O'Connell v. JP Morgan Chase Bank National Association

Filing 8

MEMORANDUM AND ORDER, For the reasons set forth above, the Orders of the bankruptcy court from which this appeal is taken are AFFIRMED. The Clerk is directed to close this case. (Ordered by Judge Eric N. Vitaliano on 12/06/2012) c/m Fwd. for Judgment. (Galeano, Sonia)

FILED

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IN CLERK'S OFFICE
US DISTRICT COURT E.D.N.Y.

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UNITED STATES DISTRICT COURT
EASTERN DISTRICT OF NEW YORK

_DEC 11 2012

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BROOKLYN OFFiCE

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RICHARD E. O'CONNELL, as Trustee in
Bankruptcy of Carlos and Maria Lopez,

MEMORANDUM & ORDER
12-CV -1951 (ENV)

Appellant,
-againstJPMORGAN CHASE BANK NATIONAL
ASSOCIATION,

Appellees.

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----------------------------------------------------------------VIT ALIANO, D.J.

On Aprill2, 2010, Carlos and Marla Lopez ("debtors") filed a voluntary petition under
Chapter 13 of the Bankruptcy Code in the United States Bankruptcy Court for the Eastern
District of New York. The case was converted to a Chapter 7liquidation, and Richard O'Connell
was appointed Trustee. On July 22,2010, the Trustee instituted an adversary proceeding against
JPMorgan Chase Bank National Association ("Chase") seeking to avoid and preserve for the
benefit of the estate a senior mortgage ("First Mortgage") held by Chase. The First Mortgage, it
is not questioned, had been improperly recorded pre-petition. The filing deficiency was later
corrected, but the correction was made after the bankruptcy proceedings had been commenced.
The Trustee claims status, under controlling New York law, as a bona fide purchaser of real
property without knowledge of the First Mortgage as of the commencement of bankruptcy
proceedings. The Trustee also claims that the post-petition correction in the First Mortgage's
recordation amounts to an impermissible post-petition transfer of an asset of the bankruptcy
estate. Chase moved to dismiss the adversary proceeding. On February 21, 2012, United States
Bankruptcy Judge Jerome Feller found in favor of Chase, denying the Trustee's motion to avoid

the First Mortgage and granting Chase's motion to dismiss the complaint. See In re Lopez, No.
1-10-43115-JF, 2012 WL 566265 (Bankr. E.D.N.Y. Feb. 21, 2012). This appeal followed.

BACKGROUND
Debtors acquired title to a residential property located at 30~36 84th Street in East
Elmhurst, New York ("84 1h Street Property") on September 8, 2004. The purchase was financed
by the First Mortgage in the amount of$280,000. On December 3, 2004, Chase attempted to
record the First Mortgage. Property records from the City Register of the City of New York,
Queens County list the 84 1h Street Property as "Block 1381, Lot 23," but the cover page for the
City Register and Endorsement erroneously described the property as "Block 1381, Lot 2."
Block 1381, Lot 2 is located at 30~05 83rd Street, also in East Elmhurst ("83rd Street Property").
In filing the recording, the City Register apparently used the erroneous description from the
cover page. The First Mortgage, as a consequence, was incorrectly recorded against the 83rd
Street Property (despite the First Mortgage's actual language) while the 84 1h Street Property was
unencumbered.
On March 6, 2006, Chase doubled down, granting debtors a $200,000 home equity line of
credit, secured by a Second Mortgage on the 84 1h Street Property. The Second Mortgage makes
multiple and unmistakable references to the existence of a prior lien on the 84th Street Property.
This time, the loan documents were correctly recorded against Block 1381, Lot 23 on March 24,
2006. Critically, pages 1 and 3 ofthe properly recorded Second Mortgage reference "Existing
Indebtedness." Page 3 specifically acknowledges an "existing obligation [having] a current
principal balance of approximately $275,374."

