In re Muller, Bankruptcy No. 93-08976. Adv. No. 95-0045A.

• Decision Date: 22 August 1995
• Docket Number: Bankruptcy No. 93-08976. Adv. No. 95-0045A.
• Parties: In re Ronald Douglas MULLER and Regina Lynn Muller, Debtors. Robert H. WALDSCHMIDT, Chapter 7 Trustee, Plaintiff, v. Leslie A. DENNIS, America's Wholesale Lender and Countrywide Funding Corp., Defendants.
• Court: United States Bankruptcy Courts. Sixth Circuit. U.S. Bankruptcy Court — Middle District of Tennessee

185 B.R. 552 (1995)

In re Ronald Douglas MULLER and Regina Lynn Muller, Debtors.

Robert H. WALDSCHMIDT, Chapter 7 Trustee, Plaintiff, v. Leslie A. DENNIS, America's Wholesale Lender and Countrywide Funding Corp., Defendants.

Bankruptcy No. 93-08976. Adv. No. 95-0045A.

United States Bankruptcy Court, M.D. Tennessee.

August 22, 1995.

Robert H. Waldschmidt, Howell & Fisher, Nashville, TN, for plaintiff.

Ernest Williams, IV, Sabin R. Thompson, Williams & Prochaska, P.C., Nashville, TN, for defendants.

MEMORANDUM

KEITH M. LUNDIN, Bankruptcy Judge.

The issue is whether the Chapter 7 trustee's status as a judgment lien creditor under 11 U.S.C. § 544(a)(1) defeats an unrecorded deed of trust. The trustee prevails because under Tennessee law an unrecorded deed of trust is null and void as to a judgment lien creditor. The following are findings of fact and conclusions of law. FED.R.BANKR.P. 7052.

I.

In July 1989, the debtors' purchase of real property was financed by Boatmen's National Mortgage Company. Boatmen's deed of trust was properly recorded on July 29, 1989.

On November 12, 1993, debtors refinanced the Boatmen's mortgage with defendant, America's Wholesale Lender ("AWL"). A new note and a new deed of trust were executed. Pursuant to the Truth in Lending Act and regulations,¹ debtors had three business days within which to rescind the refinancing contract. On November 17, 1993, debtors executed a "confirmation certificate" of nonrescission. AWL recorded its deed of trust on November 24, 1993. The mortgage and deed of trust were later assigned to defendant, Countrywide Funding Corporation. A release of Boatmen's mortgage was recorded in January, 1994.

On November 17, 1993, seven days before registration of the new deed of trust, debtors filed Chapter 7. Countywide does not claim that the debtors committed any fraud in connection with the refinancing or the filing of bankruptcy. The debtors reaffirmed the debt to Countrywide in this Chapter 7 case.

The trustee's complaint asserts that his rights as a judicial lien creditor pursuant to 11 U.S.C. § 544(a)(1) prevail over Countrywide's deed of trust which was unrecorded at the commencement of this case. Among the flood of defenses raised by Countrywide, only two are colorable: the effect of "notice" under the Tennessee recording statutes and the defense of subrogation.

II.

Section 544(a)(1) vests the trustee as of the commencement of a bankruptcy case with the rights and powers of a judgment lien creditor under applicable state law. 11 U.S.C. § 544(a)(1).² The trustee acquires the status of a judicial lien creditor by virtue of federal law, but applicable state law determines what powers that status confers. See, e.g., Midlantic Nat'l Bank v. Bridge (In re Bridge), 18 F.3d 195, 200 (3d Cir.1994) ("The scope of § 544(a) avoidance powers vis-a-vis third parties is governed entirely by the substantive law of the state in which the property in question is located as of the bankruptcy petition's filing."); Michael v. Martinson (In re Michael), 49 F.3d 499, 500 (9th Cir.1995).

Since at least 1831, it has been the law in Tennessee that an unrecorded deed of trust or mortgage is null and void as to intervening judgment lien creditors. In its current codification, the Tennessee recording statute mandates this rule:

Unregistered instruments void as to creditors and bona fide purchasers. — Any of such instruments not so proved, or acknowledged and registered, or noted for registration, shall be null and void as to existing or subsequent creditors of, or bona fide purchasers from, the makers without notice.

TENN.CODE ANN. § 66-26-103 (Miche 1993 & Supp.1994). With respect to creditors, the "pure race" nature of this Tennessee statute (and its predecessors) is traced and explained by one author as follows:

There are fundamental differences in the treatment of purchasers and creditors under the recording acts. As to the latter, the Tennessee statutes operate essentially in a "pure race" fashion, with all inquiry into notice by the creditor of the outstanding instrument being foreclosed. This doctrine is not of recent development, and since statehood, the courts have consistently permitted a creditor to levy on the basis of the record title, disregarding unrecorded instruments whether or not he was aware of them. Certain concepts relating to purchasers under the recording acts, such as actual notice and inquiry notice, therefore, have no bearing if creditors are involved. It would seem that, as to creditors, the purpose of registration is not so much to impart notice to them but rather to create a record of leviable property. The structure of the acts underscores the absolute necessity of a valid recordation as to this category. If the registration is defective in any material respect, a creditor of the grantor may levy on the record title, and it will not avail the grantee to prove the creditor had notice of the defectively recorded instrument.

