Cite as: Keith M. Lundin, Lundin On Chapter 13, § 80.5, at ¶ ____, LundinOnChapter13.com (last visited __________).
The courts do not agree on the rules for determining whether the protection from modification in § 1322(b)(2) is available when the extent of the collateral or the debtor’s use of the collateral changes between the time of the loan and the Chapter 13 petition. Three issues are presented: (1) as of what time is the extent or use of collateral determined for purposes of the protection from modification in § 1322(b)(2); (2) what facts determine the outcome—is the actual use at the magic time controlling, or should the court consider collateral that no longer exists or use that is permitted or contemplated; and (3) who has the burden of proof? These questions have fractured the reported decisions.
The words in § 1322(b)(2) are straightforward enough: the protection from modification is only available to a claim secured by a security interest in “real property that is the debtor’s principal residence.”1 Use of the present tense “is” could signal that the current function of the property is determinative. Until recently, a majority of the reported decisions concluded that entitlement to the protection from modification in § 1322(b)(2) is determined based on circumstances at the petition.
For example, in In re Lebrun,2 at the time of the loan, the real estate collateral was used by the debtor as a principal residence. At the date of the petition, the property was “used to generate rental income for the debtor.”3 Applying the date of petition rule, the court concluded that § 1322(b)(2) did not protect the mortgage from modification. Similarly, in In re Boisvert,4 at the time of the loan, the creditor was secured by a home mortgage and by two other parcels of real property. The creditor was protected from modification by § 1322(b)(2) because the two other properties were sold and the mortgages released prior to the petition. As explained by another court:
A “claim” in bankruptcy arises at the date of the filing of the petition. . . . [O]nly if a claim is secured by the debtor’s principal residence at the time of the bankruptcy petition is the debtor prohibited from modifying the creditor’s interest under the plain language of 11 U.S.C. § 1322(b)(2).5
More recently, the trend of decisions—including some appellate authority—favors the view that the status of collateral at the time of the loan transaction controls whether the claim is protected from modification by § 1322(b)(2). In In re Smart,6 a single-family residence that was the debtor’s principal residence at the time of the original mortgage was leased to unrelated third parties at the Chapter 13 petition. Looking to the time of the loan, the court concluded the claim was protected from modification by § 1322(b)(2) based on this logic:
[T]his Court believes that the critical phrase, “real property that is the debtor’s principal residence,” is intended to modify its more immediate antecedent term, “security interest” . . . . [T]he subject clause is susceptible of at least two credible interpretations. First, it can be read, as the Debtors suggest, to refer to a home’s status as a principal residence at the present time . . . . Second, it can be read, as urged by the [mortgage holder] to refer to the home’s status at the time that the security interest was created. . . . Congress left an ambiguity in the statute which compels recourse to its legislative history. . . . [T]he legislative history of Section 1322(b)(2) indicates that favorable statutory treatment of homestead mortgagees was intended to encourage and sustain a flow of affordable capital into the home lending market. . . . In construing Section 1322(b)(2) so as to give maximum effect to the intentions of Congress, this Court allies itself philosophically with those Courts which approach post-Nobelman modification issues from the perspective of the circumstances existing at the time of the subject credit transaction, not the serendipitous or manipulated facts existing on the date of the filing of the petition.7
The United States Court of Appeals for the Third Circuit in Scarborough v. Chase Manhattan Corp. (In re Scarborough)8 focused on the use of property at the inception of the mortgage to determine whether the protection from modification in § 1322(b)(2) was available. The mortgaged property in Scarborough was a multi-unit dwelling and the lender was aware, as evidenced by a rental rider, that the borrower would occupy only one unit. The Third Circuit held:
[F]or purposes of § 1322(b)(2), the critical moment is when the creditor takes a security interest in the collateral. . . . [W]e look to the terms of the mortgage. . . . [W]e look to the character of the collateral at the time of the mortgage transaction. When a mortgagee takes an interest in real property that includes, by its nature at the time of transaction, income-producing rental property, the mortgage is also secured by property that is not the debtor’s principal residence and the claim may be modified in a debtor’s later Chapter 13 proceeding.9
