This week we present for your consideration two cases: (a) an Alabama Court of Civil Appeals decision setting aside a default judgment against a car dealership because the defendant’s delay in answering complaint was not unreasonable when defendants tendered complaint to attorney when served; and (b) an Eleventh Circuit decision regarding the classification of promissory notes from an involvement developer as senior debt in a bankruptcy.

Alfa Auto Sales, L.L.C. v. Miller, No. 2140282 (Ala. Civ. App. 2014) (defendant’s delay in answering complaint was not unreasonable when defendants tendered complaint to attorney when served)

The Alabama Court of Civil Appeals reversed the Mobile County Circuit Court’s entry of a default judgment against Alfa Auto Sales, L.L.C. and Alfa Automotive, L.L.C. (“Alfa”) for $12,500 in compensatory damages and $60,000 in punitive damages. The plaintiffs purchased a car from Alfa and negotiated an interest rate of 5% on the purchase. However, the financing documents stated that the interest rate would be 21%. After bringing the discrepancy to the attention of an Alfa employee, Alfa provided the plaintiffs with a memo stating that the interest rate would be 5%. After Alfa repossessed the plaintiffs’ car, the plaintiffs filed suit seeking compensatory and punitive damages. Alfa did not respond to the complaint within the required time period, and the circuit court granted the plaintiffs’ motion for entry of default judgment and Alfa appealed.

The Alabama Court of Civil Appeals first noted a trial court’s broad discretion to enter a default judgment, but stated there is a presumption that the defaulting party is entitled to a trial on the merits. In determining whether to enter a default judgment, the court listed three factors that a trial court must analyze: (1) the defendants’ ability to present a meritorious defense; (2) the extent that the plaintiff will be unfairly prejudiced; and (3) whether the default judgment was due to the defendants’ own culpable conduct.

The court examined each of the three factors and determined Alfa was entitled to a trial on the merits. First, the court found that Alfa asserted that the financing documents were entered into voluntarily and thus, if proven, was sufficient to be able to present a meritorious defense. Next, the court noted that the prejudice required to satisfy the second factor must be substantial, and mere delay in the ultimate outcome is not sufficient. The court found that the plaintiffs would not be unfairly prejudiced because delay in the ultimate outcome was the only hardship the plaintiffs would face if the case was tried on its merits. Finally, the court addressed the culpable conduct prong. The court noted that the analysis of the third prong must examine Alfa’s actions in failing to respond to the plaintiffs’ complaint, not Alfa’s alleged wrongdoing involving the sale of the car. The court determined that Alfa was not culpable in failing to respond because after being served with the complaint, Alfa delivered it their attorney to respond. Further, the default judgement was entered thirty-one days after Alfa received the Complaint and Alfa’s counsel was attempting to negotiate a settlement. Therefore, the Alabama Court of Civil Appeals held that the case should be herd on the merits and reversed the trial court.

In re Tousa Inc., No. 14-12067 (11th Cir. 2015) (conditional land sale contracts qualified as senior debt under subordinated indenture agreements)  

The Eleventh Circuit Court of Appeals affirmed the decisions of the district court and the bankruptcy court in a case involving the priority of claims related to seven land-development contracts under the confirmed bankruptcy plan. TOUSA Homes, Inc. (“THI”) built and designed residential homes and developed the real property on which the homes were built. As part of THI’s business model, THI would sell the real property to an intermediary buyer and retain the right to market and develop the property for residential housing. There was an understanding that THI would also eventually repurchase the land prior to selling the property to the ultimate residential buyer. In conjunction with the transaction, THI provided significant up-front deposits to secure THI’s obligation to repurchase the land. The seven land-development contracts (the “Contracts”) at issue in the case also required THI to pay monthly lot option fees, insure the property, and pay property taxes. As THI began to struggle financially, THI did not adhere to the terms of the Contracts that required the company to repurchase the real property or make the required payments for insurance, taxes, and option fees.

In January of 2008 THI filed for Chapter 11 bankruptcy protection. As part of the bankruptcy proceedings, THI treated the Contracts as pre-petition damages, which meant that the intermediary buyers’ claims were unsecured. There were three classes of unsecured claims (4A, 4B, and 4C), with 4A claims receiving 58% of the value of the claim. The bankruptcy court’s structure for the class of unsecured claims was based on subordinated indenture agreements. The plan provided that if the Contracts met the definition of Senior Debt under the agreements then the Contracts were entitled to category 4A status. The bankruptcy court determined that the Contracts were Senior Debt and belonged in category 4A. The issue before the Eleventh Circuit was the priority of the claims on the Contracts.

The Eleventh Circuit examined the definition of Senior Debt under the indenture agreements to determine if THI’s liabilities under the Contracts belonged in category 4A. The indenture agreements provided that Senior Debt includes any “Obligation” with respect to “Debt.” Thus, if any of the liabilities under the Contracts met the definition of “Debt” under the indenture agreements then all liabilities under the Contracts would be Senior Debt. The indenture agreements defined “Debt” to include conditional sale obligations. The court stated that a conditional sale has four criteria: (1) the buyer takes possession; (2) the seller retains title to the property; (3) the buyer is obligated to pay the purchase price; and (4) title will transfer after the payment.

The Eleventh Circuit found that THI retained possession of the properties because of the right to eventually develop the property and pay insurance and taxes on the property. Although the court noted that THI did not have every right associated with possession, for instance THI could not lease the property, the Eleventh Circuit concluded that the THI need not retain every right to possession to satisfy the first requirement of a conditional sale. Moreover, the court found that the intermediary buyers retained title, THI was required to repurchase the property, and title would transfer to THI upon completion of the sale. Thus, the Contracts qualified as a conditional sale and the Eleventh Circuit held the Contracts were Senior Debt.