United States Bankruptcy Appellate Panel

FOR THE EIGHTH CIRCUIT

 

No. 07-6052

 

In re: *

*

Marlene H. Schwartz, *

*

Debtor. *

*

Randall L. Seaver, Trustee, * Appeal from the United States

* Bankruptcy Court for the

Plaintiff - Appellee, * District of Minnesota

*

v. *

*

Mortgage Electronic Registration *

Systems, Inc. as nominee for Intervale *

Mortgage Corporation and for Decision *

One Mortgage Company, LLC, *

Intervale Mortgage Corporation, and *

Decision One Mortgage Company, LLC, *

*

Defendants - Appellants. *

 

Submitted: February 13, 2008

Filed: March 7, 2008

 

Before SCHERMER, MAHONEY, and VENTERS, Bankruptcy Judges

SCHERMER, Bankruptcy Judge
1

The Honorable Nancy C. Dreher, Chief United States Bankruptcy Judge for

the District of Minnesota.

2

Mortgage Electronic Registration Systems, Inc. (“MERS”) as nominee for

Intervale Mortgage Corporation (“Intervale”) and for Decision One Mortgage

Company, LLC (“Decision One”), Intervale, and Decision One (collectively referred

to as “Lenders”) appeal the judgment of the bankruptcy court1

 in favor of Randall L.

Seaver (“Trustee”), Trustee of the Chapter 7 bankruptcy estate of Marlene H.

Schwartz (“Debtor”) avoiding the transfer of mortgage interests in the Debtor’s real

property to the Lenders as preferential transfers and entering monetary judgments

against the Lenders for the value of the Debtor’s interest in the property transferred

to the Lenders pursuant to the mortgages. We have jurisdiction over this appeal from

the final order of the bankruptcy court. See 28 U.S.C. § 158(b). For the reasons set

forth below, we affirm. 

ISSUES

The first issue on appeal is whether the post-petition refinancing of mortgages

delinquently perfected during the preference period prevents a trustee from avoiding

the preferential mortgages under Section 547 of the Bankruptcy Code. We conclude

that a debtor’s post-petition refinancing of home mortgages does not impact a trustee’s

ability to avoid the perfection of the mortgages as preferential transfers.

The second issue on appeal is whether a trustee may obtain a money judgment

under Section 550 of the Bankruptcy Code against entities who received preferential

mortgages which are avoided under Section 547 of the Bankruptcy Code. We

conclude that a trustee may obtain a money judgment against each recipient of an

avoided preferential mortgage equal to the value of the preferential mortgage.
3

BACKGROUND

On January 14, 2005, the Debtor signed a note and mortgage in the principal

amount of $182,800 in favor of MERS as nominee for Decision One granting

Decision One a first mortgage in certain real property. The same day the Debtor

signed a note and mortgage in the principal amount of $45,700 in favor of MERS as

nominee for Intervale granting Intervale a second mortgage on the same property.

Neither mortgage was recorded until February 24, 2005.

On May 3, 2005, the Debtor filed a petition for relief under Chapter 7 of the

Bankruptcy Code. The Trustee was appointed trustee of the Debtor’s bankruptcy

estate. In January of 2006, after the Debtor’s bankruptcy case was filed but before the

Trustee initiated any legal action against the Lenders, the Debtor refinanced her

mortgages. Pursuant to the refinancing, the Lenders were paid in full and released

their mortgages. On November 21, 2006, the Trustee filed a complaint seeking to

avoid the mortgages to Lenders as preferential transfers under Section 547 of the

Bankruptcy Code and to recover from the Lenders the value of the Debtor’s interest

in the real property transferred to the Lenders pursuant to the mortgages under Section

550 of the Bankruptcy Code. The bankruptcy court avoided the mortgages as

preferential transfers and entered judgment in favor of the Trustee and against each

Lender for the value of the Debtor’s interest in the real property transferred to each

Lender, respectively. The Lenders appeal the judgment.

STANDARD OF REVIEW

The facts are not in dispute. We review the bankruptcy court’s conclusions of

law de novo. Peltz v. Edward C. Vancil, Inc. (In re Bridge Info. Sys., Inc.), 474 F.3d

1963, 1066 (8th Cir. 2007); Silverman Consulting, Inc. v. Canfor Wood Prod. Mktg.

