing the parties to read the documents before signing. Despite these

disclosures, the Trustee never actually read the documents before signing them.

Instead, he proceeded on the assumption that the most he could validly mortgage

was the income—to which Frank was entitled—for a particular year. As a result,

the Trustee was unaware that the mortgages contained dragnet provisions

purporting to secure not only the repayment of the corresponding note, but also the

repayment of all other obligations then existing or thereafter arising—including

future advances.

When problems arose with Frank’s repayments, the Rand Estate initiated a

foreclosure action on the Trust Land pledged as security for Frank’s debts. When

the Trust filed—as a business trust—for Chapter 12 relief, the Rand Estate

submitted a claim based on the mortgages dated March 1, 2013 through July 17,

2015. Four days later the Rand Estate filed its Motion to Dismiss. The Trust

objected to the claim and resisted the Motion to Dismiss.

At the evidentiary hearing, the Trust and the Rand Estate each called a CPA

to testify. The accountants testified about the initial amounts of the debts—the

face-value of the notes versus another amount that was allegedly loaned to Frank

over and above the note amount. They each then gave opinions on the application

of payments. The accountant for the Rand Estate concluded there was an amount

due of $3,429,500.69. (Ex. 109). The Trust’s accountant concluded there was no

debt due and that there was an over payment to the Rand Estate of $1,978,024.11.

(Ex. 22).

There were only two differences in methodology between the Rand Estate’s

calculations and the Trust’s calculations. First, the Trust’s accountant used the

note amounts rather than any other number to calculate initial debt. Second, the

Trust’s accountant applied the payments as they came in, rather than isolating

payments to a specific loan. The second difference in methodology resulted in

pronounced differences in the end result. The Rand Estate’s accountant applied

payments as if no payments had been made between March 11, 2014 and

November 22, 2017. Payments were undisputedly made during that period. The

Rand Estate’s accountant however, applied those payments to a later loan. This

gap in payments allowed interest to accrue at default rates for several years, despite

the fact that Frank was making payments on amounts due. Rather than continuing

payments on the previous note—which was due—there was a switch to pay the

next note—which was not yet due. The application of payments and

corresponding gaps in payments are as follows:

Note Note Last Payment on Note

Date Maturity before Gap

03/01/2013 03/01/2014 03/11/2014

03/26/2014 04/11/2014 04/07/2015

07/17/2014 03/01/2015 Paid in Full

07/17/2015 03/01/2016 08/04/2016

DISCUSSION

A. Objection to Proof of Claim

“In the bankruptcy context, a claim is any right to payment.” Dove-Nation

v. eCast Settlement Corp. (In re Dove-Nation), 318 B.R. 147, 150 (B.A.P. 8th Cir.

2004) (citing 11 U.S.C. § 101(5)). A creditor may file a proof of its claim against a

debtor with the bankruptcy court. 11 U.S.C. § 501(a).

A claim, proof of which is filed pursuant to Section 501 of the

Bankruptcy Code, is deemed allowed unless a party in interest objects.

If an objection to a claim is filed, the court shall determine the amount

of such claim as of the date of the bankruptcy petition and shall allow

such claim in such amount except to the extent that any of nine

enumerated exceptions apply.

Dove-Nation, 318 B.R. at 150 (citations omitted) (citing 11 U.S.C. § 502(a) &

(b)(1)–(9)). Section 502(b) specifically allows for an objection to the extent “such

claim is unenforceable against the debtor and property of the debtor, under any

agreement or applicable law for a reason other than because such claim is

contingent or unmatured . . . .” 11 U.S.C. § 502(b)(1). “If the objector presents

evidence supporting an objection, the ultimate burden of persuasion shifts to the

claimant to establish its claim.” In re Schaefer, 324 B.R. 738, 744 (Bankr. N.D.

Iowa 2005) (citing Dove-Nation, 318 B.R. at 152).

