Daily Development for Thursday, October 16, 2008
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Husch Blackwell Sanders
Kansas City, Missouri

BANKRUPTCY; PREEMPTION; ROOKER-FELDMAN DOCTRINE:  Alleged fraud raised in state home-foreclosure proceeding could not be raised in federal court because Rooker-Feldman doctrine deprived federal district court of jurisdiction.

Reusser v Wachovia Bank 525 F3d 855 (9th Cir 2008)

The Reussers secured a loan from Long Beach Mortgage Company with a home that had been in the family for over 100 years. After the Reussers stopped making payments, Long Beach Mortgage Company assigned its interest to Wachovia Bank, which gave notice to the Reussers that it would foreclose through Washington Mutual Bank, its loan servicer. The Reussers declared bankruptcy, which stayed the foreclosure action; however, Washington Mutual applied for and received relief from stay under 11 USC §362(a)(3), and foreclosed in January, 2004.

When Reussers didn’t relinquish possession, Wachovia, in March, 2004,  instituted a forcible entry and detainer (FED) proceeding in Oregon state court to remove the Reussers and take possession. Although the Reussers had served Wachovia with a petition in response, as a result of errors by them and the court, they did not appear at the FED hearing. Wachovia failed to inform the court that it had been served and thereby obtained entry of a default judgment.

The Reussers moved to vacate the default judgment, arguing that their failure to appear was excused by Wachovia's alleged failures to inform the court that it had been served with the petition and to provide notice to the Reussers that Wachovia would seek a default judgment. The Reussers' motion to vacate was denied and their appeal dismissed as mooton the basis that neither Reussers nor Wachovia was in possession of the premises.

The Reussers then sued Wachovia and Washington Mutual in federal court. They claimed that the eviction was wrongful and a violation of 42 USC §1983. They also claimed that the foreclosure violated 11 USC §362 because the order granting relief from stay applied only to Washington Mutual and not Wachovia. They also asserted state-law claims for trespass, trespass to chattels, and false imprisonment.

Washington Mutual and Wachovia moved to dismiss under Fed R Civ P 12(b)(1) and 12(b)(6), asserting that the Rooker-Feldman doctrine deprived the court of jurisdiction to rehear the state action claims and that the Reussers were collaterally estopped from challenging Wachovia's reliance on the bankruptcy court's order lifting the automatic stay. The district court dismissed and the Ninth Circuit affirmed.

The Rooker-Feldman (Rooker v Fidelity Trust Co. (1923) 263 US 413, 68 L Ed 362, 44 S Ct 149; D.C. Court of Appeals v Feldman (1983) 460 US 462, 75 L Ed 2d 206, 103 S Ct 1303) doctrine bars a federal district court from exercising subject matter jurisdiction over a suit that is a de facto appeal from a state court judgment. Here, the Reussers' claims - that Wachovia failed to provide sufficient notice of its intent to seek a default judgment and then failed to inform the state court that it had been served with a copy of the Reussers' petition contesting the merits of the FED proceeding-had already been litigated in state court and had been rejected on the merits. Therefore, the federal court lacked jurisdiction to hear the §1983 claims, which were properly dismissed.

The Reussers also failed to state a claim under 11 USC §362 because bankruptcy jurisdiction is in rem.

Notwithstanding its view of the various fraud claims, the bankruptcy court order granted relief as to enforcement of Wachovia's deed of trust against the Reussers' property; it was immaterial that Wachovia was not specifically named. Moreover, the Reussers' challenge to the bankruptcy court's jurisdiction was waived because the argument could have been, but was not, made to the bankruptcy court.

Reporter’s Comment:  After a stay has been lifted and a foreclosure has been conducted, an action must be filed to get possession if the trustors have refused to leave, as they did here. Then, all of their defenses may be re-raised, relitigated, and appealed in state court.

