4th Cir. Holds Allegations of Verbal Notice of Bankruptcy Sufficient to State Claim for Willful Violation of Automatic Stay; Debtor Can Bring Suit in District Court

In Houck v. Substitute Trustee Services, Inc., et al., the United States Court of Appeals for the Fourth Circuit determined that a debtor alleged a plausible claim under 11 U.S.C. § 362(k), so as to survive a motion to dismiss, against a foreclosure trustee (the Substitute Trustee) for willful violation of the automatic stay where she alleged the trustee sold her homestead at a foreclosure sale after her fiancé had called to verbally notify them of her bankruptcy filing.  Rejecting the trustee’s argument that a willful violation required written notice, the Court explained that Section 362(k) “does not include any provision that a particular form of notice be given. Rather, it imposes liability for a willful violation of the automatic stay.”  Op. at 29.

A copy of the opinion is available here. 

In Houck, the Debtor filed a Chapter 11 bankruptcy petition, which stayed the North Carolina foreclosure proceedings filed against her.  A few weeks later, the bankruptcy court dismissed the bankruptcy petition, because the Debtor failed to file the requisite bankruptcy schedules.  Less than 180 days after dismissal, a subsequent sale was scheduled.  Prior to the sale, Debtor filed a second bankruptcy petition.  Debtor claimed that, on the same day, her fiancé called the Substitute Trustee’s lawyers to notify the firm of the bankruptcy filing, spoke with an employee who acknowledged they had a file for the Debtor, and provided the case number for the bankruptcy proceeding to the employee.  Debtor also claimed her fiancé called the lender to inform it of the bankruptcy filing as well, who indicated that it would wait for notice from the bankruptcy court before taking any action.

Nevertheless, two days later, the bankruptcy court ordered Debtor to show cause why her petition should not be dismissed.  Another two days later, the Substitute Trustee sold the homestead at a foreclosure sale.  Thereafter, the following day the bankruptcy court dismissed the second bankruptcy petition.

Debtor filed an action in the federal district court asserting a claim for a willful violation of the automatic stay under § 362(k) of the Bankruptcy Code, which provides in pertinent part, “an individual injured by any willful violation of a stay provided by this section shall recover actual damages, including costs and attorneys’ fees, and, in appropriate circumstances, may recover punitive damages.”  11 U.S.C. §362(k)(1).

The district court dismissed the claims against the Substitute Trustee, determining that Debtor failed to allege that the Substitute Trustee was aware of the bankruptcy petition at the time it conducted the foreclosure sale, concluding that Debtor had “failed to allege that [she] sent notice of the second petition to [the Substitute Trustee] or that [the Substitute Trustee] had any notice of the [bankruptcy] petition.”  Op. at 6.  The Court also granted the lender’s motion to dismiss for lack of subject matter jurisdiction, which argued that Debtor’s § 362(k) claim could not be adjudicated outside of the bankruptcy court.  Id.  On appeal, the Fourth Circuit reversed.

As an initial matter, the Court rejected the argument the Debtor’s claim should have been brought in the bankruptcy court rather than the district court, holding that “the district court had subject matter jurisdiction over Houck’s § 362(k) claim and therefore that the court had authority to rule on the Substitute Trustee’s motion to dismiss Houck’s claims against it, . . . .”  Op. at 22.

The Court explained that a claim under 11 U.S.C. § 362(k) “creates a cause of action for an individual injured by a violation of the automatic stay imposed by § 362(a). To recover under § 362(k), a plaintiff must show (1) that the defendant violated the stay imposed by § 362(a), (2) that the violation was willful, and (3) that the plaintiff was injured by the violation. See, e.g., Garden v. Cent. Neb. Hous. Corp., 719 F.3d 899, 906 (8th Cir. 2013).” Op. at 24-25.

Disagreeing with district court, the Fourth Circuit determined that “the complaint adequately alleged that the Substitute Trustee had notice of Houck’s second bankruptcy petition and that Houck sustained injury as a result of the violation.” Op. at 25.  Notably, Debtor had alleged that she had noticed the lender in her bankruptcy petition itself, that her fiancé called both the Substitute Trustee and the lender, that the lender received notice through PACER, and that defendants “were noticed of the second petition the same way they were under notice of the first petition.” Op. at 27.  

The Court rejected the Substitute Trustee’s argument that it could not have willfully violated the automatic stay because it did not have written notice before it sold the homestead, noting that the requirements of § 362(k) “[do] not include any provision that a particular form of notice be given. Rather, it imposes liability for a willful violation of the automatic stay.”  Op. at 29.

The Court also determined that the complaint alleged injuries, noting that the Complaint alleged that Debtor and her fiancé were forced to move from the homestead to a smaller cabin, they suffered certain enumerated losses relating the loss of income from the property, loss of the use and possession of the property, as well as emotional injury. 

