Lender Lessons From Consumer Bankruptcy Cases in the Eastern District of New YorkJune 2018
A trio of recent decisions written by Judge Carla Craig, the chief bankruptcy judge for the Eastern District of New York, have important lessons for lenders who deal with consumer borrowers.
Lender Vigilance Denies Debtor Discharge
Capital One Equipment Finance Corp. v Davinder Pal Singh shows how a lender can object to a discharge in a chapter 7 case where its borrower has engaged in fraud. Chapter 7 cases are designed to provide a fresh start to debtors; in the overwhelming majority of cases, the debtor receives a discharge from his pre-petition debts. But a debtor can be denied a discharge where he engages in fraud. The question then becomes: how to prove the fraud?
The answer is to review the debtor’s bankruptcy court filings and compare the answers with the debtor’s testimony at his section 341 hearing. In Davinder Pal Singh, Capital One followed that template and was successful in having the $840,000 debt owed to it excepted from discharge.
Davinder Pal Singh involved a loan secured by a New York City taxi medallion. On September 19, 2013, Mr. Singh refinanced his existing $720,000 medallion loan with an $840,000 loan from Capital One. Mr. Singh later filed a chapter 7 petition on April 11, 2016. In his bankruptcy court filings, he claimed to own a one-fourth interest in real estate in South Ozone Park, New York and claimed a homestead exemption for the property. He also certified that he had not sold, transferred or traded any property outside the ordinary course in the two years prior to filing his petition.
On July 8, 2016, Capital One conducted a Rule 2004 examination of Mr. Singh, whose bank statements showed a $55,000 deposit into his account in May 2015, less than a year prior to the bankruptcy filing. In his examination he admitted making multiple payments to his father in the year prior to the bankruptcy, however none of this was disclosed in the bankruptcy court filings. Following the Rule 2004 examination, Capital One filed a complaint to bar Mr. Singh’s discharge. In July 2017, Mr. Singh amended his bankruptcy court filings to now claim that he was the sole owner of the South Ozone Park property.
To deny a debtor a discharge, an objecting creditor must establish that: (1) the debtor made a false statement under oath with the intent to deceive, (2) the debtor knew the statement was false, and (3) the false statement was material. In Davinder Pal Singh, Judge Craig ruled that Capital One met its burden and denied the discharge. Judge Craig focused on two false statements by Mr. Singh: his conflicting story concerning the property, and his deceptions regarding the $55,000 deposit and the payments to his father.
The lesson here is that lenders need to use care in reviewing a debtor’s bankruptcy court filings and their testimony to determine whether to pursue an action to deny a discharge. Lenders often believe that a chapter 7 filing means that it’s time to close the file and that no recovery is possible. Davinder Pal Singh shows how a careful lender can keep its claim alive.
Trustee’s Claim to Claw Back Tuition Payments as Fraudulent Conveyances Fails
In Harold Adamo, Jr., Judge Craig denied a chapter 7 trustee’s attempt to claw back tuition payments that the debtor had made for his children’s college educations. In Mr. Adamo’s chapter 7 case, the trustee commenced an adversary proceeding seeking to recover approximately $280,000 in tuition payments that Mr. Adamo had made for his children that were ultimately received by Hofstra, Fairfield University and Brooklyn Law School.
The Trustee’s claim was straightforward; her argued that by making the payments Mr. Adamo had improperly decreased the pool of assets available for creditors. The trustee argued that Mr. Adamo did not receive fair consideration for the payments because he had no obligation to make education payments for children who were over the age of 18.
Judge Craig noted that the claw-back of tuition payments made by debtors for the education of their children is a developing issue, and bankruptcy courts have reached different results as to whether such payments can be recovered. The factors courts have considered include whether the child was a minor at the time of payment, whether the payment was for primary, college or post-graduate education, and whether the debtor was satisfying a legal or moral obligation.
