Reed v. Nielsen (In re Reed)

640 B.R. 932

IN RE: Gerald N. REED and Beatrice J. Reed, Debtors.

Gerald N. Reed; Beatrice J. Reed, Appellants,

v.Henrik Nielsen, Appellee.

BAP No. CC-21-1181-FLT

Bk. No. 9:09-bk-14594-DS

United States Bankruptcy Appellate Panel of the Ninth Circuit.

Filed MAY 16, 2022

Michael A. Jones of M Jones and Associates, PC, Santa Ana on brief for appellants.

Before: FARIS, LAFFERTY, and TAYLOR, Bankruptcy Judges.

FARIS, Bankruptcy Judge:

INTRODUCTION

Chapter 7¹ debtors Gerald N. Reed and Beatrice J. Reed appeal the bankruptcy court's order determining that creditor Henrik Nielsen did not violate the discharge injunction. The Reeds argue that a judgment in Mr. Nielsen's prepetition judicial foreclosure action transformed a secured obligation into a wholly in personam debt that was subsequently discharged in their bankruptcy case.

The Reeds’ arguments have no merit. We AFFIRM. We publish to explain that a bankruptcy discharge has no effect on a foreclosure judgment in a California judicial foreclosure proceeding.

FACTS

A. Prepetition events

In May 2007, the Reeds executed a promissory note for $292,500 and a deed of trust encumbering real property located in San Miguel, California (the "Property"). Mr. Nielsen holds the note and is the beneficiary under the deed of trust. The promissory note provided for an interest rate of fourteen percent per annum.

The Reeds defaulted on the promissory note. Mr. Nielsen filed a complaint in California state court to foreclose on the deed of trust. In his prayer for relief, he asked the superior court to enter judgment for the amount due on the note and requested "that the deed of trust be foreclosed and the usual judgment be made for the sale of the property according to law, by the levying officer; that the proceeds be applied to the amounts due plaintiff ...."

The superior court entered a default judgment in Mr. Nielsen's favor. The form judgment provided that "Defendant ... must pay plaintiff on the complaint" a total of $331,002.25. (Emphasis added.) An attached Judgment of Foreclosure and Order of Sale provided "that in addition to the monetary damages set forth in the Judgment[,]" the Property will be sold, the levying officer will pay Mr. Nielsen the judgment amount, and the surplus would be paid to the Reeds. (Emphasis added.)

B. The Reeds’ chapter 7 case

Months later, the Reeds filed a chapter 7 petition. They scheduled the judgment debt in favor of Mr. Nielsen as an unsecured nonpriority claim in the amount of $331,017. In their statement of financial affairs, they mentioned a "levy by creditor" and a "money judgment" in favor of Mr. Nielsen based on "Debtors Guarantors of Loan."

The Reeds received their chapter 7 discharge in March 2010, and the bankruptcy court closed the Reeds’ case.

C. The alleged violations of the discharge injunction

Mr. Nielsen continued his collection efforts against the Property. In March 2011, the superior court issued a writ of sale concerning the Property. The Sheriff's Office recorded a notice of levy and a notice of sale.

The Reeds filed in the superior court a motion to quash the writ of sale and levy. The superior court enjoined the Sheriff's Office from selling the Property.

In April 2012, the superior court ruled that the 2009 default judgment was defective because the post-judgment interest rate of fourteen percent exceeded the statutory interest rate. The superior court quashed the writ of sale and vacated the levy without prejudice.

Mr. Nielsen filed an application for a modified default judgment. The proposed judgment corrected the post-judgment interest rate and also specified that the default judgment was a non-deficiency judgment due to the Reeds’ chapter 7 discharge. The Reeds opposed Mr. Nielsen's application, arguing that the 2009 judgment was defective and void ab initio, so Mr. Nielsen never held a perfected lien prepetition and the discharge voided the judgment.

On July 31, 2012, the superior court issued a "non-deficiency court default judgment foreclosing on [the Reeds’] property." It ordered that "[a] decree of Judicial Foreclosure will be entered against [the Reeds] in favor of [Mr. Nielsen] for the secured amount of $331,002.25." It further ordered that the Property "or so much of it as may be necessary, will be sold[,]" that "the levying officer will pay to plaintiff[ ] ... the amount due plaintiff" and that "[t]here shall be no judgment for deficiency."

The Reeds twice moved the superior court to set aside the 2012 judgment. The superior court rejected these requests, and the Reeds appealed.

The California Court of Appeal affirmed the superior court's ruling to adjust the interest rate in the 2009 judgment but held that the superior court lacked authority to modify the 2009 judgment to address the availability of a deficiency judgment. It ordered the superior court to set aside the 2012 judgment and issue an order striking the post-judgment interest rate from the 2009 judgment. Other than the change of the interest rate, the 2009 judgment, including the attached Judgment of Foreclosure and Order of Sale, remained intact.

