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Mortgage Lien Wiped Out in IL Bankruptcy

A recent decision in a bankruptcy case could have serious implications for mortgage holders in Illinois.

The decision came last month out of U.S. Bankruptcy Court for the Central District of Illinois. The borrowers filed for relied under chapter 7 of the Bankruptcy Code.

The court held that a mortgage is avoidable in bankruptcy if it fails to include the maturity date and the interest rate of the underlying debt within the mortgage document as recorded.

The bankruptcy trustee for debtors Gary and Marsa Crane claims that the failure to include the information made the mortgage defective because it violated Illinois conveying statute 765 ILCS Sec. 5/11, real estate attorney Daniel J. Slattery of Reed Smith LLP said in a client letter.

U.S. Bankruptcy Judge Gerald D. Fines ruled in favor of the trustee and ordered that the mortgage lien of the Gifford State Bank was avoided. The court reportedly relied on an interpretation of section 11 of the Illinois Conveyances Act. The act dictates strict conformity with the statutory form for the mortgage to have the effect of providing constructive notice to bona fide third-party purchasers and trustees in bankruptcy.

“This decision is alarming because its strict reading of the statute, and harsh result for the mortgagor, is inconsistent with modern mortgage finance practices, including the common use of the incorporation by reference of promissory notes, as opposed to setting out the detailed terms of the note, including interest rate and maturity date, which this decision would appear to require in each instance,” Slattery said. “The statutory language states only that mortgages ‘may be substantially in the following form,’ which suggests a flexibility and a practicality not recognized in the court’s decision and reasoning.”

But Slattery said that an appeal has already been filed in the case. In addition, legislation has been introduced at the state level to supersede its effect.

He advised clients that if the decision isn’t overruled, mortgages in the state will need to include the interest rate and maturity date on the recorded document.

In re Crane.
Case No. 11-90592; Feb. 29, 2012; Supplemental Opinion and Order, April 5, 2012 (U.S. Bankruptcy Court for the Central District of Illinois).

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