Opinion
CASE NO. 00-14683-AJM-13
November 30, 2000
Mark Zuckerberg, Attorney for Debtors.
Randy Eyster, Attorney for Homecomings Financial.
ORDER AVOIDING LIEN OF HOMECOMINGS FINANCIAL AND OVERRULING HOMECOMINGS' OBJECTION TO PLAN
Background
The Debtors live at 3215 South Leonard Road, New Palestine, Indiana 46163. (the "Residence"). Prior to May 17, 2000, "Empire" held a second mortgage on the Residence in the approximate amount of $54,000. On or about May 17, 2000, the Debtors refinanced the Empire second mortgage by borrowing $75,000 (the "Refinance Loan") from Homecomings Financial ("Homecomings") from which the Empire second mortgage was paid in full and released, and approximately $13,000 of the Debtors' existing credit card debt was paid. The approximate remaining $7000 was paid to Homecomings as closing costs. Homecomings was granted a second mortgage in the Residence (the "Second Mortgage") to secure payment of the Refinance Loan.
The Debtors filed both their voluntary chapter 13 case and their Chapter 13 Plan (the "Plan") on November 30, 2000. The Plan treats the Second Mortgage as entirely unsecured based on the Debtors' assertion that the fair market value of the Residence does not exceed the balance due to the holder of the first mortgage (the "First Mortgage"), Mortgage Lenders Network. The Debtors have also moved to write down the Second Mortgage to a value of zero under § 506(a) and avoid it under § 506(d) (the "Lien Avoidance Motion"). The common thread running through both the Plan and the Lien Avoidance Motion is whether the operation of § 506(a) of the Bankruptcy Code allows the write down of the Second Mortgage in its entirety under the circumstances here. Homecomings has objected to both the confirmation of the Plan and to the Lien Avoidance Motion.
The Chapter 13 Trustee has also objected to the Plan, in part, on the basis that it is not feasible in the event the Second Mortgage is not avoided and treated as a general unsecured claim.
Hearing on the objections to both the confirmation of the Plan and the Lien Avoidance Motion was held on April 3, 2001 wherein the Debtors appeared in person and by their counsel, Mark Zuckerberg; Homecomings appeared by counsel, Randy Eyster. The Court took ruling of the matter under advisement at the conclusion of the hearing.
Since this is a contested matter under Federal Rule of Bankruptcy Procedure (Fed.R.Bankr.P.) 9014, Fed.R.Bankr.P. 7052 applies. This entry shall constitute the Court's findings and conclusions under Fed.R.Bankr.P. 7052.
Based on the evidence presented, there is no dispute that: (1) the fair market value of the Residence is no greater than $129,000; (2) Homecomings' Second Mortgage is valid, and second in priority to the First Mortgage held by Mortgage Lenders Network; (3) Homecoming took no other security to secure payment of the Refinance Loan other than the Second Mortgage; and (4) the balance of the First Mortgage is $142,000.
Creditors had up to April 18, 2001 in which to file proofs of claims. Mortgage Lenders Network filed a claim in the amount of $140,458.22 on December 22, 2000. Even if subsequent post petition mortgage payments are applied to that outstanding balance, it remains clear that Mortgage Lenders Network is still owed m ore on the Residence than what the Residence is worth, and therefore, Mortgage Lenders Network itself has an undersecured claim.