1. Validity of Mortgages

The Trust first objects to the Rand Estate’s Proof of Claim arguing that the

mortgages are invalid or unenforceable because the Trustee did not have power to

enter into the broad mortgages the Rand Estate seeks to enforce. The Trust argues

the mortgages must be limited to no more than the note amounts. The Trust also

argues the underlying debt has in fact, already been paid in full. The Court will

address each of these arguments in turn.

a. Trustee’s Power to Enter the Mortgages

The Trust argues that the Trustee did not have authority to enter into the

mortgages. The Court disagrees.

The starting point in this analysis is the Iowa Code. “(1) A trustee, without

authorization by the court, may exercise the following powers: (a) The powers

conferred by the terms of the trust.” Iowa Code § 633A.4401(1)(a) (2021). The

Iowa Code specifically protects third parties (like the Rand Estate) doing business

with a trustee:

With respect to a third party dealing with a trustee or assisting a trustee

in the conduct of a transaction, if the third party acts in good faith and

for a valuable consideration and without knowledge that the trustee is

exceeding the trustee’s powers or is improperly exercising them, the

following apply:

(a) A third party is not bound to inquire as to whether a trustee has

power to act or is properly exercising a power and may assume

without inquiry the existence of a trust power and its proper

exercise.

(b) A third party is fully protected in dealing with or assisting a trustee,

as if the trustee has and is properly exercising the power the trustee

purports to exercise.

Iowa Code § 633A.4603(1) (emphasis added); see also Shaffer v. Tewes,

466 F. Supp. 3d 980, 995 (N.D. Iowa 2020). “The code provision’s

language indicates it is intended to protect third parties who enter an

agreement with a trustee and later find out that the trustee had no authority

to enter into the agreement or had exceeded the scope of the trustee’s

authority.” Id.; see also Restatement (Third) of Trusts § 108 (Am. Law Inst.

2012) (“A third party who acquires an interest in trust property through a

breach of trust is entitled to retain or enforce the interest to the extent the

third party is protected as a bona fide purchaser.”).

Here, the Trust document specifically states that the Trustee shall

have the power “[t]o borrow money and mortgage or pledge trust property.”

(Ex. 1). The Codicil does not contain any language limiting the Trustee’s

ability to mortgage or pledge trust property. Even if the Trustee was not

specifically authorized to mortgage trust property, Roger did not have any

obligation to inquire whether the Trustee had the power to act or was

properly exercising his power. Roger, as a third party, is given a

presumption that the Trustee had power to mortgage the property and was

properly exercising this power.

The Court has not been presented with any evidence indicating that

Roger knew there were questions about the Trustee’s authority and was not

acting in good faith in obtaining the mortgage. The evidence shows Roger,

acting in good faith, gave valuable consideration in the form of millions of

dollars to Frank and relied on the mortgages to make those loans. The Court

finds that the mortgages are valid.

b. Mortgages and Note Amounts

The Trust argues that even if the mortgages are valid to some degree, they

are limited to no more than the face value of the notes. Each mortgage and each

note have a set amount of funds loaned. Some notes include a range of funds to be

loaned, and the mortgage amounts listed do not always correspond directly with

the related notes.

Future advance clauses are also called dragnet clauses. In re McMahon, Ch.

7 Case No. 18-00443, 2018 Bankr. LEXIS 1766, at *3 (Bankr. N.D. Iowa June 8,

2018). The Iowa Code provides for the enforceability of future advance clauses

provided certain conditions are satisfied. See Iowa Code § 654.12A (2021). While

still effective, “Iowa views with disfavor the inclusion of future advance clauses

within mortgages drafted by the lender, especially when those clauses are situated

within the mortgage contract in such a way that lends itself easily to lender

overreaching and surprise.” Poweshiek Cnty. Sav. Bank v. Hendrickson, No. 5-

225/04-0927, 2005 Iowa App. LEXIS 423, at *9 (Iowa Ct. App. May 25, 2005)

(citing Farmers Tr. & Sav. Bank v. Manning, 311 N.W.2d 285, 289 (Iowa 1981).

Future advance clauses “are adhesion contracts and are construed against the

writer.” Nat’l Loan Invs., L.P. v. Martin, 488 N.W.2d 163, 166 (Iowa 1992) (citing

In re Simpson, 403 N.W.2d 791, 793 (Iowa 1987)).

