Lesson. Although a Chapter 7 bankruptcy discharge eliminates personal liability for a mortgage loan, a discharge does not erase the debt or the mortgage lien. This means that borrowers will not be on the hook for the money, but lenders still can sue to foreclose the mortgage. Discharged debtors still can lose their property.
Legal issue. Whether a discharge in bankruptcy precludes a mortgage foreclosure action.
Vital facts. The Borrowers entered into a loan secured by a mortgage on their home. They later defaulted for a failure to make payments when due. They filed a Chapter 13 bankruptcy case that was converted to a Chapter 7. The Borrowers’ debts were discharged in the Chapter 7 case, which was then terminated.
Procedural history. Lender initiated an in rem foreclosure against the Borrowers and filed a motion for summary judgment. The trial court granted the motion and entered an in rem judgment against the mortgaged property. The Borrowers appealed all the way to the Indiana Supreme Court.
A Chapter 13 is a reorganization type bankruptcy in which the debtor’s assets generally are not surrendered or sold. The debtor instead “pays his creditors as much as he can afford over a three or five-year period.”
A Chapter 7 is a liquidation type bankruptcy in which the debtor generally surrenders his assets and in exchange is relieved of his debts.
A Chapter 7 discharge eliminates a homeowner’s personal liability for a mortgage loan. But a discharge has “has no bearing on the validity of the mortgage lien.” A lender’s right to foreclose on the mortgage survives.
Holding. The Indiana Supreme Court affirmed the summary judgment in favor of Lender and against the Borrowers.
Policy/rationale. The Borrowers in Mccullough asserted that the bankruptcy discharge effectively negated the debt and, as a result, Lender could no longer foreclose. However, a mortgage loan has “two different but interrelated concepts, namely: the loan due on the mortgage as evidenced by the Note, and the lien on the property as evidenced by the Mortgage.” A bankruptcy discharge “removes the ability” of a lender to collect against the borrower individually (in personam liability), but liens (in rem rights against property) remain enforceable. In Mccullough, the Supreme Court found that the Borrowers were protected from personal liability as to Lender’s debt, but the mortgage lien was enforceable as an in rem action against the Borrowers’ real estate, for which there remained an outstanding lien balance. Thus the debt survived the bankruptcy. Only the Borrowers’ personal obligation to pay it went away.
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