Heavy Traffic at the Intersection of Mortgage Foreclosure and Bankruptcy Law
| Jurisdiction | Vermont,United States |
| Citation | Vol. 2006 No. 06 |
| Publication year | 2006 |
June 2006 - #1. HEAVY TRAFFIC AT THE INTERSECTION OF MORTGAGE FORECLOSURE AND BANKRUPTCY LAW
Mortgage foreclosure law is focused primarily on the enforcement of the bargain made by a creditor and a debtor, after default. Bankruptcy law, on the other hand, is focused primarily on the twin goals of giving the honest debtor a fresh start, and equal treatment of all creditors. As the U.S. Supreme Court has stated, the general philosophy of the bankruptcy laws is "to give the [honest but unfortunate] debtor a new opportunity in life and a clear field for future effort, unhampered by the pressure and discouragement of preexisting debt."(fn1) "A co-equal purpose of the bankruptcy laws is to promote equality of treatment among creditors similarly situated."(fn2) Frequently, these goals of bankruptcy law cannot be accomplished without some modification of the pre-bankruptcy debtor-creditor relationship.
Given the inherent tension between the state law rights of creditors under mortgage foreclosure law, and a bankruptcy law designed to give relief to debtors, it is no surprise that the intersection of these two bodies of law has spawned a considerable amount of decisional law. Many of these cases are efforts by the courts (primarily bankruptcy courts) to reconcile the state law rights of foreclosing secured creditors, and the policies underlying these rights, with the federal law rights of bankrupt debtors and their other creditors, often represented by a bankruptcy trustee. Vermont has had its own unique experience in this regard, owing primarily to the substantive and procedural intricacies of its foreclosure laws, which retain strict foreclosure as the primary method for foreclosure of mortgages. Under current law, unless a mortgage contains a power of sale clause and one party to the action requests a sale in its pleadings, a judicial foreclosure must proceed in Vermont as a strict foreclosure.(fn3) Since the debtor's rights after default under Vermont law are limited to the contingent equitable right to redeem by satisfying the mortgage debt in full,(fn4) and failure to redeem results in the loss of any equity value in the property over and above the mortgage debt, bankruptcy is frequently the tool of last resort for preservation of the debtor's equitable interest in the property. Not surprisingly, numerous issues arise in connection with such efforts, such as when the debtor's equitable interest is cut-off under state law such that a bankruptcy filing cannot revive it, whether defects in the foreclosure process allow a debtor or trustee to exercise greater rights than state law would allow, and whether the forfeiture of surplus value in the property through strict foreclosure can be remedied in bankruptcy under fraudulent transfer statutes.
The last several years have seen significant developments in regard to all of these issues, the most recent of which has called into question the validity of any title derived through strict foreclosure in the last four years.(fn5) This article discusses those developments and the current state of the law, including pending legislation designed to revise strict foreclosure so that it does not run afoul of the restrictions imposed by fraudulent transfer laws.
As a result of two bankruptcy court decisions in the mid-1980's,(fn6) it was considered well-settled in this jurisdiction until 2002 that if a bankruptcy filing was made before the debtor's period of redemption under a foreclosure decree expired, the running of the redemption period would be stayed automatically under 11 U.S.C. 362(a) upon the filing, until such time as the stay was modified or terminated. The result of this was to give debtors the opportunity effectively to extend the period for redemption by a bankruptcy filing, since a creditor would have to go to the bankruptcy court for relief from the automatic stay-often a time consuming and costly process. The stay also gives the trustee in a Chapter 7 liquidation case an indefinite time within which to sell the property to recoup any value in excess of the debt,(fn7) or the debtor in a Chapter 13 individual reorganization case the chance to avoid the foreclosure (on a principal residence) entirely and cure the default under a Chapter 13 plan.(fn8)
Although the bankruptcy court's decision in LH&A Realty was contrary to three prior federal appeals court decisions, its holding was not subjected to appellate challenge until 2002, in the case of In re: Canney,(fn9) another case involving a creditor's effort to obtain relief from stay. In Canney, the Second Circuit overruled LH&A Realty and held that the automatic stay in bankruptcy does not stay the running of the redemption period under a foreclosure decree. The Court interpreted Section 362(a) narrowly to apply only to affirmative actions by a creditor. The Court reasoned that since complete title vests in the foreclosing creditor upon expiration of the redemption period as a matter of law, with no action needed by the creditor to perfect its title as to the debtor/mortgagor, the section 362 stay cannot apply. Instead, according to Canney, section 108(b) of the Bankruptcy Code controls, giving the trustee only an additional sixty days after the filing of the petition within which to act.
Canney clarified that forfeiture of the debtor's remaining equitable interest in the property, and vesting of complete title in the creditor, takes place automatically upon expiration of the period of redemption, notwithstanding the fact that Vermont law requires a creditor to file in the land records a certified copy of the foreclosure decree within thirty days of the expiration of the redemption period. Thus, as between the creditor and the debtor, the foreclosure is complete upon expiration of the redemption period. As between the creditor and "subsequent purchasers, mortgagees, or attaching creditors," the creditor must record the certified foreclosure decree(fn10) within the thirty day statutory period or prior to the attachment of additional liens, or take title subject to a right of redemption in favor of subsequent lienholders.(fn11) But in any event, under Canney the automatic stay does not prevent a foreclosing creditor in any circumstances from recording the decree in the land records, thereby perfecting title as against any interests attaching thereafter.(fn12)
Canney does not address whether an extended right of redemption could exist if a creditor fails to record a foreclosure judgment within the thirty days after redemption deadlines under a decree have passed, after which a bankruptcy filing occurs. Even though a trustee in a Chapter 7 case would not be in a position to assert a derivative redemption right of the debtor-which expires according to Canney upon entry of the foreclosure decree-the trustee would be in a position to assert the status of a hypothetical judicial lien creditor who obtains a lien on the debtor's property at the time of the bankruptcy filing, under 11 U.S.C. 544(a).(fn13) There is no reason a trustee in such a position could not assert a right of redemption under 12 V.S.A. 4530 as a...
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