Attorney Seminar: Chapter 13
Chapter 13 Restructuring of Secured Debt
Jeffrey Solomon has written and presented seminar materials for continuing education credit to attorneys about the new bankruptcy law. The materials below discuss changes in the bankruptcy law concerning payment of secured debt in Chapter 13. (Case law updates must be reviewed prior to relying on the information provided.)
SECURED DEBT IN CHAPTER 13
A. Introduction: The Bankruptcy Code provides several remedies to debtors to save their property from foreclosure or repossession by secured creditors. The basic remedies can be considered in terms of two basic goals. First, the debtor may be in default subject to foreclosure or repossession. Though creditors have a right to file a motion for relief from automatic stay to recover secured property that is in default, the debtor may force the creditor to accept payments to cure the default over time. Second, there are techniques in which the debtor is permitted to pay less than the full amount of the secured indebtedness and obtain clear title to the property. BAPCPA amended the bankruptcy code to provide greater protection to secured creditors. However, at least in some ways, the amendments may have backfired.
B. Curing Defaults and Extended Payoffs
1. A chapter 7 bankruptcy is a liquidation. The debtor may continue to make his current payments to secured creditors, but if the secured debt is already in default, the debtor will need to file a Chapter 13 bankruptcy which can force the creditor to accept payments.
11 USC §1322. Contents of Plan, provides:
(b)… the plan may
(2) 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, or of holders of unsecured claims, or leave unaffected the rights of holders of any class of claims;
(3) provide for the curing or waiving of any default;
2. As 1322(b)(3) above provides, the debtor may cure a default in a mortgage or vehicle payment. The curing of the default is not modifying the claim as provided in 1322(b)(2). A typical Chapter 13 bankruptcy involves a mortgage foreclosure. (Note that there is variation between bankruptcy courts as to the local practice in Chapter 13 cases.) A debtor can reinstate a mortgage loan over a period up to 5 years. For example, assume a debtor’s regular monthly mortgage payment is $1500.00 per month, and the debtor is $15,000 in arrears. A 50 month plan could be approved to pay $1500 per month, plus $300 per month to cure the arrears, plus the 10% chapter 13 trustee fee on the $1800 payment for a total of $1980.00 per month.
3. What if the note is a balloon note that is already matured?
Section 1322(c)(2) provides:
in a case in which the last payment on the original payment schedule for a claim secured only by a security interest in real property that is the debtor¿s principal residence is due before the date on which the final payment under the plan is due, the plan may provide for the payment of the claim as modified pursuant to section 1325(a)(5) of this title.
Presume there is a balloon payment of $100,000.00. The debtor may pay this amount over the 5 year term even with a residential mortgage. This would not be construed as modification of the claim. The debtor has a right to payoff the full amount of the mortgage. The same reasoning applies to a motor vehicle. If the payoff at the time of filing bankruptcy is $10,000.00, this amount can be paid in full during the plan.
4. Consider a principal residence secured by two mortgages of $200,000.00 and $50,000.00., and the property is worth $201,000.00. Both mortgages are secured only by the residence. Section 1322(b)(2) provides an exception that residential mortgages cannot be modified. As a result, each mortgage is still owed the full amount of the mortgage, and each can be cured in the same manner as in paragraph 2 above.
C. Reduction in Amount of Secured Claims
1. Surprise, surprise-at least to many. The debtor often does not have to pay the full amount of the secured debt. This concept can be thought of as “lien-stripping”, or bi-furcating (separating) the claim into a secured claim and unsecured claim. Consider real property worth $150,000.00 with a mortgage debt of $200,000. If the creditor foreclosed and sold the property, all it would receive is $150,000 with a deficiency claim of $50,000.00. The bankruptcy code provides a method to strip the mortgage so that the creditor’s mortgage is only worth $150,000.00. See Section 506 below.
2. Recall that pursuant to 1322(b)(2) this lien-stripping does not apply to a ” claim secured only by a security interest in real property that is the debtor’s principal residence…” The key word is “ONLY”. Thus, if a commercial loan secured by business assets is also secured by the homestead, this lien is subject to a reduction in value.
