Is a current owner search a reasonable search for a buyer to conduct when buying a property, even when the current owner did not gain title through a warranty deed arising from an arms-length transaction?  A Federal District Court judge thinks so, agreeing with a bankruptcy court judge that came to the same conclusion.

Theresa, a homeowner in New Jersey, had two daughters, Lottie and Mary.  Shortly before she died, Theresa executed a deed granting Lottie a 1/2 interest in her house.  In Theresa's will she left her remaining 1/2 interest to Mary, who was also named as the executor in the will.

After Theresa died, Mary executed and recorded two deeds.  The first deed was executed by Mary as executor of her mom's and granted the one-half interest in the house held by her mom's estate to Mary herself, as per her mom's directions in her will.  The second deed was executed jointly by Mary as executor and Lottie, conveying their interests in the property to Lottie.  The second deed did not note the first deed as a prior reference; it only noted as a prior reference the deed that Theresa had executed before she died which granted Lottie the 1/2 interest.

The second deed, of course, conveyed nothing.  The first deed had conveyed all of the interest in the property held by Theresa's estate to Mary, so there was nothing left for Mary as executor to convey to Lottie.  As to why this deed was executed and recorded, Mary only remembers that this is what her lawyer told her to do.

These two deeds were recorded in 1987.  For many years thereafter, Mary lived at the property.

Almost two decades later, in 2004, Lottie mortgaged the property.  That lender did only a current owner search, and stopped at the second deed, apparently satisfied that Lottie held sole title to the property.  The lender made its loan believing that it was secured by a full interest in the property.  Lottie later got a second mortgage loan on the property.  Again, Mary's 1/2 interest was not discovered.  Mary continued to live at the property and apparently did not know about these mortgages.

Last year, Lottie filed for bankruptcy.  Mary was still living on the property, and the bankruptcy trustee learned of Mary's interest.

As we have discussed here before, when a debtor files for bankruptcy, all of their (non-exempt) property goes into what is called the bankruptcy estate, which is controlled by the bankruptcy trustee, who administers the bankruptcy estate for the benefit of the debtor's creditors.  The bankruptcy estate is created as if the trustee had been a good-faith purchaser of the debtor's property on the date of the bankruptcy filing.  The important effect of this rule is that the trustee will be able to have the bankruptcy court wipe out any interest in the property that a hypothetical good faith purchaser, buying the real property on the date of the bankruptcy filing, would have been able to avoid.  This is called the bankruptcy trustee's strong arm power, and the trustee can apply this power even if the trustee knows of the adverse interest and knows that it is valid.

Here, the trustee knew that Mary held a 1/2 interest in the property and did not dispute that Mary's interest was valid.  Nevertheless, the trustee asked the bankruptcy judge to wipe out that interest, on the grounds that a reasonable, good faith purchaser would not have discovered the interest, because a reasonable good faith purchaser would have not searched title back beyond the current owner, which appeared to be Lottie.  As evidence that a good faith purchaser would not have discovered Mary's interest with a reasonable title search, the trustee pointed to the lender's search, which did not discover Mary's interest.

Mary objected, and intervened in the bankruptcy, asserting that a reasonable title search would have discovered her interest, and that her interest should therefore be preserved.

New Jersey does not have a Marketable Title Act, nor any other statute which indicates what records need to be searched or how far back they need to be searched in order to constitute a reasonable title search.  However, the Handbook on New Jersey Title Practice, which has been cited variously by New Jersey Courts and the New Jersey Land Title association, states that the customary period for a title search to assure a purchaser that they are receiving marketable title is to go back 60 years to a warranty deed. 

Mary had a title abstractor do a 60 year search on the property, and the search showed her 1/2 interest.  Mary asserted that this 60 year search would have been a reasonable search for a good faith purchaser to undertake... after all, anything less would be less than the customary search to assure marketable title in New Jersey!

But the bankruptcy court disagreed with Mary, and so has a Federal District Court on appeal.  These courts were swayed by the fact that a lender failed to discover Mary's interest, finding that what is reasonable is defined largely by what is customary in the title industry, and concluding that a good faith purchaser conducting what is considered to be a reasonable search would have therefore also failed to discover Mary's interest.  The courts have acknowledged that a sixty year search is the standard, but say that there is nothing in the law that indicates that a lesser search is unreasonable.  As support for its ruling, the District Court cited to cases in New Jersey which specifically indicate that a mortgagee has no duty to search title back beyond the current owner.

Both courts have issued decisions that wipe out Mary's interest.