The debtors proposed a chapter 13 plan providing that certain real property was to be surrendered to the mortgagees and title to the property was to vest in the first mortgagee over its objection. The bankruptcy court confirmed the plan.
After the house where the debtors were living suffered damage in Superstorm Sandy, they bought a second house – which is where they were living when they filed a chapter 13 bankruptcy.
Their bankruptcy schedules showed the old house with a value of ~$255,000, subject to a first mortgage with a balance of the ~$387,000 and a second mortgage with a balance of ~$30,000. The first mortgagee filed a proof of claim asserting that it was owed ~$440,000. The first mortgagee also filed a motion for relief from the automatic stay to permit it to continue a foreclosure.
Under the plan the debtors proposed to retain their current home and to surrender their former home to the mortgagees “in full satisfaction of the secured portion of the mortgage owed pursuant to 11 U.S.C. Section 1325 and 506.” It also provided that title to the old property would be vested in the first mortgagee: “‘[t]his vesting shall not merge or otherwise affect the extent, validity, or priority of any liens on the property’; and ‘the confirmation order shall constitute a deed of conveyance of the property when recorded with the county clerk’s land records.'” Further, under the plan all claims secured by the old property would be deemed paid by surrender of the property, provided that the mortgagees had 30 days after confirmation of the plan to file unsecured claims for any deficiencies.
Although the first mortgagee did not oppose surrender, it objected to being forced to take title to the property. The mortgagee argued that this was analogous to an impermissible abandonment under Section 554 of the Bankruptcy Code, and because it did not have a possessory interest, the debtors could not cause title to vest in the mortgagee.
The chapter 13 trustee filed a brief in support of the debtors’ plan, arguing that vesting title was permitted, and otherwise the “Debtors’ ‘fresh start’ would be impeded because absent vesting, Debtors will remain responsible for expenses and property taxes incurred in connection with the Property even after they have surrendered the Property.”
In response, the first mortgagee added arguments that (1) the Bankruptcy Code authorized vesting only in an “entity,” and the first mortgagee was not an entity, (2) allowing debtors to vest title and encumber a lienholder with a “dilapidated property would open a pandora’s box of unintended injurious consequences,” (3) the plan did not comply with requirements for treatment of a secured claim, and (4) as a policy matter vesting should not be permitted because it violated state laws regarding transfers.
The court focused on two sections of the Bankruptcy Code: Sections 1322(b)(9) and 1325(a)(5).
- Under Section 1322(b)(9) a plan may “provide for the vesting of property of the estate, on confirmation of the plan or at a later time, in the debtor or in any other entity.”
- Section 1325(a)(5) contains requirements for treatment of secured claims under a chapter 13 plan. With respect to the secured portion of the claim, the debtor has three options: (a) the secured creditor accepts the plan, (b) the plan meets certain cramdown requirements regarding the lien and the value of payments to the creditor, or (c) the debtor surrenders the property securing the claim to the creditor.
The court discussed several cases that addressed whether a debtor was allowed to vest title to real property in a secured creditor over its objection. In one case the bankruptcy court permitted vesting, but was reversed by the district court. Another court allowed a vesting provision, but the secured creditor did not object so was deemed to have accepted the plan. A third case held that the debtor could not vest title in full satisfaction of its debt over the secured creditor’s objection. A fourth case denied the debtor’s motion to transfer real property by quit claim deed approximately one year after confirmation without the creditor’s consent. A fifth decision, which the court found to be the closest fact pattern, allowed a debtor to use both surrender and vesting in a plan, and confirmed the plan over the creditor’s objection.
One of the courts defined “surrender” as “‘the debtor’s relinquishment of his or her right to the property at issue, such that the secured creditor is free to accept or reject that collateral,’ distinguishing it from vesting, which it defined as essentially a ‘transfer of ownership,’ eliminating the liability and responsibility of the debtor to do anything in connection with the real property.” The bankruptcy court concluded that while surrender and vesting are different, they are not mutually exclusive, so that both could be included in a plan notwithstanding the secured creditor’s objections.
To begin with, under the plain language of Section 1322(b)(9) vesting is not limited to circumstances where the secured creditor consents. The court also found support in a Supreme Court case holding that it was proper to value property using a replacement value standard when the debtor proposed to retain and use the collateral. In the court’s view this meant that valuation was based on examining what each side receives, and in the case of surrender is based on the premise that surrender results in immediate realization of the value of the collateral by the lender.
The court also believed that allowing a debtor to provide for vesting in a plan, as opposed to requiring a separate adversary proceeding, was consistent with the overall structure of chapter 13 as a more streamlined and less expensive way for individuals to adjust their financial affairs.
As pointed out by the chapter 13 trustee, if the debtors were not allowed to transfer title to the property, then they would be in limbo until the secured creditor decided whether and when to proceed with foreclosure. In the meantime the debtors would continue to incur carrying expenses associated with the property, such as accruing property taxes. Since a debtor does not include costs related to surrendered property in calculating disposable income for purposes of plan payments, this could adversely impact their ability to successfully implement the plan.
Under Section 506 of the Bankruptcy Code, a secured claim is generally treated as secured to the extent of the value of the collateral, and unsecured to the extent of any deficiency. An important consideration for the court was that the plan provided that the surrendered property was to satisfy only the secured claim of the creditors, and they were given an opportunity to file unsecured claims for any deficiency.
The first mortgagee expressed concern that under state law the transferred fee title would merge with its mortgage so that it would no longer be able to foreclose and “clean up” junior liens. The court rejected this argument, noting that (1) the Bankruptcy Code authorizes vesting provisions, (2) the plan specifically provided that the interests would not merge, and (3) federal law would preempt inconsistent state law.
The court also made short work of the first mortgagee’s argument that it was not an entity for purposes of the Bankruptcy Code provision authorizing vesting in entities: the first mortgagee was a corporation, and thus both a person and an entity under the Bankruptcy Code definitions.
A debtor has a right to surrender property to a lender over its objection, and the court viewed vesting of title to the surrendered property in the lender as entirely consistent. Adding vesting to surrender allows the lender to dispose of the property without waiting to complete foreclosure. Consequently the court confirmed the plan over the first mortgagee’s objection.
Surrender is one of those concepts that is often misunderstood. Debtors are surprised to find that they have continuing liability for property expenses after surrender, with no way to force a mortgagee to foreclose in order to cut off liability. Combining surrender with vesting title produces a result that is more aligned with debtors’ expectations – although, on the other hand, it is almost certainly the case that lenders expect to control their own destiny, which probably does not include being forced to take title to “dilapidated property.”
Vicki R Harding, Esq.
NOTE: The district court reversed the bankruptcy court. See Chapter 13 Plan: How to Really Get Rid of Unwanted Property … Or Maybe Not