3. As to residential mortgages, a slight change in the hypothetical above regarding two mortgages leads to a vastly different result. Assume the first mortgage is $200,000.00, the second mortgage is $ 50,000.00, and the property is worth $199,999.00. There is now not even $1.00 of equity after the first mortgage, so the second mortgage is totally unsecured. The second mortgage is no longer considered secured by the principal residence, so that mortgage can be stripped completely. The bankruptcy court can approve a plan that provides that the second mortgage no longer is secured by the real property.
4. This lien stripping was routinely used to reduce the secured claim on personal property loans, especially vehicles, even if recently purchased. BAPCPA contains substantial changes to protect secured creditors of personal property from this lien-stripping.
D. RELEVANT STATUTES TO REDUCE SECURED DEBT
The following statutes apply to reducing the value of the amount that must be paid on secured debt. The italics portions were added by BAPCPA.
1. 11 USC § 722. Redemption
An individual debtor may, whether or not the debtor has waived the right to redeem under this section, redeem tangible personal property intended primarily for personal, family or household use, from a lien securing a dischargeable consumer debt, if such property is exempted under section 522 of this title or has been abandoned under Section 554 of this title, by paying the holder of such lien the amount of the allowed secured claim of such holder that is secured by such lien in full at the time of redemption.
This often overlooked section applies only in Chapter 7 and only to personal property intended primarily for personal, family or household use. Assume a vehicle is worth $6,000, but the payoff is $12,000. If the debtor can raise $6,000, the debtor is entitled to pay the secured creditor $6,000 and the creditor must then provide clear title.
The statute was amended to clarify that the payment must be in full at the time of redemption. Additionally, since the payoff was in a chapter 7 liquidation case, the debtor only had to pay the wholesale value. Section 506A(2), listed below, was added to provide that valuation for purposes of both Chapter 7 and 13 was based on replacement value. These sections were interpreted in In re Ortiz, 2007 Bankr. Lexis 1286(Bankr. S. D. FL 2007)(J. Raymond B. Ray). In that case, the court concluded that the creditor was entitled to retail value, but the debtor could offset by the retail cost of repairs.
2. 11 USC 506. Determination of Secured Status:
A. (1) An allowed claim of a creditor secured by a lien on property in which the estate has an interest, or that is subject to setoff under Section 553 of this title, is a secured claim to the extent of the value of such creditor’s interest in the estate’s interest in such property, or to the extent of the amount subject to setoff, as the case may be, and is an unsecured claim to the extent that value of such creditor’s interest or the amount so subject to setoff is less than the amount of such allowed claim. Such value shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property, and in conjunction with any hearing on such disposition or use or on a plan affecting such creditor’s interest.
(2) If the debtor is an individual in a case under Chapter 7 or 13, such value with respect to personal property securing an allowed claim shall be determined based on the replacement value of such property as of the date of filing of the petition without deduction for costs of sale or marketing. With respect to property acquired for personal, family or household purposes, replacement value shall mean the price a retail merchant would charge for property of that kind considering the age and condition of the property at the time value is determined.
(b) To the extent that an allowed secured claim is secured by property the value of which, after any recovery under subsection (c) of this section, is greater than the amount of such claim, there shall be allowed to the holder of such claim, interest on such claim, and any reasonable fees, costs, or charges provided for under the agreement or State statute under which such claim arose.
As discussed previously, a debtor can reduce the amount she has to pay a secured creditor. Section 506(a) provides the basis for this lien strip because a claim is only secured “to the extent of the value of such creditor’s interest in the estate’s interest in such property… and is only unsecured as to the balance. Valuation hearings are necessary to determine the amount of the secured claim; (Usually a settlement is reached as to valuation). Section 506(a)(2) clarified the standards for valuation.
