Mortgage Errors: How Not to Correct a “Boo-Boo”

Seelen v. Couillard (In re Couillard), 486 B.R. 466 (Bankr. W.D. Wis. 2012) –

“Whether one is baking a cake, building a house, or recording a mortgage, sometimes even the slightest deviation from the directions can lead to catastrophe.  Cakes don’t rise, buildings fall down, and … mortgages aren’t perfected.”  So starts the opinion in Couillard.

The Coulillards refinanced a purchase money mortgage.  The legal description attached to the refinancing mortgage included an easement parcel, but omitted the two principal parcels.  A couple of months after the mortgage was recorded, an “affidavit of correction” to correct an “error” in the mortgage legal description was recorded that attached the missing parcel descriptions.  A few years later the Couillards filed bankruptcy.

The bankruptcy trustee brought an adversary proceeding to avoid the mortgage using the “strong arm” powers under Section 544(a) of the Bankruptcy Code.  Specifically, this section allows a trustee to assert the rights of a hypothetical bona fide purchaser of real estate that has perfected the property transfer (i.e. recorded a conveyance document) as of the commencement of the bankruptcy case.

Under applicable state law, a conveyance that is not recorded is generally void as against a subsequent purchaser who records first.  Outside of bankruptcy, there is generally an exception if the purchaser has either actual or constructive notice of unrecorded claims.  However, in exercising a purchaser’s rights in bankruptcy, a trustee is subject to only constructive notice, not actual notice.  Under applicable state law regarding constructive notice, purchasers are deemed to have notice of claims that are revealed by use or occupancy of the property or by a review of the “chain of title (i.e., the records in the office of the register of deeds and other public records)” for the property.

So, this case turned on whether the Section 544(a) hypothetical purchaser would have had constructive notice of the refinancing mortgage based on a combination of the defective mortgage and the corrective affidavit.  As an initial point, the court noted that a document must be (1) properly filed and (2) within the chain of title in order to provide constructive notice.

The recording statutes require that a mortgage contain a description of the mortgaged property.  The court acknowledged that a property can be identified by means other than a full legal description, and the bank argued that somehow the mortgage did include the omitted parcels.  However, the court drew a distinction between the specificity required to meet the statute of frauds so that the mortgage of the two parcels would be enforceable between the mortgagor and the mortgagee and the specificity required under the recording statutes to put a bona fide purchaser on constructive notice that the two parcels were mortgaged.

Since the recorded mortgage was not in the chain of title for the two parcels, the court concluded that it was not properly recorded.  Thus, it was clear that the mortgage by itself could be avoided since it did not provide constructive notice to a bona fide purchaser.

With respect to the corrective affidavit, there had been a variety of changes in the state statutes regarding corrective affidavits.  Although the use of affidavits was originally specifically authorized by statute, that provision was repealed in 1969.  Apparently people continued to use affidavits until 2007 when a state court case found that a corrective affidavit was invalid because there was no authority for correcting the description of a property by recording an affidavit.  (This was the state of the law at the time the corrective affidavit was filed.)

In response, a statute was enacted and became effective in May 2010 that authorized corrections by affidavit and retroactively validated those recorded before the statute became effective.  However, the new statute identifies the people that are authorized to sign different types of affidavits.  If an entire parcel is being added to a mortgage, the court concluded that the statute requires that the mortgagor sign the affidavit, so that the affidavit was invalid on its face.

The bank claimed nothing was “added” since the mortgage was already valid against the two parcels, so the mortgagors were not required to sign the affidavit.  But the court again rejected the bank’s arguments that the mortgage by itself was valid against the two parcels.

Since (1) a purchaser reviewing the chain of title for the two parcels would not find the mortgage, and (2) although it would find the affidavit of correction, the affidavit was invalid on its face, there was nothing that would provide constructive notice and the mortgage of the two parcels would be void as against the hypothetical subsequent purchaser.

The court also rejected an argument that the bank should be equitably subrogated to the original purchase money mortgage that it refinanced because giving the bank an equitable lien based on the refinanced mortgage would prejudice the hypothetical bona fide purchaser.

In Seelen v. Couillard (In re Couillard), 486 B.R. 481 (Bankr. W.D. Wis. 2012), the bank tried again in a motion for reconsideration, which it argued was appropriate because “the Court’s decision ‘radically misinterprets’ Wisconsin law concerning land rights.”  The court was not persuaded by the bank’s arguments the second time around any more than it was the first time:

The bank made two mistakes. First, it did not attach the legal descriptions for the two parcels to the mortgage when it was presented to the Register of Deeds. Second, it opted to file an affidavit of correction even after the Wisconsin Court of Appeals indicated that doing so was not an appropriate method to correct a conveyance. The affidavit of correction was invalid and the original mortgage did not satisfy the recording requirements. The result is that a subsequent purchaser would not have had constructive notice of the bank’s interest in the two parcels.

Message delivered loud and clear.  The bank’s claim is to be treated as unsecured.

This is one more example that details really matter.  In a bankruptcy even minor mistakes can result in a mortgage being avoided.

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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2 Responses to Mortgage Errors: How Not to Correct a “Boo-Boo”

  1. Pauline Springer says:

    Question: Homeowner inherits house and is in occupancy of a SFR property. He allegedly refinanced the property and a lender claims it has a valid mortgage, even modified it once but now admits there is no recorded Deed of Trust or record of any transaction related to a refinance even though they have collected and escrowed for several years. Home Value is underwater by at least 30%. Homeowner made payments until recently but lost income and defaulted. He wants to give house to a family member. The bank refuses to modify the loan and claims a right to foreclose despite not having recorded Deed of Trust. Homeowner can show chain of title back to 1999. Can a lender foreclose in a non-judicial state (Tennessee) without a recorded Deed of Trust/assigned Trustee, no records? What could be the bank’s move? Can the homeowner give away the house? (treat as hypothetical)

    • The answer to the questions will depend on Tennessee law. However, as an example of how things might play out:

      In Michigan the foreclosure by advertisement statute (non-judicial foreclosure procedure) specifically requires that the mortgage and any necessary assignments be recorded before the foreclosure sale. So, the mortgage would have to be recorded before the lender could proceed to a foreclosure sale. (But beware that the lender might be able to sue on the mortgage note even if it couldn’t foreclose the mortgage.)

      On the second question, a general answer (again subject to state specific law) is that an attempt to give away the home probably would not relieve the homeowner from personal liability (if any) on the mortgage loan, and may be avoidable by a creditor even outside of bankruptcy under the applicable state fraudulent transfer act.

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