Fifth Circuit Affirms Non-Dischargeability of Mortgage Fraud Debts

October 30, 2017 by Alexa P. Stephenson, Esq.

On July 18, 2017, the U.S. Court of Appeals for the Fifth Circuit ruled that debts resulting from a plan designed to defraud mortgagees of foreclosure sale proceedings could not be discharged pursuant to 11 U.S.C §§ 523(a)(4) and 523(a)(6). The holding affirmed two prior bankruptcy court decisions against the debtor, Mr. Charles Cowin.

Mr. Cowin designed a fraudulent mortgage scheme where a straw buyer acquired property contingent on a first mortgage at a condominium association’s foreclosure proceeding. The straw buyer then signed a tax-transfer loan agreement with a pair of Texas corporations managed by Cowin in order to pay overdue property taxes on the property. After paying the taxes, the tax-transfer lender obtained a tax-transfer lien on the property. The straw buyer would then proceed to default and fail to issue payments mandated by the tax-transfer loan agreement. Cowin would direct the tax-transfer deed trustee to enter into foreclosure. The trustee would then use the foreclosure sale proceeds to collect a $1,000.00 fee, pay the private lenders’ tax transfer liens in full, and transfer the remaining funds to the buyer.

The trust deed documents Cowin used to transfer title lacked wording obligating the trustee to allocate the remaining proceeds to junior lienholders based on their priority before reimbursing the grantor pursuant to Texas Tax Code § 32.06(b) & (j). By omitting this language, the bankruptcy court found that Cowin intended to divert the excess proceeds from the foreclosure sales away from the preexisting mortgage holders and to entities controlled by a co-conspirator.

Bank of America sued Cowin and his co-conspirators in federal court, seeking to recover excess funds and other damages incurred from the fraudulent foreclosure proceedings. In February 2010, while the Bank of America litigation was pending, Cowin filed for Chapter 11 bankruptcy, which was dismissed after five weeks.

Cowin filed a second bankruptcy case in May 2010. Shortly thereafter, Countrywide, Deutsche Bank, and several other banks that held preexisting mortgages on properties acquired by Cowin’s co-conspirators, brought adversary proceedings in an effort to obtain a finding of non-dischargeability. The bankruptcy court consolidated the proceedings and then dismissed Cowin’s bankruptcy case after determining that Cowin had abused the bankruptcy system by submitting two Chapter 11 petitions in two years without providing a plan or disclosure statement in either case. At the parties’ request, however, the bankruptcy court retained jurisdiction over the pending adversary proceeding.

In January 2013, the federal court action resulted in a settlement stipulating that if Cowin did not reimburse the Bank in the amount of $500,000.00 by September 1, 2013, the Bank could then pursue relief from the automatic stay for entry of an agreed judgment. The following month, prior to the court’s ruling, Cowin filed another Chapter 7 bankruptcy.

After lifting the automatic stay in order for the federal district court to enter the agreed upon judgment on April 24, 2013 in the federal court case, the bankruptcy court concluded that Cowin was liable to the Bank for $268,477.78, the cumulative total of the excess foreclosure proceeds, and that all of his debts resulting from transgressions of state statutes were non-dischargeable.

The Bank then initiated an adversary proceeding in Cowin’s Chapter 7 case, requesting a finding that the judgment was non-dischargeable. On June 12, 2013, Cowin appealed the bankruptcy court’s non-dischargeability determination to the trial court. On September 30, 2014, the court issued partial summary judgment in favor of the Bank, stating that Cowin was collaterally stopped from questioning the previous non-dischargeability ruling. The trial court then granted Cowin’s subsequent motion to certify an appeal directly to the Fifth Circuit

Cowin’s appeal claimed that (a) the bankruptcy court had ruled in error that his debts were non-dischargeable; (b) the bankruptcy court’s ruling breached the Chapter 7 automatic stay; (c) the trial court settlement agreement precluded any pre-settlement causes of actions—including those determining non-dischargeability; (d) the bankruptcy court errantly concluded he told the trustee to foreclose; and (e) the bankruptcy court wrongfully granted preclusive effect to the adversary proceeding judgment.

The Fifth Circuit first clarified that the dischargeability of a given debt is a federal issue pursuant to the Bankruptcy Code, which mandates non-dischargeability must be proven by a preponderance of the evidence. The Court next addressed section 523(a) of the Bankruptcy Code, which establishes the categories of non-dischargeable debt. Pertinent to this case, section 523(a)(4) and (6) excepts from discharge debts for both fraud while serving as a fiduciary and for malicious injury by a debtor to another entity.

The Fifth Circuit rejected Cowin’s assertion that the bankruptcy court was errant in attributing the actions and intent of his co-conspirators to him when making their determination. The Court also concluded that the Bankruptcy Code explicitly permits creditors to submit adversary actions to determine dischargeability of debt and thus, the automatic stay in Cowin’s Chapter 7 case was not violated. In sum, the Fifth Circuit affirmed the district court and bankruptcy court holdings in both adversary proceedings.