A recent decision of the U.S. Bankruptcy Court for the Central District of California highlights a troubling phenomenon: borrowers purportedly transferring ownership interests in real property to bankruptcy debtors unbeknownst to those debtors in order to invoke the protections of the automatic stay. In In re Dorsey, No. 12-18895, 2012 WL 3060646 (Bankr. C.D. Cal. July 26, 2012), the court held that a secured creditor was entitled to relief from the automatic stay pursuant to Section 362(d)(4) even though the debtor was not a party to the fraudulent scheme to delay, hinder or defraud the creditor.

On March 13, Dana Dorsey filed a petition for relief under Chapter 7 of the Bankruptcy Code. Two weeks later, Springleaf Financial Services filed a motion for relief from stay under Sections 362(d)(1), (2) and (4) in order to foreclose on a parcel of real property located in Oxnard, Calif. In the motion, Springleaf explained that the original borrower of a loan secured by a deed of trust on the property was an individual named Angelica Suarez. The deed of trust in favor of Springleaf had been recorded in 2007, and Suarez was delinquent on the loan with arrears totaling $36,552.

On December 20, 2011, Suarez purportedly transferred an ownership interest in the property to an individual named Gloria Becerra through a deed that showed that no consideration was paid for the transfer. Becerra had filed a petition for relief under Chapter 13 of the Bankruptcy Code on November 28, 2011. Becerra’s bankruptcy case was subsequently converted to a case under Chapter 7 of the Bankruptcy Code, and the court in that case granted relief to Springleaf for leave to enforce its rights against the Oxnard property. Suarez, via a trust, then purportedly transferred an ownership interest in the same property to Dorsey by way of a quitclaim deed that was presumably backdated to March 11. The deed stated that this transfer, as well, was effectuated for no consideration.

Dorsey filed a response to Springleaf’s motion in her case, stating that she had “no knowledge of this property, the alleged transferor, or that the fractional interest was transferred to her.” Dorsey had not listed the property on her schedules. She did not oppose the motion for relief from stay but objected to any finding of bad faith on her part, as she claimed to have no knowledge of the transfer from Suarez.

Upon the filing of a bankruptcy petition, the automatic stay protects the debtor and prevents the depletion of estate assets by zealous creditors. Under the Bankruptcy Code, a creditor may move the bankruptcy court for relief from the automatic stay in order to pursue state law collection remedies. Section 362(d) of the Bankruptcy Code governs relief from the stay, with (d)(1) allowing relief for cause, including lack of adequate protection of the creditor’s interest, and (d)(2) allowing relief where the debtor has no equity in the property and the property is not necessary for the debtor’s reorganization.

Section 362(d)(4) provides for in rem relief such that the court’s order is binding for two years in any bankruptcy case purporting to affect the same property. Section 362(d)(4) provides that a court shall grant relief from the stay to a creditor whose claim is secured by an interest in real property subject to the stay if the court finds that “the filing of the petition was part of a scheme to delay, hinder or defraud creditors” and the scheme involved either a transfer of all or part of the ownership interest in the real property, or multiple bankruptcy filings affecting the real property. Accordingly, the Dorsey court explained the three requisites to obtaining relief under Section 362(d)(4): (1) the bankruptcy filing was part of a scheme; (2) the object of the scheme was to delay, hinder or defraud creditors; and (3) the scheme involved either (a) the transfer of some interest in the real property without the creditor’s consent or court approval, or (b) multiple bankruptcy filings affecting the property.

The court found that Dorsey’s bankruptcy filing was part of a scheme, even though there was no evidence that the debtor was part of that scheme. Instead, it noted that the facts of the case presented an example of an increasingly common occurrence in our economic climate: A borrower finds a debtor’s name by searching the public bankruptcy records and then backdates and records a deed purporting to transfer to the debtor some interest in the borrower’s property. This act of “property dumping,” or “hijacking” the debtor’s case, allows the borrower to benefit from the automatic stay without suffering the “pain” of filing or subjecting himself or herself to the code’s rules governing debtors.

The court first looked to the language of Section 362(d)(4) and determined that the passive voice used in the statute suggests that it does not require that the debtor be involved in the scheme to “delay, hinder or defraud creditors.” The court also looked at the legislative history of Section 362(d)(4), which was added as part of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. That legislative history suggests that one purpose of the BAPCPA, in general, is to curb abuse and misconduct by debtors and others involved in the bankruptcy process. The purpose of Section 362(d)(4), in particular, is to reduce the number of abusive filings. The court further justified its rationale with a comment that its reading of the statute protected the integrity of the bankruptcy system. It also agreed with the conclusion of another bankruptcy judge in the same district in In re Duncan & Forbes Development, 368 B.R. 27 (Bankr. C.D. Cal. 2006). There, the court held that in order to grant relief under Section 362(d)(4), it was not necessary that the debtor create, carry out or be party to the fraudulent scheme. Additionally, the court explained that Section 362(d)(4) does not require any showing of bad faith or misconduct on the part of the debtor, and made it clear that there had been no bad faith or misconduct by Dorsey. Consequently, the fact that the debtor was not involved in the scheme was of no moment; the bankruptcy filing was part of a scheme, and the first element of Section 362(d)(4) was therefore met.

The court then easily concluded that the object of the scheme was to delay, hinder or defraud creditors. The court explained that the borrower had been successful in implementing the scheme in order to obstruct the foreclosure process on the Oxnard property. Accordingly, the second element of Section 362(d)(4) was met.

Finally, the court found that the scheme included both transfers without consent and multiple bankruptcy filings. The court disagreed with the Duncan court’s determination that the secured creditor’s consent under Section 362(d)(4) applies only if the secured creditor has a right based on contract or other applicable law to require consent or court approval for a transfer of the collateral. Instead, it concluded that under the express language of the statute, a secured creditor may obtain relief so long as it shows that it did not consent to the transfer; the secured creditor need not show that it had a right to require its consent in the first place. In this case, Springleaf filed a declaration stating that the transfer had been made without its consent, and the Dorsey court concluded that this was sufficient to establish a lack of consent for purposes of Section 362(d)(4). Thus, the last element of Section 362(d)(4) was satisfied, and Springleaf was entitled to relief from the automatic stay.

The Dorsey opinion sheds light on an issue that is particularly relevant for secured creditors operating in today’s economic environment. Some desperate borrowers have demonstrated that they will go to great (and creative) lengths to avoid foreclosure against their property, including manipulating the bankruptcy process to place as many obstacles as possible in a creditor’s way. The Dorsey opinion provides a positive and practical solution to creditors seeking to shut down the fraudulent practice of property dumping. The opinion does not discuss the potential repercussions for borrowers who orchestrate the scheme; presumably, these borrowers are on the hook for civil — and even criminal — penalties for their actions.

Rudolph J. Di Massa Jr., a partner at Duane Morris, is a member of the business reorganization and financial restructuring practice group. He concentrates his practice in the areas of commercial litigation and creditors’ rights. He is a member of the American Bankruptcy Institute, the American Bar Association and its business law section, the Commercial Law League of America, the Pennsylvania Bar Association and the business law section of the Philadelphia Bar Association.

Laura D. Bonner is an associate with the firm and practices in the area of business reorganization and financial restructuring.