Bankruptcy Judge C. Kathryn Preston of Columbus, Ohio, allowed a chapter 7 debtor to keep an $80,000 windfall resulting from a secured creditor’s mistake.
The debtor filed a chapter 13 petition, properly scheduling his home with a value of $360,000 encumbered by $618,000 in mortgages. He did not claim a homestead exemption.
The holder of the junior mortgage won a modification of the stay to permit foreclosure, and the trustee formally abandoned the property. The debtor converted the case to chapter 7 and got his discharge the same day as the foreclosure sale.
The holder of the first mortgage never answered the foreclosure complaint and thus waived its right to a distribution of sale proceeds. After paying off the second mortgage, there was an $80,000 surplus. The chapter 7 trustee reopened the bankruptcy case and sought a declaration that the $80,000 surplus belonged to the estate.
Judge Preston ruled against the trustee at every turn, allowing the bankrupt to retain the $80,000.
She held that the surplus was not property of the estate because the trustee had abandoned the home and thus the proceeds.
Unlike a chapter 13 case, where the debtor might have an obligation to amend his schedules, Judge Preston held that there is no “general ongoing obligation” to amend schedules “in the absence of an express provision in the Bankruptcy Code.” The proceeds were not among the types of after-acquired property that would come into the estate under Section 541(a)(5).
Judge Preston even went so far as to overrule the state foreclosure court, which had ruled that the trustee should take the surplus. She held that res judicata did not apply because the state court had not made a specific finding that the surplus was property of the estate. She also said the bankruptcy court had exclusive jurisdiction to determine what is property of the estate.
In short, the debtor owes an $80,000 debt of gratitude to Judge Preston.