Mortgage Liens Survive Chapter 7 Bankruptcy Discharge, Allowing In Rem Foreclosures

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.

Case cite. Mccullough v. Citimortgage, 70 N.E.3d 820 (Ind. 2017).

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.

Key rules.

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.

Related posts.

Indiana Follows The Lien Theory Of Mortgages

Indiana Deficiency Judgments: Separate Action Not Applicable

What Is Indiana's Definition Of A Lien?
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I frequently represent creditors and lenders, as well as their mortgage loan servicers, in contested mortgage foreclosure cases. If you need assistance with a similar matter, please call me at 317-639-6151 or email me at john.waller@woodenlawyers.com. Also, don’t forget that you can follow me on Twitter @JohnDWaller or on LinkedIn, or you can subscribe to posts via RSS or email as noted on my home page.


Creditor Avoids Host Of Damages Claims By Refunding Payments Received Pursuant To A Mistaken Proof of Claim

Lesson. If, as a lender in a bankruptcy proceeding involving a borrower, you learn that your proof of claim was false, either through mistake or otherwise, quickly withdraw the claim and reimburse the trustee or the debtor for any payments made. A quick, good-faith effort to correct the problem could help you avoid any damages arising out of the mess.

Case cite. Carter v HSBC, 2016 U.S. Dist. LEXIS 128682 (S.D. Ind. 2016) (.pdf).

Legal issue. Whether a mistaken BK proof of claim, together with debtor payments based on the claim, give rise to one or more actions for damages by the debtor.

Vital facts. In Carter, a bizarre situation, the debtor/borrower paid to the creditor/lender/mortgagee over $30,000 pursuant to the debtor’s Chapter 13 bankruptcy plan. The debtor had a mortgage loan with the lender. The mortgage itself identified MERS as lender’s nominee (see post re: MERS below). About six years after the closing of the loan, for reasons not stated in the Court’s opinion, and without the debtor’s knowledge, MERS recorded a satisfaction of mortgage. The lender continued to service the mortgage loan, however, and pursued collection of the debt from the debtor following the debtor’s default, which led to the debtor filing a Chapter 13.  In the BK case, the lender filed a proof of claim alleging secured status based on the mortgage that previously had been released. The plan was confirmed, and the debtor made payments to the trustee, which in turn paid the lender. Although not detailed in the Court’s opinion, at some point the lender discovered that the mortgage had been released, so it amended its proof of claim and withdrew its right to receive any further payments. The debtor herself later discovered the satisfaction of mortgage. Ultimately, the bankruptcy court ordered the lender to repay the 30k it received through the plan.

Procedural history. The debtor filed an action against the lender seeking damages under many theories, including: (1) violation of the automatic BK stay, (2) actual and constructive fraud and (3) unjust enrichment. The lender filed a Rule 12(b)(6) motion to dismiss the debtor’s claims.

Key rules.

11 U.S.C. 362(a)(6) bars any “act to … recover a [preexisting] claim against a debtor…” during the pendency of an automatic stay, which is triggered when a debtor files for bankruptcy.

• Both actual and constructive fraud actions require, among other things, proof of a misrepresentation that caused an injury.

• In Indiana, a party may have a claim for unjust enrichment when a “measurable benefit has been conferred on the defendant under such circumstances that the defendant’s retention of the benefit without payment would be unjust.”

Holding. United States District Judge Tonya Walton Pratt granted the lender’s motion to dismiss the debtor’s case in its entirety.

Policy/rationale.

The debtor claimed the lender violated the automatic stay by collecting a debt falsely labeled as being secured when the claim was unsecured. However, the Court reasoned that the payments were made by mutual mistake and that the money was collected pursuant to a confirmed BK plan. “Once the bankruptcy was filed, [lender] never attempted to recover a claim … rather [it] filed a claim and received … payments from the trustee.” Since the lender did not act outside of the BK process, there was no violation of the automatic stay.

The debtor’s fraud and unjust enrichment claims failed because the lender repaid the trustee in full for all payments received. The trustee, in turn, repaid the debtor in full. Further, the debtor was unable to show that alleged filing fees and administrative costs resulted from the false proof of claim.

Related posts.

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I frequently represent lenders, as well as their mortgage loan servicers, entangled in loan-related litigation. If you need assistance with such a matter, please call me at 317-639-6151 or email me at john.waller@woodenmclaughlin.com. Also, don’t forget that you can follow me on Twitter @JohnDWaller or on LinkedIn, or you can subscribe to posts via RSS or email as noted to your left.


Seventh Circuit Holds That Proof Of Claim For “Stale” Debt Does Not Violate FDCPA

Lesson. The filing of a bankruptcy proof of claim for a time-barred debt does not violate the Fair Debt Collection Practices Act (FDCPA) in the Seventh Circuit, which includes Indiana.

Case cite. Owens v. LVNV Funding, 832 F.3d 726 (7th Cir. 2016) (pdf).

Legal issue. There were two: (1) whether a “claim” includes only legally-enforceable obligations and (2) whether a creditor’s attempt to collect on a time-barred debt in bankruptcy violates the FDCPA.

Vital facts. Defendant debt collector filed a proof of claim in a Chapter 13 bankruptcy case for a time-barred (“stale”) debt. The plaintiff debtor successfully objected to the claim and then sued the debt collector alleging FDCPA violations.

Procedural history. The district court dismissed the debtor’s action. The debtor appealed to the Seventh Circuit, which issued the opinion addressed here. Please note: the debtor later appealed to the U.S. Supreme Court, which refused to hear the case.

Key rules.

  • A “claim” under the bankruptcy code is a “right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured.” A claim is not a cause of action.

  • The FDCPA prohibits the use of “any false, deceptive, or misleading representation or means in connection with the collection of any debt.” 15 U.S.C. 1692e.