Looking to use at the time of the loan has frequently, but not always,10 worked to the disadvantage of the mortgagee. If the loan documents, or the lender’s knowledge, indicate that nonresidential use was contemplated, the mortgage forfeits protection from modification.11 In In re Roemer,12 the creditor was trapped by loan documentation specifying that the debtor was required to occupy condominium property as a principal residence for at least one year. The Roemer court held this provision limited antimodification protection “to, at most, one year (and arguably [the mortgagee] was not entitled to anti-modification protection at all). . . . [T]he mortgage here had, as of the origination date, a temporal component to it that limited the duration of its being a mortgage secured by the debtor’s principal residence.”13
Once the court picks a point in time for the § 1322(b)(2) determination, there remain questions of burden of proof and what facts control. The few courts directly addressing the issue have placed the burden of proving whether debt is protected from modification by § 1322(b)(2) on the creditor.14 The United States Court of Appeals for the First Circuit in Eastern Savings Bank, FSB v. LaFata (In re LaFata)15 affirmed that a creditor objecting to confirmation has the ultimate burden to prove that it was entitled to § 1322(b)(2) protection, noting “[t]his is not in conflict with the point that a creditor bears the burden of persuasion as to its proofs of claim.”16
Whether the court looks to use at the time of the petition or earlier, the debtor’s actions and intentions can be outcome determinative. For example, although the debtor had moved from property in anticipation of foreclosure, the court in In re Salmeron17 found the move did not render the mortgage vulnerable when motions to value the property and to determine that the mortgage was subject to modification indicated the debtor intended to use the property as a residence.
The reported cases offer too many choices of facts that may control, and the relevant facts will change depending on whether the court looks to the time of the loan or the petition date. For example, in In re Howard,18 in 1976 the debtor bought two tracts, a 103-acre tract with no improvements and a smaller tract that contained the debtor’s principal residence. The deed of trust granted a security interest in both tracts. Before bankruptcy, the debt was refinanced and the 103-acre tract was foreclosed. The debtor continued to reside on the smaller tract, but the underlying paperwork was never modified to reflect the foreclosure.
The bankruptcy court first determined that the date of the petition controlled whether the protection from modification in § 1322(b)(2) was available. The court explained that the date of the petition rule “discourages creditors from disclaiming security interests postpetition in order to gain protection from modification of their claims.”19 That the only collateral in which the debtor still had an interest at the petition was the debtor’s principal residence perhaps should have carried the day for the creditor. But the court found that the § 1322(b)(2) determination should be made “by examining the language of the agreement as it exists at the time of the filing of the petition, regardless of the existence or value of collateral which is available to secure creditors’ claims as of the time of filing the case.”20 The court held that the mortgage was not protected from modification because
where loan documents grant a creditor security interests in principal residence real estate and other collateral, such creditor does not qualify for the protection of section 1322(b)(2), even where the only collateral which is still available to be levied upon at the petition date is the principal residence real estate. Creditors who take security interests in other collateral in addition to the principal residence real estate are usually attempting to secure debt transactions that are unlike the traditional home finance transactions which the statute is intended to protect. . . . [U]nless the agreement has been modified by agreement of the parties to provide that the sole collateral is the debtor’s principal residence real estate, the fact that additional collateral is no longer available or has no value is not sufficient to bring that creditor’s claim within the protection of section 1322(b)(2).21
In contrast, in GMAC Mortgage Corp. v. Marenaro (In re Marenaro),22 the lender took a security interest in three contiguous lots. The debtor resided on one of the lots, and zoning ordinances permitted the debtor to divide the lots and construct additional residences. The debtor never attempted to use the other lots.
