The "Creditor's Rights Exclusion" in light of the Ninth Circuit's Recent Decision of In re McConville?
By Keith Turner, Esq. & Robert Ryan, Esq.
Rubin & Eagan
A Professional Corporation
Beverly Hills, California
If, in a purchase and loan transaction the buyer/borrower files for bankruptcy during the escrow period and fails to mention that fact to its lender, the deed of trust subsequently executed could be voided by a bankruptcy court. In re McConville, 84 F.3d 340 (9th Cir. 1996). In that decision the Buyers agreed to purchase an apartment building on July 8, 1993. While the Buyers were attempting to secure the needed loan to finance their purchase, on July 14, 1993, they filed a Chapter 11 bankruptcy petition. On August 12, 1993, the Buyers finally obtained temporary bridge financing for their purchase and executed a note and deed of trust, which recorded the next day.
The Buyers did not disclose their bankruptcy status to their Lender. When the Lender subsequently discovered the bankruptcy, it sought leave from the Bankruptcy Code's Û362 automatic stay so that it could foreclose on its deed of trust. The Bankruptcy Trustee responded by filing a complaint to void the lien created by the deed of trust. Notwithstanding the undisputed fact that the Lender did not know about the Buyers' bankruptcy, the Bankruptcy Court, District Court, and Ninth Circuit all found in favor of the Trustee.
The Ninth Circuit's holding was based, in part, on the conclusion that it was impossible to have created the lien provided by the deed of trust because it violated the "automatic stay" provided by Bankruptcy Code Û362. That statute "'operates as a stay, applicable to all entities, of ...any act to create, perfect, or enforce any lien against property of the estate.'" The court also rejected the Lender's other arguments based on the "good faith purchaser without knowledge" exception provided by Bankruptcy Code Û549(c).
Generally, a review of the chain of title will not disclose a borrower's bankruptcy filing. Thus, arguably there would be no title insurance coverage afforded to an insured lender for an In re McConville situation because the borrower's bankruptcy and its effect on the lender's deed of trust would not be a matter of public record.
Additionally, the "Creditor's Right Exclusion" contained in the CLTA policy form could also be asserted in response to a lender's title policy claim. That exclusion, as stated in the CLTA 1990 policy form, precludes title policy coverage for a "claim, which arises out of the transaction ... creating the interest of the insured lender, by reason of the operation of federal bankruptcy ... laws."
Thus, allowing insured lenders to endorse around the Creditor's Rights Exclusion is a matter that title insurers may wish to seriously reconsider in light of the In re McConville decision.
