JAMES G. MIXON, Bankruptcy Judge.
On December 1, 2010, Stephen Caine and Rita Caine (Debtors) filed a voluntary petition for relief under the provisions of Chapter 12 of the United States Bankruptcy Code, thereby becoming the debtor-in-possession. On February 1, 2011, the Debtors filed this adversary proceeding against First State Bank (Bank) to determine the nature and extent of the Bank's lien, and for turnover.
On February 17, 2011, the Bank filed an answer to the Debtors' complaint and filed a counterclaim for reformation of a mortgage granted to it by the Debtors pre-petition. On March 7, 2011, the Debtors filed an answer to the Bank's counterclaim denying the allegations contained therein.
On April 19, 2011, the Debtors filed their first amended complaint. The amended complaint seeks to set aside the Bank's mortgage lien on real property located in Ashley County, Arkansas, pursuant to the provisions of 11 U.S.C. § 544 because the legal description found in the mortgage and filed with the Circuit Clerk is defective. The amended complaint also seeks attorneys' fees pursuant to Arkansas Code Annotated § 16-22-308.
On April 25, 2011, the Bank filed an answer to the Debtors' first amended complaint admitting that the legal description was erroneous but denying that the Debtors could avoid their mortgage and asserting that the mortgage should be reformed because of mutual mistake.
Trial on the merits on the complaint and counterclaim was held in El Dorado, Arkansas, on June 21, 2011, and the matter was taken under advisement. Both sides have filed briefs in support of their respective positions. The proceeding before the Court is a core proceeding pursuant to 28 U.S.C. § 157(b)(2)(B) & (K) and the Court has jurisdiction to enter a final judgment in the case. The following shall constitute the Court's findings of fact and conclusions of law pursuant to Federal Rule of Bankruptcy Procedure 7052.
The facts are not in dispute. On April 1, 2005, the Debtors executed a promissory note in favor of the Bank in the principal sum of $82,468.53. Also, on April 1, 2005, in order to secure said indebtedness the Debtors executed and delivered to the Bank a mortgage on real estate which is located in Ashley County, Arkansas. Said real estate is described in the mortgage as follows:
(Bank's Ex. 5.)
The legal description in the mortgage is defective because the description does not
(Bank's Ex. 3.)
The mortgage was recorded with the Circuit Clerk and Recorder of Ashley County, Arkansas, on April 11, 2005, and appears in Record Book 315 at Page 46-51. The mortgage also contains an address of the property as "601 Ashley 300 Road, Hamburg, Arkansas, 71646." (Bank's Ex. 5.) The correct description describes a five-acre tract upon which the Debtors' personal residence is located. (Bank's Ex. 3 & 4.)
11 U.S.C. § 544 gives a trustee, or in this case a debtor-in-possession, the power to avoid certain pre-petition transfers of a debtor's property that could have been avoided under applicable state law by certain types of creditors or bona fide purchasers. 11 U.S.C. § 1203. See also Sandy Ridge Oil Co., Inc. v. Centerre Bank Nat'l. Assoc. (In re Sandy Ridge Oil Co.), 807 F.2d 1332, 1335 (7th Cir.1986). These powers are commonly referred to as the trustee's "strong arm powers." 5 Collier on Bankr. ¶ 544.01 at 544-3 (Alan N. Resnick & Henry J. Sommer eds. 16th ed.) "The strong arm rights and powers are conferred on the trustee by federal law. However, the extent of the trustee's rights. . . is measured by the substantive law of the jurisdiction governing the property in question." 5 Collier on Bankr. ¶ 544.02[1] at 544-5 (Alan N. Resnick & Henry J. Sommer eds. 16th ed.); see Cox v. Griffin (In re Griffin), 319 B.R. 609, 613 (8th Cir. BAP 2005) aff'd, 178 Fed.Appx. 595 (8th Cir.2006); In re Marlar, 252 B.R. 743, 752 (8th Cir. BAP 2000); Kohut v. Quicken Loans, Inc., Mortg. Electr. Registration Sys., Inc. (In re Wohlfeil), 322 B.R. 302, 304 (Bankr.E.D.Mich.2005). Section 544 acts to cut off unperfected security interests, secret liens, and undisclosed pre-petition claims against the debtor. 5 Collier on Bankr. ¶ 544.02[2] at 544-6 (Alan N. Resnick & Henry J. Sommer eds. 16th ed.).
