FYI: 2nd Cir Holds ID Theft Claim Under NY's FCRA Not Preempted by Federal FCRA

The U.S. Court of Appeals for the Second Circuit recently held that identity theft claims under New York's Fair Credit Reporting Act based on a bank's alleged vicarious liability for identity theft supposedly perpetrated by its employees are not preempted by the federal Fair Credit Reporting Act ("FCRA").

 

However, to the extent that the claims could arguably be read to include the theory that the bank was liable because it furnished false information to consumer reporting agencies, the Court held that such claims are preempted under the FCRA because they plainly concern the bank's legal responsibilities as a furnisher.

A copy of the opinion is available at:  Link to Opinion

 

A bank customer sued the bank in New York state court under the New York Fair Credit Reporting Act, which "creates a cause of action for a victim to sue any person who engages in identity theft if, in turn, the theft results in the transmission of certain information about the consumer to a consumer reporting agency (i.e., a credit bureau)."

 

The customer alleged that over approximately 3 years, bank employees supposedly aided and abetted a money-laundering scheme designed to defraud the federal Medicare program. "In return for cash bribes and other gratuities, [the bank employees] assisted the money launderers in the fraudulent use of [plaintiff's] name as a signatory for … accounts set up in the name of phony corporations. These accounts were used to deposit and pay out proceeds of the Medicare fraud scheme."  According to the customer, bank employees supposedly also "falsified [the bank's] records to enable the members of the money laundering scheme to make withdrawals from these accounts in [plaintiff's] name, including for extravagant luxury purchases."

 

The alleged scheme supposedly resulted in many bounced checks when the fraudulent accounts were overdrawn, which allegedly damaged the plaintiff's credit rating. Eventually, the scheme was discovered and the fraudulent accounts were closed. In a bizarre twist, the customer, who supposedly knew nothing about the scheme, was arrested, indicted and tried for money laundering conspiracy. She was, however, acquitted after a seven-week trial.

 

The bank removed the case to federal district court and moved for dismissal pursuant to Fed. R. Civ. P. 12(b)(6), arguing that the plaintiff's claims for identity theft under New York law were preempted by the FCRA. The district court granted the bank's motion and the customer appealed.

 

On appeal, the Second Circuit began by discussing the principles governing preemption, which begins with the Constitution's Supremacy Clause. Article VI, clause 2 of the Constitution provides that "the Laws of the United States … shall be the supreme Law of the Land … any Thing in the Constitution of Laws of any State to the Contrary notwithstanding." Congress can "preempt (or invalidate) a state law by means of a federal statute … expressly or it may preempt state law implicitly in circumstances where it is clear that Congress intended to occupy the entire regulatory field, where state law stands as an obstacle to the objectives of Congress, or where compliance with both federal and state law is impossible."

 

In order to discern Congress' intent on preemption, the Court turned its focus to the plain language, structure and purpose of the FCRA, finding it significant that it "does not create a federal cause of action for victims against perpetrators of identity theft" and that "the FCRA's applicable preemption provisions are somewhat intricate and require consideration of multiple cross-referencing statutory provisions."

 

To begin with, the Second Circuit noted that section 1681(a) of the FCRA provides that it does not preempt state identity theft laws unless they are inconsistent with the FCRA and then only to the extent of such inconsistency.

 

However, Congress created exceptions to the general rule, including that "[n]o requirement or prohibition may be imposed under the laws of any State … with respect to any subject matter regulated under … section 1681s-2 of this title, relating to the responsibilities of persons who furnish information to consumer reporting agencies…."

 

Section 1681s-2 imposes certain duties on "furnishers of information to consumer reporting agencies, including that '[a] person shall not furnish any information relating to a consumer to any consumer reporting agency if the person knows or has reasonable cause to believe that the information is inaccurate.'"

 

The Second Circuit disagreed with the bank's argument "that plaintiff's claims under the New York law fall within the scope of the express exception to non-preemption that is set forth in § 1681t(b)(1)(F)." The Court reasoned that "the language of the provision expresses Congress's intent to preempt claims which are "with respect to any subject matter regulated under … section 1681s-2 … relating to the responsibilities of persons who furnish information to consumer reporting agencies ... [and] therefore, must be read to preempt only those claims against furnishers that are 'with respect to' the subject matter regulated under § 1681s-2."

