The U.S. Court of Appeals for the Seventh Circuit allowed a secured creditor to retain its lien and therefore the proceeds from a sale of mortgage collateral, even after the secured creditor mistakenly released its mortgage lien of record. The case is Trinity 83 Development, LLC v. ColFin Midwest Funding, LLC (In re Trinity Development, LLC), slip. op. (7th Cir. March 1, 2019).
Trinity 83 Development, LLC, borrowed about $2 million from a bank to build an office building. The note and mortgage were sold to ColFin. ColFin’s loan servicer mistakenly recorded a document entitled a “satisfaction,” which stated that the loan had been paid and released the mortgage lien. The loan was still outstanding, and Trinity 83 continued to make payments to ColFin. Trinity 83 eventually defaulted, and ColFin discovered the mortgage had been mistakenly released. ColFin then recorded a cancellation of the satisfaction, and commenced mortgage foreclosure proceedings in state court. In response, Trinity 83 filed a Chapter 11 bankruptcy case in the Bankruptcy Court for the Northern District of Illinois.
Trinity 83 commenced an adversary proceeding against ColFin, contending that the “satisfaction” and release extinguished the debt and the mortgage lien, arguing it never consented to re-mortgage the property. ColFin moved for summary judgment against Trinity 83. Bankruptcy Judge Deborah L. Thorne agreed with ColFin, and held that the unilateral release was done in error and could be corrected unilaterally. Additionally, since no liens intervened between the recording of the release and the correction, ColFin’s mortgage lien retained first priority. Trinity 83 appealed the Bankruptcy Court’s decision to the federal District Court for the Northern District of Illinois. The property was sold to a third party during the bankruptcy case pursuant to Section 363 of the Bankruptcy Code while the Bankruptcy Court’s decision was on appeal to the District Court. Thereafter, the District Court affirmed Judge Thorne’s ruling. Trinity 83 then appealed the District Court ruling to the Seventh Circuit.
The Seventh Circuit affirmed the lower courts. The court rejected Trinity 83’s attempt to rely on In re Motors Liquidation Co., 777 F.3d 100 (2d. Cir. 2015), where a mistaken release of a UCC financing statement resulted in the avoidance of a $1.5 billion security interest. Here, unlike the General Motors case, the lender caught the mistake and corrected it prior to the bankruptcy filing. Since ColFin corrected the error prior to the filing of Trinity 83’ s bankruptcy case, the debtor’s rights as a hypothetical lien creditor under 11 U.S.C. § 544(a)(1) did not come into play. ColFin maintained its first position lien when Trinity 83 went into bankruptcy. Another critical difference between this case and the GM case was, under Illinois law, a mistaken release of mortgage is ineffective as between the mortgagor and mortgagee.
If a secured creditor mistakenly releases its lien, it should correct the error as soon as possible. If it is diligent, the secured creditor may not be harmed by the inadvertent release, even if the borrower files for bankruptcy.
 Lauren Newman is a partner in Thompson Coburn’s financial restructuring and bankruptcy practice. Thompson Coburn LLP represented ColFin Midwest Funding, LLP, throughout the case.