Tag Archives: chapter 13

AVOIDING JUNIOR MORTGAGES & CHAPTER 7

Alberts Law, Debt Relief & Bankruptcy, , , ,

Bank of America, N. A. v. Caulkett from U.S. Supreme Court (2015) currently is the defining case regarding avoiding junior mortgages in a bankruptcy filed under Chapter 7. It may not be the last word on this issue, but it does set forth the current law.

Caulkett held that a debtor in a Chapter 7 bankruptcy proceeding may not permit avoiding  junior mortgages under 11 U.S. Code §506(d) if the debt owed on a senior mortgage lien exceeds the current value of the collateral while the credi­tor’s junior claim is secured by a lien and allowed under §502 of the Bankruptcy Code (found in Title 11 of the U.S. Code).

CLOSER LOOK AT “SECURED” AND “UNSECURED” CLAIMS IN BANKRUPTCIES

Defining the term “secured claim” is not easy as context plays a large role in this. 11 U.S. Code §506 is the provision in the Bankruptcy Code that defines “[d]etermination of secured status.” However, case law interprets the meaning of statutes. Dewsnup v. Timm from U.S. Supreme Court (1992) defined a “secured claim” in §506(d) to mean a claim supported by a security interest in property, without any consideration of whether the value of that property would be suffi­cient to cover the claim.

The Supreme Court in Dewsnup concluded that an allowed claim (under §502) that is “secured by a lien with recourse to the underlying collateral . . . does not come within the scope of §506(d),” which could permit the debtor to avoid the lien on the collateral. However, there is a “secured claim” under Dewsnup because the claim is supported by a security interest in property, even though the value of that property is not sufficient to cover the claim. Furthermore, Caulkett states that a claim secured by a lien that also qualifies as an allowed claim under §502 cannot be voided under the Bankruptcy Code.

IMPACT OF NOT REQUIRING FILING OF A PROOF OF CLAIM IN A NO-ASSET CHAPTER 7

According to 11 U.S. Code § 502 (“Allowance of claims or interests”), a claim or interest – upon the filing of a proof pursuant to §501 of this Code – is deemed “allowed” unless a party in interest objects. As noted in In re Smoot from the U.S. Bankruptcy Court in the Eastern District of New York (2011), one can argue that, in a no-asset chapter 7 case, the adjudicative process for claims is not even invoked because claims need not be filed; therefore, a junior mortgage claim is going to be deemed allowed under 11 U.S.C. § 502(a).

Here, a filed proof of claim to determine if a claim or interest against the Debtor’s property should be allowed is not required. Whether or not any assets are available for distribution to general unsecured creditors is not an issue in such situations. Instead, the determination of whether a lien or interest against property is unsecured, leaving it disallowed as a secured claim, is made independent of the existence of assets to be distributed to the general unsecured creditors.

“ANTIMODIFICATION” PROVISION IN CHAPTER 13 & ITS NONEXISTENCE IN CHAPTER 7

The “antimodification” provision in (b)(2) of 11 U.S.C. §1322 does not apply regarding avoiding  junior mortgages that are wholly unsecured on a Chapter 13 debtor’s home. The Third Circuit decided that, because the U.S. Supreme Court in Nobelman stated that § 506(a) still applies and determines the “status” of a creditor’s claim, a wholly unsecured junior mortgage ceases to be a secured claim under the Bankruptcy Code and hence is not subject to the “antimodification” clause. However, because there is no similar provision in Chapter 7 of the Bankruptcy Code, this reasoning from the Third Circuit’s In re McDonald cannot be directly applied to the issue of avoiding junior mortgages in bankruptcies under Chapter 7.

LOOKING AT DIFFERENCES BETWEEN JUDICIAL LIENS & MORTGAGE LIENS

When entered of record, the judgment also operates as a lien upon all real property of the debtor in that county — in Pennsylvania, see 42 Pa.C.S. Sections 4303(a)(b), 1722(b), and 2737(3). Due to this, a judgment lien is called a general lien. Meanwhile, a mortgage lien is a specific lien that encumbers a particular piece of real property. Additionally, the Bankruptcy Code and related case law have defined these two liens quite differently, which can explain why they receive different treatment when the issue of avoiding junior mortgages comes into play.

The Bankruptcy Code defines the judicial lien in Section 101(36) as those obtained by judgment, levy, or other legal or equitable processes. Under Section 522(f) of the Code, judicial liens that impair exemptions provided in bankruptcy law can be avoided so liens that fit this definition must be involved. On the other hand, mortgage liens are said to be “bargained for” and consensual, as opposed to judicial liens which are viewed as imposed by the legal system.

Mortgage liens are part of an agreement between lenders and borrowers. People are free to make deals that they later regret, and the government generally does not feel obligated to save them from themselves. This helps to explain why the opportunities of avoiding junior mortgages are more limited. Section 506, in conjunction with Section 502, sets forth the only mechanism in the Bankruptcy Code for seeking to avoid these liens while both methods of avoidance could be explored for avoiding judicial liens.