Without adopting a general rule, the Bankruptcy Appellate Panel for the First Circuit examined the circumstances at the granting of the mortgage for purposes of §1322(b)(2). At that time, the documents granted a security interest in three lots, only one of which was the debtor’s principal residence. Nonetheless, the BAP held the mortgage was protected from modification:
If an abstract potential to use property in a different way, never amounting to a gleam in the eye of the owner at the time that the mortgage is given, can withhold the protection of the anti-modification language from a mortgagee, then virtually every mortgage would be subject to modification.23
And then there is Brunson v. Wendover Funding, Inc. (In re Brunson).24 Discussed in detail below,25 entitlement to the protection from modification in § 1322(b)(2) sometimes turns on whether real estate collateral is income producing. When the debtor’s real estate was sometimes used as a principal residence and sometimes used as rental property, the protection from modification in § 1322(b)(2) becomes a moving target. Brunson offers this nightmarish formula for determining whether a mortgage on a two-family dwelling, only part of which is used as a residence by the debtor, is protected from modification by § 1322(b)(2):
[E]ach case must turn upon the intention of the parties: Was home-ownership the predominant intention (and rental income simply a means to that end) or was investment income or the operation of a business the predominant purpose of the transaction? . . . The types of factors that the Court should consider are: whether the Debtor (to the lender’s knowledge) owned other income producing properties or other properties in which she could choose to reside; whether she had a principal occupation other than as landlord, and the extent to which rental income or other business income produced from the real estate contributed to her income; whether her total income was particularly high or particularly low; whether the mortgage was handled through the commercial loan department or the residential mortgage loan department of the lender; whether the interest rates applied to the mortgage were home loan rates or commercial loan rates; the demographics of the market (e.g. are “doubles” a much more affordable “starter home” than a single, in that locale); and the extent to which, and purpose for which, potential business uses of the land (such as farming) were considered by the lender. . . . If the transaction was predominantly viewed by the parties as a loan transaction to provide the borrower with a residence, then the antimodification provision will apply. If, on the other hand, the transaction was viewed by the parties as a commercial loan transaction, then stripdown will be available.26
Debtors and creditors will be hard pressed to distill a methodology for § 1322(b)(2) analysis from cases like Howard, Marenaro and Brunson. Creditors that have the right facts at the petition should take a careful look at the underlying documents to be sure no stray security interest will defeat the protection from modification. Before the debtor rushes to Home Depot to convert the basement into a rental apartment,27 counsel should measure the gleam in the debtor’s eye at the time of the original transaction. The protection from modification in § 1322(b)(2) is too important for this level of uncertainty.
1 11 U.S.C. § 1322(b)(2) (emphasis added).
2 185 B.R. 665 (Bankr. D. Mass. Aug. 18, 1995) (Feeney).
3 185 B.R. at 666. See § 122.1 [ Rental Property, Farmland and Other Income-Producing Property ] § 80.6 Rental Property, Farmland and Other Income-Producing Property for discussion of income-producing property and the protection from modification in § 1322(b)(2).
4 156 B.R. 357 (Bankr. D. Mass. June 30, 1993) (Feeney).
