| Sixth Circuit Bankruptcy Appellate Panel Affirms Bankruptcy Court Ruling Denying Avoidance of Mortgage by Chapter 7 Trustee in In re Roberts |
| Posted: January 11, 2010 |
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The Bankruptcy Appellate Panel of the Sixth Circuit (the “B.A.P.”) affirmed the decision of the Bankruptcy Court for the Southern District of Ohio (the “Bankruptcy Court”) in Hardesty v. Citifinancial, Inc. (In re Roberts), 402 B.R. 808 (Bankr. S.D. Ohio 2009), in which the Bankruptcy Court ruled that the Chapter 7 Trustee could not avoid a mortgage on the debtors’ residence, which was granted by the debtors to Citifinancial, Inc. prior to the debtors’ bankruptcy.1 In Roberts, the Chapter 7 Trustee attempted to use his strong-arm powers as a hypothetical bona fide purchaser, pursuant to section 544(a)(3) of the Bankruptcy Code, in order to avoid the subject mortgage based upon the contention that the mortgage contained a defective acknowledgment.
Under section 544(a)(3) of the Bankruptcy Code, a trustee in bankruptcy is afforded “the rights and powers of, or may avoid any transfer of property of the debtor … that is voidable by … a bona fide purchaser of real property … from the debtor, against whom applicable law permits such transfer to be perfected, that obtains the status of a bona fide purchaser and has perfected such transfer at the time of the commencement of the case, whether or not such a purchaser exists.” Such power of the trustee is known as a trustee’s strong-arm powers as a hypothetical bona fide purchaser, and trustees in bankruptcy frequently use such powers to attempt to avoid mortgages that the trustees allege were unrecorded or improperly recorded as of the bankruptcy filing, in order that the trustees may preserve the mortgages for the benefit of the debtors’ estates. In order to determine whether a mortgage is properly recorded and whether the trustee, as a hypothetical bona fide purchaser of the real property, received notice of such recording, bankruptcy courts must look to the relevant state law and other applicable non-bankruptcy law in order to make such a decision.
Specifically, the Chapter 7 Trustee in Roberts sought to avoid the subject mortgage on the alleged theory that the acknowledgment in the mortgage was defective since it did not contain the words “acknowledged before me” or their substantial equivalent in the certificate of acknowledgment. The Chapter 7 Trustee also alleged that the acknowledgment did not follow a form of acknowledgment authorized by Ohio law. According to the Chapter 7 Trustee, the words “acknowledged before me” or their substantial equivalent must be present in order for an acknowledgment to be considered valid under Ohio law. Thus, the Chapter 7 Trustee sought to avoid the mortgage and preserve the mortgage for the benefit of the debtors’ estates.
Citifinancial, however, argued that the acknowledgment did meet each of the requirements of Ohio law since it contained the phrase “executed before me”, which combined with the other language in the acknowledgment was the substantial equivalent of “acknowledged before me”. Citifinancial also argued that although Ohio law does recognize certain acknowledgment forms, it does not preclude the use of other forms.
The Bankruptcy Court, in looking at Ohio law, noted that the Supreme Court of Ohio has not yet ruled on the validity of a certificate of acknowledgment similar to the one at issue in Roberts. Accordingly, the Bankruptcy Court based its decision upon its prediction of how the Supreme Court of Ohio would rule on the issue. Ultimately, the Bankruptcy Court held, as was affirmed by the B.A.P., that under Ohio law, substitution of the phrase “executed before me” for “acknowledged before me” did not affect the validity of the mortgage, and thus, did not permit avoidance of the mortgage by the Chapter 7 Trustee. This matter is currently on appeal to the Sixth Circuit Court of Appeals.
1 The ruling of the Bankruptcy Appellate Panel of the Sixth Circuit was entered on November 9, 2009.
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