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At the time the debtors commenced their bankruptcy action on Aprill2, 2010, only one
of the two Chase mortgages, the Second Mortgage, was properly recorded as encumbering the
84111 Street Property. There is no dispute, however, that debtors loan repayment obligations on the
First Mortgage \Vcre outstanding. After the bankruptcy petition was docketed, on or about llme
25, 2010, the City

Register~upon

a written request from Chase---corrected the prior recording

error to reflect the First Mortgage as encumbering Block 1381, Lot 23. Less than one month
later, on July 22,2010, the Trustee instituted an adversary proceeding against Chase seeking to
avoid and preserve for the benefit of the estate the First Mortgage interest. The gravamen of the
Trustee's argument, reasserted on appeal, was that, due to the recording error, the Trustee was
entitled to the status of a bona fide purchaser of real property without knowledge of the First
Mortgage. Additionally, the Trustee claimed Chase's correction to the recordation of the First
Mortgage constituted an impermissible post-petition transfer. Chase maintains that the First
Mortgage properly encumbered the residence and could not be avoided by the Trustee on the
ground that the Second Mortgage had given him prior constructive notice of the First Mortgage
and, therefore, that the Trustee did not qualify as a good faith bona fide purchaser without notice.
The Trustee appeals from Judge Feller's decision in Chase's favor.

STANDARD OF REVIEW
Pursuant to Federal Rule of Bankruptcy Procedure 8013, on appeal from the order,
judgment or decret: of the bankruptcy court, the district court may "affirm, modify, or reverse a
bankruptcy judge's judgment, order, or decree or remand with instructions for further
proceedings." The bankruptcy court's findings of fact will not be disturbed unless clearly
erroneous; due regard shall be given to the opportunity of the bankruptcy court to judge the

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credibility of the witnesses. Id.; Brunner v. N.Y. State Higher Educ. Svcs. Corp., 831 F .2d 395,
396 (2d Cir. 1987) (per curiam). The district court reviews the bankruptcy court's conclusions of
law de novo. Brunner, 831 F.2d at 396.

DISCUSSION
The Trustee argues that the bankruptcy court erred in denying him bona fide purchaser
status under New York Real Property Law § 291-e ("RPL"), which determines the extent of the
Trustee's rights in debtors' residential property under§ 544 (a) of the Bankruptcy Code.
Section 544 (a) grants a trustee unique "strong arm" powers of avoidance with respect to
certain obligations incurred by a debtor. 11 U.S.C. § 544(a). Specifically,§ 544 (a)(3) authorizes
a trustee to take on the rights and powers of a bona fide purchaser of real property in order to
avoid "any transfer of property of the debtor or any obligation incurred by the debtor ... " Id. It is
not disputed, moreover, that the question of whether or not a trustee constitutes a bona fide
purchaser is a matter to be determined by state law. McKenzie v. Irving Trust Co., 323 U.S. 365,
371 (1945); see, In re Rodriguez, 261 B.R. 92, 94, (Bankr. E.D.N.Y. 200I); In re Hardway
Rest. Inc., 3 I B.R. 322, 327 (Bankr. S.D.N.Y. I 983); see also, McCannon v. Marston, 679 F.2d
13, 16 (3d Cir. 1982); 4 Collier on Bankruptcy § 544.02 at 544-7 to 544-9 (I 5th ed. 1982). In
New York, a bona fide purchaser must have purchased real property (1) in good faith (2) for
valuable consideration and (3) without notice of a cloud, impediment, or defect in title that is
advanced to challenge the bona fides of a purchase. See In re Hardway 31 B.R. at 322. At bar,
the spotlight is on the third element, that is, whether or not the Trustee was on notice of the First
Mortgage is the critical matter at issue in determining the Trustee's bona fide purchaser status.

