In re RAG East, LP– Case no. 12-04545-CMB (Bankr. W.D. Pa. March 4, 2013)

CASE SNAPSHOT

The court granted summary judgment in favor of a defrauded lender in a lien priority dispute with subsequent third-party lenders. The court determined that the lien of a purchase money mortgage that was allegedly released pursuant to a fraudulent satisfaction piece nonetheless had priority over the liens held by innocent third parties who provided loans to the debtor without notice of the fraud.

FACTUAL BACKGROUND

The debtor, RAG East, LP, was a single-purpose entity formed to purchase a commercial building on Market Street in Philadelphia. Plaintiff in the adversary proceeding loaned the purchase money to the debtor, which loan was secured by a first priority mortgage on the property. Prior to securing additional financing from two additional lenders and unbeknownst to plaintiff, a forged satisfaction piece was recorded that purported to release plaintiff’s mortgage. Thereafter, the subsequent lenders recorded mortgages against the property to secure the additional financing to the debtor. Once the fraud was discovered, plaintiff initiated an adversary proceeding against the debtor, the subsequent lenders, and any other party that may have had an interest in the property to reinstate its mortgage and determine lien priority. Because the value of the property was significantly less than the sum of all of the liens, plaintiff risked a complete loss if it did not prevail on the lien priority issue.

COURT ANALYSIS

Relying on precedents that were more than 75 years old, the court found that under Pennsylvania law, the satisfaction piece had no force or effect because it was procured by fraud. For this reason, the mortgages of third-party lenders would be subject to plaintiff’s lien, even if these parties had no notice of the fraud. The court acknowledged "the importance of being able to rely upon the public records and recognize[d] the policy of protecting bona fide purchasers and mortgages for value," but nevertheless found "it is clear even a bona fide purchaser or mortgagee for value will not always prevail despite reliance on the public records." Accordingly, the court held that the plaintiff’s mortgage was entitled to priority status, "even to the detriment" of the subsequent lenders.

PRACTICAL CONSIDERATIONS

The court’s decision highlights the importance of lender diligence in providing secured loans. Lenders should ensure they are operating with a complete understanding of any prior financing before making such a loan. Simply relying on a title search may not suffice. In this case it was clear that a significant loan had been given and secured by the property, and the subsequent lenders made no inquiry as to how such a loan had been repaid in a short amount of time. Further investigation would have likely revealed the fraud and prevented significant pecuniary losses. By obtaining title insurance, the lenders also could hedge against the risk of a fraudulent documentation in the chain of title.