A Tale of Two Forums, the Intersection of State Law and Bankruptcy Law Determination of Property Rights

Gregory Stout, Esq.

Imagine a scenario where you service a second mortgage involving real property owned by a married couple.  The property is jointly owned, and both spouses signed the note and mortgage.  The current holder of the mortgage did not originate the loan, but was assigned the mortgage.  When the loan went into default, the creditor began a foreclosure proceeding. The mortgage creditor obtained judgment and on the eve of the sale, the wife filed for chapter 13 bankruptcy relief.

            Within the bankruptcy proceeding, the wife, now debtor, filed an adversary proceeding alleging that the mortgage was either void, or voidable.  Her argument was that she and her husband had previously filed a Chapter 7 bankruptcy and had discharged the debt nearly ten years prior.  The original lender on the second mortgage failed to timely record its mortgage. And when it did record the mortgage, it was during this prior Chapter 7 bankruptcy.  The mortgage was arguably recorded in violation of the automatic stay.  Further, the prior creditor who recorded the mortgage now has their own pending Chapter 11 bankruptcy.

            In the recent Chapter 13 case, only the spouse filed for bankruptcy relief, although she and her husband still jointly own the property.  In this new case, she argued that the mortgage recording is void, and also seeks to avoid the state court foreclosure judgment.  She also alleged that the mortgage is avoidable under 11 USC 544(a)(1) and (3).  The creditor argued that the state court judgment was not predicated on the recording of the mortgage.  Even assuming arguendo that the mortgage had never been recorded, under the relevant state law it was enforceable against the debtors.  The creditor also argued that the judgment could not be avoided under 544 as lis pendens had attached more than 90 days prior to the petition. As such any bona fide purchaser would be on notice of the foreclosure plaintiff’s mortgage interest.

            The bankruptcy judge ruled in favor of the debtor and held that the recording of the mortgage was in violation of the automatic stay, and thus was avoidable. The Court further interpreted the mortgage agreement to find that it had not attached to the real estate and thus set aside the state court judgment.

            The creditor appealed the ruling to the Bankruptcy Appellate Panel (“BAP”) which reversed the finding of the bankruptcy judge.  The BAP found that the Bankruptcy Court’s ruling ran afoul of the Rooker-Feldman doctrine and that the debtor could not collaterally attack the state court judgment.  The debtor then appealed the BAP ruling to the 6th Circuit.  The 6th Circuit ruled that Rooker-Feldman doctrine prevented collateral review of the state court foreclosure judgment.  However, the 6th Circuit found that the Bankruptcy Court had never ruled on the 544 claims and thus vacated the judgment of the BAP, in part, and remanded the matter back to the bankruptcy court.  On remand, the remaining 544 issues are currently being litigated.[1]

            This above case is a real life example of the complexities as it relates to the intersection of bankruptcy and state court law.  Namely, at what point can a bankruptcy court take action that essentially contradicts a state court judgment?  Even if the bankruptcy judge would be inclined to avoid a state court judgment, can it do so when only one of the property owners are before the court?

            The moral of the story, if you are a secured lender, and find yourself a defendant in an adversary proceeding challenging your mortgage, defend the action!  If a debtor, or trustee, is trying to collaterally attack a state court judgment, object.  Further, be mindful of milestone events within any state court foreclosure: when did Lis Pendens attach?  Did your judgment enter outside of the 90-day pre-petition window?  These events may act to cut off any strong arm power arguments raised by the trustee.

            Our firm’s litigation practice includes representing lenders in contested foreclosure or bankruptcy matters within Ohio, Kentucky, Indiana, West Virginia and Michigan. If you need assistance, please feel free to reach out to me at 513-333-7214 or Gregg.stout@rslegal.com


[1] [1]See In re Isaacs, 895 F.3d 904 (6th Cir.2018).

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