Sandy Ridge Oil Co., Inc., In re

• Decision Date: 03 December 1986
• Docket Number: No. 86-1414,86-1414
• Citation: 807 F.2d 1332
• Parties: 15 Collier Bankr.Cas.2d 1234, 15 Bankr.Ct.Dec. 789, Bankr. L. Rep. P 71,549 In re SANDY RIDGE OIL CO., INC., Debtor. SANDY RIDGE OIL CO., INC., Plaintiff-Appellee, v. CENTERRE BANK NATIONAL ASSOCIATION, et al., Defendants. and Halliburton Services, a Division of Halliburton Company, Defendant-Appellant, and Official Unsecured Creditors Committee, Intervenor-Appellee.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 1332

807 F.2d 1332

15 Collier Bankr.Cas.2d 1234, 15 Bankr.Ct.Dec. 789,

Bankr. L. Rep. P 71,549

In re SANDY RIDGE OIL CO., INC., Debtor SANDY RIDGE OIL CO., INC., Plaintiff-Appellee, v. CENTERRE BANK NATIONAL ASSOCIATION, et al., Defendants and Halliburton Services, a Division of Halliburton Company Defendant-Appellant and Official Unsecured Creditors Committee, Intervenor-Appellee.

No. 86-1414.

United States Court of Appeals, Seventh Circuit.

Argued Sept. 16, 1986.

Decided Dec. 3, 1986.

Before BAUER, Chief Judge, and FLAUM and EASTERBROOK, Circuit Judges.

FLAUM, Circuit Judge.

The plaintiff-appellee, a Chapter 11 debtor-in-possession, seeks to avoid an improperly recorded Indiana mortgage. Section 544(a)(3) of the Bankruptcy Code, 11 U.S.C. Sec. 544(a)(3) (1984), allows a bankruptcy trustee to avoid such an encumbrance when it would be voidable by a bona fide purchaser. The debtor-in-possession and the intervenor argue that the mortgage at issue does not give notice to a bona fide purchaser, and therefore the plaintiff-appellee may avoid it under Sec. 544(a)(3). The defendant-appellant responds that avoidance is precluded by the debtor-in-possession's actual knowledge of the mortgage; and that in any case the mortgage provides constructive notice to a bona fide purchaser. We reject the appellant's actual notice argument and certify the question of constructive notice to the Indiana Supreme Court.

I.

Sandy Ridge Oil Company, Inc. ("Sandy Ridge") purchased oil well services from Halliburton Services ("Halliburton") for a number of years, but fell slowly into debt. On October 10, 1981, Sandy Ridge executed a promissory note in favor of Halliburton in the amount of $244,686.31 (excluding interest). To secure this note, Sandy Ridge mortgaged its oil and gas leases on six oil wells: four wells in Gibson County, Indiana, one well in Vanderburgh County, Indiana, and one well in Wabash County, Illinois. The executed mortgage was delivered in three identical counterparts and recorded with the Vanderburgh County Recorder, the Wabash County Recorder, and the Gibson County Recorder. Only the Gibson County mortgage is at issue in this case.

On May 13, 1982, Sandy Ridge filed a petition for Chapter 11 bankruptcy. As part of the Chapter 11 proceeding, Sandy Ridge filed an adversary proceeding against the Centerre Bank National Association, Halliburton, and thirteen other defendants. In that adversary proceeding Sandy Ridge contested the validity of various liens and encumbrances on the oil properties it owned or operated, and sought approval for sale of these properties free and clear of any such encumbrances. The Official Unsecured Creditors Committee ("Creditors Committee") intervened in the adversary proceeding to contest the Gibson County mortgage.

The Gibson County mortgage, though otherwise valid, was recorded in contravention of an Indiana statute requiring the name of the person who prepared the instrument to be indicated in the document. ¹ Sandy Ridge argues that because the Gibson County mortgage was improperly recorded, it is voidable by a bona fide purchaser; therefore, Sandy Ridge's interest in the oil wells is paramount to Halliburton's. The bankruptcy court ruled in favor of Sandy Ridge, and the district court affirmed.

II.

We find first that we have jurisdiction based on 28 U.S.C. Sec. 158(d) (1984). This court may exercise jurisdiction over a bankruptcy appeal only when both the bankruptcy court's and the district court's decisions are "final" within the meaning of Sec. 158(d). Matter of Morse Elec. Co., Inc. (Appeal of Hoosier Fence Co., Inc.), 805 F.2d 262, 264 (7th Cir.1986); Matter of Cash Currency Exchange, 762 F.2d 542, 546 (7th Cir.), cert. denied sub nom. Fryzel v. Cash Currency Exchange, Inc., --- U.S. ----, 106 S.Ct. 233, 88 L.Ed.2d 232 (1985). The definition of "finality," however, is more flexible in the context of a bankruptcy proceeding than under 28 U.S.C. Sec. 1291. See Matter of Morse Elec. Co., 805 F.2d at 264; Matter of Riggsby, 745 F.2d 1153, 1154 (7th Cir.1984).

