Degiacomo v. Traverse

United States Court of Appeals
For the First Circuit

No. 13-9002

IN RE: VIRGINIA A. TRAVERSE,

Debtor.
__________

MARK G. DEGIACOMO, Chapter 7 Trustee for the
Estate of Virginia A. Traverse,

Appellee,

v.

VIRGINIA A. TRAVERSE,

Appellant.

APPEAL FROM THE BANKRUPTCY APPELLATE PANEL
FOR THE FIRST CIRCUIT

Before
Torruella, Howard, and Kayatta,
Circuit Judges.

David G. Baker for appellant.
Tara Twomey, National Consumer Bankruptcy Rights Center, and
Ray DiGuiseppe on brief for the National Association of Consumer
Bankruptcy Attorneys, Amicus Curiae.
Mark G. DeGiacomo, with whom Keri L. Wintle and Murtha Cullina
LLP were on brief, for appellee.

May 23, 2014
 HOWARD, Circuit Judge. This case requires us to explore

the contours of a bankruptcy trustee's lien avoidance and

preservation powers under 11 U.S.C. §§ 544 and 551 when a debtor's

state-law homestead exemption has been invoked.

In 2005, six years before filing a petition for Chapter

7 bankruptcy, Virginia Traverse secured a loan with a mortgage on

her home. In the years before her bankruptcy and continuing since

filing her petition, Traverse has remained current on all mortgage

payments on the property. Because Traverse's home is subject to a

homestead exemption under Massachusetts law, in these circumstances

the Bankruptcy Code would ordinarily allow Traverse to pass through

bankruptcy in possession of her home. Yet because Traverse's bank

failed to record the mortgage with the appropriate registry, the

bankruptcy trustee contends that his power to avoid and preserve

the mortgage justifies him in selling Traverse's home as property

of the bankruptcy estate. The bankruptcy judge and Bankruptcy

Appellate Panel accepted the trustee's view. We reverse.

I. Facts and Background

Virginia A. Traverse resides in a home in Lynn,

Massachusetts. She has been the title owner of the property since

April 30, 1999, when she recorded her ownership with the Essex

County South District Registry of Deeds. On July 11, 2005,

Traverse executed a mortgage on the home in favor of Washington

Mutual Bank to secure a loan of $200,000. On September 25, 2008,

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JP Morgan Chase acquired this mortgage as part of its blanket

acquisition of Washington Mutual's assets. At no point did either

mortgagee record the mortgage on Traverse's home with the Registry

of Deeds. Meanwhile, in March of 2007, Traverse executed a second

mortgage in favor of Citibank to secure a loan of $31,000, which

Citibank recorded in due course. Traverse has kept current on her

mortgage payments to both JP Morgan and Citibank.

On August 14, 2011, Traverse filed a voluntary bankruptcy

petition under Chapter 7 of the Bankruptcy Code. On her bankruptcy

schedules, Traverse valued her home at $223,500.1 She listed the

remaining claim secured by JP Morgan's mortgage as $185,777.30 and

the claim secured by Citibank's mortgage as $29,431.04. Finally,

pursuant to the Massachusetts Homestead Act, Traverse claimed a

homestead exemption in the property in the amount of $500,000.

Traverse's homestead exemption, which Traverse had formally

recorded in a Declaration of Homestead in January 2009, went

unchallenged by any interested party.

On December 15, 2011, Mark D. DeGiacomo, acting as the

Chapter 7 trustee of Traverse's bankruptcy estate, filed a

complaint to avoid JP Morgan's unrecorded mortgage and to preserve

it for the benefit of the estate. In response, Traverse filed a

1
As of March 2012, the City of Lynn assessed Traverse's home
as having a fair market value of $236,200. Because the approximate
$13,000 dollar difference between these estimates does not change
the legal analysis, the remainder of this opinion relies on
Traverse's schedules.

