The Bankruptcy Appellate Panel of the Sixth Circuit recently held that a condominium unit owners association did not violate a debtor’s Chapter 7 discharge order by scheduling a sheriff’s sale to complete a prepetition foreclosure.

Rejecting the bankruptcy court’s conclusion that the in rem foreclosure sale was scheduled to induce payment of discharged pre-petition condominium fees, the Sixth Circuit BAP noted that “all foreclosure litigation potentially can induce payments of discharged debt to avoid a foreclosure sale.”

Accordingly, the Sixth Circuit BAP held that the foreclosure was not a disguised in personam collection effort, and that the denial of foreclosure was contrary to a condominium association’s in rem rights.

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

A debtor had a mortgage loan on his condominium located in Ohio.  The mortgagee’s predecessor filed a state court foreclosure action.  The mortgagee’s predecessor as well as the debtor’s condominium unit owners association received a foreclosure judgment decree that required a sheriff’s sale of the condominium upon issuance of a praecipe by either creditor.

The debtor defaulted on his mortgage loan and filed a petition for relief under Chapter 7 of the Bankruptcy Code.  The debtor listed the condominium as his residence.  The condominium unit owners association filed a motion for relief from the stay, abandonment, and permanent in rem relief.  The bankruptcy court denied the association’s motion for a permanent in rem order for lack of cause.

The debtor received his Chapter 7 discharge and the case was closed.  Almost immediately thereafter, the condominium association filed the praecipe in the state foreclosure action to schedule a sheriff’s sale of the condominium.

The debtor moved to reopen his bankruptcy case.  The debtor requested that the bankruptcy court vacate and or stay the sheriff’s sale on the condominium.  The bankruptcy court entered an order reopening the debtor’s case to determine whether the foreclosure was a disguised in personam action against the debtor, in contempt of the discharge order.

After a hearing where the condominium association failed to present evidence, the bankruptcy court ordered the sheriff s sale to be stopped and set a hearing on whether additional contempt sanctions against the association were appropriate.

At the sanctions hearing, the condominium association presented testimony that the fees sought from the debtor were post-petition and that it was the association’s matter of course to pursue foreclosure to have a reliable paying owner take title to the condominium.  The association presented further testimony that it was struggling to address the concerns arising out of the debtor’s constant delinquency on the condominium’s assessments and fees.  At the time of the hearing, the debtor had been delinquent for approximately seven years.

The bankruptcy court ruled that the condominium association’s foreclosure was an attempt to force the debtor to pay pre-petition fees in violation of the discharge.  As part of its remedy, the bankruptcy court enjoined the association from further enforcement of its prepetition foreclosure judgment and instead suggested that the association exercise its option for a new post-petition foreclosure.  The bankruptcy court also held that the association’s attempt to collect attorney fees was an improper attempt to setoff discharged prepetition obligations.

The condominium association appealed the bankruptcy court’s order.

The Bankruptcy Appellate Panel of the Sixth Circuit held that the lower court abused its discretion in concluding that the association’s foreclosure was a disguised in personam collection of discharged debt.

The Court noted the general rule that the discharge of personal obligations through a Chapter 7 discharge does not terminate a secured creditor’s in rem rights unless the creditor’s lien was avoided during the bankruptcy.  Consequently, the Court held that the condominium association could proceed in rem against the condominium.

The bankruptcy court had concluded that the foreclosure sale was scheduled to induce payment of discharged pre-petition condominium fees.  However, the Sixth Circuit BAP explained that all foreclosure litigation potentially can induce payments of discharged debt to avoid a foreclosure sale, because a lien like the association’s statutory lien applies to all the underlying indebtedness, whether personally discharged or not.

