Case Summary: Failla v. Citibank, 542 BR 606 (S.D. Fla. 2015): The Consequences of Choosing to Surrender Property

Chapter 7 debtors who own real property need to understand their options, and the potential consequences of their choices.  In Failla v. Citibank, 542 B.R. 606 (S.D. Fla. 2015),[1] the court held that a debtor who states his or her intention to surrender under Section 521(a)(2) cannot defend a subsequent foreclosure. This case summary will review the court’s analysis, and how this decision may impact future cases.

Background

In Failla, the debtors had indicated they would surrender their real property in the initial statement of intention. At the time of the bankruptcy filing, the debtors had some equity in the property. Subsequently, the debtors decided they wanted to keep the property, and they filed an amended statement of intention to reaffirm the debt. However, the bankruptcy court determined the amended statement was untimely. The Chapter 7 trustee chose to abandon the property. After the bankruptcy discharge, the secured lien holder started foreclosure proceedings. The debtors fought the foreclosure.

Issues before the Bankruptcy Court

The lien holder filed a motion with the bankruptcy court requesting the debtors be compelled to surrender the property. The debtors claimed they intended to surrender the property to the Chapter 7 trustee, and not the secured creditor. When the Chapter 7 trustee abandoned the property and rejected the surrender offer, the debtors argued they still owned the property. The bankruptcy court had three issues to decide. First, the bankruptcy court needed to determine under the Code what actions or inactions are required by debtors to surrender the property. Next, the bankruptcy court had to decide if the debtors refuse to surrender, what remedies are available to the secured creditor under the Code, and, third, under § 521(a)(2)(B), the Court had to determine if a debtor is allowed to defend against a foreclosure action.

Bankruptcy Code § 521 outlines the debtor’s duties. Section 521(a)(2)(A) states that

within thirty days after the date of the filing of a petition under chapter 7 of this title or on or before the date of the meeting of creditors, whichever is earlier, or within such additional time as the court, for cause, within such period fixes, file with the clerk a statement of his intention with respect to the retention or surrender of such property and, if applicable, specifying that such property is claimed as exempt, that the debtor intends to redeem such property, or that the debtor intends to reaffirm debts secured by such property;

However, the Code does not define “surrender.” The bankruptcy court looked to In re Taylor[2] on how to apply § 521 in situations where a debtor will neither reaffirm nor redeem property, but wants to keep it. The Taylor court held that "allowing a debtor to retain property without reaffirming or redeeming gives the debtor not a "fresh start" but a "head start," since the debtor effectively converts a secured obligation from recourse to non-recourse with no downside risk for failing to maintain or insure the lender's collateral."[3] In Failla, the bankruptcy court warned the debtors they could lose their bankruptcy discharge if they did not surrender the property back to the secured creditor.

Issue on Appeal

The parties believed the key issue was “whether the bankruptcy court erred in finding that the duty to surrender is owed solely to the lienholder as opposed to another entity, such as the bankruptcy trustee.”[4]  However, the district court determined the critical issue was determining the “legal effect of the debtor’s decision to surrender the property.”[5]

The debtors relied on Lair[6] to support their argument that upon the Chapter 7 trustee’s decision to not accept the surrender and abandon the property, that the property then returns to the debtors. However, the district court found the debtors “misread the statement from the court relative to the restoration of rights that existed prepetition.”[7] The district court concluded the legal effect of the debtors’ decision to surrender the property meant they had relinquished their interest in the property against the secured creditor, and could not fight the foreclosure action. The court’s reasoning is in line with the Plummer court, which found the “the debtor cannot impede the creditor's efforts to take possession of its collateral by available legal means."[8]

Failla Impact
In Florida, the district court has made it quite clear that for a debtor to discharge a mortgage debt and fail to surrender the property per the statement of intention would be unfair to the secured creditor. Florida creditor attorneys will most likely be aggressive in asking the bankruptcy courts to compel debtors to surrender real property pursuant to the statement of intention. Florida debtor attorneys will need to advise their clients carefully about the ramifications of choosing to surrender real property when filing the statement of intention. Debtor attorneys in other jurisdictions should be aware of the recent Florida case law developments, and advise the clients that the choice to surrender a property in a Chapter 7 bankruptcy could prevent them from trying to save the property later. Failla is the first federal appellate court decision to address the issue of the legal impact of when a debtor declares his/her intention to surrender property. Another jurisdiction may reach a different holding, but debtor attorneys should be mindful of the Failla ruling when advising clients on whether to reaffirm, redeem or surrender property.