BVA9503693 DOCKET NO. 93-09 298 ) DATE ) ) On appeal from the decision of the Department of Veterans Affairs Regional Office in St. Petersburg, Florida THE ISSUE Recovery of loan guaranty indebtedness. REPRESENTATION Appellant represented by: Disabled American Veterans ATTORNEY FOR THE BOARD Barry F. Bohan, Counsel INTRODUCTION The appellant served on active duty in the United States Army from December 1957 to August 1958. In a March 1989 decision, the Committee on Waivers and Compromises of the Department of Veterans Affairs Regional Office in St. Petersburg, Florida (VARO) denied the appellant's request for waiver of loan guaranty indebtedness in the amount of $27,500, plus accrued interest. Because the pertinent law was amended subsequent to that decision, the appellant's request for waiver was reconsidered in January 1992. 38 U.S.C.A. § 5302 (West 1991). The request for waiver of indebtedness continued to be denied. This appeal followed. REMAND The appellant is seeking to preclude recovery of charged loan guaranty indebtedness in the amount of $27,500, plus accrued interest. The Board believes that a chronological history is necessary to an understanding of this case. History of the case The appellant and his spouse purchased the house in question, which was located in Maitland, Florida, in approximately December 1982. In April 1984, the appellant applied for a VA guaranteed home mortgage loan in the amount of $110,000 in order to refinance the house. His stated purpose was "to use my equity to invest in stocks and bonds for retirement purposes." The refinancing took place in July 1984. In November 1984, the appellant sold the house to transferees. The sale was by assumption. He did not apply for a release from liability under the loan guaranty. On January 9, 1985, one of the transferees, the wife, wrote to the mortgage lender, stating that they could not afford to pay monthly loan payments and reciting a list of personal and financial problems, including the loss of employment of the husband because the company he worked for had closed. The letter went on to state: "To make the situation even more critical, the veteran whose eligibility is used for this mortgage was the owner of the company that closed, and he is unable to assume the mortgage back." On January 15, 1985, the mortgage holder notified VARO that the loan was in default. Mortgage foreclosure proceeding were initiated in August 1985 in the Circuit Court for the Ninth Judicial District of Florida. A Final Judgment of Foreclosure was rendered in February 1986. The house was sold, at a loss, in March 1986. There is no indication that the appellant received notice of the foreclosure proceeding from either the lender or from VA. In May 1986, the lender filed a claim under the loan guaranty, which was satisfied, in the amount of $27,500, by VA in September 1986. Liability for that amount was charged to the appellant under theories of indemnity and subrogation. In May 1988, the appellant requested a waiver of the charged indebtedness. At a hearing held before the VARO Committee on Waivers and Compromises in March 1989, the appellant challenged the validity of the indebtedness, indicating that he had not been notified about the transferees' default and subsequent foreclosure until after the property had been sold. He acknowledged that one of the transferees was a former employee of his but denied that the July 1984 refinancing was in contemplation of a shady land transaction. Of particular interest is the following colloquy: REP: Had you known or been notified by the VA, would you have recouped this home or kept it from going into foreclosure? VET: Oh, absolutely. [hearing transcript, p 2] REP: Had you known that there was a need for a release of liability, would you have obtained one? VET: I certainly would have. [hearing transcript, p 3-4] The VARO decision On reconsideration in January 1992, the Committee on Waivers and Compromises found no fraud, misrepresentation of a material fact or bad faith on the appellant's part. The appellant was found to have been at fault because he refinanced the house and shortly thereafter "transferred the property to an unworthy credit risk who did not make the first payment." The Committee also found that the appellant had been unjustly enriched by the transfer and that enforcement of repayment of the indebtedness would not cause him financial hardship. Accordingly, waiver of recovery of the indebtedness was denied under the standard of equity and good conscience. The Committee went on to find that notice to a transferor veteran was not necessary to preserve VA's collection rights in Florida. VARO elaborated on and partially changed its position in a December 1992 Supplemental Statement of the Case. First, VARO stated that the appellant's contention that he did not know about the need for a release from liability was "without merit", based on his presumed sophistication in real estate dealings. Moreover, according to VARO, the appellant did not take "even the minimum precaution of insuring the assumer was a worthy credit risk to protect the interest of the Government." The Committee accordingly found bad faith on the part of the appellant, which precluded consideration of the waiver request based on the standard of equity and good conscience. The Committee continued to hold that, although the appellant "may not have received notice of the foreclosure,...that does not inhibit a claim against you under a theory of subrogation based upon Florida law." Analysis The Board believes that the appellant has raised the following issues: (1) the validity of the