11 U.S.C. § 544 provides in relevant part:
The Debtors argue that they may avoid the Bank's mortgage lien under 11 U.S.C. § 544(a)(1). This section grants a judicial lien on all real property on which a creditor on a simple contract could have obtained a judicial lien, whether or not the creditor exists. See 11 U.S.C. § 544(a)(1).
Under Arkansas law, a judgment becomes a lien on the debtor's real property the date the judgment is filed if the real property is located in the same County where the judgment is filed. Ark.Code Ann. § 16-65-117(a)(1). On the day the petition was filed, the debtor-in-possession was deemed to be a creditor holding a judgment lien. See In re Don Williams Constr. Co., Inc., 143 B.R. 865, 868-869 (Bankr.E.D.Tenn.1992) (trustee may avoid unrecorded obligation to transfer property pursuant to his status as a judgment lien creditor).
Testimony in this case is that the property in question is the Debtors' homestead. The Arkansas Constitution provides in relevant part as follows:
Constitution of the State of Arkansas, Article 9, Section 3. Accordingly, pursuant to the Arkansas Constitution a judgment lien on a simple contract does not attach to a debtor's homestead. See In re Kellar, 204 B.R. 22 (Bankr.E.D.Ark.1996). Therefore, the Debtors, as the debtor-in-possession, may not avoid the Bank's mortgage lien pursuant to 11 U.S.C. § 544(a)(1).
11 U.S.C. § 544(a)(3) gives a trustee, in this case, a debtor-in-possession, the status of a bona fide purchaser who has no knowledge of the defect in a prior instrument even if the debtor-in-possession or trustee in fact has actual knowledge. In re Griffin, 319 B.R. 609, 612-613 (8th Cir. BAP 2005); Sandy Ridge Oil Co., Inc. v. Centerre Bank Nat'l. Assoc. (In re Sandy Ridge Oil Co.), 807 F.2d 1332, 1336 (7th Cir.1986); 5 Collier on Bankr. ¶ 544.02[2] at 544-6 (Alan N. Resnick & Henry J. Sommer eds. 16th ed.).
It is well settled that the language in § 544(a)(3) "without regard to any knowledge of the trustee" refers to personal knowledge of the trustee and does not negate constructive notice under state law.
What is not so clear is whether the language in § 544(a)(3) "without regard to any knowledge of the trustee" negates inquiry notice. Inquiry notice is defined by state law and is not consistently defined nor is it treated consistently for purposes of 11 U.S.C. § 544 analysis. In some jurisdictions, inquiry notice is treated the same as constructive notice for purposes of 11 U.S.C. § 544; that is, the Trustee is subject to inquiry notice. See Briggs v. Kent (In re Prof'l. Inv. Properties of Am.), 955 F.2d 623, 627 (9th Cir.1992)(under Washington state law, "knowledge of facts sufficient to excite inquiry is constructive notice of all that the inquiry would have disclosed"); McCannon v. Marston, 679 F.2d 13, 16 (3rd Cir.1982)(under Pennsylvania law, clear and open possession of real property generally constitutes constructive notice and any prospective purchaser is obliged to inquire into the possessor's interest). But see Wonder-Bowl Prop. v. Kim (In re Kim), 161 B.R. 831 (9th Cir. BAP 1993) (pursuant to California state law, a defective abstract will not provide constructive notice, nor does the existence of the defective abstract put a purchaser on inquiry notice).
