Indiana Commercial Foreclosure Law

Actual Knowledge Defeats Indiana’s Bona Fide Purchaser Defense Too

The Indiana Court of Appeals, in Weathersby v. JPMorgan Chase Bank, 2009 Ind. App. LEXIS 836 (Ind. Ct. App. 2009) (.pdf) , reminds us that actual knowledge of a prior interest in real estate is just as important as constructive knowledge in disputes over title.

Chronology of events.  On July 24, 1998, the Blair Family Trust (“BFT”) deeded the subject property to Financial Help and Consulting Services (“FHCS”).  That deed was not recorded until November 17, 1998, however.  In the interim, BFT deeded the same property to the 5285 Adams Trust (“5285”), and the BFT/5285 deed was recorded on October 13, 1998, about a month before the recordation of the BFT/FHCS deed.  The point is that, in late 1998, both FHCS and 5285 held a deed to the same property.  By 2000, the 5285 chain of title led to Lewis, who granted a mortgage on the property to Chase.  By 2005, the FHCS chain of title led to Weathersby, who granted a mortgage on the property to MERS.  The Weathersby opinion is about which alleged owner and mortgagee should prevail.

The chain of title split.  The Weathersby suit involved an analysis of the bona fide purchaser doctrine.  In Indiana, in order to qualify as a “bona fide purchaser” one must [1] purchase in good faith, [2] for valuable consideration and [3] without notice of the outstanding rights of others.”  Indiana law recognizes both “constructive” and “actual” notice.  I previously addressed constructive notice on May 28 and June 4, 2009.  Weathersby focused on actual notice and examined the effect of BFT’s 1998 conveyances of the property to both 5285 and FHCS.  Chase’s contention was that the July 24, 1998 deed to FHCS did not provide notice to 5285 because BFT did not record the deed until November 17, 1998, a month after the BFT/5285 deed was recorded.  The Court of Appeals agreed that, under I.C. § 32-21-4-1, 5285 did not have constructive notice of the deed to FHCS, but the compelling question was whether 5285 had actual notice of the deed. 

Test for actual notice.  Indiana law provides that, “notice is actual when notice has been directly and personally given to the person to be notified.”  Actual notice may be implied or inferred:

 [f]rom the fact that the person charged had means of obtaining knowledge
 which he did not use.  Whatever fairly puts a reasonable, prudent person
 on inquiry is sufficient notice to cause that person to be charged with
 actual notice, where the means of knowledge are at hand and he omits to
 make the inquiry from which he would have ascertained the existence of a
 deed or mortgage.  Thus, the means of knowledge combined with the duty
 to utilize that means equates with knowledge itself.  Whether knowledge of
 an adverse interest will be imputed in any given case is a question of fact to be determined objectively from the totality of the circumstances.

Need for trial. The Court in Weathersby reversed the summary judgment granted to Chase and remanded the case for trial because there were factual issues surrounding the role of attorney Michael Delfine.  Mr. Delfine’s fingerprints are all over the key transactions.  Because the evidence at the summary judgment stage was not entirely clear, the Court of Appeals remanded the case for trial.  Here’s how the Court articulated the unresolved issues:

 This evidence demonstrates that Delfine was aware that the Property had
 been transferred to both FHCS and [5285] in 1998.  In June 1999, Delfine
 was identified as the trustee of [5285].  However, the designated evidence
 does not demonstrate whether Delfine was also the trustee of [5285] in
 October 1998 or whether Delfine’s knowledge would be [legally] imputed
 to [5285].  As a result, we conclude that genuine issues of material fact
 exist regarding whether [5285] had actual knowledge in October 1998 of
 the prior transfer from [BFT] to FHCS and, thus, whether [5285] was a
 bona fide purchaser of the Property.

If 5285 was not a bona fide purchaser, then the chain of title leading to Lewis and Chase must fail, in which case Weathersby/MERS would prevail.

Weathersby demonstrates that, in the absence of constructive notice of a deed or mortgage, actual notice can be outcome determinative in title disputes.  Admittedly, litigation surrounding chain of title in commercial foreclosure cases is rare.  Cases like Weathersby mainly arise out of residential transactions.  Further, Weathersby appears to be unique in terms of the role of Mr. Delfine, and the Court noted that he resigned from the Indiana bar in 2002.  In the end, like many of these cases, the over-arching message for lenders is that it’s very important to have a closing that is covered by title insurance. 

