If a debtor defaults on a mortgage only after filing for bankruptcy, will that debt survive his bankruptcy?
The Debtor had an insured, high-ratio mortgage that was in good standing when he became insolvent. After his assignment into bankruptcy, he kept the mortgage current for seven payments until June, 2019. After the mortgage went into default, the mortgagee started foreclosure proceedings and obtained a direct listing order. The Debtor is set to be discharged from bankruptcy in 2022.
The Judicial Listing started at $249,900.00 and was reduced to $240,000.00 in January, 2020. The property did not sell. A new appraisal was obtained in March which estimated the value to be $203,000.00. There was no explanation for the significant difference between the first appraisal dated at the end of October, 2019 and the more recent one.
The mortgage contained an ipso facto clause that the outstanding loan amount would become payable immediately if, inter alia, the mortgagor became insolvent. Section 84.2 of the Bankruptcy and Insolvency Act bars acting on an ipso facto clause unless the mortgage is actually in default, or the Court grants relief from that provision. The issue, then, was whether the debt would survive his bankruptcy.
Master Schlosser found that bankruptcy does not, by its very fact, extinguish the covenant to pay in an insured mortgage that is not in default. Payments post-assignment and post-discharge reaffirm liability under the covenant.
If you carry a mortgage, or an obligation, through bankruptcy, you can be liable after discharge. A default that is actionable at the instance of the secured creditor is not extinguished if the default is cured, the lender waives the default, or otherwise does not take action. The ipso facto clause gives the lender the option to act on the defaults not specifically barred by s. 84.2. Whether a default itself gives rise to a claim provable in bankruptcy will depend on timing and construction of the lending agreement.
An action on the covenant to pay, where it is available, is contingent upon two things: first, the mortgage must be in default; and second, the value of the property has to be less than the amount owing under the mortgage. If these two conditions are met over the course of the bankruptcy, pre-discharge, a claim on the covenant becomes a provable claim. If no proof is made, the debt is discharged with the bankrupt.
In this case, Master Schlosser found that the deficiency itself was not sufficiently proved. The opinions of value conflicted and the market did not respond to the initial Judicial Listing at $249,900.00, or $240,000.00. There was no way to reconcile the two appraisals.
However, Master Schlosser held that the deficiency (if there is one) is a provable claim on the facts of this case extinguished on discharge unless it fits within one of the exceptions in section 178(2), none of which apply.
Liability on a covenant to pay in an insured mortgage that is reaffirmed post-assignment (or post-discharge) is not a novation and not a new (post-bankruptcy) debt. It is thereby not outside the bankruptcy. Accordingly, a default pre-discharge makes it a provable claim unless and until the default is cured, or waived by the creditor. The obligation created by a reaffirmation is best thought of as a continuation of an existing, or underlying obligation, on a potential liability that existed at the time of assignment.
In this case, the mortgagee chose not to ignore, or excuse the default. The mortgagee started its proceedings post-assignment but pre-discharge. As such, the mortgagee’s action on the covenant to pay was a provable claim.
Counsel: Lora Lee and Kari Sejr of Bishop & McKenzie LLP for the Plaintiff
Master: Master W.S. Schlosser