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.

D.C. Circuit Holds Lender Entitled to Equitable Subrogration Despite Its Actual Knowledge That Co-Owner Refused To Sign Mortgage

In Smith v. First American Title Insurance Company, the U.S. Court of Appeals for the District of Columbia held that, under D.C. law, a lender (New Lender) was entitled to equitable subrogation for amounts paid off by its loan against a co-owner’s (Co-Owner) interest in property jointly owned with Borrower, even though New Lender had actual knowledge that Co-Owner had refused to sign its refinance loan documents.  Consequently, equitable subrogation enabled New Lender to assert the same rights against Co-Owner and Borrower’s house that their prior lender held under the paid-off mortgage.  See Op. at 3.

A copy of the opinion is available here.

Background

Co-Owner and his mother, Borrower, jointly owned a house in the District of Columbia, which was subject to a $115,000 mortgage bearing a 6.5% interest rate (the “Prior Mortgage”), which they both signed.  Thereafter, a new lender (“New Lender”) offered Borrower a $135,000 mortgage, with a 9.65% interest rate (the “New Mortgage”), which allowed for Borrower to obtain $6,000 in cash at settlement.  Co-Owner refused to sign the paperwork because he thought the rate was too high. 

Nevertheless, New Lender proceeded to make the loan without Co-Owner’s signature on the New Mortgage, and such loan was used to satisfy and release the Prior Mortgage.  The Court noted that, technically, although the New Mortgage gave New Lender rights to Borrower’s half-interest in the Property, it did not give New Lender any rights to Co-Owner’s half-interest in the Property.  “As a result, without paying a cent, [Co-Owner] ended up with a half-interest in the house free of both the [Prior] Mortgage and the [New] Mortgage” Op. at 3.

Borrower later declared bankruptcy.  Because New Lender could not foreclose against the Property as a whole, New Lender filed suit in Bankruptcy Court seeking equitable subrogation against Co-Owner’s interest, which was permitted by the Bankruptcy Court and District Court.  Co-Owner and Borrower thereafter appealed to the U.S. Court of Appeals for the D.C. Circuit, which affirmed the application of equitable subrogation. 

Discussion

“The doctrine of equitable subrogation permits courts to declare that the owner of a mortgage (New Lender) has the same rights as an earlier-in-time owner of another mortgage (Prior Lender) on the same property, if certain conditions are met.  The purpose of equitable subrogation is ‘to prevent forfeiture and unjust enrichment.’”  Op. at 3 (citing Eastern Savings Bank, FSB v. Pappas, 829 A.2d 953, 957 (D.C. 2003) (internal quotation marks omitted)).

Under D.C. law, New Lender is entitled to equitable subrogation if it meets each prong of a five-part test: (1) New Lender paid off the Prior Mortgage to protect New Lender’s “own interest”; (2) New Lender has not “acted as a volunteer”; (3) New Lender “was not primarily liable” for the Prior Mortgage; (4) New Lender paid off the entire Prior Mortgage; and (5) subrogation would “not work any injustice to the rights of others.” Id. at 4-5 (quoting Eastern Savings Bank, FSB v. Pappas, 829 A.2d 953, 961 (D.C. 2003) (internal quotation marks omitted)).

The Court of Appeals determined that the first four prongs of the test for equitable subrogation were straightforward.  See Op. at 5.  As to the fifth prong, the Court concluded that equitable subrogation would not work an injustice.  “To begin with, equitable subrogation does not in any way affect [Borrower]’s rights. And equitable subrogation likewise does not work an injustice on [Co-Owner]. The Bankruptcy Court held that [New Lender] is entitled to equitable subrogation on the same terms as the [Prior Mortgage]. So, [Co-Owner] is obligated to [New Lender] only for the balance of the [Prior Mortgage], and only at the lower interest rate of the [Prior Mortgage].  Equitable subrogation simply prevents [Co-Owner] from enjoying a windfall.  It does not work an injustice because it makes him no worse off than he would have been under the [Prior Mortgage] had [Borrower] never agreed to the mortgage with [New Lender].” Op. at 5-6 (citations omitted).

Although the Court acknowledged that “[u]nder D.C. law, it is unsettled whether ‘actual knowledge bars equitable subrogation,’” Op. at 6, it predicted that the D.C. Court of Appeals (i.e., the state court) would allow for its application, noting that that the D.C. Court “endorsed an approach in which ‘no attention should be paid to technicalities which are not of an insuperable character, but the broad equities should always be sought out so far as possible. . . .,”  and therefore adopted a “rule requiring liberal application of the doctrine of subrogation.” Op. at 7 (quoting Burgoon v. Lavezzo, 92 F.2d 726 (D.C. Cir. 1937)).  Further, the federal appellate court noted that the D.C. Court of Appeals looks to the Restatement for guidance on questions of law involving equitable subrogation, which “has adopted the more liberal approach to equitable subrogation, under which actual knowledge does not bar application of the doctrine.” Op. at 7-8 (citing Restatement (Third) of Property: Mortgages § 7.6 cmt. e (1997)).

Moreover, the Court noted that “[i]n Burgoon, the court determined that equitable subrogation was appropriate because the lender could have achieved the same result by taking an assignment of the original loan.”  Op. at 8 (citing Burgoon, 92 F.2d at 736).  Likewise, here, “[i]nstead of taking out a new mortgage on the house, New Lender could have asked [Prior Lender] to assign [the Prior Mortgage [ to [New Lender]. Through assignment, [New Lender] would have obtained [Prior Lender]’s rights to [Co-Owner]’s half-interest in the house.” Op. at 8.

