GMAC Mortgage, LLC v. Orcutt et al

Filing 23

OPINION AND ORDER Vacating and Remanding Bankruptcy Court's Order Granting Debtors' Motion for Summary Judgment and Denying Defendant's Cross-Motion for Summary Judgment. Signed by Chief Judge Christina Reiss on 12/13/2012. (pac)

UNITED STATES DISTRlCT COURT
FOR THE
DISTRICT OF VERMONT

2U120:':C 13 PM 4: 05
CLERK

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D~,PUT

GMAC MORTGAGE, LLC,
Defendant!Appellant,

v.
DAVID ROY ORCUTT and HOLLIE
JEAN STEVENS,
AppelleeslDebtors.

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Case No. 5: 12-cv-96

OPINION AND ORDER VACATING AND REMANDING
BANKRUPTCY COURT'S ORDER GRANTING DEBTORS'
MOTION FOR SUMMARY JUDGMENT AND DENYING
DEFENDANT'S CROSS-MOTION FOR SUMMARY JUDGMENT
(Doc. 1-18, 1-19)
This matter comes before the court on the appeal by GMAC Mortgage, LLC
("GMAC") from an Order of the United States Bankruptcy Court for the District of
Vermont (the "Bankruptcy Court"), granting the motion for summary judgment filed by
Debtors David Orcutt and Hollie Stevens ("Debtors") and denying GMAC's cross­
motion for summary judgment. (Doc. 1-18, 1-19.) At issue is the Bankruptcy Court's
declaratory judgment, ruling the mortgage Ms. Stevens executed and delivered to GMAC
in 2007 (the "2007 Mortgage") inoperative under Vermont law.
On July 10,2012, the court heard oral argument on GMAC's appeal. The court
raised sua sponte the issue of the Bankruptcy Court's jurisdiction in light of Stern v.

Marshall, 131 S. Ct. 2594 (2011). The parties' supplemental briefing on this issue was
completed on August 31, 2012. GMAC contends that the Bankruptcy Court lacked
subject matter jurisdiction to "adjudicate Debtors' pure state law claim against GMAC
absent its consent." (Doc. 14 at 2.) Debtors contend that the Bankruptcy Court had "core
jurisdiction under 28 U.S.C. § 157(b)(2)(k) because it has a direct and decisive impact on

whether the Chapter 13 Plan will be confirmed and on how much the creditors will be
paid" and assert that "Stern plays no part in the determination of the validity of a
Vermont mortgage." (Doc. 15 at 2.)
On November 20,2012, the court granted the parties the opportunity to file further
supplemental briefing on the issue of the Bankruptcy Court's subject matter jurisdiction
in light of a recent decision by the Court of Appeals for the Sixth Circuit in Waldman v.
Stone, 698 F.3d 910 (6th Cir. 2012), which was issued after the close of the parties'
briefing. The parties completed the filing of their supplemental memoranda on
December 6,2012.
GMAC is represented by James B. Anderson, Esq. Debtors are represented by
Michelle M. Kainen, Esq.

I.

Factual and Procedural Background.
A.

The Undisputed Facts.

Debtors are husband and wife, married on February 14, 1997. By warranty deed
dated July 20, 1999, they purchased real property located at 120 Clarksville Road,
Tunbridge, Vermont (the "Tunbridge Property"), as tenants by the entirety. At all
relevant times, the Tunbridge Property was Debtors' homestead. l At the time of the
initial purchase of the Tunbridge Property, Debtors executed a note (the "1999 Note") for
$39,000 and corresponding mortgage (the "1999 Mortgage") in favor of Katrina B. Clark.
On October 10, 2001, Debtors executed and delivered a note and mortgage on the
Tunbridge Property in favor of Beneficial Finance of New Hampshire (the "2001
Mortgage"), in the amount of$15,000. Debtors refinanced the 1999 and 2001 debts in
2004 through a note (the "1st 2004 Note") and a mortgage on the Tunbridge Property in
favor ofGMAC (the "1st 2004 Mortgage"). As a result of the 2004 refinancing, both the
1999 Mortgage and the 2001 Mortgage were discharged. Also in 2004, Debtors
1 Under Vermont law, '"[t]he homestead of a natural person consisting of a dwelling house,
outbuildings and the land used in connection therewith, not exceeding $125,000.00 in value, and
owned and used or kept by such person as a homestead together with the rents, issues, profits,
and products thereof, shall be exempt from attachment and execution except as hereinafter
provided." 27 V.S.A. § 101.

2

borrowed an additional $15,000 from GMAC. This amount was documented in a
separate note (the "2nd 2004 Note") and was secured by a new mortgage in favor of
GMAC on the Tunbridge Property (the "2nd 2004 Mortgage").
In 2007, Ms. Stevens unilaterally executed a note (the "2007 Note") and the 2007
Mortgage on the Tunbridge Property in favor ofGMAC for $105,000. Ms. Stevens used
the proceeds from the 2007 Note to pay credit card debts in the amount of $22,773.00,
received $11,206.29 in cash, paid closing costs, and obtained a discharge of the 2004
Notes and 2004 Mortgages. Mr. Orcutt did not execute either the 2007 Note or the 2007
Mortgage, although he was present at the closing. 2

B.

The Bankruptcy Court Proceedings.

