Discharge In Bankruptcy Does Not Discharge Mortgage

The title of the alert is hardly a revelation to bankruptcy or foreclosure practitioners, or to experienced mortgage lenders and servicers as well.  Nonetheless, for those new to the field, and some others, it is a critical point.  Indeed, the concept was initially missed in a recent foreclosure case which is what spurred the thought that the topic was worthy of exploration here.  In that recent case, Wilmington Savings Fund Society, FSB v. Fernandez, 62 Misc.3d 622, 89 N.Y.S.3d 832 (Sup. Ct. 2018), the court first failed to properly assess the point that while the debt may be discharged in a bankruptcy, the mortgage is not.

This is more readily understandable as a practical matter in observing that there are two basic documents to an elemental mortgage transaction: the note and the mortgage.  The note is a promise to pay, a personal obligation, and is the foundation to pursue a deficiency after a foreclosure is concluded, assuming there is a shortfall as defined by state law.   The mortgage is the security for the debt, the pledge of real property for the obligation and a mortgage foreclosure is of course against the property and is therefore defined as “in rem”.

Accordingly, the filing of a petition in bankruptcy is not as portentous a threat to the mortgagee as it might initially appear.  The principle is that while the personal monetary obligation is subject to discharge in bankruptcy, a valid mortgage is not; it survives, and this is true as a matter of law.  This critical principle is recognized in state court as well: secured interests (including judgment liens) survive the bankruptcy.  Therefore, even when the debtor is discharged in bankruptcy, it is discharged solely from personal liability and absent further decree, has no effect upon a secured interest (i.e., a mortgage).  Similarly stated, while a discharge in bankruptcy extinguishes an action against the debtor in personam, it remains intact is an action against the debtor in rem, that is on the mortgage.  Thus, a discharge in bankruptcy is not a defense to mortgage foreclosure action.

In the cited new case, the court initially did not properly evaluate the status of the law.  Upon re-argument however, it was persuaded that “a discharge in bankruptcy extinguishes only a debtor’s in personam liability for any deficiency on the debt but leaves intact the creditors right to a claim against the debtor in rem.”

Further, the court concluded that “a Chapter 7 discharge extinguishes an individual’s personal obligation under the promissory note but does not eradicate plaintiff’s security interest in the property.”

So, while the underlying concept may not be so elusive – although not universally known – it is certainly important.

Mr. Bergman, author of the four-volume treatise, Bergman on New York Mortgage Foreclosures, LexisNexis Matthew Bender (rev. 2019), is a partner with Berkman, Henoch, Peterson, Peddy & Fenchel, P.C. in Garden City, New York. He is also a member of the USFN, The American College of Real Estate Lawyers, The American College of Mortgage Attorneys, an adviser to the New York Times on foreclosure issues and writes a regular servicing column for the New York Law Journal. He is AV rated by Martindale-Hubbell, his biography appears in Who’s Who In American Law and he has been for years listed in Best Lawyers In America and New York Super Lawyers.