Bankruptcy - the Honorable W.h. Drake, Jr. and Christopher S. Strickland

• Publication year: 2000

Bankruptcyby The Honorable W.H. Drake, Jr.*and

Christopher S. Strickland**

I. Introduction

Undeniably, 1999 proved to be an important year for bankruptcy in the Eleventh Circuit Court of Appeals, with the circuit ultimately producing eleven opinions bearing upon the debt relief process. In keeping with the cosmopolitan nature of bankruptcy practice, these decisions involved the court's performance of diversified tasks, ranging from the interpretation of intricate Bankruptcy Code provisions to the construction of governing requirements from the Uniform Commercial Code and the resolution of potential conflicts between the bankruptcy process and various constitutional or state law provisions. Provided below is an overview of each decision rendered during 1999.

II. Gamble v. Brown (In re Gamble)

The first of the Eleventh Circuit's 1999 bankruptcy decisions, Gamble v. Brown (In re Gamble),¹ called into question the propriety of failing to turn over property otherwise exempted from the debtors' bankruptcy estate pursuant to 11 U.S.C. Sec. 522. The debtors had filed for Chapter 13 bankruptcy protection on October 11, 1996 in the Southern District of Georgia. In Schedule C of their petition, the Gambles claimed $10,800 of equity as exempt property, representing real estate that they owned in Illinois. Neither the Chapter 13 trustee nor any creditors filed objections to the claimed exemption, and the Gambles thereafter filed a motion in the bankruptcy court seeking permission to sell the Illinois property for $150,000 and to pay off the mortgage, property taxes, real estate commissions, and other costs associated with the closing.²

Following court approval of the sale and its closing, the debtors received net proceeds from the sale in the aggregate of $6731.22. The proceeds were remitted to the Chapter 13 trustee pending further proceedings pursuant to Matter of Deeble & McBride.³ The Gambles then filed a Motion Requesting Turnover of Exempt Property to recover the $6731.22 in proceeds held by the Chapter 13 trustee.⁴ The bankruptcy court, construing Bankruptcy Code Section 522, denied the Gambles' motion, holding that until exempt property is '" freed of creditor's claims . .. it must be safeguarded and preserved in the event of a dismissal, in order to permit those claims to attach.' "⁵ Thus, the Gambles could not receive the proceeds from the property sale until the conclusion of their Chapter 13 bankruptcy plan. The Gambles appealed, and the district court affirmed the bankruptcy court's order.⁶

On further appeal, the Eleventh Circuit observed that upon the filing of a Chapter 13 petition in bankruptcy, the property of the debtor becomes property of the bankruptcy estate.⁷ The debtor then has the opportunity to exempt certain items under Section 522(b) and applicable state law.⁸ Congress has specified the type of property that a debtor may exempt in Section 522(d).⁹ The trustee and creditors have thirty days to object to the exemptions after the debtor has listed his or her exemptions and the trustee has met with creditors pursuant to 11 U.S.C. Sec. 341.¹⁰

Most relevant to the case before it, the court noted, '"Unless a party in interest objects, the property claimed as exempt on such list is exempt.' "¹¹ Likewise, " '[u]nless the case is dismissed, property exempted under this section is not liable during or after the case for any debt of the debtor that arose, or that is determined under section 502 of this title as if such debt had arisen, before the commencement of the case.' "¹² Furthermore, "[o]nce the property is removed from the estate [through exemption], the debtor may use it as his own."¹³

Because neither the trustee nor any creditor had objected to the Gambles' exemption of the Illinois property from the bankruptcy estate, the court reasoned that the property had become exempt by operation of law.¹⁴ The court likewise found unpersuasive the pragmatic and equitable bases upon which the bankruptcy court had sought to distinguish the black-letter precedent of Taylor.¹⁵ Indeed, the court found the approach endorsed by the bankruptcy court would cause the court to disregard the time period for objecting to asset exemptions.¹⁶ Thus, the court reversed the district court's order denying turnover of the exempt property and remanded the case with instructions for the trustee immediately to turn over the property to the debtors.¹⁷

