Presentation on theme: "CHAPTER 13 AVOIDANCE OF MORTGAGES THAT ENCUMBER A PRINCIPAL RESIDENCE"— Presentation transcript:
1CHAPTER 13 AVOIDANCE OF MORTGAGES THAT ENCUMBER A PRINCIPAL RESIDENCE By: David Wm. Ruskin, C. Jason Cardasis, and John Kapitan
2UnemploymentEconomists say a nationwide unemployment rate between 4.5% and 5% is generally consistent with a good job market and solid wage growth.The January 2008 U.S. unemployment rate was 4.9%.In Michigan, it was 7.2%.The January 2009 U.S. unemployment rate was 7.6%--the highest since 1992.In Michigan, the February rate was 12%.
5Can a Debtor modify a mortgage that encumbers their principal residence in a Chapter 13 case even though 1322(b)(2) prohibits modification?
6You bet they can! Sixth Circuit Case Law Lane v. Western Interstate Bankcorp (In re Lane), 280 F.3d 663 (6th Cir. 2002)Chapter 13 debtors in the Sixth Circuit are allowed to modify the rights of holder of a secured claim on the debtor’s principal residence if the security interest is wholly unsecured.
7Basics1. Section 1322(b)(2) prohibits modification of the rights of a holder of a secured claim if the security consists of a lien on the debtor's principal residence;2. Section 1322(b)(2) permits modification of the rights of an unsecured claimholder;3. Whether a lien claimant is the holder of a "secured claim" or an “unsecured claim" depends on whether the claimant's security interest has any actual "value" under 11 U.S.C. § 506.4. If a claimant's lien on the debtor's homestead has a positive value, no matter how small in relation to the total claim, the claimant holds a "secured claim" and the claimant's contractual rights under the loan documents are not subject to modification by the Chapter 13 plan;5. If a claimant's lien on the debtor's homestead has no value at all, on the other hand, the claimant holds an "unsecured claim" and the claimant's contractual rights are subject to modification by the plan.Lane v. Western Interstate Bankcorp (In re Lane), 280 F.3d at 670 (6th Cir. 2002).
8Exactly what in the Code provides the authority to do this? It appears that the only statutory provisions available to a Chapter 13 debtor to avoid wholly unsecured liens on their principal residence are 11 U.S.C. §§ 1322(b)(2), 1325(a)(5) and 1327(c).Section 1327(c) serves to avoid the lien and 1322(b)(2) and 1325(a)(5) define the permissible scope of such avoidance.In re Hill 304 B.R. 800, (Bankr. S.D. Ohio 2003)
9Cont.A second, third, etc. mortgage may be determined to be wholly unsecured under Section 506(a) but Section 506(d) cannot be used to void the lien because this provision voids only liens that secure claims which have not been allowed under Section In re Hill 304 B.R. at 803.Thus, one must look to Section 1325 for the scope of any such modification of the lien.Looking at the plain language of Section 1325(a)(5)(B)(i) it is clear that such claim will be paid pro-rata with the other unsecured creditors but, the mortgagee will still retain the lien securing its claim until the earlier of the payment of the underlying debt determined under non bankruptcy law or discharge under Section 1328.In addition, if the Chapter 13 case is dismissed or converted without completion of the plan, the lien will also be retained by the creditor to the extent recognized by applicable non-bankruptcy law.
10But you can’t do it in a Chapter 7 Case Sixth Circuit Case LawTalbert v. City Mortg.Servs. (In re Talbert), 344 F.3d 555 (6th Cir. 2003)A Chapter 7 Debtor may not use 11 U.S.C. § 506 to “strip off” an allowed junior lien where the senior lien exceeds the fair market value of the real property.
11What about if only one spouse files a Chapter 13 case and the property is held as tenancy by the entireties?What’s entireties property?In Michigan, tenancy by the entireties is recognized as one type of joint interest in real property. A tenancy by the entireties is created when a conveyance of land is made to a husband and wife. (See Generally, Morgan v. Cincinnati Ins. Co., 411 Mich. 267, 284; 307 N.W.2d 53, 58 (1981))
12Tenancy by the entireties (cont.) When real property is so held by tenants by the entireties, neither spouse acting alone can alienate or encumber to a third person an interest in fee of land so held. Neither the husband nor the wife has an individual, separate interest in entireties property, and neither has an interest in such property which may be conveyed, encumbered or alienated without the consent of the other.Rogers v. Rogers, 136 Mich. App. 125, 134; 356 N.W.2d 288 (1994)
13Back to the original question -- Hunter v. Citifinancial, Inc. (In re Hunter), 284 B.R. 806 (Bankr. E.D. Va 2002)An individual debtor cannot avoid a lien on real property owned by the debtor and his wife as tenants by the entireties with the right of survivorship.But why? --Even if the lien were voidable as to the debtor's interest, the spouse's interest in the entirety would still be burdened with the lien. Where only one tenant by the entireties sought to sever the estate as to one aspect only, he/she could not do so.Note: the rights possessed by a Pennsylvania tenant by the entireties closely follow those held by a Michigan tenant Popky v. United States of America, 326 F. Supp. 2d 594 (E.D. Penn 2004)
14Cont.Rodriguez v. Madera County Federal Credit Union (In re Rodriguez), 156 B.R. 659 (Bankr E.D. CA 1993)A debtor holding only a fractional interest (like a 50% interest) in property cannot utilize section 506 to value a secured claim.But see: Highland Fed. Bank v. Maynard (In re Maynard), 264 B.R. 209 (B.A.P. 9th Cir. 2001) (Court held that community property of both spouses became property of the estate even though husband did not file. Thus, stripping of mortgage encumbering community property allowed)
