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U.S. Court of Appeals Resolves Lingering Conveyances Act Litigation

On May 20th, the United States Court of Appeals for the Seventh Circuit issued an opinion in a case that may be the final litigation involving the extent to which Section 11 of Illinois’ Conveyances Act (hereafter “Section 11”) either does or does not require a mortgage to cite the specific components listed in Section 11 in order for the mortgage to be safe from a challenge in a bankruptcy dispute.

In the case resolved by the Court of Appeals, Lender #1 loaned $214,044.26 to John and Jane Doe (hereafter “Mortgagees”), and recorded its first mortgage in November of 2004 (“the 2004 mortgage”).  The recorded 2004 mortgage clearly displayed on its first page a cross-collateralization clause stating that the mortgage secured the underlying note and any other obligations “whether now existing or hereafter arising” but later stated a “maximum lien” amount of $214,044.26.  In November of 2007, Lender #1 made a second loan to the same Mortgagees.  The second loan was in the amount of $400,000 and was secured by a mortgage on one or more parcels of real estate (“the 2007 mortgage”) unrelated to the 2004 mortgage.  The 2007 mortgage made no reference back to the 2004 mortgage or to the original $214,044.26 note.

In August of 2008, Lender #2 made its loan of $296,000 to the same Mortgagees and recorded a second mortgage (“the 2008 mortgage”) on the real estate secured by Lender #1’s 2004 mortgage with full knowledge of the 2004 mortgage.

When Mortgagees declared bankruptcy in 2010, their original debt of $214,044.26 to Lender #1 had been reduced by approximately $100,000 through payments made on that loan. The real estate secured by the 2004 mortgage and the junior 2008 mortgage sold in May of 2011 for $388,000.  Lender #1 argued that it was entitled to payoff of the balance due under the 2004 mortgage, and also that it had first claim on the next $100,000 of proceeds from the sale, up to its stated “maximum lien” amount of $214,044.26.  Lender #2 argued that the cross-collateralization clause was ineffective notice to constitute a valid mortgage interest in any amount other than the amount to pay off the original note, and therefore that Lender #1 was not ahead of Lender #2’s second mortgage with respect to the next $100,000 from the sale of the real estate.

Lender #2 argued that because the 2004 mortgage’s specification of the $214,044.26 as the “maximum lien” amount matched exactly the amount of Mortgagee’s original indebtedness to Lender #1, it was evident that the 2004 mortgage was intended specifically and exclusively as security for that initial loan and could not later be extended to cover any amount under Lender #1’s 2007 mortgage.  However, the Court of Appeals ruled that the 2004 mortgage’s cross-collateralization clause and “maximum lien” clause could be read and enforced in conjunction with each other (i.e., that future advances were covered under cross-collateralization and the maximum lien amount was, in fact, a hard ceiling but was re-loadable when loan payments had reduced the covered obligation to below $214,044.26.)

Lender #2 also raised the Section 11 argument, claiming that the cross-collateralization clause was ineffective notice against subsequent mortgagees because it did not identify the loan amount, interest rate and term of the covered debt as supposedly required by Section 11.  The Court of Appeals again rejected Lender #2, first noting that Section 11 used the permissive word “may” and so the listing of specific mortgage components in Section 11 was “aspirational” rather than mandatory; but the Court went further and found that the prominent and conspicuous location of the cross-collateralization clause on the first page of the 2004 mortgage constituted sufficient notice to put another commercially sophisticated lender (e.g, Lender #2) on “inquiry notice” that there may indeed be subsequent advances from Lender #1 that should be diligently investigated by a subsequent mortgagee before assuming that only the original indebtedness was secured by the 2004 mortgage.  The federal Court of Appeals found in favor of Lender #1, entitling that party to proceeds of the $388,000 bankruptcy sale sufficient to fully pay off the 2004 mortgage and $100,000 toward the 2007 mortgage before Lender #2 would receive any residual proceeds toward its 2008 mortgage.

I mentioned at the beginning that this was likely the final litigation involving whether Section 11 required specification of its listed mortgage terms in order to be safe from a subsequent challenge.  This case was the last such case of which I am aware prior to the June 1, 2013 effective date of CBAI-initiated legislation included within Public Act 97-1164, amending Section 11 to state unambiguously that the components specified in Section 11 are discretionary; that Section 11 was never intended to make them mandatory; and that the failure to include them does not make a recorded mortgage subject to being voided.