On June 9, 2011, Debtors filed a voluntary petition for bankruptcy protection (the
"Petition"). Schedule A to the Petition lists the Tunbridge Property as jointly held by the
parties as tenants by the entirety with a value of$II0,600.00. Debtors' Schedule D lists
three statutory liens totaling $7,496.00. In Schedule C, Debtors' claim an exemption in
the amount of$103,104.00. In their Petition, Debtors list GMAC as a creditor holding an
unsecured, nonpriority claim and note: "Money loan[e]d for invalid mortgage on primary
residence[.]" (Case No. 11-10553, Doc. 1 at 25.)
On June 10, 2011, Debtors filed an adversary proceeding with the Bankruptcy
Court. In their Amended Complaint dated June 17,2011, Debtors asserted: "This is an
action to determine the nature, extent and validity of the mortgage on the debtors'
residence, pursuant to 27 V.S.A. § 141,27 V.S.A. § 349, 11 U.S.c. § 522 and Federal
Rule of Bankruptcy Procedure 7001." (Doc. 1-5 at 1.) They asked the Bankruptcy Court
to issue a declaratory judgment that the 2007 Mortgage was void because Mr. Orcutt did
not sign the mortgage or join in the conveyance, and under Vermont law, "[i]n order to
This fact is not included in the Bankruptcy Court's Order but was submitted as an undisputed
fact in the cross-motions for summary judgment. GMAC contends this omitted fact is material
because it demonstrates that Mr. Orcutt had knowledge of and benefitted from the 2007
transaction which, among other things, discharged his obligations under the 2004 Notes and
Mortgages, discharged credit card debt which may be marital in nature, and brought cash into the
household of which he was a member.

2

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convey an interest in a homestead, both spouses must join in the execution of the
conveyance." Id. at 3.
On July 21,2011, GMAC moved to dismiss the adversary proceeding, arguing
that Debtors were essentially pursuing an avoidance action which could only be brought
by the Chapter 13 trustee under 11 U.S.C. §§ 544-55. It further argued that any claim
belonged to the estate and "II U.S.C. § 1303 contains an exclusive list ofthe Chapter 13
trustee powers that a Chapter 13 debtor may exercise. The right to assert a cause of
action against the estate's creditors does not appear in 11 U.S.c. § 1303." (Doc. 1-9 at
2.)
In denying GMAC's motion to dismiss, the Bankruptcy Court disagreed that the
adversary proceeding was

~~a

trustee avoidance action in disguise" and concluded that

"[t]he Debtors' amended complaint seeks a declaratory judgment determining the nature,
extent and validity of a mortgage pursuant to 11 U.S.C. § 522 and 27 V.S.A. §§ 141 and
349." (Doc. 1-11 at 2) (footnote omitted). The Bankruptcy Court did not reach the issue
of "[w]hether a debtor may independently assert the trustee's avoidance powers" because
it found that the Debtors "are proceeding under § 522[.]" Id. at 2 n.2. The court
concluded that the Debtors had standing to pursue the adversary proceeding on that basis
and were entitled to have the "Court decide the merits of their claims under § 522(h) and
27 V.S.A. §§ 141 and 349." Id. at 4.
On October 1, 2011, Debtors moved for summary judgment on Count I of the
Amended Complaint, identifying four undisputed facts as mandating judgment in their
favor: "(1) Plaintiffs purchased their homestead while married to each other; (2) Plaintiffs
remain married to each other; (3) Plaintiffs continue to occupy the property as their
homestead; and (4) the mortgage deed to GMAC was executed only by the wife." (Doc.
1-14 at 1.) Debtors cited Vermont law as the basis for the relief they sought; they did not
rely on any provision of the Bankruptcy Code.
GMAC, which had objected to both the confirmation of the Chapter 13 Plan and
to Debtors' claimed homestead exception, opposed Debtors' motion and cross-moved for
summary judgment in its favor on both counts of Debtors' Amended Complaint. Among
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other things, GMAC argued that Plaintiffs were impermissibly seeking to utilize the
trustee's powers to avoid a lien under 28 U.S.C. §§ 522 and 544 and lacked standing to
do so, especially when the outcome was to deplete the bankruptcy estate. GMAC further
argued that the Bankruptcy Court must consider the competing equities in deciding
whether to permit Mr. Orcutt to be unjustly enriched by the 2007 transaction, at GMAC's
expense and to the detriment of the unsecured creditors. On October 14,2011, GMAC
filed a proof of claim for a secured claim in the amount of $107,747.63.
By Order dated February 24,2012, the Bankruptcy Court granted Debtors' motion
for summary judgment on Count I of the Amended Complaint "because the 2007
Mortgage does not meet the requirements of27 V.S.A. § 141, and the 2007 Mortgage is
declared to be inoperative." (Doc. 1-19 at 1.) The Bankruptcy Court denied GMAC's
cross-motion for summary judgment and concluded that it did not need to reach the issues
GMAC had raised with regard to Count II. The Bankruptcy Court issued a separate
Memorandum of Decision, further explaining its decision.

C.

The Bankruptcy Court's Memorandum of Decision.