What Does “Chain Of Title” Mean?

The Indiana Court of Appeals in Weathersby v. JPMorgan Chase, 2009 Ind. App. LEXIS 836 (Ind. Ct. App. 2009) (.pdf), which I’ll discuss in more detail next week, explains the idea of “chain of title” and what it means in Indiana.  To brush up on your real estate vocabulary, keep reading.

Chain of title.  Weathersby explains what “chain of title” to a tract of land is.  Here are the Court’s words:   

 In a title search, the prospective purchaser or his abstractor assesses the
 marketability of title to a tract of land by determining the “chain of title.”  
 Beginning with the person who received the grant of land from the United
 States, the purchaser or abstractor traces the name of the grantor until the
 conveyance of the tract in question.  The particular grantor’s name is not
 searched thereafter.  As the process is repeated, the links in the chain of
 title are forged.

My trusty Black’s Law Dictionary defines “chain of title” as:

 Successive conveyances, or other forms of alienation, affecting a particular
 parcel of land, arranged consecutively, from the government or original
 source of title down to the present holder.

Indiana’s system.  Indiana counties are required to maintain a name index system for recording deeds and mortgages.  See, Ind. Code § 36-2-11-12.  These indices are organized alphabetically by grantor and by grantee, or mortgagor and mortgagee, with cross-references.  Furthermore, the indices describe the tract and show the date of the recording.  As noted in Weathersby, purchasers of real estate are presumed to have examined these county records and are legally charged with notice of the facts in them.  This rule applies to both purchasers and mortgagees.  A record outside the chain of title does not provide constructive notice to bona fide purchasers for value, however. 

Following a chain of title is sort of like connecting the dots of ownership.  As I’ll illustrate in next week’s post, there are times when parties, outside the chain of title, claim an interest in, or ownership to, real estate.  Weathersby addresses what can happen in such a scenario.

BFP Defense Denied, And IRS Lien Prioritized

Last week’s post dealt with the successful application of the bona fide purchaser (“BFP”) doctrine in connection with the Kumar case.  This week’s post illustrates the opposite result, rendered by U.S. District Court Judge Barker in CitiMortgage, Inc. v. Sprigler, 2009 U.S. Dist LEXIS 27866 (S.D. Ind. 2009) (CitiMortgage.pdf).  Among other things, CitiMortgage shows secured lenders that, in Indiana, a recorded mortgage runs with the land and should be enforceable regardless of any subsequent transfers of the real estate.  The opinion also generally addresses the relative priorities of mortgage liens and IRS liens. 

What happened.  Borrowers signed a $300,000 promissory note and executed a mortgage on the subject real estate to secure the note.  The lender recorded the mortgage on April 2, 2002.  The borrowers later conveyed the property by warranty deed for “the sum of One Dollar ($1) and other good and valuable consideration” to Sprigler (a relative), who recorded the deed on November 30, 2005.  Sprigler did not assume the mortgage in the transaction.  The borrowers failed to make payments and therefore defaulted under the note and mortgage.  The default prompted the lender to initiate the mortgage foreclosure case. 

BFP?  My May 27 post outlines the elements of the bona fide purchaser doctrine, which Sprigler used to oppose the lender’s motion for summary judgment in CitiMortgage.  Sprigler contended that he “took in good faith believing that the real estate was being conveyed to him free and clear of all liens.” 

As the Indiana Court of Appeals did in Kumar, Judge Barker in CitiMortgage turned to Ind. Code § 32-21-4-1, which she labeled the “Race-Notice Statute.”  In Indiana, the question of priority as it relates to a good faith purchaser generally is governed by that statute.  Unlike in Kumar, the BFP defense didn’t fly in CitiMortgage.

“Race-Notice” statutes give all parties an incentive to record their interests in the subject property.  Under the Indiana statute, a subsequent purchaser (Sprigler) cannot obtain priority if he knew about the mortgage to the first mortgage holder (CitiMortgage), or if he lost the “race” to record his interest.  In the case at bar, Sprigler claims that he did not know about CitiMortgage’s mortgage.  While this may be true, the facts clearly demonstrate that he lost the race to record.  CitiMortgage recorded its mortgage on April 2, 2002.  Under Indiana’s Race-Notice statute, Sprigler was constructively on notice of CitiMortgage’s interest when he recorded his interest on November 30, 2005.  Thus, CitiMortgage’s interest has priority over Sprigler’s interest, and CitiMortgage is entitled to summary judgment.