-3-
counterclaim seeking a declaratory judgment that, even if he

preserved the mortgage, DeGiacomo could sell only the mortgage

itself and not her underlying property. Traverse argued that

because the trustee's preservation of JP Morgan's mortgage gave the

estate only the rights of the original mortgagee, it created no

right to sell her home until she defaulted on her payments and

triggered the right of foreclosure. After DeGiacomo moved for

summary judgment, the bankruptcy court granted summary judgment in

his favor on all counts and the Bankruptcy Appellate Panel (BAP)

affirmed. Both tribunals concluded that, having preserved JP

Morgan's interest in Traverse's home for the bankruptcy estate, the

trustee was entitled to sell the home in order to liquidate that

interest. While not disputing that Traverse's current mortgage

payments prevented DeGiacomo from foreclosing on her home in his

capacity as mortgagee, the bankruptcy court and the BAP concluded

that DeGiacomo could nevertheless sell the home pursuant to his

core powers as a trustee administering a debtor's property under

the Bankruptcy Code.

Traverse now challenges that conclusion as a matter of

law.

II. Standard of Review

On appeal from the BAP, we train our analysis on the

underlying bankruptcy court decision, reviewing factual findings

for clear error and conclusions of law de novo. In re Canning, 706

-4-
F.3d 64, 68-69 (1st Cir. 2013). Under the de novo standard, we do

not defer to the bankruptcy court's ruling, but consider the matter

anew as though no decision were rendered below. Id. at 69.

Neither do we cede any deference to the conclusions of the BAP. In

re Hill, 562 F.3d 29, 32 (1st Cir. 2009).

III. Discussion

Under § 541 of the Bankruptcy Code, all of the debtor's

legal and equitable interests in property at the time of her

bankruptcy petition automatically become the property of the

bankruptcy estate. 11 U.S.C. § 541(a)(1); In re Barroso-Herrans,

524 F.3d 341, 344 (1st Cir. 2008) ("When an individual files for

bankruptcy, all of his property . . . becomes property of the

estate."). Nevertheless, § 522 of the Code allows a debtor to

exempt certain property, based either on an enumerated list of

federal exemptions or on any alternate exemptions provided by her

state. See 11 U.S.C. § 522(b); In re Cunningham, 513 F.3d 318, 323

(1st Cir. 2008); In re Hildebrandt, 320 B.R. 40, 43 (B.A.P. 1st

Cir. 2005). Among the state exemptions incorporated by § 522 is

the Massachusetts Homestead Act, which allows a debtor to claim an

interest of up to $500,000 in a home being used by the debtor as

her principal residence. In re Peirce, 483 B.R. 368, 376 (Bankr.

D. Mass. 2012); see also Mass. Gen. Laws ch. 188, § 1. The

debtor's declared homestead exemption is insulated from conveyance,

sale, or levy to help satisfy the debtor's debts in bankruptcy,

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with the exception of (as relevant here) a debt secured by a lien

on the property, such as a mortgage. Mass. Gen. Laws ch. 188,

§ 3(b); In re Swift, 458 B.R. 8, 15 (Bankr. D. Mass. 2011) ("[A]

debtor's homestead exemption is not effective against a mortgagee

where the mortgage in question was executed before the debtor

recorded a declaration of homestead."). The final working of the

scheme is that, when a debtor declares a property as her homestead,

proceeds realized from the sale of that property must be used first

to pay off any secured claims and subsequently to satisfy the

debtor's claimed exemption before, at last, being turned over to

her bankruptcy estate.

