DD 4/21/06 Hiding property from bankruptcy court may cost benefit of automatic stay on foreclosure.

BANKRUPTCY; AUTOMATIC STAY; RETROACTIVE RELIEF: Although a mortgagee may have at least constructive notice of a debtor’s bankruptcy, and proceeds with a foreclosure sale during the pendency of the bankruptcy, it may be entitled to retroactive annulment of the  stay where Debtor failed to list the secured property as an asset in the bankruptcy and failed to notify the bankruptcy court of the foreclosure when she learned of it or of the significant foreclosure surplus that she was trying to claim. 

In re Bright, 338 B.R.   530 (1st Cir. BAP Mass.  2006) 

Debtor had a cotenancy interest in  certain property.  Although she executed a mortgage on the property,  the note was executed only by her cotenant.  About ten year later, Debtor filed a Chapter 13 Bankruptcy case.  She did not list the property on her asset schedules in the bankruptcy proceeding. 

Thereafter, prior to the ultimate discharge in the bankruptcy, but after Debtor’s plan was approved, Bank foreclosed on its mortgage.  Debtor claimed that she didn’t receive notice of the foreclosure for some time.  The court was again dubious, but noted that in any event she did finally get notice that the foreclosure sale had occurred, still prior to the discharge in her bankruptcy.

The notice that the debtor in fact received was a big surprise: The foreclosure sale produced a surplus of over $160,000. [Note that in Massachusetts foreclosure auctions are “marketed” and thus more likely to produce market value prices.] Debtor was served with process in an interpleader action involved with the distribution of the surplus.  She appeared in that action and vigorously sought to reach the surplus, but still “neglected” to inform the bankruptcy court of its existence.

Subsequently , after the final discharge was entered in her bankruptcy, the Debtor, perhaps sensing that the property had gone up in value even more than the price paid at the foreclosure action, sought to set aside the foreclosure on the grounds that it had violated the automatic stay.

The court commented that clearly the foreclosing lender was at least on constructive knowledge of the foreclosure sale, and that the sale was in violation of the automatic stay.  But it also noted that, in cases of special equities, including bad faith on the part of the debtor, a court can reopen the bankruptcy and retroactively grant an annulment of the automatic stay.  It did so here.

Debtor’s bad faith consisted of her failing to list the property, failing to notify the court of the foreclosure, and failure to notify the court of the surplus.  Debtor  blamed her attorney for the problem with the schedule, saying that she had informed him of the property (the attorney apparently dallied in filing the bankruptcy, and ultimately was suspended and disbarred based upon other matters.)  The court clearly was dubious of the Debtor’s claims in this regard, and noted that she had signed the schedules before they were submitted.  In any event, the court responded that Debtor bore final  responsibility for the inaccuracy of the schedules, commenting that “[t]his circuit . . . has turned a "deaf ear" to the plea that "the sins of the attorney should not be visited upon the client”

As to Debtor’s failure to notify the court of the foreclosure or the surplus (which Debtor became aware of very near the final discharge, and some period after the confirmation), the court commented that all the various issues cumulated to establish bad faith.  It commented that the Debtor didn’t appear to be all that ignorant or confused when it came to stepping up to the trough to make a claim for the surplus.


Comment 1: Obviously, this ain’t always going to work.  Lenders or their title searchers need to check bankruptcy filings in logical locations.  There is some authority that even filings in illogical locations, like other states, will still provide constructive notice.  It’s unlikely that lenders well be penalized for violations of the automatic stay in such circumstances, but it is likely that the foreclosure in violation of the sale will be annulled.

Comment 2: What happened to that surplus?  We don’t find out.  Shouldn’t it pass into the estate for the creditors that got stiffed?

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