Mortgagee protected.  In Kumar, there was no notice due the failure to timely record a tax deed.  In CitiMortgage, there was notice because the lender properly and timely recorded its mortgage.  One of Kumar’s lessons was “don’t forget to record the deed.”  One of CitiMortgage’s lessons is “don’t forget to record the mortgage.”  Although not expressed in the CitiMortgage opinion, clearly Sprigler failed to search title before acquiring the real estate.  The lender adequately protected itself by recording its mortgage.  Had it failed to do so, the BFP doctrine may have negated the mortgagee’s interest in the property. 

IRS lien.  As an aside, the United States of America had interests in the property arising out of IRS liens and thus was named as a defendant in the case.  The IRS filed notices of liens beginning on March 17, 2004, after the lender recorded its mortgage on April 2, 2002.  In response to the lender’s summary judgment motion, the United States sought the recognition of its liens and their priorities.  Specifically, a foreclosure decree must spell out the right of redemption of the United States contained in 28 U.S.C. § 2410(c).  Pursuant to Indiana’s recording statute, a/k/a the race-notice statute, the IRS lien interests have priority “according to the time of the filing thereof.”   Because the lender’s mortgage interest had first priority in the property, the liens of the United States were subordinate.  However, per § 2410(c), the United States retained a right of redemption for 120 days from the sheriff’s sale.  For more on liens of the United States, study 28 U.S.C. § 2410.

Don’t Forget To Record The Deed

The Indiana Court of Appeals in Kumar v. Bay Bridge, 2009 Ind. App. LEXIS 507 (Ind. Ct. App. 2009) (.pdf) explained what might happen if one purchases real estate but fails to record the deed.  In Kumar, prior owner, INB National Bank Trust, had not paid property taxes for years.  Mr. Kumar acquired the subject real estate at a tax sale but didn’t immediately record the tax deed.  After the tax sale, the successor-in-interest to the Trust conveyed the property to Bay Bridge, which recorded the trustee’s deed shortly thereafter.  Bay Bridge later discovered that Kumar claimed an interest in the property.  Bay Bridge filed a complaint to quiet title to the real estate and named Kumar as a defendant.  In response, Kumar quickly recorded his tax deed, but the Court held it was too late.

The recording statute.  Ind. Code § 32-21-4-1 provides that deeds must be recorded in the Recorder’s Office of the county where the land is situated and, furthermore, that a conveyance “takes priority according to the time of its filing.”  The purpose of this so-called recording statute “is to provide protection to subsequent purchasers, lessees and mortgagees.”

Bona fide purchaser doctrine.  Because Kumar failed to record his tax deed as required by I.C. § 32-21-4-1, Bay Bridge did not have notice of Kumar’s interest when it purchased the property.  In the lawsuit, Bay Bridge argued for the application of Indiana’s bona fide purchaser doctrine with respect to Kumar’s claim to ownership of the real estate.   The Court of Appeals stated the general rule that “to qualify as a bona fide purchaser, one has to [1] purchase in good faith, [2] for valuable consideration, and [3] without notice of the outstanding rights of others.”  This acts as a defense to title, and the theory “is that every reasonable effort should be made to protect a purchaser of legal title for a valuable consideration without notice of a legal defect.” 

Notice.  There was no question Bay Bridge was a purchaser in good faith for valuable consideration.  The only issue was whether it was without notice of Kumar’s interest.  In Indiana:

 A purchaser of real estate is presumed to have examined the records of such deeds as constitute the chain of title thereto under which he claims, and is charged with notice, actual or constructive, of all facts recited in such records showing encumbrances, or the non-payment of purchase-money.  A record outside the chain of title does not provide notice to bona fide purchasers for value.

Kumar failed to record, so Bay Bridge wasn’t deemed to have notice.  Also, there was evidence in Kumar that, before purchasing the property, Bay Bridge had requested a title search and found nothing with regard to the tax sale or Kumar’s tax deed.