Holding. The Court first held that a claim on a time-barred debt “does not purport to be anything other than a claim subject to dispute in the bankruptcy case.” Thus a claim can include an unenforceable obligation. Next, the Court concluded that the defendant’s conduct was not deceptive or misleading so as to give rise to FDCPA liability.

Policy/rationale. The Court reasoned that the bankruptcy code contemplates that creditors will “file proofs of claim for unenforceable debts … and that the bankruptcy court will disallow those claims upon debtor’s objection.” The code and interpreting case law recognize that the term “claim” has a broad definition, including a right to payment, and whether the claim ultimately is enforceable is immaterial.

Moreover, the Court articulted that the information contained in the subject proof of claim was not misleading. Indeed, the information about the status of the debt was accurate. Whether the statute of limitations had run was apparent on the face of the proof of claim. Moreover, the debtor’s attorney successfully objected to the proof of claim.

Related posts.

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I frequently represent lenders, as well as their mortgage loan servicers, entangled in loan-related litigation. If you need assistance with such a matter, please call me at 317-639-6151 or email me at john.waller@woodenmclaughlin.com. Also, don’t forget that you can follow me on Twitter @JohnDWaller or on LinkedIn, or you can subscribe to posts via RSS or email as noted to your left.


Bankruptcy Proofs Of Claim Following A State Court Judgment: Debt Locked In

Lesson.  If a lender obtains a judgment in a foreclosure case, the borrower generally cannot re-litigate the amount of the debt in a subsequent bankruptcy action.  

Case cite.  Harris v. Deutsche Bank, 2016 U.S. Dist. LEXIS 14838 (S.D. Ind. 2016) (.pdf).  Our law firm successfully handled this appeal for one of my servicer clients.  My partner Matt Millis took the lead with the briefing.   

Legal issue.  Whether a bankruptcy court is barred from recalculating a debt amount previously determined by a state court. 

Vital facts.  Lender held a senior mortgage on real estate owned by Debtor, who defaulted on the subject promissory note and mortgage.  Lender, in state court, filed a foreclosure action and obtained a summary judgment after Debtor unsuccessfully argued that Lender improperly calculated the amount due.  One of Debtor’s points was that Lender failed to account for payments the Chapter 13 Trustee made in Debtor’s prior bankruptcy.  Debtor did not appeal the state court’s summary judgment.  Debtor later filed the instant Chapter 13 case, and Lender filed a Proof of Claim based upon debt figures in the state court’s summary judgment order.  Debtor objected to the Proof of Claim and once again argued, among other things, that Lender failed to credit payments made during the prior Chapter 13 action. 

Procedural history.  Debtor appealed the bankruptcy court’s denial of her objection to Lender’s Proof of Claim.   

Key rules. 

The federal Full Faith and Credit Act at 28 U.S.C. 1738 “requires federal courts to give the same preclusive effect to state court judgments that those judgments would be given in the courts of the State….”  In Harris, the doctrine of collateral estoppel (aka issue preclusion) applied. 

In Indiana, when used as a defense, the doctrine has five elements:  (1) a final judgment on the merits, (2) identity of the issues, (3) the party to be estopped was a party or in privity of a party in the prior case, (4) the party to be estopped had a full and fair opportunity to litigate the issue and (5) whether it would be otherwise unfair under the circumstances to permit the use of collateral estoppel. 

Holding.  The district court affirmed the bankruptcy court’s decision.  All of the elements of collateral estoppel had been met.

Policy/rationale.  The state court conclusively decided the amount owed by Debtor to Lender in the prior foreclosure action – after the parties litigated the matter.  There was an identity of the issues between the two cases.  Debtor had a full and fair opportunity to litigate the debt amount in state court.  Permitting the use of collateral estoppel was not unfair under these circumstances.  “If [Debtor] felt that the [state court] erred by disregarding her arguments or miscalculating an amount, she could have sought review by the Indiana Court of Appeals.  For whatever reason, she chose not to do that.”  As such, the law precluded Debtor from re-litigating that issue in the subsequent federal bankruptcy proceedings.   

Related posts. 

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I represent judgment creditors and lenders, as well as mortgage loan servicers, in bankruptcy-related litigation.  If you need assistance with a similar matter, please call me at 317-639-6151 or email me at john.waller@woodenmclaughlin.com.  Also, don’t forget that you can follow me on Twitter @JohnDWaller or on LinkedIn, or you can subscribe to posts via RSS or email as noted on my home page.


In Indiana, An Unrecorded Mortgage Has Priority Over A Subsequent Judgment Lien

Lesson.  While perhaps counterintuitive, in a lien priority dispute between a mortgagee holding an unrecorded prior mortgage and a creditor holding a perfected subsequent judgment lien, the mortgagee will prevail.  

Case cite.  In Re Moss, 2015 Bankr. LEXIS 4413 (N.D. Ind. 2015) (.pdf). 

Legal issue.  Whether an unrecorded mortgage has priority over a subsequent judgment lien.

Vital facts.  The facts were undisputed that the mortgage was not recorded.  There also was no dispute that the judgment lien, which had been created after the execution of the mortgage, was perfected.

Procedural history.  Moss arose out of a Chapter 7 bankruptcy case and specifically an adversary proceeding filed by the Trustee against various creditors.  The opinion dealt with cross-motions for summary judgment filed by the Trustee and a lender/mortgagee.  Without getting too far into the bankruptcy weeds, the opinion in part involved the Trustee’s 11 U.S.C. 544(a)(3) lien avoidance powers, as well as the Trustee’s section 547(b) and 551 powers to avoid preferential transfers. 

Key rules. 