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Notice can be effected, of course, by the recording of the conveyance. RPL § 291-e is the
applicable recording statute. It provides in relevant part:
A conveyance of real property within the state ... may be recorded
in the office of the clerk ofthe country where such property is
situated .... Every such conveyance not recorded is void as against
any person who subsequently purchase ... the same real property .. .
in good faith and for valuable consideration from the same vendor. .. .
Under this provision, a subsequent good faith purchaser without notice can avoid a prior
unrecorded conveyance of title or interest, including a mortgage interest, to another purchaser or
transferee. See Andy Assoc., Inc. v. Bankers Trust Co., 49 N.Y.2d 13, 16-17 (1979).ln line with
this provision, in order to defeat the claim of a would-be bona fide purchaser where the
countervailing interest is not recorded, it is necessary to prove that the purchaser had either
actual or constructive notice. In the bankruptcy context, though, since a trustee is a hypothetical
purchaser taking on the status of a bona fide purchaser without notice, his actual personal prior
notice of the transfer subject to avoidance is immaterial. See Pereira v. Ruggerite, Inc., 03 CIV.
1071 (TPG), 2004 WL 324847 (S.D.N.Y. Feb. 19, 2004) ('"In determining whether the trustee
becomes a bona fide purchaser, no regard is paid to any actual knowledge of the trustee or any
creditor."). Constructive notice, that is notice essentially equivalent to recordation notice, is
another matter. Proof that a subsequent purchaser would have had constructive notice of the prior
conveyance is sufficient to destroy the bona fide purchaser status of a trustee. See In re EuroSwiss International Corporation, 33 B.R. 872, 882 (Bankr.S.D.N.Y.l983), citing Andy Assoc.,
49 N.Y. at 424.
In New York, findings of constructive notice are made by an examination of record
evidence showing a party's actual awareness of facts that would create a duty of reasonable
inquiry, given all the circumstances. See In re Euro-Swiss 33 B.R. at 882

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(Bankr.S.D.N.Y.1983), citing Andy Assoc., 49 N.Y. at 424; Wardell v. Older, 70 A.D.2d 1008
(1979); In re Hardway, 31 B.R. at 322. Reinforcing the notion that the absence of recordation
notice does not preclude survival of an unrecorded encumbrance, in applying the state notice
requirements for recognition of bona fide purchaser status in the context of a§ 544 avoidance
application, the bankruptcy code's usc of the term "knowledge ... rather than the broader term
'notice' ... indicates that Congress did not intend to shield the trustee under§ 544(a)(3) from the
effect of constructive notice." In re Euro-Swiss, 33 B.R. at 881.
That the bankruptcy court carefully examined the appropriate factors in determining
whether the Trustee's claim of bona fide purchaser status was defeated by constructive notice is
clear from the record. See In re Lopez, 2012 WL 566265. Judge Feller found that Trustee
O'Connell was on constructive notice of the First Mortgage as a result of the information
disclosed in the Second Mortgage. Specifically, given the Second Mortgage's reference to the
existing First Mortgage encumbrance and of its precise amount, Judge Feller properly concluded
that such information put the Trustee on notice of this pre·existing obligation, notwithstanding
any recording errors. Id. at 4. The bankruptcy court reasoned that those facts would "excite" the
suspicion of an ordinarily prudent person and trigger an inquiry into possible adverse interests.
Id. at 5. Taking those facts together, Judge feller concluded that the Trustee could not be deemed
a bona fide purchaser for the purpose of avoiding the First Mortgage encurnbcrance. Id. at 2, 5
("[T1o the extent a purchaser ignores those facts he would be guilty of a degree of negligence
that is fatal to an assertion of bona fide purchaser status.").
The bankruptcy court's factual findings as to the constructive notice of the First
Mortgage chargeable to the Trustee are manifestly correct, whether reviewed deferentially or de

novo. Further, the bankruptcy court based its findings on the correct understanding of the law:

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constructive notice is simply "what may be revealed by an examination of the record or
reasonable inquiry on the basis of all circumstances." (Stip. of Facts Not in Dispute at Line 18, In
re Lopez at 3). Judge Feller's controlling assessment that the facts disclosed about the First
Mortgage in the language of the Second Mortgage trigger a duty of inquiry in a reasonably
prudent person, and thus create constructive notice defeating the claim of a bona fide purchaser
status, is compellingly correct as well.
The Trustee attacks on the law: the bankruptcy court erred, he argues, in its assessment
that the Second Mortgage's language would put a putative bona fide purchaser on constructive
notice of the improperly recorded First Mortgage because it is at odds with the statutory
language ofRPL §291-e as it applies to the insufficiency of notice of unrecorded conveyances.
Derivatively, the Trustee argues that RPL § 291-e precludes the creation of a duty to inquire as to
the previous unrecorded encumbrance. With no duty to inquire, there can be no constructive
notice by failure to inquire.
But the Trustee's attempt to sidestep, through circular reasoning, established case law
regarding the fatal effect of constructive notice on a claim of bona fide purchaser status falls flat.
Essentially, the Trustee argues that there can never be constructive notice of an unrecorded
conveyance. Judge feller's decision, clearly, does not impose a novel duty of inquiry. It merely
recognizes that the bona fide purchaser referenced in § 291-e cannot meet the "good faith"
standard also referenced in that section, which, in situations like this, asks if objective facts
revealed in a recorded document would put a reasonably prudent purchaser on notice to inquire
about unrecorded encumbrances before purchasing the property and failing to make such inquiry,
to take subject to the unrecorded encumbrance. Applying that standard here, given the language
of the Second Mortgage referencing that a First Mortgage existed, in order to establish good

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faith, the Trustee claiming bona fide purchaser status would need to inquire about the First
Mortgage. Put another way, the absence of prior proper recording did not entitle the Trustee as
putative purchaser to close his eyes as to what the Second Mortgage revealed. That is what the
proof shows the Trustee did and what Judge Feller held. His holding, furthermore, is in complete
hannony with existing precedent.
Equally, unimpressive is the Trustee's chief reliance on Stroh v. Batavia, decided 50
years ago. 17 A.D.2d 385, 234 N.Y.S.2d 40 I (41h Dep't 1962). This case, and its interpretation of
the relevant statute, has not been authoritatively followed. The bankruptcy court's reliance on the
much more recent Astoria Federal Savings and Loan v. June, 190 A.D.2d 644, 593 N.Y.S.2d
250 (2d Dep't 1993), which rejected the claim of a bona fide purchaser by finding constructive
notice where the existence of an erroneously indexed mortgage was recited in a later conveyance
deed, is considerably more compelling. Both the facts and the law in Astoria are highly relevant,
and are accurately applied, to the case at hand.
In sum, the bankruptcy court did not err when it determined that, as a matter of fact, the
language of the Second Mortgage put a putative bona fide purchaser on notice that § 291-e's
good faith requirement obliged inquiry and that the same Second Mortgage, therefore, also put
the Trustee on constructive notice of the debtors' existing First Mortgage obligations, even
though that senior encumbrance itself was not properly recorded. The bankruptcy court then
correctly concluded that the Trustee did not have bona fide purchaser status with respect to the
First Mortgage and that the First Mortgage obligation could not be avoided by the Trustee under
Bankruptcy Code §544(a)(3). Whether or not the post-petition correction by Chase of the
recording deficiency in the First Mortgage's original recording was an improper conveyance of a
property interest held by the debtors' estate is immaterial, since even if the Trustee could

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properly avoid the corrected recordation, the voiding of the correction does not supply a ground
to extinguish the Trustee's constructive notice of the underlying encumbrance, itself Perhaps
viable in other circumstances, in these circumstances, the motion is academic as is any appeal
from its deniaL At bottom, the Trustee's complaint against Chase in the adversarial proceeding
seeking to avoid the First Mortgage was properly decided by the bankruptcy court.

CONCLUSION
For the reasons set forth above, the Orders of the bankruptcy court from which this
appeal is taken are AFFIRMED.
The Clerk is directed to close the case.
SO ORDERED.
Dated: Brooklyn, New York
December 6, 2.Qll_.._

ERIC N. VITALIANO
United States District Judge

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