Unfortunate, but understandable, result.  The Court of Appeals affirmed the trial court’s summary judgment in favor of Bay Bridge on its complaint to quiet title.  The Court wiped away Kumar’s interest in the property.  Had Kumar simply recorded the tax deed, there never would have been a issue.  The Kumar case is a reminder for foreclosing lenders and their counsel to record the sheriff’s deed following a sheriff’s sale, or any deed executed in connection with a deed-in-lieu of foreclosure.  Bizarre problems like the one illustrated in Kumar are rare but can arise in connection with a commercial mortgage foreclosure.  Moreover, secured lenders need to be aware of the bona fide purchaser doctrine should unexpected claims to title arise during or after the foreclosure process. 

No Signatures, No Promissory Notes, No Problem

Has your lending institution lost its promissory note?  Is the defaulting mortgagee claiming she did not sign the mortgage?  As explained in Bonilla v. Commercial Services, 2009 Ind. App. LEXIS 112 (Bonilla.pdf), all may not be lost.

History.  In the mid-1980’s, husband arranged for two loans that were secured by real estate upon which a gasoline service station operated.  The mortgages contained the signatures of both husband and wife as co-mortgagors.  Husband died in 1991.  The mortgagee filed a foreclosure action against wife in 2000.  Wife lost at trial, and appealed.  Her appeal centered on two arguments:  (1) she did not sign the subject mortgages and (2) the plaintiff (mortgagor) failed to produce the underlying promissory notes.

Signatures.  Wife claimed that she adequately established her non-participation in the mortgage executions.  She even submitted handwriting samples to contest the alleged signatures.  The trial court found the samples to “clearly show a distinct difference between the signatures of wife in the exemplars and the purported signature of wife on the mortgages.”  Wife’s purported signatures on the mortgages, however, were notarized, which created a presumption that wife signed them.  Ind. Code § 33-42-2-6 provides that the “official certificate of a notary public, attested by the notary’s seal, is presumptive evidence of the facts stated in cases where, by law, the notary public is authorized to certify the facts.”  The trial court concluded that wife’s evidence was inadequate to rebut the presumption, and the Indiana Court of Appeals affirmed.  Significantly, the trial court found that wife admitted she knew of the debts and of her husband’s unsuccessful attempts to settle them before his death.  Furthermore, she made no effort during any of the intervening twenty years to either set aside the mortgages, to quiet title to the property or to return any of the funds associated with the mortgages.  Finally, wife admitted at trial that she benefited from the funds received from the loans associated with the mortgages. 

Damages.  Wife’s second argument on appeal was that the trial court erred in determining the damages owed.  The mortgages had been submitted into evidence, but the promissory notes were not.  Based upon the Indiana Supreme Court’s decision in Yanoff v. Muncy, 688 N.E.2d 1259 (Ind. 1997) and I.C. § 26-1-3.1-309 "Enforcement of lost, destroyed, or stolen instrument", the notes’ absence was not a bar to recovery.  In Indiana, a plaintiff in a foreclosure action does not necessarily need to produce the promissory note to recover the debt.  The debtor in Yanoff provided testimony of the essential terms of the debt, such as the amount of the original debt, the interest rate, the existence of a mortgage securing the debt, and the schedule of payments.  Such evidence, according to Yanoff, was “enough to prove both the existence of the promissory note underlying the mortgage and its essential terms.” 

In Bonilla, the Court of Appeals found that the record contained undisputed evidence establishing the terms, dates, amounts of, and interest rates on the two mortgages.  Wife also conceded that no payments had been made on the mortgages since they were executed over twenty years ago.  Even though the Court did not have the precise terms of the notes, there was a reasonable inference to draw from the evidence submitted at trial “that the failure to make a single payment on the notes in over twenty years is an event of default.” 

Wife lost the case, even though she presented fairly strong evidence that she did not sign the mortgages and even though the plaintiff mortgagee was unable to produce the promissory notes.  In the end, Indiana law allowed the mortgagee in Bonilla to dodge a bullet.

Termination Of Mortgages In Indiana

As promised, this post will speak to the second issue in the Bank of America case that was the subject of my February 15 post.  This discussion will help secured lenders who may struggle with knowing whether Indiana law permits the release of a prior mortgage when such mortgage secured a revolving line of credit that has been paid in full.

Contracts and performance.  Due to the importance of the language in the 1999 Bank One mortgage, I must outline it here:

[W]ithout limitation, this Mortgage secures a revolving line of credit, which obligates [Bank One] to make future obligations and advances to [borrower] up to a maximum amount of $ 80,000.00 so long as [borrower] complies with all the terms of the Credit Agreement.  . . .  It is the intention of [borrower] and [Bank One] that this Mortgage secures the balance outstanding under the Credit Agreement from time to time from zero up to the Credit Limit as provided above and any intermediate balance.  . . .

