Lawrence S. Walter, United States Bankruptcy Judge.
Before the court is the Motion of PNC Mortgage Company to Dismiss and/or for Judgment on the Pleadings as to the Amended Complaint ("Motion") [Adv. Doc. 42]. The Plaintiff Chapter 7 Trustee filed an objection in opposition to the Motion [Adv. Doc. 43] and Defendant PNC Mortgage Company filed a reply [Adv. Doc. 44]. In addition, the Plaintiff filed a brief and memorandum of law [Adv. Doc. 45], to which the Defendant filed a reply brief [Adv. Doc. 46], which was followed by the Plaintiff's reply and rebuttal [Adv. Doc. 47]. This matter is now ripe for decision.
On July 8, 2016, Plaintiff Chapter 7 Trustee Donald F. Harker III ("Trustee") filed an amended adversary complaint [Adv. Doc. 40] to avoid a mortgage held by Defendant PNC Mortgage Company ("PNC") on real property owned by the Debtors. The Trustee asserts that PNC's mortgage is avoidable pursuant to 11 U.S.C. § 544(a) and Ohio law because the mortgage was defectively executed in that the notary failed to properly certify the Debtors' signatures in the acknowledgment clause.
In its Motion, PNC does not deny the mortgage defect nor the judicial precedent supporting avoidance of a mortgage containing a "blank" acknowledgment clause under § 544(a) and Ohio law. Instead, PNC argues that recently enacted Ohio Rev. Code § 1301.401, a statute describing the constructive notice provided by the recording of certain types of documents, vitiates the trustee's power to avoid recorded mortgages based on defects in their execution as either a § 544(a) hypothetical bona fide purchaser or judicial lien creditor.
After thorough review of the relevant Ohio recording statutes, Ohio case law construing the state's recording statutes, and the Ohio Supreme Court's interpretation of Ohio Rev. Code § 1301.401 in In re Messer, the court disagrees with PNC. While Ohio Rev. Code § 1301.401 deems the recording of a defectively executed mortgage to provide constructive notice, such notice does not affect the priority of liens involving a defectively executed mortgage. As such, the Trustee retains the power to avoid PNC's defectively executed mortgage as a judicial lien creditor pursuant to § 544(a)(1).
For purposes of the Motion, the following facts from the complaint are deemed true. Debtors Jerry Wayne Oakes and Jennifer Anne Oakes ("Debtors") filed a
On or about May 30, 2003, PNC filed with the Warren County, Ohio Recorder's Office a document purporting to be a lien against the Property in order to secure a loan in the sum of $144,000 ("Mortgage") [Id., ¶ 7 and Ex. B]. While the Debtors' names and signatures appear on the Mortgage as the "Borrowers", their names do not appear within the acknowledgement clause signed by the notary public such that the clause does not acknowledge the signature of the Debtors [Id., ¶¶ 7-8 and Ex. B]. As such, the Trustee asserts that the acknowledgement clause is defective and does not substantially comply with the requirements of Ohio Rev. Code § 5301.01 rendering the Mortgage avoidable [Id., ¶ 8].
Defendant PNC requests dismissal pursuant to Fed. R. Civ. P. 12(b)(6) or, alternatively, judgment on the pleadings pursuant to Fed. R. Civ. P. 12(c), both of which are incorporated in bankruptcy adversary proceedings by Fed. R. Bankr. P. 7012. However, because an answer has been filed in this case [Adv. Doc. 41], the court construes the Motion as one for judgment on the pleadings. See Fed. R. Civ. P. 12(b) (requiring a Rule 12(b)(6) motion to dismiss be filed before a responsive pleading). Nonetheless, whether treated as a motion to dismiss or one for judgment on the pleadings, the Motion is reviewed under the same standard applicable to a Rule 12(b)(6) motion to dismiss for failure to state a claim. Ziegler v. IBP Hog Market, Inc., 249 F.3d 509, 511-12 (6th Cir. 2001); Michael v. Javitch, Block & Rathbone, LLP, 825 F.Supp.2d 913, 918 (N.D. Ohio 2011).
