Smith v. United National Bank-Denton (In Re Smith)

United States Court of Appeals,

Fifth Circuit.

No. 91–4856.

In the Matter of Ann B. SMITH, William L. Smith, Jr., Debtors.

Ann B. SMITH, and William L. Smith, Jr., Appellees–Cross Appellants,

v.

UNITED NATIONAL BANK–DENTON, Appellant–Cross–Appellee.

July 21, 1992.

Appeals from the United States District Court for the Eastern District of Texas.

Before HILL,* KING, and DAVIS, Circuit Judges.

PER CURIAM:

William L. Smith, Jr., and Ann B. Smith appeal from an order of the district court holding that

they are barred from asserting the invalidity of a mechanic's lien on their homestead. United National

Bank–Denton appeals from the denial of attorney's fees. We affirm the judgment of the district court

as to the validity of the lien, but vacate and remand as to the issue of attorney's fees.

I. FACTS AND PROCEDURAL HISTORY

On April 2, 1987, the Smiths executed a mechanic's lien contract and a mechanic's lien note

payable to Frank Bourland, a contractor, in the amount of $60,000. The note and contract were

contemporaneously assigned by Bourland to USBank of Denton ("USBank"). The contract described

certain improvements to be made by Bourland to the Smiths' residence in consideration for execution

of the note and the granting of a lien on their homestead.

The $60,000 was advanced by USBank to the Smiths pursuant to three draw requests, each

of which indicated that work on the residence was being completed. In fact, no work was ever

performed on the residence, and all parties involved knew that the money was actually being

*
Senior Circuit Judge of the Eleventh Circuit, sitting by designation.
advanced to pay the Smiths' delinquent taxes and other debts. According to Mr. Smith, the loan

officer at USBank told him that the "loan would look good on paper," but recognized that the loan

documents were false.

The mechanic's lien note matured in Oct ober 1987, and the Smiths defaulted. Shortly

thereafter, USBank failed, and its assets were acquired by the Federal Deposit Insurance Corporation

("FDIC") as receiver. These assets, including the mechanic's lien note and contract, were then

assigned to United National Bank–Denton ("the Bank").

In October 1988, the Smiths filed for bankrupt cy relief under chapter 11. This case was

commenced by the Bank as an adversary proceeding in the Smiths' bankruptcy case. The Bank

sought a declaration of the validity of the mechanic's lien on the Smiths' homestead, arguing that it

acquired the note and contract from the FDIC and, as an assignee of the FDIC, took the documents

free of any defenses pursuant to 12 U.S.C. § 1823(e) and D'Oench, Duhme & Co. v. FDIC, 315 U.S.

447, 62 S.Ct. 676, 86 L.Ed. 956 (1942). The Smiths counterclaimed for a declaration that the lien

was invalid, arguing that, because Texas law requires substantial performance of the work on a

homestead before a mechanic's lien attaches, the lien here was invalid inasmuch as no work at all was

performed. The bankruptcy court held for the Bank and declared the lien valid, reasoning that 12

U.S.C. § 1823(e) and the doctrine of D'Oench, Duhme estopped the Smiths from asserting their

defense to the lien. The bankruptcy court also awarded the Bank substantial attorney's fees and

expenses. Upon the Smith's objection that the Bank failed to segregate recoverable fees and expenses

from those incurred in another adversary proceeding, the court rescinded the award of attorney's fees

in an amended judgment. No written reasons for the denial of the fees in the amended judgment are

apparent in the record.

The Smiths subsequently appealed to the district court as to the validity of the mechanic's lien,

and the Bank cross-appealed as to the denial of its attorney's fees. The district court affirmed the
bankruptcy court's judgment in all respects. An appeal to this court was first perfected by the Bank

on the issue of its fees. The Smiths then cross-appealed as to the validity of the lien.

II. DISCUSSION

A.