A core power of a bankruptcy trustee under § 363(b) of

the Code is the right to sell "property of the estate" for the

benefit of a debtor's creditors. 11 U.S.C. § 363(b)(1) ("The

trustee, after notice and a hearing, may use, sell, or lease, other

than in the ordinary course of business, property of the

estate . . . ."). Because a debtor's exempted property interests

are effectively removed from the estate, however, see Owen v. Owen,

500 U.S. 305, 308 (1991), § 363 does not empower the trustee to

sell exempted interests. In re Carmichael, 439 B.R. 884, 890

(Bankr. D. Kan. 2010) ("[W]here the debtor's interest is exempted,

the estate no longer has an interest that it may sell." (quoting

Collier on Bankruptcy ¶ 363.08[3] (16th ed. 2012))); see also In re

Parker, 142 B.R. 327, 330 (Bankr. W.D. Ark. 1992) ("The trustee

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abandons property of the estate in a chapter 7 case usually because

there is no equity in the property or the property is exempt.").

Nor does a bankruptcy trustee ordinarily sell property solely for

the benefit of secured creditors. See In re Scimeca Found., Inc.,

497 B.R. 753, 781 (Bankr. E.D. Pa. 2013) ("[A] bankruptcy trustee

should not liquidate fully encumbered assets, for such action

yields no benefit to unsecured creditors."); Collier on Bankruptcy

¶ 725.01 ("It is not the proper function of the trustee to

liquidate property solely for the benefit of secured creditors.").2

Consequently, where a debtor claims a homestead exemption in her

home, a trustee will typically sell the home only where its value

exceeds both the mortgage liens on the property and the debtor's

homestead exemption. In re Ellerstein, 105 B.R. 214, 216 (Bankr.

W.D.N.Y. 1989) ("[Where] [t]he debtors' interest is subject to a

mortgage . . . and the debtors' equity is significantly more than

the amount of the homestead exemption . . . the trustee would sell

the property . . . ."); In re Early, Bankr. No. 05-01354, 2008 WL

2569408, at *3 (Bankr. D.D.C. June 23, 2008) ("[I]f the amount of

the debtor's exemption was less than the value of the

property, . . . a trustee is free to sell the property," so long as

2
The U.S. Department of Justice instructs that, "[g]enerally,
a trustee should not sell property subject to a security interest
unless the sale generates funds for the benefit of unsecured
creditors." U.S. Department of Justice, Executive Office for
United States Trustees, Handbook for Chapter 7 Trustees at 8-20
(2002).

-7-
she "distribute[s] the proceeds first to the debtor in payment of

the debtor's claimed exemption . . . ."). This excess benefit for

the unsecured creditors, calculated as the value of the estate

minus any secured claims and exemptions, represents the bankruptcy

estate's remaining "equity" in the property. In re Hyman, 123 B.R.

342, 344 (B.A.P. 9th Cir. 1991), aff'd, 967 F.2d 1316 (9th Cir.

1992) ("[T]he equity available for the estate would be any amount

exceeding . . . encumbrances . . . plus the homestead

exemption . . . ."); In re McKeever, 132 B.R. 996, 999 (Bankr. N.D.

Ill. 1991) (defining the estate's "equity" as that "which would be

left for unsecured creditors after payment of secured claims and

the debtors' homestead exemption").

Where, on the other hand, a property fails to yield any

remaining equity for the estate beyond the value of its secured

encumbrances and the debtor's homestead exemption, a trustee

generally should not sell the home, but should leave the secured

creditors to their own legal means of recovering their claims. See

Scimeca Found., 497 B.R. at 781 ("[I]t is appropriate for a chapter

7 bankruptcy trustee to . . . allow the secured creditors to

exercise their right to recover possession of their collateral.").

This is because, by definition, "[a] secured creditor can protect

its own interests in the collateral subject to the security

interest." U.S. Department of Justice, Executive Office for United

States Trustees, Handbook for Chapter 7 Trustees at 8-20 (2002).

-8-
If a debtor defaults on her mortgage payments, the secured

creditor's options include its contractual right to foreclose on

the debtor's home. If, however, a debtor continues to satisfy her

contractual obligations to the benefit of the creditor, the

mortgagee has no grounds to foreclose and the debtor may retain her

home through the bankruptcy proceedings. See Ellerstein, 105 B.R.

at 216 ("[If] [t]he debtors' home is subject to a mortgage which is

not in default and the debtors' equity is less than the properly

claimed homestead exemption . . . the trustee would abandon the

interest and the debtors would retain the home.").

