CHAPTER 13CHAPTER 13AVOIDANCE OF MORTGAGES THAT AVOIDANCE OF MORTGAGES THAT

ENCUMBER A PRINCIPAL ENCUMBER A PRINCIPAL RESIDENCERESIDENCE

By: David Wm. Ruskin, C. Jason Cardasis, and John By: David Wm. Ruskin, C. Jason Cardasis, and John KapitanKapitan

UnemploymentUnemployment

Economists say a nationwide Economists say a nationwide unemployment rate between 4.5% and 5% unemployment rate between 4.5% and 5% is generally consistent with a good job is generally consistent with a good job market and solid wage growth.market and solid wage growth.

The January 2008 U.S. unemployment rate The January 2008 U.S. unemployment rate was 4.9%. was 4.9%.

In Michigan, it was 7.2%.In Michigan, it was 7.2%. The January 2009 U.S. unemployment rate The January 2009 U.S. unemployment rate

was 7.6%--the highest since 1992.was 7.6%--the highest since 1992. In Michigan, the February rate was 12%.In Michigan, the February rate was 12%.

ForeclosuresForeclosures

Home Values PlummetHome Values Plummet

Can a Debtor modify a mortgage Can a Debtor modify a mortgage that encumbers their principal that encumbers their principal residence in a Chapter 13 case residence in a Chapter 13 case

even though 1322(b)(2) even though 1322(b)(2) prohibits modification?prohibits modification?

You bet they can!You bet they can!

Sixth Circuit Case LawSixth Circuit Case LawLane v. Western Interstate Bankcorp (In Lane v. Western Interstate Bankcorp (In

re Lane)re Lane), 280 F.3d 663 (6th Cir. 2002) , 280 F.3d 663 (6th Cir. 2002) Chapter 13 debtors in the Sixth Circuit are Chapter 13 debtors in the Sixth Circuit are

allowed to modify the rights of holder of a allowed to modify the rights of holder of a secured claim on the debtor’s principal secured claim on the debtor’s principal residence if the security interest is wholly residence if the security interest is wholly unsecured. unsecured.

BasicsBasics 1.1. Section 1322(b)(2) prohibits modification of the rights of a holder Section 1322(b)(2) prohibits modification of the rights of a holder

of a of a secured claim if the security consists of a lien on the debtor's secured claim if the security consists of a lien on the debtor's principal residence; principal residence;

2.2. Section 1322(b)(2) permits modification of the rights of an Section 1322(b)(2) permits modification of the rights of an unsecured unsecured claimholder;claimholder;

3.3. Whether a lien claimant is the holder of a "secured claim" or an Whether a lien claimant is the holder of a "secured claim" or an “unsecured claim" depends on whether the claimant's security “unsecured claim" depends on whether the claimant's security

interest interest has any actual "value" under 11 U.S.C. § 506. has any actual "value" under 11 U.S.C. § 506.

4.4. If a claimant's lien on the debtor's homestead has a positive value, If a claimant's lien on the debtor's homestead has a positive value, no no matter how small in relation to the total claim, the claimant holds matter how small in relation to the total claim, the claimant holds a a "secured claim" and the claimant's contractual rights under the "secured claim" and the claimant's contractual rights under the loan loan documents are not subject to modification by the Chapter 13 plan; documents are not subject to modification by the Chapter 13 plan;

5.5. If a claimant's lien on the debtor's homestead has no value at all, If a claimant's lien on the debtor's homestead has no value at all, on on the other hand, the claimant holds an "unsecured claim" and the the other hand, the claimant holds an "unsecured claim" and the

claimant's contractual rights are subject to modification by the claimant's contractual rights are subject to modification by the plan. plan.

Lane v. Western Interstate Bankcorp (In re Lane)Lane v. Western Interstate Bankcorp (In re Lane), 280 F.3d at 670 (6th Cir. , 280 F.3d at 670 (6th Cir. 2002).2002).

Exactly what in the Code Exactly what in the Code provides the authority to do provides the authority to do

this?this? It appears that the only statutory It appears that the only statutory

provisions available to a Chapter 13 provisions available to a Chapter 13 debtor to avoid wholly unsecured liens on debtor to avoid wholly unsecured liens on their principal residence are 11 U.S.C. §§ their principal residence are 11 U.S.C. §§ 1322(b)(2), 1325(a)(5) and 1327(c). 1322(b)(2), 1325(a)(5) and 1327(c).

