In re Crane

• Decision Date: 23 December 2013
• Docket Number: Nos. 13–1277,13–1518.,s. 13–1277
• Citation: 742 F.3d 702
• Parties: In re Gary CRANE and Marsa S. Crane, Debtors. Appeal of Jeffrey D. Richardson, Chapter 7 Trustee. In re Klasi Properties, LLC, Debtor. Appeal of Robert T. Bruegge, Trustee of the Estate of Klasi Properties, LLC.
• Court: U.S. Court of Appeals — Seventh Circuit

742 F.3d 702

In re Gary CRANE and Marsa S. Crane, Debtors. Appeal of Jeffrey D. Richardson, Chapter 7 Trustee. In re Klasi Properties, LLC, Debtor. Appeal of Robert T. Bruegge, Trustee of the Estate of Klasi Properties, LLC.

Nos. 13–1277, 13–1518.

United States Court of Appeals, Seventh Circuit.

Argued Oct. 1, 2013.

Decided Dec. 23, 2013.

Joanne Turner Stevenson, Lackey & Stevenson, Centralia, IL, for Appellee.

Steven M. Wallace, Attorney, Kunin Law Offices, Collinsville, IL, for Trustee–Appellant.

Jeffrey D. Richardson, Decatur, IL, for Plaintiff–Appellant.

Mark A Berkoff, Nicholas M. Miller, Neal, Gerber & Eisenberg LLP, Chicago, IL, for Defendant–Appellee.

Before CUDAHY, RIPPLE, and HAMILTON, Circuit Judges.

HAMILTON, Circuit Judge.

Under 11 U.S.C. § 544(a)(3), a trustee in bankruptcy has the so-called “strong-arm” power to “avoid ... any obligation incurred by the debtor that is voidable by—a bona fide purchaser of real property ... from the debtor....” In these two appeals, we address a question that has divided bankruptcy courts in Illinois and pittedmortgage lenders against unsecured creditors. The question is whether, before a 2013 amendment to the Illinois mortgage recording statute, a bankruptcy trustee could use the strong-arm power to avoid a mortgage recorded in Illinois on the ground that the mortgage did not state on its face either a maturity date or an interest rate. Our answer is no. The Illinois statute on the form for recorded mortgages upon which the trustees base their strong-arm efforts, 765 Ill. Comp. Stat. 5/11 (2012), was written in permissive rather than mandatory terms. The absence of a maturity date and/or an interest rate did not allow a bankruptcy trustee to avoid a mortgage under the pre-amendment version of 765 ILCS 5/11. Accordingly, we affirm the judgment of the district court in the Crane case, No. 13–1518, and the judgment of the bankruptcy court in the Klasi Properties case, No. 13–1277.

I. Factual and Procedural Background

The debtors in both appeals, Gary and Marsa Crane and Klasi Properties, LLC, borrowed money secured by mortgages on real estate. In both cases, the mortgages were recorded by the lenders to ensure the priority of their mortgage liens. In both cases, the recorded mortgages did not state the maturity date of the secured debt or the applicable interest rate. Those terms were included in the promissory notes, of course, which were fully incorporated by reference in the mortgages.

The Cranes sought bankruptcy protection in the Central District of Illinois, and Klasi Properties sought bankruptcy protection in the Southern District of Illinois. In both cases, the trustees filed adversary complaints under 11 U.S.C. § 544(a)(3) seeking to avoid the mortgages because they did not state the maturity dates or interest rates for the secured debts. In the Crane case, the bankruptcy court granted summary judgment in favor of the trustee, Crane v. Richardson (In re Crane), 2012 WL 669595, at *2 (Bankr.C.D.Ill. Feb. 29, 2012), but the district court reversed and granted judgment for the mortgage lender. Crane v. Richardson (In re Crane ), 487 B.R. 906, 915–16 (C.D.Ill.2013). In the Klasi Properties case, the bankruptcy court granted summary judgment in favor of the mortgage lender. Bruegge v. Farmers State Bank of Hoffman (In re Klasi Properties, LLC), 2013 WL 211111, at *8 (Bankr.S.D.Ill. Jan. 18, 2013). In light of the Crane case and other conflicting decisions among bankruptcy courts in Illinois, we accepted the trustee's request for direct review under 28 U.S.C. § 158(d)(2)(B).¹

II. Analysis

Our analysis begins with a bankruptcy trustee's “strong-arm” powers under 11 U.S.C. § 544(a)(3), which provides:

The trustee shall have, as of the commencement of the case, and without regard to any knowledge of the trustee or of any creditor, the rights and powers of, or may avoid any transfer of property of the debtor or any obligation incurred by the debtor that is voidable by ... a bona fide purchaser of real property, other than fixtures, from the debtor, against whom applicable law permits such transfer to be perfected, that obtains the status of a bona fide purchaser and has perfected such transfer at the time of the commencement of the case, whether or not such a purchaser exists.

