Essex, Vermont – When these homeowners refinanced their second mortgage they chose an out-of-state lender in nearby Plattsburgh, New York. Mortgage documents were signed at the lender's Plattsburgh office and later recorded in Chittendon County, where the property is located. First American insured the new second mortgage for $27,850. Months later the borrowers filed bankruptcy and a trustee was appointed to account for their assets. Bankruptcy trustees take this task seriously since their compensation is based on the size of the debtor's estate.

BK'd: The mortgage was doomed to fail when the borrowers filed bankruptcy.

Soon the trustee filed a complaint in bankruptcy court to void the insured mortgage on grounds it was improperly acknowledged. It seems the mortgage was acknowledged by only one witness, as is customary in New York, whereas two witnesses were required under Vermont law. The judge agreed with the trustee, and the mortgage was voided.

Avoidance of the mortgage was based on Section 544(a)(3) of the Bankruptcy Code. Section 544(a)(3) provides that a trustee or debtor-in-possession may avoid any interest in debtors' real property which is not perfected as of the date of commencement of bankruptcy.

Since the insured mortgage was defective it was not entitled to be recorded in Vermont, and the recording was considered a nullity.

Later the borrowers' unsecured obligation to repay the lender was discharged in bankruptcy. First American paid the lender its policy amount of $27,850.

The Vermont law was later amended to permit acknowledgments by one witness, duly notarized.

This is a classic example of the "trustee avoiding power" in bankruptcy.

Any material defect in a recorded document, such as by an incorrect legal description, improper notarization, or typographical error, can produce this result.

This risk is covered by title insurance even where a defect is created by the lender's carelessness, although there is no coverage for risks intentionally undertaken.

This risk is not covered by an attorney opinion letter unless the attorney takes responsibility for document preparation and recording. Likewise, other forms of title assurance do not address closing snafus.