 

Relying on a Supreme Court decision involving preemption under the Federal Aviation Administration Authorization Act, the Second Circuit found "that a claim is 'with respect to' a preempted subject matter when it concerns that subject matter." The Court then held "that § 1681t(b)(1)(F) preempts only those claims that concern a furnisher's responsibilities … [i.e.,] it does not preempt state law claims against a defendant who happens to be a furnisher of information to a consumer reporting agency within the meaning of the FCRA if the claims against the defendant to not also concern that defendant's legal responsibilities as a furnisher of information under the FCRA."

 

Turning to the ultimate question of whether the customer's claims against the bank "concern [its] responsibilities as a furnisher of information under the FCRA", the Court concluded that, "when viewed in the light most favorable to [plaintiff], the complaint plausibly alleges identity theft claims that do not concern [the bank's] responsibilities as a furnisher. Instead, the complaint advances a theory that [the bank] is vicariously liable—presumably under a respondeat superior theory—for the identity theft allegedly perpetrated by its employees."

 

The Second Circuit noted in a footnote that "[u]nder New York law, '[t]he doctrine of respondeat superior renders an employer vicariously liable for torts committed by an employee acting within the scope of employment. Pursuant to this doctrine, the employer may be liable when the employee acts negligently or intentionally, so long as the tortious conduct is generally foreseeable and a natural incident of the employment.'"

 

The Court found that the identity "theft could be actionable under the New York statute because it eventually resulted in an alert by someone to consumer reporting agencies … [and] it does not matter if the defendant who is sued for identity theft is also the furnisher of information to a consumer reporting agency."

 

In the Second Circuit's view, it didn't matter who reported the adverse information about the customer to consumer reporting agencies because "the [New York] law requires only that the theft have resulted in the transmission of the information by someone to a consumer reporting agency."

 

The Court concluded that "[i]n short, [the bank] could face vicarious liability under the New York law for its employees' theft of [plaintiff's] identity, not for any later act by [the bank] or anyone else—proper or improper—of reporting adverse information about [plaintiff] to a consumer reporting agency."

 

The Second Circuit thus rejected preemption, explaining that because "[i]n our federal system, there is no question that States possess the traditional authority to provide tort remedies to their citizens as they see fit … [and] as the Supreme Court has made clear—that 'we presume federal statutes do not … preempt state law …' [t]his means that 'when the text of a pre-emption clause is susceptible of more than one plausible reading, courts ordinary accept the reading that disfavors pre-emption."

 

Before closing, the Court clarified, however, that to the extent that the complaint "could arguably be read to include the theory that [the bank] is liable for damages (at least in part) because it furnished false information [to consumer reporting agencies] … such claims … are preempted under the FCRA because they plainly concern [the bank's] legal responsibilities as a furnisher."  The Court held that "[t]his is so because § 1681t(b)(1)F) preempts any recovery for damages based on allegations of erroneous or otherwise improper furnishing—regardless of the particular statute or common law theory that plaintiff utilizes to advance her claim."

 

The district court's judgment was vacated and the case remanded for further proceedings consistent with the Second Circuit's opinion.

 

 

 

 

 

Ralph T. Wutscher
Maurice Wutscher LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct:  (312) 551-9320
Fax: (312) 284-4751

Mobile:  (312) 493-0874
Email: rwutscher@MauriceWutscher.com

 

Admitted to practice law in Illinois

 

 

 

California   |   Florida   |   Illinois   |   Indiana   |   Massachusetts   |   New Jersey   |   New York   |   Ohio   |   Pennsylvania   |   Texas   |   Washington, DC

 

 

NOTICE: We do not send unsolicited emails. If you received this email in error, or if you wish to be removed from our update distribution list, please simply reply to this email and state your intention. Thank you.