  • Very generally, section 544(a)(3) “empowers a bankruptcy trustee to avoid any transfer of property that is avoidable by a bona find purchaser of real property.”  Indiana real estate law controls who would be a bona fide purchaser and “what constitutes constructive notice sufficient to defeat a bankruptcy trustee’s section 544(a)(3) power.”
  • Mortgages in Indiana take priority according to the time of filing.  Ind. Code 32-21-4-1(b).  This statute’s purpose “is to protect subsequent purchasers, mortgagees, and lessees of real property.” 
  • Indiana judgments constitute a lien upon real estate when the judgment “has been duly entered and indexed in the judgment docket.”  I.C. 34-55-9-2.  However, “a prior equitable interest [in the land] will prevail over a judgment lien.”  In other words, judgment liens are subordinate to prior “legal or equitable liens.” 
  • The Indiana Supreme Court has determined that “the [equitable] lien of an unrecorded mortgage has priority over that of a subsequent judgment.”  As between the parties to a mortgage, the lack of recording does not affect its validity. 

Holding.  The Court granted summary judgment for the Trustee and held that the judgment lien was subordinate to the unrecorded mortgage because the judgment creditor could not be considered a BFP (bona fide purchaser for value).  Again, the bankruptcy aspect of the opinion was somewhat complicated and beyond the scope of my blog.  But, for the record, the Court concluded that the Trustee, itself a BFP as a matter of bankruptcy law, could “effectively recover [the mortgagee’s] priority status for the benefit of the bankruptcy estate” so as to render the interest of the judgment creditor secondary and subject to the Trustee’s “recovered [senior] interest.”  Then, ironically, the Trustee was able to use that senior status to avoid the mortgage as a preferential transfer – read the opinion for a deeper dive into the BK issues.   

Policy/rationale.  The outcome in Moss turned on the purpose of the recording statute, which “operates to protect only subsequent good faith purchasers, lessees, or mortgagees for valuable consideration.”  The statute could not be used as a sword by the judgment creditor.  A judgment lien is not purchased for consideration, unlike deeds, leases or mortgages that are consensual in nature.  Judicial liens are creatures of statute and are not granted “for value.”  Thus the judgment creditor in Moss was not a BFP and, as such, could not defeat the mortgage.  In the context of the bankruptcy, the Court reasoned that “not upholding the unrecorded mortgage … would work to provide a windfall to some creditors at the expense of others who had no part in the failure to record.” 

Related posts. 

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I frequently represent judgment creditors and lenders, as well as their mortgage loan servicers, that are entangled in lien priority and title claim disputes.  If you need assistance with a similar matter, please call me at 317-639-6151 or email me at john.waller@woodenmclaughlin.com.  Also, don’t forget that you can follow me on Twitter @JohnDWaller or on LinkedIn, or you can subscribe to posts via RSS or email as noted on my home page. 


Case Study: Dismissing A Single-Asset Real Estate Debtor’s Chapter 11 Bankruptcy Case

What if, as a secured lender, your single-asset real estate entity borrower seeks refuge from your mortgage foreclosure action in bankruptcy court?  You might be able to obtain an expedited dismissal of the case, as we were able to do for our client in Uptown Business Center, LLC, 2013 Bankr. LEXIS 4324.

Generalities.  Following a two-day trial, our client prevailed on a motion to dismiss the bankruptcy filing “for cause” under 111 U.S.C. § 1112(b).  The Court’s opinion (.pdf) provides a road map for the pursuit of dismissal when there is no reasonable likelihood that a debtor’s bankruptcy plan will be confirmed within any reasonable time.  Our side essentially contended that the debtor’s filing was made in bad faith purely to delay the state court foreclosure.  In response, the debtor claimed that reorganization was feasible. 

For cause.  A creditor may move for a dismissal of a Chapter 11 case “for cause” under 11 U.S.C. § 1112(b).  Section 1112(b)(4) contains an illustrative but non-exhaustive list of scenarios that constitute “cause.”  Section 1112(b)(2) states that courts may not enter a dismissal if the debtor rebuts the showing made by the creditor by establishing “that there is a reasonable likelihood that a plan will be confirmed within applicable time frames and that acts or omissions that are the cause for dismissal were reasonably justified and will be cured within a reasonable amount of time fixed by the court.” 

SARE and bad faith.  The Court’s opinion discussed single-asset real estate (“SARE) entities and why they get special treatment.  In Re Castleton Associates Limited Partnership, 109 B.R. 347 (S.D. Ind. 1989) spelled out the “totality of the circumstances” test applicable to determining bad faith in the filing of SARE cases.  There are fourteen different factors that courts can consider:

  1. the debtor has few or no unsecured creditors;
  2. there has been a previous bankruptcy petition by the debtor or a related entity;
  3. the debtor has engaged in improper pre-petition conduct;
  4. the petition allows the debtor to evade court orders;
  5. there are few debts to non-moving creditors;
  6. the petition was filed on the eve of foreclosure;
  7. the foreclosed property is the sole or major asset of the debtor;
  8. the debtor has no ongoing business or employees;
  9. there is no possibility of reorganization;
  10. the debtor’s income is not sufficient to operate;
  11. there was no pressure (to dismiss the case) from non-moving creditors;
  12. the debtor’s reorganization essentially would involve the resolution of  a two-party dispute;
  13. a corporate debtor was formed and received title to its major assets immediately before the petition; and
  14. the debtor has filed the Chapter 11 case solely to invoke the automatic stay.

Our case for dismissal.  We put on evidence showing that there was no hope for the debtor to reorganize.  (Very early in the dispute, our client and the debtor entered into a forbearance agreement giving the debtor time to refinance the debt at a discount, which the debtor was unable to do.)  The debtor’s sole asset was a commercial, mixed-use building leased out to tenants.  The real estate had been fully leased at the time of the debtor’s payment default.  Among other things, we established that the net income was insufficient to meet the operating expenses, to service the debt and to bring the interest arrearage current.  The debtor had no employees.  The debtor was the subject of our mortgage foreclosure action and filed bankruptcy about an hour before the hearing on our motion for summary judgment.  The debtor delayed a resolution of the state court litigation for months and never asserted a viable defense.  We asserted that the debtor’s financial problem was a dispute between it and our client, a so-called “two-party dispute” that did not fit the profile of a Chapter 11 case.  We argued that the debtor was abusing the purpose of bankruptcy reorganization solely to prevent our client from exercising its contractual rights to collect its debt and foreclose on its mortgage. 

