On an issue were the courts are divided, the Sixth Circuit Bankruptcy Appellate Panel adopted the approach of the First Circuit in holding that a mortgage foreclosure deficiency judgment can be avoided under Section 522(f)(1) as an impairment of an exemption.
Before bankruptcy, the debtor’s home mortgage lender got a judgment of foreclosure and obtained a deficiency judgment. The chapter 7 debtor claimed a homestead exemption and moved under Section 522(f)(1) to avoid the deficiency judgment lien as an impairment on her exemption.
The bankruptcy court refused to avoid the deficiency judgment lien, saying it was specifically prohibited by Section 522(f)(2)(C). That provision says, “This paragraph shall not apply to a judgment arising out of a mortgage foreclosure.”
The debtor appealed to the BAP and won in a June 20 opinion by Chief Bankruptcy Judge Tracey N. Wise of Lexington, Ky.
Judge Wise framed the question as whether a deficiency judgment is a “judgment arising out of a mortgage foreclosure.” She said that the “overwhelming majority of courts” hold that a mortgage deficiency judgment does not fall under subsection (f)(2)(C). Indeed, she found only two bankruptcy courts that would not avoid mortgage deficiency judgments.
The majority courts differ on how they reach the result. Many rely on state law, for instance, by saying that a deficiency judgment results from a legal proceeding that is separate from the equitable suit to foreclose.
Judge Wise elected to follow the First Circuit, which held that using state law is “inappropriate” because Section 522(f)(2)(C) is “unambiguous.” She quoted the Boston appeals courts for saying that subsection (C) simply “‘clarifi[es] that the entry of a foreclosure judgment does not convert the underlying consensual mortgage into a judicial lien which may be avoided.’”
The First Circuit said that Congress used subsection (C) to “contrast” mortgage foreclosure judgments from other types of liens that are avoidable under subsection (f)(1).
The placement of subsection (C) is also significant. If Congress had intended to make judicial liens from mortgage deficiencies unavoidable, it would have included the exception in subsection (f)(1)(A) alongside liens for domestic support obligations that cannot be avoided. Instead, the reference to mortgages is in subsection (f)(2)(C), pertaining to the calculation of the amount of the impairment.