Legal Developments Affecting the Financial Services Industry in Alabama, Florida, Georgia & Mississippi
In In re Dukes, No. 16-16513 (11th Cir. Dec. 6, 2018), the Eleventh Circuit held that a debtor’s mortgage obligation was not discharged, despite a proof of claim not being filed, because the mortgage was not provided for by the debtor’s plan and because of the anti-modification provision of Section 1322(b)(2).
Continue Reading Eleventh Circuit: Mortgages not covered by bankruptcy discharge
This week, the United States Supreme Court issued a key decision under the Fair Debt Collection Practices Act in a case litigated by Balch & Bingham lawyers, Jason Tompkins and Chase Espy. In Midland Funding, LLC v. Johnson, the Supreme Court resolved a circuit split over the issue of whether debt collectors who file bankruptcy proofs of claim for stale debts are subject to suit under the Fair Debt Collection Practices Act. Siding with Midland, one of the nation’s largest buyers of unpaid debt, the Supreme Court held that “filing a proof of claim that on its face indicates that the limitations period has run” is not actionable under the FDCPA, thereby avoiding a potential conflict between the FDCPA and the Bankruptcy Code. Although ostensibly limited to the bankruptcy context, the Johnson decision could potentially ripple into other FDCPA cases. In the meantime, though, Johnson will undoubtedly turn off the faucet for would-be FDCPA plaintiffs who had hoped to capitalize on what the Eleventh Circuit complained is a “deluge” of out-of-statute proofs of claim.
The Eleventh Circuit recently clarified that sending periodic mortgage statements following a debtor’s bankruptcy discharge is not misleading to the “least sophisticated consumer.” In Helman v. Bank of America, 15-13672, 2017 WL 1350728 (11th Cir. April 12, 2017) Gayle Helman filed suit, alleging that Bank of America violated the Fair Debt Collections Practices Act (FDCPA), Florida Consumer Collection Practices Act (FCCPA), and other state laws when it sent Ms. Helman periodic mortgage statements after her mortgage loan was discharged in bankruptcy. She claimed that the statements unlawfully attempted to collect a discharged debt and that such communications would be misleading to the least sophisticated consumer because it suggested she remained liable for the debt.
Few issues involving the Fair Debt Collection Practices Act (FDCPA) are more hotly contested than whether filing a proof of claim on a time-barred debt violates the FDCPA. In bankruptcy, creditors have a right to file proofs of claim outlining the debt owed to them by the bankrupt debtor. In some instances, the statute of limitations for filing a lawsuit on that debt has run, and up until July 10, 2014, when the Eleventh Circuit Court of Appeals issued its decision in Crawford v. LVNV Funding, LLC, it was common practice to file a proof of claim on such a time-barred debt. Crawford—for the first time—likened the filing of a proof of claim to the filing of a lawsuit, finding that if one is wrongful, so is the other. After Crawford, debt collectors have faced a tidal wave of cases across the country, raising numerous defenses, one of which is res judicata. The argument goes like this: if a debt collector files a proof of claim to which neither the debtor nor the trustee objects and the court subsequently confirms the debtor’s plan, then a final judgment exists stating the debt is valid. Thus the debtor is barred by res judicata from further challenging the debt.
Despite a chorus of cases adopting this reasoning, the United States District Court for the Southern District of Georgia recently dealt a blow to the res judicata argument, finding that the grounds upon which the FDCPA claim was raised and the grounds upon which the proof of claim was confirmed were not sufficiently similar such that one could foreclose the other. For two years the so-called Crawford cases have raged; circuit splits exist; and this recent decision from the Southern District of Georgia shows that further disagreement is likely. Creditors and debt collectors alike should monitor the development of these cases to ensure they know how their claims will be treated in the bankruptcy courts.
