Courts are split on whether an individual chapter 11 debtor can strip down a home mortgage when the property is used in part to generate income.
At issue is Section 1123(b)(5), which provides that a plan may strip down a secured claim, but not “a claim secured only by a security interest in real property that is the debtor’s principal residence.”
Interpreting that section pits the Third Circuit on one side of the answer and the Ninth Circuit Bankruptcy Appellate Panel on the other. District Judge Richard Seeborg of San Francisco had to decide which court had the better answer. He sided with his circuit’s appellate panel on one issue in the case and with the Third Circuit on another.
In a 2006 case called Scarborough, the Third Circuit concluded that “only” defines both “security interest” and “principal residence.” In other words, a debtor could strip down a mortgage if the property was secured only by a lien on real property and only if the property was the principal residence.
The Ninth Circuit BAP reached the opposite conclusion in 2014 in In re Wages. The panel held that plain meaning bars bifurcation even if the property is used for more than just the debtor’s principal residence.
Judge Seeborg adopted the appellate panel’s Wages approach, holding that “only” defines only “security interest,” not also “principal residence.” He thus held that a debtor cannot bifurcate a home mortgage even if the property has a dual use.
The judge nonetheless declined to follow the appellate panel on the second issue in the case: whether the bar to bifurcation applies when the lien covers personal property as well as real property.
In the case at bar, the mortgage was a construction loan with liens on the real property as well as on virtually all personal property on the premises. In In re Lee, the Ninth Circuit BAP had held in 2007 that the bar to bifurcation applies if the lender also has a lien on personal property of “little independent value.”
Following what he saw as the statute’s plain language, Judge Seeborg parted company with the appellate panel, this time following the Third Circuit’s 1994 Hammond opinion allowing modification of a mortgage also secured by personal property like machinery and equipment.