Cite as: Keith M. Lundin, Lundin On Chapter 13, § 80.8, at ¶ ____, LundinOnChapter13.com (last visited __________).
Many Chapter 13 debtors are members of credit unions in which membership requirements include that the debtor own “shares.” It is not uncommon for Chapter 13 debtors to have home mortgages at the same bank, savings and loan or credit union at which the debtor also maintains a checking account or a savings account. It is also common for the standard checking account, savings account or credit union agreement to include that any deposits or shares that the debtor may have are “additional security” for any loan to the debtor. Even in the absence of such a contract in most states, by statute or common law, a financial institution holding balances in a debtor’s account has a right of setoff if the debtor defaults in repayment of a loan.
Balances in an account or shares in a credit union are not real property for purposes of § 1322(b)(2). Is a financial institution secured “only by a security interest in real property that is the debtor’s principal residence” when, in addition to a mortgage on real property, the financial institution has a security interest or right of setoff in the debtor’s account or shares? The answer should be that the financial institution is not protected from modification by § 1322(b)(2) if it is also secured by bank deposits or shares. Most of the reported cases hold otherwise.
In Loader v. Charlton Credit Union (In re Loader),1 the credit union had a home mortgage and a security interest in the debtor’s account deposits. The court concluded that this additional security interest did not forfeit the modification protection in § 1322(b)(2) because “a so-called ‘security interest’ in deposits with a payee would seem merely a confirmation of the common law right of setoff.”2 Similarly, in In re Foster,3 the court concluded that a security interest in the debtor’s Land Bank stock did not forfeit the protection from modification in § 1322(b)(2), because the value of the Land Bank stock certificates was “illusory”: “Credit unions and other lenders which take a security interest . . . in a borrower’s membership interest do not appear to have taken additional security, as that term is used in 11 U.S.C. § 1322(b)(2), until there has been a showing that such an interest has actual independent value.”4
Many real estate mortgages require the borrower to pay taxes and insurance, typically by including one month’s portion of the taxes or insurance premium in each monthly installment. Many mortgage instruments grant the lender a separate security interest in the tax and insurance escrow payments. Sometimes the escrow payments are accumulated in a special account by the mortgage servicer and are separately accounted for in the borrower’s name (sometimes with interest) until paid to the taxing authority or insurer.
Several reported cases, most from the bankruptcy courts in Pennsylvania, find that a security interest in escrow account balances forfeits the protection from modification in § 1322(b)(2). For example, in Dent v. Associates Equity Services Co. (In re Dent),5 an addendum to the deed secured by the debtor’s principal residence also granted the mortgage holder a security interest in monthly escrow payments for taxes and insurance. The bankruptcy court found that this additional security interest defeated the protection from modification:
The escrow account is not an incorporeal hereditament which is part of the possessory bundle of rights known as seizin in property . . . . While the obligation to pay taxes may exist from the ownership of real property, it is not a possessory right. The obligation to maintain property insurance is a covenant . . . a contractual obligation between the debtor and the lender. The cash escrow payments are separate and distinct from the real property. Therefore, the taking of a security interest in . . . the escrow payments, removed . . . the limitation of § 1322(b)(2).6
Not all courts agree. In In re Libby,7 the mortgagee had a security interest in a tax escrow account into which the debtor made monthly payments and a security interest in “all money, securities and other personal property on deposit or in [the mortgagee’s] possession or control.” The bankruptcy court held that the security interest in the tax escrow account was not an additional security interest because “if the debtors don’t hold a property interest in the money placed in the escrow account, then [the mortgagee] cannot be said to be holding a security interest in the Debtors’ property.”8 However, the security interest in “money, securities and other personal property on deposit” did forfeit the protection from modification in § 1322(b)(2) because “this language is not simply ‘describing the fee simple absolute.’ . . . The note . . . on its face takes additional security.”9
One has to wonder if the outcome of cases like Loader and Foster would be different if the money on deposit was thousands of dollars or if the debtor’s shares in the Land Bank or credit union were worth thousands of dollars. Section 1322(b)(2) does not suggest that the protection from modification extends to mortgage holders with collateral other than a principal residence if the other collateral isn’t worth much. The section is phrased that security interests realize protection from modification only if there is no collateral other than the principal residence. After Nobelman v. American Savings Bank,10 the protection from modification arises from a security interest in the debtor’s principal residence without regard to the value of that residence as collateral11—it is the existence of the right kind of security interest that triggers the protection from modification in § 1322(b)(2). A plain reading of the section forfeits the protection if the lender took a security interest in any other collateral. The value of that other security interest is not mentioned in § 1322(b)(2). For example, the protection from modification for a lender with a security interest in the debtor’s principal residence and an adjoining rental property would not be resurrected by evidence that there is a glut in the rental real estate market.
