Daily Development for
Tuesday, May 14, 1996

by: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law

The Reporter for today's item is Jim Stillman, Murphy, Weir & Butler, San Francisco

BANKRUPTCY; AUTOMATIC STAY; "STANDING" TO INVOKE STAY; PRE-PETITION TRANSFER BY PARENT (MORTGAGOR): Bankruptcy decision casts doubt on bankruptcy standing of owners of property who have taken subject to mortgage to invoke bankruptcy protections agains that mortgage. In re Kizelnik, 190 B.R. 171 (Bankr. S.D.N.Y. 1995). Mr. & Mrs. Stein, assisted most recently by their live-in granddaughter Kizelnik, kept a defaulted local savings bank at bay for three and a half years through the use of state court litigation and multiple, seriatim bankruptcy filings. Ultimately, the Stein's bankruptcy was dismissed with prejudice. Kizelnick then brought her own Chapter 13 proceeding and attempted to stay the foreclosure in that proceeding. She claimed that, in addition to her occupancy of the residence as a tenant, she held an option to acquire the title in the form of a Jewish right transliterated by counsel as a shtariska. (In light of the disposition, the document embodying this interest was never produced in court).

The Bankruptcy Court held that there was no bona fide "debtor-creditor" relationship between the bank and the debtor, and therefore the debtor lacked standing to raise the stay.

The court acknowledged that, under Johnson v. Home State Bank, 501 U.S. 78 (1991), the definition of "claim" in the Bankruptcy Code does not require a debtor creditor relationship between the parties, but recognizes that a "claim" exists when a debtor has an ownership interest in land secured by a mortgage held by the claimant. But the court emphasized that the factual setting in Johnson involved a single debtor whose personal liability had been discharged in a prior Chapter 7 proceeding and later was attempting to forestall foreclosure under a Chapter 13 proceeding. The claim of the lender in such cases was deemed to be a "claim" and the landowner entitled to raise the protection of the automatic stay.

But the court criticized those Bankruptcy Courts which have applied Johnson so as to accord relief in "Chapter 13 cases involving a transfer of property from a mortgagor-parent to a debtor-child." (p. 178.) It contended that Johnson should be limited to its facts and applied only to cases involving successive bankruptcy suits involving the same mortgagor.

Reporter's Comments: While lifting the stay is the correct result in cases such as this (see, for example, In re Mitchell, 184 B.R. 757, and In re Wright, 183 B.R. 541, discussed in the Summer 1995 Quarterly Reports), the concept of a "debtor-creditor relationship" test for bankruptcy "standing" ultimately raises more questions than it might answer. There is nothing per se in the lack of privity between the creditor and the debtor in this case that required stay relief; that fact coupled with other obvious circumstances warranted lifting the stay (or dismissing the case) on other grounds, for cause. The "relationship" test is inconsistent with Johnson, supra, and is quite insensible in those commercial situations where the protection of the automatic stay has been extended to tenants (e.g., In re Comcoach Corp., 698 F.2d 571 (2d Cir. 1983)) and junior lienors (e.g., In re Capital Mortgage & Loan, Inc., 35 B.R. 967 (Bankr. E.D. Cal. 1983)).

Editor's Comment 1: It is difficult to make out from the opinion the precise procedural positions of the parties. The court characterizes the granddaughter as attempting to "intervene" in the grandparent's bankruptcy. But the grandparent's bankruptcy petition had been dismissed with prejudice prior to the events giving rise to this case. It appears, rather that the granddaughter was trying to stay and later "deaccelerate" and schedule payments on the lender's mortgage in her own Chapter 13 proceeding. The editor's comments are predicated on that view of the case.

Editor's Comment 2: The editor concurs with the reporter's comment that the court goes too far in requiring a debtor/creditor relationship. But the editor also is concerned about the court's apparent definition of a debtor/creditor relationship in real estate transactions. It appears to conclude that a party may not undertake a "debtor/creditor" relationship by taking property "subject to" a mortgage, or even by assuming a mortgage, if the lender has not consented.

Although, with the prevalence of the "due on sale" clause, one might conclude that the court's premise is true as a practical matter, it clearly should not be viewed as true as a matter of law. Without a due on sale clause, property is freely transferable, and parties may take title to land and create liabilities on a mortgage debt by contract with the prior owner, without the knowledge (and, by extension, without the consent) of the lender.

To conclude that persons in title to land subject to mortgages who have accepted by contract the responsbility to pay the debt or suffer foreclosure, are not "debtors" entitled to invoke bankruptcy protection, is certainly at odds with the editor's understanding of bankruptcy law and policy. Even more significant, to conclude that a party who takes title to property and assumes personal liability on the debt has not become a "debtor" unless the lender's consent is sought and obtained, is at odds with any rationale understanding of mortgage law.

Although the case itself involved only a tenant with some loose kind of option rights, the court's analysis does not differentiate ordinary fee transferees who take "subject to" a mortgage but without mortgagee's consent.

The court's real target was "parent-child" transactions in which quitclaim deeds are used as part of a bankruptcy "debt dodge." But its analysis is far broader than that.

It appears that the court here, in its zeal to make a mockery of what it viewed as an overly technical attempt to protect the homeowners in this case, has posited law that presents real threats to debtor's expectations in many legitimate real estate transactions.

Reporter's Rejoinder: (Having read the above editor's comments): "Take a deep breath and get on with your life." You're right, Pat, but if we worried about every incoherent bankruptcy opinion we'd never get anything done. The judge reached the right result, and just made the mistake of publishing the opinion.

Editor's Response to rejoinder: Someone, somewhere, somehow has to address the problem that Bankruptcy judges nationwide, with an information base as slim as a debtor's wallet, are writing wrong and nonsensical pronouncements of law that affect the lives of our citizens and institutions in profound ways. I wouldn't worry so much about this opinion except that some other judge in some other court, equally uninformed, will follow it to justify a result. Our clients pay us on the premise that sensible arguments will be weighed by sensible courts. If this turns out to be demonstrably false, then we, and the legal institution we serve, might was well close down.

Items in the Daily Development section generally are extracted from the Quarterly Report on Developments in Real Estate Law, published by the ABA Section on Real Property, Probate & Trust Law. Subscriptions to the Quarterly Report are available to Section members only. The cost is nominal. For the last five years, these Reports annually have been collated, updated, indexed and bound into the Annual Survey of Developments in Real Estate Law, volumes 1-5, published by the ABA Press. The Annual Survey volumes are available for sale to the public. For the Report or the Survey, contact Laprica Mims at the ABA. (312) 988 6233.

Items reported here and in the ABA publications are for general information purposes only and should not be relied upon in the course of representation or in the forming of decisions in legal matters. Accuracy of data and opinions expressed are the sole responsibility of the DIRT editor and are in no sense the publication of the ABA.