5 In re Wetherbee, 164 B.R. 212, 215 (Bankr. D.N.H. Jan. 14, 1994) (Yacos). Accord In re Baker, 398 B.R. 198 (Bankr. N.D. Ohio Sept. 10, 2008) (Speer) (Date of petition controls availability of protection from modification in § 1322(b)(2); mortgage that included residential and nonresidential property at execution but only residential property at petition cannot be modified. Court adopted majority view that “the critical date for deciding whether a creditor qualifies for protection under the antimodification clause is the date the petition is filed.” Section 1322(b)(2) refers to “claim,” and bankruptcy claim arises at petition.); In re Donahue, 221 B.R. 105, 111 (Bankr. D. Vt. May 27, 1998) (Conrad) (“A determination as to when Debtor’s property is his primary residence for purposes of § 1322(b)(2) is made at the commencement of the case.” Claim was originally secured by a 50-acre parcel. Before the petition, 10 of the 50 acres were sold and the proceeds paid to the creditor. Remaining 40 acres were divided into four lots of 10 acres each. The debtor’s mobile home together with a well and an outhouse were located on lot “3D.” Plan proposed to surrender the three (undeveloped) lots and to pay for the residential lot with interest. “At the commencement of this case, the ten acre lot designated ‘3D’ and a mobile home was Debtor’s primary residence, and the remaining thirty acres were divided into three additional lots.” Debtor can modify the creditor’s claim because three of the lots were either commercial or income-producing property that forfeited the protection from modification in § 1322(b)(2).), rev’d on other grounds, 232 B.R. 610 (D. Vt. Apr. 8, 1999) (Sessions); In re Howard, 220 B.R. 716 (Bankr. S.D. Ga. Feb. 18, 1998) (Walker) (Determine whether security interest is protected from modification by § 1322(b)(2) with reference to the date of the Chapter 13 petition and the language of the security instrument without regard to whether collateral described in the agreement continues to exist or has any value.); In re Churchill, 150 B.R. 288, 289 (Bankr. D. Me. Feb. 3, 1993) (Goodman) (“Claims secured only by a security interest in a real property which is the debtor’s principal residence, at the time of filing, may not be modified.” That the debtor’s real property was not her principal residence at the time of loan origination does not defeat the protection from modification in § 1322(b)(2) where the property was the debtor’s principal residence at the time of filing of the Chapter 13 case.); In re Amerson, 143 B.R. 413 (Bankr. S.D. Miss. July 29, 1992) (Gaines) (There being no indication that the release of an automobile lien two and one-half years prior to filing of Chapter 13 petition was intended to circumvent or abuse the anti-modification provisions of § 1322(b)(2), mortgagee’s claim was secured only by real property at the filing and was entitled to the protection of § 1322(b)(2).); Southern Disc. Co. v. Ivey, 13 B.R. 27 (Bankr. W.D.N.C. Apr. 27, 1981) (Wooten) (Creditor with security interest in household goods and second mortgage on principal residence who released lien on household goods prior to the petition is protected by § 1322(b)(2).).
6 214 B.R. 63 (Bankr. D. Conn. Oct. 14, 1997) (Dabrowski).
7 214 B.R. at 67–68. Accord Parker v. Federal Home Loan Mortgage Corp. (In re Parker), 179 B.R. 492 (E.D. La. Mar. 8, 1995) (Vance) (Single-family home 46% of which is used by the debtor as office space for his legal practice is protected from modification by § 1322(b)(2) because at the time of purchase the property was intended for residential purposes and the loan was not a commercial loan. That the debtor converted part of the property to business purposes does not change its nature especially where the debtor claimed the property as a homestead in prior bankruptcy petitions.); In re Hildebran, 54 B.R. 585 (Bankr. D. Or. Nov. 13, 1985) (Wilhardt) (At the time of execution of the original note, debtors did not reside on the real estate securing the loan and creditor was not providing residential financing. The fact that the debtors used the property as their principal residence at the time of filing does not invoke the protection of § 1322(b)(2) and cannot change the original character of the loan.). See GMAC Mortgage Corp. v. Marenaro (In re Marenaro), 217 B.R. 358 (B.A.P. 1st Cir. Feb. 4, 1998) (Lamoutte, Hillman, Carlo) (Declining to determine when to look at the use of property for purposes of § 1322(b)(2), BAP adopts view most favorable to debtor and examines status of property at granting of the mortgage.).
8 461 F.3d 406 (3d Cir. Aug. 28, 2006) (Rendell, Ambro, Roth).
9 461 F.3d at 412.
10 United States Dep’t of Agric. v. Jackson, No. 5:05-CV-20(CAR), 2005 WL 1563529 (M.D. Ga. July 1, 2005) (unpublished) (Royal) (Date of loan agreement, rather than date of petition, governs use of property for purposes of § 1322(b)(2); since property was used as residence at time of loan, Department of Agriculture was protected by § 1322(b)(2).).
