Sunday, December 29, 2013

Innovative Use of Chapter 13 to Save Principal Residences and Non-Principal Residences from Foreclosure - A Working Blog Post

The widely-anticipated bankruptcy amendment, The Helping Families Save Their Homes in Bankruptcy Amendment of 2008, has not yet been enacted by Congress. This amendment would provide the Bankruptcy Courts with the power to modify mortgages secured only by principal residences. It is reported though that Senator Christopher Dodd (D. Conn.) may push this legislation again as early as next week. In the meanwhile, the provisions of the present Bankruptcy Code may offer substantial relief to the distressed homeowner and may be considered by a person who is running out of time before an impending foreclosure sale. The relief available under the present Bankruptcy Code for a homeowner involves various considerations, including whether the real property is a principal residence, whether the mortgage is secured "only by" a principal residence, the value of the real property, and the amounts owed on the involved mortgages.

Mortgages on Non-Principal Residences in Chapter 13
An owner of investment real estate or non-primary residence real estate may also be able to achieve a modification of their mortgage under chapter 13. The "anti-modification" provision of Section 1322(b)(2) of chapter 13 does not apply. This mortgage modification may include a reduction of principal to the value of the property, a reduction in interest rate, and a modification in term. My recent experience has shown that a substantial portion of mortgage companies are presently agreeing to or not objecting to mortgage modification as many mortgage companies realize it is in their own interest to agree to a mortgage modification rather than suffer another foreclosure and "REO." First priority and junior mortgages may be avoided to the extent that they exceed in amount the value of the underlying collateral. To the extent that a real property owner is able to prove that a mortgage is unsecured, the Bankruptcy Court will usually grant an order "avoiding" the mortgage lien under Section 506 of the Bankruptcy Code. This order would be recorded in the county public records for reference by future title examinersIn addition to the reduction in mortgage principal, the chapter 13 plan may also propose to reduce the interest rate to a market rate of interest. One may also consider proposing a chapter 13 plan that modifies the terms of the mortgage. The payments to the mortgage company would be made for perhaps 30 months (of a 36 month plan for an under-median income debtor) through the chapter 13 trustee under the chapter 13 plan and then would continue on directly to the mortgage company after the chapter 13 plan is completed.

Second or Other Junior Mortgages on Principal Residences
The present chapter 13 provisions already offer the owner of real property used as his principal residence the ability to avoid a mortgage that is "wholly" unsecured. A claim in bankruptcy is deemed "unsecured" to the extent it is not secured by an interest in collateral. Second and third priority junior mortgages would be deemed unsecured where the amount owed on the first priority mortgage exceeds the value of the real estate collateral, leaving no value to "secure" the second and third priority junior mortgages. If a real property owner is able to prove that a junior mortgage is "wholly" unsecured, the Bankruptcy Court will usually grant an order "avoiding" the junior mortgage under Section 506 of the Bankruptcy Code. This order would be recorded in the county public records for reference by future title examiners.

First Mortgages on Principal Residences
A principal residence owner may also be able to achieve a modification of a first priority mortgage while under the protection of the Bankruptcy Court under chapter 13 in a manner like that described above for non-principal residence real estate. This modification may be voluntary by the first mortgage or perhaps involuntary. Although chapter 13 generally prohibits the modification of a mortgage secured "only by a security interest in real property that is the debtor's principal residence" (11 U.S.C. 1322 (b)(2)), there may be various legal theories that may apply or be developed to possibly avoid application of this "anti-modification" provision.

Due to the present economic and political situation, a mortgage holder may agree to or not contest a proposed chapter 13 modification of a first priority mortgage on principal residential real property as it may recover more under a modified mortgage than that received in a mortgage foreclosure. Professor Nouriel Roubini of the Stern Business School at New York University estimates that foreclosure recoveries are averaging 30% in some markets. It appears that the Bankruptcy Court would be able to approve a chapter 13 plan that includes a modification of a first priority primary residential mortgage if the mortgage holder agrees to the modification or does not oppose the chapter 13 plan.

