Monday, December 26, 2011

Recent Decisions Regarding Bankruptcy & Foreclosure in the 1st Circuit (December 2011) Part 3 of 4

BAP reaffirms that mortgagee did not violate discharge injunction by failing to foreclose on property the debtors had abandoned, the mortgagee failing to foreclose for business reasons as it was not cost effective to do so in this case:

(IN RE CANNING)CANNING v. BENEFICIAL MAINE, INC., HSBC MORTGAGE SERVICES, INC., and HSBC MORTGAGE CORP., 2011 Bankr. LEXIS 4756 (1st Cir. BAP 12/12/11)(Before Judges Feeney, Tester & Hoffman, Opinion by Tester).
PROCEDURAL POSTURE: Plaintiff debtors appealed from a judgment of the U.S. Bankruptcy Court for the District of Maine holding that defendants (collectively "mortgagee") did not violate the discharge injunction by refusing to foreclose or release its mortgage lien on debtors' residence. Debtors complaint below was brought under 11 U.S.C.S. §§ 105, 524(a)(2).
OVERVIEW: Debtors relied on In re Pratt to contend that the mortgagee's conduct effectively eradicated their right to surrender and indefinitely kept them from a fresh start. The Panel stated that it followed from Pratt that after debtors surrendered the Property, the mortgagee was not required to take possession. Thus, the bankruptcy court correctly concluded that the mortgagee did not violate the discharge injunction when it refused to foreclose. The surviving question was whether the mortgagee improperly failed to discharge its mortgage. Assessing the particular facts, the Panel could not conclude that there was a particular confluence of circumstances that rendered the mortgagee's refusal to discharge its mortgage tantamount to coercing payment of a discharged prepetition debt. Unlike Pratt, the record reflected that the Property had significant value, that the mortgagee did not suggest it would discharge the mortgage only upon the full payment of the loan, and that debtors were not incurring any attendant costs. Also,
11 U.S.C.S. § 524(a) was not a license for courts to go beyond the particular prohibitions specified in the statute to shield debtors from adverse contingencies.
OUTCOME: The judgment was affirmed.

Chapter 7 Trustee validly avoided Bank’s lien on debtor’s property, the Court rejecting Bank’s claims of equitable subrogation or reformation. Here, the Bank in a re-fi, failed to properly include both parcels as its collateral and mistakenly included only one of the two parcels in the re-financed mortgage (the fact that the old and the new mortgage referenced the property as having the same street adress does not change the outcome):

(IN RE TRASK, d/b/a Marsh River Steel) PASQUALE PERRINO, Chapter 7 Trustee v. BAC HOME LOANS SERVICING, 2011 Bankr. LEXIS 4799 (1st Cir. BAP 12/15/11) (Before Judges Hillman, Boroff & Cabán, Opinion by Boroff).
Appeal from the United States Bankruptcy Court for the District of Maine. (Hon. Louis H. Kornreich, U.S. Bankruptcy Judge). Bankruptcy Case No. 09-11698-LHK, Adversary Proceeding No. 10-01005-LHK.
PROCEDURAL POSTURE: Defendant mortgage creditor appealed from a judgment of the U.S. Bankruptcy Court for the District of Maine in favor of plaintiff Chapter 7 trustee, and against the creditor as to their competing interests in certain real estate.
OVERVIEW: The creditor asserted an equitable interest in the subject real property arising from a mutual mistake when the correct property description in a prepetition mortgage now held by the creditor was omitted. The bankruptcy court concluded that the Trustee, given the status of a hypothetical lien creditor by
11 U.S.C.S. § 544(a), was an intervening party with an interest superior to the creditor's equitable claims. The creditor argued that the bankruptcy court erred as a matter of law in determining that, because the Trustee was an intervening party, the new mortgage should not be equitably reformed to express the intended agreement of the parties that the house be the mortgaged property. However, the Panel agreed with the bankruptcy court. The Panel concluded that the use of the same street address to describe two abutting parcels would not be sufficient to constitute inquiry notice. Second, and here more important, there was nothing in the record that supported the creditor's assertion that the old mortgage and the new mortgage did, in fact, contain the same street address. Finally, the Panel found that the doctrine of equitable subrogation was here inapplicable.
OUTCOME: The judgment was affirmed.
BAC Home Loans Servicing, LP ("BAC") appeals from a judgment of the United States Bankruptcy Court for the District of Maine in favor of Pasquale Perrino, chapter 7 trustee (the "Trustee"), and against BAC as to their competing interests in certain real estate. BAC asserts an equitable interest in the subject real property arising from a mutual mistake (among BAC's predecessor in interest and the Debtors, defined below) when the correct property description in a prepetition mortgage now held by BAC was omitted. The bankruptcy court concluded that the Trustee, given the status of a hypothetical lien creditor by § 544(a) of the Bankruptcy Code,2 was an intervening party with an interest superior to the equitable claims of BAC.
BACKGROUND:  Sara and Douglas Trask (the "Debtors") are record owners of an unimproved sixteen-acre lot in a subdivision in Winterport, Maine, known as "Lot #6, James R. Greene Subdivision, Map File 10, Page 224" ("Lot #6"). They are also record owners of an abutting 1.74-acre lot on which their residence is located (the "House").