Bankruptcy courts are currently divided on whether a debtor has a right to redeem property sold at a tax sale after the redemption period has run. The time for redemption depends on the law of the state where the property is located. In Alabama, for example, the statutory redemption period is three (3) years. Usually, a debtor must redeem by paying the full amount within the redemption period or be time barred. However, recent bankruptcy cases in Pennsylvania allowed debtors to treat tax purchasers as secured creditors, thereby permitting the debtors to pay the redemption amount as a secured claim over the life of a confirmed chapter 13 plan. See In re Gonzalez, Case No. 15-10628 (Bankr. E.D. Pa. May 18, 2016); In re Pittman, Case No. 14-17665 (Bankr. E.D. Pa. May 6, 2016). In these cases, the debtors filed chapter 13 petitions before the right of redemption expired under local law, but confirmation of their chapter 13 plans did not occur until after the redemption period would have expired. The rationale for this treatment is based on the view that a debtor’s right to redeem property after a tax sale resembles a mortgagor / mortgagee relationship with the tax purchaser. The opposing view—expressed by a California bankruptcy judge last year In re Richter, 525 B.R. 735 (Bankr. C.D. Cal. 2015)—is that the right of redemption following a tax sale is an asset of the debtor, rather than a claim. Until this issue is resolved by higher courts, tax sale purchasers should consult the law of their local jurisdiction so that they are not left waiting for years while a Chapter 13 debtor repays the redemption amount.
On June 1, 2015, the United States Supreme Court handed down its opinion in the case of Bank of America, N.A. v. Caulkett. In this case, the Court unanimously decided that a debtor in chapter 7 bankruptcy cannot “strip off” a junior lien that is fully underwater at the time the bankruptcy case is filed. This ruling benefits lenders holding junior liens on real property.
In Caulkett, the Court consolidated cases involving debtors David Caulkett and Edelmiro Toledo-Cardona. Both chapter 7 debtors successfully used Section 506(b) of the Bankruptcy Code to “strip off” a junior mortgage on property where the debt secured by the first mortgage exceeded the value of the property. The junior lienholders appealed the lower court’s decision and the Eleventh Circuit Court of Appeals affirmed.
Section 506(d) of the Bankruptcy Code provides
To the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void, unless—
(1) such claim was disallowed only under section 502(b)(5) or 502(e) of this title; or
(2) such claim is not an allowed secured claim due only to the failure of any entity to file a proof of such claim under section 501 of this title.
The Court provided that a plain reading of Section 506(d) seemed to favor the debtors’ position that the definition of “secured claim” in 11 U.S.C. §506(d) should mirror the definition in 11 U.S.C. §506(a)(1). However, the Court’s prior ruling in Dewsnup v. Timm, 502 U.S. 410 (1992) previously defined “secured claim” as used in Section 506(d) and resolved the issue to the contrary. In Dewsnup, the Court found that a junior lien on property where the property value was not enough to fully satisfy the junior lien could not be “stripped down” under Section 506(d) to the value of the property.
In Dewsnup, the Court reasoned that the definition of “secured claim” in Section 506(d) was ambiguous and thus that if a claim “has been ‘allowed’ pursuant to §502 of the Code and is secured by a lien with recourse to the underlying collateral, it does not come within the scope of §506(d).” The Court applied this definition in Caulkett and held that “Dewsnup defined the term ‘secured claim’ in Section 506(d) to mean a claim supported by a security interest in property, regardless of whether the value of that property would be sufficient to cover the claim.” After application of this definition to Section 506(d), a lien can only be “stripped off” if the claim is one not allowed under Section 502.
This decision is an important win for lenders. In its amici curiae brief filed with the Court, the American Bankers Association estimated that nearly $40 billion in loans secured by junior mortgages are presently outstanding. Lenders now will be affected less in chapter 7 bankruptcies in periods when real property values decrease.
The Eleventh Circuit Court of Appeals recently issued an opinion resolving any question as to whether or not a chapter 11 plan of reorganization may include enforceable releases of third parties who are not in bankruptcy.[1] This ruling reinforces the importance of carefully reviewing proposed chapter 11 plans as these plans could impact a creditor’s rights against third parties that are not in bankruptcy such as guarantors and co-borrowers.
The Facts
Seaside Engineering & Surveying, Inc. (“Seaside”) was a civil engineering and surveying firm principally owned by five individuals. Prior to Seaside filing bankruptcy, the principals branched out into real estate development and formed other entities to further those endeavors. These entities borrowed money from a creditor that was secured by personal guaranties from the principals. After the loans went into default, the creditor filed suit to collect under the personal guaranties. Three of the principals/guarantors filed chapter 7 bankruptcy and listed their ownership interest in Seaside as assets of the bankruptcy estate. Through the bankruptcy case, one of the principal’s ownership interest in Seaside was sold to the creditor. Seaside then commenced its chapter 11 bankruptcy case.
