Riley v. Instamortgage.Com (In re Smith)

• Decision Date: 15 July 2015
• Docket Number: Adversary Proceeding No. 13-1357,Case No. 07-14013-FJB
• Parties: In re JOHN BENJAMIN SMITH, JR., Debtor LYNNE F. RILEY, CHAPTER 7 TRUSTEE, Plaintiff v. INSTAMORTGAGE.COM and UNITED STATES OF AMERICA, Defendants and UNITED STATES OF AMERICA, Crossclaim Plaintiff v. PHH MORTGAGE CORPORATION, d/b/a INSTAMORTGAGE.COM and JOHN BENJAMIN SMITH, JR., Crossclaim Defendants
• Court: United States Bankruptcy Courts. First Circuit. U.S. Bankruptcy Court — District of Massachusetts

In re JOHN BENJAMIN SMITH, JR., Debtor

LYNNE F. RILEY, CHAPTER 7 TRUSTEE, Plaintiff v. INSTAMORTGAGE.COM and UNITED STATES OF AMERICA, DefendantsandUNITED STATES OF AMERICA, Crossclaim Plaintiff v. PHH MORTGAGE CORPORATION, d/b/a INSTAMORTGAGE.COMand JOHN BENJAMIN SMITH, JR., Crossclaim Defendants

Case No. 07-14013-FJB

Adversary Proceeding No. 13-1357

UNITED STATES BANKRUPTCY COURT DISTRICT OF MASSACHUSETTS EASTERN DIVISION

July 15, 2015

Chapter 7

MEMORANDUM OF DECISION

The complaint and crossclaims in this adversary proceeding seek to determine the validity of a mortgage held by defendant PHH Mortgage Corporation, d/b/a InstaMortgage.com ("PHH"), as against one-half of the debtor's interest in certain real property and the priority of various interests in the same property. The adversary proceeding is before the Court on four motions: (i) a motion by the debtor to dismiss the complaint and the crossclaim of the United States; (ii) a cross-motion by the United Statesfor declaratory relief and for relief from the automatic stay; (iii) a motion by PHH to dismiss the claims and crossclaims against it as time-barred; and (iv) a motion by the plaintiff chapter 7 trustee for judgment on the pleadings as to the validity and extent of PHH's mortgage.

PROCEDURAL HISTORY

On June 27, 2007, John Benjamin Smith, Jr. ("the Debtor") filed a petition for relief under chapter 7 of the Bankruptcy Code, thereby commencing the present bankruptcy case. Lynne F. Riley (the "Trustee") was appointed chapter 7 trustee and continues to serve in that capacity. On the date of the filing, the Debtor's assets included a single-family home in Cambridge, Massachusetts (the "Property"); and the Property was subject to a tax lien in favor of the United States (the "First IRS Lien") and, at least in part, to a mortgage in favor of PHH (the "Mortgage"). The United States now also asserts against the Property a second tax lien (the "Second IRS Lien"), which arose postpetition. With his petition the Debtor filed a schedule of exemptions in which he claimed a homestead exemption as to the Property under Massachusetts law in the amount of $350,000. No objection was filed to this claim of exemption.

On September 11, 2013, the Trustee filed the complaint commencing this adversary proceeding, and on October 29, 2013, she filed an amended complaint, the currently operative iteration (the "Amended Complaint"). It demands declaratory relief against PHH and the United States of America in three counts as follows:¹

(i) in Count I, a declaration that the Mortgage (a) is subordinate to the First IRS Lien and (b) will continue to be subordinate to the penalty portion of that lien if and when the Trustee avoids that portion of the lien under 11 U.S.C. § 724(a)(1) and preserves the same for the benefit of the estate under 11 U.S.C. § 550;(ii) in Count II, a declaration that the Mortgage encumbers only one-half of the Debtor's interest in the property, the half that belonged to a Michael Connolly when the Mortgage was granted; and

(iii) in Count III, a declaration that the Second IRS Lien is valid but subject to (and only to) (a) the First Position IRS Lien (including the portion of the First Position IRS Lien that will be preserved for the bankruptcy estate under 11 U.S.C. §§ 724(a) and 550), (b) PHH's Mortgage against the fifty percent interest in the Property that formerly belonged to Connolly, and (c) the Trustee's rights under 11 U.S.C. § 544(a), including as a hypothetical bona fide purchaser of the Property.

