U.S. Supreme Court Holds Debt Collectors Are Not Liable under the FDCPA for Pursuing Time-Barred Claims in Bankruptcy Court

By: Jonathan Robbin and Sholom Wohlgelernter

In a 5-3 decision in Midland Funding, LLC v. Johnson, No. 16-348, 2017 WL 2039159 (U.S. May 15, 2017), the United States Supreme Court held that a debt collector’s filing of a time-barred proof of claim in a Chapter 13 bankruptcy proceeding is not “false,” “deceptive,” “misleading,” “unfair,” or “unconscionable” within the meaning of the Fair Debt Collection Practices Act (“FDCPA”).

In overturning the Eleventh Circuit Court of Appeals, the Supreme Court held that the protections and remedies afforded to consumers under the FDCPA with respect to time-barred claims, are unavailable in Chapter 13 bankruptcy proceedings. The Supreme Court’s decision makes clear that debt collectors may pursue time-barred debts in a debtor’s bankruptcy proceeding.

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Ohio Supreme Court Decides A Defectively Executed Recorded Mortgage Acts As Constructive Notice to the World (Including Bankruptcy Trustees)

By: Chrissy Dunn Dutton

The Ohio Supreme Court recently issued its decision in In re Messer, Slip Opinion No. 2016-Ohio-510, holding that a defectively executed recorded mortgage acts as constructive notice of that mortgage to the world.

In the opinion, the Court decided the following two questions of state law, which were certified from bankruptcy court: (1) whether R.C. 1301.401 applies to all recorded mortgages in Ohio; and (2) whether R.C. 1301.401 acts to provide constructive notice to the world of a recorded mortgage that was deficiently executed under R.C. 5301.01.

The court unanimously answered yes to both questions.

R.C. 1301.401(A) and 1301.401(C) provide that the recording of certain documents with the county recorder is constructive notice “to the whole world of the existence and contents of [the] document as a public record and of any transaction referred to in that public record…” and that “[a]ny person contesting the validity or effectiveness of any transaction referred to in a public record is considered to have discovered that public record and any transaction referred to in the record” as of the date and time of recording.

R.C. 5301.01, which sets forth the requirements for a mortgage in Ohio, provides, in relevant part, that a mortgage shall be signed by the mortgagor and the signing shall be acknowledged by the mortgagor in front of an appropriate state official who shall certify the acknowledgement and subscribe the official’s name to the certificate of the acknowledgment.

The notary acknowledgment on the mortgage at issue was left blank, providing no indication as to whether the borrowers executed the mortgage in front of a notary. When the borrowers filed a Chapter 13 bankruptcy and a companion adversary proceeding, seeking to avoid the mortgage as defectively executed under R.C. 5301.01, the bankruptcy court determined that its interpretation of R.C. 1301.401 would be dispositive. However, finding no interpretation of that statute by any Ohio court, the bankruptcy court certified the questions of state law to the Ohio Supreme Court. In its order for certification to the Supreme Court, the bankruptcy judge noted that the borrowers may have been able to avoid the mortgage before O.R.C. §1301.401 was enacted. However, the court questioned whether O.R.C. §1301.401 changed this result.

The full impact of the decision remains to be seen, as the bankruptcy court has not yet issued a decision on whether the mortgage can be avoided in the underlying adversary proceeding. However the Supreme Court decision is likely dispositive of that issue. The finding that a recorded but defectively executed mortgage puts subsequent parties (including bankruptcy Trustees) on constructive notice is therefore likely to defeat avoidance actions typically brought under Sec. 544 of the U.S. Bankruptcy Code.



