Summary of a Recent
Judicial Development in
Bankruptcy

Court Finds Marshaling Doctrine Was Not Applicable

Walt McCarter
National AgLaw Center Research Associate

Summary of Decision

In In re Laufenburg, No. 03-12989-122004 Bankr. LEXIS 1428 (Bankr. D. Kan. June 3, 2004), the United States Bankruptcy Court for the District of Kansas held that the creditor was entitled to relief from stay to foreclose on the debtors' relatives' real estate, and that the relatives were not entitled to use the marshaling doctrine to force the creditor to foreclose on other assets first.

Background

Two brothers borrowed money from Met Life in 1995, secured by their relatives' property (Tracts A and F) as well as their own. Id. at *3. One brother, William, sued the other, James, in state court in 1999, and James subsequently filed for Chapter 7 bankruptcy and discharged his personal obligation on the Met Life debt. Id. at *5. Among other things, the settlement in the state court action established additional terms for Luella's (a relative) sale of certain real property to William, and the relatives' lease of 640 acres of farmland, including Tracts A and F, to William on a cash rent basis for five years or until Luella's death, whichever occurred last. Id.

The Debtors (William and his spouse) failed to make their September 2002 payment to Met Life, and the following December, Met Life declared the entire amount immediately due. Id. at *6. The Debtors continued to miss their payments until Met Life filed a foreclosure action in March 2003. Id. The Debtors subsequently filed for Chapter 12 bankruptcy, and Met Life filed motions for relief from the automatic stay of foreclosure, for declaration that the relatives were not protected by the stay, and for adequate protection. Id. The Debtors proposed a plan of reorganization, under which they would pay Met Life the entire principal owed to it over a longer period of time and at a lower interest rate than provided by the original note. Id. They conceded that they could not reorganize without debt reduction to Met Life. Id. at *7. The Debtors' amended plan proposed to allow Met Life to foreclose on the relatives' property but not their own property, and the relatives objected to the plan. Id.

Arguments

Met Life argued that: (1) it was entitled to stay relief to allow it to foreclose on the relatives' property since the debtors waived their interests in those tracts, and (2) the relatives could not require Met Life to foreclose on the Debtors' property before enforcing its lien on their property. Id. at *8.

The relatives argued that: (1) the Debtors' leasehold interests were sufficient to make the automatic stay apply to Tracts A and F; (2) under their amended plan, the Debtors were improperly assuming part of their lease with Luella and rejecting the part that applies to Tracts A and F; and (3) the court should apply the doctrine of marshaling to require Met Life to collect from the debtors' property before proceeding against their property. Id. at *8-9.

Analysis and Holdings

The court held that because the Debtors had agreed to relief from the automatic stay as to Tracts A and F, Met Life was entitled to stay relief under § 362(d)(2) to foreclose on those tracts. Id. at *9-10. The court also held that "while it may be true that § 365(a) authorizes debtors to assume only the full extent of an unexpired lease and not to assume part and reject part, the Court is convinced that the debtors are proposing to assume all of their lease with Luella." Id. at *10. The Debtors had told the court that they intended to continue making rent payments to Luella even after the foreclosure. Id. The court stated that "with the Debtors promising to pay the same cash rent for the reduced acreage, the Relatives' rent rights under the lease will not be reduced, making their assertion that the Debtors are rejecting part of the lease unconvincing." Id.

Regarding the application of the marshaling doctrine, the court explained that generally three circumstances must coincide in order for marshaling to be available: "(1) the existence of two creditors with a common debtor; (2) the existence of two funds belonging to the debtor; and (3) the legal right of one creditor to satisfy his demand from either of the funds, while the other may resort to only one fund." Id. at *12 (quoting In re Muir, 89 B.R. 157, 160 (Bankr. D. Kan. 1988)). The court noted that there were numerous reasons why the relatives were not entitled to the doctrine of marshaling, including the fact that Tracts A and F did not belong to the Debtors, and also that the relatives were not competing creditors but were instead more similar to debtors themselves. Id. at *14-16. Finally, the doctrine of marshaling would harm the Debtors' unsecured creditors because it would effectively reduce the liquidation value of their estate. Id. at *18. Thus the court concluded that Met Life was entitled to stay of relief and allowed to proceed in its foreclosure action. Id. at *21-22.

*Note-this decision was affirmed by the Tenth Circuit Bankruptcy Appellate Panel on November 30, 2004.

The case was decided on June 3, 2004.