In its answer to the Amended Complaint, the United States agrees with the Trustee as to the declaratory relief sought in each count. With its answer the IRS asserted crossclaims against PHH and the Debtor for declarations that, in the event the Property is sold by the Trustee, the United States shall be entitled to the following:

(i) a distribution satisfying the First IRS Lien from the proceeds of the sale after the payment of expenses of administration qualifying under § 506(c), except to the extent that the Trustee exercises her right to avoid the penalty portion of said tax lien and preserves the same for the estate under § 724(a) and § 550 ("First Cross Claim"²);

(ii) a distribution satisfying the Second IRS Lien from the proceeds that remain after the satisfaction of § 506(c) expenses and the First IRS Lien (hereafter referred to as the "divisible proceeds") by dividing the divisible proceeds into two equal halves and treating them as follows: (1) satisfying the claim of PHH first from one half of the divisible proceeds and thereafter distributing the remainder, if any, to the United States; and (2) distributing to the United States so much of the other half of the divisibleproceeds (up to the full amount thereof) as may be needed to satisfy the Second IRS Lien, notwithstanding that the balance left to distribute to the Debtor in respect to his homestead exemption may be less than the maximum amount of that exemption ("Second Cross Claim"); and

(iii) to the extent that the Trustee avoids the penalty portion of the First IRS Lien and preserves it for the estate under §§ 724(a) and 550, the United States may collect said penalties from any remaining proceeds of the sale of the Property that would otherwise be available to the Debtor as a result of his homestead exemption ("Third Cross Claim").

PHH filed an answer to the Amended Complaint in which it conceded nothing. Two months later, PHH also moved under Fed R. Civ. P. 12(b)(6) to dismiss both the Amended Complaint and the Crossclaim. As to both, PHH argues that its mortgage is valid under Massachusetts law, that the Trustee can therefore prevail only by exercise of her avoidance powers under 11 U.S.C. § 544(a), but that the Trustee is time-barred from doing so by the two-year limitation in 11 U.S.C. § 546(a)(1)(A). Though the motion to dismiss purports to seek dismissal of the Amended Complaint and the Crossclaims in their entirety, it does not address the issues of priority that would remain even if the Court were to rule for PHH on the validity of its mortgage.

The Debtor, too, has moved under Rule 12(b)(6) to dismiss both the Amended Complaint (though it states no claim against him) and the Counterclaims. The asserted grounds for dismissal are three: that (essentially as PHH argues) the Amended Complaint is time-barred by 11 U.S.C. § 546(a)(1)(A); that the Trustee has released the Debtor from any and all causes of action; and that the Amended Complaint is barred by laches, the Trustee having waited over six years to bring this action, during which time the Debtor expended hundreds of thousands of dollars to preserve his home. Though this motion seeks in part dismissal of the Counterclaim, the Debtor's arguments address only the Amended Complaint, not the Counterclaim. In addition, near the end of his motion to dismiss, theDebtor indicates that, if the Trustee persists in prosecuting this adversary proceeding and selling the Property—which he suggests is an abuse of the Trustee's powers—he might commence a new case under chapter 13 of the Bankruptcy Code

Both the Trustee and the United States oppose the Debtor's motion to dismiss. With its opposition, the United States has filed a cross-motion for (i) a declaration that the Debtor's filing of a chapter 13 petition at this juncture would be inappropriate and in bad faith and, in the alternative, (ii) an order that the automatic stay arising from any such petition shall be deemed modified to permit the Trustee's sale of the Property and the continuation of this adversary proceeding. The Debtor filed no response to this cross-motion.

In addition, the Trustee has filed a motion for judgment on the pleadings. The motion purports to seek judgment on the Amended Complaint as a whole and is not expressly limited to a particular count or defendant. However, the memorandum submitted in support of the motion addresses only Count II, for a declaration that the Mortgage encumbers only one-half of the Debtor's interest in the property. I therefore understand the motion to be limited to this count. PHH opposes the motion.

At a hearing on all four motions, the Debtor withdrew the laches argument that he had advanced in support of his motion to dismiss. At the close of the hearing, the Court afforded PHH, the Trustee, and the United States an opportunity to file supplemental briefs, which they did. The Court then took the motions under advisement.

During the pendency of this adversary proceeding, there have been related developments in the bankruptcy case itself. First, the Trustee sought and obtained authority to sell the Property to a third-party purchaser for $1,200,000 and has completed the sale of the property. The Property was sold to the purchaser free and clear of liens, claims, interests, and encumbrances of any kind or nature, withany liens, claims, interests, and encumbrances, as allowed, to attach to the proceeds of the sale.³ The Debtor opposed the sale by objecting on the basis of (among other things) the same defense of laches that he has raised in this adversary proceeding as a basis for dismissing the Amend Complaint and Crossclaim. In allowing the sale motion, the Court expressly ruled that this defense had no merit. No appeal was taken from the order approving the sale.

Second, after completion of the sale, the Debtor moved to amend his schedule of exemptions to claim as exempt, pursuant to 11 U.S.C. § 522(g), those proceeds from the sale that are attributable to the penalty portion of the First IRS Lien that the Trustee succeeds in avoiding under 11 U.S.C. § 724(a)(1) and preserving for the benefit of the estate under 11 U.S.C. § 550 (the "Tax Penalty Proceeds"). The Tax Penalty Proceeds are in the amount of $66,539; and the Debtor was seeking to claim this full amount as exempt. Over objections of the Trustee and the United States to this claim of exemption, the Court allowed the amendment and the exemption. The Trustee then appealed from that...