Southern California Bankruptcy Law Blog

The Chapter 13 Bankruptcy Debt Limits And An Undersecured Mortgage On A Principal Residence

Posted in Chapter 13, Debt, Home Loans

Chapter 13 bankruptcy has an important limitation.  If the debtor’s debts are too large, Chapter 13 is unavailable:

Only an individual with regular income that owes, on the date of the filing of the petition, noncontingent, liquidated, unsecured debts of less than $383,175 and noncontingent, liquidated, secured debts of less than $1,149,525, or an individual with regular income and such individual’s spouse, except a stockbroker or a commodity broker, that owe, on the date of the filing of the petition, noncontingent, liquidated, unsecured debts that aggregate less than $383,175  and noncontingent, liquidated, secured debts of less than $1,149,525 may be a debtor under chapter 13 of this title.

11 U.S.C. § 109(e).

By the way, the numbers at the Cornell Law School site to which this links haven’t been updated for some time.  I corrected them in the quote above.  The modified quote is correct as of September 2014.

If either debt ceiling — either the secured, or unsecured — is exceeded, the debtor is ineligible for Chapter 13 protection, and must consider Chapter 11 bankruptcy.  This leads to the following question that was posed by a fellow bankruptcy attorney:

Question:

Suppose a debtor has a mortgage — for simplicity let’s say a first mortgage — that is undersecured, i.e., the value of the house is less than the current balance on the mortgage.  Does the unsecured portion of the mortgage count toward the $383,175 unsecured debt ceiling?

My answer was:  It depends on whether or not the house is the debtor’s principal residence.  But it’s a bit more complicated than you might imagine.  Let’s start with the simpler “nonprincipal residence” scenario.

Case I:  The Asset Is Not The Debtor’s Principal Residence

Here the simple answer is that the unsecured portion of the debt does count towards the unsecured debt ceiling.  As the Bankruptcy Appellate Panel for the Ninth Circuit held:

The overwhelming majority of courts, including every circuit that has considered the question, have concluded that the undersecured portion of a secured creditor’s claim should be counted as unsecured debt for § 109(e) purposes.  Matter of Day, 747 F.2d 405 (7th Cir. 1984); Miller v. U.S., 907 F.2d 80 (8th Cir. 1990); Brown & Co. Securities Corp. v. Balbus, (In re Balbus), 933 F.2d 246 (4th Cir. 1991).  This is impressive authority.  The majority view advocates importing a § 506(a) analysis to § 109(e) to define “secured” and “unsecured”.  This prevents raising form over substance and manipulation of the debt limits.  Refusing to count the undersecured portion of a secured creditor’s claim as unsecured debt ignores reality and could lead to absurd results.

In re Soderlund, 236 B.R. 271, 274-75 (B.A.P. 9th Cir. 1999).

Thus, the general principal is that an undersecured debt must be bifurcated into its secured and unsecured parts, and the unsecured portion counts against the unsecured debt limit in § 109(e).

However, although the above quote doesn’t distinguish between debts secured by a debtor’s home and those secured by something else, footnote 5 of the opinion does, to wit:

We note that a different question might be presented if the debts in question were entitled to the protection afforded by § 1322(b)(2), i.e., claims secured only by a security interest in real property that is the debtor’s principal residence.  See Nobelman v. American Savings Bank, 508 U.S. 324, 113 S.Ct. 2106, 124 L.Ed.2d 228 (1993) and Dewsnup v. Timm, 502 U.S. 410, 112 S.Ct. 773, 116 L.Ed.2d 903 (1992).  Here, the debts are not entitled to such protection, accordingly, we do not attempt to resolve this issue.

Id. at 275, n. 5.

This means that if the collateral is anything other than the debtor’s principal residence — it could be a rental property, a business, vats of tapioca — and the debt against it is undersecured, the unsecured portion counts against the unsecured debt limit.  But notice that the Soderlund Court didn’t address the principal residence question, and instead punted.

