McCarthy v. Financial Freedom Senior Funding Corporation

UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF COLUMBIA
In re
WILLIAM EARLY,
Debtor.
___________________________
KEVIN R. McCARTHY, Trustee,
Plaintiff,
v.
FINANCIAL FREEDOM SENIOR
FUNDING CORPORATION,
Defendant.
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Case No. 05-01354
(Chapter 7)
Adversary Proceeding
No. 05-10079
Not for Publication in
West’s Bankruptcy Reporter
SUPPLEMENTAL MEMORANDUM DECISION
AND ORDER RE CROSS-MOTIONS FOR SUMMARY
JUDGMENT, AMENDING PRIOR MEMORANDUM DECISION AND ORDER,
AND DIRECTING THE PARTIES TO FILE A STATUS REPORT IN OCTOBER 2008
On May 28, 2008, the court held a scheduling conference to
address the further course of this proceeding after entry of the
court’s Memorandum Decision and Order of May 12, 2008. 	At that
hearing, the court set a schedule for discovery because the
defendant, Financial Freedom Senior Funding Corporation, had not
The Supplemental Memorandum Decision and Order below
is hereby signed. Dated: June 23, 2008.
_____________________________
S. Martin Teel, Jr.
United States Bankruptcy Judge
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yet consented to a sale of the entire lien it was granted on the
debtor’s and his wife’s real property (the “Property”).
Financial Freedom has now filed a consent to the sale by the
plaintiff McCarthy, as chapter 7 trustee, of the entire lien
subject to higher and better offers, and subject to the right of
Financial Freedom to credit bid under 11 U.S.C. § 363(k) its
unavoided portion (one-half) of the lien. 	This addresses the
effect of that consent.
I
The court’s prior Memorandum Decision and Order ruled that
the lien was avoided to the extent that it was a transfer of the
debtor’s interest in the Property (but not of the wife’s interest
in the Property). 	The reason the court denied Financial
Freedom’s motion for partial summary judgment (seeking a decree
that the plaintiff was not entitled to a monetary judgment) was
that a sale of only the part of the lien that was granted by the
debtor would likely not yield one-half of the amount that a sale
of the entire lien would yield.
A sale of that entire lien is the most efficient way of
fixing the fair market value of the avoided lien on the debtor’s
interest in the Property. 	McCarthy is therefore not entitled to
a monetary judgment against Financial Freedom for one-half of the
balance due under the avoided deed of trust and related loan
agreement, and Financial Freedom is entitled to partial summary
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judgment in its favor unless an attempt by the trustee to sell
the entire lien were to prove infeasible for some reason,
regulatory or otherwise.
II
As McCarthy notes, it is doubtful that the court would
permit a sale of the entire Property because of the hardship that
would cause for the debtor’s wife, and thus he has not sought to
sell the Property. 	He proceeded instead by way of attempting to
obtain a monetary judgment for the value of the lien he avoids or
to sell the lien he avoids. 	The lienor’s consent to a sale of
the entire lien will assure that the estate realizes one-half of
the value of the entire lien, whereas a sale of only the lien on
the debtor’s interest in the Property might yield far less
because a purchaser might not want to be a co-owner with
Financial Freedom of the lien on the Property.
McCarthy contended that he would have difficulty proceeding
pursuant to having the lien preserved for the benefit of the
estate under § 551 instead of recovering a monetary judgment. 	He
so contended, for one reason, because he would likely not be able
to sell the entire Property under § 363(b) because he would not
likely be able to show under 11 U.S.C. § 363(h)(3) that “the
benefit to the estate of a sale of such property free of the
interests of [the debtor’s wife] outweighs the detriment . . . to
[the debtor’s] wife.” 	In the court’s prior Memorandum Decision
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and Order, the court opined that:
[T]he avoided and preserved lien would not give
McCarthy the right to attempt to sell even the debtor’s
interest in the Property under § 363(b). 	The lien
would not confer title to the Property on the estate,
and thus McCarthy is not entitled to sell title to the
Property under § 363(b). 	Were the law otherwise, a
debtor who files a bankruptcy case could see his home
sold under § 363(b) by the trustee who avoids an
unperfected lien on the home even though the debtor is
current on the mortgage and was looking to live there
indefinitely by continuing to make mortgage payments.
Congress surely did not intend that result.
McCarthy v. Fin. Freedom Senior Funding Corp. (In re Early), No.
05-10079, 2008 WL 2073917, at *3 (Bankr. D.D.C. May 12, 2008).
The court further observed that:
A trustee’s rights pursuant to the lien to which she is
subrogated pursuant to § 551 are no greater than those
of the creditor who held the avoided lien.
Accordingly, except as provided by nonbankruptcy law,
the avoided lien here does not give the trustee a right
to sell the debtor’s interest in the Property itself.
Under nonbankruptcy law, the avoided lien does not give
McCarthy an ownership interest in the Property, it only
gives him the enforcement rights available to a lienor.
Id. at * 4. 	[Citation and footnote citing additional decisions
omitted.] 	At the scheduling conference, McCarthy challenged the
correctness of that reasoning on the question addressed. 	If the
debtor’s granting of a lien was a conveyance of an interest in
the Property, McCarthy notes, then that interest becomes property
of the estate upon avoidance, and a trustee should be entitled to
attempt to sell that interest (and to request to sell the entire
Property pursuant to § 363(b)) even though the Property was the
debtor’s residence which would have been fully exemptible under
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1 	The version of § 522(c) applicable to this case is the
version in effect before the effective date of 2005 amendments to
the Bankruptcy Code, but those amendments would not have altered
the analysis.
