Monday, March 22, 2010

Indiana Court Denies Bank BFP Status; Leaves It Holding The Bag As Unrecorded Rights Of Occupant In Possession Trumps Lender's Recorded Mortgage

The following facts have been extracted from a recent ruling by the Indiana Court of Appeals:
  1. Benjamin purchased his home in Gary, Indiana in 1965 and has lived there ever since.
  2. 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.(1)
  3. In October of 1995, David conveyed Benjamin's home by quit claim deed to another of Benjamin's sons, Richard Thomas.
  4. Benjamin and Richard agreed that Richard would return title to the home to Benjamin upon request.
  5. At no time did Benjamin relinquish possession of the home.
  6. 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.
  7. On August 1, 2001, Benjamin filed a notice of intention to hold a mechanic's lien on the home for $200,000.
  8. 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.
  9. 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.
  10. 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."
  11. Trustcorp did not contact Benjamin regarding the purported release, and the loan agreement was completed.
  12. As it happened, Richard never made any payments on the mortgage loan.
  13. On July 3, 2002, Benjamin filed suit to foreclose his mechanic's lien on the home, a suit that included Trustcorp as a defendant.

Question:

Does Trustcorp's recorded security interest in Benjamin's home as a mortgagee have priority over Benjamin's earlier acquired, but 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)?

Answer:

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 Trustcorp mortgage loan (and thereby screwing over his father out his home equity that had been built up over 35+ years), the Indiana appeals court affirmed the lower court in ruling that Trustcorp was not entitled to the protection of the recording statutes as a bona fide purchaser. Accordingly, the court ruled 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.

For the longer version of this post, with excerpts from the court ruling applying Indiana law in this case, see Failure To Inspect Property & Inquire Into Rights Of Parties In Possession Prior To Making Loan Leaves Indiana Lender With Voided Mortgage.(2)

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) While this ruling doesn't explicitly say it, courts have typically held that this type of oral arrangement gives rise to a trust implied by law, commonly referred to as a "resulting trust," where the grantee is deemed to hold title to the property on behalf of the grantor/beneficiary, even though there is nothing in writing to this effect.

(2) 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:

posted by Home Equity Theft Reporter at 4:01 AM