Stripoff of Completely Secured Mortgage Covering Debtors Principal Residence

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Sep 1997

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Section 1322(b)(2) of the Bankruptcy Code provides
that a chapter 13 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...." 11 U.S.C.
§1322(b)(2). Prior to the U.S. Supreme Court's 1993 decision in

Nobelman v. American Savings Bank, 508 U.S. 324, 113 S.Ct. 2106,
124 L.Ed.2d 228 (1993), the courts held that §1322(b)(2) prohibited
modification of a partially unsecured homestead mortgage only to the
extent of the current market value of the homestead residence, referred
to as a "secured claim." The balance of the mortgage debt (the amount by
which the mortgage debt exceeded the value of the homestead residence)
was treated as an "unsecured claim," which thus reduced ("stripped
down") the mortgage lien and was subject to modification by the plan.
However, this view was rejected by the Supreme Court in
Nobelman, supra, decided June 1, 1993.In that case, the
debtors' homestead residence had a market value of $23,500, though the
outstanding mortgage debt was $71,335. The debtors' chapter 13 plan
proposed to make payments to the mortgage only up to the $23,500 and
further proposed to treat the remainder of the mortgage debt as
unsecured, with unsecured creditors receiving nothing. The court ruled
that §1322(b)(2) prohibited the debtors' plan from providing that
the unsecured portion of the claim could be treated the same as other
unsecured claims, because a plan providing that the claim would not be
paid in full would modify the rights of the holder of the claim, to wit,
the right to be paid for the full term of the note.<a name="RET1"></a><a href="#FN1">[1]</a> Nobelman
involved a partially unsecured homestead mortgage. The
question arises as to what treatment should be given a completely

unsecured homestead mortgage. Since the decision in
Nobelman, a split in authority has developed from the many
bankruptcy courts that have been confronted with this question. Several
courts have ruled that a creditor who holds a mortgage on homestead
property that has no value (such as where the property was fully
encumbered by prior mortgages) is not entitled to protection by
§1322(b)(2), and the entire mortgage lien may be "stripped off" and
the mortgage debt modified pursuant to a chapter 13 plan.<a name="RET2"></a><a href="#FN2">[2]</a> The
holdings of the courts in most of these cases are based on dicta <a name="RET3"></a><a href="#FN3">[3]</a> in the
Nobelman opinion which (in the view of those courts) implies that
if the creditor's collateral in the debtor's residence is wholly
unsecured, then a complete stripoff of the mortgage is permissible.On
the other hand, a few of the decisions take the view that a creditor
holding a completely unsecured homestead mortgage is entitled to the
same protection under §1322(b)(2) as one who holds a partially
unsecured mortgage, as in Nobelman.<a name="RET4"></a><a href="#FN4">[4]</a> Their reasoning is that
the reliance by some courts on the dicta from Nobelman (see
footnote 2) is "…out of context with the rest of the

Nobelman decision"; and "that the proper reading of that opinion
was an endorsement of creditor rights, where ‘rights' were defined
by state law and the underlying mortgage contact." In re Barnes,
1997 WL 189500, page 4 (Bankr. N.D. Ill., March 5, 1997). Reliance
on the "still the holder" dicta in Nobelman yields an absurd
result. If §1322(b)(2)'s protection against modification were
limited solely to security interests with underlying collateral, junior
mortgagees with a single penny of equity in collateral in the debtor's
principal residence would still retain complete protection from a
stripdown while junior mortgagees who lacked that penny of equity would
find their entire claim stripped off. Nobelman did not foster
this absurd result because that decision did not delineate that any
level of equity protecting the secured creditors is required for
§1322(b)(2) protection. Instead, Nobelman flatly held that
"[s]ection 1322(b)(2) prohibits [a §506(a)]
modification where, as here, the lender's claim is secured only by a
lien on the debtor's principal residence. Id. at 4.The only
appellate court to decide the issue agreed with the first approach and
concluded that the Nobelman decision, holding that
§1322(b)(2) bars a chapter 13 plan from modifying the rights of
holders of claims secured by the debtor's principal residence, does not
apply to holders of totally unsecured claims. In In re Lam, BAP
No. NC-96-1773 –hryo (9th Cir. BAP Cal. July 3, 1997), the
bankruptcy appellate panel referred to Justice Steven's concurring
opinion in Nobelman which noted, that protecting "holders of
secured claims" is consistent with the congressional intent of
encouraging home lending by residential mortgagees. The Lam court
went on to cite the In re Plouffe, 157 B.R. 198 (Bankr. D. Conn.
1993) court's interpretation of Justice Steven's opinion, which held
that it only referred to first mortgagees. In the Plouffe case,
the court found that "there are no such concerns when dealing with the
second mortgage market. The bankruptcy appellate panel went on to say
that it agreed with In re Plouffe's interpretation of