Other courts have held that the language "without regard to any knowledge of the trustee" precludes the trustee from being subject to inquiry notice. As the Sixth Circuit explained in an unpublished opinion, "the `strong arm' provisions of federal bankruptcy law specifically prohibit trustees from having actual knowledge of the interest. Thus, the trustee can only be charged with constructive notice." Rogan v. America's Wholesale Lender (In re Vance), 99 Fed.Appx. 25, *3 (6th Cir.2004) (unpublished) (In Kentucky an improperly recorded security interest failed to provide constructive notice and therefore the trustee was not on notice.) See also Gregory v. Ocwen Fed. Bank (In re Biggs), 377 F.3d 515, 521 (6th Cir.2004); Burden v. CIT Group/Consumer Finance, Inc. (In re Wilson), 318 Fed.Appx. 354, 364 (6th Cir. 2009) (unpublished); Wholesale Lender v. Gardner (In re Henson), 391 B.R. 210, *6 (6th Cir. BAP 2008) (unpublished); Consumer Finance, Inc. v. Burden (In re Trujillo), 378 B.R. 526, 536 (6th Cir. BAP 2007). In In re Coletta Bros. of North Quincy, Inc., a Massachusetts Bankruptcy Court held, the recorded notice of the judgment "which would cause a reasonable person to inquire about the outcome of the action" was ineffective to bind the Trustee. Gray v. Burke (In re Coletta Bros. of North Quincy, Inc.), 172 B.R. 159, 163 (Bankr.D.Mass.1994). The court explained:
Gray v. Burke (In re Coletta Bros. of North Quincy, Inc.), 172 B.R. 159, 163 (Bankr.D.Mass.1994). The Tenth Circuit Bankruptcy Appellate Panel analyzes the problem as follows:
Morris v. Kasparek (In re Kasparek), 426 B.R. 332, 345, fn. 51 (10th Cir. BAP 2010).
Ultimately, whether the trustee is subject to inquiry notice for purposes of § 544 analysis depends on state law.
In order to be a bona fide purchaser under Arkansas law, one must take property in good faith, for valuable consideration, and without notice of a prior interest. Bill's Printing, Inc. v. Carder, 357 Ark. 242, 249, 161 S.W.3d 803, 807 (2004).
A mortgage is perfected against a subsequent transfer by recording the mortgage in the office of the circuit clerk of the county in which the mortgaged lands are located and the recording constitutes constructive notice against claims of bona fide purchasers or subsequent encumbrances. Ark.Code Ann. § 18-40-102 (Michie 2003); Williams v. JPMorgan Chase Bank, N.A. (In re Stewart), 422 B.R. 185, 188 (Bankr. E.D.Ark.2009); Hawkins v. First Nat'l. Bank (In re Bearhouse), 99 B.R. 926, 927 (Bankr.W.D.Ark.1989).
An instrument including a deed or mortgage that has been filed but contains a defective description does not constitute constructive notice if the description does not describe definite land. See McClelland v. McClelland, 219 Ark. 255, 241 S.W.2d 264 (1951) (insufficient description of land in the deed and therefore no notice provided by recorded deed); Gardner v. Johnson, 220 Ark. 168, 246 S.W.2d 568 (1952) (tax sale was invalid because the deed from the state contained a defective description); Neas v. Whitener-London Realty Co., 119 Ark. 301, 178 S.W. 390 (1915) (range omitted from legal description in the deed rendered the deed ineffective to pass title); Cooper v. Lee's Heirs, 59 Ark. 460, 27 S.W. 970 (Ark.1894) (The description of land in the assessment or notice using abbreviations was not sufficient and therefore the tax sale was void.).
The Court notes that the Debtors and the Bank argue about whether "the defect was apparent on the face of the mortgage"; however, they argue over an issue that arises pursuant Minnesota law.
In Arkansas "[a] subsequent purchaser will be deemed to have actual notice of a prior interest in property if he is aware of such facts and circumstances as would put a person of ordinary intelligence and prudence on such inquiry that, if diligently pursued, would lead to knowledge
The Arkansas Supreme Court explains why a bona fide purchaser is not constructively bound to inquire further than the information in the records:
Neas v. Whitener-London Realty Co., 119 Ark. 301, 178 S.W. 390, 394 (1915)(emphasis added). Purchasers in Arkansas are only charged with notice of facts exhibited by the record made under the recording statutes, and not with facts that can be found outside the record that the record might have induced a prudent man to inquire into. Neas v. Whitener-London Realty Co., 119 Ark. 301, 178 S.W. 390 (1915). Therefore, in Arkansas a defective description found in the records does not impose upon a subsequent purchaser a duty to inquire outside the record to be qualified as a bona fide purchaser.