The so-called “hanging paragraph” was enacted to reduce the rights of debtors to utilize Section 506. A treatise could be written to cover all the litigation that has and will continue to occur to interpret BAPCPA’s efforts to protect secured creditors based on the amendment set forth below.
3. 11 U.SC. § 1325 Confirmation of Plan-910 Vehicles:
(5) with respect to each allowed secured claim provided for by the plan;
(After several subsections, without any separate number, is the following new section which is now known as “the hanging paragraph” for personal property secured claims.)
For purposes of paragraph (5), section 506 shall not apply to a claim described in that paragraph if the creditor has a purchase money security interest securing the debt that is the subject of the claim, the debt was incurred within the 910-day preceding the date of the filing of the petition, and the collateral for that debt consists of a motor vehicle (as defined in section 30102 of title 49) acquired for the personal use of the debtor, or if collateral for that debt consists of any other thing of value, if the debt was incurred during the one-year period preceding that filing.
The statute attempted to provide a 910 day period for vehicles and one year period as to other personal property. The focus of this discussion will be on vehicles. It is important to review each of the elements of the statute, because each term is subject to litigation. The following elements must apply to prevent the debtor from being able to utilize Section 506 to reduce the amount that must be paid as a secured claim.
a. Purchase money security interest:
The issue is whether all or a portion of the purchase price can be treated as wholly unsecured when all of the purchase price is not actually “purchase money.” This issue is based on interpreting the particular state statutes and case law to define a purchase money security interest. See FL Stat. 679.1031. For example, see In re Vega, 344 B.R. 616 (Bankr. D. Kan. 2006)(purchase money lien on vehicle existed only to the extent that portion of loan was actually used to acquire new vehicle, so claim was a 910- claim but debtor only had to pay the purchase money portion). In re White, 2006 WL 2827321 (Bankr. E.D. La. Sept. 29, 2006)(Only portion of claim attributable to purchase price of vehicle is a purchase money security interest under Louisiana law including sales tax, notary documentation, license, title, registration, and recordation fees; creditor did not hold purchase money security interest in insurance deficiency or extended warranty contracts because they are insurance contracts) Generally, see In re Acaya, 2007 Bankr. Lexis 1773(Bankr. N. D. CA May 18, 2007), In re Horn 338 BR 110(Bankr MD Ala 2006), and In re Graupner, 356 BR 907(Bankr. MD GA 2006), affirmed Case No. 4:07CV-37, 2007 US Dist. Lexis 46144((MD GA 2007). Recently, In re Pajot, 2007 Bankr. Lexis 2493(Bankr ED VA July 17, 2007) reviewed case law involving these issues including “negative equity” involving a trade-in when purchasing a new vehicle. These cases discuss a “transformation rule” compared to a “dual status” rule to determine if all or a portion of the debt is to be treated as purchase money. Pajot recognized that the majority rule was a dual status rule, meaning that the purchase price can have a dual status between purchase money( a 910 claim) and non-purchase money which can be bifurcated. Also compare In re Peaslee, 358 BR 545 (Bankr. W. D. NY 2006), which adopted the “transformation rule”. See fn 4, describing the rule as transferring into non-purchase money when collateral secures more than its own purchase price. Peaslee also recognized severe proof problems if a court had to determine the separate values. But see In Re Cohrs, 2007 Bankr. Lexis 2559(Bankr. ED CA July 31, 2007)(finding close nexus at time of purchase does not eliminate purchase money status).
b. Debt incurred within 910 days: Be careful to count the days and review the facts of each case. Issues overlap with purchase money security issues. Consider when the was incurred in a cross-collateral agreement or refinancing.
