A recent decision of Maryland's intermediate appellate court illustrates the risks of making a mortgage loan secured by real property that is the subject of pending litigation.

In Murphy v. Fishman, the Court of Special Appeals of Maryland ruled that a lender's deed of trust was invalid because, at the time that the loan was made, the borrower's title to the collateral property was being challenged in a pending lawsuit.

The case involved an allegedly fraudulent property transfer by an elderly woman to her son, just days before she died and for no consideration.  After the deed was recorded, the woman's estate sued to invalidate the conveyance to the son.  While that litigation was pending, the son obtained a mortgage loan and granted the lender a deed of trust on the property as collateral. 

The estate ultimately prevailed in its lawsuit. As a result, the court imposed a constructive trust on the property, and it was conveyed back to the estate.  When the lender sought to foreclose on its deed of trust, the estate moved to dismiss the foreclosure.  The estate argued that the son had obtained title by fraudulent conveyance, and therefore was never in a position to grant the lender an interest in the property.

The Maryland court agreed with the estate.  Relying on the well-established doctrine of lis pendens, the court rejected the lender's assertion that it was entitled to protection as a bona fide purchaser for value under Maryland law.

The court ruled that "because the Lender had constructive notice of the Estate Lawsuit . . . at the time it acquired an interest in the Property, it was not entitled to the protections to which a bona fide purchaser is entitled, and was not entitled to foreclose on the Property. In sum, the lis pendens provided constructive notice, at the time the mortgage was acquired, of the existing interest in the Property, thereby precluding the Lender from protection as a bona fide purchaser."

The case serves as a cautionary tale of the importance of a thorough search of court records for pending litigation prior to extending a mortgage loan.

Ballard Spahr's Mortgage Banking Group includes litigators with extensive experience defending the validity of mortgages and deeds of trust for lenders, loan servicers and foreclosure trustees.  For further information, please contact Robert A. Scott at 410.528.5527 or scottr@ballardspahr.com.