Economists say a nationwide unemployment rate between 4.5% and 5% is generally consistent with a good job market and solid wage growth.
The December 2011 U.S. unemployment rate was 8.5%; in March 2014, it was 6.6% and Pennsylvania’s rate in March 2014 was 6%.
The October 2009 U.S. unemployment rate was 10.0%--the highest since 1992. So, even though the “Great Recession” is roughly 5 years old now, the economy is still far from healthy and home values remain depressed.
In December 2011, 1 in 1481 housing units in Pennsylvania received a foreclosure filing with a total of 3747 properties.
This compares with 1 in 634 housing units for December of 2011 for the entire U.S.
Approximately one in four homes with mortgages are “underwater.”
• Home Values Plummet
Can a Debtor modify a mortgage that encumbers their principal residence in a Chapter 13 case even though Section 1322(b)(2) of the Bankruptcy Code prohibits modification?
You bet they can!
Third Circuit Case Law
McDonald v. Master Fin., Inc. (In re McDonald), 205 F.3d 606 (3d Cir. 2000)
Chapter 13 debtors in the Third Circuit are allowed to modify the rights of holder of a secured claim on the debtor’s principal residence if the security interest is wholly unsecured.
Second or more junior mortgage lienholder may be treated as an unsecured creditor in a Chapter 13 plan and obligated to satisfy lien at the end of case.
1. Section 1322(b)(2) prohibits modification of the rights of a holder of a secured claim if the security consists of a lien on the debtor's principal residence;
2. Section 1322(b)(2) permits modification of the rights of an unsecured claimholder;
3. Whether a lien claimant is the holder of a "secured claim" or an “unsecured claim" depends on whether the claimant's security interest has any actual "value" under 11 U.S.C. § 506.
4. If a claimant's lien on the debtor's homestead has a positive value, no matter how small in relation to the total claim, the claimant holds a "secured claim" and the claimant's contractual rights under the loan documents are not subject to modification by the Chapter 13 plan;
5. If a claimant's lien on the debtor's homestead has no value at all, on the other hand, the claimant holds an "unsecured claim" and the claimant's contractual rights are subject to modification by the plan.
McDonald v. Master Fin., Inc. (In re McDonald), 205 F.3d 606 (3d Cir. 2000)
Exactly what in the Code provides the authority to do this?
It appears that the only statutory provisions available to a Chapter 13 debtor to avoid wholly unsecured liens on their principal residence are 11 U.S.C. §§ 1322(b)(2), 1325(a)(5) and 1327(c).
Section 1327(c) serves to avoid the lien and 1322(b)(2) and 1325(a)(5) define the permissible scope of such avoidance.
In re Hill 304 B.R. 800, 803-5 (Bankr. S.D. Ohio 2003)
A second, third, etc. mortgage may be determined to be wholly unsecured under Section 506(a) but Section 506(d) cannot be used to void the lien because this provision voids only liens that secure claims which have not been allowed under Section 502.
Thus, one must look to Section 1325 for the scope of any such modification of the lien.
Looking at the plain language of Section 1325(a)(5)(B)(i) it is clear that such claim will be paid pro-rata with the other unsecured creditors but, the mortgagee will still retain the lien securing its claim until the earlier of the payment of the underlying debt determined under non bankruptcy law or discharge under Section 1328.
In addition, if the Chapter 13 case is dismissed or converted without completion of the plan, the lien will also be retained by the creditor to the extent recognized by applicable non-bankruptcy law.
But you can’t do it in a Chapter 7 Case
Fourth and Sixth Circuit Case Law
Ryan v. Homecomings Fin. Network, 253 F.3d 778 (4th Cir. 2001)
Talbert v. City Mortg.Servs. (In re Talbert), 344 F.3d 555 (6th Cir. 2003)
A Chapter 7 Debtor may not use 11 U.S.C. § 506 to “strip off” an allowed junior lien where the senior lien exceeds the fair market value of the real property.