(In re Payless Cashways, Inc.), 394 F.3d 1082, 1083 (8th Cir. 2005). 
4

DISCUSSION

Recording a Mortgage is a Transfer Subject to Avoidance

as Preferential under Section 547 of the Bankruptcy Code

A trustee may avoid a pre-petition transfer of an interest of the debtor in

property to or for the benefit of a creditor, for or on account of an antecedent debt,

made within ninety days before the filing of the bankruptcy petition while the debtor

was insolvent which enables the creditor to receive more than such creditor would

receive under a hypothetical Chapter 7 liquidation. 11 U.S.C. § 547(b). Section 547

of the Bankruptcy Code is designed to discourage creditors from racing to dismember

a debtor sliding into bankruptcy and to promote equality of distribution among

creditors. Jones Truck Lines, Inc. v. Central States, Southeast and Southwest Areas

Pension Fund (In re Jones Truck Lines, Inc.), 130 F.3d 323, 326 (8th Cir. 1997).

The concept of a preference is simple. Id. at 325. A trustee can avoid any

transfer to a creditor within ninety days before the bankruptcy petition which places

the creditor in a better position on the date of the bankruptcy petition than such

creditor was in before such transfer was made. As of February 2, 2005, ninety days

before the date of the Debtor’s bankruptcy petition, the Lenders held unsecured claims

against the Debtor. On February 4, 2005, the Lenders recorded mortgages

encumbering the Debtor’s residence. The recording of a mortgage is a transfer of a

property interest subject to avoidance as preferential. Lindquist v. Dorholt (In re

Dorholt), 224 F.3d 871, 873 (8th Cir. 2000); Superior Bank, FSB v. Boyd, 398 F.3d

735, 746 (6th Cir. 2005); Givens v. Countrywide Home Loans, Inc. (In re Jarosz), 322

B.R. 662, 671 (Bankr. E.D. Wis. 2005). On May 3, 2005, the Lenders held claims

against the Debtor secured by mortgage interests in her residence. The recording of

the Lenders’ mortgages constituted an avoidable preference under Section 547(b) of

the Bankruptcy Code. The Lenders do not dispute that the mortgage liens are subject

to avoidance as preferences under Section 547 of the Bankruptcy Code. [See
2

 See Appellants’ Brief, p. 7, where the Lenders state: “But for the actions of

the Debtor and the new lender in violation of 11 U.S.C. § 362(a), the Mortgage

Liens were subject to avoidance as preferences because the mortgage instruments

were not timely filed.”

5

Appellants’ Brief, p. 7. ] The Lenders argue that the post-petition refinancing

somehow “undoes” the preferential nature of the transfer.2

 We disagree.

The Debtor’s Post-Petition Refinancing does not Alter the

Fact that the Mortgage Liens are Avoidable Preferences

As discussed above, Section 547 of the Bankruptcy Code governs the avoidance

of preferential transfers. Section 547(c) sets forth the situations in which an otherwise

preferential transfer may not be avoided. The most common defenses are the

contemporaneous exchange defense, the ordinary course of business defense, and the

new value defense. 11 U.S.C. § 547(c)(1), (2), and (4). The Bankruptcy Code

provides additional defenses with respect to certain security interests, statutory liens,

and payments of domestic support obligations, and places monetary minimums on

amounts which can be recovered as preferential. 11 U.S.C. § 547(c)(3) and (5) – (9).

The voluntary post-petition release of a lien pursuant to a loan refinance is nowhere

listed as a defense to the avoidance of a preferential transfer.

The Lenders cite no statutory authority for their asserted post-petition refinance

defense because none exists. Instead, the Lenders argue that the post-petition

refinancing renders the preference claims moot, relying on the unpublished opinion

Burchiel v. Fed One Savings Bank (In re Burchiel), 1993 WL 597969 (Bankr. N.D.

Ohio). In Burchiel, the debtors entered into a contract with a construction company

for certain home improvements. The debtors signed a promissory note and granted

a mortgage to the construction company to secure payment of the note. The

construction company immediately assigned the mortgage to the bank with recourse

and agreed to indemnify the bank for any claim against it by the debtors. The debtors
6

filed bankruptcy and sued the bank to avoid the mortgage as preferential. The bank

meanwhile sued the construction company in state court under the indemnity

agreement and obtained judgment against the construction company for the balance

due under the mortgage. The bankruptcy court determined that the state court

judgment had the effect of satisfying the mortgage and without a valid mortgage the

mortgage avoidance action was moot.