15What about if I attempt to avoid the mortgage(s) through a plan modification after confirmation? MaybeThe power to modify a wholly unsecured mortgage must be exercised at confirmation, or it’s lost.See, e.g., In re Cruz, 253 B.R. 6387, (Bankr. D.N.J. 2000)But see, Waters v. Money Story (In re Waters), 276 B.R. 879 (Bankr. N.D. Ill 2002) (allowed post-confirmation avoidance because value post-confirmation was same as it was pre-confirmation
16Well, what method should I employ to strip a mortgage? To file or not to file - an A.P. that is.Some believe an A.P. is necessary.A creditor is entitled to a declaratory action to determine the validity and extent of its lien in order to satisfy due process. Fed. R. Bankr. P. 7001(2) provides in pertinent part, "An adversary proceeding is a proceeding … to determine the validity, priority, or extent of a lien...";When a party asks the Bankruptcy Court to determine the extent of a lien or the value of the collateral forming the basis of the lien, adversary proceedings are required as contemplated by Fed. R. Bankr. P. 7001(2) and 3012, see Wright v. Commercial Credit Corporation, 178 B.R. 703 (Bankr. E.D. Virginia 1995)
17Cont.While some courts believe doing it through the Plan is fine– as long as you follow certain requirements.Judge Shapero - In re: Juszkowski, Chapter 13 No , *2 (December 18, 2007) (Chapter 13 debtor, may, as part of a plan, modify the rights of a secured creditor. However, all necessary due process requirements, including notice, potential discovery, etc. available in a contested matter context, and, as such, satisfy the legal, practical, and other needs of the situation.)Notice – Rule 7004 provides guidance as to how service should be made on parties.
18Method to avoid (cont.) What about a motion? Probably the least liked method.DISCUSSION ON EASTERN DISTRICT PREFERRED METHODS.
19Practice Pointer!When applying for a default judgment, it is good practice to include, not only proof of service of the summons and complaint, but also statement(s) of the amounts owed to each mortgage lender, and something that will verify the value of the property. If you don’t, you may wind up getting the application scheduled for hearing, and/or worse, having it denied.
20DRAFTING ADVERSARY COMPLAINT/PLAN A. Language/documents needed in AP.B. Language needed in Plant to effectuate AP or “lien strip”.1. Class Two Language.2. Proof of Claim Language in Plan.3. Recordable Form of Plan/Order.C. When to file AP to avoid mortgage.
21Service of AP 1. Who to Serve. 2. F.R. Civ. P. 4 a. Corporationi. Registered Agentii. Officerb. Bank3. MERS -
22Uncontested APA. Application under Rule 55 and what documents are required.B. Language and terms of the Default Judgment
23Things to watch forMake sure you are as specific as possible as to which mortgage you are attempting to avoid (legal description, liber, page, date and amount of mortgage, etc.)You don’t want to get an objection or response simply because the complaint attempts to avoid all of the lender’s mortgages even the first (example: “Mortgagee has no liens on the property” when they have a first and second)
24Cont. Service of Process on an insured depository institution (bank) F.R.Civ.P. 4(h)Service of Summons and Complaint after 10 days of issuance.Wrong party as the defendantMortgagee
25Burdens Okay, now that we’re litigating, who has what burden? Burden of Proof is on the debtor to demonstrate that there is not even $1.00 of value over prior valid liens to support the mortgage lien to be avoided.Moving party bears the burden of proof on all avoidance issues
26Cont.In In re Dziendziel, 295 B.R. 184 (Bankr. W.D.N.Y. 2003) the court described the debtor’s burden as:Naturally higher when:1) it appears there was equity to support it at the time the mortgage was executed;2) the deficiency is not substantial; and
273) the lack of value may have been created, in part, because of a debtor’s failure to make payments on superior mortgages, or other obligations (taxes), or for some other reason ………………………………………
28EXPERT OPINIONS Can I use my client’s opinion? Yes. Property owner is competent to give an opinion under Fed.R.Evid See, In re Jamison, 93 B.R. 595 (Bankr. S.D. Ohio 1988)
29Experts (cont.) Expert (Fed.R.Evid 702) Foundation for qualification of expertExperienceEducationLicenses and CertificationsAppraiserCan be used if proper foundation is laid (Note: Appraisal alone is hearsay when no foundation is provided)Real Estate Agent/BrokerOnly if they have extensive experience. See, In re: Schweizer 354 B.R. 272 (Bankr. D. Idaho 2006); Donoway v. Tucker, 139 B.R. 156 (Bankr. D. Md. 1992)
30Experts (cont.) Fair market value as of the petition date. Methods of valuationSales Comparison Approach: this is where the property being appraised is compared to recent sales of other properties.Used most often to derive value.Cost Approach: Cost of constructing an equivalent structure with cost of propertyIncome Approach: cash flow value - rentals
31What will the court do?The court will take testimony and review the appraisals and then, most likely, use a weighted average based on the evidentiary weight given to each.
32Consent Judgment Language for a Consent Judgment Mortgage is avoided only upon successful completion of the Chapter 13 Plan and the debtor(s) obtaining an order of discharge.Creditor has an allowed unsecured claim.In the event of a refinance or sale prior to the completion of the Chapter 13 case and receipt of a Chapter 13 order of discharge, the mortgage is paid in full at closing.Mortgage is reinstated if case is converted or dismissed.
33What happens if the Chapter 13 Case is Converted or Dismissed?