Cite as: Keith M. Lundin, Lundin On Chapter 13, § 82.3, at ¶ ____, LundinOnChapter13.com (last visited __________).
The powers to cure default in § 1322(b)(3) and § 1322(b)(5) are broadly worded to include “any” default.1 The typical default cured through a Chapter 13 plan is a monetary default that can be satisfied with money through the plan.
Though less often litigated, Chapter 13 debtors are regularly in default of nonmonetary provisions and covenants of mortgage instruments such as use restrictions, insolvency provisions and the like. The filing of the Chapter 13 case breaches the insecurity or insolvency clause in the boilerplate of most form mortgage contracts. Although § 1322(b) does not contain language nullifying bankruptcy clauses similar to 11 U.S.C. § 365(b)(2),2 the power to cure or waive any default in § 1322(b)(3) and (b)(5) is broad enough to permit Chapter 13 debtors to overcome insolvency clauses and other nonmonetary defaults. It is conceptually difficult to describe how a Chapter 13 debtor cures the default under a bankruptcy clause, but it may be that confirmation of a plan is satisfaction of the creditor’s rights under its contract.
Chapter 13 debtors sometimes violate covenants that are difficult or impossible to repair through the plan. For example, in In re McCullough,3 mortgages on two pieces of property were linked with cross-default provisions. The debtor defaulted prepetition, and a foreclosure sale was completed with respect to one property. The bankruptcy court held that the Chapter 13 plan could not preserve the second property because “the triggering event”—default with respect to the property already lost to foreclosure—could not be cured through the plan.
Clauses prohibiting renting and requiring the debtor to occupy real property subject to a mortgage might require the debtor to move back into a home that was being rented at the petition to cure the default. Or the debtor might argue that the owner-occupied clause can be modified because rental of the property forfeited the protection from modification in § 1322(b)(2).4
The Supreme Court’s decision in Nobelman v. American Savings Bank5 forces Chapter 13 debtors to provide for the curing of nonmonetary defaults. As detailed elsewhere,6 in Nobelman Justice Thomas explained that § 1322(b)(2) prohibits a Chapter 13 debtor from modifying any of the contract or state law rights of a mortgage holder secured only by real property that is the debtor’s principal residence. The endless pages of microscopic covenants and conditions contained in modern mortgage documents fit Justice Thomas’s description of rights protected from modification by § 1322(b)(2). Chapter 13 debtors use § 1322(b)(3) and (b)(5) to cure the resulting nonmonetary defaults.
Due-on-sale clauses and restrictions on transfer contained in many standard form mortgages produce particularly troublesome nonmonetary defaults.7 In In re Threats,8 the court cited Nobelman for the proposition that a due-on-sale clause and a consent restriction on mortgage assumption were rights protected from modification by § 1322(b)(2) that could not be rehabilitated under § 1322(b)(3) or (b)(5). In Threats, the owners and mortgagors of real property quitclaimed title to the debtor before the petition. The debtor did not assume the debt, and the mortgage instrument contained both a due-on-sale clause and a prior approval restriction on assumption. The mortgage was in default at the petition, and the plan proposed to cure the defaults. The court recognized that § 1322(b)(3) and (b)(5) permit a Chapter 13 debtor to cure defaults under a nonrecourse mortgage,9 but the court refused the debtor’s proposed cure with respect to the due-on-sale clause or the assumption condition:
Defeating the due-on-sale and assumption clauses would impermissibly modify Fleet’s rights. . . . The term “rights” is not defined. . . . [Debtors’] proposed plan would be a de facto assumption, enabling them to substitute their performance for the Mortgagors . . . [and] would eviscerate the due-on-sale clause without the benefit of restoring rights that the Debtors previously held under any agreement. . . . Fleet’s rights in the property arise and are defined in the mortgage instruments, yet there is no mortgagee-mortgagor relationship to restore. There can therefore be no cure. . . . [P]art of the consideration Fleet bargained for was the right to payment in full upon sale of the property and the right to have the Department of Veterans Affairs approve any proposed assumption of the mortgage. These rights may not be modified in a Chapter 13 plan.10
Curing the broken condition on assumption of the mortgage in Threats might have been accomplished by proposing in the plan to make the necessary application to the Department of Veterans Affairs—assuming that the debtors could satisfy the lender’s and the guarantor’s criteria for assumption.11 It would be awkward to do these things retroactively through a Chapter 13 plan, but not impossible. On the other hand, how would a Chapter 13 debtor cure the prepetition breach of a due-on-sale clause in a mortgage? Presumably, the debtor could undo the sale—in Threats, the debtor would have to deed the property back to its original owners. Could the plan then propose a reconveyance to the debtor with management of the mortgage lien through the plan? If the mortgage is not protected from modification by § 1322(b)(2),12 could the debtor modify the contract to eliminate the incurable condition, then maintain payments through the plan? These are not particularly attractive options for most Chapter 13 debtors, but Threats is not the last word on curing a prepetition transfer in violation of a due-on-sale clause.
