Secured creditors need not file a proof of claim to lift the automatic stay to proceed with a foreclosure action

In the Matter of Richard Louis Alexander (7th Cir., 2011) U.S. App. LEXIS 17110, (August 16, 2011)

CASE SNAPSHOT

An individual debtor appealed the Bankruptcy Court’s orders lifting the automatic stay to permit two creditors to proceed with foreclosure proceedings on real property. The debtor argued that relief from the automatic stay was improper because neither creditor filed a proof of claim. The Seventh Circuit affirmed the relief from stay order, holding that a secured creditor need not file a proof of claim to exercise its secured real property interests, and that such in rem rights “pass through” the bankruptcy case unaffected.

FACTUAL BACKGROUND

Kondaur Capital and Prime Asset Fund II were assignees of a promissory note and mortgage executed by Richard Alexander. Alexander defaulted, and these two secured creditors initiated foreclosure proceedings in state court. Alexander filed bankruptcy, and the creditors moved to lift the automatic stay so that they could proceed with the foreclosure. The creditors provided sufficient proof that the debtor failed to make monthly payments and that the debtor lacked any equity interests in the property. The debtor objected to the motions, arguing that neither creditor had filed a proof of claim. The Bankruptcy Court held that the secured creditors did not have to file proofs of claim, and that they could pursue their claims in state court. The District Court affirmed.

COURT ANALYSIS

In reviewing the findings of the lower courts, the Seventh Circuit Court of Appeals found no clear error in the factual conclusions, and it was evident that the creditors’ interests were not adequately protected and the debtor had no equity in the properties.

The court considered the debtor’s arguments that creditors could not seek to lift the automatic stay unless they filed proofs of claim. The Seventh Circuit summarily disposed of the argument, holding that a “secured creditor can bypass his debtor’s bankruptcy proceeding and enforce his lien in the usual way, which would normally be by bringing a foreclosure action in a state court. This is the principle that liens pass through the bankruptcy unaffected.”  

The court therefore denied the debtor’s objections, finding that no proofs of claim were required, and that there was cause to lift the automatic stay.  

PRACTICAL CONSIDERATIONS

This decision bolsters black letter bankruptcy law that a secured creditor’s real property rights against collateral “pass through” the bankruptcy case unaffected, and that a secured creditor may “opt out” of the distribution-of-assets scheme provided for by the Bankruptcy Code. Nevertheless, it is usually advisable to timely file a proof of claim, and a secured creditor should seek the advice of bankruptcy counsel before choosing to not file a proof of claim for strategic reasons.