Daily Development for Thursday, February 15, 2007
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri

BANKRUPTCY; CHAPTER 13; REINSTATEMENT OF HOME MORTGAGE: Non-assuming grantee can reinstate home mortgage in face of default, but can it be done in face ofdue on sale acceleration? 

In re Ramos, 2006 Westlaw 3733252 (Bankr. S.D. Fla. 2006)

One day after securing a mortgage on a residence, the mortgagor transferred to a third party,  Ramos, who took subject to the mortgage, but did not assume it.  The mortgage contained a due on sale clause, and there appears to be no dispute that the transferred triggered an acceleration right under that clause.  Of course, no one bothered to tell the mortgagee of the transfer.

A year later, Ramos, who had been making payments on the mortgage loan, defaulted.  Lender brought sued to foreclose and obtained a foreclosure judgment, but no foreclosure sale had been held before Ramos filed a Chapter 13 bankruptcy proceeding. Lender petitioned for relief from the stay. 

In its petition, Lender asked in the alternative that it be granted relief from the stay to complete the pending foreclosure or that  it receive adequate protection and that the court reinstate of the Mortgage for that purpose.

The court concluded that, contrary to the Lenders assertions, there was value in the property in excess of Lenders loan amount.  But it noted that there were a number of other liens against the property (four mortgages) that more than exhausted any equity in the borrower.  Nevertheless, the court concluded, unsurprisingly, that the home was critical to carrying out an effective reorganization..  In fact, the borrower asserted in its brief that the whole purpose of the bankruptcy was to salvage the home and prevent it being lost to foreclosure.  The court acknowledged that most probably an evidentiary hearing would be necessary in most cases to resolve any dispute on these issues, but it stated that since the Lender had asked in the alternative for reinstatement of the Mortgage and adequate protection, no evidentiary hearing was necessary.

But Lender pressed the claim that there was an additional basis for relief from the stay -cause in the form of what the court characterized asbreach of the due on sale clause.  The court acknowledged thatmany cases appear to support this notion, and indicated that the apparent rationale for these cases wasthe reasoning that a debtor who is not a borrower can not cure a default under the relevant Chapter 13 Section - 1322(b)(3). 

But the court pointed to another line of cases that deny relief notwithstanding a due on sale acceleration.  Prominent in this line of cases was In re Garcia, 276 B.R. 627 (Bankr. Ariz. 2002).It stated that the appropriate interpretation of the Bankruptcy Law is that a party holding property subject to a mortgage is always in a debtor-creditor relationship with the mortgagee and thus entitled to reinstatement, whether or not the debtor has personal liability on the mortgage note. 

The court then decided that, despite this reasoning, it would not decide that the sale in the face of a  due on sale clause did not constitutecause justifying relief from the stay.  It did not have to decide because, the court concluded, Lender had waived its right to make such a claim when it asked for alternative relief in the form of reinstatement and adequate protection.  We are not told why such a waiver resulted.

The court did hold, however, that Ramos was not entitled to reinstatement of the mortgage by paying off the defaulted back payments over time as part of the plan, but would have to make up defaults upon confirmation of the plan. 

Comment 1: This is not the editors area of expertise, but he still expresses wonder that the bankruptcy court basically reads the due on sale clause right out of the mortgage.  The clause give the lender a right to accelerate.  This right, incidentally, is protected by federal law, so one wonders why the Bankruptcy law would be seen as preemptive.  The only default that could be cured, one would think, would be the failure to pay the lawfully accelerated total loan balance, rather than reinstatement of the loan to the payments.  The court seems to be of the view, however, that the borrower can preserve her ownership and simply continue on with the old payment structure.  This is not a holding, per se, since the court makes that crazy waiver ruling.  But the court certainly has a peculiar view of the situation. 

Comment 2: Lacking any ability to make sense of this case from what the court said, the editor turned to the case that influenced this decision, Garcia.  Here, indeed there is a much more thorough analysis of the issues.  First, the court in Garcia clearly treated as separate the issues of whether a non-assuming debtor may reinstate and the issue of whether a due on sale acceleration can be cured.  As to the latter, the court still, and incorrectly, characterized the sale under the due on sale clause as a breach, but still had this to say, that does seem relevant in any event:

No Defaults Are Inherently Incurable Even if the drafters did not intend to exclude any kinds of defaults from the legal right to cure, the Bank could argue that the drafters meant to grant legal authority to cure only when that could be accomplished as a practical matter, such as where missed installment payments can be made up. But if a default could not be cured as a practical matter, then the legal authority to do so is irrelevant. And here, the Bank can well argue that the predefault conditions cannot be restored because the original borrower is dead. In any event it would little benefit the Debtors to cure the default by selling their home back to Emmet Murray even if they could, and then, having no ownership rights to the property, they would have no right to cure because there would be no secured claim against the Debtors or against property of the estate.

Again, of course, there is no language in the Code to suggest the drafters recognized a practical limitation on the legal ability to cure. And in any event, that argument has also been rejected by the Ninth Circuit.