The Burchiel case is distinguishable from the case at hand. In Burchiel, no

mortgage encumbered the property at the time of the decision in the preference

avoidance action. By bringing the state court action, the bank agreed to exchange its

mortgage for a judgment against the construction company. After the release of the

mortgage, the debtor’s property was no longer subject to any encumbrance and the

estate owned the property free and clear. The estate thus had the benefit of the

unencumbered land and the construction company had an unsecured claim against the

debtor’s estate as a result of the state court judgment. All parties were in the same

position they were in before the mortgage was granted. No avoidance was necessary.

In the present situation, the Debtor’s land is subject to an encumbrance in favor

of the post-petition mortgagee. The estate is in a worse position than the Debtor was

in before the mortgages were recorded. Pre-recording, the Debtor owned the property

free of the mortgage liens. Now the estate lacks the benefit of the property because

it is subject to liens. With respect to the Lenders, they are in a better position now

than they were in before the preferential transfer. Pre-recording, the Lenders held

unsecured claims against the Debtor. Now, they have been paid in full and hold no

claims. The Lenders have received more than other creditors who held unsecured

claims against the Debtors immediately before the mortgages were recorded. The

avoidance of the mortgages is thus not moot. Rather, avoidance is necessary to

prevent the Lenders from receiving a windfall while other similarly situated creditors

receive nothing. This is the text-book definition of a preference and illustrates the
7

reason why Section 547 of the Bankruptcy Code exists. The doctrine of mootness

does not apply.

The decision of the Eighth Circuit Court of Appeals in Halverson v. Le Sueur

State Bank (In re Willaert), 944 F.2d 463 (8th Cir. 1991) is much more instructive for

the situation at hand. In Willaert, the debtors granted a mortgage to the bank on

account of antecedent debts during the applicable preference period. The debtors later

sold the mortgaged property and delivered the sale proceeds to the bank within the

preference period. The trustee sued to recover as preferential the portion of the sale

proceeds equal to the preferential transfer. The Eighth Circuit Court of Appeals

concluded that the granting of the mortgage was an avoidable preferential transfer and

that the subsequent payment of the sale proceeds to the bank was nothing more than

the proceeds of the preferential transfer. 944 F.2d at 464. The Eighth Circuit Court

of Appeals further concluded that the avoidance of the preferential transfer would not

be futile notwithstanding the fact that the property had been sold to a third party and

was thus not property of the bankruptcy estate. Id. Avoidance under Section 547 was

still appropriate. To the extent the property was no longer available to the estate,

avoidance under Section 547 would allow the trustee to recover the value of the

property under Section 550 of the Bankruptcy Code. Such is the situation in the case

at hand. The Lenders’ mortgages are avoidable as preferential transfers under

Section 547 of the Bankruptcy Code notwithstanding subsequent events including the

post-petition refinancing. 

The Lenders’ argument attempts to re-write the Bankruptcy Code to add an

additional defense to the avoidance of a preferential transfer. Under the Lenders’

argument a post-petition transfer by the recipient of the preferential transfer would

allow the recipient to avoid liability. The Bankruptcy Code expressly provides to the

contrary. Section 550 of the Bankruptcy Code, which is discussed more fully below,

authorizes the trustee to recover the preferential transfer from the initial transferee or

any immediate or mediate transferee of such initial transferee. 11 U.S.C. § 550(a).
8

The drafters of the Bankruptcy Code thus contemplated the possibility of post-petition

transfers of property the original transfer of which constituted an avoidable

preferential transfer and did not elect to make such subsequent transfer a defense to

the avoidance of the preference. Instead the drafters of the Bankruptcy Code chose

to make it easier for the estate to recover the preferential transfer by permitting

recovery from not only the original recipient of the preferential transfer but also from

subsequent transferees. The Lenders’ argument thus runs contrary to both the spirit

and letter of the Bankruptcy Code’s provisions governing the avoidance and recovery

of preferential transfers.