It is also worth noting that this decision is almost a rarity in forgiving what might have been the potential error of the loan servicer, rather than the deed of trust holder, being the party seeking relief from the automatic stay. Most federal courts appear to take a much harder line on this issue. See, e.g., In re Maisel (Bankr D Mass 2007) 378 BR 19 and In re Foreclosure Cases (ND Ohio 2007) 521 F Supp 2d 650. This lender was lucky in having the court hold that the in rem feature of bankruptcy moots the personal jurisdiction issue as to creditors. Will that also work for a mortgage assignee who cannot produce a perfect chain of title back to the original loan funder?

Editor’s Comment 1:   We may see more of the Roocker-Feldman doctrine in the interplay of state and federal activities in connection with the ongoing rash of contested foreclosures.  For another example of a court dealing with the issue, see In re Denaro, 383 B.R. 879 (D. N.J. 2008).

In Denaro, a creditor foreclosed a secured debt in a state foreclosure action.  The property sold at this sale for $401,000 on November 6, 2006.  The secured debt, with interest, was about $124,000 higher than the sale price.  While the foreclosure was pending, the creditor was simultaneously pursuing an action on the note, and the trial court had found debtor liable on the note on September 15, 2006.  Subsequent to the foreclosure, on November 27, 2006, the court in the case on the note entered judgment on the note, crediting the amount bid in by the creditor at the foreclosure sale. [According to the bankruptcy court, the court in this action did not make a finding that the foreclosure price was inadequate, as it had not occurred in September, at the time the hearing occurred.]

In connection with efforts to collect on the judgment, creditor sought an information subpoena and, three months later, Debtor requested an appraisal of the foreclosed property.   [We are not informed why the court that authorized the appraisal felt that it was relevant.] The appraisal report found the property as of January, 2007,  was worth $750,000, well in excess of the amount of creditor’s claim.  Note that at that time the debtor didn’t own the property.  It had been foreclosed upon and purchased by debtor.

Then the debtor filed bankruptcy.  The creditor entered an unsecured claim for the $124,000 it claimed it was still owed, and the debtor attempted to challenge the claim on the basis of fact that it appeared that the value of the property significantly exceeded the amount bid at the foreclosure sale. 

The creditor responded that Rooker-Feldman and principles of res judicata and issue preclusion prevented the federal court from undertaking what it argued was an appeal of the state court decision to grant a deficiency claim based upon the results of the foreclosure sale.  But the bankruptcy court, claiming that it had studied the record in the state court proceedings, concluded that the issue of whether the property sold at fair market value was never before the various state courts.  Thus, the bankruptcy court was free to assess this issue in connection with the ruling on the creditor’s claim in bankruptcy.
Ironically, after all that ado, the bankruptcy court upheld the creditor’s claim.  It concluded that the appraisal, significantly after the foreclosure sale, was a market value appraisal, and did not take into account the “emergency nature” of the foreclosure.  It noted that the foreclosure auction was not uncontested - other parties bid against the creditor, and its bid ultimately prevailed, suggesting that the property sold for a “fair foreclosure value.” 

Although the court refused to apply Rooker-Feldman here, it is easy to see how it could be used to preclude bankruptcy court analysis of the validity of a state court deficiency claim, despite argued defects in the claim, if those arguments could have been made in the state court which issued the deficiency judgment.

Editor’s Comment 2: The editor is intrigued by Professor Bernhardt’s suggestion that the Reusser court’s second point of analysis, which characterizes bankruptcy proceedings as in rem, may preclude arguments about the ownership of secured notes and the mortgages that secure them.  But it appears that bankruptcy courts in Ohio and Pennsylvania, as previously reported here, have found lack of jurisdiction to carry out state law foreclosures when the jurisdictional requirements of state law - including clear evidence of ownership of the note - have not been met.  

The Reporter for the first item was Roger Bernhardt of the Golden Gate Law School, reprinted with permission (albeit edited) from the California CEB Real Property Reporter. 

Readers are encouraged to respond to or criticize this posting.

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