PAYMENT AND PERFORMANCE. Except as otherwise provided in this Mortgage, [borrower] shall pay to [Bank One] all amounts secured by this Mortgage as they become due, and shall strictly perform all of [borrower's] obligations under this Mortgage.  . . .

FULL PERFORMANCE.  If [borrower] pays all the indebtedness when due, terminates the Credit Agreement, and otherwise performs all the obligations imposed upon [borrower] under this Mortgage, [Bank One] shall execute and deliver to [borrower] a suitable satisfaction of this Mortgage and suitable statements of termination of any financing statement on file evidencing [Bank One's] security interest in the Rents and the Personal Property. [Borrower] will pay, if permitted by applicable law, any reasonable termination fee as determined by [Bank One] from time to time.  . . .

In 2001, when a portion of the proceeds from the Bank of America loan was used to pay the entire outstanding balance of the Bank One loan, Bank One did not send “correspondence or instructions” to Bank of America or the borrower.  In addition, neither the borrower nor Bank of America took action to terminate the Bank One credit agreement. 

The fight.  The litigation surrounded whether the prior Bank One mortgage had priority over the subsequent Bank of America mortgage.  Bank of America contended that, under I.C.§ 32-28-1-1(b), it was entitled to a release of the Bank One mortgage because Bank of America discharged the debt underlying that mortgage and, furthermore, because that mortgage was ambiguous as to whether written notice of termination by the mortgagor was required for the mortgage to be released.  I.C. § 32-28-1-1(b) states, in pertinent part:  “When the debt . . . on . . . the mortgage . . . has been fully paid, lawfully tendered, and discharged, the owner, holder, or custodian shall:  (1) release; (2) discharge; and (3) satisfy of record; the mortgage . . ..”  The Court concluded that the Bank One mortgage stated three requirements for “full performance:”  (1) borrower must pay all the indebtedness when due, (2) borrower must terminate the credit agreement and (3) borrower must perform all other obligations.  Each of those three was required of the borrower before Bank One was obligated to release the mortgage. 

Bank One the winner.  It was undisputed that, even though the indebtedness under the mortgage had been paid, the borrower took no affirmative action to terminate the credit agreement.  As a result, the Court held that Bank One was not required to release its lien on the real estate.  Bank of America complained that the Bank One mortgage did not require written notice of termination and that Bank One failed to notify the borrower or Bank of America what act was required to terminate the credit agreement.  The Court rejected the argument and reasoned that the Bank One mortgage “clearly require[ed] some affirmative act of termination.  . . .  The Bank One mortgage required [borrower] to terminate the Credit Agreement; Bank One did not need to reiterate to [borrower] her contractual obligations.”

Always follow-up.  The important court holding here is that “absent documentation to the contrary, we decline to hold that merely to pay off an outstanding balance is sufficient to terminate a revolving line of credit, as that would violate the very nature of the credit.”  Unlike a mortgage securing a term note, the Bank One mortgage secured a revolving line of credit that contemplated future advances, regardless of whether there was an occasional zero balance. 

Secured lenders operating in Indiana, particularly those involved in refinancing, need to be aware that, if confronted with facts similar to the Bank of America case, merely paying off a line of credit may be insufficient in itself to terminate a prior note/credit agreement/mortgage.  So, review and analyze the loan documents and ensure you jump through all the hoops to terminate the prior transaction and lien.  Otherwise, you may be faced with an unexpected subordinate lien position.

Inattention To Detail: Another Lesson In Mortgage Loan Documentation

Judge Philip Klingeberger of the U.S. Bankruptcy Court for the Northern District of Indiana addressed a unique situation in In Re Canaday, 2007 Bankr. LEXIS 3121 (N.D. Ind. 2007) (CanadayOpinion.pdf).  The loan transaction involved a note, which identified the holder to be a trust (the Don Wilson Revocable Living Trust), and a mortgage, which identified the mortgagee to be an individual (Don Wilson).  The 19-page opinion provides an impressive summary of various Indiana mortgage laws and illustrates once again the consequences of sloppy transactional work.    

