Equitable Mortgage Doctrine In Illinois - Part 2

This post will address the following two points (one briefly, one not so briefly) regarding the application of the equitable mortgage doctrine in Illinois (Please note that all text appearing in bold, especially when quoting from the court cases are my own attempt to emphasize the text, and are not emphasized in that manner in the statute or court cases being quoted from):

• Whether the new Ilinois Mortgage Rescue Fraud Act (effective 1-1-07) preempts the equitable morgage doctrine, and

• The purported "bona fide purchaser" status of those third parties who purchase, or lend money on, a property from a foreclosure rescue operator ("operator") subsequent to the operator having gotten a homeowner to sign the ownership papers of said property to him/her.

Ilinois Mortgage Rescue Fraud Act

The Mortgage Fraud Rescue Act (765 ILCS 940) was passed by the Illinois legislature to strictly regulate foreclosure rescue transactions and to curb the abuses arising therefrom. After a quick reading of the Act, it appears quite clear that the new law has no effect at all on the future application of the equitable mortgage doctrine. More specifically, the new statute says the following at Section 55(b) of the Act

• "A consumer who suffers loss by reason of any violation of any provision of this Act may bring a civil action in accordance with the Consumer Fraud and Deceptive Business Practices Act to enforce that provision. All remedies and rights granted to a consumer by the Consumer Fraud and Deceptive Business Practices Act shall be available to the consumer bringing such an action. The remedies and rights provided for in this Act are not exclusive, but cumulative, and all other applicable claims, including, but not limited to, those brought under the doctrine of equitable mortgage, are specifically preserved." (emphasis added)

A clear reading of the statute appears to indicate that the new statute not only does not preempt the equitable mortgage doctrine, but it specifically preserves it, as well as any other legal claims that may have already been available prior to its passage (ie. fraud, racketeering, conspiracy, etc.).

(It may very well be that equitable mortgage claims and claims of violations of the new law can be brought together, in one lawsuit, either as part of one cause of action or as alternative causes of actions).

Bona Fide Purchaser Issue

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There is, what appears to be, an incorrect belief among many people that if, after a financially strapped homeowner unwittingly signs over title to his/her home to an operator, the operator sells the property to a third party, who then causes the property to be mortgaged, the homeowner automatically loses all possibility of ever getting their home back. Stated another way, the belief is that the purported interests of the subsequent third party "purchasers" (the buyer and any mortgage lender financing the purchase) have priority over any interest that the victimized homeowner may claim inder the equitable mortgage doctrine.

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My assertion is that as long as the financially strapped homeowner retains possession of the home after the purported transfer to the operator, that possession generally imparts "notice to the world" of any interest the homeowner has in the home. Therefore, the subsequent purchaser and mortgagee of the property may not qualify for "bona fide purchaser" status, in which case their interests in the property would be subordinate to the interests of the homeowner. This is generally true even if the homeowner receives a "judicial declaration of equitable mortgage" after the sale and mortgage to the third parties. The judicial declaration, under "relation back" principles, generally will relate back to the date of the homeowner's purported transfer to the operator (which typically pre-dates the subsequent sale and mortgage to third parties).

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One case (a Federal district court case) I came across makes the following observations of the bona fide purchaser issue, emphasizing the "duty of inquiry" imposed on any party claiming to be a "bona fide purchaser" under Illinois law (the case involved a foreclosure rescue situation):

• "A person who takes property for valuable consideration without notice of another's adverse claim is regarded as a bona fide purchaser whose rights are superior to competing claims. Life Savings & Loan Association v. Bryant, 125 Ill. App. 3d 1012, 81 Ill. Dec. 577, 582, 467 N.E.2d 277 (1st Dist. 1984)."

• "A mortgagee of realty is afforded the same protections as a bona fide purchaser if the mortgagee secures the mortgage without knowledge or notice of adverse claims to its mortgage. Id."

