Broad Scope, or Slippery Slope? Justification of Johnson

By Jeffrey Fraser

In Johnson v. Home State Bank,1 the U.S. Supreme Court rendered a seemingly benign ruling regarding the impact of a chapter 7 discharge on a mortgage claim, concluding that a chapter 13 reorganization is not categorically foreclosed to a debtor who previously filed for and received a chapter 7 discharge. Thus, the primary and, arguably, sole determination from Johnson was the authorization for the so-called “chapter 20”: a colloquial bankruptcy term referring to a debtor who first obtains a chapter 7 discharge and eliminates personal liability on a mortgage note, and subsequently files for chapter 13 seeking to cure arrearage in connection with the same mortgage. Through Johnson, the Supreme Court emphasized that Congress intended for claims in chapter 13 to be construed broadly.2 But just how broadly?

Courts have since pushed Johnson’s boundaries, leading to an increasingly expansive definition of what constitutes a “claim.” Nearly 35 years later, Johnson’s ruling has morphed into a decree that claims should not only be construed broadly, but also into a declaration that a prior contractual relationship with a creditor is not a prerequisite for a debtor to pay (or “treat”) such creditor’s claim in a bankruptcy plan. This article explores the apparent merging of personal liability with contractual privity; to what extent as a result of such merger a debtor not in contractual privity with a creditor has been permitted to pay such creditor’s claims through a bankruptcy plan; and why this has created a slippery slope as it relates to expanding the concept of a “claim.”

The Majority Approach: “No Privity, No Problem”

The facts of Johnson are straightforward and relatively common. Curtis Johnson entered into a mortgage relationship to secure promissory notes payable to Home State Bank. He defaulted on the notes, Home State initiated foreclosure, and — to halt the process — Johnson filed for chapter 7, eventually receiving a discharge. Thereafter, Home State reinitiated its foreclosure, obtained judgment and scheduled a foreclosure sale. Johnson filed another bankruptcy case — this time a chapter 13 proposing to cure the mortgage arrears. Johnson firmly established that a debtor could address a surviving mortgage lien in a chapter 13 case, after a chapter 7 discharge. Notwithstanding this narrow holding, courts (old and new) have expanded Johnson’s scope, creating the “majority approach,” which allows for the inclusion of claims in bankruptcy plans that lack contractual privity.

An early champion of the “broad claim cause” is Matter of Hutcherson.3 In Hutcherson, the court concluded that the objecting bank held a “claim” against the debtor’s estate, even though no “privity of contract” ever existed between it and the debtor, who inherited interest in the property following her mother’s death. The Hutcherson court eschewed the bank’s argument that Johnson should be limited to its unique facts and only govern the resolution of cases involving mortgagors who follow a chapter 7 case with one under chapter 13.4 Instead, the Hutcherson court focused/relied on the Supreme Court’s description of “nonrecourse” obligations:

Insofar as Congress did not expressly limit § 102(2) to nonrecourse loans but rather chose general language broad enough to encompass such obligations, we understand Congress’s intent to be that § 102(2) extends to all interests having the relevant attributes of nonrecourse obligations regardless of how these interests come into existence.5

While the Hutcherson court conceded that the facts before it and the facts of Johnson did not arrive at their common controversy through the same chain of events, the court still determined that it was bound by Johnson on the premise that nonrecourse obligations fall within the definition of a claim, and “[t]hus ‘claimholder’ status presumptively forms a condition precedent to a creditor’s mandatory participation in the Debtor’s plan.”6

In re Stevenson7 recently found the existence of a claim whereby the debtor, who inherited real property from a relative, sought to cure the relative’s mortgage arrears through a chapter 13 plan, pursuant to § 1322(b)(2). Although the Stevenson debtor was not the original mortgagor (similar to the Hutcherson debtor), the Stevenson court found “no reason to distinguish Johnson” and determined that the creditor has a “claim” that might be included in a chapter 13 plan “‘if it is enforceable against either the debtor or his property.”8 As such, even in the absence of personal liability against the debtor, the bank’s in rem claim against the property is a “claim” for purposes of § 101(5) of the Bankruptcy Code and can be cured through the debtor’s plan in accordance with § 1322(b)(2) and (3). As in Hutcherson, the Stevenson court, over objection, compelled a bank’s “mandatory participation” with a party absent its loan documents.9