Dismissed.  The Court found that the debtor was not likely to be rehabilitated through the Chapter 11 process and did not have the economic wherewithal to reorganize.  The debtor’s proposed plan was not feasible. The debtor could not obtain alternative financing to secure infusion of capital in the near future.  The Court said:

[i]t was mismanagement of the Debtor that prompted the Debtor’s financial woes with [creditor].  The Court finds that this is essentially a two party dispute that should be adjudicated in State Court.  [Creditor] has borne its burden of showing that ‘cause’ exists to dismiss the case under § 1112(b) and the Debtor has not come forward with credible evidence to establish there is a reasonable likelihood that a plan will be confirmed with a reasonable amount of time. 

Following dismissal, we were able to obtain summary judgment in state court and proceed to a sheriff’s sale.  Our client, which purchases distressed debt, currently owns and operates the property.  (Note:  The Indianapolis Business Journal followed this case, so for more, click here.)


Claim For Contribution Against “Accommodation Party” Fails

In re Simpson, 2012 Bankr. LEXIS 3021 (S.D. Ind. 2012) (.pdf), decided by the United States Bankruptcy Court for the Southern District of Indiana, involved a Chapter 7 Trustee’s adversary proceeding seeking contribution from the debtor’s spouse.  The opinion is thorough and complicated.  My goal here merely is to touch upon the concepts of common law contribution  and accommodation parties, which are similar to guarantors but ultimately treated differently under the law. 

Loan basics.  In Simpson, the debtor, an individual, operated a farm on residential real estate that he and his spouse owned.  To help fund the business, the debtor borrowed money from a lender secured by a mortgage on the real estate.  Interestingly, the wife also signed the subject promissory note, but the opinion doesn’t specifically explain why.  The spouse was not a partner in the debtor’s business and did not directly benefit from the proceeds of the subject loan.  But, to make the loan, the lender needed the mortgage, which the debtor could not have granted without the signature of his spouse.

Contribution.  Within the Chapter 7 bankruptcy case, the Trustee sought a judgment against the debtor’s spouse to recover half the amount of the joint loan.  In cases like these, the Trustee stands in the shoes of the debtor.  The Trustee claimed that the spouse was liable to the bankruptcy estate pursuant to Indiana’s doctrine of contribution, about which I wrote on 2/1/12 and 10/10/08.   

Accommodation party defense.  Following a lengthy discussion, the Court concluded that Indiana law permits an action for contribution as between spouses.  The opinion next focused on the affirmative defense asserted by the spouse.  Specifically, Indiana’s UCC provides that an action for contribution may lie “except as provided in I.C. § 26-1-3.1-419(f) . . ..”  See, I.C. § 26-1-3.1-116(b).  Section 419(f) states that:

[a]n accommodation party who pays the instrument is entitled to reimbursement from the accommodated party and is entitled to enforce the instrument against the accommodated party . . . [but a]n accommodated party that pays the instrument has no right of recourse against, and is not entitled to contribution from, an accommodation party.

The legal question became whether the spouse was an “accommodation party” under I.C. § 26-1-3.1-419(a)

Accommodation party defined.  Generally, an accommodation party “signs the instrument for the purpose of incurring liability on the instrument without being a direct beneficiary of the value given for the instrument.”  I.C.§ 26-1-3.1-419(a).  The Court addressed various cases regarding who qualifies as an accommodation party.  This included the Keesling case, which was the subject of my 2/23/07 post.  The Court concluded that any benefit to the spouse was “indirect within in the meaning of I.C. § 26-1-3.1-419(a) and Keesling.”  Because the debtor’s spouse was an accommodation party, the Court held that the Trustee’s claim for contribution failed.
 
Simpson tells us that, in Indiana, there isn’t a viable claim for contribution against an accommodation party.    


7th Circuit Holding Impacts Single Asset Entity Chapter 11 Bankruptcy Cases

While sophisticated bankruptcy issues fall outside the scope of my blog, the February 14th opinion by the Seventh Circuit in the matter of Castleton Plaza, LP, No. 12-2639 (.pdf) warrants a mention. 

Castleton dealt with the absolute-priority rule in 11 U.S.C. 1129(b)(2)(B)(ii), which provides that creditors "in bankruptcy are entitled to full payment before equity investors can receive anything."  The technical issue was "whether an equity investor can evade the competitive process by arranging for the new value to be contributed by (and the new equity to go to) an 'insider,' as 11 U.S.C. 101(31) defines that term."  The Court said no. 

For more on the Castleton decision, including comments by attorneys involved in this important Southern District of Indiana case, please click on the following link to an article in The Indiana LawyerBankrupcty ruling locks out insiders.


Bankruptcy Proofs Of Claim And Standing/Loan Assignment Issues

Secured lenders faced with loans in default may find themselves entangled in a borrower’s or guarantor’s bankruptcy case and thus forced to file a proof of claim (POC).  In my April 27, 2007 post, I wrote about POCs, including when a creditor should file one.  In the Matter of Larkin, 2010 Bankr. LEXIS 3609 (N.D. Ind. 2010) (click and save for .pdf), Judge Dees provides a thorough opinion surrounding the sufficiency of the documentation needed to support a POC, which opinion also touches upon the “standing” issue that has been prevalent in mortgage foreclosure law for the past three or four years.

POC general rules.  The main POC rule is located at Federal Rule of Bankruptcy Procedure 3001.  A POC, if executed and filed in accordance with the Rules, “shall constitute prima facie evidence of the validity and amount of the claim.”  Fed. R. Bankr. P. 3001(f).  If the claim is based on a writing, the original or a duplicate of the written document must be filed with the proof of claim.  F.R.B.P. 3001(c).  If the creditor asserts a security interest in the debtor’s property, the POC “shall be accompanied by evidence that the security interest has been perfected.”  F.R.B.P. 3001(d).  The POC is deemed allowed, unless a party in interest objects. 