In its Memorandum of Decision, the Bankruptcy Court described its jurisdiction
over the adversary proceeding as follows: "This Court has jurisdiction over this adversary
proceeding and the instant motions pursuant to 28 U.S.C. §§ 157 and 1334 and declares it
to be a core proceeding pursuant to 157(b)(2)(K)." In re Orcutt, 2012 WL 627675, at *1
(Bankr. D. Vt. Feb. 24, 2012). The Bankruptcy Court noted that it had initially treated
the matter as one arising under 11 U.S.C. § 522, but now concluded that the prefatory
statement in Debtors' Amended Complaint, which referenced § 522, was in error because
neither count of the Amended Complaint actually referred to that statutory section but
"[r]ather, the two counts of the amended complaint rely solely upon 27 V.S.A. § 141 and
27 V.S.A. § 349." Id. at 3. The court acknowledged that in its previous opinion denying
GMAC's motion to dismiss Debtors' Amended Complaint, the court had relied on 11
U.S.C. § 522, explaining that "there are several aspects to this dispute over whether the
granting of the Mortgage was a voluntary transfer for purposes of § 522." (Doc. 1-11 at
3.) The court stated that it was "now persuaded that [Debtors'] reference to § 522 in the
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opening paragraph ofthe amended complaint is not determinative of the outcome, and in
fact was superfluous [because] [t]he clear thrust of the [Debtors'] amended complaint is
for a ruling as to the validity of the Defendant's mortgage lien." In re Orcutt, 2012 WL
627675, at *3. The Bankruptcy Court thus concluded that Debtors were not seeking
relief under 11 U.S.C. §§ 522 and 544, but were instead "seeking a determination
regarding the extent and validity ofa lien under 28 U.S.C. § 157(b)(2)(K)[.]" ld. at *4.
The court further observed that the Debtors were seeking relief "that is more akin to an
objection to the Defendant's claim or a determination of the Defendant's secured status
under § 506, than to a trustee avoidance action." ld. Based on these conclusions, the
Bankruptcy Court ruled that "[Debtors] have standing to seek a determination as to the
validity of [GMAC's] mortgage lien as a core proceeding in this [Bankruptcy] Court. To
the extent this [Bankruptcy] Court's earlier ruling suggested otherwise, it is hereby
overruled." ld. at 3.
The Bankruptcy Court then proceeded to issue a declaratory judgment under
Vermont law, and concluded that the 2007 Mortgage was void based upon 27 V.S.A. §
141 which provides:
A homestead or an interest therein shall not be conveyed by the owner
thereof, if married, except by way of mortgage for the purchase money
thereof given at the time of such purchase, unless the wife or husband joins
in the execution and acknowledgement of such conveyance. A conveyance
thereof, or of an interest therein, not so made and acknowledged, shall be
inoperative so far only as relates to the homestead provided for in this
chapter.
ld. at *4 (quoting 27 V.S.A. §141(a». In declaring the 2007 Mortgage "inoperative," the
Bankruptcy Court relied upon the undisputed facts that Debtors held the Tunbridge
Property as tenants by the entirety, were married at the time Ms. Stevens executed the
2007 Mortgage, and Mr. Orcutt did not join in that conveyance.
The Bankruptcy Court rejected GMAC's challenge to the adequacy of the
Debtors' homestead exemption and found that Debtors had fully exempted their interest
in their homestead property by listing its value and the three statutory liens with the

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"claimed homestead exemption of $103, 104.00 [being] the difference between the value
of the property and the amount due on the statutory liens." Id. at *5.
The Bankruptcy Court also considered and rejected GMAC's arguments that: (1)
the 2007 Mortgage could be traced to the 1999 Mortgage and should therefore benefit
from the security interest created by that mortgage, and (2) the 2007 Mortgage should be
equitably subrogated to the 2004 Mortgages because the proceeds from the 2007 Note
discharged the obligations of the 2004 Notes. Id. at *5-6.

D.

GMAC's Motion for Reconsideration.

GMAC sought reconsideration of the Bankruptcy Court's Order, arguing that
"[Debtors] [were] attempt[ing] to usurp the avoided mortgage for their benefit rather than
for their creditors' benefit" and further asserting that Debtors "cannot meet their burden
under 11 U.S.C. § 522(h) which bars debtors from avoiding consensual mortgage liens on
exempt property." (Doc. 1-20 at 2) (citing In re Terry, 56 B.R. 538, 540 (Bankr. D. vt.
1986) ("Grant of a mortgage is a voluntary transfer and debtors lack standing under 11
U.S.C. § 522(h) to avoid the mortgage.")). GMAC further argued that regardless of how
Debtors described their cause of action, they lacked the trustee's powers to litigate causes
of actions that belong to the estate. GMAC pointed out that the Bankruptcy Court had
previously rejected the Debtors' theory that they had standing to bring a declaratory
judgment action to challenge the 2007 Mortgage and asked the court to resurrect that
earlier conclusion which GMAC claimed was consistent with Second Circuit precedent.
Finally, GMAC asked the Bankruptcy Court to reconsider its decision on GMAC's
tracing argument, asserting that under Vermont law, Debtors "may not exempt their
homestead in bankruptcy to the extent of any traceable debt that existed at the time they
acquired their homestead, including purchase money debt" (Doc. 1-20 at 7-8) which
GMAC calculated as being $29,857.60. GMAC argued the 2007 Mortgage remained
enforceable as to that allegedly traceable amount. Debtors opposed reconsideration.
By Order dated March 12,2012, the Bankruptcy Court denied reconsideration,
concluding that GMAC pointed to no change in the law or new evidence. The
Bankruptcy Court ruled that the issue of whether "the Court erroneously found Plaintiffs
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have standing to bring a declaratory judgment action to determine the validity of
GMAC's mortgage ... is an issue for appeal, not reconsideration." In re Orcutt, 2012
WL 909323, at

II.

