Stites & Harbison, PLLC

On November 9, 2009, the Bankruptcy Appellate Panel of the Sixth Circuit released a favorable opinion in Rogan v. New South Federal Savings Bank (In re Pelfrey) regarding the avoidance of mortgages with defective notary acknowledgments.  Erica N. Galyon of Stites & Harbison, PLLC represented New South Federal Savings Bank and Richard Vance of Stites & Harbison, PLLC represented the Kentucky Bankers Association as amicus curiae in the case.  Specifically, the Court addressed the application of KRS § 382.270 to defective mortgages holding that it will apply prospectively to protect present and future mortgages. 

During the last few years, bankruptcy trustees in Kentucky have successfully avoided recorded mortgages with immaterial and clerical errors by alleging that the mortgages are defective and do not provide constructive notice.  In this particular action before the Court, the bankruptcy trustee alleged that the recorded mortgage was defective because the notary public acknowledging execution of the mortgage was not a duly appointed and lawful notary public.  The trustee argued that the notary public was not properly appointed because the notary bond did not include the county clerk’s signature indicating that the oath of office was administered and the bond did not include a notarized signature of the surety.  As a result, the bankruptcy trustee alleged that the mortgage did not provide constructive notice making it avoidable by a trustee in bankruptcy under 11 U.S.C. § 544. 

The Court disagreed and held that the recorded mortgage provided constructive notice despite any defects in the notary public’s bond.  Under Kentucky law, the notary public was a de facto notary public and the acknowledgement was valid.  Additionally, pursuant to KRS § 61.060 the trustee was prohibited from attacking the acknowledgment because the action was not a direct action against the notary public nor did it allege fraud or mistake on behalf of the notary public.  Since the acknowledgment was valid, the mortgage was properly recorded and provided constructive notice to the trustee.

At the insistence of New South Federal Savings Bank and the Kentucky Bankers Association, the Court also interpreted the recent amendments to KRS § 382.270 to resolve the case at issue and a number of other Kentucky cases addressing the avoidance of mortgages.  Before it was revised in 2006, § 382.270 provided that a mortgage was not valid against a bona fide purchaser unless the mortgage was properly acknowledged.  In 2006, the General Assembly revised § 382.270 to clarify that a defective mortgage provides constructive notice to a purchaser if the mortgage is or has been recorded prior to July 12, 2006.  The title to the statute was also revised but the revision to the title implied that the statutory exception only applied to mortgages recorded prior to July 12, 2006.  The trustee seized on the complex language of § 382.270 and the new title to argue that § 382.270 only applied to mortgages recorded prior to July 12, 2006.  He asserted that defective mortgages filed after this date, including the mortgage at issue, did not provide constructive notice. 

The Court disagreed and concluded that the revisions to § 382.270 apply to all recorded mortgages, whether recorded before or after July 12, 2006.  The revised title had no legal effect on interpretation of the statute because Kentucky statutory law states that a statutory title has no legal effect.  See KRS § 446.140.  Other principles of statutory construction required the Court to give each word in the statute operative effect and to apply the statute prospectively.  Thus, the trustee’s limited interpretation was incorrect and, according to § 382.270, a properly recorded mortgage provides constructive notice despite any defects in the acknowledgment.  A copy of the opinion can be found on the Court’s website at http://www.ca6.uscourts.gov/opinions.pdf/09b0010p-06.pdf. 

The Court’s opinion is the first opinion to address the substantive effect of the revisions to § 382.270, and the favorable ruling will be significant in other cases addressing whether a recorded, yet defective, mortgage provides constructive notice.  Many bankruptcy trustees have disputed the application of § 382.270 but this decision clearly holds that § 382.270 has prospective application and should eliminate future cases based on technical notarial defects in recorded mortgages.

Erica N. Gaylon is an Associate in the firm's Lexington office where she focuses her practice on bankruptcy and creditors' rights matters.

Richard A. Vance is a Member in the Louisville office where he focuses his practice on all aspects of residential mortgage finance, including compliance, licensing and litigation.