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Stripoff of Completely Secured Mortgage Covering Debtors Principal Residence

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Section 1322(b)(2) of the Bankruptcy Code provides that a chapter 13 plan may "modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor's principal residence...." 11 U.S.C. §1322(b)(2). Prior to the U.S. Supreme Court's 1993 decision in Nobelman v. American Savings Bank, 508 U.S. 324, 113 S.Ct. 2106, 124 L.Ed.2d 228 (1993), the courts held that §1322(b)(2) prohibited modification of a partially unsecured homestead mortgage only to the extent of the current market value of the homestead residence, referred to as a "secured claim." The balance of the mortgage debt (the amount by which the mortgage debt exceeded the value of the homestead residence) was treated as an "unsecured claim," which thus reduced ("stripped down") the mortgage lien and was subject to modification by the plan. However, this view was rejected by the Supreme Court in Nobelman, supra, decided June 1, 1993.

In that case, the debtors' homestead residence had a market value of $23,500, though the outstanding mortgage debt was $71,335. The debtors' chapter 13 plan proposed to make payments to the mortgage only up to the $23,500 and further proposed to treat the remainder of the mortgage debt as unsecured, with unsecured creditors receiving nothing. The court ruled that §1322(b)(2) prohibited the debtors' plan from providing that the unsecured portion of the claim could be treated the same as other unsecured claims, because a plan providing that the claim would not be paid in full would modify the rights of the holder of the claim, to wit, the right to be paid for the full term of the note.[1]

Nobelman involved a partially unsecured homestead mortgage. The question arises as to what treatment should be given a completely unsecured homestead mortgage. Since the decision in Nobelman, a split in authority has developed from the many bankruptcy courts that have been confronted with this question. Several courts have ruled that a creditor who holds a mortgage on homestead property that has no value (such as where the property was fully encumbered by prior mortgages) is not entitled to protection by §1322(b)(2), and the entire mortgage lien may be "stripped off" and the mortgage debt modified pursuant to a chapter 13 plan.[2] The holdings of the courts in most of these cases are based on dicta [3] in the Nobelman opinion which (in the view of those courts) implies that if the creditor's collateral in the debtor's residence is wholly unsecured, then a complete stripoff of the mortgage is permissible.

On the other hand, a few of the decisions take the view that a creditor holding a completely unsecured homestead mortgage is entitled to the same protection under §1322(b)(2) as one who holds a partially unsecured mortgage, as in Nobelman.[4] Their reasoning is that the reliance by some courts on the dicta from Nobelman (see footnote 2) is "…out of context with the rest of the Nobelman decision"; and "that the proper reading of that opinion was an endorsement of creditor rights, where ‘rights' were defined by state law and the underlying mortgage contact." In re Barnes, 1997 WL 189500, page 4 (Bankr. N.D. Ill., March 5, 1997).

Reliance on the "still the holder" dicta in Nobelman yields an absurd result. If §1322(b)(2)'s protection against modification were limited solely to security interests with underlying collateral, junior mortgagees with a single penny of equity in collateral in the debtor's principal residence would still retain complete protection from a stripdown while junior mortgagees who lacked that penny of equity would find their entire claim stripped off. Nobelman did not foster this absurd result because that decision did not delineate that any level of equity protecting the secured creditors is required for §1322(b)(2) protection. Instead, Nobelman flatly held that "[s]ection 1322(b)(2) prohibits [a §506(a)] modification where, as here, the lender's claim is secured only by a lien on the debtor's principal residence. Id. at 4.

The only appellate court to decide the issue agreed with the first approach and concluded that the Nobelman decision, holding that §1322(b)(2) bars a chapter 13 plan from modifying the rights of holders of claims secured by the debtor's principal residence, does not apply to holders of totally unsecured claims. In In re Lam, BAP No. NC-96-1773 –hryo (9th Cir. BAP Cal. July 3, 1997), the bankruptcy appellate panel referred to Justice Steven's concurring opinion in Nobelman which noted, that protecting "holders of secured claims" is consistent with the congressional intent of encouraging home lending by residential mortgagees. The Lam court went on to cite the In re Plouffe, 157 B.R. 198 (Bankr. D. Conn. 1993) court's interpretation of Justice Steven's opinion, which held that it only referred to first mortgagees. In the Plouffe case, the court found that "there are no such concerns when dealing with the second mortgage market. The bankruptcy appellate panel went on to say that it agreed with In re Plouffe's interpretation of Nobelman in the factual context before it.

As other cases are decided by circuit courts of appeals and bankruptcy appellate panels, furthering the split of authority, the ultimate resolution may once again require a ruling by the Supreme Court, unless, of course, the National Bankruptcy Review Commission and/or Congress beats "the Supremes" to a resolution.

NBRC Proposal

In June, the Commission adopted the following proposal as part of its "Consumer Bankruptcy Framework":

A chapter 13 plan could not modify obligations on first mortgages and refinanced first mortgages, except to the extent currently permitted by the Bankruptcy Code. Payments on all other secured debts should be subject to modification; such payments should be spread over the life of the plan, according to fixed criteria for valuation and interest rates.

