Old Law Is Still Good Law, but Sometimes You Still Have to Explain It . . .
On July 11, 2016, in Edmundson v. Bank of America, the Washington Court of Appeals summarized settled law governing the interplay between an installment promissory note secured by a deed of trust, a bankruptcy discharge, and the statute of limitations. What is most surprising about the case is how thoroughly the trial court erred on every issue, which suggests that neither the borrower nor bank counsel squarely presented the law to the trial court. It further illustrates the aphorism that anytime one goes to a courtroom, two things can happen and one of them is bad.
In 2007, the Edmundsons obtained a 30-year installment loan secured by a deed of trust on real property. They defaulted on their loan in 2008, and sought Chapter 13 bankruptcy relief in 2009. Their plan was confirmed, and their personal liability on the Note was discharged in December 2013. The grant of the discharge terminated the automatic stay by statute. A foreclosure notice of default followed in October 2014, based upon the failure to make the Note payments, with a trustee’s sale scheduled for May 2015. In March 2015, the Edmundsons sought to enjoin the sale. The trial court permanently enjoined the sale, concluding that the Note was not enforceable due to the bankruptcy discharge and enforcement of the Note was barred by the statute of limitations. Recognizing this decision to be contrary to well-established law, the Court of Appeals reversed on all grounds.
First, in a 1991 decision, Johnson v. Home State Bank, the U.S. Supreme Court held that the bankruptcy discharge extinguishes only the debtor’s personal liability, but does not extinguish existing liens on the debtor’s property or the related right to foreclose that lien. In addition to this quarter-century-old precedent, the bankruptcy court’s Order granting the Edmundsons' discharge was explicit, saying “a creditor may have the right to enforce a valid lien, such as a mortgage or security interest against the debtor’s property after the bankruptcy, if that lien was not avoided or eliminated in the bankruptcy.” An examination of the very bankruptcy order on which the trial court relied should have led the trial court to a denial of the injunction on the first ground relied on by the Edmundsons. The appellate court minced no words:
The trial court’s ruling in this case has a practical effect. That effect is that the Edmundsons retain ownership of property without repaying the loan used to purchase it. The loss shifts to the lender because the Edmundsons no longer have any personal obligation on the promissory note due to its discharge in bankruptcy. Under the trial court’s ruling, the lender also has no right to realize on the collateral for the loan. Neither the equity nor logic of this result is apparent to this court. In sum, nothing . . . under either federal or state law supports the conclusion that the discharge of personal liability on the note also discharges the lien of the deed of trust securing the note. The deed of trust is enforceable. (emphasis added).
Second, the Court of Appeals reversed the trial court’s finding that enforcement of the Note was barred by the statute of limitations. The appellate court relied upon decades-old precedent involving an installment note, which had not been the subject of acceleration to hold that each ensuing monthly payment default begins a new 6-year limitations period. Further, the Court held that issuance of a foreclosure notice of default under the Deed of Trust Act was sufficient to toll, or stop, the statute of limitations from running.
Frankly, here the Court of Appeals engaged in its own analytical lapse. The Court sought to gloss over the acceleration of the Note in order to rely on the installment loan analysis from a 1968 case arising from foreclosure of a mechanic’s lien, where the property owner was paying the underlying debt in installment payments. The prior decision involved foreclosure of a mechanic’s lien where no acceleration had occurred. The appellate court glibly quoted the prior court’s remark that “Default in payment alone does not work an acceleration.” Read in context, however, the additional step required in conjunction with the default was simply for the lender to have accelerated the loan as a consequence of the default. It is easy to anticipate that the appellate court’s out of context quote will be echoed—erroneously—in briefings to other courts.
Additionally, the Court of Appeals did not mention 11 U.S.C. §108(c) of the bankruptcy code, which tolls the statute of limitations while the bankruptcy stay is in effect, and for 30 days thereafter. This alone should have resolved the question at both the trial court and appellate court, but was not addressed in either forum. The absence of consideration of the bankruptcy code in this setting will lead to mischief later, based upon the path taken by the appellate court to obtain the desired result.
Why Does This Case Matter?
In our bulletins about new developments in the law, we always try to demonstrate why the case should matter to our lender clients. Here, the grand lesson is the importance of providing trial judges with a comprehensive and integrated approach to the law governing borrowers, lenders and collateral, in all their forms and in all the courts that govern them. Many judges have had no exposure to these principles and may not understand how these concepts fit together. A more complete education in trial court briefing may save costly clean-up down the road.
If you have questions regarding this ruling's impact, please contact a member of the Stokes Lawrence Financial Services Group.