Lack Of Knowledge Or Partcipation In Fraud Not Enough To Sustain Bona Fide Purchaser Status In Equity Stripping, Foreclosure Rescue Deal

(This post is a reprint of an entry posted January 28, 2009.)

In a 2005 court decision, the Colorado Supreme Court, in Martinez v. Affordable Hous. Network, Inc., 123 P.3d 1201 (Colo. 2005), ruled on a case involving a foreclosure rescue operator ("AHN") who was said to have acquired title to a home through fraudulent means from a financially strapped husband and wife ("Martinez"), and who then sold the home to a subsequent third party purchaser ("Troco"). Troco, as reflected in the decision, neither participated in AHN's alleged fraud, nor had any knowledge thereof. The case dealt with homeowner Martinez' attempt to undo the transactions involved by attacking subsequent purchaser Troco's asserted status as a bona fide purchaser in order to void the title transfers.(1)

The understanding between AHN and Martinez was that the former would assist Martinez in attempting to refinance the home and failing that, it would help Martinez sell the home, pay off the existing two mortgages encumbering the property, and help Martinez buy a new home with their equity from the sale proceeds.

Their agreement called for AHN to obtain an option on the property, in which it agreed to pay $9,020 to bring the mortgages current, and for Martinez to sign over a deed to AHN, to be unrecorded and placed in escrow with the understanding that the deed could be removed from escrow only after receiving written instructions from AHN and with proof that the two existing mortgages had been paid in full or would be satisfied at closing. The unrecorded deed was to serve as "protection" for AHN in the event Martinez abandoned the home after AHN paid the $9,020.

After six months, Martinez became increasingly dissatisfied with AHN's lack of communication, lack of effort to sell or refinance the home, and failure to show the couple comparable homes for purchase in the event their home sold. Martinez ultimately decided to keep the home, refinance, and reimburse AHN the $ 9,020.00 for the deficiency.

Despite the Martinez' decision, a prospective buyer representing the company, Troco, Inc., was brought over to see the home by a real estate agent, who forced her way into the home despite Martinez' protest. Within a week, Troco, Inc. agreed to purchase the property. At that point, AHN, without ever having placed the Martinez deed in escrow, recorded the Martinez' deed.

One day after recording the deed, AHN flipped its interest in the home, via a quit claim deed, to Troco, who had no knowledge of the allegedly fraudulent means used by AHN to acquire the home. Troco paid $25,000 for AHN's interest, and took subject to the existing two mortgages, without assuming any personal liability thereon.

The next day, Martinez received a letter from AHN indicating that the home had been sold to Troco. In a letter dated about a week later, Martinez was informed by Troco that Martinez had the option of repurchasing the home for $ 150,000.00 or vacating it by June 15, 2000. Martinez then filed suit.(2)

The trial court, affirmed by the Colorado Court of Appeals, ruled that Troco was the true owner of the home and quieted title in its name, and that, because it lacked any knowledge of the fraud perpetrated by AHN, was a bonafide purchaser for value and without notice of any defect in the title by reason of any claim the allegedly defrauded Martinez may have had in the home.

Martinez then filed an appeal with the Colorado Supreme Court.

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In reversing the appellate court, and ruling that Troco was not entitled to the protection of the recording statutes as a bona fide purchaser, the Colorado Supreme Court made the following analysis and conclusion, which appears below in its entirety:
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Analysis

• Martinez argues that the deed to AHN is void because the deed was never delivered into escrow and, consequently, the conditions precedent to the release of the deed from escrow were never satisfied. In response, Troco asserts that Martinez was fraudulently induced to quitclaim the deed to AHN and fraudulent inducement renders the deed merely voidable. Therefore, Troco asserts, it is protected as a subsequent bona fide purchaser for value, notwithstanding the agreement between Martinez and AHN to hold the deed in escrow.

• In Part A, we begin with a review of the determinations made by the courts below with particular focus on the courts' treatment of whether Troco qualifies as a bona fide purchaser.

• In Part B, we address whether inquiry notice was triggered by the circumstances of this case. In that latter part of our analysis, we look closely at the factual circumstances of the case to determine whether the knowledge of AHN's fraud may be correctly imputed to Troco, thereby defeating Troco's bona fide purchaser status.

Part A

• In its order quieting title with Troco, the trial court found that Martinez had abandoned the claim for rescission and that Troco was a bona fide purchaser entitled to rely upon the deed recorded by AHN. The court of appeals affirmed the trial court on both issues.