Consequently, the Court determined that New Lender was entitled to equitable subrogation under D.C. law.

Va. Supreme Ct. Holds After-Acquired Property Statute Does Not Affect Priority Of Third Parties; Prior Recorded Deed Of Trust Not “Duly Admitted To Record” Where Outside Chain Of Title

In Deutsche Bank National Trust Company v. Arrington, a priority dispute concerning real property, the Supreme Court of Virginia held that the after-acquired property statute, which validated prior conveyances where the grantor subsequently obtains an interest in property, “only applies between the parties to a deed and does not affect the rights of third parties or influence the relative priority of their interests.” Op. at 12.  The Court further held that a bank whose deed of trust was recorded first, but was made by a grantor outside the chain of title, was not “duly admitted to record” and therefore was not entitled to priority against lien creditors.

A copy of the opinion is available here.

In Arrington, the Court considered a priority dispute between a Bank’s deed of trust, and a subsequently recorded deed of trust in favor of the borrower’s former spouse (Wife) to secure payments as part of a contempt order.  Specifically, a divorce decree provided that certain property held by the couple would be conveyed solely to Husband, and that Husband would make several payments over time to Wife for ten years.  Following the entry of this divorce decree, in 2004, Wife conveyed her interest by deed of gift to Husband, which was recorded in the land records.

The following year, in 2005, Husband conveyed the Property to Third Party by general warranty deed, which was also recorded in the land records.  Despite such conveyance, which had divested Husband of record title, in 2006, Husband executed a deed of trust in favor of Bank, which was also recorded in the land records. 

Thereafter, in 2009, because he had fallen behind in his payments to Wife as provided in the divorce decree, to purge his contempt, the court required Husband to execute a deed of trust in favor of Wife (“Wife’s Deed of Trust”), which was recorded in the land records to secure repayment of amounts referenced in the divorce decree.

Prior to Wife’s recording her deed of trust, Third-Party executed a general warranty deed re-conveying the property back to Husband, which was recorded in the land records.   Immediately thereafter, Wife’s Deed of Trust was recorded, together with a copy of the divorce decree and contempt order.  

Bank filed a complaint seeking a declaration that the Bank Deed of Trust was a valid first priority lien on the Property.  In response, Wife filed an answer requesting a declaration that Wife’s Deed of Trust was a valid first priority lien.  Upon cross-motions for summary judgment, the trial court held that Wife’s Deed of Trust enjoyed priority, because when she recorded her deed of trust, Husband was the record owner of the property, whereas when the Bank recorded its deed of trust, Third Party was the record owner of the property.  The trial court also held that the after-acquired property statute, Virginia Code § 55-52, could not elevate the Bank Deed of Trust in priority over Wife’s Deed of Trust.  On appeal, the Supreme Court of Virginia affirmed.

The Court rejected the Bank’s argument that it held priority once Husband was re-vested with the property from Third Party under the after-acquired property statute.  The Court held that the statute itself was limited by its terms to the grantor and grantee, i.e., Husband and the Bank.  Specifically, the statute, Virginia Code § 55-52, provides:

When a deed purports to convey property, real or personal, describing it with reasonable certainty, which the grantor does not own at the time of the execution of the deed, but subsequently acquires, such deed shall, as between the parties thereto, have the same effect as if the title which the grantor subsequently acquires were vested in him at the time of the execution of such deed and thereby conveyed.

Id.  (Emphases added).

Determining that the statute applied not only to deeds, but also to deeds of trust, see Op. at 7, the Court explained, “[r]ead in its entirety, Code § 55-52 provides that when a grantor purports to convey property — without holding title — to a grantee, the grantor cannot thereafter deny that title has actually passed to the grantee. . . . Code § 55-52 governs the rights of a grantee vis-à-vis the grantor. It does not purport to affect the deeds of third parties, in this instance [Wife], or influence the relative priority of their interests.” Op. at 5-6. 

The Court thereafter determined the priorities of the parties based upon the recording act, Virginia Code § 55-96, which provides:

Every (i) such contract in writing, (ii) deed conveying any such estate or term, (iii) deed of gift, or deed of trust, or mortgage conveying real estate . . . shall be void as to all purchasers for valuable consideration without notice not parties thereto and lien creditors, until and except from the time it is duly admitted to record in the county or city wherein the property embraced in such contract, deed, or bill of sale may be.

Id.  Under the Recording Act, the Court explained, the “[Bank] Deed of Trust does not impair [Wife’s] priority if she is either (1) a purchaser for valuable consideration without notice or (2) a lien creditor, and the [Bank] Deed of Trust was not ‘duly admitted to record’ before she qualified as either. If she is a lien creditor and the [Bank] Deed of Trust has not been ‘duly admitted to record,’ then it is irrelevant whether she had notice of Bank's interest.” Op. at 8-9.

After easily determining Wife to be a lien creditor under her deed of trust, see Op. at 10-11, the Court determined that the Bank Deed of Trust was void as to Wife, because it was not “duly admitted to record” as it was recorded prior to Husband holding record title.  Op. at 12.  “Because the [Bank] Deed of Trust was not properly recorded in the chain of title, it was not ‘duly admitted to record’ even though it was recorded before [Wife] acquired her interest. Finally, because [Wife] is a lien creditor, whether she had actual or constructive notice of the [Bank] Deed of Trust is irrelevant. See Code § 55-96(A)(1). Therefore, [Wife] qualifies as a lien creditor under Code § 55-96(A)(1), and as a result, the [Wife] Deed of Trust has priority over the [Bank] Deed of Trust.”  Id.

Accordingly, the Supreme Court affirmed, concluding that the Wife’s deed of trust was entitled to priority.