Under this standard, the court construes the complaint in a light most favorable to the plaintiff accepting all of the complaint's well pleaded factual allegations as true to determine whether the plaintiff states a claim for relief that is plausible on its face. Ashcroft v. Iqbal, 556 U.S. 662, 678, 129 S.Ct. 1937, 173 L.Ed.2d 868 (2009); Ziegler, 249 F.3d at 512. "A claim has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged." Iqbal, 556 U.S. at 678, 129 S.Ct. 1937. The plausibility standard is "not akin to a `probability requirement,' but it asks for more than a sheer possibility that a defendant has acted unlawfully." Id. (further citation omitted).
The factual allegations provided in the complaint need not be detailed. Id.; Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 555, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007). Instead, a complaint must include "a short and plain statement of the claim showing that the pleader is entitled to relief" in order to give the defendant fair notice of what the claim is and the grounds upon which it rests. Fed. R. Civ. P. 8(a)(2) (incorporated in bankruptcy adversary proceedings by Fed. R. Bankr. P. 7008). See also Twombly, 550 U.S. at 555, 127 S.Ct. 1955. Nonetheless, the facts provided must be sufficient to raise a right to relief "above the speculative level" and the plaintiff has the obligation to provide more than just "labels and conclusions" or a "formulaic recitation of the elements of a cause of action." Twombly, 550 U.S. at 555, 127 S.Ct. 1955; Iqbal, 556 U.S. at 678, 129 S.Ct. 1937
In his amended complaint, the Trustee sets forth five causes of action, all of which fundamentally rely on the Trustee's power to avoid a defectively executed mortgage under a combination of bankruptcy and state law. In the Motion, PNC alleges the Trustee has failed to state any claim upon which relief can be granted. As PNC sees it, the Trustee's claims are built upon an application of a trustee's avoidance powers under 11 U.S.C. § 544(a) that has been vitiated by the enactment of Ohio Rev. Code § 1301.401 and the interpretation of this new state statutory provision by the Supreme Court of Ohio in In re Messer, 145 Ohio St.3d 441, 50 N.E.3d 495 (2016). More precisely, PNC argues that Ohio Rev. Code § 1301.401 and Messer abrogate a trustee's ability, under § 544(a), to avoid defectively executed but recorded mortgages in Ohio. The Trustee agrees with PNC regarding the impact of Ohio Rev. Code § 1301.401 on his § 544(a)(3) powers to avoid a mortgage as a hypothetical bona fide purchaser. The Trustee maintains, however, that his powers under § 544(a)(1) as a hypothetical lien creditor remain viable notwithstanding these new developments under Ohio law. To better understand the interpretive distinction dividing the parties, the court begins with a review of trustee avoidance powers and the manner in which they have been indisputably limited, but not abolished, by Ohio Rev. Code § 1301.401.
One tool used by a bankruptcy trustee to maximize distribution to unsecured creditors is § 544(a) and the "strong arm" powers it provides allowing a trustee to succeed to the rights of a judicial lien holder, execution creditor, and bona fide purchaser of real property whether or not such an entity exists. 11 U.S.C. § 544(a);
When the real property at issue is located in Ohio, as it is in this case, the state laws of Ohio govern the extent of the trustee's avoidance powers as one of the § 544(a) hypothetical entities. Simon v. Chase Manhattan Bank (In re Zaptocky), 250 F.3d 1020, 1024 (6th Cir. 2001). Prior to the enactment of Ohio Rev. Code § 1301.401, bankruptcy trustees routinely avoided defectively executed mortgages on real property located in Ohio using their ability to obtain the status of a hypothetical bona fide purchaser without actual notice (meaning only constructive notice matters in the bankruptcy context). See, e.g., Rhiel v. Central Mortg. Co. (In re Kebe), 469 B.R. 778 (Bankr. S.D. Ohio 2012); Rhiel v. Huntington Nat'l Bank (In re Phalen), 445 B.R. 830 (Bankr. S.D. Ohio 2011); Noland v. Burns (In re Burns), 435 B.R. 503 (Bankr. S.D. Ohio 2010). A trustee's ability to avoid defectively executed mortgages arose from a combination of Ohio statutory and case law to the effect that defectively executed mortgages were not entitled to be recorded, derived no efficacy from being placed on record and, as such, the recording did not provide constructive notice to subsequent purchasers. See Ohio Rev. Code § 5301.25; Nowak, 820 N.E.2d at 338; Citizens Nat'l Bank v. Denison, 165 Ohio St. 89, 133 N.E.2d 329, 332-33 (1956); Mortgage Elec. Regis. Sys. v. Odita, 159 Ohio App.3d 1, 822 N.E.2d 821, 825-26 (2004).
