Court: Bankruptcy Appellate Panel of the First Circuit; April 17, 2019; Us Bankruptcy; United States Bankruptcy Court
The appeal addresses the bankruptcy court's decision regarding an unrecorded mortgage under Puerto Rico law, specifically whether the court correctly denied the chapter 7 trustee's request to avoid the mortgage and preserve the lien for the bankruptcy estate. The bankruptcy court dismissed the trustee's complaint for failure to state plausible claims under sections 544 and 551 of the Bankruptcy Code. The appellate panel concluded that there was no error in the bankruptcy court's actions and affirmed the decision.
Background details include that the debtor, Eduardo Rivera Mercado, acquired property in Orocovis, Puerto Rico, in 2002 and executed a mortgage in favor of Metro Island Mortgage Inc. in 2014, which was never recorded in the Puerto Rico Property Registry. The debtor filed for chapter 7 bankruptcy in December 2015, listing a 50% interest in the property and claiming a homestead exemption. Banco Popular de Puerto Rico (BPPR) later became the holder of the mortgage note. In November 2017, the chapter 7 trustee filed a complaint against BPPR seeking to avoid the unrecorded mortgage, arguing it was either a post-petition transfer or not properly perfected, allowing avoidance as a hypothetical lien creditor.
BPPR admitted the mortgage was unrecorded but denied that it was a post-petition transfer or that it created an avoidable lien. They argued that the debtor, who claimed a homestead exemption, was an indispensable party not included in the complaint. The bankruptcy court ultimately granted BPPR's motion to dismiss the trustee’s complaint, leading to the appeal.
In February 2018, the Trustee filed a motion for judgment on the pleadings under Rule 12(c), asserting that the facts were undisputed and that he had the legal right to avoid an unrecorded Mortgage under Sections 549 and 544, preserving it for the estate under Section 551. The Trustee claimed the Mortgage could be recorded at any time, representing a post-petition property transfer that needed court authorization under Section 549. He did not provide legal support for this claim. Alternatively, he argued that the Mortgage was "unperfected" under Puerto Rican law at the time of the petition, making it voidable under Section 544, referencing two cases for support: Matienzo Lopez, which found an unrecorded mortgage avoidable, and Traverse, which upheld a trustee's ability to avoid unperfected liens.
In opposition, BPPR argued that the Trustee's reliance on Traverse was erroneous, citing the case of Schwarz Reitman, where the court ruled that under Puerto Rican law, an unrecorded mortgage is a nullity and Sections 544 and 551 do not apply. BPPR highlighted that the Trustee failed to address or differentiate the ruling in Schwarz Reitman. The Trustee requested the bankruptcy court to declare the Mortgage an "avoidable transfer," preserve the mortgage lien for the estate, and grant any other appropriate remedies.
On June 15, 2018, the bankruptcy court issued an order denying the Trustee's request for judgment on the pleadings and dismissing the complaint without a hearing. The court determined that the unrecorded mortgage did not qualify as a "transfer" that could be avoided under sections 544 and 551 of the Bankruptcy Code. Under Puerto Rico law, a mortgage must be recorded to create a valid lien; unrecorded mortgages are deemed non-existent, thus BPPR's unrecorded mortgage did not establish a lien or security interest over the property. The court found that no pre-petition transfer had occurred in favor of BPPR and ruled that the Trustee could neither avoid the unrecorded mortgage nor preserve it for the estate.
The court also differentiated this case from the precedent set in Traverse, citing fundamental differences in mortgage laws between Puerto Rico and Massachusetts. In Massachusetts, an unrecorded mortgage is enforceable between the mortgagee and mortgagor, while in Puerto Rico, it is unenforceable among all parties. In lien theory jurisdictions like Puerto Rico, the mortgagee must record the mortgage to secure a lien, and without a recorded deed, the mortgage does not permit foreclosure rights. Therefore, the court dismissed the complaint for failure to state plausible claims for relief under the relevant bankruptcy provisions.