Discussion Treatment of Secured Claims Under § 1322(b)(2) and § 1325(a)(5)
A chapter 13 plan may "modify" the rights of holders of secured claims under § 1322(b)(2), but if the plan is to be confirmed, it must at a minimum provide that the holder of a secured claim retains the lien securing the claim and that the value, as of the effective date of the plan, of property to be distributed under the plan on account of such claim is not less than the allowed amount of such claim under § 1325(a)(5)(B)(ii). To determine what the allowed amount of such claim is, and therefore what a plan must provide with respect to treatment of that secured claim in order to be confirmed, one must consult § 506(a). Under § 506(a), "a claim is secured only to the extent of the value of the property on which the lien is fixed; the remainder of that claim is considered unsecured". U.S. v. Ron Pair Enterprises, Inc., 489 U.S. 235, 238-39; 109 S.Ct. 1026, 103 L.Ed.2d 290 (1989). See, In re Dinsmore, 141 B.R. 499, 508 (Bankr. W.D. Mich., 1992). (§ 1325(a)(5)(b)(ii)'s "allowed amount of such claim" language has been interpreted as meaning the value of the creditor's claim determined by Section 506(a)). Thus, the combination of § 1322(b)(2) (which allows a debtor to "modify the rights of holders of secured claims") and § 1325(a)(5)(b)(ii) (which allows a debtor to use § 506(a) to bifurcate a claim into secured and unsecured portions) enables a chapter 13 debtor to propose a confirmable plan which repays only the secured portion (i.e. portion supported by value) of the claim. This practice, referred in bankruptcy parlance as "cramdown", see, In re Bartee, 212 F.3d 277, 280, fn 2, (5th Cir. 2000) is the "essence" of § 1325(a)(5)'s treatment of holders of secured claims, and indeed, chapter 13 in general. ("The very essence of a Section 1325(a)(5) modification is the write down or "cramdown" of a secured claim to the value of the collateral securing the debt"), In re Young, 199 B.R. 643, 647 (Bankr.E.D.Tenn., 1996).
The § 1322(b)(2) Exception
Within § 1322(b)(2)'s general rule that a chapter 13 plan may "modify the rights of holders of secured claims" is an exception (known as the "antimodification clause") which provides ". . . the 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 . . ." (italics added). How this antimodification clause dovetails with § 506(a) (which does allow modification of a secured claim by bifurcation), was the subject of at least four circuit court opinions, all of which were handed down before Nobelman and all of which concluded that a chapter 13 debtor could use § 506(a) to ascertain what portion of the mortgage was supported by collateral value, and then could bifurcate the mortgage into secured and unsecured portions, of which only the secured portion would be protected from modification by § 1322(b)(2). In re Bartee, 212 F.3d 277, 285, (5th Cir. 2000) and fn 10 therein. The import of these decisions, then, was that a chapter 13 debtor could still "cramdown" an undersecured mortgage, even if it was secured only by the residence.
For purposes of this entry, an "undersecured" claim is one that is supported by collateral valued at less than the amount of the claim and the attempt to write it down to its fair market value under § 506(a) is referred to as a "strip down" of the claim. A "wholly unsecured" claim is one for which the supporting collateral holds no remaining value and the attempt to write it down to its zero value under § 506(a) is referred to a "strip off" of the claim. See, In re Bartee, 212 F.3d 277, 280 (5th Cir. 2000) fn2 and 3.
The Nobelman Decision
Nobelman changed all that. In Nobelman v. American Savings Bank, 508 U.S. 324, 113 S.Ct. 2106, 124 L.Ed.2d 228 (1993), the debtors, in their chapter 13 plan, proposed to bifurcate the secured creditor's total claim of $71,335 into a secured claim of $23,500 (the undisputed fair market value of the residence), with the balance to be treated as an unsecured claim under the plan. Holders of unsecured claims were to receive nothing under the plan. The secured creditor objected, arguing that the bifurcation of its mortgage into secured and unsecured portions, with payment of only the secured portion violated the antimodification clause under § 1322(b)(2). The United States Supreme Court held that, under Section 1322(b)(2)'s antimodification clause, claims secured only by real property that is the debtor's principal residence can be modified only to the extent allowed by Section 1322(b)(5), but cannot be modified to the extent of a Section 506(a) "cramdown". Thus, the full outstanding balance of the mortgage — and not just the secured portion which is supported by value after a § 506(a) analysis — was subject to the antimodification clause and the allowed secured claim to be paid to the secured creditor under the chapter 13 plan could not be written down to its fair market value, but was the full amount of the mortgage debt.