The Minority Approach: “There’s a Stranger in My House”

With every majority approach, there must exist a minority. In re Kizelnik10 presents the other side to Johnson. In Kizelnik, the court was confronted with a debtor who sought to deaccelerate a mortgagor’s loan and repay arrearages through a chapter 13 plan. Described as a “stranger” to the loan documents, the debtor was the granddaughter of the mortgage creditor’s original borrowers, and she resided as a tenant in the property subject to the litigation. After several bankruptcies filed by the borrowers, the granddaughter filed her own case to stop a foreclosure sale. While not mentioned by the parties via the pleadings, the Kizelnik court deemed it appropriate to discuss Johnson and proclaimed that “[w]hile Johnson clearly does not dictate a different result here, cases that claim to follow Johnson impermissibly extend its holding beyond the same-debtor situation to chapter 13 cases involving a transfer of property from a mortgagor-parent to a debtor-child.”11

The Kizelnik court stressed that Johnson should be limited to its peculiar facts and should therefore only govern the resolution of “chapter 20” cases involving a single mortgagor whose chapter 13 is preceded by one under chapter 7.12 The “single mortgagor” rationale in Kizelnik was further underscored by In re Parks.13 Without specifically invoking Johnson, the Parks court examined why — even if proceeding with respectable intentions — a debtor cannot satisfy the requirements to include payment of a claim under § 1322 without having a preexisting relationship with such creditor.

In Parks, the debtor inherited real property following his father’s death, and occupied it the same as his primary residence (analogous to the factual circumstances in Hutcherson and Stevenson). At the time of his father’s death, the mortgage on the property was in default. In addressing the bank’s motion to lift the automatic stay, the Parks court framed the issue as follows: “[W]hat kind or degree of relationship is sufficient to be within the scope of a debtor’s privilege of ‘cure’ under § 1322? Does it suffice that a debtor now has ‘title’ to the property?”14 In answering this question, the Parks court concluded that the reach of § 1322(b)(2) cannot extend to include modification of a secured claim already in place when the debtor equitably or legally acquired the property.15 Because the mortgage encumbered the property before the son/debtor acquired it, and because the debtor lacked privity with the bank, any default under the note and mortgage was neither curable through the son’s chapter 13 plan, nor subject to modification.16

A public policy or benevolent consideration is that inheritances, heirs or other “family” issues should presumably be viewed to have at least a tangential link to the original creditor. The Parks court displays (perhaps unintentionally) how the majority approach’s reach might still extend beyond the parent/child transaction by permitting connections between entirely unrelated parties and compelling de facto (and nonconsensual) partnerships between strangers with questionable intent/motive:

[T]his may be an honest Debtor simply trying to save his home, but who may not do so because any statutory interpretation which would permit him to do so must also permit, for example, a tenant to take title in the eleventh-hour and thwart foreclosure of the landlord’s mortgage, even if the tenant is secretly a shill for the landlord.17

Likewise, in In re Mullin,18 the court, confronted with the enforceability of “due-on-sale” clauses, refused to force a new owner (the debtor) on a bank where the original mortgagors deeded the subject property to the debtor without the lender’s consent. The Mullin court identified the similarities in Johnson to the facts before it, but (like Parks) cemented its decision on the limitations of the Bankruptcy Code: “[I]t is the case here, as in Johnson, that the [bank’s] claim is in rem as to the Property, not in personam with recourse against [the debtor]. However, the fact [that] such ‘rights are claims’ as defined in § 101(5) ... does not override or nullify the prohibition on modification contained in § 1322(b)(2).”19

The Mullin court was persuaded by a line of cases that held “that a debtor who obtained residential property from the mortgagor without adhering to a due-on-sale clause is not permitted to cure the mortgage defaults through the chapter 13 plan over the objection of the mortgageholder.”20 In so finding, the court proclaimed that forcing a new owner on the bank would disregard Texas law that due-on-sale clauses are enforceable.21 While the Mullin court linked its decision directly to the existence and enforceability of a due-on-sale clause, the analysis is informative, as the due-on-sale clause (if waived by lender) resolves the privity issue by effectively creating (or accepting) privity between the creditor and the new title owner.