• In its analysis of the rescission issue, the court of appeals correctly determined that Martinez signed the deed and that material changes to the deed were insufficient to render the deed a forgery. Thus, the deed was not void and the burden was on Martinez to rescind the fraudulently procured deed prior to its conveyance to a subsequent bona fide purchaser. The court correctly determined that Martinez' failure to tender to AHN the $9,020.00 resulted in the abandonment of Martinez' right to rescind. However, because a deed voidable for fraud only protects a subsequent purchaser if the subsequent purchaser took the property for value and without notice of any defect in title, see Upson v. Goodland State Bank & Trust Co., 823 P.2d 704, 705-06 (Colo. 1992), the disposition of this case turns upon whether Troco was a bona fide purchaser.

• In the quiet title order, the trial court found that Troco was a bona fide purchaser of the property. The court of appeals subsequently affirmed, finding that Troco qualified as a bona fide purchaser because Troco paid value, in good faith, without any notice of defect in title. Martinez v. Affordable Hous. Network, Inc., 109 P.3d 983, 2004 Colo. App. LEXIS 867 (Colo. Ct. App., 2004). Upon examination of the record, we find no error with the determination that Troco paid value in good faith. A closer examination of whether Troco took the property without notice of a defect in title, however, is warranted.

• We have traditionally recognized three forms of notice: actual notice, constructive notice, and inquiry notice. Franklin Bank, N.A. v. Bowling, 74 P.3d 308, 313 (Colo. 2003). Actual notice occurs when a party has actual knowledge of a title defect. Id. While both "constructive and inquiry notice operate to impute knowledge to a party under certain specific conditions," we recognize them as separate inquiries. Id. at 313 n.11. Constructive notice arises where a search of the title records would have revealed a defect. See id. at 313. "Inquiry notice arises when a party becomes aware or should have become aware of certain facts which, if investigated, would reveal the claim of another." Id. However, notice will not be "imputed to a purchaser if a reasonable search would prove, or would have proven, futile." Littlefield v. Bamberger, 32 P.3d 615, 619 (Colo. App. 2001).

• From the record below, it is clear that Troco did not have actual notice of a defect in title. It is also clear that constructive knowledge of a defect in title cannot be imputed from the record title at the time of Troco's purchase. The record title would have revealed that title was recorded in Martinez' name, but it would not have revealed a defect in the then unrecorded quitclaim deed held by AHN, or the underlying fraud used to procure said deed.

• The trial court addressed inquiry notice only briefly during the court's oral order at trial: "This claim against them is really on the weakest thread, which is - is that at the time they went over to the house and Ms. Martinez expressed some regret about showing the house or about wanting to go through with it, that this should have put them on notice . . . . The law is not intended to ask bona fide purchasers to inquire into whether or not a manifestation of some outward response is . . . buyer's remorse."

• At this stage of the trial, the court properly considered the facts in the light most favorable to Martinez by assuming that Troco had knowledge of the conversation between the real estate agent and JoRene Martinez. The court then found that this knowledge was not enough to give rise to a duty of inquiry.

• The court of appeals largely adopted the trial court's conclusion that inquiry notice had not been triggered. Martinez, 109 P.3d at 988-89. The court of appeals further held that even if a reasonable inquiry had been conducted, it "would have shown that AHN possessed legitimate title pursuant to the terms of an executed option agreement and that [Martinez'] possession of the property was in accordance with this agreement." Id. at 989.

• Both the trial court and the court of appeals concluded that even if an appropriate inquiry were conducted, such an inquiry would have led to the discovery of the option agreement, but would not have revealed the fraud of the underlying transaction. In its suggestion that an inquiry would have merely revealed "buyer's remorse," the trial court implicitly acknowledged the sales arrangement that was embodied in the option agreement.

• The court of appeals explicitly recognized that an inquiry would have led to the option agreement: "The evidence at trial indicates that a reasonable investigation would not have revealed the fraud perpetrated by AHN. Instead, a reasonable inquiry would have shown that AHN possessed legitimate title pursuant to the terms of an executed option agreement and that [Martinez'] possession of the property was in accordance with this agreement." Id.

• We do not find any error with the analysis of the lower courts recognizing that the option agreement would have been discovered upon reasonable inquiry. However, for reasons discussed below, we reject the conclusion of the lower courts that the facts of this case did not require reasonable inquiry that would have revealed the underlying fraud.

Part B

• Because the court of appeals determined that an inquiry would not have revealed that the deed was voidable due to the underlying fraud, the court never fully addressed whether inquiry notice was triggered by the circumstances of this case. Mindful of the procedural posture of this case, we now examine the evidence presented at trial to resolve this issue before returning to the conclusion of the lower courts that a reasonable inquiry would have been futile.