 

The Trustee May Recover Money Damages from the Recipient of a Mortgage

Avoided as Preferential under Section 550 of the Bankruptcy Code

Under Section 550 of the Bankruptcy Code, once a transfer is avoided as

preferential under Section 547 or avoided for another reason under certain other

sections of the Code, the trustee may recover for the benefit of the estate the property

transferred or, if the court so orders, the value of such property from the initial

transferee, the entity for whose benefit the transfer was made, or from any immediate

or mediate transferee of the initial transferee. 11 U.S.C. § 550(a). The purpose of

Section 550 is to restore the debtor’s financial condition to the state it would have

been had the avoided transfer not occurred. In re Willaert, 944 F.2d at 464; Stalnaker

v. DLC, Ltd. (In re DLC, Ltd.), 295 B.R. 593, 606-07 (B.A.P. 8th Cir. 2003). The

court has the discretion to order either the return of the property or the payment of its

value – whichever remedy is appropriate to fulfill the statutory purpose. 

The Lenders are the initial transferees of the avoided mortgages. The Trustee

is entitled to recover the avoided mortgages or the value thereof as determined by the

bankruptcy court. In this case the bankruptcy court entered a money judgment against

each Lender for the value of such Lender’s mortgage interest in the real property as

authorized by Section 550 of the Bankruptcy Code in order to restore the estate to the

position it would be in if the mortgages had not been recorded. Without the
9

mortgages, the Lenders would have unsecured claims and the estate would include the

real property unencumbered by the mortgages. The unencumbered property would

be available for sale by the Trustee with the proceeds available for distribution to

creditors. If the Lenders’ mortgages were avoided but no money judgment entered as

the Lenders seek, the Lenders would be paid in full, the real property would still be

encumbered by the liens in favor of the new lenders, and no asset would be available

for distribution to creditors. Under this scenario, the Lenders would remain in a

“preferred” position vis-a-vis other unsecured creditors and the estate would remain

depleted by the amount of the mortgages. The purpose of Section 550 would not be

served without a money judgment.

The Lenders argue that Section 550 of the Bankruptcy Code does not apply to

the transfer of a conditional interest in property such as a mortgage. According to the

Lenders, the avoidance of the mortgages under Section 547 is the sole remedy

available to the Trustee. We disagree. Sections 547 and 550 of the Bankruptcy Code

create separate and distinct causes of action. Cent. Va. Cmty. Coll. v. Katz, 546 U.S.

356, 371-72 (2006); In re Willaert, 944 F.2d at 464; In re DLC, Ltd., 295 B.R. at 606-

07. Relief under Section 547 is limited to avoidance of the transfer. In certain

instances avoidance of a transfer is sufficient to undo the preferential transfer and

make the estate whole. For example, the avoidance of a lien on property under

Section 547 is a sufficient remedy where the property is part of the estate and the

avoidance results in the value of the avoided lien becoming available for liquidation

and distribution to creditors. Such was the case in Lindquist v. Household Indus. Fin.

Co. (In re Vondall), 352 B.R. 193 (Bankr. D. Minn. 2006), aff’d 364 B.R. 668 (B.A.P.

8th Cir. 2007), upon which the Lenders rely. In contrast, the Debtor’s estate would not

be made whole by the mere avoidance of the Lenders’ mortgages because the property

would still be encumbered by the mortgages in favor of the post-petition lenders.

Accordingly, mere avoidance is an insufficient remedy in the case at hand.
10

Again, the decision in In re Willaert is instructive. The Eighth Circuit Court

of Appeals recognized that the bankruptcy court has the discretion under Section

550(a) to remedy a preferential transfer by ordering either the property or its value

returned to the estate; however, the court does not have discretion to order neither

remedy. 944 F.2d at 464. The Lenders no longer hold the mortgages. Therefore the

Lenders cannot merely return them to the estate. Accordingly, the only remedy

available to the estate is a money judgment for the value of the mortgages.

The Lenders also argue that bankruptcy jurisdiction is primarily in rem. The

Lenders argue that Section 550(a) does not apply to a transfer of a non-possessory

interest such as a mortgage because it is not a “thing” which can be recovered under

the bankruptcy court’s in rem jurisdiction. This argument is without merit. The

Bankruptcy Code expressly authorizes the recovery of the transferred property or its

value. Where the “thing” itself is not available, its value may be recovered instead.

11 U.S.C. § 550(a).

The Lenders also argues that the value of the avoided mortgages which can be

recovered under Section 550(a) is limited to the amounts of payments made to the

Lenders during the preference period. This argument also lacks merit. The estate is

entitled to recover the preferential value of the mortgages. In re Willaert, 944 F.2d

at 465. The bankruptcy court valued the transfer of the mortgage to MERS as

nominee for Decision One at $182,800 and the transfer of the mortgage to MERS as

nominee for Intervale at $45,700. This valuation was proper. The mortgage in favor

of MERS as nominee for Decision One gave MERS as nominee for Decision One an

interest in the Debtor’s real property sufficient to satisfy the indebtedness of $182,800.

