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Miller-Francis’: A Disturbance in the Force

By Adam Leitman Bailey and Dov Treiman

When the Empire destroyed the planet Alderaan in Star Wars IV, Obi-Wan Kenobi sensed “a great disturbance in the Force, as if millions of voices suddenly cried out in terror, and were suddenly silenced.” When the Appellate Division, First Department decided Miller-Francis v. Smith-Jackson,1 there was a great disturbance in the Force known as stability in real estate transactions, specifically the enforceability of mortgages.

The Virtue of Stability

In Holy Properties v. Kenneth Cole Productions,2 the Court of Appeals wrote:

Parties who engage in transactions based on prevailing law must be able to rely on the stability of such precedents. In business transactions, particularly, the certainty of settled rules is often more important than whether the established rule is better than another or even whether it is the “correct” rule. This is perhaps true in real property more than any other area of the law, where established precedents are not lightly to be set aside.

Miller-Francis disregards this dictum. Under previous law, courts nullified mortgages written in favor of a mortgagee based on the mortgagee’s notice of something amiss in the transaction. Mortgagees enforcing their mortgages had only to establish the three elements of a “bona fide encumbrancer for value”: (1) bona fides; (2) an encumbrance; and (3) value. Funding transactions automatically made them encumbrancers for value. Bona fides had been nearly as automatic. Miller-Francis found two factors that alone or together would put an encumbrancer on constructive notice that the element of bona fides was missing: (i) non-standard practices or unconventional methods used at a real estate closing; and (ii) suspicious aspects of the transaction.

Miller-Francis Facts

While the lender was probably not aware of the transaction’s earlier unsavory history, there was enough at the closing to alert the encumbrancer something was amiss.

The borrower first signed the mortgage application at the closing and made statements there that he had no intention of buying the property and did not have enough money to pay a mortgage. The lender’s representative never examined the borrower’s paystubs, tax returns, or credit history before approving his application. Further, the lender knew the property was patently over-appraised. The court found that the lender should have inquired further about the sale’s and loan’s legitimacy, writing:

The rights of an encumbrancer for value are protected “unless it appears that [the encumbrancer] had previous notice of the fraudulent intent of [its] immediate grantor, or of the fraud rendering void the title of such grantor.” A mortgagee will be charged with constructive notice if it is “aware of facts that would lead a reasonable, prudent lender to make inquiries of the circumstances of the transaction at issue.” If a “reasonable inquiry” would reveal some evidence of fraud, then failure to “make some investigation” will divest the mortgagee of bona fide encumbrancer status. (citations omitted)

Hard Cases

Hard cases make bad law.3 The facts in Miller-Francis are very hard. For some trial judges, the court’s two-part inquiry will likely find application to vastly more benign facts in innocent workaday transactions. Some will downgrade a requirement to be on guard for outrageous irregularities to generally mandating detailed inquiry, even on ordinary facts. Even allowing Miller-Francis prophylactic virtues, more cases must establish the threshold exciting a prudent lender’s suspicions.

Earlier Rumblings

While Miller-Francis comes from the idea of the “reasonably prudent lender” or “reasonably prudent encumbrancer,”4 it makes the lender’s obligations under this doctrine more pro-active than any earlier standards. Consumer advocates would claim the decision to be a logical extension of the earlier holdings; those favoring stability in real estate would claim it has gone too far. Although the court cites to Fleming-Jackson v. Fleming,5 for the idea that notice of fraud voids the encumbrancer’s bona fides, Fleming, itself did not void the encumbrance. Miller-Francis introduces the idea of constructive notice without citation, and then cites to MERS v. Rambaran,6 where the lender had actual possession of mutually contradictory documents. MERS required inquiry when there was actual knowledge of a contradiction in the deal rather than mere “constructive notice” as in Miller-Francis, when the deal looked odd, but had nothing explicitly crooked on its face.

Constructive notice does previously appear in cases like 89 Pine Hollow Rd. Realty v. American Tax Fund,7 where the presence of an outstanding lis pendens impugned the purchaser’s bona fides. Unlike the “constructive notice” that Miller-Francis finds from things like failure to examine pay stubs, by law, a lis pendens puts the world on constructive notice of a cloud on title. This constructive notice is a pure common law development, and regards entirely private, that is to say, unrecorded, documents.

For Miller-Francis, “reasonably prudent encumbrancer” incorporates not only “knew or should have known,” but also “should have wanted to know.” Similarly, not reciting its facts, Booth v. Ameriquest,8 ruled that if “a purchaser or encumbrancer (who) knows facts that would ‘excite the suspicion of an ordinarily prudent person’ and fails to investigate, (then) the purchaser or encumbrancer will be chargeable with that knowledge which a reasonable inquiry, as suggested by the facts, would have revealed.” Just recently, the Second Department reaffirmed this principle without setting forth its facts in Williams v. Mentore.9

A review of all the historical reported cases on this issue has revealed only two instances when the court nullified a mortgage as a result of a duty to investigate. One, 89 Pine Hollow, supra, held a loan extinguishable for the seller’s obvious fraud.10 The second, LaSalle Bank v. Ally,11 held a loan inferior in lien priority to a later recorded mortgage due to constructive notice of fraud. LaSalle Bank was the first case to hold that a lender will be charged with constructive notice if it is aware of facts that would lead a reasonable, prudent lender to make inquiries of the circumstances of the transaction. However, these cases build on the idea that one has as a matter of law constructive notice of the things in the public record and cast a duty of inquiring into anomalies to which the public record points. This is vastly different from the Miller-Francis duty of inquiry into the purely private phenomena observed at the closing.