AVOIDANCE WHEN OBLIGATION IS SECURED BY MULTIPLE AGREEMENTS

When an obligation is secured by more than one agreement, the extinguishment of a debtor’s obligation under one agreement does not necessarily end all of the obligations. However, in In re Stendardo from Pennsylvania, the bankruptcy court concluded that any right the creditor had to attorney’s fees and costs under the note was extinguished once it entered judgment on the note.

The analysis did not end at this point, though. The court went on to hold that the rights created by the continuing lien of the secured creditor’s mortgage and its asset purchase agreement that also secured the debtor’s obligation were not extinguished until the creditor received payment. In addition, the court cited In re Clark Grind & Polish, Inc., 137 B.R. 172 (Bankr.W.D. Pa. 1992), which stated that a confessed judgment on the promissory note did not extinguish the independent provisions of the mortgage and the asset purchase agreement. Since the various debt instruments were not seen as relying on each other for their continued existence, when one ceased to exist, the others still remained in place.

DIFFERENT INTEPRETATIONS OF SECTION 506 IN CHAPTER 13 & CHAPTER 7

U.S. Bankruptcy Court for the Eastern District of Pennsylvania noted in In re Cusato that “a discharge extinguishes only the personal liability of the debtor [while] a creditor’s right to foreclose on the mortgage survives or passes through the bankruptcy.” While the debt that was owed by the mortgagor cannot be obtained from the mortgagor after a discharge, the mortgagee retains the ability to pursue a judgment against the property to obtain a foreclosure sale to satisfy the mortgage lien on the property. This highlights the importance of Section 506’s applicability, as it can result in a mortgage debt being treated as an unsecured debt that would be discharged at the completion of the bankruptcy case, which could be permitted in Chapter 13 bankruptcies. When this occurs, a mortgage lender has no recourse for seeking repayment.

Courts, in the belief that Chapter 7 debtors would reap a windfall if in personam and in rem liabilities were eliminated through the bankruptcy action, have read and applied laws such as 11 U.S. Code §506 more strictly in Chapter 7 cases. The idea that the impact is different for debtors in Chapter 7 versus those in Chapter 13 could be viewed as unfair, but it seems to stem from the belief that a Chapter 7 debtor can walk away from a discharge without paying any money to creditors while the debtor in Chapter 13 will repay some amount on debts under a Chapter13 Plan. However, the justification for differing treatment of debtors regarding avoiding junior mortgages that are wholly underwater and are not subjects to payments under either bankruptcy chapter could be questioned. However, at this point in time, while potentially questionable, it also is unquestionably the applicable law under these circumstances.

Surrender of Property in Consumer Bankruptcy

Alberts Law, Debt Relief & Bankruptcy, , , , ,

When individuals with sizable debts decide to file for bankruptcy, they face other decisions that include whether or not to surrender property in their possession. The property to be surrendered secures debt that no longer can be paid. The implications of this decision are defined by definition of “surrender.” This is the necessary starting point.

What Does Surrender Really Mean?

The Bankruptcy Code does not provide a definition of the word. Instead, one is left to reviewing cases to determine what actually happens when property is surrendered. Also, property surrender can occur in Chapter 13 as well as Chapter 7. The main focus is on Chapter 7 bankruptcies since it is more often seen in this context. Following this post is a look at instances in which Chapter 13 surrenders can differ from those under Chapter 7 as well as what the differences can mean to debtors.

One Analysis of Surrender

In re Kasper is a 2004 case involving a Chapter 7 bankruptcy decided by the U.S. District Court in Washington, D.C. It provides an extensive analysis of relevant parts of the Bankruptcy Code to interpret “surrender.” The debtor had filed for bankruptcy under Chapter 7. As a result, he had to file a Statement of Intention regarding what he planned to do with property that acted as collateral for secured loans according to Section 521 of the Bankruptcy Code.

The debtor filed this form but did not select any of the choices that were listed. Instead, since he was current with the loan payments owed to Ford Motor Credit Company, the debtor’s stated intent was to “retain possession” of the car (which had a loan balance greater than the car’s current value).

Before the estate closed, Ford filed a motion to compel the debtor to file a statement in which he had to make one of three choices: surrender the property; redeem the property; or reaffirm the debt. Redemption would involve the payment of the amount of the allowed secured claim on the property. Reaffirmation restores personal liability that would cease with the closing of the case, although the car itself still would be collateral for the debt.

Defining “surrender” was the key to the court’s decision regarding the motion. The court focused on the 3 options listed with the retention of property in the Statement of Intention. These are exempting property, redeeming property, and reaffirming debt. A person who decides to retain property can choose among these options “if applicable.”

