In re Cates – 10th Cir. BAP 10th Cir BAP holds that deed of trust recorded prior to title ownership of borrower provides inquiry notice of the lien to borrower’s creditors

The following is a case update prepared by Dan Schechter, Professor Emeritus, Loyola Law School, Los Angeles, analyzing a recent decision of interest:

SUMMARY:

The Tenth Circuit Bankruptcy Appellate Panel has held that although a deed of trust had been recorded while the debtor had no record title to the property in question, a hypothetical purchaser of the debtor’s property would have been on inquiry notice of the deed of trust, due to the debtor’s quitclaim executed in favor of her family trust. [In re Cates, 2018 Westlaw 4042816 (10th Cir. BAP).]

FACTS: The owner of a condominium executed a note and a deed of trust in favor of two family members, but it was not recorded at that time. Less than a year later, she quitclaimed the property to her family trust. A month after the property had been conveyed to the family trust, the two family members holding the unrecorded deed of trust executed by the debtor finally recorded it. Just prior to the filing of the homeowner’s bankruptcy petition, her family trust quitclaimed it back to her.

Her bankruptcy trustee then brought an adversary proceeding against the two family members, seeking to avoid the deed of trust as a preferential transfer. The parties filed cross-motions for summary judgment. The trustee claimed that the deed of trust was a transfer deemed to have occurred just before bankruptcy, when the property was quitclaimed from the family trust back to the homeowner. The secured creditors, the holders of the deed of trust, asserted that the transfer of the deed of trust occurred on the date that it was first recorded; since that date was more than 90 days before bankruptcy, the transfer was not preferential.

REASONING: The bankruptcy court ruled in favor of the secured creditors, and the BAP affirmed. The trustee argued that under 11 U.S.C.A. §547(e)(1)(A), the timing provision of the preference statute, the transfer in question could not have occurred until the lien of the deed of trust would have been superior to the interests of a hypothetical bona fide purchaser of the real property. Since the title was not in the debtor’s name at the time the deed of trust was recorded, the hypothetical bona fide purchaser would not have had notice of the existence of the deed of trust until (at the earliest) the reconveyance of the property from the family trust back to the homeowner.

The court disagreed, holding that under Colorado’s “race-notice” recording statute, a hypothetical bona fide purchaser would have been on notice of the recording of the deed of trust, even though it was recorded when the debtor did not have record title. The court acknowledged that “[a] conveyance recorded after the record title reflects that the transferor had already parted with title is not within the chain of title because a searcher has the right to assume that a party who has parted with record title will make no further conveyances of the property.” Thus, the deed of trust, which was recorded after the debtor had parted with record title, was not within the hypothetical searcher’s chain of title. Nevertheless, the court held that a hypothetical searcher would have found the deed of trust by conducting a normal inspection of the chain of title:

Here, if a bona fide purchaser from the Debtor after the recordation of the Deed of Trust had searched the grantor-grantee index for the Property under the Debtor’s name, the bona fide purchaser would have found the quitclaim deed from the Debtor to the Family Trust. The Chapter 7 Trustee argues that the quitclaim deed does not contain any irregularities indicating the existence of an interest in the Property outside the chain of title and therefore triggered no duty on the part of a purchaser from the Debtor to investigate. But the existence of the quitclaim deed in the chain of title itself is an irregularity viewed from the standpoint of a purchaser from the Debtor. The quitclaim deed shows the Debtor had transferred the Property to the Family Trust, which suggests the Debtor could not still convey good title to the Property. A bona fide purchaser from the Debtor, exercising reasonable diligence, after learning from a search within the chain of title that the Debtor had already parted with record title, would have continued to search the grantor-grantee index under the name of the Debtor for transactions affecting the Property after recordation of the quitclaim deed to the Family Trust. That search would have disclosed the Deed of Trust.

Therefore, since the hypothetical searcher would have found the deed of trust, the lien in favor of the secured creditors was superior to the interest of the hypothetical bona fide purchaser as soon as it was first recorded. Hence, the “transfer” of the lien occurred long before bankruptcy and could not be attacked as preferential.

AUTHOR’S COMMENT: Is there anything more fun than a good old-fashioned chain of title problem? Even more entertainingly, the court got it wrong. Here is where the court went off the rails: “[T]he existence of the quitclaim deed in the chain of title itself is an irregularity viewed from the standpoint of a purchaser from the Debtor. The quitclaim deed shows the Debtor had transferred the Property to the Family Trust, which suggests the Debtor could not still convey good title to the Property.”

The problem is that at the time of the bankruptcy filing, the debtor had reacquired record title to the property. Therefore, the linchpin of the court’s reasoning, the fact that title was in the hands of the trust, is false. If the title to the property had really remained in the hands of the family trust, then a hypothetical purchaser at the moment of bankruptcy might have had some reason to be concerned (and to investigate further), since the debtor could not have conveyed unencumbered record title to that hypothetical purchaser.

However, in this case, the property was reconveyed from the family trust back to the debtor, a few days prior to the petition date. The searcher would have had no reason to look for deeds out from the debtor during the period of time stretching from (1) the debtor’s conveyance to the family trust, all the way forward to (2) the reconveyance from the family trust back to the debtor. During that period of time, in which the debtor no longer had title to the property, there would have been no reason to look for conveyances from the debtor. After all, why look for conveyances from a party who does not have title? The deed of trust was a classic “wild deed,” one recorded outside the chain of title. For a case involving a very similar set of facts, see Far West Savings & Loan Assn. v. McLaughlin, 201 Cal.App.3d 67, 246 Cal.Rptr. 872 (1988). The court explained how the “wild deed” doctrine applies to a conveyance made by someone who is in the chain of title but who makes a conveyance that is recorded prior to his acquisition of record title:

This . . . rule applies to a conveyance by a person who is in the chain of title, but who makes a conveyance prior to his acquisition of record title. His conveyance, at the time it is made, is that of a stranger to the title; and, although he afterwards gains record title and makes another conveyance, the second grantee is not bound, in his search of the record, to determine whether his grantor, or any grantor in the chain, made a conveyance before such grantor became a part of the chain . . . . The second grantee who purchases for value and records first will prevail by virtue of the terms of the recording statute . . . . He has no constructive notice of the deed to the first grantee, for the record of such deed, made before the grantor had title, is not in the chain of title. For the first grantee to prevail he would have to have recorded his deed again (1) after record title had come to his grantor and (2) before the second grantee had given value.

I do not know if the trustee will seek review before the Tenth Circuit; but I think that there is a good chance of reversal if he does.

These materials were written by Dan Schechter, Professor Emeritus, Loyola Law School, Los Angeles, for his Commercial Finance Newsletter, published weekly on Westlaw. Westlaw holds the copyright on these materials and has permitted the Insolvency Law Committee to reprint them.