MORTGAGES; PRIORITY; DEFECTIVE EXECUTION:.  Defectively executed mortgage was not entitled to priority over subsequent, properly recorded mortgage.

Mortgage Electronic Registration Systems v. Odita, 822 N.E. 2d 821 (2004). 

Eric Odita was the president and owner of Tempest Properties and Management Corporation, the owner of certain real property in Columbus, Ohio.  Odita granted first and second mortgages on the subject property to Labyrinth Mortgage and Investment Company in August of 1998, both of which were also recorded in August of 1998. 

Odita signed the second mortgage in his individual capacity, not in his capacity as president of Tempest.  Upon discovering this mistake, the mortgageee rerecorded in September of 1998.  The rerecorded mortgage was executed by Odita in his representative capacity, but his signature was not properly notarized. 

The plaintiff Mortgage Electronic Registration Systems (“MERS”) is the holder of this rerecorded second mortgage.  In October of 1999, First National Security Corporation filed a foreclosure action against Odita and the junior mortgagees, and obtained a judgment in June of 2000.  The property was subsequently conveyed to Robinson, and another mortgage was put in place in November of 2000. 

In October of 2002, MERS filed a claim for monies, foreclosure, and other equitable relief against Odita and the other mortgagees, which was later amended to add Tempest and others. 

The trial court held that MERS was entitled to summary judgment based upon both defendants’ actual knowledge of the MERS mortgage and upon equitable subrogation.  Defendant-appellants argued that (1) the defectively executed mortgage was not entitled to record; (2) mortgage lien priority in Ohio is determined by looking to the first properly executed and recorded mortgage; and (3) the trial court erred in allowing reformation of the defectively executed mortgage where plaintiff-appellees never plead reformation nor any facts relative to mistake in accordance with Ohio Civil Rule 9(b). 

The appeals court, citing Citizens National Bank v. Denison, 133 N.E. 2d 329 (1956), held that the recording of a defectively executed mortgage does not establish lien priority over subsequently recorded properly executed mortgages, and that there is no need to read into Citizens Bank (as the trial court did) an exception to that rule in cases of actual rather than constructive notice.  The court also held that reformation was inapposite in this case, because the purpose of reformation is to change an instrument so that it expresses the actual intent of the parties as to the contents of an instrument, not to validate an invalid instrument.  Delfino v. Paul Davies Chevrolet, Inc., 209 N.E. 2d 194 (1965).  The lower court’s award of summary judgment was reversed and the cause remanded.

Comment 1: Note that, for mortgages, Ohio maintains a “pure race” system.  Thus, although the later recorded mortgagee had actual knowledge of the prior mortgage, it still had priority over the prior mortgage is the prior mortgage had not been properly recorded.

Comment 2: I asked Dale Whitman, co-reporter of the Restatement of Mortgages and co-author of a leading mortgage treatise, to comment on this one.  Here are Dale’s comments:

When I first read this opinion (which was several weeks ago), I was initially outraged by it, since it seemed to disregard notice issues entirely.  But then I remembered something that caused me to calm down: Ohio has a pure "race" recording statute for mortgages (though not for other types of conveyances).  In other words, in Ohio an unrecorded mortgage is ineffective against any subsequent purchaser, whether the subsequent purchaser paid  value, or had notice of the mortgage, or not.  Notice is  simply irrelevant.  This is obviously contrary to the way the issue of recordation is treated in most states, and for most types of conveyances in Ohio, but it is the law.

I don't know that it's such a bad law, either.  We do waste a lot of time litigating issues of constructive and inquiry notice in most states, and the beauty of a pure "race" statute is that it completely eliminates that inquiry.  Either the mortgage is recorded or it's not.  If it's not, it's void as against any subsequent taker of any interest in the property.  The recording statute in Ohio is quite clear on this point.

On the other hand, do I agree with the notion that a defectively acknowledged mortgage should be treated as unrecorded?  That's by far the majority view, but in this case, the fact that the acknowledgement was defective was subject to debate.  What apparently happened (the court is not crystal clear on the facts) is that the notary used the wrong form of acknowledgement when Odita acknowledged the second version of the mortgage -- they used a corporate acknowledgement form when Odita had signed the mortgage individually, and not as an officer of the corporation.  (It seems to me that he should have signed as a officer of the corporation, since title to the land was held by the corporation, but the court doesn't seem to think that this error, if it was an error, is relevant.)

If my understanding of the facts is correct, then it is true that the acknowledgement was technically defective (since it didn't agree with form of the signature), but it was a sort of chicken-feed defect,.  After all, Odita did sign the mortgage and did appear before the notary.  There is not the slightest suggestion of fraud or forgery.  I would have preferred the court to hold that, despite the technical defect, the mortgage was sufficiently acknowledged to be validly recorded.  Otherwise, the penalty on the mortgagee for allowing a minor error to occur is rather Draconian.

Comment 3: Then I asked Roger Bernhardt to comment.  Roger is the dean of mortgage commentators in California.  Here are Roger’s thoughts:

I like race statutes, and so does the UCC, which provides a nice source of authority to answer questions like these.

If Ohio's recording act really is pure race for mortgages, then MERS should win if its mortgage was recorded, and it should lose if it wasn't. What the other parties knew wouldn't matter (and shouldn't matter, since that only invites perjury).

Was this mortgage recorded? It was 1) delivered to the right office, as many statutes require, and 2) it got placed in the records and 3) was properly noted in the right index, as a lot of other statutes require, but 4) the notarial seal wasn't the way some other statutes require. It depends on how you define “recording.”

How you define recording ought to depend on what your system's goals are. A race system should protect B as first to record even when he knows that nonrecording A took first, so should the same be true where A did record first, but did so defectively?  I think its meaningless formalism to say A did not record if he is in the records, and I say so for race purposes, and even though notice is not a part of the statute. 

Race statutes contain an implicit notice component.  The real policy reason for letting first recording A win in a race state is  that by being in the records for B to see, B can avoid harm by searching and then declining to proceed when he does see A. Conversely, If B cannot see A in the records, A should be deemed to have not recorded. And conconversely, if A is there enough to be seen (like an adverse possessor being open & notorious), then A should be deemed to have recorded, even if there is something slightly wrong in the way he did it, if B can see it.

That is an objective test that doesn't depend on anybody's testimony.  If a standard search of the records should turn up the mortgage, then it should be deemed recorded.

Article 9,  which is about as tough as you can get in favor of a pure system, says a minor error does not ruin a filing unless it makes the financing statement seriously misleading, and that that depends on the office's search logic.  Under any search logic, a notarial seal is what a searcher sees last, so its absence ipso facto cannot be seriously misleading. Searchers ought to be able to stop their search (even though the news is bad), without having to go on to study the notary stamp after they read the document, and filers shouldn't have to go back to their prior recordings to double check that each detail was done right.

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