Traverse's homestead exemption leaves no residual equity

for her unsecured creditors, and her lack of default on her monthly

payments precludes both Citibank and JP Morgan from foreclosing on

her property. There is consequently no dispute that, if Traverse's

mortgages remained with their respective banks, the foregoing

analysis would dispose of the case: the bankruptcy trustee would

have no claim to sell Traverse's property and Traverse would retain

possession of her home. Indeed, this appears to be the trustee's

precise position with regard to Citibank's second mortgage. In the

case of JP Morgan, however, the trustee notes a further wrinkle:

neither Washington Mutual nor JP Morgan perfected the first

mortgage on Traverse's home by recording the lien with the Registry

of Deeds.

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 Where a creditor has an unperfected lien on a debtor's

property, the Bankruptcy Code empowers a trustee to avoid and

preserve the lien for the benefit of the estate. The trustee

exercises this power through two strong-arm provisions. First, the

trustee's right of avoidance under 11 U.S.C. § 544 "vests the

trustee with the powers of a bona fide purchaser of real property

for value, and allows the trustee to invalidate unperfected

security interests." In re Sullivan, 387 B.R. 353, 357 (B.A.P. 1st

Cir. 2008). Second, his right of preservation under 11 U.S.C.

§ 551 automatically preserves the benefit of the avoided interest

for the estate by "put[ting] the estate in the shoes of the

creditor whose lien is avoided." In re Carvell, 222 B.R. 178, 180

(B.A.P. 1st Cir. 1998). Together, these provisions benefit the

unsecured creditors by allowing the trustee to eliminate

unperfected liens on a debtor's property and subsequently to apply

the value represented by those liens to the general estate,

bypassing any junior lienholders. See In re French, 440 F.3d 145,

154 (4th Cir. 2006) ("[T]he Code's avoidance provisions protect

creditors by preserving the bankruptcy estate against illegitimate

depletions."); In re Nistad, Bankr. No. 10-17453-WCH, 2012 WL

272750, at *5 (Bankr. D. Mass. Jan. 30, 2012) ("The purpose of 11

U.S.C. § 551 is to allow a trustee to preserve the avoided interest

for the estate so that junior interest holders do not benefit from

the avoidance to the detriment of the estate and its creditors.").

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In this case, the trustee exercised his strong-arm powers to avoid

and preserve JP Morgan's mortgage on Traverse's home.3 He now

argues that, by preserving the mortgage lien, he may sell the

property that is subject to the lien in order to realize the value

of the mortgage for the bankruptcy estate.

Before addressing the trustee's argument, it is important

to clarify what the trustee does not argue. First, he does not

suggest that his preservation of JP Morgan's mortgage empowers him

to sell Traverse's home in his position as mortgagee. Nor could

he, since Traverse correctly notes that her current payments on her

mortgage insulate her property from foreclosure.4 Rather, the

3
In addition to objecting to the sale, Traverse also
challenges the bankruptcy court's jurisdiction to enter a final
order approving the trustee's avoidance and preservation in light
of the Supreme Court's decision in Stern v. Marshall, 131 S. Ct.
2594 (2011). Traverse suggests that Stern strips the bankruptcy
court of jurisdiction because the trustee's complaint seeks to
augment the bankruptcy estate and depends on Massachusetts state
law.
Under Stern, a bankruptcy court's jurisdiction to enter final
judgments is limited by Article III to issues in bankruptcy that
"stem[] from the bankruptcy itself or would necessarily be resolved
in the claims allowance process." Id. at 2618. Both the trustee's
complaint in this case, arising out of his § 554 and § 551 powers,
and Traverse's counterclaim, disputing the bankruptcy estate's
rights to her real property, stem directly from Traverse's
bankruptcy filing. The bankruptcy court correctly exercised
jurisdiction in entering a final order on all claims.
4
Under 11 U.S.C. § 524(c), a debtor who remains current on
her loan payments must also enter into a valid reaffirmation
agreement in order to prevent a mortgagee from foreclosing on its
security interest after she has filed for bankruptcy. Id.; see
also In re Golladay, 391 B.R. 417, 421 (Bankr. C.D. Ill. 2008).
Although the record does not reveal whether Traverse properly
reaffirmed her mortgage, because the trustee makes no claims to