Our updates and webinar presentations are available on the internet, in searchable format, at:

 

Financial Services Law Updates

 

and

 

The Consumer Financial Services Blog™

 

and

 

Webinars

 

and

 

California Finance Law Developments

 

and

 

Insurance Recovery Services

 

 

 

 

FYI: Fla Court (App Div) Holds HOA Declaration Absolved Mortgagee from Liability for Pre-Acquisition Dues

The Appellate Division of the Circuit Court of the 15th Judicial Circuit in Palm Beach County, Florida recently held that a first mortgagee who took title by foreclosure was not liable for homeowner's association assessments coming due before it acquired title because the association's declaration of restrictive covenants absolved a first mortgagee from liability for assessments coming due before it acquires title.  A copy of the opinion is attached.

 

An individual purchased real property in a subdivision that was subject to a recorded declaration of covenants, restrictions, conditions and easements. The homeowner defaulted on her mortgage and the holder of the mortgage sued to foreclose, ultimately acquiring title at a foreclosure sale in July of 2011.

 

The homeowner's association demanded payment of over $11,000 in delinquent assessments, interest, attorney's fees and costs, which the mortgagee paid under protest. The mortgagee then sued to recover the payment, arguing that the declaration of covenants, restrictions, conditions and easements absolved the first mortgagee of any liability for assessments coming due before it acquired title. The association countered that this exemption applied only if it was joined as a party in the foreclosure action.

 

After a bench trial, the County Court held that the association breached its declaration of covenants by seeking payment of assessments coming due before the mortgagee acquired title, even if the association was not named in the foreclosure action. The association appealed.

 

The appellate division of the circuit court found that that declaration was a contract, and that it would apply the intention of the parties based on the contract's plain language, ensuring that all of its provisions be read together.

 

Using this standard, the appellate division reasoned that even though "in order for a junior lien to be wiped out as a result of a senior lien foreclosure, the senior lien holder must join the junior lien holder as a defendant to the senior lien foreclosure action [and] a failure to do so leaves the junior lien intact," this did not contradict the clear language of the declaration, under which the association relinquished "its right to collection unpaid assessments from entities such as [the bank that foreclosed its mortgage]."

 

The trial court's decision was affirmed, the association's motion for appellate attorney's fees was denied, and the bank's motion for attorney's fees was granted, with the case remanded for the lower court to determine reasonable attorney's fees. 

 

 

 

Ralph T. Wutscher
Maurice Wutscher LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct:  (312) 551-9320
Fax: (312) 284-4751

Mobile:  (312) 493-0874
Email: rwutscher@MauriceWutscher.com

 

Admitted to practice law in Illinois

 

 

 

California   |   Florida   |   Illinois   |   Indiana   |   Massachusetts   |   New Jersey   |   New York   |   Ohio   |   Pennsylvania   |   Texas   |   Washington, DC

 

 

NOTICE: We do not send unsolicited emails. If you received this email in error, or if you wish to be removed from our update distribution list, please simply reply to this email and state your intention. Thank you.

Our updates and webinar presentations are available on the internet, in searchable format, at:

 

Financial Services Law Updates

 

and

 

The Consumer Financial Services Blog™

 

and

 

Webinars

 

and

 

California Finance Law Developments

 

and

 

Insurance Recovery Services

 

 

 

 

FYI: Fla App Ct (1st DCA) Cuts Off Extensive Discovery Requests to Mortgagee As to Standing and Satisfaction of Mortgage

The District Court of Appeal of Florida, First District, recently denied a property owner's effort to appeal the trial court's order limiting the property owner's extensive discovery requests to a mortgagee relating to standing and satisfaction of mortgage.

 

In so ruling, the Appellate Court concluded that the trial court's order limiting discovery did not effectively eviscerate the property owner's affirmative defenses.

 

A copy of the opinion is available at:  Link to Opinion

 

A property owner ("Property Owner") propounded broad discovery requests related to the defenses that the mortgagee lacked standing to foreclose; and that all mortgages on the property had been satisfied before Property Owner acquired the property.

 

Property Owner requested all documents in the entire chain of assignments since origination of the subject loan.  The trial court granted discovery of documents evidencing the mortgagee's acquisition of the subject note. 

 

Property Owner also requested internal bank documents relating to the recorded satisfactions of the subject mortgage.  The mortgagee objected on privacy grounds to producing the internal documents, and the trial court granted limited discovery of "correspondence, payments and documentation" regarding the satisfactions.

 

Property Owner filed a petition for writ of certiorari before the District Court of Appeal of Florida, First District.

