April 15, 2008

Kentucky & Ohio Laws Regarding Notary Acknowledgments On Mortgage Deeds Lead To Different Results in the 6th Circuit In Mortgage Avoidance Actions

In Kendrick v. Deutsche National Trust Company (In re Saint Clair), 380 B.R. 478 (B.A.P. 6th Cir. Jan. 16, 2008), the Chapter 7 Trustee appealed the decision of the United States Bankruptcy Court for the Eastern District of Kentucky to the Sixth Circuit Bankruptcy Appellate Panel (“BAP”). The issue on appeal was whether summary judgment was warranted against the Appellee-Mortgagor (“Mortgagor”) on the Appellant- Trustee’s (“Trustee”) complaint seeking to avoid a mortgage on the Debtors’ real property.

The BAP considered whether Kentucky Revised Statute § 61.060, which provides the bases upon which a notary’s acknowledgment may be attacked, prevented the Trustee from avoiding the mortgage based on a defective acknowledgment where the Debtors did not sign the mortgage in the presence of a notary, but the acknowledgment was facially valid. After a fact, statute, and policy driven discussion and application of the requirements under § 61.060, the BAP concluded that pursuant to Kentucky law, there was no fraud or mistake in the transaction or acknowledgment, and a direct action against the notary was inapplicable. Accordingly, the BAP affirmed the decision of the Bankruptcy Court.

Background Facts Considered and BAP Analysis:

• The Debtors purchased real estate in Dayton, Kentucky for $95,000.00.
• To partially finance the real estate purchase, the Debtors borrowed $80,750.00 from Ardent Mortgage Company LLC, and the mortgage was recorded with the deed in the county clerk’s office one week later.
• The deed and mortgage contained signed and stamped notary certificates.
• Four months later, the mortgage was assigned to Deutsche Bank National Trust Company and AMC Mortgage Services. The assignment was properly recorded.
• The Debtors subsequently filed bankruptcy and during their meeting of creditors, the Debtors testified that the notary public was not present at the closing.
• The Trustee filed an adversary complaint to avoid the mortgage under 11 U.S.C. § 544(a), asserting that: (1) the acknowledgment on the deed and mortgage were defective because the Debtors were not present before the notary when they executed the documents, and (2) as a bona fide purchaser, he could avoid the mortgage because it was not recordable and failed to provide constructive notice.
• Pursuant to a Motion for Summary Judgment by the Mortgagor, asserting that the mortgage was properly acknowledged and facially correct, the Bankruptcy Court determined that Kentucky law favored the Mortgagor, but allowed the Trustee to amend his complaint to allege fraud or mistake.
• The Trustee filed such amended complaint but did not seek recovery from the notary.
• Consequently, the notary failed to answer and a default judgment was entered against her.
• Considering cross motions for summary judgment, the Bankruptcy Court granted summary judgment in favor of the Mortgagor.

With an analysis similar to the Bankruptcy Court, the BAP determined that the dispute on appeal was whether the mortgage was properly acknowledged according to Kentucky law. Concluding that the acknowledgment was facially valid, the inquiry turned to whether § 61.060 prevented the Trustee from avoiding the mortgage.

Under Kentucky law, a notary’s acknowledgment may only be attacked by (1) a direct action against the notary; (2) an allegation of fraud by the party benefited (i.e. lender, mortgagor); or (3) mistake by the notary. See Ken. Rev. Stat. Ann. § 61.060. The BAP concluded as follows:

1. The direct action exception was inapplicable, because the Trustee’s amended complaint sought no recovery from the notary;
2. The “allegation of fraud collapse[d] into nothingness,” because the Trustee failed to assert the requisite elements of fraud, or that direct fraud was committed by the Mortgagor. Additionally, the BAP determined that fraud under Kentucky law must relate to the obtaining of the certificate itself, and not the making of the certificate; and 
3. The facts alleged by the Trustee did not constitute mistake under Kentucky law, because § 61.060 was specifically intended to prevent unnecessary challenges to real estate records, especially where any purchaser would believe the mortgage was binding and valid. The BAP noted that no subsequent purchaser would have suspected that the acknowledgment failed but for the 341 testimony of the Debtors.

Finally, the BAP acknowledged that this decision was different from the prior Sixth Circuit Court of Appeals decision under Ohio law, holding that the Trustee could avoid a mortgage where the mortgagors testified that only one witness was present at the signing rather than two as required by Ohio law. Simon v. Chase Manhattan Bank (In re Zaptocky), 250 F.3d 1020 (6th Cir. 2001). The BAP noted that it was applying Ohio law in Zaptocky, and that Ohio does not have a statute comparable to § 61.060.

 This E-alert was prepared by Andria M. Beckham. Please contact any member of the Bricker & Eckler Creditor Rights & Bankruptcy group for more information.