The problem.  Debtor Canaday, the owner of real estate, executed a note in favor of the Wilson Trust and, contemporaneously, a mortgage in favor of Don Wilson, individually.  So, the Wilson Trust held the note, but Wilson individually held the mortgage.  (It also bears mentioning that the mortgage referred to a January 12 note, but the date of the note was January 13.)  When the debtor filed bankruptcy, Don Wilson, as a creditor, filed a secured claim in the bankruptcy case.  The debtor objected to the secured status of the claim and asserted that the mortgage was invalid.  The issue was whether the mortgage was effective against a hypothetical bona fide purchaser under 11 U.S.C. § 544(a)(3).  Canaday at 5. 

Gap in the law.  According to Judge Klingeberger:

  [T]here is an amazing, incredible lack of case law on the issue
  of the validity of a mortgage – both in relation to the parties to
  that instrument and in relation to third parties potentially having
  interests in the real estate subject to the mortgage – in a
  circumstance in which no indebtedness is owed in any manner
  to the designated mortgagee. 

Id. at 11.  The absence of case law probably has to do with the unique set of facts.  How often, if ever, would a lender execute loan documents in which the lender’s name in the note and the mortgage was not identical?  Judge Klingeberger sidestepped the opportunity to create new law as to this issue but instead based his holding on more settled principles.   

Indiana’s mortgage statutes.  The rules upon which the Judge primarily focused can be found in two Indiana statutes, Indiana Code § § 32-21-4-1 and 32-29-1-5. 

     I.C. § 32-21-4-1, Indiana’s recording statute, generally provides that constructive notice sufficient to defeat the interests of a bona fide purchaser is given only if the mortgage is recorded.  Canaday at 9.  The purpose of the recording statute is to give subsequent purchasers constructive notice of a prior conveyance.  Id.  “Constructive notice” means “a legal inference from established facts.”  Id. at 10.  For example “deeds and mortgages, when properly acknowledged and placed on record as required by statute, are constructive notice of their existence.”  Id.  “Actual notice” means that a party actually knows, for instance, of the existence of a mortgage.  In instances of constructive notice, a party may not actually know of a fact but is deemed to know it.

     I.C. § 32-29-1-5, the second statutory piece of the puzzle, defines both the elements of a mortgage that is valid between the mortgagor and the mortgagee, and – in conjunction with I.C. § 32-21-4-1 – also defines the requirements for a mortgage to be valid against a bona fide purchaser of the subject property from the mortgagor.  Canaday at 10.  At issue in Canaday were requirements surrounding the description of the indebtedness.  “Indiana has a long line of cases which cogently define the elements of the description of an indebtedness in a mortgage which caused that mortgage to be valid both between the parties, and with respect to third persons . . ..”  Id. at 13.  Judge Klingeberger ultimately concluded that the indebtedness description in the mortgage instrument, for purposes of giving rise to a secured claim, was insufficient:

Indiana case law … requires far more than the mortgage instrument at issue in this case provides in order to sustain the validity of that mortgage against a bona fide purchaser.  The mortgage instrument in this case does not direct an individual reviewing the real property records with respect to the subject real estate to an individual who can be assumed, based upon this record, to have knowledge as to the indebtedness secured by the mortgage.  The mortgage instrument in this case describes a promissory note which does not exist – there is simply no evidence of any obligation evidenced by a promissory note dated January 12, 2005, and the mis-description of the date of the actual note evidencing the underlying obligation secured by the mortgage creates exactly the situation in which Indiana case law seeks to avoid with respect to substitution of indebtedness.  In similar manner, even apart from the erroneous designation of the date of the promissory note, there is insufficient information in the mortgage to clearly identify the indebtedness to which it relates.  Finally, there is no statement in the mortgage of “the date of the repayment” of the indebtedness which the mortgage purports to secure.

Id. at 18-19 (emphasis in original). 

Canaday is another example of the consequences of inattention to detail in the preparation of loan documents.  The creditor’s secured claim was relegated to an unsecured claim with significantly less value, if any value at all.  It’s hard for lien enforcement lawyers like me to meet the needs of banking clients when the underlying loan documents are flawed.  Remember – enforcement of a creditor’s rights begins when the parties initially draft the docs. 