It is also unclear why the protection from modification in § 1322(b)(2) is available to a creditor with a right of setoff in a debtor’s account balances. A creditor with a right of setoff under § 553 is the holder of a secured claim “to the extent of the amount subject to setoff.”12 A right of setoff by virtue of the depositor agreement, state law or common law is an interest in collateral other than the debtor’s principal residence. The creditor would be entitled to freeze the debtor’s accounts13 and after stay relief to apply those balances against debts owed by the debtor. A mortgage holder with a right of setoff in the debtor’s account balances is not secured only by a security interest in real property that is the debtor’s principal residence.
The 2001 revisions to Article 9 of the Uniform Commercial Code may increase the incidence of lenders with security interests in a Chapter 13 debtor’s bank account. Prior to the 2001 revisions, the use of deposit accounts as collateral was generally excluded from the reach of Article 9. With the 2001 revisions, except in consumer transactions,14 security interests in deposit accounts are now covered by Article 9. Chapter 13 debtors sometimes enter into commercial transactions with banks, and when they do, it is not uncommon for the bank to look to the debtor’s principal residence as the best source of collateral. A bank that takes a mortgage on the debtor’s home and requires the debtor to maintain a business account may find itself with a dangling security interest in the account that forfeits the protection from modification in § 1322(b)(2).
1 128 B.R. 13 (Bankr. D. Mass. 1991).
2 128 B.R. at 16.
3 61 B.R. 492 (Bankr. N.D. Ind. 1986).
4 61 B.R. at 495.
5 130 B.R. 623 (Bankr. S.D. Ga. 1991).
6 130 B.R. at 628. Accord Donadio v. Countrywide Home Loans, Inc. (In re Donadio), 269 B.R. 336 (Bankr. M.D. Pa. 2001) (Pledge of escrow account for taxes and insurance “as additional security” forfeits protection from modification in § 1322(b)(2).); Stewart v. U.S. Bank (In re Stewart), 263 B.R. 728, 731–32 (Bankr. W.D. Pa. 2001) (Second mortgage secured by pledge of escrow account for taxes and insurance is not protected from modification by § 1322(b)(2) notwithstanding that the escrow account has not been funded. “[Section] 1322 does not require the interest to be perfected. It merely requires the Bank to have an interest secured by something other than real property that is the Debtor’s principal residence. . . . This the Bank acquired when it demanded the pledge in its form mortgage and Debtors conveyed the pledge by signing the document. . . . [T]he pledge conveyed a security interest separate from the realty within the meaning of § 1322, although no delivery of funds has yet occurred.”); Reed v. Norwest Mortgage, Inc. (In re Reed), 247 B.R. 618 (Bankr. E.D. Pa. 2000) (Applying Hammond v. Commonwealth Mortgage of America (In re Hammond), 27 F.3d 52 (3d Cir. 1994), mortgage that “pledged as additional security” escrow deposits for taxes and insurance premiums was not protected from modification by § 1322(b)(2).); Steslow v. Citicorp Mortgage, Inc. (In re Steslow), 225 B.R. 883 (Bankr. E.D. Pa. 1998) (Security interest in tax and escrow account is personalty under Pennsylvania law and forfeits the protection from modification in § 1322(b)(2).); Lewandowski v. United States Dep’t of Hous. & Urban Dev. (In re Lewandowski), 219 B.R. 99, 102 (Bankr. W.D. Pa. 1998) (Security interest in escrow account that contained accumulated payments toward taxes, assessments and hazard insurance premiums was a security interest in personal property under Pennsylvania law; accordingly, “under § 1322(b)(2), the mortgage is modifiable because HUD has taken a security interest in collateral other than real property that is Debtors’ principal residence.”); In re Pinto, 191 B.R. 610 (Bankr. D.N.J. 1996) (Lien that extended to funds held in escrow for payments of taxes and hazard insurance premiums not protected from modification.).
