In the space of six weeks, two bankruptcy judges adopted what may be the minority view and barred chapter 13 debtors from cramming down a modified mortgage on a secured lender, even though the property had actual or potential use in addition to being the debtors’ principal residences.
Section 1322(b)(2) allows modification of a secured claim in a chapter 13 plan, but not when it is “secured only by a security interest in real property that is the debtor’s principal residence.”
In April, we reported on In re Brooks, authored by Bankruptcy Judge Paul R. Warren of Buffalo, N.Y. He precluded modifying the mortgage on the debtor’s home even though it had two smaller rental units. He followed the Ninth Circuit Bankruptcy Appellate Panel’s 2014 In re Wages decision, which does not allow stripping down a mortgage if “some portion” of the property is used as the debtor’s principal residence.
To read ABI’s synopsis of Brooks, click here. The Brooks story lays out various approaches that courts have adopted in deciding questions under Section 1322(b)(2).
In his decision on May 23, Bankruptcy Judge John K. Sherwood of Newark, N.J., was in a box because the Third Circuit seemed to hold in Scarborough v. Chase Manhattan Mortgage Corp. that the strip-down prohibition does not apply if the property has a use in addition to being the debtor’s principal residence.
Judge Sherwood’s case involved a home with a 420 square-foot guest house that had been rented intermittently, but not when the debtor obtained the mortgage. The guest house was unoccupied and in a state of disrepair when the debtor filed his petition.
Distinguishing Scarborough factually, Judge Sherwood relied on “representations by the debtor at closing that reflect that the guesthouse was and would be used as part of the debtor’s principal residence, not a separate income-producing unit.”
Judge Sherwood believed it would be inequitable to represent that the property was a non-income-producing principal residence and “then disregard this representation in the debtor’s bankruptcy proceedings.”