indebtedness based on lack of due process due to purported lack of notification concerning the transferees' default; (2) the possibility of a retroactive release from liability; (3) his lack of bad faith; and (4) equity and good conscience, due to his claimed financial hardship. The United States Court of Veterans Appeals (the Court) has pointed out distinctions between an obligor challenging the validity of a loan guaranty debt and requesting a waiver of recovery of a validly established loan guaranty debt. Smith v. Derwinski, 1 Vet.App. 267 (1991). An appellant may challenge the existence of a home loan guaranty debt, 38 C.F.R. §1.911(c) (1993), and/or request waiver of recovery of the debt. 38 U.S.C.A. § 5302 (West 1991) In this case, the appellant has done both. The right of VA to recover loan guaranty debts from veterans is predicated on two legal theories: indemnity and subrogation. VA may seek reimbursement from transferor veterans under either or both theories. 38 C.F.R. § 36.4323 (1993); Stone v. Derwinski, 2 Vet.App. 56, 57 (1992). VA, as the guarantor of a home loan, has a right of indemnity which is independent of any right of the mortgage holder. 38 U.S.C.A. § 3732 (West 1991); 38 C.F.R. § 36.4323(e) (1993); United States v. Church, 736 F. Supp. 1494, 1497 (N.D. Ind. 1990). Subrogation places VA in the position of the lender. 38 U.S.C.A. § 3732(a)(1) (West 1991), 38 C.F.R. § 36.4323(a) (1993). With respect to subrogation, the veteran obligor may avail himself of any defenses which are available to a debtor under state law. In this case, the theory of subrogation is being relied upon by VARO. United States v. Whitney, 602 F. Supp. 722 (W.D.N.Y. 1985) extended due process considerations to VA loan guaranty cases involving indemnity. Whitney dealt with a situation in which a veteran who transferred his interest in property subject to a VA loan guaranty to a third party did not receive notice of the transferee's subsequent default. In Whitney, the court found that VA's right to enforce collection of a loan guaranty debt based on a theory of indemnity was defeated in a situation in which VA could easily have ascertained the address of the original veteran- obligor, but did not do so. The court held that failure to provide actual notice of the transferee's default and foreclosure proceedings violated the veteran's constitutionally protected right to due process. 602 F. Supp. at 732. Until recently, as evidenced by the December 1992 Supplemental Statement of the Case, there was some doubt concerning whether the Whitney reasoning was applicable in subrogation cases, particularly in Florida. The United States District Court for the Middle District of Florida, in Jensen v. Turnage, 782 F. Supp. 1527 (M.D. Fla. 1990), specifically disagreed with the reasoning in Whitney. However, VA Office of General Counsel Precedent Opinion 15-94 (June 23, 1994) specifically applied the reasoning in Whitney to subrogation cases. The opinion stated, in pertinent part,: "case law contains nothing to suggest that veterans do not have the same constitutional due process protections with regard to a claim by VA under subrogation....It, therefore, appears clear that when VA knows about a foreclosure and VA expects to hold the veteran liable under subrogation, VA is constitutionally required to notify the veteran, assuming the veteran may be reasonably located." The General Counsel's opinion went on to make a distinction between in rem and in personam foreclosure judgments. Briefly, the General Counsel doubted that a transferor veteran who had not been notified of the transferee's default could be held liable in the case of an in rem judgment.. With respect to an in personam judgment, the General Counsel believed that VA may collect on the judgment, since the veteran obligor would have been served and would therefore have the opportunity to present any available defenses, including lack of notice, in a court of law. Since the December 1992 Supplemental Statement of the Case, which specifically rejected the Whitney rationale to subrogation cases in Florida, has been called into question by VA Office of General Counsel Precedent Opinion 15-94 (June 23, 1994), the Board believes that it is necessary to remand this case so that VARO may readjudicate the issue of validity. In transferee cases, such as this, another legal mechanism exists for determining that a veteran does not have responsibility to repay an indebtedness under a VA guaranteed loan: release of liability. 38 U.S.C.A. § 3713 (West 1991). There two methods of securing such a release: an application at the time of transfer [§ 3713(a)] and retroactive release [§ 3713(b)]. The Court has emphasized the role a retroactive release of liability may play where a veteran has disposed of property to a transferee without having obtained a release of liability. 38 U.S.C.A. § 3713(b) (West 1991); 38 C.F.R. § 36.4323(g) (1993); Travelstead v. Derwinski, 1 Vet.App. 344, 347-8 (1991); Schaper v. Derwinski, 1 Vet.App. 430, 434-6 (1991); and Carlson v. Derwinski, 2 Vet. App. 144 (1992). In pertinent part, 38 C.F.R. § 36.4323(g) (1992) reads as follows: "...the Secretary may relieve the veteran of such liability if he determines that: (1) A transferee either immediate or remote is legally liable to the Secretary for the debt of the original veteran-borrower established after the termination of the loan, and (2) The original loan was current at the time such transferee acquired such property, and (3) The transferee who is liable to the Secretary is found to have been a satisfactory credit risk at the time he acquired the property." In short, "the law and regulations require the Secretary to look back and make a hypothetical decision as to what decision he would have made on a release-of-liability request made contemporaneous with the transfer." Schaper, at 435. If the underlying indebtedness is determined to be valid, and a release from liability cannot be granted, the analysis then moves to the consideration of a waiver of recovery of the indebtedness. A waiver of recovery of a debt may be authorized in a case in which collection of the debt would be against equity and good conscience. 