A chapter 7 trustee sought to avoid the lien of a recorded deed of trust because (1) it contained both correct and incorrect parcel numbers and (2) it was improperly indexed. The issue turned on whether a bona fide purchaser would have had inquiry or constructive notice of the deed of trust.
Section 544(a) of the Bankruptcy Code gives a trustee the power to avoid a lien on real property if a bona fide purchaser (or judgment lien creditor) could avoid the lien under state law. Under applicable state law, a deed of trust is not effective against a subsequent bona fide purchaser unless it has notice. Notice can be actual, inquiry or constructive. For purposes of Section 544 a trustee steps into the shoes of a purchaser without actual notice. So the question was whether a purchaser would have inquiry or constructive notice of the deed of trust.
In this case the deed of trust included a legal description in exhibit A (describing a unit in a condominium), a street address, and parcel numbers. The legal description and street address were correct. However, the parcel number was correct in exhibit A (square 1601, lot 3675) but incorrect in the body of the deed of trust following the reference to exhibit A and the correct street address (square 1607, lot 58 – the parcel number for another parcel owned by the debtors).
The deed of trust was submitted for recording with a recordation and transfer tax form that correctly identified the street address and parcel number for the property. However, the recorder of deeds indexed the deed of trust in both the grantor/grantee index and the square and lot index using the incorrect square and lot number.
Under state law a purchaser is put on inquiry notice when it becomes aware of “circumstances which generate enough uncertainty about the state of title that a person of ordinary prudence would inquire further about the circumstances.” The purchaser is then deemed to have notice of circumstances that a reasonable inquiry would have disclosed.
First, the court concluded that a search of the grantor/grantee index would have put a purchaser on inquiry notice even though the index incorrectly indicated that it related to the debtors’ residence. At a minimum, review of the contents of the deed of trust would have raised a question since the street address was correct and was consistent with one square and lot description, but not the other. So, a purchaser would have been put on notice to inquire further to determine the correct property.
Second, the grantor/grantee index showed a notice of foreclosure sale relating to the correct property. A review of the notice would have identified the deed of trust – again raising questions that should have been pursued.
Third, a power of attorney from Mr. El‑Erian to Mrs. El‑Erian authorizing her to execute documents in connection with a refinancing was correctly indexed and filed the same day as the deed of trust. The court provided a lengthy explanation of why this would also put a purchaser on inquiry notice.
In addition, the court concluded that there was constructive notice of the deed of trust since it was recorded. Although the trustee argued that an improperly indexed document does not provide constructive notice, the court responded that there is no statutory requirement that a document be indexed in order for recording to be effective.
Rather, mortgages and deeds of trust are treated the same as absolute deeds, and absolute deeds take effect between the parties upon delivery to the grantee and take effect as to creditors and subsequent bona fide purchasers from the time of delivery to the recorder of deeds. So, a purchaser is charged with constructive notice once a document has been delivered for recording even if it is not properly indexed. In the words of the court:
Unless and until the legislature adopts a statutory scheme making proper indexing an element of perfecting a recorded lien, a prospective purchaser of a property is on notice that it must examine all documents recorded that are in the chain of title, i.e., recorded after the owner acquired the property.
Note that just because a recorder of deeds maintains grantor/grantee and/or tract indexes does not mean that they are official indexes. In analyzing whether a lien on real estate is perfected, an important point to consider is whether there is an official index that parties are entitled to rely on.
And as illustrated by this case, if a searcher has no legal basis under local law for relying on information in an index, the only safe way to identify potentially senior interests is to actually review all documents recorded after the applicable party acquired an interest in the property to confirm that the documents say what the index suggests that they say. Forget about the fact that this is not very practical.