DEBTOR CASE NO. 94-60460





VS. ADV. NO. 95-6002







This matter is before the Court by Order entered herein on December 16, 1997, submitting it for adjudication. This matter had been set for trial and a Motion for Summary Judgment was pending as well. The issues before the Court on the Motion for Summary Judgment by defendant National City Bank ("NCB") and response by the plaintiff were whether NCB's 1993 mortgage is first and prior to the plaintiff's January 15, 1987 mortgage and whether the plaintiff should be allowed to reform its mortgage. NCB contends that the plaintiff's mortgage is not valid because it was entered into with an entity identified as Deby Coal Company, Inc., which did not own the property. The plaintiff counters that it was the intention of all the parties to the 1987 mortgage that Deby Coal Co., a partnership, was the mortgagor, and that any designation otherwise was an error. The plaintiff has also raised the issue of notice, arguing that the priority of NCB's claim depends on whether NCB had knowledge of the plaintiff's mortgage sufficient to prevent NCB from taking its mortgage without notice of the plaintiff's claim.

The plaintiff and NCB have entered into stipulations which set out the following pertinent facts: The property which is the subject of this action is located in Clay County, Kentucky ("the Clay County property"), and is made up of three tracts of land conveyed in deeds dated September 6, 1956, August 15, 1962, and April 26, 1973. The "Deby Coal Company" referred to in these deeds was a partnership ("Deby I"). The debtor, Jack McGhee, became the sole surviving partner of Deby I at some point before Deby Coal Company, Inc. ("DCCI") was incorporated on November 1, 1978. DCCI was the operating company of a coal-mining business that utilized the Clay County property as the site of a coal tipple. On August 2, 1982, Jack McGhee and Clayborn Wooton executed a partnership agreement that memorialized a partnership named Deby Coal Company ("Deby II"). No deed was executed that conveyed ownership of the Clay County property to Deby II.

On September 2, 1982, Pikeville National Bank ("PNB") and Deby II entered into a "Revolving Credit Loan Agreement." The agreement was secured by a mortgage on a portion of the Clay County property. On January 15, 1987, the plaintiff and DCCI entered into a financing agreement which was purportedly secured by a mortgage on the Clay County property ("Minemet mortgage") executed as mortgagor, not by the record owner of the property, but by DCCI. In addition to the agreement and mortgage instruments, the transaction included a promissory note, guaranty of payment and security agreement. The documentation reveals that the parties understood the mortgage would be a second mortgage on the property. The plaintiff, who provided the documents for execution, did not perform a title search of the Clay County property prior to execution of the Minemet mortgage. The Minemet mortgage was recorded in Mortgage Book 85 at page 234 by the Clay County Clerk.

In October 1992, DCCI filed suit against Minemet in Clay Circuit Court. Minemet removed the action to the U.S. District Court for the Eastern District of Kentucky, where the action was designated No. 92-226 ("District Court action"). Minemet then answered and counterclaimed, initiating a foreclosure action on its mortgage on the Clay County property. No lis pendens notice based on the foreclosure action was filed in the Clay County Clerk's records prior to the execution of the NCB mortgage.

On May 28, 1993, First State Bank and Trust Company of Manchester, now NCB, entered into a loan agreement with "Jack McGhee d/b/a Deby Coal Company and individually" and his wife "Lawyette McGhee d/b/a Deby Coal Company and individually" by which the PNB first mortgage was paid off. The transaction was evidenced by a promissory note and secured by a mortgage on the Clay County property. NCB did not perform a title search on the Clay County property prior to execution of the NCB mortgage. The NCB mortgage was recorded by the Clay County Clerk in Mortgage Book 103 at page 94.

The record of this case also reveals that the debtor filed his Chapter 7 case in this Court on October 18, 1994. Schedule B, Personal Property, includes the following entry at item 12: "Stock and interest in incorporated and unincorporated businesses--Deby Coal Company, Inc." The debtor is listed as the "person in possession" and identified as "partner". The "co-owners" are identified as the debtor's four children. The following is entered at item 13: "Interests in partnerships--None". Schedule D, Creditors Holding Secured Claims, includes the plaintiff's claim of $544,000.00 In regard to this claim, DCCI is listed as the "co-debtor", with reference to the January 15, 1987 mortgage. On June 9, 1997, the debtor's counsel filed a notice of the debtor's death.

