Avoiding A Mortgage Lien In Bankruptcy & What It Means

From Bankruptcy-RealEstate-Insights.com:

• A chapter 7 trustee sought to avoid an unrecorded first mortgage on the debtor’s property and to preserve the mortgage lien for the benefit of the bankruptcy estate. The debtor responded by claiming that even if the trustee was successful, he could not sell the property without first foreclosing the mortgage in accordance with state law. The bankruptcy court rejected the debtor’s claims and granted the trustee’s motion for summary judgment. The debtor appealed to the bankruptcy appellate panel.
  
  The debtor executed a mortgage on her home to secure a $200,000 loan. Unfortunately for the mortgagee, the mortgage was never recorded. The debtor later granted a second mortgage to secure a line of credit (which was recorded), and recorded a homestead declaration under state law.
  
  The debtor’s bankruptcy schedules showed the value of the home as $223,500, the second mortgage claim of ~$30,000 and the unperfected first mortgage claim of ~$186,000. She also claimed a homestead exemption of $500,000.
  
  Since the first mortgage was unrecorded, the trustee was able to exercise the strong arm powers under Section 544 of the Bankruptcyto avoid the mortgage. (See Bankruptcy “Strong Arm” Powers: Bye Bye Mortgage.) Under Section 551 of the Bankruptcy Code, a transfer that is avoided (in this case the grant of a lien pursuant to the mortgage) is “preserved for the benefit of the estate.” It was clear that the trustee could avoid the mortgage and that some sort of benefit would be preserved for the benefit of the bankruptcy estate.
  
  The question was exactly what benefit. [...]

For more, see Strong Arm Powers: What Happens When a Mortgage Is Avoided – Does It Go Poof?

For the ruling, see DeGiacomo v. Traverse (In re Traverse), 45 B.R. 815 (1st Cir. B.A.P. 2013).