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Wachovia Mortgage v. Pnc Bank

September 20, 2012

WACHOVIA MORTGAGE,
APPELLEE. SONIA L. SMOOT,
APPELLANT,
v.
PNC BANK, N.A. APPELLANT,
v.
JOSEPH CONTRINO, APPELLEE.



The opinion of the court was delivered by: Spatt, District Judge.

MEMORANDUM OF DECISION AND ORDER

Presently before the Court are two distinct appeals from the Bankruptcy Court that pose precisely the same issue: whether a debtor who has filed for Chapter 7 bankruptcy may "strip off" the lien of a junior mortgage pursuant to 11 U.S.C. § 506(d), when the outstanding balance due on a senior mortgage exceeds the fair market value of the secured property. Because the appeals are identical, they will be addressed simultaneously. For the reasons set forth below, namely because of binding Supreme Court precedent, the Court reverses the Bankruptcy Court determinations.

I. BACKGROUND

Before delving into the Bankruptcy Court decisions that underlie the present appeals, it is necessary to fully set forth the dispute that is before this Court.

As will be further explored below, this controversy is the result of a clash between two distinct lines of cases; two separate bankruptcy chapters; and different provisions of the Bankruptcy Code. The question presented is whether a debtor in a Chapter 7 proceeding may "strip off"(or cancel) a junior lien on their residential property, when the value of the property at the time of the bankruptcy filing is less than the amount due under a senior mortgage. In other words, can a Chapter 7 debtor avoid liability on a totally "underwater" second mortgage? This question hinges on the interpretation of one particular provision in the Bankruptcy Code----11 U.S.C. § 506(d)----which states that a lien that secures a claim against the debtor is void unless it is an "allowed secured claim".

The Supreme Court has twice faced the issue of whether in bankruptcy a debtor may strip off a mortgage on their residential property. See Dewsnup v. Timm, 502 U.S. 410, 112 S. Ct. 773, 116 L. Ed. 2d 903 (1992) and In re Nobelman, 508 U.S. 324, 113 S. Ct. 2106, 124 L. Ed. 2d 228 (1993). However, both of these cases address whether an undersecured senior mortgage may be "stripped down", meaning that there was some collateral underlying the lien. Whether this distinction is a significant one and thus whether these cases control the present dispute, forms the crux of the debate. To further complicate matters, Dewsnup arose in the Chapter 7 context and relied solely on the Court's interpretation of the phrase "allowed secured claim" in § 506(d). On the other hand, Nobelman arose in the Chapter 13 context and thus interpreted a Chapter 13 specific statute----§ 1332----and defined "allowed secured claim" in light of § 506(a), which the Dewsnup Court did not do. Whether the bankruptcy chapter the debtor is proceeding under is dispositive is another issue that muddies this dispute.

The two bankruptcy decisions that led to the present appeals both disregarded the Dewsnup precedent----although it arose in the same Chapter 7 context----and found that a debtor may strip off a wholly unsecured junior mortgage. However, as will be explained below, this is the minority view. Most of the courts that have faced this issue have found Dewsnup to be controlling; that the undersecured versus unsecured distinction was insignificant; and consequently that a debtor may not strip off a wholly unsecured junior mortgage.

With this framework in mind, the Court now turns to a review of the underlying bankruptcy determinations and will then analyze the legal issues presented.

A. The Wachovia Appeal

The facts relevant to Wachovia Mortgage v. Sonia Smoot (the "Wachovia Appeal") are undisputed. On September 20, 2006, Sonia Smoot ("Smoot") purchased the real property located at 115-38 238th Street, Elmhurst, NY 11003 (the "Wachovia Property"). In order to finance this purchase, Smoot entered into a transaction with World Savings Bank, a predecessor of Wachovia Mortgage ("Wachovia"), for a first mortgage in the original principal amount of $349,800.00 (the "First Lien Mortgage"). In addition, Smoot obtained a home equity line of credit in the original principal amount of up to $69,960.00, secured by a credit line mortgage (the "Credit Line Mortgage"). Both of these mortgages were perfected and recorded in the Nassau County Clerk's Office.