Section 1327(c) serves to avoid the lien Section 1327(c) serves to avoid the lien and 1322(b)(2) and 1325(a)(5) define the and 1322(b)(2) and 1325(a)(5) define the permissible scope of such avoidance. permissible scope of such avoidance.

In re HillIn re Hill 304 B.R. 800, 803-5 (Bankr. S.D. 304 B.R. 800, 803-5 (Bankr. S.D. Ohio 2003) Ohio 2003)

Cont.Cont. A second, third, etc. mortgage may be determined to be wholly A second, third, etc. mortgage may be determined to be wholly

unsecured under Section 506(a) but Section 506(d) cannot be unsecured under Section 506(a) but Section 506(d) cannot be used to void the lien because this provision voids only liens that used to void the lien because this provision voids only liens that secure claims which have not been allowed under Section 502. secure claims which have not been allowed under Section 502. In In re Hillre Hill 304 B.R. at 803. 304 B.R. at 803.

Thus, one must look to Section 1325 for the scope of any such Thus, one must look to Section 1325 for the scope of any such modification of the lien. modification of the lien.

Looking at the plain language of Section 1325(a)(5)(B)(i) it is clear that 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, 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 the mortgagee will still retain the lien securing its claim until the earlier of the payment of the underlying debt determined under non of the payment of the underlying debt determined under non bankruptcy law or discharge under Section 1328. bankruptcy law or discharge under Section 1328.

In addition, if the Chapter 13 case is dismissed or converted without 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 completion of the plan, the lien will also be retained by the creditor to the extent recognized by applicable non-bankruptcy law. the extent recognized by applicable non-bankruptcy law.

But you can’t But you can’t do it in a Chapter 7 Casedo it in a Chapter 7 Case

Sixth Circuit Case LawSixth Circuit Case LawTalbert v. City Mortg.Servs. (In re Talbert v. City Mortg.Servs. (In re

Talbert)Talbert), 344 F.3d 555 (6th Cir. 2003) , 344 F.3d 555 (6th Cir. 2003) A Chapter 7 Debtor may not use 11 U.S.C. § A Chapter 7 Debtor may not use 11 U.S.C. §

506 to “strip off” an allowed junior lien 506 to “strip off” an allowed junior lien where the senior lien exceeds the fair where the senior lien exceeds the fair market value of the real property. market value of the real property.

What about if only one spouse What about if only one spouse files a Chapter 13 case and the files a Chapter 13 case and the property is held as tenancy by property is held as tenancy by

the entireties?the entireties?What’s entireties property?What’s entireties property?

In Michigan, tenancy by the entireties is In Michigan, tenancy by the entireties is recognized as one type of joint interest recognized as one type of joint interest in real property. A tenancy by the in real property. A tenancy by the entireties is created when a conveyance entireties is created when a conveyance of land is made to a husband and wife. of land is made to a husband and wife. (See Generally, (See Generally, Morgan v. Cincinnati Ins. Morgan v. Cincinnati Ins. CoCo., 411 Mich. 267, 284; 307 N.W.2d 53, ., 411 Mich. 267, 284; 307 N.W.2d 53, 58 (1981)) 58 (1981))

Tenancy by the entireties Tenancy by the entireties (cont.)(cont.)

When real property is so held by tenants by When real property is so held by tenants by the entireties, neither spouse acting alone the entireties, neither spouse acting alone can alienate or encumber to a third person can alienate or encumber to a third person an interest in fee of land so held. Neither an interest in fee of land so held. Neither the husband nor the wife has an individual, the husband nor the wife has an individual, separate interest in entireties property, and separate interest in entireties property, and neither has an interest in such property neither has an interest in such property which may be conveyed, encumbered or which may be conveyed, encumbered or alienated without the consent of the other.alienated without the consent of the other.Rogers v. RogersRogers v. Rogers, 136 Mich. App. 125, 134; , 136 Mich. App. 125, 134; 356 N.W.2d 288 (1994) 356 N.W.2d 288 (1994)

Back to the original question Back to the original question ---- Hunter v. Citifinancial, Inc. (In re Hunter),Hunter v. Citifinancial, Inc. (In re Hunter),

284 B.R. 806 (Bankr. E.D. Va 2002)284 B.R. 806 (Bankr. E.D. Va 2002) An individual debtor cannot avoid a lien on real An individual debtor cannot avoid a lien on real

property owned by the debtor and his wife as property owned by the debtor and his wife as tenants by the entireties with the right of tenants by the entireties with the right of survivorship.survivorship.