Seaside proposed a chapter 11 plan of reorganization in which Seaside would continue operations as an entity named Gulf Atlantic, LLC (“Gulf”). Some of the owners of Gulf were the same owners of Seaside. The proposed chapter 11 plan provided that non-debtors (including officers, directors and members of Seaside and Gulf) would not be liable for claims related to the bankruptcy case except to the extent such liability is based on fraud, gross negligence or willful conduct. The bankruptcy court confirmed the chapter 11 plan over the creditor’s objection and the district court affirmed the ruling. The creditor then appealed to the Eleventh Circuit Court of Appeals.
The Court’s Ruling
In its analysis, the court recognized the split among circuits as to whether a chapter 11 plan can effectively release a non-debtor from claims. The Court of Appeals for the Fifth, Ninth and Tenth Circuits prohibit such releases while the Second, Third, Fourth, Sixth and Seventh Circuits allow such releases under certain circumstances. Citing the case of In re Munford, 97 F.3d 449 (11th Cir. 1996), the Court of Appeals for the Eleventh Circuit stated that its circuit was within the majority view.
The minority view looks to Section 524(e) of the Bankruptcy Code[2] as the reason why a chapter 11 plan cannot effectuate the release of a non-debtor third party. The majority view interprets this statute as providing that while a discharge itself does not release a third party from liability, it does not limit a bankruptcy court’s equitable powers under Section 105 of the Bankruptcy Code to approve such a release.
While the Court of Appeals for the Eleventh Circuit finds itself in the majority view, it states that such releases “ought not to be issued lightly, and should be reserved for those unusual cases in which such an order is necessary for the success of the reorganization, and only in situations in which such an order is fair and equitable under all the facts and circumstances. The inquiry is fact intensive in the extreme.”[3] The court set out seven factors adopted by the Sixth Circuit[4] to be considered when determining if a release of third parties should be approved:
While adopting these seven factors, the Eleventh Circuit cautioned that these factors should be viewed as a non-exclusive list to be applied flexibly and that bankruptcy courts should remember that releases of non-debtor third parties should be used “cautiously and infrequently.”[6]
In the Seaside bankruptcy, the court of appeals concluded that an analysis of the above-cited factors supported the non-debtor releases. The court stated that the releases “prevent claims against non-debtors that would undermine the operations of, and doom the possibility of success for, the reorganized entity, Gulf.”[7] The court based its conclusion on the fact that it was the principals who provided the services being sold by Gulf and that if required to defend such claims, the principals would be unable to devote proper time and resources to seeing that Gulf succeeds. In reaching its conclusion, the court also noted that the fact the plan provided for payment in full of the creditor “weighs heavily in favor of the releases.” [8]
Takeaways for Creditors
Creditors often take solace that they have personal guarantors or co-borrowers when a borrower files bankruptcy. Creditors may even go so far as to elect not to take an active role in the bankruptcy case on the assumption that they will be able to pursue the other obligors. However, rather than completely disregarding a borrower’s bankruptcy case and focusing solely upon those other obligors, it is critical that creditors stay engaged in the bankruptcy process. Otherwise, a chapter 11 plan of reorganization may be confirmed that prevents the creditor from pursuing co-obligors.
Footnotes:
[1] In re Seaside Engineering & Surveying, Inc., 2015 U.S. App. LEXIS 3831, at *1 (11th Cir. March 12, 2015).
[2] This statute provides in relevant part that the “discharge of a debt of the debtor does not affect the liability of another entity on . . . such debt.” 11 U.S.C. § 524(e).
[3] In re Seaside, 2015 U.S. App. LEXIS 3831 at *14.
[4] In re Dow Corning Corp., 280 F.3d 648, 658 (6th Cir. 2002).
[5] Id.
[6] In re Seaside, 2015 U.S. App. LEXIS 3831 at *15.
[7] Id. at *8.
[8] Id. at *19.