The Miller-Francis version of the standard of “reasonable inquiry,” is based not only on what was present, but indeed on what was absent—the paystubs, tax returns, and credit history, an inquiry into the dog that failed to bark.

In attempting to draw guidance from the stare decisis, we have to be careful of such cases as Thomas v. LaSalle Bank,13 appearing to hold that the mortgage can be invalidated for the mortgagee’s failure to abide by its duty of inquiry, without stating what in the record gave rise to that duty. More than a lack of recitation of the record, Thomas is on a motion to dismiss for failure to state a cause of action rather than after a trial or trial-equivalent like a motion for summary judgment.

On such a motion to dismiss, Thomas is completely in the mainstream, holding that “the complaint is to be afforded a liberal construction, the facts alleged are presumed to be true, the plaintiff is afforded the benefit of every favorable inference, and the court is to determine only whether the facts as alleged fit within any cognizable legal theory.” Thus the case is allowed to go to the discovery phase for what it may turn out to be, rather than for what it did turn out to be.

In our other LaSalle Bank case, LaSalle Bank v. Ally, supra, the validity of a mortgage hinged on the authority of the so-called president of a corporation. The Second Department, finding that the bank had failed to make adequate inquiry of the signer’s actual authority from the corporation, refused to accord to the encumbrancer bona fide status. Here, the court noted, that the would-be encumbrancer “also failed to offer evidence that it lacked knowledge of facts that would lead a reasonable, prudent lender to make inquiries of the circumstances of the transaction at issue. Under the circumstances, (it) possessed facts that would lead a prudent lender to investigate (the supposed president’s) purported corporate status and authority to act on (the corporation’s) behalf, and it is undisputed that (the encumbrancer) did not do so.” Therefore, the court made a rare finding that the subject mortgage would be inferior to a later recorded mortgage.

Parsing this, it is hard to determine whether the encumbrancer had other information calling the “president’s” credentials into suspicion or whether the court is casting a duty on the encumbrancer to effect such a challenge on its own. The latter would be greater precedential support for Miller-Francis, but certainly not direct support as it is a question of checking corporate credentials rather than whether a so-called purchaser is really buying the property for which he is giving a mortgage.

In short, nothing in the previous stare decisis gives genuine prior indication of the route Miller-Francis is going to take, at least when the mortgagor is a natural person, especially not the cases to which the caseitself cites. Only two very rare and fact-specific cases have held that the subject mortgage would be nullified.

Applying the Standards

As is often the case in a new precedent with a new rule, Miller-Francis announces new standards without equipping practitioners with a methodology for applying them. The court writes, “If an initial submission and signing of a mortgage application at a real estate closing is not standard practice, then defendants must explain why this unconventional method did not excite Accredited’s suspicion that some nefarious activity tainted the transaction.”(emphasis supplied)

The court assumes, probably correctly, that something took place at the Miller-Francis closing that was “not a standard practice” and was an “unconventional method.” This begs the questions: Who determines what is standard and what is conventional? And how is that determination made?

Are the conventions and standards matters of fact to be proven at trial, thus eluding summary judgment? Or are the conventions and standards common knowledge a court can determine on its own by reference to whatever authority it wishes? Or are the conventions and standards things that can only be proven by expert witnesses? There are hundreds of things that take place in an ordinary mortgage closing that are completely within the cultural expectations of the transactional community, but for an outsider are utterly unknown and unknowable except by experiencing enough closings to share the expectations that make these things “standard” or “conventional.”

Miller-Francis mantles such cultural expectations with serious legal consequences, but does not provide the connective tissue that gets them from unspoken expectations to data that a litigator can argue, an author can brief, or a judge can decide. Worse for the free flow of commerce and its growth and expansion, Miller-Francis implies that now, even the most benign introduction of a new or creative way of handling things means that novelty impugns validity. It is as if Miller-Francis has taken a snapshot of the early 21st century mortgage closing typical methodology and frozen it for all eternity as the standard of all validity. This, taken together with the hazards Miller-Francis places before lenders can have the effect of forcing banks into highly anti-consumer behavior.


If other courts follow Miller-Francis, lenders most likely will become stingy in granting loans to the middle class. Already existing in New York is a housing crisis where for the first time in our nation’s history sons and daughters can no longer afford to buy a home that their parents were able to do under similar financial constraints. The American dream of saving money to buy that first home has become more of a dream than a reality. Decisions like Miller-Francis have the potential of further dampening home ownership. We call upon our higher courts to revisit this rule of law to come to a more just result. Or as Yoda famously stated to a young Luke in “The Empire Strikes Back”: “Try not. Do. Or do not. There is no try.”

Adam Leitman Bailey is the founding partner of Adam Leitman Bailey, P.C. Dov Treiman is a partner at the firm. Zachary Wender, a law school student, assisted in the preparation of this article.


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