The Continuing Saga of Mortgage Errors: Not All “Boo-Boos” Are Fatal

The Willows II, LLC v. Branch Banking & Trust Co. (In re The Willows II, LLC), 485 B.R. 528 (Bankr. E.D.N.C. 2013) –

A deed of trust defined the secured indebtedness as a note and related documents, together with future advances.  “Note” was defined as “the promissory note dated September 7, 2005, in the original principal amount of $675,000 from Grantor to Lender.”  The note was actually dated September 8 (vs. 7).  After filing a chapter 11 bankruptcy proceeding, the debtor brought an adversary proceeding against the lender claiming that the deed of trust was invalid and unenforceable because it referenced a note dated September 7, 2005, when no note of that date existed.  Mortgages have been avoided for less.

The lender first contended that the debtor was estopped from contesting the deed of trust since it executed a “Change in Terms Agreement” that explicitly acknowledged that the note was secured by the deed of trust.  Section 544(a) of the Bankruptcy Code authorizes the avoidance of transfers that would be voidable by a bona fide purchaser of real estate or by a hypothetical judgment lien creditor.  This section explicitly provides that these rights are without regard to any knowledge of the trustee or of any creditor.  However, it does not specifically address whether the knowledge of a debtor should be attributed to itself in exercising a trustee’s rights as the debtor-in-possession.

According to the bankruptcy court, the 4th Circuit holds that the knowledge of a debtor is imputed to a chapter 11 debtor-in-possession when it is proceeding as a bona fide purchaser, but not when it is proceeding as a hypothetical judgment lien creditor.  Consequently, even if the prepetition debtor had acknowledged the validity of the deed of trust, that knowledge was not imputed to the debtor-in-possession.  (The agreement was not recorded in the public records, so there was also no question of constructive notice.)

In proceeding with its analysis, the court noted that a “mortgage which purports to secure the payment of a debt has no validity if the debt has no existence.”  Consequently, an obligation secured by a deed of trust must be adequately identified in order for the deed of trust to be valid.

The court listed a number of cases that dealt with the issue of whether the secured obligation was properly identified.  Of particular relevance were two cases that held that a deed of trust did not sufficiently identify an obligation when the obligor identified in the deed of trust was not the same as the obligor on the note.  In both cases, there was no indication that the deed of trust secured debts owed by the person named in the note.  However, there was no case that concluded a note was not properly identified based solely on an incorrect date.

The bottom line was that the court concluded there were no specific requirements under state law regarding the information that must be included in a deed of trust to identify the secured obligations.  In particular, the court was not willing to establish a bright line test that the description must include the proper date of a note.

In pursuing a fact specific approach to this case, the court considered (1) whether the mortgage was sufficient to put subsequent purchasers on notice, (2) whether the obligations were intended to be secured by the parties, and (3) whether there was any concern about a “fraudulent substitution” of “fictitious debts.”

Since the description included a number of facts regarding the note (the borrower, the lender, the loan number, the commitment letter associated with the loan, the collateral, future advances of up to $675,000, etc.), the court concluded that no one would have been misled as to the identity of the secured obligations.  While acknowledging that an incorrect date could be fatal, the court found that this was not such a case.

As discussed in prior blog posts (see, for example, Mortgage Legal Descriptions: When Is a “Boo-Boo” Fatal (Round 1)? and Bankruptcy “Strong Arm” Powers: Bye Bye Mortgage), even minor errors in a mortgage can result in avoiding the mortgage in a bankruptcy.  In this case the lender prevailed.  However, the minor error of identifying a September 8 note as a September 7 note was enough to result in litigation that took eight months to resolve.  I expect all will agree that it is better not to make mistakes in the first place.

Vicki R. Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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