* 2 (Bankr. D. Vt. Mar. 12,2012).

Conclusions of Law and Analysis.
On appeal, GMAC challenges the decision of the Bankruptcy Court on four

grounds. It asserts: (I) the Bankruptcy Court lacked subject matter jurisdiction over
Debtors' adversary proceeding; (2) Debtors lack standing to challenge the enforceability
of the 2007 Mortgage in Bankruptcy Court; (3) the 2007 Mortgage is enforceable or
partially enforceable under Vermont law; and (4) if void, discharge of the 2007 Mortgage
should accrue to the benefit of the bankruptcy estate and unsecured creditors, not
Debtors. The court reaches only the first of these issues as it requires remand to the
Bankruptcy Court.

A.

Standard of Review.

The court has jurisdiction over this appeal pursuant to 28 U.S.C. § 158(a)(1).
Federal Rule of Bankruptcy Procedure 8013 establishes the standard governing a district
court's review of a bankruptcy court's order, and states that a district court functions as
an appellate court and may affirm, modify, reverse, or remand an order with instructions
for further proceedings. See Fed. R. Bankr. P. 8013.
Findings of fact "shall not be set aside unless clearly erroneous." Id.; see also In

re Lehman Brothers Inc., 478 B.R. 570, 582 (S.D.N.Y. 2012) ("Findings of fact, whether
based on oral or documentary evidence, shall not be set aside unless clearly erroneous.")
(citation omitted). A bankruptcy court's conclusions oflaw, however, are reviewed de

novo. See Teamsters Airline Div. v. Frontier Airlines, Inc., 2009 WL 2168851, at *5
(S.D.N.Y. July 20,2009) (citing In re Maxwell Newspapers, Inc., 981 F.2d 85,89 (2d
Cir. 1992)). As a result, this court must "review[] the Bankruptcy Court's grant of
summary judgment de novo." Schackner v. Breslin Realty Development Corp., 2012 WL
32624, at *3 (E.D.N.Y. Jan. 5,2012).

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B.

Whether the Bankruptcy Court Had Subject Matter Jurisdiction Over
Debtors' Adversary Proceeding.

GMAC asserts that the Bankruptcy Court lacked subject matter jurisdiction to
grant a final judgment on the state law question of whether the 2007 Mortgage was a
valid conveyance. Debtors respond that the Bankruptcy Court had statutory authority
pursuant to 28 U.S.C. §§ 1334(b) and 157(b)(2)(K) to determine the validity of the lien,
the authority under 11 U.S.C. § 502 to allow or disallow GMAC's secured claim, and the
authority under 11 U.S.C. § 506 to determine a creditor's secured status. Debtors
contend their adversary proceeding was a core proceeding under § 157(b)(2)(K) "because
it has a direct and decisive impact on whether the Chapter 13 Plan will be confirmed and
on how much the creditors will be paid." (Doc. 15 at 2.) Debtors do not address whether
the Bankruptcy Court has constitutional authority to decide their adversary proceeding
but instead merely assert that "Stern plays no part in the determination of the validity of a
Vermont mortgage." Id.
On appeal, GMAC concedes that the Bankruptcy Court had statutory authority
when the matter began as a core proceeding because Debtors' Amended Complaint
invoked 11 U.S.C. § 522 and state law to challenge whether GMAC's 2007 Mortgage
impaired the Debtors' homestead exemption. It also acknowledges that "Stern and §
157(b)(2) & (3) allow the bankruptcy court to adjudicate state law rights in the context of
administering the Bankruptcy Code in a core proceeding." (Doc. 14 at 1.) However, it
contends "this matter became a non-core proceeding when the bankruptcy court, with no
prior notice to GMAC, held § 522 completely irrelevant, and declared Debtor [s '] rights
against GMAC solely under 27 V.S.A. § 141(a)." Id. at 2. This court agrees that, in the
circumstances of this case, the Bankruptcy Court lacked the constitutional authority to
adjudicate Debtors' adversary proceeding solely as a matter of state law.

C.

Stern v. Marshall and its progeny.

"[T]he district courts shall have original but not exclusive jurisdiction of all civil
proceedings arising under title 11, or arising in or related to cases under title 11." 28
U.S.C. § 1334(b). "Each district court may provide that ... any or all proceedings arising
9

under title 11 or arising in or related to a case under title 11 shall be referred to the
bankruptcy judges." 28 U.S.C. § 157(a).3 The federal courts' "related to" jurisdiction is
broad and a claim is "related to" a bankruptcy case if the "outcome of that [claim] could
conceivably have any effect on the estate being administered in bankruptcy." Waldman,
698 F.3d at 916 (citations omitted); In re Cuyahoga Equip. Corp., 980 F.2d 110, 114 (2d
Cir. 1992) (same). Accordingly, a debtor's purely state law claim, even for affirmative
relief, "may be adjudicated in federal court on the basis of its relationship to the
[bankruptcy] petition[.]" N Pipeline Constr. Co. v. Marathon Pipe Line Co., 458 U.S.
50, 72 n.26 (1982) (plurality opinion).
In Stern v. Marshall, the United States Supreme Court considered the extent to
which the federal court's jurisdiction could be exercised by a bankruptcy court. It
concluded that the adjudication of so-called "private rights" meaning "the liability of one
individual to another under the law as defined" is part of the judicial power reserved to
Article III courts under the Constitution. Stern, 131 S. Ct. at 2612 (quoting Crowell v.

