Unpublished Disposition, 874 F.2d 815 (9th Cir. 1987)

MEMORANDUM^* 

Trustee, Robert G. Ludwick, Inc. appeals the district court's decision reversing the bankruptcy court and remanding the case: (1) to deny the trustee's application to avoid a deed of trust given to F. Warren Lovell and Mary M. Hudson ("Lovell-Hudson") by the debtors Don Paul Bick and Katherine Marie Bick and (2) to grant the Lovell-Hudsons' application for reformation and for a determination of their motion for relief from stay. The deed of trust was recorded initially with an inadequate description of the property securing the debt and was recorded a second time with a wrong description. The trustee argues that, as a hypothetical bona fide purchaser under 11 U.S.C. § 544(a) (3), he was entitled to avoid the deed of trust because he would not have had notice through the deed of trust. We affirm.

Factual and Procedural Background

The Bicks purchased from the Lovell-Hudsons in 1984, real property which was located on the west half of the west half of Section 27, Township 38 North, Range 30, E.W.M., in Okanogan County, Washington. To effectuate the purchase, the Bicks executed a promissory note, secured by a deed of trust. On April 26, 1984, the deed of trust with an incomplete legal description because it was without a range number, was recorded along with the warranty deed that had the correct range number. Four days later, the deed of trust was recorded again but with a wrong range number which then described United States Forest Service property rather than the purchased property. On June 30, 1986, after the Bicks had filed their Chapter 11 petition, the deed of trust with the correct range number was finally recorded.

In December of 1986, the Lovell-Hudsons moved for relief from stay pursuant to 11 U.S.C. § 362(d) and the trustee responded by asserting that the Lovell-Hudson's lien was avoidable under 11 U.S.C. § 544. On February 27, 1987, the bankruptcy court denied Lovell-Hudson's motion for relief from stay and granted the trustee's application for avoidance.

On September 21, 1987, the district court reversed the bankruptcy court, holding that the trustee's reliance upon McCannon v. Marston, 679 F.2d 13 (3rd Cir. 1982) to argue that actual knowledge does not affect a trustee's ability to avoid a lien, was in error because McCannon had been overruled.

The district court also ruled that Section 544 did not entitle the trustee to avoid the Lovell-Hudson's lien. The court focused upon the record that contained: (1) a debtors' schedule from the Bicks listing Lovell-Hudson as a secured creditor; (2) a warranty deed that correctly described the property in question; and (3) two deeds of trust that incorrectly described the property. The court concluded that the "character and total content" of information available to the trustee would have put a bona fide purchaser on notice as to the Lovell-Hudson's security interest.

Discussion

1. Actual Knowledge Gained from the Bankruptcy Schedules

This court independently reviews the bankruptcy court's decision. Ragsdale v. Haller, 780 F.2d 794, 795 (9th Cir. 1986). The issue of whether actual knowledge of a lien prevents the trustee from avoiding that lien involves an interpretation of 11 U.S.C. § 544(a) (3). The interpretation of a statute is to be reviewed de novo. In re Southwest Aircraft Services, 831 F.2d 848 (9th Cir. 1987).

Section 544(a) (3) provides that a trustee, without regard to "any knowledge" of the trustee, can avoid an obligation incurred by a debtor that is voidable by a bona fide purchaser of real property. The term "any knowledge" includes actual knowledge, according to the trustee. Therefore, the trustee's actual knowledge of the deed of trust, gained from the bankruptcy schedules should not prevent him from avoiding Lovell-Hudson's lien. For support, the trustee relies upon McCannon v. Marston, 679 F.2d 13 (3rd Cir. 1982), a case which he argues, has not been overruled.

In McCannon, the Third Circuit reviewed the legislative history of Section 544(a) (3) and stated:

[T]he reference to the trustee's or creditor's knowledge appears to have originated out of a concern that actual knowledge might affect the trustee's status as a hypothetical judicial lien creditor. [T]he trustee's status as hypothetical lien creditor should not be affected by any knowledge which he, personally, or any or all creditors may have.

McCannon, 679 F.2d at 16. McCannon retains its validity and the district court erred by relying upon the trustee's actual knowledge from the bankruptcy schedule as one of the reasons for denying the trustee's application. However, the case is not dispositive for the reasons hereinafter delineated.

2. Constructive Notice from the Warranty Deed and Deeds of Trust

Under 11 U.S.C. § 544(a) (3), trustees are placed in the position of a hypothetical bona fide purchaser of real property with respect to their ability to void an obligation incurred by a debtor. The rights of a bona fide purchaser are determined by state law. In re Washburn and Roberts, Inc., 795 F.2d 870, 872 (9th Cir. 1986). We review the district court's construction of Washington state law de novo. In the Matter of McLinn, 739 F.2d 1395, 1397 (9th Cir. 1984).

Under Washington law, a bona fide purchaser is: 1) a purchaser, 2) who acts in good faith, 3) has paid value, and 4) does not have "notice", actual or constructive, of the rights, equities, or claims of others to or against the property. Biles-Coleman Lumber Co. v. Lesamiz, 49 Wash. 2d 436, 302 P.2d 198 (1956).

