A secured creditor with a nonrecourse mortgage cannot assert a deficiency claim under Section 1111(b) if the property is foreclosed during the owner’s bankruptcy, the Ninth Circuit held on April 20.
Section 1111(b)(1)(A) provides, in pertinent part, that a “claim secured by a lien on property of the estate” will be allowed as though “the holder of such claim had recourse against the debtor” unless “such holder does not have such recourse and such property is sold under Section 363 of this title or is to be sold under the plan.” [Emphasis added.]
The lender had a second, nonrecourse mortgage on the debtor’s property. In the chapter 7 case, the senior lender won a modification of the automatic stay and proceeded to foreclose, generating enough to pay off the first mortgage with about $150,000 left for the holder of the second mortgage.
The holder of the second mortgage filed an unsecured claim for its $300,000 deficiency. The junior lender had not objected to the stay modification.
The bankruptcy court expunged the claim and was upheld by the Bankruptcy Appellate Panel.
Affirming the BAP, Circuit Judge Mary M. Schroeder framed the question as “whether the creditor continues to have a right of recourse after there has been a non-judicial foreclosure, so that the property is no longer part of the estate and the liens have been extinguished.”
The junior lender contended that Section 502 requires the court to determine the amount of the claim on the filing date, when the lender had the right of a recourse creditor by virtue of Section 1111(b). Judge Schroeder disagreed, finding the answer in the plain language of the statute.
Although there were no appeals court cases on point, Judge Schroeder cited decisions from the Fifth and Seventh Circuits leading to the conclusion that recourse rights are lost on foreclosure.
In the opinion of Judge Schroeder, the “plain language of Section 1111(b) mandates that it cannot apply if the lien does not exist.” She said that the junior lender got “exactly what he bargained for in the non-bankruptcy context”: the inability to pursue a deficiency against the property owner if its lien were foreclosed.
Broadly stating the holding beyond the facts of the case, Judge Schroeder said, “if a creditor’s claim, for any reason, ceases to be secured by a lien on property of the estate, the creditor can no longer transform a non-recourse claim into a recourse claim.”