But in Adamo, the record was clear that Mr. Adamo made the tuition payments by funding an account in the name of each child in a portal maintained by the colleges. The colleges made it clear that the students, and not the institutions, were the owners of those accounts, and that the students had to take an affirmative act to transfer funds to the institution. If a child chose not to use funds on deposit to pay tuition, the institutions could not access the account, and as Judge Craig noted, would have to deal with a parent’s anger. But the structure of the student portal accounts, and that fact that the students had dominion and control over funds deposited there, was the key to the opinion.
Based on the evidence, Judge Craig ruled that Mr. Adamo’s children were the initial transferees of the tuition payments, and that the institutions were subsequent transferees without knowledge of Mr. Adamo’s bankruptcy proceeding. Based on their status as subsequent transferees, she ruled, the schools were entitled to assert a “good faith” defense to the trustee’s claims. The good faith defense is available under section 550 of the Bankruptcy Code to a subsequent transferee of an otherwise avoidable transfer who shows that it had acted in good faith, and had provided reasonably equivalent value for the transfer it received. The reasonably equivalent value was the educational services they provided to Mr. Adamo’s children.
Judge Craig’s decision turned on a technical construction of the fraudulent conveyance statutes. But it enabled her to reach a narrow decision without having to decide whether the payments were protected or not based on criteria such as the age of the child, the type of education being provided, or the questions of moral or legal obligation. The message for educational institutions could not have been clearer: make sure that tuition payments from students are channeled through portals of the type used by Hofstra, Fairfield University and Brooklyn Law, where the students are the owners of the accounts at issue, and preserve your ability to assert a good faith defense under section 550 of the Bankruptcy Code.
Homeowner’s Claim to Void Mortgage Debt Dismissed
In Joy Taylor-Simmons, Judge Craig dismissed a claim by a homeowner who sought to have a bank’s mortgage lien declared unenforceable, based upon the lender’s alleged failure to comply with the statute of limitations in New York CPLR 213(4), which provides that an action to foreclose must be commenced within six years. Under this statute, the statute of limitations begins to run when the lender accelerates the note.
Plaintiff Joy Taylor-Simmons and her husband owned a home in Brooklyn, and took a mortgage loan in April 2005, which was held by Bank of New York as trustee. When the borrowers defaulted, Bank of New York brought a foreclosure action in February 2010, following which there were settlement conferences between July 2010-September 2013. In February 2016, Bayview, the servicer for Bank of New York, sent the borrowers a letter saying that the loan had been de-accelerated and reinstituted as an installment loan. The foreclosure action was discontinued in July 2016.
On April 5, 2017 the plaintiff filed a chapter 11 petition, listing Bank of New York as a secured creditor with a claim of $462,000. The plaintiff filed an adversary proceeding, seeking a determination that Bank of New York’s claim was unenforceable because the six-year statute of limitations to foreclose had elapsed.
New York law under CPLR 213(4) provides that a foreclosure proceeding must be commenced within six years of the acceleration of a note or other debt. The lender has the right to de-accelerate the loan so long as such de-acceleration occurs within the same six-year window. But CPLR 213(4) does not state what actions are necessary or sufficient to constitute a de-acceleration, so the law on point has developed through judges’ rulings.
In Joy Taylor-Simmons the plaintiff argued that Bayview’s February 2016 notice was not sufficient, and that because the stipulation of discontinuance was filed in July 2016, it was outside the six-year window. Relying on prior New York decisions, Judge Craig found that the de-acceleration letter sent in February 2016 was sufficient to establish an affirmative act of revocation if sent before the expiration of the six-year period. Based on those decisions, she ruled that the fact that the discontinuance was filed in July 2016 was not controlling and dismissed the borrower’s claim.
The lesson for lenders is clear. If a lender chooses to work with a borrower and modify or reinstate a loan following the commencement of a foreclosure proceeding, part of the checklist should be a letter of de-acceleration of the loan. The letter should state that it is being sent pursuant so New York CPLR 213(4) and should state that it is a revocation of all prior acceleration(s) of the debt.