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THREE STRIKES AND YOU ARE OUT: The Court Refuses to Invalidate a Foreclosure Sale in Light of a Eleventh Hour Bankruptcy Filing because of Two Previous Filings

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  • Posted on: May 25 2018

Litigation of residential mortgage foreclosure actions in New York remains prevalent at the trial and appellate court levels.  Issues related to residential mortgage foreclosure are frequently treated in this Blog. (Here, here, here, here and here.)

It is not uncommon for an individual faced with the prospect of losing a home to foreclosure, to file a bankruptcy petition on the eve of a foreclosure sale in an effort to stop the sale.  Section 362 of the Bankruptcy Code, provides that the filing of a bankruptcy petition “operates as a stay, applicable to all entities, of…the commencement or continuation … of a judicial … or other action or proceeding against the debtor that was or could have been commenced before the commencement of the case under this title….”  (11 U.S.C. 362(a)(1).)  There is no doubt that the filing of a bankruptcy petition, in general, operates to stay mortgage foreclosure actions.  See Lubonty v. U.S. Bank National Association, 159 A.D.3d 962 (2d Dep’t 2018).

The stay of a foreclosure sale frequently serves a legitimate purpose consistent with the objectives of the Bankruptcy Code.  Many times, however, the opposite is true and, in such cases, the Bankruptcy Code has some built in protections to prevent abuse.  One such provision of the Bankruptcy Code, known as “Three Strike Rule”, provides that:

If a single or joint case is filed by or against a debtor who is an individual under this title, and if 2 or more single or joint cases of the debtor were pending within the previous year but were dismissed, other than a case refiled under a chapter other than Chapter 7 after dismissal under section 707(b), the stay under subsection (a) shall not go into effect upon the filing of the later case.

11 U.S.C. 362(c)(4)(A)(i).

In USAA Federal Savings Bank v. Gotsch (Sup. Ct. Suffolk Co. May 10, 2018) (here), the Court relied on this provision to deny the mortgagor defendant’s request that the court invalidate the foreclosure sale of residential real property that he owned (the “Property”).

The facts in Gotsch are simple. Gotsch borrowed $350,000 from plaintiff and secured the obligation to repay the resulting note with a mortgage on the Property.  When Gotsch defaulted in the repayment of the loan, USAA commenced a residential foreclosure action. Gotsch defaulted in answering the complaint and failed to appear at the scheduled foreclosure settlement conference.  Both of plaintiff’s subsequent motions, for an order of reference and then for a judgment of foreclosure and sale, were granted on default.

On the day of the first foreclosure sale, Gotsch filed a petition under Chapter 13 of the Bankruptcy Code that stayed the sale (the “First Bankruptcy”).  The First Bankruptcy was dismissed a few months later.  A second foreclosure sale was scheduled and, on the day that it was to occur, Gotsch filed his second petition under Chapter 13 of the Bankruptcy Code (the “Second Bankruptcy”).  The Second Bankruptcy was dismissed two months later. A third foreclosure sale was scheduled and, on the day it was to occur, Gotsch filed a third petition under Chapter 13 of the Bankruptcy Code (the “Third Bankruptcy”).

Despite Gotsch’s “bald” allegation that he notified the lender’s attorney, and that his realtor notified the foreclosure sale referee, of the filing of the Third Bankruptcy, the scheduled sale went forward, and the subject property was sold at public auction.  Within a few weeks of the foreclosure sale, Gotsch moved by Order to Show Cause (the “OSC”) to “invalidate the foreclosure sale” based on, inter alia, violations of the automatic stay provisions of the Bankruptcy Code.  The OSC contained a temporary restraining order prohibiting, inter alia, the transfer of the Property.

The several arguments were made in opposition to the motion.  The lender argued that, by virtue of the Three Strike Rule, there was no automatic stay in place upon the filing of the Third Bankruptcy because there were “two or more bankruptcy cases … pending against [Gotsch] within the previous year [that] were dismissed….”  It was also argued that because there was ample evidence in the record that Gotsch did not reside at the Property, he would not be prejudiced or irreparably harmed if the sale was sustained.

The Third Bankruptcy was dismissed within two months of the filing of the OSC.

Relying on the Three Strike Rule and Second Department authority interpreting same, the Gotsch court held that there was no automatic stay in effect on the day of the third foreclosure sale.  The Court also held that there was no evidence to set aside the sale using its “broad equitable powers” that could be invoked in the face of “fraud, collusion, mistake, or misconduct cast[ing] doubt on the fairness of the sale.”  The Court further found that “the evidence suggests that [Gotsch’s] three bankruptcy filings, each one initiated on the same day as a scheduled Foreclosure Sale, were brought simply to delay the sale of the subject property and may fairly be characterized as an abuse of the legal system.”  (Citations omitted.)

 

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