Legislative Intent
Bankruptcy Judge Robert D. Berger recently reviewed the legislative intent of the "anti-modification" provision of Section 1322(b)(2) noting that is was "meant to protect traditional home mortgage lenders." In re Picht, Slip Copy, 2008 WL 4382658 (Bkrtcy.D.Kan.,2008). One just might question whether the likes of Countywide and their two month teaser rates and "pick a payment" mortgages are what Congress had in mind as worthy of protection from modification pursuant to Section 1322(b)(2). Other Courts have noted that the legislative history of § 1322(b)(2) “indicates that it was designed to protect and promote the increased production of homes and to encourage private individual ownership of homes as a traditional and important value in American life.” In re Davis, 989 F.2d 208, 210 (6th Cir.1993). The statute does that by affording anti-modification protection to home mortgage lenders in order to “to encourage the flow of capital into the home lending market.” See Nobelman v. Am. Sav. Bank, 508 U.S. 324, 331, 113 S.Ct. 2106, 124 L.Ed.2d 228 (1993) (Stevens, J., concurring). Is a "cash out refinance" with a teaser rate of 1.9% for 2 months followed by a "pick a payment" or Libor plus 7% actually in accordance with the legislative intent of Section 1322(b)(2)? Seems like many of the vintage 2004- 2007 "cash out" mortgage refinancing of real estate already owned may not be in accordance with this Congressional intent of furthering individual homeowner. Indeed, many or most of these subprime-mortgages have had just the opposite effect and created substantial damage to the American economy.

One may also question whether the mortgage's explicit provisions actually provide that the mortgage is to be secured only by a "principal residence" as per the anti-modification provision of Section 1322(b)(2). One wonders whether the language of standard mortgage paragraph six actually implicates Section 1322(b)(2). A typical paragraph six seems quite ambivalent in providing that borrower need only "occupy, establish, and use" the real estate as his principal residence within 60 days after the execution of the mortgage and only use it as his principal residence for at least one year "unless the Lender otherwise agrees...which consent shall not be unreasonably withheld..." Is this standardized provision something less than that required to implicate Section 1322(b)(2)? Apparently the standardized mortgage form has evolved over the years and perhaps this language is not that which Congress had in mind when it drafted Section 1322(b)(2). Could this standardized paragraph be a drafting error?

One might also question how a particular bankruptcy court, a court of equity, may view standard paragraph six and its implication or non-implication of Section 1322(b)(2) upon consideration of old fashion principles of contract law, including issues of procedural or substantive unconscionability, good faith, fair dealing, unclean hands, breach of fiduciary duties, fraud, and misrepresentation. Other issues may include "predatory" or "improvident" lending. How should the maxim that "the plaintiff who seeks equity must behave equitably" apply? What about the holding that "Courts do not favor oppressive acts on the part of mortgagees, even though claimed to be founded on strict legal rights." Graf v. Hope Building Corp., 254 N.Y. 1 (1930). Why would the mortgage contract's requirement as to use as a principal residence be enforced against the homeowner when a particular mortgage and mortgage note contain unconscionable and unfair provisions? Perhaps a bankruptcy court could be persuaded that mortgage company should not withhold its hypothetical consent as to non-use as a principal residence.

Plain Meaning
One might even question who really is the "holder" of the secured claim and whether its secured claim is secured "only by" a principal residence. Although the mortgage servicer has the right to service the mortgage and the securitized trust may hold or have the right to "enforce" the mortgage note and/or mortgage, perhaps further thought should be given as to whether the actual secured creditor is in reality the various beneficiaries of the trust, ie. the certificate holders issued by the securitized trust. One might further question that if the certificate holders are deemed to be the actual secured creditors, whether their secured claim is secured "only by security interest in real property that is the debtor's principal residence." Were not the certificate holders of the securitized mortgage trust given all kinds of other added-on collateral or contractual rights in addition to the mortgage note when they bought their interests in the mortgage notes that form the corpus of the securitized trust?

It is interesting to review the Bankruptcy Court's decision in In re Lago, 301 B.R. 365, (Bkrtcy.S.D.Fla.,2003)(Cristol, J.). In this decision, county tax certificate holders normally serviced by the county tax collector were recognized as creditors and the real parties in interest. Although it would appear to be black-letter law that the trustees of the securitized trusts are normally able to act on behalf of the certificate holders (as the county tax collector was unwilling in In re Lago), this does not detract from the fact that the ultimate holder or benefactor of the mortgage note and its flow of capital is the holder of the certificates issued by the securitized trust. Are the various holders of the fragmented interests (ie. tranches) in the secured claim secured only by the principal residence?