 

As you may recall, certiorari is appropriate only "when a discovery order departs from the essential requirements of law, causing material injury to a petitioner throughout the remainder of the proceedings below and effectively leaving no adequate remedy on appeal."  Allstate Ins. Co. v. Langston, 655 So. 2d 91, 94 (Fla. 1995).  The requirement of material, irreparable harm is jurisdictional, and a court must dismiss the petition if it is not met.  See Bd. Of Trs. of Internal Improvement Trust Fund v. Am. Educ. Enters., LLC, 99 So. 3d 450, 454-44 (Fla. 2012).

 

The Appellate Court noted that it has "adhered to the view that orders having the effect of denying discovery are almost invariably not reviewable by certiorari because of the absence of irreparable harm."  Boyd v. Pheo, Inc., 665 So. 2d 294, 295 (Fla. 1st DCA 1995).  For denial of discovery to constitute material, irreparable harm, the denial must "effectively eviscerate[] a party's claim, defense, or counterclaim." Giacalone v. Hellen Ellis Mem'l Hosp. Found., Inc., 8 So. 3d 1232, 1234 (Fla. 2d DCA 2009).

 

Next, the Appellate Court considered Property Owner's requested standing discovery.  The Appellate Court noted that the trial court granted discovery of documents evidencing the mortgagee's acquisition of the subject note.  Because standing to foreclose required only proof that the foreclosing party held the note when it filed the action, proof of prior assignments was unnecessary.  See Keifert v. Nationstar Mortg. LLC, 153 So. 3d 351, 352-53 (Fla. 1st DCA 2014). 

 

Although the Appellate Court noted that some of the other documents Property Owner requested could be relevant to the standing defense, the lack of these additional documents did not effectively eviscerate the standing defense because standing is based on the possession of the note and not the chain of ownership.

 

Next, the Appellate Court considered Property Owner's proposed discovery as to a possible satisfaction of the mortgage.  The Appellate Court noted that the mortgagee had objected on privacy grounds to producing internal documents and therefore could not use such documents against Property Owner.  See Alterra Healthcare Corp. v. Estate of Shelley, 827 So. 2d 936, 947-48 (Fla. 2002).  However, the trial court granted discovery of "correspondence payments and documentation" regarding the satisfactions.  Thus, although some of the other documents Property Owner requested could be relevant to the satisfaction defense, the lack of the internal memoranda did not effectively eviscerate the defense of satisfaction.

 

Accordingly, the Appellate Court concluded that Property Owner failed to demonstrate material harm not remedial on appeal, and dismissed Property Owner's Petition for Writ of Certiorari for lack of jurisdiction.

 

 

 

 

Ralph T. Wutscher
Maurice Wutscher LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct:  (312) 551-9320
Fax: (312) 284-4751

Mobile:  (312) 493-0874
Email: rwutscher@MauriceWutscher.com

 

Admitted to practice law in Illinois

 

 

 

California   |   Florida   |   Illinois   |   Indiana   |   Massachusetts   |   New Jersey   |   New York   |   Ohio   |   Pennsylvania   |   Texas   |   Washington, DC

 

 

NOTICE: We do not send unsolicited emails. If you received this email in error, or if you wish to be removed from our update distribution list, please simply reply to this email and state your intention. Thank you.

Our updates and webinar presentations are available on the internet, in searchable format, at:

 

Financial Services Law Updates

 

and

 

The Consumer Financial Services Blog™

 

and

 

Webinars

 

and

 

California Finance Law Developments

 

and

 

Insurance Recovery Services

 

 

 

 

FYI: Fla App Ct (1st DCA) Cuts Off Extensive Discovery Requests to Mortgagee As to Standing and Satisfaction of Mortgage

The District Court of Appeal of Florida, First District, recently denied a property owner's effort to appeal the trial court's order limiting the property owner's extensive discovery requests to a mortgagee relating to standing and satisfaction of mortgage.

 

In so ruling, the Appellate Court concluded that the trial court's order limiting discovery did not effectively eviscerate the property owner's affirmative defenses.

 

A copy of the opinion is available at:  Link to Opinion

 

A property owner ("Property Owner") propounded broad discovery requests related to the defenses that the mortgagee lacked standing to foreclose; and that all mortgages on the property had been satisfied before Property Owner acquired the property.

