February 6, 2013
by Teresa L. Bailey
Aldridge Connors LLP
USFN Member (Georgia)
by Elizabeth S. Marcus & Britney Beall-Eder
The Castle Law Group, LLC
USFN Member (Colorado, Wyoming)
Real estate attorneys representing default servicers never find it easy to inform a client that its security interest is not recorded; is recorded — but in the wrong county; or is so flawed that it fails to provide notice of the lien. While these defects often can be remedied without a loss to the client, in other circumstances the blemishes can result in a complete failure of the lien. Outcomes vary state to state and often turn on the matter of notice. The injection of the federal bankruptcy process into this scenario further complicates the analysis and can lead to some unusual outcomes.
Under Bankruptcy Code § 544, a bankruptcy trustee may file an adversary proceeding to avoid a mortgage lien on the basis that the lien was not properly perfected prior to the filing of a bankruptcy. 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 — a harsh result for the lender.
State Law Controls
Whether or not a lien may be avoided by the trustee will be dictated by state law. [See, generally, Montoya v. Litton Loan Servicing, LLC, 367 B.R. 825 (Bankr. D.N.M. 2007) (mortgage lien avoided because applicable state law rendered the lien unperfected; Royal v. First Interstate Bank, 2011 Bankr. LEXIS 4481 (Bankr. D. Wyo.) (lien property perfected under state law when recorded).] However, the determination that a lien may be avoided is factually driven. For example, failing to record the mortgage lien in the correct county or failing to record the document at all will usually render the lien avoidable by the trustee. To the contrary, other technical issues potentially affecting lien perfection may not be so clear.
In Hamilton v. Washington Mutual Bank, FA, 563 F.3d 1171 (10th Cir. 2009), the Tenth Circuit held that the trustee was not entitled to avoid a mortgage lien under 11 U.S.C. § 544(a) due to a scrivener’s error. Specifically, the legal description in the mortgage described the property with an incorrect lot number. The Tenth Circuit concluded under Kansas law 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.”
Similar to the Hamilton decision, the Bankruptcy Court for the District of Colorado issued its opinion in Hill v. Bayview Loan Servicing, LLC 422 B.R. 270 (Bankr. D. Colo. 2009). In Hill, both the recorded vesting deed and the deed of trust contained an error in the legal description listing Block 4 instead of Block 34. The chapter 7 trustee sought to use his “strong-arm” powers to avoid the lender’s deed of trust.
The court in Hill ruled that the trustee was not entitled to avoid the deed of trust, finding that sufficient information existed to place a reasonably prudent purchaser on inquiry notice. The court noted that under Colorado Real Estate Title Standards, an examination of title includes 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 been placed on notice to further investigate.
More recently, the case of Sender v. Cygan (In re Rivera, 11SA261, 2012 LEXIS 398 (Colo. June 4, 2012) has placed Colorado real estate lawyers, bankruptcy counsel and title insurers into a tailspin. In Cygan, the deed of trust in question contained the correct grantor, grantee, and property address. The document was recorded in the proper county. However, the legal description to be attached to the document as Exhibit A was omitted.
The Bankruptcy Court for the District of Colorado asked the Colorado Supreme Court for guidance under state law to determine whether the lien was properly perfected. The Colorado Supreme Court responded that the complete omission of the legal description rendered the deed of trust defectively recorded and could not provide the chapter 7 trustee with constructive notice of the lien. A petition for rehearing is pending as of this writing.
To appreciate the possible sweeping implications of this decision, the Land Title Association of Colorado’s amicus curiae petition states that between 2002 and 2011 approximately 4,000 deeds of trust and warranty deeds a year were recorded without the legal descriptions attached.
Similarly, the Supreme Court of Georgia is considering the impact of certain technical defects upon the perfection of a security deed. The case of Wells Fargo Bank N.A. v. Gordon, No. S122067, began as an adversary proceeding initiated by the bankruptcy trustee seeking to avoid Wells Fargo’s security interest in real property. The security deed at issue lacks the signature of an unofficial witness. On that basis, the trustee asserted that the security deed was not “duly recorded” under state law, as only security deeds that have been attested by or acknowledged before one official and one unofficial witness are permitted to be recorded by the clerk and deemed to provide constructive notice to subsequent bona fide purchasers.
The subject security deed expressly incorporates the terms of any rider attached thereto. Although the security deed lacked the signature of an unofficial witness, the attached rider was expressly incorporated into the security deed and contained the borrower’s signature, attested to by both an unofficial witness and an official witness with a notary seal.
Summary judgment avoiding the security deed was granted to the trustee by the bankruptcy court, and was affirmed by the district court. Wells Fargo appealed to the Eleventh Circuit. The Eleventh Circuit asked the Georgia Supreme Court for guidance regarding whether the security deed under these circumstances was “duly recorded, thereby placing a subsequent purchaser on constructive notice or, in the alternative, inquiry notice.
In its brief, Wells Fargo argues that if the rider and the security deed are treated as a single document, the proper execution of the rider satisfies the requirement of the statute, as both the rider and security deed incorporate the terms of the other, and the rider has all of the proper signatures, thereby providing constructive notice. Wells Fargo reasons that there is no prescribed form or limitation on where the borrower’s signature or the attestations to that signature may appear on the documents.
In the alternative, Wells Fargo asserts that if the rider was insufficient to rehabilitate the security deed, then the attestations created the appearance that the security deed was in recordable form as determined by the clerk who recorded the documents. There is Georgia Supreme Court precedent holding that a security deed is duly recorded when it appeared to be properly attested and was later recorded by the clerk.
Finally, Wells Fargo contends that should the court find that the security deed was not “duly recorded,” the rider was sufficient to put the world on inquiry notice of the existence of the security deed. The rider identified the grantor of the security deed, the date the interest was conveyed, and the lender. Thus, the rider alone should trigger the duty of a bona fide purchaser to investigate the nature of Wells Fargo’s interest in the property.
Oral argument before the Georgia Supreme Court took place on November 6, 2012. A decision will be made in the coming months.
Look for more coverage on this topic by USFN as further judicial decisions are issued in the pending cases referenced in this article, as well as in new cases.
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Winter 2013 USFN Report