Knowledge Center

Tuesday, May 22, 2012

Bankruptcy Trustee Avoids Mortgages Missing Interest Rate, Maturity Date

Real Estate Group Bulletin sent on Tuesday, May 22, 2012.

The United States Bankruptcy Court for the Central District of Illinois recently held that two mortgages did not comply with the Illinois Conveyance Act (the "Act") and thus were avoidable by a trustee in bankruptcy.

In the case of In re: Crane, No. 11-9067, 2012 Bankr. LEXIS 776 (Bankr. C.D. Ill. 2012), the trustee filed an adversary complaint against the defendant bank, claiming that two mortgages securing notes held by the bank were defective and subject to avoidance. Pursuant to Chapter 7 of the United States Bankruptcy Code, bankruptcy trustees assume the hypothetical status, rights and powers of a bona fide purchaser of real property and thus are able to avoid any transfer for which there was no actual or constructive notice. The bankruptcy trustee in In re: Crane claimed that he did not have constructive notice of the two mortgages because although they were recorded, they failed to comply with the requirements of the Act.

The Act provides that a mortgage may "...recite the nature and amount of indebtedness, showing when due and the rate of interest, and whether secured by note or otherwise..." 765 ILCS 5/11. Judge Schmetterer held in In re: Berg, 387 B.R. 524 (Bankr. N.D. Ill. 2008) that the provisions of 765 ILCS 5/11 are not permissive, but required in order for a mortgage to provide constructive notice to a bona fide purchaser or a trustee in bankruptcy.

The court in In re: Crane agreed with the holding in In re: Berg that the two mortgages at issue failed to provide constructive notice to the bankruptcy trustee because they did not state either an interest rate or a maturity date. As a result, the court held that the mortgages were avoidable as to the trustee and, as such, ordered both mortgages avoided.

In light of this decision, it is important that secured lenders begin practicing strict compliance with the requirements of the Act. An essential step toward full adherence to the Act would be to update all form mortgages so that they contain the nature and amount of indebtedness, the maturity date, the interest rate and whether secured by note or otherwise. Secured lenders would be well advised to implement this practice for all new mortgages, renewals, extensions and amendments related to Illinois real property, and should consider whether or not they wish to amend their existing mortgages. 

To discuss specific recommendations regarding these issues, please feel free to contact the attorneys in the Real Estate Group at Horwood Marcus & Berk Chartered.

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