March 20, 2023 – Claims by residents of a senior living facility for entrance fee refunds are subordinate to a perfected security interest in the property of the company that operates the facility, the Wisconsin Supreme Court has unanimously ruled.

In Casanova v. Polsky, 2023 WI 19 (March 16, 2023), the supreme court also held (7-0) that a 1995 Wisconsin Court of Appeals case that imposed a constructive trust for the benefit of senior living facility residents when the facility went into receivership did not apply.

Justice Rebecca Bradley wrote the opinion.

Project Financed by Bonds​​​

In 2002, Atrium decided to build an assisted living home called Bay Pointe. Atrium executed a contract with the City of Racine’s Elderly Housing Authority (Authority) to issue bonds, to finance building Bay Pointe.

The Authority sold the bonds to Bank One Trust Company/National Association (Bank One). Bank One acts as trustee for a group of about 800 investors (Trustee).

As part of the sale of the bonds, the parties executed the following contracts:

• a project contract (Project Contract) between the Atrium and the Authority;

• a mortgage and security agreement (Mortgage) between the Atrium and the Authority;

• a trust indenture (Indenture) between the Authority and the Trustee.

The bond underwriter prepared an official statement summarizing the material terms and conditions of the bond issuance. The statement was not signed by any party and was not incorporated by reference into any of the contracts.

Secured Transactions

Bank One perfected its security interest in the Atrium’s real property by filing the mortgage with the Register of Deeds for Racine County.

Bank One also filed a UCC statement with the state Department of Financial Institutions. The UCC filing detailed Bank One’s security interest in the Atrium’s assets and perfected the Bank’s interest in all the other forms of collateral.

Residency Fees

Each resident of the Atrium had signed a residency agreement requiring him or her to pay an entrance fee ranging from $40,000 to $238,000. When the lawsuit that led to the supreme court case was filed, Atrium residents had paid a combined $7.5 million in entrance fees.

The Atrium deposited residence fee payments in its general operating account, where the payments were commingled with the funds the Atrium used to cover day-to-day expenses.

Receivership; Money Fight

In 2017, Atrium defaulted on its debt payments. The Atrium began a receivership proceeding in Racine County Circuit Court under Wis. Stat. chapter 128.

The circuit court appointed attorney Michael S. Polsky as receiver.

The Atrium’s residents filed a proof of claim in the amount of about $7 million. The bondholders filed a proof of claim in the amount of about $6.26 million.

The receiver noted that the bonds were secured by perfected security interests and determined that the Atrium owed the bondholders’ trust about $6.09 million.

Appeal and Reversal

The receiver asked the circuit court to declare that the bondholders’ mortgage lien claims were superior to residents’ claims for their entrance fee payments. In April 2018, the circuit court granted the receiver’s motion for declaratory relief.

In 2019, PC39, a healthcare company, bought the Atrium for $5.5 million. Included in the sale were all the Atrium’s real and personal property; excluded was any liability for the entrance fees paid by the residents.

The residents objected to the sale. But in July 2019, the circuit court authorized the receiver to go ahead with the sale, and the residents appealed.

The Wisconsin Court of Appeals reversed the circuit court and held that the residents’ entrance fee payments were security deposits which, under M&I First National Bank v. Episcopal Homes Management, 195 Wis. 2d 485, 536, N.W.2d 175 (Ct. App. 1995), were superior to the bondholders’ mortgage lien rights.

The receiver appealed.

Official Statement Provision

Justice R.G. Bradley began her opinion by explaining that under Wis. Stat. section 128.17(f), the claims of secured creditors have priority over those of unsecured creditors.

The residents argued that the bondholders had contracted away the superiority of their mortgage lien rights.

The residents argued that: 1) entrance fees were explicitly included with the definition of “permitted liens” and “permitted encumbrances” in the financing documents; and 2) under the bond underwriter’s official statement, the bondholders’ mortgage lien was “subject in each case to Permitted Liens as defined in the Project Contract.”

Justice R.G. Bradley agreed that the entrance fees were included within the Project’s Contract definition of “permitted liens.” But, she explained, the official statement filed by the bond underwriter was not a contract.

“Because the Official Statement is not a contract, it is incapable of containing a subordination agreement,” R.G. Bradley wrote. “It is not an agreement at all, in whole or in part.”

Mortgage Provision

The residents argued that under the Mortgage, the bondholders’ mortgage lien was “subject in each case to Permitted Liens as defined in the Project Contract.”

But Justice R.G. Bradley concluded that the phrase “subject to” did less work than the residents contended it did.

“To be affected or possibly affected by something is not necessarily to be trumped, dominated, or primed by it,” Justice R.G. Bradley wrote. “These provisions merely contemplate the possibility entrance fees could take priority over the bondholders’ Mortgage; they do not create a lien, much less accord it priority over a properly recorded mortgage.”

Episcopal Homes Inapplicable

Justice R.G.​ Bradley also reasoned the court of appeal’s reliance on Episcopal Homes was misplaced.

In Episcopal Homes, R.G. Bradley pointed out, the circuit court relied on its equitable powers to impose a constructive trust against a separate account into which a senior living facility had placed residents’ entrance fees – an account that was not in receivership under ch. 128.

“Whatever equitable powers courts may possess, nothing in law or equity authorizes courts to disrupt the statutorily prescribed priority of secured lenders,” Justice R.G. Bradley wrote.