Section 53.059 of the Texas Property Code provides that a mechanic's lien can be created

on a homestead if the parties execute a written contract which is signed by both spouses, entered into

before the material is furnished or the labor is performed, and properly recorded. Tex.Prop.Code

Ann. § 53.059 (Vernon 1984). The Bank asserts that, inasmuch as these requirements were met, the

mechanic's lien attached. The Bank also cites Section 53.124(a), which provides as follows:

(a) For purposes of section 53.123 [lien priority], the time of inception of a mechanic's lien
is the earlier of:

(1) commencement of construction of improvements or delivery of materials to the land on
which the improvements are to be located and which the materials are to be used; or

(2) recording of a written agreement to construct all or part of any improvement or to
perform labor, furnish material, or provide specially fabricated material in connection with the
construction.

Tex.Prop.Code Ann. § 53.124(a). The Bank argues that this section indicates that the mechanic's lien

at issue here attached as of the date of recordation.

According to the Smiths, however, the lien never attached to their homestead because the

improvements called for by the lien contract were never constructed. The Texas Constitution

provides, in relevant part, as follows:

The homestead of a family ... shall be, and is hereby protected from forced sale, for the
payment of all debts except for the purchase money thereof, or a part of such purchase
money, the taxes due thereon, or for work and materials used in constructing improvements
thereon.... No mortgage, trust deed, or other lien on the homestead shall ever be valid, except
for the purchase money therefor, or improvements made thereon, as hereinbefore provided....

Tex. Const. Art. XVI, § 50 (emphasis added). The Smiths argue that the emphasized language in the
Texas Constitution suggests that the work must actually be performed before a mechanic's lien

attaches. They also contend that this reading of § 50 is echoed in Texas Property Code § 41.001(b),

which provides, in relevant part, as follows:

Encumbrances may be properly fixed on homestead property for:

.....

(3) work and material used in constructing improvements on the property if contracted for
in writing before the material is furnished or the labor is performed and in a manner required
for the conveyance of a homestead, with joinder of both spouses if the homestead claimant
is married.

Tex.Prop.Code Ann. § 41.001(b) (emphasis added). The Smiths contend that, as a matter of Texas

law, the improvements called for in a lien contract must be performed before a lien attaches,

regardless whether the lien contract is assigned to a third party. Fidelity Savings & Loan Association

of Port Arthur v. Baldwin, 416 S.W.2d 482, 483 (Tex.Civ.App.—Beaumont 1967, writ ref'd n.r.e.),

appears to support this position:

The law of this state requires substantial performance of a mechanic's and materialmen's lien
contract before such lien attaches to a homestead. This is true whether the person claiming
the lien is the original contractor, or the contractor's assignee, as in this case. As stated by
the Supreme Court ... the assignee bought the note before the contract was performed, and
the assignee's lien depended upon the performance either by the original contractor or the
assignee of that which such contractor had undertaken to do to create or perfect the lien.

Id.; see also Houston Lumber Supply Co. v. Wockenfuss, 386 S.W.2d 330, 334

(Tex.Civ.App.—Houston 1965, writ ref'd n.r.e.). Furthermore, contend the Smiths, § 53.124(a),

which provides that a mechanic's lien arises at the time of recordation, is relevant only to disputes

over lien priority, and is therefore inapposite to the instant dispute.

We need not here determine whether, or when, under the peculiar circumstances presented

in this case, the mechanic's lien attached to the Smith's homestead, because we find that, even

assuming the lien never attached, the Smiths are estopped from denying the validity of the lien. Under

Texas law, homestead owners may not be estopped from asserting the invalidity of a lien on their
homestead except in three cases:

1. When the owners, not actually occupying the property, or so using it that its status is dubious at
the time the mortgage is executed, represent that it is not their homestead;

2. When the owners create a lien by entering into a simulated transaction which has all the outward
appearance of a valid, unconditional sale, but which is in fact a mortgage; or

3. when the owners represent that existing notes are valid mechanic's lien notes for improvements,
secured by a mechanic's lien contract properly executed.

