Daily Development for Wednesday, January 31, 2007

by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri

RECORDING ACTS; PRIORITIES; CHAIN OF TITLE: Complex Virginia decision evaluates scope of Virginia title searches, after acquired property doctrine, purchase money priority, and more, and more and more.

Wilson v. Moir (In re Wilson), 2006 Westlaw 3804543 (Bkrtcy E.D. Va. 12/27/06)

In August, 2004, Wilson developed a grandiose plan to acquire a high end home in McLean, Virginia and either to remodel and sell it for a huge and quick profit, or, if she felt she could afford to do so, refinance and reside in the completed luxurious residence.  She contracted to buy the house from Toone for $3.68 million and sought bank financing for a combination acquisition/construction loan for $5.9 million.  Toone agreed to take back a small purchase money mortgage for $360,000. 

Wilson worked with Amendola, a mortgage broker, to arrange the necessary bank financing.    According to her mortgage broker, she had a contract to resell the remodeled home for $7.5 million.  (In her deposition in this case, she testified that this contract was a sham developed by the mortgage broker to induce the construction lender to loan.)  Armed with this purchase commitment, Amendola was able to get Mariner to commit to a one year acquisition/construction loan.  

But Wilson apparently lacked sufficient other liquid assets to satisfy Mariner, so Mariner made several conditions on its loan commitment, most important that Wilson provide $700,000 in certificates of deposit as additional security and that she establish an additional $100,000 account at Mariner to pay the interest during construction. 

Wilson didnt have this kind of cash.  In fact her apparent available cash was the $50,000 that was the sum total of her down payment in this deal.  (We said the plan was grandiose.)  But she did claim to have $250,000 in certificates of deposit at another bank.  A party described as a friend or business associate of Wilson contributed $300,000 or so of the necessary $800,000, but she was still $500,000 short.  So Amendola, whose company (he as a junior employee) stood to make $118,000 in commissions on the deal, went to work. 

Amendola found Moir, who was otherwise unrelated to this deal, and worked out an investment plan by which Moir would provide the needed $500,000.   He presented to Moir a document entitled Investment Synopsis in which, in addition to describing the apparently fictitious $7.5 million buyer, he represented that the funds would be deposited in a non-accessible certificate of deposit at Mariner, and that, after one year, when either Ms. Wilson provides refinancing to satisfy her debts with Mariner or sells the property, the funds will be distributed back to the investor with a 50% return on investment.

Sounds pretty bullet proof, eh?  But Moir wasn convinced.  Moir also wanted a deed of trust on the house securing the debt of $750,000 investment return that he was promised, and a guarantee from Amendola and his father  of $200,000 of the obligation, as well as a collateral assignment of the $250,000 certificate of deposit that Ms. Wilson had at another bank. Wilson also was required to pay to Moir a monthly cost of carry computed at 6.5% per annum (we are not told on what amount - presumably the $750,000).   Everything was in fact provided, and Moir did deposit the $500,000 in the bank.  One tiny little problem was that Wilson certificate of deposit had already been pledged to others to secure other debts, but the court does not tell us when this information surfaced.

It first became apparent that Wilson lacked the needed $800,000 at the original scheduled closing, and at that time the parties had conducted a dry closing, in which the original parties signed all the documents, including the deed, the Mariner Deed of Trust and the Toone Deed of Trust, and left them in escrow pending Wilson raising the additional $800,000 collateral she needed to provide to Mariner in order for it to fund its commitment.  The $800,000 ultimately were wired to the closing agent, an attorney, who recorded the deed and the two mortgages he had.  But the closing attorney had no knowledge of all the arrangements between Moir and Wilson and did not know of the Moir deed of trust.

Wilson paid Moir the cost of carry payments for seven months, then stopped.  She later defaulted on the Mariner loan.  Then she declared bankruptcy, listing the value of the home on her asset schedule at $10.6 million.  If it had been worth that much, Wilson might have been able to pay everyone their grand expectations.  But, alas, the house didn quite meet these expectations.  Wilson did manage to sell the house for $4.56 million, but as she also had not paid over $30,000 in property taxes, she couldn pay everyone what she owned them.  In fact, claims against the estate exceeded the sale proceeds by over $800,000, and there didn appear to be much more in the estate available for creditors. 

