Bankr. L. Rep. P 77,533, 11 Tex.bankr.ct.rep. 359in the Matter Of: Charles Hamilton, Jr., Debtor.realty Portfolio, Inc., Appellant, v. Charles Hamilton, Jr., Appellee, 125 F.3d 292 (5th Cir. 1997)

Michael J. Pledger, Houston, TX, for Appellant.

John Vincent Burger, The Keeling Law Firm, Houston, TX, for Appellee.

Appeal from the United States District Court for the Southern District of Texas.

Before KING and PARKER, Circuit Judges, and ROSENTHAL^* , District Judge.

ROSENTHAL, District Judge:

A debtor filed a Chapter 13 bankruptcy petition three days after his homestead was sold in a foreclosure sale. When the homeowner filed for bankruptcy protection, the foreclosure purchaser had not filed the substitute trustee's deed. Indeed, the purchaser failed to file and record the deed for another eleven days. The debtor asked the bankruptcy court to avoid the transfer of title to his homestead under 11 U.S.C. §§ 522(h) and 544(a) (3). The bankruptcy court found that the debtor had standing to seek such relief and voided the transfer; the district court affirmed.

This appeal presents the issue of whether a Chapter 13 debtor may avoid a prepetition foreclosure conveyance when the purchaser at the foreclosure sale fails to record the substitute trustee's deed before the bankruptcy filing.

The facts are undisputed. On September 2, 1966, Charles Hamilton, Jr. ("Hamilton"), plaintiff-appellee, executed a promissory note payable to First Continental Corporation. The note was secured by a deed of trust executed on the same date and properly recorded in Harris County, Texas. The deed of trust gave Federal National Mortgage Association ("FNMA") a first lien on Hamilton's homestead property, described as Tracts 8A and 8E, Block 3 of Houston Gardens, in Harris County, Texas. FNMA was the owner and holder of the note and deed of trust; Bank United of Texas, FSB ("Bank United") was the servicing agent for FNMA.

In December 1994, Hamilton defaulted on his note payments and Bank United accelerated the indebtedness. On May 2, 1995, on behalf of Bank United, a substitute trustee conducted a nonjudicial foreclosure sale of the property under the deed of trust. Notice of the foreclosure sale was posted in the Harris County, Texas courthouse. The sale was properly conducted under state law. Defendant-appellant Realty Portfolio, Inc. ("Realty Portfolio") purchased the foreclosed property at the sale.

On May 5, 1995, Hamilton filed personal bankruptcy under Chapter 13. On May 16, 1995, Realty Portfolio recorded its substitute trustee's deed in Harris County, Texas. Hamilton filed this adversary proceeding to avoid the transfer to Realty Portfolio and regain title to the property under 11 U.S.C. §§ 522(h) and 544(a) (3).

On October 17, 1995, following a bench trial, the bankruptcy court divested Realty Portfolio of title to the property, revested title in Hamilton, and awarded Realty Portfolio a lien on the property in the amount of $3,600, the price Realty Portfolio paid for the property at the foreclosure sale. The district court affirmed the judgment of the bankruptcy court. Realty Portfolio appeals.

This court reviews the bankruptcy court's findings of fact for clear error and its conclusions of law de novo. In re Kemp, 52 F.3d 546, 550 (5th Cir. 1995), cited in Traina v. Whitney Nat'l Bank, 109 F.3d 244, 245 (5th Cir. 1997).

A. A CHAPTER 13 DEBTOR'S POWERS OF AVOIDANCE

The threshold issue is whether Hamilton, the Chapter 13 debtor, has standing to exercise the avoidance powers of a Chapter 13 trustee under the Bankruptcy Code. Section 544 of the Bankruptcy Code grants Chapter 13 trustees strong-arm powers to avoid certain prepetition property transfers. 11 U.S.C. § 544(a) (3).¹  Section 1303 of the Bankruptcy Code grants Chapter 13 debtors certain powers otherwise reserved to trustees. 11 U.S.C. § 1303.²  Section 1303 does not include trustees' section 544 strong-arm avoidance powers. There is no specific statutory provision generally authorizing Chapter 13 debtors to exercise trustees' avoidance powers.³ 

