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Bankruptcy Weapons to Terminate a Zombie Mortgage

Bankruptcy’s strongest public policy is the possibility of a fresh start for a borrower – a way for a debtor to free himself from the burdens of pre-petition obligations and re-commence his or her financial life. A debtor can surrender property burdened by a lien to the lien-holder and thereby release him or herself from ongoing obligations under the loan. This is true even in cases where the collateral’s value is less than the secured loan – for in bankruptcy, a lender’s secured claim is limited to the value of its lien. In chapter 13, a debtor who elects to keep secured property must pay off the secured claim through an acceptable plan, and if the debtor opts to liquidate the secured property, then the debtor may sell it free and clear of liens if it is authorized to do so under § 363 of the Bankruptcy Code. This straightforward method of wiping the slate clean in bankruptcy has recently been threatened by home mortgage holders’ reluctance to foreclose. If the secured lender refuses to accept a debtor’s surrender and foreclose on its lien, the mere filing of bankruptcy will not operate to release the borrower from legal responsibility for property carrying costs and associated liabilities. In cases of foreclosure delay, the defaulted mortgage becomes impossible to kill off completely, even when a borrower has abandoned the home and sought a bankruptcy fresh start. This undead mortgage prevents the property from entering the flow of commerce and poses a barrier to acquisition by a new owner willing to shoulder its upkeep. Neighborhoods and municipalities also pay the cost of zombie mortgages, as years can drag by with no resident owner paying homeowner association dues or property taxes. Furthermore, vacant, unmaintained properties pose a safety hazard and drive down community property values. Borrowers and communities have tried – with varying success – to address this zombie mortgage apocalypse with creative tools, as have bankruptcy debtors and courts.When mortgage lenders refuse to foreclose real property surrendered in bankruptcy, courts have variously attempted to address the zombie mortgage. One underutilized way to kill off a zombie mortgage is to order the home be sold, free and clear of liens, under § 363 of the Bankruptcy Code. This section permits a trustee (or debtor-in-possession) to sell property free of outstanding liens in certain enumerated cases, including cases of lender assent, cases where the sale price will cover the aggregate value of liens encumbering the property, and cases where a free-and-clear sale would otherwise be available under a legal or equitable proceeding. Each of these options provides an interesting possible route to clearing title and providing a debtor with a fresh start in cases of foreclosure delay. Section 363 sales are also available in cases of a dispute about the underlying obligation, and this raises the possibility that lender misbehavior during the life of a mortgage loan can create lien vulnerability in bankruptcy.This article explores the utility of the various subparts of § 363 as a tool to terminate zombie mortgages in bankruptcy. We believe that this bankruptcy power of sale provides a useful avenue to free debtors from the haunting shadow of a defaulted, un-foreclosed mortgage and associated involuntary homeownership. At the same time, the bankruptcy trustee sale power of § 363 can provide great community and market benefits and alleviate foreclosure crisis fallout by encouraging home occupancy and maintenance, wiping out stale liens, and releasing real property back into the stream of commerce.