In April 2007, the Debtors refinanced their first mortgage on the House ("Old Mortgage") with Home Loan Center, Inc. ("Home Loan"). By the refinancing, the previous mortgage loan was paid and the Old Mortgage was discharged. In one of two mortgage loans related to the refinancing, the Debtors executed and delivered to Home Loan a promissory note in the amount of $195,000.00. To secure the new note, the Debtors executed and delivered, inter alia, a mortgage (the "New Mortgage") to Mortgage Electronic Registration Systems, Inc., acting solely as nominee for Home Loan. The promissory note and the New Mortgage were subsequently assigned to BAC.   As part of the refinancing, the Debtors provided Home Loan with a second note in the amount of $25,450.00, payment of which was secured with a second mortgage having the same infirmity as the first. The second note and mortgage were not assigned to BAC and therefore are not at issue in this appeal.

Although the Old Mortgage described the intended collateral as the House, the New Mortgage erroneously employed the description for Lot #6. It is undisputed that both the Debtors and BAC's predecessor, Home Loan, intended the mortgaged property to be the House. The error was not discovered until shortly before the filing  of the bankruptcy case in the spring of 2009.
At a status conference immediately before the hearing, the parties agreed that BAC's equitable claim was valid as against the Debtors and that the Debtors were no longer asserting an exemption in their residence. As a result, the sole dispute at trial was between the trustee as an intervening lien creditor under § 544(a) and BAC as the holder of an equitable claim.
Equitable Reformation:  BAC argues that the bankruptcy court erred as a matter of law in determining that, because the Trustee was an intervening party, the New Mortgage should not be equitably reformed to express the intended agreement of the parties that the House be the mortgaged property.

The Power to Reform:  Bankruptcy courts are courts of equity.
Katchen v. Landy, 382 U.S. 323, 336, 86 S. Ct. 467, 15 L. Ed. 2d 391 (1966); Thinking Machs. Corp. v. Mellon Finan. Servs. Corp. (In re Thinking Machs. Corp.), 67 F.3d 1021, 1028 (1st Cir. 1995). Accordingly, they have the power to reform written instruments, including deeds and mortgages, under applicable state law to effectuate the intent of the parties.6 Even as a court of equity, however, the bankruptcy court's discretion is limited and cannot be used in a manner inconsistent with the commands of the Bankruptcy Code. See In re Plaza de Diego Shopping Ctr., Inc., 911 F.2d 820, 830-31 (1st Cir. 1990).
Although the Trustee's status is crafted by federal law, the effect of those rights against other parties claiming a competing interest is determined by applicable state law.  Thus, although a trustee's actual knowledge will not preclude bona fide status, constructive notice, as determined by state law, will "defeat the Trustee's rights under § 544(a)(3) just as such notice would defeat the rights of any bona fide purchaser of real property."

Under Maine law, a deed or mortgage may be reformed in equity if the petitioner shows a mutual mistake of fact. It is well settled, however, that the Maine courts will not exercise their power to reform documents if the result will prejudice third parties or if the rights of third parties have intervened.
As of the date of case commencement, the Trustee held all of the rights and powers of a judicial lien holder and/or hypothetical bona fide purchaser with respect to all of the Debtors' property. See 11 U.S.C. § 544(a).   Thus, pursuant to § 544(a), the Trustee may subordinate BAC's secured claim to the Debtors' estate if, under applicable state law, a hypothetical lien holder would have prevailed over the claim as of the date of the bankruptcy case filing.

Bankruptcy court decisions denying motions to reform deeds or mortgages based on a chapter 7 trustee's status as an intervening lienholder or bona fide purchaser under § 544(a) are legion. Indeed, it is difficult to identify a purpose for § 544(a) other than to achieve the result of which BAC complains. BAC argues, however, that the facts here provide a distinguishing factor: that is, matters of record giving even an intervening lien creditor or bona fide purchaser constructive notice of BAC's competing interest. This is the crux of BAC's argument; it contends that even the holder of an intervening interest would have had constructive notice of BAC's mortgage.