Case 2:  The Asset Is The Debtor’s Principal Residence

As I told you, things are a bit more complicated here.  There are several sources to which we must appeal to answer the question.

 

I.     Modifying Secured Debts In Chapter 13 Bankruptcy

First let’s consider 11 U.S.C. § 1322(b)(2) (with emphasis added):

[T]he [Chapter 13 ] plan may . . . 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, . . .

This Code subsection permits a Chapter 13 debtor to modify a secured debt through the plan, with one important exception:  It protects mortgages secured solely by the debtor’s primary residence from modification.

If you read my post on lien stripping in a Chapter 13 bankruptcy, you might suspect that there is an  inconsistency here.  There isn’t.  In that previous post I said that a debtor can strip off a wholly unsecured second mortgage on the debtor’s principal residence, pursuant to In re Zimmer, 313 F.3d 1220 (9th Cir. 2002),  because it is deemed to be unsecured.  That’s not the same thing as an undersecured mortgage.

For example, suppose the house is worth $300,000, the current balance on the first mortgage is $400,000, and the current balance on the second mortgage is $100,000.  Then the first mortgage is partially secured by the house up to $300,000 and cannot be modified because of § 1322(b)(2), but the second mortgage has no house behind it, so it is unsecured and can be stripped off.

 

II.     Determining The Secured Status Of A Debt

To what extent is a debt secured by an asset?  That question is answered by 11 U.S.C. § 506(a)(1):

An allowed claim of a creditor secured by a lien on property in which the estate has an interest . . . is a secured claim to the extent of the value of such creditor’s interest in the estate’s interest in such property . . . , and is an unsecured claim to the extent that the value of such creditor’s interest . . . is less than the amount of such allowed claim.

Alright, I admit this statutory prose is less than sparkling, but it means what I hope you think it should mean.

Suppose, for example, that you want to determine the extent to which the nth mortgage is secured and unsecured.  Begin by listing the encumbrances against the property in the order of their priority — first mortgage, second mortgage, etc.  Subtract the current balance of the first mortgage from the value of the property.  If you get a positive number, the first is entirely secured and you can move on to the second mortgage.  Take the positive number from the preceding calculation and subtract the current balance of the second mortgage from it.  If you get a positive number, the second is entirely secured and you can move on to the third mortgage.  Keep repeating this process through all of the encumbrances against the title.

If at any point you get a negative number, then the encumbrance at that point is either wholly unsecured, or partially secured up to the value of the positive number from the previous step, and unsecured to the absolute value of the negative number.

Do I see some glazed over eyes?  Unglaze them by keeping in mind the example I gave you above:  Suppose the house is worth $300,000, the current balance on the first is $400,000, and the current balance on the second is $100,000.  Then the first is secured up to $300,000 and unsecured by $100,000 (= $400,000 – $300,000), and the second is wholly unsecured.

 

III.       The Supreme Court’s Nobelman Decision

We know that a debtor can strip off a wholly unsecured second mortgage in a Chapter 13 because of Zimmer.  When that’s done, the current balance on that second mortgage is included in § 109(e)’s unsecured debt limit because of In re Smith, 435 B.R. 637, 648-49 (B.A.P. 9th Cir. 2010):

Section 1322(b)(2) allows chapter 13 debtors to “strip off” from their residences wholly unsecured liens.  Section 506(a) provides that an allowed “claim” of a “creditor” secured by a “lien” on “property in which the estate has an interest … is a secured claim to the extent of the value of such creditor’s interest in the estate’s interest in such property, … and is an unsecured claim to the extent that the value of such creditor’s interest … is less than the amount of such allowed claim.”  Thus, by its terms, § 506(a) provides that the undersecured portion of a lien claim is an unsecured claim.  Section 506(d) implements § 506(a) by providing that the lien is void as to any unsecured portion of the claim. . . .  The bankruptcy court correctly determined that the Smiths and the Hamburgs exceeded the unsecured debt limits for chapter 13 eligibility in light of Scovis.

