Monday, February 22, 2010

Bankruptcy Court OKs Home Mortgage Cramdown For NC Homeowner, Despite Congress' Failure To Change Law

Despite Congress' recent failed attempts to change the Federal bankruptcy law that restricts cramdowns of mortgages secured by a Debtor's residence in a Chapter 13 bankruptcy proceeding, such cramdowns are apparently already permissible in certain cases, and has been for quite some time, based on my reading of a recent ruling by a North Carolina bankruptcy court.

The ruling is somewhat technical in nature, but essentially revolves around the following:
  • The applicable provisions of the Bankruptcy Code (ie. sections 506(a) and 1322(b)(2)) provide a mechanism for modifying the rights of a holder of a secured claim by bifurcating the secured creditor's claim into secured and unsecured portions if the amount of the claim exceeds the value of the collateral securing the claim;

  • However, under section 1322(b)(2), some secured claims are protected against modification. Specifically, section 1322(b)(2) excludes from modification "a claim secured only by a security interest in real property that is the debtor's principal residence." [bold text emphasis mine, not in the statute];

  • Under the terms of the deed of trust in this case, the Debtor was to include in her monthly payment principal and interest plus an additional sum to cover the payment of "Escrow Items" consisting of taxes and special assessments, leasehold payments or ground rents, and insurance premiums; and

  • The lender's loan documents required the borrower to pledge the escrow funds as "additional security" for the principal and interest due under the promissory note and deed of trust.
In this case, the bankruptcy court, relying on the legal analysis by a Federal appeals court in In re Ennis, 558 F.3d 343 (4th Cir. 2009), found that the deed of trust was not "a claim secured only by a security interest in real property [...]" as set forth in section 1322(b)(2) - it was a claim secured by both:
  • a security interest in real property, and
  • a security interest in the funds sitting in the escrow account which, under North Carolina law, was found by the court to constitute personal property.

On the basis that the security for the deed of trust was not limited only to an interest in real property, but also included personal property in the form of the escrow funds sitting in the escrow account, the court ruled that the anti-modification clause was inapplicable and, accordingly, the Debtor was permitted to modify (ie. cram down) her home loan.(1)

For the ruling, see In re: Bradsher, Case No. 09-80942, USBC M.D. N.C., Durham Division (February 16, 2010).

(1) For those (like me) who were unaware that a mortgage cramdown was possible in a case involving a deed of trust or mortgage secured by the Debtor's residence, this case illustrates the importance of reading every single word contained in both the:

  • the statute (the ruling in this case turns on the presence of the words "only" and "real property" in the anti-cramdown rule in section 1322(b)(2) of the Bankruptcy Code), and
  • the mortgage/deed of trust (the pledging of the escrow funds as "additional collateral" rendered the anti-cramdown rule inapplicable since, under North Carolina law, said funds were found by the court to constitute "personal property").

For those of you looking to cram down the mortgages/deeds of trust secured by your "underwater" homes, a review of your mortgage/deed of trust paperwork may be called for (and hope that any escrow funds paid with the principal and interest are pledged as additional collateral for the loan, as they were in this case).

Further, for those homeowners looking to modify their home loans, it may be a good idea to make sure the escrow account is pledged as additional collateral for the loan (if it isn't already). This way, if (or when) the modification doesn't work out, you may have the option to file a Chapter 13 bankruptcy, and then possibly cram down (ie. write down) the loan as part of your payment plan - provided the escrow funds constitute personal property under the applicable state law (and, if you have a 2nd mortgage on the home that is completely underwater, you can also avail yourself of the "lien stripping" statute found elsewhere in the Federal Bankruptcy Code). Go here for More On Lien Stripping Of Wholly Unsecured 2nd Mortgages Encumbering Underwater Homes In Chapter 13 Bankruptcy Proceedings.

Finally, keep in mind that the anti-modification (anti-cramdown) law only impacts homeowners with first mortgages secured by their residence. Investors with first mortgages on their investment property can, and have always been able to, cram down those mortgages.