Daily Development for Tuesday, February 19, 2002

By: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
prandolph@cctr.umkc.edu

MORTGAGES; PRIORITY; INQUIRY NOTICE: Recorded deed of trust that refers to an unrecorded $"65,000 note" does not put subsequent purchase of encumbered land inquiry notice of additional indebtedness described in the note but not described in the deed of trust.

Kalange v. Rencher, 30 P.3d 970 (Idaho 2001).

In 1991 Kalange sold to Farnsworth all outstanding stock in the Twin Falls Athletic Club. Farnsworth executed a note to Kalange (the "1991 note") which was secured by a deed of trust which was later re-conveyed of record.

In 1994 Farnsworth borrowed additional monies from Kalange and recorded a deed of trust (the "1994 Deed of Trust") which stated that it "secured a $65,000 note" (the $65,000 Note"). The $65,000 Note addressed a current debt of $65,000, but also contained provisions that added certain sums still owed under the 1991 Note as a debt and that would allow Kalange to share in the proceeds of certain sales or to receive an "alternative performance payment" equal to $50,000 if such sales did not take place.

Thereafter Farnsworth borrowed certain additional monies from Rencher. Rencher filed a deed a trust on November 21, 1995. Farnsworth defaulted to Kalange, Kalange brought suit to foreclose against Farnsworth and sought a determination that the 1994 Deed of Trust was prior to Rencher's both with respect to (a) the $65,000 as recited on the face of the 1994 Deed of Trust and (b) the balance due on the 1991 Note and the $50,000 alternative performance payment. The District Court held that while the 1994 Deed of Trust to Kalange would take priority over Rencher's liens to the extent of the $65,000 note described on its face, the 1994 Deed of Trust did not take priority over Rencher for the unpaid balance of the 1991 Note and the $50,000 alternative performance payment. The District Court held that since Rencher did not have constructive notice of the 1991 Note or the alternative performance payment, he therefore took his interests as a bona fide purchaser with respect to those ite ms.

Kalange appealed to the Idaho Supreme Court, arguing that the 1994 Deed of Trust should have put Rencher on notice of the 1991 Note and the $50,000 alternative performance payment because the 1994 Deed of Trust put Rencher on notice of the terms of the $65,000 Note and the associated loan agreement. The Idaho Supreme Court noted that there is a presumption that a mortgage secures the sum expressed therein and that the mortgagee bears the burden of proof on the claim that the mortgage covers an amount greater than the sum stated.

While noting that a purchaser is charged with every document shown by the public record and is presumed to know every other fact which an examination suggested by the record would have disclosed, the Idaho Supreme Court stated that nothing on the face of the 1994 Deed of Trust suggested that a more complete description of the underlying debt would be found in documents outside of the record. Therefore, Kalange failed to protect himself by including information concerning the 1991 Note and $50,000 alternative performance payment in the 1994 Deed of Trust.

Kalange also asserted that because Rencher had knowledge that Farnsworth owed additional amounts to Kalange, that knowledge was sufficient to put Rencher on inquiry notice and thus to give the 1994 Deed of Trust priority with respect to amounts noted stated on its face, but known to Rencher. The Idaho Supreme Court found that Rencher's knowledge that Farnsworth owed amounts to Kalange was not equivalent to Rencher's knowledge that there was a security interest created by the 1994 Deed of Trust on behalf of the 1991 Note or the alternative performance payment. Therefore, again, Rencher's deed of trust remained superior to those interests.

Comment: The court got it right, of course. Recorded instruments might refer to lots of other documents, but one shouldn't, by that reference, be placed on notice of the contents of all of them. Unless there is some other reason to believe that the recorded documents contain something relevant to understanding the transaction at hand, there ought to be no duty of examination. Typically, promissory notes do not contain information about various debts. Kalange should have seen to it that the debt was reflected in the record.

Having said that, the Editor confesses that there is a lot of room for ambiguity here. What if the deed of trust had referred to a loan agreement, rather than to a promissory note, and the loan agreement provided for future advances? What if a memorandum of lease referred to a lease, but didn't mention an option to purchase contained in it? In both of the above examples, the editor would prefer a rule requiring the party doing the recording to see to it that complete evidence of its rights goes into the record. But the Editor wouldn't be surprised to see cases go the other way.

One could argue, of course, that both a loan agreement and a lease are more likely to contain relevant information, and that inquiry notice of the contents of those documents might exist even when there is no duty of inquiry regarding an apparently simple promissory note. The Editor would go further. The party that has the power to prevent misunderstanding ought to have the duty to do so.

Readers are urged to respond, comment, and argue with the daily development or the editor's comments about it.

Items in the Daily Development section generally are extracted from the Quarterly Report on Developments in Real Estate Law, published by the ABA Section on Real Property, Probate & Trust Law. Subscriptions to the Quarterly Report are available to Section members only. The cost is nominal. For the last six years, these Reports have been collated, updated, indexed and bound into an Annual Survey of Developments in Real Estate Law, volumes 1‑6, published by the ABA Press. The Annual Survey volumes are available for sale to the public. For the Report or the Survey, contact Maria Tabor at the ABA. (312) 988 5590 or mtabor@staff.abanet.org

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