In the absence of clear, supportive evidence of a contrary intention a

mortgage containing a dragnet type clause will not be extended to cover

future advances unless the advances are of the same kind and quality

or relate to the same transaction or series of transactions as the

principal obligation secured or unless the document evidencing the

subsequent advance refers to the mortgage as providing security

therefor.

Freese Leasing, Inc. v. Union Tr. & Sav. Bank, 253 N.W.2d 921, 927 (Iowa 1977)

(emphasis added) (quoting Emporia Bank & Tr. Co. v. Mounkes, 519 P.2d 618,

623 (Kan. 1974)); see also Nat’l Bank of Waterloo v. Moeller, 434 N.W.2d 887,

891 (Iowa 1989) (finding 654.12A consistent with Freese Leasing, Inc.).

The Iowa Court of Appeals specifically stated when a future advance can

apply:

The language of the future advances clause applies to any future

advances under any promissory note, and specifically disavows any

relatedness requirement. The clause also rejects any requirement the

mortgage be specifically referenced in a future note. The clause is

broad in its scope, and is not buried in the document in a way that

might be misleading or allow for surprise. The title of the mortgage

itself, as an “open-end real estate mortgage” alerts any reader to the

presence of a future advances clause and the possibility of later loans

being superior, further minimizing the risk of surprise. The parties

clearly stated their intent to cover such notes in the future advances

clause.

Wells Fargo Bank, N.A. v. Valley Bank & Tr., No. 3-523/12-2031, 2013 Iowa

App. LEXIS 951, at *6 (Iowa Ct. App. Sept. 5, 2013) (emphasis added).

When determining whether a future advance clause is effective, Courts

consider the intent of the parties, whether the mortgage contains warnings

including bold typeface or typeface noticeable from the rest of the document, and a

relatedness requirement or waiver. See Freese Leasing, Inc., 253 N.W.2d at 927;

Wells Fargo Bank, N.A., 2013 Iowa App. LEXIS 951, at *2; In re McMahon, 2018

Bankr. LEXIS 1766, at *3; In re Freed, Ch. 7 Case No. 18-01211, 2020 Bankr.

LEXIS 1133, at *11 (Bankr. N.D. Iowa Apr. 24, 2020).

Here, the Trustee did not have any knowledge of the excess amounts loaned

to Frank over and above the amounts included in the notes. The mortgages contain

the future advance clauses in normal typeface, with no corresponding warning:

b. All other obligations of Borrower and/or Mortgagors to Mortgagee,

not existing or hereafter arising, whether direct or indirect,

contingent or absolute and whether as maker or surety, including but

not limited to, future advances and amount advanced and expenses

incurred by Mortgagee pursuant to this Mortgage and any and all

obligations of Borrower contained in the Loan Agreement dated

March 1, 2011 and/or Security Agreement dated March 1, 2011

entered into between Mortgagee and Borrower.

(Ex. 17). Such a format is ineffective to comply with the applicable Iowa law. See

Wells Fargo Bank, N.A., 2013 Iowa App. LEXIS 951, at *2; In re McMahon, 2018

Bankr. LEXIS 1766, at *3; In re Freed, 2020 Bankr. LEXIS 1133, at *11. In

addition, the mortgages did not include a waiver of the “relatedness” requirement.

See Freese Leasing, Inc., 253 N.W.2d at 927. There is similarly no evidence in the

record to determine how the “excess loans” were used and whether they were

related to the notes at issue. See Id. at 926.

The Court finds the future advance clauses in the documents fail to meet the

legal standard. Thus, the mortgages are limited to the notes amount listed and not

enforceable against the excess loans. The Trustee had no knowledge of the excess

loans. There is no evidence the Trustee intended to pledge collateral for amounts

$2,732,467.99 over the face value of the amounts listed in the mortgages and notes.

