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United States: Bankruptcy Court In Illinois Holds That A Mortgage Is Avoidable In Bankruptcy If The Mortgage As Recorded Does Not State The Maturity Date And Interest Rate Of The Underlying Debt
In a decision that potentially has serious implications for
mortgage financing transactions in Illinois, the Bankruptcy Court
for the Central District of Illinois recently held that a mortgage
is avoidable in bankruptcy if it fails to include the maturity date
and the interest rate of the underlying debt within the mortgage
document as recorded. In re Crane, Case No. 11-90592, U.S.
Dist. Ct. C.D.Ill., February 29, 2012; Supplemental
Opinion and Order, April 5, 2012. The court found that the
failure to include the maturity date and the interest rate in the
mortgage violated the express requirements of Illinois conveyancing
statutes, and thus did not provide the constructive notice to the
trustee necessary to prevent the avoidance.
The facts of the case are simple and undisputed. The Debtors,
Gary and Marsa Crane, filed for relief under chapter 7 of the
Bankruptcy Code, and a trustee was appointed. The Gifford State
Bank claimed a mortgage lien on various parcels of real estate
owned by the Debtors. In an adversary proceeding, the trustee
claimed that the mortgages were defective and subject to avoidance
pursuant to 11 U.S.C. § 544, because both mortgages failed to
state the interest rate and the maturity date thereof, in violation
of the Illinois conveyancing statutes, specifically 765 ILCS Sec.
5/11. This failure to comply with Illinois statutes, argued the
trustee, meant that the mortgages did not give constructive notice
to subsequent bona fide purchasers, and that the trustee had the
power to avoid the mortgages per 11 U.S.C. § 544(a)(3).
In a succinct opinion and order, United States Bankruptcy Judge
Gerald D. Fines ruled in favor of the trustee, and ordered that the
mortgage lien of the Gifford State Bank was avoided as to the
subject real estate. The court relied on an interpretation of
section 11 of the Illinois Conveyances Act (as set out in relevant
part below), which dictates strict conformity with the statutory
form for the mortgage to have the effect of providing constructive
notice to bona fide third-party purchasers (and trustees in
bankruptcy). The relevant statutes states:
"Sec. 11. Mortgages of lands
may be substantially in the following form:
The Mortgagor (here insert name or
names), mortgages and warrants to (here insert name or names of
mortgagee or mortgagees), to secure the payment of (here recite
the nature and amount of indebtedness, showing when due and the
rate of interest, and whether secured by note or otherwise),
the following described real estate (here insert description
thereof), situated in the County of ...., in the State of Illinois.
Dated (insert date). (signature of mortgagor or
mortgagors)..." Emphasis supplied. 765 ILCS 5/11.
In this regard, the court relied on the earlier decision of In
re Berg, 387 B.R. 524 (Bankr. N.D. Ill. 2008), where a trustee in a
chapter 7 proceeding was also able to avoid a mortgage because of
the mortgage's failure to comply with the requirements of the
same section 11. In Berg, the court relied upon 19th-century
precedent, particularly Bullock v. Battenhousen, 108 Ill.
28 (1883), to construe the Illinois statutory mortgage requirements
strictly, reasoning that disclosing the underlying detail as to the
indebtedness on the record serves to lessen possible prejudice to
subsequent purchasers or creditors because of possible "secret
conspiracies" between mortgagor and mortgagee as to the nature
and extent of the indebtedness.
This decision is alarming because its strict reading of the
statute, and harsh result for the mortgagor, is inconsistent with
modern mortgage finance practices, including the common use of the
incorporation by reference of promissory notes, as opposed to
setting out the detailed terms of the note, including interest rate
and maturity date, which this decision would appear to require in
each instance. The statutory language states only that mortgages
"may be substantially in the following form," which
suggests a flexibility and a practicality not recognized in the
court's decision and reasoning.
This may not be the last word on the subject, however, as an
appeal of this decision has been filed, and legislation has been
introduced at the state level to supersede its effect, presumably
by amending the Conveyances Act appropriately. We will continue to
monitor the status of this case as it is addressed by the higher
courts and/or the state legislature.
Practice Tip: Unless and until the
Crane decision is overruled by the higher courts or
through legislation, mortgages secured by real estate located in
Illinois should include the interest rate and maturity date on the
mortgage document as recorded, and otherwise fully comply with
section 11 of the Illinois Conveyances Act, to prevent an avoidance
in bankruptcy.
This article is presented for informational purposes only
and is not intended to constitute legal advice.
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