In re Houston, C/A No. 05-07975-DD.

• Decision Date: 30 July 2009
• Docket Number: C/A No. 05-07975-DD.
• Citation: 409 B.R. 799
• Court: U.S. Bankruptcy Court — District of South Carolina
• Parties: In re James A. HOUSTON, Debtor(s).

409 B.R. 799

In re James A. HOUSTON, Debtor(s).

C/A No. 05-07975-DD.

United States Bankruptcy Court, D. South Carolina.

July 30, 2009.

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Lawrence Keitt, Orangeburg, SC, for Debtor.

ORDER

DAVID R. DUNCAN, Bankruptcy Judge.

THIS MATTER is before the Court pursuant to the Consent Order Authorizing the Sale of Real Property and Escrowing One-Half of the Proceeds From the Sale of Real Property ("Consent Order") between Robert F. Anderson ("Trustee") and EMC Mortgage Corporation ("EMC"). The remaining issues between Trustee and EMC are questions of law and the parties agreed to submit briefs to the Court arguing their respective positions. Pursuant to Fed.R.Civ.P. 52, made applicable to this proceeding by Fed. R. of Bankr.P. 9014 and 7052¹, the Court makes the following findings of fact and conclusions of law.

FINDINGS OF FACT

James A. Houston ("Debtor") and his wife, Penny, bought a home on Cameron Road in Calhoun County, South Carolina for $115,000 on November 22, 2004. The purchase was made with $26,793.63 in proceeds from Debtor's pension plan and a loan from Home Source Mortgage Corporation ("Home Source") of $92,000. The loan was secured by a mortgage on the property. The property was titled in Mrs. Houston alone.

Mrs. Houston later borrowed $98,950 from RBC Mortgage Company ("RBC") to refinance the Home Source loan. Mortgage Electronic Registration Systems, Inc. ("MERS") is the nominee of RBC and is the mortgagee on the instrument securing the RBC loan. The mortgage was recorded in the Richland County RMC Office on June 9, 2005. It should have been recorded in Calhoun County. RBC's interest in the loan was transferred to CitiBank, the current beneficial holder of the loan. The loan is serviced by EMC. The Home Source mortgage was satisfied of record in Calhoun County on June 6, 2005.

Debtor filed a voluntary petition for relief under chapter 7 of the Bankruptcy Code on July 14, 2005. He did not list the Cameron Road property as an asset in his schedules nor did he report the use of the pension funds in connection with the property purchase. Debtor did, however, claim an unspecified "pension payment" as exempt property. Following the meeting of creditors Trustee objected to the exemption of the pension payment on the ground that a debtor cannot exempt property not owned and/or not disclosed.

Debtor moved to convert his case to one under chapter 13, which motion was granted on September 20, 2005. Subsequently the case was converted to chapter 7 on motion of the chapter 13 trustee by order entered May 25, 2006. Anderson again entered into service as chapter 7 trustee and renewed his objection to exemption of the pension payment. Debtor and his wife were examined by Trustee pursuant to Rule 2004 on August 9, 2006. An order was entered denying the exemption on September 14, 2006 and Debtor's discharge was denied February 21, 2007 in connection with, among other things, the failure to disclose the use of the pension funds to purchase the Cameron Road property.²

During the Rule 2004 examinations of Debtor and Mrs. Houston, testimony was elicited to the effect that Debtor contributed $26,793.63 from his pension plan to the purchase of the Cameron Road property, that Debtor and Mrs. Houston considered Debtor the owner of a one-half interest in the Cameron Road property, and that Mrs. Houston was making monthly mortgage payments on the property. Trustee initiated an adversary proceeding against Mrs. Houston to recover the transfer by Debtor of the pension funds and for a determination that Debtor jointly owned the Cameron Road property with his wife. Mrs. Houston defaulted and judgment that Debtor was owner of a one-half undivided interest in the property was entered for Trustee on July 11, 2007³. A copy of this order was recorded in Calhoun County on August 8, 2007.

Next, Trustee sued⁴ Mrs. Houston, Home Source, and EMC seeking authority to sell both the estate's interest and the co-owner's interest of Mrs. Houston pursuant to 11 U.S.C. § 363(h)⁵ and for a determination that the satisfied mortgage of Home Source and any assignment of the mortgage to EMC were void as to Trustee pursuant to § 544(a)(3). Mrs. Houston and Home Source defaulted and Trustee was awarded relief on March 12, 2008. EMC answered the complaint. EMC and Trustee then stipulated to the dismissal of the action without prejudice on May 12, 2008. The mortgage serviced by EMC was finally recorded in Calhoun County on October 27, 2008.