c. Acquired for the personal use:
What if the vehicle was a pick-up truck that the debtor uses to haul materials for work? This might not be construed for a 910 claim. For example, see In re Solis, 356 BR 398 (Bankr. S.D Tex. Nov. 14, 2006). The vehicle was purchased for mixed personal and business use. The “personal use” requirement of the statute is satisfied if personal use of the debtor is significant and material. The vehicle was used for personal purposes within the statute where it was only family vehicle and debtor used it to go to and from work. In re Wilson, 2006 Bankr Lexis 3325 (Bankr. D. Kan. Dec. 5, 2006), adopted the Solis “significant and material” test for determining personal use and held that personal use of vehicles was neither inconsequential nor immaterial where routinely used for personal activities. Also see In re Smith, 2007 Bankr. Lexis 1872(Bankr. SD TX May 29, 2007). But compare cases such as In Re Medina, 362 BR 799(Bankr SD TX 2007)(look at the totality of the circumstances and if a significant contribution to income. Commuting to work is not for personal use, though IRS considers the use personal.)
Lenders may want the purchaser to sign a document that the vehicle is for the personal use of the purchaser. In re Andoh, 2007 Bankr. Lexis 2084(Bankr. D. CO June 2007) reviewed several cases and listed the numerous factors courts were using under a totality of the circumstances test. The court rejected the argument that checking a box for personal, family or household use was dispositive. Also see the Phillips case in the next section.
d. Of the debtor(not son or perhaps even spouse):
Cases have held that a debt for a motor vehicle purchased primarily for the use of the Debtor’s spouse was not a 910 vehicle thus a section 506 valuation to reduce the secured amount was permissible. The vehicle must have been acquired for the use of a particular person, the Debtor, for the paragraph to apply. In re Jackson, 338 B.R. 923 (Bankr.M.D.Ga.2006).Also see In Re Adams, 2007 Bankr Lexis 616(Bankr. MD GA 2007)(purchased for wife of debtor).
Judge Olson in the Southern Distsrict of Florida reached this conclusion in In re Press, 2006 WL 2724335 (Bankr. S.D. FL. Jul. 26, 2006)(Case No. 06-10978)(where husband and wife have only one car, but evidence demonstrated that car acquired for personal use of non-debtor spouse, vehicle was not within the meaning of hanging paragraph.)
But compare In Re Phillips, 362 BR 284(Bankr. ED Va 2007) which rejected the above decisions, in part based on Fourth Circuit opinions interpreting personal use. The hanging paragraph refers to personal use, not to personal, family or household use as in other code sections. Phillips essentially construed personal use to not include business use, but that it does include other household or family use.
e. Or if collateral for that debt consists of any other thing of value:
Does this clause also apply to vehicle loans that have any additional collateral? This provision precedes the clause as to debt incurred within one year. This clause is designed to prevent lien stripping of other personal property such as collateral for furniture loans and might have nothing to do with motor vehicle loans. However, vehicle loans that are not purchase money collateral should be covered by this section.
E. Surrender or eat steel
Fine, we now have a 910 vehicle that the debtor cannot reduce the valuation and is stuck with the full amount of the debt. In a 910 vehicle, the debtor cannot bifurcate the claim between the secured and unsecured portion. With what has been described as what is good for the goose is good for the gander, cases have generally held that if the claim cannot be bifurcated, and if the debtor wants to surrender the vehicle, the creditor must accept the vehicle as full payment without any deficiency and no longer has any unsecured claim. For the first principal case on this issue, see In re Ezell, Also see In re Brown, 346 B.R. 868 (Bankr. N.D. Fla. 2006), In re Roth, 2007 Bankr Lexis 1647(Bankr. ND IN May 4, 2007)(finding that courts are 3 to 1 in favor of surrender in full satisfaction); In re Williams, 2007 Bankr. Lexis 1754 (Bankr MD FL May 21, 2007)(J. Jennemann). Appellate courts have recently split. Adopting the majority view, see in In re Quick, 2007 WL 1941749)(10th Cir BAP July 5, 2007), and In re Osborne, 363 BR 72 (8th Cir. BAP. 2007). However, the minority position has recently been adopted by appellate courts in In re Wright, 2007 WL 1892502(7th Cir. July 3, 2007), and In re Natalie Rodriquez, -BR-, (9th Cir BAP August 28, 2007), Case No. WW-07-1046-MoDJ.
