By: John Murray, Vice President-Special Counsel, First American Title Insurance Company
Illinois case law has consistently held that a mortgage that fails to state the amount of indebtedness secured is insufficient, under the recording laws, to impart constructive notice and is subject to being subordinated to a subsequent mortgage recorded by a purchaser without adequate notice; in addition, a statement in a mortgage that it secures a specific amount and “any future advances” (i.e., is completely open-ended as to future indebtedness) is not sufficiently definite under Illinois law because it does not show (or cap) the amount of indebtedness on its face.
See, e.g., Flexter v. Woomer, 46 Ill. App. 2d 456, 459 (5th Dist. 1964) (“the policy, though not the letter, of our statutes requires, in all cases, a statement upon the record of the amount secured”); Peoples National Bank, N.A. v. Banterra Bank, 719 F.3d 608, 611-12 (C.A. 7-Ill. 2013) (“longstanding Illinois case law seems to hold that a mortgage must at least include the amount of indebtedness the mortgage is meant to secure in order to impart record notice”); Northridge Bank v. Lakeshore Com. Fin. Corp., 48 Ill. App. 3d 82, 87 (1st Dist. 1977) (stating that “the mortgage executed in favor of [the lender] . . . is completely open-ended as to future indebtedness.
It is impossible, from a reading of the . . . mortgage, to ascertain the amount of indebtedness secured thereby, and also stating that “language which would set a ceiling on the amount of any future advances has been deleted.”)
Recently, the language of the statute regarding the form and content of Illinois mortgages, 765 ILCS 5/11, has come into question with respect to whether the items mentioned in the form provided in the statute are permissive or mandatory based on the specific language in the statute and Illinois case law. Fortunately for mortgage lenders, this issue appears to now be resolved in the lenders’ favor with respect to the ability of a bankruptcy trustee to avoid a mortgage not containing all the elements stated in the statutory form; in particular the maturity date and the interest rate.
AVOIDANCE POWER OF A BANKRUPTCY TRUSTEE
Under § 544(a)(3) of the Bankruptcy Code, a trustee in bankruptcy has the “strong-arm” power to: avoid … any obligation incurred by the debtor that is voidable by -- a bona fide purchaser of real property … from the debtor…. and has perfected such transfer at the time of the commencement of the case, whether or not such a purchaser exists.
Section 544(a)(3) grants the trustee the status of a hypothetical bona fide purchaser of real property at the time of the bankruptcy filing. Furthermore, § 544(a)(3) provides that a bankruptcy trustee cannot be charged with “actual notice” of another’s adverse interest in property, i.e. knowledge that the purchaser had at the time of the conveyance. However, the trustee can be charged with constructive notice, which under Illinois law constitutes either record notice (i.e., knowledge that could be gained from an examination of the grantor-grantee index in the office of the Recorder of Deeds, as well as the probate, circuit, and county court records for the county in which the property is located) or inquiry notice. Under Illinois law, inquiry notice has been described as follows: Inquiry notice describes the situation where the transferee has been made aware of facts or circumstances from which the existence or possibility of a prior claim might reasonably be inferred. If so, the purchaser then has a duty to verify or dispel the inference through further inquiry.
If he fails to make inquiry, he is nonetheless chargeable with knowledge of facts that a diligent inquiry would have disclosed, the same as if he had acquired actual knowledge of those facts. In re Shara Manning Properties, Inc., 475 B.R. 898, 906 (Bankr. C.D. Ill., 2010).
THE BANKRUPTCY COURT’S DECISION IN IN RE CRANE
The Bankruptcy Court for the Central District of Illinois, in In re Crane, 2012 WL 669595 (Bankr. C.D. Ill., Feb. 29, 2012), held that the bankruptcy trustee could avoid a properly executed and timely recorded mortgage under § 544(a)(3) of the Bankruptcy Code if it failed to state the maturity date and interest rate on the face of the mortgage and accordingly, pursuant to the Bankruptcy Court’s interpretation of 765 ILCS 5/11, the mortgages on the two separate parcels of land executed by the debtor on behalf of the lender in this case were not enforceable as to third-party creditors.
This ruling sent shock waves through the Illinois mortgage-lending community, because no previous Illinois case (federal or state) had specifically held that insertion of these particular elements in a mortgage was required (as opposed to being permissive) under Illinois law.
Mortgage lenders and their attorneys were unsure, as a result of the Bankruptcy Court’s decision in Crane, whether all existing mortgages that did not contain these elements were subject to avoidance by the trustee in the event of a borrower bankruptcy; whether amendments to existing mortgages would need to be recorded (and would be effective) to incorporate missing maturity dates and interest rates; whether to record the note in addition to the mortgage; and whether to draft future mortgages to specifically include the maturity date and interest rate.