Can a debtor strip off the unsecured portion of a partially secured mortgage on the principal residence?  Given what I have said above, you know the answer is, No.  The authority for this is the Supreme Court’s holding in Nobelman v. American Savings Bank, 508 U.S. 324 (1993).

The Nobelman Court applied § 1322(b)(2) to § 506(a) to conclude that if the collateral securing the debt is the debtor’s principal residence, then a partially secured mortgage is deemed to be entirely secured for § 506(a) and lien strip purposes.

 

IV.      Application To The § 109(e) Unsecured Debt Limit

Since the Nobelman Court held that a Chapter 13 debtor may not bifurcate an undersecured mortgage on the principal residence for § 506(a) and lien strip purposes, it seems reasonable to conclude that the debt cannot be bifurcated for § 109(e) eligibility purposes.  This has been the position of the Ninth Circuit courts that have faced the question.  For example:

It is also readily determinable that the obligation is partially secured by Debtors’ principal residence and thus Debtors cannot modify the claim.  Accordingly, the entire amount of the debt must be counted as secured for purposes of eligibility.

In re Blackwell, Case Nos. 12-57109-ASW, 12-57115-ASW (Bankr. N.D. Cal. 2014).

The “undersecured” portion of a lien that cannot be modified in Chapter 13 should not be included in the amount of unsecured debts for purposes of determining eligibility under 11 U.S.C. § 109(e), but as part of the amount of secured debts.

In re Munoz, 428 B.R. 516, 519 (Bankr. S.D. Cal. 2010).

The court notes that some courts have held that since § 1322(b)(2) of the Code prevents a bankruptcy court from modifying a lien secured only by the debtor’s principal residence through a Chapter 13 plan, this anti-modification protection applies to the entire claim, even if the debt is undersecured, so that a lien against the debtor’s personal residence should not be bifurcated into secured and unsecured claims for eligibility purposes. . . . [T]he court agrees with these decisions . . .

In re Tolentino,  No. 10-10511 (Bankr. N.D. Cal. 2010) (internal cites omitted).

However, there are some courts in other circuits that have held the contrary.  For example:

The Court, therefore, holds that the undersecured portion of a debt must be included within the unsecured portion of the debt limits in § 109(e) even when the debt in question is a mortgage on the debtors’ primary residence.

In re Werts, 410 B.R. 677, 686 (Bankr. D. Kan. 2009).

Nothing in § 1322(b)(2) warrants abandoning that rationale and jettisoning § 506(a) in the determination of the amount of unsecured claims for purposes of § 109(e).  When some of those unsecured debts arising from the application of § 506(a) in making the eligibility determination under § 109(e) are attributable to the undersecured portion of a claim secured by a security interest on the debtor’s principal residence, the holders of unsecured claims still ought to enjoy the same protections of chapter 11 if the unsecured claims (determined by applying § 506(a)) exceed the § 109(e) unsecured debt limit.

In re Brammer, 431 B.R. 522 (Bankr. D.C. 2009).

My own feeling is that the Ninth Circuit courts are correct because “it is unfair to require [a debtor] to treat the claim as fully secured under § 1322(b)(2), and pay that debt in full during the plan, but then treat that same ‘unsecured’ portion as part of unsecured debt to determine eligibility under § 109(e).”  In re Werts, 410 B.R. at 686.

However, for the bankruptcy attorney who practices outside of the Ninth Circuit, my opinion and a couple of dollars will get you coffee at Starbucks, and not much else.  The case law on this question is sparse — I have found no appellate cases — and in most jurisdictions will therefore be one of first impression.  I will keep you posted.

If you’re a debtor and need Chapter 13 bankruptcy protection, contact an extremely knowledgeable and highly skilled bankruptcy attorney to guide you through the process.

 

Image courtesy of Flickr (Licensed) by Chris Potter