A bankruptcy order will be considered final for Sec. 158(d) purposes when it "finally determines" one creditor's position. Matter of Morse Elec. Co., 805 F.2d at 264. This is so even when there is continuing action in the bankruptcy court adversary proceeding. Id. In this case, Halliburton's position as to the Gibson County mortgage was "finally determined" by the bankruptcy court because that court held that Sandy Ridge could avoid the mortgage. The bankruptcy court's order, and the district court's affirmance, are therefore final within the meaning of Sec. 158(d). ²

III.

Section 1107(a) of the Bankruptcy Code gives a chapter 11 debtor-in-possession all the rights of a trustee, other than the right to compensation, and all the duties of a trustee, other than the investigatory duties. Section 544(a)(3), the "strong arm clause," permits a trustee to avoid any transfer of property of the debtor, or obligation incurred by the debtor, that would be voidable by a bona fide purchaser of the property. Sandy Ridge seeks to use these sections of the Code to avoid the improperly recorded Gibson County mortgage.

Halliburton, however, argues that Sandy Ridge is bound by the Gibson County mortgage, both because it had actual knowledge of the mortgage and because a bona fide purchaser would have constructive notice of the mortgage. The first argument requires us to interpret the Bankruptcy Code; the second argument requires us to interpret Indiana law. We consider Halliburton's "actual knowledge" argument first.

A.

Halliburton argues that Sandy Ridge may not avoid the Gibson County mortgage under Sec. 544(a)(3), because Sandy Ridge had actual knowledge of that mortgage. In support of this argument, Halliburton relies on In re Hartman Paving, Inc., 745 F.2d 307 (4th Cir.1984). In Hartman Paving the Fourth Circuit looked to state law to determine whether a debtor-in-possession with actual notice of a deed of trust should be allowed to avoid that instrument under Sec. 544(a). The court concluded that because the West Virginia law of deeds of trust was not designed to protect a subsequent purchaser with actual knowledge of the transaction, the debtor-in-possession could not assert Sec. 544(a). Hartman Paving, 745 F.2d at 310. Under the Hartman Paving analysis, therefore, this court would determine whether Indiana law was intended to protect parties to a mortgage with actual notice. If not--and the answer is presumably no--then Sandy Ridge would not be permitted to rely on Sec. 544(a)(3). The district court in this case considered the rule of Hartman Paving, but declined to follow it, noting that its reasoning appeared to conflict with the Bankruptcy Code. We agree with the district court's conclusion.

The rights enforced in bankruptcy are rights created by state law. Matter of Kaiser, 791 F.2d 73, 74 (7th Cir.1986). Accordingly, the courts generally look to state law to determine whether property is an asset of a debtor. In re Brass Kettle Restaurant, Inc., 790 F.2d 574, 575 (7th Cir.1986); see also In re K & L Limited, 741 F.2d 1023, 1030 n. 7 (7th Cir.1984); Matter of Gladstone Glen, 628 F.2d 1015, 1018 (7th Cir.1980). Here, however, Congress has required that we do otherwise.

Section 544(a) states that a trustee "shall" be able to avoid an encumbrance that would be voidable by a bona fide purchaser "without regard to any knowledge of the trustee or of any creditor." ³ The natural interpretation of this language is that actual knowledge of the encumbrance will never prohibit a trustee from invoking Sec. 544(a)(3).

The Third Circuit's analysis of the legislative history of Sec. 544(a) in McCannon v. Marston, 679 F.2d 13 (3d Cir.1982), supports the view that Congress meant what it said. In McCannon, the issue before the court was whether the "actual knowledge" clause in Sec. 544(a) gave a trustee the powers of a bona fide purchaser, regardless of the trustee's actual knowledge and regardless of any constructive notice that otherwise would be imputed to a subsequent purchaser. The McCannon court noted that the legislative history of Sec. 544(a) itself was sparse, and therefore turned its attention to a 1973 draft bankruptcy code that contained a similar provision. The language of this provision was very close to the language eventually adopted by Congress as Sec. 544(a). ⁴ The Commission on Bankruptcy Laws of the United States explained that this 1973 draft language was "designed to make clear that the trustee's status under the subdivision is purely hypothetical and unaffected by any knowledge which he, personally, or any or all creditors may have." Report of the Commission on the Bankruptcy Laws of the United States, H.R. Doc. No. 93-137, Part II, 93rd Cong., 1st Sess. 161, n. 3; see McCannon, 679 F.2d at 16. The McCannon court concluded that under Sec. 544(a), actual knowledge was irrelevant regardless of the state law of actual notice. See McCannon at 16-17. ⁵ This evidence of intent, although not conclusive, supports the inference that Congress intended actual knowledge of a transfer of property or encumbrance on property to be irrelevant, regardless of state law.

Despite the plain language of the statute and some evidence of congressional intent, however, Halliburton argues that this court should follow Hartman Paving and look to state law and policy to decide when a trustee or debtor-in-possession with actual knowledge of a transaction may invoke Sec. 544(a). This approach is faulty for several reasons.

First, the Hartman Paving approach ignores a distinction Congress makes between Sec. 544(a) and Sec. 544(a)(3). The phrase "bona fide purchaser" in Sec. 544(a)(3) is qualified by the words "against whom applicable law permits such transfer to be perfected." This language has been interpreted to mean that the state law of constructive notice remains applicable in the context of Sec. 544(a)(3). See McCannon, ...