Mr. Nielsen resumed his foreclosure efforts, and the superior court issued another writ of sale. A few days before the scheduled foreclosure sale, the Reeds filed a new chapter 7 petition. After Mr. Nielsen sought and obtained relief from the automatic stay, the Sheriff's Office sold the Property on April 10, 2019. A few weeks later, the bankruptcy court granted the Reeds their discharge and closed the case.

D. The Reeds’ first motion for sanctions

In April 2020, the Reeds filed in their 2009 bankruptcy case a motion for an order to show cause why Mr. Nielsen should not be held in contempt for his alleged violation of the discharge injunction. They took the view that the 2009 state court judgment was an in personam money judgment because it provided that the Reeds "must pay" Mr. Nielsen and directed the levying officer to pay Mr. Nielsen the judgment debt from the proceeds of the sale. They argued that the March 2010 discharge had discharged all liability to Mr. Nielsen, including the foreclosure judgment. They concluded that the chapter 7 discharge "voided the judicial foreclosure judgment that had been entered against the Debtors in 2009 and thus invalidated the purported conveyance and sale of the property by the Sheriff. As a result of the judgment being void, the Debtor's [sic] interest in the subject property remains intact and vested in the Debtor [sic]."

The bankruptcy court denied the motion without prejudice. It ruled that the Reeds had failed to demonstrate that the discharge had extinguished the secured debt owed to Mr. Nielsen.

E. The Reeds’ second motion for sanctions

The Reeds were undeterred. They filed another motion seeking damages for the alleged discharge violation (the "Sanctions Motion").

The Sanctions Motion expanded on the factual and procedural history of the case. The Reeds argued that: (1) Mr. Nielsen did not have a secured interest in the Property because the March 2009 judgment was not recorded prior to the petition date; (2) the March 2010 discharge discharged the 2009 judgment, which was an in personam money judgment by the terms of the order; and (3) Mr. Nielsen's post-discharge collection actions violated the discharge injunction.

The bankruptcy court held a hearing on the Sanctions Motion. Only the Reeds appeared. The bankruptcy court began by reminding the Reeds’ counsel of his "ethical obligations and obligations under [Civil] Rule 11 to put forth legal theories that are based in reality, because I think that that is where the motion really falls short."

Nevertheless, the Reeds insisted that the 2009 judgment was an in personam money judgment. They reasoned that the judgment "indicates directly that the plaintiff is entitled to recover the dollar amount, $331,000 from the Debtors[,]" and as a result "the Reed family then becomes personally liable on that event." They argued that California foreclosure law "creates an in personam judgment against the individual debtors, that the judgment creditor is then authorized to collect through levy that's done through that state-issuance process." They concluded that, pursuant to § 524, the discharge voided the 2010 judgment.

The bankruptcy court rejected the Reeds’ argument as "completely unsupported by the law." It stated that the dollar amount in the 2009 judgment did not transform the judgment into a simple money judgment. It explained that there was a loan, a consensual lien, a default, and a foreclosure judgment with a specific dollar amount that allows the creditor to sell the property to satisfy the judgment. It quoted the U.S. Supreme Court's decision in Johnson v. Home State Bank , 501 U.S. 78, 82-83, 111 S.Ct. 2150, 115 L.Ed.2d 66 (1991), for the proposition that a secured creditor may foreclose on the debtor's real property securing the loan and that right survives the bankruptcy discharge. It held that the Reeds failed to show that the foreclosure judgment established any personal liability that was discharged.

The court similarly rejected the Reeds’ argument that a security interest becomes a judicial lien upon issuance of a judgment of judicial foreclosure. It quoted In re Chu , 258 B.R. 206, 209 (Bankr. N.D. Cal. 2001) : "[W]hen a claim based on a security interest is reduced to judgment, while the claim may merge into the judgment, the security interest remains intact unless the judgment expressly cancels or avoids it." The court further explained that a consensual lien "doesn't just disappear."

Accordingly, the bankruptcy court denied the Sanctions Motion. The Reeds timely appealed.²

JURISDICTION

The bankruptcy court had jurisdiction under 28 U.S.C. §§ 1334 and 157(b)(2)(A). We have jurisdiction under 28 U.S.C. § 158.

ISSUE

Whether the bankruptcy court erred in holding that Mr. Nielsen did not violate the discharge injunction and denying the Sanctions Motion.

STANDARDS OF REVIEW

An award or denial of sanctions for an alleged violation of the...