Summary of a Recent
Judicial
Development in
Secured Transactions
Filing of Lis Pendens Does Not Create a Lien; Bona Fide Purchasers
Have a Duty to Examine Every Record in the Chain of Title
Walt McCarterNational AgLaw Center Research Associate
Summary of Decision
In In re Perosio, 364 B.R. 868 (N.D.N.Y. 2006), the United States District Court for the Northern District of New York held that a creditor's lis pendens was not an avoidable preferential transfer, and as bona fide purchasers of real property the debtors had constructive notice of potential adverse claims and thus could not avoid their mortgages.
Background
In 1980, the Debtors obtained three parcels of land (Parcels I, II and III), and the deed contained descriptions for the three parcels plus four parcels excepted from Parcels I and II. Id. at 870. In February 1999, the Debtors executed a note in the amount of $292,000 and mortgages in the amounts of $50,000 and $240,000 in favor of Central National Bank, predecessor in interest to NBT National Bank (NBT). Id. The parties intended the mortgages to cover the three parcels of land but the mortgages only contained a description of the exceptions to Parcels I and II, and a description of Parcel III (Parcels I and II were not described in the mortgage). Id. In May 2001, the Debtors executed two notes and mortgages in the amounts of $200,000 and $30,250 in favor of Farm Service Agency (FSA), and the mortgages were intended to cover Parcels I, II and II, but again the descriptions in the mortgages were of the exceptions and Parcel III, and did not include Parcels I and II. Id. at 870-71. In October 2003, NBT filed a notice of pendency in actions (lis pendens) to foreclose its two mortgages and to reform the real property descriptions found in the mortgages. Id. at 871. The Debtors filed for Chapter 12 bankruptcy the following month, and in February 2004, they brought an action seeking to avoid NBT's and FSA's mortgages under 11 U.S.C. § 544(a)(3), and to avoid NBT's lis pendens as preferential transfers under 11 U.S.C. § 547. Id. The Bankruptcy Court dismissed their complaint and the Debtors appealed. Id. at 870.
Arguments
The Debtors argued that NBT's lis pendens was an avoidable preferential transfer under § 547 because it perfected or created additional rights in their property in favor of NBT, and it was also a transfer on account of an antecedent debt. Id. at 872. Alternatively, Debtors argued they were entitled to avoid the mortgages as bona fide purchasers without notice of potential adverse claims. Id. at 873.
Analysis and Holdings
Filing of lis pendens does not create a lien
The court noted that the lis pendens must first be a transfer under New York law before a preferential analysis under the Code is appropriate. Id. at 872. Section 547(b) states that a debtor "may avoid any transfer of an interest of the debtor in property." Id. Transfer is defined by § 101(54) as: "(A) the creation of a lien; (B) the retention of title as a security interest; (C) the foreclosure of a debtor's equity of redemption; or (D) each mode, direct or indirect, absolute or conditional, voluntary or involuntary, of disposing of or parting with [] property or [] an interest in property." Id. In their argument, the Debtors relied on the "creation of a lien" language of § 101(54), but the court pointed out that New York courts have consistently held that the filing of a lis pendens is merely a method of giving notice and does not create a lien. Id.
Bona fide purchasers
Section 544(a)(3) allows a debtor to avoid "any transfer of property of the debtor . . . that is voidable by . . . a bona fide purchaser of real property . . . against whom applicable law permits such transfer to be perfected." Id. at 873. The rights of a bona fide purchaser are determined by state law. Id. The court noted that under New York law, bona fide good faith purchaser status is destroyed by adverse claims, because "a good faith purchaser is deemed to have constructive notice of any deed or instrument properly recorded," and "presumed to have known every fact disclosed or to which an inquiry suggested by the record would have led." Id. The Debtors argued that the lack of a description of Parcels I and II in the mortgages supported their claim for status as bona fide purchasers without knowledge of adverse interests, but the court responded that a bona fide purchaser has a duty to examine every deed or record properly recorded within the chain of title and not just mortgages, and if they had done so they would have had "ample notice of discrepancies and possible adverse claims." Id. The court therefore affirmed the holding of the Bankruptcy Court and dismissed the Debtors' complaint. Id. at 874.
The case was decided on November 21, 2006.