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Bankruptcy Anti-Modification Provision and Mortgages Secured by Principal Residences

Posted By USFN, Monday, November 7, 2016
Updated: Wednesday, October 26, 2016

November 7, 2016

by Graham Kidner
Hutchens Law Firm
USFN Member (North Carolina, South Carolina)

The Fourth Circuit Court of Appeals recently reasserted the integrity of the anti-modification provision of the Bankruptcy Code with respect to mortgages secured by a borrower’s principal residence. [Anderson v. Hancock, 2016 WL 1660178 (4th Cir. Apr. 27, 2016)].

In Anderson, the seller (Hancock) of a residential property took back a note and deed of trust from the purchaser (Anderson). Following default, the seller invoked a clause in the note increasing the interest rate from five percent to seven percent, and commenced foreclosure. The purchaser-borrower filed for Chapter 13 bankruptcy protection, followed by a plan proposing to pay arrears over 60 months and post-petition payments at a five percent interest rate.

Bankruptcy Court: Sustained Seller’s Plan Objections
The bankruptcy court found that the proposed five percent interest rate violated the Bankruptcy Code’s anti-modification provision applicable to principal residences. [11 U.S.C § 1322(b)(2)]. Further, the bankruptcy court rejected the purchaser-borrower’s contention that the increased rate was a consequence of default that bankruptcy could “cure,” consistent with § 1322(b)(3) and (b)(5). The bankruptcy court also determined that arrears on the loan should be calculated using a seven percent rate of interest for a specified period, and then it entered an order confirming the plan as modified. The purchaser-borrower appealed to the district court.

District Court: Affirmed Except in One Respect
The district court disagreed with the bankruptcy court’s interpretation of the note. Specifically, the district court: “[H]eld that acceleration and foreclosure was a ‘disjunctive alternative remedy’ to the default rate of interest, and that once the Hancocks accelerated the loan, the rate of interest reverted back to five percent. J.A. 71. It held that this period of acceleration (and thus only five percent interest) lasted from September 16, 2013 [the petition filing date] until December 2013 (the effective date of the plan), after which the seven percent rate of interest reactivated due to the bankruptcy plan’s deceleration of the loan. In the district court’s view, the rate of interest thus see-sawed depending on whether the loan was in accelerated or decelerated status.” Anderson, at *2.

Court of Appeals: Affirmed in Part; Reversed in Part; and Remanded
The Fourth Circuit “agree[d] with the courts below on the basic question, namely that the cure lies in decelerating the loan and allowing the debtors to avoid foreclosure by continuing to make payments under the contractually stipulated rate of interest.” The Court of Appeals held that the proposed change to the interest rate was an impermissible modification rather than a permissible cure because otherwise the rate reduction would modify the bargained-for rights, enforceable under state law, expressed in the security agreement, citing Nobelman v. American Savings Bank, 508 U.S. 324, 329, 113 S. Ct. 2106, 124 L. Ed. 2d 228 (1993). “Courts have accordingly ‘interpreted the no-modification provision of § 1322(b)(2) to prohibit any fundamental alteration in a debtor’s obligations, e.g., lowering monthly payments, converting a variable interest rate to a fixed interest rate, or extending the repayment term of a note.’ In re Litton, 330 F.3d 636, 643 (4th Cir. 2003).” The court found that “[t]he meaning of ‘cure’ thus focuses on the ability of a debtor to decelerate and continue paying a loan, thereby avoiding foreclosure.” Anderson, at *3.

Rejecting the purchaser’s contention that this result was unfair and denied a “fresh start,” the Fourth Circuit observed that the fresh start was the opportunity to escape foreclosure and resume the opportunity to make payments. The ability to impose a default interest rate in this case was a “risk premium” contracted for between the parties and to provide a measure of protection to the lender when the debtor demonstrates behavior that reveals an increased likelihood of loss.

Rejecting the district court’s disjunctive alternative remedy theory, the Court of Appeals observed that “[n]othing in the contract indicates that the parties intended for [the] invocation [of the remedy of acceleration and foreclosure] to unravel the earlier, less-severe remedy.”

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