On December 23, 2013, a collective sigh of relief could be heard from secured lenders across Illinois as the United States Court of Appeals for the Seventh Circuit held that a mortgage that does not state on its face the maturity date or the interest rate is valid and proper, and that a trustee in bankruptcy could not use his “strong-arm” power to avoid such mortgages (In re Gary Crane and Marsa S. Crane). Had the court ruled opposite the way that it did, thousands of mortgages across the state could have been deemed ineffective and would have left many mortgage lenders completely unsecured.
In Crane, two bankruptcy cases were consolidated for purposes of appeal to the Seventh Circuit: Crane and Klasi Properties, LLC. In Crane, the Bankruptcy Court in the Central District of Illinois held in favor of the trustee and ruled that the language of the Illinois statute directing the form of mortgages on real property was mandatory, and not permissive. It also stated that a mortgage that did not contain the interest rate and maturity date on its face (as noted in the form given in the statute) was not valid and could be “avoided” by a trustee in bankruptcy. In Klasi Properties, LLC, the Bankruptcy Court in the Southern District of Illinois held in favor of the secured lenders and against the trustee on the exact same issue. With such an obvious conflict of opinions in existence, the Seventh Circuit consolidated the cases for appeal.
Both of these cases arose because of the special powers of bankruptcy trustees. A bankruptcy trustee has the power to avoid any transfer of property of the debtor that is voidable by a bona fide purchaser of real property. A “bona fide purchaser” is someone who acquires an interest in the property for valuable consideration without actual or constructive notice of another’s adverse interest in the property. A trustee in bankruptcy, however, can only be charged with “constructive notice.” The trustees in these cases argued that Illinois’ mortgage recording law stated mandatory requirements for information to be included in mortgages and the failure of the mortgages at issue to contain all of the required information (including interest rate and maturity date) rendered them ineffective to provide the trustee with such “constructive notice.” Therefore, the trustees reasoned that they were “bona fide purchasers,” had the power to avoid the mortgages and could take the properties free and clear of the mortgages.
The Seventh Circuit, in ruling against the trustees, held that the information to be included in mortgages under Illinois’ mortgage recording statute was merely permissive, rather than mandatory. The mortgages at issue in the cases included the names of the mortgagors, the names of the mortgagees, the amount of the indebtedness, the descriptions of the properties subject to the mortgages and the dates of the mortgages. The only information not included on the mortgages that are listed in Illinois’ mortgage statute was the interest rates and the maturity dates. According to the Seventh Circuit, the information that was included in each of the mortgages was sufficient to put the trustees on “constructive notice” and eliminate their arguments that they could be considered “bona fide purchasers”; therefore, their attempts to avoid these mortgages failed.
While the Crane decision is certainly a victory for mortgage lenders throughout the state, it also clarifies a very basic rule of secured lending – banks and their attorneys must ensure that their security interests are properly perfected. While the Seventh Circuit held that the information noted in Illinois’ mortgage recording statute was only permissive, it also held that any secured lender that follows this permissive scheme puts their mortgage in a “safe harbor” that ensures that the mortgage cannot be successfully challenged due to its form. Had the lenders in these cases simply followed the “safe harbor” form noted in the statute, these cases would never have been brought by the bankruptcy trustees.