Restoring Balance to the Commercial Foreclosure Process

Restoring Balance to the Commercial Foreclosure Process
By Ellen M. McDowell, Esq.

Picture yourself representing a client whose business recently failed. Your client owned the building out of which she operated and personally guaranteed the mortgage on the building. Business has been bad for months and the bank finally foreclosed on the property. Your client believes the building is worth $500,000. She owes the bank $525,000. She has come to you to discuss filing a bankruptcy since she does not have the ability to pay the Bank and she has a relatively small amount of trade debt as well. She also has a home with equity of $100,000.

Logic would dictate that you would be safe advising your client that since the Bank now owns the property worth around $500,000, client’s obligation to Bank is somewhere in the neighborhood of $25,000, right? The answer is not so clear, at least in New Jersey.

In the spring of 2010, the New Jersey Appellate Division decided Borden v. Cadles of Grassy Meadows II, LLC , 412 N.J. Super. 567 (App. Div. 2010). The facts in Borden are complicated and tortured, but the short version is that the Bank obtained a judgment against the borrower and Borden, one of the guarantors of the debt, for $4 million. Around the time the judgment was entered, guarantors obtained an appraisal valuing the property at between $3.7 million and $4 million. At Sheriff’s sale, a third party bidder paid $640,035 for the property. Notably, no objection was made to the sale.

Years later, the Bank assigned the judgment to a different party and the assignee began to pursue Borden as guarantor. Borden sued to prevent enforcement of the judgment on the basis that (1) the holder of the judgment had waited too long to collect the debt and (2) Borden was entitled to a credit for the amount generated by the Sheriff’s sale of the property. The trial court agreed and extinguished the judgment against Borden. On appeal, the Appellate Division reversed, holding that the burden was on the guarantor to object to the sale within ten days after the sale under R. 4:65-6, thus initiating a deficiency action to determine the amount remaining on the debt. Since Borden had failed to object to the sale or otherwise take steps to seek a court determination of the remaining balance due, the Court found that Borden had waived his right to a credit and was obligated for the entire amount of the claim, presumably $4 million plus interest.

The Borden decision sent shock waves through commercial bankruptcy practices all over New Jersey. Too often debtors retain counsel long after the Sheriff’s sale takes place and the time to object to the sale under R. 4:65-6 has passed. Under Borden, this would result in debtors and guarantors being liable for the entire amount of the Bank’s claim, regardless of the amount
generated at the sale or the value of the property now owned by the Bank.

In another sea change, however, the Bankruptcy Court in New Jersey recently held that a Chapter 13 debtor whose property was foreclosed on in 2010 and taken back by the Bank was entitled to a credit for the fair market value of such property even though she did not object to the sale.

In In re Karagiannis, 2011 Lexis 1806 (Bankr. N.J. 2011), Judge Stern conducted a painstaking analysis of New Jersey law as it pertained to Borden and its genesis. While the decision is well reasoned and thorough in its application of the law to the facts before the court, it is clear that Judge Stern was offended by the notion that the Bank in that case might obtain a windfall if he applied the holding in Borden and refused to allow a credit for the value of the property taken back at the sale. Judge Stern offered that such a result would be, in his opinion, “rank unfairness.” Id. at 4.

Although Judge Stern set forth several reasons why Karagiannis should be distinguished from Borden, including the extreme facts of the Borden case, the overriding basis for his opinion was his belief that fairness and equity demanded that the debtor be given a credit, especially in the bankruptcy context, where the Court has jurisdiction to “determine the value of a claim secured by a lien on property in which the estate has an interest.” Fed. R. Bankr. P. 3012. In fact, Judge Stern called that valuation hearing “a bankruptcy process imperative.” Id. at 59.

Judge Stern’s opinion in In re Karagiannis is the right decision. While the outcome of Borden may have been required under the facts of that case, it did not lead to a fair and equitable result for the parties. In re Karagiannis restores balance to the commercial foreclosure process, at least in New Jersey Bankruptcy Court.


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