Technical Errors In Mortgage Language May Not Be Fatal

On August 2, 2007, Judge Philip Simon of the Northern District of Indiana, Hammond Division, issued an opinion about the impact of a mortgage that incorrectly defined the borrowers.  See, In Re:  Camp, 2007 U.S. Dist. LEXIS 57292 (N.D. Ind. 2007) (CampOpinion.pdf).  Judge Simon’s opinion discusses some of the general rules applicable to Indiana mortgage instruments, and there are lessons to be learned from the case.

Background.  Only husband signed the note.  But, both husband and wife executed the mortgage as “borrowers.”  Husband subsequently filed a Chapter 13 petition for bankruptcy, and the assignee of the note and mortgage filed a secured claim in the bankruptcy proceeding.  Husband-debtor argued that the secured claim should be avoided because the mortgage was invalid.  He wanted the property to be free and clear of all liens.  The legal basis of his argument was that the mortgage did not sufficiently describe the debt it purported to secure. 

Bankruptcy context.  11 U.S.C. § 544(a)(3) governed the ruling.  The two specific issues were (1) whether the debt was adequately described in the mortgage and (2) whether the mortgage provided constructive notice to a bona fide purchaser as required by federal bankruptcy law.  (11 U.S.C. § 544 (a)(3) is known as the “strong-arm statute”.)  Generally, an encumbrance can be avoided if a bona fide purchaser would not have constructive notice of it.

Indiana mortgage laws.  Here are some of the relevant Indiana statutes and common law rules:

1.  Ind. Code § 32-21-4-1 provides that constructive notice is given by a properly-recorded instrument.

2.  I.C. § 32-21-2-3 states that a mortgage must be acknowledged by the grantor to be recorded.

3.  I.C. § 32-29-1-5 sets forth the requirement for a form mortgage.  Among other things, the mortgage must describe the debt sought to be secured, and it must be dated and signed, sealed and acknowledged by the grantor. 

4.  The mortgage must be properly acknowledged and recorded to provide constructive notice to subsequent purchasers.  The mortgage must be recorded in the proper county and must contain an accurate legal description of the property. 

5.  The mortgage must be in the chain of title.

6.  In Indiana, the recording of a document not entitled to be recorded (due to statutory violations) does not afford constructive notice.  Exceptions to this general rule could include, for instance, a mortgage that omits the preparer’s name.  Although technically in violation of I.C. § 36-2-11-15(b) , constructive notice is still afforded because the defect “was not one which would have been fatal to a conveyance or encumbrance.  Thus, a title searcher wishing to verify the legal title of the property would have found all the formalities necessary to prepare a valid conveyance or [encumbrance].”  Camp at 8.

Camp technicality.  The mortgage indicated that husband and wife collectively were the “borrower.”  Actually, only husband executed the note.  This error breached the statute requiring a proper description of the debt.  I.C. § 32-29-1-5.  The question for the Court in Camp was whether this statutory violation defeated constructive notice or whether it was, in the final analysis, immaterial.  Here is what a prior Indiana opinion stated:

  The description in the mortgage of the indebtedness secured
  need not be literally accurate, but must be correct so far as it
  goes, and full enough to direct attention to the sources of correct
  information in regard to it, and be such as not to mislead or
  deceive, as to the nature or amount of it, by the language used.

Pioneer v. First Merchants, 349 N.E.2d 219, 222 (Ind. Ct. App. 1976). 

The mortgage in question “complied with almost all of Indiana’s statutory requirements.”  Camp at 9.  It expressly stated that an encumbrance (by virtue of the note) existed on the property.  The Court found that “any bona fide purchaser would have constructive notice of the existence of the Note and its amount - - the most important aspects of the debt - - even if the defined executor of the Note was incorrect.”  Id.  The Court further concluded that a bona fide purchaser then would have a duty to inquire into the substance of the note and, ultimately, would find that the note and the mortgage were signed on the same day, stated the same amount, described the same lender and included the same repayment date.  Accordingly, the mortgage passed the operative test:  a proper examination of the record would have led a reasonable man to conclude that the property to be mortgaged was subject to a prior encumbrance.  As such, the husband-debtor’s objection to the mortgage lender’s secured claim was overruled.

Be careful.  Sometimes technical errors will be fatal.  Sometimes they won’t.  Fortunately for the lender in Camp, other accuracies in the loan documents trumped the isolated inaccuracy.  Despite the ultimate victory, however, it appears much time and effort went into litigating the issue.  Aside from the obvious lesson that not all language errors will be fatal to a mortgage lien, perhaps a more important lesson is that the loan documents on the front end of a deal should be perfect.  Time and legal fees would have been saved had the borrower been described properly.  A simple, innocent oversight I’m sure, but a costly one nonetheless.