U.S. Supreme Court Rules That Chapter 7 Debtors Cannot Void Wholly Unsecured Liens

By: Diana M. Eng and Joshua B. Alper

In Bank of America v. Caulkett, No. 13-1421, 575 U.S. __ (2015) and Bank of America v. Toledo-Cardona, No. 14-163, 575 U.S. __ (2015), the Supreme Court of the United States recently held that a Chapter 7 debtor cannot void a junior mortgage, where the value of the collateral securing the debt is less than the outstanding indebtedness owed on the first mortgage.  In essence, even though a junior lien may be wholly unsecured, Section 506(d) of the Bankruptcy Code (the “Code”) does not permit the debtor to void the lien.  Moreover, these Supreme Court decisions resolved a conflict amongst many courts across the country, both at the Bankruptcy Court and Circuit Court levels.

Section 506(d) of the Code states that “[t]o the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void.”  11 U.S.C. § 506(d) (2015).  By its terms, an allowed claim generally has been construed to mean (with certain exceptions not relevant here) a claim to which no objection has been made or a claim that is adjudicated as allowed despite a party objecting to the claim. See 11 U.S.C. § 502(a)–(b).

Significantly, Caulkett and Toledo-Cardona involved substantially similar facts. Both debtors had two mortgage liens on their homes and the mortgages held by Bank of America were both subordinate liens.  Furthermore, the total outstanding indebtedness the debtors owed to the senior lenders exceeded the fair market value of the property. In this posture, the liens held by Bank of America were characterized as “totally underwater.”

In 2013, both debtors filed petitions for relief under Chapter 7 of the Code. Likewise, they each moved to void or “strip off” the junior liens, relying on Section 506(d) of the Code.  In both cases, the Bankruptcy Court granted the debtors’ motions, which were subsequently affirmed by the District Courts and the Eleventh Circuit.  The Supreme Court of the United States granted certiorari to consider “whether a debtor in a Chapter 7 bankruptcy proceeding may void a junior mortgage under 11 U.S.C. § 506(d) when the debt owed on the senior mortgage exceeds the present value of the property.” Caulkett, No. 1341, slip op. at 1 (2015).

Notably, in Caulkett and Toledo-Cardona, there was no dispute regarding whether Bank of America’s claims were allowed.  Instead, the crux of the dispute, and the focus of the Supreme Court’s opinion, centered on the definition of a “secured claim” for purposes of Section 506(d).

As an initial matter, the Supreme Court noted that Section 506(a) of the Code appeared to provide support for the debtors’ position.  In this regard, Section 506(a) (1) states that “[a]n allowed claim of a creditor secured by a lien on property . . . is a secured claim to the extent of the value of such creditor’s interest in . . . such property . . . and . . . an unsecured claim to the extent that the value of such creditor’s interest . . . is less than the amount of such allowed claim.”  11 U.S.C. § 506(a).  As a result, the Supreme Court acknowledged that a straightforward textual application of Section 506(a) appeared to support the conclusion that a claim cannot be classified as secured if the value of the creditor’s interest in the collateral is zero.  However, the Supreme Court emphasized that it had previously considered this textual application and had rejected it in Dewsnup v. Tim, 502 U.S. 410 (1992).

In Dewsnup, the Supreme Court held that a Chapter 7 debtor could not reduce or “strip” down a partially underwater lien to the value of the collateral securing the claim.  In reaching this conclusion, the Dewsnup Court found that pursuant to Section 506(d), a ”secured claim” is simply “a claim supported by a security interest in property, regardless of whether the value of that property would be sufficient to cover the claim.” Caulkett, No. 1341, slip op. at 4.  Moreover, if a claim is “allowed” and otherwise “secured with recourse to the underlying collateral, it does not come within the scope of 11 U.S.C. §506(d).” Id. (citing Dewsnup, 502 U.S. at 415, 417-20).