Entire document.  In the Larkin matter, the debtor’s first objection surrounded the mortgagee creditor’s attachment of only certain pages of the underlying loan documents.  The issue was whether this “substantially” complied with Rules 3001(c) and (d).  The Court held that the attachment requirement in Rule 3001(c) mandates specific, not substantial, compliance and, as such, the Court initially ruled that the POC was not valid.  (After a continuance of the hearing on the objection, the creditor corrected the problem by attaching a complete set of documents.  You always should do the same.)

Mortgage assignment.  The creditor in Larkin was an assignee of the loan.  The mortgage assignment had not been recorded.  Indiana’s recording statutes regarding assignments of mortgages “are designed to protect third party purchasers and mortgagees, not mortgagors.”  The recording of an assignment of mortgage “is not necessary to the validity of the mortgage, but is simply a protection to a good-faith purchaser of the mortgage itself . . ..”  Since the debtor was a mortgagor, not a subsequent purchaser, the debtor could not challenge the validity of her properly-recorded mortgage for failure to record a subsequent assignment.  (We would advise recording all mortgage assignments as soon as possible, but the act of recording does not affect the enforceability of the mortgage as between the mortgagor and the mortgagee’s assignee.) 

Post-petition assignment.  The debtor also contended that, because the mortgage assignment was post-petition, it was ineffective because it violated the automatic stay.  Not so, said the Court.  Bankruptcy law provides that “once the original grant by the mortgagor to the mortgagee has been perfected, the later assignment of that mortgage does not involve a transfer of property of the debtor . . . and cannot constitute a violation of the automatic stay.”  Larkin supports the notion that post-petition loan assignments are appropriate. 

Note assignment.  The debtor also attacked the validity of the transfer of the promissory note from the original holder to the current creditor.  This is the “real party in interest” and “standing” defense advanced by debtors over the last few years.  (See my November 15, 2007 post.)  The Larkin opinion provides a solid summary of the law applicable to the assignment of promissory notes via endorsement or allonge.  Endorsement is defined by Black’s Law Dictionary as “the placing of a signature, sometimes with an additional notation, on the back of a negotiable instrument to transfer or guarantee the instrument or to acknowledge the payment.”  “Allonge” is a “French term used in legal contexts for a paper that is annexed to a note.”  In Indiana, an endorsement “on an allonge is valid even though there is sufficient space on the instrument for an indorsement.”  I.C. § 26-1-3.1-204(a).  The Court in Larkin concluded that the subject allonge that was affixed to the debtor’s note (and included with the POC) was a part of the note, and thus constituted a valid endorsement.

POCs filed by our firm, whether secured or unsecured, that are based upon written documents include a complete copy of the underlying loan documents and any assignment papers.  It is also our practice to prepare and attach an “Attachment to Proof of Claim” that gives a brief description of the nature of the claim and references the attachments.  The Attachment would spell out, among other things, the factual and documentary basis that the creditor is the holder of the note and mortgage, and has the present ability to enforce the subject loan. 


Negative Equity/PMSI - Split Of Authority In The Seventh Circuit

On August 29, 2008, I addressed the question of "What is a 'purchase money security interest?'"  The case giving rise to my discussion was In Re: Myers, 2008 Bankr. LEXIS 2172, and the circumstances surrounded a bankruptcy case and whether a creditor's purchase money security interest (PMSI) extended to the negative equity part of a loan to purchase a vehicle.  Although the primary purpose of my post was to define and illustrate a PMSI, I necessarily had to point out that Myers concluded that the entire loan was secured -- the creditor's PMSI covered the money used to finance the negative equity. 

The purpose of today's post simply is to provide a footnote that bankruptcy courts within Indiana's circuit (the Seventh Circuit) are split on the negative equity issue.  Although representative of the minority view, In Re: White, 2009 Bankr. LEXIS 3156 (.pdf) is a strong opinion from Judge Lorch that negative equity "is merely the debtor's antecedent debt which is assumed by the [creditor]."  Thus it "does not fit within the definition of a PMSI...." 

The Myers and White opinons offer differing views on the negative equity question, but both are helpful in understanding the nature of a PMSI and a secured lender's rights in such a lien.   

 


Unsettled: Recoverability Of Attorney’s Fees For In-House Counsel

If your lending institution uses staff lawyers to prosecute mortgage foreclosure actions, you may be interested in the case In Re Waugh, 2009 Bankr. LEXIS 254 (N.D. Ind. 2009) (Waugh.pdf).   Waugh touches upon the issue of whether, in Indiana, attorney’s fees can be awarded to a lender when that lender is represented by an in-house, salaried counsel.  Unfortunately, the issue remains unresolved. 

Lender’s contention.  Waugh arises out of a Chapter 13 bankruptcy case, specifically the debtor’s objection to a claim filed by People’s Bank.  People’s received a $3,000 attorney fee award in a state court residential foreclosure action.  The debtor in the subsequent bankruptcy case objected to the inclusion of the fee award in the bankruptcy claim.  People’s reasoned that, although it paid in-house counsel solely on a salary, “time expended in the prosecution of legal matters, and the fees collected, are not irrelevant in determining the salary paid to in-house counsel.”  Furthermore, People’s could locate no Indiana cases or statutes prohibiting or limiting the collection of attorney’s fees paid by a mortgagee to salaried, in-house counsel. 

Debtor’s contention.  The debtor cited a single case, Crum v. AVCO Financial Services, 552 N.E.2d 823 (Ind. Ct. App. 1990), for the proposition that a real estate mortgagee can only collect attorney’s fees if they were actually incurred in the foreclosure proceeding.  Bankruptcy judge Lindquist noted in his opinion, however, that Crum did not assist in resolving the Waugh matter because “Crum merely held that when awarding attorney’s fees, the trial court is empowered to exercise its sound discretion.” 

