Property Surrender Round 2: Can a Mortgagee Really Be Forced to Take Title?

In re Williams, 542 B.R. 514 (Bankr. D. Kan. 2015)

A chapter 13 debtor obtained confirmation of a plan which provided for surrender of his residential property to a secured creditor. The debtor later moved to amend the plan to provide for vesting of title to the property in the creditor, and the creditor objected.

The debtor had granted a mortgage on his residence to secure a note. The mortgagee filed a foreclosure action and the debtor filed bankruptcy. The property was valued at ~$190,000 in the debtor’s schedules, and was estimated at ~$191,000 for property tax purposes. At the time the petition was filed the mortgagee was owed ~$170,000 and the property was subject to a junior lien securing ~$48,000. Thus the mortgagee was over secured, but overall the property was underwater.

Initially the debtor proposed a plan that provided he would retain the property as his principal residence. The mortgagee did not object and the court confirmed the plan. A couple of months later the debtor moved to amend the plan to provide for surrender of the property. Again the mortgagee did not object and the court granted the motion.

Subsequently the debtor abandoned the property and the mortgagee took control, including changing the locks, winterizing the home, and maintaining the property. Six months later the debtor once again moved to amend the plan – this time to provide:

[The Property] is surrendered in full satisfaction of the underlying secured claim of [mortgagee]. Pursuant [to] U.S.C. §§1322(b)(8) and (9), title to the [Property]… shall vest in [mortgagee] upon confirmation of this amendment to the… Plan, and the Order approving this modification shall constitute a deed of conveyance to the Property when recorded with the Douglas County, Kansas Register of Deeds. All secured claims secured by the [Property] will be paid by surrender of the collateral and foreclosure of the security interests.

This time the mortgagee objected. It contended that the Bankruptcy Code did not allow forcible vesting of title to property in an unwilling creditor.

Section 1322(9) states that a plan may “provide for the vesting of property of the estate, on confirmation of the plan or at a later date, in the debtor or in any other entity.” Although the court concluded that the proposed amendment did not violate Section 1322, that did not answer the question of whether the change could be confirmed over the mortgagee’s objection.

Section 1325 provides that a plan that includes an allowed secured claim may be confirmed only if (1) the holder of the claim accepts the plan, (2) the plan provides for payments that satisfy a “cram down” standard or (3) the plan provides that the debtor will surrender the property securing the claim to the holder.

The plan as first amended both was accepted by the secured creditor (since the mortgagee was deemed to accept the amended plan when it failed to object) and provided for surrender of the property. With respect to the proposed second amendment, the mortgagee objected and the debtor did not claim that he satisfied the cram down test, so confirmation turned on whether the plan still provided for surrender as required by Section 1325.

Everyone agreed that surrender and vesting were two different concepts. The court described surrender as “relinquishment of all rights in the property, including the right to possess the collateral.” However, it does not involve transfer of title. Rather the debtor must make the property available so that the secured creditor can exercise its state law will rights if it chooses. So surrender means making the property available, while vesting means actually transferring title.

The court acknowledged that a number of other courts have confirmed chapter 13 plans that provide for surrender and vesting of title in the mortgagee. It noted that in several of these cases the mortgagee did not object. Thus the plans were confirmable based on a deemed acceptance.

In other cases that involved approving a plan providing for both surrender and vesting over the objection of the mortgagee, there were no junior liens.

  • One court justified this as advancing the policy of providing debtors with a “fresh start,” and noted the parallel with chapter 11 – which allows “dirt for debt” plans.
  • Another court concluded that Congress did not limit vesting to circumstances where the creditor consents. This court also noted Section 1327(b), which provides that confirmation vests all property of the estate in the debtor unless the plan or confirmation order provides otherwise. In its view, vesting title in the creditor helped avoid confusion about the status of property that has been surrendered but title is still being vested in the debtor.
  • Yet another court justified amendment to provide for vesting of title of surrendered property in the creditor as furthering the concept of a debtor’s fresh start. This court held the creditor’s consent was not required as long as vesting was done in good faith. (In this case the property remained in the debtors’ names four years after the property had been surrendered.)

However, other courts have found that the mortgagee cannot be compelled to accept title.

  • In reversing a bankruptcy court decision, a district court concluded that providing for vesting was in essence creating a fourth option for confirmation under Section 1325 and was that odds with the plain language of the statute. Further, just because vesting was a permitted term for a plan did not mean that the plan was automatically confirmable. In its view, finding that surrender could be combined with vesting “impermissibly transforms the secured creditor’s right into an obligation, thereby rewriting both the Bankruptcy Code and the underlying loan documents, while at the same time belying the secured creditor’s state-created property rights.”
  • In another case where the debtors had surrendered property, but a year later the secured creditor had not taken any action to start foreclosure or assert control, the court rejected the debtors’ motion for authority to transfer title to the secured creditor by quit claim deed. It reasoned that the Bankruptcy Code did not require the secured creditor to accept title, Section 105 did not permit the court to alter substantive rights, and state law did not require the mortgagee to initiate foreclosure or accept title. Involuntary transfer of title would force the lender to accept burdens that it did not bargain for.

The Williams court sided with the view that a secured creditor cannot be compelled to accept title. Vesting title in the mortgagee would impair its rights under state law. In the court’s view the confirmation requirements relating to secured claims permit a mortgagee’s rights to be modified in connection with the cram down (which includes certain protections for the mortgagee), but not otherwise. It rejected the argument that the provision authorizing vesting provided a sufficient basis:

As the United States Supreme Court has stated [in Butner], “[T]he federal bankruptcy court should take whatever steps are necessary to ensure that the mortgagee is afforded in federal bankruptcy court the same protection he would have under state law if no bankruptcy had ensued.”

Consequently, the court rejected the debtor’s motion to amend the plan to provide for vesting.

If the first mortgagee was over secured so that equity was left for the benefit of the junior creditor (as was the case at the beginning of the bankruptcy) then there might be a stronger argument than usual that vesting title in the first mortgagee could unfairly alter its rights: i.e. if the first mortgagee ended up with fee title subject to the junior lien without the ability to foreclose its first mortgage to extinguish the junior lien.

Regardless, the inability to compel transfer of title can leave a debtor in a difficult position since it has no way to force a lender to take action so that merely “surrendering” property does not necessarily relieve the debtor from the associated burdens (paying taxes, maintaining the property, etc.). See Property Surrender: Surrender Means Surrender – Really for another discussion of this issue from the perspective of a court that permitted combining surrender with vesting.

Vicki R Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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