First Nat'l Bank of Manchester v. Elza

• Decision Date: 21 August 2015
• Docket Number: Civil No. 14–184–GFVT
• Citation: 536 B.R. 415
• Parties: First National Bank of Manchester, Appellant, v. Paul Edward Elza and Judith Elaine Elza, Appellees.
• Court: U.S. District Court — Eastern District of Kentucky

536 B.R. 415

First National Bank of Manchester, Appellant

v.Paul Edward Elza and Judith Elaine Elza, Appellees.

Civil No. 14–184–GFVT

United States District Court, E.D. Kentucky, Southern Division.

Signed August 21, 2015

R. Aaron Hostettler, Hamm, Milby & Ridings, London, KY, for Appellant.

Joe T. Roberts, London, KY, for Appellees.

MEMORANDUM OPINION & ORDER

Gregory F. Van Tatenhove, United State District Judge

This case comes before the Court on appeal from the United States Bankruptcy Court for the Eastern District of Kentucky. Creditor First National Bank of Manchester challenges the bankruptcy court's Order of May 22, 2014, which granted the Debtors' motion to avoid two judicial liens held by First National, pursuant to 11 U.S.C. § 522(f). For the reasons set forth below, the Court will AFFIRM the bankruptcy court's Order.

I

Debtors Paul and Judith Elza filed a voluntary petition for Chapter 7 bankruptcy on May 10, 2012. [In re Elza, Bankr. Pet. No. 12–60612, Bankr. R. 1]. Pursuant to 11 U.S.C. § 522(f), they moved to avoid several judicial liens, including two held by First National. [Bankr. R. 41]. First National objected. [Bankr. R. 42]. The nature of those liens is the subject of this appeal.

On June 12, 2009, Elza Construction, LLC, a Kentucky limited liability company solely owned by Paul Elza, obtained a second mortgage on commercial property located on the KY–192 Bypass in Laurel County from First National in the principal amount of $203,569.50. [Mortgage, Bankr. R., Claims Register 5–1, Pts. 4–5; Promissory Note, id., Pt. 1 at 3]. The terms of that loan included personal guaranties on the debt from Paul and Judith Elza. [Id. at 5–1, Pts. 2, 3]. The Elzas' residential property, also located in Laurel County, was not given to secure this debt. [See Mortgage, Bankr. R., Claims Register 5–1, Pts. 4–5]. Some time later, Elza Construction defaulted, and First National joined the senior mortgagee in instituting a foreclosure action on the commercial property in Laurel Circuit Court. The state court entered a foreclosure judgment and order of sale. [Ex. State Court Judgment, R. 7–1]. It also ordered that Elza Construction, Paul Elza, and Judith Elza were jointly and severally liable for the balance owed to the senior mortgagee. [See id. at ¶¶ 14, 21, 25]. After the judicial sale of the property and distribution to the senior mortgage holder, a deficiency of $209,486.62 remained owing to First National. On April 25, 2011, First National filed two judgment liens on the Elzas' residential property, claiming the full $209,486.62 deficiency, plus interest, against both Paul and Judith. [Ex. Judgment Liens, R. 7–2].

After a hearing on May 21, 2014, [Bankr. R. 47], the Bankruptcy Court granted the Debtor's motion to avoid these liens. [Order, Bankr. R. 48 at ¶ 7]. First National filed a motion to alter, amend, or vacate that order, [Bankr. R. 49], which the Court denied, [Bankr. R. 54]. This appeal followed.

II

“This Court reviews de novo questions of statutory interpretation, statutory application, and a bankruptcy court's conclusions of law.” Deutsche Bank Nat. Trust Co. v. Tucker, 621 F.3d 460, 462 (6th Cir.2010) (citing In re Ruehle, 307 B.R. 28, 31 (6th Cir. BAP 2004) ). “De novo review requires [this court] to review questions of law independent of the bankruptcy court's determination.” First Union Mort. Corp. v. Eubanks (In re Eubanks ), 219 B.R. 468, 469 (6th Cir. BAP 1998).

This case presents a question of statutory interpretation that has not yet been addressed by the Sixth Circuit, the Sixth Circuit Bankruptcy Appellate Panel, or bankruptcy courts sitting in Kentucky: whether a mortgage foreclosure deficiency judgment lien is a “judgment arising out of a mortgage foreclosure” that is excluded from avoidance under § 522(f)(2)(C). Section 522 of the Bankruptcy Code exempts certain property from the bankruptcy estate. 11 U.S.C. § 522 (2012). Section 522(f) addresses the avoidance of certain liens and provides, in relevant part:

(1) ... [T]he debtor may avoid the fixing of a lien on an interest of the debtor in property to the extent that such lien impairs an exemption to which the debtor would have been entitled under subsection (b) of this section, if such lien is—

(A) a judicial lien, ...

....

(2) (A) For the purposes of this subsection, a lien shall be considered to impair an exemption to the extent that the sum of—

(i) the lien;

(ii) all other liens on the property; and

(iii) the amount of the exemption that the debtor could claim if there were no liens on the property;

exceeds the value that the debtor's interest in the property would have in the absence of any liens.

(B) In the case of a property subject to more than one lien, a lien that has been avoided shall not be considered in making the calculation under subparagraph (A) with respect to other liens.