Section 1322(b)(5) provides that, notwithstanding Section 1322(b)(2), a plan may provide for the curing of any default within a reasonable time and maintenance of payments while the case is pending on any unsecured claim or secured claim on which the last payment is due after the date on which the final payment under the plan is due.
Central to Justice Thomas's opinion in Nobelman was his discussion of how § 1322(b)(2)'s language focuses on the "rights" of holders of secured claims. Because "rights" was not defined in the Bankruptcy Code, Justice Thomas concluded that Congress left the determination of property "rights" that were unmodifiable under § 1322(b)(2) to state law. Those "rights" could be gleaned from the mortgage documents, and included the secured creditor's right to repayment of the principal in monthly installments over a fixed term at a specified interest rates, the right to retain the lien in the property until the debt is paid off, the right to accelerate the loan upon default and to proceed against the residence by foreclosure, and the right to recover the deficiency after foreclosure. Nobelman, 113 S.Ct. at 2110. Certainly, some of these "rights" — such as the ability to proceed with foreclosure, and to accelerate the amount of the loan upon default — were tempered by an intervening bankruptcy which stays actions against the debtor (§ 362) and allows a chapter 13 debtor to cure prepetition defaults by paying off the arrears over the life of the plan (§ 1322(b)(5)). However, other rights for which the secured creditors bargained when it initially made the loan were to remain intact and hence were unmodifiable under § 1322(b)(2), and among such rights were secured creditor's rights as to "interest rates, payment amounts and [other] contract terms". 113 S.Ct. at 2111.
With respect to these "rights", Justice Thomas focused on the literal language of § 1322(b)(2) which reads "the 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". Because the passage "other than a claim secured only by a security interest in . . . the debtor's principal residence" does not read "other than a secured claim secured only by a security interest in . . . the debtor's principle residence", Justice Thomas took the absence of the word "secured" before "claim" as a deliberate intent by Congress to mean that "claim" in this context was to be given its broad, generic meaning, i.e. both a secured and unsecured portions of a mortgage. And, since the secured and unsecured portions of the mortgage arise out of the same loan documents that defined the secured creditor's "rights", a modification of rights of the unsecured portion likewise modified the rights of the secured portion. See, In re Bartee, 212 F.3d 277, 286 (5th Cir. 2000). Certainly, then, a "cramdown" of the full amount of the mortgage into secured and unsecured portions, with the secured creditor receiving full payments only on the secured portion and nothing with respect to the unsecured portion, violated that secured creditor's "rights" which were protected by § 1322(b)(2).
Although it may have appeared from this result that a preliminary § 506(a) analysis was no longer proper, Nobelman itself suggests otherwise. Nobelman did not disregard the use of § 506(a) in determining whether the "claim" was the type protected by the antimodification clause, but rather, used § 506(a) as a starting point. ("[D]ebtors were correct in looking to § 506(a) for a judicial valuation of the collateral to determine the status of the bank's secured claim") Nobelman, 113 S.Ct. at 2110. In fact, as case law has further developed in the wake of Nobelman, it is this blessing to which Justice Thomas gave a preliminary § 506(a) analysis that is considered pivotal, because his entire analysis of a secured creditor's "rights" is based on the fact that the secured creditor's lien had at least some collateral value to support it. (". . . the Bank is still the holder of a "secured claim", because the [debtors'] home retains $23,500 of value as collateral".) 113 S.Ct. at 2110.