In Arkansas, a duty to inquire outside the record only arises from facts and circumstances of which the subsequent purchaser has actual notice. Because "actual knowledge of the encumbrance will never prohibit a trustee [or debtor-in-possession] from invoking § 544(a)(3)"; this Court holds that pursuant to Arkansas law and § 544, a trustee or debtor-in-possession is only charged with notice of facts in the recording books to qualify as a bona fide purchaser. Quoting Sandy Ridge Oil Co. v. Centerre Bank Nat'l. Ass'n. (In re
The Bank put on proof that a simple check of the Grantor/Grantee index would have revealed the existence of the mortgage and that a title examiner who examined the title would have noticed the description did not close. The description in the mortgage goes from the point of beginning, then north, then south the same number of feet as the north call, then mostly west 518 feet. When drawn out the calls result in the shape of the letter "L." All this description tells a subsequent purchaser is that the mortgage concerns a tract of land located in the East Half of the Northwest Quarter, Section 2, T17N (Township 17 North), R6W (Range 6 West), Ashley County, Arkansas. The Bank introduced a survey and the deed using the correct legal description which contains five acres including a house. (Bank's Ex. 3 & 4.) Unrefuted testimony was presented that a title examination would have uncovered the mortgage by doing either a direct index search based upon the name of the grantors or searching through the computer using a name search or the legal description.
The recorded mortgage does not put a bona fide purchaser on constructive notice because it is not possible to tell exactly what land is being described because it does not close. The deed does not help matters because the land intended to be mortgaged could have been a smaller portion than the land described in the deed. It is simply impossible to tell by the record what land is being mortgaged. Linking the mortgaged property to the deed would be speculative. See In re Poteat, 176 B.R. 734 (Bankr.D.Del.1995). Extrinsic evidence would be necessary and the debtor-in-possession is only subject to evidence that would be found in the records to qualify as a bona fide purchaser. Accordingly, the debtor-in-possession can avoid the lien pursuant to 11 U.S.C. § 544(a)(3).
The Bank seeks to reform the mortgage to recite the correct legal description alleging that the omitted call was a mutual mistake due to a scrivener's error. As this Court explained in Stewart:
In re Stewart, 422 B.R. 185, 190 (Bankr. W.D.Ark.2009).
The debtor-in-possession's rights as a bona fide purchaser would by prejudiced if the mortgage were to be reformed. Therefore, the Bank is not entitled to reformation.
It has long been the rule in the United States that absent unusual circumstances, parties are not entitled to recover
Ark.Code Ann. § 16-22-308 (Michie 1994). A court's award of attorneys' fees pursuant to this statute is permissive and discretionary. Logue v. Seven-Hot Springs Corp., 926 F.2d 722, 725 (8th Cir.1991).
This section 544 cause of action allows the debtor-in-possession to set aside a lien due to the debtor-in-possession's bona fide purchaser status. It is a cause of action peculiar to the Bankruptcy Code and differs from the types of actions which § 16-22-308 addresses. Arkansas Code Annotated § 16-22-308 is inapplicable to the case at bar. Accordingly, the Court finds that the Debtors are not entitled to attorneys' fees.
Pursuant to 11 U.S.C. § 544, the defective description does not provide the required notice; therefore, the debtor-in-possession qualifies as a bona fide purchaser and can avoid the mortgage lien. For the foregoing reasons, neither reformation nor attorneys' fees pursuant to Arkansas Code Annotated § 16-22-308 are appropriate in this matter. A separate judgment shall be entered pursuant to Federal Rule of Bankruptcy Procedure 9021.
IT IS SO ORDERED.