In a Memorandum Opinion entered on December 28, 1995, this Court previously considered the question of the ownership of the Clay County property at the time the Minemet mortgage was executed, but did not rule on that question. The Court stated as follows:

Kentucky law provides in K.R.S. 362.195(3) that "[w]here title to real property is in the name of one or more but not all the partners, and the record does not disclose the right of the partnership, the partners in whose name the title stands may convey title to such property, ..." subject to a limitation in K.R.S. 362.190 which is not applicable here. There is nothing in the record to indicate that the debtor ever conveyed title to the Clay County property after it came to him in 1973. ....

The plaintiff contends that the question is whether the debtor intended to contribute the Clay County property to [Deby II] , and that the presence or absence of documents of conveyance is irrelevant. It cites Sanderfur v. Ganter, 259 S.W.2d 15, Ky. (1953) in support of its position. The Sanderfur decision is not determinative of the question being considered here, however, as it resolved a dispute over a leasehold interest where, clearly, no formal transfer, such as by way of deed, was required. The distinction between the contribution of real or personal property to a partnership becomes critical because of real estate law requiring recording of documents conveying an interest in real estate for the purpose of giving notice to foreclose the rights of future claimants including judgment lien creditors and bona fide purchasers.

It appears to the Court that the plaintiff has not strengthened its position concerning the ownership of the Clay County property, as it continues to make exactly the same arguments as it had previously. As stated in In re Jones, 186 B.R. 71 (Bkrtcy.W.D.Ky. 1995): "In order to grant a valid mortgage in property one must have present valid title, whether legal or equitable, or some other recognized property interest in the property sought to be mortgaged." At 77. The plaintiff has not demonstrated that DCCI had any "recognized property interest" which it could mortgage, however, and it continues to argue that the debtor "donated" the property to Deby II. As set out above, the Court has already rejected that argument.

It therefore appears that the plaintiff's arguments concerning the reformation of the January 15, 1987 mortgage must be discounted, since it continues to contend that the mortgage should be reformed to show that an entity which does not own the property was the mortgagor. Consequently, its argument concerning the "relation back" of any reformed mortgage is futile, as well.

While determination of NCB's status as an "subsequent purchaser for value without notice" which, according to Johnson v. Beaver Creek Fuel Co., 227 S.W.2d 792, 793, Ky.,(1921), is required in order to block reformation of an instrument, is no longer crucial since the plaintiff's efforts at reformation must fail, the Court will make the following observations.

As concerns constructive notice, the court stated in Wides v. Wides' Ex'r, 184 S.W.2d 579, Ky. (1944), at page 584:

It is familiar law that constructive notice is charged against a party in two ways. One is conclusive notice of instruments properly recorded in the office of the county court clerk, and the other is the implication of the law arising from negligent failure to ascertain any given situation.

Failure to search the record does not relieve a party of the consequences of constructive notice; otherwise, it would be meaningless.

The plaintiff maintains that NCB had constructive notice of plaintiff's claimed mortgage against the subject property because its defective mortgage was recorded prior in time to NCB's mortgage. It is axiomatic, however, that a mortgage from a party who does not own the property and would not appear in the chain of title to the property and has a different name from the true owner does not give constructive notice of the claimed interest in the property by the mortgagee to the defective instrument. It is unnecessary for the Court to make further findings and reach further conclusions of law on the question of notice in light of the above conclusion that the deed may not be reformed.

Having found that the plaintiff's request to reform its mortgage to make Deby II the mortgagor should be denied, this Court therefore concludes that NCB's mortgage against the property is enforceable as a first lien with any excess proceeds belonging to the estate of the debtor pursuant to the provisions of 11 U.S.C. '544(a). An order in conformity with this opinion will be entered separately.


By the Court -




Copies to:

Leslie Rosenbaum, Esq.

Gary W. Napier, Esq.