The Ninth Circuit Bankruptcy Appellate Panel held in a nonprecedential opinion that consumer debtors in chapter 7 have neither constitutional nor prudential standing to appeal an order selling their overencumbered home.
Typically, trustees do not liquidate secured lenders’ collateral in chapter 7 when it is worth less than the debt. Although the procedural setting was atypical, the case before the BAP was a variation on the strategy used by secured creditors to liquidate their collateral by subordinating a portion of their claims to create a surplus that is mostly consumed by administrative creditors, leaving little or nothing for unsecured creditors or the debtors’ homestead exemption.
When considering the issues raised by this June 17 BAP opinion, keep in mind that the debtors would have had no recovery on their homestead exemption had their home been foreclosed at a price below the cumulative liens and mortgages. But also keep in mind that the subordinate lenders who cut a deal with the trustee might have been wiped out in foreclosure by senior lenders.
The Underwater Home
The debtors owned a home with a scheduled value of $2.9 million. They claimed a $175,000 California homestead exemption.
The home was subject to four mortgages totaling some $2,675,000. There was another $307,000 in tax and judgment liens, for total encumbrances of about $2,980,000. The first and second mortgages totaled about $1.8 million. The third and fourth mortgages were $875,000.
The holders of the third and fourth mortgages agreed with the trustee to subordinate a portion of their mortgages to the claims of the trustee, professionals, and general unsecured creditors.
The trustee estimated that the agreement (characterized as a settlement) would generate about $295,000 for the estate.
Separately, the trustee filed a motion to sell the property to a stalking horse bidder for $2,860,000, or less than the total encumbrances of $2,980,000. At the sale hearing, another bidder appeared, raised the bid, and won the auction at $2,880,000, an increase of $20,000 but still less than the encumbrances.
According to the BAP opinion, the trustee told the bankruptcy judge that the fee allowances to the trustee and counsel would be “adjusted, if necessary, to ensure a meaningful distribution to unsecured creditors.” The trustee said that the debtors would be paid about $46,000 toward their homestead exemption.
The debtors objected to both the settlement and the sale. Among other things, they contended that the trustee and counsel would be the primary beneficiaries of the sale and that the law disfavors the sale of fully encumbered property.
The bankruptcy court approved the settlement and the sale. Appealing but unable to obtain a stay pending appeal, the debtors moved out of their home. The trustee closed the sale, reporting that he was holding $225,000 after paying a tax lien. A BAP motions panel denied a motion by the trustee to dismiss the appeal as moot.
Appellate Jurisdiction
Conceding that the sale could not be set aside, the debtors argued on appeal that the BAP could modify the distribution of the sale proceeds. The BAP never reached the merits, finding no appellate standing.
The BAP analyzed whether the debtors had appellate standing as “persons aggrieved” by the settlement and sale. If the settlement were set aside, there would be no equity above the liens, leaving the debtors with no monetary benefit to show standing, the BAP said.
The debtors argued that they were affected pecuniarily because they were forced to relocate. Because the debtors had admitted that they could not set aside the sale, the BAP said that the settlement had no effect on them.
The BAP characterized another argument by the debtors:
[W]here a chapter 7 debtors’ homestead is apparently overencumbered, the opportunity to realize value through a creative transaction
“belongs” to the debtors, and that value should invariably flow to them via their resuscitated homestead exemption.
The BAP answered the argument by alluding to In re KVN Corp., 514 B.R. 1 (B.A.P. 9th Cir. 2014), where the BAP found “a rebuttable presumption of impropriety when a chapter 7 trustee seeks to sell overencumbered property subject to a carve-out agreement.” The panel said that KVN confirmed “the Trustee’s ability to structure and complete transactions like the ones utilized here” because KVN found “no per se bar on a trustee’s efforts to realize value for the estate in similar circumstances.”
“[E]ven more fundamentally,” the BAP said, giving standing to the debtors
would fundamentally alter the role of the Trustee, who is empowered by the Code to take control of estate assets and prioritize finding
value for creditors. Debtors fail to realize that, once they filed their chapter 7 case, they gave up their ability, i.e., their standing, to control
their property.
By filing a chapter 7 petition, the BAP said that the “Debtors took the risk that [the] Trustee might sell the Property, and they would be paid their homestead exemption only to the extent there were proceeds left over after payment of costs of sale and consensual liens.”
The BAP saw no constitutional standing because the settlement resulted in no injury in fact and no injury that would be redressed by reversal. The debtors similarly lacked prudential standing because “they are [not] directly and adversely affected pecuniarily by the orders on appeal,” the BAP said.
Holding that the debtors had neither constitutional nor prudential standing, the BAP dismissed the appeal.
The judges on the BAP panel were Bankruptcy Judges William J. Lafferty, Scott H. Gan and Laura S. Taylor. The memorandum opinion was unsigned.
Observations
Given the significance of the holding, this writer wonders why the panel made the opinion nonprecedential. Was the panel unsure of the holding? Did the panel intend on ensuring that bankruptcy judges and subsequent panels would feel free to hold otherwise?
Consider this: Did the facts of the case validate the debtors’ argument about an intrinsic, intangible value in removing owners from their homes without the ardors of foreclosure? The panel’s counterargument accurately describes the lenders’ legal rights but disregards the realities of foreclosure and litigation.
In the case on appeal, the third and fourth mortgagees realized some recovery in bankruptcy by taking voluntary haircuts. To realize the same recovery in foreclosure, they would have been required to protect the prior mortgages, pay taxes and insurance, and incur the risk that a sale price might not pay off their investments.
To realize a recovery without risk, the third and fourth mortgagees needed to pay someone. Should it have been the trustee or the debtors? Should principles of standing consider business realities or only theoretical legal rights? Would the debtors have been able to cut the same deal with the third and fourth mortgage holders and keep more proceeds for themselves in a short sale?
A home is a debtor’s most important asset, whether there is equity or not. Perhaps rules about standing should be more flexible when dealing with homesteads.
If there is no rationale for reviewing the merits of cases like this, short sales could become commonplace in bankruptcy, and debtors would be unable to appeal.
The Ninth Circuit Bankruptcy Appellate Panel held in a nonprecedential opinion that consumer debtors in chapter 7 have neither constitutional nor prudential standing to appeal an order selling their overencumbered home.
Typically, trustees do not liquidate secured lenders’ collateral in chapter 7 when it is worth less than the debt. Although the procedural setting was atypical, the case before the BAP was a variation on the strategy used by secured creditors to liquidate their collateral by subordinating a portion of their claims to create a surplus that is mostly consumed by administrative creditors, leaving little or nothing for unsecured creditors or the debtors’ homestead exemption.
When considering the issues raised by this June 17 BAP opinion, keep in mind that the debtors would have had no recovery on their homestead exemption had their home been foreclosed at a price below the cumulative liens and mortgages. But also keep in mind that the subordinate lenders who cut a deal with the trustee might have been wiped out in foreclosure by senior lenders.