38 U.S.C.A. § 5302(b) (West 1991); 38 C.F.R. § 1.964 (a)(2) (1993). "Equity and good conscience" involves a variety of elements, including the elements of the fault of the debtor, balancing of faults, and unjust enrichment. undue hardship. 38 C.F.R. § 1.965 (a) (1993). In essence, however, "equity and good conscience" means fairness to both the appellant and to the government. Under pertinent law and VA regulations, however, no debt may be waived under the standard of equity and good conscience if fraud, misrepresentation, or bad faith is found to exist. 38 U.S.C.A. § 5302(c) (West 1991); 38 C.F.R. § 1.965 (b) (1993). In other words, if fraud, misrepresentation or bad faith is found, the elements of equity and good conscience are not for consideration, since the granting of waiver of recovery is precluded by law. "Bad faith" is defined in VA regulations as "unfair or deceptive dealing by one who seeks to gain thereby at another's expense. Thus, a debtor's conduct in connection with a debt arising from participation in a VA benefits/services program exhibits bad faith if such conduct, although not undertaken with actual fraudulent intent, is undertaken with intent to seek an unfair advantage, with knowledge of the likely consequences, and results in a loss to the government." 38 C.F.R. § 1.965(b) (1993). In general, "bad faith" implies actual or constructive fraud, or neglect or refusal to perform some contractual obligation, prompted not by honest mistake but by some interested motive. Black's Law Dictionary 139 (6th ed. 1990). VA guidelines refer to bad faith as a willful intention to either seek an unfair advantage or to neglect or refuse to fulfill some duty or contractual obligation. VBA Circular 20-90-5, (February 12, 1990). A determination of bad faith may be based on the circumstances which led to the default and the foreclosure, as well as the appellant's attitude toward contractual obligations, and his actions or omissions with respect to avoiding foreclosure, as indicated by the evidence of record. In recent communications to VA, the appellant has referred to financial hardship, based on the failure of his business and on recent medical problems. The appellant's representative, in the August 1993 informal presentation, requested that this case be remanded so that an updated Financial Status Report (VA Form 4- 5655) could be obtained from the appellant. As discussed above, the issue of the appellant's alleged financial hardship was rendered moot by VARO's finding of bad faith. However, the Board believes that the development of the evidence on remand should include securing an updated Financial Status Report form from the appellant, even though such may not be ultimately necessary to the final outcome of this case. The Board believes that all of the issues which have been identified above must be fully developed and adjudicated by VARO. 38 U.S.C.A. § 5107(a) (West 1991); 38 C.F.R. § 19.9 (1993) and EF v. Derwinski, 1 Vet.App. 324 (1991). Therefore, this case is REMANDED to VARO for the following actions: 1. VARO should obtain a legal opinion from VA District Counsel which specifically addresses the issue of the validity of the indebtedness, in light of VA Office of General Counsel Precedent Opinion 15-94 (June 23, 1994). The opinion of VA District Counsel should be associated with the appellant's loan guaranty file. 2. The appellant should be furnished a Financial Status Report (VA Form 4-5655), which he should complete and return to VARO. The completed Financial Status Report form should be associated with the appellant's loan guaranty file. 3. After the above development has been completed, VARO should readjudicate the appellant's claim. The issues of validity of the indebtedness, retroactive release, bad faith and equity and good conscience, should be discussed as necessary. All appropriate laws, regulations, and court decisions should be applied. If the claim remains denied, in whole or in part, the case should be returned to the Board after compliance with all requisite appellate procedure. The purpose of this REMAND is to procure clarifying data and to satisfy due process requirements. The Board intimates no opinion as to the ultimate conclusion warranted, pending completion of the requested development. No action is necessary on the appellant's part until he receives further notice. KENNETH R. ANDREWS, JR. Member, Board of Veterans' Appeals (CONTINUED ON NEXT PAGE) The Board of Veterans' Appeals Administrative Procedures Improvement Act, Pub. L. No. 103-271, § 6, 108 Stat. 740, ___ (1994), permits a proceeding instituted before the Board to be assigned to an individual member of the Board for a determination. This proceeding has been assigned to an individual member of the Board. Under 38 U.S.C.A. § 7252 (West 1991), only a decision of the Board of Veterans' Appeals is appealable to the United States Court of Veterans Appeals. This remand is in the nature of a preliminary order and does not constitute a decision of the Board on the merits of your appeal. 38 C.F.R. § 20.1100(b) (1994).