Likewise the mortgage in favor of MERS as nominee for Intervale gave MERS as

nominee for Intevale an interest in the Debtor’s real property sufficient to satisfy the

indebtedness of $45,700. The Debtor listed the value of the real property at $228,500

in the loan applications she submitted to the Lenders and in her Schedule A filed with

the bankruptcy court. [See Appellee’s Appendix, Exhibit 8, pp. AA-52-64.] The
11

property had sufficient value to support the mortgages. The record thus demonstrates

that the value of the Lenders’ interests in the Debtor’s property received pursuant to

the mortgages equaled the amounts due under their respective mortgages. In fact these

are the very amounts the Lenders received on account of their interests in the Debtor’s

real property. These are likewise the amounts the Trustee is entitled to recover from

the Lenders under Section 550(a) of the Bankruptcy Code. Any preferential cash

payments received by the Lenders from the Debtors are proceeds of the mortgages and

their recovery is included in the judgment amounts.

Next the Lenders resort to public policy arguments. The Lenders complain that

if the Trustee is entitled to money judgments against them the Lenders will be

punished although they committed no wrong. Preference recovery is designed to

ensure that all similarly situated creditors receive the same treatment. Without the

money judgments, the Lenders will have been paid in full while other unsecured

creditors are not. In short, they will have received a preference over other creditors.

The Bankruptcy Code favors equality of distribution. The Lenders are not being

punished; rather they are receiving the same treatment that the Debtor’s other creditors

are receiving.

The Lenders argue that the Trustee should pursue the post-petition mortgagee

which entered into a post-petition transaction with the Debtor without court authority

rather than the Lenders. It is unclear from the record before this Court whether or not

court authority was necessary for such refinancing. Additionally, whether or not the

Trustee has pursued any litigation against the post-petition mortgagee is not before

this Court. Regardless, the Bankruptcy Code does not require the Trustee to sue the

post-petition mortgagee. The Bankruptcy Code does authorize the Trustee to sue the

Lenders to avoid the preferential mortgages and to recover the value thereof for the

bankruptcy estate. This is what the Trustee has properly done.
12

Finally, the Lenders argue that the judgment issued by the bankruptcy court

“penalizes innocent parties.” [Appellant’s Reply Brief, p. 10.] This argument is no

different than the argument claimed by any preference defendant. The policy behind

preference recovery is equality of treatment. While the preference defendant feels

punished, he or she is merely giving up preferential treatment and instead being placed

on par with other creditors. The Lenders argue that by releasing their mortgages they

lost any recourse to title insurance policies which might otherwise have provided them

with indemnity for the judgments. Most preference defendants lack recourse against

third parties for amounts owed under Section 550 of the Bankruptcy Code. Indeed the

availability or lack of third party recourse is irrelevant to the Lender’s preference

liability under Section 550 of the Bankruptcy Code. The Lenders argue that their

“only ‘sin’” was not ensuring that the mortgage instruments were timely recorded.

[Appellant’s Reply Brief, p. 10.] This underscores the fact that with careful practice

the Lenders could have removed themselves from preference exposure. Accordingly,

by affirming the judgment below which properly applied preference law to the facts

of the case, this opinion should not have the effect of further destabilizing the

mortgage industry as feared by the Lenders. [Appellant’s Reply Brief, p. 12.] Rather,

it should encourage mortgagees to promptly record mortgage interests. 

CONCLUSION

The recording of the mortgages in favor of the Lenders in the ninety day

period preceding the Debtor’s bankruptcy petition constituted preferential transfers

subject to avoidance under Section 547 of the Bankruptcy Code. The Debtor’s

post-petition refinancing of the mortgages did not impact the Trustee’s ability to

avoid the perfection of the mortgages as preferential transfers. Once the mortgages

were avoided under Section 547, the Trustee was entitled to a money judgment

against each Lender equal to the value of such Lender’s preferential mortgage

under Section 550(a) of the Bankruptcy Code. A money judgment under Section

550(a) was the only remedy available to restore the bankruptcy estate to the pre-
13

preference position of the Debtor because the Lenders no longer held the

mortgages and thus could not return them to the bankruptcy estate. The judgment

of the bankruptcy court is affirmed.