Much of bankruptcy law and practice seems mysterious. It is also ever-changing, as all law is. But as an almost inevitable component of mortgage servicing, understanding the process has considerable meaning. Bankruptcy law is a federal statute which controls throughout the states. Nonetheless, state courts do become involved in interpreting the bankruptcy statute as it relates to actions in state courts – such as mortgage foreclosure.
Of course, the mortgage servicing industry well recognizes that the filing of a petition in bankruptcy imposes an automatic stay upon a foreclosure action. But what if the debtor (the borrower) didn’t list the mortgage holder as a creditor in its filing (so that the mortgagee didn’t know about the bankruptcy)? This is a not uncommon event. And what if the resultant continuation of the foreclosure did not prejudice the debtor-borrower? Would those factors be sufficient for a state court where the foreclosure was pending to allow the foreclosure prosecuted during the stay to be valid? Yes, said a trial court in New York; no said the appeals court. [Carr v. McGriff, 8 A.D.3d 420, 781 N.Y.S.2d 34 (2d Dept.2004)].
From the viewpoint of a mortgage lender or servicer, the trial court opinion was welcome and seemingly reasonable. Why it was overturned on appeal, though, was understandable. The facts and applicable law tell the story and at the same time offer a helpful primer on the sometimes perplexing rules of bankruptcy as they relate to a defaulted mortgage.
Lender began a foreclosure (upon a second mortgage) on November 2, 1995. Borrower, a one-half owner of the property, was personally served a few days later but defaulted in the action and so the case proceeded eventually to issuance of a judgment of foreclosure and sale in September of 2001. What the foreclosing plaintiff never knew was that back in March, 1996 this very same borrower filed a chapter 13 petition, although that was dismissed in August, 1997. But a second Chapter 13 petition was filed in late October, 1997 with the plan confirmed and later completed, leading to a bankruptcy court discharge in November, 2002.
By February, 2003 the borrower moved in the foreclosure action to vacate the referee’s appointment, the computation and the judgment, all on the grounds that each issued in violation of the automatic stay provision in the Bankruptcy Code. In denying the borrower’s motion to vacate the various foreclosure stages, the state trial court concluded that the acts violative of the stay were not void, but merely voidable – an important distinction. It also ruled that continuation of the foreclosure during the stay imposed by bankruptcy filings did not prejudice the borrower and so should be allowed to stand.
In its reversal, these succinct points made by the appeals court highlight the applicable law.
While an action violative of a stay is void, power to then validate the action is given to the bankruptcy court itself ( but not the state court). As a matter of law, the foreclosure steps taken in state court were simply of no effect. The bankruptcy court could have ratified those, but it did not. State court in effect annulled the bankruptcy stay from the inception – a power it just did not have.
It may very well be that the borrower here suffered no prejudice by the foreclosure going forward even though a bankruptcy petition had been filed. And lenders could argue that a stay should not be imposed upon a lender who is never mentioned in the bankruptcy case and never given any notice whatsoever of the existence of a bankruptcy filing. This seems particularly valid because the uninformed lender is likely to spend much time and money endeavoring to enforce its rights blissfully unaware of any impediment to continuing. But case law is to the contrary.
Mr. Bergman, author of the four-volume treatise, Bergman on New York Mortgage Foreclosures, LexisNexis Matthew Bender (rev. 2017), is a partner with Berkman, Henoch, Peterson, Peddy & Fenchel, P.C. in Garden City, New York. He is also a member of the USFN, The American College of Real Estate Lawyers, The American College of Mortgage Attorneys, an adviser to the New York Times on foreclosure issues and writes a regular servicing column for the New York Law Journal. He is AV rated by Martindale-Hubbell, his biography appears in Who’s Who In American Law and he has been for years listed in Best Lawyers In America and New York Super Lawyers.