2. Application of Payments

The Trust’s final objection to the claim is the Trust does not owe the debt

because the claim has already been paid in full. See 11 U.S.C. § 502(b)(1)

(objection when claim is unenforceable against the debtor and property of the

debtor). The Trust contends the Rand Estate applied the payments made on the

various loans incorrectly under Iowa law. The Rand Estate applied payments

individually to the loans it chose. For example, payments credited to the 2013

Loan stopped as soon as Loan 2014B was established. It essentially applied the

payments to the newest loan first, and thus treating the older loan as being in

default. This resulted in the older loan continuing to accrue interest at default rates

until all of the newer loans were paid in full.

The Trust argues that under Iowa law payments should have been applied to

the oldest debt first. The Rand Estate does not really dispute that this is the law in

Iowa. The Rand Estate instead argues federal law applies and that absent an

express instruction from Frank, Roger was free to apply the payments in the

manner he chose. See, e.g., In re Custer, 88 B.R. 573, 575 (Bankr. D. Conn. 1988)

(“A debtor making a voluntary payment has the absolute right to have that payment

allocated among various obligations in accordance with his or her instructions.”);

In re S & W Exporters, Inc., 16 B.R. 941, 945 (Bankr. S.D.N.Y. 1982) (“It is an

accepted principle of contract law that a debtor has the right to direct the

application of payment by the creditor at the time of or prior to payment and in

failing to do so, the creditor has the right to apply payment as he sees fit.”).

The mortgage and note documents, however, provide that Iowa law applies.

The Court agrees with the Trust and will apply Iowa law.

Absent an agreement to the contrary, Iowa law applies payments on a first-

in-time basis. See, e.g., Johnson v. Foster, 101 N.W. 741, 742 (Iowa 1904)

(“There having been no agreement or direction as to the application of payments,

the law will make application thereof so as to cancel the items of indebtedness first

incurred in point of time.”); Cain v. Vogt, 116 N.W. 786, 788 (Iowa 1908)

(“Indeed, in the absence of an express agreement or an application by the debtor,

the trend of authorities is to the effect that, as between two debts, one due, and one

not due, the creditor has no choice, and the application must be upon the latter.”).

Applying these payments on a first-in-time basis, the Court finds the Trust

substantially overpaid the loans—as its accountant noted. At a minimum, there is

no debt left to pay and the claim is unenforceable against the Trust under 11 U.S.C.

§ 502(b)(1).

B. Motion to Dismiss

The Rand Estate also made a Motion to Dismiss arguing the Trust does not

qualify as a debtor. The Trust resisted. It argued it qualified as a debtor and that

“the Rand Estate is not a creditor, and therefore has no standing” to raise an

argument. (ECF Doc. 20). The Trust asserts that the only connection between it

and the Rand Estate are the Mortgages which already have been paid.

The court may dismiss a case upon request of a party in interest. 11 U.S.C.

§ 1208(c). A “party in interest” is not defined in the Bankruptcy Code, however,

Section 1109 states a “party in interest” includes “the debtor, the trustee, a

creditors’ committee, an equity security holders’ committee, a creditor, an equity

security holder, or any indenture trustee.” 11 U.S.C. § 1109(b).

Given the findings made above, the Rand Estate has no pecuniary interest in

the bankruptcy. Absent a pecuniary interest in the bankruptcy, the Rand Estate

lacks standing to make a Motion to Dismiss. The Rand Estate does not explicitly

address standing but argues that it has a valid claim against the bankruptcy estate.

There is no claim remaining for the Rand Estate to assert. Section 101(10)

defines a creditor as an entity having a claim against the debtor and section

101(5)(A) defines a claim as any right to payment. The Rand Estate’s right to

payment was satisfied prior to the bankruptcy. Thus, it does not have an

enforceable claim and is not a creditor. Without a pecuniary interest in the

bankruptcy estate, the Rand Estate does not have standing to file the motion to

dismiss.

CONCLUSION

WHEREFORE, the Trust’s objection to the Rand Estate’s Proof of Claim is

GRANTED.

FURTHER, the Rand Estate’s Motion to Dismiss is DENIED.

Dated and entered:

April 22, 2021

__________________________

THAD J. COLLINS,

CHIEF BANKRUPTCY JUDGE