Nobelman in the factual context before it.As other cases are
decided by circuit courts of appeals and bankruptcy appellate panels,
furthering the split of authority, the ultimate resolution may once
again require a ruling by the Supreme Court, unless, of course, the
National Bankruptcy Review Commission and/or Congress beats "the
Supremes" to a resolution.<h4>NBRC Proposal</h4>In June, the
Commission adopted the following proposal as part of its "Consumer
Bankruptcy Framework":<blockquote>A chapter 13 plan could not modify
obligations on first mortgages and refinanced first mortgages, except to
the extent currently permitted by the Bankruptcy Code. Payments on all
other secured debts should be subject to modification; such payments
should be spread over the life of the plan, according to fixed criteria
for valuation and interest rates.</blockquote> As the Commission's
analysis explained: "...subsequent mortgages should be treated like all
other secured debts, thus the secured claim would be calculated under
§506. This means that second mortgages would be protected in full
when they do not exceed the value of the home. If the loan secured by
the second mortgage exceeded the value of the home, debts secured by
second mortgages could be bifurcated into secured and unsecured
portions."At the Commission's August meeting, the proposal was
modified with respect to junior liens as follows:<blockquote>A chapter
13 plan could not modify obligations on first mortgages and refinanced
first mortgages, except to the extent currently permitted by the
Bankruptcy Code. Section 1322(b)(2) should be amended to provide that
the rights of a holder of a claim secured only by a junior security
interest in real property that is the debtor's principal residence may
not be modified to reduce the secured claim to less than the appraised
value of the property at th time the security interest was
made.</blockquote>As the Commission's analysis described
it:<blockquote>This modest change to current law would continue the
policy that mortgage liens generally are fully protected notwithstanding
§506 of the Bankruptcy Code, but would permit modification to a
limited extent for certain loans that were made on a partly secured
basis.</blockquote>Under this recommendation, the rights of a bank or
other lender holding a mortgage that was fully secured when the loan was
granted could not be modified. Yet, if junior interests were
partially unsecured when the secondary mortgage was made, the lender
would be treated as a fully secured creditor only to the extent it was
secured when it made the loan. However, even these lenders would get
special protection as compared to other creditors: the secured claims
of undersecured mortgage lenders would not be reduced below the value of
the property when the loan was made, even if the value of the property
has since declined.Permitting this modification of junior mortgages
taken on a partly unsecured basis comports with the continuing effort to
treat like creditors alike. Enabling certain unsecured mortgagees to
remain entitled to payment in full on account of a partly unsecured lien
diverts assets from other creditors and prefers some creditors over
others. This recommendation also is consistent with underlying federal
policies promoting home ownership. Mortgage loans can put home ownership
at risk as the loan-to-value ration continues to climb, and particularly
when the loans exceed the value of the property. To the extent that
creditors who lend far in excess of a home's value can demand full
repayment or can force a foreclosure, some homeowners will lose their
homes, and debtors with second and third mortgages that exceed the value
of the homes are less likely to confirm a chapter 13 plan, thereby
yielding no payments to any creditors.<hr> <h3>Footnotes</h3><a name="FN1"> [1] The court enumerated various
of the mortgagee's rights under state law which are protected from
modification by §1322(b)(2) as follows: "They include the right to
repayment of the principal in monthly installments over a fixed term at
specified adjustable rates of interest, the right to retain the lien
until the debt is paid off, the right to accelerate the loan upon
default and to proceed against petitioners' (debtors') residence by
foreclosure and public sale, and the right to bring an action to recover
any deficiency remaining after foreclosure." 113 S.Ct. at 2110.</a><a href="#RET1">[RETURN TO TEXT]</a> <a name="FN2">

[2]SeeIn re Sanders, 202 B.R.
986 (Bankr. D.Neb. 1996); In re Geyer, 203 B.R. 726 (Bankr.
S.D.Cal. 1996); Associates Fin. Servs. Corp. v. Purdue, 187
B.R.188 (S.D. Ohio 1995); In re Sette, 164 B.R. 453 (Bankr.
E.D.N.Y. 1994); In re Woodhouse, 172 B.R. 1 (Bankr. D.R.I. 1994);
In re Hornes, 160 B.R. 709 (Bankr. D.Conn. 1993); In re
Lee, 161 B.R. 271 (Bankr. W.D.Okla. 1993); In re Moncrief,
163 B.R. 492 (Bankr. E.D.Ky. 1993); In re Plouffe, 157 B.R. 198
(Bankr. D.Conn 1993); Wright v. Commercial Credit Corp., 178 B.R.
703 (E.D. Va. 1995); In re Libby, 200 B.R. 562 (Bankr. D.N.J.
1996); In re Lee, 177 B.R. 715 (Bankr. N.D.Ala. 1995); Norwest
Fin. Georgia Inc. v. Thomas, 177; B.R. 750 (Bankr. S.D.Ga. 1995);

Castellanos v. PNC Bank, 178 B.R. 393 (Bankr. M.D.Pa. 1994);
In re Mitchell, 177 B.R. 900 (Bankr. E.D.Mo. 1994); In re
Brown, 1993 WL 544385 (Bankr. E.D.N.C. 1993); In re Kidd, 161
B.R. 769 (Bankr. E.D.N.C. 1993); In re Williams, 161 B.R. 27
(Bankr. E.D.Ky. 1993).</a><a href="#RET2">[RETURN TO
TEXT]</a> <a name="FN3"> [3] In
this respect, the opinion states: "…even if we accept petitioners'
(debtors') valuation, the bank is still the ‘holder' of a
‘secured claim,' because petitioners' home retains $23,500 of value
as collateral." 113 S.Ct. at 2110.</a><a href="#RET3">[RETURN TO
TEXT]</a> <a name="FN4">

[4]See In re Barnes,
1997 WL 189500 (Bankr. N.D.Ill. 1997); In re Neverla, 194 B.R.
547 (Bankr. W.D.N.Y. 1996); In re Jones, 201 B.R. 371 (Bankr.
D.N.J. 1996); In re Barnes, 199 B.R. 256 (Bankr. W.D.N.Y.
1996).</a><a href="#RET4">[RETURN TO TEXT]</a>

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Journal Authors

Janna L. Countryman

Journal Date

Monday, September 1, 1997 - 12:00