A number of bankruptcy courts have found that Chapter 13 debtors may exercise trustees' strong-arm avoidance powers. See Freeman v. Eli Lilly Fed. Credit Union (In re Freeman), 72 B.R. 850, 854 (Bankr.E.D. Va. 1987); Ottaviano v. Sorokin & Sorokin (Matter of Ottaviano), 68 B.R. 238, 240 (Bankr.D. Conn. 1986); Einoder v. Mount Greenwood Bank (In re Einoder), 55 B.R. 319 (Bankr.N.D. Ill. 1985); In re Boyette, 33 B.R. 10, 10-11 (Bankr.N.D. Tex. 1983); In re Hall, 26 B.R. 10, 11 (Bankr.M.D. Fla .1982). In these cases, the courts emphasized the "reality" of Chapter 13 bankruptcies, the limited role of Chapter 13 trustees, and the perceived unfairness to Chapter 13 debtors of denying them standing under section 544.⁴ 

More recently, bankruptcy courts addressing the issue have receded from their earlier opinions and refused to use section 544 to allow Chapter 13 debtors to exercise strong-arm powers reserved for Chapter 13 trustees. See In re Redditt, 146 B.R. 693, 696-701 (Bankr.S.D. Miss. 1992); In re Henderson, 133 B.R. 813, 816-17 (Bankr.W.D. Tex. 1991); In re Tillery, 124 B.R. 127 (Bankr.M.D. Fla .1991); In re Coan, 134 B.R. 670 (Bankr.M.D. Fla .1991); In re Driver, 133 B.R. 476 (Bankr.S.D. Ind. 1991); Bruce v. RepublicBank-South Austin (In re Bruce), 96 B.R. 717, 720-23 (Bankr.W.D. Tex. 1989); In re Mast, 79 B.R. 981 (Bankr.W.D. Mich. 1987). These courts have acknowledged the "realities" of Chapter 13 bankruptcies and the trustees' limited role, the factors emphasized by earlier courts. However, they have also noted the lack of "explicit statutory foundation for the debtor to seek avoidance." In re Redditt, 146 B.R. at 701; In re Bruce, 96 B.R. at 720-21; cf. In re Pointer, 952 F.2d 82, 87-88 (5th Cir.), cert. denied, 505 U.S. 1222, 112 S. Ct. 3035, 120 L. Ed. 2d 904 (1992) (relying on the "plain language of the Code," the court denied standing to a Chapter 11 creditor seeking to invoke avoidance powers under section 549 of the Bankruptcy Code).⁵ 

Under these cases, the debtor, Hamilton, would not have standing through section 1303. However, Congress has specifically authorized narrow exceptions to the general rule that Chapter 13 debtors lack standing to exercise the strong-arm powers of Chapter 13 trustees. In section 522(h), Congress granted debtors the authority to exercise section 544 avoidance powers under specific and limited circumstances.⁶ 

Section 522(h) specifically grants debtors standing to avoid certain involuntary transfers of exempt property, such as homesteads, if the trustees have not themselves attempted to avoid the transfers. 11 U.S.C. § 522(h); see also DeMarah v. United States (In re DeMarah), 62 F.3d 1248 (9th Cir. 1995); cf. In re Henderson, 133 B.R. at 817. The Ninth Circuit has identified a five-part test, that generally tracks section 522(h), to determine the power of a debtor to avoid a transfer of exempt property under section 522(h): (1) the transfer was not a voluntary transfer of property by the debtor; (2) the debtor did not conceal the property; (3) the trustee did not attempt to avoid the transfer; (4) the debtor seeks to exercise an avoidance power usually used by the trustee, listed within § 522(h); and (5) the transferred property is of a kind that the debtor would have been able to exempt from the estate if the trustee had avoided the transfer under one of the provisions in § 522(g). In re DeMarah, 62 F.3d at 1250. The bankruptcy courts addressing this issue have applied section 522(h) to Chapter 13 debtors. See In re Elam, 194 B.R. 412 (Bankr.E.D. Tex. 1996) (citing Young v. Washington Fed. Sav. & Loan Ass'n (In re Young), 156 B.R. 282 (Bankr.D. Idaho 1993)); In re Bruce, 96 B.R. at 721-22; Willis v. Borg-Warner Acceptance Corp. (In re Willis), 48 B.R. 295 (Bankr.S.D. Tex. 1985).⁷ 

