Unrecorded Deeds Of Trust: Take Them Out Of Your Pocket Before They Burn A Hole

• Jurisdiction: United States,Federal
• Law Firm: Shulman Rogers
• Subject Matter: Finance and Banking, Real Estate and Construction, Insolvency/Bankruptcy/Re-structuring, Charges, Mortgages, Indemnities, Financial Services, Insolvency/Bankruptcy, Real Estate
• Author: Michael J. Lichtenstein and Rebekah F. Paradis
• Published date: 07 February 2023

An issue that estate and trust lawyers have to confront is the "pocket deed" which is a non-delivered deed conveying title to property.¹ The grantor signs the deed but instructs that it not be recorded until after the grantor's death.² This procedure has led to problems with the effectiveness of the conveyance because without delivery nothing passes to the grantee.³

Bankers face a similar problem when they extend a loan to a borrower and secure that loan in part with a "pocket" deed of trust. The deed of trust serves as collateral for the loan but remains unrecorded until some trigger event, at which point it may be too late because other liens have been recorded or because the recordation is deemed ineffective. As can be seen below, courts have held that the consequence of holding a "pocket" deed of trust and failing to record can be quite significant and detrimental.

When a financial institution or any other lender extends a secured loan, the collateral for that loan can take various forms. For example, the collateral might be a guaranty, accounts receivable, furniture, fixtures and equipment or real estate. If real estate secures the loan, typically a deed of trust, an indemnity deed of trust or a mortgage is signed by the property owner and then the instrument is recorded upon execution of the loan documents and delivery of the funds to the borrower. However, some lenders take a deed of trust as collateral but agree not to record the deed of trust unless some trigger event occurs. This instrument is known colloquially as a "pocket deed of trust."

Reasons for not recording a deed of trust might include a lender's level of comfort with other collateral securing the loan. In other instances, the property owner (borrower or guarantor) might convince the lender that recordation is not necessary and could affect the borrower or guarantor's credit worthiness. In any event, failing to record the deed of trust and holding a "pocket deed of trust" can have dire consequences, including rendering a lender an unsecured creditor in or outside of a bankruptcy proceeding.

UNRECORDED DEED OF TRUST ISSUES OUTSIDE OF BANKRUPTCY

Failure to record a deed of trust outside bankruptcy may cause a loss of priority, and thus difficulty or inability for a lender to be repaid. For example, in a non-bankruptcy setting, the first lender's deed of trust was recorded six months after a second lender acquired a lien on the disputed property.⁴ Because the second lender was the only...