Failure To Inspect Property & Inquire Into Rights Of Parties In Possession Prior To Making Loan Leaves Indiana Lender With Voided Mortgage
The following facts have been extracted from a recent ruling by the Indiana Court of Appeals:
- Benjamin purchased his home in Gary, Indiana in 1965 and has lived there ever since.
- In July of 1987, as part of his retirement planning, Benjamin conveyed his home to son David Thomas by quit claim deed with the understanding that it remained Benjamin's home and that he could recover title at any time upon request.
- In October of 1995, David conveyed Benjamin's home by quit claim deed to another of Benjamin's sons, Richard Thomas.
- Benjamin and Richard agreed that Richard would return title to the home to Benjamin upon request.
- At no time did Benjamin relinquish possession of the home.
- In June of 2001, following a family dispute, Benjamin requested that Richard convey title of the home back to him, but Richard refused to do so.
- On August 1, 2001, Benjamin filed a notice of intention to hold a mechanic's lien on the home for $200,000.
- On September 12, 2001, Benjamin filed a quiet title suit against Richard but did not record a lis pendens notice at the time or at any time thereafter.
- On December 6, 2001, Richard obtained a $118,000 loan from Trustcorp in exchange for a mortgage on the home. Richard was unemployed and living in Georgia at the time and, in connection with the loan application process, submitted a release of mechanic's lien that bore what purported to be Benjamin's signature but was not.
- Additionally, the release instrument indicates only the presence of Richard as signatory and refers to the lien instrument as bearing the designation "2001 003334" when the actual designation on the notice was "2001 060516."
- Trustcorp did not contact Benjamin regarding the purported release, and the loan agreement was completed.
- As it happened, Richard never made any payments on the mortgage loan.
- On July 3, 2002, Benjamin filed suit to foreclose his mechanic's lien on the home, a suit that included Trustcorp as a defendant.
Does Trustcorp's recorded security interest in Benjamin's home as a mortgagee have priority over Benjamin's unrecorded interest in the home that he has occupied since 1967 (remember that Benjamin is not the owner of record, and he failed to record a lis pendens against the home when he initiated an action to quiet title in order to recover the title from his deadbeat son, Richard, who was the title holder of record)?
Even though Trustcorp presumably had no actual knowledge of the oral understanding between Benjamin and his sons about the ownership of the home, and presumably had no actual knowledge of Richard's intent to drain the equity out of the home by pocketing the proceeds of the mortgage loan from Trustcorp. (and thereby screwing over his father out his home of 35+ years), the Indiana appeals court affirmed the lower court in ruling that Benjamin's earlier-acquired, but unrecorded, ownership rights in the home pursuant to the oral understanding he had with his sons trumped Trustcorp's later-acquired recorded mortgage, and further, ruled that Trustcorp's mortgage was invalid.
The trial court concluded that Trustcorp's mortgage was a product of a fraud (specifically, the forged mechanic's lien release) and therefore invalid. The trial court also concluded that, despite Benjamin's failure to file a lis pendens, Trustcorp had constructive notice of his claims due to Benjamin's pending litigation with Richard and the irregularities in the mechanic's lien release.
Instead, the appeals court attacks the forged mechanics' lien release by ostensibly treating it as a voidable instrument (in which case it then becomes necessary to attack Trustcorp's claimed status as a bona fide purchaser in order to void its interest as a mortgagee in Benjamin's home) as opposed to an absolutely void instrument (in which case the bona fide purchaser doctrine is inapplicable, which consequently leaves subsequent purchasers without the recording statute protection).
In doing so, the appeals court appears to take a "belt & suspenders approach" in upholding the lower court ruling.
First, it focuses on Benjamin's continued possession of his home while his son went behind his back and obtained the mortgage loan from Trustcorp to rule that Trustcorp is not entitled to the protection of the state recording statute as a bona fide purchaser.
Next, it focuses on the irregularities that appeared on the face of the forged mechanics' lien release that enabled Benjamin's son Richard to go forward and pocket the proceeds from the mortgage loan from Trustcorp. On this basis, it ruled (again) that Trustcorp had constructive notice of Benjamin's ownership interst and accordingly, was not entitled to the protections afforded by the recording statutes to bona fide purchasers.
(While the court could have found support for the lower court's decision to void Trustcorp's mortgage on either basis to find that Trustcorp was not a bona fide purchaser, I guess it just wanted to be extra sure that it isn't overruled in a possible appeal of its ruling should the case be appealed further. Accordingly, it used both approaches to invalidate the mortgage - hence, a "belt & suspenders approach," so to speak.)
