Posting for

Wednesday, February 23, 2000

by: Bert Rush

DEFECTIVE DOCUMENTS/ACKNOWLEDGMENTS/NOTARY SEAL/ CONSTRUCTIVE NOTICE/BONA FIDE PURCHASER/ BANKRUPTCY/ TRUSTEE AVOIDING POWER

The Tennessee Supreme Court has held that a deed of trust recorded without the required notary seal is not "legally registered," and is null and void for purposes of imparting constructive notice.

The case is In re Marsh (Limor v. Fleet Mortgage Group), 12 S.W.3d 449 (Tenn. 2000). Here's what happened.

In May 1988 Harry and Trudi Marsh gave a deed of trust against their property in Robertson County, Tennessee, to Dominion Bankshares Mortgage Corporation. The deed of trust was promptly recorded. The note and deed of trust were later assigned to Fleet Mortgage Group, and the loan was serviced by Bank United.

Ten years later, in May 1998, the Marshes filed Chapter 7 bankruptcy, and Susan R. Limor was appointed trustee. In reviewing the Marshes' assets and liabilities, the trustee noticed that the May 1988 deed of trust was defectively acknowledged because the notary's seal was missing.

The trustee filed an adversary proceeding in bankruptcy court, seeking to avoid the defective deed of trust as an interest in the debtors' real property on the ground that the seal was not affixed as required by Tennessee law. This filing was based on Bankruptcy Code section 544 (11 U.S.C. section 544) which, as seasoned (LandSakes) Savants know, gives the trustee in bankruptcy (or a debtor in possession) the status of a hypothetical creditor or bona fide purchaser as to the debtor's estate, allowing the trustee to avoid any interest in the debtor's real property which was not perfected as of the date of commencement of bankruptcy.

The adversary proceeding was opposed by Fleet Mortgage and the servicing agent. Cross motions for summary judgment were filed. Neither party disputed authenticity of the deed of trust, the signatures of the debtors, nor the authority of the notary. The sole question was:

"Whether the omission of the official notary seal

in the acknowledgment on a Tennessee deed of

trust as required by Tennessee Code Annotated

section 66-22-110, renders the instrument 'null and

void as to...subsequent creditors...or bona fide

purchasers...without notice' as provided in

Tennessee Code Annotated section 66-26-103."

Finding this to be question not previously addressed by Tennessee courts, the bankruptcy court certified the question to the Tennessee Supreme Court, and the Supreme Court agreed to resolve it.

The Court first explained the purpose of the acknowledgment under Tennessee law, which is to "authenticate" an instrument for valid recording. The acknowledgment may be made before certain specified officers of the court, or made before a notary public. If made before a notary, Tennessee statutes specify that the notary's seal must be affixed in order to provide "prima facie proof of a notary's official character or, simply stated, that the notary is a notary." Without the seal, a party later examining the document may be unsure of its validity and/or proper acknowledgment.

And so, the Court held:

"(A) deed of trust which is improperly acknowledged

because it lacks an official notary's seal is not legally

registered (recorded) and is null and void as to

subsequent creditors or bona fide purchasers without

notice under Tenn. Code Ann. section 66-26-103."

In so holding, the Court distinguished this sort of fatal defect from lesser defects, such as omission of words required by statute from the language of an acknowledgment, explaining that in the latter case there may nevertheless be substantial compliance with the statutes.

Comment: The Court's decision paves the way for the disputed deed of trust (insured, wouldn't you know, by First American) to be avoided back in the bankruptcy court. If it was not "legally" recorded, it follows the deed of trust was not "perfected" as an interest in the debtors' real property as of the date of commencement of the bankruptcy.

This would make our insured lender an unsecured creditor.

Note the Court's reference to subsequent creditors and/or bona fide purchasers "without notice." It remains the general rule that a subsequent party with actual notice of an off-record interest in property will take subject to the off-record interest. But this rule doesn't apply to the so-called "trustee avoiding power," because Bankruptcy Code section 544 specifies that the trustee (or debtor-in-possession) enjoys the status of a hypothetical creditor or b.f.p. "without regard to the knowledge of the trustee or of any creditor."

The purpose of section 544 is to protect unsecured creditors from "side deals" and dubious off-record claims, which may be created to benefit a favored creditor over the others. But here, where there's no question of the authenticity of the deed of trust or the intentions of parties to its creation, application of section 544 appears harsh indeed.

A not-so-gentle reminder of the importance of checking the contents of documents to be insured before they're sent off to the recorder's office.

**********

Following Wednesday's posting, Jim Dondero (Grand Rapids, MI) writes:

As you say, a "not-so-gentle reminder"! I am continually amazed that such matters are anything more than mere "recording defects" under the laws in these states. What an incredibly harsh legal fiction to say that, once recorded, the documents do not impart constructive notice. And, what about ACTUAL notice ??? You might wish to remind Sevants of similar results under recording statutes in the Carolinas and, I believe recently, Ohio, ... and other states ???

