In deciding whether an individual in chapter 11 can cram down a mortgage lender’s secured claim to the value of the property, Bankruptcy Judge Frank J. Bailey of Boston focused on the filing date to decide whether the debtor’s principal residence also generated income, not the date when the debtor granted the mortgage.
The case involved two issues where the courts are divided. On the first, Judge Bailey was bound by precedent in favor of the debtor in Lomas Mortgage Inc. v. Louis, 82 F.3d 1 (1st Cir. 1996), where the First Circuit held that the prohibition in Section 1322(b)(2) on modifying a mortgage on a principal residence does not apply if the property also generates income. The parties agreed that Lomas applied equally to Section 1123(b)(5), an identical prohibition in chapter 11 cases.
The essential facts were undisputed. The debtor refinanced the mortgage on his home in 2006, saying he would use the proceeds to improve the property by building a 1,600 square foot, two-bedroom residential unit. In the loan application and at closing, the debtor represented that the property was his principal residence.
After the debtor completed the addition, his mother and father-in-law occupied the unit but paid no rent. At the time of filing, his brother-in-law was residing there, paying $300 a month in rent, below market.
The lender argued that the condition of the home at the time the mortgage was made determines whether it was considered a dual-use property. In his April 6 opinion, Judge Bailey conceded that the courts are split on whether the critical date is the filing date or the date when the mortgage was made.
Although the First Circuit did not address the issue in Lomas, Judge Bailey said that the majority of courts and every bankruptcy court in the First Circuit to confront the question have looked to the filing date. He said that the filing date is “consistent with the language of the antimodification provision.”
Section 1123(b)(5), he said, “asks whether the real property in question ‘is’ the debtor’s principal residence, not whether it was the principal residence when the security interest first arose.” He saw no reason to consult legislative history given the “clarity of the statute.”
Judge Bailey found that that the property was producing income on the filing date and was not exclusively the debtor’s principal residence. Even though $300 a month in rent might be below market, he said the income was not a “nominal sum.” He also said it was “of no moment” that the unit was rented to family.
Significantly, Judge Bailey said the court looks to the characteristics of the property, not the mortgage.
Judge Bailey rejected the lender’s attempts at distinguishing Lomas. Among other things, it was irrelevant that the debtor’s mortgage did not include a one-to-four family rider, unlike Lomas.
The lender argued that the mortgage application should estop the debtor from claiming the property was income-producing because he made contrary representations in the mortgage application. Judge Bailey found no grounds for estoppel.
The debtor, he said, was asked to represent his intention at the time, and those representations were accurate. There was no evidence, Judge Bailey said, that the debtor was asked to promise not to change his intent.
In addition, Judge Bailey found no inconsistency between occupying the property as a principal residence and leasing a portion of the property to generate income.
For ABI’s discussion of a case dealing with the split of authority on the applicability of the antimodification provision to multi-use properties, click here.