The Seventh Circuit Court of Appeals recently held that, under Wisconsin law, a mortgage can properly attach a lien to the vendor’s interest in a land contract. The court stated that the mortgage’s broad language encompassed the borrowers’ interest in the land contract as collateral and the lender perfected its lien by recording the mortgage in county land records. See In re Blanchard, 819 F.3d 981 (7th Cir. 2016).

In 2010, Troy and Heather Blanchard agreed to sell a residential property in Marathon County to Benjamin and Debra Hoffman under a land contract. Land contracts provide an alternative way of transferring ownership of a property. Rather than the buyer paying the full purchase price to the seller at closing (often by obtaining a portion of the money by taking out a mortgage), under a land contract the buyer agrees to make scheduled payments to the seller until the purchase price is paid in full and, if at any point the buyer fails to make the payments as scheduled, the seller can regain title to the property. Land contracts are often utilized where the buyer has trouble securing financing and therefore cannot pay the purchase price in full at the outset.

In this instance, the Blanchards agreed to sell the property to the Hoffmans for approximately $172,000. The Hoffmans made a $30,000 down payment. The Blanchards agreed to take out a mortgage loan in their names for the remaining $142,000, with the property offered as collateral. The Hoffmans could pay off the land contract in either of two ways: (1) pay the rest of the purchase price to the Blanchards no later than September 2015 or (2) prior to that deadline, pay off the remaining balance on the mortgage loan the Blanchards had obtained. As long as the land contract remained in effect, the Hoffmans were required to make $500 monthly “rental” payments to the Blanchards. This arrangement allowed the Blanchards to receive the full sales price of the property up front (some from the down payment and the rest from the mortgage loan), while providing the Hoffmans several years to assemble the balance of the sales price.

Neither party recorded the land contract in the county land records. The Blanchard’s mortgage company, Intercity State Bank, secured the mortgage loan with an Assignment of Leases and Rents as collateral. The bank did not obtain an Assignment of Land Contract and therefore was not a party to the land contract between the Blanchards and the Hoffmans.

Several years after signing the land contract (but before the September 2015 deadline for the Hoffmans to pay off the balance of the purchase price), the Blanchards filed for Chapter 7 bankruptcy relief. The trustee in the Blanchards’ bankruptcy filed an adversary proceeding against Intercity State Bank. The bankruptcy trustee sought to use its “strong-arm power,” which allows a trustee (acting on behalf of a debtor’s unsecured creditors) to step in line ahead of a secured creditor (such as a bank that issued a mortgage loan) if the secured creditor failed to perfect its security interest prior to the bankruptcy petition. The Blanchards’ trustee sought to ensure that the bank’s claim for repayment of the mortgage loan was not given priority over other creditors’ claims. The trustee reasoned that, because the Blanchards transferred their interest in the real property to the Hoffmans upon entering the land contract, their only remaining interest was one in personal property—their claim to money due under the land contract. The trustee further reasoned that because a mortgage can attach a lien only to real property, the Blanchards’ interest in the money due under the land contract was unencumbered for purposes of the bankruptcy proceedings and should be shared among all of the Blanchards’ creditors.

The bankruptcy court granted summary judgment in favor of the bank, rejecting the trustee’s theory and holding that the money due to the Blanchards’ under the land contract was subject to a lien arising from the mortgage. According to the court, the vendors in a land contract retain an interest in real property, and the Blanchards’ interest was therefore subject to the bank’s mortgage. The bank could not foreclose on the property, because the bank’s interest was subordinate to the Hoffmans’ interest as the purchasers. Because the mortgage had been properly recorded, the trustee could not avoid the bank’s lien.

After the district court affirmed the bankruptcy court’s judgment on a different rationale, the Seventh Circuit agreed with the bankruptcy court’s outcome and its reasoning. On appeal to the Seventh Circuit, the trustee argued that the bank could not have a valid lien on the Blanchards’ anticipated future income from the land contract because that income was personal property. The trustee also asserted that the bank had not properly recorded its mortgage, depriving the trustee of constructive notice of the bank’s alleged lien on the income under the land contract. The Seventh Circuit relied on Wisconsin precedent in dismissing both arguments.

Adopting the bankruptcy court’s rationale, the Seventh Circuit concluded that the Blanchards’ interests as vendors under the land contract properly secured the mortgage. The court based its reasoning on a nineteenth-century Wisconsin Supreme Court case, First National Bank of Stevens Point v. Chafee, 98 Wis. 42, 73 N.W. 318 (1897). Chafee held that a mortgagee of a land-contract vendor had priority over an earlier unrecorded assignment of the land contract vendor’s interest. Common law has followed the principles set forth in Chafee ever since.

The Seventh Circuit found that the Blanchards’ mortgage contained language sufficiently broad to include a land-contract vendor’s interest as collateral and therefore to grant the bank a lien on future payments under the land contract. The Blanchards’ mortgage applied to the property that was the subject of the land-contract vendors’ interest, which had been pledged as collateral. The Seventh Circuit interpreted the mortgage’s inclusion of “all … rents, leases, issues, and profits” to encompass income arising from the Blanchards’ ownership of the property. Under this rationale, it agreed with the bankruptcy court that the mortgage supported a valid lien on the Blanchards’ interest in the property, even if the extent of that interest was only the expectation of income from future payments under the land contract.

The Seventh Circuit also agreed with the bankruptcy court that the bank perfected its lien by recording the mortgage in county land records, even though it did not file a financing statement with the Wisconsin Department of Financial Institutions as required under Wisconsin’s enactment of Article 9 of the Uniform Commercial Code. On this point of Wisconsin law, the Seventh Circuit cited In re Hoeppner for the proposition that “the goal of the filing system is to make known to the public whatever outstanding security interests exist in the property of debtors.” 49 B.R. 124 (Bankr. E.D. Wis. 1985).

Although the trustee had argued that Hoeppner was no longer good law as it predated Wisconsin’s adoption of the Revised UCC Article 9 in 2001, the Seventh Circuit disagreed, finding no change between Revised UCC Article 9 and its predecessor statute, so that the controlling authority remained Wisconsin’s land recording statute, which applies to every transaction by which an interest in land is created, including a lien on a land-contract vendor’s interest. Furthermore, because the Seventh Circuit found that the bank properly recorded its mortgage, it dismissed the trustee’s attempt to use the strong-arm power to redistribute the Blanchards’ interest in the land contract among the creditors. The court also found that there was no need to reform the mortgage.

The Seventh Circuit’s holding demonstrates that a bank recording a mortgage in county records is an effective manner to retain its interest against a vendor’s interest in a land contract. This decision is of significant important both in resolving future bankruptcy disputes and in providing guidance to both banks and parties to land contracts. In particular, banks should obtain and record assignments that accurately reflect their interests in land contracts to avoid similar disputes in the future.

Law clerk Syed Madani assisted in researching and writing this post.

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