Among other arguments, the debtors attempted to persuade the Court that Dewsnup should be limited to the facts of that case, mainly instances involving partially secured or under-secured liens. Caulkett, No. 1341, slip op. at 5.  Additionally, the debtors also posited that the definition of “secured claim” could be redefined to mean “any claim that is backed by collateral with some value,” but the Supreme Court ultimately rejected both arguments. Id.  The Supreme Court refused to limit Dewsnup’s general application and it also declined to adopt an alternative definition of “secured claim” than what was already decided by prior Supreme Court precedent.  In its final analysis, the Supreme Court held that the construction of “secured claim” under Dewsnup mandated the conclusion that a Chapter 7 debtor cannot void a wholly unsecured junior mortgage lien.

In light of this decision, lenders and the banking industry can be reassured that wholly underwater junior liens generally will not be stripped off in a Chapter 7 bankruptcy case. Previously, Chapter 7 debtors in various jurisdictions had success with voiding junior liens where the property was underwater.  Caulkett and Toledo-Cardona are particularly significant because as the value of real property fluctuates over time, the value of a junior lien can change when the property increases in value.  As a result, debtors will not be able to obtain a windfall by taking advantage of the value of their real property at the time of the filing of the Chapter 7 petition.

Lenders Beware: Private Student Loans May Soon Be Dischargeable in Bankruptcy

By:  Joshua B. Alper, Esq.

The Consumer Financial Protection Bureau has its eye on the default rate of private student loans.  In an effort to address this issue, a bill was recently introduced in the United States Senate entitled “The Fairness for Struggling Students Act of 2015” (the “Act”).  Significantly, the Act aims to help students and graduates struggling with repaying private student loans the ability to discharge such debt in bankruptcy.  The Act will essentially treat private student loan debt similar to that of other forms of private unsecured debt like credit cards and medical bills.

When the reforms to the Bankruptcy Code were enacted in 2005, private and government-backed student loans were afforded similar protection when a borrower filed for bankruptcy.  Both were generally deemed nondischargeable (although private student loans could be discharged in rare and extreme circumstances)With the introduction of the Act, the Senate seeks to alleviate the financial pressure experienced by students and graduates when they are obligated to begin repaying private student loans.  Significantly, the Act leaves intact the nondischargeability of student debt arising from federal student loans.  Federal loans are typically backed by revenue received from taxpayers.  As a result, it is no surprise that the Senate chose not to change the law in this area.  Federal loans usually have low interest rates and have flexibility with respect to available repayment options.  By contrast, private loans generally have higher interest rates and limited flexibility regarding repayment.  Therefore, the Act would ease the burden of repaying private student loans, especially when the total outstanding debt on private loans that are in default is reported to be extreme.

While critics of the Act may suggest the Act does not protect against bad faith bankruptcy filings, the Bankruptcy Code already contains provisions that were enacted in 2005 to guard against debtors abusing the bankruptcy system for their own personal gain.  For a variety of reasons, the enactment of legislation is oftentimes a difficult task because there are a multitude of interests to consider.  Consequently, it will be interesting to see how lawmakers and the financial industry react to the Act, especially during the current economic climate.

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.

New Jersey Bankruptcy Court Holds that Mortgage Was No Longer Enforceable and Borrower Was Entitled to a “Free House”

By: Daniel A. Cozzi and Donna Bates

The United States Bankruptcy Court for the District of New Jersey recently held in In re Washington, No. 14-14573-TBA, 2014 WL 5714586 (Bankr. D.N.J. Nov. 5, 2014) that the mortgagee and mortgage servicer (“the Creditors”) are time-barred under New Jersey state law from enforcing either the note or the accelerated mortgage against the debtor, essentially entitling a defaulting borrower to a “free house.”[1]

The Court’s analysis focused on the issue of whether the Fair Foreclosure Act (“FFA”), N.J.S.A. § 2A:50-56.1(which governs statutes of limitations relative to foreclosure proceedings), and the Bankruptcy Code, specifically sections 11 U.S.C. §§ 502(b)(1) and 506(d) (which deal with allowable claims), operate to make the mortgage unenforceable because the creditor waited too long to institute a foreclosure after the maturity date of the loan was accelerated because the borrower defaulted.

