Lien Perfection in Bankruptcy: Recent Judicial Decisions
by Britney Beall-Eder
With the rise in foreclosure and bankruptcy filings in recent years, an increasing number of mortgage-related title issues occurring at loan origination have become ripe for resolution or legal determination. Whether the title issue is purely typographical or pertains to an issue of perfection, title issues generally must be addressed and resolved prior to any transfer of title through sale of the property or foreclosure. Bankruptcy can often times complicate, or make impossible, resolving such issues.
Under 11 U.S.C. § 544, a bankruptcy trustee may file an adversary proceeding to avoid a mortgage lien on the basis that the mortgage lien was not properly perfected prior to the filing of a bankruptcy petition. An order by a bankruptcy court, determining that a mortgage lien may be avoided by a bankruptcy trustee, will leave the lender with only an unsecured lien. Accordingly, an order avoiding a mortgage lien can lead to an extreme, harsh result for the lender. Recently, however, favorable decisions for the mortgage lender have come from both the Tenth Circuit Court of Appeals and the U.S. Bankruptcy Court for the District of Colorado, limiting a bankruptcy trustee’s mortgage lien avoidance powers.
The Colon Case
In reviewing the matter to determine whether the trustee was entitled to avoid the mortgage lien in Colon, the Tenth Circuit determined “to what extent a purchaser is put on notice of the contents of title documents properly filed with a county register of deeds.” In making its determination concerning whether adequate grounds existed to avoid the mortgage lien, the court of appeals reviewed what the applicable state court would expect a purchaser to know from examining title., the court of appeals looked to KansasState law and determined that a purchaser in Kansas was “deemed to know the contents of every recorded document in the vendor’s chain of title.” The court additionally found that a purchaser in Kansas has a duty to make additional inquiry based upon what is “deemed known about the contents of recorded documents in title.”  Accordingly, a purchaser has constructive notice of any defect that could be discovered through reasonable inquiry.
After examining the recorded documents in the chain of title and the grantor-grantee index pertaining to the Colon case, an examination of title disclosed inconsistencies in the chain of title concerning the lot number in the legal description. Based upon such inquiry and disclosed inconsistencies, the Tenth Circuit concluded that a purchaser “would be on constructive notice that the Bank’s mortgage created a lien on that property or, at the least, a purchaser would be on constructive notice of facts that would require a reasonably prudent person to investigate and then determine that the Bank’s mortgage burdened the property.” Therefore, the Tenth Circuit concluded that the trustee was not entitled to avoid the mortgage lien under 11 U.S.C. § 544(a)(3).
In Taylor, both the recorded vesting deed and the deed of trust contained an error in the legal description, listing block 4, instead of block 34. 
Due to the typographical error, the mortgage lender caused the deed of trust to be re-recorded to correct the legal description. Unbeknownst to the lender, the borrowers had filed a Chapter 7 bankruptcy petition a few hours prior to the re-recording of the deed of trust.  The Chapter 7 trustee sought to use his “strong-arm” powers under 11 U.S.C. § 544(a)(3) to avoid the lender’s deed of trust. The Chapter 7 trustee also alleged that the re-recording of the deed of trust violated the automatic stay under 11 U.S.C. § 362(a), and that, therefore, the re-recording of the deed of trust to correct the legal description was void.
Consistent with the Tenth Circuit’s decision in Colon, the U.S. Bankruptcy Court for the District of Colorado found that the Chapter 7 bankruptcy trustee was not entitled to avoid the deed of trust under its strong-arm powers pursuant to 11 § U.S.C 544(a)(3) due to a clerical error in the legal description of the deed of trust. The bankruptcy court primarily based its decision on the fact that the chain of title, if inquired into, would have disclosed that the incorrect block number on the documents was due to a typographical error.
In finding that
sufficient information existed to put a reasonably prudent purchaser on
inquiry notice concerning the issue, the court noted that under Colorado
Real Estate Title Standards, an “examining attorney’s
examination of title will include a search of the direct and inverted
(grantor-grantee) indices of recorded documents maintained by the clerk
and recorder of the county in which the property is located,” and
that, if such examination had been performed, the trustee would have
noticed that an issue existed concerning the legal description of the
property and inquired further. Therefore, the court, quoting
Colon, noted, “[w]e cannot imagine a reasonably prudent
purchaser who would not recognize that a problem exists, make inquiry,
and ascertain that the bank’s mortgage has an inadvertent
error” in the legal description.
With regard to the trustee’s allegations that the re-recording of the deed of trust violated the automatic stay, the court found that since the deed of trust provided constructive notice of the correct block number and the lender had no knowledge of the automatic stay when it re-recorded the deed of trust, that the re-recording of the deed of trust had little practical impact on any party’s rights. Accordingly, the court annulled the automatic stay and denied the trustee’s request to declare the re-recording a nullity.
Editor’s Note: For additional discussion of this topic, see “Lien Perfection Issues in Bankruptcy” by Jennifer M. West, which appeared in the USFN Report (Autumn 2009).
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563 F.3d 1171 (10th Cir. 2009).
Id. at 1179.
Id. at 1179.
Id. at 1181.
Id. at 1186.
No. 09-01050-HRT, 2009 LEXIS 4136 (Bankr. Colo. Dec. 3, 2009).
Taylor at *1-2.
 Id. at *2.
Id. at *5.
Id. (quoting Hamiton v. Washington Mutual Bank, FA (In re Colon), 563 F.3d 1171, 1183).
Taylor at *7.
See id. at *7-8.
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