Friday, August 3, 2018

FYI: 6th Cir Holds BK Debtor's Challenge to Mortgage Not Barred by Rooker-Feldman

The U.S. Court of Appeals for the Sixth Circuit recently held that a debtor's claim seeking to use a bankruptcy trustee's § 544(a) strong-arm power to avoid a mortgage on the ground that it was never perfected did not require appellate review of the state court foreclosure judgment, and therefore was not barred by the Rooker-Feldman doctrine.

 

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

 

In 2003, the debtor ("Debtor") and her husband took out a home-equity loan secured by a mortgage on their home in Kentucky.  The original mortgagee did not immediately record the mortgage, and while the mortgage remained unrecorded, the Debtor and her husband filed a Chapter 7 bankruptcy.

 

While the bankruptcy was pending, the mortgagee recorded the mortgage in violation of the automatic stay, although the issue was never raised.  The loan was not reaffirmed, and the bankruptcy court entered a discharge order.

 

A decade later, the new owner of the mortgage loan sought to foreclose the Debtor's home in Kentucky state court.  On August 22, 2014, the state court entered an in rem judgment of foreclosure, and ordered a foreclosure sale.  The foreclosure sale was scheduled for September 30, 2014, but one day before the sale, the Debtor filed a voluntary Chapter 13 petition.

 

The Debtor then filed an adversary complaint against the new mortgagee ("Mortgagee") seeking to avoid the mortgage through the so-called "strong arm" power conferred by 11 U.S.C. § 544(a), which permits the bankruptcy trustee to "avoid transfers of the property that would be avoidable by certain hypothetical parties." 

 

Specifically, the Debtor sought to use the strong-arm power to avoid the mortgage on the ground that it was never properly perfected because it was recorded in violation of the automatic stay, and actions taken to perfect a lien are "invalid" if they violate the automatic stay.  The parties filed cross-motions for summary judgment, which were initially denied. 

 

In a renewed motion for summary judgment, the Debtor presented an "alternate argument" that the mortgage lien never attached in the first place, and thus the Mortgagee had no valid lien to enforce.  In support, the Debtor argued that the mortgage contained conflicting language about when its lien would attach to the collateral. One section could be read to mean the mortgage lien attached when the mortgage was signed, while another section could be reach to mean that the lien would not attach until it was recorded. 

 

Based on the latter section, the Debtor argued that the lien could not attach until it was recorded, and that because it was not recorded before the Chapter 7 bankruptcy was filed, and because the recording during the bankruptcy was invalid, the mortgage remained unattached and the unsecured debt was discharged in 2004. 

 

In response, the Mortgagee argued that the lien attached when the Debtor signed the mortgage, and that the bankruptcy court lacked jurisdiction under the Rooker-Feldman doctrine because the Debtor was effectively asking the bankruptcy court to sit as an appellate court over the state court's final foreclosure judgment.

 

The bankruptcy court granted summary judgment in favor of the Debtor, concluding that the mortgage agreement unambiguously did not attach until it was recorded.  The bankruptcy court also rejected the Mortgagee's Rooker-Feldman argument based on the Sixth Circuit decision in Hamilton v. Herr (In re Hamilton), 540 F.3d 367 (6th Cir. 2008), which recognized a narrow exception to Rooker-Feldman under which a federal bankruptcy court may determine whether a state-court decision correctly interpreted a prior bankruptcy discharge order.

 

The matter was appealed to the Bankruptcy Appellate Panel ("BAP"), which reversed.  The BAP concluded that the mortgage agreement was unambiguous, but in the opposite way.  That is, the BAP held that the mortgage unambiguously provided that its lien attached when the parties signed it.  Thus, the BAP ruled that the state court's judgment was not void ab initio under In re Hamilton because it correctly construed the discharge order, and therefore the BAP held that Rooker-Feldman deprived the bankruptcy court of subject matter jurisdiction. 

 

The matter was then appealed to the Sixth Circuit.

 

On appeal, the Sixth Circuit first noted that "[t]o determine whether the Rooker-Feldman doctrine bars this action, we must distinguish between [the Debtor's] two different claims." 

 

The first claim sought "to avoid the mortgage on the ground that its lien never attached, that [the Mortgagee] therefore lacks an enforceable mortgage altogether, and that the Kentucky court wrongly enforced it."  The second claim sought "to use the trustee's § 544(a) strong-arm power to avoid the mortgage on the ground that it was never perfected, regardless of whether the Kentucky court properly acted when it did."

