The Surrender of Collateral in Bankruptcy: What Does “Surrender” Really Mean? Part I

It is not uncommon for debtors in a chapter 7 case to express their intent to surrender collateral in their statement of intention. In chapter 13 cases, debtors may propose in their plan that they will surrender collateral. In either case, there are instances when a debtor actively defends a state foreclosure action after either receiving a discharge or surrendering the property. This article will address the question of whether such debtor has the right to take action to oppose the foreclosure of the collateral it has purportedly surrendered.

Applicable Law

Bankruptcy Code § 521(a)(2) provides that the debtor must file a written statement regarding secured collateral indicating that he or she will either redeem, reaffirm or surrender it. Section 1325 provides the requirements for confirming a plan. With respect to secured claims, if the debtor is unable to comply with § 1325(a)(5)(A) or (B), then § 1325(a)(5)(C) provides that “the debtor surrenders the property securing such claim to such holder….”

Although “surrender” is not defined in the Code, this definition has been widely accepted:

[S]urrender, at a minimum, requires a debtor to relinquish secured property and make it available to the secured creditor … i.e., not taking an overt act to prevent the secured creditor from foreclosing its interest in the secured property.[1]

Prevailing View

Thus, debtor’s counsel beware: A new foreclosure theory has emerged in Florida forging a rather harsh majority view that when a debtor elects to surrender property in his bankruptcy schedules, he is, in effect, relinquishing rights to defend against a foreclosure action. A proposal before the Florida legislature to amend Fla. Stat. 702 to this effect did not pass, but a majority of bankruptcy judges in Florida do not agree with the legislature.

In reviewing the history of § 521, only one case in the Eleventh Circuit remotely sets a precedent, In re Taylor, which dates back to 1993.[2] In Taylor, the issue was whether a debtor could retain real property without redeeming or reaffirming the debt securing the property — allowing the debtor to “ride through” the bankruptcy. The court found that this was not permissible because it allowed a debtor to be released from all personal liability on the debt while retaining the collateral so long as the debtor remained current on the loan. While the Taylor court prohibits a “ride-through,” it suggests the alternate option that a debtor can surrender the property. Unfortunately, the Taylor court doesn’t provide guidance on the ramifications of electing to surrender. However, a majority of recent rulings have made it clear that a debtor may not elect to surrender property as a strategy to effectuate a “ride-through.”

Recent cases interpreting the meaning of “surrender” state that a debtor who schedules the surrender of property in a Statement of Financial Affairs or a chapter 13 plan is not required to deed the property back to the lender or otherwise deliver physical possession of the property until a foreclosure judgment has been obtained.[3] In In re Plummer, the court found that surrender is not tantamount to foreclosure. A lender must still go through the legally mandated process of foreclosing on property and may not seek fees and costs for that foreclosure on the grounds that the debtor failed to sign over a deed as part of his obligation to surrender. The bankruptcy judges in Florida are in agreement with this proposition; however, a majority split prescribes that a debtor who elects to surrender property on his bankruptcy schedules must not simultaneously act inconsistently with that stated intention, and is therefore prohibited from defending the lender’s foreclosure action.[4]

The rationale for these decisions stems from the concept that a debtor who (1) admits the validity of a debt, (2) represents that the collateral is to be surrendered to receive a discharge of the underlying debt, and (3) receives the benefit of the wildcard exemption, but actually has a different agenda, is not only in violation of 11 U.S.C. § 521(a)(2)(B), which requires a debtor to perform his intentions within 30 days after the § 341(a) meeting of creditors, but more significantly is committing a fraud on the court.[5] Almost all the case law suggests that the court will direct the debtor to withdraw any defenses in the foreclosure action under the threat of sanctions, revoking confirmation and/or revoking a discharge.

In In re Burnett Jr.,[6] the court found that a debtor who chose to surrender property but defended a subsequent foreclosure action obtained the discharge by fraud. Consequently, the court revoked the discharge. In Meltzer, the debtor was in the midst of a chapter 13 case. After a finding that the debtor failed to comply with his stated intentions under § 1325 by defending a foreclosure, the court revoked the debtor’s confirmation order.[7] A debtor may also be subject to sanctions for engaging in this behavior.[8] Similar facts were at issue in In re Fallia and In re Trout, where Judge Hyman and Judge Kimball ordered that if the debtors did not cease efforts to defend the pending foreclosures, the debtors would be subject to sanctions and a withdrawal of discharge for noncompliance.

Likewise, in In re Lapeyre,[9] the debtors provided for the surrender of property in their chapter 13 plan but submitted affirmative defenses and counterclaims to the state court in the foreclosure action. Judge Mark declined the lender’s argument that the debtors were barred by judicial estoppel, because that is an issue for state court. However, the judge found authority under the confirmed plan to order debtors to dismiss their defenses and counterclaims in the foreclosure action.

In Florida, many chapter 13 debtors attempt to modify their mortgage under the Mortgage Modification Mediation Program (MMM) rather than cure their mortgage arrears or surrender the property. However, if the MMM fails, the debtor is now required to modify the plan to set forth either a cure of arrears or surrender of the property.[10] In Calzadilla and Espinosa, Judge Mark found that after an unsuccessful MMM attempt, amending the plan to provide for relief from stay was not sufficient to meet the requirements of § 1325; a debtor must stipulate to surrender and relinquish their right to contest the foreclosure (absent an ability to confirm a plan that provides for the cure or mortgage arrears).

