Friday, January 22, 2010

Strip-Down of Undersecured Junior Mortgage Lien Prohibited

In re Nobleman v. American Savings Bank, 508 U.S. 324 (1993). Debtor’s attempted to strip-down an undersecured mortgage lien via the plan confirmation process. In their Chapter 13 debt repayment plan, debtor relied on §506(a)---which provides, inter alia, that an allowed claim secured by a lien on the debtor’s property “is a secured claim to the extent of the value of the property” and “is an unsecured claim” to the extent it exceeds that value--- to propose that the mortgage on their principal residence be reduced from approximately $70,000 to the residence’s $23,500 current fair market value.

The junior mortgage lender objected to the plan, arguing that the proposed bifurcation of the lender’s claim into a secured claim of $23,500 and an effectively worthless unsecured claim modified creditor’s rights as a homestead mortgage in violation of the anti-modification provisions of §1322(b)(2).

Section 1322(b)(2) allows a plan to “modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor’s principal residence…”

The Supreme Court held that §1322(b)(2) prohibits a Chapter 13 debtor from relying on §506(a) to reduce an undersecured homestead mortgage to the fair market value of the mortgaged residence. Although debtor was correct in looking to §506(a) for a judicial valuation of their residence to determine the status of the lender’s secured claim, that valuation does not necessarily limit the lender’s rights as a claim holder, which are the focus of the anti-modification provisions of §1322(b)(2).

In the absence of a controlling Bankruptcy Code definition, it must be presumed that Congress left the determination of property “rights” in bankruptcy estate assets to state law. The court noted that the junior mortgagee’s “rights,” therefore, were reflected in the relevant mortgage instruments, which are enforceable under state law. Those rights included, among others, the right to repayment of the principal in monthly installments over a fixed term at specified interest rates, which were protected from modification by §1322(b)(2).

That section’s “other than” exception could not be read to protect only that subset of allowed “secured claims,” determined by application of §506(a), that are secured by a lien on the debtor’s home. Rather, the court found that the more reasonable interpretation was to read “a claim secured only by a homestead lien” as referring to the lienholder’s entire claim, including both its secured and unsecured components, since it would be impossible to reduce the junior mortgagee’s outstanding mortgage principal to $23,500 without modifying the mortgagee’s contractual rights as to interest rates, monthly payment amounts, or repayment terms.

Warmest Regards,

Bob Schaller

Your Lien Stripping Defense Blog
By: Attorney Robert Schaller (Bob's bio) of the Schaller Law Firm

Bob is a member of the American Bankruptcy Institute and the National Association of Consumer Bankruptcy Attorneys.

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