On February 19, 2009 Trustee gave notice of intention to sell the Cameron Road property to a third party, free and clear of liens and free and clear of Mrs. Houston's interest, for $120,000. EMC objected to the sale. At the hearing on the objection Trustee and EMC proposed a consent order authorizing the sale, providing for payment of the expenses of sale and one-half of the amount due EMC in recognition of the lien against Mrs. Houston's interest in the property, and reserving the issue of entitlement to the remaining proceeds. The Court adopted the consent order and the parties stipulated to the facts (which have been supplemented from the record in the bankruptcy case and adversary proceedings for clarity) and agreed to the submission of the legal issues on briefs.

The sale has taken place and Trustee has filed his report of sale. Trustee holds $54,296.35.

CONCLUSIONS OF LAW

Trustee contends that EMC's improperly recorded mortgage is not enforceable against a trustee in bankruptcy. A bankruptcy trustee has the rights and powers of a bona fide purchaser of real property from the Debtor at the time of the commencement of the case pursuant to § 544(a)(3)⁶. A trustee may avoid any transfer, here the fixing of EMC's lien, that contravenes the bona fide purchaser status. EMC argues that it is entitled to the proceeds from the sale of the Cameron Road property pursuant to the doctrine of equitable subrogation. EMC contends that through equitable subrogation to the Home Source mortgage it should be awarded the remaining proceeds from the sale of the Cameron Road property. In the alternative, EMC argues that allowing the Trustee to retain the proceeds from the sale of the Cameron Road property will unjustly enrich Trustee and that it should therefore have an equitable lien in the proceeds.

I

Pursuant to § 544(a)(3) of the Bankruptcy Code, a trustee in bankruptcy may avoid any obligation incurred by the debtor that is voidable by a hypothetical bona fide purchaser of real property under state law. The trustee's "strong arm powers" pursuant to § 544 serve the purpose of cutting off unperfected security interests and secret liens. 5 Collier on Bankruptcy ¶ 544.03 (Alan N. Resnick & Henry J. Sommer eds., 15th ed. rev.2008). Trustee's status as a bona fide purchaser arises from the Bankruptcy Code, federal law, yet the effect of the status depends on state law. See Midlantic Nat'l Bank v. Bridge (In re Bridge), 18 F.3d 195, 200 (3d Cir.1994) (holding that while federal law defines a trustee's avoidance powers, state law governs the determination of property rights). A trustee's strong-arm powers confer on the trustee no greater rights than those accorded by the applicable state law in legal or equitable proceedings. Havee v. Belk, 775 F.2d 1209, 1218-19 (4th Cir.1985).

Under South Carolina law, a purchaser is a bona fide purchaser for value, without notice of defect in his title when (1) he has actually paid in full the purchase money (giving security for the payment is not sufficient, nor is past indebtedness a sufficient consideration); (2) he purchased and acquired legal title, or the best right to it; and (3) he purchased bona fide, i.e., in good faith and with integrity of dealing, without notice of a lien or defect. Spence v. Spence, 368 S.C. 106, 628 S.E.2d 869, 874-75 (2006). While state law requires these elements to establish bona fide purchaser status, the status is conferred on a bankruptcy trustee on the date of the commencement of the bankruptcy case. Recording acts dating back to colonial days protect innocent or bona fide purchasers of real property, who pay valuable consideration, from the claims of creditors or lienholders whose claims were not on record at the time of conveyance to the bona fide purchaser. Id. at 876. Federal bankruptcy law implements this same policy.

While state law tests a purchaser's bona fides by examining his actual knowledge, bankruptcy law renders a trustee's actual knowledge of a lien or defect irrelevant by virtue of the provisions of § 544(a)(3). The trustee does however have constructive notice of transfers perfected in accord with state or federal recordation acts. See In re Michigan Lithographing Co., 997 F.2d 1158, 1159 (6th Cir.1993). Constructive notice is measured on commencement of the case; just as the avoidance power itself springs from commencement of the case. Any knowledge, constructive or actual, that might be imputed from the schedules or statements or from examination of the debtor and other parties can only come after the commencement of the case and is of no avail to defeat the trustee's status. See In re Deuel, 361 B.R. 509, 511 (9th Cir. BAP 2006).

Under South Carolina law the importance of properly perfecting and giving public notice of one's claim is quite significant. Subsequent purchasers are entitled to rely on recorded deeds and plats to determine their rights in respect to property. Murrells Inlet Corp. v. Ward, 378 S.C. 225, 662 S.E.2d 452 (S.C.App.2008). A mortgage recorded out of time is held to take effect in respect to priority only from the date it was properly recorded. In re Syleecau Mfg. Co., 17 F.2d 503 (D.S.C. 1922) (a Bankruptcy Act case reviewing South Carolina's recording acts to that date). A mortgagee is not entitled to share with subsequent creditors who acquired rights by mortgagee's failure to record a mortgage. Simmons v. Greer, 174 F. 654...