As the creditors jostled for priority, an interesting tale was told.  On the very day that the closing agent recorded Wilson deed and the Mariner and Toome deeds of trust, Moir deed of trust was also put of record.  The recording of the Moir deed of trust occurred several hours earlier than the other documents and, of course, at that time neither the closing agent, Mariner or Toome knew anything about them.

We thus have a fascinating hornets nest of recording issues, the after acquired title doctrine, bankruptcy avoidance issues, and equitable subordination thrown in as well. 

Wilson, as debtor in possession trustee of the estate, sought to avoid the Moir deed of trust as unperfected because it had not been recorded in the chain of title.  Note that at the time it was recorded, Toome, not Moir, was shown as the record owner of the property.  A 20-year-old 4th Circuit decision, however, had held that a debtor in possession with actual notice of a creditor secured claim cannot invoke the strong arm power to avoid it on the basis that it was not perfected.  The instant court noted that this decision has not been followed and that, in fact, most other courts passing on the issue have ignored it and found the opposite.  But, as it was a higher court precedent in the Circuit, the bankruptcy court here accepted its teaching.  So Wilson, debtor in possession, could not avoid Moir deed of trust.

Nevertheless, anticipating perhaps that the precedent would be changed on appeal, and also for purposes of resolving other issues, the court proceeded to evaluate whether the Moir deed of trust was in fact perfected.  There is a statute in Virginia codifying the after acquired title concept, to the effect that where a party purports to transfer property to another at a time when the transferor does not have such title, if the transferor later obtains good title, it holds such title subject to the rights it had earlier transferred. 

Another statute, however, states that third party purchasers are not bound by transfers made by their seller before seller has obtained his title:

A purchaser shall not, under this chapter, be affected by record of a deed or contract made by a person under whom his title is not derived; nor by the record of a deed or contract made by any person under whom the title of such purchaser is derived, if it was made by such person before he acquired the legal title of record. 

The literal language of this statute would seem to tie things up for Mariner and Toome.  But not so fast!!!  Searching Nineteenth Century legislative history, the court concluded that the statute was not intended to permit third party purchasers to prevail against the prior recorded interest where the subsequent purchasers were on actual or inquiry notice of such interest.  The court did conclude that constructive notice alone would not be sufficient to disable Mariner or Toome claims. 

Although it did not appear necessary to decide whether Mariner or Toome had constructive notice of the Moir deed of trust (remember that it was recorded hours before theirs on the same day), the court nevertheless went on to evaluate that question.  It concluded that Virginia is a short up jurisdiction - in other words the hypothetical chain of title that a search must examine does not require that the searcher look for transfers by a grantee occurring prior to the grantee obtaining title.  It discussed testimony that Virginia title searchers customarily do not inquire for earlier recorded instruments made by grantees prior to their getting title.  But, interestingly, the court concluded that there is no way to search a Virginia title without actually looking at instruments recorded on the very day in which a party takes title, even if earlier recorded that day.  Hence, the court concluded, a reasonable title search probably would have discovered the Moir deed if it had checked title at some subsequent time.

But were Mariner or Toome on constructive notice of the Moir deed of trust when they took their interests on the same day that is was recorded?  The court concluded that even though the Moir document had been recorded earlier enough in the day that it probably was available in the electronic data base that is the standard search tool today in Virginia, searchers customarily do not double check for instruments recorded on the day of closing.  Maybe this helped Mariner and Toome (because of issues discussed below, it really doesn matter).  But the court conclusion concerning those two lenders doesn mean that Moir wasn perfected for purposes of the strong arm power.  First, originally, there was the precedent that the power couldn be invoked by a debtor in possession with notice.  Later in the proceeding, however, the debtor in possession was replaced.  But even in that case, the court deemed the Moir deed of trust still to be perfected because the test has to do not with an individual lienholder, but a hypothetical bona fide purchaser/judgment lienholder.  Any subsequent title searcher (other than on the day of recording) would find mention of the Moir deed of trust recorded on the same day as the Wilson deed, and would have a duty to inquire as to its significance.  Thus, versus hypothetical lien creditors and BFP, the Moir lien was perfected.  


