Bankruptcy Court Denies Chapter 7 Trustee's Attempt to Avoid Chase Bank's Mortgage
Dena Kaufman | Bloomberg Law
The U.S. Bankruptcy Court for the Eastern District of New York dismissed an adversary proceeding to avoid an improperly recorded senior mortgage on estate property held by JPMorgan Chase Bank N.A. pursuant to 11 U.S.C. § 544(a)(3). The Court concluded that the chapter 7 trustee could not avoid the mortgage because as of the petition date a hypothetical bona fide purchaser of the property could not have done so.
Carlos and Maria Lopez (Debtors) purchased real property located on 84th Street in Queens, New York, in 2004. The property was identified in the real property records as Block 1381, Lot 23. Debtors obtained a loan from Chase in the amount of $280,000 to purchase the property and gave Chase a first mortgage on the property. The cover page prepared to record the first mortgage erroneously described the property as Block 1381, Lot 2, and, due to this error, the first mortgage was recorded against the wrong property.
Thereafter, in March of 2006, Debtors took out a home equity line of credit from Chase in the amount of $200,000, secured by a second mortgage on the property. The second mortgage was properly recorded against the Debtors’ property and specifically provided the following language referring to the first mortgage:
The lien of this Security Instrument securing the Sums Secured may be secondary and inferior to the lien securing payment of an existing obligation. The existing obligation has a current principal balance of approximately $275,374.
Debtors filed a chapter 13 petition on April 12, 2010. Approximately one month later, the bankruptcy case was converted to a case under chapter 7 and a chapter 7 trustee was appointed. As of the commencement of the bankruptcy case, Chase’s first mortgage was not properly recorded against Debtors’ property but Chase’s second mortgage was properly recorded against the property.
The Adversary Proceeding
The chapter 7 trustee initiated an adversary proceeding against Chase seeking to avoid the first mortgage pursuant to 11 U.S.C. § 544(a)(3) and New York Real Property Law § 291 and to preserve the lien for the benefit of the estate pursuant to 11 U.S.C. § 551, asserting that the first mortgage was avoidable because it was not properly recorded against the property. Thereafter, the trustee and Chase filed a joint motion for judgment on stipulated facts. The trustee argued that the first mortgage was void as against a hypothetical bona fide purchaser of the property as of the petition date because it was not properly recorded against the property and, thus, it was subject to avoidance by the trustee. In opposition, Chase argued that the properly recorded second mortgage gave notice of the first mortgage to any hypothetical bona fide purchaser and, as such, the trustee was not entitled to the status of a bona fide purchaser without knowledge of the first mortgage.
Chase’s First Mortgage Was Not Avoidable
The Court noted that section 544(a)(3) vests the trustee, as of the petition date, with the same rights to avoid liens on a debtor’s property as those possessed by a bona fide purchaser of the property from the debtor. Thus, to the extent a hypothetical bona fide purchaser of the property could avoid the mortgage as of the petition date, the trustee had the power to avoid it. After explaining that the requirements of bona fide purchaser status are governed by substantive state law, the Court found that, under New York law, a purchaser must have purchased the property in good faith for valuable consideration and without notice in order to be deemed a bona fide purchaser. Thus, the issue before the Court was whether a hypothetical purchaser would be deemed to have had actual or constructive notice of the mortgage as of the petition date (i.e., whether the trustee was imputed with actual or constructive notice of Chase’s first mortgage as of the petition date).
The Court noted that resolution of the issue hinged on whether the references to the improperly recorded first mortgage in the second mortgage were sufficient to charge the trustee with notice of the first mortgage. The Court found that, under a recording system such as New York’s, a purchaser is imputed with knowledge of all properly recorded documents and all of the information contained therein. Thus, because the second mortgage was propertly recorded in the correct chain of title, a hypothetical purchaser who properly examined the second mortgage would have discovered the reference to first mortgage. Because the trustee stood in the shoes of a hypothetical purchaser, he was “charged with both the duty to make further inquiry to determine the status of that senior encumbrance and with notice of the facts that a proper inquiry would have disclosed.” Thus, the Court held, the trustee was imputed with notice of the first mortgage and could not achieve bona fide purchaser status to avoid the first mortgage under section 544(a)(3).
Accordingly, the Court held that the trustee could not avoid Chase’s first mortgage and dismissed the adversary proceeding.
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