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WBK Industry News - Litigation Developments

Indiana Supreme Court Rules that a Liquidation Bankruptcy does not Discharge a Mortgage Lien

On March 14, 2017, the Supreme Court of Indiana (the “Court”) ruled that a liquidation bankruptcy under Chapter 7 discharges the borrower’s personal liability on any mortgage loans, but does not extinguish a mortgage lien on real property.

As background, the plaintiff property owners took out a mortgage loan in 1994 from a lender who eventually became the defendant in the case.  The plaintiffs subsequently filed several Chapter 13 bankruptcy petitions, the third of which was filed in 2012 and was converted to a Chapter 7 plan.  This led to a discharge of the plaintiffs’ debts on March 14, 2014.  When the defendant filed a complaint to foreclose the mortgage, the plaintiffs filed a cross-motion arguing that they no longer owed any debt to the defendant.  The trial court granted summary judgment in favor of the defendant and denied the plaintiffs’ motion.  The trial court essentially granted the defendant an in rem judgment against the property in the amount of the unpaid balance together with interest plus various expenses, and ordered a Sheriff’s sale.

The Court’s ruling in this case, which upholds the trial court’s determination, differentiates between a Chapter 13 and a Chapter 7 bankruptcy petition.  Specifically, Chapter 13 is a reorganization-type bankruptcy where the debtor’s assets are not surrendered or sold.  Instead, the debtor pays his creditors as much as he can afford over a three- or five-year period.  In contrast, Chapter 7 is a liquidation bankruptcy where the debtor surrenders his assets (subject to certain exemptions) and in exchange is relieved of his debts (with certain exceptions), thus giving the debtor a fresh start.

Here, the plaintiffs’ Chapter 7 bankruptcy discharged their personal liability for the mortgage loan by eliminating the plaintiffs’ obligation to pay back the loan.  However, a discharge of debt has no bearing on the validity of the mortgage lien.  While the Bankruptcy Code provides a mechanism for avoidance of liens, it does not appear that the plaintiffs in this case sought to avoid the debt secured by the defendant’s lien or that the mortgage was otherwise declared void.  Accordingly, the plaintiffs’ Chapter 7 bankruptcy protected the plaintiffs from an in personam deficiency judgment, but did not affect the lien on their property, which is in rem.

The case is McCullough v. CitiMortgage, and is available here: http://www.in.gov/judiciary/opinions/pdf/03141701rdr.pdf.