The Gavel Falls

In affirming the District Court's holding, the Third Circuit described two divergent lines of cases addressing cure rights under section 1322(c)(1) for New Jersey Chapter 13 debtors. One line of cases (known as the 'gavel rule') holds that the right to cure a default under section 1322(c)(1) lasts only until the gavel falls at a foreclosure sale. The second line of cases holds that a residence is not 'sold' pursuant to section 1322(c)(1) until the deed is actually delivered to the winning bidder. The Connors opinion contains footnotes listing New Jersey bankruptcy and district court cases going both ways. The Third Circuit adopted the gavel rule. The courts holding that section 1322(c)(1) rights survived until delivery of the deed did so to give the debtor the greatest opportunity to save his principal residence by filing a Chapter 13 petition and to arranging to cure the defaults and reinstate the mortgage under a Chapter 13 plan. The legal justification behind the second line of cases lies in what some courts found to be an ambiguity in section 1322(c)(1)'s use of the phrase 'a foreclosure sale that is conducted in accordance with applicable nonbankruptcy law.' Some courts have found it unclear whether the phrase refers to the actual sale event (the auction) or completion of the entire sale process (such as delivery of the deed or a court's confirmation of the sale), which can take many days after the gavel falls at the auction. The apparent ambiguity traces back to the legislative history of section 1322(c)(1), which includes a statement that Congress's intent was to 'allow[] the debtor to cure home mortgage defaults at least through completion of a foreclosure sale under applicable nonbankruptcy law.' H.R. Rep. 103-835, at 52 (1994), reprinted in 1994 U.S.S.C.A.N. 3340, 3361 (emphasis added).

As an initial point, the Connors court found, without the need to refer to legislative history, that the phrase 'sold at a foreclosure sale conducted in accordance with applicable nonbankruptcy law' unambiguously refers to a foreclosure sale that complies with state law procedures. The court then reasoned that the preposition 'at' in the phrase 'sold at a foreclosure sale' signifies a discrete event and not an ongoing process. In adopting the gavel rule, the Third Circuit was persuaded by the fact that at least one bankruptcy court had taken judicial notice of the practice of New Jersey foreclosure practitioners to refer to the auction as the 'sale' ' not the subsequent steps such as deed delivery. Similarly persuasive was the fact that certain New Jersey statues and rules affecting sheriff's sales treated 'sale' as being synonymous with the auction itself, as did several decisions from the Supreme Court of New Jersey. The Connors court also noted that, in New Jersey, the successful bidder at a foreclosure auction acquires equitable title not subject to defeasance except in narrow circumstances (such as exercise by the owner of his right of redemption or a timely objection to the sale process that is judicially sustained). Finally, although title is actually conveyed when the deed is delivered, the court found the act of delivery to be effectively a ministerial act. The court also found that the adoption of the gavel rule made sound policy sense because a foreclosure sale (as contrasted to deed delivery) requires advance notice to the debtor, giving the debtor time to file a bankruptcy petition prior to the sale, and because uncertainties as to the finality of the sale process would likely serve to lower bids.

Larger Implications

The Connors decision has implications beyond resolving the split that existed between the gavel rule and the deed-delivery rule in the New Jersey federal courts. The decision brings courts within the Third Circuit into line with many other courts, including the Sixth Circuit, which appears to be the only other circuit court to have addressed the appropriateness of the gavel rule under section 1322(c)(1). See In re Cain, 423 F.3d 617, 620 (6th Cir. 2005).

