Finding neither constitutional nor prudential standing to appeal, the Ninth Circuit permitted a chapter 7 trustee to sell a home out from underneath the debtors when the home was worth less than the encumbrances.
The issue presented to the Ninth Circuit has divided lower courts.
Some courts permit lenders to carve out a portion of their liens to pay administrative expenses and some portion of unsecured claims, in return for having the trustee sell the homestead.
Other courts, like a district court last year in New York, have held that a debtor is entitled to a homestead exemption in sale proceeds when the mortgage lender offers to buy the home and voluntarily takes a haircut designed to create an estate for unsecured creditors and the trustee’s commission. See Stark v. Pryor (In re Stark), 20-4766, 2022 BL 222985, 2022 US Dist. Lexis 114275 (E.D.N.Y. June 28, 2022). To read ABI’s report, click here.
In bankruptcy, the general rule is that courts don’t liquidate collateral for the benefit of secured creditors. When lenders construct a scheme to sell a home and avoid the rigors of foreclosure, notions of fairness suggest that the debtor should have standing to appeal, else the decision of the bankruptcy court is beyond review.
As described below, this writer submits that a factual presentation by a debtor might establish appellate standing.
The Short Sale
The Ninth Circuit’s unsigned, memorandum opinion on September 13 is short on the facts. The opinion only tells us that the home of the husband and wife was worth less than the liens. In reporting the Ninth Circuit Bankruptcy Appellate Panel’s opinion from June 17, 2022, we described the facts as follows:
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.
The BAP dismissed the debtors’ appeal, finding neither constitutional nor prudential standing, because reversing would pay nothing toward the debtors’ homestead exemption. Babaee v. Marshack (In re Babaee), 21-1230, 2022 BL 211184 (B.A.P. 9th Cir. June 17, 2022). To read ABI’s report on the BAP decision, click here.
The Circuit Affirmance on Standing
To no avail, the debtors appealed to the Ninth Circuit, which affirmed in a three-page, unsigned, nonprecedential opinion. Like the BAP, the panel held that the “Debtors do not have constitutional or prudential standing to challenge the lien assignments.”
Reciting the circuit’s precedent, the circuit panel said, “Constitutional standing requires an injury in fact that is caused by, or fairly traceable to, some conduct, and which the requested relief will likely redress.”
Prudential standing, a more rigorous standard, demands that the appellant be “a person aggrieved” who can demonstrate that she was directly and adversely affected pecuniarily.
The debtors argued that the impairment of their homestead exemption demonstrated injury in fact. The panel rebutted the argument by saying that there was no equity in the property, meaning that the debtors would not have received their exemption even if there were no agreement between the lenders and the trustee and the lenders had foreclosed.
Observations
When a bankruptcy court sells a home out from underneath the debtor in a short sale, no one will appeal aside from the debtor. Something seems amiss when the only conceivable appellant is held to lack appellate standing.
This writer suggests that debtor’s counsel in a similar situation should endeavor to establish injury in fact by filing an affidavit and requesting a hearing with witnesses when faced with a motion to dismiss the appeal for lack of appellate standing.
An affidavit and witnesses could show that lenders outside of bankruptcy are sometimes willing to forgo a portion of the recovery from foreclosure if the homeowner consents to foreclosure, thus enabling the lender to avoid the delay and expense inherent with foreclosure. If a homeowner might extract value from lienholders by stepping aside and permitting foreclosure outside of bankruptcy, an appellate court might reach the merits by finding injury in fact to establish appellate standing.
Finding neither constitutional nor prudential standing to appeal, the Ninth Circuit permitted a chapter 7 trustee to sell a home out from underneath the debtors when the home was worth less than the encumbrances.
The issue presented to the Ninth Circuit has divided lower courts.
Some courts permit lenders to carve out a portion of their liens to pay administrative expenses and some portion of unsecured claims, in return for having the trustee sell the homestead.