A chapter 7 trustee sought to use his strong-arm powers to avoid the transfer of several properties from the debtor to his ex-wife pursuant to an unrecorded prepetition divorce decree. The trustee was successful in his quest.
The debtor and his ex-wife (Ms. Golemo) had owned four properties as tenants by the entirety. In April 1998, Ms. Golemo obtained a divorce decree that (1) ordered the debtor to transfer all of his interest in the four properties to her, (2) provided that if he failed to execute deeds, then he would be divested of his title and Ms. Golemo would become vested with both his interest and hers pursuant to statute, and (3) authorized Ms. Golemo to record a copy of the divorce decree in the land records, which would operate to vest title as if a deed had been executed and recorded. Unfortunately for Ms. Golemo, the debtor never deeded the properties to her, and neither one of them recorded the divorce decree with the registry of deeds.
Fast forward almost 14 years. Creditors of the debtor filed an involuntary bankruptcy petition and the court entered an order for relief in 2011. In 2012 the chapter 7 trustee sought to sell the debtor’s interests in the properties free and clear of all liens, claims and encumbrances, including any ownership interest held by Ms. Golemo. Ms. Golemo objected, contending that she owned the properties free and clear of any claim of the trustee.
The trustee based his position on exercise of his “strong-arm” powers as a hypothetical bona fide purchaser of real estate. Under Section 544 of the Bankruptcy Code, if a bona fide purchaser could acquire title superior to the interests of Ms. Golemo under state law, the trustee would be allowed to avoid the transfers.
As a general matter, the applicable state recording statute provided that a conveyance is not valid against third parties without “actual” notice unless it is recorded in the registry of deeds. Similarly, another statutory provision regarding divorce decrees provided that a judgment or decree affecting title to real property does not have effect against third parties without “actual” notice unless a certified copy of the decree is recorded in the registry of deeds (along with a memorandum, if necessary to sufficiently identify the property). Consequently, although the unrecorded divorce decree was effective as between the debtor and Ms. Golemo, it was not effective against third parties without “actual” notice.
The court noted that there were two types of notice under applicable state law: actual and constructive. Actual notice involves having information which would lead to a fact if investigated, while constructive notice means that people are charged with notice regardless of the information they have. In particular: “Constructive notice is an essential element of the land recording system: if a deed is properly recorded, all future purchasers have constructive notice of the deed.”
Although Ms. Golemo argued that the trustee had actual knowledge of her interest, this was not relevant because under Section 544 the trustee has the rights and powers of a bona fide purchaser of real property “without regard to any knowledge of the trustee or of any creditor.” Thus, the trustee’s actual knowledge (if any) would not prevent him from avoiding the transfer as a bona fide purchaser.
The court went on to address the argument that a bona fide purchaser would have inquired about the marital status of the debtor, which in turn would have led to the divorce decree. However, the court characterized “inquiry notice” as a “species of actual notice,” so the trustee was deemed to have notice.
Note that many courts would disagree with collapsing inquiry notice into actual notice. Instead, they would recognize inquiry notice as separate from actual notice, with the result that the trustee would be subject to facts resulting from inquiry notice. (See, for example, Prepetition Fire Insurance Proceeds: Who Gets the Cash? and Mortgage Execution: Even A “Teensy-Weensy Boo-Boo” Can Come Back To Bite You.)
The court also rejected the argument that a bona fide purchaser would have searched the probate court records, and thus should be charged with constructive notice of the divorce decree: The recording statute governs land recordation, so a conveyance must be recorded in the registry of deeds in order to provide constructive notice. Probate records are not equivalent to registry of deeds records, and purchasers are not required to examine documents extraneous to the land records, even if available.
Finally, Ms. Golemo argued that her long time exclusive possession and control of the properties should constitute a form of constructive notice. Even if the court had not concluded that the only form of constructive notice came through recorded documents, it did not agree that her possession of the properties was inconsistent with a continuing interest of the debtor. According to testimony in the case, the debtor had had no involvement with the properties for at least four years prior to the divorce.
Consequently, the court granted summary judgment in favor of the trustee.
A word to the wise: Any time you have a court order disposing of interests in real estate –regardless of whether it is a divorce decree, disposition of property of an estate, or something else – you should record the order and make sure that it is accompanied by an adequate legal description. Otherwise, the transferee may be out of luck, particularly if there is a bankruptcy.
Also, note that unlike other avoidance actions, such as fraudulent transfers, there is no limit on the look back period. If a deed or other transfer document is unrecorded, typically it can be avoided by a bona fide purchaser regardless of how long ago the transfer was made.
Vicki R. Harding, Esq.