7 200 B.R. 562, 567 (Bankr. D.N.J. 1996).
8 200 B.R. at 567. Accord In re Rosen, 208 B.R. 345, 351–53 (D.N.J. 1997) (Rejecting dicta in Hammond v. Commonwealth Mortgage of America (In re Hammond), 27 F.3d 52 (3d Cir. 1994), security interest in escrow account for taxes and insurance did not forfeit antimodification protection in § 1322(b)(2). “In dicta, the Circuit has stated that ‘creditors who demand additional security interests in personalty or escrow accounts and the like pay a price. Their claims become subject to modification.’ . . . Hammond, 27 F.3d at 57 . . . . [O]ther courts which have addressed related issues have determined the provision of items such as insurance in a mortgage does not create additional security within the meaning of the Bankruptcy Code. See [Allied Credit Corp. v. Davis (In re Davis), 989 F.2d 208, 211 (6th Cir. 1993),] . . . . In the instant matter, the Mortgage states: ‘The Funds are pledged as additional security for the sums secured by this Security Instrument.’ . . . [D]espite the ‘additional security’ language in the Mortgage, the Funds provided no additional collateral, apart from the realty, to secure the loan. Once the Funds were placed in the Escrow Account, the Debtor lost property interest in the collateral. . . . [T]he ‘additional security’ created by the Funds did not have an independent existence and served only to protect Nationsbanc’s interest in the Residence Property.”); Boehmer v. Essex (In re Boehmer), 240 B.R. 837, 839 (Bankr. E.D. Pa. 1999) (Security interest in escrow for the payment of taxes and insurance does not forfeit protection from modification in § 1322(b)(2). “Notwithstanding [Lewandowski v. United States Dep’t of Housing & Urban Development (In re Lewandowski), 219 B.R. 99 (Bankr. W.D. Pa. 1998),] and [In re Klein, 106 B.R. 396 (Bankr. E.D. Pa. 1989)], however, this Court and several others have held that such forms of property do not have independent value beyond the maintenance and protection of the collateral and do not, therefore, take a mortgage which provides for them outside the scope of Code Section 1322(b)(2)’s protection. See: Rodriguez v. Mellon Bank (In re Rodriguez), 218 B.R. 764 (Bankr. E.D. Pa. 1998)[.]”); Rodriguez v. Mellon Bank, N.A. (In re Rodriguez), 218 B.R. 764, 774–77 (Bankr. E.D. Pa. 1998) (Cautioning that “it is an error to read [Sapos v. Provident Institute of Savings in the Town of Boston, 967 F.2d 918 (3d Cir. 1992),] too broadly on the issue of what constitutes personal property as opposed to real estate within the meaning of section 1322(b)(2),” security interest in escrow account used to pay insurance and taxes does not forfeit protection from modification. “Although the funds themselves are personal property, . . . as a matter of federal bankruptcy law . . . they are not separate from the real estate within the meaning of section 1322(b)(2). The escrow funds, however much they might be, are certain to have negligible independent value in comparison to the real estate and are held for the purpose of protecting Mellon’s mortgage. Escrow accounts are, moreover, a typical feature in every home mortgage, and to hold that their existence removes a mortgage from the anti-modification clause emasculates the statute.”); In re French, 174 B.R. 1 (Bankr. D. Mass. 1994) (Security interest that included “any deposits” does not forfeit protection from modification in § 1322(b)(2).).
9 200 B.R. at 567.
10 508 U.S. 324, 113 S. Ct. 2106, 124 L. Ed. 2d 228 (1993).
11 See §§ 118.1 [ Most Home Mortgages Cannot Be Modified: § 1322(b)(2) and Nobelman ] § 79.1 Most Home Mortgages Cannot Be Modified: § 1322(b)(2) and Nobelman and 128.1 [ Modification of Unsecured Home Mortgage: Before and After BAPCPA ] § 80.13 Modification of Unsecured Home Mortgage: Before and After BAPCPA.
12 11 U.S.C. § 506(a).
13 See § 72.1 [ Setoffs and Recoupments ] § 58.12 Setoffs and Recoupments.
14 See U.C.C. § 9-109(d)(13).