Defective Mortgages: There Is Constructive Notice, and Then There Is Inquiry Notice

Kelley v. USAA Fed. Sav. Bank (In re Jones), 580 B.R. 916 (Bankr. M.D. Ga. 2017) –

A chapter 7 trustee sought to avoid a lender’s lien on property of the debtor. The recorded deed of trust was not signed by the borrower since it was missing a signature page. The trustee argued that as a consequence the document was not eligible to be recorded, and thus did not provide constructive notice of the lender’s interests.

Under section 544 of the Bankruptcy Code a trustee has the power to avoid transfers that are voidable by a bona fide purchaser of real estate. Typically, state law provides that a bona fide purchaser can acquire real estate clear of interests unless it has actual, constructive, or inquiry notice of the interests.

In exercising the section 544 strong arm powers a trustee is not held responsible for any actual notice. So, the issue will be whether there was constructive or inquiry notice. State law also generally provides that a properly recorded document provides constructive notice of the transaction evidenced by the document as well as other matters identified in the document. Hence the focus on whether the deed of trust was properly recorded, and thus whether it provided constructive notice of the lender’s lien.

The applicable state statutes required that the deed of trust be signed by the borrower and attested by at least two witnesses, and case law held that a document is duly recorded only if it can be determined from the face of the document that it is in proper form for recording. Obviously since the deed of trust was missing a signature page with the borrower’s signature, it was not in proper form for recording. Accordingly, notwithstanding the fact that the deed of trust had been accepted for filing, the court determined that it did not provide constructive notice of the lender’s interest in the property.

However, an Acknowledgment and Waiver of Borrower’s Rights Rider and a Closing Attorney’s Affidavit were filed contemporaneously with the deed of trust. The waiver was properly signed by the debtor and attested to by witnesses. It stated that the waiver “is incorporated into and shall be deemed to amend and supplement the… Security Deed.”

Under state law a purchaser has constructive notice of the contents of any document in the chain of title. The chain of title includes all recorded documents executed by someone holding a recorded interest in the property at the time of execution. (Conversely a document that is recorded outside the chain of title does not provide constructive notice. So, an affidavit of interest signed only by the lender would not solve the problem of an unrecorded mortgage since it would be outside the chain of title.)

An additional concept used by the court in ruling on this matter was inquiry notice: “The concept of inquiry notice ‘imputes knowledge of an earlier interest to a later purchaser of an interest in land whenever there is ‘[a]ny circumstance which would place a man of ordinary prudence fully upon his guard, and induce serious inquiry.”” A purchaser is charged with notice of facts that would have been found as a result of the inquiry.

Putting the pieces together, the court determined that the waiver was properly recorded and provided inquiry notice. It distinguished some other cases holding that a waiver did not provide inquiry notice on the basis that the documents in those cases did not adequately identify the property. Here the waiver included a postal address which was a legally sufficient description under state law.

Thus, based on the waiver a subsequent purchaser was put on inquiry notice, and if it had done further inquiry it would have discovered the lender’s lien on the property. Consequently, the trustee could not avoid the deed of trust using its strong arm powers.

Even a casual follower of bankruptcy law is likely to be struck by the large number of cases where a mortgage lien is avoided because of a technical defect that could easily have been avoided if someone had paid attention to detail. Usually the analysis starts and ends with a discussion of whether the mortgage was properly recorded given the defect. A lender in this position would be well advised to consider the further issue of inquiry notice if available under applicable law.

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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