The Sixth Circuit BAP found persuasive the condominium association’s struggle to address the debtor’s length of delinquency of condominium fees and assessments.  The debtor’s delinquency issues had been ongoing for approximately seven years at the time of the sanctions hearing.  Furthermore, the association’s representative testified that the association was attempting to stop the bleeding of fees and replace the debtor with a fee paying unit owner.  The Court noted that the association’s only legal redress was to complete the long delayed foreclosure scheduling the sheriff’s sale.

The Sixth Circuit BAP also noted that the bankruptcy court gave too little weight to the fact that a condominium association is not a typical mortgagee or lienholder.  Rather, the Court noted, such associations have statutory obligations to other owners, and here the association had a reason to believe that the debtor may not pay the ongoing post-petition fees and assessments or the arrears that existed at the time of discharge

The Sixth Circuit BAP determined that to uphold the bankruptcy court’s order would allow bankruptcy courts to second guess a state ordered foreclosure proceeding, conducted in compliance with state law, as a disguised effort to collect discharged debt.

The Sixth Circuit BAP rejected the bankruptcy court’s emphasis on the condominium association’s lack of equity due to the superiority of the mortgagee’s lien.  The Sixth Circuit BAP noted that the bankruptcy court did not consider that the costs of completing the foreclosure would be paid to the association, that the burden was on the debtor to show contempt, and that the sale price for a foreclosure cannot be known until the sale is actually completed.   The Sixth Circuit BAP held that by ignoring these factors, the bankruptcy court imposed an equity requirement that is absent in Ohio foreclosure sale process.

As to the remedy imposed, the Sixth Circuit BAP held that the bankruptcy court abused its discretion by enjoining the condominium association from enforcing the prepetition foreclosure judgment.

The Sixth Circuit BAP also rejected the bankruptcy court’s injunction, in part, because it was contrary to state law.  In essence, the Sixth Circuit BAP noted, the bankruptcy court’s injunction prohibiting the association from pursuing the prepetition foreclosure to be effectuated under any circumstances was a collateral attack on the state foreclosure judgment.

The Sixth Circuit BAP additionally rejected the injunction because it deprived the condominium association’s in rem rights.  The Court noted that a foreclosure judgment is a property interest which replaces a lien and the lienholder is entitled to its enforcement as part of its in rem rights.  The exercise of in rem rights includes either the intended or unintended consequence of requiring the debtor to voluntarily cure arrearages, including prepetition arrearages, or face the loss of the collateral.

The Court noted that the foreclosure here did not distinguish between prepetition and post-petition amounts owed.  The distinction is crucial if a creditor is attempting to collect in personam.  However, for in rem purposes, the Sixth Circuit BAP held that a creditor may enforce its lien as to all sums due, not just post-petition arrears.  Consequently, the Sixth Circuit BAP held that the condominium association could enforce its lien as to all sums due.

Last, the Sixth Circuit BAP held that the bankruptcy court abused its discretion in determining that the condominium association’s post-petition assessment of attorney fees, related to the foreclosure sale, violated the debtor’s discharge.

In support of this holding, the Sixth Circuit BAP first noted that Ohio law permits an association to charge reasonable attorney fees to collect delinquent obligations.  Furthermore, the Court also noted that under the Bankruptcy Code, a discharge under section 727 does not discharge an individual from any debt for a fee that becomes due and payable after the order for relief to a condominium association for as long as the individual has equitable or possessory ownership in that property.   See 11 USC § 523(a)(16).

The Sixth Circuit BAP noted that a condominium association cannot charge attorney fees to collect discharged in personam debts because that would violate a debtor’s discharge.  However, the facts in this matter did not suggest this impermissible action.  Rather, the Court found that the debtor voluntarily continued post-petition to maintain his interest in the condominium and the association had ongoing post-petition obligations that are not related to the in personam collection of a prepetition debt.  In sum, the Court held, the condominium association’s fees were not discharged because they were due or payable post-petition and consequently the association did not violate the debtor’s discharge.

The Bankruptcy Appellate Panel of the Sixth Circuit reversed the lower court’s ruling and vacated the sanctions order in its entirety.