What about if only one spouse files a Chapter 13 case and the property is held as tenancy by the entireties?
What’s entireties property?
In Pennsylvania, tenancy by the entireties is recognized as one type of joint interest in real property. A tenancy by the entireties is created when a conveyance of land is made to a husband and wife. (See generally, In re Hope, 77 B.R. 470, 472-75 (Bankr. E. D. Pa. 1987) (discussing Pennsylvania precedents regarding the nature of this concurrent estate).
When real property is so held by tenants by the entireties, neither spouse acting alone can alienate or encumber to a third person an interest in fee of land so held. Neither the husband nor the wife has an individual, separate interest in entireties property, and neither has an interest in such property which may be conveyed, encumbered or alienated without the consent of the other.
Back to the original question --
Hunter v. Citifinancial, Inc. (In re Hunter), 284 B.R. 806 (Bankr. E.D. Va 2002)
An individual debtor cannot avoid a lien on real property owned by the debtor and his wife as tenants by the entireties with the right of survivorship.
But why? --Even if the lien were voidable as to the debtor's interest, the spouse's interest in the entirety would still be burdened with the lien. Where only one tenant by the entireties sought to sever the estate as to one aspect only, he/she could not do so.
Accordingly, BOTH spouses must file Chapter 13 and participate in the lien stripping adversary proceeding against the lender.
Rodriguez v. Madera County Federal Credit Union (In re Rodriguez), 156 B.R. 659 (Bankr. E.D. Cal. 1993)
A debtor holding only a fractional interest (like a 50% interest) in property cannot utilize section 506 to value a secured claim.
But see: Highland Fed. Bank v. Maynard (In re Maynard), 264 B.R. 209 (Bankr. 9th Cir. 2001) (court held that community property of both spouses became property of the estate even though husband did not file. Thus, stripping of mortgage encumbering community property allowed)
What about if I attempt to avoid the mortgage(s) through a plan modification after confirmation?
The power to modify a wholly unsecured mortgage must be exercised at confirmation, or it’s lost.
See, e.g., In re Cruz, 253 B.R. 6387, 643-44 (Bankr. D.N.J. 2000)
But see, Waters v. Money Story (In re Waters), 276 B.R. 879 (Bankr. N.D. Ill. 2002) (allowed post-confirmation avoidance because value post-confirmation was same as it was pre-confirmation
Well, what method should I employ to strip a mortgage?
To file or not to file - an A.P. that is.
Some believe an A.P. is necessary.
A creditor is entitled to a declaratory action to determine the validity and extent of its lien in order to satisfy due process. Fed. R. Bankr. P. 7001(2) provides in pertinent part, "An adversary proceeding . . . is a proceeding … to determine the validity, priority, or extent of a lien..."; see SLW Capital, LLC v. Mansaray-Ruffin (In re Mansaray-Ruffin), 530, F.3d 230 (3d Cir. 2008)
When a party asks the Bankruptcy Court to determine the extent of a lien or the value of the collateral forming the basis of the lien, adversary proceedings are required as contemplated by Fed. R. Bankr. P. 7001(2) and 3012, see Wright v. Commercial Credit Corporation, 178 B.R. 703 (Bankr. E.D. Va. 1995)
“Due process” usually requires filing an adversary proceeding. SLW Capital, LLC v. Mansaray-Ruffin (In re Mansaray-Ruffin), 530, F.3d 230 (3d Cir. 2008)
An “adversary proceeding” parallels a civil suit governed by the Federal Rules of Civil Procedure; it is a lawsuit unto itself under the umbrella of the debtor’s main bankruptcy case. This is in contrast to motion practice in bankruptcy courts or “contested matters” which are governed by Fed. R. Bankr. P. 9014. The Fourth Circuit held that an adversary proceeding was a necessary “affirmative step” to avoid mortgage or deed of trust liens against the debtors’ real property.