Loan docs.  As with most (if not all) loan documents, the mortgage in Waugh contained written provisions permitting the recovery of attorney’s fees and litigation costs upon the default by the mortgagor.  None of the language, however, specifically referred to in-house counsel or fees/costs associated with salaried personnel.  Certainly it was undisputed that the loan documents in Waugh provided for the recovery of reasonable attorney’s fees in the case. 

Not this time.  Ultimately, the Court in Waugh never reached the issue of whether the attorney fee claim was appropriate.  This is because People’s based its claim upon a summary judgment previously entered in the state court foreclosure action, which judgment already provided for the recovery of $3,000 in attorney’s fees.  As such, the issue in the bankruptcy case was not whether the attorney’s fee claim was viable, but whether the bankruptcy court should give preclusion effect to the state court summary judgment. 

Too late.  The Waugh opinion provides a lengthy, technical discussion of the legal doctrines of res judicata (claim preclusion) and collateral estoppel (issue preclusion) and whether a state court judgment entered before the date of the debtor’s petition has preclusive effect regarding issues subsequently raised by the parties in the bankruptcy court.  The Court noted that, in Indiana, the entry of summary judgment is a judgment on the merits.  The judgment thus barred the bankruptcy objection.  The Court had no choice but to overrule the debtor’s objection to People’s claim for $3,000 in attorney’s fees.  Although the lender in Waugh won on a technicality, Judge Lindquist expressed that the underlying issue is unsettled: 

Without this Court so deciding, the State Court may or may not have erred in awarding attorney’s fees in the sum of $3,000 when counsel for People’s was in-house counsel on a salary…. 

It’s unclear to me whether, or to what extent, lenders utilize in-house counsel to prosecute commercial foreclosure actions.  Those who do should remain mindful that there appears to be a gap in Indiana law as to whether the lender can recover attorney’s fees in a foreclosure case.  Perhaps some day there will be a definitive Indiana appellate decision on this issue.  If that happens, I will discuss it here.


Respect The Automatic Bankruptcy Stay

The purpose of this post is to discuss the automatic stay provision of 11 U.S.C. § 362(a) in the Bankruptcy Code and to provide an illustration of a violation of the stay.  Judge Philip Klingeberger’s 7-25-08 opinion in In Re:  Galmor, 2008 Bankr. LEXIS 2201 (N.D. Ind. 2008) (Galmore.pdf) is a very thoughtful decision intended “to send a clear message” that willful stay violations “will not be tolerated.”

Primer.  Courtesy of Judge Klingeberger, here are some general principles: 

 When a debtor files a bankruptcy petition, the automatic stay takes effect, and Section 362(a) prohibits creditors from taking certain actions to collect their debts.
 The stay is self-executing and is effective upon filing of the bankruptcy petition.
 The stay prohibits, among other things, the enforcement of a deficiency judgment or collection on a claim that arose before the commencement of the bankruptcy case. 
 The rationale behind the stay is, in part, to give the bankruptcy court an opportunity to assess the debtor’s situation and to embark on an orderly course of resolving the estate.  The stay prevents a “chaotic and uncontrolled scramble for the debtor’s assets in a variety of uncoordinated proceedings in different courts.” 
 “The debtor has the burden of providing the creditor with actual notice of the bankruptcy and, upon so providing, the burden shifts to the creditor to prevent violations of the automatic stay.”
 If uncertain about the applicability of the stay, the creditor may petition the bankruptcy court for clarification. 
 Sanctions should not be imposed where there has been a technical violation of the stay.
 However, Section 362(k) provides monetary relief for willful violations of the automatic stay.

Backdrop.  Dykstra held a pre-petition judgment, had filed a motion to enforce the judgment by proceedings supplemental and had requested that defendant/judgment debtor Galmor appear in court to answer as to any assets.  The state court issued an order to appear, which Galmor ignored.  The state court then directed Galmor to appear and show why she should not be held in contempt.  Galmor blew off that hearing too, so the state court issued a bench warrant.  Subsequently, Galmor filed a petition for bankruptcy relief.  Amazingly, Dykstra showed up at Galmor’s Section 341 meeting of creditors in bankruptcy court and facilitated the arrest of Galmor pursuant to the bench warrant previously issued in state court.   

Elements of action.  Galmor sued Dykstra for damages for alleged willful violations of the automatic stay.  Here is what debtor’s must prove in order to recover:

1. That a bankruptcy petition was filed;
2. That the debtor is an “individual” under the automatic stay provision;
3. That the creditor had notice of the petition;
4. That the creditor’s actions were in willful violation of the stay; and
5. That the debtor is entitled to a form of relief provided by section 362(k).

The contested issue in Galmor was #4.   

Be proactive.  One of the interesting questions in Galmor was whether the creditor had a duty to take affirmative action to halt the effect of the pre-petition bench warrant in the wake of the automatic stay.  In Galmor, Dykstra not only permitted but indeed assisted with the arrest - at the first meeting of creditors in bankruptcy court no less.  Judge Klingeberger held:

Galmor was at risk of being arrested on a state court “collection device” bench warrant during her appearance at her section 341 meeting, an appearance mandated by the federal law of the Bankruptcy Code.  This is completely contrary to the purpose of the Bankruptcy Code and has the effect of rendering section 362(a) ineffective as to Dykstra’s debt.  The circumstances in this case raise the issue of whether a creditor, or an attorney, who has notice of a bankruptcy filing and had previously caused a bench warrant to be issued in order to collect a debt, has an affirmative duty to request that the warrant-issuing court recall the warrant.  The court determines that this affirmative duty should be imposed.  . . .   

Willful violation.  Based upon the following rationale, the Court held Dykstra’s actions to be a willful violation of the automatic stay and awarded punitive damages. 

