In re Iowa-Missouri Realty Co., Inc., Bankruptcy No. 86-02438-SJ-11

• Decision Date: 16 May 1988
• Docket Number: Bankruptcy No. 86-02438-SJ-11,86-02437-SJ-11,Adv. No. 86-0414-1-SJ.
• Citation: 86 BR 617
• Parties: In re IOWA-MISSOURI REALTY CO., INC., Debtor. In re IOWA-MISSOURI WALNUT CO., INC., Debtor. IOWA-MISSOURI REALTY CO., INC., Plaintiff, v. UNITED STATES of America, SMALL BUSINESS ADMINISTRATION, Defendant.
• Court: U.S. Bankruptcy Court — Western District of Missouri

86 B.R. 617 (1988)

In re IOWA-MISSOURI REALTY CO., INC., Debtor In re IOWA-MISSOURI WALNUT CO., INC., Debtor IOWA-MISSOURI REALTY CO., INC., Plaintiff, v. UNITED STATES of America, SMALL BUSINESS ADMINISTRATION, Defendant.

Bankruptcy Nos. 86-02438-SJ-11, 86-02437-SJ-11, Adv. No. 86-0414-1-SJ.

United States Bankruptcy Court, W.D. Missouri.

May 16, 1988.

Irvin C. Ness and Dennis M. Alt, Stinson, Mag & Fizell, Kansas City, Mo., for plaintiff.

F.O. Griffin, Jr., Asst. U.S. Atty., Kansas City, Mo., for defendant.

MEMORANDUM ORDER AVOIDING LIEN AND DENYING MOTION FOR TERMINATION OF AUTOMATIC STAY

KAREN M. SEE, Bankruptcy Judge.

This opinion decides 1) plaintiff's complaint which seeks to avoid, pursuant to 11 U.S.C. § 544(a)(3), a lien claimed by the Small Business Administration on real property; and 2) SBA's motion to terminate automatic stay. Plaintiff Iowa-Missouri Realty Co. (hereinafter Realty) is the wholly owned subsidiary of Iowa-Missouri Walnut Co. (hereinafter Walnut). Both Realty and Walnut are debtors in possession in Chapter 11 cases (with plans that were confirmed subsequent to trial of this matter). The bankruptcy cases of the two related debtors were consolidated for joint administration. However, they were not substantively consolidated, so the assets and debts of the two companies have at all times remained separate. Walnut and Realty are separate Missouri corporations. They have some common officers and shareholders. However, at all times they have maintained separate businesses, books and accounting records. Plaintiff Realty is in the business of buying and selling real estate. Walnut produces high grade lumber and gun stocks.

Since 1965, Realty (and its predecessor, Iowa-Missouri Sales Co.,) has been the record owner of the real property in St. Joseph, Buchanan County, Missouri which is at issue in this action. Walnut has never owned any interest in the property. In 1984, after flood damage to its business, Walnut applied for an SBA disaster loan. In processing Walnut's application, SBA collected substantial data, including information about the corporate history and structure of Walnut and its subsidiary, Realty, tax returns of the entities, and a warranty deed and title opinion showing Realty owned the property at the time of the loan application and at all times dating back to 1965. SBA then approved a $116,000 loan to Walnut. It is undisputed that SBA knew that Realty owned the property.

On February 15, 1985, Walnut executed a $116,000.00 promissory note. To secure the note, Walnut also executed a deed of trust in favor of SBA on the St. Joseph tract. The deed of trust prepared by SBA was defective on its face because Realty owned the property. On February 19, 1985, SBA recorded the defective deed of trust with the Buchanan County Recorder of Deeds. The Recorder's Office recorded the deed in the grantee-grantor index pursuant to the requirements of § 59.440 RSMo., and also in a separate, unofficial tract index kept by the Recorder's Office.

The issues presented are 1) whether recording a deed of trust from Walnut, which did not own the property, gave SBA a lien on the property; 2) whether, if SBA does have a lien, plaintiff Realty, a debtor in possession, can avoid SBA's lien pursuant to § 544(a)(3); 3) whether the defective deed of trust, executed pre-petition, can be reformed post-petition due to alleged mutual mistake of the parties; and 4) whether the separate corporate entities can be disregarded in order to "cure" SBA's defective deed of trust.

Whether SBA Has A Lien

This case is easily disposed of because Walnut had no ownership interest in the property and therefore, no title or other interest to convey. Recording a deed of trust granted by a stranger to the title created no ownership interest or lien whatsoever for SBA. Walnut did not have any interest in the property and as a matter of law, could not convey any interest to SBA. Because SBA could not acquire any interest from Walnut, it could not obtain a valid lien against the property under Missouri law. See Phillips v. Dukes (In re Dukes), 24 B.R. 404, 409 (Bankr.E.D.Mich.1982). SBA contends that it has a perfected lien because it has a recorded deed of trust. The contention is without merit because SBA did not receive its recorded "interest" in the property from a party who held an interest in the property which it could grant. The mere fact that the deed of trust was recorded does not give the erroneous grantor, Walnut, a valid ownership interest which would place the deed of trust in the chain of title to the property. See Drzewiecki v. Stock-Daniel Hardware Co., 293 S.W. 441, 444-45 (Mo.App.1927). Accordingly, the Court finds SBA has no lien on the property.

