Facing Foreclosure? Here’s Another Slap in the Face

It seems that the Federal Courts of Appeal are getting a decent amount of publicity lately. Usually, only attorneys and their clients worry about what is going in these courts. The Federal Courts of Appeal sits just below the United States Supreme Court and handles appeals primarily from the U.S. District Courts.

Unless you have been living under a rock lately, you must know that a portion of President Trump’s recent Executive Order was ruled upon by the Ninth Circuit Court of Appeals.

Recently, the Eleventh Circuit Court of Appeals (the federal appeals court that sits over federal cases hailing from Florida) ruled that when a Chapter 7 debtor who "surrenders" a property during his bankruptcy to a creditor that has a lien against the property will be in violation of the Bankruptcy Code if the debtor attempts to contest the creditor's actions to recover the property in a foreclosure proceeding.

What’s Really Happening

Let me break it down like this:

A debtor files bankruptcy to get a fresh start. In this case, the debtor had a parcel of real property that had no equity. The debtor chose to surrender the property back to the creditor. In essence, the debtor is saying, ‘I do not want to pay for this property any longer.’

In addition, the debtor is seeking to discharge the financial obligation that is attached to the property. In other words, the debtor is seeking to discharge the promissory note. This is fancy bankruptcy terminology that means once the debt is discharged, the debtor is no longer legally liable for the debt. However, bankruptcy does not deal with the lien on the property or the title to the property, and that is where the problems begin.

The Real Details

The creditor is still required under state law to foreclose on the property or accept a deed in lieu of foreclosure so that it can acquire proper title to the property. Usually, the creditors would rather foreclose just to get a clean title from any and all title defects.

At first blush, the 11th Circuit's recent decision may not seem like a surprising ruling or one which anyone should be upset about. If you think about it, the creditor shouldn't have a problem getting their property/collateral back once a debtor says: "I surrender." However, the 11th Circuit's decision failed to consider scenarios where such a blanket ruling would work to hinder a debtor's fresh start (the entire purpose of the bankruptcy filing) and post-intention actions of the creditor.

What happens when a creditor chooses not to foreclose, or a different lender or mortgage services starts a foreclosure auction? These are legitimate questions that need to be answered. 

Digging a Bit Deeper

As an aside (and just for your knowledge) when people choose to file Chapter 7 bankruptcy, they are required to state their intention concerning their secured debts, i.e., debts that are collateralized by assets of the debtor; such as car loans and mortgages.

The bankruptcy code gives a debtor three choices: reaffirm; redeem or surrender. 

  • Reaffirmation means to re-obligate yourself to the debt, effectively entering into a new agreement to repay the exact same debt you are filing bankruptcy on. While this may sound crazy, many debtors choose to keep their cars and have no problem signing an agreement to keep and pay for the car going forward. This is not a very viable option when it comes to a piece of real estate with no equity.
  • Redeem means to pay the creditor the current fair market value of the collateral in full in exchange for a release of the lien on the collateral. Again, not a very viable option for a debtor in chapter 7.
  • Surrender means to give the collateral to the creditor so it can be sold and the creditor can recoup some or all of the funds owed on the collateral. While the term "surrender" is not defined by the Bankruptcy Code, the Eleventh Circuit held debtors must be bound by their representation in their statement of intentions.

The Problems

But what happens when a debtor surrenders the collateral to ABC Company in their bankruptcy paperwork, but XYZ Inc. later files a foreclosure action to recover it? The debtor did not surrender to XYZ Inc. and, in fact, has never heard of XYZ Inc. prior to its foreclosure action. This scenario happens all the time.

Is it fair to tell the debtor, ‘you surrendered the collateral and now you are bound by that decision so you cannot take any steps against XYZ, Inc.?’

Yet, state courts and bankruptcy courts across the State of Florida are disallowing a chapter 7 debtor who surrendered collateral in a bankruptcy case to raise any defense in the action to recover the collateral, even where no "surrender" was ever made to the company bringing the suit.

Likewise, what happens when, after the bankruptcy, a debtor enters into a loan modification or makes payments under a trial plan based upon representations made by the creditor; then, the creditor pulls the rug out from under the debtor's feet having accepted months, sometimes years of monthly payments?

Under the Eleventh Circuit's broad ruling, debtors are having a tough time convincing some state court judges that they should be allowed to defend themselves based upon the circumstances that came about post-bankruptcy.

Finally, what happens to a debtor who surrenders property in bankruptcy and makes every effort to give the property back to the creditor but the creditor flat out refuses to accept it such as a deed in lieu of foreclosure?

Believe it or not, this is more the norm than the exception. In fact, debtors have sought to force a creditor to take back the property and have received contest from the creditors and, in almost all circumstances, lost.

Thus, a debtor is stuck with a property that he cannot reasonably sell (due to the lien). In many instances, the surrendered property creates a liability for the debtor such as when homeowners or condo association fees accrue, mandatory utility requirements of various government bodies, and ownership liability if a person is injured on it. These are all post-bankruptcy obligations that are not discharged in the debtor's bankruptcy case.

Thus, a debtor's fresh start is now robbed, sometimes for years, because he cannot unload the property and must continue paying for expenses related to it until the creditor decides it is ready to take it back. Under the Eleventh Circuit's decision, the debtor would not be able to stand in the creditor's way nor would he be able to recover the funds expended.

The Eleventh Circuit's ruling is not the only federal appellate case on the issue as the Ninth Circuit has recently ruled on the same issue, and the Ninth Circuit's decision disagreed with the 11th Circuit's decision. 

Adding Insult to Injury

A bill was recently presented to the Florida Legislature that would, in effect, largely adopt the ruling made by the Eleventh Circuit. Florida H.B. 471 states that, in a foreclosure action, a lienholder may submit any papers filed by a defendant in a prior bankruptcy case evidencing an intent to surrender the property and such creates a rebuttable presumption that the defendant waived any defenses to the action.

This proposed law has its good and bad points for debtors. On the good side, (1) it only creates a rebuttable presumption so, as opposed to the Eleventh Circuit's holding, there is some wiggle room if it can be shown it was not the intent to actually surrender; and (2) it expressly allows for a defendant to raise defenses based upon a lienholder's post-bankruptcy conduct (or perhaps lack thereof).

The negative points are it only expressly allows for a "defendant's" documents filed in bankruptcy to used as an admission against the defendant. What about documents filed by the lienholder?

Some may argue that such documents would be admissible under the party-opponent hearsay rule but the same argument could be made for the defendant's documents. I foresee an argument that the specific reference to the defendant's documents cuts against the court being able to look at a lienholder's documents.

Additionally, "lienholder" is not defined and is not necessarily the person to whom the debtor surrendered to yet it seems such would not matter under this law.

Florida H.B. 471 clearly seems designed to give an edge to foreclosure plaintiffs, and that is not surprising considering it was proposed by a state senator who was a former CEO and chairman of a bank. However, there are some good points to the law in it that may leave a prior debtor/defendant in a better position than where the Eleventh Circuit left them.

There is more to come on this topic in the future, and I will be watching out for you - as always!