Published on August 8, 2023
On July 20, 2023, the Washington Supreme Court decided Merritt v. USAA Fed. Sav. Bank, in which the Court held that a bankruptcy discharge does not trigger the statute of limitations to enforce a deed of trust. The Court ruled in favor of USAA and affirmed the Court of Appeals. The decision provides important lessons for debtors and creditors alike.
Gary and Jeanette Merritt (the “Debtors”) opened five home equity lines of credit between 2005 and 2007 with USAA (the “Creditor”), which were secured by deeds of trust on four properties. The Debtors executed five promissory notes in favor of the Creditor and each of the notes was an installment contract that required the Debtors to make monthly payments on their loan. The Debtors filed for bankruptcy protection in the United States District Court for the Western District of Washington, under Chapter 7 of the United States Bankruptcy Code, in November 2012. The Debtors received a discharge under 11 U.S.C. § 727 in February 2013. After receiving a discharge, the Debtors stopped making monthly payments on the loans before their November 2012 bankruptcy filing and made no further payments. The Creditor never accelerated the loans or foreclosed upon the properties encumbered by the deeds of trust.
The Debtors subsequently filed multiple quiet title complaints in July 2020 and sought to remove the Creditor’s liens from each of the encumbered properties. The Debtors argued that the six-year statute of limitations under RCW 4.16.040(1) expired six years after the day before their discharge, on February 12, 2013. The trial court and Court of Appeals each ruled in favor of the Creditor and held that the six-year statute of limitations had not begun to run on the enforcement of the deeds of trust because none of the loans had matured. The earliest maturity date of any loan would not occur until 2025. The Debtors subsequently sought review by the Washington Supreme Court, which granted their petition, yet affirmed the Court of Appeals.
The Washington Supreme Court held that the Debtors’ discharge following their bankruptcy only extinguished their personal liability under the loans. The debts, however, remained valid post-discharge. The Creditor as such retained its ability to foreclose upon the properties encumbered by liens created through execution of the deeds of trust. The Court further explained that the statute of limitations does not begin to run until a breach of the contract (i.e., the promissory notes) occurs. The statute of limitations would run on the due date of each missed payment. The Court drew an important distinction in clarifying that the final statute of limitations does not begin to run until the promissory note reaches maturity. The Creditor therefore could still foreclose upon each deed of trust. Creditors therefore retain the right to pursue their collateral in accordance with agreements executed with debtors and applicable law even if the debtors’ personal liability is discharged through a bankruptcy.
This decision provides some critical considerations for both debtors and creditors. Debtors should remember that bankruptcy provides many benefits, but it is not a solution to all debt obligations. Debtors like the Merritts may extinguish their personal liability for outstanding debts even though the debts will remain valid post-discharge. Bankruptcy affords the opportunity to protect a debtor’s other assets that are not encumbered by a deed of trust or other valid contracts with creditors. Creditors cannot use these separate assets as repayment for a debt that was not secured by such assets. This protection is very beneficial to debtors. Creditors, however, mustn’t fret. The Court importantly clarified that a bankruptcy discharge does not void or modify the terms of contracts that a debtor entered into prior to filing for bankruptcy protection. When the contract at issue is an installment contract, as in Merritt, each installment under the contract continues to become due under the terms of that contract. Creditors also retain the ability to foreclose upon properties secured by deeds of trust or other security agreements. Creditors seeking to foreclose or otherwise collect on a debt simply cannot pursue actions in personam, or actions brought against a specific person. They instead must pursue actions in rem, which are brought against a thing (e.g., real property), to enforce the respective debt. Payments on a debt remain valid post-discharge.
If you have any questions about repaying or collecting upon an outstanding debt, please contact Matthew B. Audish or Alexandra K. Yerigan Funk, attorneys within the Corporate Bankruptcy, Receivership & Finance group at Ryan, Swanson & Cleveland, PLLC.
This message has been released by the Corporate Bankruptcy, Receivership & Finance Group at Ryan, Swanson & Cleveland, PLLC to advise of recent developments in the law. Because each situation is different, this information is intended for general information purposes only and is not intended to provide legal advice on any specific facts and circumstances. Ryan, Swanson & Cleveland, PLLC is a full-service law firm located in Seattle, Washington.