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District of Columbia law had the conveyance of the lien not been
made. 	Upon avoidance of the lien interest, the debtor is not
entitled to exempt that interest in the Property. 	Accordingly,
argues McCarthy, he should be able to sell the debtor’s interest
in the Property. 	Although the lien is preserved for the benefit
of the estate (thus giving the trustee priority over later liens
filed after belated perfection of the avoided lien), and the
trustee’s rights in enforcing the lien are no greater than those
the lienor would have enjoyed, that does not answer whether the
recovery of the interest in the property that was transferred by
way of the conveyance of the avoided lien entitles the trustee to
sell what was the debtor’s interest in the property as property
of the estate under 11 U.S.C. § 363.
A possible response to McCarthy’s arguments is as follows.
Section 522(b)(1) provides that “an individual debtor may exempt
from property of the estate” certain property, including (if the
debtor elects nonbankruptcy law exemptions) property exempt under
the applicable state’s law. 	Here, District of Columbia law
permitted the debtor an unlimited exemption of his residence. 	In
turn, 11 U.S.C. § 522(c) 1 provided in relevant part:
Unless the case is dismissed, property exempted under
this section is not liable during or after the case for
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any debt of the debtor that arose, or that is
determined under section 502 of this title as if such
debt had arisen, before the commencement of the case,
except–-
(1) a debt of a kind specified in section
523(a)(1) or 523(a)(5) of this title; [or]
(2) a debt secured by a lien that is--
(A)(i) not avoided under subsection (f) or
(g) of this section or under section 544,
545, 547, 548, 549, or 724(a) of this title;
and
(ii) not void under section 506(d) of this
title[.]
This suggests that a property may be claimed as exempt from being
property of the estate even though subject to a lien, with §
522(c) then addressing the effect of the lien on the property.
When a trustee avoids such a lien, and it is preserved for the
benefit of the estate under § 551 and made property of the estate
under § 541(a)(4), she can look to enforcement of that lien (not
avoided in her hands once preserved for the benefit of the
estate) as a property interest of the estate that may be enforced
as a lien that remains effective by reason of § 522(c). 	But when
the debtor has exempted the entire ownership interest, the only
interest recovered via avoidance is the avoided lien, not an
ownership interest in the property.
In contrast, if the amount of the debtor’s exemption was
less than the value of the property, the property remains
property in which the estate has the ownership interest under §
541, with the debtor’s exemption claim being a right to payment
from the property the amount of the claimed exemption. 	In that
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circumstance, a trustee is free to sell the property. 	She is
required to distribute the proceeds first to the debtor in
payment of the debtor’s claimed exemption, but she is entitled to
the balance of the proceeds to use to pay claims in the case.
This case, however, is not one in which the debtor exempted less
than his full ownership interest in the Property.
Nevertheless, the question of whether a trustee, upon
avoiding a lien on property whose ownership interest has been
claimed as fully exempt, may sell the property under 11 U.S.C. §
363 (in lieu of enforcing the avoided lien), is a serious
question, and a decision regarding that issue does not appear to
be necessary to the court’s decision of this proceeding, as the
trustee is not attempting to sell the entire Property (or even
the debtor’s ownership interest in the Property). 	Accordingly,
the court withdraws from its observations on the question that it
made in the prior Memorandum Decision and Order (without deciding
whether those observations were correct or in error), and will
address the question anew should it arise in some future case.
III
In light of the foregoing, it is
ORDERED that the trustee shall proceed in the main case to
attempt to sell the entire lien, subject to the receipt of higher
and better offers, and subject to the right of Financial Freedom
to credit bid under 11 U.S.C. § 363(k) for its unavoided portion
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(one-half) of the entire lien, and Financial Freedom shall be
entitled to partial summary judgment in its favor based upon this
court’s ruling that a monetary judgment against Financial Freedom
is not appropriate unless an effort by the trustee to sell the
entire lien proves infeasible for some reason. 	It is further
ORDERED that the scheduling order resulting from the
scheduling conference is stayed unless a party shows good cause
why the scheduling order ought not be stayed. 	It is further
ORDERED that the parties file a status report in this case
during the month of October 2008 to alert the court to whether
the efforts in the main case to sell the entire lien have reached
a stage that permits entry of a final judgment concluding this
adversary proceeding or whether, instead, those efforts have not
yet concluded. 	It is further
ORDERED that the Memorandum Decision and Order dated May 12,
2008, is amended by replacing the sentence reading:
The holding in In re Salintro ought not apply when the
avoided lien is not preserved intact without having
been diminished via enforcement or other events, then a
monetary recovery under § 550 may be necessary and
appropriate.
with the following:
The holding in In re Salintro ought not apply when the
avoided lien is not preserved intact without having
been diminished via enforcement or other events. 	In
that circumstance, a monetary recovery under § 550 may
be necessary and appropriate.
[Signed and dated above.]
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9	O:\TEEL\Laura\OPINIONS\McCarthy v Financial Freedom\McCarthy v Financial Freedom - co-owners avoidable reverse mortgage lien_order re lienor's consent to sale of entire lien_v2.wpd
Copies to: All counsel of record; Office of U.S. Trustee.
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