Application of § 1322(b)(2) to Wholly Unsecured Mortgages
What, "rights" of a secured creditor, then, does § 1322(b)(2)'s antimodification provision protect when, unlike Nobelman, the chapter 13 debtors' home retains no value to support the mortgage, as is the case here? According to at least one circuit court and two bankruptcy appellate panels that have considered the question, the answer can be summed up as "none". The Bankruptcy Appellate Panel for the Ninth Circuit Court of Appeals put it this way:
A lien is: "A charge or security or encumbrance upon property." (Black's Law Dictionary, Fourth Edition, 1968). If a lien has no "security" interest in the property of a debtor, its status as a lien is questionable . . . An analysis of the state law "rights" afforded a holder of an unsecured lien, if such a situation exists, indicates these rights are empty rights from a practical, if not a legal, standpoint. A forced sale of the property would not result in any financial return to the lienholder, even if a forced sale could be accomplished where the lien attaches to nothing. Nothing secures the "right" of the lienholder to continue to receive monthly installment payments, to retain the lien until the debt is paid off, or the right to accelerate the loan upon default, if there is no security available to the lienholder to foreclose on in the event the debtor fails to fulfill the contract payment obligations.
In re Lam, 211 B.R. 36, 40 (9th Cir. BAP 1997). Another court put it more bluntly when it described these purported rights as "illusory, hyper-technical, and possibly relevant only in law review articles." In re Mann, 249 B.R. 831, 837 (1St Cir. BAP 2000), quoting, In re Woodhouse, 172 B.R. 1, 2 (Bankr.D.R.I. 1994). These courts have concluded, after considering Nobelman's use of § 506(a) and its statement of retention of value, that where, after application of § 506(a), there is no collateral value to support a mortgage, a § 506(a) write down of said "mortgage" does not modify that creditor's rights, and therefore does not run afoul of § 1322(b)(2) or Nobelman, since there are no § 1322(b)(2) — intended-type "rights" left to protect. Taking these types of "mortgages" out of the protective ambit of § 1322(b)(2), then, allows a chapter 13 debtor to cramdown the "mortgage" to zero and treat the amount of the mortgage as any other unsecured claim under the plan. Having found no circuit court or bankruptcy appellate panel that has ruled to the contrary, this Court adopts the reasoning set forth in those cases and finds that the Second Mortgage here may be avoided in its entirety under § 506(a), that it may be "crammed down" to a value of zero, and that is may be treated as an unsecured claim under the Debtors' chapter 13 plan.
So far, it appears that all of the Circuit Courts and Bankruptcy Appellate Panels that have considered whether § 1322(b)(2)'s antimodification provision protects wholly unsecured mortgages have held that it does not: see, (in chronological order) In re Lam, 211 B.R. 36 (9th Cir. BAP 1997); In re McDonald, 205 F.3d 606 (3rd Cir. 2000); In re Bartee, 212 F.3d 277 (5th Cir. 2000) In re Mann, 249 B.R. 831 (1st Cir. BAP 2000); and In re Tanner, 217 F.3d 1357 (11th Cir. 2000).
This holding is in agreement with a prior decision from this district, In re Goda, Case No. 99-80983-FJO-13 (January 10, 2000) (Otte, J.)
The Growing Minority and the Class of Claims that § 1322(b)(2) was Intended to Protect
The fact that the Circuit Courts and Bankruptcy Appellate Panels that have considered the issue have agreed and ruled in favor of chapter 13 debtors should not give those debtors with wholly unsecured mortgages a false sense of security: there remains a split of authority on this issue, with a growing minority applying § 1322(b)(2)'s antimodification provisions to wholly unsecured mortgages. Even cases from courts within the Seventh Circuit are divided on the issue. See, In re Barnes, 207 B.R. 588 (Bankr.N.D.Ill. 1997) (where § 1322(b)(2)'s antimodification provision was applied to a wholly unsecured mortgage and "strip off" was not permitted); and In re Reeves, 221 B.R. 756 (Bankr.C.D.Ill. 1998) (where, under § 1322(c)(2), the antimodification provision was held not to apply to a short term mortgage, and therefore, "strip down" of the claim was permitted). Those courts adhering to the minority (but ever growing) view point are lead by Judge Keith Lundin who has concluded that "even a completely unsecured claim holder "secured" only by a lien on real property that is the debtor's principal residence would be protected from modification by § 1322(b)(2), notwithstanding that such an "unsecured" lienholder could not have an allowable secured claim under § 506(a) . . . the trigger for Justice Thomas's protection of rights analysis is the existence of a lien, not the presence of value to support the lien." Lundin, Keith M., Chapter 13 Bankruptcy, § 4.46, at 4-56 (2d ed. 1994). Given the fact that scholars on both sides of this issue can find language in Nobelman to support their positions, the Court must look to something else to justify its adherence to the majority view.