As previously noted, both parties agree that 11 U.S.C. § 544(a)(3) can no longer be effectively employed in Ohio to avoid defectively executed but recorded mortgages as a hypothetical bona fide purchaser because Ohio Rev. Code § 1301.401 has dramatically altered the ground rules. Ohio Rev. Code § 1301.401, effective March 27, 2013, provides:
Ohio Rev. Code § 1301.401.
Taking certified questions from the bankruptcy court, the Supreme Court of
The court further concluded that § 1301.401 is compatible with other mortgage related statutes including Ohio Rev. Code § 5301.01, § 5301.23, and § 5301.25. Id. at 498. The debtors argued that application of Ohio Rev. Code § 1301.401 to recorded mortgages conflicts with Ohio Rev. Code § 5301.25(A), which provides as follows:
Ohio Rev. Code § 5301.25(A). Reading the two statutes closely and literally, the Ohio Supreme Court found them to be consistent in that the more recent statute makes no mention "of whether the mortgage has been properly executed, whether it was required to be filed, or whether it is free from defects. If it is a `mortgage,' notice of the contents is provided." Messer, 50 N.E.3d at 498.
The court went on to explain that Ohio Rev. Code § 1301.401 is simply the latest act of Ohio's General Assembly recognizing "instances in which the recording of a deficiently executed mortgage can provide constructive notice." Id. It cited two other instances where the legislature created such exceptions. Ohio Rev. Code § 5301.01(B)(1) states that a recorded mortgage executed prior to February 1, 2002 which lacks the acknowledgment of two witnesses (mandatory prior to that date) nevertheless is deemed to provide constructive notice of the mortgage. Ohio Rev. Code § 5301.23(B) states that the failure to include the correct mailing address of a mortgagee on a recorded mortgage does not affect the validity of the mortgage or its effectiveness for purposes of constructive notice. Therefore, Ohio Rev. Code § 1301.401 is merely the latest addition to the list of exceptions.
The paramount and determinative focus of the Messer court and the referenced Ohio statutes is constructive notice. As will be discussed below, notice is fatal to a trustee obtaining bona fide purchaser status, but of no relevance when determining the priority of liens. While it is unquestionably true that, in the broadest sense, the purpose of all recording statutes is to provide public notice to third parties, the effect of such notice under Ohio law traditionally depends upon technical compliance with the recording statutes and also the
Because Ohio Rev. Code § 1301.401 has been ruled to provide constructive notice of a defectively executed mortgage to the world, a bankruptcy trustee's power to avoid such a mortgage as a bona fide purchaser of real property under 11 U.S.C. § 544(a)(3) is undermined. The change in a trustee's avoidance powers wrought by § 1301.401's constructive notice provision stems from the definition of a bona fide purchaser itself. More specifically, a lack of notice is a qualifying element for such status, inherent in the definition. According to Black's Law Dictionary, a bona fide purchaser is:
Black's Law Dictionary (10
Because Ohio Rev. Code § 1301.401 plainly deems defectively executed but recorded mortgages to be notice to the world, it undercuts an essential element of bona fide purchaser status. Accordingly, the statute precludes a bankruptcy trustee from avoiding a mortgage as a bona fide purchaser under § 544(a)(3) because under Ohio law, a purchaser of real estate cannot obtain bona fide purchaser status if the purchaser has constructive notice of the prior defectively executed mortgage. See Phalen, 445 B.R. at 838-39.
While acknowledging that constructive notice defeats his claim for avoidance
Turning to Ohio law, the question becomes whether the constructive notice of a defectively executed but recorded mortgage provided in Ohio Rev. Code § 1301.401 defeats a subsequent properly perfected lienholder in the same manner it defeats a bona fide purchaser. PNC argues that, logically, lienholders and bona fide purchasers should be treated the same with respect to constructive notice of prior recorded but defective liens. However, "[n]either the Bankruptcy Code nor Ohio law requires that a judgment creditor have the same attributes of a bona fide purchaser as it pertains to notice of a prior interest; neither requires a judgment creditor to lack notice of an unrecorded or defective lien in order to obtain a superior lien on a judgment debtor's property." Stubbins v. Wells Fargo Bank (In re Gibson), 395 B.R. 49, 57 (Bankr. S.D. Ohio 2008). Indeed, a review of Ohio case law demonstrates that notice of a prior recorded but defectively executed mortgage has no impact on the lien priority dispute.
