Florida District Court upholds bankruptcy court’s decision that when debtors surrender property they no longer have the right to assert a defense in state court foreclosure

On November 23, 2015, the District Court for the Southern District of Florida affirmed a bankruptcy court order to compel chapter 7 debtors to surrender real property by directing them to cease defending the state court foreclosure. In Failla v. Citibank, N.A. (In re Failla) No. 15-80328-CIV (Nov. 23, 2015), after falling into default, resulting in the lender bringing a foreclosure action in state court, the debtors filed a chapter 7 bankruptcy. There was no dispute that the lender’s mortgage constituted a valid first mortgage lien and that the value of the home was less than the lien amount. Consequently, the chapter 7 trustee abandoned the property and the debtors were discharged. They continued to contest the state foreclosure, however. The lender moved the bankruptcy court to compel surrender of the property. The debtors argued they already surrendered the property to the bankruptcy trustee, who abandoned it, which meant they were free to defend against the foreclosure. The bankruptcy court held that under section 521(a)(2) of the Bankruptcy Code a debtor who is unwilling to reaffirm or redeem the mortgage must indicate an intent to surrender the home and tender the property to the mortgagee. Thus, while the debtors did not have to physically surrender the property to the lender, they could not defend contest the foreclosure in state court. On appeal the court was asked to decide 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. Ultimately the court rejected the debtor’s position that the trustee abandoned the property and thence they and the lender were restored to their prepetition status quo as if no bankruptcy petition was filed. It concluded the debtors were wrong about the restoration of rights that existed prepetition. If their position were correct, there would be no discharge of their personal liability on the note associated with the mortgage on the property. The underlying principal of the cases debtors relied on in advancing their theory 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. Any suggestion in the cases that an [sic] abandonment by the trustee has a broader or more expansive legal effect on the relationship of the parties relative to the secured property is an overstatement with no authoritative support. Thus, the abandonment of secured property by the trustee to the debtor pursuant to 11 U.S.C. § 554(c) only restores title to the debtor as if no bankruptcy petition had been filed.

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