Avoiding a split of circuits, the Ninth Circuit affirmed the Bankruptcy Appellate Panel by holding that the exception in Section 1322(c)(2) permits a chapter 13 debtor to bifurcate a home mortgage that matures before the end of the plan.

Adopting the BAP analysis by Bankruptcy Judge Robert J. Faris, the opinion by Circuit Judge William A. Fletcher rejected the idea that the exception only permits modifying the payment, not the claim.

Judge Fletcher’s May 22 opinion also upheld the BAP’s decision that the court’s valuation of collateral after filing can be used in deciding whether the debtor has too much unsecured debt for chapter 13 and that the court is not required to use the valuation contained in the debtor’s schedules at filing.

Valuation of the Home

On filing, the chapter 13 debtors scheduled their home with a value of just over $1 million, subject to first and second mortgages totaling about $1.4 million. By itself, the deficiency on the second mortgage meant that the debtors had $400,000 in unsecured debt.

Taking other unsecured debts into consideration, the debtors had more than about $420,000 in unsecured debt, the maximum at the time under Section 109(e) for eligibility in chapter 13. However, the holder of the second mortgage evidently didn’t realize that the debtors were over the debt limit.

At the debtors’ behest, the bankruptcy court held a valuation trial and decided that the home was actually worth $1,225,000 as of the filing date. The new valuation meant that the debtors had less than $420,000 in total unsecured debt, because the higher valuation reduced the unsecured portion of the junior lender’s claim.

Based on the higher valuation of the home and the second mortgage maturing before the end of the five-year plan, the debtors filed an amended plan to bifurcate the secured claim of the junior lender into a secured claim and an unsecured claim. The amended plan called for paying the secured portion in full over the life of the plan. The unsecured portion would be discharged.

The junior lender objected to confirmation, asking for dismissal by contending that the debtors should be stuck with the lower valuation of the home contained in the debtors’ original schedules. The lender also objected to confirmation by arguing that the exception in Section 1322(c)(2) only allows modifying the payment, not the claim itself.

Bankruptcy Judge Mark Houle overruled the objections and confirmed the plan. The BAP affirmed. Mission Hen LLC v. Lee (In re Lee), 655 B.R. 340 (B.A.P. 9th Cir. Nov. 13, 2023). To read ABI’s report on the BAP opinion, click here. The junior lender appealed to the circuit.

Chapter 13 Eligibility

On the merits, Circuit Judge Fletcher began with eligibility and cited the Ninth Circuit’s own precedent for the proposition that “eligibility should normally be determined by the debtor’s originally filed schedules, checking only to see if the schedules were made in good faith.” Scovis v. Henrichsen (In re Scovis), 249 F.3d 975, 982 (9th Cir. 2001).

The case was not normal, he said, because the lender had not objected to eligibility until after the bankruptcy court had given the home a higher value and thereby reduced the amount of the debtors’ unsecured debt. It “makes sense,” he said, “to use the court’s valuation as the basis for an eligibility determination under § 109(e).”

Upholding the BAP’s affirmance on the question of eligibility, Judge Fletcher said,

We conclude in the circumstances of this case that strict adherence to the generally applicable Scovis rule would result in an inaccurate valuation of the Property and undermine the goals of Chapter 13.

Antimodification and Section 1322(c)(2)

The debtors’ ability to bifurcate and cram down the junior mortgage was seemingly precluded by Section 1322(b)(2), which does not permit modifying “a claim secured only by a security interest in real property that is the debtor’s principal residence . . . .” Following Nobelman in 1993, where the Supreme Court held that Section 1322(b)(2) would not permit bifurcation, Congress adopted Section 1322(c)(2) a year later.

When the last payment on a home mortgage is due before the last payment under the plan, Section 1322(c)(2) allows the plan to “provide for the payment of the claim as modified.”

The junior lender argued once more in the circuit that Section 1322(b)(2) only permitted modification of the payment but does not allow bifurcation and stripping down the secured claim.

Judge Fletcher said that the BAP was “in good company,” because three circuits and courts “across the country” have “held that § 1322(c)(2) permits bifurcation of a short-term claim like [the junior lender’s].” Among others, he cited Hurlburt v. Black, 925 F.3d 154 (4th Cir. 2019) (en banc). To read ABI’s report, click here. [Note: There had been a split of circuits until the Fourth Circuit sat en banc and reversed the circuit’s prior holding.]

Judge Fletcher found two reasons in the language of the statute that indicate permission for bifurcation. First, the prefatory clause in Section 1322(c)(2), “Notwithstanding subsection (b)(2),” “indicates that the provision is an exception to § 1322(b)(2),” he said.

Second, Judge Fletcher said, “§ 1322(c)(2) specifies that ‘the plan may provide for the payment of the claim as modified pursuant to section 1325(a)(5) of this title.’” Citing Hurlburt, he said that the “reference to § 1325(a)(5) makes clear that § 1322(c)(2) was intended to allow debtors to bifurcate and cram down such claims that are to be paid off before the final payment of the plan is due.”

Judge Fletcher affirmed the BAP’s decision affirming confirmation of the chapter 13 plan.