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Indiana Supreme Court Rejects Borrowers’ Argument Bankruptcy Discharge Wiped Out Mortgage Loan, Lien

The Supreme Court of Indiana recently confirmed a mortgagee’s ability to seek an in rem judgment against property for which there was an outstanding lien balance after the borrowers obtained a discharge of their Chapter 7 bankruptcy.

In so ruling, the Court distinguished the difference between an in rem and in personam judgment, and rejected the borrowers’ unsupported argument that the debt was paid in full by the time the mortgagee initiated foreclosure proceedings against the borrowers.

A copy of the opinion in McCullough v. CitiMortgage, Inc. is available at:  Link to Opinion.

The borrowers obtained a loan from the lender to purchase their home, and executed a promissory note for the principal amount of the loan. The borrowers also executed a mortgage in favor of the lender using the property as security for repayment of the loan.

The borrowers later filed Chapter 13 bankruptcy (“Bankruptcy I”).  The mortgagee filed a proof of claim in Bankruptcy I for an arrearage in the amount of $18,665.85 and a total claim for $124,154.04.  Both of the mortgagee’s claims were allowed.  Bankruptcy I was later dismissed because the borrowers defaulted on the plan payments, and Bankruptcy I was terminated without an order of discharge.  The Trustee’s Final Report showed principal paid in the amount of $53,002.79.

Later, the borrowers filed a second Chapter 13 bankruptcy (“Bankruptcy II”).  The mortgagee filed a proof of claim for a total amount due of $131,633.84, with a claim for an arrearage of $19,453.14.  Both of the claims in Bankruptcy II were allowed.  Bankruptcy II was dismissed on the borrowers’ motion, and the borrowers’ debts were not discharged.  The Trustee’s Final Report in Bankruptcy II showed principal paid in the amount of $42,492.75 and $9,988.72 toward the arrearage.

The borrowers later filed a third Chapter 13 bankruptcy (“Bankruptcy III”).  The mortgagee filed a proof of claim with $13,343.26 in arrearage and a total claim of $113,279.23.  Bankruptcy III was converted from a Chapter 13 to Chapter 7.  The Trustee’s Final Report, issued in November 2013, discharged the borrowers, showed nothing was paid toward the arrearage, and reflected a “Mortgage Ongoing” in the amount of $106,491.26.

After the discharge was entered, the mortgagee filed its complaint on the note and to foreclose on the mortgage.  The mortgagee sought “[J]udgment, IN REM, against the real estate being foreclosed herein, in the sum of the outstanding principal balance of $100,806.90 . . .”  The mortgagee filed a motion for summary judgment and submitted with the motion the note and mortgage, and an affidavit from the mortgagee’s representative establishing the borrowers were in default under the loan documents.

The borrowers filed a cross-motion for summary judgment, and tendered several documents with their cross-motion.  Included among the borrowers’ documents, the Court noted, was a letter to the mortgagee acknowledging the borrowers were in arrears on their mortgage. The borrowers, however, did not submit any affidavits in support of their own cross-motion or in opposition to the mortgagee’s motion.

The trial court granted summary judgment in favor of the mortgagee and denied the borrowers’ cross-motion.  The trial court granted the mortgagee an in rem judgment against the property in the principal sum of $100,806.90.

The borrowers appealed the trial court’s judgment. Despite giving the borrowers multiple chances to comply with the appellate rules, the Indiana Court of Appeals found the borrowers’ Appellant’s Brief was “woefully defective” and dismissed the appeal with prejudice.  The borrowers filed a petition to transfer, which the Court initially denied.  The borrowers filed a motion to reconsider, and the Court vacated the order denying transfer and assumed jurisdiction over the appeal to address the merits.

On appeal, the borrowers asserted that the foreclosure was improper because by the time the mortgagee initiated the foreclosure action they no longer owed any debt to the mortgagee.  The borrowers based their argument on (i) documentation showing they paid $122,007.21 in principal to the mortgagee during their three bankruptcies, (ii) their assertion the mortgagee did not properly apply the borrowers’ payments, and (iii) their assertion the mortgage was paid in full when the Final Report in Bankruptcy III showed the borrowers had been “discharged.”

The Court quickly pointed out that the borrowers submitted no evidence to support their argument that their bankruptcy payments were not properly applied. The Court also observed that the borrowers had not submitted admissible evidence establishing they had paid more than $120,000 in principal to the mortgagee.

Next, the Court clarified that the difference between Chapter 13 and Chapter 7 is one of reorganization versus liquidation.  In the liquidation bankruptcy (Chapter 7), the debtor surrenders his assets and in exchange is relieved of his debts.  In contrast, in a Chapter 13 reorganization a debtor’s assets are not surrendered or sold.  Instead, the debtor retains his assets and pays his creditors as much as he can afford over a certain period of time.  Once the debtor makes all of the required payments under the plan, the bankruptcy court discharges most of the debtor’s remaining debts.

The Court observed that Bankruptcy I and II were terminated without an order discharging the borrowers’ remaining debts.  Bankruptcy III, which as converted to Chapter 7, resulted in the borrowers’ debts being “discharged.”

The borrowers relied on the “discharge” from Bankruptcy III to assert they were no longer indebted to the mortgagee.  The Court, in response, corrected the borrowers’ misunderstanding of (i) owing on the loan, and (ii) the lien on the property provided by the mortgage.

In addressing whether the borrowers owed on the loan, the Court conceded a Chapter 7 discharge “wipes out” a borrower’s obligation to pay back the loan.  According to the Court, however, “such a discharge extinguishes only the personal liability of the debtor” and it has no bearing on the validity of a mortgage lien.

As to the lien on the property provided by the mortgage, the Court affirmed a century-old rule that the right to foreclose on the mortgage survives the bankruptcy.  The Court then summed up the distinction between in personam and in rem judgments: “a bankruptcy discharge removes the ability of creditors to seek to collect against the debtor individually (known as in personam liability).  Liens, on the other hand are in rem meaning they are rights against the property which are enforceable.”

The Court concluded that the discharge in Bankruptcy III only protected the borrowers from personal liability for their debts, and the mortgage lien survived and is enforceable as an in rem action.

Because the mortgagee’s complaint and motion for summary judgment did not seek an in personam judgment against the borrowers, and only sought an in rem judgment against the property for which there was an outstanding balance, the Court affirmed the granting of the mortgagee’s motion for summary judgment.

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