Generally, there are two kinds of notice: actual and constructive. The First Circuit explained in detail the different kinds of notice in
Stern v. Continental Assurance Co. (In re Ryan), 851 F.2d 502 (1st Cir. 1988). It would seem that one might properly be said to have actual notice when he has information in regard to a fact, or information as to circumstances an investigation of which would lead him to information of such fact, while he might be said to have constructive notice when he is charged with notice by a statute or rule of law, irrespective of any information which he might have, actual notice thus involving a mental operation on the person sought to be charged, and constructive notice being independent of any mental operation on his part . . . . Constructive notice is an essential element of the land recording system: if a deed is properly recorded, all future purchasers have constructive knowledge of the deed.

If a party has knowledge of such facts as would lead a fair and prudent man, using ordinary caution, to make further inquiries, and he avoids the inquiry, he is chargeable with the notice of the facts which by ordinary diligence he would have ascertained. He has no right to shut his eyes against the light before him. He does a wrong not to heed the "signs and signals" seen by him. It may be well concluded that he is avoiding notice of that which he in reality believes or knows. Actual notice of facts which, to the mind of a prudent man, indicate notice — is proof of notice.

BAC maintains that inquiry notice is the same as actual notice for purpose of the Maine statute, and the Trustee should be held to have inquiry notice in this case. According to BAC, although the Old Mortgage included the property description for the House and the New Mortgage contained a property description for Lot #6, both mortgages described the mortgaged property as located at 51 Stream Road, Winterport, Maine, which BAC claims is the street address for the House. BAC contends that because the mortgages used a common street address but provided different property descriptions, any potential buyer would have been placed on inquiry notice of an irregularity in title, and an inquiry would have quickly revealed the error.  As the First Circuit noted in Ryan, "inquiry notice" is not really a third distinct type of notice, but a corollary of both actual and constructive notice. "Inquiry notice follows from the duty of a purchaser, when he has actual or constructive notice of facts which would lead a prudent person to suspect that another person might have an interest in the property, to conduct a further investigation of the facts."

The Trustee counters that reference to a street address in the body of a mortgage deed is irrelevant under Maine title law and would not place a purchaser on constructive or actual inquiry notice of a title problem that a reasonable person would investigate further. According to the Trustee, under Maine law, title is based upon the legal description of the parcel to be encumbered and street addresses are irrelevant to Maine title practice. "[A] description of land to be conveyed should be clear enough for a person who reads it to draw a sketch of it, either by the wording of the deed itself or by reference to the lot on a recorded plan . . ." Furthermore, "[t]o convey a piece of real estate, the description should identify that piece and no other." The Trustee also notes that there is nothing in the appellate record establishing that both mortgages employed the same street address.

We believe that the Trustee has the better of the argument for two distinct reasons. First, we conclude the use of the same street address to describe two abutting parcels would not be sufficient  to constitute inquiry notice. There was nothing in the New Mortgage that would have directed a judicial lien creditor or bona fide purchaser to any inquiry. What appeared of record was a description of property to which a street address was assigned. Street addresses are provided by local government, not title examiners, and may very well be combined for separate but adjoining parcels. And one of those parcels may be encumbered without changing the street address of the others. Consequently, it would not necessarily be apparent to a diligent title searcher that because the property description of Lot #6 used the same street address as the House, that description was in any way suspect.

Second, and here more important, there is nothing in the record that supports BAC's assertion that the Old Mortgage and the New Mortgage do, in fact, contain the same street address. Neither party included in the record copies of the Old Mortgage to demonstrate that the street address was the same as the New Mortgage, and the parties did not stipulate to any facts from which the trial court (or we) could rely in reaching that conclusion.  Accordingly, the fact on which BAC would have us base a conclusion as to inquiry notice has not been properly put before us by BAC.

Equitable Subrogation:  BAC also argues that the bankruptcy court erred as a matter of law in finding that the Trustee, as a lien creditor under § 544(a), holds a superior interest to an equitable subrogation interest claimed by BAC. According to BAC, when its predecessor extended a loan to the Debtors to pay off the Old Mortgage, it became the holder of the rights and remedies under that mortgage by subrogation with priority above all other interests.

