Chapter 7 Discharge: When Is In Rem Not In Rem?

In re Jackson 554 B.R. 156 (BAP 6th Cir. 2016)

At the request of a chapter 7 debtor, the bankruptcy court reopened his case and sanctioned the debtor’s condominium association for violating his discharge. On appeal the Bankruptcy Appellate Panel (BAP) reversed, finding an abuse of discretion.

The debtor owned a residential condominium unit that was the subject of a foreclosure action. Both the first mortgagee and the condominiums association obtained a foreclosure judgment. Before a foreclosure sale could be scheduled the debtor filed bankruptcy. After the debtor obtained a discharge and the chapter 7 bankruptcy case was closed, the condominium association scheduled a sheriff’s sale.

Under section 727 of the Bankruptcy Code an individual chapter 7 debtor is generally entitled to a discharge from all prepetition debts. Under section 524 the discharge voids a judgment that is a determination of personal liability of the debtor with respect to a discharged debt and operates as an injunction against collection of a discharged debt as a personal liability of the debtor. A discharge does not preclude in rem remedies.

Consequently, the condo association was enjoined from collecting prepetition fees and assessments from the debtor personally, but was entitled to exercise its in rem remedies against the condominium unit. Although it would seem that pursuing a foreclosure sale is the epitome of an in rem action, the bankruptcy court concluded that the foreclosure was a disguised in personam action on the basis that there was no legitimate purpose for the foreclosure sale.

The bankruptcy court’s reasoning was based on the fact that the first mortgage debt clearly exceeded the value of the condo unit. Consequently, the condo association was unlikely to receive any proceeds from the sheriff’s sale. Rather in its view the objective of the foreclosure was to force the debtor to pay to avoid losing the property.

In the view of the BAP, this ignored the duty of the condo association to the other owners. As explained by association counsel, the condo board of directors had “an obligation, a duty, to stop the bleed, to get a new homeowner into this property who is going to have the intent to pay fees.” The BAP held that the bankruptcy court’s conclusion that the sale was a disguised in personam action was an abuse of discretion.

The bankruptcy court also prohibited the condo association from enforcing the pre-petition foreclosure judgment. The bankruptcy court commented that it was “perplexed” why the condo association did not just certify post-petition, post-discharge liens and proceed with a new foreclosure action to avoid any argument about violation of the discharge. However, the BAP pointed out that this may not even be permissible under state law since typically a new foreclosure action would not be allowed while another foreclosure action was pending. Consequently, the prohibition on enforcing the foreclosure judgment was also an abuse of discretion.

Finally the bankruptcy court concluded that an ~$800 post-petition charge for attorney fees incurred in connection with scheduling the foreclosure sale was also a violation of the discharge. The BAP turned to section 523(a)(16) of the Bankruptcy Code, which provides an exception to the discharge “for a fee or assessment that becomes due and payable after the order for relief to a membership association with respect to the debtor’s interest in a unit that has condominium ownership.” The special assessment for the attorney fees was made post-petition and became due and payable after that date. Thus, the charges were not discharged and did not provide a basis for finding a violation of the discharge by the condo association.

Accordingly, the BAP reversed the bankruptcy court and vacated the sanctions order.

As the BAP pointed out, an argument that a permitted in rem foreclosure sale is prohibited as a disguised in personam action does not hold water because “all foreclosure litigation potentially can induce payments of discharged debt to avoid a foreclosure sale, since a lien, like the statutory lien of [the condo association], applies to all the underlying indebtedness – whether discharged personally as to the property owner or not.” Of course, that does not stop someone from making the argument in the first place.

Vicki R Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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