Chapter 13 debtors brought an adversary proceeding against mortgage loan servicers (1) seeking a determination that a deed of trust lien was extinguished when a proof of claim filed for the lender was disallowed and (2) seeking to recover for violations of the automatic stay and the debtors’ confirmed plan. The bankruptcy court granted the loan services’ motion to dismiss, and the debtors appealed to the district court.
The debtors’ bankruptcy petition listed a disputed debt secured by a deed of trust on residential real property. An entity filed a proof of claim on behalf of the deed of trust lender. The trustee objected because the “name of the creditor on the face of the proof of claim is not supported by the documents attached.” In response, the bankruptcy court disallowed the proof of claim on the grounds that it was not filed by the actual holder of the note.
The debtors confirmed a plan that included the debt and provided for postconfirmation payments and received a discharge. However, they made no payments on the debt. Almost a year later the defendants became the servicers and attempted to collect the debt from the debtors. The debtors responded by bringing an adversary proceeding in bankruptcy court. Their primary argument was that disallowance of the proof of claim voided the deed of trust lien.
The district court began its review by noting that section 501(a) of the Bankruptcy Code states that a creditor may file a proof of claim. If the creditor elects not to file, the debtor or trustee may file a proof of claim on its behalf. If a secured creditor elects not to file a proof of claim and no proof of claim was filed on its behalf, that generally will not adversely affect its lien rights.
In particular, the failure to file a proof of claim will not result in loss of the lien and generally after the bankruptcy the creditor will be able to pursue its collateral to satisfy its claim. Citing a Supreme Court case (Dewsnup v. Timm) (citation omitted): “[A] creditor with a loan secured by a lien on a debtor’s assets may ignore the bankruptcy proceeding and look to the lien for satisfaction of the debt. It is a well-established principle of bankruptcy law that liens pass through bankruptcy proceedings unaffected.”
The debtors argued that since a proof of claim was indeed filed, when it was disallowed the lien was rendered void. In response the servicers argued that the claim was disallowed on procedural, not substantive, grounds. Since the bankruptcy court never made a determination on the merits, the lien was unaffected.
The district court agreed with the servicers noting that (1) failing to provide supporting documentation (i.e. establishing the authority of the entity filing the proof of claim) was not a substantive basis for disallowance, and (2) disallowance for failure to timely file a proof of claim does not extinguish the underlying lien. To avoid a lien there must be a substantive determination that the it is invalid.
The district court concluded that failure of the actual noteholder to file a claim was similar to a failure to file any claim at all. The claim was not disallowed with respect to the actual holder of the note since it did not file a proof of claim. Further the substance of the claim was not considered.
The debtors had various options: they could have sought reconsideration of the disallowance, filed a proof of claim themselves, modify the plan, or pursued a loan modification. Instead they simply did not make any payments. Even though they supposedly disputed the claim, their plan treated the deed of trust as valid. Accordingly, the bankruptcy court was correct in ruling that disallowance of the proof of claim did not avoid the lien.
As for the automatic stay issue, the debtors argued that the servicers’ predecessors improperly continued to assess fees and other charges during the bankruptcy. However, the servicers were not involved while the automatic stay was in effect. To the extent that the debtors disputed the amount of the debt, the district court viewed that as a contract law issue that could be brought in state court, noting that there was no request for a declaratory judgment to determine the amount of the debt in the adversary proceeding.
The district court also rejected the contention that attempts to collect the debt a year after the bankruptcy case was closed was a violation of the plan. The debtors did not identify any particular plan provisions that were supposedly violated. The plan included the debt as “long term debt,” and the debtors defaulted. End of story.
Accordingly, the district court affirmed the bankruptcy court on all counts.
Outside the wonderful world of bankruptcy, the mantra of a real estate lawyer is likely to be that a mortgage without a debt is a nullity. However, the status of a mortgage in bankruptcy is a different kettle of fish.
Vicki R Harding, Esq.