Benson, 285 U.S. 22, 50, 51 (1932)). As a result, regardless of any statutory authority,
bankruptcy courts could not enter a final judgment on state law claims adjudicating the
liability as between individuals unless the claim fell within the so-called "public rights"
exception to Article III. See id. at 2613. A public rights claim is one that "derives from a
federal regulatory scheme, or in which resolution of the claim by an expert government
agency is deemed essential to a limited regulatory objective within the agency's
authority." Id. at 26l3.
The Stern Court recognized an important distinction between proceedings which
are entrusted to the bankruptcy courts' special expertise, and proceedings which are not.
The Bankruptcy Code, itself, reflects this distinction. See Waldman, 698 F.3 d at 916-17
("Congress has granted bankruptcy judges differing authority depending on whether a
claim in bankruptcy is 'core' or not."). Bankruptcy judges are statutorily authorized to
3 At the time of the Bankruptcy Court's Order, the United States District Court for the District of
Vermont had a standing order that "any or all proceedings arising under Title 11 or arising in or
related to a case under Title 11, shall be, and hereby are, referred to the United States Bankruptcy
Court for the District of Vermont." Standing Reference Order (D. Vt. May 14, 1986).

10

Ifl _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ __ _

"hear and determine ... all core proceedings arising under title 11, or arising in a case
under title 11, referred under subsection (a) of this section." 28 U.S.C. § 157(b)(l); see
also In re Ben Cooper, Inc., 896 F.2d 1394,1397 (2d Cir. 1990) ("The jurisdiction of the
bankruptcy court over core proceedings is set forth in 28 U.S.C. § 157(b)(l)[.]"). In
non-core proceedings, the bankruptcy judge "shall submit proposed findings of fact and
conclusions of law to the district court, and any final order or judgment shall be entered
by the district judge after ... reviewing de novo" the objections of either party. 28
U.S.C. § 157(c)(l).
"Whether a proceeding is core is determined on a claim-by-claim basis."
Waldman, 698 F.3d at 921 (citing In re Exide Techs., 544 F.3d 196,206 (3d Cir. 2008».
"Claims that clearly invoke substantive rights created by federal bankruptcy law
necessarily arise under Title 11 and are deemed core proceedings. So too are proceedings
that, by their nature, could arise only in the context of a bankruptcy case." MBNA Am.
Bank, N.A. v. Hill, 436 F.3d 104, 108-109 (2d Cir. 2006) (internal citations omitted);
DeWitt Rehab. and Nursing Ctr., Inc. v. Columbia Cas. Co., 464 B.R. 587, 591 (S.D.N.Y.
2012) ("A proceeding that involves rights created by bankruptcy law, or that could arise
only in a bankruptcy case, is a core proceeding.").
In this case, in addition to state law, the Bankruptcy Court cited 28 U.S.C. §
157(b)(K)(2), governing "determination of the validity, extent, or priority of liens," as the
source of its authority to enter final judgment in Debtors' adversary proceeding and as the
basis for its conclusion that the adversary proceeding before it was a "core" proceeding.
In Stern, the Court noted that although in "past cases, we have suggested that a
proceeding's 'core' status alone [under §157] authorizes a bankruptcy judge, as a
statutory matter, to enter final judgment in the proceeding," Stern, 131 S. Ct. at 2604,
there are instances in which § 157(b) statutorily permits a bankruptcy court to enter final
judgment, but "Article III of the Constitution does not." Id. at 2608. Accordingly,
notwithstanding § 157(b)(2)(C)'s designation of "counterclaims by the estate against
persons filing claims against the estate" as a "core proceeding," some counterclaims fall
within the bankruptcy courts' authority to enter a final judgment and some counterclaims
11