But why? --Even if the lien were voidable as to the But why? --Even if the lien were voidable as to the debtor's interest, the spouse's interest in the entirety debtor's interest, the spouse's interest in the entirety would still be burdened with the lien. Where only one would still be burdened with the lien. Where only one tenant by the entireties sought to sever the estate as tenant by the entireties sought to sever the estate as to one aspect only, he/she could not do so. to one aspect only, he/she could not do so.

Note: the rights possessed by a Pennsylvania tenant by Note: the rights possessed by a Pennsylvania tenant by the entireties closely follow those held by a Michigan the entireties closely follow those held by a Michigan tenant tenant Popky v. United States of AmericaPopky v. United States of America, 326 F. , 326 F. Supp. 2d 594 (E.D. Penn 2004)Supp. 2d 594 (E.D. Penn 2004)

Cont.Cont.

Rodriguez v. Madera County Federal Credit Rodriguez v. Madera County Federal Credit Union (In re Rodriguez),Union (In re Rodriguez), 156 B.R. 659 (Bankr 156 B.R. 659 (Bankr E.D. CA 1993)E.D. CA 1993) A debtor holding only a fractional interest (like a A debtor holding only a fractional interest (like a

50% interest) in property cannot utilize section 50% interest) in property cannot utilize section 506 to value a secured claim.506 to value a secured claim.

But seeBut see: : Highland Fed. Bank v. Maynard (In re Highland Fed. Bank v. Maynard (In re Maynard),Maynard), 264 B.R. 209 (B.A.P. 9 264 B.R. 209 (B.A.P. 9thth Cir. 2001) Cir. 2001) (Court held that community property of both (Court held that community property of both spouses became property of the estate even spouses became property of the estate even though husband did not file. Thus, stripping of though husband did not file. Thus, stripping of mortgage encumbering community property mortgage encumbering community property allowed)allowed)

What about if I attempt to avoid What about if I attempt to avoid the mortgage(s) through a plan the mortgage(s) through a plan modification after confirmation?modification after confirmation?

MaybeMaybeThe power to modify a wholly unsecured The power to modify a wholly unsecured

mortgage must be exercised at mortgage must be exercised at confirmation, or it’s lost.confirmation, or it’s lost.See, e.g., See, e.g., In re CruzIn re Cruz, 253 B.R. 6387, 643-44 , 253 B.R. 6387, 643-44

(Bankr. D.N.J. 2000) (Bankr. D.N.J. 2000) But see, But see, Waters v. Money Story (In re Waters v. Money Story (In re

Waters),Waters), 276 B.R. 879 (Bankr. N.D. Ill 2002) 276 B.R. 879 (Bankr. N.D. Ill 2002) (allowed post-confirmation avoidance (allowed post-confirmation avoidance because value post-confirmation was same because value post-confirmation was same as it was pre-confirmationas it was pre-confirmation

Well, what method should I Well, what method should I employ to strip a mortgage?employ to strip a mortgage?

To file or not to file - an A.P. that is.To file or not to file - an A.P. that is.

Some believe an A.P. is necessary.Some believe an A.P. is necessary. A creditor is entitled to a declaratory action to A creditor is entitled to a declaratory action to

determine the validity and extent of its lien in order to determine the validity and extent of its lien in order to satisfy due process. Fed. R. Bankr. P. 7001(2) satisfy due process. Fed. R. Bankr. P. 7001(2) provides in pertinent part, "An adversary provides in pertinent part, "An adversary proceeding . . . is a proceeding … to determine the proceeding . . . is a proceeding … to determine the validity, priority, or extent of a lien...";validity, priority, or extent of a lien...";

When a party asks the Bankruptcy Court to determine When a party asks the Bankruptcy Court to determine the extent of a lien or the value of the collateral the extent of a lien or the value of the collateral forming the basis of the lien, adversary proceedings forming the basis of the lien, adversary proceedings are required as contemplated by Fed. R. Bankr. P. are required as contemplated by Fed. R. Bankr. P. 7001(2) and 3012, 7001(2) and 3012, see Wright v. Commercial Credit see Wright v. Commercial Credit CorporationCorporation, 178 B.R. 703 (Bankr. E.D. Virginia 1995), 178 B.R. 703 (Bankr. E.D. Virginia 1995)

Cont.Cont.