Connors clarifies that, throughout the Third Circuit, the phrase 'sold at a foreclosure sale conducted in accordance with applicable nonbankruptcy law' in section 1322(c)(1) means a foreclosure sale that complies with state law foreclosure procedures. Accordingly, it seems clear that the debtor's right to cure under section 1322(c)(1) does not expire if the sale was not properly conducted in accordance with state law procedures. See, e.g., In re Danaskos, 254 B.R. 416, 418 (Bankr. N.D. Ill. 2000) (lifting the automatic stay to allow a successful bidder to continue with state court sale confirmation hearing and stating 'If the state court finds that the sale was not conducted in accordance with Illinois law ' the Debtor may proceed with her Chapter 13 attempt to reinstate the mortgage.'). Similarly, holding that the phrase 'sold at a foreclosure sale conducted in accordance with applicable nonbankruptcy law' means a foreclosure sale that complies with state law foreclosure procedures certainly ends any future argument within the Third Circuit about whether state law ' as opposed to federal law ' determines when the foreclosure sale is complete. See, e.g, In re Beeman, 235 B.R. 519, 525 (Bankr. D.N.H. 1999) ('This language indicates that Congress intended state law to be determinative of when a foreclosure sale is complete.').

Also, in adopting the 'gavel rule,' the Connors court put to rest the ambiguity some courts had found over whether Congress intended the phrase 'sold at a foreclosure sale' to apply to the event of a sale ' or to the entire sale process. In New Jersey, the sale process would include post-sale actions such as delivery of the deed ' an event which could take some weeks after the sale concluded. For other courts, the sale process ' and thus the right to cure ' could mean judicial confirmation of a sale or some other act. See, e.g., In re Barham, 193 B.R. 229, 232 (Bankr. E.D.N.C. 1996) (holding that right to cure terminated after expiration of 10-day statutory upset bid period).

The court held that the modifier 'at' immediately proceeding 'a foreclosure sale' signified a discrete event and not an ongoing process. Because 'foreclosure sale' is not defined in the Bankruptcy Code, the court discerned its ordinary meaning by looking to New Jersey state law, and the law of other jurisdictions to determine the discrete point in time at which the 'foreclosure sale' had occurred and determined that point to be the conclusion of the auction.

Connors also makes clear that imposition of the gavel rule does not terminate a debtor's post-sale remedies allowed under state law. In New Jersey, those post-sale remedies include a 10-day period for the debtor either to object to the sale or exercise the right of redemption. See N.J. Ct. R. 4:65-5, Hardyston Nat'l Bank of Hamburg v. Tartamella, 267 A.2d 495, 498 (N.J. 1970) ('[W]e believe the just course is to permit the mortgagor to redeem within the ten-day period fixed by R. 4:65-5 for objections to the sale and until an order confirming the sale if objections are filed under the rule.'). Accordingly, Connors stands for the proposition that a debtor can still exercise his state law rights to object to the sale or redeem.

In connection with these state law remedies, the Connors court stated that, by operation of section 108(b) of the Bankruptcy Code, New Jersey's 10-day period to redeem or object was extended until 60 days from the petition date. While the debtor had not exercised these rights within the 60-day period, the Connors decision serves as authority for the proposition that not only are post-sale state law remedies still available to bankruptcy debtors, but debtors may have even more time to exercise those rights than would otherwise be available outside of bankruptcy. This may be of limited value, however, in states such as New York, where the right of redemption actually terminates at the foreclosure auction itself. See, e.g, Bank of New York v. Ortiz, 817 N.Y.S.2d 154, 155 (2d. Dep't 2006) (discussing how, under New York law, the right of redemption 'is extinguished by the foreclosure sale itself, regardless of whether a deed has been delivered to the sale purchaser.').

In New Jersey, the right to redeem would continue through a judicial resolution of an objection to the foreclosure sale, even if the objection is or would have been overrruled; if the objection was sustained and the sale was defective, the debtor's section 1322(c)(1) rights would presumably survive. While the number of Chapter 13 debtors that will have the financial ability to exercise the right of redemption (i.e., pay the full amount owed) may be small, the option is still there for those few debtors who can do so within the 60-day period provided by section 108(b) of the Bankruptcy Code. Should it turn out, however, that there is any possible basis for objecting to the sale under a particular state's law, and if the sale is not deemed to be complete as a matter of state law until a judicial resolution of the objection, then the filing of a bankruptcy petition prior to that resolution should preserve the ability to cure under a Chapter 13 plan.