The Bankruptcy Court for the District of Arizona took a fresh look at the due-on-sale clause problem in In re Garcia.13 The debtor in Garcia purchased real property subject to a mortgage without assuming personal liability. Citing Johnson v. Home State Bank14 and Arizona law, the bankruptcy court first quickly dispatched the argument that there was no debtor-creditor relationship between the mortgage holder and the debtor. Then, citing Nobelman, the bankruptcy court resurrected an important piece of statutory interpretation that was missing in Threats:
[T]he cure rights found in § 1322(b)(3) and (b)(5) are not “subsets” of the “modification” right found in (b)(2). The right to cure is not limited to cures that are not deemed to be modifications when a principal residence is involved. . . . [C]ases rejecting proposed cures on the ground the cure would constitute an impermissible modification are not good law.15
Digging into the meat of the issue, the Garcia court rejected the mortgage holder’s argument that violation of a due-on-sale clause was an incurable default in a Chapter 13 case:
To restore the lender to a predefault situation, which is the essence of cure, it would seem the debtor must compensate the lender for any loss occasioned by the default. . . . Both state and federal law . . . suggest that due on sale clauses are really all about money or the security for its payment, not about the sanctity of the personal relationship between lender and borrower. . . . [T]he Arizona Supreme Court held that enforcement of a due on sale clause is an unlawful restraint on alienation unless the lender can show that its security is jeopardized. . . . In 1982, the federal government passed the Garn-St. Germain Depository Institutions Act of 1982, superseding state laws restricting due on sale clauses. . . . Consequently, both Arizona law and Garn-St. Germain suggest that a cure of a violation of a due on sale clause should consist of ensuring that the purchaser will not damage or destroy the lender’s collateral, and possibly an increase in the interest rate if the market has risen since the loan was originally made. . . . [P]lans may cure any default, at least absent a showing of an entitlement to an equitable remedy that would give rise to a nondischargeable claim because neither damages nor a surrender of the collateral could ever provide an adequate remedy at law, and a showing that the debtor’s plan could not provide that remedy. . . . There is no basis in law to conclude that a violation of a due on sale clause cannot be compensated in money, perhaps in a higher interest rate, if the market warrants it.16
Garcia is carefully reasoned and convincing. If the power to cure “any default” in § 1322(b)(3) and (b)(5) means anything, it is not an invitation for the bankruptcy courts to pick and choose which defaults are curable and which are not. Instead, the issue is, what constitutes a cure for a nonmonetary default such as a transfer in violation of the due-on-sale clause. The suggested cures in Garcia are clever and translate into plan provisions that mortgage holders might find palatable despite having to deal with a debtor not of their choosing. That state law supported the outcome in Garcia at several levels further supports the basic premise that curing a default with respect to a due-on-sale clause is within bounds for a Chapter 13 debtor.
1 11 U.S.C. § 1322(b)(3), (b)(5).
2 Cases permitting Chapter 13 debtors to cure nonmonetary defaults in leases and executory contracts support the argument that debtors can cure nonmonetary defaults in real estate mortgages under § 1322(b)(3) and (b)(5). See § 173.1 [ Debtor Must Cure Defaults and Assure Future Performance ] § 102.2 Debtor Must Cure Defaults and Assure Future Performance.
3 120 B.R. 425 (Bankr. S.D. Ohio 1990).
4 See § 122.1 [ Rental Property, Farmland and Other Income-Producing Property ] § 80.6 Rental Property, Farmland and Other Income-Producing Property.