While some courts believe doing it through the While some courts believe doing it through the Plan is fine– as long as you follow certain Plan is fine– as long as you follow certain requirements.requirements.

Judge Shapero - Judge Shapero - In re: JuszkowskiIn re: Juszkowski, Chapter 13 No. 07-, Chapter 13 No. 07-53472, *2 (December 18, 2007) (Chapter 13 debtor, 53472, *2 (December 18, 2007) (Chapter 13 debtor, may, as part of a plan, modify the rights of a secured may, as part of a plan, modify the rights of a secured creditor. However, all necessary due process creditor. However, all necessary due process requirements, including notice, potential discovery, requirements, including notice, potential discovery, etc. available in a contested matter context, and, as etc. available in a contested matter context, and, as such, satisfy the legal, practical, and other needs of such, satisfy the legal, practical, and other needs of the situation.)the situation.)

Notice – Rule 7004 provides guidance as to how service Notice – Rule 7004 provides guidance as to how service should be made on parties.should be made on parties.

Method to avoid (cont.)Method to avoid (cont.)

What about a motion?What about a motion?Probably the least liked method.Probably the least liked method.

DISCUSSION ON EASTERN DISTRICT DISCUSSION ON EASTERN DISTRICT PREFERRED METHODS.PREFERRED METHODS.

Practice Pointer!Practice Pointer! When applying for a default judgment, it is good practice to When applying for a default judgment, it is good practice to

include, not only proof of service of the summons and include, not only proof of service of the summons and complaint, but also statement(s) of the amounts owed to each complaint, but also statement(s) of the amounts owed to each mortgage lender, and something that will verify the value of mortgage lender, and something that will verify the value of the property. If you don’t, you may wind up getting the the property. If you don’t, you may wind up getting the application scheduled for hearing, and/or worse, having it application scheduled for hearing, and/or worse, having it denied.denied.

DRAFTING ADVERSARY DRAFTING ADVERSARY COMPLAINT/PLANCOMPLAINT/PLAN

A.A. Language/documents needed in Language/documents needed in AP.AP.

B.B. Language needed in Plant to Language needed in Plant to effectuate AP or “lien strip”.effectuate AP or “lien strip”.1.1. Class Two Language.Class Two Language.2.2. Proof of Claim Language in Plan.Proof of Claim Language in Plan.3.3. Recordable Form of Plan/Order.Recordable Form of Plan/Order.

C.C. When to file AP to avoid mortgage.When to file AP to avoid mortgage.

Service of APService of AP1.1. Who to Serve.Who to Serve.2.2. F.R. Civ. P. 4F.R. Civ. P. 4

a.a. Corporation Corporation http://www.dleg.state.mi.us/bcs_corp/sr_corp.asphttp://www.dleg.state.mi.us/bcs_corp/sr_corp.asp

i.i. Registered Agent Registered Agent

ii.ii. Officer Officer

b.b. BankBank3.3. MERS - MERS - http://www.mersinc.org/http://www.mersinc.org/

Uncontested APUncontested APA.A. Application under Rule 55 and what Application under Rule 55 and what

documents are required.documents are required.

B.B. Language and terms of the Default Language and terms of the Default JudgmentJudgment

Things to watch forThings to watch for

Make sure you are as specific as Make sure you are as specific as possible as to which mortgage you are possible as to which mortgage you are attempting to avoid (legal description, attempting to avoid (legal description, liber, page, date and amount of liber, page, date and amount of mortgage, etc.)mortgage, etc.)You don’t want to get an objection or You don’t want to get an objection or

response simply because the complaint response simply because the complaint attempts to avoid all of the lender’s attempts to avoid all of the lender’s mortgages even the first (example: mortgages even the first (example: “Mortgagee has no liens on the property” “Mortgagee has no liens on the property” when they have a first and second)when they have a first and second)

Cont.Cont.

Service of Process on an insured Service of Process on an insured depository institution (bank)depository institution (bank)F.R.Civ.P. 4(h)F.R.Civ.P. 4(h)

Service of Summons and Complaint Service of Summons and Complaint after 10 days of issuance.after 10 days of issuance.

Wrong party as the defendantWrong party as the defendantMortgageeMortgagee

BurdensBurdens

Okay, now that we’re litigating, who Okay, now that we’re litigating, who has what burden?has what burden?Burden of Proof is on the debtor to Burden of Proof is on the debtor to

demonstrate that there is not even demonstrate that there is not even $1.00 of value over prior valid liens to $1.00 of value over prior valid liens to support the mortgage lien to be support the mortgage lien to be avoided.avoided.

