Mortgage Priority & the
“Reclassified” Chapter 13 Claim
In
June 2013, Bank commenced an action against McKenna for an order directing the
recording of a 2006 mortgage and a declaration that the mortgage had priority
over junior mortgages already of record. In September, McKenna filed for
Chapter 13, automatically staying the state court action. In August 2014, the
Bankruptcy Court lifted the automatic stay while it simultaneously “reclassified”
the debt “for purposes of that court,
from ‘secured’ to ‘unsecured’...” [emphasis supplied]. In December, the
Bankruptcy Court confirmed McKenna’s plan and discharged the “unsecured” debt.
McKenna
then moved for dismissal of the complaint in the state court action “on the ground that the confirmed bankruptcy plan
‘serves as res judicata’ on the issue of the subject mortgage.” The trial court
rejected that argument and the Second Department affirmed. U.S. Bank
N.A. v. McKenna, 2017 NY Slip Op
03215 [149 AD3d 1136] (2nd Dept. 2017).
“While an order confirming a Chapter 13
bankruptcy plan may constitute a final judgment on the merits (see In re Layo, 460 F3d 289, 294 (2d Cir
2006); cf. 11 USC §?1327
(a)), the res judicata effect of a confirmed plan does not apply when a state
court action concerning the validity of a lien remains unresolved at the time
the bankruptcy proceedings were commenced [citations omitted]. Here, the
instant action was pending when the McKennas filed their bankruptcy petition,
and, therefore, the Supreme Court properly concluded that the subsequent
confirmation of the amended Chapter 13 bankruptcy plan had no res judicata
effect on the instant action.”
Comment:
The key
to this decision is the Bankruptcy Court’s simultaneous recognition of
the “unsecured” status of the loan vis-à-vis McKenna’s personal liability and
the lender’s pre-bankruptcy action to perfect its lien against the real
estate and the priority thereof. In Layo, the proceeding to enforce the
mortgage post-dated plan confirmation. Similarly, §1327(a) provides that “a confirmed plan bind[s] the debtor and each
creditor,” which the McKenna plan does with respect to the debt, while leaving
the lender free to pursue its pre-existing attempt to perfect the lien.