Lance R. Pomerantz
Attorney at Law

Land     Title     Law

“Constructive Notice”  The  Newsletter

Excerpted from the July 19, 2017 mailing of "Constructive Notice":

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.”


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.