What happens when a debtor surrenders real estate in a bankruptcy case and the lender does not foreclose? The recent First Circuit case, In re Canning, III, 2013 WL 388060 (Feb. 1, 2013), expresses the consensus view that a creditor cannot be forced to foreclose or take possession of surrendered property. In Canning, III, the debtors’ bankruptcy schedules reflected that they intended to surrender their house to their mortgage lender. After the debtors received their discharge, they received a letter from the mortgage lender advising that it did not intend to initiate foreclosure proceedings and that it would not advance any payments for insurance or taxes. The letter stated that the debtors would be solely responsible for maintenance of the property. The debtors filed an adversary proceeding against the lender seeking actual and punitive damages for its failure to foreclose on the basis that the lender violated the discharge injunction by its actions. The First Circuit found in favor of the lender:
[The lender’s] chosen course of action, or inaction, did not make things easy for the Cannings. Forces remained at work that could make their continued ownership of the real estate uncomfortable-forces like accruing real estate taxes and the desirability of maintaining liability insurance for the premises. But those forces are incidents of ownership. Though the Code provides debtors with a surrender option, it does not force creditors to assume ownership or take possession of collateral. And although the Code provides a discharge of personal liability for debt, it does not discharge the ongoing burdens of owning property.
Id. (quoting In re Canning, 442 B.R. 165, 172 (Bankr. D. Me. 2011)).
Most courts have ruled similarly using the same rationale. See In re Service, 155 B.R. 512 (Bankr. E.D. Mo.1993) (The Court cannot compel acceptance of the surrendered property); In re White, 282 B.R. 418 (Bankr. N.D. Ohio 2002) (bankruptcy code does not provide for the court or the debtor to direct the means by which the secured creditor deals with the surrendered property); In re Arsenault, 456 B.R. 627 (Bankr.S.D. Ga. 2011)(Chapter 13 debtors’ surrender of property to secured creditor in full satisfaction of debt, pursuant to their confirmed plan, did not obligate creditor to take affirmative action to transfer title to property out of debtors’ names).
I found two cases that held otherwise. See In re Pigg, 453 B.R. 728 (Bankr. M.D. Tenn. 2011)(An equitable remedy was fashioned to address the attempted surrender of a condominium made uninhabitable by a flood, where a bank had actively taken possession of the property.) and In re Perry, 2012 WL 4795675 (Bankr. E.D. N.C. 2012)(The court allowed a lender 60 days to foreclose, and if a foreclosure proceeding was not commenced, the debtor was authorized to execute, deliver and record a quitclaim deed to the creditor.).
Is this really a widespread problem? I asked a couple of colleagues and confirmed that it is happening in Mississippi; however, they did not believe it was necessarily a problem. The debtors either lived on the property “for free” or they leased it and collected rent. If the surrendered property is a condominium (or located in a neighborhood with an owners’ association), the association dues that accrue post-petition are not discharged in the bankruptcy, and the debtor should understand that he may remain responsible for the fees.
What do you generally advise your debtor clients to do when a lender refuses to take title to surrendered property? When would you advise your bank client NOT to foreclose?