See In re Niland, 825 F.2d 801, 809 (5th Cir.1987); Lincoln v. Bennett, 138 Tex. 56, 156 S.W.2d

504, 506–07 (1941). Only exception 3 is relevant here.

Several Texas cases have discussed this exception to the State's paternalistic policy toward

homestead rights. According to these cases,

[i]t has long been held that when owners of a homestead represent that existing notes are
valid mechanic's lien notes for improvements, secured by a mechanic's lien contract properly
executed, and thereby induce innocent third parties to invest funds on the faith and credit of
such liens, they are estopped as to such third parties to plead that the lien is invalid.

Mazow v. Brazle, 337 S.W.2d 734, 737–38 (Tex.Civ.App.—Eastland 1960, no writ); see also Engell

v. Union Central Ins. Co., 81 S.W.2d 738, 739–40 (Tex.Civ.App.—Fort Worth 1935, no writ);

Ackerson v. Farm & Home Sav. & Loan Ass'n of Missouri, 77 S.W.2d 559, 561 (Tex.Civ.App.—San

Antonio 1934, writ ref'd); Garrett v. Katz, 23 S.W.2d 436, 438 (Tex.Civ.App.—Dallas 1929, no

writ).1

1
The Smiths contend that they cannot be equitably estopped from asserting the invalidity of the
lien because of Texas' "paternalistic general rule providing that homestead owners are not
estopped by their own false representations...." Their contention is meritless. The Smiths base
their argument on the following quote:

The constitution forbidding the fixing on the homestead of liens other than
such as are thereby expressly permitted, no estoppel can arise in favor of a lender
who has attempted to secure a lien on a homestead in actual use and possession of
the family, based on declarations of the husband and wife made orally or in writing,
contrary to the fact. To hold otherwise would practically abrogate the
constitution.

If property be homestead in fact and law lenders must understand that liens
 The circumstances of the instant case satisfy the requirements of this third exception. There

is little doubt that the FDIC, and subsequently the Bank, were deceived by the Smiths' loan file.

Indeed, the bankruptcy court specifically found that the Smiths, Bourland, and USBank entered into

this transaction to defraud federal banking authorities. The Smiths clearly represented within the bank

records, by means of the mechanic's lien note and contract and the three draw orders, that the work

on the homestead was taking place, and thereby induced the FDIC to invest funds for the note and

contract in the purchase and assumption transact ion. The Bank, as assignee of the FDIC, was

similarly misled by the Smith's representations as to the validity of the mechanic's lien.

The Smiths contend, however, that estoppel is improper in this case because the initial

assignee of the note and contract, USBank, was not an innocent third party purchaser, because it was

found by the bankruptcy court to have full knowledge of the fraud. We recognize that, based upon

USBank's knowledge of the fraud, the Smiths would probably not be estopped from asserting the

invalidity of the mechanic's lien if it were still held by USBank. The lien note and contract are no

longer held by USBank, however, and are now in the possession of a subsequent assignee. This

subsequent assignee, the Bank, was not a party to the creation of t he fraudulent lien. Indeed, the

Bank (and its assignor, the FDIC) took the lien note and contract in good faith, for value, and without

knowledge of the fraud, and was therefore an innocent third party purchaser. Cf. Garrett, 23 S.W.2d

cannot be fixed upon it, and that declarations of husband and wife to the contrary,
however made, must not be relied upon. They must further understand that no
designation of homestead, contrary to fact, will enable parties to evade the law,
and encumber homesteads with liens forbidden by the constitution.

