Two Indiana Bankruptcy-Related Cases: Impact on Real Estate Liens
Lesson 1. The home of two spouses generally is exempt from the bankruptcy estate (and thus is immune from foreclosure) if only one spouse owes the underlying debt.
Lesson 2. Mortgaged real estate is not immune from foreclosure simply because the borrower obtained a discharge in bankruptcy.
Vital facts. I discuss two cases today, both of which touch upon bankruptcy issues in relation to certain liens. Although the facts in the cases are somewhat different, both matters deal with a creditor’s pursuit of a lien foreclosure – in the case of WBL, a mortgage lien, and in the case of Carrington, a judgment lien.
Procedural history. In Carrington, the bankruptcy court concluded that Creditor could not pursue an alleged judgment lien on a home that the Debtor owned with his spouse as tenants by the entirety. Creditor appealed.
WBL arose out of an in rem mortgage foreclosure action. The trial court, following a bankruptcy discharge of Debtor’s debt, (1) granted summary judgment for Mortgagor (property owner), which pledged the real estate to guarantee Debtor’s loan, and (2) denied summary judgment for Mortgagee (lender). Mortgagee appealed.
Key rules.
“Indiana law exempts from the bankruptcy estate any interest held as a tenant by the entirety, unless … the spouses are jointly liable for the debt.”
The bankruptcy discharge of a debt has no bearing on the validity of a mortgage lien.
Holding 1. The Indiana Court of Appeals reversed the trial court’s ruling in WBL and actually entered summary judgment for Mortgagee.
Holding 2. The 7th Circuit Court of Appeals affirmed the bankruptcy court’s ruling in Carrington.
Policy/rationale. Under common law “the marriage” holds title to a couple’s home such that “one spouse cannot individually encumber such property.” Because, in Carrington, both spouses did not owe the debt that formed the basis of the claimed judgment lien, Debtor successfully avoided the lien against the property co-owned with his wife. This is why a personal guaranty executed by only one spouse ultimately will have no impact on a residence the guarantor owns with his or her spouse.
In WBL, Debtor’s (borrower’s) personal liability for the debt was discharged through bankruptcy. Mortgagor was not a party to the bankruptcy proceeding. The trial court erroneously concluded that, because the debt had been discharged, so too had the mortgage. However, “the bankruptcy court’s discharge of Debtor from its obligation to pay the debt underlying the Note ‘operates only for the benefit’ of Debtor and ‘does not affect the liability’ of [Mortgagor] under the Mortgage.” Another way to look at this is – in bankruptcy, a debt is not discharged, only the debtor’s individual responsibility for it is.