Bar News - July 17, 2009
A Primer on Residential Mortgage Cramdowns in Bankruptcy
By: William J. Amann
Cramdowns in Chapter 13 cases have resurfaced recently after disappearing in the later 1990s when we last faced a plunging real estate market and related economic turmoil. A mortgage can be "crammed down" when its balance is less than the value of the property securing it. During the early 1990s, when property values were declining as they are today, it was relatively uncomplicated to file a chapter 13 cramdown plan. The claim is bifurcated into secured and unsecured portions. The unsecured portion is treated in the same manner as other general, unsecured claims in Chapter 13, often receiving a small dividend through the plan.
|William J. Amann
First mortgages secured only by a debtor’s home cannot be crammed down at all. However, cramdowns are permissible when there is additional collateral for a mortgage besides the home, when a property is an investment or vacation home, or in cases of multi-family dwellings. In such cases, the mortgage claim can be bifurcated and the secured claim paid in one of the ways that the Code allows. Once a secured claim in a Chapter 13 case is successfully bifurcated under 11 U.S.C. § 1322(b)(2), the claim can either be modified or cured within the plan pursuant to either U.S.C. § 1322(a)(5) or U.S.C. § 1322(b)(5) respectively.
If the former is chosen, and the claim is to be modified, the entire amount of the secured portion of the bifurcated claim must be paid in full during the life of the plan pursuant to U.S.C. § 1322(a)(5) and § 1322(d). See also, In re Plourde, 2009 BNH 7 (2009); In re McDonald, 397 B.R. 175, 176 (Bankr. D. Me. 2007); In re Kheng, 202 B.R. 538, 539 (Bankr. D.R.I. 1996); Brown v. Shorewood Fin. Inc. (In re Brown), 175 B.R. 129, 133 (Bankr. D. Mass. 1994); In re Murphy, 175 B.R. 134, 137 (Bankr. D. Mass. 1994); In re McGregor, 172 B.R. 718 (Bankr. D. Mass. 1994); In re DeMaggio, 175 B.R. 144 (Bankr. D. NH 1994); and In re Legowski, 167 B.R. 711, 716 (Bankr. D. Mass. 1994).
Debtors typically filed 11 U.S.C. §506(b) motions to determine the amount of the secured claim and after either agreement with the mortgagee or court determination, a secured value was set and an interest rate determined under the "formula" method. See In re St. Cloud 209 B.R. 801 Bkrtcy.D.Mass.,1997.) See also, Till v. SCS Credit Corp., 541 U.S. 465 (2004). An appropriate rate should compensate creditors for deferred payments on the value of their present claims. Rake v. Wade, 508 U.S. 464, 472, (1993). In determining the correct interest rate, the Court, "should aim to treat similarly situated creditors similarly and to ensure that an objective economic analysis would suggest the debtor’s interest payments will adequately compensate all such creditors for the time value of their money and the risk of default." Id. at 477, 478.
Debtors then filed a balloon payment plan calling for sale or refinance of the property in the 60th month of the bankruptcy plan. If the debtor made all the payments under the confirmed plan, the big reward at the end of the plan was the so-called super discharge and freedom from a mortgage payment. All of the payments were paid to the trustee. If the debtors made all the payments, the plan worked because the economic conditions had improved considerably during the life of the plan such that the debtors were able to take advantage of refinancing and/or a sale to complete their balloon payments. However, mortgagees did not receive the benefit of the improved market conditions and were stuck having to accept a "payoff" pursuant to the terms of the confirmed plan.
(On April 30, 2009 a proposed amendment to 11 U.S.C. §1322(b) before the U.S. Senate was defeated. The bill would have allowed bankruptcy judges to modify first mortgages on residential properties.)
The ability of debtors to craft feasible Chapter 13 cramdown plans significantly decreased with the Amendment of the Bankruptcy Code in 2005 (BAPCPA). In order to draft a feasible cramdown plan, the debtors have to either propose other than a periodic payment plan or a plan that calls for maintenance of payments to satisfy § 1322(b)(5) during the life of the plan.
