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Foreclosure Without Closure: Sixth Circuit Analyzes Claims Asserted by Borrower Following State Court Foreclosure Proceedings

The financial and housing crisis that began in 2008 led to a huge wave of foreclosures and foreclosure-related litigation. While foreclosure is rooted in state law, the initiation of a foreclosure proceeding by a lender often leads to federal bankruptcy proceedings initiated by a borrower, giving rise to interesting legal issues involving the interplay of state foreclosure law and federal bankruptcy law. Recently, the U.S. Court of Appeals for the Sixth Circuit (the "Sixth Circuit") considered the implications of a foreclosure on a residence following the borrowers' Chapter 7 bankruptcy proceeding.[1]

The Facts

In 2002, a husband and wife (the "Borrowers") owned a home in Farmington Hills, Michigan, that was encumbered by two mortgages totaling approximately $400,000. In 2003, the husband applied for a promotional, low-interest mortgage with Standard Federal Bank in the amount of $400,000. The husband closed on the loan by himself, signing documents for both himself and his wife (allegedly with the knowledge of the loan officer).

In 2008, Standard Federal Bank - which at that point had been acquired by ABN AMBRO and rebranded as LaSalle Bank Midwest, N.A. ("LaSalle") - sued the borrowers for breach of their loan obligations in state court, requesting that the Borrowers be ordered to pay the full amount due or order a foreclosure sale and then require the Borrowers to pay any deficiency.

The wife answered the complaint and counter-claimed, alleging that because she never signed the mortgage, it was invalid. The Borrowers then filed a voluntary Chapter 7 bankruptcy case while the state court litigation was still pending, and pursuant to the automatic stay imposed under section 362 of the Bankruptcy Code, the state circuit court entered an order administratively closing LaSalle's action against the Borrowers. The administrative order made clear that it did "not constitute a dismissal or a decision on the merits." In their bankruptcy, the Borrowers reaffirmed the mortgage debt and they received a discharged on July 28, 2009.

Following the bankruptcy, the Borrowers again missed payments on their loan and Bank of America (which acquired LaSalle) retained a law firm, Randall S. Miller Associates, PC (“RSM”), which commenced a foreclosure by advertisement on the property. Bank of America purchased the property at a foreclosure sale on May 1, 2012.

The Borrowers then filed suit against RSM in state court alleging that RSM violated the Fair Debt Collections Practice Act ("FDCPA") and improperly completed a foreclosure by advertisement under Michigan law. The case was removed to federal court and RSM filed a motion to dismiss alleging that the Borrowers failed to state a claim upon which relief could be granted.

The Law at Issue and the Parties' Arguments

The Borrowers argued that RSM violated two portions of the FDCPA by not complying with Michigan’s foreclosure by advertisement statute. The first portion prohibits a debt collector from “[t]aking . . . any nonjudicial action to effect dispossession or disablement of property if . . . there is no present right to possession of the property claimed as collateral through an enforceable security interest.” 15 U.S.C. § 1692f(6)(A).

The Borrowers’ complaint states:

[RSM’s] actions constitute a violation of [15 U.S.C. § 1692f(6)(A)] because it took non-judicial action to effect dispossession or disablement of property where there was no present right to possession through an enforceable security interest in a foreclosure by advertisement while the lawsuit seeking statutory foreclosure remained filed and pending.

The second portion prohibits a debt collector from “[t]aking . . . any nonjudicial action to effect dispossession or disablement of property if . . . the property is exempt by law from such dispossession or disablement.” 15 U.S.C. § 1692f(6)(C).

The Borrowers’ complaint states:

[RSM’s] actions constitute a violation of [§ 1692f(6)(C)] because it took nonjudicial action to effect dispossession or disablement of property when the property was exempt by law from dispossession or disablement while the lawsuit seeking statutory foreclosure remained filed and pending.

RSM's motion to dismiss argued that Bank of America had an enforceable security interest and that the Michigan state court’s administrative closure order had discontinued LaSalle’s judicial foreclosure action, thereby allowing RSM to pursue foreclosure by advertisement. In responding to RSM's motion, the Borrowers raised a new argument: since the husband forged the wife's signature on the loan documents, the mortgage was invalid.

RSM's reply to this argument was that the Borrowers' complaint did not raise this theory, and that allowing them to amend their complaint would be futile under the doctrines of ratification, judicial estoppel, equitable subrogation, and equitable mortgage.

The U.S. District Court for the Eastern District of Michigan granted RSM's motion to dismiss.

The Appeal and Ruling

The Borrowers appealed to the Sixth Circuit. The Sixth Circuit explained that the Borrowers' claims on appeal could "be distilled into two points: (1) RSM violated the FDCPA by foreclosing while the 2008 suit in the Oakland County Circuit Court remained pending and (2) RSM violated the FDCPA by foreclosing when Bank of America did not hold a valid mortgage on the [Borrowers’] property."

In analyzing the Borrowers' arguments, the Sixth Circuit explained that under Michigan law, a mortgagee may only foreclose by advertisement if “[a]n action or proceeding has not been instituted, at law, to recover the debt secured by the mortgage or any part of the mortgage; or, if an action or proceeding has been instituted, the action or proceeding has been discontinued; or an execution on a judgment rendered in an action or proceeding has been returned unsatisfied, in whole or in part.” Mich. Comp. Laws § 600.3204(1)(b) (emphasis added).

The Borrowers argued that the foreclosure by advertisement was invalid because the 2008 state court action "remained filed and pending." The Sixth Circuit rejected this argument. The Sixth Circuit noted that the term "discontinued," while not defined by the statute, is not to be defined as narrowly as the Borrowers suggested. Rather, the Sixth Circuit held that the state court's administrative order, coupled with the dictates of the Bankruptcy Code's automatic stay provisions, effectively "discontinued" the state court action. Therefore, the Sixth Circuit ruled that RSM did not violate the FDCPA or Michigan law by proceeding with the foreclosure by advertisement.

Turning to the Borrowers' remaining argument - that the mortgage was void because only the husband signed - the Sixth Circuit ruled that the Borrowers were judicially estopped from challenging the validity of the mortgage. Judicial estoppel is an equitable doctrine that prevents a party from taking aposition inconsistent with one asserted by it in an earlier proceeding.

In their bankruptcy proceeding, the Borrowers made sworn representations that the mortgage was valid and uncontested. These declarations were made, under penalty of perjury, by both the husband and wife, and the Sixth Circuit determined that the Borrowers' prior positions were not mistakenly or inadvertently taken.

Because the state court action was "discontinued" and because the Borrowers were judicially estopped from arguing that the mortgage was invalid, the Sixth Circuit affirmed the lower court's decision, which dismissed the Borrower's complaint against RSM.

This case demonstrates just a few of the complex and myriad issues that can arise in connection with a lender's attempt to foreclose on property. If you have any questions on foreclosure or bankruptcy law, please contact a Foster Swift bankruptcy attorney.

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[1] Haddad v. Randall S. Miller Association, P.C., Case No. 13-2492 (6th Cir., Oct. 17, 2014)

Categories: 6th Circuit Court of Appeals, Chapter 7, Eastern District of Michigan

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 concentrates her practice in the areas of Bankruptcy, Finance, Collections, Real Estate, and Commercial Litigation. In the bankruptcy area she represents creditors and Chapter 7 Trustees in all aspects of bankruptcy. Patricia also represents small and mid-sized businesses to large corporations in multi-faceted litigation matters in state and federal court. Her work with financial institutions includes collections, loan workouts, foreclosures, receiverships and various complex banking and finance issues. 

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