Saturday, January 23, 2010

Mortgage Can't be Avoided by Bankruptcy Court After State Court Foreclsoure Default Order

Mortgagees should argue that a wholly unsecured mortgage cannot be avoided by a bankruptcy court after a state court judge enters a default judgment in favor of the junior mortgagee in a state court foreclosure action. Mortgagee should assert that a bankruptcy court’s order to strip would be a violation of the Rooker-Feldman doctrine and would be outside of the court’s subject matter jurisdiction.

A court addressed a similar issue in Calabria v. CIT Consumer Group (In re Calabria), 20 CBN 212 (Bankr. W.D.Pa 2009). There, the court dismissed the debtors' complaint to strip-off a mortgage because it found that the court lacked subject matter jurisdiction to do so. The court found that the Rooker-Feldman doctrine precluded the bankruptcy court from considering whether a mortgage on the debtors’ home was invalid after a state court judgment of foreclosure had been granted on the mortgage.

The facts of the case showed that debtors executed two notes and mortgages on their principal home. The junior mortgage was assigned to a third party, which filed a foreclosure action against debtors after the debtors defaulted on the second loan. The junior mortgagee obtained a default judgment against debtors in the mortgage foreclosure case.

Shortly thereafter, debtors filed for Chapter 13 bankruptcy relief. Debtors petitioned the court to avoid the mortgagee’s junior lien because the recorded mortgage referenced the wrong address or contained no legal description. Debtors argued that state law required that a valid mortgage describe the property sufficiently to enable it to be located and identified. If the mortgage was invalid, there could be no foreclosure.

Nevertheless, the bankruptcy court rejected debtors’ argument stating that any ruling that the mortgage instrument was defective would be tantamount to the bankruptcy court concluding that the state court foreclosure judgment was “erroneously entered.” After al, the debtors’ complaint expressly requested that the bankruptcy court strike the junior mortgagee’s secured claim and issue an order to the state court requesting that the state court strike the judgment in mortgage foreclosure.

The bankruptcy court found that if it were to grant the requested relief, then it clearly would have the effect of negating the state court judgment. Under those circumstances, the bankruptcy court concluded that the affirmative claim asserted in debtors’ complaint was “inextricably intertwined” with the state court judgment rendered against debtors. So, the bankruptcy court found that debtors were requesting that the bankruptcy court do precisely what Rooker-Feldman prohibited: to undo the effect of the state court judgment. The bankruptcy court refused to do so and dismissed the case.

So, the Calabria opinion could be cited for the proposition that bankruptcy court’s cannot strip wholly unsecured junior mortgages if a state foreclosure court has already issued an order finding the junior mortgage lien as a valid, enforceable lien.

But, a clever debtor could attempt to distinguish Calabria on a factual basis, arguing that Calabria addressed the validity of the lien and not the value of the lien property. In a typical lien strip case, the validity of the second mortgage lien is not in question. The real question is the value of the lien property and whether the lien is wholly unsecured. So, a debtor could argue that the Rooker-Feldman doctrine in Calabria only emasculated the bankruptcy court’s power to address the validity of the lien, but did not affect the bankruptcy court’s power to value the lien property pursuant to Section 506(a).

Warmest Regards,

Bob Schaller

Your Lien Stripping Defense Blog
By: Attorney Robert Schaller (Bob's bio) of the Schaller Law Firm

Bob is a member of the American Bankruptcy Institute and the National Association of Consumer Bankruptcy Attorneys.

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