Conclusion

The use of bankruptcy to protect an individual's home from foreclosure is sufficiently commonplace that practitioners would be well advised to understand the foreclosure process in their state and, in particular, when that process will be deemed completed for purposes of section 1322.

Jeff J. Friedman, a member of this newsletter's Board of Editors, is a partner and Merritt A. Pardini is an associate in the Bankruptcy and Creditors' Rights Department of the New York office of Katten Muchin Rosenman LLP. The authors gratefully acknowledge the assistance of Alexander B. Barton, an associate in the firm's Real Estate Department of the New York office, in the preparation of this article.

On Aug. 3, 2007, the United States Court of Appeals for the Third Circuit broke what it called a 'virtual tie' among the New Jersey bankruptcy and district courts over the application of Bankruptcy Code section 1322(c)(1): whether a Chapter 13 debtor can cure a default on a mortgage secured by the debtor's principal residence between the time the residence is sold at a foreclosure sale and the time the deed is delivered to the successful bidder. In re Connors, __ F.3d, (3d Cir. 2007), 2007 WL 2215606. Although the Third Circuit resolved the rule for New Jersey, the issue exists in any state where the deed is delivered or further judicial proceedings contesting the foreclosures sale can occur after the foreclosures auction. In Connors, the debtor executed a note and mortgage on his New Jersey residence. He subsequently defaulted on the note and, at a foreclosure sale, the property was sold to a purchaser who had tendered the 20% deposit as required by
New Jersey state law. Four days later, the debtor petitioned for relief under Chapter 13 of the Bankruptcy Code and two weeks after that filed a Chapter 13 plan that proposed to cure the pre-bankruptcy arrearages on the note. The debtor did not, however, exercise his right to object to the foreclosure sale as allowed under N.J. Ct. R. 4:65-5 (which allows ten days to object to a foreclosure sale) or redeem the property within the 60-day grace period conferred by section 108(b) of the Bankruptcy Code.

After the 60-day period under section 108(b) expired, the successful bidder moved to lift the automatic stay so that it could tender the remainder of the purchase price and receive the deed to the property. The Bankruptcy Court granted the motion, holding that the debtor no longer had the right to cure under section 1322(c)(1) and that his state law redemption period had passed. The District Court affirmed.

Section 1322 sets forth the requirements for a Chapter 13 plan. Subsection (b)(3) states that a plan may 'provide for the curing or waiving of any default', and subsection (b)(5) states that the plan may 'provide for the curing of any default within a reasonable time and maintenance of payments while the case is pending on any unsecured claim or secured claim on which the last payment is due after the date on which the final payment under the plan is due.' 11 U.S.C. ' 1322(b)(3)(5). Subsection (c)(1) limits these rights, however, by providing, in relevant part, that '[A] default with respect to, or that gave rise to, a lien on the debtor's principal residence may be cured under paragraph (3) or (5) of subsection (b) until such residence is sold at a foreclosure sale that is conducted in accordance with applicable nonbankruptcy law.' 11 U.S.C.
' 1322(c)(1) (emphasis added).