Borrower Gordon Washington (“Debtor” or “Washington”) purchased a three-family home in Morris County, New Jersey, on February 27, 2007, paying a $130,000 deposit and obtaining a 30-year mortgage and note for $520,000 with the first payment due on April 1, 2007. In re Washington, *2. Debtor failed to make the July 1, 2007 mortgage payment, and the loan went into default and remained in default since that time. Id. On December 14, 2007, the Creditors filed a foreclosure complaint in the Superior Court of New Jersey, Chancery Division. Id. at *3. The Complaint alleged that “[p]laintiff herein, by reason of said default, elected that the whole unpaid principal sum due on the aforesaid obligation and mortgage …. shall be now due.” Id. at *5. On October 28, 2010, the Office of Foreclosure returned the foreclosure judgment package to the creditors for deficiencies, notably, failure to produce an attorney certified copy of the Note and Mortgage. Id. at *6. On July 5, 2013, the Superior Court Clerk’s Office issued an Order dismissing Creditors’ foreclosure complaint for lack of prosecution, without prejudice. Id. The foreclosure was not re-filed, and on March 12, 2014, Debtor filed a petition for Chapter 7 bankruptcy. Id. On March 18, 2014, Debtor filed an adversary complaint to determine the validity of the mortgage lien on the property. Id. at *3.

Each party moved for summary judgment in the adversary proceeding. Id. at *1. Debtor argued that the 6-year statute of limitations applicable to negotiable instruments set forth in New Jersey’s Uniform Commercial Code (“UCC”), N.J.S.A. § 12A:3-118(a), had expired and thus Defendants were out of time to sue on the mortgage note. Id. Debtor also argued that the FFA similarly had a 6-year statute of limitations, because it required that a residential mortgage foreclosure must be commenced within “[s]ix years from the date fixed for the making of the last payment or the maturity date set forth in the mortgage or the note, bond or other obligation secured by the mortgage . . .” N.J.S.A. § 2A:50-56.1(a)In contrast, the Creditors argued that they had “[t]wenty years from the date on which the debtor defaulted . . .”of to file a foreclosure action as set forth in § 2A:50-56.1(c) of the FAA, and since that time had not expired they may still foreclose on the mortgage.

The Court’s opinion focused on the narrow issue of whether “N.J.S.A. § 2A:50-56.1(a) and 11 U.S.C. §§ 502(b)(1) and 506(d) operate to make the mortgage unenforceable, to disallow the Defendants’ claim, and to void the mortgage lien so that the Defendants have no claim against the Debtor, the property or the estate.” Id. In its analysis, the Court reviewed N.J.S.A. § 2A:50-56.1, which states in relevant part the following:

An action to foreclose a residential mortgage shall not be commenced following the earliest of :

  1. Six years from the date fixed for the making of the last payment or the maturity date ….;
  2. Thirty-six years from the date of the recording of the mortgage ….
  3. Twenty years from the date on which the debtor defaulted … as to any of the obligations or covenants contained in the mortgage…

The Court reviewed N.J.S.A. § 2A:50-56.1(a) and determined that, in this case, the maturity date for the subject loan had been accelerated to either July 1, 2007 (the date of default), or December 14, 2007 (the date of the filing of the foreclosure complaint). In re Washington, *12.     Id. The mortgage had an original maturity date of the year 2037. However, the Court found that the maturity date had been accelerated to the year 2007 [2] and held that, because the maturity date was accelerated by the Creditor, the applicable statute of limitations is six years (and not the twenty years set forth in § 2A:50-56.1(c)), which statute of limitation runs from the date of the accelerated maturity date. Since the accelerated maturity date in this case was either July 1, 2007 or December 14, 2007, the foreclosure had to be commenced no later than July 1, 2013 or December 14, 2013, which it was not. In re Washington, *12.    The Court noted that even though the foreclosure complaint was originally filed on December 14, 2007, it was dismissed in 2013, was never reinstated, and neither Debtor nor Creditors took any action under the mortgage instruments or the FFA to de-accelerate the maturity date.[3] The Court held that therefore the Creditors “are time-barred under New Jersey state law from enforcing either the note or the accelerated mortgage.”