11 See In re Moore, 441 B.R. 732 (Bankr. N.D.N.Y. Nov. 18, 2010) (Davis) (Date of mortgage transaction controls for § 1322(b)(2) purposes; mortgage that originally included rental property was not protected from modification by § 1322(b)(2). Mortgage included two different property addresses, one portion in which debtors resided and second portion that was rental property.); In re Reyes, No. BKY 09-17532, 2009 WL 4825200, at *3 (Bankr. W.D. Wash. Dec. 9, 2009) (unpublished) (Overstreet) (Mortgage was not protected from modification because at time of loan debtor occupied one bedroom and rented out several others. Agreeing with Scarborough v. Chase Manhattan Mortgage Corp. (In re Scarborough), 461 F.3d 406 (3d Cir. Aug. 28, 2006) (Rendell, Ambro, Roth), under plain language of § 1322(b)(2), when debtor conducted boarding business, had history of income from boarders in her home and had informed loan officer of rental income at time of loan, mortgage was not protected from modification. At time security interest was taken, debtor occupied only one of five bedrooms, renting remaining bedrooms to boarders, for whom she also provided some meals. “[T]he Creditor knew of Debtor’s rental income and boarding business when the Creditor took a security interest in the Property and should have known that the loan could be subject to modification in a Chapter 13 proceeding. It is clear that without the additional income, Debtor would not have been able to make the payments under the Note and would not have qualified for the loan.”); In re Picht, No. 08-20677, 2009 WL 1766820, at *2 (Bankr. D. Kan. June 20, 2009) (unpublished) (Berger) (On remand, because loan documents determine whether debt is protected from modification by § 1322(b)(2), when bank financed business and took security interest in equipment, fixtures, inventory and accounts in addition to second mortgage on residence, debt was not protected from modification. Debtors discharged personal liability in a prior Chapter 7 case, and all security for the bank’s loan was liquidated except second mortgage on residence. “The determinative factor is the language granting the security interests in the underlying loan documents, regardless whether additional collateral in fact exists. If the loan documents provide for security in addition to the debtor’s principal residence, then the creditor is not entitled to the benefits of § 1322(b)(2).”), rev’d on other grounds, 428 B.R. 885, 894 (B.A.P. 10th Cir. May 4, 2010) (Thurman, Rasure, Romero) (“Because the provision requiring the Bank to release its lien after payments totaling less than the full amount of its in rem judgment rendered the plan unconfirmable under § 1325(a)(5)(B)(i)(I)(aa), we need not decide whether the lien release provision might also have been objectionable under § 1322(b)(2) in this case.”); In re Grimes, No. 08-34275-rld13, 2009 WL 960143 (Bankr. D. Or. Feb. 5, 2009) (unpublished) (Dunn) (Section 1322(b)(2) does not prohibit modification when property was income producing and not debtor’s residence at time of mortgage execution; that debtor had residence in triplex at time of petition does not revive protection from modification. When lender was aware of income-producing use of property at time of mortgage, protection from modification is not available.).
12 421 B.R. 23 (Bankr. D.D.C. Dec. 28, 2009) (Teel).
13 421 B.R. at 26.
14 In re Santiago, 404 B.R. 564, 570 (Bankr. S.D. Fla. Mar. 30, 2009) (Isicoff) (Mortgage was subject to modification because creditor failed to prove that property was principal residence. Determination whether property is debtor’s principal residence requires analysis of two possible dates—the date of the mortgage or the petition date. Eleventh Circuit has not ruled on issue. Debtor was not residing in property on date of mortgage, and creditor had burden to prove that debtor resided in property at petition. Citing Eastern Savings Bank, FSB v. LaFata (In re LaFata), 483 F.3d 13 (1st Cir. Apr. 3, 2007) (Stahl, Torruella, Lipez), “the only courts to specifically address who bears the burden of proof on the applicability of the section 1322(b)(2) exception, including the only circuit court to address the issue, have each held the burden of proof lies with the creditor.”). But see In re Perez, No. 09-35053-AJC, 2010 WL 2821882 (Bankr. S.D. Fla. July 14, 2010) (Cristol) (Mortgage was protected from modification by § 1322(b)(2) when note, mortgage and modification agreement provided that property would be used as principal residence and debtor failed to prove that property was not so used. Debtor surrendered other property that she claimed to be her residence, but court found testimony self-serving, conflicting and unreliable.).
