Posting for

Friday, October 9, 1998

by: Bert Rush

brush@firstam.com

DEFECTIVE DOCUMENTS/TRUSTEE AVOIDING POWER/BANKRUPTCY

Robert Hull of the Home Office Legal Dept. recently brought to my attention a Pennsylvania claim which he suggested could be part of a new trend in claims.

Then last week in Ohio I learned there are, indeed, signs of a trend. Here's what's happening.

In the Pennsylvania case a married couple (Hans and Elizabeth) gave a deed of trust for $161,000 against their home in Harleysville (just north of Philly) during July 1995. First American issued its loan policy to the new lender--and the mortgage was assigned to an investor.

Hans and Elizabeth stopped making mortgage payments in November 1995--and instead wrote letters to their Congressman and the PA Dept. of Banking complaining about the way their mortgage loan was originated. Mainly, they complained that when their "settlement" took place at the originating lender's office, no representative of the title company was present--nor was there a notary in attendance. They signed the note and mortgage--and were told everything else would be taken care of.

So the next day they went on vacation expecting their bills to be paid--and some loan accounts paid off--by the originating lender, or the title company, or someone. But instead the originating lender merely cut checks to the couple's creditors and mailed all the checks to Hans and Elizabeth. When the couple returned from vacation they were faced with duns, late charges and additional interest charges. So you might say they were ticked.

The letter-writing and non-payment continued until 1997, when Hans and Elizabeth filed a chapter 13 bankruptcy. By this time our insured lender was owed $205,536. But now Hans and Elizabeth have filed an adversary proceeding seeking to have the insured mortgage avoided as an interest in their real property under Bankruptcy Code sections 544(a) and 522(g) and (h).

The main section in play is section 544(a)(3), which gives a trustee in bankruptcy (or a debtor-in-possession) the status of a hypothetical bona fide purchaser of the debtors' real property as of the date of commencement of bankruptcy--so that the trustee (or d.i.p.) may avoid any interest in the debtors' real property not "perfected" (such as by recording) as of that date.

Through their attorney, Hans and Elizabeth claim that the insured mortgage was not perfected as of commencement of their bankruptcy because the insured mortgage was not properly notarized. The mortgage is notarized, by person who appears to be an employee of our title agent, but Hans and Elizabeth claim the notary was not present at the signing--so the notary's recitals that they personally appeared before her, that they are known to her to be the persons whose names are "subscribed to the within instrument," and that they acknowledged executing the instrument--all those recitals are false.

As a result of the false recitals, the debtors contend the mortgage was not "duly recorded" and, therefore, should now be avoided under section 544(a). They cite as authority two decisions in the same case: In re Rice (E.D. Penn. 1991) 126 B.R. 189; and In re Rice (E.D. Penn 1991) 133 B.R. 722.

In the Rice case a chapter 7 debtor filed an adversary proceeding to avoid a mortgage on grounds the notary was not present when the mortgage was signed, relying on Bankruptcy Code sections 522(g) and (h) and 544(a). The Bankruptcy Court ruled in favor of the debtor--holding that if it was a simple suit between the debtor and her lender the debtor would lose since even an unperfected mortgage is enforceable as between the parties thereto. But this case was different, said the Court, because the debtor was cloaked with the fictional status of a b.f.p. under section 544(a).

The Court went on to reason that the failure of the signing party/debtor to actually appear before the notary and acknowledge the signing rendered the notarization "entirely bogus"--so under Pennsylvania statutes it was not entitled to be recorded nor to impart constructive notice when it did get recorded. The Court said this result was in harmony with "the law of many other states," naming Indiana, Ohio, Georgia and Tennessee as examples.

Georgia???

LandSakes Savants may recall our posting for 7/30/98, in which the Georgia Supreme Court reached the opposite result of the above--in a case where false witness attestations were at issue. The case is Leeds Building Products v. Sears Mortgage Corp. (1996) 267 Ga. 300, 477 S.E.2d 565. Note, however, that in the Leeds case the Court's decision was based on state recording statutes--and Bankruptcy Code section 544(a) was not in play.

So now we're paying for the defense of our insured lender against Hans and Elizabeth's adversary proceeding, and the probable outcome is uncertain.

Last week in Ohio I learned we have three similar claims pending in the Cleveland area--I think resulting from the activities of a former agent. In the Ohio cases I'm told the problem is that state law requires two witness attestations--but originating lenders tend to cut corners by sending only one witness to sign-ups--then they add the signature of an absentee witness at a later date. Those are the allegations anyway.

Obviously, at some point a lender's failure to cause notary and/or witness attestation statutes to be complied with must be considered a matter excluded from coverage by title insurance--as "created, suffered, assumed of agreed to" by the lender. But how can we deny coverage when our own employee or agent supplies the needed notarization of attestation? Never mind. Rhetorical question.

This problem of false notarizations is older than dirt--it's one of the first lines of resistance I met when I joined the Company in 1982. "Good customer" lenders didn't want to be told they had to comply with notary laws.