The Sixth Circuit concluded that the Rooker-Feldman doctrine barred the first claim but not the second.

 

In so ruling, the Court noted that the first claim was barred because where "the source of the injury is the state court decision," then Rooker-Feldman applies.  As the Debtor's requested relief sought a "declaration that the . . . mortgage is unenforceable and that the court order foreclosing said mortgage, entered by the [Kentucky state court] be declared unenforceable," the "request effectively asks the bankruptcy court to vacate the state-court judgment, and thus it clearly identifies the state-court judgment as the source of [the Debtor's] injury."  Accordingly, the Rooker-Feldman doctrine applied.

 

Moreover, the Sixth Circuit ruled that the In re Hamilton doctrine did not apply, because it was only created to reconcile Rooker-Feldman with the protection for debtors provided by section 524(a), but 524(a) only protects debtors from being personally liable for discharged debts. 

 

"When a debtor forecloses on a lien, the debtor's personal liability is not at stake, and therefore § 524(a) does not come into the picture."  Thus, Hamilton did not apply as the state court only entered an in rem judgment of foreclosure.

 

However, the Sixth Circuit held that the Debtor's second claim, which sought "to use the trustee's § 544(a) strong-arm power to avoid the mortgage on the ground that it was never perfected," was not barred by Rooker-Feldman because it did "not require federal appellate review of the state court's judgment."

 

Instead, "the bankruptcy court could hold for [the Debtor] on this claim without finding any error in the state court's judgment whatsoever," because the state-court foreclosure judgment determined only that the mortgage debt "is secured by a certain mortgage," which "constitutes a valid second mortgage upon the real estate."  It did not make any findings with regard to perfection.  

 

"No Rooker-Feldman problem is presented, then, because the bankruptcy court need not review the state court's judgment at all." 

 

However, "[n]either the bankruptcy court nor the BAP passed on that claim, and the parties have not focused on its merits in their briefing before this court."  Therefore, the matter was remanded for further proceedings.

 

 

 

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

 

 

 

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Monday, July 30, 2018

FYI: 8th Cir Rejects Arguments That Collecting Interest Not Allowed Under State Law Did Not Violate FDCPA

The U.S. Court of Appeals for the Eighth Circuit recently held that seeking to collect compound interest in violation of state usury law results in a misrepresentation of the amount of a debt in material violation of the federal Fair Debt Collection Practices Act, 15 U.S.C. 1692, et seq. ("FDCPA").

 

In so ruling, the Eighth Circuit reversed and remanded the trial court's judgment against the consumer, in part, as to his claims for alleged violation of the FDCPA based on a letter that sought to collect compound interest on the subject debt, in violation of Minnesota's usury statute.

 

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

 

A consumer cardholder ("consumer") received a letter from a law firm ("law firm") regarding credit card debt in his name, and asserting that the consumer owed an "account balance of $17,230.29 consist[ing] of the principal balance of $13,205.30 and interest of $3,871.39 at the rate of 6.00% plus incurred costs of $153.60" (the "debt-collection letter").  Two additional letters were sent on behalf of the debt's current owner by another debt collection entity, but these letters were not at issue.

 

The consumer filed a putative class action lawsuit against the law firm, as well as a non-law firm debt collector and the owner of the debt, alleging violations of subsections § 1692e and § 1692f of the FDCPA for using "false, deceptive, or misleading representation or means" and "unfair or unconscionable means" in attempting to collect interest on the debt's principal balance not authorized by the underlying card agreement not permissible under Minnesota law.  See Minn. Stat. § 334.01(1) ("[i]n the computation of interest upon any . . . instrument or agreement, interest shall not be compounded" unless the parties have contracted for compound interest).

 

The law firm, debt collector, and debt owner moved to dismiss the amended complaint for failure to state a claim, which was granted on the grounds that the consumer failed to allege that any statement in the letters "was not only false but materially so."  The trial court denied the consumer's request for leave to file a motion for reconsider, holding that the letters' representations "regarding interest were either not material or did not violate the FDCPA."  This appeal followed.

 

The only issue considered on appeal was whether the law firm violated 15 U.S.C. 1692e and 1692f by attempting to collect, and representing plaintiff owed, compound interest on the debt in violation of Minn. Stat. 334.01.

 

Though the parties initially disputed in the lower court whether the "unsophisticated consumer" or "competent lawyer" standard should apply to the collection letter at issue, due to the fact that the consumer is a licensed attorney, the law firm chose not to contest the trial court's holding that the unsophisticated consumer standard applies, and thus the allegations were evaluated under this standard on appeal. 