For courts that have held, as this Court does today, that § 1322(b)(2)'s antimodification provisions do not apply to wholly unsecured mortgages, see, In re Mann, 249 B.R. 831 (1st CIr. BAP 2000), footnote 8; In re McDonald, 205 F.3d 610 (3rd Cir. 2000), footnote 2; and In re Bartee, 212 F.3d 277 (5th Cir. 2000), footnote 15.
Courts that have held that § 1322(b)(2)'s antimodification provisions do apply to wholly unsecured mortgages are set forth in In re Mann, 249 B.R. 831 (1st CIr. BAP 2000), footnote 9; In re McDonald, 205 F.3d 610 (3rd Cir. 2000), footnote 3; and In re Bartee, 212 F.3d 277 (5th Cir. 2000), footnote 16.
A common theme running through those cases adhering to the majority view focuses upon the public policy behind the enactment of § 1322(b)(2). The legislative history suggests that Congress intended to distinguish between secured and unsecured claims, not secured and unsecured creditors. Hence, this emphasis on claims "supports the position that the lienholder must be a holder of a secured claim, rather than merely a holder of a security interest, to be protected from modification under § 1322(b)(2). Lam, 211 B.R. at 41. See also, In re Hornes, 160 B.R. 709, 718 (Bankr.D.Conn. 1993) ("the code does not generally classify creditors based on the existence of a piece of paper purporting to give a creditor rights in specified collateral, but rather on whether a creditor actually holds a claim supported by valuable estate property"). Justice Stevens's concurrence in Nobelman recognized Congress' "favorable treatment of residential mortgagees [in order] to encourage the flow of capital into the home lending market", Nobelman, 113 S.Ct. at 2112, and to that end, § 1322(b)(2) was enacted to increase lending for home purchases by providing home mortgage lenders greater protection under the Bankruptcy Code. Bartee, 212 F.3d at 292. The scenarios in which courts are asked to apply § 1322(b)(2) to wholly unsecured mortgages are typically cases where the junior lienholders have taken secondary mortgages in undersecured property. Because the secondary mortgage market's focus is lending money for personal spending and not lending money to purchase a home, it follows that extending the protective umbrella of § 1322(b)(2) to them would not have the effect of promoting home building and buying. Bartee, 212 F.3d at 293. Such mortgages do not fall within the narrow class of mortgages in which § 1322(b)(2)'s antimodification provisions were enacted to protect, and this Court declines the invitation to bring them under such protection.
". . . second mortgages are based on very little on the value of the home and more on the leverage provided by having a mortgage on a debtor's homestead." Bartee, 212 F.3d at 294 (discussing second mortgages in the context of § 1322(c)(2)).
A wholly unsecured mortgage is essentially a general unsecured claim, and extending § 1322(b)(2) protection to it and treating it as if it were fully secured could invite other challenges, i.e. that the plan unfairly discriminates against an unsecured class of creditors under § 1322(b)(1). See, In re Mann, 249 B.R. at 838.