• "Notice of a competing interest in the realty may be predicated upon actual or constructive knowledge, and may also be imputed if the circumstances impose a duty of inquiry upon the purchaser/mortgagee. Burnix oil Co. v. Floyd, 106 Ill. App. 2d 16, 23, 245 N.E.2d 539 (1st Dist. 1969)."

• "A person is charged with the duty of inquiry only upon gaining knowledge of facts inconsistent with the mortgagor's claim or those "facts which would make a prudent person suspicious." In re Ryan, 851 F.2d 502, 511 (1st Cir. 1988)."

• "Inquiry notice imputes knowledge of all those facts which a diligent inquiry would have revealed. In re Cutty's-Gurnee, Inc., 133 Bankr. 934, 950 (N.D. Ill. 1991)."

• "The most common example of inquiry notice charged to a mortgagee is when a person other than the vendor is in possession of the property. Life Sav. & Loan Ass'n v. Bryant, supra, 81 Ill. Dec. at 582, 467 N.E.2d 277."

• "However, inquiry notice is imputed whenever the cumulative facts or circumstances create a reasonable suspicion that the mortgagee's interests are subject to an adverse claim. See, e.g., In re Cutty's-Gurnee, Inc., supra, 133 Bankr. at 952-53."

• "Factors, besides possession, which can serve as red flags to place a party on inquiry notice include: the extensive involvement of the putative bona fide purchaser in the transaction; the precarious financial status of the plaintiff; the low purchase price of the property; and the ease at which minimal investigation would uncover the fraudulent nature of the transaction. Shacket v. Roger Smith Aircraft Sales, 651 F. Supp. 675, 691-92 (N.D. Ill. 1986)."

For more, see Newman v. 1st 1440 Invest., Inc., 1993 U.S. Dist. LEXIS 354 (USDC N.D. Ill.)

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In another case, the following observations were made in connection with whether a subsequent claimant had knowledge imputed to it of a prior equitable mortgage (pursuant to the "inquiry notice" principle) :

• "[t]he issue of notice and priority of an equitable lien must be addressed on a case-by-case basis according to the facts and equities. Specifically, the facts must be examined to determine whether the subsequent claimant held actual or inquiry notice of the prior equitable mortgage."

• "Actual notice is that knowledge the subsequent claimant had at the time he acquired his claim. Constructive notice is knowledge that the law imputes to a purchaser or lien claimant, regardless of the actual knowledge held at the time he acquired his claim."

• "There are two kinds of constructive notice: record notice and inquiry notice. Under the doctrine of record notice, when a mortgage is properly recorded, the public record provides constructive notice of this interest to the whole world."

• "Inquiry notice is the knowledge the law imputes to a lien claimant or purchaser of real property when such claimant is under a duty of inquiry. Inquiry notice imputes knowledge of all facts that a diligent inquiry would have brought to light. Miller v. Bullington, 381 Ill. 238, 44 N.E.2d 850 (1942)."

• "The lien claimant's duty of inquiry depends upon all the facts and circumstances.

• It is clear that where a physical inspection of the property would reveal an adverse interest or where there is a party in possession other than the record title owner, the subsequent lien claimant has a duty to inquire of the possessor as to his interest and is charged with knowledge of the facts discoverable from such an inquiry or inspection. Miller, 381 Ill. at 244, 44 N.E.2d at 853; Burnex Oil Co. v. Floyd, 106 Ill. App. 2d 16, 23, 245 N.E.2d 539, 544 (1st Dist. 1969); In re Ehrlich, 59 Bankr. 646, 650 (Bankr. N.D. Ill. 1986)."

• "Outside of these types of obvious inconsistencies, however, it is not so clear what facts will suffice to create a duty of further inquiry."

