Contributed by Kyle J. Ortiz
In Primerock Real Estate Fund, LP v. Rag East, LP (In re Rag East, LP), Case No. 12-02454 (CMB) (ECF No. 42) (Bankr. W.D. Pa. Mar. 4, 2013), the United States Bankruptcy Court for the United States District Court for the Western District of Pennsylvania was forced to choose between two principles of property law: the invalidity of forged and unauthorized filings and the interest of bona fide mortgagees for value. Thanks to a forged document, the court was left to decide who among three good faith mortgagees for value would have to bear the cost of a fraud that none of them perpetrated or were even aware of until after their respective mortgages had been recorded.
This situation arose when, in the spring of 2011, the debtor obtained a loan from Primerock Real Estate Fund, LP to buy a property for the purposes of establishing a restaurant with Primerock taking a first mortgage on the property as security. The Primerock mortgage was recorded with the Commissioner of Records on June 10, 2011. In December 2011, the debtor obtained a construction loan from MileStone Bank, which was secured by a construction mortgage that granted a lien upon, and security interest in, the property.
After the MileStone mortgage was recorded, a forged satisfaction piece was filed with the Commissioner of Records indicating that the Primerock mortgage had been satisfied. The satisfaction piece was allegedly executed on August 30, 2011 and bore the forged signature of the managing director of Primerock. The forged satisfaction piece released all liens and security interest granted to Primerock under the Primerock mortgage. Milestone had no knowledge that the satisfaction piece was fraudulent or forged and relied on the fact that it would receive a first mortgage in providing the construction loan.
On March 8, 2012, yet another lender, Zhong Zhuang, made a loan to the debtor and certain of its affiliates to help fund the restaurant. At the time that Zhuang made his loan he was unaware that Primerock continued to claim a mortgage lien and was under the impression that the Primerock mortgage had been satisfied based on a review of the public records. Zhuang would not have made his loan had he known about the Primerock mortgage. Zhuang’s loan was secured by a mortgage that was properly recorded.
Eventually, after both the Milestone and Zhuang mortgages were recorded, the fraud came to light, and Primerock was made aware of the existence of the fraudulent satisfaction piece. Shortly thereafter, on May 2, 2012, Zhuang filed an involuntary chapter 7 petition against the debtor. Following the involuntary petition, Primerock instituted an adversary proceeding against the debtor and the later mortgagees seeking a declaratory judgment striking the fraudulent satisfaction piece, quieting title with respect to the Primerock mortgage, and determining the priority of liens among the mortgagees. Primerock filed a motion for summary judgment and the subsequent mortgagees filed cross motions for summary judgment. The debtor did not answer the complaint or participate in the proceeding.
The court acknowledged that both Primerock and the subsequent mortgagees were “innocent victims” but noted that “unfortunately, the hardship must inevitably fall on one of these parties.” The court noted that although Primerock “clearly recorded its mortgage first,” it would only maintain its priority “if the forged satisfaction piece [was] determined to be without effect as to third parties.” The court determined that Primerock’s priority must be restored because “a true owner cannot be deprived of his property even by a bona fide purchaser or mortgagee for value.” Primerock, as the mortgage holder, was the only entity that could discharge its lien. Thus, because Primerock did not file (or even have knowledge of) the fraudulent satisfaction piece, its lien remained intact and the satisfaction piece was without effect to the subsequent mortgagees. Although the court recognized the “importance of being able to rely upon the public record and recogniz[ed] the policy of protecting bona fide purchasers and mortgagees for value,” the court noted that this policy concern would not be served in the present case by elevating the subsequent mortgagees above Primerock, because Primerock “did record its mortgage thereby giving notice of its interest through the public records.” Furthermore, because it was not Primerock’s fault or neglect that led to the filing of the satisfaction piece, the court found the principle of protecting bona fide purchasers for value was “inapplicable to Primerock in this case.”
Rag East provides lenders a cautionary tale that “even a bona fide purchaser or mortgagee for value will not always prevail despite reliance on the public records.” Thus, no matter what the public records say, title insurance is always a good idea.