Unrecorded Mortgage Assignment: If You Snooze, You Can Lose

In re First Mortgage Fund, Inc ., 498 B.R. 180 (E.D. Mich. 2013) -

A debtor (First Mortgage), which was the mortgagee of record, foreclosed a mortgage and obtained title to the foreclosed property notwithstanding that it had assigned the note and mortgage to another party several years before the foreclosure sale. After the assignee sought to make a claim based on the assignment, the debtor's chapter 7 trustee sought to avoid the rights of the assignee using his strong-arm powers. After the bankruptcy court found in favor of the chapter 7 trustee, the assignee appealed.

A borrower had obtained a loan that was secured by mortgages on four properties. The original lender assigned the note and mortgages to the debtor, and the mortgages and assignments were recorded. Shortly afterwards, the debtor assigned its interest in the note and mortgages to an affiliate (Stavenkan). This second assignment was not recorded, and the debtor remained the mortgagee of record with no record evidence of Stavenkan's interest.

About three years later the debtor foreclosed the mortgages and purchased the properties with a credit bid. Sheriff's deeds transferring the properties to the debtor were recorded. Three years after that First Mortgage filed for bankruptcy.

After the bankruptcy filing, Stavenkan sought to assert its assignee interests for the first time. (The court noted that the debtor and Stavenkan were affiliates and that the owner and operator of Stavenkan was also the majority shareholder and president of the debtor. So, it appears that Stavenkan should have been aware of what was going on all along.)

The chapter 7 trustee sought to avoid the transfer of the debtor's interests to Stavenkan using his strong-arm powers. In particular, under Section 544(a)(3) of the Bankruptcy Code a trustee can assert the rights of a bona fide purchaser of real estate. Under applicable state law, a bona fide purchaser took free of unrecorded interests. Since Stavenkan's interests were unrecorded, the bankruptcy court concluded that the transfer to Stavenkan could be avoided.

On appeal Stavenkan made several arguments that were rejected by the district court.

The court responded to its argument that the foreclosure was void by noting that under state law a party is entitled to foreclose if it is the mortgagee of record (as evidenced by a record chain of title from the original mortgagee to the foreclosing party). Although the foreclosure was defective as a result of the...