Once a lender records a deed of trust, isn’t that sufficient under California law to perfect the deed against a Chapter 7 trustee’s attempt to set it aside? Based on the recent bankruptcy court decision of In re Nowlin, the answer may be no, especially if the deed was not properly indexed with the county recorder’s office.
In the Nowlin case, the Chapter 7 trustee sought to sell certain real property owned by the bankruptcy debtors which, according to their bankruptcy schedules, they owned “free and clear” of all liens. After the Chapter 7 trustee filed her motion to sell the real property, Plaintiffs objected to the trustee’s sale motion, claiming to hold both a recorded quitclaim deed to the property. The Chapter 7 trustee sought to set aside both deeds under the strong arm provisions of Bankruptcy Code Section 544(a)(3).
Section 544(a)(3) of the Bankruptcy Code confers upon a Chapter 7 trustee the status of a bona fide purchaser, which under California law allows the trustee to set aside a sale of real property provided that the trustee does not have actual or constructive knowledge of a prior interest in the property. The Nowlin Court appeared to have little difficulty in establishing that the trustee had no actual knowledge of Plaintiffs’ deed concerning the property. Thus, the primary issue facing the Nowlin Court was whether the recordation of the deed constituted perfection sufficient to provide constructive knowledge of the deeds to the trustee.
The Nowlin Court ruled that the mere act of recording the deed, did not, by itself, provide constructive knowledge of the deed to the trustee. Instead, according to the Nowlin Court, a party does not have constructive knowledge of a recorded instrument until the instrument has been properly indexed by the county recorder’s office so that it can later be located through a search of the public records. Specifically, under California law, deeds are not only required to be recorded with the appropriate county recorder’s office, they must also be indexed in the county grantor/grantee index by the names of the grantors who convey the interest in the property and by the names of the grantees who receive the property interests. To the extent that an instrument does not appear in the county grantor/grantee index, it is not on the chain of title and does not impart constructive notice.
Although not raised in the Nowlin case, it would seem that Plaintiffs may have had a source of recovery for any loss sustained as a result of the setting aside of their deed had they obtained title insurance for the deed. I have been involved in numerous real property transactions in which parties have refused to obtain title insurance to save costs. Even assuming that the likelihood that a county recorder’s office may improperly index a deed is slight, it would seem that this risk well warrants the additional costs for obtaining title insurance in most instances. I also believe that this applies to both deeds vesting title to real property as well as to deeds of trust.
This alert is intended to note current legal trends in commercial lending and risk management issues. No alert should be construed as representing advice on specific, individual legal matters, but rather as an overview of the subject discussed. Your questions and comments are always welcome. Please do not hesitate to contact me at firstname.lastname@example.org or (310)281-6321 to further discuss this alert or to answer any questions.