Debtor’s counsel may not be able to rely on laches as a viable defense for a debtor in this situation. A particularly “grim” decision was handed down in In re Grimm when Judge Briskman granted a motion to compel surrender five years after the case was closed.[11] The judge threatened that the case would be reopened and the discharge revoked if the debtor did not comply with the motion to compel surrender and cease defending the foreclosure action.

 Luckily, it is not all doom and gloom for debtors. In In re Guerra,[12] a lender who came back three years after discharge was denied an order reopening the case to compel surrender. While the Guerra court found that it could revoke the debtor’s discharge and order the debtor to withdraw its defenses to the foreclosure, it declined to do so. The court found that the debtor did not intend to perpetuate a fraud as a substantial amount of time had passed from when the debtor stated her intent to surrender to when she resisted foreclosure. It is interesting to note that the debtor was successful in getting her state court foreclosure action dismissed in that case.

Further, good counsel with some creative thought (and the right facts) may be able to escape some of the tough consequences of these rulings and afford some protection to debtors. In In re Townsend, the chapter 13 was filed in 2008.[13] The debtor opposed foreclosure in 2014, one year after obtaining a chapter 13 discharge. The lender relied on Metzler and Fallia in seeking a motion to compel surrender. However, there was a significant factual distinction in Townsend: The plan proposed to surrender the property but had additional language, stating, “[N]othing herein is intended … to abrogate Debtor’s state law contract rights.”[14] Since the debtors reserved their state law rights in a confirmed plan, the court could not find that the debtors acted inconsistently with the confirmed plan. Further, while Judge Delano concurred with the rationale in Meztler, Plummer and Fallia, she did not believe that those rulings should be applied retroactively.

Minority View

While the Florida line of cases in particular supports the argument that a debtor’s declaration in bankruptcy to surrender is more than just lip service, a few cases call into question the conclusion of those courts holding that surrender necessarily stops a debtor from continuing to defend a state foreclosure action.

In In re Elkouby, when the debtor filed his chapter 7 petition, he was involved in a foreclosure action brought by the lienholder.[15] The debtor’s statement of intention indicated that he planned to surrender the property involved. The debtor received his discharge having never turned over the property, and continued to defend the foreclosure litigation. In response, the lienholder filed a motion to reopen the case and to compel the debtor to surrender, arguing that the debtor’s defense was barred by his stated intention to surrender. The debtor countered that “surrender” only required him to surrender to the trustee, and since the trustee did not administer the property, it was abandoned back to the debtor. Consequently, he should not be precluded from defending the foreclosure action. Rejecting the analysis in In re Failla, the court accepted the debtor’s abandonment argument:

In fact, there is no Bankruptcy Code section that provides that if a chapter 7 trustee doesn’t administer surrendered real property what follows is a second surrender — surrender to the lienholder. Rather, what the Bankruptcy Code specifically provides is that what follows is the property is abandoned to the debtor.[16]

The court concluded that it did not need to determine whether and to what extent surrender to a lienholder requires a debtor to relinquish defenses to foreclosure since the debtor’s surrender in this case was to the trustee, not the lienholder. The motion to reopen and compel surrender was denied.

Two other recent cases challenge automatic surrender to the secured creditor in this context. More than five years after the chapter 7 case was closed, the creditor in In re Kourogenis sought an order reopening the case to compel the surrender of real property, as the debtor had agreed to do in her statement of intention, and barring the debtor from contesting the state foreclosure action.[17] The court ruled that the creditor had slept on its rights and barred the relief requested based on the defense of laches. Additionally, the court noted the distinction between “surrender” and “foreclosure”: “Whatever the meaning of ‘surrender’ under Section 521, it cannot possibly mean that a party who, for instance, does not own the note and mortgage can nonetheless foreclose on the property, without the Debtor being heard, solely because the Debtor indicated an intent to surrender.”[18]

In In re Trussel, the chapter 7 debtor filed a statement of intention indicating that he planned to reaffirm the debt secured by real property, but the parties were unable to reach a reaffirmation agreement.[19] After the debtor received his discharge, the secured creditor continued its previous foreclosure action in state court and the debtor asserted affirmative defenses in that action. The creditor filed a motion with the bankruptcy court to compel the debtor to stop defending the foreclosure action, arguing that he must surrender the property because he did not carry out his intent to reaffirm the debt. The court first observed that stay relief was the best remedy for § 521(a) violations rather than compelling surrender. It also concluded that “[t]rying to avoid responding to legitimate defenses does not constitute sufficient compelling cause to obtain the extraordinary remedy of an injunction.”[20] The creditor’s motion was denied.

To conclude, bankruptcy attorneys and debtors alike should be warned that manipulating the system by making unintended statements on the bankruptcy schedules, obtaining a discharge of personal liability and then fighting a foreclosure is not well tolerated in Florida. Specific facts, reservations in the plan and the schedules may lead to varying results, but until the Eleventh Circuit or Supreme Court rules on these matters, one should proceed with caution.