With regard to Benjamin's continued possession of the home and its effect on Trustcorp being placed on notice of his ownership interest in it, the Court of Appeals made this statement [bold text is my emphasis, not in the original text; text broken up for ease of reading]:
- "[T]o qualify as a bona fide purchaser,[Footnote 1: The law regarding bone fide purchasers applies with equal force to mortgagees. See, e.g., Weathersby v. JPMorgan Chase Bank, N.A., 906 N.E.2d 904, 910 (Ind. Ct. App. 2009).] one has to purchase in good faith, for a valuable consideration, and without notice of the outstanding rights of others." Kumar v. Bay Bridge, LLC, 903 N.E.2d 114, 116 (Ind. Ct. App. 2009) (citation omitted). "The theory behind the bona fide purchaser defense is that every reasonable effort should be made to protect a purchaser of legal title for a valuable consideration without notice of a legal defect." Id. (citation omitted).
- There is no dispute that Benjamin failed to file a lis pendens notice when he filed his quiet title action against Richard on September 12, 2001. The trial court, however, concluded that Trustcorp did not qualify as a bona fide mortgagee because it did not act in good faith and had constructive notice of Benjamin's lawsuit. Trustcorp contends that these conclusions were erroneous.
- The record supports conclusions that Trustcorp did not act in good faith and can be imputed with notice of Richard's fraud and Benjamin's lawsuit. The Indiana Supreme Court has squarely held that "one who fails to examine land which he is about to purchase, and to inquire as to the rights of one in possession, is not acting in good faith and will not be treated as a bona fide purchaser." Mishawaka-St. Joseph Loan & Trust Co. v. Neu, 209 Ind. 433, 443, 196 N.E.2d 85, 90 (1935).
- Regarding notice of competing claims, the Court also held that "means of knowledge, with the duty of using them, are equal to knowledge itself." Id. The Indiana Supreme Court has also held that possession of land puts the world on notice that the possessor may have a claim of ownership and right to possession. See Olds v. Hitzemann, 220 Ind. 300, 308, 42 N.E.2d 35, 38 (1942) ("[Appellees] were still in possession of their land, and their possession was notice to the world of their claims to ownership and right to possession.").
- Quite simply, it is undisputed that Benjamin was in possession of the property in question and that Trustcorp nonetheless did nothing to ascertain his rights to it. It is apparent that even a cursory investigation would have quickly uncovered both Richard's fraud and Benjamin's claims on the home. Under the circumstances, Trustcorp cannot have been a bona fide mortgagee, and we therefore affirm the trial court's judgment in this regard.
The court said the following in this respect [bold text is my emphasis, not in the original text; text broken up for ease of reading]:
- Moreover, even in the absence of a duty to inspect the property, we believe that irregularities on the face of the forged release of mechanic's lien would have put a reasonably prudent person on inquiry notice that something was amiss.
- The law recognizes two kinds of notice, constructive and actual. Constructive notice is provided when a deed or mortgage is properly acknowledged and placed on the record as required by statute. However, an otherwise valid instrument which is not entitled to be recorded, improperly recorded, or recorded out of the chain of title does not operate as constructive notice, although binding upon persons having actual notice. Notice is actual when notice has been directly and personally given to the person to be notified. Additionally, actual notice may be implied or inferred from the fact that the person charged had means of obtaining knowledge which he did not use. Whatever fairly puts a reasonable, prudent person on inquiry is sufficient notice to cause that person to be charged with actual notice, where the means of knowledge are at hand and he omits to make the inquiry from which he would have ascertained the existence of a deed or mortgage. Thus, the means of knowledge combined with the duty to utilize that means equates with knowledge itself. Whether knowledge of an adverse interest will be imputed in any given case is a question of fact to be determined objectively from the totality of the circumstances. Keybank Nat. Ass'n v. NBD Bank, 699 N.E.2d 322, 327 (Ind. Ct. App. 1998) (citations omitted).
- As an initial matter, it is clear to us that the trial court, although purporting to find that Trustcorp had constructive notice of Richard's fraud and Benjamin's quiet title lawsuit, actually found that it had inquiry notice of those things. Trustcorp cannot have had constructive knowledge of the quiet title action because Benjamin never filed his lis pendens notice. Nonetheless, we will affirm the trial court's judgment on this point if the record contains sufficient evidence to support a finding of inquiry notice. "The Court of Appeals may affirm the trial court's ruling if it is sustainable on any legal basis in the record, even though it was not the reason enunciated by the trial court." Moore v. State, 839 N .E.2d 178, 182 (Ind. Ct. App. 2005), trans. denied.
