HSBC Bank USA, N.A. v. Zair, 550 B.R. 188 (Bankr. E.D. N.Y. 2016) –

The debtors proposed a chapter 13 plan that provided for surrendering real property to the first mortgagee, with title to the property vesting in the mortgagee over its objection. The bankruptcy court confirmed the plan and the mortgagee appealed.

As discussed in a prior post (Chapter 13 Plan: How to Really Get Rid of Unwanted Property), the debtors’ home was damaged during Superstorm Sandy and became uninhabitable. So they moved out and bought a second house. According to the bankruptcy schedules, the old damaged house was subject to two mortgages, and the value of the property was less than the outstanding balance of the first mortgage. The first mortgagee filed a motion for relief from the automatic stay to permit it to continue a foreclosure.

Under their plan the debtors proposed to surrender the damaged home to the mortgagee “in full satisfaction of the secured portion of the mortgage owed pursuant to 11 U.S.C. Section 1325 and 506.” The plan also provided that title to the 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.'”

The first mortgagee agreed that it was proper to surrender the property so that it could pursue its state foreclosure remedies, but strenuously objected to the transfer of title arguing that it was “legally untenable” because the concepts of surrender and vesting could not coexist in a plan. The bankruptcy court did not agree and confirmed the plan.

The issue turned on the interaction of section 1325(a)(5) of the Bankruptcy Code – which addresses treatment of secured claims, and section 1322(b)(9) – which states that a plan may provide for the vesting of property of the bankruptcy estate in another entity.

In particular, under section 1325 a plan can be confirmed only if each secured claim is treated in one of three ways: (1) the creditor accepts the plan, (2) the debtor surrenders the secured property, or (3) there is a cramdown where the debtor retains the property and it makes certain required payments. In this case the creditor did not accept and the debtor did not propose a cramdown, so the plan was confirmable only if it provided for “surrender” of the mortgaged property as required by section 1325.

The district court echoed the view that “surrender means only that the debtor will make the collateral available so the secured creditor can, if it chooses to do so, exercise its state law rights in the collateral.” In contrast, vesting is a more “consequential event” that involves transferring title to the property.

The mortgagee argued that “surrender” and “vesting” were mutually exclusive so that a plan could not contain both. While the court did not agree that the concepts were inconsistent in all cases, it concluded that a debtor could not transfer title to a mortgagee over its objections.

The required treatment in section 1325 was intended to provide protection to secured creditors. The surrender option contemplates that the creditor can pursue its state law remedies against the collateral. If title to the collateral was transferred to the creditor over its objections that would impermissibly modify its rights.

For example, if there are junior liens, a mortgagee could lose its first priority position due to a merger of interests under state law. It would also become liable for maintenance, taxes and other expenses of ownership. And if the property had environmental contamination the mortgagee could become liable for remediation. In this case the property had been destroyed and rendered uninhabitable by a hurricane. It was understandable that the mortgagee might not want to take on responsibility for property that could be declared a public nuisance.

In response the debtor and chapter 13 trustee argued that the mortgagee’s interests had to be weighed against the overarching goal of giving a chapter 13 debtor a “fresh start.” Without the ability to cause title to vest in the mortgagee, a debtor could continue to be saddled with the expenses of ownership for an extended period of time since there is nothing that requires the mortgagee to act.

The court proceeded to analyze the two lines of cases that have been developing in this area: one line supported the debtors’ position while the other line supported the mortgagee’s position. The court discussed a dozen cases in detail. It found the cases supporting the mortgagee’s position more persuasive. Among other things the court noted that some of the key cases supporting the debtors’ view were distinguishable because the mortgagee did not object. This meant that a plan could have been confirmed based on the mortgagee consent option as opposed to the surrender option.

It concluded its analysis by commenting:

Finally, the Court rejects the theory that the Debtors’ pursuit of a fresh start in bankruptcy should be elevated above the other interests of the parties in this case. Given the very clear delineation of secured creditors’ rights in §1325(a)(5) and the fact that Congress saw fit to fortify those rights by conditioning confirmability of all Chapter 13 plans upon conformance with them; the Court can discern no principled basis for exalting the policy rationale in favor of “fresh starts” for debtors over the Code’s obvious goal of preserving the well-settled property rights of secured creditors.

Consequently the court reversed the bankruptcy court decision, vacated the confirmation order and remanded for further proceedings.

There is certainly some appeal to the viewpoint that a mortgagee did not bargain for involuntary liability for its collateral and should be the allowed the discretion to choose to exercise its remedies or not. However, if for whatever reason a mortgagee chooses to do nothing, the debtor does not appear to have any way to force the issue and can end up in a difficult position.

Vicki R Harding, Esq.