THE DISTRICT COURT’S DECISION IN IN RE CRANE
The Bankruptcy Court’s decision in In re Crane was immediately appealed to the U.S. District Court. On February 28, 2013, the U.S. District Court for the Central District of Illinois issued its ruling in Crane v. Gifford State Bank (In re Crane), 487 B.R. 906 (C.D. Ill. 2013). The District Court reversed the order of the Bankruptcy Court. The District Court noted that 765 ILCS 5/11 stated (prior to being amended after the Crane case was filed, as described below) in relevant part that: § 11. (a) Mortgages of lands may be substantially in the following form:
The Mortgagor (here insert name or names), mortgages and warrants to (here insert name or names of mortgagee or mortgagees), to secure the payment of (here recite the nature and amount of indebtedness, showing when due and the rate of interest, and whether secured by note or otherwise), the following described real estate (here insert description thereof), situated in the County of ...., in the State of Illinois.
Dated (insert date).
(signature of mortgagor or mortgagors)
Such mortgage, when otherwise properly executed, shall be deemed and held a good and sufficient mortgage in fee to secure the payment of the moneys therein specified …
According to the U.S. District Court:
[T]his court holds that § 5/11 was intended to create a safe harbor, rather than a mandatory checklist of requirements to be completed pro forma. Since § 5/11 advises lenders how best to provide sufficient detail so as to provide constructive notice to a third party purchaser, this court cannot permit the Trustee to avoid the mortgages in question because both were recorded, identified the Debtors, provided a description of the mortgaged property, set forth the amount and purpose of the indebtedness, and incorporated the interest rate and maturity date by reference to a promissory note. The court therefore respectfully disagrees with the Bankruptcy Court’s decision.
Id. at 915.
The District Court noted that on February 8, 2013, 765 ILCS 5/11 was amended by adding new subsection (b), which specifically states that the provisions of 765 ILCS 5/11(a) regarding the form of an Illinois mortgage “are, and always have been permissive and not mandatory,” and that the failure of a new or prior mortgage to state one of the items mentioned in subsection (a) (including the interest rate or the maturity date) shall not affect the validity or priority of the mortgage or cause the recordation of the mortgage to be ineffective for notice purposes. The District Court reasoned that although the effective date of the amendment was not until June 1, 2013, the statute merely clarified existing law and did not alter the existing statute, and thus “reinforces this court’s reasoning.” Id.
Since the District Court’s holding in Crane, several bankruptcy courts have agreed with and followed the District Court’s decision. [Note: Most bankruptcy judges state that they are bound only by decisions that have been handed down by the United States Supreme Court and their respective circuit court of appeals. Cases from other circuit courts, from other district courts, and even from other bankruptcy courts within the same district, may be persuasive, but are not binding on bankruptcy judges. See John C. Murray, The Lender’s Guide to Single Asset Bankruptcy Cases, 31 REAL PROP. PROB. & TR. J. 393, 411 (Fall 1996).]
See In re Banbury Metrolofts, LLC, 2013 WL 1191230 (Bankr. N.D. Ill., March 25, 2013), at *2-3 (“Crane, the only case directly holding that a mortgage that does not specifically state the maturity date and the interest rate fails to give constructive notice and can be avoided by a trustee solely on this basis, has been reversed . . . This court agrees with and adopts the reasoning in . . . the district court’s opinion in Crane. . . [T]he provisions of section 11 of the Conveyances Act are not mandatory”); PNC Nat. Ass’n. v. Nordwall, 499 B.R. 599, 605 (C.D. Ill. 2013) (noting District Court’s opinion in Crane, and holding that “§ 11 of the [Illinois] Conveyances Act is permissive and . . . failure to include the maturity date and interest rate on the face of a mortgage does not render it invalid, nor does it necessarily mean the mortgage did not give constructive notice of the lien.”) In re HIE of Effingham, LLC, 490 B.R. 800, 820 (Bankr. S. D. Ill., March 29, 2013) the court also noted the District Court’s opinion in Crane, and stated that:
Clearly, a mortgage that contains all of the enumerated elements of § 11 provides constructive notice to a third party purchaser. However, this Court cannot say that a mortgage that fails to do so is per se deficient for purposes of constructive notice.
THE SEVENTH CIRCUIT’S
DECISION IN IN RE CRANE
The bankruptcy trustee subsequently appealed the District Court’s ruling in In re Crane to the Seventh Circuit Court of Appeals. The Seventh Circuit combined this case with an appeal from the bankruptcy trustee in In re Klasi Properties, LLC, 2013 WL 211111 (Bankr. S.D. Ill., Jan. 18, 2013), at *4 (which held that “based on the express and unambiguous language of § [765 ILCS 5/]11… its provisions are permissive and . . . failure to include all of the specified terms -- such as the interest rate or the maturity date -- is not necessarily fatal to the mortgage.” Id. at *4).
The Seventh Circuit issued its highly anticipated opinion on December 23, 2013 in In re Crane, 2013 WL 6731850 (C.A. 7-Ill., Dec. 23, 2013), and noted that “we address a question that has divided bankruptcy courts in Illinois and has pitted mortgage lenders against unsecured creditors.” Id. at *1. The Seventh Circuit affirmed the holding of the District Court and ruled that the mortgage form set forth in 765 ILCS 5/11 (before it was amended) was written in permissive and not mandatory terms, and therefore constituted a “safe harbor” and provided the trustee with constructive notice; thus the trustee could not avoid the mortgage even though it did not state the maturity date or the interest rate.
