Thursday, December 1, 2011

FYI: 1st Cir Holds Recorder's Office Delay in Recording Does Not Cause Mortgages to Be Voidable

The U.S. Court of Appeals for the First Circuit recently held in a
bankruptcy action that a lender has an unavoidable pre-petition "interest
in property" where mortgage deeds, still waiting to be recorded, had been
presented for recording three years prior to the bankruptcy filing. The
Court also held that the debtors could not avoid the mortgages as
preferential transfers because the mortgages had been presented for
recording prior to the preference period.

A copy of the opinion is available at:

The bankruptcy debtors here executed three mortgages to secure two loans
from a lender (the "Bank"). The Bank timely presented the mortgage
documents for recording to Puerto Rico's recording office, but, due to an
administrative backlog, the mortgage documents remained unrecorded as of
the date of the debtors' Chapter 11 bankruptcy filing three years later.
Even though the mortgages had not yet been recorded as of the date of the
bankruptcy filing, the Bank filed a secured proof of claim with respect to

The debtors then filed an adversary proceeding seeking to avoid the
mortgages under various provisions of the Bankruptcy Code governing the
automatic stay and a trustee's "strong-arm powers." The debtors asserted
that they were bona fide purchasers of the property not subject to the
Bank's claim in the property, because the Bank did not hold a pre-petition
"interest in the property." The debtors also sought to avoid the
mortgages as prohibited preferential transfers. See 11 U.S.C. §§
362(a)(5), 544(a), 547(b), 547(e)(1)(A).

Rejecting the debtors' argument that the Bank merely held an unsecured
claim because the mortgages remained unrecorded as of the petition date,
the bankruptcy court granted the Bank's motion for summary judgment. The
bankruptcy court also rejected the debtors' assertion that the mortgages
could be avoided as preferential transfers. The District Court affirmed.

On appeal to the First Circuit, the debtors challenged the application of
exceptions to the automatic stay and strong-arm powers, arguing that the
Bank never held a pre-petition "interest in the property" and could not
take post-petition steps to perfect the mortgages. The debtors again
asserted that the mortgages could be avoided as preferential pre-petition
transfers. The First Circuit affirmed the rulings in favor of the Bank in
the lower courts.

The debtors' challenge to the enforceability of the mortgages hinged on
whether the Bank, as the holder of the unrecorded mortgages, held a
pre-petition "interest in property" sufficient to provide an exception to
the automatic stay and Debtors' powers to avoid statutory liens. 11
U.S.C. §§ 362(b)(3), 546(b). As you may recall, the automatic stay in
bankruptcy bars "any act to create, perfect, or enforce any lien against
property of the estate," except where, among other things, an "interest in
property" has been perfected pre-petition. See 11 U.S.C. §§ 362(a)(4),
362(b)(3). In addition, in acquiring the status of bona fide purchasers of
real property or of judicial lien holders, debtors may ordinarily avoid
any transfer of property or obligation to the extent allowed by state law,
unless applicable law "permits perfection of an interest in property to be
effective" against one acquiring subsequent rights in the property before
the interest is perfected. See 11 U.S.C. §§ 544(a)(3), 546(b(1)(A).

Noting that in bankruptcy, the term "interest in property" is a federal
statutory term "informed" by state law, the First Circuit followed its
analysis in In re 229 Main St. Ltd. P'ship, 262 F.3d 1 (1st Cir. 2001).
There, the Court determined that the term "interest in property" is
broader than the term "lien" and that "the filing of a bankruptcy petition
does not prevent the holder of an interest in property from perfecting its
interest if, absent the bankruptcy filing, the interest holder could have
perfected its interest against an entity acquiring rights in the property
before the date of perfection."

The Court also noted that Puerto Rico's "relation back" doctrine provides
that the time at which a mortgage deed is presented for recording is the
point at which priority is established among competing property
registrations, because the act of presentment places third parties on
notice as to the existence of the mortgage. See P.R. Laws Ann. Tit. 30, §
2256. The Court pointed out that the Bank affirmatively took all steps to
effectuate the recording of the mortgage deeds and that nothing suggested
that the mortgage documents submitted for recording were in any way
defective and would not be recorded under Puerto Rico's mortgage recording
statutes. Thus, the Court concluded that the acts of presentment
"sufficiently vested" the Bank with a pre-petition interest in Debtors'
real property not subject to the automatic stay or strong arm powers.

The First Circuit also ruled that the debtors could not avoid the
mortgages as preferential transfers made during the 90-day period prior to
the commencement of the bankruptcy proceeding. In so ruling, the court
noted that the timing of a transfer depends on when and whether the
transfer was perfected, which, under Puerto Rico's relation-back doctrine,
occurred at the time of the presentment of the mortgage deeds for
recording -- almost three years before the debtors filed for bankruptcy

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

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