 

Property Owner requested all documents in the entire chain of assignments since origination of the subject loan.  The trial court granted discovery of documents evidencing the mortgagee's acquisition of the subject note. 

 

Property Owner also requested internal bank documents relating to the recorded satisfactions of the subject mortgage.  The mortgagee objected on privacy grounds to producing the internal documents, and the trial court granted limited discovery of "correspondence, payments and documentation" regarding the satisfactions.

 

Property Owner filed a petition for writ of certiorari before the District Court of Appeal of Florida, First District.

 

As you may recall, certiorari is appropriate only "when a discovery order departs from the essential requirements of law, causing material injury to a petitioner throughout the remainder of the proceedings below and effectively leaving no adequate remedy on appeal."  Allstate Ins. Co. v. Langston, 655 So. 2d 91, 94 (Fla. 1995).  The requirement of material, irreparable harm is jurisdictional, and a court must dismiss the petition if it is not met.  See Bd. of Trs. of Internal Improvement Trust Fund v. Am. Educ. Enters., LLC, 99 So. 3d 450, 454-44 (Fla. 2012).

 

The Appellate Court noted that it has "adhered to the view that orders having the effect of denying discovery are almost invariably not reviewable by certiorari because of the absence of irreparable harm."  Boyd v. Pheo, Inc., 665 So. 2d 294, 295 (Fla. 1st DCA 1995).  For denial of discovery to constitute material, irreparable harm, the denial must "effectively eviscerate[] a party's claim, defense, or counterclaim." Giacalone v. Hellen Ellis Mem'l Hosp. Found., Inc., 8 So. 3d 1232, 1234 (Fla. 2d DCA 2009).

 

Next, the Appellate Court considered Property Owner's requested standing discovery.  The Appellate Court noted that the trial court granted discovery of documents evidencing the mortgagee's acquisition of the subject note.  Because standing to foreclose required only proof that the foreclosing party held the note when it filed the action, proof of prior assignments was unnecessary.  See Keifert v. Nationstar Mortg. LLC, 153 So. 3d 351, 352-53 (Fla. 1st DCA 2014). 

 

Although the Appellate Court noted that some of the other documents Property Owner requested could be relevant to the standing defense, the lack of these additional documents did not effectively eviscerate the standing defense because standing is based on the possession of the note and not the chain of ownership.

 

Next, the Appellate Court considered Property Owner's proposed discovery as to a possible satisfaction of the mortgage.  The Appellate Court noted that the mortgagee had objected on privacy grounds to producing internal documents and therefore could not use such documents against Property Owner.  See Alterra Healthcare Corp. v. Estate of Shelley, 827 So. 2d 936, 947-48 (Fla. 2002).  However, the trial court granted discovery of "correspondence payments and documentation" regarding the satisfactions.  Thus, although some of the other documents Property Owner requested could be relevant to the satisfaction defense, the lack of the internal memoranda did not effectively eviscerate the defense of satisfaction.

 

Accordingly, the Appellate Court concluded that Property Owner failed to demonstrate material harm not remedial on appeal, and dismissed Property Owner's Petition for Writ of Certiorari for lack of jurisdiction.

 

 

 

 

Ralph T. Wutscher
Maurice Wutscher LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct:  (312) 551-9320
Fax: (312) 284-4751

Mobile:  (312) 493-0874
Email: rwutscher@MauriceWutscher.com

 

Admitted to practice law in Illinois

 

 

 

California   |   Florida   |   Illinois   |   Indiana   |   Massachusetts   |   New Jersey   |   New York   |   Ohio   |   Pennsylvania   |   Texas   |   Washington, DC

 

 

NOTICE: We do not send unsolicited emails. If you received this email in error, or if you wish to be removed from our update distribution list, please simply reply to this email and state your intention. Thank you.