It is a well-settled rule that where a purchaser has knowledge or information of facts which are sufficient to put an ordinarily prudent man upon inquiry, and the inquiry, if followed with reasonable diligence, would lead to the discovery of defects in the title or of equitable rights of others affecting the property in question, the purchaser will be held chargeable with knowledge thereof and will not be heard to say that he did not actually know of them. In other words, knowledge of facts sufficient to excite inquiry is constructive notice of all that the inquiry would have disclosed.

Miebach v. Colasurdo, 102 Wash. 2d 1770, 685 P.2d 1074, 1078 (1984), citing Peterson v. Weist, 48 Wash. 339, 341, 93 P. 519 (1908). All real property conveyances are to be recorded in the office of the county auditor in order to give the conveyances priority over subsequent interests. Conveyances are defined as any written instrument by which the title to real property may be affected. Wash.Rev.Code Sec. 65.08.060 (1927). At the county auditor's, conveyances are indexed by the date of recording, names of the grantor and grantee, nature of the instrument, volume and page where recorded, remarks and description of the property. Wash.Rev.Code Sec. 65.04.070 (1881).

The trustee concedes that the original recording of the deed of trust without the range number would have put him on constructive notice even with its inadequate description. However, the trustee argues that the second recording of the deed, with its description of existing property, relieved him of the duty to inquire about the Lovell-Hudson's interest.

For support, the trustee relies upon Koch v. Swanson, 4 Wash. App. 456, 481 P.2d 915 (1971) where the court held that a purchaser was not put on notice as to a security interest in Tract 124 property when the mortgage and warranty deed erroneously referred to Tract 125. The court reasoned that the strength of the Washington recording system would be destroyed if all purchasers were required to investigate each and every conveyance of a grantor recorded in the county auditor's office for possible errors in instruments describing existing property. Id. at 918.

The Koch case, however, is not applicable to the instant appeal. In Koch, the only documents indicating the plaintiff's interest, the mortgage and warranty deed, both referred to the wrong piece of property, whereas in the instant case, there exists considerably more information.

Indeed, not only was there a deed of trust referring to the wrong piece of property (U.S. Government property), but there was also a similar deed of trust describing nonexistent land as well as a warranty deed describing the correct piece of property and each involved the same parties.

The existence of the warranty deed with the correct legal description would have compelled a reasonable person to have investigated further because: " [a] party cannot rely on so much of a public record as is favorable to his contention, and close his eyes to the remainder." Schmidt v. Olympia Light and Power Co., 46 Wash. 360, 90 P. 212, 216 (1907).

In Schmidt, the owners of a one-acre tract brought a quiet title action over a water right easement across an adjoining four-acre tract. Although the record for the dominant estate only contained evidence of a lesser water right, the plaintiffs claimed entitlement to a greater water right due to an unrecorded deed reserving the greater right for the one-acre tract.

Not persuaded, the court in Schmidt relied upon the fact that the owners of the one-acre estate were unable to prove that the purchasers of the servient four-acre estate had notice of the unrecorded deed. The court found it also significant that a lis pendens existed in the record for the servient four-acre estate, advising of foreclosure proceedings in which judgment had been entered declaring that the one-acre tract only had a lesser water right. Based upon that record, the Schmidt court concluded that the purchasers of the four-acre tract were bona fide purchasers of property subject to the lesser water right.

Applying the analysis in Schmidt, we find all conveyances in the record to be significant to subsequent purchasers. In the instant appeal, the record contained a warranty deed recorded on the same date as the deed of trust indicating that a sale took place between the same parties. Furthermore, the warranty deed described property in almost the same way as the property had been described in the deed of trust except for the missing range number. These circumstances would have made it reasonable to inquire whether the three documents were in a related transaction, especially since the warranty deed property actually existed, while the property described by the deed of trust did not.

When an intending purchaser searches the records to ascertain the state of the title, and finds a deed of record good on its face, made by a common grantor, he cannot with impunity ignore it simply because he fails to find of record any property to which the given description is applicable, but must inquire outside of the record whether or not there was at the time the deed was made property to which the description can be applied, and whether the deed conflicts with the title to the property he intends purchasing.

Wetzler v. Nichols, 53 Wash. 285, 101 P. 867, 868 (1909), citing Sengfelder v. Hill, 21 Wash. 379, 58 P. 250, 253 (1899).

Based on the facts of this case, we agree with the district court and hold that the original deed of trust in the instant appeal, though incomplete, could not be ignored even though it was followed by a second incorrect deed of trust because the contemporaneously recorded warranty deed with the correct property description involving the same parties was sufficient to put a purchaser on inquiry notice. The trustee, therefore, was not qualified to avoid the deed of trust as a bona fide purchaser. 11 U.S.C. § 544(a) (3).

The judgment of the district court is AFFIRMED.

O'SCANNLAIN, Circuit Judge, dissenting:

I dissent from the majority's conclusion that the trustee is not qualified to avoid the deed of trust as a bona fide purchaser under 11 U.S.C. § 544(a) (3). Had the trustee searched the index he would have found documents affecting nonexistent property or property other than that referred to in the recorded deed. In my view, this is not enough to constitute constructive notice under Washington law. Instead, I would follow Koch v. Swanson, 4 Wash. App. 456, 481 P.2d 915 (1971), which states: "where existing property is described, the index and the recorded document imparts notice only as to matters within its chain of title.... Therefore, one searching the index has a right to rely upon what the index and recorded document discloses and is not bound to search the record outside the chain of title of the property presently being conveyed."