Bankruptcy: Foreclosure Sale Voided due to Violation of Co-debtor Stay

     In the case of Harris v. Margaretten & Co., Judge Spencer of the United States District Court at Richmond, Virginia reviewed and affirmed a bankruptcy court decision to set aside a foreclosure sale due to a mortgage serving agent's violation of the co-debtor stay provisions of Bankruptcy Code §1301. 

     The District Court found that the debt at issue was a consumer debt upon which the debtor's wife, who had previously received a Chapter 7 discharge, owed an enforceable obligation, notwithstanding her Chapter 7 discharge. The District Court further found that the co-debtor stay was in effect. 

     Judge Spencer ruled that the Bankruptcy Code defines "consumer debt" as "debt incurred by an individual primarily for a personal, family or household purpose." Judge Spencer noted that while courts are split over whether a debt secured by real property qualifies as "consumer debt" under the code, the better reasoned view is that a loan secured by realty may indeed be a "consumer debt." By its plain language, Bankruptcy Code §101(8) requires courts to inquire whether the debt was "incurred...primarily for a personal, family or household purpose." Moreover, Congress elsewhere indicated that such a debt plainly could fall within the statutory definition. Thus, a blanket statement that an obligation secured by realty is never "consumer debt" could not stand. 

     Judge Spencer further stated that the statute requires an inquiry into the purpose of the debt. The Bankruptcy Code afforded this case such scrutiny, finding that the debtors used the loan proceeds to purchase their residence. This finding was indisputably correct, and because such a use constituted a "personal, family or household purpose," the obligation at issue was a consumer debt. 

     The creditor also argued that no co-debtor stay was in effect because the wife's personal obligation on the note had been extinguished by her own Chapter 7 discharge. Again, the District Court stated that the creditor ignored the clear language of the statute, for the stay protects any individual who is liable on such debt with the debtor, or that secured the debt. Personal liability on the debt is not required. Hence, the District Court agreed that a co-debtor stay was in effect at the time of the foreclosure sale, and that the sale was a violation of Bankruptcy Code §1301(a). 

     The creditor argued that even if the Bankruptcy Court had properly found a violation of Bankruptcy Code §1301, it erroneously refused to annul the stay under the facts of this case, and erroneously voided the foreclosure sale. This argument was unpersuasive to Judge Spencer. Even assuming that the Bankruptcy Court was empowered to act sua sponte, the record did not suggest that the Bankruptcy Court erred in refusing to annul the sale and in declaring the foreclosure sale void. Judge Spencer ruled that under the facts of this case, he was unable to find any abuse of discretion. The District Court affirmed that portion of the Bankruptcy Court's ruling that the creditor challenged on appeal.

     The lesson in Harris, as in so many cases, is to ensure competent and experienced legal advice.