“Privity of Contract” and “Personal Liability”: Similar, but Not Synonymous

Ultimately, the divide between the majority and minority centers around the distinction, relationship and comparison between “privity of contract” and “personal liability.” The interplay — and in many cases, the merging — of these two distinct and separate realities has created an informal bankruptcy policy, birthed by Johnson, that any ownership interest (regardless of origin) is enough for a debtor to include such interest as a claim in a bankruptcy plan.

As previously mentioned, the core link of Johnson’s text that opened the claim floodgates is the Supreme Court’s directive that “nonrecourse obligations” fall within the definition of a “claim.” In Johnson, the Court framed the issue narrowly: “The issue in this case is whether a mortgage lien that secures an obligation for which a debtor’s personal liability has been discharged in a Chapter 7 liquidation is a ‘claim’ subject to inclusion in an approved Chapter 13 reorganization plan.”22

The Kizelnik court’s contention that the majority’s perspective is an impermissible extension beyond the “same-debtor situation” (and that Johnson should only govern cases involving a “single mortgagor”) is instructive. Perhaps instead of focusing solely on the term “nonrecourse,” due attention should also be given to the terms “enforceable,” “obligation” and (most importantly) “survive.” Dissecting the Supreme Court’s rationale, the “single mortgagor” perspective harmonizes and supports Johnson’s ruling:

[T]he conclusion that a surviving mortgage interest is a “claim” under § 101(5) is consistent with other parts of the Code.... In other words, the court must allow the claim if it is enforceable against either the debtor or his property. Thus, § 502(b)(1), through a Chapter 7 proceeding, may consist of nothing more than an obligation enforceable against the debtor’s property.23

This brings us back to the flawed connection between personal liability and privity of contract: While the survival of “personal liability” is discussed extensively in Johnson, the phrase “privity of contract” is entirely absent from the Supreme Court’s opinion. Nevertheless, the majority’s interpretation connects privity of contract to the Johnson creditor’s nonrecourse obligation. However, in Johnson, “nonrecourse obligation” is not related to contractual privity, but rather defined as the bank’s in rem rights that survived the debtor’s chapter 7 discharge. The Court explicitly stated that “there can be no doubt that the surviving mortgage interest corresponds to an ‘enforceable obligation’ of the debtor ... and is a ‘claim’ under § 101(5).”24

Thus, implicit in Johnson is the notion that in order for a creditor to have a “nonrecourse obligation” against property of a debtor, actual privity of contract must have existed between the parties at some point in time. This marks the precise point where personal liability and privity of contract dramatically diverge. At inception, a mortgage simultaneously creates personal liability against an individual and an in rem right against a piece of collateral (collectively, the “mortgage rights”). A chapter 7 discharge, as in Johnson, removes one of those mortgage rights (personal liability), but the other (in rem right to collateral) survives.

Conclusion

While the majority approach offers a more “inclusive” standard for what constitutes a “claim,” the only nonrecourse obligation (after a chapter 7 discharge) available for bankruptcy plan treatment (pursuant to Johnson) is the original bank’s in rem right to foreclose on the collateral — nothing more, nothing less. The term “obligation” inherently requires both an “obligor” (the party responsible for fulfilling the obligation) and an “obligee” (the party or entity to enforce the obligation). An individual (a debtor) with no prior connection to an entity (an alleged creditor) cannot legitimately owe an obligation to such entity.

As stated in Parks,25 a “common sense interpretation” is that “only a right or status lost by the debtor may be cured,” meaning that a “debtor may not ‘cure’ someone else’s default.” Such an interpretation complements the “single mortgagor” principle proffered by Kizelnik and further emphasizes the fact that Johnson exclusively dealt with one individual, one creditor and the dynamics of what rights remained (or could be “revived”) between those two entities that were connected pre-petition.

The majority approach’s synonymous use of privity of contract and personal liability has created a broader definition for the phrase “nonrecourse obligation,” which is a slippery slope. In short, Johnson was a case about the survival of rights, not the expansion of them.

Jeffrey Fraser focuses on creditor representation at Albertelli Law (ALAW) and is the firm’s national Bankruptcy partner. He was named a 2017 Blackshear Fellow by the National Conference of Bankruptcy Judges and received a 2021 Junior Professional of the Year Award by the American Legal & Finance Network, and he is a 2020 ABI “40 Under 40” honoree.