Failla v. Citibank, N.A. (In re Failla), 838 F.3d 1170 (11th Cir. 2016) –

After chapter 7 debtors filed a statement of intention to surrender their house to their mortgagee, they continued to oppose the lender in a state court foreclosure action. The mortgagee argued that this breached their duty to surrender.

As discussed in a prior post (Property Surrender: Surrender Means Surrender – Really), the bankruptcy court agreed with the mortgagee and granted its motion to compel surrender. The district court affirmed, and the debtors appealed to the 11th Circuit.

The debtors filed bankruptcy after the mortgagee filed a state court foreclosure action. During the bankruptcy the debtors filed a statement of intention to surrender their mortgaged house pursuant to section 521 of the Bankruptcy Code. They also admitted that the mortgage was valid and the balance of the mortgage exceeded the value of the house. Since the property was underwater the trustee chose to abandon it back to the debtors.

Under section 521 a debtor is required to file a statement of intention about what it plans to do with collateral for its debts. There are only four options: the collateral is exempt, the debtor will surrender or redeem the collateral, or the debtor will reaffirm the debt. Once a debtor makes a choice it must perform the selected option.

The court began by addressing to whom the collateral must be surrendered. Congress merely said that collateral must be surrendered without specifying to whom. The court decided that this made sense because the debtor was required to surrender to both the trustee and the creditor based on both the text and the context of the Bankruptcy Code.

For example, “surrender” was used in the context of “redeem” and “reaffirm” – which plainly referred to creditors. Similarly, other sections of the Bankruptcy Code gave creditors a remedy for violations of section 521 – which suggested that surrender does not refer exclusively to trustees. Thus when the trustee abandoned the property to the debtors, they were not entitled to keep the property but rather were required to surrender it to the mortgagee.

Next the court addressed whether surrender required the debtors to drop opposition to the state foreclosure action. Since “surrender” is not defined in the Bankruptcy Code the court decided it must be given its “contextually appropriate ordinary meaning.” While acknowledging that one dictionary definition of surrender would be to physically turn over property, the court determined that this was not contextually appropriate. When physical delivery is intended the Bankruptcy Code uses “deliver.”

Instead the alternate meaning of “giving up of a right or claim” was deemed the most sensible connotation. When a debtor surrenders property it must “get out of the creditor’s way.” In particular, it must not contest foreclosure efforts.

With respect to the issue of the “hanging paragraph” – which provides that nothing in the applicable subparagraphs “shall alter the debtor’s or the trustee’s rights with respect to such property under this title” – the court emphasized that this relates to bankruptcy rights such as the automatic stay and the trustee’s right to control the property until it is abandoned. This language does not mean that the debtor can surrender the property during bankruptcy and then undo the surrender afterwards by opposing a state court foreclosure.

The 11^th Circuit was very clear that a debtor who surrenders property cannot continue to oppose a state court foreclosure action. “In bankruptcy, as in life, a person does not get to have his cake and eat it too.”

The debtors then argued that even if they breached their duty to surrender the only remedy was to lift the automatic stay so that the mortgagee could foreclose. The court rejected this argument since bankruptcy courts have broad powers to remedy violations. It viewed the debtors’ actions as an abuse of the bankruptcy process and determined that it was clear that the bankruptcy court could order the debtors to withdraw their affirmative defenses and dismiss the counterclaims in the state foreclosure case.

The court appears to have a strongly held view that the debtors had no business interfering with the mortgagee’s exercise of its rights once they elected to surrender the property. However it is interesting to note that the Bankruptcy Code leaves a lot to the imagination when it comes to interpreting the consequences of a surrender.

Vicki R Harding, Esq.