[1]On Jan. 15, 2016, the U.S. Bankruptcy Court for the Middle District of Alabama decided In re Moorer, 15-30422-WRS, 2016 WL 199061 (Bankr. M.D. Ala. Jan. 15, 2016), wherein the court allowed the debtor to bifurcate a loan and treat the value of the property as the secured claim, with the balance of the loan being treated as an unsecured claim even though the debtor used the real estate as his principal residence.
William Moore (the debtor) purchased 98 acres of real property in Alabama in 2007. He then obtained a commercial loan from Community Bank and Trust for $289,000 and pledged the property as collateral for a mortgage. The debtor testified during the process that the loan was to be used for a startup chemical company. The loan was subsequently modified after inception by the parties, ending with a balance of $224,660 at 8 percent per annum.
The debtor then filed a bankruptcy petition in February 2015. The debtor’s original plan bifurcated the loan into secured and unsecured portions, proposing to pay a secured value of $147,000 and discharging the balance of the loan. The bankruptcy court, after a hearing on valuation, set the value of the real estate at $198,000. The debtor amended his plan to pay the secured portion with 4.75 percent per annum while discharging the unsecured portion of the loan.
The court held evidentiary hearings on the issue of whether the debtor could modify the rights of Community Bank. The debtor testified that the land was mortgaged for use in a business relating to a chemical company and that the land was used as a cattle farm. He further testified that he didn’t use the real estate as his residence until he affixed a mobile home upon it in 2014. The bank’s president testified that the bank had classified the loan as commercial. A real estate appraiser testified that the property was used as a farm, but had a mobile home affixed permanently to the property.
The bankruptcy court held that the anti-modification clause found in Bankruptcy Code § 1322(b)(2) did not apply to the real estate in question.[2] Consequently, the court approved the plan amendment and confirmed the debtor’s plan. Community Bank moved for reconsideration of that order, arguing that the court had misconstrued § 1322(b) and the case law that supported it.
In reorganization plans, debtors may modify the contract rights of secured creditors other than “a claim secured only by a security interest in real property that is the debtor’s principal residence.”[3] This Code section protects mortgage-holders from being modified under § 506(a) of the Bankruptcy Code as long as the mortgage is secured only by the debtor’s principal residence.[4] Community Bank argued throughout the confirmation process that this provision applied to the loan between it and the debtor.
The bankruptcy court found that the evidence clearly established that, although the real estate was the debtor’s principal residence, the land was also used for farming and other purposes. The court found that the real estate was not the debtor’s principal residence exclusively, and therefore continued to review whether the modification bar applied to real estate that includes the debtor’s principal residence but also had other uses. Not surprisingly, the court found a split of authority on the issue of whether the real estate must be used exclusively as a principal residence.
Community Bank made the argument that Alabama’s homestead exemption, for which the debtor had taken, should show the court that the debtor used the property as his principal residence. Moreover, Community Bank put forth cases holding that the real property securing a mortgage need not be exclusively used as the principal residence.[5] The reasoning this line of cases provided was that the use of the word “only” in the statute was used only once within the text, providing that as long as the residence was used as the debtor’s principal residence and the mortgage is secured only by that residence, the mortgage is protected by the provision.
On the other hand, the court wrote, the majority of cases provided that the anti-modification clause applies to mortgages secured by real property that is used exclusively as the debtor’s principal residence.[6] The reasoning in this line of cases was the word “is” within the statute. By using “is” within the statutory language, the court wrote, Congress qualified the word “only” to both the phrases “real property” and the “debtor’s principal residence.” Curiously, the Third Circuit found in Scarborough that the language of § 1322(b) was unambiguous and that provision required exclusive use based on the statute text, while the First Circuit found the text to be ambiguous and referred to the legislative history to find that the clause only protects mortgages on properties that are used exclusively as principal residences.[7] Consequently, if even a part of the real estate is not used as the debtor’s principal residence, the modification bar does not apply.
The court decided to follow the majority line of cases and held that the anti-modification clause protects loans that are only used exclusively for a debtor’s principal residence. As the court had previously ruled that the real estate was not only used as the debtor’s principal residence, but also as a cattle pasture, the debtor in this case could modify the rights of Community Bank. Additionally, the court found that the debtor could modify the creditor’s rights under § 1322(c)(2), as the loan was set to mature during the life of the debtor’s plan. These two facts led the court to rule that the anti-modification clause did not protect Community Bank from being modified by the debtors plan.
In conclusion, practitioners must look to the use of the property when determining whether to propose a plan that will modify the rights of a secured creditor where the collateral is the debtor’s residence. Use of a residence for any other purpose, especially upon inception of the loan, may take the protections afforded by § 1322(b) out of the hands of the mortgagee and allow the debtor to propose a plan that should greatly benefit the debtor and its estates. Allowing the debtor to bifurcate a loan may provide a windfall to the debtor and allow the debtor to take use of depressed real estate values in today’s current market.
[1] The views expressed herein are solely those of the author.
[2] In re Moorer, 15-30422-WRS, 2016 WL 199061, at *3 (Bankr. M.D. Ala. Jan. 15, 2016); see also 11 U.S.C. § 1322(b).
[3] Id.
[4] Nobleman v. Am. Sav. Bank, 508 U.S. 234 (1993).
[5] In re Wages, 508 B.R. 161, 167 (Bankr. App. 9th Cir. 2014); In re Schayes, 483 B.R. 209, 216 (Bankr. D. Ariz. 2012).
[6] In re Scarborough, 461 F.3d 406, 411 (3d Cir. 2006); Lomas Mortg. Inc. v. Louis, 82 F.3d 1, 7(1st Cir. 1996).
[7] Lomas Mortg. Inc. v. Louis, 82 F.3d 1, 7(1st Cir. 1996).