Foreclosure Sales, Deficiency Claims and the § 1111(b) Election

• Published in: American Bankruptcy Institute journal Vol. 36; no. 10; p. 28
• Main Authors: Costella, Richard L, Siracusa, Kristen M
• Format: Journal Article
• Language: English
• Published: Alexandria American Bankruptcy Institute 01.10.2017
• Subjects: Bankruptcy; Bankruptcy laws; Bankruptcy reorganization; Commercial banks; Federal court decisions; Foreclosure; Liens; Loans; Petitions; State court decisions; State laws; Los Angeles California; United States > US; California
• ISSN: 1931-7522

Salamon also executed a note in the amount of $325,000 in favor of the trust (the "fourth loan"), secured by a fourth lien on the apartment building.6 Behrend filed for chapter 11 protection in 2010, and Peter J. Mastan was appointed as chapter 11 trustee.7 The case was subsequently converted to chapter 7, and Mastan was appointed as the chapter 7 trustee.8 Jeanne and David Salamon filed their own chapter 11 petitions in 2012.9 Mastan filed a secured proof of claim on behalf of Behrend's chapter 7 estate for the principal amount due on the AITD and fourth loan.10 United Commercial Bank and the Salamons agreed that the automatic stay could be terminated so that the bank could foreclose on the apartment building under the first-priority deed of trust.11 The building was subsequently sold at foreclosure for $1,275,500.12 Mastan subsequently learned that the proceeds from the foreclosure sale were sufficient to pay the first and second loans in full and that there were additional funds available to pay Behrend's estate.13 Mastan made demand on the foreclosing trustee and received a check for $150,560.14, which was sufficient to retire the remaining balance on the AITD and a portion of the amount due on the fourth loan.14 He thereafter amended his proof of claim to assert an unsecured claim for the remaining amounts due on the fourth loan.15 The Salamons then sought to disallow the amended claim pursuant to California's anti-deficiency statute Cal. Code § 580b (a) (2).16 Mastan argued that § 1111 (b) (1) overrides the state law prohibiting the deficiency claim, notwithstanding that the claim would be barred under applicable state law.17 The Salamons argued that because Mastan's claim was no longer secured by a lien on property of the estate, § 1111 (b) did not apply.18 The bankruptcy court granted the Salamons' motion to disallow Mastan's unsecured claim - agreeing that the apartment building remained property of the estate up and until the foreclosure sale occurred, at which point Mastan no longer had a claim that was "secured by a lien on property of the estate" for purposes of § 1111 (b).19 The Ninth Circuit BAP's Decision On appeal to the Bankruptcy Appellate Panel (BAP) for the Ninth Circuit, the parties agreed that resolution of the appeal centered on the interpretation of § 1111 (b) (1) (A). Mastan argued that since § 1111 (b) (1) (A) instructs that a "claim secured by a lien on property of the estate shall be allowed or disallowed under section 502," and under § 502 a court "shall determine the amount of such claim ... as of the date of the filing of the petition," the bankruptcy court erred in concluding that Mastan did not have a claim secured by a lien on property of the estate.22 The BAP noted that case law interpreting that specific phrase in § 1111 (b) (1) (A) was sparse, but what case law does exist was contrary to Mastan's position.23 He was not able to offer any case law to support his position that if a claim is secured by a lien on the property of a debtor's bankruptcy estate as of the date of the case filing, an otherwise nonrecourse debt will thereafter be afforded treatment as a recourse debt - even though the property is sold at a foreclosure sale.24 The BAP ultimately concluded that under applicable nonbankruptcy law (here, California law), the liens that secured Mastan's claims were extinguished by the foreclosure sale, and as a result, at the time the Salamons objected to the claim, he no longer held a lien on estate property.25 As there was no lien on the property of the estate, the BAP determined that the bankruptcy court did not err in deciding that § 1111 (b) (1) (A) did not apply to the amended proof of claim, and that under the antideficiency laws of California, the claim was unenforceable.26 The Ninth Circuit Court of Appeals Decision Mastan appealed, and the Ninth Circuit Court of Appeals was tasked with determining whether Mastan could treat his claim based on a non-recourse lien as a recourse claim after the apartment building was sold at foreclosure.27 Mastan maintained that the determination as to whether he had a claim secured by a lien on property of the estate must be made at the time the Salamons filed their bankruptcy petition - not at the time his amended proof of claim was objected to by the debtors.28 But the Ninth Circuit determined that the interpretation of the phrase "property of the estate" in § 1111 (b) (1) (A) as a reference to the property that existed at the time of filing was not supported by either § 502 or 1111 (b) (1) (A) of the Bankruptcy Code. Because legal advice must vary with individual circumstances, do not act or refrain from acting on the basis of this article without consulting professional legal counsel. 2 11 U.S.C. § 1111(b)(1)(A).