What Constitutes a Mortgage? – Part 2


A few months ago, I wrote about a couple of cases in Illinois which successfully challenged the sufficiency of mortgages which failed to include the interest rate and maturity date, which if upheld could have drastic consequences for the mortgage lending community. [FN1]*

While those cases remain on appeal, a sister court in Illinois has issued its opinion departing from those cases’ conclusions. Judge Grandy, in Bruegge v. Farmers State Bank of Hoffman (In re Klasi Properties, LLC), on cross-motions for summary judgment, denied a chapter 7 trustee’s motion to avoid a mortgage on these grounds, and granted the defendants’ motion. [FN2]**

The court focused its analysis on two components.

First, it discussed the quantum of information required to impart constructive notice under the strong-arm provision of federal bankruptcy law. The court cites to Illinois decisions finding that while a trustee cannot be charged with actual notice, constructive notice in Illinois charges the trustee with both record notice (i.e. documents in the recorded chain of title for real estate), and facts in such recorded notice which might put such a trustee on duty of further inquiry.

The court concludes first that the trustee had record notice of the “mortgage” because it was recorded and was in the chain of title. This may seem unassailable in principle, but this conclusion doesn’t reach the issue of whether the recorded document was a “mortgage” in the first instance as defined under state law sufficient to impart constructive notice – the whole gist of the challenging party’s argument.

Recognizing this, the court follows up on this second issue with its analysis of whether the mortgage was “sufficient in substance” under state law to impart constructive notice to the trustee. It first found that a matter of statutory construction, the provisions regarding the form of a mortgage are permissive, and not mandatory. It found further support for its conclusion in pending legislation clarifying that provision of Section 11 of the Illinois Conveyances Act. [FN3]

However, the court’s analysis noted that even if the Conveyances Act was read to require recitation of the interest rate and maturity rate, the mortgage included these terms by reference to the underling promissory note. It suggests that the court in Crane, which reached the opposite conclusion, did not address the doctrine of incorporation by reference. It also distinguished the Jones case by noting that the terms of the underlying mortgage may have been ambiguous for other reasons than just failure to contain all the enumerated components of the Conveyances Act. [FN4]

While the lending community will want the courts considering the appeals of Crane and Jones to follow the reasoning of the court in Klasi Properties, I think the issue will come down to those courts’ assessments of how strictly the Illinois Supreme Court would interpret the Conveyances Act, in the form as it exists prior to the enactment of any clarifying legislation. The court’s decision in Klasi Properties notes that there is authority, even if in dicta, that the Illinois Supreme Court would rule that the terms of the Conveyances Act are mandatory. [FN5]

In other jurisdictions where the statute governing the form for recorded documents is interpreted strictly, even a small technical defect has constituted grounds for avoidance of the mortgage. [FN6] If the appeals courts follow the reasoning of the court in Klasi Properties in distinguishing previous authority or utilizing the doctrine of incorporation by reference, it would be a sensible result; but courts are charged with interpreting the law as it exists, so in light of previous authority, I believe this remains a close question.

[FN1] The Gifford State Bank v. Richardson (In re Crane), 2012 WL 669595, Bankr. No. 11-90592, Adv. No. 11-9067 (Bankr. C.D. Ill. Feb. 29, 2012), appeal docketed, No. 12-2146 (C.D. Ill. June 4, 2012); Peoples Nat’l Bank v. Jones et al., 482 B.R. 257 (S.D. Ill. 2012), appeal docketed, No. 12-3079 (7th Cir. September 10, 2012).

*Crane was subsequently reversed by the District Court and the District Court’s ruling was affirmed by the Seventh Circuit. In re Crane, 2012 WL 669595 (Bankr.C.D.Ill. Feb 29, 2012), rev’d 487 B.R. 906, 57 Bankr.Ct.Dec. 179 (C.D.Ill. Feb 28, 2013) (NO. 12-CV-2146), aff’d 742 F.3d 702, 70 Collier Bankr.Cas.2d 1226, 58 Bankr.Ct.Dec. 232, Bankr. L. Rep. P 82,555 (7th Cir.(Ill.) Dec 23, 2013) (NO. 13-1277, 13-1518).

Peoples Nat’l Bank was subsequently reversed by the Seventh Circuit. Peoples Nat. Bank, N.A. v. Banterra Bank, 719 F.3d 608, 57 Bankr.Ct.Dec. 281 (7th Cir.(Ill.) May 20, 2013) (NO. 12-3079).

[FN2] Bruegge v. Farmers State Bank of Hoffman (In re Klasi Properties, LLC), 2013 WL 211111, Bankr. No. 12-60013, Adv. No. 12-6028 (Bankr. S.D. Ill. January 18, 2013).

**The ruling by the Court in Klasi Properties was affirmed by the Seventh Circuit on 12/23/13 in the consolidated appeal with the CraneSee [FN1].

[FN3] Senate Bill 0016, clarifying 765 ILCS 5/11. See Klasi Properties, p.8.

[FN4] Klasi Properties, pp.10-11, discussing Crane and Jones, supra FN1.

[FN5] See, e.g., Klasi Properties, pp.11-12, citing Caraway v. Sly, 222 Ill. 203 (1906) and Bullock v. Battenhousen, 108 Ill. 28 (Ill. 1883).

[FN6} See, e.g., Agin v. Mortgage Electronic Registration Systems, Inc. (In re Giroux), Bankr. No. 08-14708, Adv. No. 08-1261, 2009 WL 1458173 (Bankr. D. Mass. May 21 2009), affirmed by Mortgage Electronic Registration Systems, Inc. v. Agin, No. 09-CV-10988, 2009 WL 3834002 (D. Mass. November 17, 2009) (trustee entitled to avoid mortgage under Massachusetts law which observed strict formalities in completion of notary acknowledgment, and failure to properly complete acknowledgment rendered mortgage unrecordable and void).


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