by Under the claims allowance process, a bankruptcy court must consider competing equities even where the mortgage is “inoperative” under state law. GMAC Mortgage v. Orcutt, No. 13-82 and 13-83 (D. Vt. Feb. 28, 2014).
After executing the original note and mortgage, the debtors, Mr. Orcutt and Ms. Stevens, a married couple, executed subsequent notes and mortgages on the property. In 2007, the debtor, Ms. Stevens, refinanced again with GMAC, using the funds to pay off the previous notes as well as some credit card debt. Her husband and co-debtor, Mr. Orcutt, did not sign either the 2007 Note or the 2007 Mortgage, although he was present at the closing.
In June, 2011, the debtors filed a chapter 13 petition listing the residence as a homestead owned as tenants by the entirety and claiming a homestead exemption. They listed GMAC as an unsecured creditor and claimed the mortgage was invalid because it was not signed by both homeowners. GMAC filed an objection to the exemption and opposed confirmation. The debtors concurrently filed an adversary proceeding to determine the status of GMAC’s mortgage arguing that under Vermont law both spouses have to sign the mortgage to GMAC or it is “inoperative.” The bankruptcy court issued two orders: 1) overruling GMAC’s objection and confirming the debtors’ plan, and 2) granting the debtors’ motion for summary judgment finding the mortgage inoperative under state law. In re Orcutt, 2012 WL 627675 (Bankr. D. Vt. Feb. 24, 2012). On an initial appeal, the district court remanded with instructions to the bankruptcy court to address the statutory and constitutional authority for its decision under Stern v. Marshall, 131 S. Ct. 2594 (2011). On remand the Bankruptcy Court invoked the claims allowance process under 11 U.S.C. § 506(a) for its adjudication of the 2007 Mortgage’s validity. The court went on to find that section 105(a) did not provide a basis in equity to declare a mortgage that was invalid under state law, valid for bankruptcy purposes merely to prevent a “windfall” to successful debtors.
Stern Issue:
On this appeal, the district court began with a discussion of whether the bankruptcy court complied with the jurisdictional mandate expressed in Stern to decides cases only where “the action at issue stems from the bankruptcy itself or would necessarily be resolved in the claims allowance process.” Stern at 2618. The court noted that “post-Stern, several courts have concluded that a bankruptcy court possesses statutory and constitutional authority when a particular state law issue necessarily would have been resolved in a bankruptcy proceeding.” See, e.g., In re Frazin, 732 F.3d at 319-20; Sharif, 727 F.3d at 775; In re Bellingham Ins. Agency, Inc., 702 F.3d 553, 564 (9th Cir. 2012), cert. granted sub nom. Exec. Benefits Ins. Agency v. Arkison, 133 S. Ct. 2880 (2013); Waldman v. Stone, 698 F.3d 910,919-21 (6th Cir. 2012), cert. denied, 133 S. Ct. 1604 (2013); In re Sun dale, Ltd., 499 F. App’x 887, 892-93 (11th Cir. 2012). The court found that the issue of the validity of the mortgage and GMAC’s status would have been resolved in the claims allowance process. Furthermore, those issues were integral to the bankruptcy court’s ruling on GMAC’s objections to the debtors’ homestead exemption. It therefore affirmed the Bankruptcy Court’s determination of its statutory and constitutional authority to adjudicate the validity of the 2007 Mortgage.
Validity of Mortgage:
The court turned to whether the bankruptcy court correctly found that state law rendered the mortgage inoperative. 27 V.S.A. § 141(a) provides that, except for a purchase money security interest, no interest may be conveyed in a homestead owned by a married couple without the signature of both husband and wife. The State Supreme Court found that a conveyance signed by only one spouse is not void ab initio but is voidable and may be set aside by the non-signing spouse. Estate of Girard v. Laird, 621 A.2d 1265 (Vt. 1993). In light of the husband’s election to set aside the mortgage and the bankruptcy court’s finding that the mortgage would not apply to the debtors’ homestead, it did not err in finding that the mortgage was “inoperative” under state law. (The court declined to address GMAC’s argument that, due to their lack of equity in the property, the debtors could not claim a homestead exemption in it, because GMAC did not raise that issue in the court below).
Equities
It was in the battle of the equities that the bankruptcy court committed reversible error. The district court found that “because the Bankruptcy Court invoked the claims allowance process under 11 U.S.C. § 506(a) as a basis for its statutory and constitutional authority to adjudicate the 2007 Mortgage’s validity, its conclusion that a Vermont statute is ‘controlling’ and ‘categorically’ applies to render the 2007 Mortgage ‘inoperative’ in the claims allowance process constitutes a clear error of law.” Citing Granfinanciera, S.A. v. Nordberg, 492 U.S. 33, 58 (1989) and Pepper v. Litton, 308 U.S. 295, 304 (1939), the court found that the claims allowance procedure is equitable in nature. Therefore, when passing on the allowance of claims, a bankruptcy court must go beyond state law to “sift the circumstances surrounding” Debtors’ exemption and GMAC’s proof of claim as a secured creditor. In finding that section 105(a) did not provide the necessary authority to weigh equities, the bankruptcy court failed to recognize that the claims allowance procedure is equitable in nature.
Finally, the court found that the bankruptcy court erred in failing to consider GMAC’s claimed state law defense of equitable subrogation and in finding that that doctrine was precluded by its finding that GMAC was a “volunteer.” Although the doctrine of equitable subrogation had not been applied in the context of a mortgage, the court found that “GMAC’s apparent mistake in accepting the 2007 Note without Mr. Orcutt’s signature, however, does not render equitable subrogation unavailable. Instead, it is precisely for such circumstances that the doctrine was created.” It found that the court erred in finding that GMAC would be a “volunteer” and that it should have addressed whether application of the doctrine would “work any injustice to the rights of others,” including other unsecured creditors.
The court affirmed in part and reversed in part the orders below, and remanded the case with an order that the bankruptcy court consider the equities in the claims allowance process, including the state law defense of equitable subrogation.