In a recent appeal to the Sixth Circuit Bankruptcy Appellate Panel, In re Collins, 2011 WL 4445451 (6th Cir. BAP Aug. 12, 2011), the trustee sought a declaratory judgment to determine the validity, extent, and priority of liens on the debtor’s real property held by four defendants.  The trustee appealed the district court’s dismissal of his complaint as to purported holders of the debtor’s first and second mortgages on the debtor’s property.

The debtor filed her bankruptcy petition on March 25, 2010.  On January 28, 2005, she had granted both first and second mortgages on her home to Wilmington Finance.  Both mortgages were recorded on February 4, 2005.  The first mortgage was assigned to Mortgage Electronic Registration Systems, Inc. (MERS) on February 5, 2005 and recorded on June 16, 2005.  One day after the debtor filed her petition, it was assigned to Bank of New York Mellon f/k/a The Bank of New York, as successor to JPMorgan Chase Bank, N.A. as trustee for the benefit of the certificate holders of Popular ABS, Inc. Mortgage Pass-Through Certificates Series 2005-3 c/o Litton Loan Servicing, and was not recorded until April 7, 2010.

Litton Loan Servicing filed a proof of claim in the bankruptcy, but the note it attached did not demonstrate a complete chain of endorsements.  Accordingly, the trustee filed an adversary complaint seeking priority over the first mortgage because only an allonge from JP Morgan Bank to Bank of New York dated May 25, 2010 was produced – there was no prepetition endorsement or assignment of the note payable to Wilmington Finance.  The Trustee argued that the Bank of New York had not perfected an attachment of the mortgage prior to the filing of the debtor’s petition, and therefore, was not actually a creditor of the debtor.  The bankruptcy court dismissed the trustee’s complaint pursuant to Federal Rule of Civil Procedure 12(c).

The record was silent on the subsequent history of the second mortgage, but the debtor listed GMAC Mortgage as the second mortgagee on her petition.  GMAC Mortgage did not file a proof of claim, but did respond to the trustee’s adversary complaint which alleged that because Wilmington Finance and GMAC failed to file a proof of claim that contained an endorsed and executed note to evidence the indebtedness described in the second mortgage, there was no evidence of indebtedness secured by the second mortgage.  GMAC did assert that it was the owner and holder of the note and mortgage and had the originals of both in its possession, but failed to produce the documents.  The bankruptcy court dismissed the trustee’s complaint pursuant to Federal Rule of Civil Procedure 12(b)(6) for failure to state a claim upon which relief can be granted..

The trustee alleged that his interest in the debtor’s property was superior to that of both Litton Loan Servicing and GMAC Mortgage by virtue of his status of a hypothetical judicial lien creditor under 11 U.S.C. § 544(a)(1) as of the commencement of the debtor’s case.  Under § 544(a)(1), a trustee is granted the status of a “hypothetical lien creditor” who is deemed to have perfected his interest as of the date of the filing of the bankruptcy petition and is granted the power to avoid transfers of property that could be avoided by a judicial lien creditor.  A trustee can avoid security interests that are unperfected under applicable state law and take priority.

Together, 11 U.S.C. § 544 and Kentucky law, KRS §§ 355.9- 102(1)(az)(3), § 355.9-317(1)(b), provide that a trustee’s interest as a hypothetical judicial lien creditor is superior to those security interests which are unperfected as of the filing of the petition.

As to the second mortgage, the BAP agreed that because GMAC Mortgage had not produced the original note, the mortgage was subject to attack by the trustee as a hypothetical lien creditor.  The BAP determined, however, that the lower court had erred in dismissing the trustee’s complaint for failure to state a claim upon which relief could be granted because the trustee did allege that GMAC was not the holder of the note and could not produce evidence of the debt.  If the Trustee were able to prove the facts alleged in his complaint, as a judicial lien creditor he would have priority over a creditor who was unable to prove an enforceable mortgage on the date of filing.  Therefore, the complaint stated a plausible claim against GMAC and the bankruptcy court erred in dismissing the complaint.

As to the first mortgage, the BAP determined that MERS, who was assigned the mortgage by Wilmington Finance on February 5, 2005 and recorded the mortgage on June 16, 2005, appeared to be the secured creditor on the date the petition was filed, March 25, 2010.  The record, however, was unclear.  The complaint left MERS out of its description of the chain of title, moving from Wilmington Finance to Bank of New York to Litton Loan Servicing, although documentation produced did indicate that Wilmington Finance and assigned the mortgage to MERS.  Further, the debtor inexplicably listed Litton Loan Servicing as servicing agent for Bank of New York on her petition, although the assignment of the mortgage did not occur until after the petition was filed.  Further, the trustee’s only allegations against Litton Loan Servicing addressed the postpetition chain of title, and a § 544 claim can be used only to address a trustee’s power as a hypothetical lien creditor on the date of filing the petition.

The BAP decided that in order to determine whether the trustee had stated a claim under § 544, the bankruptcy court had to first determine who the secured party was on the date of the filing of the petition.  If the trustee’s complaint did not challenge the perfection or enforceability of the mortgage as it was held on that date, it did not state a claim under § 544.  Accordingly, the BAP vacated the order of the bankruptcy court dismissing the trustee’s complaint as to Bank of New York and Litton Loan Servicing, and instructed the lower court to first determine who held the first mortgage on the date of the petition.  If MERS was the secured creditor, then Bank of New York and Litton Loan Servicing would not be proper parties to the § 544 claim.  If Bank of New York/Litton Loan Servicing was the secured creditor, the lower court would need to determine whether Bank of New York/Litton Loan Servicing could establish a proper chain of title of the note to establish its right to payment.