In Sharper Focus: Guest Post on the Intersection of Bankruptcy Law and Ohio’s Recording Statutes

On October 14, 2015, the Supreme Court of Ohio heard oral argument in the case of In re: Daren A. Messer, Angela Messer, Debtors Daren Messer & Angela Messer v. JPMorgan Chase Bank, NA, Case Number 2014-2036.  This case involves two certified state law questions from Judge Charles M. Caldwell, U.S. Bankruptcy Judge for the Southern District of Ohio, Eastern Division:  (1) whether R.C. 1301.401 applies to all recorded mortgages in Ohio, and (2) whether R.C. 1301.401 acts to provide constructive notice to the world of a recorded mortgage that was deficiently executed under R.C. 5301.01.

For those of us unfamiliar with bankruptcy law, this argument was difficult to follow.  So, I have asked two excellent Cincinnati lawyers, Cynthia M. Fischer and Rick D. DeBlasis of Lerner, Sampson, & Rothfuss to explain the intersection of bankruptcy law and the recording statutes to provide some useful background information in understanding this argument.

In Sharper Focus Guest Post

By Cynthia M. Fischer and Rick D. DeBlasis, Lerner, Sampson & Rothfuss

For a very long time, the law in Ohio has been that:

  1. Under the provisions of R.C. 5301.25, a defectively executed mortgage, although recorded, does not establish a lien with priority over a properly executed mortgage which is recorded subsequently; and the defective execution may be proved by evidence of defects which are not apparent on the face of the instrument.

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2.  A mortgage by two persons is not properly executed in accordance with the provisions of R.C. 5301.01, and is not entitled to record under R.C. 5301.25 and the recording thereof does not constitute constructive notice to subsequent mortgagees, where there is a failure to follow the statutory requirements in that the mortgage is not signed and acknowledged by either mortgagor in the presence of two witnesses, and the signing by one mortgagor is not in fact acknowledged before a notary public. Citizens National Bank v. Denison, 165 Ohio St. 89, 133 N.E.2d 329 (1956).

On March 27, 2013, the Ohio Legislature passed a new law, which may or may not change the Denison holding.  The new law, R.C. 1301.401, provides as follows:

(A) For purposes of this section, “public record” means either of the following:
(1) Any document described or referred to in section 317.08 of the Revised  Code; (2) Any document the filing or recording of which is required or allowed under any provision of Chapter 1309 of the Revised Code.

(B) The recording with any county recorder of any document described in division (A)(1) of this section or the filing or recording with the secretary of state of any document described in division (A)(2) of this section shall be constructive notice to the whole world of the existence and contents of either document as a public record and of any transaction referred to in that public record, including, but not limited to, any transfer, conveyance, or assignment reflected in that record.

(C) Any person contesting the validity or effectiveness of any transaction referred to in a public record is considered to have discovered that public record and any transaction referred to in the record as of the time that the record was first filed with the secretary of state or tendered to a county recorder for recording.

R.C. 1301.401 does not refer to Chapter 53 of the Revised Code, however, and is located in Ohio’s Uniform Commercial Code, which traditionally is not applicable to real estate questions.  So, on November 24, 2014, the Supreme Court of Ohio was asked to decide the following questions:

1. Does R.C. 1301.401 apply to all recorded mortgages in Ohio?

2. Does R.C. 1301.401 act to provide constructive notice to the world of a recorded mortgage that was defectively executed under R.C. 5301.01?

See Messer v. JPMorgan Chase Bank, N.A. (In re Messer). If the Supreme Court of Ohio should decide, in Messer, that R.C. 1301.401 does apply to all recorded mortgages in Ohio and does act to provide constructive notice of mortgages  defectively executed under R.C. 5301.01, the result would be to do away with the legal fiction, articulated in Denison, that lawyers have become so accustomed to, namely that mortgages that are matters of public record may nevertheless provide no notice of their existence to title examiners if, for some reason, not necessarily apparent within the four corners of the document, they were not executed with all the formalities of R.C. 5301.01.

The Messer case began, as defective mortgage cases often do, in the bankruptcy court.  Daren Andrew Messer and Angela Lynn Messer are owners of a home located in Canal Winchester, Ohio, which they bought with the help of a first mortgage loan in the amount of $160,942.00.  The mortgage is initialed by the Messers on each page and bears their signatures.  It is recorded and therefore a matter of public record.  But, there is no notary signature following the acknowledgement clause.

The loan is now held by JPMorgan Chase Bank and it is in default for payment.  The Messers filed a Chapter 13 bankruptcy petition ostensibly to rehabilitate their finances.  The Second Amended Chapter 13 plan, which was confirmed, provides, in part, as follows:

1.Unsecured creditors will receive a total of 10.50 percent of the amount of their timely-filed claims during the course of the Chapter 13 plan.

2.Upon an entry confirming the proposed Chapter 13 plan, all assets of the Chapter 13 estate vest in the Messers. The plan also includes the following specific provision:  “Debtor has standing and authority to file the motion or adversary proceeding [seeking to treat JP Morgan Chase Bank as an unsecured creditor and to avoid the mortgage]; to the extent that the Trustee has standing to bring such action, standing is hereby assigned to Debtor.” [This transfer of standing is also contemplated under 11 U.S.C. § 522(h)(1).]

