Lender recorded first—still lost. The red flags that flipped priority
Investors, not an earlier-recording lender, win lien priority in EquityBuild fallout, the Seventh Circuit ruled on December 4.
If you lend against properties with a tangled backstory, this one’s for you. The US Court of Appeals for the Seventh Circuit affirmed that individual investors – not Shatar Capital Partners – get first claim to the sale proceeds of two South Side Chicago properties tied to the EquityBuild Ponzi scheme. The panel held that Shatar’s earlier recordings did not control because the firm had warning signs that others already held interests.
Here’s the backdrop. From about 2010 to 2018, Jerome and Shaun Cohen ran EquityBuild and EquityBuild Finance and pitched high-yield, property-backed notes, later rolling into pooled real estate funds. The pitch promised double-digit returns and first liens; the reality routed new money to pay earlier investors and inflated property values. By late 2017, investors in more than 1,200 notes had not been repaid principal, and delinquent payments were almost $75 million. By May 2018, EquityBuild and EBF had less than $100,000. The SEC sued in August 2018, obtained an asset freeze, and a receiver was appointed to liquidate properties and distribute proceeds.
This appeal focused on two addresses: 7749 South Yates and 5450 South Indiana. Individual investors had put up money for both. EquityBuild bought Yates on March 14, 2017 and executed a mortgage to those investors that day; it bought Indiana on March 30, 2017 and executed a mortgage to investors the next day. The investors recorded both mortgages on June 23, 2017.
Meanwhile, Shatar agreed to lend $1,800,000 secured by both properties. EquityBuild executed mortgages to Shatar on March 30, 2017, and Shatar recorded on April 4 – well ahead of the investors’ June recordings. On paper, and absent other facts, Shatar looked first in line.
The court said not so fast. Under Illinois law, recording first does not prevail if you had reason to know someone else had a prior interest. For Yates, the judges pointed to four red flags. Shatar understood EquityBuild’s model of pooling crowdfunded investors who expected first-lien security. Shatar’s principal had specifically asked about refinancing “already closed deals.” EquityBuild then sent rollover and template lending documents, which Shatar’s principal later testified he did not review. And critically, before Shatar funded, it learned the Yates purchase had already closed – indicating the buy was funded by other means. Those clues should have triggered follow-up. Reasonable inquiry, the court concluded, would have uncovered the investors’ stake – including through a known investor who had referred the deal and who had independently invested in Yates.
For Indiana, the court agreed the investors held an equitable mortgage before Shatar’s mortgage. The investors’ package – a February 6, 2017 promissory note securing loans with the Indiana property, an unsigned mortgage identifying the property and aggregate loan, and a December 27, 2016 collateral agency and servicing agreement cross-referencing those documents – showed a clear intent to secure their loans with the Indiana property. The court also noted an unusual circumstance at closing: a title company email showed EquityBuild would receive cash from the Indiana purchase closing, and the closing documents reflected the borrower ultimately received nearly $110,000. That kind of funds flow when a loan is expected to finance a purchase should prompt more questions about other financing – questions that would have revealed the investors’ prior interest.
The court also confirmed that Shatar could bring the claim as agent and servicer for its lenders, based on letter agreements authorizing it to act and to “retain a split on payments made.” But Shatar’s challenge to how proceeds were distributed did not affect the outcome. The accounts holding sale proceeds contained $564,284.59 for Yates and $1,789,813.98 for Indiana, while the investors’ secured claims totaled $2,689,293.00 and $2,782,692.60, respectively. After paying senior claims, nothing would remain for Shatar, so its distribution challenge was moot.
What this means for mortgage professionals is straightforward. Recording is not a shield when the facts in front of you tell you to ask more questions. If you see a sponsor who pools retail investors and relies on rollovers, a purchase that closes before your funds arrive, or a purchase closing where cash is flowing to the borrower, pause. Get payoffs. Obtain valid releases from prior lienholders. Reconcile funds flows. And if you’re lending against multiple properties in one go, assume each title may carry its own history and verify it.