As the Commission's analysis explained: "...subsequent mortgages should be treated like all other secured debts, thus the secured claim would be calculated under §506. This means that second mortgages would be protected in full when they do not exceed the value of the home. If the loan secured by the second mortgage exceeded the value of the home, debts secured by second mortgages could be bifurcated into secured and unsecured portions."

At the Commission's August meeting, the proposal was modified with respect to junior liens as follows:

A chapter 13 plan could not modify obligations on first mortgages and refinanced first mortgages, except to the extent currently permitted by the Bankruptcy Code. Section 1322(b)(2) should be amended to provide that the rights of a holder of a claim secured only by a junior security interest in real property that is the debtor's principal residence may not be modified to reduce the secured claim to less than the appraised value of the property at th time the security interest was made.

As the Commission's analysis described it:

This modest change to current law would continue the policy that mortgage liens generally are fully protected notwithstanding §506 of the Bankruptcy Code, but would permit modification to a limited extent for certain loans that were made on a partly secured basis.

Under this recommendation, the rights of a bank or other lender holding a mortgage that was fully secured when the loan was granted could not be modified. Yet, if junior interests were partially unsecured when the secondary mortgage was made, the lender would be treated as a fully secured creditor only to the extent it was secured when it made the loan. However, even these lenders would get special protection as compared to other creditors: the secured claims of undersecured mortgage lenders would not be reduced below the value of the property when the loan was made, even if the value of the property has since declined.

Permitting this modification of junior mortgages taken on a partly unsecured basis comports with the continuing effort to treat like creditors alike. Enabling certain unsecured mortgagees to remain entitled to payment in full on account of a partly unsecured lien diverts assets from other creditors and prefers some creditors over others. This recommendation also is consistent with underlying federal policies promoting home ownership. Mortgage loans can put home ownership at risk as the loan-to-value ration continues to climb, and particularly when the loans exceed the value of the property. To the extent that creditors who lend far in excess of a home's value can demand full repayment or can force a foreclosure, some homeowners will lose their homes, and debtors with second and third mortgages that exceed the value of the homes are less likely to confirm a chapter 13 plan, thereby yielding no payments to any creditors.


Footnotes

[1] The court enumerated various of the mortgagee's rights under state law which are protected from modification by §1322(b)(2) as follows: "They include the right to repayment of the principal in monthly installments over a fixed term at specified adjustable rates of interest, the right to retain the lien until the debt is paid off, the right to accelerate the loan upon default and to proceed against petitioners' (debtors') residence by foreclosure and public sale, and the right to bring an action to recover any deficiency remaining after foreclosure." 113 S.Ct. at 2110.[RETURN TO TEXT]

[2]SeeIn re Sanders, 202 B.R. 986 (Bankr. D.Neb. 1996); In re Geyer, 203 B.R. 726 (Bankr. S.D.Cal. 1996); Associates Fin. Servs. Corp. v. Purdue, 187 B.R.188 (S.D. Ohio 1995); In re Sette, 164 B.R. 453 (Bankr. E.D.N.Y. 1994); In re Woodhouse, 172 B.R. 1 (Bankr. D.R.I. 1994); In re Hornes, 160 B.R. 709 (Bankr. D.Conn. 1993); In re Lee, 161 B.R. 271 (Bankr. W.D.Okla. 1993); In re Moncrief, 163 B.R. 492 (Bankr. E.D.Ky. 1993); In re Plouffe, 157 B.R. 198 (Bankr. D.Conn 1993); Wright v. Commercial Credit Corp., 178 B.R. 703 (E.D. Va. 1995); In re Libby, 200 B.R. 562 (Bankr. D.N.J. 1996); In re Lee, 177 B.R. 715 (Bankr. N.D.Ala. 1995); Norwest Fin. Georgia Inc. v. Thomas, 177; B.R. 750 (Bankr. S.D.Ga. 1995); Castellanos v. PNC Bank, 178 B.R. 393 (Bankr. M.D.Pa. 1994); In re Mitchell, 177 B.R. 900 (Bankr. E.D.Mo. 1994); In re Brown, 1993 WL 544385 (Bankr. E.D.N.C. 1993); In re Kidd, 161 B.R. 769 (Bankr. E.D.N.C. 1993); In re Williams, 161 B.R. 27 (Bankr. E.D.Ky. 1993).[RETURN TO TEXT]

[3] In this respect, the opinion states: "…even if we accept petitioners' (debtors') valuation, the bank is still the ‘holder' of a ‘secured claim,' because petitioners' home retains $23,500 of value as collateral." 113 S.Ct. at 2110.[RETURN TO TEXT]

[4]See In re Barnes, 1997 WL 189500 (Bankr. N.D.Ill. 1997); In re Neverla, 194 B.R. 547 (Bankr. W.D.N.Y. 1996); In re Jones, 201 B.R. 371 (Bankr. D.N.J. 1996); In re Barnes, 199 B.R. 256 (Bankr. W.D.N.Y. 1996).[RETURN TO TEXT]

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Monday, September 1, 1997

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