Missing Mortgage Details: This Time a Mortgage Survives the Trustee’s Attack

PNC Bank, Nat’l Ass’n v. Nordwall, 499 B.R. 599 (C.D. Ill. 2013) –

A mortgagee moved for entry of a default judgment in its foreclosure action.  The mortgagor’s chapter 7 trustee intervened and claimed that the mortgage could be avoided using his strong arm powers because the mortgage did not include the interest rate or due date for the mortgage loan.

Under Section 544 of the Bankruptcy Code, a trustee or debtor in possession may avoid a mortgage that is voidable by a hypothetical bona fide purchaser of real property.  These rights can be exercised without regard to any actual knowledge of the trustee or any creditor.  However, they are subject to matters constructive notice as determined under state law.  Typically, a trustee will use this to avoid an unrecorded mortgage or a mortgage that is not properly recorded so that it does not provide constructive notice of the lien (since typically a bona fide purchaser will be able to acquire property free of the mortgage under state law).

Although the mortgage had been recorded in this case, the trustee claimed that it did not comply with the applicable state conveyances act, and consequently did not provide constructive notice of the mortgage.  The relevant statutory provision is as follows:

Mortgages of land may be substantially in the following form:  The mortgagor (here insert name or names), mortgages and warrants to (here insert name or names of mortgagee or mortgagees), to secure the payment of (here recite the nature and amount of indebtedness, showing when due and the rate of interest, and whether secured by note or otherwise), the following described real estate (here insert description thereof), situated in the County of …, in the State of Illinois.

His argument was that a mortgage was required to include all of the information in the statutory form.  If it did not, then it was not valid and did not constitute constructive notice of the lien.

To begin with, the court noted that the provision says that a mortgage “may” be in the statutory form.  The clear and unambiguous meaning is that the form is permissive, not mandatory.  (Consistent with this interpretation, the court also noted a recent amendment to the statute that asserted that the provisions regarding the form of a mortgage “are, and have always been permissive and not mandatory.”)  The court next reviewed a variety of cases and concluded in each instance that the decisions did not mean that the statutory form was mandatory or that failure to use the form caused the mortgage to be invalid.

However, that was not the end of the matter.  The court went on to consider whether the mortgage provided constructive notice of the mortgagee’s interest.  Under the court’s analysis, notice must be both sufficient in substance and properly recorded to provide constructive notice.  It described record notice as knowledge that could be gained from the grantor/grantee index and other court records, and inquiry notice as knowledge that could be discovered by diligent inquiry.

In this case, the court noted that there was record notice of the existence and terms (including the amount) of the debt.  So, the only question was whether this information was sufficient even though it did not include the interest rate and maturity date.  Since the mortgage included seven out of the nine pieces of information in the statutory form, and the nature and amount of debt was conspicuously placed in the first two pages, there was no doubt that the mortgagee had a lien that clearly corresponded to a particular note with a designated amount.  Consequently, the court held that the trustee had constructive notice and could not avoid the mortgage.

The court noted another question was whether additional loans were secured by the mortgage.  In requesting relief from the automatic stay, the mortgagee asserted that the mortgage secured three loans.  Since only one loan was identified, the mortgagee would have had to rely on the cross-collateralization clause for the other two.  According to the trustee, if this was true, it would invalidate the mortgage for failing to state all of the debt that it secures.  However, regardless of the merits of the trustee’s argument, the mortgagee only referenced the identified note in its foreclosure action.  So, the court did not see any basis for invalidating the mortgage.

It is disconcerting to find that a mortgage that recites that it secures a note dated X in the original principal amount of $Y can be subject to a dispute about whether it provides constructive notice that the identified note is secured.  The side comments about cross collateralization are also troubling and serve as a reminder that these clauses may not be as strong as you might think.

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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