Our updates and webinar presentations are available on the internet, in searchable format, at:

 

Financial Services Law Updates

 

and

 

The Consumer Financial Services Blog™

 

and

 

Webinars

 

and

 

California Finance Law Developments

 

and

 

Insurance Recovery Services

 

 

 

 

FYI: 9th Cir Holds "Chapter 20" Debtor May Void Mortgage In Chpt 13 After Obtaining Discharge in Chpt 7 Bankruptcy

The U.S. Court of Appeals for the Ninth Circuit, in a case of first impression, recently held that section 1328(f) of the Bankruptcy Abuse Prevention and Consumer Protection Act ("BAPCPA"), which bars so-called "Chapter 20" debtors from receiving a discharge at the conclusion of their Chapter 13 reorganization if they received a Chapter 7 discharge within four years of filing the petition for Chapter 13 relief, does not prevent a debtor from voiding a secured creditor's lien under section 506(d) of the Bankruptcy Code.

 

A copy of the opinion is available at:  http://cdn.ca9.uscourts.gov/datastore/opinions/2015/10/01/13-35354.pdf

 

In 2007, husband and wife debtors filed for bankruptcy protection under Chapter 7 of the Bankruptcy Code. They received a discharge of their unsecured debts in 2009. The next day after receiving the discharge, the debtors filed a second bankruptcy proceeding under Chapter 13 of the Code, seeking to restructure the debt on their primary residence.

 

There were two mortgages on the unit. The first mortgagee filed a proof of claim, to which the debtors objected on the basis that the mortgagee failed to attach a copy of the promissory note to its proof claim.

 

The mortgagee failed to respond to the debtors' objection to its proof of claim.  In November of 2009, the bankruptcy judge entered an order disallowing the claim.

 

In April of 2010, the debtors filed an adversary proceeding, seeking to void the first mortgagee's lien pursuant to section 506(d) of the Bankruptcy Code, which provides that "[t]o the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such claim is void."

 

The bankruptcy court held a hearing the following month, at which it advised the first mortgagee that it needed to address the disallowance order. Despite this, almost 18 months passed before the first mortgagee filed a motion for reconsideration of the disallowance order. Finding no legal basis excusing the delay, the bankruptcy court denied the motion to reconsider the disallowance order.

 

The debtors moved for summary judgment in the adversary proceeding. The first mortgagee responded, arguing that it would be improper and unfair to void its lien due to a mere failure to respond, relying upon the Seventh Circuit's decision in In re Tarnow, 749, F.2d 464 (7th Cir. 1984), which held that because a secured creditor is not required to file a proof of claim at all and may rely on its lien for payment of the debt, voidance of the lien under section 506(d) is a "disproportionately severe sanction" for a late-filed claim.

 

After a hearing, the bankruptcy court ruled that despite the case law standing for the proposition that a secured creditor need not participate in a Chapter 13 case without imperiling its lien, the text of Bankruptcy Code section 506(d) provides that a lien securing a disallowed claim can be avoided.  he court distinguished Tarnow, reasoning that it involved a late-filed claim, while in the case at bar, the first mortgagee filed a timely claim, which was then disallowed. It then ordered that upon debtors' completing the Chapter 13 plan, the first mortgagee's deed of trust would be void and cancelled.

 

The Chapter 13 case proceeded to the plan confirmation stage, with the bankruptcy court ultimately approving the debtors' eleventh amended plan in April of 2012. The confirmed plan voided the first-position lien, but reinstated the second-position lien.

 

The first mortgagee appealed to the U.S. District Court for the Western District of Washington, which affirmed the bankruptcy court's orders, reasoning that it lacked jurisdiction over the disallowance order and the order denying reconsideration because the first mortgagee did not timely appeal those orders. The district court also denied the debtors' request for attorney's fees.

 

The first mortgagee then appealed the district court's order affirming the bankruptcy court's order permanently voiding its lien to the Ninth Circuit. The debtors cross-appealed the denial of their request for fees.

 

Several months after filing the appeal, the debtors completed their Chapter 13 plan. Before the closure of the case and consequent permanent voiding of the first mortgagees lien, the first mortgagee moved for an emergency stay of the bankruptcy court's order closing the case, which the Ninth Circuit granted pending the outcome of the appeal.

 

On appeal, the Ninth Circuit first addressed a question of first impression -- i.e., whether the bankruptcy court properly voided the first mortgagee's lien under section 506(d) of the Bankruptcy Code.

