In a case addressing what it means to "surrender" property under the Bankruptcy Code, the U.S. District Court for the Southern District of Florida recently held that a Chapter 7 trustee's abandonment of real property only restores legal title to the debtors as if no bankruptcy petition had been filed, and does not also give the debtors the right to contest the mortgagee's foreclosure if the debtors elected to surrender the property.

A copy of the opinion is available at: Link to Opinion

Husband and wife debtors defaulted on their mortgage and the mortgagee sued to foreclose. The debtors then filed a chapter 7 bankruptcy case.

In their schedules, the debtors acknowledged that they owned the collateral and that it was encumbered by a valid first mortgage lien that was undisputed, non-contingent and liquidated. The debtors also filed a statement of intention indicating that they would surrender the property.  Although they later tried to amend their statement to reaffirm the mortgage, this effort was untimely under the Bankruptcy Code.

The Chapter 7 trustee eventually abandoned the property and the debtors received a discharge. The state court mortgage foreclosure action filed as to the surrendered and abandoned property was then set for trial.

The mortgagee filed a motion in the bankruptcy court to compel surrender of the property, which the bankruptcy court granted, reasoning that although the term "surrender" is not defined in the bankruptcy code, the Eleventh Circuit Court of Appeals' holding in Taylor v. AGE Fed. Credit Union (In re Taylor) requires a debtor who is unwilling to reaffirm or redeem the mortgage obligation to indicate an intent to surrender the home and tender the property to the mortgagee.

The bankruptcy court also held that although the debtors did not have to physically surrender the property to the mortgagee, they could not defend against or contest the foreclosure in state court, and if they did not surrender the property, their bankruptcy discharge would be in jeopardy.

On appeal to the district court, the debtors argued that the bankruptcy court erred in ruling that the debtors were required to surrender the property to the creditor instead of the bankruptcy trustee, and because the trustee had abandoned the property, the debtors argued they retained all of their rights to the property, including the right to defend the foreclosure action, as if the bankruptcy had never been filed.

The Southern District of Florida began its analysis by examining section 521 of the federal Bankruptcy Code, which requires a debtor with secured debts to file a statement of intention within 30 days after the petition is filed or before the meeting of creditors, whichever is first, indicating whether the property is exempt, will be retained and the debt reaffirmed, or will be surrendered.  The Court noted that section 521 also requires a debtor to "perform his intention with respect to such property" within 30 days after the first date set for the meeting of creditors or within such additional time as the court allows for cause.

The Court held that "[i]f a debtor retains nonexempt collateral under section 521(a)(2), the debtor has the options of reaffirmation, redemption or surrender."  It then characterized the issue before it as "whether the bankruptcy court erred in finding that the duty to surrender is owed solely to the lienholder as opposed to another entity, such as the bankruptcy trustee."

The debtors, relying on a Louisiana federal district court's holding in In re Lair, argued that if the bankruptcy trustee abandons the asset back to the debtor during the case due to a lack of equity or if the property is returned at the end of the case by operation of law, then the debtor and creditor are left to state law remedies and the debtor's surrender would have no effect on the debtors state law rights with respect to the creditor.

The Southern District of Florida pointed out that Lair disagreed with the Eleventh Circuit's ruling in Taylor, which rejected what was called the "ride-through' option," which allowed a chapter 7 debtor to retain the collateral property and make payments without either redeeming the property or reaffirming the debt because it "'gives the debtor not a 'fresh start' but a 'head start' since the debtor effectively converts his secured obligation from recourse to nonrecourse with no downside risk for failing to maintain or insure the lender's collateral.'"

The Court reasoned that the critical question was not whether the property should be surrendered to the trustee or the secured creditor, but rather "what is the legal effect of the debtor's decision to surrender the property?"

The Southern District of Florida agreed with the bankruptcy court that once the debtor decides to "surrender" secured property, the debtor has abandoned any interest or claim that he may have had to the property as against the trustee, if the trustee decides to administer the property, as well as against any secured creditor the debtor listed in the filed schedules as having a valid, undisputed, non-contingent and enforceable secured lien on the property.

The Court held that, although the debtor need not physically deliver the property to the secured party, the debtor is precluded from taking any action which would interfere with the secured creditor's ability to obtain legal title to, and possession of, the property through legal means. "Defending against a foreclosure proceeding relating to the secured property would be inconsistent with the debtor's stated intention to surrender the property within the meaning of 11 U.S.C § 521(a)(2)."

The Court rejected the debtor's argument that after the trustees abandonment, the property reverts to the debtor and stands as if no bankruptcy petition was filed, reasoning that the debtors misunderstood the case law, and if their position was correct, "there would be no discharge of their personal liability on the note associated with the mortgage on the property."

After examining the opinions cited by the debtors, the Southern District of Florida concluded that "the underlying principle which is being espoused is that title to the abandoned property reverts back to the debtor to the same extent as it was held prior to the filing of the bankruptcy."  Abandonment by the bankruptcy trustee, the Court held, has no effect on the "debtor's rights and responsibilities relative to the property that flow from the bankruptcy. Just as a discharge of personal liability to pay the obligation on the note survives after abandonment of the property by the trustee, so too does the legal effect of the debtor' decision to surrender the property pursuant to 11 U.S.C. § 521(c)(2). This legal effect includes a relinquishment of the debtor's interest in the secured property as against the secured creditor, as well as a prohibition against interfering or impeding the secured creditor's efforts to take possession of the property by available legal means."

The Southern District of Florida affirmed the bankruptcy court's order compelling the debtors to surrender the real property in accordance with their statement of intention.