The appeals court in Chicago in substance told bankruptcy courts in the Seventh Circuit that they should refrain from deciding state law issues governing the enforceability of mortgages, and instead allow the questions to be fought out in state court foreclosure proceedings.
It remains to be seen whether the March 22 opinion will be interpreted more broadly as recommending that bankruptcy courts in chapter 11 cases should similarly deflect state law claims to state courts.
A woman filed a chapter 7 petition to halt foreclosure. In bankruptcy court, she filed an adversary proceeding designed to preclude the lender from foreclosing the mortgage. The lender filed a motion to modify the stay.
The debtor’s complaint had two prongs. One alleged that the assignments of the mortgage and the mortgage note to the lender were void under the pooling and servicing agreement, or PSA. The second prong contended that the note was void under Illinois law because it was in the name of the lender’s fictitious entity. Also under Illinois law, the complaint alleged that the lender was an unlicensed debt collector lacking authority to foreclose.
Addressing only the first prong, the bankruptcy court held under New York law governing the PSA that a mortgagor lacks standing to challenge the validity of assignments of the note and mortgage. The bankruptcy court dismissed the adversary proceeding and modified the stay without mentioning the second prong. The district court upheld the bankruptcy judge.
In the appeals court, Circuit Judge Kenneth F. Ripple held that the lower courts correctly interpreted New York law and properly dismissed claims regarding the PSA. But, he said, the lower courts did not address Illinois-based claims not related to the PSA. That was error and required remand.
The importance of the opinion does not appear until the penultimate paragraph. There, Judge Ripple notes that the bankruptcy court on remand could abstain from ruling on the Illinois-law claims “in the interest of comity with state courts” under 28 U.S.C. Section 1334(c)(1).
On remand, Judge Ripple said the bankruptcy court “ought to consider” abstaining so that the state court in the foreclosure proceeding could rule on Illinois-law claims.
Circuit Judge Richard A. Posner was on the panel.