Sitting en banc, the Fourth Circuit voted 11-3 to overrule its own precedent and held that Section 1322(c)(2) permits a debtor to strip down a claim on a home mortgage that matures before the last payment is due under a chapter 13 plan. In other words, a debtor with an underwater, short term mortgage is only required to pay the value of the home and may discharge the remainder as an unsecured claim.
The 11-3 decision eliminated a split of circuits by aligning the Fourth Circuit with the Eleventh Circuit’s opinion in American General Finance Inc. v. Paschen (In re Paschen), 296 F.3d 1203, 1209 (11th Cir. 2002). However, the dissenters in the Fourth Circuit believe that Section 1322(c)(2) only permits modifying the payment schedule in a short term mortgage, not the amount of the claim.
Oddly, the Fourth Circuit had validated the so-called chapter 20 strategy six years ago in Branigan v. Davis (In re Davis), 716 F.3d 331 (4th Cir. 2013), a seemingly more exaggerated employment of the same provisions of the Bankruptcy Code.
In a chapter 20 case, the consumer first files under chapter 7 to extinguish personal liability on an underwater mortgage. Later, the consumer initiates a separate chapter 13 case to strip off the mortgage lien that survived chapter 7 as an in rem liability solely against the real property. Although the Supreme Court’s 1992 Dewsnup decision holds that a mortgage cannot be stripped off in chapter 7, the high court so far has thrown up no explicit roadblock to prevent chapter 20 from stripping off an underwater mortgage.
The Facts
The debtor purchased a home for $136,000, paying $5,000 down and giving the seller a purchase money, 10-year, interest-only mortgage for $131,000. Before bankruptcy, the mortgage matured, but the debtor did not refinance the mortgage or pay off the balance.
The holder of the mortgage initiated foreclosure proceedings that were halted when the debtor filed a chapter 13 petition. The debtor submitted a chapter 13 plan pegging the value of the home at $47,000, the amount shown in a recent appraisal. There was a tax lien of approximately $6,000 on the home.
The plan bifurcated the lender’s claim into a secured claim of about $41,000, representing the $47,000 value of the home less the tax lien. The plan called for paying off the $41,000 over the five-year life of the plan with interest at 4.5%.
The plan classified the remainder of the lender’s claim as an unsecured claim to receive no payment under the plan.
Bound by the Fourth Circuit’s precedent in Witt v. United Companies Lending Corp. (In re Witt), 113 F.3d 508 (4th Cir. 1997), the bankruptcy court sustained the lender’s objection to the plan. Witt held that Section 1322(c)(2) only permits modifying the payment schedule of a short term mortgage, not the amount of the secured claim.
The district court affirmed and so did a three judge panel of the Fourth Circuit. The appeals court granted rehearing en banc and heard oral argument in January.
Nobelman, Rash and the Statutory Provisions
Section 506(a) provides for bifurcating a claim of a secured creditor, that is, allowing a secured claim to the extent of the value of the collateral together with an unsecured claim to the extent that the claim exceeds the value of the collateral. Section 1325(a)(5) provides that cramdown is one of the methods for dealing with a secured claim in a chapter 13 plan.
Section 1322(b)(2) allows a chapter 13 plan to modify secured claims, but not “a claim secured only by a security interest in real property that is the debtor’s principal residence.” In Nobelman v. American Savings Bank, 508 U.S. 324 (1993), the Supreme Court interpreted Section 1322(b)(2) to mean that a chapter 13 debtor may not employ Section 506(a) to strip down an undersecured home mortgage, that is, reduce the amount of the mortgage to the fair market value of the residence.
On the heels of Nobelman and as part of the Bankruptcy Reform Act of 1994, Congress added 1322(c)(2). “Notwithstanding subsection (b)(2) and applicable nonbankruptcy law,” subsection (c)(2) becomes applicable when the last payment on a debtor’s home mortgage falls before the last payment under the chapter 13 plan. In those circumstances, subsection (c)(2) permits the chapter 13 plan to “provide for the payment of the claim as modified pursuant to section 1325(a)(5).”
In Associates Commercial Corp. v. Rash, 520 U.S. 953, 957 (1997), the Supreme Court ruled that a chapter 13 debtor may cram a plan down on a secured creditor under Section 1325(a)(5) as long as the debtor pays the “total the present value of the allowed secured claim” under Section 506(a).
The Majority’s Opinion on Rehearing En Banc
Witt was not popular among courts and commentators. In Paschen, the Eleventh Circuit declined to follow Witt, and the Collier treatise disagreed with the result in Witt. In his May 24 opinion, Circuit Judge James A. Wynn, Jr., explained why the Fourth Circuit was overruling Witt and aligning with “every other court that has considered the issue.”
According to Judge Wynn, the “plain text” of Section 1322(c)(2) permits modifying a mortgage when the last payment is due before the last payment under the plan. Witt, he said, incorrectly concluded that the subsection was ambiguous.
Judge Wynn defined the question as follows: Does the phrase “payment of the claim as modified pursuant to section 1325(a)(5)” allow the debtor to modify the amount of the secured claim or only the payment schedule? In other words, does the subsection permit reducing the amount of the secured claim to the value of the property or does it only allow the debtor to stretch out payment of the entire claim (secured and unsecured) over the life of the plan?
Judge Wynn said that other courts “universally criticized Witt’s finding of ambiguity and attendant reliance on the statute’s legislative history.” For instance, Collier said that Witt was contrary to canons of statutory construction.
Differing with the conclusion reached by a panel 22 years earlier, Judge Wynn said that the “most natural reading of statutory language” in subsection (c)(2) “allows bifurcation of such claims into secured and unsecured components” when a home mortgage matures before the last payment under the plan. He therefore reversed and remanded, because the statute permits the debtor to strip down a short term mortgage to the value of the property, not merely to modify the payment schedule.
On behalf of the National Association of Bankruptcy Attorneys and the National Consumer Bankruptcy Rights Center, Tara Twomey submitted an amicus brief supporting the debtor’s petition for rehearing en banc.
The Dissenters
Circuit Judge J. Harvie Wilkinson, III, dissented, joined by Circuit Judges Barbara Milano Keenan and Stephanie D. Thacker. They continue to believe that subsection (c)(2) only permits altering the payment schedule on a home mortgage.
Beyond the significance of the case for chapter 13 debtors, the opinions by the majority and the dissent are important for their differing approaches to statutory interpretation when Congress has overruled or modified a decision from the Supreme Court. The dissenters do not believe the statute itself and its legislative history clearly showed that Congress intended to change the result of Nobelman in some situations.
Sitting en banc, the Fourth Circuit voted 11-3 to overrule its own precedent and held that Section 1322(c)(2) permits a debtor to strip down a claim on a home mortgage that matures before the last payment is due under a chapter 13 plan. In other words, a debtor with an underwater, short term mortgage is only required to pay the value of the home and may discharge the remainder as an unsecured claim.
The 11-3 decision eliminated a split of circuits by aligning the Fourth Circuit with the Eleventh Circuit’s opinion in American General Finance Inc. v. Paschen (In re Paschen), 296 F.3d 1203, 1209 (11th Cir. 2002). However, the dissenters in the Fourth Circuit believe that Section 1322(c)(2) only permits modifying the payment schedule in a short term mortgage, not the amount of the claim.
Oddly, the Fourth Circuit had validated the so-called chapter 20 strategy six years ago in Branigan v. Davis (In re Davis), 716 F.3d 331 (4th Cir. 2013), a seemingly more exaggerated employment of the same provisions of the Bankruptcy Code.