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trustee suggests that, even in the absence of default, his

preservation of the mortgage has given the bankruptcy estate an

equity interest in the home that triggers his core power of sale as

bankruptcy trustee.

Second, the trustee does not argue that the preserved

mortgage freed up equity in Traverse's home for the bankruptcy

estate by eliminating a secured debt to be satisfied before the

home's value can begin accruing to unsecured creditors. Nor,

again, could he do so, because Traverse's unchallenged exemption of

$500,000 swallows the full $223,500 value of her home regardless of

whether the sale's proceeds are first used to satisfy the

$185,777.30 mortgage claim. Rather, the trustee insists that the

preserved mortgage itself, as a senior lien on the home, has

created equity in the home for the estate. He suggests, in short,

that the preserved mortgage has turned some corresponding share of

the home's value into the "property of the estate" to be liquidated

through sale.

The trouble with the trustee's argument is that his

preservation of an undefaulted mortgage on Traverse's home for the

benefit of the bankruptcy estate is not co-extensive with an

ownership right over the underlying property. Under § 551, the

trustee preserves any liens or transfers avoided under § 544 by

Traverse's property based on his position as mortgagee we find no
reason to challenge her reaffirmation in this case.

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claiming those liens for the benefit of the estate, but he

preserves the benefit of only that which has been avoided--in this

case, the mortgage. "When the Trustee avoided the lien granted by

Debtor . . . , the avoided lien and only the avoided lien became

property of the estate under § 541(a)(4)." Carmichael, 439 B.R. at

890; cf. In re Haberman, 516 F.3d 1207, 1208 (2008) ("[A]

bankruptcy trustee who successfully avoids a lien pursuant to 11

U.S.C. §§ 544 and 551 preserves for the bankruptcy estate the value

of the avoided lien . . . ."). Preservation gives the bankruptcy

estate an exclusive interest in the avoided lien, but it does not

give the estate any current ownership interest in the underlying

asset. See Early, 2008 WL 2569408, at *3 ("[T]he only interest

recovered via avoidance is the avoided lien, not an ownership

interest in the property."). As far as the trustee's § 363 powers

are concerned, avoidance and preservation thus empower the trustee

to sell the newly avoided mortgage as property of the estate. But

if the underlying property has been exempted and withdrawn from the

"property of the estate" for the purposes of § 363, the

preservation of a mortgage does not resurrect the trustee's § 363

powers over that property itself. See Carmichael, 439 B.R. at 890

("The only property interest which the Trustee may sell under

§ 363(b) is the estate's one-half interest in the unperfected

lien . . . ."); In re Early, Bankr. No. 05-01354, 2008 WL 2073917,

at *4 (Bankr. D.D.C. May 12, 2008), order amended and supplemented,

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2008 WL 2569408, at *4 ("[T]he avoided lien here does not give the

