By: Jacob J. Payne & Scott St. Amand
Some of you who read the title of this post may have done a quick double-take, as it is well established that lenders may not collect a deficiency on a nonrecourse loan under state law. However, the Bankruptcy Code provides some relief to a holder of a wholly unsecured nonrecourse loan when the debtor files for Chapter 11 protection.
Nonrecourse loans limit creditors to look only to debtor’s collateral for repayment. This means that after a foreclosure sale, a creditor may not seek a deficiency judgment against the debtor. Because there is no state law right to a deficiency, debtors have argued that the Bankruptcy Code should likewise not permit a wholly-unsecured nonrecourse creditor’s claim to be an allowed claim in bankruptcy.
The Seventh Circuit, in In re B.R. Brookfield Commons , held that by operation of § 1111(b) of the Bankruptcy Code, wholly-unsecured nonrecourse claims are treated as if the creditor had recourse, and its unsecured deficiency claim is allowed.
Section 1111(b) provides that a “claim secured by a lien on property” of the bankruptcy estate is to be allowed against the debtor, as if the claimant had recourse against the debtor, whether or not by contract or law the creditor actually had such recourse. Application of this section prevents a windfall to the debtor, and “puts the Chapter 11 debtor who wishes to retain collateral property in the same position as a person who purchased property ‘subject to’ a mortgage lien would face in the non-bankruptcy context.”