III. Continental National Bank of Miami v. Sanchez (In re Toledo)

In Continental National Bank of Miami v. Sanchez (In re Toledo) ¹⁸ the Eleventh Circuit found itself revisiting the perennial debate over bankruptcy court jurisdiction. Some ten years prior to filing for Chapter 11 bankruptcy protection, the joint debtors formed a partnership with appellee and her since-deceased husband, the business purpose of which was to develop and deal in certain contiguous parcels of real estate in downtown Miami. As they began to experience financial difficulties, Orlando Toledo convinced a personal creditor (the "Bank") not to foreclose its mortgage upon the debtors' residence by purportedly conveying a supplemental mortgage on partnership property to the Bank and by convincing McDonald's Corp., which had a $275,000 pre-existing purchase money mortgage on the property, to subordinate its mortgage to the one being granted to the Bank. Toledo took these actions without the knowledge of appellee, who was then a fifty percent owner of the partnership.¹⁹

As the Toledos' situation worsened, the Bank ultimately obtained a judgment of foreclosure on both the partnership property and the debtor's residence. Despite her status as fifty percent partner, appellee did not receive notice of the foreclosure and, therefore, was not a party to those foreclosure proceedings. The state court's foreclosure judgment provided that the debtors' residence would be sold first, and if the debt to the Bank which totaled approximately $1.8 million remained outstanding, it would order sale of the partnership property. On the day before the scheduled foreclosure sale of their residence, the Toledos filed for Chapter 11 bankruptcy and thus avoided the forced sale of their home.²⁰

Under the terms of a postpetition negotiated sale, the partnership property was sold to McDonald's Corp. for $825,000, with approximately $474,000 going to satisfy amounts due under the McDonald's purchase money mortgage, and the $351,000 balance reserved for the Bank and the partnership.²¹ Appellee, as a fifty percent partner, consented to the terms of sale but filed an adversary complaint "(i) to determine entitlement to the proceeds of the sale of the Partnership Property to McDonald's Corp., and (ii) to contest the validity of the Bank's lien (formerly on the Partnership Property, and now on $200,000 of the proceeds therefrom)."²²

Given Orlando Toledo's apparent lack of any authority to mortgage the partnership's property and the Bank's knowledge that Toledo was conveying the mortgage for improper, nonpartnership purposes, the bankruptcy court determined that the Bank held no valid lien on the partnership property. As such, the court directed the Bank to pay appellee the $200,000 it had previously received from the sale of the partnership property. In the course of rendering this decision, the court observed that it had jurisdiction under 28 U.S.C. Sec. 1334 but never directly addressed whether the adversary proceeding was core or noncore pursuant to 28 U.S.C. Sec. 157.²³

Appealing to the district court, the Bank argued as follows:

(i) the bankruptcy court lacked subject matter jurisdiction to hear the adversary proceeding filed by [appellee]; (ii) the bankruptcy court erred in finding that the Bank knew [the debtor] lacked authority to mortgage the Partnership Property for personal purposes; and (iii) the doctrines of waiver or estoppel should have precluded the bankruptcy court from granting [appellee] relief.²⁴

Finding that the bankruptcy court had subject matter jurisdiction and that the matter was core, the district court held that Toledo lacked authority to mortgage the partnership property for his own purposes and that the Bank was aware of that fact. Accordingly, the district court affirmed the bankruptcy court's decision.²⁵

On further appeal to the Eleventh Circuit, the court first addressed whether the district court itself had jurisdiction to entertain the subject adversary proceeding pursuant to Bankruptcy Code Section 1334(b).²⁶ Noting that the underlying proceeding did not arise under or arise in a case under the Bankruptcy Code,²⁷ the court therefore concluded that jurisdiction only could have existed if the proceedings were "'related to cases under title 11.' "²⁸ Applying the seminal holding in Miller v. Kemira, Inc. (In re Lemco Gypsum, Inc.),²⁹ the court noted that appellee had first sought a determination of the extent and priority of liens and other interests in the partnership property, so that the proceeds of a sale approved by the bankruptcy court could be properly distributed.³⁰ That said, a nexus to the bankruptcy estate existed because (1) the payment of approximately $200,000 to the Bank from nonestate property could ultimately free up an additional $200,000 to be distributed among unsecured creditors, and (2) if the mortgage were adjudged invalid, there would be more equity in the partnership property, thereby enhancing the partnership interest of the debtors that had become estate property at the time of their bankruptcy filing.³¹

Having found that the district court did have jurisdiction over the earlier proceeding, the court then addressed whether it had properly given the bankruptcy court's findings deference as the product of a core proceeding under Bankruptcy Code Section 157(b).³² Although Section

157(b)(2)(K) specifically refers to "determinations of the validity, extent, or priority of Hens" as the subject of a core proceeding, the court deemed the lower courts' reliance upon this provision to...