A “Free and Clear” Sale Order Does Not Necessarily Extinquish Defenses

On February 20, 2008, the Court of Appeals of Ohio, rendered a decision in the case of EMC MTGE. Corporation v. Atkinson, 175 Ohio App. 3d 571, 2008, that is of particular interest to mortgage companies, as well as bankruptcy professionals.

EMC Mortgage Corporation (“EMC”), purchased the assets of United Companies Lending Corporation (“UCLD”) for $493,750,000. Prior to the purchase, Mr. Robert Atkinson, Sr. executed a mortgage with UCLC and never made a payment on the note. UCLC instituted a foreclosure action on the property covered by the mortgage, to which Mr. Atkinson, Sr. counterclaimed on the grounds of fraud, negligence and misrepresentation. UCLC subsequently filed bankruptcy, and the foreclosure action was automatically stayed. Thereafter, Mr. Atkinson, Sr. passed away, and his son, Atkinson, Jr. (“Atkinson”) filed a proof of claim in the bankruptcy action against UCLC, alleging fraud, negligence and misrepresentation.

Subsequent to the purchase of EMC’s purchase of UCLC’s assets – approximately four years later -- EMC filed a foreclosure complaint against Atkinson for failure to pay, to which Atkinson counterclaimed. While this foreclosure action was pending, Atkinson ultimately settled his proof of claim against UCLC for $15,000 and expressly reserved his claims against EMC. The bankruptcy court approved the settlement and Atkinson withdrew his claim against UCLC, and also voluntarily withdrew the counterclaim against EMC in the bankruptcy action. However, Atkinson sought and was granted leave to amend his answer in the foreclosure action by EMC, to which he added the affirmative defenses of fraud, coercion, duress and incapacity.

EMC moved for summary judgment on the foreclosure action on the grounds that [1] there was no dispute over the default under the note and [2] that the settlement agreement approved by the bankruptcy court and the bankruptcy court’s order of sale barred the affirmative defenses asserted by the Plaintiff. The trial court granted the motion for summary judgment, and the Court of Appeals reversed.

In contrast to the trial court, the Court of Appeals concluded that Atkinson would not recover twice for the same cause of action if permitted to proceed with his defenses of fraud, coercion, duress and incapacity. In addition, the court concluded that Atkinson had reserved these claims against EMC and thus could not be barred from pursuing these defenses.

In addition, the Court of Appeals concluded that the Order of the Bankruptcy Court did not preclude Atkinson’s assertion of these defenses to the foreclosure action. The Court relied upon the fact that there was no reference to “defenses” in the sale order. Rather, the sale order only spoke to “claims,” stating that: “None of the EMC Parties or the Guarantor shall have any liability or responsibility with respect to any Claim against any of the Debtors or any prior owner of any Mortgage Loan or for any action, or failure to take action, . . ..” In other words, the Court concluded that the sale order only stated that “EMC shall have no ‘responsibility’ for UCLC’s action or inaction.” The Court also noted that no authority had been nor could be cited for the proposition that a defense may be extinguished as a result of a ‘free and clear’ sale. Accordingly, the Court concluded that Atkinson could raise the defenses in the foreclosure action.

Posted by: Bridget H. Papalia

Categories: Bankruptcy & Banking Law