In In re Elam, the court found that a Chapter 13 debtor had standing under the "narrow exception" of section 522(h) to seek to avoid the prepetition foreclosure of his homestead. 194 B.R. at 415. The court explained that:

Generally, Chapter 13 debtors may not exercise the statutory avoiding powers, at least not without prior authorization of the Court obtained after notice and a hearing and upon a showing that the Chapter 13 Trustee has neglected or refused to prosecute the action. In re Young, 156 B.R. 282, 284 (Bankr.D. Idaho 1993). However, there is a narrow exception to the general rule. Section 522(h) of the Code specifically grants a debtor standing to avoid certain involuntary transfers of exempt property. 11 U.S.C. § 522(h); In re Young, 156 B.R. at 284.... The transfer involved here was the foreclosure of Debtor's homestead. This clearly falls within the exception. Therefore, Debtor has standing to bring an avoidance action under section [ ] ... 544.

In re Elam, 194 B.R. at 415.

In this case, as in In re Elam, the debtor's property was exempt as his homestead; the foreclosure was an involuntary transfer; and the Chapter 13 trustee did not attempt to avoid the transfer. 11 U.S.C. § 522(h). Debtor Hamilton fits the narrow exception under section 522(h) and has standing to seek avoidance of his homestead's foreclosure sale under section 544(a) (3) of the Bankruptcy Code.

B. CONSTRUCTIVE AND INQUIRY NOTICE: THE BONA FIDE PURCHASER

Section 544(a) provides in pertinent part that:

(a) The trustee shall have, as of the commencement of the case, and without regard to any knowledge of the trustee or of any creditor, the rights and powers of, or may avoid any transfer of property of the debtor or any obligation incurred by the debtor that is voidable by--...

(3) a bona fide purchaser of real property, other than fixtures, from the debtor, against whom applicable law permits such transfer to be perfected, that obtains the status of bona fide purchaser at the time of the commencement of the case, whether or not such a purchaser exists.

11 U.S.C. § 544(a) (3). Section 544(a) (3) allows the avoidance of a transfer of real property that is not perfected and enforceable against a bona fide purchaser at the time the bankruptcy petition is filed. In re Elam, 194 B.R. at 416; In re Young, 156 B.R. at 285.⁸ 

While the Bankruptcy Code creates the status of a hypothetical bona fide purchaser, state law defines that status. Mutual Benefit Life Ins. Co. v. Pinetree, Ltd. (In re Pinetree, Ltd.), 876 F.2d 34, 36 (5th Cir. 1989); In re Elam, 194 B.R. at 416. Under Texas law, a "bona fide purchaser is one who acquires (apparent) legal title to property in good faith for a valuable consideration without ... notice of an infirmity in the title." Williams v. Jennings, 755 S.W.2d 874, 881 (Tex.App.--Houston [14th Dist.] 1988, writ denied); see also Strong v. Strong, 128 Tex. 470, 98 S.W.2d 346, 347 (1936). A conveyance of an interest in real property, including a deed of trust, is void as to a subsequent purchaser if the interest was not recorded at the time of the subsequent purchase and the purchaser paid valuable consideration without notice of the unrecorded interest. See TEX. PROP.CODE ANN. § 13.001(a).⁹ 

Under Texas law, a hypothetical purchaser would gain good title to Hamilton's property after it was sold at a valid foreclosure sale but before the substitute trustee's deed was recorded, unless the purchaser had notice of the foreclosure purchase. See TEX. PROP.CODE ANN. § 13.001(a). Under section 544, the actual knowledge of the trustee is not relevant. 11 U.S.C. § 544(a). The issue is therefore whether a hypothetical purchaser would be charged with implied knowledge of the foreclosure purchase, by constructive or inquiry notice.