3. The Messers have 30 days from the entry confirming the Chapter 13 plan to file an adversary case in the Bankruptcy Court against JP Morgan Chase Bank seeking determination of whether JPMorgan Chase Bank’s mortgage will be treated as secured or unsecured. If the mortgage is found to be valid and secured, then the Messers will file a motion to modify the plan to surrender the real estate or to cure the arrearage and maintain monthly mortgage payments.

The Chapter 13 plan does not specifically say what will become of the home if the mortgage is avoided; however, the implication is that the Messers will continue to live in the home free and clear of any mortgage so long as they complete five years of payments derived from their disposable income. That payment stream, suggests the Messers, will pay unsecured creditors, apparently including JPMorgan Chase, 10.5% of their claims.  JPMorgan Chase would receive 10.5% of its claim of $153,195.15, or about $16,000.00.

Following confirmation of the Second Amended Plan, the Messers filed the proposed adversary proceeding (a separate civil suit within the bankruptcy case) against JPMorgan Chase.  The Messers challenge the validity of the mortgage under Bankruptcy Code §544 (11 U.S.C. §544(a)(3)), the “strong arm” clause of the Bankruptcy Code, which cloaks the bankruptcy trustee with the rights and powers of a bona fide purchaser of real property and allows the trustee to avoid any transfer of the debtor’s property that would be avoidable under state law by a hypothetical bona fide purchaser.  Debtors, such as the Messers, have been permitted to exercise the rights of a bankruptcy trustee under the “strong arm clause” when the trustee declines to do so.

JPMorgan Chase filed a motion to dismiss the adversary proceeding upon the contention, in part, that R.C. 1301.401 enacts a change in Ohio state law, such that an interest holder could no longer claim bona fide purchaser status and could no longer seek to avoid the defective, but recorded, mortgage.  The Bankruptcy Court certified the above-stated questions to the Supreme Court of Ohio for decision. In the Order of Certification, the Bankruptcy Court noted:

Upon reviewing the briefing of both Parties and the arguments made at the hearing on Defendant’s Motion to Dismiss, this Court determined that its interpretation of O.R.C. §1301.401 would be dispositive of the case.  Upon research, this Court found no interpretation of O.R.C. §1301.401 by the Supreme Court of Ohio – or any other court.  There is no dispute in this case that the Mortgage was improperly executed under O.R.C. §5301.01, and there is no dispute that prior to the enactment of O.R.C. §1301.401 the Plaintiffs could have avoided the mortgage.  The questions concern whether the new statute changes the result.

Although the Messer case, and many others like it, leaves the impression that if the Supreme Court of Ohio decides the certified questions in the negative, the Messers will have achieved the impossible “free lunch,” that is not necessarily the case.

Other provisions of the Bankruptcy Code discuss the result of lien avoidance under §544.  For example, Bankruptcy Code §551 provides, “Any transfer avoided under section … 544 … is preserved for the benefit of the estate but only with respect to property of the estate.”  The official “Revision Notes and Legislative Reports” interpreting the statute provide, in part, “The section as a whole prevents junior lienholders from improving their position at the expense of the estate when a senior lien is avoided.”

Together, §§544 and 551 have been held to “benefit the unsecured creditors by allowing the trustee to eliminate unperfected liens on a debtor’s property and subsequently to apply the value represented by those liens to the general estate, bypassing junior lienholders.” DeGiacomo, Trustee v. Traverse (In re Traverse), 753 F.3d 19, 26 (1st Cir. 2014), cert. denied, ___ U.S. ___, 135 S. Ct. 459, 190 L. Ed. 2d 332 (2014). In the Messer case, the JPMorgan Chase mortgage is in default for lack of payment. The default ordinarily would empower JPMorgan Chase to liquidate its collateral by foreclosure. That power, should the lien be avoided, would be preserved for the benefit of the estate by virtue of Bankruptcy Code §551. Thus, the bankruptcy trustee, after mortgage avoidance, would be entitled to liquidate the property and distribute its value to general unsecured creditors along with the debtors’ 60-month payment stream, adjusted for the added expense of a fair rental payment incurred by the debtors’ relocation from the premises.

Applying these principles in the Messer case, JP Morgan Chase’s claim of $153,000 would be added to the general unsecured debt of approximately $80,000, providing total unsecured debt of $233,000.  That debt would be paid first by distribution pro rata of the liquidated value of the real estate ($150,000 appraised value less 10% expenses of sale = $135,000).  The remaining unsecured debt of approximately $100,000 would be paid from the plan payment stream, which, over 60 months, adjusted for debtors’ reasonable rental expense, equals approximately $60,000.  Thus, unsecured creditors would receive – not 10.5% of claims, but 84% of claims (total payments of $195,000 divided by total claims of $233,000).  It could reasonably be expected that the Messers, under these circumstances, would prefer to withdraw their adversary proceeding and modify their plan to cure JPMorgan Chase’s default while resuming regular monthly plan payments.

Of course, a decision by the Supreme Court of Ohio dispensing with the legal fiction that a recorded mortgage does not provide notice to the world because of a technical defect in its execution, would have the effect of ending these adversaries and Ohio debtors’ quest for the elusive “free lunch.”

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