This interpretation led the court to see “surrender” as meaning turning over property to the trustee (and not directly to the lienholder) for administration under the debtor’s surrender obligation in  Section 521(a)(4) of the Code. Essentially, this would result in the car being subject to any lien enforcement rights under nonbankruptcy law that the creditor could exercise after the Chapter 7 automatic stay ended. The court denied Ford’s motion, believing that the debtor actually stated the intention to surrender the collateral to the trustee’s administration. This would result in Ford eventually having the option to enforce its rights under nonbankruptcy laws to get the car returned to it.

Courts Have Differed In Interpreting Surrender

Other courts, including the Bankruptcy Court for the Western District of Pennsylvania, have not made as an extensive of an analysis of “surrender” and have found a simpler meaning that seems to leave out a step (although the Bankruptcy Code’s lack of a clear definition for “surrender” makes this debatable). For example, in In re Losak (2007), the Western District of Pennsylvania decided that surrender means that collateral is given to the lienholder, which then can decide to pursue its rights under nonbankruptcy law. In re Failla, from Florida’s Southern District in 2014, focused on surrender meaning that a debtor agrees to not fight the lienholder’s exercise of rights under nonbankruptcy law. Of course, the endpoint is the same, and, ultimately, this is what matters.

When property that secures a debt is surrendered, a lienholder can pursue enforcement rights via nonbankruptcy law while the debtor indicates no intent to fight these actions, as long as those laws are not violated (see In re Ryan, 560 B.R. 339 (2016), from Hawaii that makes this point). However, until the creditor acts, the debtor retains title or ownership in the property. This last point is the main concern: surrender, by itself, does not change the owner of property.

Implications of Surrender for the Debtor Remain the Same

Since the owner has not changed, who is responsible for the property has not changed unless there is further action. Many debtors who have decided to surrender property seem to be caught unaware of the implications of this.

The Statement of Intention in Chapter 7 provides a blueprint for the future because the debtor does not transfer ownership or title immediately to the creditor. The implications are easiest to see if real property is involved. When a house secured by a mortgage note is surrendered, the debtor’s obligation regarding the mortgage payments and any deficiency balance that may exist will cease after the bankruptcy. While personal liability ends, there remains a property lien on which the creditor can foreclose. Obligations that arise after the date that the bankruptcy was filed belong to whoever is the named owner on the deed.

Problems When the Creditor Is In No Hurry to Foreclose On a House

The debtor’s problem is that the creditor may decide not to foreclose, and, until a foreclosure sale occurs, the debtor remains the person whose name is on the deed. This leads to consequences that a debtor often did not anticipate when the surrender option was chosen.

As long as the debtor in bankruptcy remains the owner on the deed, this individual remains responsible for property taxes that will be assessed. In addition, if a third party gets injured while on the property, the record owner of the property could face liability. This means that insurance should be maintained, despite the surrender of the property. Maintenance and upkeep also must be considered – for example, some utilities may need to remain turned on, and the debtor will get the bills.

The individual could look at options to get rid of the property when the creditor is in no hurry to foreclose. The property potentially could be sold, but anyone who has a lien in place must agree to the sale. Offering a deed in lieu of foreclose is a possibility, but acceptance by the creditor is not likely. Then again, the debtor could wait for the foreclosure process to occur, although a Chapter 7 bankruptcy as well as nonbankruptcy laws do not provide ways to force the issue. However, even after a surrender of this property, the debtor could decide to remain there as long as possible because ownership has not changed. Depending on the condition of the real estate, this could be the best choice.

Consider Possible Problems When Surrendering Property

Other types of property securing debts that were surrendered during the course of the bankruptcy can present similar problems, although on a somewhat smaller scale. A car must be maintained and insured, for example. If the debtor’s name remains on the title, then the debtor will be responsible for the collateral. Therefore, whenever property surrender is the chosen method of dealing with secured debt, the debtor filing the Statement of Intention under Chapter 7 first must consider the consequences since surrender does not mean an instantaneous change in ownership.

A Few Words about Surrender in Chapter 13

A Chapter 13 bankruptcy can involve surrender of property, too. This can occur when the Chapter 13 plan does not provide for payments regarding property that secures a debt. The creditor in this situation may pursue a deficiency claim and follows this by participating in the distributions to unsecured creditors. This debt must be handled in this way because, after the collateral has been surrendered under this chapter, the debt that had secured specific property becomes unsecured debt.

However, the surrender of property in Chapter 13 does not automatically change ownership of that property so debtors are in the same position here as with a Chapter 7. There is a potential mechanism for a surrender to result in the creditor being forced to take ownership in a Chapter 13 bankruptcy. When a debtor’s Chapter 13 plan is confirmed, the case does not end because the plan may take 3 to 5 years to be completed. During this time, the Bankruptcy Court continues to have jurisdiction over issues involving the plan. If a confirmed plan’s success is jeopardized when a creditor leaves property to be returned in limbo, the Court could issue an order that forces the completion of the transfer.