15 483 F.3d 13 (1st Cir. Apr. 3, 2007) (Stahl, Torruella, Lipez).
16 483 F.3d at 23 (Even if burden was improperly placed, error was harmless, since bankruptcy court properly held mortgage could be modified.).
17 No. 09-25864-TJC, 2010 WL 1780119 (Bankr. D. Md. May 4, 2010) (unpublished) (Catliota).
18 220 B.R. 716 (Bankr. S.D. Ga. Feb. 18, 1998) (Walker).
19 220 B.R. at 718.
20 220 B.R. at 718.
21 220 B.R. at 718–19. Accord In re Bosch, 287 B.R. 222, 227–28 (Bankr. E.D. Mo. May 17, 2002) (McDonald) (Lien on principal residence and business assets could be modified notwithstanding that business assets are worthless or beyond levy at the petition. Loan was originally secured by business assets and residence. Business closed and bank liquidated all business assets before the petition. “The Court adopts the well reasoned decision of the [In re Howard, 220 B.R. 716 (Bankr. S.D. Ga. Feb. 18, 1998) (Walker),] court. The critical date to determine whether a secured claim is exempt from modification under section 1322(b)(2) is the petition filing date. . . . [A] court should look to the loan agreement, which is the basis of a secured claim, to determine whether the claim is secured solely by the debtor’s principal residence . . . . If the loan documents grant a security interest in additional collateral, then the claim can be modified regardless of the value or availability of that collateral to satisfy the claim. . . . Eagle Bank’s claim may be modified under section 1322(b)(2) because the loan documents which form the basis of that claim reflect that the loan was secured by collateral in addition to Debtors’ principal residence. The fact that the additional collateral may now be worthless or unavailable to levy upon is of no consequence.”); In re Larios, 259 B.R. 675, 678 (Bankr. N.D. Ill. Mar. 22, 2001) (Squires) (Whether viewed at the origination of the loan or at the petition, second mortgage was not protected from modification because lender took a security interest in business assets and a second mortgage on the debtors’ personal residence. “[O]n the date the loan originated, the Bank was granted both a security interest in J & H Marble’s personal property and a junior mortgage on the Debtors’ personal residence. Accordingly, the Bank could not properly invoke the benefits of § 1322(b)(2) under the line of cases that looks to the date of the creation of the security interest. . . . [T]he Bank still retained a security interest in the J & H Marble assets at the time of the Debtors’ bankruptcy petition. In short, under an analysis utilizing either point in time, it is the existence of the security interest in the J & H Marble assets that is fatal to the Bank’s proper invocation of § 1322(b)(2). . . . [T]he language of the security agreement purported to take a security interest in additional collateral, other than the junior mortgage in the residence, namely J & H Marble’s inventory, receivables and equipment. The language in the underlying security agreement determines whether a creditor is entitled to protection from modification . . . . For purposes of applying § 1322(b)(2), it matters not whether the security interest has attached, nor whether it is perfected, only whether it is extant and not released, satisfied or otherwise terminated.”).
22 217 B.R. 358 (B.A.P. 1st Cir. Feb. 4, 1998) (Lamoutte, Hillman, Carlo).
23 217 B.R. at 361.
24 201 B.R. 351 (Bankr. W.D.N.Y. Sept. 25, 1996) (Kaplan).
25 See § 122.1 [ Rental Property, Farmland and Other Income-Producing Property ] § 80.6 Rental Property, Farmland and Other Income-Producing Property.
26 201 B.R. at 353–54.
27 See § 122.1 [ Rental Property, Farmland and Other Income-Producing Property ] § 80.6 Rental Property, Farmland and Other Income-Producing Property.