Mortgage Deficiency Judgment Liens Are Avoidable

Posted by NCBRC - July 24, 2017

Section 522(f)(2)(C) does not create an exception to lien avoidance for mortgage deficiency judgment liens. In re Pace, No.16-8036 (B.A.P. 6th Cir. June 20, 2017).

Antoinette Pace filed a chapter 13 petition in which she scheduled her residence with a value of $147,630 and claimed a homestead exemption in the amount of $132,900. At that time, Farmers National Bank (FNB) held two judicial liens resulting from post-foreclosure deficiency judgments (though the two liens appeared duplicative, the bankruptcy court and the BAP treated them as separate liens). There were also two liens on the house held by Midland Credit Management (MCM) and Matthew Giannini, as well as a county lien against the property for unpaid real estate taxes. Ms. Pace converted to chapter 7 and moved to avoid the non-tax liens as impairing her homestead exemption. The motion was unopposed. The bankruptcy court granted the motion to avoid the MCM and Giannini liens, but denied the motion to avoid the liens held by FNB.

On appeal, the Bankruptcy Appellate Panel began by rejecting Ms. Pace’s argument that because her motion was uncontested it should have been granted with respect to all the liens. The court found that a movant has the burden of demonstrating the merits of her motion and a court has the authority and obligation to assess its merits without regard to whether it is opposed.

Ms. Pace next argued that FNB’s liens were avoidable under section 522(f)(1) in accordance with the specification in 522(f)(2)(A) that a lien impairs an exemption when the sum of all liens plus the amount of the exemption “exceeds the value that the debtor’s interest in the property would have in the absence of any liens.” It was undisputed that, based on this calculation alone, Ms. Pace would have been entitled to judgment in her favor.

The bankruptcy court, however, interpreted section 522(f)(2)(C), which provides that “[t]his paragraph shall not apply with respect to a judgment arising out of a mortgage foreclosure,” as an exception to the larger avoidance provision and found that FNB’s liens were not avoidable.

The BAP disagreed, noting that, while the Sixth Circuit has not addressed the issue, the majority of courts have found that deficiency judgments are not “judgment[s] arising out of a mortgage foreclosure.” The panel walked through the various analyses courts have used to reach this conclusion, beginning with courts that have found that deficiency judgments are incidental to the judgment of foreclosure to which section 522(f)(2)(C) actually applies. Other courts have examined state foreclosure laws to determine that deficiency judgments are based on the promissory note rather than the security interest and do not, therefore, fit within the meaning of the avoidance exception.

Still other courts, notably the First Circuit in Banknorth, N.A. v. Hart (In re Hart), 328 F.3d 45 (1st Cir. 2003), have found that the text of section 522(f)(2)(C) does not create an exception to avoidance at all, and that, therefore, resort to state law to determine the nature of a deficiency judgment is unnecessary. The Hart court reasoned that section 522(f)(1) generally authorizes avoidance of judicial liens that impair exemptions. Section 522(f)(2)(A) provides, for “purposes of this subsection,” a method for determining whether a lien is subject to avoidance under section 522(f)(1). Subparagraph (f)(2)(C), however, is limited to “this paragraph,” and serves to further define the terms within paragraph (f)(2) rather than carve out a separate exception to the lien avoidance provision. The Hart court found that section 522(f)(2)(C) “clarifies that the entry of a foreclosure judgment does not convert a consensual mortgage into a judicial lien which may be avoided.” A deficiency judgment lien, on the other hand, is a judgment lien like any other for purposes of avoidance.

The BAP agreed with and adopted the reasoning set forth by the First Circuit in Hart. The panel reasoned further that had Congress intended section 522(f)(2)(C) to create an exception to avoidance, it would have made section 522(f)(1) subject to paragraph (2)(C), as it did with the exception set forth in paragraph (3). The panel concluded that “522(f)(2)(C) can and must be applied in accordance with its plain meaning; it does not preclude avoidance of mortgage deficiency judgment liens.”

Pace 6th BAP opinion June 2017



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