On August 30, 2010, Smoot filed a petition for bankruptcy relief under Chapter 7. (Case No. 10-76793). On November 5, 2010, she commenced an adversary proceeding against Wachovia in connection with the two mortgages, requesting the Bankruptcy Court to deem the Credit Line Mortgage as a wholly unsecured claim and thus declare the entire subordinate mortgage lien to be declared null and void. (Adv. Pro. No. 10-8750). At the time, the total balance due on the first mortgage lien was $370,601.02, and the total balance due on the credit line mortgage was $70,749.67. Smoot's appraisal of the Wachovia Property valued it at $340,000.00, while Wachovia's appraisal valued it at $325,000.00. Thus, under either appraisal, the balance due on the First Lien Mortgage exceeded the value of the Property.

In the adversary proceeding, Smoot and Wachovia filed cross-motions for summary judgment. The only inquiry before the Bankruptcy Court was whether the Credit Line Mortgage could be voided, i.e., "stripped off", pursuant to 11 U.S.C. § 506. The Bankruptcy Court first assessed whether the Credit Line Mortgage, which was based on a home equity line of credit, should be treated the same as a traditional mortgage. After some analysis, not relevant here, the Bankruptcy Court concluded that the Credit Line Mortgage should be treated the same as any other mortgage lien.

On the basis of the determination that there were two mortgage liens, the Bankruptcy Court then went on to address the more fundamental question of whether the Credit Line Mortgage could be "stripped off" under the Bankruptcy Code. Under 11 U.S.C. § 506(d), a lien that secures a claim that is not an "allowed secured claim" is void. Thus, the Bankruptcy Court needed to determine whether the Credit Line Mortgage was an "allowed secured claim" under the Bankruptcy Code. The Court looked to the Supreme Court precedents of Dewsnup v. Timm, 502 U.S. 410, 112 S. Ct. 773, 116 L. Ed. 2d 903 (1992) and In re Nobelman, 508 U.S. 324, 113 S. Ct. 2106, 124 L. Ed. 2d 228 (1993), in which debtors had sought to "strip down" an undersecured primary mortgage lien to the value of the underlying collateral. As stated above, Dewsnup arose in the Chapter 7 context, and Nobelman arose in the Chapter 13 context.

After acknowledging this relevant precedent, the Bankruptcy Court chose not to follow either case for guidance, finding that "both decisions were limited to [their] specific facts and thus, these cases should be narrowly construed." (Wachovia Order at 4.) In particular, the Court found that neither case dealt with the "stripping off" of a subordinate lien that was wholly unsecured by any value in the debtor's property.

Instead, the Bankruptcy Court relied upon the Second Circuit decision of In re Pond, 252 F.3d 122 (2d Cir. 2001), as the present controlling precedent for a debtor's ability to "strip off" a subordinate mortgage lien that is wholly unsecured. While the Pond case stands for the proposition that a wholly unsecured subordinate mortgage lien can be declared void under section 506(d) only in a Chapter 13 case, the Bankruptcy Court applied its holding to the Chapter 7 context it faced. The Court referred to its previous decision in In re Lavelle, No. 09 Civ. 72389, 2009 Bankr. LEXIS 3795 (Bankr. E.D.N.Y. Nov. 25, 2009), where it stated that "[t]he plain meaning is applied to Chapter 13 section 1322(b)(2) analysis where the lien is wholly unsecured, and there is no logical reason to read the text differently when applied to chapter 7 wholly unsecured liens." Lavelle, 2009 Bankr. LEXIS 3795, at *16.

