Partridge Snow & Hahn LLP
First Circuit K.O.'s Lenders in Chapter 3 Mortgage Modifications
Did Congress Intend to Encourage Banks to Lend Only to Single-Family Home Buyers?
To a greater degree than in most areas of the country, real property values in Massachusetts and Rhode Island are still far below their peaks of the 1980's. The volume of foreclosure sales remains high, and depreciation is a major stumbling block for creditors trying to recoup their investments. Fortunately for creditors, Section 1322(b)(2) of the Bankruptcy Code (the "Code") allows a foreclosing mortgagee to prohibit a Chapter 13 debtor from modifying a mortgage on a principal residence. However, a recent First Circuit case may take some of the punch out of that weapon, as well. Unfortunately, the First Circuit in Lomas Mortgage, Inc. v. Louis, 82 F.3d 1 (1st Cir. 1996) has now made law which can be referred to nationwide, based on regional factors more peculiar to the Northeast, where there is an especially high percentage of multi-family housing stock.
While Section 506(a) of the Code allows a debtor to limit a creditor's secured claim to the value of the underlying collateral, Section 1322(b)(2) prohibits a debtor from doing so where the creditor's claim is secured only by a lien on the debtor's principal residence. Nobleman v. American Sav. Bank, 508 U.S. 324, 332 (1993) (emphasis supplied). Such a mortgage modification (also called a "bifurcation" or a "strip-down") would limit the bank's secured interest to the property's actual value (often, much lower than the total debt), and leave the balance as an unsecured claim, paid at cents on the dollar. Thus, the policy behind Section 1322(b)(2) is to ensure creditors that they will be able to enforce their secured interests, where their mortgage encumbers a debtor's principal residence.
Until recently, Massachusetts and Rhode Island Bankruptcy Courts differed in their application of the Code and Nobleman to the issue of what constitutes a "principal residence." In Massachusetts, bifurcation of secured claims had been liberally granted. Even though the real property was clearly the debtor's principal residence, other uses to which the property was put were generally not a bar to modification. See, e.g., In re McGregor, 172 B.R. 718, 719 (Bankr. D. Mass. 1994) (debtor, residing in one unit of a four-unit apartment building, was permitted to modify the mortgage); In re Brown, 175 B.R. 129, 131 (Bankr. D. Mass. 1994) (modification permitted where debtor resided in one unit of a two-unit complex).
Meanwhile, Judge Votolato made clear that in Rhode Island, even though property was used as more than a principal residence, the secured claim could still not be bifurcated. In re Guilbert, 165 B.R. 88 (Bankr. D.R.I. 1994). In Guilbert, the debtor resided in one unit of a three-unit complex, the second occupied by a relative and the third occasionally rented. The Court stated that Section 1322(b) does not "say, or in any way imply, that if the debtor's principal residence is also used to house other tenants, paying or otherwise, that it may be open to modification by the home owner." Id. at 89. Thus, although the property was more than a principal residence, the mortgagee's objection to the modification was upheld, and the secured claim could not be bifurcated.
Earlier this year, the First Circuit Court of Appeals was squarely presented with the question of whether the term "principal residence" applies to cases in which a mortgage covers both the debtor's principal residence and other property, such as rental units. The Court in Lomas began its analysis by considering case law which had held modification permissible on notes secured by both personal and real property. In re Hammond, 27 F.3d 52 (3d Cir. 1994). Then, turning to the legislative history of Section 1322(b)(2), the Court noted that the bill's language as reported out of the House differed too dramatically from that of the Senate to be instructive on the issue of how property with both residential and investment characteristics should be treated. Lomas at 5. The Court did, however, state that "[i]t is unlikely Congress intended the antimodification provision to reach a 100-unit apartment complex simply because the debtor lives in one of the units." Id. at 6. Finally, the Court found a case to which a Judiciary Committee Report referred, and relied on that case to hold that Section 1322(b)(2) does not apply to a mortgagee's interest in a multi-family house, one unit of which is the debtor's principal residence. Id.(citing In re Ramirez, 62 B.R. 668 (Bankr. S.D. Cal. 1986).) Thus, a debtor residing in a multi-family residence can limit the mortgagee's secured interest to the value of the real property, leaving the balance as an unsecured deficiency.
Clearly, Lomas means Rhode Island (and the remainder of the First Circuit- Maine, New Hampshire and Puerto Rico) must conform its definition of "principal residence" to that used by the First Circuit and Massachusetts. But what does Lomas mean in the long run to mortgagors and mortgagees? Certainly, Section 1322(b)(2) has lost some of its punch- a mortgagee can no longer argue that Chapter 13 Plans dealing with mortgages on certain multi-unit property cannot be modified. Now, the scope of the term "principal residence" is expanded to include multi-unit complexes, if not 100-unit complexes, as long as the debtor is one of the residents (subject, of course, to a Chapter 13 Debtor's secured debt limitation of $750,000.00). However, looking back to the policy behind Section 1322(b)(2), perhaps mortgagees, already suffering from depreciation at the end of the ownership cycle, may take another hit, this time at the start of the ownership cycle: lenders reading the Lomas opinion may cringe at the thought of losing their security interests to Chapter 13 Plan modifications, and balk at new lending to owners of multi-family real property.
http://64.233.169.104/search?q=cache:JlqSVEnr36wJ:library.findlaw.com/1999/Aug/1/126316.html+multi-family+bankruptcy+modification&hl=en&ct=clnk&cd=6&gl=us&client=firefox-a
