Borrowers Judicially Estopped from Asserting Claims in their Mortgagee’s Chapter 11 Bankruptcy Proceeding Due to Failure to Disclose Such Claims in Borrowers’ Own Chapter 7 Proceeding

By:  Shane M. Biffar

On November 18, 2014, the Bankruptcy Court of the Southern District of New York issued an opinion and order finding, inter alia, that two residential mortgage borrowers are judicially estopped from bringing claims against debtor GMAC Mortgage, LLC (“GMAC”) in its chapter 11 proceeding because the factual events underlying the claims preceded the borrowers’ own chapter 7 bankruptcy case and the borrowers never disclosed the claims as assets in their bankruptcy case.  In re Residential Capital, LLC, et al., Case No. 12-12020 (MG) (Bankr. S.D.N.Y. July 24, 2014).

The claims the borrowers sought to assert in the chapter 11 proceeding were predicated on GMAC’s conversion from a corporation to a limited liability company by merger in October, 2006 (the “Conversion”).  The borrowers alleged violations of federal and Illinois state law relating to GMAC’s foreclosure on their residential mortgage loan following the Conversion.  Specifically, the borrowers alleged that GMAC foreclosed their mortgage loan without providing notice that the loan had been “transferred,” as required by the Real Estate Settlement Procedures Act (“RESPA”).  As a result of the alleged RESPA violation, the borrowers claimed that GMAC’s foreclosure of their mortgage was wrongful, causing the Borrowers considerable damages, including lost value of their home, moving expenses, living expenses, and other “personal harms.”

The Bankruptcy Court’s decision disallowed and expunged the borrowers’ claims by invoking Section 521(1) of the Bankruptcy Code and the doctrine of judicial estoppel.  Section 521(1) requires a debtor in a bankruptcy proceeding to disclose all of her actual or potential assets, including any and all known causes of action.  See 11 U.S.C. §§ 521(1); 1306.  To invoke judicial estoppel in the Second Circuit, “(1) the party against whom it is asserted must have advanced an inconsistent position in a prior proceeding, and (2) the inconsistent position must have been adopted by the court in some matter.” Peralta v. Vasquez, 467 F.3d 98, 205 (2d Cir. 2006).  Judicial estoppel does not apply where the inconsistent statement in the first proceeding was the product of a “good faith mistake or an unintentional error.” Ibok v. Siac-Sector, Inc. 2011 WL 293757, at *7 (S.D.N.Y. Feb. 2, 2011).

The Bankruptcy Court found that all of the factual allegations supporting the borrowers’ claims preceded their chapter 7 bankruptcy filing.  Specifically, the Conversion occurred in October 2006, the borrowers’ mortgage was referred to foreclosure in May 2010, GMAC foreclosed on the Loan in February 2011, and the borrowers commenced their chapter 7 proceeding in July 2011.  Further, the borrowers’ schedules of assets in their joint chapter 7 proceeding (1) failed to disclose any potential claims against GMAC, and (2) were relied upon by that court to calculate the discharge the borrowers ultimately received.  Accordingly, the borrowers’ claims were barred by the doctrine of judicial estoppel.

In reaching this decision, the Court discounted any possibility that the borrowers’ failure to list the causes of action in the chapter 7 proceeding was the product of a “good faith mistake or unintentional error.”  Indeed, the fact that the borrowers had scheduled certain potential causes of action against other parties as assets in the chapter 7 proceeding belied any possibility that the borrowers lacked knowledge of the significance of scheduling potential causes of action as assets.

The Bankruptcy Court further noted that even assuming the borrowers’ claims were not barred, the borrowers also failed to meet their burden on the merits.  Specifically, the Bankruptcy Court explained that a mortgage loan servicer that changes its name “d[oes] not violate sections 2605(b)-(c) of RESPA, which require transferor and transferee mortgage loan servicers, respectively, to notify the applicable borrower in writing of any transfer of loan servicing.”  Under RESPA, transfers between affiliates or resulting from mergers or acquisitions are not considered “transfers” requiring a RESPA notice if “there is no change in the payee, address to which payments must be delivered, account number, or amount of payment due.” See Madura v. BAC Home Loans Servicing L.P., 2013 WL 3777094, at *8-9 (M.D. Fla July 17, 2013) (citing 24 C.F.R. 3500.21(d)(1)(i)).

This decision highlights the importance of mining borrower’s prior bankruptcy filings when evaluating borrower claims that are subsequently asserted against a mortgage loan servicer.  Such filings may provide ammunition that bars a borrower’s claims.

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