The bankruptcy court determined that the Trustee could not assert superior rights over BPPR due to BPPR's failure to record its mortgage deed in the Puerto Rico Property Registry, rendering the mortgage lien nonexistent under local law. Consequently, the Trustee could not avoid the mortgage under 11 U.S.C. § 544 or preserve it for the estate under § 551, as no property transfer occurred. The court rejected the Trustee's alternative argument regarding post-petition transfer under § 549, stating that this provision was irrelevant since the mortgage deed was executed prepetition. The court denied the Trustee's request for judgment on the pleadings, dismissing the action for failure to state plausible claims related to avoidance and preservation actions.
On June 26, 2018, the bankruptcy court issued a judgment dismissing the adversary proceeding, which the Trustee did not seek to vacate or reconsider. Two days later, the Trustee filed a notice of appeal, questioning whether the bankruptcy court erred in its dismissal regarding the unrecorded mortgage under §§ 544 and 551. The Trustee argued that the bankruptcy court wrongly concluded that the case law from Traverse did not apply to the mortgage in question, while BPPR maintained that the court correctly deemed the unrecorded mortgage nonexistent under Puerto Rico law, thus not subject to avoidance or preservation.
The appellate court emphasized the necessity to confirm its jurisdiction prior to addressing the merits of the appeal.
The appeal involves two rulings: the denial of a motion for judgment on the pleadings and the sua sponte dismissal of the complaint. Although the Trustee's notice of appeal primarily addressed the dismissal, subsequent filings clarified his intention to challenge both rulings. BPPR's acknowledgment of both orders in its brief indicates that it was not misled by the notice. Therefore, the appeal includes both the denial under Rule 12(c) and the dismissal under Rule 12(b)(6), aligning with precedents that expand the scope of appeals to include unlisted orders when the intent is clear and both parties treat the appeal as encompassing those orders.
Regarding finality, the Panel can hear appeals from final judgments as per 28 U.S.C. 158(a) and (b). Typically, a denial of a motion for judgment on the pleadings is considered interlocutory and not immediately appealable. However, since the bankruptcy court dismissed the complaint, concluding the dispute, this dismissal is a final, appealable order. Under the "merger rule," prior interlocutory orders can merge with the final order, allowing for review of both the dismissal and the denial of the motion for judgment on the pleadings. The standard of review includes clear error for factual findings and de novo for conclusions of law, with appellate courts also reviewing motions for judgment on the pleadings and dismissals under Rule 12(b)(6) de novo.
A motion for judgment on the pleadings, governed by Rule 12(c) and applicable in bankruptcy through Bankruptcy Rule 7012, allows a party to seek a ruling after pleadings are closed but before trial, provided it does not delay the proceedings. The standard for evaluating this motion parallels that of a Rule 12(b)(6) motion to dismiss for failure to state a claim. Both rules require that pleadings favoring the non-movant must establish a plausible claim. A complaint must allege a plausible entitlement to relief, demonstrating facial plausibility through factual content that enables the court to infer the defendant's liability for the alleged misconduct. Key cases cited include Pérez-Acevedo v. Rivero-Cubano, In re Best, and In re Blackstone Financial Holdings, which reinforce the necessity of a reasonable inference of liability based on the plaintiff's allegations.
The Bankruptcy Code grants trustees "avoidance powers" to recover property for the estate, set aside liens, and manage executory contracts and leases. The Trustee aimed to utilize these powers under Sections 549 and 544 to avoid a Mortgage. Section 549(a) allows a trustee to avoid property transfers made post-bankruptcy filing that lack authorization by the Bankruptcy Code or court. The burden of proof for a valid transfer under this section lies with the entity asserting its validity. Section 544(a) enables the trustee to avoid transfers by the debtor that could be voided by a hypothetical lien creditor or bona fide purchaser (BFP). The rights of these hypothetical parties are dictated by state law. If a trustee successfully avoids a transfer under either section, it is preserved for the estate under Section 551. However, if a transfer is not avoidable, the trustee cannot preserve it under Section 551. Cases cited illustrate that if a mortgage cannot be avoided under Section 544(a)(3), it cannot be preserved under Section 551.