The Seventh Circuit noted that it was required to predict Illinois law in this case, and that, after reviewing the language of 765 ILCS 5/11 and Illinois case law, the mortgages at issue “supplied the indispensable elements of a mortgage under Illinois common law,” Id. at *4, i.e., “the existence of the debt and the intention to secure its payment,” Id. (citation omitted). The court found that Illinois common law was broader than the safe harbor provided by 765 ILCS 5/11 and did not require setting forth the maturity date and interest rate. The court also noted that the mortgages in the Crane and Klasi cases “accurately disclosed the mortgagors, the mortgagees, the amounts of the indebtedness, the descriptions of the properties subject to the mortgages and the dates of the mortgages,” Id. at *3, and that the underlying debts were secured by separate promissory notes executed simultaneously with the mortgages. The court further stated that it had not found “any Illinois cases holding that a recorded mortgage must state the maturity date and/or the interest rate to ensure priority over later claims.” Id. at *4.
The Seventh Circuit stated that its decision specifically overruled People’s National Bank, N.A. v. Jones, 482 B.R. 257 (S.D. Ill., 2012), in which the District Court stated that it “finds that the bankruptcy court erred in failing to apply controlling Illinois law, which requires a mortgage to describe the nature of the debt secured, amount secured, due date and interest rate.” Id. at 259 (emphasis added). Interestingly (and incorrectly, based on the Seventh Circuit’s decision), the court in Jones also stated that:
Under Illinois law, 765 ILCS 5/11 provides that a mortgage should “... recite the nature and amount of indebtedness, showing when due and the rate of interest, and whether secured by note or otherwise …
Id. at 263 (emphasis added). (The District Court in Jones apparently decided that the word “may” contained in the statute actually means “should” or “requires” … an interesting bit of semantic gymnastics though perhaps not as decisive as “must”).
The Seventh Circuit also specifically overruled the Illinois Bankruptcy Court’s holding in Peterson v. Berg (In re Berg), 387 B.R. 524, 560-61 (Bankr. N.D. Ill. 2008) (which ruled that mortgage that did not state debt amount, interest rate, or maturity date of loan was insufficient under 765 ILCS 5/11 and could be avoided by Chapter 7 trustee).
Finally, the Seventh Circuit declined to address the arguments by the mortgage lenders that the maturity date and interest rate were incorporated into the mortgages by reference to the simultaneously executed promissory notes, and whether the recorded mortgages were sufficient to give the trustees constructive inquiry notice under Illinois law. According to the court, “Because the recorded mortgages were sufficient to supply constructive record notice, we do not address these alternative arguments.” In re Crane, 2013 WL 6731850, at *6.
The Seventh Circuit’s decision should settle the issue of whether 765 ILCS 5/11(either under the original or the amended version) requires the maturity date and interest rate to be set forth on the face of the mortgage -- it does not. The court specifically noted, Id. *6 n. 2, that:
We do not decide whether the 2013 amendment should be treated as merely clarifying and applied here. We reach the same result under the 2012 version of the statute because we agree that the terms listed in section 5/11 have always been permissive rather than mandatory.
For further discussion and analysis of the Seventh Circuit’s opinion in Crane, see Mortgage’s Missing Terms Were Not Essential, 24 No. 5 CONSUMER BANKRUPTCY NEWS 28 (2014); Mortgages Lacking Maturity Date Gave Constructive Notice, 01-8-14 WEST’S BANKRUPTCY NEWSLETTER 5 (2014).
The Seventh Circuit’s decision in In re Crane should alleviate the concerns of mortgage lenders and their counsel, as well as title insurers, regarding the ability of the thousands of mortgages outstanding in Illinois that do not state the maturity date or interest rate to withstand a bankruptcy trustee’s action for avoidance. (Fannie Mae’s approved form of mortgage, used in almost all residential mortgage transactions, does not state the interest rate). Thankfully, the end of Western civilization as we know it has not occurred and the mortgage-lending business in Illinois can continue apace.
Although in the future some mortgage lenders in Illinois may decide, in an abundance of caution, to nonetheless include all of the permissive elements stated in the mortgage form provided in 765 ILCS 5/11 to take full advantage of the statutory “safe harbor,” and to specifically reference the promissory note in the mortgage, failure to include the maturity date and the interest rate of the loan in the mortgage will have no effect on the priority and validity of the mortgage.
* Nothing contained in this article is to be considered as the rendering of legal advice for specific matters, and readers are responsible for obtaining such advice from their own legal counsel. This article is intended for educational and informational purposes only. The views and opinions expressed in this article are solely those of the author and do not necessarily reflect the views, opinions, or policies of the author’s employer, First American Title Insurance Company.