 

After analyzing the statutory text, the Court concluded that "[t]he most straightforward reading of the text suggests that if a creditor's claim has not been 'allowed' in the bankruptcy proceeding, then 'such lien is void.'"  In so ruling, the Ninth Circuit noted that Congress, by enacting section 506(d), made clear that its "manifest purpose is to nullify a creditor's legal rights in a debtor's property if the creditor's claim is 'not allowed,' or disallowed."

 

The Court reasoned that the Supreme Court's decision in Dewsnup v. Timm, 502 U.S. 410 (1992), which held that a Chapter 7 debtor could not void an under-secured lien because the claim had been fully "allowed" under section 502, supported its interpretation of section 506(d).

 

The Ninth Circuit noted that "Dewsnup's holding clarifies that § 506(d)'s voidance mechanism turns on claim allowance," and that "section 506(d) does not void liens on the basis of whether they are secured under section 506(a), but on the basis of whether the underlying claim is allowed or disallowed."  The Court concluded that  because the first mortgagee's "claim was disallowed, § 506(d) leaves [it] with 'a claim against the debtor that is not an allowed secured claim,' and therefore its lien is void."

 

The Court then considered the novel "Chapter 20" question of whether the lien would be resurrected upon completion of the Chapter 13 plan or was permanently voided.

 

The Court pointed out that in 2005, Congress enacted BAPCPA in part "to correct perceived abuses of the bankruptcy  system … [and] provide greater protections for creditors … [including] reforms 'prohibiting abusive serial filings and extending the period between successive discharges." One of these new provisions is § 1328(f), which prohibits the bankruptcy court from granting a discharge of the debts included in a Chapter 13 plan "if the debtor has received a discharge in a case filed under chapter 7, 11, or 12 … during the 4-year period preceding the date of the order for relief …."

 

The Court noted that whether debtors who are ineligible for a discharge under § 1328(f) of BAPCPA can permanently void a lien has divided courts within the Ninth Circuit, and that the two other courts of appeals and three bankruptcy appellate panels that have addressed the question have all concluded that so-called "Chapter 20 debtors may void liens irrespective of their eligibility for a discharge."

 

The Court rejected, as resting upon a "fatal flaw," the first mortgagee's argument that because the debtors were ineligible for a discharge under § 1328(f), their case must either be converted to a Chapter 7 liquidation or dismissed "for cause," both of which would resurrect the lien that was voided under § 506(d).

 

The fatal flaw was that the language relied upon by the borrowers and lower courts in the Ninth Circuit's earlier decision in In re Leavitt, 171 F.3d 1219 (9th Cir. 1999), that a Chapter 13 case could end only through a "discharge pursuant § 1328, conversion to a Chapter 7 case pursuant to § 1307(c) or dismissal of a Chapter 13 case 'for cause' under § 1307(c)" was dictum. The Court explained that "Leavitt imposed no 'rule' that a Chapter 13 case must end in conversion, dismissal, or discharge, and the Bankruptcy Code is devoid of any such requirement."

 

By way of example, the Ninth Circuit pointed out that the Bankruptcy Code "contemplates closure of a case pursuant to § 350(a), which provides that '[a]fter an estate is fully administered and the court has discharged the trustee, the court shall close the case.' With closure, no conversion, dismissal, or discharge is necessary."

 

The Court reasoned that "[f]undamentally, a discharge is neither effective nor necessary to void a lien or otherwise impair a creditor's state-law right of foreclosure" because a discharge only enjoins a creditor from collecting a debt personally against the debtor and does not affect an otherwise valid, pre-petition lien. It follows logically that there is no reason to make the Bankruptcy Code's in rem modification or voidance provisions contingent upon a debtor's eligibility for a discharge, when discharges do not affect in rem rights."

 

Thus, the Ninth Circuit joined the Fourth and Eleventh Circuits "in concluding that Chapter 20 debtors may permanently void liens upon the successful completion of their confirmed Chapter 13 plan irrespective of their eligibility to obtain a discharge…" holding that the debtors' "ineligibility for a discharge does not prohibit them from permanently voiding [the first mortgagee's] lien."