F. Interest rate
There are a number of issues pertaining to the appropriate interest rate. Prior to the enactment of BAPCPA, the United States Supreme Court in Till v. SCS Credit Corp., 541 US 465(2004) addressed the issue of the appropriate interest to pay the value of the secured claim over time. The Court essentially concluded that the bankruptcy courts should look at the prime rate as the base plus a risk factor. Typically, at least in the Southern District of Florida, plans provide for the prime rate plus 2% to payoff the vehicle. The application of Till especially in relation to the new 910 creates several legal issues. The wide range of decisions and local practice lead to different results in different jurisdictions. Some of these issues and example cases are listed below.
1. Compare contract rate to Till rate. If the contract rate is higher than the Till rate, the debtor will be able to confirm a plan using the lower Till rate. However, consider a case where the contract rate is 1.9% and the Till rate of prime plus 2% is 10.25%. There are numerous fact scenarios which require interpretation, and the case holdings have differed. Consider the following fact patterns:
a. Term of note ends in two years, but debtor proposes to pay in full over 5 years. Does contract rate or Till rate apply? Does it make a difference if the vehicle was purchased within 910 days? In other words, does Till apply to 910 vehicles?
b. Same as above, term ends in 2 years, the car is not a 910 claim, and the debtor can strip the value of the vehicle and extend the car payments. Can the debtor strip and only pay 1.9% interest? Several cases have held that the higher Till rate applies even when contract rate is lower. In re Pryor, 341 B.R. 648 (Bankr. C.D. Ill. 2006). In re Scruggs, 342 B.R. 571 (Bankr. E.D. Ark. 2006). In re Soards, 344 B.R. 829 (Bankr. W.D. Ky. 2006), and In re Brill, 350 B.R.853 (Bankr. E.D. Wis. Sept. 22, 2006). At least one case has held that the contract rate applies in a 910 case, In Re Taranto, 344 BR 857(Bankr. N. D. Oh 2006), but as discussed below, this case was reversed.
2. Is the 910 claim a secured claim which requires the payment of any interest? An intriguing argument is that since the hanging paragraph expressly does not use Section 506 to value collateral to reduce the amount that has to be paid to the secured creditor, that a 910 vehicle paid in the plan does not have to pay any interest. This was the holding in In re Carver, 338 B.R. 521 (Bankr. S.D. Ga. 2006) and In re Wampler, 345 B.R. 730 (Bankr. D. Kan. 2006); In re Green 348 BR 601(Bank M. D Ga 2006)(finding that the creditor could receive the greater of the full balance with no interest or the bifurcated amount of the secured claim plus interest). However, this view seems to be the clear minority. In the Southern District of Florida, though in only a footnote, this view was rejected in In re Press, cited above. Also, the Taranto case cited above was reversed on appeal. In re Taranto, 365 BR 85 (BAP 6th Cir 2007). The courts concluded that the 910 creditor remains entitled to the present value of its claim pursuant to 1325(a)(5). The secured creditor is entitled to payments over time equal in value to its claim. If only the full principal amount of the claim were to be paid over time with no interest, the creditor would not be receiving the value of its claim. Finally, the judge in the Wampler case cited above had a similar ruling in In re Kinsey, 368 BR 888 (Bankr. D. KS May 9, 2007), but was reversed on this issue in Citifinancial Auto v. Hernandez-Simpson, 2007 US Dist Lexis 36416(KS DC May 17, 2007).
E: Payment Changes in Chapter 13
As a final note, a recent case is important on the issue of changes in the amount of required mortgage payments after the bankruptcy is filed. In re Dominque, 368 BR 913 (Bankr. S.D FL 2007)(J. Isicoff) The case should be reviewed by debtors and creditors attorneys for the proper way to handle changes in the amount of required escrow during the term of the chapter 13. The lender is not violating the automatic stay and is actually required to provide notice of payment changes. By failing to provide these notices the debtor could discharge the additional amounts that would have been owed for post-petition escrow payments.