Ch. 7 Trustees in Ohio Can Avoid Defective Mortgages…Again

By Steven Patterson, Esq.

                In 2013 the Ohio Legislature enacted protections for mortgagees that included constructive notice “to the world” of the existence of a mortgage that was defectively executed. Thus, a trustee was no longer able to avoid a mortgage as a bona fide purchaser. In relevant part, O.R.C. §1301.401(C) provides that  “Any person contesting the validity or effectiveness of any transaction referred to in a public record is considered to have discovered that public record and any transaction referred to in the record as of the time that the record was first filed with the secretary of state or tendered to a county recorder for recording.”

                On March 5, 2019, the United States Court of Appeals for the Sixth Circuit decided Donald F. Harker, III v. PNC Mortgage Company, ultimately holding that O.R.C. §1301.401(C)’s constructive notice provisions had no effect on a trustee’s avoidance powers as a judicial lien creditor. In this case, PNC’s mortgage was recorded with no notary acknowledgment of the debtors’ signatures.

                Bankruptcy trustees, in exercising their avoidance powers, may succeed to the rights of judicial lien creditors, execution creditors, and bona fide purchasers.  Relevant here are the Bankruptcy Code’s provisions concerning avoidance powers as a bona fide purchaser or as a judicial lien creditor found. The trustee acting as a judicial lien creditor is deemed to have perfected his interest as of the date of the filing of the bankruptcy.  One of the powers of the trustee acting as a judicial lien creditor is the ability to take priority over or “avoid” security interests that are unperfected under applicable state law.

                The Circuit Court decided that neither 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. In Ohio, a defectively executed mortgage is invalid to a subsequent lienholder even if the subsequent mortgagee-lienholder had actual knowledge of the prior defectively executed mortgage.

                Under Ohio law, notice—whether constructive or actual—does not affect the priority of recordings.  That is, regardless of notice, a defectively executed mortgage is not “perfected” so it does not trump a subsequently perfected lien.  Though § 1301.401 provides that a recorded mortgage, even if defectively executed, gives notice to the world, it does not turn a defectively executed mortgage into a properly executed one.  Such notice is irrelevant in considering whether the Trustee may avoid a mortgage as a judicial lien creditor, as Ohio law makes clear that a judicial lien creditor may still avoid a defectively executed mortgage, even if he has notice of such mortgage.  Thus, PNC recorded its mortgage but, because the mortgage was “defectively executed,” PNC did not “perfect” that mortgage, whereas the Trustee, as a judicial lien creditor, “perfected” his lien on the property filing of the bankruptcy petition.

Therefore, under Ohio law, because the Trustee was the first to record a perfected lien, the Trustee’s lien had priority— the Trustee cut ahead of PNC in line. Because the Trustee in his role as a hypothetical judicial lien creditor was the first to perfect his lien on the property in this case, his lien had first priority, which allowed him to avoid subsequent competing liens or mortgages.

                It will be up to Ohio’s General Assembly to decide whether further revisions to O.R.C. §1301.401(C) will be enacted to reverse this ruling.

            If you have any questions about this or any other Bankruptcy matter, our team stands ready to assist.

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