• The general rule is that where the court is satisfied that the subsequent purchaser acted in bad faith, and that he either had actual notice or might have had that notice had he not willfully or negligently shut his eyes against those lights which with proper observation would have led him to knowledge, he must suffer the consequences of his ignorance and be held to have had notice so as to taint his purchase with fraud in law. . . . The law will not allow him to shut his eyes when his ignorance is to benefit himself at the expense of another, when he would have had them open and inquiring had the consequences of his ignorance been detrimental to himself and advantageous to the other."
  German-American Bank v. Martin, 277 Ill. 629, 115 N.E. 721 (1917) (quoting Doyle v. Teas, 4 Scam. 202).

• "Whatever is notice enough to excite attention and put the party on his guard and call for inquiry is notice of everything to which such inquiry might have led, and every unusual circumstance is a ground of suspicion and prescribes inquiry. . . . One having notice of such facts as would put a prudent man on inquiry is chargeable with the knowledge of other facts which he might have discovered on diligent inquiry." Blake v. Blake, 260 Ill. 70, 102 N.E. 1007 (1913).

For more, see In re Cutty's-Gurnee, Inc., 133 B.R. 934 (USBC N.D. Ill. 1991)

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In a third case, decided by an Illinois appellate court, the following observation is made regarding possession of real estate and its effect on providing "notice to the world" of the rights of the possessor.

• The final question to be answered then is, exactly to what priority was the Bryants' interest restored upon negation of the subordination agreement in relation to the subsequently executed mortgage. The answer turns on whether Life, as Mortgagee, was a bona fide purchaser such that its interest was protected by the recording act. Metcalf v. Altenritter (1977), 53 Ill. App. 3d 904, 369 N.E.2d 498.

• A bona fide purchaser is one who takes without notice of a prior claim or encumbrance. (Guard ex dem. Robinson v. Rowan (1840), 3 Ill. (2 Scam.) 499.) A mortgagee of realty is regarded as a purchaser, and, if the mortgage is supported by consideration and is taken in good faith, the mortgagee will be protected against adverse claims of which it has no notice. (59 C.J.S. Mortgages sec. 232 (1949).)

• Where, however, the mortgagee, at the time of taking the mortgage, has knowledge or legal notice of a prior conveyance, it is not entitled to the protection of a bona fide purchaser. (Fidelity Trust & Savings Bank v. Williams (1936), 285 Ill. App. 131, 1 N.E.2d 739.) One who takes a mortgage upon property with knowledge, either actual or constructive, of an earlier although unrecorded conveyance of it, takes it subject thereto and will not be permitted by placing his mortgage first on the record to gain priority over the earlier lien. St. Boniface Building & Loan Association v. Demopoulos (1939), 302 Ill. App. 614, 24 N.E.2d 171.

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• "Illinois courts have uniformly held that the actual occupation of land is equivalent to the recording of the instrument under which the occupant claims interest in the property. (Bullard v. Turner (1934), 357 Ill. 279, 192 N.E. 223; Beals v. Cryer (1981), 99 Ill. App. 3d 842, 426 N.E.2d 253). The open and visible possession of land by the equitable owner is sufficient to charge a mortgagee with notice of the rights of such owner, and the mortgagee will take subject to the rights of the person in possession. Williams v. Spitzer (1903), 203 Ill. 505, 68 N.E. 49."

For more, see Life Savings & Loan Association v. Bryant, 125 Ill. App. 3d 1012, 81 Ill. Dec. 577, 467 N.E.2d 277 (1st Dist. 1984)

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Based on the foregoing judicial observations in these three cases, it appears clear that in the State of Illinois a subsequent claimant (either purchaser or mortgagee) of property that is purchased from a foreclosure rescue operator (where the homeowner who unwittingly signed over his title to the operator is still in possession) has a duty not only to physically inspect the property, but also, to inquire of the person in possession as to what rights to the property the possessor has. Failing that, the rights of subsequent buyers and mortgagees will be subject and subordinate to any rights the homeowner may have pursuant to the equitable mortgage doctrine.