In [the Ninth Cirucit decision in Entz-White], the bank argued that because the debtor's balloon note obligation naturally matured prepetition, without acceleration, that was a default that could not be cured underC2=A7 1123.It argued that cure was limited to deceleration of an accelerated obligation, which would not apply to an obligation that naturally matured prepetition. In other words, the failure to pay the obligation when it fully matured was an historical fact that could not be undone by payment later. The Ninth Circuit rejected this argument, primarily by relying on the plain language of the statute that permits cure of "any default." [FN39] It also relied on the House Report onC2=A7 1124, stating that "Reinstatement consists of curing any default (other than a default under an ipso facto or bankruptcy clause) and reinstatement of the maturity of the claim or interest." It added: "This broad language, subject only to two listed exceptions, mirrors the language of the statute an

d refutes [the bank's] position." (citations omitted)

Further, a bit later:

Most, Possibly All, Nonmonetary Defaults May Be Cured:  If plans may cure all defaults, this leaves the question of what is required for cure. For missed payments the answer is easy--make up the payments. But what if the default is a nonmonetary default such as a violation of a due on sale clause or a "goiing dark" provision?

Certainly one aspect of cure must be to cease any ongoing violation. For example, one part of a cure of a "going dark" clause must be to reopen the store. This does not seem to help here, however, where there is no ongoing violation of the due on sale clause--the Debtors are not in the process of selling the home without the lender's consent, nor do they seek the right to do so in  the future. The prohibited sale has already occurred.

What else, if anything, must be done to cure a nonmonetary default other than to cease any ongoing violations? Perhaps nothing. For example, what would be necessary to cure a default of an ipso facto clause, a default arising solely from the fact of filing the bankruptcy case? [FN46] AlthoughC2=A7 365(b)(2)(B) makes it unnecessary to cure such defaults in executory contracts and leases, there is no similar provision excusing cure of such breaches in nonexecutory contracts, such as the note and deed of trust involved here. It might be contended thatC2=A7 541(c)(1) voids such clauses upon the filing of the bankruptcy case. [FN47] That seems to have been the intent of the Bankruptcy Commission's original draft of what became the Bankruptcy Code, because it "invalidated" ipso facto clauses and restraints on alienation, [FN48] and the Ninth Circuit has referred to the provision ultimately adopted as "voiding" such provisions. But there is contrary authority *640 that =C2=A7 541(c)(1) does so only

 to the limited extent necessary to permit property to become property of the estate, so such clauses remain effective thereafter and thus binding on the trustee. If such clauses survive, how can the default be cured so that the nondebtor party cannot assert the default postconfirmation? Perhaps nothing more is required for the cure other than complying with the Code's confirmation requirements.

. . . To restore the lender to a predefault situation, which is the essence of cure, it would seem the debtor must compensate the lender for any loss occasioned by the default. For example, if "going dark" caused a loss of percentage rents, perhaps those should be estimated and paid as part of a cure.

The Bank may object that the violation of its due on sale clause cannot be compensated by money. But that argument is not well supported by the parties' conduct, by state or federal nonbankruptcy law, or by the Bankruptcy Code.

The Bank argues strenuously (even in the absence of any waiver argument by the Debtors) that the Bank has not waived its right to enforce its due on sale clause. The Bank argues that it did not know these Debtors were the source of the payments it received for the four or five months between Debtors' acquisition of the property in November, 2000, and the monetary default in April, 2001. It says the checks were received at a P.O. Box and deposited without discerning the source, and that it did not learn of the sale until notified by its foreclosure trustee after it had commenced the trustee's sale due to the monetary default.

But the Debtors' purchase agreement was promptly and duly recorded, and under Arizona law that recording constitutes constructive notice to the world of the Debtors' interest in the property. Moreover, because Arizona law requires notice to any subsequent purchaser of a trustee's sale, the Bank's agent had to actually  know of the Debtors' ownership before the trustee's sale was commenced; it could not have been validly commenced as against the Debtors unless the Bank notified them.

Although all this seems to argue that the Bank is without a remedy in Garcia, the court does not reach that conclusion.  Rather, it states that thedue on sale acceleration is mostly all about money - the lenders right to increase its interest rate to reflect new money market conditions.  Consequently, the court concludes, except in the rare case where the borrower is demonstrably a risk to the physical security of the mortgage property, the Banks primary concern resulting from the sale under the due on sale clause can be addressed by the reorganization giving the Bank a higher interest rateas market conditions justify.

Actually, the editor thinks this is probably an accurate reading of the significance of the due on sale clause.  It does tend to negate the Lenders argument that it is entitled to a borrower that meets its lending standards, and one who has just gone through a Chapter 13 proceeding probably doesnt, but the editor is not so concerned with this problem as the wholefresh start purpose of bankruptcy would suggest that the court could justify this aspect of the lenders concerns.  It can always foreclose later if its new borrower defaults again (and, of course, be faced with a new Chapter 13 proceeding - thats the lenders fate.)

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