The U.S. Court of Appeal for the Eighth Circuit recently affirmed a bankruptcy court’s rejection of a proof of claim filed by a creditor where the claim was based upon a debt which was time barred by the creditor’s failure to comply with the applicable state law deadline for pursuing a deficiency judgment following a non-judicial foreclosure. 

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

The underlying debt at issue arose from a commercial loan from the creditor to a company owned by the debtors which was secured by a mortgage against certain real property located in Arizona. The debtors were guarantors on the loan from the creditor. Following the default on the loan, the creditor filed an action in the state court of Arizona to recover the balance of the note or alternatively, the deficiency balance due following a trustee’s sale of the property.

Shortly after the creditor filed the state court action, the debtors filed a petition for relief pursuant to chapter 11 of the Bankruptcy Code – effectively preventing the creditor from affecting service on the debtors in that action. The state court dismissed the creditor’s complaint for its failure to perfect service. In a parallel non-judicial foreclosure, the trustee’s sale of the property proceeded on Oct. 9, 2012. 

The creditor then proceeded to file a proof of claim in the debtors’ chapter 11 proceeding based upon their guarantee of the loan to which the debtors objected because it allegedly failed to reflect the market value of the property. The chapter 11 plan was approved and the bankruptcy case closed as fully administered on Nov. 14, 2013. Due to various delays, the hearing on the debtors’ objection to the proof of claim was not heard until several months after the close of the bankruptcy matter in April 2014.

In support of their objection, the debtors argued that the creditor’s claim was barred by Arizona law because the creditor failed to maintain a deficiency action within 90 days of the trustee’s sale. In opposition to the objection, the creditor argued that the Arizona law was preempted by various provisions of the Bankruptcy Code.

The bankruptcy court determined that automatic stay provisions of Section 362 of the Bankruptcy Code impliedly preempted the state law concerning the 90-day deadline — by preventing the creditor from perfecting service on the debtors — but, Section 108(c) provided for the resumption of any state limitations following the expiration of the automatic stay. Under this legal framework, the bankruptcy court determined that the creditor was required to proceed with its deficiency action per Arizona state law no later than Dec. 16, 2013 which it failed to do so. Thus, the bankruptcy court concluded that the creditor’s claim was barred. 

The creditor appealed to the district court which upheld the bankruptcy court’s ruling, and subsequently, this appeal was brought to the Eighth Circuit.

On appeal the creditor raised four primary arguments: (1) the Bankruptcy Code broadly preempts the Arizona law such that the creditor was not required to comply with the statutory deadlines due to the bankruptcy; (2) the mere filing of its state court action was sufficient to comply with the Arizona law; (3) the bankruptcy court had exclusive jurisdiction over the claim which obviate the need for a separate state court action for the deficiency; and (4) the limitations imposed by the Arizona law never lapsed.

The Eighth Circuit began its analysis by explaining the extent of implied preemption of state law by the Bankruptcy Code. 

As explained by the Court, preemption may be “implied, for example, when federal and state laws directly conflict, when state law stands as an obstacle to accomplishing the purpose of federal law, or when federal law is so pervasive that it reflects an intent to occupy the regulatory field.” Symens v. SmithKline Beecham Corp., 152 F.3d 1050, 1053 (8th Cir. 1998). Absent clear congressional intent, there is a general presumption against implied preemption.

The creditor argued that the mandatory language of Section 502 of the Bankruptcy Code concerning the adjudication of claims precluded the need to comply with the Arizona time limits for deficiency judgments. 

Section 502 states that the bankruptcy court “shall determine the amount of [a] claim” following a hearing. The Court disagreed, and explained that the right to a claim arises in the first instance from the underlying substantive law creating the debtor’s obligation, and thus, the bankruptcy courts must “consult state law in determining the validity of most claims.” Travelers Cas. & Surety Co. of America v. Pacific Gas & Elec. Co., 549 U.S. 443, 450 (2007).

The applicable Arizona statute provides that “[W]ithin ninety days after the date of [a trustee’s sale], an action may be maintained to recover a deficiency judgment] against any person” obligated — directly or indirectly — under the contract secured by the deed of trust. Ariz. Rev. Stat. s. 33-814(A) (“Section 33-814”). If no action is brought within that timeline the statute provides that “the proceeds of the sale, regardless of amount, shall be deemed to be in full satisfaction of the obligation and no right to recover a deficiency in any action shall exist.” Id. at s. 33-814(D). Per the courts in Arizona, this provision has been deemed a statute of repose.

The Court determined that Section 502 did not impliedly preempt Section 33-814 of the Arizona Statute. Consequently, the Eighth Circuit held, the bankruptcy court correctly looked to the Arizona statute to determine the validity of the creditor’s proof of claim.

Similarly, the Court rejected the creditor’s argument that Section 362 of the Bankruptcy Code impliedly preempted Section 33-814 because it made it impossible to comply with the 90-day deadline in Section 33-814. The Court declined to directly address whether or not the automatic stay of Section 362 preempted state law, because it held that Section 108 of the Bankruptcy Code governed this situation. 

As you may recall, Section 108 of the Bankruptcy Code provides that if a nonbankruptcy law fixes a time period for commencing a civil action against a debtor “and such period has not expired before the date of the filing of the petition” then the period does not expire until the later of: (1) the end of the period provided by the nonbankruptcy law or (2) “30 days after notice of termination or expiration of the stay under Section 363.” 

Pursuant to Section 33-814, the 90-day period at hand expired on Jan. 7, 2013 – i.e. 90 days after the trustee’s sale on Oct. 9, 2012. However, the automatic stay in the bankruptcy did not expire until Nov. 14, 2013 when the chapter 11 case was closed. Accordingly, the Court found that the bankruptcy court correctly concluded that pursuant to Section 108(c)(2) the operative deadline for the creditor to seek a deficiency judgment under Section 33-814 lapsed on Dec. 16, 2013.

The Eighth Circuit quickly rejected the creditor’s argument that a motion filed by a cocreditor after the close of the chapter 11 was effective in extending the automatic stay. As explained by the Court, these types of motions in reopening a chapter 11 by creditors is typically ministerial in nature and lacks independent legal significance. 

The Court found no merit to the creditor’s argument that its state court complaint was sufficient to comply with Section 33-814. In reliance on a state court opinion applying Section 33-814, the Court agreed that the state court action would have been sufficient but determined that the creditor’s failure to continue or preserve its state court action after the trustee’s sale was dispositive. See Valley Nat’l Bank of Ariz. v. Kohlhase, 897 P.2d 738, 741 (Ariz. Ct. App. 1995).

The creditor’s argument that the bankruptcy court had exclusive jurisdiction was also unavailing. As explained by the Eighth Circuit, regardless of the exclusive jurisdiction provided to the bankruptcy court to determine the validity of the claim under Section 502 of the Bankruptcy Code, it was still required pursuant to the Bankruptcy Code and Supreme Court precedent to apply the underlying state law framework — which the Eighth Circuit held the bankruptcy court correctly did in this matter. 

Accordingly, the Eighth Circuit affirmed the bankruptcy court’s rejection of the creditor’s claim.