In re Thulis

• Decision Date: 04 June 2012
• Docket Number: 11–10043–7.,Nos. 10–16841–7,s. 10–16841–7
• Citation: 474 B.R. 668
• Parties: In re Brian Edward THULIS, Debtor. In re Matthew Jay Weiler, Debtor.
• Court: U.S. Bankruptcy Court — Western District of Wisconsin

474 B.R. 668

In re Brian Edward THULIS, Debtor.

In re Matthew Jay Weiler, Debtor.

Nos. 10–16841–7, 11–10043–7.

United States Bankruptcy Court,

W.D. Wisconsin.

June 4, 2012.

Mark J. Wittman, Esq., Marshfield, WI, for Trustee.

Eric S. Teske, Esq., Milwaukee, WI, for Creditor River Valley State Bank.

ORDER SUSTAINING OBJECTION TO CLAIM

THOMAS S. UTSCHIG, Bankruptcy Judge.

In this, the third volume of a trilogy on the recording of real estate interests, the Court is called upon to crown the victor in a dispute between a bankruptcy trustee and a secured creditor.¹ The debtors were the co-owners of some real estate located in Merrill, Wisconsin. They owned two adjoining parcels which were conveniently identified in the relevant legal descriptions as Lot 1 and Lot 2. River Valley State Bank filed a proof of claim asserting a secured claim against both lots even though its mortgage only appears to grant an interest in Lot 2. The chapter 7 trustee sold Lot 1 and received the net proceeds. He also objected to the bank's claim and contends that the bank's mortgage does not cover Lot 1.² The trustee requests that the Court enter an order finding that the bank is an unsecured creditor with regard to that lot (or, more accurately, as to the proceeds from the sale of that lot). This is a core proceeding under 28 U.S.C. § 157(b)(2)(B), and the Court has jurisdiction under 28 U.S.C. § 1334. The parties submitted statements of fact and legal briefs. The following constitutes the Court's findings of fact and conclusions of law pursuant to Fed. R. Bankr.P. 7052, as applicable in a contested matter under Fed. R. Bankr.P. 9014(c).

The parties agree on the basic facts. When the debtors bought the property, both lots were vacant and unimproved.³ In October of 2004, the debtors obtained a $210,000.00 construction loan from the bank in order to build a single-family residence on the property. The debtors always intended to build on Lot 1, and there is no hint that they misrepresented their plans to the bank. Unfortunately for the bank, the mortgage described the collateral as Lot 2 rather than Lot 1.⁴ After the home was completed, the debtors refinanced the construction loan.⁵ The bank satisfied the construction mortgage and the parties executed a new note and mortgage to secure the refinancing loan in the amount of $198,450.00.⁶ This subsequent mortgage also erroneously referenced Lot 2 instead of Lot 1, although it did include a statement that the collateral was “Homestead Property.” ⁷

Mr. Thulis filed bankruptcy in September of 2010, while Mr. Weiler filed his case the following January. From the date of the initial loan until the bankruptcy filings, the debtors and the bank apparently believed the mortgage actually covered the home.⁸ After an investigation of the title record, the chapter 7 trustee concluded that the mortgage was defective as to the homestead property. He received a purchase offer as to Lot 1 for $170,000.00 and filed a motion to sell the property in June of 2011. The sale was approved and consummated. The trustee is presently holding the net proceeds pending resolution of his objection to the bank's claim. In his objection, the trustee does not deny that the bank intended to take a mortgage on Lot 1. He simply points out that in real estate transactions it is not the thought that counts, but what is recorded with the register of deeds.⁹

In support of his objection, the trustee submitted a title report prepared by Lincoln County Abstract Company which demonstrates that the debtors held title to Lot 1 under a warranty deed dated June 22, 2002.¹⁰ The title company found no mortgages recorded against Lot 1, although there were two judgments docketed against Matthew Weiler in 2010. The title report also indicates that Lot 1 has a different tax key and parcel identification number than Lot 2, and a review of the bank's mortgage documents confirms that they only contain the legal description, tax key, and parcel identification number of Lot 2.¹¹ The bank characterizes the failure to include Lot 1 in its various mortgage documents as a mistake. The trustee asserts that under Wisconsin's recording statute this mistake means the bank does not have an enforceable mortgage against Lot 1 and its claim is not secured by the sale proceeds.