For present purposes, the key is that a bankruptcy trustee may avoid any obligation or transfer of the debtor's property that a hypothetical bona fide purchaser could avoid, “without regard to any knowledge of the trustee or of any creditor.” State law governs who would count as a bona fide purchaser and what constitutes constructive notice sufficient to defeat a bankruptcy trustee's section 544(a)(3) power. See Sandy Ridge Oil Co. v. Centerre Bank N.A. (In re Sandy Ridge Oil Co.), 807 F.2d 1332, 1336 (7th Cir.1986); Brown v. Job (In re Polo Builders, Inc.), 433 B.R. 700, 707 (Bankr.N.D.Ill.2010).

The question before us is therefore at bottom a question of Illinois state law. We review de novo the conclusions of law reached by both the district court and the bankruptcy court. Illinois v. Chiplease, Inc. (In re Resource Technology Corp.), 721 F.3d 796, 799–800 (7th Cir.2013); Ojeda v. Goldberg, 599 F.3d 712, 716 (7th Cir.2010).

A bona fide purchaser in Illinois is one who acquires an “interest in [the] property for valuable consideration without actual or constructive notice of another's adverse interest in the property.” U.S. Bank N.A. v. Villasenor, 365 Ill.Dec. 847, 979 N.E.2d 451, 464 (Ill.App.2012), quoting Goldberg v. Ehrlich (In re Ehrlich), 59 B.R. 646, 650 (Bankr.N.D.Ill.1986). Actual notice is knowledge the purchaser had at the time of the conveyance, U.S. Bank, 365 Ill.Dec. 847, 979 N.E.2d at 465, but the terms of section 544(a)(3) provide that a bankruptcy trustee cannot be charged with actual notice. A trustee can be charged with constructive notice, however. Sandy Ridge Oil Co. v. Centerre Bank N.A. (In re Sandy Ridge Oil Co.), 832 F.2d 75 (7th Cir.1987) (defectively recorded mortgage was sufficient under Indiana law to serve as constructive notice and to defeat debtor-in-possession's strong-arm claim under § 544(a)(3)).

Illinois defines constructive notice as knowledge that the law imputes to a purchaser, whether or not the purchaser had actual knowledge at the time of the conveyance. U.S. Bank, 365 Ill.Dec. 847, 979 N.E.2d at 465. There are two kinds of constructive notice: record notice and inquiry notice. LaSalle Bank v. Ferone, 384 Ill.App.3d 239, 322 Ill.Dec. 948, 892 N.E.2d 585, 590 (2008), citing Ehrlich, 59 B.R. at 650. Record notice “imputes to a purchaserknowledge that could be gained from an examination of the grantor-grantee index in the office of the Recorder of Deeds, as well as the probate, circuit, and county court records for the county in which the land is situated.” Ehrlich, 59 B.R. at 650.

The trustees argue here that the mortgages were legally insufficient to give constructive notice to hypothetical bona fide purchasers because they failed to satisfy what the trustees call the formal “requirements” in the mortgage recording statute as it existed when these debtors filed their bankruptcy petitions, 765 ILCS 5/11 (2012).²

Before the 2013 amendment, the statute said in relevant part:

Mortgages of lands may be substantially in the following form:

The Mortgagor (here insert name or names), mortgages and warrants to (here insert name or names of mortgagee or mortgagees), to secure the payment of (here recite the nature and amount of indebtedness, showing when due and the rate of interest, and whether secured by note or otherwise), the following described real estate (here insert description thereof), situated in the County of ..., in the State of Illinois.

Dated (insert date).

(signature of mortgagor or mortgagors)

...

Such mortgage, when otherwise properly executed, shall be deemed and held a good and sufficient mortgage in fee to secure the payment of the moneys therein specified....

The recorded mortgages at issue in these appeals accurately disclosed the mortgagors, the mortgagees, the amounts of indebtedness, the descriptions of the properties subject to the mortgages, and the dates of the mortgages. The mortgages also stated that the underlying debts were secured by separate but contemporaneously-signed promissory notes. The recorded mortgages did not set forth the maturity dates or the interest rates of the underlying loans.

If all the elements set forth by in the pre-amendment form of 765 ILCS 5/11, including the interest rate and maturity date, were mandatory, the trustees would have a stronger argument that each element listed in the mortgage “form” set forth in that section, including the interest rate and maturity date of the underlying debt, would need to appear on the face of the recorded mortgage for that document to serve as effective notice of the mortgage to a potential buyer of the property. If the elements listed in section 5/11's “form” were permissive, a recording may be deemed sufficient if it contains the indispensable elements of a mortgage even if the recorded document does not include every element listed in the recording statute.

Statutory interpretation here is a question of state law, and our role is to predict how the Illinois Supreme Court would decide the question. E.g., Pippen v. NBCUniversal Media, LLC, 734 F.3d 610, 615 (7th Cir.2013) (our role in diversity action “is to predict how the state's highest court would answer the question if asked”); Bogie v. Rosenberg, 705 F.3d 603, 609 (7th Cir.2013) (because state law applied to plaintiff's claims, “our task is to interpret the state's law as we predict the state's highest court would”).

This particular question of state law has an unusually hypothetical flavor to it. We find it hard to imagine that any prospective buyers or mortgage lenders for these properties would, upon discovering the recorded mortgages in the chain of title in the county land records,...