do not. Id. at 2620 (holding that the bankruptcy courts lack "the constitutional authority
to enter a final judgment on a state law counterclaim that is not resolved in the process of
ruling on a creditor's proofofclaim.") (emphasis supplied).
To the extent Debtors' adversary proceeding sought a declaratory judgment under
state law that the 2007 Mortgage was invalid, the claim could have been brought in state
court at any time subsequent to the 2007 transaction and did not in any way require a
bankruptcy proceeding for its existence. Moreover, Debtors' claim is not one that falls
"within any of the varied formulations of the public rights exception in [the Supreme]
Court's cases." Stern, 131 S. Ct. at 2614. "It is not a matter that can be pursued only by
grace of the other branches, ... or one that 'historically could have been determined
exclusively by' those branches[.] The claim is instead one under state ... law between
two private parties. It does not 'depend[ ] on the will of congress,' Congress has nothing
to do with it." Id. (internal citations omitted). "In addition, [Debtors'] claimed right to
relief does not flow from a federal statutory scheme, ... [i]t is not 'completely dependent
upon' adjudication of a claim created by federal law," and "[t]his is not a situation in
which Congress devised an 'expert and inexpensive method for dealing with a class of
questions of fact which are particularly suited to examination and determination by an
administrative agency specially assigned to that task. ", Id. at 2614-15 (internal citations
omitted). Finally, GMAC never consented to resolution of Debtors' claim in the
bankruptcy court proceedings; it proceeded in that forum because it was required to do so
if it sought to collect its debt. See id.
Accordingly, Debtors' request for a declaratory judgment regarding the
application of Vermont law to the 2007 Mortgage neither involved substantive rights
created by federal bankruptcy law, nor constituted proceedings that, by their nature, could
only arise in the context of a bankruptcy case. See Stern, 131 S. Ct. at 2618
(characterizing counterclaim as lying outside bankruptcy court's jurisdiction to enter a
final judgment because it "is in no way derived or dependent upon bankruptcy law; it is a
state tort action that exists without regard to any bankruptcy proceeding."). Consistent
with Debtors' request, the Bankruptcy Court appears to have adjudicated Debtors'
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adversary proceeding entirely under state law and entered a final declaratory judgment
solely on that basis. See In re Orcutt, 2012 WL 627675, at *4 (noting that "[t]he
Plaintiffs seek a declaration, under count I of the amended complaint, that the 2007
Mortgage is void based upon 27 V.S.A. § 141."); Doc. 1-19 at 1 (ordering that judgment
be "entered in favor of the [Debtors] on count I of the amended complaint because the
2007 Mortgage does not meet the requirements of27 V.S.A. § 141, and the 2007
Mortgage is declared to be inoperative."); Doc. 1-22 at 2 (denying reconsideration and
ruling whether the court had jurisdiction to issue a declaratory judgment action to
determine the validity of the 2007 Mortgage under state law was a question for appeal).
This case appears to present no alternate ground for the Bankruptcy Court's
subject matter jurisdiction. The Bankruptcy Code does not authorize a bankruptcy court
to issue a declaratory judgment in a vacuum and, in this case, the Bankruptcy Court's
ruling appears to be untethered to any proceeding recognized by the Bankruptcy Code.
As GMAC points out:
[T]he bankruptcy court, as a court of limited jurisdiction, does not have the
general jurisdiction of the Vermont Superior Court to adjudicate state law
property rights in a vac[u]um. The bankruptcy court's power to adjudicate
state law property rights is derived from and limited by the Code. The
bankruptcy court may not adjudicate debtors' state law property rights
independently of administering a case under title 11 or adjusting the debtor
creditor relationship in compliance with the Code. But that is just what the
bankruptcy court did.
(Doc. 9 at 4.) It thus remains unclear whether the Bankruptcy Court was engaged in a
function entrusted to it by the Bankruptcy Code, or was simply acting as a court of
general jurisdiction.
The First Circuit's decision in DiVittorio v. HSBC Bank USA, NA, 670 FJd 273
(Ist Cir. 2012), is distinguishable because, in that case, the bankruptcy court considered a
question of state law in the context of deciding a motion for relief from the automatic
stay, not as an independent declaratory judgment action based exclusively on state law.

See DiVittorio, 670 FJd at 282 nA (finding Stern did not affect "the jurisdiction of the
bankruptcy court to render a decision in this matter ... [because] [h]ere, however, it first
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was necessary to resolve the validity of Mr. DiVittorio's claim under the [Massachusetts
Consumer Credit Cost Disclosure Act] to determine whether HSBC was entitled to relief
from the automatic stay."). As the Sixth Circuit recently pointed out, the distinction is
critical:
Stern thus provides a summary of the law in this area: When a debtor
pleads an action under federal bankruptcy law and seeks disallowance of a
creditor's proof of claim against the estate ... the bankruptcy court's
authority is at its constitutional maximum. [Stern,] 131 S. Ct. at 2617-18.
But when a debtor pleads an action arising only under state-law, as in
Northern Pipeline; or when the debtor pleads an action that would augment
the bankrupt estate, but not "necessarily be resolved in the claims
allowance process[,]" 131 S. Ct. at 2618; then the bankruptcy court is
constitutionally prohibited from entering final judgment. Id. at 2614.
Waldman, 698 F.3d at 920. Waldman provides further guidance regarding how a court

should proceed when, as here, the two types of claims overlap.
In Waldman, a Chapter 11 debtor brought an adversary proceeding against his
principal creditor, Waldman, among others, asserting fraud claims. The debtor asked for
two forms of relief: a discharge of the creditor's claims (the "disallowance claim") and
affirmative relief in the form of damages or specific performance (the "affirmative
claims"). Waldman filed a counterclaim, seeking to collect unpaid debts and relief from
the automatic stay. Following a bench trial, the bankruptcy court found that Waldman
had obtained virtually all of the debtor's business assets by fraud. Accordingly, the court
granted relief in the form of a discharge of the debtor's debts to Waldman and an award
to the debtor of more than three million dollars in compensatory and punitive damages.
On appeal, Waldman challenged, among other things, the bankruptcy court's
constitutional authority to adjudicate the parties' claims. The debtor pointed out that his
affirmative claims were based upon the same conduct as his disallowance claim. The
Waldman court, however, rejected the notion that "some overlap" between the claims was

