Lenders received good news yesterday from the Ohio Supreme Court in the form of a potential defense to mortgage avoidance actions commonly brought by bankruptcy trustees. Generally, a bankruptcy trustee has the power to avoid a mortgage of which he or she has no notice, and to treat the lender as an unsecured creditor. The practical effect of being treated as an unsecured creditor, as opposed to a secured creditor, often means that the lender receives “pennies on the dollar” in the bankruptcy case filed by its borrower. In the past, Ohio courts have determined that mortgages with certain defects, notwithstanding being recorded, do not provide constructive notice of the existence and contents of the mortgage document, leaving them vulnerable to avoidance actions by bankruptcy trustees and even Chapter 13 debtors in some cases.
In re Messer, decided on February 16, 2016, involved a mortgage executed by the Messers in favor of Mortgage Electronic Registration Systems, Inc., however, the notary acknowledgement was left blank. The mortgage was recorded and later assigned to JP Morgan. The Messers filed a Chapter 13 bankruptcy petition along with an adversary proceeding to avoid the defectively-executed mortgage and to treat JP Morgan as an unsecured creditor. Specifically, the Messers argued that a mortgage that is not “properly executed” does not provide constructive notice and is therefore subject to the trustee’s (and their derivative) avoidance powers. The Court rejected the Messers’ position and found that under applicable Ohio statutes, the act of recording a mortgage provides constructive notice to the whole world of the existence and contents of the mortgage document, whether or not the mortgage is free from defects. The Ohio Supreme Court got this one right by reading the relevant statutes and applying a little bit of common sense.