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Lenders Beware—Here's One More Twist When You Fail to Record That Mortgage!

January 28, 2010

Here's the scenario—in the rush of closing a home mortgage loan amidst a mass of loan documents, the mortgage is not recorded. Some time later the borrower files for bankruptcy protection and, under the assumption that the mortgage was properly recorded, lists the lender as a secured creditor. After the bankruptcy filing, the loan is sold into the secondary market. The bankruptcy trustee discharges the debt and the new purchaser records the mortgage. What happens when the bankruptcy trustee eventually learns that the original lender never recorded the mortgage? If you guessed that there would be "no harm, no foul" because the original lender was really an unsecured creditor anyway and therefore would have dropped to the bottom of the list behind the secured creditors and therefore would not have received anything from the bankruptcy estate, you would only be half right.

In one recent case out of Minnesota with precisely the facts above, Wells Fargo Home Mortgage, Inc. v. Lindquist, No. 08-3442 (8th Cir. Jan. 11, 2010), the bankruptcy trustee reopened the case when it learned of the initial failure to record. Thereafter, the court not only treated the bank as an unsecured creditor but also ordered it to pay to the bankruptcy trustee the unpaid principal balance of the note! In so doing, the court accepted the bankruptcy trustee's argument that, because the bank failed to record the mortgage, the security interest was never perfected. Moreover, under the Bankruptcy Code, because the interest was not perfected, the granting of the mortgage was a preferential transfer under 11 U.S.C. § 547(e)(2)(C). Because the debtor erroneously listed the bank as a secured creditor, the bank was able to retain and then sell the mortgage it received from the debtor without objection by the trustee. According to the trustee, but for the transfer of the mortgage to the bank, the bankruptcy estate would have included an interest in the home equal to the value of the mortgage, which interest the trustee would have been able to liquidate. Accordingly, on these facts, the bankruptcy court, and ultimately, the Eighth Circuit Court of Appeals, held that the transfer of the mortgage to the bank diminished the bankruptcy estate, and that the transfer enabled the bank to "receive more than [it] would receive" in a hypothetical liquidation.

Thus, the failure to record the mortgage resulted in not only the lender not receiving a portion of the bankruptcy estate because it was not a secured creditor, it was also required to pay into the bankruptcy estate the unpaid principal balance of the note. A copy of the decision is set forth here.

If you have any questions regarding this Consumer Financial Services Alert or the Act and its implementing regulations, you may contact Richard Gottlieb, director of the Financial Industry Group, at 312-627-2196.


As part of our service to you, we regularly compile short reports on new and interesting developments in consumer financial services and the issues the developments raise. Please recognize that these reports do not constitute legal advice and that we do not attempt to cover all such developments. Readers should seek specific legal advice before acting with regard to the subjects mentioned here. Rules of certain state supreme courts may consider this advertising and require us to advise you of such designation. Your comments on this newsletter, or any Dykema publication, are always welcome. © 2010 Dykema Gossett PLLC. 

As part of our service to you, we regularly compile short reports on new and interesting developments and the issues the developments raise. Please recognize that these reports do not constitute legal advice and that we do not attempt to cover all such developments. Rules of certain state supreme courts may consider this advertising and require us to advise you of such designation. Your comments are always welcome. © 2017 Dykema Gossett PLLC.