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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.