A chapter 7 trustee sought to avoid mortgages on three properties using his “strong arm” powers, arguing that they were improperly recorded and thus did not provide constructive notice to a purchaser or lien creditor.
Section 544 of the Bankruptcy Code allows a trustee to avoid transfers that could be avoided under state law by a hypothetical lien creditor or a bona fide purchaser of real estate as of the commencement of the bankruptcy. In the case of mortgages, this technically boils down to whether the mortgage was properly recorded so that it provided constructive notice of the lien.
All three mortgages in this case were prepared using the same form. The form included a section titled “Secured Debt And Future Advances” with a space to insert a description of the secured obligations, together with the following text:
Debt incurred under the terms of all promissory note(s), contract(s), guaranty(s) or other evidence of debt described below and all their extensions, renewals, modifications or substitutions. (When referencing the debts below it is suggested that you include items such as borrowers’ names, note amounts, interest rates, maturity dates, etc.)
The mortgages included the following handwritten information to describe the secured obligations:
- Mortgage 1: Maturity Date = 11-14-2035
- Mortgage 2: [Stamped: MATURITY DATE] 11-2-2025
- Mortgage 3: Mat Date 6/01/36
The relevant recording statute provided (emphasis in original):
Instrument not to be recorded unless date of maturity shown; exception.
No county clerk shall record a deed or deed of trust or mortgage covering real property by which the payment of any indebtedness is secured unless the deed or deed of trust or mortgage states the date and the maturity of the obligations thereby secured which have been already issued or which are to be issued forthwith. In the case of obligations due on demand, the requirement of stating a maturity thereof shall be satisfied by stating that such obligations are “due on demand.”
The trustee argued that the mortgages did not comply with the statute because they did not include the date of the underlying note. Consequently they should not have been recorded. The mortgagee responded that only the maturity date was required, and in any event they provided constructive notice since they were actually recorded.
The court began by noting that the statute required that there be a statement of “the date and the maturity” of the debt. As stated in a Sixth Circuit case: “dictionary definitions, legal usage guides and case law compels us to start from the premise that ‘and’ usually does not mean ‘or.’” So, notwithstanding the caption of the section (which refers only to the maturity date), the plain meaning is that both the date of the instrument and the maturity date were required. In addition, the court was of the view that the language of the provision regarding the maturity of a demand obligation indicated that the maturity date was only part of the recording requirements.
The court proceeded to distinguish case law raised by the mortgagee. The court declined to read cases finding that the failure to include the maturity date did not comply with the statute implied that the date of the secured obligation was not necessary.
The court did note several cases in which a court found that it was sufficient if a date could be easily calculated or was obvious from the information provided in the mortgage even though the date itself was not stated. However, since the mortgages in the case did not include either the date of the underlying note or information that would have allowed a party to determine that date, the court found that the mortgages did not comply with the statute and should not have been recorded.
Since the county clerk nevertheless did accept the mortgages for recording, the mortgagee argued that they were sufficient to provide notice. A trustee exercising strong arm powers is able to assert rights “without regard to any knowledge of the trustee or of any creditor.” So actual knowledge is insufficient and the mortgages would be relevant only if they provided constructive notice.
In this case applicable state case law was clear that instruments that were not authorized for recording did not provide constructive notice even if they were accepted and filed. As one court explained, if it held otherwise “the effect would be to remove the technical requirements of mortgages and leave subsequent creditors liable for the mistakes of those before them.”
The court found support for its decision in another recording statute regarding defective acknowledgements. Several cases had determined that mortgages with defective acknowledgements did not provide constructive notice. In response, the state legislature amended the statute to provide that an improperly acknowledged mortgage that was accepted and filed would provide constructive notice notwithstanding the improper acknowledgement. Since the section regarding the date and maturity of the secured obligation did not include a similar remedial provision, the mortgagee was out of luck.
There are a surprisingly large number of cases that avoid mortgages based on technical defects. As illustrated by this case, two points to remember: (1) on the one hand, just because a document was recorded does not mean that it was properly recorded so that it provides constructive notice, and (2) on the other hand, there may be remedial provisions that lead to the result that once a document is recorded specified defects are no longer relevant.