To avoid the unrecorded Mortgage under sections 549 or 544, the Trustee must first establish that a "transfer" of property occurred. This determination is essential for both avoidance actions as established in Oliveras v. Banco Popular de P.R. and Schechter v. Weiler. The critical question is whether BPPR's unrecorded Mortgage qualifies as a "transfer" of the Debtor's interest in the Property, as defined by the Bankruptcy Code. The term "transfer" encompasses the creation of a lien, retention of title as a security interest, foreclosure of a debtor's equity of redemption, and various methods of disposing of property or interests in property (11 U.S.C. 101(54)). A "lien" is defined as a charge against or interest in property to secure a debt (11 U.S.C. 101(37)). State law governs the creation and definition of property interests, including mortgages. Therefore, to determine if the Debtor transferred any interest to BPPR, applicable state law must be consulted, referencing the principles established in Stern v. Marshall and Butner v. United States, which emphasize the primacy of state law in defining property interests in bankruptcy contexts.
Applicable laws in this case are those of Puerto Rico, regarded as equivalent to state laws. Until December 8, 2015, the Puerto Rico Mortgage and Property Registry Act of 1979 and certain portions of the Civil Code governed mortgages in Puerto Rico. The Civil Code outlines essential requirements for a mortgage, emphasizing that it must secure a principal obligation. A mortgage is considered valid only if it is stipulated in a deed and recorded in the Property Registry. Recording is crucial for the validity of a mortgage; an unrecorded mortgage is deemed a nullity under Puerto Rico law. The First Circuit has asserted that without proper recording, a creditor only holds an unsecured personal obligation concerning the debt. Consequently, failure to record a mortgage deed transforms the promissory note into a personal obligation, enforceable only against the maker, and does not grant the lender a lien or security interest in real property. Recording is thus a necessary prerequisite for the valid constitution of a mortgage in Puerto Rico.
A mortgage serves as a conveyance of interest in real property to secure a debt, with its nature depending on jurisdictional theory. In title theory states, like Massachusetts, the mortgagee holds legal title until the mortgage is satisfied, while the mortgagor retains the equity of redemption. The mortgage in these states acts as a title transfer document. Conversely, lien theory jurisdictions, such as Puerto Rico, allow the mortgagor to retain both legal and equitable title, with the mortgage representing merely a security interest. This distinction is crucial when dealing with unrecorded mortgages. In Massachusetts, an unrecorded mortgage grants the lender an unperfected interest in the property, whereas in Puerto Rico, it has no legal effect. The First Circuit has ruled that a chapter 7 trustee can avoid unrecorded mortgages under 11 U.S.C. §§ 544 and 551, preserving the mortgage for the estate's benefit. The trustee can invalidate unperfected liens using strong-arm provisions, allowing the estate to assume the position of the avoided lien creditor.
Recent cases in the U.S. Bankruptcy Court for the District of Puerto Rico have addressed whether a chapter 7 trustee can avoid an unrecorded mortgage and preserve it for the estate's benefit. The court in Schwarz Reitman determined that a trustee cannot avoid and preserve such a mortgage. Initially, another bankruptcy judge had ruled that a chapter 7 trustee could avoid and preserve an unrecorded mortgage but later reversed this decision, consistently ruling thereafter that a trustee cannot avoid and preserve an unrecorded Puerto Rico mortgage under Sections 544 and 551.
In Schwarz Reitman, the court ruled that a Chapter 7 trustee cannot avoid and preserve an unrecorded Puerto Rico mortgage under sections 544 and 551 of the Bankruptcy Code. The judge clarified that the precedent set in Traverse, which is based on Massachusetts law where an unrecorded mortgage is an unperfected interest, does not apply to Puerto Rico law. In Puerto Rico, an unrecorded mortgage is considered a "nullity," meaning it does not confer any title, lien, or security interest in real property. The law mandates that mortgages must be recorded in the Property Registry to be valid; otherwise, the lender lacks any claim to the property.
Puerto Rico operates under a lien theory and judicial foreclosure system, contrasting with Massachusetts's title theory and non-judicial foreclosure approach. An unperfected mortgage deed in Puerto Rico does not allow the mortgagee to foreclose on the property, and the lender must take additional legal actions to establish an interest. Consequently, the trustee cannot pursue avoidance or preservation actions because, under local law, there is no enforceable interest in the property beyond that of the debtor. The ruling affirms that a lender without a recorded mortgage deed has no rights superior to the debtor's.
