Wrongful Possession Does Not Confer Property Interest

Posted by NCBRC - September 13, 2022

“[A] debtor’s mere possession of a property, without a good-faith claim to it, does not save an installment contract for § 1322(c)(1) relief.” In re Peralta, No. 20-3496 (3rd Cir. Sept. 7, 2022).

The debtor bought his house on an installment contract rather than through a traditional mortgage. After he breached the contract, he and the seller entered into a new agreement where the debtor agreed to resume regular payments but if he defaulted again, the seller would exercise its right to get a judgment for possession, and the debtor would vacate the house. The agreement specified that a second breach would “extinguish[ ] any and all rights, liens, and/or interest” the debtor had in the house.

The debtor defaulted again. The seller exercised his state remedy for breach of the installment contract and obtained the judgment for possession. But, instead of vacating the house, the debtor filed for chapter 13 bankruptcy. He listed an interest in the property in his schedules and sought to cure the default.

The bankruptcy court found he had an equitable interest in the property that could be provided for in his bankruptcy under section 1322. The district court vacated, finding that once the seller obtained a judgment of possession, the debtor’s entire interest in the property was extinguished. The debtor appealed to the Third Circuit.

As a general principle, the court found that section 1322(c)(1), which allows a debtor cure a “default with respect to, or that gave rise to, a lien on the debtor’s principal residence,” applies to installment contracts. That section specifies that a debtor’s right to cure expires once a foreclosure sale has taken place.

Because default on an installment contract does not end in foreclosure, the court noted that the text of section 1322(c)(1) is not a perfect fit. It found, however, that judgment for possession available to sellers in defaulted installment contracts was analogous to mortgage foreclosure. Drawing on that analogy, the court noted that the Third Circuit has adopted the “gavel rule” for determining when the mortgage debtor loses all interest in the mortgaged property. Under that rule, equitable interest transfers when the gavel falls to mark the successful bidder in the foreclosure sale, rather than at the later date of legal transfer of the deed to the new owner.

The court held in the case of installment contracts that equitable title transfers when the seller obtains a judgment for possession. Because the debtor loses all interest in the property at that time, continued physical possession does not confer any rights on the debtor.

The court found the bankruptcy court’s reliance on In re Grove, 208 B.R. 845 (Bankr. W.D. Pa. 1997), was erroneous. That case, dealing with the same factual situation as this case, held that a debtor’s continued possession of the property conferred a possessory interest that was subject to protection in bankruptcy. The court here found that Grove failed to address the similarity between a mortgage foreclosure and a judgment for possession. Also, Grove erroneously relied on another case where the debtor remained on the property with the owner’s permission.

The court concluded that because the seller had obtained a judgment for possession prior to the debtor’s bankruptcy filing, the debtor entered bankruptcy with no property interest in the home and could not avail himself of the right to cure offered by section 1322.

Peralta 3rd Cir Sept 2022


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