Dykstra was not at all sensitive to any potential violation of the automatic stay, nor did he make any statement at the meeting of creditors that the warrant fell into the hands of federal law enforcement personnel by mere happenstance.  It is clear that it was Dykstra’s intent to appear at the section 341 meeting to have Galmor arrested as either punishment for not paying the debt and/or as a method to attempt to collect the debt.

Secured lenders and their counsel need to be sensitive to the automatic stay and cease all non-bankruptcy collection proceedings.  As Judge Klingeberger noted, the automatic stay “is a powerful tool” and should be respected accordingly.  For more on the automatic stay, please see my 7-18-08 post “Does a Guarantor’s Bankruptcy Stop a Foreclosure Case Against the Borrower?” 


Does A Guarantor’s Bankruptcy Stop A Foreclosure Case Against the Borrower?

Sometimes when secured lenders file suit to enforce a note and a guaranty and to foreclose a commercial mortgage, the guarantor (but not the borrower) files a bankruptcy petition.  Pursuant to 11 U.S.C. 362, the collection action, as to the debtor (the guarantor), is stayed.  Some wonder whether the entire case is stayed. 

Borrower idle.  The defendant borrower may not seek bankruptcy protection if, for example, there are no assets to protect beyond the loan collateral, the value of which may not cover the debt and the collection costs.  So, while the borrower essentially throws in the towel, the guarantor runs for cover in bankruptcy court.

The issue.  The question is whether the bankruptcy stay applies only to the guarantor or whether it extends to the borrower.  The answer, generally, is no, despite the confusion that sometimes arises out of this situation.  Meaning no disrespect to state court judges, but because they rarely deal with bankruptcy issues, they sometimes conclude, perhaps intuitively, that a bankruptcy filing by one defendant will stay the case as to all defendants, at least until the bankruptcy court orders otherwise.  To be fair, this scenario has puzzled lawyers and lender reps too (including me).

General rule.  In Pitts v. Unarco Industries, Inc., 698 F. 2d 313, 314 (7th Cir. 1983), the Seventh Circuit, which includes Indiana, stated that “the clear language of Section 362(a)(1) thus extends the automatic stay provision only to the debtor filing bankruptcy proceedings and not to non-bankrupt co-defendants.”  This is because the language in Section 362 “unambiguously states that the stay operates only as ‘against the debtor.’”  Id.; 555 M Manufacturing, Inc. v. Calvin Klein, Inc., 13 F. Supp. 2d 719 (E.D. Ill. 1998); Federal Land Bank v. Stiles, 700 F. Supp. 1060, 1062-63 (Mon. 1988) (noting generally that stays pursuant to Section 362(a) are limited to debtors and that there are no special exceptions for circumstances involving a co-defendant who is jointly liable on a debt with the debtor). 

LLC’s.  The United States Bankruptcy Court for the Northern District of Iowa in In Re Calhoun, 312 B.R. 380 (N.D. Iowa 2004) addressed the issue of who was covered by the automatic stay.  An individual debtor had sought Chapter 7 bankruptcy relief.  The debtor, however, had an interest in a limited liability company (an LLC).  In Iowa, not unlike Indiana, an LLC is an entity separate and distinct from its members and managers.  The Court held that the automatic stay did not apply to the LLC.  “The separate legal existence of a corporation is respected in bankruptcy.  The automatic stay does not stay actions against separate entities associated with the debtor.”  Id. at 384.  The bankruptcy court concluded, therefore, that only the named petitioner (debtor) is protected by the automatic stay.  “None of the LLCs referred to are parties to the bankruptcy.  They are not proper parties and not protected by the provisions of the automatic stay.”  Id. at 384-385.  See also, In Re Merlyn L. Johnson, 209 B.R. 499, 500 (Neb. 1997) (a creditor generally is permitted to sue a guarantor or a co-debtor and to collect from property of a third party that is pledged to secure debts of the debtor).

Proceed.  Thus the law seems to be clear that, in general, a secured lender should be permitted to proceed to judgment against a borrower and to foreclose on a borrower’s mortgage.  Note that courts recognize limited exceptions to this general rule, not to mention the fact that the guarantor could seek an order from the bankruptcy court to extend the stay to the borrower.  There are “special circumstances” that may permit the extension of the stay, but the onus should be on the guarantor or borrower to prove them.  (A couple of recognized exceptions that the guarantor or borrower might seek to prove are, first, where the relationship between the debtor and the third-party defendant is such that a judgment against the third-party defendant will effectively be a judgment against the debtor and, second, where the litigation against the third-party defendant would cause “irreparable harm” to the debtor or estate.)  Otherwise, as long as the plaintiff secured lender and its counsel provide notice to the parties of the intention to proceed with foreclosure despite the bankruptcy filing, the plaintiff lender should be free to continue with the foreclosure case.  Thanks to my bankruptcy colleague, Chris Jacobson, for her insights.


Indiana Tax Sale And Related Proceedings Violate Bankruptcy Stay

From time to time, rights arising out of property tax liens collide with rights arising out of mortgage liens.  Priority determinations and related issues sometimes can be complicated.  The Indiana Court of Appeals case ATFH Real Property v. Stewart, 879 N.E.2d 1184 (Ind. Ct. App. 2008) (ATFHOpinion.pdf) provides some clarity regarding whether and when formal property tax lien proceedings impact a mortgagor and, in turn, a mortgagee when the mortgagor has filed for bankruptcy protection.