Cen-Pen Corp. v. Hanson (In re Hanson), 58 F. 3d 89, 92-93 (4th Cir. 1995).
Notwithstanding Hanson, the U.S. Bankruptcy Court for the District of Maryland Local Bankruptcy Rule 3012-1 prescribes that strip offs be done by way of motion. (Maryland is in the Fourth Circuit).
What about a motion?
Probably the least liked method. But it’s better than doing the strip off principally through the Chapter 13 plan.
An adversary proceeding is the best method from a “due process” standpoint but is also the most expensive and time-consuming.
• Drafting Adversary Complaint/Plan
A. Language/documents needed in AP.
B. Language needed in incorporate to effectuate AP or “lien strip”.
1. Class Two Language.
2. Proof of Claim Language in Plan.
3. Recordable Form of Plan/Order.
C. When to file AP to avoid mortgage.
• Service of AP
1. Who to Serve.
2. F.R. Civ. P. 4
a. Corporation http://www.dleg.state.mi.us/bcs_corp/sr_corp.asp
i. Registered Agent
3. MERS - http://www.mersinc.org/
A. Application under Rule 55 and what documents are required.
B. Language and terms of the Default Judgment
Service of Process on an insured depository institution (bank)
Service of Summons and Complaint after 10 days of issuance.
Wrong party as the defendant
Okay, now that we’re litigating, who has what burden?
Burden of Proof is on the debtor to demonstrate that there is not even $1.00 of value over prior valid liens to support the mortgage lien to be avoided.
Moving party bears the burden of proof on all avoidance issues
• EXPERT OPINIONS
Can debtor give an opinion of value?
Property owner is competent to give an opinion under Fed.R.Evid 701. See, In re Jester, 344 B.R. 331, 339 (Bankr. E.D. Pa. 2006). However, debtor’s testimony is usually given little weight by the Bankruptcy Court and outcome is determined through a “battle of the experts.”
Expert (Fed.R.Evid 702)
Foundation for qualification of expert:
Licenses and Certifications
Can be used if proper foundation is laid (Note: Appraisal alone is hearsay when no foundation is provided)
Real Estate Agent/Broker
Only if they have extensive experience. See, In re: Schweizer 354 B.R. 272 (Bankr. D. Idaho 2006); Donoway v. Tucker, 139 B.R. 156 (Bankr. D. Md. 1992)
Fair market value as of the petition date.
Methods of valuation:
Sales Comparison Approach: this is where the property being appraised is compared to recent sales of other properties.
Used most often to derive value.
Cost Approach: Cost of constructing an equivalent structure with cost of property
Income Approach: cash flow value - rentals
What will the court do?
The court will take testimony and review the appraisals and then, most likely, use a weighted average based on the evidentiary weight given to each.
If the court finds the home’s value less than the first mortgage, the junior lien will be stripped and treated as an unsecured claim.
Stripping Junior Mortgages
The mortgage lender whose lien is stripped will normally be paid just a few cents on the dollar through the Chapter 13 plan.
The debtor must complete the Chapter 13 plan before the lender is required to satisfy the recorded mortgage; if the case is dismissed or converted to a Chapter 7 case, the mortgage lien will stay intact.
• Consent Judgment
Language for a Consent Judgment
Mortgage is avoided only upon successful completion of the Chapter 13 Plan and the debtor(s) obtaining an order of discharge.
Creditor has an allowed unsecured claim.
In the event of a refinance or sale prior to the completion of the Chapter 13 case and receipt of a Chapter 13 order of discharge, the mortgage is paid in full at closing.
Mortgage is reinstated if case is converted or dismissed.
Mark A. Cronin, Esquire
I am a seasoned bankruptcy attorney who has represented both debtors and creditors for over 23 years. I thoroughly know the lien stripping process which can wipe off a second or third mortgage in a Chapter 13 case. Contact me to learn more about this powerful tool that is available to my clients who avail themselves of it in a Chapter 13 case.