Illinois Mortgages Subject to Avoidance In Bankruptcy Absent Strict Adherence to Illinois Mortgage Statute: Finance, Insolvency & Restructuring Alert

The United States Bankruptcy Court for the Central District of Illinois recently held that an Illinois mortgage is subject to avoidance in bankruptcy pursuant to 11 U.S.C. § 544(a)(3) unless the mortgage contains among other things, (i) the amount of the debt, (ii) the maturity date of the debt, and (iii) the underlying interest rate. Richardson v. The Gifford State Bank (In re Crane), Adv. Pro. No. 11-9067 (Bankr. C.D. Ill.).

In In re Crane, a secured lender obtained mortgages on two parcels of real estate located in Illinois and owned by the debtors, a husband and wife. The mortgages were properly executed and recorded in the county recording office. After the debtors jointly filed for relief under Chapter 7 of the Bankruptcy Code, the Chapter 7 trustee commenced an adversary proceeding against the secured lender alleging that the mortgages were defective and subject to avoidance under 11 U.S.C. § 544(a)(3) because the mortgages failed to state the interest rate and maturity date in violation of 765 ILCS 5/11. According to the trustee, although the mortgages were effective between the debtors and the secured lender, the mortgages were deficient due to their failure to provide constructive notice to subsequent bona fide purchasers. The secured lender, in turn, asserted that although the mortgages were technically deficient, they were in substantial compliance with Illinois law.

In an opinion issued on Feb. 29, 2012 , the bankruptcy court explained that as of the commencement of the bankruptcy case, the trustee was granted the hypothetical status, rights and powers of a bona fide purchaser of real property who has perfected the transfer of real property from the debtor at the time of the bankruptcy filing. The bankruptcy court, citing to and relying on In re Berg, 387 B.R. 524 (Bankr. N.D. Ill. 2008) and In re Shara Manning Properties, 2010 Bankr. LEXIS 3688 (Bankr. C.D. Ill. 2010), noted that the trustee, standing in the shoes of a bona fide purchaser, did not have constructive notice of the mortgages because they failed to contain the maturity date and the interest rate of the underlying debt. The bankruptcy court further explained that the provisions of 765 ILCS 5/11 are not permissive; rather, they are required in order to provide constructive notice of a mortgage. As such, the mortgages were subject to avoidance by the trustee because they failed to provide constructive notice to a bona fide purchaser, and thus the trustee under 11 U.S.C. § 544(a)(3).

The decision in In re Crane serves as yet another reminder to secured lenders to strictly comply with the statutory requirements under Illinois or other applicable state law. It is imperative that mortgage lenders examine 765 ILCS 5/11 and other applicable law in Illinois when documenting a mortgage loan. In addition, mortgage lenders should attempt to correct defects in their existing Illinois mortgage as part of any forbearance agreement and even consider attempting to correct such defects by amending current mortgages.