 

The Court next turned to whether the voiding of the first mortgagee's lien violated the bank's right to due process. The first mortgagee argued that Federal Rule of Bankruptcy Procedure 7001(2) "requires actions determining the 'validity, priority, or extent of a lien' to be brought in an adversary proceeding, which imposes certain notice requirements on plaintiffs." Although the debtors did file an adversary proceeding and moved for summary judgment seeking to void the first mortgagee's lien, the first mortgagee argued that the lien was actually voided by the earlier disallowance order. In addition, the debtors never mentioned that they intended to void the lien in their 2009 objection to the first mortgagee's proof of claim.

 

The Court rejected both arguments, relying upon the Supreme Court's decision in United Student Aid Funds, Inc. v. Espinosa, 559 U.S. 260 (2010), which held that a student loan creditor's due process rights were not violated because it received actual notice of the debtor's proposed Chapter 13 plan, which provided for repayment of the principal but discharge of the accrued interest, and the creditor filed a proof of claim reflecting both, but failed to object to the proposed plan's discharge of interest or the debtor's failure to bring an adversary proceeding to determine the debt's dischargeability.

 

The Ninth Circuit reasoned that under Espinosa, once the first mortgagee received notice of the debtors' objection to its proof of claim, "it was deemed to have notice that its claim might be affected and it ignored the ensuing proceedings to its peril." The district court's ruling that the bankruptcy court afforded the first mortgagee due process was affirmed.

 

Finally, the Court addressed whether the bankruptcy court erred in ruling that debtors' Chapter 13 petition was filed in good faith. It began by explaining that "[a] Chapter 13 petition may be dismissed "for cause," pursuant to § 1307(c) of the Bankruptcy Code, if it was filed in bad faith."

 

Citing its decision in Leavitt, which set out 4 factors that a bankruptcy court must consider as part of the "totality of the circumstances" in determining whether a debtor acted in good faith, the Court rejected the first mortgagee's argument that the Chapter 13 petition was filed in bad faith because it was filed while the earlier Chapter 7 case was still technically open in order to stop the state court foreclosure action.

 

Although the Ninth Circuit had previously held that successive filings did not constitute bad faith per se, it had never addressed whether simultaneous filings should be treated differently.

 

Rejecting the per se rule adopted by the Seventh Circuit, the Court agreed with the Eleventh Circuit's more flexible "fact-sensitive good faith inquiry" test in In re Saylors, 869 F.2d 1434 (11th Cir. 1989),which "concluded that a per se rule against filing a Chapter 13 proceeding while a Chapter 7 case remained open (although the discharge had been issued) 'would conflict with the purpose of Congress in adopting and designing chapter 13 plans.'" The Court reasoned that "[b]ecause nothing in the Bankruptcy Code prohibits debtors from seeking the benefits of Chapter 13 reorganization in the wake of a Chapter 7 discharge, we see no reason to force debtors to wait until the Chapter 7 case has administratively closed before filing for relief under Chapter 13."

 

The Ninth Circuit concluded that "the bankruptcy court did not err in finding that the petition and plan were filed in good faith."

 

The bankruptcy court's order voiding the lien, the order confirming the plan and the order implementing the plan were affirmed.

 

As to the debtors' cross-appeal on the issue of attorney's fees, the Court held that "the district court lacked jurisdiction to determine whether the [debtors] were entitled to attorneys' fees because this issue was not addressed, in the first instance, by the bankruptcy court," vacated the district court's denial of fees and instructed the district court to remand the matter to the bankruptcy court to determine whether the debtors were entitled to attorney's fees.

 

 

 

Ralph T. Wutscher
Maurice Wutscher LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct:  (312) 551-9320
Fax: (312) 284-4751

Mobile:  (312) 493-0874
Email: rwutscher@MauriceWutscher.com

 

Admitted to practice law in Illinois

 

 

 

California   |   Florida   |   Illinois   |   Indiana   |   Massachusetts   |   New Jersey   |   New York   |   Ohio   |   Pennsylvania   |   Texas   |   Washington, DC

 

 

NOTICE: We do not send unsolicited emails. If you received this email in error, or if you wish to be removed from our update distribution list, please simply reply to this email and state your intention. Thank you.

Our updates and webinar presentations are available on the internet, in searchable format, at:

 

Financial Services Law Updates

 

and

 

The Consumer Financial Services Blog™

 

and

 

Webinars

 

and

 

California Finance Law Developments

 

and

 

Insurance Recovery Services