(C) This paragraph shall not apply with respect to a judgment arising out of a mortgage foreclosure.

Id. (emphasis added). Section 522(f)(1) sets forth the general rule of avoidance. Section 522(f)(2) then provides some explanation on that rule: Sub-paragraph (A) provides a formula “to be utilized in determining whether a particular lien impairs an exemption.” In re Hart, 282 B.R. 70, 73 (1st Cir. BAP 2002), aff'd 328 F.3d 45 (1st Cir.2003). In essence, this Section permits a debtor to avoid certain judicial liens to the extent that the value of the lien, all other liens on the property, and the claimed exemption exceed the value of the debtor's interest in the property. See § 522(f)(1)–(2)(A).

First National does not necessarily dispute that its two deficiency judgment liens are “judicial liens” within the meaning of this section. See 11 U.S.C. § 101(36) (defining “judicial lien as a “lien obtained by judgment, levy, sequestration, or other legal or equitable process or proceeding”). Nor does it necessarily dispute that the application of § 522(f)(1) and (2)(A) would generally require avoidance of its two deficiency liens. Rather, First National's argument is premised solely on § 522(f)(2)(C) : It contends that the deficiency judgments obtained in connection with its foreclosure on the Elzas' business property “aris[e] out of a mortgage foreclosure” under § 522(f)(2)(C) and are therefore unavoidable for the Elzas in their residential Chapter 7 bankruptcy.

A split in authority has emerged on this issue. The overwhelming majority of courts hold that mortgage deficiency liens are not “judgments [that] aris[e] out of a mortgage foreclosure” and are therefore avoidable under § 522(f). E.g., In re Hart, 328 F.3d 45 (1st Cir.2003) ; In re Maxwell, 2010 Bankr. LEXIS 4082, 2010 WL 4736206 (Bankr.E.D.Tenn. Nov. 16, 2010) ; In re Burns, 437 B.R. 246 (Bankr.N.D.Ohio 2010) ; In re Linane, 291 B.R. 457 (Bankr.N.D.Ill.2003) ; In re Carson, 274 B.R. 577 (Bankr.D.Conn.2002) ; In re Smith, 270 B.R. 557 (Bankr.W.D.N.Y.2001). First National points to two bankruptcy court decisions that reach the opposite conclusion and hold that § 522(f)(C) precludes avoidance of such liens. In re Criscuolo, 386 B.R. 389 (Bankr.D.Conn.2008) ; In re Vincent, 260 B.R. 617 (Bankr.D.Conn.2000). Two grounds support these decisions: Some courts turn to substantive state foreclosure law to determine whether a deficiency judgment lien indeed “arises out of” a mortgage foreclosure judgment in their respective states. Others, led by the First Circuit and the First Circuit Bankruptcy Appellate Panel, find the language and structure of § 522(f) “sufficiently clear” to resolve the issue and therefore do not resort to state law. Many, including two bankruptcy courts within this circuit, rely on both rationales.

The Sixth Circuit has made clear that statutory interpretation of a Bankruptcy Code provision begins with the “language of the statute itself,” Tucker, 621 F.3d at 463, so the First Circuit's statutory analysis in In re Hart, 328 F.3d 45 (1st Cir.2003), is a useful place to start. See also In re Hart, 282 B.R. 70 (1st Cir. BAP 2002), aff'd 328 F.3d 45 (1st Cir.2003) (hereinafter Hart B.A.P. ). In that case, the bank had previously foreclosed on the debtors' real property located in Maine and had obtained a deficiency judgment. The bank then domesticated that judgment in Massachusetts, where the debtors owned another residential property, and recorded a deficiency lien against that property. When the debtors filed for bankruptcy in Massachusetts, the bank argued that its mortgage deficiency lien was unavoidable pursuant to § 522(f)(2)(C).

After scrutinizing the language and structure of § 522(f), the First Circuit and First Circuit Bankruptcy Appellate Panel in Hart determined that the statute was “sufficiently clear” that mortgage deficiency liens are avoidable despite § 522(f)(2)(C). First, the court clarified the relevant internal references: § 522(f) is a “subsection;” § 522(f)(2) is a “paragraph;” and § 522(f)(2)(C) is a “subparagraph.” Hart B.A.P., 282 B.R. at 74. With this taxonomy in mind, the court determined that the phrase “this paragraph” in § 522(f)(2)(C) is a reference to § 522(f)(2). In turn, the formula in § 522(f)(2)(A) applies to “this subsection,” meaning the entirety of § 522(f). Under the general rule in § 522(f)(1), “the only liens which may be avoided under § 522(f) are ‘judicial liens.’ ” Hart B.A.P., 282 B.R. at 76 (internal quotation marks added). Consequently, the court explained, the formula in the formula set forth in § 522(f)(2)(A) is to be applied to all “judicial liens,” Hart, 328 F.3d at 48 —and not to the “judgments” in § 522(f)(2)(C).

This structure also convinced the Hart Court that § 522(f)(2)(C) was not intended as an exception, but as a clarification about the scope of avoidability. The phrase “this paragraph” in § 522(f)(2)(C) is a reference to § 522(f)(2) —not the entirety of § 522(f). That is, it was not drafted as an exception to the general rule stated in § 522(f)(1), or, for that matter, § 522(f). See id. at 77. The First Circuit's Bankruptcy Appellate Panel was...