A chapter 13 debtor proposed a plan that bifurcated an undersecured mortgage loan into a secured claim and an unsecured claim. The mortgagee objected and moved for relief from the automatic stay.
Generally if the property securing a mortgage loan is worth less than the outstanding balance of the loan, under section 506 of the Bankruptcy Code the loan can be bifurcated into a secured claim equal to the value of the collateral and an unsecured claim for the deficiency. However, in the context of a chapter 13 case section 1322 prohibits modification of “a claim secured only by a security interest in real property that is the debtor’s principal residence” (emphasis added).
At the time the loan was made the will and debtor owned both a residence and an investment commercial property. The loan was originally secured by both properties. Prior to the bankruptcy the mortgagee foreclosed on the commercial property so that it was no longer collateral for the loan.
The loan, which continue to be secured by the residence, maturity. So the lender proceeded with a foreclosure of the residence. A state court entered a judgment of foreclosure and sale in the amount of ~$393,000. The debtor’s right of redemption expired and a judicial sale was scheduled. On the day the sale was to take place the debtor filed bankruptcy in an effort to save his home.
The chapter 13 plan treatment of the mortgage loan proposed by the debtor provided for a secured claim for $140,000, which he proposed to pay with a balloon payment during the last month of plan, and an unsecured claim for the balance. Regardless of whether $140,000 was the exact value of the house, all parties agreed that the mortgage loan was significantly undersecured.
The lender objected for a number of reasons, including its claim that the plan violated the anti-modification prohibition in section 1322. The court identified this as the key issue since the debtor would not be able to propose a confirmable plan if he was not allowed to modify the loan.
The debtor did not dispute that the property was his principal residence. Rather he argued that section 1322 was not applicable because (1) at the time the loan was made it was secured by both the residence and the commercial property, and (2) the security under the loan documents included personal property, so that the loan was not secured “only” by the debtor’s principal residence.
As discussed in other blog posts (for example, Chapter 13 Residential Mortgages: Anti-Modification Round 2), there has been substantial litigation about what it means for a loan to be secured “only” by the debtor’s principal residence. The twist in this case was the timing of the determination: Should the determination be made based on circumstances (1) at the time the loan was made or (2) as of the bankruptcy petition date?
The bankruptcy court determined that a majority of courts use the petition date. Since the lien on the commercial property was released as a result of a foreclosure prior to the bankruptcy, that property was no longer part of the collateral base as of the petition date.
The debtor’s second argument was based on the grant of a security interest that included “the assignment of rents and the security interest in the Rents and personal property.” However, the court noted the 2005 amendments to the Bankruptcy Code that defined “debtor’s principal residence” to include “incidental property,” and then defined “incidental property” to include property “commonly conveyed with a principal residence” together with a laundry list of items that included rents. The debtor was not able to identify any personal property that was not incidental property.
Turning to the request for stay relief, both parties acknowledged that the debtor had no equity in the property. So the only question was whether the property was “necessary for reorganization.” The court found that since the debtor did not show he had the ability to cure the mortgage arrearage – even over the full term of the 60-month plan – he could not propose a confirmable plan, and thus property was not necessary for reorganization.
Accordingly the court granted the mortgagee relief from the automatic stay.
The Bankruptcy Code was enacted about 40 years ago, and the last major amendments (the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005) are more than 10 years old. It is interesting to see how many open issues remain after that period of time.
Vicki R Harding, Esq.