Procedural history.  Mortgagor petitioned for Chapter 13 bankruptcy protection.  Among mortgagor’s assets was mortgaged real estate.  Post-petition, a tax lien on the property was sold to a party in a Marion County, Indiana tax sale.  The County, however, had not applied for relief from the bankruptcy automatic stay.  The purchaser of the tax lien then assigned its lien to another party (assignee).  Months later, mortgagee had the bankruptcy automatic stay lifted so it could foreclose on its mortgage on the property.  After the bankruptcy case concluded, and the mortgagor/debtor was discharged, the Marion County Tax Auditor issued a deed to the property to the assignee of the tax sale lien.  The assignee then conveyed its interests in the property to ATFH, the plaintiff in the current case.  ATFH filed an action to quiet title, essentially claiming that its interest in the property, which arose from the tax lien, was superior to the interests of the mortgage lender that foreclosed on the property. 

Property tax lien primer.  The Indiana Court of Appeals in ATFH Real Property set out the following general rules applicable to property tax liens in Indiana:

 When the owner of real property fails to pay property taxes, the property may be sold to satisfy the delinquent taxes. 

 The process by which property is sold to satisfy delinquent taxes is governed by statute, and a valid sale requires material compliance with those statutes.

 At such a “tax sale,” when a bid from a member of the public equals at least the amount of the delinquent taxes (plus some miscellaneous expenses), the buyer receives a certificate of sale and a lien against the property in the amount paid.  I.C. § 6-1.1-24-5 and 9.

 This lien is superior to all other liens that exist against the property.  I.C. § 6-1.1-24-5.

 Any person, however, may redeem (buy back) the real property in question by paying to the county treasurer an amount specified by I.C. § 6-1.1-25-2.  See, I.C. § 6-1.1-25-1.

 If no redemption is made within the specified period, the purchaser of the tax lien (or his assignee) may then petition the court in which the judgment of sale was entered to order the auditor to issue a tax deed, which, when issued, vests in the grantee an estate in fee simple absolute.  I.C. § 6-1.1-25-4.6.

Bankruptcy automatic stay.  The issue in ATFH Real Property was whether the purchase of the tax lien on the property at the tax sale violated the bankruptcy stay.  More specifically, did the purchase constitute an “act to obtain possession of property” under 11 U.S.C. § 362(a)(3)?  The Court concluded that it did, “even if the immediate result was not actual possession.”  The rationale was that one cannot obtain possession of property from a tax sale without first purchasing the tax lien.  The Court held that the tax sale and all proceedings flowing therefrom were therefore void as violative of the automatic stay.   


6 THINGS TO REMEMBER ABOUT PROOFS OF CLAIMS IN INDIANA BANKRUPTCY COURTS

Although my blog primarily is devoted to issues surrounding Indiana state court foreclosure and lien enforcement actions, some discussion of bankruptcy matters will be warranted.  This is because, not infrequently, a real estate foreclosure or UCC lien enforcement proceeding that starts in state court will end up in bankruptcy court.  So, I would be remiss if, from time to time, I did not address legal opinions arising out of Indiana bankruptcy courts.  One such case is In The Matter Of:  David Burr Fink, 2007 Bankr. LEXIS 1149 (N.D. Ind. 2007), a March 15, 2007 decision by Judge Robert E. Grant that tackles questions regarding whether a late-filed proof of claim should be allowed.  (Fink Opinion.pdf)

1. General bankruptcy rule.  An unsecured creditor that has notice or knowledge of a bankruptcy case but fails to timely file a proof of claim may have its claim disallowed or, in a Chapter 7 liquidation case, subordinated (see #3). 11 U.S.C. 502(b)(9); Fink at 2.

2. “Excusable neglect” exception.  In a chapter 11 proceeding only, a court can, but is not required to, allow late filed claims if the failure is due to excusable neglect.  Bankr. Rule 3003(c) and 9006(b)(1); Fink at 2, n.1. Proving “excusable neglect” can  be difficult, particularly where a creditor is sophisticated and/or represented by counsel.

3. Chapter 7 late claims.  In Chapter 7 cases, theoretically the failure to file a timely proof of claim is not fatal.  11 U.S.C. 726(a)(3); Fink at 2.  The result is the subordination of the claim to the full payment of all other timely filed unsecured claims. Thus the tardy creditor is at the back of the line for any distribution.  11 U.S.C. 726(a)(3); Fink  at 14. But chapter 7 plans that pay unsecured creditors in full are extremely rare.  For all practical purposes, a late-filed claim in a Chapter 7 case ultimately will mean no distribution to an unsecured creditor.

4. “No asset” cases.  In most Chapter 7 cases, courts will issue an order indicating that there is no need to file a proof of claim until further notice. The reason for this is that, absent a finding that there are assets, there may well be no distribution to unsecured creditors.

5. Secured creditors and deficiency claims.  As a general rule, only unsecured creditors need to file proofs of claim in order to be placed “in the distributional queue.” But if a secured creditor desires to retain a deficiency claim, it too should file.  Fink at 14.  In other words, secured creditors should file in order to preserve possible distribution on account of any unsecured deficiency.  Significantly, the failure to file a claim will not destroy or eliminate a secured creditor’s lien or interest in the property of the estate.  Fink at 14-15.  A lien remains unaffected by bankruptcy unless it specifically is altered by the court.   

6. Informal proof of claim.  Bankruptcy courts have developed an equitable doctrine known as an “informal proof of claim” that can sometimes permit a claim to be asserted via something other than a formal proof of claim.  The Fink opinion provides a thorough analysis of this doctrine.  Judge Grant found that the situations in which “informal claims” should be allowed are extremely narrow.  In Fink, the Court found that a creditor had not, via a motion for relief from stay, asserted an informal claim.  The creditor was unable to avoid strict enforcement of the claims bar date.
 
Turning to this blog’s true purpose, which is to provide a resource for secured lenders facing loans in default, Judge Grant’s opinion provides a nice refresher on the rules for filing proofs of claims.  The message is to determine quickly whether you need a proof of claim and, if so, to ensure you timely file it, even if you have or will be seeking other relief in the bankruptcy proceeding such as an order modifying the automatic stay.  Actually, the filing of a proof of claim is fairly painless, and there really is no downside to filing one.  When in doubt - file.