- As for the purported lien release, first, the instrument was improperly notarized in that it indicates that only Richard was present when it was notarized, even though it was supposedly executed by Benjamin. A notary public is prohibited from acknowledging any instrument unless the person executing it signs it in her presence or affirms to her that the signature on the instrument is the person's own, and there is no indication that either of those things happened in this case. Ind. Code § 33-16-2-2 (2001) (now Ind. Code § 33-42-2-2 (2009)). Indeed, it occurs to us that the whole purpose of a notary public acknowledgment is to prevent just the sort of forgery and fraud that occurred here.
- Second, and perhaps even more compelling, was the fact that the lien the instrument was purporting to release was designated "2001 003334" when the actual notice of intention to hold mechanic's lien filed by Benjamin was designated "2001 060516." Plaintiff's Exs. 3, 4. Trustcorp clearly had the means to discover that the lien the forged instrument purported to release did not exist under that designation, and yet did not use those means. In light of the amount of the loan, $118,000, we believe that a reasonably prudent lender would have taken the simple steps necessary to verify that a superior $200,000 mechanic's lien had indeed been released, especially when the release instrument had been improperly notarized.
- The trial court specifically found that the mechanic's lien release Richard provided to Trustcorp was forged, a finding that has ample support in the record. Benjamin contended below that Trustcorp's mortgage was rendered invalid by virtue of Richard's fraud, and the trial court agreed. "It is a fundamental principle, worthy of the rank of a maxim, that what fraud creates equity will destroy."[Footnote 2: The version of this citation found in the www.westlaw.com database places quotation marks around the phrase "what fraud creates equity will destroy." While this error does not seem to alter the meaning of the citation, we will continue to exercise caution in citing to non-official authorities.] Ralph v. George, 78 Ind. App. 491, 495, 136 N.E. 44, 45 (1922) (citation omitted).
- On appeal, Trustcorp counters that Indiana courts have recognized a bone fide purchaser exception to the above rule, and we agree that this is indeed the case. See, e.g., Scott v. Davis, 117 Ind. 232, 233, 20 N.E. 139, 139-40 (1889) ("A purchaser who buys land and pays a consideration for it will hold the land against the creditors of the vendor, unless the creditors affirmatively show that the purchaser had notice of the intention of the vendor to defraud his creditors, or that he participated in his grantor's fraud. It is not enough to show fraud on the part of the vendor, where the purchaser is not a mere volunteer, but pays a consideration for the land. To set aside the conveyance as fraudulent, much more must be shown.") (citations omitted). As in the lis pendens context, the question here is whether Trustcorp qualifies as a bona fide mortgagee. As we previously decided, however, Trustcorp could not have been a bona fide mortgagee due to its failure to investigate Benjamin's interest in the home. Consequently, we affirm the trial court's judgment in this respect as well.
For case law in other states addressing the effect of possession and a real estate purchaser's or lender's duty to inquire into the rights of the occupants when seeking the protection of the recording statutes as a bona fide purchaser, see Bona Fide Purchaser Doctrine, Possession Of Property By Occupants Other Than The Vendor & The Duty To Inquire.
For some of the basics on the bona fide purchaser doctrine, generally, see The Bona Fide Purchaser for Value of a Legal Estate Without Notice.
(1) For other court cases on the application of the bona fide purchaser doctrine where real estate buyers/lenders end up screwing themselves by failing to inspect the subject property and inquiring into the rights of persons in possession prior to closing on the purchase/mortgage loan (and risked having their interests ultimately voided), see:
- Illinois: Lender's Failure To Inquire Into Possession Disqualifies It For Bona Fide Purchaser Protection In Suit To Undo Foreclosure Rescue Sale Leaseback Scam,
- Colorado: Lack Of Knowledge Or Partcipation In Fraud Not Enough To Sustain Bona Fide Purchaser Status In Equity Stripping, Foreclosure Rescue Deal,
- Minnesota: Stone v. Jetmar Props., LLC, 733 N.W.2d 480 (Minn. App. 2007) ("A prospective purchaser is obligated to discover anyone in possession of the land at issue and to inquire into the nature and extent of the occupant's interest"),
- Minnesota: Claflin v. Commercial State Bank, 487 N.W.2d 242; 1992 Minn. App. LEXIS 532 (Mn. App. 1992) (Lender's mortgage voided due to failure to inspect premises and failure to inquire into rights of persons in occupancy),
- United Kingdom: Mortgage Voided As Lender Fails To Make Inquiries Of Persons In Possession; Unrecorded Rights Of Occupants Take Priority Over Lender's Recorded Lien.