Under Ohio law, a mortgage becomes operative as to third parties only upon its recording. GMAC Mortg. Corp. v. McElroy, 2005 WL 1364580, at *2 (Ohio Ct. App. June 6, 2005) (citing Sidle v. Maxwell, 4 Ohio St. 236 (1854)). However, to be entitled to recording, a mortgage must be properly executed. Ohio Rev. Code § 5301.23(A);
One example of this rule of law applied to a lien priority dispute involving a defectively executed mortgage like the one held by PNC can be found in Mortg. Elec. Regis. Sys. v. Odita, 159 Ohio App.3d 1, 822 N.E.2d 821 (2004). In Odita, Mortgage Electronic Registration Systems ("MERS") held a first mortgage that was defectively acknowledged. Id. at 822. Following a foreclosure sale of the property to a new owner, a subsequent mortgage was recorded against the real property. Id. at 823. MERS's debt was not paid off with the proceeds of the foreclosure sale leading it to file a complaint against several parties including the subsequent mortgagee. Id. On appeal, the Franklin County Court of Appeals addressed whether MERS's first recorded but defectively executed mortgage could take priority over the validly recorded and executed lien of the subsequent mortgagee. Id. at 825. The court relied on Ohio recording statutes and a long line of cases holding that a defectively executed mortgage, like that held by MERS, could not take priority over a subsequent validly recorded mortgage. Id. Nevertheless, MERS argued that the subsequent mortgagee could not take priority because it had actual knowledge of the prior mortgage. Id. The Franklin County Court of Appeals rejected MERS's argument noting "significant authority" for the proposition that a defectively executed mortgage will be afforded no priority over a subsequent lien even when the subsequent mortgagee or lienholder had actual knowledge of the defectively executed mortgage. Id. at 826-27.
Odita and the other cases demonstrate the different treatment of lienholders under Ohio law. While notice (or a lack thereof) is imperative to obtaining bona fide purchaser status, notice is irrelevant to prioritizing a defectively executed mortgage with other liens. Instead, the important factor in the lien priority dispute is determining which lien is the first in time that strictly adhered to recording statutes. The rationale for treating lien priorities in this manner appears to be a public policy favoring those who comply with the recording statutes over those who do not. The earliest explanation of this rationale comes from a Supreme Court of Ohio case decided in 1847 which gave priority to
White v. Denman, 16 Ohio 59, 61 (1847). The court cannot ignore a century of Ohio case law that has grown out of this policy consistently holding that a subsequent properly perfected lien takes priority over a defectively executed but recorded mortgage despite either actual or constructive notice.
Ohio Rev. Code § 1301.401 has been interpreted to simply allow a defectively executed but recorded mortgage "to provide constructive notice to the world" of its existence and contents. Messer, 50 N.E.3d at 499. The statute contains no explicit language attempting to cure defects in the execution of a mortgage or change lien priorities and this court will not expand the statute through supposition. Given the limited scope of this constructive notice statute and the long line of Ohio cases holding that notice is not relevant to prioritizing a defectively executed mortgage with other liens, the court holds that Ohio Rev. Code § 1301.401 does not curtail the Trustee's ability to avoid PNC's defectively executed mortgage as a hypothetical judicial lien creditor pursuant to 11 U.S.C. § 544(a)(1).
The court would be remiss if it did not mention new legislation that may limit the significance of this holding and further suggests that the Ohio General Assembly has recognized the need for additional statutory provisions in order to change lien priorities involving defectively executed mortgages. Wholly revised language in Ohio Rev. Code § 5301.07, effective April 6, 2017, appears poised to alter the lien priority analysis discussed in this decision.
For the reasons given, the court hereby denies the Motion of PNC Mortgage Company to Dismiss and/or for Judgment on the Pleadings as to the Amended Complaint [Adv. Doc. 42].
2016 Ohio Laws 156 (Am. Sub. S.B. No. 257).