Under Texas law, constructive notice is notice given by properly recorded instruments and charged to a person as a matter of law, regardless of the person's actual knowledge. Mooney v. Harlin, 622 S.W.2d 83, 85 (Tex.1981); TEX. PROP.CODE ANN. § 13.002. The deed of trust to the Hamilton property was properly recorded in Harris County, Texas, in 1966. "An instrument that is properly recorded in the proper county is notice to all persons of the existence of the instrument." TEX. PROP.CODE ANN. § 13.002. As a matter of law, a hypothetical purchaser of the Hamilton property had constructive notice of the deed of trust and would purchase the property subject to the deed of trust. See Inwood North Homeowners' Ass'n v. Harris, 736 S.W.2d 632, 635 (Tex.1987); Seals v. First Nat'l Bank (In re Church & Institutional Facilities Dev. Corp.), 122 B.R. 958 (Bankr.N.D. Tex. 1991); cf. Smith v. Morris & Co., 694 S.W.2d 37 (Tex.App.--Corpus Christi 1985, writ ref'd n.r.e.) (" [W]here a deed of trust was on record, a purchaser of land is chargeable with notice of the deed of trust and takes title subject to the rights of the mortgagee under the deed of trust.").

The substitute trustee's deed to Realty Portfolio was not recorded by the date of the bankruptcy petition filing. On the date of the bankruptcy petition, a hypothetical purchaser could not be charged with constructive notice of the substitute trustee's deed, as a matter of law. TEX. PROP.CODE ANN. §§ 13.001, 13.002; see also In re Elam, 194 B.R. at 415-16; cf. McEvoy v. Watkins, 105 B.R. 362, 365 (Bankr.N.D. Tex. 1987).

Realty Portfolio argues that constructive notice of the deed of trust would trigger a duty of inquiry that would place a hypothetical purchaser on inquiry notice of the foreclosure purchase. The first issue is whether the deed of trust placed the hypothetical purchaser on inquiry notice. If so, the second issue is whether the hypothetical purchaser is chargeable with inquiry notice of the foreclosure purchase.

Texas law recognizes the doctrine of inquiry notice, triggered by notice of facts that would put a reasonably prudent person on a duty of inquiry. See Woodward v. Ortiz, 150 Tex. 75, 237 S.W.2d 286, 289 (1951); Prewitt v. United States, 792 F.2d 1353, 1358-59 (5th Cir. 1986); Teofan v. Cools (In re Spring Creek Invs.), 71 B.R. 157, 159-60 (Bankr.N.D. Tex. 1987); T-Vestco Litt-Vada v. Lu-Cal One Oil Co., 651 S.W.2d 284 (Tex.App.--Austin 1983, writ ref'd n.r.e.). Under Texas law, constructive notice of a recorded deed of trust in the chain of title puts a subsequent purchaser under a duty to make a reasonable inquiry into the status of the deed of trust. See Lumpkin v. Adams, 74 Tex. 96, 11 S.W. 1070, 1073 (1889); accord Olsen v. Bank One (In re Bruder), 207 B.R. 151, 159 (N.D. Ill. 1997).

The bankruptcy and district courts in this case reasoned that although state law determines whether a hypothetical purchaser is a bona fide purchaser without notice for the purpose of section 544(a), bankruptcy law precludes the application of inquiry notice because inquiry notice refers to actual knowledge. Under Texas law, however, inquiry notice is a form of implied knowledge; it is not actual, personal knowledge of the type made irrelevant under section 544(a). See Woodward, 237 S.W.2d at 289 (" [T]hose things which a [n] ... inquiry ... would have discovered.") (emphasis added); cf. Exxon Corp. v. Raetzer, 533 S.W.2d 842, 846 (Tex.Civ.App.--Corpus Christi 1976, writ ref'd n.r.e.) ("implied notice"). A hypothetical purchaser on inquiry notice is chargeable with implied knowledge of facts that would be discovered by a reasonably diligent inquiry. To find inquiry notice inapplicable to a hypothetical purchaser or trustee under section 544(a) would place the hypothetical purchaser or trustee in a better position than other purchasers under state law. Section 544(a) (3) does not give Chapter 13 trustees any greater rights than bona fide purchasers have under state law. Maine Nat'l Bank v. Morse (In re Morse), 30 B.R. 52, 54 (1st Cir.BAP1983); Calcasieu v. Marine Nat'l Bank (In re Quirk), 119 B.R. 99, 100 (W.D. La. 1990).

