by The Sixth Circuit agreed with the position advanced in NACBA / NCBRC’s amicus brief that the Rooker-Feldman doctrine does not preclude application of the trustee’s strong-arm power to avoid a lien notwithstanding a state court judgment of foreclosure. Isaacs v. DBI-ASG Coinvestor Fund III, LLC (In re Isaacs), No. 17-5815 (6th Cir. July 18, 2018).
Linda Isaacs and her husband entered into a mortgage agreement with GMAC Mortgage Corporation. The contract provided in the “description of security,” that “By signing this Mortgage, we hereby mortgage, grant and convey [the collateral],” and, in the “priority of advances” section, that “The lien of this Mortgage will attach on the date this mortgage is recorded.” Shortly after signing the agreement, Ms. Isaacs filed for chapter 7 bankruptcy. She scheduled GMAC as a secured creditor not realizing that it had not yet recorded the mortgage. GMAC recorded the mortgage while the automatic stay was in effect. Ten years after Ms. Isaacs obtained her chapter 7 discharge, the successor to GMAC, sought an order of foreclosure against the Isaacs. The state court issued a default order of foreclosure and, one day before the scheduled sale, Ms. Isaacs filed for chapter 13 bankruptcy.
In an adversary proceeding against the mortgage purchaser, DBI-ASG Coinvestor Fund (“DBI”), Ms. Isaacs filed a summary judgment motion seeking to avoid the mortgage lien under the Code’s “strong-arm” provision. When that failed, she filed a second motion for summary judgment arguing that the state court judgment of foreclosure was erroneous because the lien had never attached.
The bankruptcy court agreed. It found that Rooker-Feldman did not deprive it of jurisdiction to grant summary judgment to Ms. Isaacs because the exception to that doctrine established by the Sixth Circuit in Hamilton v. Herr (In re Hamilton), 540 F.3d 367 (6th Cir. 2008), applied. In Hamilton, the court held that “[w]hen a state court interprets the discharge order incorrectly, its judgment is void ab initio and therefore poses no Rooker–Feldman bar to subsequent review in the lower federal courts.” Here, the bankruptcy court found that because GMAC had failed to record the lien, the debt was unsecured at the time Ms. Isaacs filed her chapter 7 petition. Thus, there was no lien to survive the bankruptcy and the state court order was contrary to the discharge order.
On appeal, the Bankruptcy Appellate Panel reversed, finding that the lien attached when it was signed by the parties and therefore the Hamilton exception did not apply and the bankruptcy court lacked jurisdiction under the Rooker-Feldman doctrine to review the state foreclosure order. The panel did not address Ms. Isaac’s initial argument that the lien was avoidable in bankruptcy. Isaacs v. DBI-ASG Coinvestor Fund III, LLC (In re Isaacs), 569 B.R. 135 (B.A.P. 6th Cir. 2017).
On appeal, the Sixth Circuit addressed both arguments Ms. Isaacs had raised in the bankruptcy court: 1) the mortgage lien never attached in the first place and the state court erred in enforcing it in its foreclosure order, or 2) the lien was never perfected and could be avoided under the trustee’s strong-arm power without regard to the validity of the foreclosure order.
With respect to the first argument, the Rooker-Feldman doctrine would prohibit the bankruptcy court from addressing the foreclosure order if that order is considered the source of the debtor’s injury. Here, Ms. Isaacs sought a ruling that the state court erred in finding that the mortgage lien had attached. This, the circuit court found, required the bankruptcy court to review the state court judgment for error: an action prohibited by the Rooker-Feldman doctrine. Furthermore, because the foreclosure order did not touch Ms. Isaac’s personal liability on the debt, it did not violate the discharge order under section 524(a) and the Hamilton exception did not apply.
The court went on to note that, while it is true that the bankruptcy court has the power to address the validity of a mortgage lien, under Rooker-Feldman, it loses that power when its exercise would be in the context of reviewing a state court order for error. For that reason, the court found that the bankruptcy court lacked jurisdiction to address Ms. Isaac’s challenge to the state court foreclosure order.
That did not end the question, though, as Ms. Isaac also appealed the bankruptcy court’s rejection of her argument that the chapter 13 trustee could avoid the unperfected mortgage lien, by stepping into the shoes of the “hypothetical judicial lien creditor” under section 544(a)(1) or of the “hypothetical bona fide purchaser” under section 544(a)(3). Because the state court’s foreclosure order did not rely on a finding that the lien was perfected, the bankruptcy court could have ruled in favor of Ms. Isaacs without finding error in the state court order and, therefore, Rooker-Feldman did not apply.
On the merits, DBI argued that any strong-arm power to avoid its lien belonged to the previous chapter 7 trustee rather than the current chapter 13 trustee. The court disagreed, finding nothing in the language of section 544(a) to support DBI’s position and, in fact, finding that section’s grant of avoidance rights “as of the commencement of the case,” contradicted it. The court also rejected DBI’s argument that Ms. Isaac lacked derivative standing to enforce the trustee’s strong-arm power noting that the bankruptcy court had conferred that standing after the adversary proceeding commenced. The court found no requirement that standing be granted prior to the adversary complaint.
Because neither the bankruptcy court nor the BAP addressed Ms. Isaac’s claim that DBI’s lien could be avoided under the trustee’s strong-arm power, the court remanded for review of that issue.
The court declined to address NACBA’s argument that the mortgage could have been avoided as a preferential transfer under section 547 because that argument had not been raised below.