Finally, the Court rejected the trustee’s argument that no stay was in effect under 11 U.S.C. § 362(b)(21)(A) because the debtor was an “ineligible debtor” pursuant 11 U.S.C. § 109(g)(1), which bars an individual from being a bankruptcy debtor where a prior bankruptcy had been dismissed within 180 days of a subsequent bankruptcy petition and “the case was dismissed for willful failure of the debtor to abide by orders of the court, or to appear before the court in proper prosecution of the case; . . .”  Id.  The Court noted that neither the Substitute Trustee nor the record established that the Debtor had willfully failed to abide by the bankruptcy court’s order, and such determination “is a fact bound question that requires evidentiary support.”  Op. at 32.

Accordingly, the Fourth Circuit vacated the dismissal of the complaint, and remanded the case to the district court for further proceedings.

U.S. Supreme Court holds Chapter 7 Bankruptcy Debtor Cannot Strip Down a Wholly Underwater Lien

In Bank of America, N.A. v. Caulkett, the U.S. Supreme Court reversed an Eleventh Circuit decision that permitted a junior lien to be “stripped down” or voided under Section 506(d) of the Bankruptcy Code because it was wholly underwater.  In doing, so, the Court reaffirmed its holding in Dewsnup v. Timm, 502 U.S. 410 (1992), which defined the term ‘secured claim’ in §506(d) to mean “a claim supported by a security interest in property, regardless of whether the value of that property would be sufficient to cover the claim.”  Slip Op at 4.

Consequently, the Court held that, so long as a claim is supported by a security interest in property, then it is not subject to being “stripped down” or voided under Section 506(d) of the Bankruptcy Code “regardless of whether the value of that property would be sufficient to cover the claim.”  Slip Op at 4.

A copy of the opinion is available here.

In Caulkett, the Court considered two consolidated cases on appeal, each of which involved debtors (“Debtors”) who had a primary and secondary mortgage lien on their respective homes.  The Bank held the junior mortgage lien on each house.  The Debtors each filed for Chapter 7 bankruptcy.  By that time, however, the amount owed under the senior mortgage was greater than each home’s current market value, meaning that the Bank would receive nothing under the junior mortgage lien if the respective property were sold at foreclosure.

The Debtors each moved to “strip off” or void the junior mortgage lien under Section 506(d) of the Bankruptcy Code.  That statute provides that a lien is void “[t]o the extent that a lien secures a claim against the debtor that is not an allowed secured claim.”  Slip Op. at 2 (citing 11 U. S. C. § 506(d)).  The bankruptcy court granted the Debtors respective motions, and both the District Court and the Court of Appeals for the Eleventh Circuit agreed.  Granting certiorari, the U.S. Supreme Court reversed.

The Court noted that, although the parties agreed that BANA’s claim is “allowed” as defined under 11 U. S. C. § 502(a)-(b), at issue was whether BANA’s allowed claims were “secured.”  See Op. at 3.  The Court acknowledged that a strict reading of the applicable statutes “suggests” that BANA’s lien is not “secured.”  Notably, under Section 506(a)(1), “[a]n allowed claim of a creditor secured by a lien on property . . . is a secured claim to the extent of the value of such creditor’s interest in . . . such property,” and “an unsecured claim to the extent that the value of such creditor’s interest . . . is less than the amount of such allowed claim.”  Op. at 3 (citing 11 U. S. C. § 506(a)(1)).

However, the Court determined that its interpretation of the term “secured claim” in Dewsnup v. Timm, 502 U.S. 410 (1992), was controlling, which would include BANA’s junior mortgage liens.  In Dewsnup, the Court defined the term ‘secured claim’ in §506(d) to mean “a claim supported by a security interest in property, regardless of whether the value of that property would be sufficient to cover the claim.”  Slip Op at 4.

Thus, in Dewsnup, the Court had rejected a Chapter 7 debtor’s argument seeking to “strip down” (or reduce) a partially underwater lien to the value of the collateral under Section 506(d).  Notably, in Dewsnup, the debtor asserted that the creditor’s claim was “secured only to the extent of the judicially determined value of the real property on which the lien [wa]s fixed.”  Op. at 3-4 (citing Dewsnup, 502 U.S. at 414).  In rejecting such argument, the Dewsnup Court determined that if a claim “has been ‘allowed’ pursuant to § 502 of the Code and is secured by a lien with recourse to the underlying collateral, it does not come within the scope of § 506(d).”  Op. at 4 (citing Dewsnup, 502 U.S. at 415).  Consequently, under Dewsnup’s interpretation of an “allowed secured claim,” the Court concluded that BANA’s liens could not be voided.

Although Debtors sought to limit the Dewsnup interpretation to apply only to partially underwater liens, rather than wholly underwater liens, the Supreme Court refused to adopt such a distinction.  See Op. at 5.  The Court explained that such proposition would leave an “odd statutory framework . . . [where] if a court valued the collateral at one dollar more than the amount of a senior lien, the debtor could not strip down a junior lien under Dewsnup, but if it valued the property at one dollar less, the debtor could strip off the entire junior lien.”  Slip Op. at 6-7.

Accordingly, the U.S. Supreme Court reversed the judgment of the Eleventh Circuit, and remanded the cases for further proceedings.