The Court went on to determine that, because the Creditors could not foreclose on Debtor’s loan, Creditors’ proof of claim in bankruptcy also was barred because the underlying lien is unenforceable. The Court relied on11 U.S.C. § 502(b)(1), which states in pertinent part that, for disputed claims, the court shall determine the amount of the claim unless, “such claim is unenforceable against the debtor and property of the debtor, under any agreement or applicable law for a reason other than because such claim is contingent or unmatured.” The court also relied on 11 U.S.C. § 506(d), which states that if the claim underlying the lien is disallowed, the lien is void. [4]

In light of this decision, lenders should evaluate their loan portfolios for mortgages which have been in default for five (5) or more years. On a case by case basis, lenders may want to ensure that a mortgage foreclosure has been filed on the property, and if one has not been filed, expedite the foreclosure filing process to avoid running afoul of the six-year statute of limitations. Lenders should also exercise caution in dismissing foreclosures without prejudice while the loan is in default. The mortgage and note may be rendered void and unenforceable if the foreclosure is not re-filed prior to the six year statute of limitations.

[1] The Court expressed its distaste for rendering a decision that retreated from the long standing admonition that “No one gets a free house.” Nevertheless, it opined that the current statutes and the facts of the case warranted summary judgment in favor of the Debtor.

[2] In determining that the maturity date had been accelerated, the Court referenced the language in an Assignment of Mortgage, effective November 12, 2007, that listed the accelerated balance as the amount due as of June 1, 2007, as well as the allegations contained in the December 14, 2007 foreclosure complaint, which stated that the Plaintiff has elected that the whole unpaid principal balance and all interest and advances made were now due. In re Washington, *8-9. It was not relevant to the Court’s decision whether the original maturity date was accelerated to the date of default or the date the foreclosure complaint was filed, because in either case, the statute of limitations had clearly expired.

[3] The Court noted that the Creditors argued at the September 30, 2014 hearing that a foreclosure complaint filed now would “relate back” to the original complaint filed on December 14, 2007. The Court did not specifically rule on this issue, but merely noted that Debtor opposed that argument.

[4] Even though this case involves a bankruptcy and denial of a proof of claim, the same New Jersey statutes and analysis would apply to determine if a creditor is precluded from foreclosing on a property because the statute of limitations has expired.

New York Bankruptcy Court Rules that Borrower Can Proceed with a Claim for Non-Economic Damages Resulting from a RESPA Violation

By:  Diana M. Eng

On July 24, 2014, the Bankruptcy Court of the Southern District of New York issued an opinion and order ruling that the majority of a borrower’s claims against GMAC Mortgage LLC (GMAC) were barred by res judicata, but borrower could proceed with his claim for emotional distress for GMAC’s violation of the Real Estate Settlement Procedures Act (RESPA).  In re Residential Capital, LLC, et al., Case No. 12-12020 (MG) (Bankr. S.D.N.Y. July 24, 2014).  The Bankruptcy Court reasoned that given the remedial purpose of RESPA, the interpretation of “actual damages” under RESPA should be consumer-oriented to allow for emotional distress damages in appropriate cases.

Notably, however, Judge Glenn indicated that borrower “faces an uphill battle in demonstrating causation and damages” with respect to his emotional distress claim; these issues will be resolved in the course of litigating borrower’s claim.  The Bankruptcy Court also expressly reserved the ability to revisit the issue of recovery of non-economic harm for a RESPA violation before the borrower’s claim is fully resolved.

The resolution of borrower’s claim will be a decision of interest, as courts are divided on the issue of whether a plaintiff can recover non-economic damages from a loan servicer under RESPA.