Toxey H. Sewell, The Tennessee Recording System, 50 TENN.L.REV. 1, 54-5 (1982) (citations omitted) (hereinafter, "Tennessee Recording System").

The Tennessee courts have long recognized that the lien of a judgment creditor defeats the rights of an unrecorded mortgage holder. See, e.g., McCoy v. Hight, 162 Tenn. 507, 39 S.W.2d 271, 272 (1931) ("Under our registration laws a deed is not effectual against creditors, . . . until placed of record.");³City Nat'l Bank v. City, 158 Tenn. 143, 11 S.W.2d 853, 854 (1928) (An unregistered deed is void against creditors of the vendor.); McAllester v. Aldridge (In re Anderson), 30 B.R. 995, 1008 (M.D.Tenn. 1983) (same result with respect to an improperly recorded deed).

Notwithstanding Countrywide's protests to the contrary, it has never been the law of Tennessee that "notice" or "knowledge" affects a levying creditor's precedence over an unrecorded instrument. See McCoy v. Hight, 39 S.W.2d at 272; Hunt v. Curry, 153 Tenn. 11, 27, 282 S.W. 201 (1925) ("Curry's creditors perhaps had no actual knowledge of the defectively recorded . . . trust deed, and would not have been affected by such knowledge had they possessed it."); Lookout Bank v. Noe, 86 Tenn. 21, 5 S.W. 433, 436 (1887) ("It is well settled that attaching creditors are not affected by notice of unregistered instruments."). See generally Tennessee Recording System, supra, at 53-7.

Here, the Chapter 7 trustee became a judicial lien creditor on November 17, 1993. On that date, neither Countrywide nor its predecessor, AWL, had recorded its deed of trust. Under Tennessee law the trustee prevails over the unrecorded instrument.

Waldschmidt v. Mid-State Homes, Inc. (In re Pitman), 843 F.2d 235 (6th Cir.1988), does not require a different result. In Pitman the Sixth Circuit considered whether the recording of a mortgage one month after an executory sale contract was a "contemporaneous exchange" for "new value" for purposes of the defense to preference recovery in 11 U.S.C. § 547(c)(1). The debtors in Pitman executed a land sale contract a month before the lender recorded a mortgage to secure the debtors' promises to pay. Bankruptcy ensued within 90 days. The trustee avoided the recording of the mortgage as a preference under § 547 before the bankruptcy and district courts. Reversing, the Sixth Circuit criticized "their rush to apply the statutory provisions in a mechanical way that increases the size of the bankruptcy estate, and their failure to consider the unfair and inefficient implications of the results they reached." Id. at 239. The Sixth Circuit stated that a "court of equity under normal principles of contract law would not have refused specific performance of either the duty to convey or the duty to mortgage because of the buyer's insolvency." Id. at 240.

The concerns and criticisms of the Pitman court do not apply here. Unlike § 547, § 544(a)(1) does not grant to the trustee "a substantial additional mantle of power not available to any actual creditor or subsequent purchaser under state law. . . ." In re Bridge, 18 F.3d at 200 (citations omitted). Section 544(a)(1) gives the trustee the remedies available to any judgment lien creditor under state law. For over 150 years the priority of an unrecorded mortgage has been vulnerable to an intervening judicial lien creditor under Tennessee law. See generally Tennessee Recording System, supra, at 55 & n. 325 (noting that Tennessee adopted many of the laws of the state of North Carolina upon statehood in 1796, and that North Carolina had a "pure race" system of recordation at that time). Had there been no bankruptcy filing, a judgment lien creditor of these debtors levying on November 17, 1993, would defeat Countrywide's unrecorded deed of trust under Tennessee law. The intervention of bankruptcy here causes nothing "unfair" or "inefficient" beyond the ordinary application of state law.

The Sixth Circuit was concerned in Pitman with the "economic consequences" of avoidance of the mortgage: "The principles adopted by the courts below would make it difficult for a careful builder or lender to justify making a home loan to anyone who could conceivably have financial problems in the near future. The result would be to increase the cost of mortgages. . . ." In re Pitman, 843 F.2d at 242 (emphasis added).

A careful lender would easily avoid the fate that here befalls Countrywide. Countrywide's (AWL's) handling of this transaction was slipshod. Countrywide knowingly took a substantial business risk by not immediately recording its deed of trust on November 12, 1993. Countrywide concedes that it could have recorded its mortgage on November 12, and admits that it chose not to do so because of the uncertainty of recovering its costs of recording if the borrowers rescinded within the truth-in lending rescission period. In other words, rather than "front" recording costs of a few hundred dollars, Countrywide undertook the risk that an intervening creditor would trump its unrecorded...