A hypothetical purchaser of Hamilton's property on the date of the bankruptcy filing would be on inquiry notice resulting from constructive notice of the recorded deed of trust and the information contained therein. " [A] purchaser is bound by every recital, reference and reservation contained in or fairly disclosed by any instrument which forms an essential link in the chain of title under which he claims.... The rationale of the rule is that any description, recital of fact, or reference to other documents puts the purchaser upon inquiry, and he is bound to follow up this inquiry, step by step, from one discovery to another and from one instrument to another, until the whole series of title deeds is exhausted and a complete knowledge of all the matters referred to and affecting the estate is obtained." Westland Oil Dev. Corp. v. Gulf Oil Corp., 637 S.W.2d 903, 908 (Tex.1982) (citations omitted); see also In re Spring Creek Invs., 71 B.R. at 159-60; FRED A. LANGE & ALOYSIUS A. LEOPOLD, LAND TITLES AND TITLE EXAMINATION § 886 (West 1992) (" [A] purchaser of land is not only put upon notice of the contents of a prior recorded deed, but of any fact contained therein which would put a reasonable man upon inquiry, so that while a recorded deed is constructive notice only of the facts which it recites, yet a party is chargeable with notice of what a reasonably prudent person, with knowledge of the facts, would have ascertained by inquiry [;] ... a purchaser of land must search records since they are the primary source of information as to the title and he is charged with knowledge of the existence and contents of recorded instruments affecting title, and a purchaser is charged with notice of the contents and legal effect of instruments which are in his chain of title although he may never have had any actual knowledge thereof.").

The duty of inquiry is governed by standards of reasonableness, extending to "those things which a reasonably diligent inquiry and exercise of the means of information at hand would have discovered." Woodward, 237 S.W.2d at 289; see also Prewitt, 792 F.2d at 1359 ("a reasonably diligent inquiry and exercise of the means of information at hand ") (emphasis added); In re Spring Creek Invs., 71 B.R. at 160 ("the duty does not extend to exhaustive inquiry or investigation of speculation and conjecture"); Westland, 637 S.W.2d at 908 ("diligent inquiry and search") (emphasis added); Flack v. First Nat'l Bank, 148 Tex. 495, 226 S.W.2d 628, 631 (1950); Hobbs v. Hutson, 733 S.W.2d 269, 272 (Tex.App.--Texarkana 1987, writ denied) (citing Miles v. Martin, 159 Tex. 336, 321 S.W.2d 62 (1959)); cf. Briggs v. Kent (In re Professional Inv. Props.), 955 F.2d 623, 627 (9th Cir. 1992), cert. denied, Miller v. Briggs, 506 U.S. 818, 113 S. Ct. 63, 121 L. Ed. 2d 31 (1992) (" [W]here a purchaser has knowledge of 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 ... the purchaser will be held chargeable with knowledge thereof.") (emphasis added).

Courts have found that a purchaser's reasonably diligent inquiry, through information at hand, can lead to a purchaser's implied knowledge of a foreclosure sale under a recorded deed of trust, even in the absence of a recorded substitute trustee's deed. See Clarkson v. Ruiz, 140 S.W.2d 206, 210 (Tex.Civ.App. --San Antonio 1940, writ dism'd) (purchasers on notice of an unreleased deed of trust "would have [been] put upon inquiry, which, if diligently pursued, would have in all probability, [led] to a discovery of the foreclosure under the power of the deed of trust"); see also Chavis v. Gibbs, 198 Va. 379, 94 S.E.2d 195, 201 (1956) (" [I]f reasonable and prudent inquiry had been made and full answers obtained, [the purchaser] would have discovered that because of default in the payment of the notes, the property had been sold in accordance with the provisions of the deed of trust."); cf. Parker v. Wear, 230 S.W. 75, 78 (Mo.1921) (" [I]t was immaterial that the purchaser at the foreclosure had not then filed his deed from the trustee, where not only was the deed of trust on record, but [the purchaser's] deed itself recited the outstanding incumbrance, as these facts put plaintiff on inquiry which, if it had been followed, would have disclosed that her grantor at that time had no title."). The determination of whether a purchaser may be charged with such knowledge depends on the facts of each case. See Miles, 321 S.W.2d at 69 (" [W]hether a diligent search would have led to a discovery of the [facts is an] issue [ ] to be determined by the trier of fact under all the evidence."), quoted in Hobbs, 733 S.W.2d at 272.