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Conclusion

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Given that the observations made in these court decisions seem so fundamentally basic, my guess is that one can readily find the same or strikingly similar observations made by courts in applying the state law in most, if not all, of the other 49 states. For all the non-Illinois readers, I do not wish to create the impression that the foregoing presentation of the "bona fide purchaser" issue and the principle of the "duty to inquire" is somehow limited or unique to Illinois law.

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Finally, the reason I included two Federal court cases for this post is not because of any force as binding precedent that they may have (since they are Federal cases applying state law, they probably have no weight as precedent; see the Erie Doctrine). Setting aside the fact that I just happened to "stumble into them", the observations made in both cases are either based on, or are quotes, from decisions of the Illinois judiciary (decisions which probably are binding precedent in the state of Illinois). Accordingly, these cases represent a handy summary of what some earlier Illinois state court decisions have said regarding these issues. For anyone looking to quickly get up to speed on the issues discussed herein, the two Federal cases may provide an acceptable alternative for gaining a quick perspective of the issues involved in lieu of digging up all the Illinois cases cited therein, and then reading them.

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Addendum (2-4-10)

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Fidelity Trust & Savings Bank v. Williams (1936), 285 Ill. App. 131, 1 N.E.2d 739:

• The rule of law which seems to control in a like situation is that the retention of possession by the grantor of the property conveyed is notice of his or her interest in the property, and to those claiming under the grantee, and such rule is laid down in the case of Ford v. Marcall, 107 Ill. 136, wherein the court said: "The law is, as this court has declared in White v. White, 89 Ill. 460, that when the grantor of real estate remains in possession, all persons acquiring title from the grantee are chargeable with notice of all the claims of the grantor."

• This rule was followed and approved in the case of Ronan v. Bluhm, 173 Ill. 277, where the court said: "It is proper we should remark, in answer to the discussion upon the point, that as it is conceded by all parties that the said Thomas Ronan did not deliver possession of the premises in question to the grantee, Carbine, but remained in the open and exclusive occupancy thereof, appellee, Bluhm, is deemed, as matter of law, to have taken the conveyance from Carbine with full notice of all the rights and equities of said Ronan in the premises. Illinois Central Railroad Co. v. McCullough, 59 Ill. 166; White v. White, 89 id. 460; Ford v. Marcall, 107 id. 136." It is to be noted from what the court said in this opinion that Bluhm was deemed as a matter of law to have taken the conveyance from Carbine, the grantee of Ronan, with full notice as to all the rights and equities of Ronan in the premises.

• This rule has been passed upon by the courts of this State, and the law is again discussed and approved in the case of Rock Island & Peoria Ry. Co. v. Dimick, 144 Ill. 628. The court in this opinion said: "The law is well settled in this State, as generally elsewhere, when not changed by the recording acts, that open and exclusive possession of lands, under an apparent claim of ownership, is notice to those subsequently dealing with the title of whatever interest the possessor has in the premises, whether the interest be legal or equitable in its nature. Wade on Notice, sec. 273; Davis v. Hopkins, 15 Ill. 519; Truesdale v. Ford, 37 Ill. 210; Smith v. Jackson's Heirs, 76 Ill. 254; Partridge v. Chapman, 81 Ill. 137. It has been held also in this State, that if the grantor remains in possession after conveyance, purchasers from the grantee are affected with notice of the grantor's rights in the land. White v. White, 89 Ill. 460; Ford v. Marcall, 107 id. 136."

• In the case of Porter v. Clark, 23 Ill. App. 567, this rule was also approved, and in discussing the subject matter of the litigation, the court there stated what we regard as pertinent in its application to the instant case. This statement is: "If Porter, knowing as he did that Clark was in possession, had gone to him and inquired as to his rights, he would undoubtedly have been told that the purchase money had not been paid, and that he, Clark, claimed a vendor's lien on the land."

Illinois equitable mortgage beta Illinois bona fide purchaser alpha