trustee a right to sell the debtor's interest in the Property

itself.").5

The trustee makes much of the Supreme Court's holding in

Schwab v. Reilly, in which the Court held that exemptions claimed

under the Code remove only a monetary "interest" in a debtor's

asset, rather than the asset itself, from the property of the

bankruptcy estate. 560 U.S. 770, 782 (2010). Various courts have

applied this same principle to state-created homestead exemptions,

including that in Massachusetts. See Peirce, 483 B.R. at 376

(Mass. Gen. Laws ch. 188 only protects the owner's interest in the

home to the extent of the monetary exemption."); In re Gebhart, 621

F.3d 1206, 1210 (9th Cir. 2010) ("The homestead exemptions

available to the debtors . . . do not permit the exemption of

entire properties, but rather specific dollar amounts."). The

trustee reasons that, if Traverse's home remains part of the

bankruptcy estate despite Traverse's homestead exemption, he may

dispose of it like any other property so long as he repays Traverse

the value of her exemption from the proceeds.

As a preliminary matter, we note that the rule

articulated in Schwab does not apply directly to this case. In

5
Although the bankruptcy court in Early ultimately concluded
that the issue of the trustee's power of sale was not ripe before
it, withdrawing without repudiating its observations on the matter,
see 2008 WL 2569408, at *3, we believe that the court's reasoning
is precisely on point.

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each of the cases above, the debtor's exemption could not prevent

the trustee from selling the underlying asset because that asset's

value surpassed the exemption amount, creating additional equity

for the bankruptcy estate. Schwab, 560 U.S. at 776; Peirce, 483

B.R. at 376; Gebhart, 621 F.3d at 1210. By contrast, where a

debtor's homestead exemption equals or surpasses the total value of

her property, the bankruptcy court has construed the Massachusetts

homestead exemption to protect the debtor's physical ownership of

as well as her financial rights in her home. Peirce, 483 B.R. at

376 ("[S]o long as the available monetary exemption is greater than

or equal to the value of that property, the owner's possessory and

pecuniary interests are both fully protected."). This reading

accords with the established policy behind the Massachusetts

homestead exemption, which "favors preservation of the family home

regardless of the householder's financial condition" and inclines

courts to construe the exemption "liberally in favor of debtors."

Shamban v. Masidlover, 705 N.E.2d 1136, 1138 (Mass. 1999); see also

Hildebrandt, 320 B.R. at 44 ("Homestead laws are designed to

benefit the homestead declarant and his or her family by protecting

the family residence from the claims of creditors." (internal

quotation marks omitted)). We decline to depart from that practice

today.

More to the point, neither Schwab nor its progeny address

the precise legal question before us. The issue raised by this

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case is not whether Traverse's homestead exemption withdrew her

home or merely the right to its proceeds from the property of the

estate. The issue is whether a trustee's powers of sale under

§ 363 justify selling a debtor's asset where no equity remains for

the estate beyond the senior claims of secured creditors and the

debtor's own exempt interest. The distinction may best be

illustrated by the fact that the issue facing us today could arise

even if there were no homestead exemption involved. Imagine, for

example, a case in which a debtor fails to claim any homestead

exemption, but the full value of her home falls short of her

undefaulted mortgages on the property. In this scenario, even

absent any debates about whether the debtor had withdrawn her home

or merely an "interest" in her home from the bankruptcy estate, the

trustee's § 363 powers would not justify selling the asset, because

there would be no residual equity in the property for unsecured

creditors. The trustee himself admits as much, as he acknowledges

that he would not sell Traverse's home if both her mortgages

remained with their banks--even though, under his own reading of

Schwab, the home is technically "property" of the estate.

The trustee suggests that his preservation of Traverse's

first mortgage for the bankruptcy estate makes this case different.