Under this Court's (and the majority view's) application of § 1322(b)(2) and § 506(a) to wholly unsecured mortgages, it is possible that, if the property retains a value of even $1 for the second mortgage, it is eligible for protection under § 1322(b)(2) and treated as fully secured, while a property that retains a value of $1 less than the full amount of the first mortgage is voided in its entirety. Critics of the majority view argue that to have a creditor's status as fully secured or fully unsecured hinge on a $1 difference in valuation invites manipulation of the valuation process and is an unjustified adherence to an unfair "bright line rule" that promotes an "all or nothing" approach. However, such an approach is not skewed in favor of any particular party; a result that allows a second mortgage holder with only $1 of value to support its second mortgage to be treated as fully secured is no more "fair" to a chapter 13 debtor than allowing the avoidance of a second mortgage that just misses the mark by $1. As for adherence to a bright line rule:
Bright line rules that use a seemingly arbitrary cut-off point are common in the law. A day beyond the statute of limitations and the plaintiff must lose, even if the claim was unquestionably a winning one. If the evidence is just over a preponderance, the plaintiff wins full damages; just under, the plaintiff gets nothing. In bankruptcy law, the Chapter 7 trustee cannot contest the validity of a debtor's claimed exemption when the 30-day period for objecting has expired and the trustee failed to obtain an extension; and this is true even if the debtor has no colorable basis for claiming the exemption . . . What these examples show is that line drawing is often required in the law and, at the boundary, the appearance of unfairness is unavoidable.
McDonald, 205 F.3d at 613 (citations omitted). Another concern of critics is that a clever chapter 13 debtor through pre-bankruptcy planning could manipulate the bankruptcy process by eliminating "the collateral of a junior mortgagee by synchronizing the date of bankruptcy filing with defaults on debt to a senior mortgagee." See, In re Neverla, 194 B.R. 547, 551-52 (Bankr.W.D.N.Y. 1996). The fact that a potential chapter 13 debtor may have some ability to "manipulate" the process to garner a self-serving result doesn't dictate a different result than that which is reached today; chapter 13 debtors still need to make an affirmative showing that they proposed their plan in good faith under § 1325(a)(3) to get it confirmed. This Court is comfortable that its decision today is in keeping with the public policy behind the enactment of § 1322(b)(2) and that it reconciles the operation of § 1322(b)(2), § 506(a) and the holding of Nobelman to situations where a mortgage is wholly unsecured.
It is still the law within the Seventh Circuit that the "totality of circumstances" test is used to determine whether a debtor has proposed a chapter 13 plan in good faith under § 1325(a)(3). Among the factors considered in the "totality of the circumstances" is the debtor's pre-filing conduct, see, In re Smith, 848 F.2d 813 (7th Cir. 1988). So, to the extent the pre-filing debtor becomes too clever in thinking up ways to manipulate the timing of events so as to entirely avoid a second mortgage, she may have more than just a § 1322(b)(2) challenge to overcome.
Eubanks and this Court's Bright Decision Do Not Apply to the Facts Here
While Congress carved out an exception under § 1322(b)(2) by protecting certain types of claims from "cramdown" in a chapter 13, it likewise carved out an "exception to an exception" when it enacted § 1322(c)(2). This Court has sided with the majority view and has interpreted this section to specifically eliminate protection from cramdown for mortgages secured only by real property that is the debtor's principal residence if the last payment under the original payment schedule is due before the final payment under the chapter 13 plan is due (i.e. "short term mortgages"). See, In re Eubanks, 219 B.R. 468 (6th Cir. BAP 1998); In re Bright, Case No. 98-13781-AJM-13 (May 6, 1999). Homecomings is correct that the Second Mortgage does not fall within this provision. However, it does not follow that even though its Second Mortgage does not fall under § 1322(c)(2), it cannot be avoided. Homecomings urges the Court to "look at the equities". It has, and has concluded, for the foregoing reasons, that § 1322(b)(2)'s antimodification provisions do not apply to the Second Mortgage here.
Accordingly it is ORDERED that: the Debtors' Lien Avoidance Motion is GRANTED; the Second Mortgage is valued at zero under § 506(a) and avoided under § 506(d); and Homecomings' objection to confirmation of the Debtors' Plan is DENIED. To the extent the Trustee has objected to the Plan on the same grounds, that objection, too is DENIED. The Court will set for hearing the Trustee's remaining objections to the Plan.