Conflict in Statute of Limitations in Home Equity Litigation Still Exists

Conflict in Statute of Limitations. Waiting more than four years after the closing to move to invalidate a home equity loan based on a constitutional violation is, for the most part, too late except in the bankruptcy court for the Eastern District of Texas where one bankruptcy judge has found an exception to the four year statute of limitations when the creditor filed a proof of claim to establish the home equity lien in bankruptcy court in the case of In re: Johnson, 62 C.B.C. 2d 1380 (Bank. E. D. 2009) and filed a proof of claim, moved to lift the automatic stay and filed a complaint to determine dischargeability of debt in the case of In re Shankles, 11-43075, 2013 WL 5348879 (Bankr. E.D. Tex. Sept. 23, 2013). The court reasoned that Section 16.069(a) of the Texas Civil Practices and Remedies Code allows for constitutional complaints to be asserted defensively against the proof of claim which operates as the filing of a federal complaint. However, the same bankruptcy court held in the case of In re Chambers, 419 B.R. 652, 668 (Bankr. E.D. Tex. 2009), subsequently aff’d, 544 Fed. Appx. 347 (5th Cir. 2013) that the four year statute of limitations barred the debtors and Chapter 7 trustee’s adversary action against the lender to invalidate a home equity lien and that the bankruptcy court had jurisdiction over the complaint and the exempt property because the lender filed a proof of claim and the court’s jurisdiction over exempt property had not ended.

Prior to these decisions the bankruptcy court in the Western District applied the four year statute of limitations to bar a complaint filed by the debtor and Chapter 13 trustee to forfeit a home equity loan and to recover payments made against the loan in the case of In re Ortegon, 398 B.R. 431, 434 (Bankr. W.D. Tex. 2008). The creditor in the Ortegon case filed a proof of claim in the bankruptcy proceeding and there was no discussion by the bankruptcy court of the lender’s claim being filed or the application of Section 16.069(a) of Texas Civil Practices and Remedies Code to the filing of a proof of claim.

The bankruptcy court in the Johnson and Shankles cases cited to Ortegon but chose not to follow it or that of the Priester decision by contending that Priester had no application in the bankruptcy context. The result is that the bankruptcy court in the Johnson and Shankles decisions forfeited two home equity liens where the borrower’s complaints would have been subject to the four year statute of limitations had the proceedings been litigated in state or federal court.

The Johnson, Chambers and Shankles decisions are troublesome particularly in chapter 13 proceedings where the home equity lender may file a proof of claim to participate in the plan but later find that the claim is objected to because of a constitutional violation with the lien. The creditor’s filed a proof of claim opens up the possibility to resurrect the time barred complaints leaving them to litigate in that forum where they could enjoy better success in state and federal courts. For the time being debtors can resurrect their time barred complaints by filing for bankruptcy if the creditor files a proof of claim or takes other affirmative action against the debtor such as filing a complaint to determine dischargeability of debt that places the creditor in the position of being the plaintiff and the debtor as a defendant.

The Shankles decisions will be discussed in this paper because it raises multiple issues such as: (1) the lender’s attempt to secure a valid lien on property being converted from agricultural use to homestead to combine with an existing two acre homestead, (2) the borrower’s closing affidavit as to non-agricultural property, (3) estoppel, (4) notice of the constitutional violation, (5) failing to respond to the notice of violation, (6) capping the debtor’s exemption under federal law, (7) after acquired property, (8) filing a complaint to determine dischargeability of debt based on a false financial statement under 11 U.S.C. §523 and (8) the debtor being able to raise time barred constitutional complaints in response to the creditor’s more aggressive action in the bankruptcy court when the creditor would have been successful in validating the lien had it take no action whatsoever and passively observed the bankruptcy proceeding as a non-participant.

The “defensive” use of constitutional violations argument used in the Johnsonand Shankles decisions has caused some borrowers to ask that the Fifth Circuit revisit the Priester decision and argue that it was wrongly decided or that no statute of limitations should apply at all to home equity violations. So far the Fifth Circuit has refused to deviate from its Priester decision. Nunez v. CitiMortgage, Inc., 606 Fed. Appx. 786, 789 (5th Cir. 2015). As will be noted the Shankles decision is not being followed in federal and state courts and the concept of “defensive use” of constitutional violations being raised more than four years after the closing has been rejected as a misinterpretation of Texas law that the lien is void instead of being voidable.