sufficient. It explained that Stern held that in order for a bankruptcy court to adjudicate
the affirmative state law claims on that basis, "there must have been, at the outset of the
claims-disallowance process, 'reason to believe that the process of adjudicating [the]
14

proof of claim would necessarily resolve'" the affirmative claims. Id. at 921 (quoting
Stern, 131 S. Ct. at 2617). Because the debtor's affirmative claims required proof of

facts beyond what would be required in the claims disallowance process, they were
outside the bankruptcy court's jurisdiction. The Waldman court thus found that the
bankruptcy court was within its constitutional authority to adjudicate the disallowance
claim, but held that it could not enter final judgment on Stone's affirmative claims. It
explained that, like the counterclaim in Stern, those claims sought an adjudication of
private rights and "arose exclusively under state law and existed without regard to any
bankruptcy proceeding." Id. at 921. It thus remanded Stone's affirmative claims to the
bankruptcy court to "recast its final judgment as to these claims as proposed findings of
fact and conclusions oflaw, which the district court shall review de novo." Id. at 923.
In contrast, the Waldman court found that "Stone's disallowance claims were part
and parcel of the claims-allowance process in bankruptcy." Id. at 920. It rebuffed
Waldman's argument that because he did not file a proof of claim, claims allowance
never occurred. As the Waldman court pointed out, "[h]ere Waldman was Stone's
principal creditor and surely would have filed a proof of claim if Stone had not beat him
to the courthouse with an adversarial proceeding. Indeed it was Waldman's attempt to
collect on Stone's debts that pushed Stone into bankruptcy in the first place." Id. The
court then concluded that the bankruptcy court had constitutional authority to enter final
judgment on a claims-disallowance basis:
[W]e recognize that the Supreme Court has never squarely decided whether
Article III allows a bankruptcy court to enter judgment on a debtor's
objections to a creditor's proof of claim. But neither has the Court ever
intimated that Article III bars a bankruptcy court from performing this
function -"which is of basic importance in the administration of the
bankruptcyestate[.]" Katchen [v. Landy,] 382 U.S. [323,] 329 [(1966)]
(internal quotation marks omitted). All the intimations instead point the
other way: in Northern Pipeline, for example, the Court said that this
function-"the core of the federal bankruptcy power"-"may well be" a
matter of public right. 458 U.S. at 71 (plurality opinion). And in Stern, the
Court explained its result in that case, and in prior ones, partly by reference
to whether the claims were practically subsumed in the claims-allowance
process. 131 S. Ct. at 2617. We do not read the Court's precedents to
15

require the bankruptcy courts to abandon this power, which they have
exercised for more than two centuries. See Act of Apr. 4, 1800, ch. 19,2
Stat. 19 (repealed 1803 ) (creating the federal bankruptcy courts). We
therefore hold that the bankruptcy court here was authorized to enter final
judgment on Stone's disallowance claims.

Id. at 920-21.
Under Stern and Waldman as applied to this case, the Bankruptcy Court lacked the
constitutional authority to issue a declaratory judgment under Vermont law in order to
adjudicate a purely state law claim involving private rights. It, however, possessed the
constitutional authority to determine the validity of the 2007 Mortgage as part of the
claims allowance process,4 or as an integral part of another proceeding under the
Bankruptcy Code. See In re Sundale, Ltd., 2012 WL 5974125, at *4 (lith Cir. Nov. 29,
2012) (affirming bankruptcy court's declaratory judgment regarding the extent, validity
and priority of claims and debtor's recoupment counterclaim because both claims were
"necessarily resolved in the process of ruling on a creditor's proof of claim."); DiVittorio,
670 F.3d at 282 n.4; In re Pulaski, 475 B.R. 681, 683 (W.D. Wis. 2012) (ruling
bankruptcy court has jurisdiction to enter a final judgment in debtors' adversary
proceeding in which debtors challenged creditor's proof of claim because "[c]learly this
is part of the claims process, as the [debtors'] claims will be resolved at exactly the same
time that there is a final determination as to whether the creditor is secured or not.").
Although the Bankruptcy Court aptly observed that, "[Debtors] are seeking relief
that is more akin to an objection to the Defendant's claim or a determination of
Defendant's secured status under § 506[,]" In re Orcutt, 2012 WL 627675, at *4, it did
not adjudicate the claim on this basis but instead decided the issue purely as a matter of
state law. As a result, this court thus cannot affirm the Bankruptcy Court's decision on
the basis of claims allowance as the Sixth Circuit did in Waldman.

Debtors would have standing to object to GMAC's proof of claim. See 11 U.S.C. § 502(a) ("A
claim or interest, proof of which is filed under section 501 of this title, is deemed allowed, unless
a party in interest ... objects."); see also In re Hudson Shipbuilders, Inc., 794 F.2d 1051, 1055
(5th Cir. 1986) ("Equally clear is the standing of the debtor and any interested creditor to object
to the claim of a secured creditor filed in the bankruptcy proceeding.").

