April 30, 2002
CANNEY V. MERCHANTS BANK HOLDING
By: Susan Price-Livingston, Associate Attorney
You asked for a summary of the Canney v. Merchants Bank decision and whether it changes the options that Connecticut homeowners have in bankruptcy court. The Office of Legislative Research is not authorized to give legal opinions and this report should not be considered as such.
In Canney v. Merchants Bank, the U. S. Court of Appeals for the Second Circuit held that a defaulting mortgagor could not gain an indefinite extension of time to cure the default by filing a bankruptcy petition after judgment was issued in a strict foreclosure action. The court held that the foreclosure order, which set a deadline for the mortgagor to pay back the loan ("equity of redemption period") was not subject to the federal Bankruptcy Code's automatic stay provisions (284 F. 3d 362 (2002)). The ruling allowed the Vermont lender to take full title to the property when neither the bankruptcy trustee nor the debtor/mortgagor redeemed the mortgage within 60 days of the bankruptcy petition filing.
Prior to Canney, federal bankruptcy courts in Vermont and Connecticut had interpreted the code's automatic stay provisions as tolling indefinitely the running of the equity of redemption period. Canney is an interpretation of the interplay between the code and Vermont's strict foreclosure laws, but the holding suggests that the outcome would be the same under Connecticut's similar statutory scheme.
We enclose a copy of the Second Circuit opinion.
Vermont Mortgage Foreclosure Law
Vermont is one of only two states (Connecticut is the other) that permit a creditor to use "strict foreclosure" rather than "foreclosure by sale" when a debtor defaults on mortgage payments (Vt. Stat. Ann. tit. 12 ch. 163, sub ch. 6). In Vermont, a mortgage conveys legal title to the mortgagee (lender) at the time the mortgage is granted, while the mortgagor has equitable rights to use and possession. Once a mortgage condition is broken, the mortgagee is entitled to immediate possession (Rassman v. Am. Fid. Co. , 142 Vt. 623 (1983)).
The lender can formally take possession of the property by obtaining a foreclosure judgment in the county court where the property is located. This judgment gives it full legal and equitable title to the property, unless the mortgagor cures his default (e. g. , repays the loan) within the equity of redemption period set by the court (Stowe Ctr. V. Burlington Sav. Bank, 141 Vt. 634 (1982)).
Connecticut's similar statutory scheme can be found at CGS §§ 49-1, et seq.
Federal Bankruptcy Law
Two sections of the Bankruptcy Code deal with a creditor's right to secure a debtor's property once the debtor has filed a bankruptcy petition. The first, concerning automatic stays, provides:
a. Except as provided in subsection (b) of this section, a petition filed under section 301, 302, or 303 of this title.... operates as a stay, applicable to all entities, of-
1. the commencement or continuation ... of a judicial, administrative, or other action or proceeding against the debtor that was or could have been commenced before the commencement of the case under this title, or to recover a claim against the debtor that arose before the commencement of the case under this title;
2. the enforcement, against the debtor or against property of the estate, of a judgment obtained before the commencement of the case under this title;
3. any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate;
4. any act to create, perfect, or enforce any lien against property of the estate; or
5. any act to create, perfect, or enforce against property of the debtor any lien to the extent that such lien secures a claim that arose before the commencement of the case under this title (11 USC § 362(a)).
The second relevant section of the code concerns the validity of nonbankruptcy orders or agreements made before the petition was filed. It provides:
[I]f applicable nonbankruptcy law, an order entered in a nonbankruptcy proceeding, or an agreement fixes a period within which the debtor...may file any pleading, demand, notice, or proof of claim or loss, cure a default, or perform any other similar act, and such period has not expired before the date of the filing of the petition, the trustee may only file, cure, or perform, as the case may be, before the later of-
1. the end of such period, including any suspension of such period occurring on or after the commencement of the case; or
2. 60 days after the order for relief (11 USC § 108(b)).
After obtaining several loans from Merchants Bank and securing the loans, in part, by mortgages on his property in Vermont, Maxwell Frazer defaulted on the loans. The bank obtained a strict foreclosure judgment from a county court that specified the amounts due and a deadline for Frazer to cure his default. Days before the deadline, Frazer filed for bankruptcy protection in Vermont's federal bankruptcy court.