The traditional doctrine of equitable subrogation "enables '[o]ne who pays, otherwise than as a volunteer, an obligation for which another is primarily liable,' to be 'given by equity the protection of any lien or other security for the payment of the debt to the creditor,' and to 'enforce such security against the principal debtor or collect the obligation from him.” The Supreme Judicial Court of Maine has stated that equitable subrogation is "a device adopted by equity to compel the ultimate discharge of an obligation by him who in good conscience ought to pay it."  It is "a concept derived from principles of restitution and unjust enrichment." Under the doctrine, when one, not a volunteer, loans money to another and takes a mortgage to discharge a first mortgage, it may be proper to apply the doctrine and to subrogate the lender to the discharged mortgage.  The doctrine requires that the equities of the parties be weighed and balanced. "Subrogation, itself a creature of equity, must be enforced with due regard for the rights, legal or equitable, of others. It should not be invoked so as to work injustice, or defeat a legal right, or to overthrow a superior or perhaps equal equity, or to displace an intervening right or title."
The doctrine of equitable subrogation applies only when the party seeking to rely on the doctrine makes payment other than as a volunteer. BAC's predecessor may not have intended to take the wrong property as collateral, but it surely intended to make the instant loan and take the instant mortgage for security. It did so voluntarily. Accordingly, the doctrine of equitable subrogation is here inapplicable.

Bankruptcy Court used valuation date as the date of confirmation, rather than date of petition filing, for debtor to strip off second & third mortgage as wholly unsecured under Section 506:

In re: MARYANN LANDRY, 2011 Bankr. LEXIS 4861 (Bankr. D. Mass. 12/14/11)(Henry J. Boroff, Bankruptcy Judge).
PROCEDURAL POSTURE: In connection with a motion for relief from stay per 11 U.S.C.S. § 362 by movant creditor, a mortgagee, and the motion to avoid filed by debtor, issues arose as to the proper date for the valuation of debtor's residential property, the determination of which was relevant to whether debtor might avoid or strip off movant's interest, a second mortgage lien, under 11 U.S.C.S. § 1322(b) and 11 U.S.C.S. § 1325.
OVERVIEW: When the creditor argued that debtor lacked equity in the property, debtor, citing
11 U.S.C.S. § 522, replied that the creditor’s mortgage was wholly unsecured given the value of senior liens and her homestead exemption. Once the issue of property valuation was thus raised, the creditor argued that as the property’s value as of the date of filing exceeded the balance due on the first mortgage, avoidance of its second mortgage was prohibited by § 1322(b)(2), with debtor replying that whatever the value at the date of filing, since the asset’s current value was less than the first mortgage, the junior mortgages were properly stripped off. The court agreed with debtor that the relevant property value was the current value. After rejecting debtor’s § 522 claim on a finding that it did not apply to a real estate mortgage, the court held that because the purpose of the valuation was to determine the treatment of the property in debtor’s Chapter 13 plan, the appropriate date for valuation was not the date on which the Chapter 13 was filed but was the property’s current value. Thus, the current valuation was to be used in determining whether the second mortgage was wholly unsecured.
OUTCOME: The court held that the property was properly valued as of the present time, ordered debtor to file an amended Chapter 13 plan treating all but the first mortgage on the property as wholly unsecured, denying the motion to avoid for the time, and deferring a decision on the motion for stay.

Withdrawal of the reference prudent in light of the potential reach of Stern v. Marshall:

(In Re: SCHWARTZ) SCHWARTZ v. DEUTSCHE BANK , 2011 U.S. Dist. LEXIS 144470, (D. Mass. 12/15/11)(William G. Young, District Judge).
Pending before this Court is an appeal of the above action from the bankruptcy court pursuant to 28 U.S.C. § 158(a). The District of Massachusetts referred the case to the bankruptcy court pursuant to 28 U.S.C. § 157(a). This Court may "withdraw, in whole or in part, any case or proceeding" referred by the authority of 28 U.S.C. § 157 for cause. 28 U.S.C. § 157(d). The Court withdraws the reference for Counts II, IV, V, VI and VII to "preserve a higher interest.  Here, the Court withdraws the reference for these proceedings on these counts in the interest of judicial economy and to ensure that the adversary proceeding conforms with the constitutional requirements elucidated in Stern v. Marshall,     U.S.    , 131 S. Ct. 2594, 180 L. Ed. 2d 475 (2011). At this juncture, the Court expresses no opinion on Stern v. Marshall's reach. Rather, it simply appears to be the better part of valor to assume responsibility for the further course of these proceedings now. The careful work of the Bankruptcy Judge is, of course, entitled to all proper deference.  The Court affirms the bankruptcy court on Count III, Void Lien.

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