He insists that the preserved mortgage empowers him to sell

Traverse's home because, with the bankruptcy estate now standing in

the shoes of the secured lienholder, the sale would directly

-16-
benefit the unsecured creditors. Just because the preserved

mortgage entitles the estate to benefit from the sale of Traverse's

property, however, does not mean that the trustee is by that fact

empowered to sell the property so as to immediately realize that

benefit. In itself, a mortgage carries neither a right of

immediate ownership of Traverse's property, nor a right of

immediate payment of the secured loan's outstanding value, but only

a right to foreclose on Traverse's property in the event that she

defaults on her loan or to receive payment in full when the home is

sold through other means. And that is the extent of the rights

gained by the estate by through the trustee's preservation. See

Haberman, 516 F.3d at 1210 ("[T]he trustee, on behalf of the entire

bankruptcy estate, in some sense steps into the shoes of the former

lienholder, with the same rights in the collateralized property

that the original lienholder enjoyed."); Carvell, 222 B.R. at 180

("Preservation is just that. It simply puts the estate in the shoes

of the creditor whose lien is avoided."). We make this observation

not to revive the red herring argument that the trustee would need

to exercise a mortgagee's power of foreclosure in order to sell

Traverse's home; of course he could accomplish such a sale, when

appropriate, simply in the exercise of his powers under § 363. We

make the observation simply to clarify that, as far as the

trustee's § 363 powers are concerned, the trustee may only sell

"property of the estate," and the preserved mortgage in this case

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carries no immediate ownership rights that might be seen to turn

Traverse's home into the property of the estate.

To put it another way, contrary to the trustee's

assertions, just because the preserved mortgage promises the

bankruptcy estate a benefit from the sale of Traverse's home does

not mean that the preserved mortgage creates "equity" for the

estate. Bankruptcy courts have defined the equity that justifies

a sale of property, consistently and explicitly, in one way: the

value remaining for unsecured creditors above any secured claims

and the debtor's exemption. See, e.g., Hyman, 123 B.R. at 344; In

re White, 409 B.R. 491, 495 (2009); McKeever, 132 B.R. at 999. It

is this equity for unsecured creditors that authorizes a trustee to

liquidate the property in the first place, as the trustee should

not exercise his § 363 powers for the benefit of secured creditors

alone. See Scimeca Found., 497 B.R. at 781; U.S. Department of

Justice, Executive Office for United States Trustees, Handbook for

Chapter 7 Trustees at 8-20 (2002); Collier on Bankruptcy ¶ 725.01.

Here, having avoided and preserved JP Morgan's mortgage for the

benefit of the bankruptcy estate, the trustee has inherited the

standing of the secured creditor. Haberman, 516 F.3d at 1210; In

re Kors, Inc., 819 F.2d 19, 23 (2d Cir. 1987); Carvell, 222 B.R. at

180. But he has not changed the status of the lien as a secured

lien, to be subtracted from the value of the asset before any

remaining equity may be calculated. In this sense, for the very

-18-
reason that the preserved mortgage entitles the bankruptcy estate

to any proceeds from Traverse's property, as a senior secured claim

overriding Traverse's claimed homestead exemption, it cannot double

as the unsecured equity triggering the trustee's sale powers under

§ 363.

The trustee, in essence, would have the preserved

mortgage function as both the senior secured interest that entitles

the bankruptcy estate to derive value from Traverse's property

ahead of junior lienholders and the unsecured equity interest that

excuses him from leaving the secured creditors to satisfy their

claims contractually.6 Yet precisely because of their contractual

means of protecting their interests, the bankruptcy scheme

typically entrusts secured creditors such as mortgagees to

vindicate their claims based on their privately negotiated terms.

That in some cases a mortgagee will have no immediate means for

claiming the value of its collateral--for example, when the

mortgagor remains current on her mortgage payments pursuant to the

contractual agreement--is not a flaw in the system, but rather

reflects Congress's intent not to augment the mortgagee's rights

over a compliant mortgagor simply because the mortgagor enters the

world of bankruptcy. Cf. Dewsnup v. Timm, 502 U.S. 410, 418 (1992)

6
The secured creditors' contractual remedies would, of
course, be subject to any lien enforcement procedures set by
statute.

