Michigan Bankruptcy Blog

BAP: Chapter 7 trustee cannot avoid erroneously discharged mortgage if discharge is rescinded pre-petition

Richardson v. Citimortgage, Inc. (In re Emerson), unpublished opinion, BAP No. 11-8015 (Oct. 7, 2011).

The Bankruptcy Appellate Panel of the Sixth Circuit ("BAP") has rejected a trustee's efforts to avoid a mortgage that was mistakenly discharged because the discharge was rescinded before the debtor's bankruptcy filing.

In Emerson, Citimortgage held a mortgage on the debtor's real property, which was properly recorded with the county register of deeds.  Thereafter, although the debtor's payment obligation was not satisfied, Citimortgage erroneously filed a certificate of discharge and released its mortgage.  The certificate of discharge undisputedly rendered the mortgage unperfected.  Several months later, Citimortgage realized its error and recorded a rescission of the certificate of discharge, which purported to withdraw the release of the mortgage.

The debtor later filed bankruptcy, and the Chapter 7 trustee filed an adversary proceeding to avoid Citimortgage's interest under the "strong-arm" power of § 544(a)(3).  The bankruptcy court entered summary judgment in favor of Citimortgage, and the trustee appealed.

On appeal, the trustee argued that when the certificate of discharge was recorded, the mortgage became unperfected, and the recording of the rescission did not "re-perfect" the mortgage.  The trustee pointed to the fact that the rescission was not signed by the mortgagor, as required to perfect an interest under Michigan law.

The BAP disagreed and held the mortgage was not avoidable.  In so holding, the BAP emphasized that the bankruptcy case was filed after the rescission was recorded, so a search of the real estate records would reveal the mortgage, the discharge, and the rescission.  The BAP held that this record was sufficient to put a bona fide purchase – and thus the trustee – on constructive notice of Citimortgage's interest.  The BAP rejected the trustee's argument that Citimortgage's lien was extinguished by the erroneous discharge and held, instead, that equity allows for the restoration of mortgages that are discharged by mistake.

This case provides guidance to trustees and secured creditors as to the extent of the trustee's strong-arm power under § 544(a)(3).  It is unknown whether the trustee will appeal to the Sixth Circuit.

Categories: 6th Circuit Court of Appeals, Chapter 7