Texas Land & Loan Co. v. Blalock, 13 S.W. 12, 13 (Tex.1890) (emphasis added). The
policy in the State of Texas, as articulated above, is to prevent homestead owners from
encumbering their homesteads with improper liens—those that are neither for purchase
money, taxes thereon, or improvements, see Tex. Const. Art. XVI, § 50—by falsely
representing that the property sought to be used as collateral is not their homestead.
Here, all parties recognize that the Smiths' residence is their homestead. The instant
situation, where the homestead owner has participated in the creation of a sham
mechanic's lien, is very different from that which gave rise to the policy as described in
Blalock. Indeed, Texas law, see supra, specifically permits the estoppel of a homestead
owner from asserting the invalidity of a mechanic's lien when the homestead owner has
previously represented that the lien is valid. See Niland, 825 F.2d at 809; Lincoln, 156
S.W.2d at 506–07.
at 438 ("In a number of cases, where simulated or fictitious transactions, giving rise to ostensible liens

on homesteads, were involved, our appellate courts have repeatedly held that bona fide purchasers

of such liens should be protected."); NCNB Texas Nat'l Bank v. Campise, 788 S.W.2d 115, 118

(Tex.App.—Houston [14th Dist.] 1990, writ denied) ("When the FDIC ... acquires a note in good

faith, for value, and without actual knowledge of any defenses against the note, it takes the note free

of all defenses that would not prevail against a holder in due course."). We need not here determine

whether the Bank satisfied the myriad requirements of a holder in due course; rather, we find only

that the Bank is an innocent third party purchaser of the mechanic's lien note and contract for

purposes of this estoppel exception under Texas law.

Texas law clearly calls for estoppel in the circumstances we confront here. See Lincoln, 156

S.W.2d at 506–07. We therefore hold that the Smiths are estopped under Texas law from asserting

the invalidity of the mechanic's lien.

B.

The Bank sought attorney's fees for recovery on a contract claim under Texas Revised Civil

Statute article 2226, recodified at Chapter 38, Texas Civil Practice and Remedies Code. The award

of reasonable attorney's fees to a plaintiff recovering on a valid claim founded on a written or oral

contract preceded by proper presentment of the claim is mandatory. See Caldwell & Hurst v. Myers,

714 S.W.2d 63, 65 (Tex.App.—Houston [14th Dist.] 1986, writ ref'd n.r.e.). As a general rule, the

party seeking to recover attorney's fees carries the burden of proof. See Stewart Title Guar. Co. v.

Sterling, 822 S.W.2d 1, 10 (Tex.1991); Kimbrough v. Fox, 631 S.W.2d 606, 609 (Tex.App.—Fort

Worth 1982, no writ). This burden includes the duty to segregate recoverable fees from those that

are not recoverable. See Stewart Title Guar. Co, 822 S.W.2d at 10–11; Wood v. Component Constr.

Corp., 722 S.W.2d 439, 444–45 (Tex.App.—Fort Worth 1986, no writ).

Here, the district court affirmed the bankruptcy court's denial of the Bank's fees because a
small portion of the fee request submitted by the Bank represented fees generated in a different

adversary proceeding. Denial of all fees based on this mistake by the Bank was error. Under Texas

law, "an award of attorney's fees erroneously based upon evidence of unsegregated fees requires a

remand." Stewart Title Guar. Co., 822 S.W.2d at 11; see Marcotte v. American Motorists Ins. Co.,

709 F.2d 378, 381 (5th Cir.1983) (following Texas law, granting a hearing to determine which fees

were recoverable).

Moreover, while a trial court has discretion in fixing the amount of attorney's fees, it does

not have discretion to deny attorney's fees entirely under article 2226. Caldwell & Hurst, 714 S.W.2d

at 65. Here, the bankruptcy court abused its discretion in completely denying the Bank's request for

fees. We therefore vacate the judgment denying the Bank its attorney's fees and remand to the district

court with instructions to remand to the bankruptcy court to calculate the Bank's recoverable

attorney's fees.

III. CONCLUSION

For the foregoing reasons, the judgment of the district court with regard to the validity of the

mechanic's lien is AFFIRMED; with regard to the issue of the Bank's attorney's fees, the judgment

is VACATED and REMANDED with instructions to calculate the recoverable fees. Costs shall be

borne by the Smiths.