Several months after Frazer filed the bankruptcy petition and after the redemption period specified in the foreclosure action had passed, the bank attempted to assert its right to full title in the mortgaged property. It argued that the running of the equity of redemption period was not stayed by 11 USC § 362, the portion of the bankruptcy code that stops creditor collection efforts when a bankruptcy petition is filed. The bank relied on decisions from the federal appeals courts for the 6th, 7th, and 8th circuits that concluded that another portion of the code, § 108(b), takes precedence over § 362 in this situation. Under § 108(b), the redemption period ended 60 days after Frazer filed his bankruptcy petition.
Bankruptcy Court's Ruling. The bankruptcy court denied the bank's motion. Relying on unappealed decisions of bankruptcy courts in Vermont and Connecticut, the two states in which strict foreclosure is the usual method of foreclosure, the court held that § 362 stays indefinitely the running of the equity of redemption period (In re Frazer, 238 B. R. 262 (Bankr. Vt. 1999)). Merchants Bank appealed.
District Court's Ruling. The federal court for the district of Vermont reversed the bankruptcy court (253 B. R. 513 (D. Vt. 2000)). It found persuasive decisions from other circuits that analyzed how § 108(b) and § 362(a) interrelate and concluded that the timing provisions of § 108(b) take precedence over § 362(a) tolling provisions in cases where no affirmative act is required to acquire title. The district court noted that the Vermont cases taking a contrary view relied primarily on the legislative history of § 362(a) but did not consider the uniqueness of Vermont's strict foreclosure laws. The district court concluded that, with respect to an entity holding a mortgage secured by property in Vermont, title passes automatically when the redemption period expires, without any additional act required after the filing of the bankruptcy petition.
The court also stated that, while debtors are generally protected from their creditors under the indefinite stay provisions of § 362(a), "that protection is limited for those who had pre-existing agreements to pay by a particular date under § 108(b)" (p. 518).
Second Circuit Decision. The Second Circuit affirmed the district court's holding that the Bankruptcy Code's automatic stay provisions do not toll the running of the equity of redemption period. In analyzing whether § 362(a) or 108(b) apply in the case, it noted that state law creates and defines property interests while federal law determines what property passes into the bankruptcy estate. Because Frazer sought bankruptcy protection after the Vermont strict foreclosure judgment had been entered but during the redemption period specified in that judgment, Frazer's equity of redemption, a contingent equitable interest in the property subject to extinguishment absent redemption within the allotted time, became "property of the estate" within the meaning of federal bankruptcy laws.
The Second Circuit agreed with the district court that § 108(b), not § 362(a), governs the tolling of the equitable redemption period. The automatic stay prevents only certain affirmative acts taken by a creditor, and the running of time is not one of those acts. It held that the period of equitable redemption was extended by § 108(b) by 60 days after Frazer filed the bankruptcy petition. The equity of redemption was foreclosed when the extended period lapsed without redemption by Frazer or the bankruptcy trustee, and under Vermont law Merchants Bank acquired full legal and equitable title at that time. Having failed to redeem during the period of equitable redemption, neither Frazer nor the trustee had a legal interest in the property that justified encumbrance by federal bankruptcy laws.
POSSIBLE IMPACT ON BANKRUPTCY FILINGS IN CONNECTICUT
Like Vermont, Connecticut permits creditors to use strict foreclosure procedures in some circumstances (Baxter Dunaway, The Law of Distressed Real Estate: Foreclosure, Workouts, Procedures § 12. 16 (1999)). Its bankruptcy court has used reasoning similar to that overruled in Canney in finding the equity of redemption period to be indefinitely tolled by the filing of a bankruptcy petition (In re St. Amant, 41 B. R. 156 (Bankr. Conn. 1984). As the Second Circuit's interpretations of the Bankruptcy Code are binding on Connecticut federal courts, absent a conflicting ruling from the U. S. Supreme Court, it appears likely that in future cases involving pre-petition strict foreclosures in Connecticut, the running of the equity of redemption period will be limited to 60 days after the filing of the bankruptcy petition.