Will Illinois Lenders Be Required to Include Interest Rates in Recorded Loan Documents?

A recent decision by the bankruptcy court for the Central District of Illinois has created additional uncertainty for mortgage lenders in this state. The Court recently held that a mortgage is avoidable in bankruptcy if it fails to include the maturity date and interest rate of the underlying debt.

In the case of re Crane, the debtors sought protection under Chapter 7 of the U.S. Bankruptcy Code, and the bankruptcy trustee brought an adversary proceeding challenging the validity of two commercial mortgages. The trustee argued that the mortgages were defective and subject to avoidance because they did not state the applicable interest rates or maturity dates, purportedly in violation of the Illinois Conveyances Act.¹ The mortgagee conceded that the interest rates and maturity dates were not included in the mortgages, but argued the mortgages were sufficient under Illinois law to provide the trustee with constructive notice.

The Court held that the mortgages were defective under Illinois law and could be avoided by the trustee. The Court reasoned that strict compliance with Section 11 of the Act—which suggests inclusion of the interest rate and maturity date in recorded mortgages—is required in order to provide constructive notice to bona fide purchasers. As a result, the mortgages held by the defendant were avoidable by the bankruptcy estate, and the lender was forced to take the position of an unsecured creditor.

On April 5, 2012, the court denied the mortgagee's motion to reconsider. Thereafter, on April 18, 2012, the mortgagee appealed to the U.S. District Court for the Central District of Illinois. As of the date of this article, that appeal remains pending.

Not all Illinois courts have agreed with the holding in Crane. For example, in the case of re Jones, the Southern District of Illinois has interpreted the provisions of Section 11 of the Act as providing permissive, rather than restrictive, language. Thus, the interpretation of the Section 11 of the Act remains unsettled.

While it is unknown how the Central District will resolve the issue, a legislative response is already in the works. Illinois House Bill 1337 would amend Section 11 of the Act to provide that "no person may challenge the validity or priority of an otherwise lawfully executed and recorded mortgage solely on the basis that the rate of interests was not expressed in the recorded mortgage instrument." H.B. 1337, 97th Gen Ass. (Ill. 2011).  The bill is pending before the Illinois General Assembly's Rules Committee for review.

In the meantime, Illinois lenders will need to weigh the risks of recording mortgages without including an interest rate or maturity date against the business considerations that weigh against including this information, at least until the legislature or the Seventh Circuit clarify the law on this point.

_{1 Under the Bankruptcy Code, a trustee maintains the hypothetical status of a bona fide purchaser of real estate who has perfected the transfer of real property from the debtor at the time of the bankruptcy filing.See 11 U.S.C. § 544(a)(3). The question then becomes whether the trustee, as a bona fide purchaser, had constructive notice of the mortgages.}