Bruegge v. Farmers State Bank of Hoffman (In re Klasi Props., LLC)

• Decision Date: 18 January 2013
• Docket Number: Adversary No. 12-6028,Case No. 12-60013
• Court: U.S. Bankruptcy Court — Southern District of Illinois
• Parties: In re: KLASI PROPERTIES, LLC, Debtor(s). ROBERT T. BRUEGGE, Trustee of the Estate of Klasi Properties, LLC, Plaintiff(s), v. FARMERS STATE BANK OF HOFFMAN Defendant(s).

IN RE: KLASI PROPERTIES, LLC, Debtor(s).ROBERT T. BRUEGGE, Trustee of the Estate of Klasi Properties, LLC, Plaintiff(s),

v.FARMERS STATE BANK OF HOFFMAN Defendant(s).

Case No. 12-60013

Adversary No. 12-6028

UNITED STATES BANKRUPTCY COURT FOR THE SOUTHERN DISTRICT OF ILLINOIS

ENTERED: January 18, 2013

In Proceedings

Under Chapter 7

OPINION

Plaintiff Robert Bruegge, as Trustee of the Estate of Klasi Properties, LLC ("Plaintiff"), filed an adversary complaint pursuant to 11 U.S.C. § 554(a)(3) and §11 of the Illinois Conveyances Act (765 ILCS 5/11) seeking to avoid the mortgage of defendant Farmers State Bank of Hoffman ("Defendant"). The complaint alleges that the Defendant's mortgage is insufficient pursuant to Illinois law to provide constructive notice to a bona fide purchaser of the Defendant's interest and, therefore, may be avoided. This matter is before the Court on the parties' cross-motions for summary judgment on the complaint.

FACTS

Debtor Klasi Properties, LLC ("Debtor") filed a petition under Chapter 7 of the Bankruptcy Code on January 18, 2012. At the time of filing, the Debtor owned certain real estate and improvements located at 426 West Broadway, Centralia, Illinois (the "Property").

Defendant is a creditor and party in interest in this case by virtue of a promissory note executed June 17, 2005 (the "Note"), and asserts a lien against the property pursuant to a Commercial Real Estate Mortgage (the "Mortgage") also dated June 17, 2005. There is no dispute that the mortgage was recorded in the office of the Marion County Illinois Clerk and Recorder on June 22, 2005. The mortgage includes a legal description of the property and states that it is a purchase money mortgage securing a principal indebtedness of $75,000. The mortgage also includes the following two clauses:

INDEBTEDNESS. This mortgage secures the principal amount shown above as may be evidenced by a promissory note or notes of even, prior, or subsequent date hereto, including future advances and every other indebtedness of every kind now and or later owing from Mortgagor to Lender however created or arising, whether primary, secondary, or contingent, together with all interest or charges provided in or arising out of such indebtedness, as well as the agreements and covenants of this Mortgage and all Related Documents (and referred to in this Mortgage as the Indebtedness).

RELATED DOCUMENTS. The words "Related Documents" means all promissory notes, security agreements, prior mortgages, business loan agreements, construction loan agreements, resolutions, guaranties, environmental agreements, subordination agreements, assignments of leases and rents and all other documents and agreements executed in connection with this Mortgage, whether now or later existing. The Related Documents are made a part of this Mortgage, with the same force and effect as if they were fully set forth herein.

Plaintiff's Complaint, Exhibit A, pp. 1-2. It is undisputed that the mortgage does not state on its face the interest rate or maturity date of the underlying indebtedness. However, this information is included in the underlying note. The note also specifically states that it is secured by a mortgage on the Property.¹

On February 3, 2012, Defendant filed a Motion for Relief from Stay and Abandonment. The Trustee objected to the motion, but the matter was resolved prior to trial. An agreed orderwas entered May 9, 2012, in which the Trustee agreed to entry of an order lifting the automatic stay in order to allow Defendant to commence foreclosure proceedings. However, pursuant to the parties' agreement, the property was not abandoned. Instead, the agreed order provided that any remaining sale proceeds, after payment of all amounts due the Defendant and satisfaction of any other liens, would be paid to the Trustee. The Defendant subsequently initiated a foreclosure action in Marion County Circuit Court and named the Plaintiff as a party defendant. While the Plaintiff entered his appearance in that action, he did not answer or otherwise respond to the complaint.

On August 20, 2012, the Plaintiff filed the instant adversary complaint to avoid Defendant's mortgage pursuant to 11 U.S.C. § 544(a)(3). The Trustee asserts that the Defendant's mortgage on the property fails to comply with the requirements of § 11 of the Illinois Conveyances Act and, therefore, is invalid as to a bona fide purchaser such as the Trustee. Specifically, the Plaintiff maintains that two facial deficiencies--the lack of a stated interest rate and maturity date--"remove [the mortgage] from the statutory protection of a mortgagee's interest vis-à-vis a good faith purchaser." Trustee's Second Amended Memorandum of Law in Support of Motion for Summary Judgment at p. 5. The Plaintiff has moved for summary judgment on the complaint.

