Unlawful Possession of Real Property Does Not Create Property Interest

Posted by NCBRC - December 11, 2020

Where the debtor was subject to a state court judgment cutting off his right to cure the default on an installment land contract, he had no interest in the property despite his continued unlawful possession and, therefore, the bankruptcy court erred in confirming the debtor’s chapter 13 plan that provided for payment of the default judgment. In re Peralta, No. 20-2380 (E.D. Pa. Dec. 4, 2020).

The debtor entered into an installment contract with the creditor for the transfer of real property. After the debtor defaulted on the contract, a new agreement was reached obligating the debtor in the event of future default to submit to a default judgment and vacate the property. He defaulted and the creditor obtained a judgment in the amount of $41,151.70, as well as a Judgment for Possession in state court. But rather than vacate the property, the debtor filed for chapter 13 bankruptcy and proposed a plan under which he would pay off the judgment and obtain possession of the property free and clear of the creditor’s interest. The bankruptcy confirmed the plan over the creditor’s objection.

On appeal to the district court, the creditor argued that confirmation of the debtor’s plan violated the Rooker-Feldman doctrine which comes into play when “(1) the federal plaintiff lost in state court, (2) the plaintiff complains of injuries caused by the state-court judgment, (3) that judgment issued before the federal suit was filed, and (4) the plaintiff invites the [federal] court to review and reject the state-court judgment.” Here the court found that the doctrine was inapplicable because the bankruptcy court did not review and reject the state court judgment, but rather, allowed the debtor to provide for that default judgment in his plan. Thus, the prohibited appellate review by a federal court of a state court judgment did not take place.

The court moved on to whether the bankruptcy court erred when it found that the debtor entered bankruptcy with a possessory interest in the property which could be provided for in his plan. Property of the bankruptcy estate under section 541 includes all property the debtor has a legal or equitable interest in when he files his petition. While federal bankruptcy law determines what interests become part of the bankruptcy estate, non-bankruptcy law governs the nature of a debtor’s property interests.

Under Pennsylvania law an installment land contract is a security device giving the purchaser an equitable interest in the property. Once the state court rendered the judgment against the debtor and gave the creditor possessory rights, the debtor’s right to cure the default under section 1322(c) was cutoff. At that point, the debtor no longer had any legal or equitable interest in the property. The court stated, “Continued possession alone of the property by the debtor post-judgment will not extend the cutoff point, because the debtor no longer has what is necessary for inclusion within the scope of § 541: ‘a good-faith, colorable claim to possession.’”

The court found the bankruptcy court’s reliance on, In re Grove, 208 B.R. 845 (Bankr. W.D. Pa. 1997), which interpreted In re Atlantic Business and Community Corp., 901 F.2d 325, 328 (3d Cir. 1990), was misplaced. In Atlantic Bus., the Third Circuit held “that a debtor’s possession of a tenancy at sufferance creates a property interest as defined under Section 541.” The Grove court erroneously applied this to an installment land contract where the debtor’s continued possession of the subject property was not authorized, explicitly or implicitly, by the creditor. The court here concluded that because the debtor’s right to cure under section 1322(c) was cut off by the state court judgment, the property should never have been considered to be part of his bankruptcy estate.

The court vacated and remanded.

Peralta ED Pa Dec 2020


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