Rosas Garcia and Lopez Cancel involve a bankruptcy judge in the District of Puerto Rico who ruled that a chapter 7 trustee could not avoid an unrecorded Puerto Rico mortgage under sections 544 and 551, aligning with the reasoning from the case Schwarz Reitman. The judge's decision in Segarra v. Banco Popular de P.R. (Lopez Cancel) and Segarra Miranda v. Banco Popular de P.R. (Rosas Garcia) reflects a reversal of his earlier stance in Matienzo Lopez, which had supported the Trustee's position. In affirming the dismissal of the Trustee's complaint, the bankruptcy court applied relevant First Circuit and Puerto Rico law correctly.
The appeal encompasses both the dismissal of the complaint and the denial of the motion for judgment on the pleadings, despite the Trustee's notice of appeal primarily focusing on the dismissal. BPPR's acknowledgment of both rulings indicates that it was not misled, thereby validating the broader scope of the appeal.
Regarding finality, while an order denying a motion for judgment on the pleadings is typically interlocutory, the simultaneous dismissal of the complaint concludes the dispute, allowing for review. Under the "merger rule," prior interlocutory orders merge with the final judgment, making them subject to appellate review. Orders dismissing complaints are considered final and appealable, as established in various precedents.
Jurisdiction is established to review both the dismissal of the complaint and the denial of the motion for judgment on the pleadings. The standard of review for bankruptcy court findings of fact is for clear error, while conclusions of law are reviewed de novo. Appellate courts also apply de novo review for motions for judgment on the pleadings and dismissals under Rule 12(b)(6) for failure to state a claim.
A motion for judgment on the pleadings, governed by Rule 12(c) and applicable in bankruptcy via Bankruptcy Rule 7012, allows a party to seek judgment after pleadings are closed but before trial. The evaluation standard for Rule 12(c) is similar to that of Rule 12(b)(6), requiring that pleadings in favor of the non-movant establish a plausible claim. To survive a Rule 12(c) motion, a complaint must show a plausible entitlement to relief, meaning it must present factual content that supports a reasonable inference of the defendant's liability.
The Bankruptcy Code provides the trustee with avoidance powers to recover property, set aside certain liens, and manage executory contracts. The Trustee aimed to utilize these powers under sections 549 and 544 to avoid a Mortgage. Section 549(a) allows the trustee to avoid unauthorized transfers of estate property made post-bankruptcy filing. The burden of proof for asserting the validity of such a transfer lies with the entity claiming it. Section 544(a), known as the "strong arm" clause, grants the trustee the ability to avoid transfers that could be voided by hypothetical lien creditors or bona fide purchasers.
A bankruptcy trustee may avoid a mortgage under § 544(a) if it could be avoided by a hypothetical lien creditor or bona fide purchaser (BFP), as established in Hamilton v. Wash. Mut. Bank FA. The rights and status of these hypothetical parties are determined by state law. If a trustee successfully avoids a transfer under §§ 549 or 544, the property is preserved for the bankruptcy estate under § 551. However, if a transfer cannot be avoided, preservation under § 551 is not possible, as illustrated in Hutchinson v. United States and Hardesty v. Citifinancial, Inc.
To avoid an unrecorded mortgage, the trustee must first establish that a "transfer" occurred, as defined by the Bankruptcy Code. The definition includes the creation of a lien and various modes of disposing of property. A lien, as defined under § 101(37), secures payment of a debt and must be assessed based on applicable state law, as property interests are created by state law. The determination of whether the debtor transferred an interest to BPPR requires an analysis of Puerto Rico's laws, which are comparable to state laws.
Puerto Rico's Mortgage Law, until December 8, 2015, was governed by the Mortgage and Property Registry Act of 1979 and relevant sections of the Civil Code, which defined the essential requisites for a valid mortgage. A mortgage must be established through a deed that is recorded in the Property Registry; failure to do so renders the mortgage invalid and converts the underlying obligation into an unsecured personal debt. Recording is deemed a constitutive act necessary for the mortgage's validity, as emphasized by various court cases, notably Soto-Rios v. Banco Popular de P.R.
