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Bankruptcy Code Anti-Modification Statutes: Application to Principal Residence/Multi-Use Property

Posted By USFN, Monday, November 6, 2017
Updated: Monday, October 23, 2017

November 6, 2017

by Adam Diaz
SHD Legal Group, P.A.
USFN Member (Florida)

It is always fascinating to see bankruptcy courts read the “plain language” of the Bankruptcy Code in so many ways. This, in turn, results in differing opinions on common bankruptcy-related issues — such as the application of the anti-modification provisions.

Principal Residence: Multiple Uses?
From time to time, Chapter 11 and Chapter 13 debtors will use their principal residence for multiple purposes. Whether it be as a home office or renting out a room, debtors are permitted to use their home to derive income. Multi-use property creates a predicament under the application of Bankruptcy Code sections 1123(b)(5) and 1322(b)(2) (anti-modification statutes). In the context of a cramdown plan, debtors essentially argue that they have no principal residence and seek to cramdown the debt on the subject property. The best example is a principal residence containing rental units. Savvy debtors will attempt to describe this as income property, where they happen to also reside; this is a frequent scenario in Florida, particularly in Miami-Dade County.

Judicial construction of sections 1123(b)(5) and 1322(b)(2) generally fall along one of three views: (1) a bright-line test absolutely allowing modification of a lien where the collateral is not only the debtor’s primary residence but is also used to produce income; (2) a bright-line test absolutely prohibiting modification of a lien if the collateral is real property that is also the debtor’s primary residence, without regard to any other use of the property; and (3) a case-by-case approach that examines the totality of the circumstances. The various outcomes result from opposing statutory interpretations, and consideration of the legislative intent of the anti-modification provision by courts that deem the statute ambiguous.

As the law continues to evolve in this area, it is difficult to establish the majority or minority view. Therefore, references here will be made to “The Strict View,” “The Moderate View,” and “Something in the Middle.”

The Strict View
In reviewing bankruptcy court rulings, the First and Third Circuit Courts of Appeals have held that “a mortgage secured by property that includes, in addition to the debtor’s principal residence, other income-producing rental property is secured by real property other than the debtor’s principal residence and, thus, that modification of the mortgage is permitted” (emphasis added) In re Scarborough, 461 F.3d 406, 408 (3d Cir. 2006). Pursuant to this view, a creditor’s options are limited under the anti-modification provision of the Bankruptcy Code, and would only apply if the mortgage at issue is secured by the principal residence solely.

Proponents of this application contend that the result is supported by the plain language of sections 1123(b)(5) and 1322(b)(2), allowing such multi-use properties to be modified through a Chapter 11 or Chapter 13 proceeding. Additionally, proponents cite to the legislative history as further validation. In short, under this view, if any portion of the secured property derives income, the loan is subject to modification.

The Moderate View
Bankruptcy courts out of the Ninth Circuit Court of Appeals (and sporadic district courts) elect to take a bright-line approach to the anti-modification statutes. Under this method, the courts look at three elements: (1) the security interest must be in real property; (2) the real property must be the only security for the debt; and (3) the real property must be the debtor’s principal residence. In the end, “either a property is a debtor’s principal residence or it is not; the existence of other uses on the property does not change that.” In re Wages, 508 B.R. 161 (B.A.P. 9th Cir. 2014); see also In re Brooks, 550 B.R. 19 (Bankr. W.D.N.Y. 2016).

Not surprisingly, proponents also believe that the application is supported under the plain language of the Bankruptcy Code because it is not ambiguous. Particularly when reading sections 1123(b)(5) and 1322(b)(2) in connection with section 101(13A), the definition of principal residence, the application does have support.

Although debtors maintain that this perspective is a cold and callous analysis, it results in more consistent rulings. Under this view, the creditor’s interest in the property would be protected by section 1123(b)(5). This means the debtors would not be permitted to modify their principal residence based on the plain language of the statute.

Something in the Middle
The position uses a factual rationale. Under this application of the anti-modification statutes, the court and parties would be required to undertake a case-by-case analysis. The intent of the parties at the time the loan was originated, as well as the amount of time that the property has been used for other purposes, would be taken into consideration. This approach increases inconsistency in application, plus there is more confusion between the parties regarding their rights under the Bankruptcy Code.

Observations in Florida
Currently, there is no binding authority from the Eleventh Circuit Court of Appeals. The cases from Florida are not consistent in application of the anti-modification provision. Some courts would allow modification of a property that is a commercial duplex, but disallow modification for a property used for business purposes (i.e., home office). This application results in an inconsistent outcome across the courts, which could be eliminated under “The Strict View” articulated above. However, the few published opinions on the subject appear to make clear that, in the Southern and Middle Districts of Florida, the type of property is pertinent to the analysis. The former Chief Judge of the Southern District Court of Florida recently ruled in favor of a creditor on this issue, finding the fact that the debtor resided in the property prevented cramdown. [In re Hock, Case No. 14-32157-BCK-PGH.] In Hock, the court even noted that its decision conflicted with other cases within the district — namely, In re Zalidivar, 441 B.R. (Bankr. S.D. Fla. 2011), and In re Ramirez, Case No. 13-20891 (Bankr. S.D. Fla. 2014). Nonetheless, it is the first case in Florida to conduct a statutory analysis of the Bankruptcy Code.

The Takeaway
Creditors have options and are not limited to one position. They should be diligent in the prosecution of these cases and raise appropriate stances to the court. “The Strict View” requires creditors to actively conduct discovery on the debtors to fully present the facts to the court. This should be done in each case to help develop this area of the law, hopefully resulting in more judicial authority to guide creditors.

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