Unrecorded Mortgage Avoidable as Preferential Transfer

The following is a summary of a Minnesota bankruptcy case or a case relevant to Minnesota bankruptcy law.

Minnesota Bankruptcy Case:

Wells Fargo Home Mortgage, Inc. v. Lindquist (In re Westlund), 592 F.3d 838 (8th Cir. (Minn.) 1/11/10) (Gruender, J.).

Case Summary:

Unrecorded Mortgage Avoidable as Preferential Transfer

The Eighth Circuit Court of Appeals affirms the bankruptcy court’s order avoiding an unrecorded mortgage on the debtor’s home, deeming the preferential transfer to have occurred immediately before the bankruptcy filing and not when the mortgage was later sold to a third party and recorded. In 2003, the debtor granted Wells Fargo a mortgage in exchange for a loan. Wells Fargo failed to record the mortgage, and in 2005 the debtor filed Chapter 7, listing Wells Fargo as a secured creditor. After the bankruptcy filing, Wells Fargo sold the mortgage, in a bundle with others, to EMC. EMC recorded the mortgage in 2006. When the trustee learned in 2007 that Wells Fargo had not recorded the original mortgage, he filed a complaint to avoid the mortgage as a preference and to recover the value of the mortgage for the estate. The bankruptcy court granted summary judgment and ordered Wells Fargo to pay the estate approximately $190,000, the mortgage balance as of the bankruptcy filing. The district court affirmed. On appeal, Wells Fargo argues that the relevant transfer was EMC’s post-petition recording, and that such transfer did not meet the requirements of a preference, and that the trustee should have sued EMC, and that the court erred in valuing the mortgage.

In affirming the lower courts, the Eighth Circuit finds that because Wells Fargo failed to record, the transfer of a security interest in the home is deemed under § 547(e)(2)(C) to have occurred immediately before the date of filing. On that date, Wells Fargo was a creditor by reason of its prior loan to the debtor, so the transfer was “to or for the benefit of a creditor.” The transfer also allowed Wells Fargo to receive more than it would in a hypothetical liquidation because the schedules treated it as a secured creditor rather than as an unsecured creditor, thereby diminishing the value of the bankruptcy estate for other creditors. The appellate court also finds that the trustee properly sued Wells Fargo, because he can recover from the initial transferee rather than an immediate transferee, as he chooses. Finally, the court rejects Wells Fargo’s valuation arguments. Although the mortgage could have been valued by the amount EMC paid Wells Fargo for it, Wells Fargo failed to submit admissible evidence about that transaction, so the lower court’s valuation was based on the uncontested fact of the mortgage balance at filing. Moreover, Wells Fargo was not forced to “pay twice,” because it would share in the estate, recovering as an unsecured creditor.

Credit: The preceding was a summary of a case relevant to Minnesota bankruptcy law. The case summary was prepared by the U.S. Bankruptcy Court through Judge Robert J. Kressel & attorney Faye Knowles.

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