Since the price peak in 2006, home values have fallen more than 30%, leaving millions of Americans with negative equity in their homes. Until the Supreme Court’s 1993 decision in Nobelman v. American Savings Bank, the bankruptcy system would have provided many such homeowners with a remedy. They could have filed bankruptcy, discharged the negative equity, committed to pay the mortgage holders the full values of their homes, and retained those homes. In
Nobelman, the Court misinterpreted reasonably clear statutory language and invented legislative history to resolve a 3-1 split of circuits in favor of the minority view. The Court ruled that debtors could not modify even the unsecured portions of the mortgages on their principal residences. Courts and commentators have since assumed that modification of home mortgages in bankruptcy is impossible.
This Article presents a legal strategy for modifying home mortgages despite Nobelman. The strategy requires that debtors move out of their houses, lease the houses for one year, file bankruptcy, and
propose mortgage modification plans that pay mortgage holders the full current values of the houses. This Article argues that despite the artificiality of a move-out with the intention to return, bankruptcy judges will approve the plans. The judges will do so because existing precedent requires approval and because the modification plans will be in the best interests of not only the debtors, but also the mortgage holders and the American economy. The strategy may enable hundreds of thousands of homeowners to retain homes they would otherwise have lost to foreclosure.
11 U.S.C. § 1322(b)(2) prohibits cram-down on “a claim secured only by a security interest in real property that is the debtor’s principal residence.” Read literally, this does not restrict cram-down on property that is not currently the Debtor’s principal residence. Accordingly, if two neighbors were matched , each seeking to retain their homes through bankruptcy, they could simultaneously, leases the home of the other for a period of one year, moves into the other house, and then file bankruptcy. Each Debtor could then strip down the mortgage, and, at the end of the lease, move back into his or her own home.
The Article addresses the inevitable good faith argument that mortgage lenders would raise by recognizing that a debtor cannot “ move out of his home the day before bankruptcy and then modify
his home loan; such manipulation and trickery would be evidence of bad faith which might render a plan unconformable….” In re Putnam, 2011 WL 5839692 (Bankr. N.D. Cal. Nov. 21, 2011). The Article points out, however that the Deeds of Trust, particularly Fannie Mae/Freddie Mac Uniform Deeds of Trust, commonly have Occupancy provisions that require the homeowner to reside at a property for one year, which clearly implies a right to move out after one year. “The debtor who moves out after fulfilling his or her contract obligation to remain for at least one year is not acting in bad faith, but merely exercising a right provided under the contract.”
It is not clear how Debtors and their attorneys would logistically manage such temporary housing swaps nor whether Debtors would be able to overcome the bankruptcy shame to disclose their filing.
In addressing the means for paying the secured claim of a swapped house mortgage cram down, the Article first discusses conflicting decisions regarding the “stacking” of modification and payment maintenance provisions of 11 U.S.C. §§ 506(a), 1322(b)(2), and 1322(b)(5). See e.g., In re Enewally, 368 F.3d 1165 (9th Cir. 2004) (stacking not allowed), and Federal Nat. Mortg. Ass’n. v. Ferreira (In re Ferreira), 223 B.R. 258, 262 (D. R.I. 1998) (stacking allowed.)
The second alternative proposed is for a “balloon payment” on the cram-down, likely to come from a refinancing due to equity from post-petition appreciation and pay down on cram-down principal. The difficulty with this approach, which the Article does address, is the BAPCPA requirement in 11 U.S.C. § 1325(a)(5)(B)(iii)(I) that payments to secured claims “be in equal monthly amounts.” This would seem to abrogate the earlier decisions, relied on by the Article, that allowed “balloon payments.”
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