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California Lis Pendens, or Notice of Action, may be a avoided by a bankruptcy trustee as a Preference

A lis pendens, or “notice of action,” is a document recorded to perfect a claim being alleged in a lawsuit regarding title to real property. Once recorded, the world has notice of the lawsuit, and no purchaser may buy the property free of the claim – if the plaintiff wins in the suit, the new owner of the property is subject to the decision of the court. It is not a lien on the property, but it effectively renders the title unmarketable. A question posed to Sacramento and El Dorado real estate attorneys is how the lis pendens plays out in a bankruptcy. In a bankruptcy the trustee may avoid certain transfers (get them reversed) if they were made within 90 days (and in some cases, one year) before the bankruptcy filing if they would benefit one or more creditors at the expense of other creditors. These transfers are called “preferences.” (11 USC § 547(b)). Is recording the lis pendens a preference?

The reasons behind this are to promote equal distribution of assets to creditors, and to prevent aggressive collection efforts that may be undone by the court. A Ninth Circuit Court of Appeals decision, which governs California Federal Courts (plus several other western states), has held that the recording of a lis pendens is a “transfer” for purposes of determining whether it is a preference. While this position is law in California, not all circuits agree.

el dorado real estate attorney.jpgIn re Lane, 980 F.2d 601, the Ninth Circuit decision, involved a creditor who had sued Lane, and apparently recorded a lis pendens on filing the suit, or sometime thereafter. The creditor obtained a judgment, and recorded abstracts of the judgment on June 24. Lane filed bankruptcy September 16. Thus, the abstracts were recorded in the 90 day preference period, but the lis pendens was recorded prior to the start of the 90 day period. In the bankruptcy there was a motion to determine whether the creditor was secured, as it had recorded the abstract within the preference period, and the debtor wanted it to be unsecured.

The bankruptcy code states:
A transfer of real property other than fixtures, but including the interest of a seller or purchaser under a contract for the sale of real property, is perfected when a bona fide purchaser of such property from the debtor against whom applicable law permits such a transfer to be perfected cannot acquire an interest that is superior to the interest of the transferee.
11 U.S.C. § 547(e)(1)(A)

The court found the issue to be whether, following the creditor’s filing of its lis pendens, a bona fide purchaser of the debtors’ real property could acquire an interest superior to the debtors’s interest in the property. It could not. Once the lis pendens was recorded, no purchaser of the debtor’s property could acquire an interest superior to that of the creditor.

The court found that the judgment relates back to the recording of the lis pendens. Under California law, a party attains an interest superior to subsequent purchasers upon recondition of the lis pendens. It is the fact of attainment of a superior interest, not the creation of a lien or the rendering of a judgment, that creates a transfer under the Bankruptcy Code in both California.

A recent decision in the Tenth Circuit concerning a Colorado case (Ute Mesa Lot 1 LLC v First Citizens Bank, 11-25-13) found that the Lane decision was too broad. It narrowed its holding to the consideration that the judgment had been recorded before the bankruptcy, and that Lane court was only concerned with whether the transfer (recording the judgment) relates back in time to the lis pendens, not whether the lis pendens itself constitutes a transfer. That is a reasonable way to look at the issue before the Lane court. But give the language of the decision- “it is the fact of attainment of a superior interest, not the creation of a lien or the rendering of a judgment, that creates a transfer under the Bankruptcy Code in both California….” – a bankruptcy or district court judge would be hard presses to rule otherwise.