A chapter 7 trustee and a debtor sought to avoid as a preference a mortgage assignment that was recorded within 90 days prior to the bankruptcy filing. Underlying this claim was their contention that the original mortgage was void as against subsequent purchasers (thus allowing the trustee to avoid the lien) because no legal description was attached to the mortgage.
Under section 544 of the Bankruptcy Code a trustee has the power to avoid transfers that would be voidable by a bona fide purchaser of real property as of the commencement of the bankruptcy case. As is typical, applicable state law provided that:
- “[E]very conveyance that is not recorded as provided by law shall be void against any subsequent purchaser, in good faith and for a valuable consideration, of the same real estate or any portion of the same real estate whose conveyance is recorded first.”
- “A bona fide purchaser (or good faith purchaser) is one without notice, either actual or constructive of any existing rights in the land.”
- Constructive notice “[A]rises when a purchaser without knowledge is subjected on grounds of public policy to the liabilities he would be subject to had he in fact had knowledge, because he was in such a position that if he had exercised a reasonable degree of care in availing himself of the avenues of information open to him he could have acquired the knowledge.”
Thus, the status of the original mortgage boiled down to whether a bona fide purchaser of the property would have had constructive notice of the mortgage.
The court identified 3 sources of information which should be consulted: (1) documents recorded with the register of deeds, (2) other appropriate records such as judgment and lien records, and (3) the land itself. The first category was the issue in this case: Although the mortgage was accepted by the register of deeds and physically recorded, that did not necessarily mean that it was properly recorded or that it provided constructive notice of the lien as a legal matter.
In this case the mortgage identified the property street address and tax key number. A legal description was supposed to be attached as Exhibit A, but no exhibit was attached to the recorded mortgage. When the original mortgagee subsequently assigned the mortgage, the assignment did include a legal description of the property, as well as a reference to the mortgage and its recording date.
Obviously a search of the tract index (i.e. based on property description) would not have disclosed the mortgage itself (as opposed to the assignment). However, a search of the grantor/grantee index did identify the mortgage as an encumbrance on the property (as shown by a screenshot of a search conducted on the Register of Deeds grantor/grantee database).
The trustee and debtor pointed to a state statute defining “chain of title,” which referred to items discoverable by a reasonable search of public records and indexes, and noted that “the tract index shall be deemed an index where the same is publicly maintained.” They contended that this meant that only the tract index served to give constructive notice of recorded documents.
This was consistent with the reasoning of a prior bankruptcy case. However, the prior decision was reversed by the district court, which held that the purchaser must search both the tract index and the grantor/grantee index (if one exists) in order to be considered bona fide and without notice.
The Wenzel court agreed with the district court. Thus it found that disclosure of the mortgage through the grantor/grantee index was sufficient to provide constructive notice even though the mortgage did not contain a legal description. As a result, the trustee was not able to avoid the mortgage using his strong arm powers.
Once the mortgage was found to be valid, the fact that the assignment was recorded within 90 days prior to bankruptcy did not matter because the assignment did not involve a transfer of an interest of the debtor. The only transfer of the debtor’s interest occurred when he granted the original mortgage. Accordingly the mortgage assignment did not constitute a preference.
Consequently, the court dismissed the claims of the trustee and the debtor.
Unlike the UCC, real estate law can be very state specific. This case highlights one of those areas where it is important to determine local law – namely the sanctioned indexes of the real estate records. Often as a practical matter a register of deeds office will have both a tract index and a grantor/grantee index. However, it is not unusual to find that one is an official index and the other is maintained informally as a matter of convenience.
Then a key question becomes which index a purchase must search in order to obtain bona fide purchaser status. This court decided that the purchaser had the burden of checking both. However, other courts have held that it is sufficient to check only the “official” index – which may or may not be the most commonly used index.
Vicki R Harding, Esq.