Tardy Recordation of a Mortgage Not Salvaged by Relation-Back Arguments

A bankruptcy judge must have a command of the intricacies of state law, as shown in an opinion by Bankruptcy Judge Paul W. Bonapfel of Atlanta. He rejected creative defenses proffered by a lender who neglected to record a mortgage for so long that eventual perfection was subject to preference attack.

A homeowner refinanced a mortgage on January 30, but the lender did not immediately record the new mortgage. Instead, the lender cancelled the “old” mortgage on February 26. The lender did not record its “new” mortgage until March 17, 56 days after the homeowner executed the mortgage.

The homeowner filed a chapter 7 petition on June 8, which was 73 days after the lender recorded the mortgage and within the 90-day preference window.

The chapter 7 trustee sought to avoid the “new” mortgage as a preferential transfer made within 90 days of filing under Section 547(b)(4)(A). For several reasons, the lender contended that perfection of the mortgage related back to the closing date and was therefore outside of the preference window.

Judge Bonapfel ruled in favor of the trustee is his 21-page opinion on March 18.

The Applicable Statutes

The outcome turned on a combination of bankruptcy law and Georgia real estate law. Under the Bankruptcy Code, Section 547(e)(2)(A) provides that a transfer occurs “at the time such transfer takes effect between the transferor and the transferee, if such transfer is perfected at, or within 30 days after, such time . . . .”

If the transfer is perfected more than 30 days after the transfer between the parties, Section 547(e)(2)(B) says that the transfer occurs “at the time such transfer is perfected.”

The new lender mostly relied on Section 547(e)(1), which provides that a transfer of real property “is perfected when a bona fide purchaser of such property from the debtor against whom applicable law permits such transfer to be perfected cannot acquire an interest that is superior to the interest of the transferee.”

Georgia has a “race notice” statute. A “purchaser of real property for value and without notice of a preexisting but unrecorded interest acquires title unencumbered by the unrecorded interest,” Judge Bonapfel said.

The Lender’s Arguments

The lender contended that the principle of equitable subrogation in Georgia protected the mortgage from attack as a preference. When a new lender pays off an existing mortgage, Judge Bonapfel explained that the new lender is subrogated to the rights of the prior encumbrance, subject to certain exceptions. However, the basis for subrogation “no longer exists,” he said, when the “old” encumbrance was cancelled of record.

Between the date of the cancellation of the “old” mortgage and the recordation of the new lender’s mortgage, a purchaser for value could have acquired title superior to the new lender’s unrecorded mortgage, Judge Bonapfel said, because equitable subrogation did not apply. Consequently, the new lender would have a defense to preference only if it could establish that a purchaser would have been charged with inquiry notice of the unrecorded mortgage.

To that end, the lender made several arguments. For instance, Judge Bonapfel said, the lender argued that the absence of any mortgage would “excite attention and trigger a duty to inquire further.” Or, the lender said that a purchaser would always hire a lawyer who would demand an affidavit from the seller about the absence of an existing mortgage.

Judge Bonapfel said there was no caselaw to support the arguments based on inquiry notice. The arguments, he said, were “fundamentally inconsistent with established principles of Georgia law.” For example, he said that a bona fide purchaser “is not charged with inquiry notice of a security deed in the chain of title if it is not properly attested.”

Even if they were true, the lender’s allegations did not show that the new lender’s mortgage was perfected until it was recorded. As a matter of law, Judge Bonapfel said, the transfer occurred within the preference period when the new lender recorded its mortgage.

Judge Bonapfel thus ruled that the transfer was subject to attack as a preference because the transfer took place when the mortgage was eventually recorded, not when the homeowner-debtor granted the mortgage at the closing of the refinancing.