-19-
(noting the rule, valid since the Bankruptcy Act of 1898, that "a

lien on real property passe[s] through bankruptcy unaffected").7

Our holding today comports not only with the most

coherent reading we can make of the trustee's powers under the

Bankruptcy Code, but also with any sense of fairness on these

facts. As noted above, there is no dispute that if Traverse's

first mortgage remained with JP Morgan she would retain her home in

these exact same circumstances. We see no reason why the trustee's

preservation of the mortgage under § 551 should alter that result.

The objective behind the trustee's powers of avoidance and

preservation is to change the priority of creditors' claims to

property falling under a debtor's estate, boosting the standing of

unsecured creditors against both illegitimate secured claims and

junior secured creditors. See French, 440 F.3d at 154; Connelly v.

Marine Midland Bank, N.A., 61 B.R. 748, 750 (W.D.N.Y. 1986). It

remains a mystery to us why a provision clearly aimed at regulating

the distribution of a debtor's estate among her creditors should

exacerbate the debtor's substantive obligations and vulnerabilities

in bankruptcy. That is especially the case here, where the

7
Our analysis here is limited to a trustee's attempts to
benefit unsecured creditors by avoiding a security interest on
fully exempt property, selling that property, and then capturing
the proceeds of the sale for the estate up to the amount of the
security interest. We do not decide whether a trustee may sell
fully-secured property to benefit the estate in other scenarios,
for example, when selling secured property as part of a package
with unsecured property would increase the value of the unsecured
property itself. See Handbook for Chapter 7 Trustees at 8-20.

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trustee's ability to preserve JP Morgan's mortgage derives

exclusively from the failure of two banking corporations to perform

due diligence and record their mortgage on Traverse's home. To

sanction the sale of the debtor's home in this case would be to

punish an individual consumer for the administrative oversights of

the banks.8

We affirm today the principle that the preservation of a

lien entitles a bankruptcy estate to the full value of the

preserved lien--no more and no less. Where this lien is an

undefaulted mortgage on otherwise exempted property, the trustee

may for the benefit of the estate enjoy the liquid market value of

that mortgage, claim the first proceeds from a voluntary sale, or

wait to exercise the rights of a mortgagee in the event of a

8
We note that, in general, our interpretation enhances
predictability and lower transaction costs. Under the trustee's
view, without first paying to confirm the perfection of the
mortgage, no homeowner contemplating bankruptcy could predict
whether the family will lose its residence merely because of a
quirk in the bank's practices that no one could view as adverse to
the debtor.
We also note that, to be sure, a bankruptcy trustee's
avoidance powers extend to far less blameless and sympathetic
scenarios, such as avoidance of fraudulent transfers under 11
U.S.C. § 548 or post-petition transfers under 11 U.S.C. § 549.
None of these other circumstances is implicated by our opinion,
however, in that none of them overrides a debtor's homestead
exemption under § 522. Furthermore, to the extent that an avoided
fraudulent or post-petition transfer of a debtor's home allows a
trustee to sell the underlying property, it does so precisely by
permitting the trustee to include in the estate the putatively
transferred asset: the home.

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default.9 But the trustee may not repurpose the mortgage to

transform otherwise exempted assets, to which neither the estate

nor the original mortgagee boasted any ownership rights, into the

property of the bankruptcy estate.

IV. Conclusion

In the end, we see the matter differently than did the

lower courts. Accordingly, we reverse the decision of the BAP and

remand to that tribunal with directions to vacate the bankruptcy

court's judgment and to remand the matter to the bankruptcy court

for further proceedings consistent with this opinion.

9
The parties in this case have presented to us no issue
regarding who is entitled to Traverse's post-petition payments.
Absent a separate agreement to the contrary, avoidance and
preservation of a security interest do not entitle the trustee to
payments on the underlying debt. In re Rubia, 257 B.R. 324, 327
(B.A.P. 10th Cir. 2001), aff'd, 23 F. App'x 968 (10th Cir. 2001);
In re Trible, 290 B.R. 838, 845 (Bankr. D. Kan. 2003).

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