In terms of mortgage theory, Puerto Rico adheres to the lien theory, where a mortgage creates a lien interest without transferring legal title from the mortgagor to the mortgagee. This contrasts with jurisdictions like Massachusetts, which follow the title theory, where the mortgagee holds legal title until the debt is satisfied or the property is foreclosed. Under the lien theory, the mortgagor retains both legal and equitable title during the debt repayment period.
The distinction between title theory and lien theory in mortgage law is crucial, particularly regarding unrecorded mortgages. In title theory jurisdictions, such as Massachusetts, an unrecorded mortgage grants the lender an interest in the property, albeit an unperfected one. Conversely, in lien theory jurisdictions like Puerto Rico, an unrecorded mortgage is ineffective, providing neither title nor a valid lien. Recent First Circuit cases have examined whether a Chapter 7 trustee can avoid unrecorded mortgages to benefit the estate. The First Circuit ruled in Traverse that under Massachusetts law, a trustee could avoid an unrecorded mortgage due to the creditor's unperfected lien, utilizing the avoidance and preservation powers under 11 U.S.C. §§ 544 and 551. In contrast, bankruptcy courts in Puerto Rico, including the case of Schwarz Reitman, have concluded that a Chapter 7 trustee cannot avoid an unrecorded mortgage, differentiating Puerto Rico's mortgage law as treating such mortgages as a nullity, thus not subject to avoidance or preservation under the same federal provisions.
Under Massachusetts law, an unrecorded mortgage grants a lender an interest in real property, whereas Puerto Rico law treats unrecorded mortgages differently, denying lenders any title, lien, or security interest in real property. Puerto Rico operates under a lien theory and judicial-foreclosure jurisdiction, requiring mortgages to be recorded in the Registry of Property to be valid. Without recording, a mortgage is unperfected, meaning the lender lacks the right to foreclose. To perfect an interest, a lender must either file a collection action or obtain a judgment and record it.
The legal framework in Puerto Rico specifies that an unrecorded mortgage deed does not constitute a lien or provide an enforceable interest, unlike Massachusetts, which recognizes the mortgagee's legal title upon execution. Consequently, a bankruptcy trustee cannot assert avoidance or preservation actions related to unrecorded mortgages in Puerto Rico, as no enforceable interest exists to challenge. This principle has been upheld in recent rulings by bankruptcy judges in Puerto Rico, confirming that a chapter 7 trustee is unable to avoid or preserve unrecorded mortgages.
The bankruptcy court's decision in Segarra v. Banco Popular and In re Lopez Cancel, as well as in In re Rosas Garcia, reflects a shift from previous rulings, specifically Matienzo Lopez, which supported the Trustee's argument. The court ruled that since the mortgage in question was not recorded in the Property Registry, it was deemed "nonexistent" under Puerto Rico law, thus negating any pre-petition transfer of property interest. This ruling, aligned with First Circuit and Puerto Rico law, particularly as articulated in Soto-Rios and followed in Schwarz Reitman, led to the conclusion that the Trustee could not avoid the unrecorded mortgage under § 544 nor preserve it for the estate under § 551.
Furthermore, the bankruptcy court rejected the Trustee's assertion that the Massachusetts mortgage law was nearly identical to Puerto Rico law, primarily because the Trustee cited the wrong Massachusetts statute and failed to address relevant precedents like Schwarz Reitman. The Trustee's reliance on Mass. Gen. Laws ch. 185, § 67, which concerns registered land, was deemed inappropriate as it did not apply to the case at hand. The court maintained that the differences in mortgage laws between the two jurisdictions were significant enough to render the Massachusetts law inapplicable to the current case.
In Massachusetts, real property is categorized as either "registered" land, governed by a land registration system, or "unregistered (recorded)" land, governed by a land recording system. Registered land undergoes an adjudication process in the Land Court to quiet title, with the Commonwealth guaranteeing and insuring the title. The title for registered land is certified, and a certificate issued by the Land Court details the land description and encumbrances. Conversely, most real property is unregistered and conveyed through deeds.
