In re Heaver (Fed)

Summary:  A mortgage recorded prior to the recording of the warranty deed vesting title in the grantor of the mortgage is considered outside the chain of title and does not give constructive notice to third persons, including Chapter 7 bankruptcy trustees.

In re Heaver, BR 09-B-73096, 2012 WL 2126952 (Bankr. N.D. Ill., 2012).

Facts:  Jeanine Heaver obtained a warranty deed for property in Hebron, Illinois on September 30, 2008. The same day, Heaver signed a promissory note and mortgage on the property in favor of First Centennial Mortgage Corporation. The mortgage was recorded in the McHenry County Recorder’s Office on October 24, 2008, but the warranty deed was not recorded until October 31, 2008. Heaver filed for Chapter 7 bankruptcy on July 27, 2009. Sometime after the mortgage recording but before Heaver’s petition for bankruptcy, First Centennial transferred the promissory note to Branch Banking & Trust Co, the party to this action.

Branch Banking argued that because the deed and the mortgage were recorded before the bankruptcy petition, the bankruptcy trustee cannot avoid the mortgage. The Chapter 7 Trustee filed this adversary complaint to determine the validity of the mortgage, arguing that the mortgage was recorded before the deed and therefore if falls outside the chain of title, making it avoidable under the “strong arm” clause of the bankruptcy code. This clause gives a bankruptcy trustee bona fide purchaser status and the power to avoid any transfer of property of the debtor, or obligation incurred by the debtor that would be voidable by a bona fide purchaser of the property. Based on the undisputed facts, Branch Banking filed a motion for summary judgment.

Holding:  The Northern District of Illinois, Western Division, denied Branch Banking’s motion for summary judgment after determining the mortgage to be avoidable by the Bankruptcy Trustee. The express language of Section 544(a) of the Bankruptcy Code directs bankruptcy courts to ignore any knowledge of the trustee or of any creditor, and therefore “actual knowledge of a transfer or encumbrance on the property is irrelevant.” The pertinent question was whether under Section 544(a)(3), state law requirements of constructive notice to a bona fide purchaser were met with these facts.

The court held that constructive notice was not present because the mortgage was not within the “chain of title,” relying on Illinois court’s emphasis that the relevant time for establishing whether a record of a mortgage is in the chain of title is the date of “record title,” not the date a deed is signed.

The deed and mortgage must be of record and show that the grantor owned the land at the time the mortgage was granted. Record of a mortgage given prior to the time of the acquisition of record title is not in the chain of title and does not offer constructive notice to third persons. The Illinois Conveyance Act states that “deeds and mortgage shall only take effect and be in force from and after the time of filing the same for record, and not before” and shall “be adjudged void” except to those with actual notice until recorded. Because Branch Banking’s mortgage was recorded before title was vested, it is outside the chain of title and does not give constructive notice to a hypothetical bona fide purchaser, or a bankruptcy trustee who carries the same status. 

The court also rejected Branch Banking’s alternate argument that even if the mortgage did not create constructive notice, it was still sufficient to create “inquiry notice.” In Illinois, one is put on inquiry notice when they have “notice of facts which put a prudent man on inquiry, is chargeable with knowledge of other facts which he might have discovered by diligent inquiry.” The court held that some types of facts that would create inquiry notice under state law would not create constructive notice under bankruptcy law. Under Section 544(a) of the Bankruptcy Code, a trustee disregards any actual knowledge of the facts so the trustee would have to have had constructive knowledge of the facts that would supposedly put him on inquiry notice.

While it may have been possible for a diligent purchaser to attain notice by thoroughly examining the records and dates, Illinois imposes no such duty on prospective purchasers to search for encumbrances prior to the date the seller acquired record title, which is the date the deed is recorded. In this case the deed recording date came after the recording of the mortgage so a trustee is only charged with constructive notice of interests going back to the date of the deed recording, which does not include the mortgage recording.

Opinion Year: 
By: ATG Underwriting Department | Posted on: Fri, 08/31/2012 - 9:10am