Remember, however, the court had already decided that constructive notice wouldn spoil the priority of Mariner and Toome, so whether they truly were on constructive notice is moot.

Failing as to the significance of constructive notice, Moir argued that Mariner, at least, had actual notice of the Moir mortgage because Mariner agent, Amendola, the loan broker, knew all about it.  Not a bad argument.  But the court said that it wasn ready to conclude whether a loan broker knowledge binds a lender, and in any event it didn have to, because although Amendola knew of the Moir deed of trust, he did not know of its recording or that Moir intended to have a deed of trust senior to the Mariner and Toome deeds of trust.  So Amendola lacked critical information. 

Further, in response to Moir claim that the other lienholders were on inquiry notice of Moir, the court again demurred.  Even though Mariner and Toome might have had some knowledge that Wilson was getting the $800,000 from somewhere, and could have anticipated that she was borrowing it, they also lacked any basis to inquire whether such borrowing would result in a priority lien claim against them.

If you are a particularly well-schooled reader, you might have noticed another basis for Mariner and Toome to argue priority over Moir, even if in fact they had knowledge of Moir.  Mariner and Toome were purchase money lenders.  Moir was not.  The court noted that Virginia recognizes the super priority of purchase money lenders against preexisting liens against their mortgagor interest.  It applied that super priority here. 

At this point, if youare not a true title/recording geek, youare probably asleep.  But true geeks, the editor is confident, are finding all of this a rich broth indeed, and weare not done yet.

The court then turned to another series of claims by the trustee - its desire to limit the priority of Moir not only versus Mariner and Toome, but as against unsecured creditors as well.  The court first held that the estate was not entitled to Moir first lien priority.  Moir wasn strongarmed, rather it lost to the other secured creditors because of their superior status as purchase money lenders.  Consequently, Mariner and Toome occupied the first two priority claims.  But did Moir come next, or did the estate?

The question likely had little significance, as the state tax lien and the other two lienholders probably would gobble all the available proceeds of the property sale.  But the court, likely a geek as well, decided to pursue the question anyway.  The court dealt with the estate claim that Moir lien should be equitably subordinated to the claims of unsecured creditors. 

Typically an secured creditor is subordinated in cases in which the secured claim has resulted from fraud or other inequitable conduct.  There was no showing that Moir had done anything so unethical here, other than attempt to circumvent Virginia usury laws by characterizing the $250,000 equity kicker claim as an investment return.  The court decided it would not try to fathom Virginia usury laws, and didn specifically hold that there had been a violation. It concluded that Moir had not been guilty of fraud or egregiously inequitable conduct in making the $500,000 loan, and was entitled to third priority secured creditor status as to that amount.

But the court granted subordination of Moir $250,000 kicker.  As noted, Moir himself had stated in some of the loan documents, it was a capital investment, and not a loan.  Consequently, to that extent Moir was not a secured creditor.  But why should Moir nevertheless be subordinated to unsecured creditors?  Again, the typical test of egregious inequitable conduct doesn seem to apply.  But here what the court said did the trick:

[T]he court is persuaded that a claim for what amounts to dashed expectations of a large profit rather than out-of-pocket losses unfairly dilutes the claims of creditors who will likely not recover even their principal.  For that reason, the court concludes that under the specific facts of this case, the $250,000 =E2=80=98equity returna should be subordinated to the claims of general creditors.

Alternatively, and perhaps more appropriately, the court recharacterize the $250,000 kicker as a return of equity, and thus subordinate to general creditors.  =E2=80=98Nuff said about that.  The court refused to recharacterize the balance of Moir $500,000 claim, since it was treated by the parties as an indebtedness with interest accruing and security given.  Further, it refused to reduce the secured claim by the amount of the Amendola guaranty, as there was no evidence that that had yet been paid, or ever would. 

Comment: Many of the editor views are set forth in asides in the discussion above.  Of course, the $200,000 guarantee may only be the beginning of Amendola problems.  There are allegations of fraud and misrepresentation.  It appears, however, that Moir more or less dug his own hole for some of the bankruptcy conclusions by drafting the documents himself.  It the old rule - can be a bull or a bear, but never a pig. 

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