In re: Denny St. Clair (Kendrick v. Deutsche Bank Nat’l Trust Co.), 2008 FED App. 0001P (6th Cir. B.A.P. Jan. 16, 2008)
In Denny St. Clair, the Bankruptcy Panel of the Sixth Circuit Court of Appeals considered the issue of whether a notary’s acknowledgment of a mortgage in a real estate loan transaction is valid.

This issue can often generate conflict among secured and unsecured creditors when the borrower defaults on the underlying loan.  Validity of the notary’s acknowledgment of a mortgage or deed of trust can impact whether the security instrument is given priority as a secured obligation.  Historically, this issue has created disputes among creditors seeking recovery upon the default of the underlying loan in a bankruptcy situation.  Lately, with courts closely scrutinizing every aspect of the mortgage documents, validity of the notary’s acknowledgment has become more significant for borrowers, lenders, servicers and title insurance companies.

The vulnerability a notary’s acknowledgment to attack turns on applicable state law and provokes a specific inquiry of the facts underlying the transaction.  In Denny St. Clair, the Sixth Circuit Court of Appeals confirmed that it is difficult to successfully challenge a notary’s acknowledgment-- at least in Kentucky.  The difficulty is that successfully challenging an acknowledgment that is valid on its face requires proof of fraud or a mistake that harms the borrower.

The Denny St. Clair Case 
 In Denny St. Clair, the bankruptcy trustee sought to avoid a mortgage on the bankruptcy debtors’ real property by alleging that the notary’s acknowledgment on the mortgage was defective.  The parties stipulated that the debtors did not sign the mortgage in the presence of a notary, yet neither the bankruptcy court nor the appellate panel invalidated the mortgage for this defect.   

The court first decided that the notary’s acknowledgment was valid on its face.  The test the court used was whether a potential bona fide purchaser could have known that the acknowledgment was defective by looking at it.  This decision was important to the court’s ultimate conclusion, as facially invalid acknowledgments fail to provide the necessary element of constructive notice to potential bona fide purchasers.   

The next step in the court’s analysis was to review KRS Sec.61.060 to see if it would allow the trustee to avoid the mortgage. Section 61.060 permits a notary’s acknowledgment to be challenged in three situations:  (1) a direct action against the notary; (2) an allegation of fraud by the party benefited; and (3) a mistake by the notary.  The trustee did not seek recovery directly from the notary, so the court focused on the existence of proper allegations of fraud or mistake. 

The court concluded that the Trustee had not properly alleged fraud because there was no claim that fraud was committed by, or on behalf of, the party who would have benefited from the fraud, which was the lender.  Thus, the fraud claim failed. 

Next, the court considered the allegation of mistake.  Concluding that there was no actionable mistake, the court emphasized that not only was there no allegation that the debtors were harmed by the notary’s “mistake”, the debtors actually benefited from it!   Citing precedent, the court then observed that the legislative purpose of Sec.61.060 “to stabilize the public records and make title to real estate in Kentucky more secure.”   The court ruled that the mortgage was effective, notwithstanding the defective acknowledgment.   In its opinion, the court warned that allowing outside evidence to effectively question a facially valid and legally compliant real estate document “would promote uncertainty about, and invite unnecessary litigation regarding, innumerable real estate documents.” 

The Consequences 
The ruling that facially valid notary acknowledgments will be upheld, except in narrow and unusual instances, injects stability and certainty to Kentucky real estate transactions.  Of course, we must emphasize that Denny St. Clair involved Kentucky state real estate law is not uniform from state to state.  Lenders, servicers and title companies should take care to ensure that acknowledgments are properly executed, notwithstanding the holding in Denny St. Clair.

To view a copy of the ruling, please click here.

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Safeguard Properties is the largest privately held field services company in the country. Located in Cleveland, Ohio and founded in 1990 by Robert Klein, Safeguard has grown from a regional preservation company with a few employees and a handful of contractors performing services in the Midwest, to a national company with over 450 employees. Safeguard is supported by a nationwide network of subcontractors able to perform any requested superintendence, preservation, and maintenance functions, as well as numerous ancillary services in the U.S., the Virgin Islands, and Puerto Rico.