[co-author: Frank DeBorde]
On April 14, 2022, in an unpublished, divided opinion affirming lower-court orders disallowing a creditor’s claim and declaring the creditor’s mortgage invalid and unenforceable, the U.S. Court of Appeals for the Fifth Circuit suggested (yet did not definitively rule) that a bankruptcy court cannot reform a mortgage to fix clerical errors in such mortgage after the bankruptcy petition date. Michael Worley was the sole owner and managing member of W Resources, which filed for bankruptcy in July 2018. Before bankruptcy, the owner secured a personal $8 million loan from NCC Financial and executed a promissory note in his name only. That same day, the owner (in his capacity as managing member) executed a mortgage in favor of NCC, which purported to encumber W Resource’s property and secure any debt the company (as mortgagor) owed NCC. Notably, NCC never made any loans to W Resources, only to the owner personally. W Resources later filed for Chapter 11 bankruptcy and in a challenge to NCC’s proof of claim in excess of $8 million supported by the promissory note and mortgage, the bankruptcy court granted summary judgment in favor of Investar Bank, a competing creditor, with respect to the mortgaged properties, invalidating NCC’s mortgage as unenforceable and disallowing NCC’s claim. On direct appeal, the district court affirmed the bankruptcy court. Both courts agreed with the competing creditor that the mortgage (i) was clear and unambiguous, thus barring extrinsic evidence to interpret the mortgage, and (ii) only secured the debt of W Resources, not Worley’s personal debt (including the note), rendering the mortgage unenforceable under Louisiana law because there was there was no underlying debt obligation (i.e., no W Resources debt owed to NCC).
On appeal, the divided Fifth Circuit panel rejected NCC’s arguments to clarify the mortgage to fix an “obvious scrivener’s error” as ignoring “the iron rule of bankruptcy: creditor claims are fixed for allowance purposes as of the date of filing of the debtor’s petition.” Further, the panel noted there were no remotely similar cases where “a secured creditor was allowed to clean up its documentation and perfect an otherwise unenforceable claim post-bankruptcy.” Because the Bankruptcy Code Section 544 “strong-arm clause takes effect” to invalidate any liens or agreements that were unperfected or unenforceable as of the petition date (including NCC’s defective mortgage), the majority held that the exception allowing extrinsic evidence to demonstrate the incompleteness of the mortgage outside of bankruptcy does not apply in the bankruptcy context.
In a dissent, Judge Higginson found the mortgage documents were ambiguous as to the definition of mortgagor, noting that it would be “absurd for a document purporting to be a mortgage not to secure any underlying debt.” The dissent asserted that the panel erred by declining to consider parol evidence as to whether the mortgage gave third parties, such as Investar, sufficient notice of the encumbrance under Louisiana law because the dispute was between two non-debtor competing creditors (i.e., Investar and NCC), one of which was not a party to the mortgage in dispute.
The case is In re W Resources, L.L.C., No. 21-30291 (5th Cir. 2022). INCC is represented Chaffe McCall, L.L.P. Investar is represented by Akerman, LLP. W. Resources is represented by Stewart, Robbins, Brown & Altazan, L.L.C. The order is available here.
