Continuing Perfection: Does a Mortgage Lapse During Bankruptcy If State Law Would Otherwise Require Steps to Maintain Perfection?

River Parishes Dirt & Gravel, LLC v. BankPlus (In re Willow Bend Ventures, LLC), 603 B.R. 293 (Bankr. E.D. La. 2019) –

A lender’s secured claim was challenged on the basis that postpetition it failed to take steps required to maintain perfection of its mortgage as required by state law. The matter turned on whether section 108(c) of the Bankruptcy Code extended the deadline for taking those steps.

The lender made loans secured by a mortgage on the debtor’s property. After the debtor filed a chapter 11 bankruptcy, the lender filed a proof of claim for ~$6.6 million asserting a secured claim. The case then meandered for a while.

The debtor filed a motion to sell property free and clear of liens. The motion listed the lender’s loans, which were to be paid from the sale proceeds, and provided that the rest of the proceeds would be placed in the registry of the court pending resolution of certain tax claims.

The court approved the sale. However, there were various complications and the debtor ended up filing a motion with the court to cancel the sale because of difficulties with the buyer. And there were various other issues, such as a purported breach of the debtor’s agreement to sell membership interests in the debtor to the buyer that was entered into postpetition without approval of the court.

The debtor eventually sought to avoid the lender’s lien, but no hearing was held after the parties agreed to deposit the entire purchase price into the registry of the court. However, the secured status of the lender’s lien finally came to a head when the buyer filed an objection to the debtor’s plan of reorganization, and then filed an adversary proceeding objecting to the lender’s secured claim on the grounds that the mortgage had lapsed.

State law provides:

Except as otherwise expressly provided by law, the effect of recordation of an instrument creating a mortgage or pledge or evidencing a privilege ceases 10 years after the date of the instrument.

Once a mortgage expires, it can no longer be foreclosed. However, the mortgage can be extended by recording an acknowledgement or affidavit that the mortgage was not satisfied prior to expiration.

In this case, the 10 year anniversary of the mortgage fell on the date that the court entered its order approving the debtor’s motion to sell the property. The lender did not take any steps to reinscribe the mortgage prior to that date. Accordingly, the buyer argued that the mortgage no longer had any effect as to third parties, and thus the lender’s claim was unsecured.

In response, the lender contended that it did not have to reinscribe its mortgage to maintain perfection because the deadline was tolled by section 108(c):

[I]f applicable nonbankruptcy law … fixes a period for commencing or continuing a civil action in a court other than the bankruptcy court on a claim against the debtor, … and such period has not expired before the date of the filing of the petition, then such period does not expire until the later of – (1) the end of such period … or (2) 30 days after notice of the termination or expiration of the stay … with respect to such claim.

However, it was the buyer’s position that section 108(c) did not apply since section 362(b)(3) provides an exception from the automatic stay relating to actions to maintain or continue perfection of an interest in property. The lender countered that even though the stay did not prevent it from reinscribing the mortgage, it was not required to do so.

The parties each cited a case supporting its position. The court was not persuaded by the buyer’s authority. It noted that there was only one case supporting the buyer’s position, while there were additional cases supporting the lender’s position (i.e. that the stay exception is permissive rather than mandatory). The court also took issue with a holding in the buyer’s case that section 108(c)(2) applies only in circumstances involving litigation. This proposition came from Collier on Bankruptcy. The court considered the cases cited by Collier and concluded they were not on point.

Finally, the court looked to a First Circuit opinion that focused on the purpose for filing continuation statements and then concluded that under the circumstances of that case the continuation statement “was as unnecessary and useless an act as can be imagined. … We see no need to apply the rules here when to do so would give an unjustified advantage to a party.”

The bankruptcy court echoed this analysis:

There is no way that [the buyer] was not aware of the [lender] mortgages. But now, [the buyer] seeks to exploit a perceived loophole through which it might be able to gain an advantage by knocking out [the lender’s] mortgage, and thus free up funds from which it might be paid in the event that it is ever adjudged to have a claim against the debtor.

Accordingly, the court held that the lender was not required to reinscribe its mortgage to maintain its secured status because section 108(c)(2) tolled the 10 year period until 30 days after the stay was lifted in the debtor’s case.

Putting aside the question of whether section 108(c)(2) applies only in the context of litigation, it is certainly reasonable to argue that it does not apply to actions that are not subject to the automatic stay in the first place. A secured creditor would be well advised to take steps to maintain perfection in a timely manner during a bankruptcy as permitted by section 362(b)(3). There is no assurance that all courts would reach the same conclusion as this court, and a delay may create practical issues. For example, a state filing office may decide to reject a “late” filed UCC continuation statement as untimely.

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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