• Inquiry notice imputes knowledge where the circumstances are such that they would have aroused the suspicions of an ordinary purchaser. See Littlefield, 32 P.3d at 618-19. And, once there is a duty to inquire, the purchaser "will be charged with all knowledge that a reasonable investigation would have revealed." Franklin Bank, N.A., 74 P.3d at 313; see also Burman v. Richmond Homes Ltd., 821 P.2d 913, 919 (Colo. App. 1991).

• It is well settled in Colorado that, with certain exceptions inapplicable here, possession of real estate is sufficient to put an interested person on inquiry notice of any legal or equitable claim the person or persons in open, notorious, and exclusive possession of the property may have. See Hitchens v. Milner Land, Coal & Townsite Co., 65 Colo. 597, 601, 178 P. 575, 576 (1919); Colburn v. Gilcrest, 60 Colo. 92, 94, 151 P. 909, 910 (1915); Yates v. Hurd, 8 Colo. 343, 344, 8 P. 575, 576 (1885); Tiger v. Anderson, 976 P.2d 308, 310 (Colo. App. 1998).

• This court has found that the rule applies where "the party having and alleging possession is the plaintiff in a suit to reform an instrument which purports to vest title to the land, so possessed, in another." Hitchens, 65 Colo. at 601, 178 P. at 577. Further, where the party in possession is the sole tenant and lessee, certain circumstances may give rise to a duty to inquire as to their rights as tenants beyond mere possessory rights. See Cohen v. Thomas & Son Transfer Line, Inc., 196 Colo. 386, 388, 586 P.2d 39, 41 (1978).

• In Cohen, we rejected the assertion that a prospective purchaser with constructive notice of the lessee's tenancy has only the limited duty to inquire about the possessory rights of the tenant. Id. The party in possession of the property in Cohen was the lessee of a commercial property which had been conveyed from the lessor/grantor to a third-party grantee. Id. at 387, 586 P.2d at 40. The lessee sought specific performance of a right of first refusal contained in the lease. Id. The lease was never recorded, and the lease term had actually expired at the time of the sale. Id. Although the purchasers were aware of the existence of the expired lease, they never asked to see the lease, nor did they question the lessee. Cohen, 196 Colo. at 387-88, 586 P.2d at 40. Under those circumstances, we concluded that a "reasonable inquiry would have included inquiry of the lessee who was the sole tenant in possession." Id. at 388, 586 P.2d at 41.

• The present case is not dissimilar on the facts. Troco was aware that Martinez was in physical possession of the property. Troco also had a duty to inquire as to Martinez' rights as a lessee, and is deemed to have constructive notice of those rights. Id. at 388, 586 P.2d at 40. See also Cook v. Hargis, 164 Colo. 368, 376, 435 P.2d 385, 390 (1967). Here, the lease agreement was contained within the option agreement. Thus, Troco was on inquiry notice of Martinez' rights as contained in the option agreement. As in Cohen, the lessee had both tenancy and possessory rights contained in an agreement of which the purchaser had inquiry notice. Consequently, Troco had a duty under the circumstances to inquire as to both the Martinez' possessory and tenancy rights.

• In determining that the circumstances of this transaction were sufficient to put Troco on inquiry notice, we also consider that these conveyances were made by quitclaim deeds.

• Colorado has rejected the now disfavored notion that a quitclaim deed is enough, in itself, to put a purchaser on notice of a defect in title. Franklin Bank, N.A., 74 P.3d at 313 n.12. Although it is true that a quitclaim deed does not convey title but only that interest that the grantor has to convey, we do not find this limitation so unusual that a purchaser should, on this basis alone, be wary of the validity of this type of conveyance. However, while a conveyance by quitclaim should not automatically raise suspicion, it should not shield a transaction from scrutiny either. When a grantor chooses to convey property by quitclaim, an element of risk is imposed upon the buyer that would not otherwise be present if the conveyance were by warranty deed. Thus, although by no means dispositive, a conveyance by quitclaim is a significant factor to be considered when assessing inquiry notice. See id.

• Here, there were two back-to-back quitclaim conveyances. Troco purchased the second quitclaim deed from AHN without conducting a title search or making any further inquiry into the transaction. Troco also purchased the property fully aware that the Martinez' two recorded mortgages had not been satisfied. It does not appear that Troco made any inquiry as to why the property remained subject to these liens. From the buyer's standpoint, this is an unusual transaction to simply accept at face value.

• Pursuant to two back-to-back quitclaim conveyances - neither of which satisfied the attendant mortgages prior to sale - Troco purchased the property from AHN fully aware that Martinez was in physical possession of the property. We find that an ordinary purchaser in Troco's position would have been suspicious of the circumstances surrounding this transaction and should have inquired further. A reasonable inquiry would have included both an inquiry into Martinez' tenancy rights as well as into Martinez' possessory rights. Moreover, a reasonable inquiry into the tenant's rights in this case would have led, without further inquiry, to the possessory interests precisely because the lease was contained in the fraudulent option agreement.

