Wednesday, January 1, 2014

FYI: 7th Cir Holds Mortgage Need Not Include Maturity Date or Interest Rate to Be Enforceable

The U.S. Court of Appeals for the Seventh Circuit recently held that, under the Illinois mortgage recording statute in effect prior to a June 2013 corrective amendment occasioned by this litigation, the absence of a maturity date and/or an interest rate in a mortgage instrument did not allow a bankruptcy trustee to avoid a mortgage through the trustee's "strong-arm" powers under 11 U.S.C. § 544(a)(3).  A copy of the Court's opinion is attached.   


The Seventh Circuit addressed appeals from two separate bankruptcy cases.  In both matters, the recorded mortgages did not state the maturity date of the secured debt or the applicable interest rate.  Each mortgage did however incorporate by reference their respective promissory notes, which included these terms. 


The bankruptcy trustee in each matter filed adversary actions under 11 U.S.C. § 544(a)(3) seeking to avoid the mortgages because they did not state the maturity dates or interest rates for the secured dates.  In one of the matters, the bankruptcy court granted summary judgment in favor of the trustee, but this ruling was reversed by the district court judge.  In the other action, the bankruptcy court granted summary judgment in favor of the mortgage lender.  The bankruptcy trustees appealed in both actions.


As you may recall, 11 U.S.C. § 544(a)(3) provides a trustee with so-called "strong-arm" powers which provide the trustee the "rights and powers of … a bona fide purchaser of real property" to void any obligation of the debtor or avoid the transfer of property.  Importantly, the strong arm power makes any actual notice of the trustee irrelevant. 


As the Seventh Circuit noted, the determination of whether a party is a bona fide purchaser and what constitutes constructive notice is governed by state law.  Accordingly, in rejecting the trustees' appeals, the Court's analysis was based upon Illinois law. 


In Illinois, a bona fide purchaser is one who acquires an "interest in [the] property for valuable consideration without actual or constructive notice of another's adverse interest in the property."  U.S. Bank N.A. v. Villasenor, 979 N.E.2d 451 (Ill. App. 2012).  Under the strong-arm statute the trustee cannot be charged with actual notice; however, constructive notice is effective against a trustee.   


Constructive notice, in Illinois, is defined as knowledge that the law imputes to a purchaser, whether or not the purchaser had actual knowledge at the time of the conveyance.  U.S. Bank., 979 N.E.2d at 465.  There are two kinds of constructive notice:  record notice and inquiry notice.  Record notice imputes to a purchaser 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 land is situated.


The trustees argued that each respective mortgage was legally insufficient to give constructive notice to a bona fide purchaser, because the instruments did not provide all the required information under the Illinois mortgage recording statute, 765 ILCS 5/11 (2012). 


As may recall, 765 ILCS 5/11 (2012), in relevant part provides a form for which mortgages recorded in Illinois to follow.  However, the statute also provides that "Mortgages of lands may be substantially in the following form."  Id. 


The Court noted that the mortgages at issue substantially followed the suggested form, and specifically provided that the underlying debts were secured by separate but contemporaneously signed promissory note.  However, the mortgages did not set forth the maturity dates or the interest rates of the underlying loans, information which was provided for in the Illinois statutory form. 


Applying the Illinois rules of statutory interpretation and attempting to predict how the Illinois Supreme Court would resolve the issue, the Seventh Circuit determined that the form in the Illinois mortgage recording statute was permissive and not mandatory.  Thus, the trustee's section strong-arm powers could not avoid the mortgages at issue. 


In so holding, the Seventh Circuit noted that statutes operative language was clearly permissive.  Accordingly, the Court determined that strict compliance with the suggested form is not required to ensure a valid mortgage enforceable against subsequent lenders and purchasers. 


The Seventh Circuit then examined the Illinois common law to determine which elements were required in a mortgage for it to be effective as to subsequent bona fide purchasers.  In doing so, the Court first noted that the trustees failed to cite and indeed the Court did not find any Illinois cases holding that a recorded mortgage must state the maturity date and/or the interest rate to ensure their validity, enforceability, and priority.  According to the Illinois Supreme Court, as noted by the Seventh Circuit, the "essential things" in a mortgage "are the existence of a debt and the intention to secure its payment."  Caraway v. Sly, 78 N.E. 588, 589 (Ill. 1906).


The Court further noted that  under Illinois law the amount of the debt is an indispensable element of a mortgage, and must be included in a recording for it to be effective against a third party.  However, the Seventh Circuit was not persuaded by the trustees' arguments that the interest rate and maturity date were similarly indispensable elements, and determined that providing these terms was not necessary to give constructive record notice of the mortgage to subsequent lenders and purchasers. 


Accordingly, the Seventh Circuit held that the trustees had constructive notice of the mortgages in both of the cases on appeal, and the trustees could not rely upon their strong-arm powers to avoid the mortgages.   


Notably, the amended version of 765 ILCS 5/11 which went into effect on June 1, 2013, explicitly provides that the provisions in the suggested form "are, and have always been, permissive and not mandatory" and the specifically the "failure to state the interest rate or the maturity date, or both, shall not affect the validity or priority of the mortgage."  See 765 ILCS 5/11(b) (2013). 





Ralph T. Wutscher
McGinnis Wutscher Beiramee LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
(312) 551-9320
(312) 284-4751
(312) 493-0874


Admitted to practice law in Illinois



          McGinnis Wutscher Beiramee LLP





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