Daily Development for Friday, November 14, 2008
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Husch Blackwell Sanders
Kansas City, Missouri

MORTGAGES; FORECLOSURE; DEFENSES: Affirmative defenses in foreclosure action were not precluded by bankruptcy order of sale of mortgagee's assets.

EMC Mtge. Corp v. Atkinson, 888 N.E.2d 456 (Ohio App. 9 Dist. 2008).

In 1996, Atkinson, Sr. executed a mortgage agreement with UCLC.  Apparently a dispute arose immediately, and Atkinson, Sr. never made a payment on the mortgage debt.  Less than a year later, UCLC attempted to foreclose.  In response Atkinson, Sr. counterclaimed, alleging fraud, negligence, and misrepresentation. During the action, Atkinson, Sr. passed away. UCLC filed bankruptcy, automatically staying the foreclosure action.

On 1999, Atkinson Jr. ("Atkinson") filed a proof of claim against UCLC for an amount in "excess of $25,000," alleging fraud, negligence, and misrepresentation. With that claim pending, in 2000,  EMC agreed to purchase UCLC's assets at a “free and clear” bankruptcy sale.  EMC allegedly had actual notice of Atkinson Sr.’s counterclaims.  In addition to the expected language in the sale order stating that the sale was “free and clear of liens, mortgages, security interests, encumbrances, liabilities, claims or any other interests, whether arising before or after the Petition Date,” the sale order also had more specific language about claims:

“[EMC] shall [not] have any liability or responsibility with respect to any Claim against any of the Debotrs [UCLC] or any prior owner of any Mortgage Loan or for any action, or failure to take action, except to the extent [EMC] is found to have liability as a successor under applicable law.”

Atkinson became the legal owner of the mortgage property through the probate of his father's estate.

In 2003, EMC filed a foreclosure complaint against Atkinson.

While that foreclosure was pending, in 2005, Atkinson  negotiated the outstanding proof of claim with UCLC, which settled for $15,000.  Atkinson expressly reserved his claims against EMC.
Atkinson amended his answer and added the affirmative defenses of fraud, coercion, duress, and incapacity.

EMC moved for summary judgment on its complaint and Atkinson's defenses. EMC argued that Atkinson's settlement of the proof of claim and the bankruptcy court's order of sale barred Atkinson's affirmative defenses. It indicated that it was clear that the defenses raised by Atkinson did not fall within the “successor liability” exception. [The court doesn’t describe the claims, but appears to accept that characterization.]  The trial court granted EMC's motion for summary judgment.

Atkinson appealed, claiming that the trial court erred when it determined that other documents precluded his affirmative defenses.

The Court of Appeals of Ohio reversed the trial court decision and held that: 1) defenses were not barred by settlement agreement between successor and original mortgagee, and 2) the bankruptcy court's order of sale did not preclude assertion of the defenses.

The Court of Appeal, applying federal bankruptcy law as applied by the Third Circuit,  first determined that summary judgment was improper because there was a genuine issue of material fact arising from Atkinson's settlement of his claim against UCLC during UCLC's bankruptcy, which stated that it did not in any way represent a full and final settlement as to the claims of Atkinson by and against EMC. The Court found nothing in Atkinson's prior settlement with UCLC that would bar his affirmative defenses in this action. EMC then asserted that res judicata barred Atkinson from raising affirmative defenses because the defenses could have been litigated in the bankruptcy action. The Court rejected this claim because EMC provided no authority to support its proposition that the bankruptcy court could have resolved the foreclosure suit filed by UCLC.

Second, the Court held that the bankruptcy court's order of sale did not preclude Atkinson from raising affirmative defenses. The Court used an analogous matter in the Third Circuit, where an entity that was purchasing assets attempted to equate the affirmative defenses raised by the debtor to its own claims to the free and clear provision of the Federal Bankruptcy Code. Section 363(f) provides "The trustee may sell property under subsection (b) or (c) of this section free and clear of any interest in such property of an entity other than the estate." 11 U.S.Code 363(f).   The cited precedent, and this court, concluded that this language did not permit sale free and clear of defenses.

What about the separate sale order, which stated categorically that the sale was made free and clear of “claims.”  The Court concluded that the term "defenses" did not appear specifically in the sale order.  It characterized the order as stating that EMC shall have no responsibility for UCLC's “action or inaction.”  Therefore, the court declined to accept EMC's proffered interpretation that the order restricted Atkinson from raising defenses and held that permitting EMC to purchase UCLCS's assets and preclude Atkinson's assertion of his contractual defenses would enhance the value of the assets at Atkinson's expense which is against public policy. It concluded that to read the sale order so broadly would be inconsistent with the court’s authority under the Bankruptcy Code, and that it elected to read it more narrowly.

Thus, the Court concluded that the trial court erred in granting summary judgment on those defenses, and reversed.

Comment: Clearly the court was egregiously misreading the sale order to place the meaning on it that it did.  The statement that the sale was free of “claims” - not just claims caused by the action or inaction of UCLC, but all claims - seems grammatically inescapable, but the court makes the reading because it views Section 363 as not permitting sales free of claims raised as foreclosure defenses.  So the real news here is the reading of Section 363.

The editor believes that bankruptcy courts in other contexts have read the “free and clear sale” provisions much more broadly than this.  It will be interesting to see whether the lender elects to appeal this ruling, to get clarity, or simply to settle up on what appears to be a relatively small matter.  

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