Court Confirms That Defective Notary Acknowledgments, if Facially Valid, Are Immune From Attack in Kentucky Except In Very Narrow Circumstances

Whether a notary’s acknowledgment of a mortgage in a real estate loan transaction is valid can be a source of conflict among secured and unsecured creditors when the borrower defaults on the underlying loan. 

The validity of the notary’s acknowledgment of a mortgage often determines whether the mortgage that secures the loan deserves priority as a secured obligation.  This issue has always been a battleground for creditors seeking recovery upon the default of the underlying loan in a bankruptcy situation, but the issue is even more pertinent today for borrowers, lenders, title insurance companies and other financial institutions in the midst of the current subprime lending crisis. 

Whether a notary’s acknowledgment is vulnerable to attack depends on the applicable state law and always entails a fact-specific inquiry.  The Bankruptcy Panel of the Sixth Circuit Court of Appeals recently confirmed that at least in Kentucky, successfully challenging a notary’s acknowledgment is difficult because outside the context of a direct action seeking recovery directly from the notary, a challenge to a facially valid acknowledgment requires proof of fraud or mistake that harms the borrower.

This issue was recently litigated and decided in 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) [See pdf attachment].  There, the bankruptcy trustee sought to avoid a mortgage on the bankruptcy debtors’ real property because the notary’s certificate of acknowledgment on the mortgage was defective.  In Denny St. Clair, the parties stipulated that the debtors were not present before a notary when they executed the mortgage, but both the bankruptcy court and the appellate panel nevertheless refused to invalidate the mortgage, finding that outside the context of a direct action against the notary, KRS 61.060 will operate to invalidate a facially valid acknowledgment, and hence the underlying mortgage, only in the presence of fraud or mistake that harms the borrower. 

The court first determined that the notary’s acknowledgment was facially valid – that is, no potential bona fide purchaser could have known by looking at the acknowledgment that it was defective.  This determination was crucial to the court’s ultimate conclusion because facially invalid acknowledgments do not provide the requisite constructive notice to potential bona fide purchasers.  The court then turned to KRS 61.060 to determine whether the trustee could nevertheless avoid the mortgage. 

Pursuant to KRS 61.060, a notary’s acknowledgment may be attacked 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.  Because the trustee sought no recovery directly from the notary, the court focused on whether the trustee properly alleged fraud or mistake. 

The court first determined that fraud was not properly alleged because the trustee did not claim that the fraud was committed by, or on behalf of, the party benefited, the lender.  Because the trustee merely alleged that the notary’s fraud should be imputed to the lender, the court found that the fraud claim failed. 

Turning to the trustee’s allegation of mistake, the court emphasized that there was no allegation that the debtors were harmed by the notary’s “mistake” and that they in fact benefited from it.  The court also noted that KRS 61.060 “was enacted to stabilize the public records and make title to real estate in Kentucky more secure.”  Denny St. Clair at 8 (citing cases).  The court then concluded that “[t]o allow parol evidence to question the legal effectiveness of a real estate document which is facially proper and in compliance with the law would promote uncertainty about, and invite unnecessary litigation regarding, innumerable real estate documents.”  Id. at 9.  The court therefore denied the trustee’s challenge to the certificate, finding the mortgage to be effective. 

The Denny St. Clair case no doubt provides stability and certainty to Kentucky real estate transactions in that facially valid notary acknowledgments will be upheld except in extraordinary circumstances.  It must be noted, however, that for lenders, title insurers and other financial institutions involved in real estate closings, state law on this subject varies from state to state.  Indeed, the Denny St. Clair court noted that had the action been decided under Ohio law, the trustee may have been successful in his challenge.

Posted by: Peter M. Cummins

Categories: Bankruptcy & Banking Law, Liens