Keith Pearson (Glendale/Los Angeles) writes:

Interesting case. Seems like a harsh remedy. California as you know allows that an unacknowledged document that gets recorded anyway becomes constructive notice one year after recording, See Cal. Civil Code Sec. 1207.

Also, I found an interesting case in Miller & Starr called Eichler v. Gray 27 F.2d 328 (9th Circ.1928) which held that under the old bankruptcy statute a trustee in bankruptcy may challenge the validity of a trust deed only if, under state laws, creditors having qualifications prescribed could have assailed it. The case went on to hold that the trustee could not challenge the trust deed even though it had a void acknowledgement because under the old statute the rights of the trustee were the same as those of a creditor of the bankrupt only.

I believe this case (Eichler v. Gray) would come down with the opposite ruling if the bankruptcy was filed within one year of the recording of the defectively acknowledged, but nonetheless recorded trust deed in California today. Under the new bankruptcy statute, which unlike the old statute grants the rights of a bona fide purchaser to the trustee in bankruptcy (I believe, but am relying on the portion of the statute cited in the case above which only refers to rights of the trustee as a creditor of the estate), but after the one year period, the ruling would be the same.

Interestingly, Texas law holds that a defectively acknowledged trust deed that is recorded anyway may be challenged within four years of recording. The same comments I make about one year within California should also apply within four years under Texas law.

The issue that is still outstanding is whether the defectively recorded documents impart constructive notice from the date of recording for priority purposes or do they lose they priority until the one or four year period has expired. I think their priority will go back to recording but could not find any California or Texas cases on point.

Oscar Beasley (Santa Ana) writes:

This raises another interesting question. I understand the court's reasoning and we have seen this in several areas. My query is would the court have the same answer in a state such as California where there is a curative statute so that after a year for instance by statute these matters (notarization) are deemed cured. Can something that is bad be cured. I've always thought so but now??????

Comment by Bert Rush: After receiving his reply, I spoke with Oscar further. He puts the dilemma this way; If the recording is null and void, how can a curative statute operate to allow constructive notice to be imparted as to any matter contained in the recording? I guess an answer might be that in states where curative statutes have been enacted courts would not be inclined to hold that the recording of a defective document was "null and void."

**********

Following up on last Wednesday's posting, David Dickson (Memphis) writes:

I have two additional thoughts from here in Tennessee:

Catch 22-The policy department gets the recorded instrument back from the register's office for policy prep and realizes it was missing the vital seal (in Tennessee impression seals are still widely used and are often hard to detect on the register's microfilm/copy-in our case we had the original-there may be such a thing as too good an investigation!!). its been more than 10 days. Now do we get the notary to affix the missing seal and rerecord-redflagging the problem for some future BK trustee, or hunker down?

Does the Tennessee curative statute help? TCA 66-26-106(1858, last revised 1969) reads:

Whenever a deed has been registered twenty years or

more the same shall be PRESUMED to have been upon

lawful authority; and the probate or acknowledgment

shall be good, though the certificate has not been

transferred to the register's book, without regard to the

form of the certificate; provided, that an acknowledgment

to an instrument which has been of record in the register's

office for a period of seven years shall be PRESUMED

valid as to comply with form of acknowledgment set out

in (citations omitted).

I don't know of any county in Tennessee that still transfers documents to the register's book the way that phrase is used in the statute. They are either copied on microfilm, scanned or photocopied and put in bound volumes. Can one PRESUME contrary to what one KNOWS? I am looking at a picture of the actual document, not a hand copied version created by a clerk who hand writes or types a copy into the books. Is that knowledge as opposed to notice? Isn't that the essence of the recording statutes? I have always been able to look at the 7 year and 20 year statutes as comfort in certain u/w decisions but now. I realize as a practical matter it probably only arises in a BK case.

Gil Lebovitz (Hartford, CT) writes:

Connecticut has for many years had a series of Validating Acts which validate, among other things, instruments recorded prior to the effective date of the Act which lack such things as acknowledgments. Validating Acts have been adopted by the legislature every odd numbered year going back to about 1931.

In 1999 the legislature adopted a "permanent" act which validates specified conveyancing defects in "any deed, mortgage, lease ... or other instrument made for the purpose of conveying, leasing, mortgaging or affecting any interest in real property in this state..." unless an action challenging the validity of the instrument is commenced and a lis pendens is recorded in the land records within 2 years after the instrument is recorded. The specified defects include, among other things:

1. a defective acknowledgment or no acknowledgment;
2. no witnesses;
3. conveyance to an entity not recognized by law to have the capacity to hold an interest in real property.

It's too early to know how the courts will interpret this new permanent act. Hopefully it will be construed to mean what it says.