INDIANA FOLLOWS THE LIEN THEORY OF MORTGAGES

An interesting dispute in the United States Bankruptcy Court for the Northern District of Indiana resulted in a March 27, 2007 opinion by Judge Harry C. Dees, Jr. about a borrower’s attempt to transfer ordinance citations, fines and other property-related liabilities to a lender.  The issue was whether a mortgagor’s/borrower’s unilateral execution and recordation of a quit-claim deed effectively transferred the real estate to the mortgagee/lender.  Although the case involved residential property, the rules and holding are equally applicable to commercial real estate and business borrowers.  The lesson of Phillips v. City of South Bend, 2007 Bankr. LEXIS 1503 (N.D. Ind. 2007) is:  a borrower simply can’t unload its real estate-based problems onto a secured lender without some kind of agreement or consent.  (PhillipsOpinion.pdf).   

The facts.  The City of South Bend pursued a residential property owner for nuisance violations related to property, which was in disrepair and had documented unsanitary conditions in the yard.  Potential fines and penalties were around $5,000.  Citifinancial held a mortgage on the property.  The borrower/mortgagor, in an apparent effort to avoid municipal liability, executed and recorded a quit-claim deed purporting to abandon the property and transfer title to Citifinancial.  Citifinancial, however, never “acknowledged transfer of the property” or took “responsibility for maintaining the property.”  Id. at 3.  Citifinancial “did not accept the transfer” (although it is not entirely clear how Citifinancial manifested that non-acceptance).  The borrower did not enter into any kind of written agreement with Citifinancial, and Citifinancial “took no action at all” with regard to the property.  Id. at 14.  There was no written consent by Citifinancial or any activity demonstrating consent, such as the physical possession of the property.  Evidently, Citifinancial simply ignored the quit-claim deed.

Indiana mortgages, generally.  Indiana follows the “lien theory” of mortgages.  This means that a mortgage creates a lien on property but not title to it.  Mortgagees do not have an ownership interest in the real estate.  Id. at 15.  Title to property cannot be transferred to the mortgagee unless there is a foreclosure and sale (or a deed-in-lieu of foreclosure).  Indiana defines “foreclosure” as a legal proceeding that terminates a mortgagor’s interest in property.  Id.  “The right to possession, use and enjoyment of the mortgaged property, as well as title, remains in the mortgagor, unless otherwise specifically provided, and the mortgage is a mere security for the debt.  Id.  So, secured lenders holding Indiana mortgages merely have liens as security for their loans.

Transfer is a two-way street.  In Phillips, the borrower executed and recorded a quit-claim deed in order to surrender the property, but no foreclosure took place.  The Court held that the borrower could not compel the mortgage holder to accept the surrendered, quit-claimed property and that the borrower continued to be the owner of the property, with all the rights and obligations.  The City properly enforced its property maintenance codes against the borrower, not the lender, as owner of the property.  Id. at 15.  The unilateral execution of a quit-claim deed in an effort to surrender the property to mortgage holder, while clever, ultimately accomplished nothing from the standpoint of avoiding liability. 

Impact on commercial cases.  Phillips impacts the handling of commercial foreclosure cases as well.  A corporate borrower in possession of commercial real estate collateral could decide, in an effort to avoid certain liabilities related to the ownership of the land (such as public nuisance fines, utility charges or maybe even real estate taxes), to dump these problems back on a commercial lender simply by quit-claiming the property and surrendering possession.  A secured lender may, for a variety of reasons, not want the property, particularly by quit-claim deed, until the property is run through a foreclosure.  In that case, according to Phillips, the secured lender should take every possible action to show that it has not acknowledged or accepted transfer of the property or otherwise consented to ownership.  Don’t sign any paperwork indicating you are the owner.  Avoid physical presence on the premises.  Make sure there are no communications with the mortgagor/borrower other than with statements that unequivocally demonstrate you do not want title to the property at that time (unless through a deed-in-lieu of foreclosure with a supporting agreement).  That way, if and when you want to liquidate the collateral or become the owner of the property, you can do it on your own terms and avoid the potential liability found in Phillips.