The Bankruptcy Court then went on to discuss the rationales other courts had used to preclude such lien stripping in the Chapter 7 context. With regard to whether it would result in a windfall to the debtor at the expense of the creditor, the Bankruptcy Court looked again to Pond and noted that "any windfall to a chapter 7 debtor as a result of avoidance of a wholly unsecured mortgage lien would not be greater than the debtor would have received if the debtor had filed for chapter 13 relief instead." (Wachovia Order at 9.) Moreover, the Bankruptcy Court noted that while a subordinate mortgage lien is consensual and "bargained for", it was questionable that such a mortgage lien holder bargained for different treatment of its lien under different chapters of the Bankruptcy Code with the debtor having control of the type of bankruptcy relief sought. Finally, the Bankruptcy Court found no significant difference between the two bankruptcy chapters that would warrant different treatment of a wholly subordinated mortgage lien under the same section of the Bankruptcy Code, concluding that there was no reason why the holding in Pond could not be extended to Chapter 7 cases.

In sum, the Bankruptcy Court concluded that where the amount outstanding on the first mortgage is greater than the value of the Property, the lienholder's subordinate Credit Line Mortgage is wholly unsecured pursuant to section 506(a). Because such Credit Line Mortgage is wholly unsecured, it held such mortgage lien to be null and void pursuant to section 506(d) and the mortgage claim shall be recharacterized as a general unsecured claim against the Debtor's bankruptcy estate.

B. The PNC Appeal

Similar to the Wachovia Appeal, all of the facts relevant to PNC Bank, N.A. v. Joseph Contrino (the "PNC Appeal") are undisputed. Joseph Contrino ("Contrino") is the owner of real property located at 195 Howard Street, Port Jefferson Station, New York 11776 (the "PNC Property"). On January 19, 2011, Contrino filed a voluntary petition for relief pursuant to Chapter 7 of the Bankruptcy Code. As of that date, the PNC Property was encumbered by a first mortgage held by Bank of America, and a second mortgage held by the Appellant PNC. The first mortgage had an approximate balance of $309,457.20, while the second mortgage had an approximate balance of $38,186.72. However, at the time of Contrino's initial filing for relief with the Bankruptcy Court, the value of this property was estimated only to be about $290,000.00. Therefore, as in the Wachovia Appeal, the amount due under the first mortgage exceeded the approximate fair market value of the home as of the time of the bankruptcy filing.

On March 17, 2011, Contrino filed a Complaint against PNC, requesting the Bankruptcy Court to: (1) declare PNC, the second mortgage holder, as having a wholly unsecured claim and to declare PNC's lien null and void; (2) direct the Clerk of Suffolk County to cancel and discharge PNC's mortgage lien; and (3) for other and further relief as the Court deemed just, proper, and equitable. On April 21, 2011, PNC filed its Answer to Contrino's Complaint. PNC subsequently argued that a debtor such as Contrino could not avoid a second lien mortgage in a Chapter 7 bankruptcy case, merely because the value of the home at the time of the bankruptcy filing exceeded the amount due under the first lien mortgage.

On June 14, 2011, the Bankruptcy Court ordered that the lien debt created by the second lien of PNC was deemed wholly unsecured; that the mortgage lien of PNC was deemed null, voided, and released; and that the Clerk of Suffolk County was directed to cancel and discharge the mortgage lien of PNC.

II. DISCUSSION

A. Legal Standard of Review on a Bankruptcy Appeal

Federal district courts have jurisdiction to hear appeals from final judgments, orders, and decrees of bankruptcy judges. Fed. R. Bankr. P. 8013. The standard of review in a bankruptcy appeal is plenary. In re MarketXT Holdings Corp., 346 Fed App'x 744, 745 (2d Cir. 2009). The reviewing court "review[s] the bankruptcy court decision independently, accepting its factual findings unless clearly erroneous, but reviewing its conclusions of law de novo." Ball v. A.O. Smith Corp., 451 F.3d 66, 69 (2d Cir. 2006).

B. The Bankruptcy Code

As a preliminary matter, in order to fully review the relevant case precedent and to properly analyze the legal issue presented, it is useful to set forth the main differences between ...


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