In affirming the District Court's holding, the Third Circuit described two divergent lines of cases addressing cure rights under section 1322(c)(1) for New Jersey Chapter 13 debtors. One line of cases (known as the 'gavel rule') holds that the right to cure a default under section 1322(c)(1) lasts only until the gavel falls at a foreclosure sale. The second line of cases holds that a residence is not 'sold' pursuant to section 1322(c)(1) until the deed is actually delivered to the winning bidder. The Connors opinion contains footnotes listing New Jersey bankruptcy and district court cases going both ways. The Third Circuit adopted the gavel rule. The courts holding that section 1322(c)(1) rights survived until delivery of the deed did so to give the debtor the greatest opportunity to save his principal residence by filing a Chapter 13 petition and to arranging to cure the defaults and reinstate the mortgage under a Chapter 13 plan. The legal justification behind the second line of cases lies in what some courts found to be an ambiguity in section 1322(c)(1)'s use of the phrase 'a foreclosure sale that is conducted in accordance with applicable nonbankruptcy law.' Some courts have found it unclear whether the phrase refers to the actual sale event (the auction) or completion of the entire sale process (such as delivery of the deed or a court's confirmation of the sale), which can take many days after the gavel falls at the auction. The apparent ambiguity traces back to the legislative history of section 1322(c)(1), which includes a statement that Congress's intent was to 'allow[] the debtor to cure home mortgage defaults at least through completion of a foreclosure sale under applicable nonbankruptcy law.' H.R. Rep. 103-835, at 52 (1994), reprinted in 1994 U.S.S.C.A.N. 3340, 3361 (emphasis added).

As an initial point, the Connors court found, without the need to refer to legislative history, that the phrase 'sold at a foreclosure sale conducted in accordance with applicable nonbankruptcy law' unambiguously refers to a foreclosure sale that complies with state law procedures. The court then reasoned that the preposition 'at' in the phrase 'sold at a foreclosure sale' signifies a discrete event and not an ongoing process. In adopting the gavel rule, the Third Circuit was persuaded by the fact that at least one bankruptcy court had taken judicial notice of the practice of New Jersey foreclosure practitioners to refer to the auction as the 'sale' ' not the subsequent steps such as deed delivery. Similarly persuasive was the fact that certain New Jersey statues and rules affecting sheriff's sales treated 'sale' as being synonymous with the auction itself, as did several decisions from the Supreme Court of New Jersey. The Connors court also noted that, in New Jersey, the successful bidder at a foreclosure auction acquires equitable title not subject to defeasance except in narrow circumstances (such as exercise by the owner of his right of redemption or a timely objection to the sale process that is judicially sustained). Finally, although title is actually conveyed when the deed is delivered, the court found the act of delivery to be effectively a ministerial act. The court also found that the adoption of the gavel rule made sound policy sense because a foreclosure sale (as contrasted to deed delivery) requires advance notice to the debtor, giving the debtor time to file a bankruptcy petition prior to the sale, and because uncertainties as to the finality of the sale process would likely serve to lower bids.

Larger Implications

The Connors decision has implications beyond resolving the split that existed between the gavel rule and the deed-delivery rule in the New Jersey federal courts. The decision brings courts within the Third Circuit into line with many other courts, including the Sixth Circuit, which appears to be the only other circuit court to have addressed the appropriateness of the gavel rule under section 1322(c)(1). See In re Cain, 423 F.3d 617, 620 (6th Cir. 2005).

Connors clarifies that, throughout the Third Circuit, the phrase 'sold at a foreclosure sale conducted in accordance with applicable nonbankruptcy law' in section 1322(c)(1) means a foreclosure sale that complies with state law foreclosure procedures. Accordingly, it seems clear that the debtor's right to cure under section 1322(c)(1) does not expire if the sale was not properly conducted in accordance with state law procedures. See, e.g., In re Danaskos, 254 B.R. 416, 418 (Bankr. N.D. Ill. 2000) (lifting the automatic stay to allow a successful bidder to continue with state court sale confirmation hearing and stating 'If the state court finds that the sale was not conducted in accordance with Illinois law ' the Debtor may proceed with her Chapter 13 attempt to reinstate the mortgage.'). Similarly, holding that the phrase 'sold at a foreclosure sale conducted in accordance with applicable nonbankruptcy law' means a foreclosure sale that complies with state law foreclosure procedures certainly ends any future argument within the Third Circuit about whether state law ' as opposed to federal law ' determines when the foreclosure sale is complete. See, e.g, In re Beeman, 235 B.R. 519, 525 (Bankr. D.N.H. 1999) ('This language indicates that Congress intended state law to be determinative of when a foreclosure sale is complete.').

