What happens if a bank in Massachusetts fails to record a foreclosure deed promptly? Evidently not much, apart from the fact that the trustee apparently regains the ability to exercise the right of redemption.
A bank conducted a foreclosure sale of a debtor’s home. The debtor filed a chapter 7 petition before the bank got around to recording a deed four months after the foreclosure sale.
The trustee mounted an adversary proceeding to avoid the transfer of title under Section 544(a)(3) and preserve the avoided transfer for the benefit of the estate under Section 551. The trustee perhaps thought he could acquire title free of the bank’s lien.
No such luck, although the bank did not emerge unscathed from Chief Bankruptcy Judge Melvin S. Hoffman’s Feb. 14 opinion.
Section 544(a)(3) gives the trustee the status of a bona fide purchaser of real property to avoid a transfer. In Massachusetts, Judge Hoffman said that a transfer of an interest in land is not valid until recorded, or unless the person has actual notice of the unrecorded conveyance.
But there’s more. Massachusetts uses the so-called title theory of mortgages, meaning that the mortgage gives legal title to the lender. Equitable title remains with the homeowner.
A corollary to the title theory is the homeowner’s equity of redemption, which is the right to redeem legal title upon paying the mortgage debt in full.
Since foreclosing a right of redemption is a transfer subject to the avoiding power under Section 544(a)(3), Judge Hoffman concluded that the transfer that took place on recording the deed could be set aside. However, he said, the trustee could not recover any greater rights than a bona fide purchaser under state law.
Judge Hoffman said there are no Massachusetts cases saying whether a bona fide purchaser of a right of redemption takes clear of or subject to an unrecorded transfer of the right of redemption.
Looking to the law of other states, Judge Hoffman said that “a transfer of a debtor’s interest in property through a foreclosure sale is avoidable if, at the time of the bankruptcy filing, the foreclosure documents had not been recorded.” The result is otherwise, he said, in states where a bona fide purchaser is on inquiry notice, which is not the law in Massachusetts.
Therefore, Judge Hoffman held that the trustee could avoid the transfer of the debtor’s right of redemption. Exactly what that means bears little significance in chapter 7, where a trustee ordinarily would not sell encumbered property without paying the lien in full.
The lender argued that requiring immediate recordation of a foreclosure deed would be “an absurd result.” Judge Hoffman countered that “requiring diligence . . . can hardly be called absurd.”
In chapters 11 and 13, the consequence of such a holding is less clear. Could a debtor reinstate the mortgage and retain the property by paying the arrears? The result might turn on the consequences of a foreclosure sale in Massachusetts, even before the deed is recorded.
The opinion has no discussion of Section 549(c), which precludes a trustee from avoiding an unauthorized post-petition transfer to a good faith purchaser without knowledge of the pending bankruptcy. Perhaps the bank knew about the bankruptcy at the time it recorded the deed.