Commonwealth Land Title Insurance v. Miller (In Re Project Homestead, Inc.)
374 B.R. 193, 48 Bankr. Ct. Dec. (CRR) 237, 2007 Bankr. LEXIS 2853 (2007)
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Rule of Law:
A bankruptcy trustee's 'strong-arm' power as a hypothetical bona fide purchaser under § 544(a)(3) of the Bankruptcy Code defeats unrecorded equitable interests, such as a constructive trust. However, a lender who provides funds to pay off a prior recorded lien may be equitably subrogated to that lien's priority status, defeating the trustee's claim, if the prior lien was not cancelled of record before the bankruptcy petition was filed.
Facts:
- Community Housing and Development Corp. (the Debtor), a non-profit, developed and sold affordable housing.
- In early 2003, several individuals (the Purchasers) entered into contracts to buy homes from the Debtor.
- The Purchasers obtained loans from various Lenders to finance their home purchases.
- The parties held closings where the Debtor received the purchase price, delivered executed deeds to the Purchasers, and the Purchasers executed promissory notes and deeds of trust in favor of their Lenders.
- All properties were encumbered by the Debtor's pre-existing construction loan deeds of trust.
- The closing attorney, Armina Swittenberg, was entrusted with the new deeds and deeds of trust for recordation, along with funds to pay off the Debtor's pre-existing construction loans.
- Swittenberg successfully used the Lenders' loan proceeds to pay off the Debtor's underlying construction loans.
- Swittenberg failed to record the new deeds from the Debtor to the Purchasers or the new deeds of trust from the Purchasers to the Lenders before the Debtor filed for bankruptcy on January 24, 2004.
Procedural Posture:
- Commonwealth Land Title Insurance Company and various Lenders (plaintiffs) filed adversary proceedings in U.S. Bankruptcy Court against William P. Miller, the Chapter 7 Trustee for the Debtor, and the individual Purchasers.
- The plaintiffs sought a declaratory judgment to establish the Purchasers' ownership of the properties and the priority of the Lenders' liens.
- The Trustee filed a counterclaim against the plaintiffs and a cross-claim against the Purchasers, seeking a judgment that he holds title to the properties free and clear of all unrecorded interests.
- Both the plaintiffs and the Trustee filed cross-motions for summary judgment before the U.S. Bankruptcy Court for the Middle District of North Carolina.
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Issue:
Under the Bankruptcy Code, does a Chapter 7 trustee's 'strong-arm' power as a hypothetical bona fide purchaser of real property under § 544(a)(3) defeat the unrecorded equitable claims of property purchasers seeking a constructive trust and their lenders seeking equitable subrogation to a prior, uncancelled deed of trust?
Opinions:
Majority - Stocks, J.
Yes, in part, and no, in part. A trustee's strong-arm power under § 544(a)(3) defeats a claim for a constructive trust, but it does not defeat a lender's claim for equitable subrogation to the position of a prior, recorded deed of trust that remained uncancelled at the time of the bankruptcy filing. The court reasoned that § 541(d), which limits the estate's interest to the debtor's bare legal title, does not trump the trustee's avoidance powers under § 544(a)(3). Following the reasoning in In re Reasonover, the court held that the 1984 amendments to § 541(d) signaled Congress's intent that the trustee's avoidance powers prevail over claims based solely on the debtor's lack of equitable title. Under North Carolina law, a bona fide purchaser's rights are superior to the beneficiary of an unrecorded constructive trust, so the Trustee prevails on that claim. However, the claim for equitable subrogation succeeds where the prior deeds of trust were still on record at the time of the bankruptcy petition. North Carolina's 'pure race' recording statute means a bona fide purchaser (like the trustee) takes property subject to any prior recorded encumbrances. Thus, the Lenders could 'step into the shoes' of the prior construction lenders whose deeds of trust were paid off but not yet cancelled, giving them a recorded lien with priority over the Trustee.
Analysis:
This decision clarifies the critical interaction between a bankruptcy trustee's 'strong-arm' powers under § 544(a)(3) and unrecorded equitable interests under state law. It establishes that while § 544 can defeat purely unrecorded claims like a constructive trust, it is not absolute. The case demonstrates that the doctrine of equitable subrogation can serve as a powerful exception, but only when it allows a claimant to step into the priority position of a previously recorded instrument that was still of record when the bankruptcy was filed. This holding emphasizes that the ultimate outcome of such disputes is heavily dependent on the specifics of state recording statutes, particularly whether the state follows a 'race,' 'notice,' or 'race-notice' system.
