A chapter 7 debtor walked away with $80,000 of surplus proceeds in his pocket from the sale of his home without using a homestead exemption. How could that happen, and why was it upheld on appeal?
The answer is simple: The debtor was entitled to profit from a mortgage lender’s mistake.
The debtor owned real property that he scheduled as being worth $360,000 and encumbered by two mortgages totaling almost $620,000. When the holder of the second mortgage won a modification of the automatic stay to permit foreclosure, the trustee secured an order abandoning the property.
On foreclosure of the second mortgage, the property brought in $320,000, generating $80,000 in surplus proceeds after paying the second mortgage. Because the holder of the first mortgage had not filed an answer in the foreclosure, it was entitled to no sale proceeds. After intervention by the chapter 7 trustee, the foreclosure court directed that the surplus proceeds be turned over to the trustee.
Back in bankruptcy court, the trustee sought to administer the surplus proceeds for the benefit of creditors. The trustee contended that he had abandoned only the property, not the proceeds.
The bankruptcy court ruled that the surplus was not estate property following abandonment. District Judge James L. Graham of Columbus, Ohio, affirmed the bankruptcy court in a March 16 opinion.
To the argument that the trustee had not abandoned proceeds because proceeds didn’t exist, Judge Graham said that estate property includes property and proceeds of property, under Section 541(a)(6).
Judge Graham then cited Sixth Circuit authority for the proposition that abandonment is irrevocable and that a trustee cannot reassert control if it turns out that property has greater value than previously believed.
Although the opinion does not say so, the debtor evidently could keep the $80,000 because his personal liability for the first mortgage debt would have been discharged.