Moving party bears the burden of proof Moving party bears the burden of proof on all avoidance issueson all avoidance issues

Cont.Cont.

In In In re DziendzielIn re Dziendziel, 295 B.R. 184 (Bankr. , 295 B.R. 184 (Bankr. W.D.N.Y. 2003) the court described the W.D.N.Y. 2003) the court described the debtor’s burden as: debtor’s burden as:

Naturally higher when: Naturally higher when: 1) it appears there was equity to 1) it appears there was equity to

support it at the time the mortgage support it at the time the mortgage was executed; was executed;

2) the deficiency is not substantial; 2) the deficiency is not substantial; andand

3) the lack of value may have been created, in part, 3) the lack of value may have been created, in part, because of a debtor’s failure to make payments on because of a debtor’s failure to make payments on superior mortgages, or other obligations (taxes), or superior mortgages, or other obligations (taxes), or

for some other reason for some other reason ………………………………………………………………………………

EXPERT OPINIONSEXPERT OPINIONS

Can I use my client’s opinion?Can I use my client’s opinion?Yes.Yes.Property owner is competent to give an Property owner is competent to give an

opinion under Fed.R.Evid 701. See, In re opinion under Fed.R.Evid 701. See, In re Jamison, 93 B.R. 595 (Bankr. S.D. Ohio Jamison, 93 B.R. 595 (Bankr. S.D. Ohio 1988)1988)

Experts (cont.)Experts (cont.)

Expert (Fed.R.Evid 702)Expert (Fed.R.Evid 702)

Foundation for qualification of expertFoundation for qualification of expert ExperienceExperience EducationEducation Licenses and CertificationsLicenses and Certifications

Appraiser Appraiser Can be used if proper foundation is laid (Note: Can be used if proper foundation is laid (Note:

Appraisal alone is hearsay when no foundation is Appraisal alone is hearsay when no foundation is provided)provided)

Real Estate Agent/BrokerReal Estate Agent/Broker Only if they have extensive experience. See, Only if they have extensive experience. See, In re: In re:

SchweizerSchweizer 354 B.R. 272 (Bankr. D. Idaho 2006); 354 B.R. 272 (Bankr. D. Idaho 2006); Donoway v. TuckerDonoway v. Tucker, 139 B.R. 156 (Bankr. D. Md. , 139 B.R. 156 (Bankr. D. Md. 1992)1992)

Experts (cont.)Experts (cont.)

Fair market value as of the petition Fair market value as of the petition date.date.

Methods of valuationMethods of valuationSales Comparison Approach: this is where Sales Comparison Approach: this is where

the property being appraised is compared the property being appraised is compared to recent sales of other properties. to recent sales of other properties. Used most often to derive value.Used most often to derive value.

Cost Approach: Cost of constructing an Cost Approach: Cost of constructing an equivalent structure with cost of propertyequivalent structure with cost of property

Income Approach: cash flow value - rentalsIncome Approach: cash flow value - rentals

What will the court do?What will the court do?

The court will take testimony and The court will take testimony and review the appraisals and then, most review the appraisals and then, most likely, use a weighted average based likely, use a weighted average based on the evidentiary weight given to on the evidentiary weight given to each. each.

Consent JudgmentConsent Judgment

Language for a Consent JudgmentLanguage for a Consent JudgmentMortgage is avoided only upon successful Mortgage is avoided only upon successful

completion of the Chapter 13 Plan and the completion of the Chapter 13 Plan and the debtor(s) obtaining an order of discharge.debtor(s) obtaining an order of discharge.

Creditor has an allowed unsecured claim.Creditor has an allowed unsecured claim.In the event of a refinance or sale prior to the In the event of a refinance or sale prior to the

completion of the Chapter 13 case and receipt of a completion of the Chapter 13 case and receipt of a Chapter 13 order of discharge, the mortgage is Chapter 13 order of discharge, the mortgage is paid in full at closing.paid in full at closing.

Mortgage is reinstated if case is converted or Mortgage is reinstated if case is converted or dismissed. dismissed.

What happens if the Chapter 13 What happens if the Chapter 13 Case is Converted or Dismissed?Case is Converted or Dismissed?

QUESTIONS?QUESTIONS?