But no one had ever heard of section 544(a)(3) back then--times and the rules have changed. Now I think its fair to say that in some cases section 544(a)(3) is a "license to steal."

We need to include this topic in our training. We may not be able to convert mortgage lenders--but we can certainly alert our employees and agents to the real risks involved with false notarizations.

Questions, comment, argument? Just press the "reply" button....

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

Congress did not intend Section 544(a) as a "license to steal" by its abuse in this manner by liberal-minded bankruptcy judges who choose to ignore the true purpose of witness and notary requirements - namely, to attest the GENUINENESS of the signature(s). In the absence of forgery, the mere fact that a document is facially sufficient to pass muster by the Recorder's Office SHOULD be deemed to constitute at least INQUIRY notice, if not CONSTRUCTIVE notice, to any subsequent purchaser (especially the "fictional" purchaser of a trustee in bankruptcy).

I am continually amazed at how far astray from seemingly fundamental legal concepts some of these lawyers and judges will go. Nevertheless, we must keep abreast of these "current legal trends" which impact our business. So, I certainly agree that settlement personnel must remain on guard against the sloppy execution of documents although, unlike the law in some states, I believe the law in most Mid-Western states still deems the document to have been "duly recorded" for purposes of imparting notice.

Here's a thought: Maybe Penn State should not have been allowed to join the "Big 10" and we should replace Ohio State with Colorado State (then Rick Garlick and I could vent our legal spleens in the same conference! Oh, I forgot - bankruptcy jurisdiction is under FEDERAL law....)

Reply to Jim: I agree with your criticism of the reasoning of In re Rice. If you read the two Rice decisions (the first for the facts and the second for the offending opinion) you may get the impression (as I did) that the Court may have simply gotten tired of this bothersome case and allowed itself to issue a shortsighted opinion. Here's what happened:

The debtor, Sharon Rice, agreed to purchase vinyl siding from a salesman who visited her home. The salesman had her sign a document describing work to be done and another doc titled "Home Improvement Installment Contract." Within the Home Improvement Installment Contract were financing terms as well as the language creating a mortgage against her home to secure payment. It's unclear whether there was also another document titled as a mortgage involved--but in any case Rice denied signing a mortgage whereas the Court ruled she did.

This became a second mortgage on her home. After her bankruptcy Rice sold the home, resulting in a total of $2,500 available to pay off the second mortgage--which was held in escrow by her realtor while she went back to Bankruptcy Court to seek to avoid the second mortgage.

The case was hotly contested and--probably due to the small amount in controversy--fouled up procedurally. The first Rice decision is a recital of the facts and directions to Ms. Rice as to how to proceed further.

After the first decision the Court suggested strongly that the parties settle by splitting the $2,500--but neither side would give in so the case was set for hearing and, of course, postponed several times.

The second (offending) decision chastises the parties for not settling--then holds that the mortgage will be avoided because of its false notarization. The Court said in passing that notarization is an important formality because it "brings home" to the borrower that a mortgage is being signed. In fact, the Rice Court was persuaded that Ms. Rice signed the mortgage in question without realizing it was a mortgage. So it was in this context that the Court held that in PA a false notarization will "not be tolerated."

But now the Rice decision is being used in cases against our insureds where there is no question the borrowers intended to give a mortgage. So I think the recent decision of the Georgia Supreme Court (Leeds) sets forth reasoning more appropriate to disposition of our pending claims than does the Rice decision.

The fact remains that cases involving facts such as these go both ways--and as claims they can be very expensive.

Meanwhile David Dickson (Memphis) writes:

I'm sure many of our people know this but when I was in law school and working as a closer/title examiner for a competitor (Mid-South Title aka LTIC) I got my notary commission. The president of MST told me to always require personal appearance and acquaintance--and (made) a statement that it was their free ace--that way 10 years from now when you are being cross examined you can say with a straight face, "because it is my unvarying practice."

Reply to David: Why didn't we think of that?

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Following up on Friday's posting Keith Pearson (Glendale/L.A.) writes:

Seems like a time to push for a law requiring notaries to get thumbprints similar to the one in California. If you have a thumbprint, there is no doubt the person was there when they signed.

Much like American Express with regards to someone's thumb, they never leave home without it. It also takes out of play people who sign their name multiple ways, and experts who are willing to say that this is not someone's signature. It also serves as a deterrent to rogue notaries since it will be patently obvious if they had the person signing in front of them or not.

Jim Dondero (Grand Rapids, MI) writes:

Thanks for the factual detail. As you say, it is a troublesome and short-sighted decision which seems to be based more on achieving a "fair" result than on what the recording laws require. The attorneys might have better argued this result based on theories of "fraud in the inducement" or "fraud in the execution" of the contract containing the mortgage.

Reply to Jim: I agree--if Rice didn't know what she was signing as the result of fraud, negligent misrepresentation or excuseable neglect (tough one) it seems the mortgage could've been declared void. The same result but a better reason--less capacity for creating mayhem as legal precedent.