Bankruptcy Judge Christopher J. Panos of Boston joined the majority of courts by holding that a Subchapter V plan may affect a mortgage even when the debtor was not a maker of the mortgage and is not personally liable on the mortgage debt.

When a chapter 11 debtor is only a part owner of property subject to a mortgage, Judge Panos held in his August 12 opinion that the debtor’s plan may not impair the mortgagee’s rights against the nonbankrupt part owner.

The Subchapter V debtor was pursuing confirmation of a plan impairing two parcels of real property that evidently were not the individual debtor’s homestead. The debtor came into ownership after the mortgages were made on the two properties. Different banks held mortgages on the properties.

The two banks objected to confirmation, contending that the plan could not affect their mortgages because the debtor was not a maker of the mortgages and had no personal liability on either of them. On one parcel, the debtor was a part owner. The lender on that parcel objected to features of the plan that would have affected the lender’s rights against the nonbankrupt part owner.

Personal Liability Doesn’t Matter

To decide whether a plan could affect a mortgage on which the debtor has no personal liability, Judge Panos looked principally to Johnson v. Home State Bank, 501 U.S. 78 (1991), and the definitions in Sections 101(5) and 102(2). Section 101(5) defines a “claim” to mean both a “right to payment” and a “right to an equitable remedy for breach of performance if such breach gives rise to a right to payment . . . .”

Sometimes forgotten, Section 102(2) says that “‘claim against the debtor’ includes claim against property of the debtor.”

Judge Panos described Johnson as holding “that a ‘right to payment’ includes a ‘right to the proceeds from the sale of the debtor’s property,’ even where the debtor is not liable on the underlying mortgage.” Johnson, supra, at 84. More specifically, he cited Johnson for saying that the right to foreclose is an equitable remedy flowing from the debtor’s default on the mortgage.

Judge Panos quoted a Virginia bankruptcy court for saying that a majority of courts see Johnson’s broad interpretation of “claim” to permit confirmation of a chapter 13 plan that cures arrears when there was no contractual privity between the debtor and the lender. However, he cited a “minority of courts [that] have ruled that a debtor may not utilize Bankruptcy Code provisions to treat a debt where the debtor is not personally liable on the debt.”

In chapter 11, Judge Panos cited courts that “extended” Johnson by allowing “restructuring of secured claims even where debtors lack privity with the secured creditor.”

Judge Panos overruled the confirmation based on a lack of privity applying the “reasoning” of Johnson, because the lenders have a right to proceed against the debtor’s property in rem.

Affecting Rights of a Nondebtor

On one of the properties where the debtor was neither an owner nor a maker of the mortgage, he later obtained the 50% ownership from one of the two original tenants in common. The debtor’s plan would have created a new mortgage for the 50% that the debtor owned and would have affected some of the lender’s rights against the nonbankrupt part owner.

Judge Panos cited courts that “have denied confirmation of plans that propose to modify the rights of non-debtor co-owners.” Nonetheless, he said there were chapter 13 cases allowing debtors to modify secured liens “so long as the secured creditor’s rights against the non-debtor co-owner are not affected.” He cited the Supreme Court’s Purdue decision for saying that plans may affect creditors’ rights against nondebtors “only in extraordinary circumstances and with consent.”

Leaving aside the question of whether the debtor was proposing the plan in good faith, Judge Panos upheld the objection of the lender whose rights to foreclose the nondebtor would have been affected by the plan.