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Punished for trying to fix a flawed mortgage
Slade Smith's Blog
May 27 2014

A bank lost another mortgage because they made an error in recording their mortgage-- as is all too common, they attached the wrong legal description.  However, in this unusual case, the bank caught the error before anybody else and applied to the court to get the incorrect legal description fixed, but a judge still voided it. 

In reading the facts of the case, I thought the court got it wrong, resulting in a very unfair decision.  See what you think.

In this bankruptcy case, In re Simmons, the mortgage lender, Full Spectrum Lending, made its mortgage loan to a Mississippi homeowner.  In the mortgage document itself, the correct address parcel ID number are included.  However, they attached an incorrect legal description to the mortgage document, and recorded it. 

Full Spectrum later assigned the mortgage to Bank of New York Mellon, which later discovered the error.  They filed a case with the court to have the deed reformed to show the correct legal description.  On the same day, they filed a lis pendens, which included the correct legal description.

One month later, the homeowner filed for bankruptcy.

When a bankruptcy is filed, the bankruptcy trustee takes ownership of the debtor's property as if they bought it from the debtor.  If an ordinary buyer of the debtor's property would be able to have a lien invalidated because of some flaw in the lien, the trustee can also have that lien wiped out, so that there's more money to pay off the creditors with valid liens. 

Here, the trustee became aware of the incorrect legal description on the mortgage, and applied to the bankruptcy court to have the mortgage voided.

Naturally, BNY Mellon objected.  After all, they had applied to the court to get the problem fixed a full month before the bankruptcy was filed, and they had filed a lis pendens to give notice to the world that they were seeking to have this mortgage fixed so that it would show the correct legal description.

But despite the bank's protest that they had applied to fix the defect in time, the bankruptcy judge wiped out the mortgage, based on its interpretation of Mississippi's lis pendens statute.

Mississippi's lis pendens statute states:

When any person shall begin a suit in any court, whether by declaration or bill, or by cross-complaint, to enforce a lien upon, right to, or interest in, any real estate, unless the claim be founded upon an instrument which is recorded, or upon a judgment duly enrolled, in the county in which the real estate is situated, such person shall file with the clerk of the chancery court of each county where the real estate, or any part thereof, is situated, a notice containing the names of all the parties to the suit, a description of the real estate, and a brief statement of the nature of the lien, right, or interest sought to be enforced.

The court interpreted the phrase "unless the claim be founded upon an instrument which is recorded" to be an exception which prohibited the filing of a lis pendens in a situation where a claim is based on an instrument which is recorded.  Finding that BNY Mellon's attempt to reform the legal description was based on a recorded instrument, the court found that the lis pendens was prohibited by the statute and therefore invalid and not effective at preserving the mortgage at least until the court in the reform action had a chance to issue its decision in that case.

I think the judge's interpretation must be wrong.

I think what the statute is saying is that if your claim in your suit is expressed in something already recorded so that the world has proper notice of the claim, including the property it concerns, you do not have to file a lis pendens. 

Here, the incorrect recording does not have the correct legal description, and therefore the bank was properly concerned that anyone interested in the property would not have notice of their potential interest.  How else was BNY Mellon supposed to provide notice of their potential interest in the property?  The bankruptcy judge does not say.

* * *

The court noted that even if it had not struck down the bank's attempt to fix the mortgage based on the lis pendens statute, it would have struck it down because the bank's attempt to fix the mortgage shortly before the bankruptcy amounted to a  "preferential transfer" that the bankruptcy trustee can reverse. 

Normally, the term "preferential transfer" refers to payments the debtor makes to creditors shortly before it files bankruptcy.  Say that a debtor, Sam, knows he is going to file for bankruptcy.  He owes his best friend John $10,000, so he pays him off completely the day before he files.  Under the law, this is considered unfair Sam's other creditors, so the bankruptcy trustee can make John pay the $10,000 he received back into the bankruptcy estate so that it can be distributed among all the creditors.

In this case, the court decided that the bank's attempt to turn its defective mortgage into a valid mortgage was an attempt to make a preferential transfer to itself.  I am not an expert in bankruptcy law and I did not extensively research the application of the preferential transfer rule in this sort of situation, but I tend to doubt that the preferential transfer rule was intended to apply in a situation like this.

* * *

I think there are other grounds whereby the court could have ruled that the mortgage was still valid.  The error in the legal description is somewhat unusual in that the legal description attached to this particular mortgage could not possibly be correct, because the property described is not in the state of Mississippi!  The attached property description begins:

All that certain parcel of land situated in the Township of Dingman, County of Pike, and Commonwealth of Pennsylvania...

So, we have a mortgage for a property with a Mississippi address, recorded in Mississippi, with a legal description which obviously describes property in Pennsylvania. 

To my thought, this situation is distinct from the more frequent occurrence where the legal description attached to a mortgage is for the wrong property, but it's not obvious from looking at the recording itself that anything is wrong.  In that case, you may find out from looking at other documents that the legal description is wrong but you can't tell but just looking at the document itself.  Here, it's very obvious from just looking at this mortgage document that the legal description must be wrong! 

So I wondered if the court would make that distinction, and perhaps treat the situation more like a situation where the legal description was simply missing, because in both situations, the document obviously does not contain the correct legal description.

As I discussed in an article last week, an incorrect legal description may have different legal consequences depending on the county, because some counties index legal descriptions and others don't.  In a county that indexes legal descriptions, a title search may not be expected to even look at documents with incorrect legal descriptions, and so a court may rule that they fall outside the chain of title, even if there are other elements within the document that indicate that it might have been intended to apply to the subject property.  But here, unlike the case I wrote about last week, there was no legal description index in the county.  In other words, a searcher would not be eliminating this document from the scope of their search because of the incorrect legal description without looking at the legal description. 

I've also recently discussed how a legal description that is entirely missing on a recorded document may have an entirely different legal effect than an incorrect legal description-- it will depend on the state.  Some states have statutes that flatly state that certain recorded documents must have legal descriptions, period.  If the state does not explicitly declare documents without legal descriptions to be valid, a court is probably going to look at the rest of the document and make some determination as to whether the property can be identified with enough certainty as to give the document the desired legal effect.  Courts will look for previous court rulings as to whether an address or a tax or parcel ID or other information on a document sufficiently identify a property and give the document effect.

As it turned out, the court didn't even come close to making this distinction.  According to the court, the law in Mississippi is that the absence of the correct legal description makes a mortgage ineffective in providing notice of the mortgage as to a bona fide purchaser, or in this case, a bankruptcy trustee-- even though the court cited no Mississippi statute that requires this, and there are prior Mississippi cases, brought up by the bank, that arguably indicate otherwise.

All in all, I do not think this mortgage should have been voided.  Yes, the lending bank or whoever did its paperwork was sloppy and they recorded an obviously flawed mortgage.  But the bank holding the mortgage (not the same bank that recorded the defective mortgage) ultimately did what it should have done-- it tried to fix the problem.  Perhaps the bankruptcy trustee wouldn't have even become aware of the defect if the bank hadn't tried to fix it.  At any rate, the result seems unduly harsh for the bank.  Nobody in this case disputes that the homeowner intended to mortgage their property, and mortgage debt is generally subject to elimination in bankruptcy under current law.  Now, with the mortgage eliminated, the debt will likely be discharged in the bankruptcy. 

What do you think?