• Although it was not necessary for the trial court to resolve the issue of whether Troco was aware of the conversation between JoRene Martinez and the real estate agent in a mid-trial order, it is a circumstance relevant to inquiry notice. If Overton was aware of JoRene Martinez' statements to the real estate agent (i.e., her statements that they did not wish to sell their home, planned to repay AHN, and remain in the home), her statements would have put Troco on notice that there was a potential problem with the quitclaim conveyance to AHN. JoRene Martinez' statements, described by the trial court as "buyer's remorse," indicated a conflict in the ownership of the property.

• Contrary to the trial court's legal conclusion, it is not too much to ask that a buyer make further inquiries when made aware that the person in physical possession of the property believes they are in fact the true owner of the property. When a reasonable person is made aware that someone in physical possession of property claims ownership, the prudent course of action is to make further investigations.

• Whether Troco was aware of JoRene Martinez' statements is a relatively minor consideration in our analysis of inquiry notice in this case. That Troco knew Martinez was living in the home, especially when considered together with the quitclaim deeds and unsatisfied mortgages, created a duty on the part of Troco to inquire further.

• As noted in Part A and in our discussion of tenancy rights, a reasonable inquiry would have led to the option agreement between Martinez and AHN. The lower courts concluded that the discovery of the option agreement would not have revealed the underlying fraud. Martinez, 109 P.3d at 989. However, upon review of the agreement, we find this conclusion in error.

• By its express terms, the option agreement would have plainly revealed that AHN had not purchased the quitclaim deed according to the option terms. This conclusion may be drawn from Troco's averment that they took the quitclaim deed subject to the mortgages, in conjunction with the plain language of the option agreement that required that the two mortgages be satisfied as a condition precedent to the release of the deed from escrow. Given that Martinez remained liable on the mortgages and the property remained subject to the liens when Troco purchased the property, it would have been apparent that the conditions of the contract were breached by AHN.

• In sum, a reasonable investigation would have revealed the option agreement and the underlying fraud. Hence, because Troco had a duty to inquire, we impute the knowledge of the contract breach and resultant defect in delivery of the deed to Troco. Therefore, Troco is not protected as against Martinez' claim, because Troco was on inquiry notice that the deed was fraudulently procured.

Conclusion

• We conclude that the trial court erred when it found at mid-trial that Troco was a bona fide purchaser without notice. Accordingly, we reverse(3) the decision of the court of appeals affirming the trial court's quiet title order. We remand for further proceedings consistent with this opinion.

(1) In this case, there was no mortgage lender involved providing new financing for Troco's purchase. He took title subject to existing mortgages. Had Troco obtained a new mortgage to finance its purchase, and the lender failed in its duty to inquiry as to Martinez' rights in the home, I suspect the court's ruling would have been equally applicable to the lender as it was to Troco.

In addition, even in cases where there is no fraud (or no provable fraud) on the part of the foreclosure rescue operator, the same approach taken by the homeowner in this case may be available to a homeowner seeking to void the deed by recharacterizing the arrangement as an equitable mortgage. For the equitable mortgage doctrine as applied in Colorado, see generally, Beeghly v. Mack, 20 P.3d 610; (Colo. 2001).

(2) Martinez' amended complaint alleged claims of breach of contract, fraud, rescission, unjust enrichment, filing a fraudulent deed in the public record, and violations of the Colorado Organized Crime Control Act, § 18-17-104 to § 18-17-109, C.R.S. (2003), the Uniform Consumer Credit Code, § 5-1-101 to § 5-13-101, C.R.S. (2003) (UCCC), and the Colorado Consumer Protection Act, § 6-1-101 to § 6-1-1001, C.R.S. (2003). The trial court dismissed the UCCC claim on summary judgment motion and the remaining claims proceeded to trial.

Pursuant to a court order, Martinez remained in the home and continued to make all mortgage payments on the home. As part of the order, the mortgage payments are said to be the equivalent of rent. Martinez contributes to the equity in the home in exchange for physical occupation of the home and the reduction of Martinez' personal liability on the two mortgages.

(3) This goes to show that, if you're a homeowner in this position, not only do you have to be lucky enough to find an attorney to represent you who really knows what he/she is doing in this area of law, but the attorney may have to be willing to ignore, what in retrospect are, the incorrect rulings of the lower courts and appeal those decisions up the ladder until the justice system ultimately - and hopefully - gets it right. I can't imagine how many homeowners there must be who found themselves similarly situated, but were either unable to retain affordable counsel, or if represented, unable to finance an appeal of an incorrect trial court (and, in this case, an appellate court) ruling. ColoradoBonaFidePurchaserTheta