Property of Estate

The debtors’ claim against lenders for charging improper fees during their bankruptcy belonged to the bankruptcy estate, but the lenders’ appeal of the bankruptcy court’s order of abandonment was dismissed because they lacked a direct financial stake in the outcome of the bankruptcy court’s decision and, therefore were not “persons-aggrieved.” In so holding, the Sixth Circuit indicated that had the lenders challenged the “person-aggrieved” standard it would likely have been found to have been abrogated by subsequent Supreme Court precedent and congressional action. Schubert v. Litton Loan Servicing, No. 21-3969 (6th Cir. March 28, 2023).

The debtors alleged that from 2000 to 2004, while they were in bankruptcy, Litton Loan Servicing, L.P., JPMorgan Chase Bank, N.A., and Ocwen Financial Corporation (collectively, “the lenders”), breached their mortgage agreement by collecting fees to which they were not entitled. The debtors received their discharge in 2006 without having disclosed the claim against the lenders to the bankruptcy court, apparently because they only discovered the overcharges a decade later during foreclosure proceedings. Upon discovery, the debtors sued the lenders in state court for breach of contract. The lenders argued that the claim belonged to the bankruptcy estate. The debtors had the state court case stayed and they reopened their bankruptcy case, seeking abandonment of the claim. The lenders opposed abandonment and countersued for an injunction to prevent the debtors from pursuing the state action. The debtors moved to dismiss the lenders’ complaint.

After a hearing, the bankruptcy court denied the debtor’s motion to dismiss and ruled that the claim belonged to the estate. It ordered the trustee to abandon the claim and declined to issue an injunction. Upon appeals by both sides, the district court affirmed.

The case came before the Sixth Circuit on the lenders’ appeal of the abandonment order, and the debtor’s appeal of the denial of their motion to dismiss.

As an initial matter, the court found the lenders had standing to pursue the appeal. The prospect of state court litigation established the necessary “injury fairly traceable to the defendant’s conduct and likely redressable by a favorable decision.”

Another jurisdictional question was more troublesome. The court found the lenders did not pass the “person-aggrieved” test, which bars appeals in bankruptcy by a party “who lack[s] a direct financial stake in the appeal’s outcome.” The person-aggrieved test was included in section 158 of the Bankruptcy Code until Congress removed it in the 1978 amendments to the Code.

The court indicated that the test, which has been deemed to be jurisdictional, is a likely candidate for abrogation in light of the subsequent Supreme Court decision in Lexmark Int’l, Inc. v. Static Control Components, Inc., 572 U.S. 118, 125–27 (2014). Lexmark prohibited a court from limiting its jurisdiction for prudential or policy reasons. “[W]hen Congress creates a right to sue consistent with the Constitution, a court may not take it away.”

However, the lenders did not seek abrogation of the test, so the court rendered its decision based on the test’s continued viability. It found that the lenders did not have the requisite financial stake in the appeal’s outcome because they sought only to preclude state court litigation. “[U]nder our precedent, staving off the threat of litigation doesn’t count. In re LTV Steel Co., Inc., 560 F.3d 449, 452–53 (6th Cir. 2009).”

The court turned next to the debtors’ appeal of the bankruptcy court’s denial of their motion to dismiss the lenders’ adversary complaint. The circuit court stated that the lenders had standing to bring the adversary complaint for the same reason they had standing to appeal. The court also rejected the debtor’s argument that the bankruptcy court lacked the power to determine which claims belong in the estate, finding that that determination is well within the bankruptcy court’s administrative powers under section 157(b)(2)(A).

Finally, the court disagreed with the debtors’ contention that the lenders were not parties in interest. On the contrary, the lenders had “a practical stake in maintaining the settlement of claims the bankruptcy produced.” Had the claim against them been raised during the bankruptcy proceedings, they could have addressed it at that time.

The court dismissed the lenders’ appeal and affirmed the ruling that was the subject of the debtors’ appeal.

In a concurring opinion, Judge Moore stated that the person-aggrieved standard, rather than being at odds with more recent law, “reflects a zone-of-interests analysis that is consistent with Lexmark Int’l, Inc. v. Static Control Components, Inc., 572 U.S. 118 (2014).” Judge Moore observed that the person-aggrieved standard, while most often requiring a financial stake in the proceedings, may also be met when there is a public interest in the outcome of an appeal. In her opinion, when properly applied, the person-aggrieved standard “directs the courts to perform a zone-of-interest analysis in line with Lexmark.”

She agreed with the majority, however, that the lenders’ appeal did not fall under the zone-of-interests the abandonment statute, section 554, was intended to address. That provision was designed to prevent trustees from pursuing the sale of property only to increase the trustee’s commission without benefit to the estate. In this case, the lenders’ appeal was solely intended to free them from state court litigation and would not benefit the bankruptcy estate. Therefore, the appeal was outside the zone of interest.

Schubert 6th Cir March 2023