4

16

Moreover, as GMAC repeatedly points out, by adjudicating the claim as purely a
question of state law, the Bankruptcy Court did not consider the competing equities,
especially those that pertain to the unsecured creditors. 5 "For many purposes, courts of
bankruptcy are essentially courts of equity," Pepper v. Litton, 308 U.S. 295, 304 (1939),
and the claims allowance process, which resolves debtor-creditor relations, is specifically
equitable in nature. See Grandfinanciera, S.A. v. Nordberg, 492 U.S. 33, 58 (1989)
(when an issue "arises as part of the process of allowance and disallowance of claims, it
is triable in equity.") (quoting Katchen, 382 U.S. at 336). Accordingly, "[e]ven though a
claim may be valid and enforceable under state law, the bankruptcy court has sole
jurisdiction and discretion to allow or disallow the claim under federal law." In re

Murgillo, 176 B.R. 524, 531 (B.A.P. 9th Cir. 1995) (citing Pepper, 308 U.S. at 304).
"The bankruptcy court does not apply the law of the state in determining what
claims are allowable and how a debtor's assets will be distributed." Id. (citing Vanston

Bondholders Protective Comm. v. Green, 329 U.S. 156, 161 (1946». This, of course,
does not mean state law is irrelevant. See Green, 329 U.S. at 162 ("What claims of
creditors are valid and subsisting obligations against the bankrupt at the time a petition in
bankruptcy is filed, is a question which, in the absence of overruling federal law , is to be
determined by reference to state law."); Travelers Casualty & Surety Co. ofAmerica v.

Pacific Gas & Elec. Co., 549 U.S. 443, 451 (2007) ("'[P]roperty interests are created and
defined by state law,' and '[u ]nless some federal interest requires a different result, there
is no reason why such interests should be analyzed differently simply because an
interested party is involved in a bankruptcy proceeding. "') (citation omitted). Instead, it
is "clear that the principles of equity may not be invoked in a 'freewheeling fashion ...
they also necessarily operate within the boundaries set by statute.'" In re Murgillo, 176
B.R. at 531 (quoting Matter ofTucson Yellow Cab Co., 789 F.2d 701, 704 (9th Cir.
1986».

5 The Bankruptcy Court's determination ofGMAC's equitable subordination and tracing claims
reflected equitable considerations but this was not the basis on which it decided Debtors'
affirmative claim for a declaratory judgment.

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"The bankruptcy court derives its equitable powers from § 105(a) of the code" and
"may exercise its equitable power only as a means to fulfill some specific code provision;
it may not use its equitable powers to achieve a result not contemplated by the code." Id
(citing Norwest Bank Worthington v. Ahlers, 485 U.S. 197,206 (1988) (internal footnote
omitted). The Second Circuit has explained that:

"It has long been a basic function of the bankruptcy court, both by reason
of its equitable powers and the bankruptcy statute, to pass upon the validity
of creditors' claims." In re Farrell, 27 B.R. 241,245 (Bankr. E.D.N.Y.
1982). The bankruptcy court "in passing on allowance of claims sits as a
court of equity ... In the exercise of its equitable jurisdiction the
bankruptcy court has the power to sift the circumstances surrounding any
claim to see that injustice or unfairness is not done in administration of the
bankrupt estate," Pepper [ ],308 U.S. [ ]at 307-08 []. This sifting includes
"full power to inquire into the validity of any claim asserted against the
estate and to disallow it if it is ascertained to be without lawful existence.
And the mere fact that a claim has been reduced to judgment does not
prevent such an inquiry." Pepper, 308 U.S. at 305 (citations omitted)
(emphasis supplied). These broad powers have been "invoked to the end
that fraud will not prevail, that substance will not give way to form, that
technical considerations will not prevent substantial justice from being
done." Pepper, 308 U.S. at 305[.]
Kelleran v. Andrijevic, 825 F .2d 692, 698-99 (2d Cir. 1987).
Here, GMAC contends that Debtors will receive a windfall and unjust enrichment
at the expense of GMAC and their unsecured creditors if the Bankruptcy Court does not
exercise its equitable powers. See Doc. 4 at 24 (arguing that Mr. Orcutt signed all
mortgages that encumbered his homestead except for the 2007 Mortgage thereby
demonstrating a willingness to waive his homestead rights to borrow money, was present
at the closing of the 2007 transaction and thus the conveyance did not occur without his
implied consent, and received a discharge of 2004 Notes as well as mortgage proceeds
for his household from the 2007 transaction which will result in Debtors' unjust
enrichment if they are able to escape their liabilities under the 2007 Note and Mortgage);
Doc. 4 at 16 ("Under the bankruptcy court's Rule 7001 Analysis, Debtors avoid the 2007
Mortgage, keep their home and pay nothing extra to their unsecured creditors to remain
in their home.").
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111 _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ __

Because the Bankruptcy Court did not consider the equities in adjudicating
Debtors' request for a declaratory judgment, this appeal cannot be resolved simply by
directing the Bankruptcy Court to recast its decision. On remand, the Bankruptcy Court
is directed to clarify the statutory and constitutional basis under which it is proceeding
and adjudicate the issues raised by the parties consistent with that statutory and
constitutional authority. Although the Bankruptcy Court may well reach the same
conclusions, that outcome is not certain.
CONCLUSION
For the foregoing reasons, the court hereby VACATES the Bankruptcy Court's
Order granting summary judgment to Debtors and denying GMAC's cross-motion for
summary judgment and REMANDS this proceeding to the Bankruptcy Court for further
proceedings consistent with this Opinion and Order.
SO ORDERED.
Dated at Rutland, in the District of Vermont, this

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ay of December, 2012.