 

The Eighth Circuit first examined the consumer's allegations that he did not agree to pay compound interest on the debt, and that the debt's principal balance already contained contractual interest.  

 

The trial court agreed that an unpaid credit-card debt sold to another party would include "the interest and fees [the credit-card company] originally charged." Because neither party contested this ruling on appeal, the Eighth Circuit concluded that the consumer plausibly alleged that the principal balance mentioned in the debt-collection letter included contractual interest.  See Haney v. Portfolio Recovery Assocs., L.L.C., 837 F.3d 918, 921, 924 (8th Cir. 2016) (per curiam).

 

In reviewing the debt-collection letter's assertion that the consumer owed "interest of $3,871.39 at the rate of 6.00% on "the principal balance of $13,205.30," the Eighth Circuit calculated this amount to be consistent with amounts that would have accrued on the principal balance from the date the credit card company sold the debt (April 14, 2011, according to the debt-collection letter) to the date of the debt collection letter (February 26, 2016). 

 

The Court reasoned that if the principal balance already included contractual interest, that the debt collection letter sought to collect interest on contractual interest.  Thus, the Eighth Circuit held, the consumer's amended complaint plausibly alleged that the law firm attempted to collect, and told him he owed, an amount and type of interest not permitted under state law.  See Minn. Stat. § 334.01(1);  Lampert Lumber Co. v. Ram Constr., 413 N.W.2d 878, 883 (Minn. Ct. App. 1987) ("[i]n the computation of interest upon any . . . instrument or agreement, interest shall not be compounded" unless there is a "contract to pay [such] interest.").

 

In Haney v. Portfolio Recovery Assocs., LLC, the Eighth Circuit previously held that under the unsophisticated-consumer standard, a debtor's allegations that a debt-collection letter sought to collect "an interest-on-interest amount not allowed as a matter of state law," stated valid claims under sections 1692e and 1692f of the FDCPA, but did not address whether attempts to collect a debt amount that the debtor does not legally constituted material violations of those subsections.  Haney  at 931-932. 

 

The Eighth Circuit since established that a materiality standard applies to 1692e (Hill v. Accounts Receivable Servs., LLC, 888 F.3d 343, 346 (8th Cir. 2018)), but had not yet clarified whether the standard applies to 1692f.  However, the Court did not address the issue here, because "an attempt to collect a debt not owed is a material violation of 1692f(1)."  Demarais v. Gurstel Cargo, P.A., 869 F.3d 685, 699 (8th Cir. 2017).

 

Here, the Eighth Circuit held that a false representation of the amount of debt that overstates what is owed under state law materially violates section 1692e(2)(A) as well. 

 

The Court found that the representation not only violates the plain language of the statute prohibiting the "false representation" of the "amount" of "any debt," but also because an overstatement of the debt's amount necessarily misleads the debtor about the amount he owes under his agreement with the creditor. See Hill, 888 F.3d at 345–46; cf. Demarais, 869 F.3d at 699. 

 

Although the Eighth Circuit did not outright reject the law firm's argument that the debt collection letter did not violate the FDCPA because the amount of interest stated in its letter was contractually authorized, at the pleading stage, it must accept the consumer's allegations that he did not agree to be charged compound interest and so may not be charged it.  See Minn. Stat. § 334.01(1). 

 

Moreover, the Court declined to consider the law firm's argument that a debt collector may try to collect compound interest (which state law does not allow) without materially violating the FDCPA so long as the total amount of interest sought does not exceed the maximum amount permitted under the debtor's contract, as neither of the lower court's orders support its contention that requesting less interest than the amount owed does not materially violate the FDCPA.

 

Lastly, the Eighth Circuit rejected the law firm's claims at oral argument that the trial court noted that the debt collection letter was not, in fact, a collection letter, as the trial court did not make that observation, and could not do so at the pleading stage, as doing so would conflict not only with the allegations of the amended complaint, but the plain language on the face of the debt collection letter that it "is from a debt collector and is an attempt to collect a debt."

 

Accordingly, the Eighth Circuit concluded that the trial court erred in holding that the debt-collection letter's assertion that the consumer owed, and attempts to collect, compound interest in violation of Minn. Stat. § 334.01 did not state a plausible claim under §§ 1692e and 1692f.  The Appellate Court therefore reversed the trial court's judgment only as to these claims against the law firm, and remanded for further proceedings.

 

 

 

 

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

 

 

 

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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.


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