Transcript CHAPTER 13

CHAPTER 13
AVOIDANCE OF MORTGAGES THAT
ENCUMBER A PRINCIPAL RESIDENCE
By: David Wm. Ruskin, C. Jason Cardasis, and John Kapitan
Unemployment





Economists say a nationwide unemployment rate
between 4.5% and 5% is generally consistent
with a good job market and solid wage growth.
The January 2008 U.S. unemployment rate was
4.9%.
In Michigan, it was 7.2%.
The January 2009 U.S. unemployment rate was
7.6%--the highest since 1992.
In Michigan, the February rate was 12%.
Foreclosures
Home Values Plummet
Can a Debtor modify a mortgage that
encumbers their principal residence
in a Chapter 13 case even though
1322(b)(2) prohibits modification?
You bet they can!
Sixth Circuit Case Law
 Lane
v. Western Interstate Bankcorp (In re
Lane), 280 F.3d 663 (6th Cir. 2002)
 Chapter
13 debtors in the Sixth 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.
Basics

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.
Lane v. Western Interstate Bankcorp (In re Lane), 280 F.3d at 670 (6th Cir.
2002).
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)
Cont.

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. In re Hill 304 B.R. at 803.

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

Sixth Circuit Case Law
 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
Michigan, 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,
Morgan v. Cincinnati Ins. Co., 411 Mich. 267,
284; 307 N.W.2d 53, 58 (1981))
Tenancy by the entireties (cont.)

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.
Rogers v. Rogers, 136 Mich. App. 125, 134; 356
N.W.2d 288 (1994)
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.
Note: the rights possessed by a Pennsylvania tenant by the
entireties closely follow those held by a Michigan tenant
Popky v. United States of America, 326 F. Supp. 2d 594 (E.D.
Penn 2004)
Cont.

Rodriguez v. Madera County Federal Credit
Union (In re Rodriguez), 156 B.R. 659 (Bankr
E.D. CA 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 (B.A.P. 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?

Maybe
 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 postconfirmation avoidance because value postconfirmation 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...";

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. Virginia 1995)
Cont.

While some courts believe doing it through the Plan is
fine– as long as you follow certain requirements.

Judge Shapero - In re: Juszkowski, Chapter 13 No. 0753472, *2 (December 18, 2007) (Chapter 13 debtor, may, as
part of a plan, modify the rights of a secured creditor.
However, all necessary due process requirements, including
notice, potential discovery, etc. available in a contested
matter context, and, as such, satisfy the legal, practical, and
other needs of the situation.)

Notice – Rule 7004 provides guidance as to how service should
be made on parties.
Method to avoid (cont.)
 What
about a motion?
 Probably
the least liked method.
 DISCUSSION
METHODS.
ON EASTERN DISTRICT PREFERRED

Practice Pointer!
 When applying for a default judgment, it is good practice to
include, not only proof of service of the summons and
complaint, but also statement(s) of the amounts owed to each
mortgage lender, and something that will verify the value of
the property. If you don’t, you may wind up getting the
application scheduled for hearing, and/or worse, having it
denied.
DRAFTING ADVERSARY
COMPLAINT/PLAN

A. Language/documents needed in AP.

B. Language needed in Plant to effectuate
AP or “lien strip”.
 1.
 2.
 3.

Class Two Language.
Proof of Claim Language in Plan.
Recordable Form of Plan/Order.
C. When to file AP to avoid mortgage.

Service of AP
 1.
Who to Serve.
F.R. Civ. P. 4
 2.
 a.
b.
 3.
Corporation http://www.dleg.state.mi.us/bcs_corp/sr_corp.asp
i.
Registered Agent
ii.
Officer
Bank
MERS -
http://www.mersinc.org/

Uncontested AP
 A.
Application under Rule 55 and what
documents are required.
 B.
Language and terms of the Default
Judgment
Things to watch for

Make sure you are as specific as possible
as to which mortgage you are attempting
to avoid (legal description, liber, page,
date and amount of mortgage, etc.)
 You
don’t want to get an objection or
response simply because the complaint
attempts to avoid all of the lender’s
mortgages even the first (example:
“Mortgagee has no liens on the property”
when they have a first and second)
Cont.

Service of Process on an insured
depository institution (bank)
 F.R.Civ.P.
4(h)
Service of Summons and Complaint after
10 days of issuance.
 Wrong party as the defendant

 Mortgagee
Burdens

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
Cont.
 In
In re Dziendziel, 295 B.R. 184 (Bankr. W.D.N.Y.
2003) the court described the debtor’s burden as:
 Naturally higher when:
 1) it appears there was equity to support it
at the time the mortgage was executed;
 2) the deficiency is not substantial; and
3) the lack of value may have been created, in part,
because of a debtor’s failure to make payments on superior
mortgages, or other obligations (taxes), or for some other
reason ………………………………………
EXPERT OPINIONS

Can I use my client’s opinion?
 Yes.
 Property
owner is competent to give an
opinion under Fed.R.Evid 701. See, In re
Jamison, 93 B.R. 595 (Bankr. S.D. Ohio 1988)
Experts (cont.)

Expert (Fed.R.Evid 702)

Foundation for qualification of expert




Appraiser


Experience
Education
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)
Experts (cont.)
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
 Cost
most often to derive value.
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.
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.
What happens if the Chapter 13 Case
is Converted or Dismissed?
QUESTIONS?