In re Smith
40 Bankr. Ct. Dec. (CRR) 229, 288 B.R. 675, 2003 Bankr. LEXIS 91 (2003)
Rule of Law:
In New York, a true purchase money mortgage given to a seller to secure a portion of the purchase price generally has priority over a contemporaneous mortgage given to a third-party lender, even if the third-party mortgage is recorded earlier, absent an express subordination agreement or fraudulent concealment.
Facts:
- Scott V. Smith owned a residence at 383 Englewood Avenue in Tonawanda, New York, with an estimated full market value of $65,606.
- On January 7, 1999, Smith executed two mortgages encumbering the property.
- Smith gave a mortgage to PCFS to secure a note of $68,000, which was recorded on January 12, 1999.
- Smith also gave a mortgage to Robert and Mary Jane Zak to secure a note of $16,217; the Zaks were the prior owners of the property and accepted the note as partial consideration for the transfer of title.
- The Zak mortgage was recorded on January 22, 1999, and contained no provision subordinating it to the PCFS lien.
- As of the date Smith filed for bankruptcy, he owed approximately $67,225.01 plus interest to PCFS and about $15,000 to the Zaks.
Procedural Posture:
- Scott V. Smith filed for Chapter 13 bankruptcy.
- Scott V. Smith filed a motion in the United States Bankruptcy Court for the Western District of New York to avoid the mortgage held by Robert and Mary Jane Zak.
- The mortgagees, Robert and Mary Jane Zak, did not respond to the motion.
- The Bankruptcy Court required Scott V. Smith to provide proof of entitlement to the requested relief before rendering a decision on the motion.
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Issue:
Does a purchase money mortgage given to a seller to secure a portion of the purchase price lose its priority to a contemporaneously executed mortgage given to a third-party lender that was recorded earlier, thereby allowing the debtor to avoid the seller's mortgage under 11 U.S.C. § 1322(b)(2) and § 506(a) as a wholly unsecured lien?
Opinions:
Majority - Carl L. Bucki
No, a purchase money mortgage given to a seller does not lose its priority to a contemporaneously executed mortgage given to a third-party lender merely because the third-party mortgage was recorded earlier, and thus, the debtor cannot avoid the seller's mortgage as a wholly unsecured lien under 11 U.S.C. § 1322(b)(2) and § 506(a). The court acknowledged that under In re Pond, a wholly unsecured junior lien on a debtor’s principal residence may be avoided in Chapter 13 bankruptcy. However, the determination of a lien's secured status first requires an assessment of its priority under state law. In New York, the general rule is that a vendor's purchase-money mortgage has priority over a contemporaneous mortgage given to a third-party lender, even if the third-party's mortgage was recorded first. Citing Dusenbury v. Hulbert and Boies v. Benham, the court explained that the deed and the vendor’s purchase-money mortgage are considered an indivisible act, establishing the seller's priority due to a pre-existing equitable lien for the unpaid purchase price. The debtor, Scott Smith, failed to present any evidence of a subordination agreement or fraudulent concealment that would alter this established priority. Since the Zak mortgage is a true purchase money mortgage given by the prior owners as partial consideration for the property, it is presumed to hold first lien priority over the PCFS mortgage, regardless of recording dates. With the Zak mortgage as a first lien, its outstanding amount of approximately $15,000 is less than the property's fair market value of $65,606. Consequently, the Zak mortgage is not a wholly unsecured lien under 11 U.S.C. § 506(a), and therefore, Scott Smith cannot avoid it under the authority of In re Pond.
Analysis:
This case clarifies that the federal bankruptcy power to 'strip off' wholly unsecured junior liens under 11 U.S.C. § 1322(b)(2) and § 506(a) is contingent upon a correct determination of lien priority under state law. It reaffirms the strong protection afforded to vendor purchase-money mortgages in New York, establishing their priority over contemporaneous third-party financing even if recorded later. This ruling provides crucial certainty for sellers who provide financing, ensuring their equitable interest is preserved. It limits the application of the In re Pond precedent by requiring a preliminary state law analysis of lien priority before assessing a lien's 'wholly unsecured' status, thus influencing how debtors can restructure real estate debts in Chapter 13.