The determination of value is a key component to any cramdown. In general, the appropriate standard for establishing value for both residential and commercial real estate is the replacement value. See In re Young, 390 B.R. 480, Bkrtcy.D.Me., 2008. See also In re Winthrop Old Farm Nurseries, 50 F.3d 72 (1st Cir. 1995). After the cramdown, the property is to be retained by the debtors. After fixing the value of the property, either through agreement with the lender or through litigation, a secured claim must generally be paid with interest during the life of the plan.
This creates a practical difficulty: secured claims are usually quite large and the duration of a Chapter 13 plan cannot exceed five years. A debtor will seldom have sufficient income to pay such a large claim in such a short time. One way that bankruptcy practitioners handled this problem prior to the BAPCPA amendments was to file a plan with a sale or refinancing provision. The BAPCPA amendments imposed a new requirement on the treatment of secured claims, requiring that "if property to be distributed pursuant to this subsection is in the form of periodic payments, such payments shall be in equal monthly amounts." 11 U.S.C. 1325(a)(5)(B)(iii).
Although practitioners have proposed plans containing balloon payments since this amendment, these attempts have largely been unsuccessful. Recently, the First Circuit Bankruptcy Appellate Panel sharpened this point by affirming the denial of confirmation of a Chapter 13 plan because of a balloon payment provision. See Hamilton v. Wells Fargo Bank, 1st Cir. BAP NO. MB 08-046 (March 6, 2009).
Two seemingly viable, yet underutilized, possibilities remain when trying to achieve confirmation of a cramdown plan. The first option is to avoid the statute’s conditional prohibition on balloon payments by proposing a plan without periodic payments. Another option for paying the secured portion of a crammed down mortgage is a so-called McGregor plan. These plans were first articulated by former Massachusetts bankruptcy judge Hon. James F. Queenan, Jr. in the case In re McGregor, 172 B.R. 718 (Bankr.D.Mass.1994), and adopted by Hon. Joseph Feeney in the case of In Re Trenton Murphy, 175 B.R. 134 (Bankr.D.Mass. 1994).
The key to such a plan is Section 1322(b)(5), which states that a debtor may "provide for the curing of any default within a reasonable time and maintenance of payments while the case is pending on any unsecured claim or secured claim on which the last payment is due after the date on which the final payment under the plan is due." This is the provision that allows for the commonplace Chapter 13 plan proposing to cure mortgage arrears while maintaining regular, post-petition mortgage payments in order to stave off a foreclosure and bring a mortgage back into good standing.
The only difference between a McGregor plan and a normal cure-and-maintain plan is that the amount of the secured claim will have changed. In a McGregor plan, a debtor cannot re-amortize the secured portion and avoid making normal post-petition mortgage payments as called for by the note; he will simply pay off the mortgage more quickly because the secured amount will have been reduced. However, these normal payments need only be maintained during the life of the plan, which might be as little as three years. After that, the debtor could resolve with the lender the amount of the outstanding secured claim (or seek a judicial declaration of this amount) and seek a refinancing of the new balance to reduce the ongoing mortgage payment.
Understanding that a debtor has a loan that may be modified does not mean that the debtor will be able to draft a plan that can be confirmed even if he reaches an agreement on the secured claim amount and interest rate. Most debtors will not have the means to pay the cramdown claim within the life of the plan or, if they chose the McGregor route, repaying the claim pursuant to the original loan documents to the amount of the new secured claim.
Other avenues may provide relief for debtors, such as voluntary loan modifications which typically take the claim out of Chapter 13 by rewriting it to eliminate the arrearages. There are also the standard forbearance agreements which spread out the arrearages over a shorter period of time than a five-year plan, but may also temporarily reduce the payments and the interest rate. Any voluntary modifications have to be done directly with the servicer but in the end may better provide the permanent relief the debtor seeks in order to save his/her residence.
William J. Amann is with Sheehan, Phinney, Bass + Green, P.A. in Concord. He may be reached at firstname.lastname@example.org.