Defendant has also filed a motion for summary judgment. It contends that contrary to the Trustee's assertions, applicable law does not require recitation of the interest rate and maturity date on the face of the mortgage. It also affirmatively argues that by consenting to relief from the stay and failing to respond to the state court foreclosure complaint, the Plaintiff is now judicially estopped from challenging the Defendant's mortgage.

DISCUSSION

The Court begins its discussion with the issue that is common to both motions—whether the Trustee may avoid the Defendant's mortgage pursuant to 11 U.S.C. § 544(a)(3).

Section 544(a)(3) of the Bankruptcy Code confers on the Trustee at the commencement of the bankruptcy case, "the hypothetical status, rights and powers of a bona fide purchaser of real property who has perfected the transfer of real property from the debtor at the time of the bankruptcy filing." In re Berg, 387 B.R. 524, 559 (Bankr. N.D. Ill. 2008). Section 544(a)(3) states:

(a) The Trustee shall have, as of the commencement of the case, and without regard to any knowledge of the trustee or 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-

* * *

(3) 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.

11 U.S.C. § 544(a)(3). Hence, the trustee may avoid any 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." Id.

Under Illinois law, a bona fide purchaser is "one who acquires an interest in property for valuable consideration without actual or constructive notice of another adverse interest in the property." In re Polo Builders, Inc., 433 B.R. 700, 707 (Bankr. N.D. Ill. 2010), quoting Goldberg v. Ehrlich (In re Ehrlich), 59 B.R. 646, 650 (Bankr. N.D. Ill. 1986). By the express terms of § 544(a)(3), a trustee cannot be charged with actual notice.² However, the trustee cannotavoid an interest under § 544(a)(3) of which he or she has constructive notice. In re Sandy Ridge Oil Co., Inc., 807 F.2d 1332 (7th Cir. 1986).

Constructive notice is "notice that is deemed to be provided by an instrument of conveyance that is both sufficient in substance and properly recorded in the statutory office designated to maintain land title records for the county in which the subject real estate is located." Shara Manning Properties, 475 B.R. 898, 906 (Bankr. C.D. Ill. 2010). Constructive notice can take two forms: record notice and inquiry notice.³ Ehrlich, 59 B.R. at 650; Polo Builders, 433 B.R. at 707; In re Bulgarea, 2010 WL 3614278 (Bankr. N.D. Ill. 2010); US Bank Nat. Ass'n v. Villasenor, 2012 WL 4761748 (Ill. App. 1st Dist, Oct. 5, 2012); LaSalle v. Ferone, 384 Ill. App. 3d 239, 245, 892 N.E.2d 585, 591, 322 Ill. Dec. 948, 954 (2nd Dist. 2008). Record notice "imputes to a purchaser knowledge 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. It is axiomatic in Illinois that a purchaser of land "has a duty to examine the record of the chain of title and is chargeable with notice of whatever is shown by that record. Even if he fails to search the real estate records and is without actual knowledge of a prior properly recorded instrument, the subsequent transferee is deemed to be on notice of the instrument by operation of the principal of constructive notice." Ehrlich, 59 B.R. at 650, citing Clark v. Leavitt, 335 Ill. 184, 190, 166 N.E. 538, 540-41 (1929).

Inquiry notice, on the other hand, charges to a purchaser knowledge of facts that a diligent inquiry would have revealed. Miller v. Bullington, 381 Ill. 238, 243, 44 N.E.2d 850, 852(1942). See also Davis v. Elite Mortgage Services, Inc., 592 F. Supp. 2d 1052, 1056 (N.D. Ill. 2009) ("[u]nder the doctrine of constructive notice, the law imputes to a buyer or lien claimant knowledge of the facts that a diligent inquiry would have brought to light."); Source Once Mortgage Services Corp. v. Jones, 1994 WL 13664 at *4 ("[i]nquiry notice, a form of constructive notice, encompasses all facts that a diligent inquiry would have brought to light."). The type of notice chargeable to a Trustee in bankruptcy was recently discussed in In re Heaver, 473 B.R. 734 (Bankr. N.D. Ill. 2012). In examining the interplay of actual, constructive and inquiry notice, the court explained:

In Illinois, one 'having notice of facts which would put a prudent man on inquiry is chargeable with knowledge of other facts which he might have discovered by diligent inquiry. Whatever is notice enough to excite attention and put the party on his guard is notice of everything to which such inquiry might have led and every unusual

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