The U.S. Court of Appeals for the Third Circuit recently held that, because the home seller in an installment sale contract received a judgment of possession before the buyer filed for bankruptcy, the home was not part of the buyer’s bankruptcy estate.
A copy of the opinion in In re Belarminio Peralta is available at: Link to Opinion.
The buyer here bought a house through an installment sale contract with the seller. The buyer stopped making payments, and the seller sued. To obtain a second chance, the buyer agreed that if he breached again, the seller could get a judgment for possession and immediately evict him. Another breach would extinguish any rights that the buyer had in the house.
Nevertheless, the buyer stopped paying again, and the seller obtained a judgment for possession. The buyer stayed in the house and filed for Chapter 13 bankruptcy. In the bankruptcy petition, the buyer argued that Chapter 13 lets a bankrupt homebuyer “cure” a “default” on a mortgage during the bankruptcy process until the home “is sold at a foreclosure sale” 11 U.S.C. § 1322(c)(1). Pennsylvania treats foreclosed installment contracts like mortgages, and therefore the buyer also alleged that said cure gave him an interest in his property.
The bankruptcy court agreed with the buyer’s theory. The judge reasoned that, because the buyer remained living at the property, he still had an interest in the property subject to the installment contract and a § 1322(c)(1) remedy. Thus, the bankruptcy judge included the buyer’s home in his bankruptcy estate. 11 U.S.C. § 541(a)(1).
On appeal, the trial court vacated the bankruptcy court’s order, reasoning that, because the judgment for possession was entered before the buyer filed for bankruptcy, no § 1322(c)(1) remedy existed and the home was not part of the bankruptcy estate. The buyer timely appealed.
Section 1322 of the Bankruptcy Code lets debtors cure defaults only until their homes are “sold at a foreclosure sale that is conducted in accordance with applicable nonbankruptcy law.” 11 U.S.C. §1322(c)(1).
However, unlike a defaulted mortgage, a breached installment contract never ends in a foreclosure sale; the property’s title stays with the seller until the contract is paid off. Thus, to determine whether a §1322(c)(1) remedy existed here, the Third Circuit needed an analogue of a foreclosure sale applicable to installment contracts.
The Third Circuit has adopted the gavel rule to define a “foreclosure sale.” Under the gavel rule, although the legal interest passes at delivery of the deed, a property is “sold” as soon as there is a new equitable owner. In re Connors, 497 F.3d 314, 320-21 (3d Cir. 2007). That sale happens when a bidder wins an auction. So a property is “sold at a foreclosure sale” as soon as the gavel falls. Id.
In re Connors thus pegged the “foreclosure sale” to the transfer of equitable ownership. The Court here determined the installment contract analogue of a foreclosure sale is when a default removes the bankrupt homebuyer’s equitable title. Under Pennsylvania law, that happens when a judgment for possession is entered against the homebuyer. See In re Butko, 624 B.R. 338, 378–80 (Bankr. W.D. Pa. 2021) (analyzing a state statute akin to §1322(c)(1)).
Thus, the Third Circuit concluded that, when the buyer here filed for bankruptcy months after the seller had obtained a judgment for possession, the buyer had already lost his equitable interest in the house and the house was not part of his bankruptcy estate. 11 U.S.C. §541(a)(1). The analogue of a foreclosure sale had passed, and it was too late to cure. And though the buyer still lived in the home, he had no other good-faith claim to possession.
Accordingly, the Third Circuit agreed with the trial court’s assessment that the buyer’s effort to use §1322(c)(1) came too late, and the Court affirmed the trial court’s ruling.