Whether SBA's Alleged Lien Can Be Avoided

The Court has determined that SBA has no lien to avoid. However, even if SBA had a lien it would be avoidable under § 544(a)(3). Accordingly, the following alternative findings are made in regard to issues raised by the parties as to lien avoidance under the "bona fide purchaser" provision of § 544(a)(3), which states:

(a) 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 —

* * * * * *

(3) A bona fide purchaser of real property . . . from the debtor, against whom applicable law permits such transfer to be perfected, that obtains the status of a bona fide purchaser at the time of the commencement of the case, whether or not such a purchaser exists. (emphasis added.)

Under this section, a trustee may avoid a lien against property of the estate if under state law a hypothetical bona fide purchaser of the property would have prevailed over the lien as of the date of bankruptcy. In re Boardwalk Dev. Co., Inc., 72 B.R. 152, 154 (Bankr.E.D.N.C.1987), citing In re Dlott, 43 B.R. 789, 792-93 (Bankr.D.Mass. 1983). Thus, if plaintiff Realty, as debtor in possession, can stand in the shoes of a bona fide purchaser, Realty may avoid SBA's lien under § 544(a)(3).

The components of § 544(a)(3) will be reviewed in the order set forth in the statute. First, the section states that a trustee may exercise the avoiding power. In this case there is no trustee, but rather, Realty, a debtor in possession. 11 U.S.C. § 1107(a) grants a debtor in possession all the rights and powers of a trustee and directs the debtor in possession to perform all the functions and duties of a trustee. This section places a debtor in possession in the shoes of a trustee in every way. See S.Rep. No. 95-989, 95th Cong.2d. Sess. 116-17 (1978) U.S.Code Cong. & Admin. News 5787, 5902, 5903; McEwan v. Westphal, 809 F.2d 1356, 1362 n. 17 (8th Cir. 1987); In re Herr, 79 B.R. 793, 797 (Bankr. N.D.Ind.1987). Accordingly, the avoidance power granted to a trustee in § 544 clearly extends to a debtor in possession under § 1107(a).

The Fourth Circuit in In re Hartman Paving, Inc., 745 F.2d 307 (4th Cir.1984), held a debtor in possession was not entitled to use § 544 to avoid a deed of trust which under state law was invalid against purchasers having notice of a prior interest. That court held the debtor in possession could not invalidate the deed of trust because as an original party to the transaction, debtor had actual notice of its existence. However, several courts have found the Fourth Circuit holding conflicts with the clear language of § 544(a). See In re Sandy Ridge Oil Co., 807 F.2d 1332, 1336 (7th Cir.1986); In re Boardwalk Dev. Co. Inc., 72 B.R. 152, 155 (Bankr.E.D.N.C. 1987); In re M.S.C., Inc., 54 B.R. 650, 653-54 (Bankr.D.S.C.1985).

The Court concludes the debtor in possession is entitled, under § 1107(a), to stand in the shoes of a trustee and pursue lien avoidance actions under § 544. To rule otherwise would contravene the policy of Chapter 11 to retain debtors in possession to operate the business and administer the estate for the benefit of creditors. It is common for a debtor in possession to have knowledge of defects in pre-petition transfers which may be subject to attack as preferences, fraudulent transfers or avoidable liens. Liens are avoided for the benefit of all creditors of the estate. It would be inequitable to creditors in Chapter 11 cases with debtors in possession rather than trustees if debtors in possession could not collect assets of the estate through avoidance actions if the debtor had any pre-petition knowledge that would prevent him from being an actual bona fide purchaser. If Congress had intended to prohibit debtors in possession from exercising certain powers of a trustee, it is logical to assume that § 1107(a) would have specified those restrictions rather than, on its face, granting debtors in possession all the rights and powers and directing the debtor to perform all the functions and duties of a trustee.

The second consideration in § 544(a) is the provision that the trustee may exercise avoidance powers "without regard to any knowledge of the trustee or of any creditor." That phrase means that any actual knowledge the trustee might have had of competing interests will not prevent the trustee from asserting the rights of a hypothetical purchaser without such knowledge. Griswold State Bank v. Rieber, 740 F.2d 10 (8th Cir.1984); In re Boardwalk Dev. Co., 72 B.R. at 154. Thus, the trustee or debtor in possession is accorded the status of a hypothetical bona fide purchaser and does not have to qualify as an actual bona fide purchaser by proving it had no knowledge or notice of the defect.

A trustee will rarely have actual knowledge of a prior transaction involving title to the debtor's property, but a debtor in possession will often have actual knowledge or at least notice of prior transactions. In re Matos, 50 B.R. 742 (Bankr.D.C.Ala.1985), held that the pre-petition debtor's actual knowledge of a...