As an update to our blog post of November 25, 2014 (below), the United States District Court for the District of Oregon recently changed course with regard to property surrendered in bankruptcy, vacating and remanding In re Watt. Judge Ann Aiken recognized the lack of clarity to 11 USC 1322(b)(9), which at first blush may appear to allow property to vest in parties other than the debtor without consent. As you may recall, by Order of the Bankruptcy Court a bank was shocked to learn that it was the owner of property it had decided to abandon. Judge Aiken indicated that a number of other protections should have prevented the Bankruptcy Code from being misconstrued in a way that allowed vesting without a secured creditor’s consent. Specifically, while 11 USC 1325(a)(5) allows surrender of the property, it does not then go on to provide for transfer and vesting without a secured creditor’s approval. Judge Aiken went on to find that had the legislature intended to give bankruptcy courts such broad authority to vest property in secured creditors, they could have done so in the bankruptcy code, but did not. Finally, the court paid deference to the contractual remedies available to debtors and creditors under loan contracts. No contractual provision provided such an incredible remedy to a debtor in bankruptcy.
This is a positive decision that protects financial institutions from vesting of property which may be more of a liability than an asset. Refreshingly the Court pointed out that the prior result was not in fact equitable to the bank, which had been forced to accept the vesting of a property fraught with liabilities. Rather it found that a balancing of the equities required an even handed approach that would not simply absolve debtors of the consequences of their own decisions and place the burden of those decisions on the bank. Nonetheless, careful review to evaluate debtors’ petitions in bankruptcy remains sound advice. The best way to prevent surprises is to anticipate them by working with legal counsel.
November 24, 2014 — Financial Services clients are in for a surprise if they read In Re Watt from the US Bankruptcy Court for the District of Oregon stating that, without consent, banks own property surrendered in bankruptcy. The court wrote that USC 1322(b)(9) does not restrict a court from vesting real property in a bank’s name even if the bank does not consent after the debtor surrenders the property in bankruptcy. Essentially the court found that there is no difference between surrender and surrender with vesting. The court did, thankfully, recognize an exception to this rule. A debtor may not surrender and seek to vest property in the name of a bank, if the debtor does so in bad faith. Bad faith is present, for example, in cases of nuisance or environmental problems.
As a result of this ruling, financial institutions must more carefully evaluate petitions of debtors under the bankruptcy code. If a borrower/debtor seeks to surrender real property, a bank could find itself with a surprise gift of title to the surrendered real property, together with all the legal and regulatory ramifications that may follow. If you need help, our Creditors’ Rights and Bankruptcy team frequently reviews bankruptcy petitions and would be happy to advise you.