A reasonably prudent hypothetical purchaser of the Hamilton property, on constructive notice of the deed of trust, two days after the foreclosure sale but before the substitute trustee's deed was recorded, would have made a reasonable inquiry into whether the deed of trust had been released, extended, renewed, or foreclosed, using information at hand. See Lumpkin, 11 S.W. at 1073 (if the purchaser had notice of the mortgage "at the time of his purchase, he would be put on inquiry, and would be required to exercise reasonable diligence to ascertain the facts constituting any change in or renewal of the mortgage, reasonable diligence to inform himself if the mortgage had been satisfied, and, if satisfied, how it had been satisfied"). Inquiring into the real property records of the chain of title, the hypothetical purchaser would have found no record that the deed of trust had been extinguished. A hypothetical purchaser, acquiring the property subject to an unreleased deed of trust, would inquire further into the status of the lien, exercising other available means of information readily at hand.¹⁰ 

The deed of trust, properly filed and recorded, and within the hypothetical purchaser's constructive knowledge, revealed that FNMA was the holder of the deed of trust and Bank United its servicing agent. The records showed no transfer of ownership of the deed of trust. A hypothetical reasonably diligent purchaser would have inquired of FNMA or Bank United as to the status of the deed of trust.¹¹  The record does not disclose whether such an inquiry would have led to the discovery of facts sufficient to charge the hypothetical purchaser with inquiry notice of the foreclosure sale and substitute trustee's deed.

Under Texas law, constructive notice of a recorded deed of trust does not trigger a duty to monitor litigation announcements and all other sources potentially containing information about real property to learn of any unrecorded extensions, renewals, releases, or foreclosure sales. Such a duty of investigation would be more exhaustive and burdensome than the duty of "reasonable and diligent inquiry" required under Texas law. See In re Spring Creek Invs., 71 B.R. at 159-60 (" [T]he duty does not extend to exhaustive inquiry or investigation."). A hypothetical purchaser is only under a duty of reasonable inquiry, by exercise of the means of information at hand, including a search of the real property records in the chain of title, and if the deed of trust remained unsatisfied, to inquire of the mortgage company identified in the recorded deed of trust. If such an inquiry would not disclose the foreclosure sale and substitute trustee's deed, then the hypothetical purchaser could rely on the absence of any record of the substitute trustee's deed in the chain of title and acquire the Hamilton property without notice of the foreclosure sale.

The bankruptcy and district courts in this case reasoned that to require a bankruptcy court to make a determination as to inquiry notice would impose an "onerous burden" on the court to make a factual determination based on "hypothetical facts" or the actual knowledge of the trustee. A determination of whether a reasonable inquiry into the status of the recorded deed of trust would lead to knowledge of the foreclosure sale depends on the actual facts of the case, the actual documents in the real property records, the sources of information fairly suggested by those records, and the means of information actually at hand, such as the identity of the mortgage company. The determination depends neither on the actual knowledge of the trustee nor on hypothetical facts.

The court notes that had Realty Portfolio not delayed in recording its substitute trustee's deed, the problem in this case would not have arisen. A purchaser of real property at a foreclosure sale has the ability to protect the newly-acquired property interest by promptly recording the deed. Cf. Little v. Duncombe (In re Duncombe), 143 B.R. 243, 246-47 (Bankr.C.D. Cal. 1992) (a "foreclosing secured creditor can ... deliver a deed immediately upon the completion of the sale [; a] purchaser ... can ... record the deed immediately").

For the foregoing reasons, we REVERSE and REMAND to the bankruptcy court for a determination of whether, based on the narrow facts of this case, a reasonably diligent inquiry into the recorded deed of trust in the purchaser's chain of title and exercise of the means of information at hand on the date of the bankruptcy filing would have disclosed facts sufficient to place a hypothetical purchaser of the Hamilton property on notice of the foreclosure sale and substitute trustee's deed.¹²