Massachusetts General Laws chapter 183, section 4, mandates that certain conveyances, including mortgages, must be recorded in the appropriate registry of deeds to be valid against third parties without actual notice. An unrecorded mortgage is ineffective against those parties, as established in case law. However, Massachusetts operates under a title theory, meaning an unrecorded mortgage still grants the lender a lien on the property, albeit unperfected.
In contrast, Puerto Rico law treats unrecorded mortgages as nonexistent, providing no lien or security interest to the lender. This distinction highlights that Massachusetts and Puerto Rico mortgage laws are not identical, countering the Trustee's claims and affirming the bankruptcy court's decision not to follow precedent from other cases cited by the Trustee.
An unrecorded mortgage in Puerto Rico is deemed "nonexistent" and does not confer any property interest, as established by case law. The Trustee acknowledges some contrary decisions but fails to differentiate them or address the distinctions between Massachusetts and Puerto Rico law impacting those rulings. Consequently, the Trustee has not met the burden to show that the bankruptcy court erred in its assessment, leading to the conclusion that the court correctly ruled under Rule 12(c) that the Trustee did not present a plausible claim for avoiding the unrecorded mortgage under 11 U.S.C. § 544 or preserving it under § 551.
Regarding the avoidance of the mortgage as a post-petition transfer under 11 U.S.C. § 549, the Trustee's argument lacks merit. Section 549(a) allows a trustee to avoid post-petition property transfers that are unauthorized. The Trustee claims that the mortgage could be recorded post-petition, but recording is a constitutive act in Puerto Rico, meaning the mortgage is ineffective and does not create a lien until recorded. Since BPPR never recorded the mortgage, no post-petition transfer occurred, and any future recording is speculative and does not qualify as a post-petition transfer under § 549.
The bankruptcy court dismissed the complaint sua sponte under Rule 12(b)(6), determining that the Trustee did not present plausible claims for relief concerning avoidance and preservation actions under §§ 544 and 551. While a court may dismiss without notice if it is clear the plaintiff cannot prevail, it did not provide the Trustee with notice or an opportunity to amend the complaint in this instance.
Amending the complaint was not necessary to evaluate its dismissal since the Trustee waived any issues regarding the sua sponte dismissal by not including them in the appeal's statement of issues or briefs. The First Circuit has established that failing to adequately address arguments in an appellate brief results in waiver. Specifically, issues related to due process were also waived due to insufficient development in the Trustee's briefs. At oral argument, the Trustee's counsel indicated no desire to amend the complaint, limiting the review to the appropriateness of dismissal under Rule 12(b)(6). This rule allows for dismissal if a claim fails to state a legally cognizable theory or lacks sufficient factual allegations. To survive dismissal, a plaintiff must present enough factual matter for a plausible claim of relief, enabling the court to infer the defendant's liability. The standards for evaluating motions under Rule 12(b)(6) and Rule 12(c) (judgment on the pleadings) are essentially the same. Since the Trustee's complaint did not establish a plausible claim for relief under either rule, it was deemed insufficient and subject to dismissal.
The bankruptcy court concluded that the Trustee did not present a colorable claim for relief under sections 544, 549, and 551 of the Bankruptcy Code, leading to the dismissal of the complaint under Rule 12(b)(6). The appeals court affirmed the bankruptcy court’s decision, noting that the Trustee failed to show plausible claims for avoiding the unrecorded mortgage and preserving it. Additionally, the Trustee waived arguments regarding due process violations related to the lack of notice about the dismissal. The bankruptcy court also identified the Debtor as an "indispensable party" under Bankruptcy Rule 7019, a point that the Trustee did not challenge on appeal, thus waiving the issue. The court criticized the Trustee for not disclosing adverse legal authority relevant to the case. The mortgage in question, executed in 2014, falls under the Mortgage and Property Registry Act of 1979, as the 2015 Property Registry Act does not apply. Under Puerto Rican law, while recording is essential for a valid mortgage, it is the presentment to the Property Registry that establishes priority. Since neither event occurred prior to the Debtor's bankruptcy filing, the court ruled that the Trustee's failure to secure a valid security interest resulted in a windfall for the Debtor, consistent with the Bankruptcy Code and Puerto Rican law. The Trustee conceded that amending his complaint would be futile, anticipating dismissal under Rule 12(b)(6) regardless.