Also, in adopting the 'gavel rule,' the Connors court put to rest the ambiguity some courts had found over whether Congress intended the phrase 'sold at a foreclosure sale' to apply to the event of a sale ' or to the entire sale process. In New Jersey, the sale process would include post-sale actions such as delivery of the deed ' an event which could take some weeks after the sale concluded. For other courts, the sale process ' and thus the right to cure ' could mean judicial confirmation of a sale or some other act. See, e.g., In re Barham, 193 B.R. 229, 232 (Bankr. E.D.N.C. 1996) (holding that right to cure terminated after expiration of 10-day statutory upset bid period).

The court held that the modifier 'at' immediately proceeding 'a foreclosure sale' signified a discrete event and not an ongoing process. Because 'foreclosure sale' is not defined in the Bankruptcy Code, the court discerned its ordinary meaning by looking to New Jersey state law, and the law of other jurisdictions to determine the discrete point in time at which the 'foreclosure sale' had occurred and determined that point to be the conclusion of the auction.

Connors also makes clear that imposition of the gavel rule does not terminate a debtor's post-sale remedies allowed under state law. In New Jersey, those post-sale remedies include a 10-day period for the debtor either to object to the sale or exercise the right of redemption. See N.J. Ct. R. 4:65-5, Hardyston Nat'l Bank of Hamburg v. Tartamella , 267 A.2d 495, 498 (N.J. 1970) ('[W]e believe the just course is to permit the mortgagor to redeem within the ten-day period fixed by R. 4:65-5 for objections to the sale and until an order confirming the sale if objections are filed under the rule.'). Accordingly, Connors stands for the proposition that a debtor can still exercise his state law rights to object to the sale or redeem.

In connection with these state law remedies, the Connors court stated that, by operation of section 108(b) of the Bankruptcy Code, New Jersey's 10-day period to redeem or object was extended until 60 days from the petition date. While the debtor had not exercised these rights within the 60-day period, the Connors decision serves as authority for the proposition that not only are post-sale state law remedies still available to bankruptcy debtors, but debtors may have even more time to exercise those rights than would otherwise be available outside of bankruptcy. This may be of limited value, however, in states such as New York, where the right of redemption actually terminates at the foreclosure auction itself. See, e.g, Bank of New York v. Ortiz , 817 N.Y.S.2d 154, 155 (2d. Dep't 2006) (discussing how, under New York law, the right of redemption 'is extinguished by the foreclosure sale itself, regardless of whether a deed has been delivered to the sale purchaser.').

In New Jersey, the right to redeem would continue through a judicial resolution of an objection to the foreclosure sale, even if the objection is or would have been overrruled; if the objection was sustained and the sale was defective, the debtor's section 1322(c)(1) rights would presumably survive. While the number of Chapter 13 debtors that will have the financial ability to exercise the right of redemption (i.e., pay the full amount owed) may be small, the option is still there for those few debtors who can do so within the 60-day period provided by section 108(b) of the Bankruptcy Code. Should it turn out, however, that there is any possible basis for objecting to the sale under a particular state's law, and if the sale is not deemed to be complete as a matter of state law until a judicial resolution of the objection, then the filing of a bankruptcy petition prior to that resolution should preserve the ability to cure under a Chapter 13 plan.

Conclusion

The use of bankruptcy to protect an individual's home from foreclosure is sufficiently commonplace that practitioners would be well advised to understand the foreclosure process in their state and, in particular, when that process will be deemed completed for purposes of section 1322.

Jeff J. Friedman, a member of this newsletter's Board of Editors, is a partner and Merritt A. Pardini is an associate in the Bankruptcy and Creditors' Rights Department of the New York office of Katten Muchin Rosenman LLP. The authors gratefully acknowledge the assistance of Alexander B. Barton, an associate in the firm's Real Estate Department of the New York office, in the preparation of this article.