When the debtors filed bankruptcy, their assets became part of a bankruptcy estate. The trustee's job is to turn any non-exempt estate assets into cash for the benefit of unsecured creditors.¹² The bankruptcy code provides the trustee with a variety of powers designed to equalize the distribution of assets to creditors. Some of these provisions allow the trustee to reel assets back into the estate even though the debtor transferred them away before the case was filed. See11 U.S.C. §§ 547 and 548. Others allow the trustee to take advantage of state laws, such as Wisconsin's recording statute, to avoid (or knock out) improperly perfected security interests and mortgages. Under 11 U.S.C. § 544(a)(3):

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, and 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.

This provision—part of the trustee's so-called “strong arm” powers—allows the trustee to act as a bona fide purchaser as of the petition date and avoid interests to the extent such a purchaser could do so under state law. See Resop v. Farmers & Merchs. State Bank, 379 B.R. 831, 832 (W.D.Wis.2007); HSBC Bank USA v. Perkins, 451 B.R. 555, 561 (N.D.Ala.2011) (citing Realty Portfolio v. Hamilton (In re Hamilton), 125 F.3d 292, 298 (5th Cir.1997)).

In Wisconsin, unrecorded conveyances or mortgages are void as against any subsequent purchaser who acts “in good faith.” Wis. Stat. § 706.08(1)(a) provides that:

[E]very conveyance that is not recorded as provided by law shall be void as against any subsequent purchaser, in good faith and for a valuable consideration, of the same real estate or any portion of the same real estate whose conveyance is recorded first.

The purpose of the statute is to compel the filing of relevant instruments so that the complete title history of the property can be determined from the public record and subsequent purchasers are not hurt by hidden transactions. See Kordecki v. Rizzo, 106 Wis.2d 713, 317 N.W.2d 479, 482 (Wis.1982). A bona fide purchaser (or a good faith purchaser) is one without notice, either actual or constructive, of any existing rights in the land. Bump v. Dahl, 26 Wis.2d 607, 133 N.W.2d 295, 299 (Wis.1965); Osberg v. Fibison (In re Fibison), No. 10–25, 2011 WL 6149269, at *2 (Bankr.W.D.Wis. Dec. 12,2011).

Other Wisconsin statutes also reflect the importance of proper recording. Wisconsin law anticipates that subsequent purchasers and other parties will normally obtain notice of earlier conveyances from the title record. SeeWis. Stat. § 706.09(1)(b). A prior adverse interest which relies upon a conveyance outside the chain of title for its validity or priority is essentially subordinated to later—but properly recorded—interests. The statute clearly states that a subsequent purchaser's interest is superior to that created by:

Any conveyance, transaction or event not appearing of record in the chain of title to the real estate affected, unless such conveyance, transaction or event is identified by definite reference in an instrument of record in such chain. No reference shall be definite which fails to specify, by direct reference to a particular place in the public land record, or, by positive statement, the nature and scope of the prior outstanding interest created or affected by such conveyance, transaction or event, the identity of the original or subsequent owner or holder of such interest, the real estate affected, and the approximate date of such conveyance, transaction or event (emphasis added).

In addition, Wis. Stat. § 706.09(2)(a) describes the limited situations in which a purchaser is deemed to have notice of a prior claim apart from the title record. A purchaser is presumed to have affirmative notice of a prior claim apart from the title record only if there is “notice, actual or constructive, arising from use or occupancy of the real estate by any person at the time such purchaser's interest therein arises.” ¹³

Actual notice means exactly what it says. Someone who actually knows about a prior claim or interest cannot claim the benefit of the recording statute. However, actual notice is no defense against the bankruptcy trustee. In re Sandy Ridge Oil Co., 807 F.2d 1332, 1336 (7th Cir.1986) (“actual knowledge is irrelevant under § 544(a)”). Constructive notice is a different story. Courts have typically concluded that a bankruptcy trustee's avoidance powers are subject to any state law limitations regarding constructive notice. See In re Probasco, 839 F.2d 1352 (9th Cir.1988); Brown v. Job (In re Polo Builders, Inc.), 433 B.R. 700 (Bankr.N.D.Ill.2010). In that regard, Wisconsin law reflects a public policy that prospective purchasers are subject to any liabilities or interests which could have been discovered through a reasonable degree of care in consulting certain “avenues of information.” Bump, 133 N.W.2d at 299.

The relevant avenues are the records in the office of the appropriate register of deeds, other public records, and the land itself, by which it is possible to “discover by observation the rights which arise outside of the recording system by virtue of possession or use.” Bump, 133 N.W.2d at 300 (emphasis added). If it is possible to discover...