5 508 U.S. 324, 113 S. Ct. 2106, 124 L. Ed. 2d 228 (1993).
6 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.
7 The nonrecourse debt that results after a transfer of mortgaged property is discussed in §§ 146.1 [ Debts Discharged in Prior Bankruptcy and Nonrecourse Debts ] § 85.5 Debts Discharged in Prior Bankruptcy and Nonrecourse Debts and 305.1 [ Nonrecourse Claims and Claims Discharged in Prior Bankruptcy Case ] § 138.4 Nonrecourse Claims and Claims Discharged in Prior Bankruptcy Case.
8 159 B.R. 241 (Bankr. N.D. Ill. 1993).
9 See § 146.1 [ Debts Discharged in Prior Bankruptcy and Nonrecourse Debts ] § 85.5 Debts Discharged in Prior Bankruptcy and Nonrecourse Debts.
10 159 B.R. at 243. Accord In re Lippolis, 228 B.R. 106 (E.D. Pa. 1998) (Mortgage provision that prohibited transfer without the lender’s consent and that gave lender option to require full payment immediately upon transfer could not be cured through Chapter 13 plan without a retransfer of the property from the debtor to the original owner/mortgagor. Debtor can’t cure defaults under § 1322(b)(5) because part of curing default would be to reconvey the property to a nondebtor, and at that point the debtor would be “out of title” and could not use § 1322(b)(5).); In re Allen, 300 B.R. 105, 116–19 (Bankr. D.D.C.) (Arguably in dicta, mortgage holder is entitled to annulment of automatic stay and of codebtor stay to validate postpetition foreclosure sale when debtor acquired interest in property from her son three days before petition in violation of due-on-transfer clause. “Congress obviously did not intend § 1322(b)(2) to be readily circumvented through a conveyance of a fractional interest to a third-party not residing in the encumbered home. . . . [In re Garcia, 276 B.R. 627 (Bankr. D. Ariz. 2002),] erroneously reasons that allowing a transfer that violated a due-on-transfer clause to remain in place does not constitute a modification . . . . [A]nything short of restoring ownership to the original owner is not a cure, as it does not restore the status quo ante. . . . [D]ue-on-transfer clauses are a fundamental aspect of a mortgagee’s rights, and permitting the circumvention of such clauses under a chapter 13 plan works an impermissible modification of those rights.”), stay denied pending appeal, 300 B.R. 127 (Bankr. D.D.C. 2003); In re Parks, 227 B.R. 20, 23–24, 24 n.3 (Bankr. N.D.N.Y. 1998) (Debtor who received mortgaged real estate from his deceased father’s estate after judgment of foreclosure, but before sale, cannot cure or waive defaults and pay mortgage in full through the plan because the debtor cannot cure or waive decedent’s defaults. “A common-sense interpretation requires that only a right or status lost by the debtor may be ‘cured’; and once cured, there must be no new ipso facto default. In other words, this Debtor may not ‘cure’ someone else’s defaults under a contract to which he was neither a party nor a third-party beneficiary, nor may he ‘cure’ or ‘waive’ in defaults that would not restore this Debtor (rather than his father) to an enforceable status under contract or law. And, even if we assume that this Debtor has somehow inherited contract rights under the Note and Mortgage, and that the Debtor, consequently, could ‘revive’ rights of his own thereunder if he could ‘cure’ the defaults in payment of the mortgage installments and property taxes, he would nonetheless be immediately in default again because of ipso facto clauses in the note dealing with the father’s property being subject to trusteeship, guardianship, or the like (11 U.S.C. § 541(c)(1)(B) would protect his father from the operation of certain ipso facto clauses in the event of his father’s petition under the Bankruptcy Code, but it does not protect the son.) As to ‘cure,’ then, it either (1) would make no sense to construe the statute so as to permit a ‘cure’ of defaults under his father’s contract, or (2) such a ‘cure’ would be construed to be permissible under the statute, but useless.”); In re Martin, 176 B.R. 675, 676–77 (Bankr. D. Conn. 1995) (Citing In re Threats, 159 B.R. 241 (Bankr. N.D. Ill. 1993), debtor cannot use § 1322(b)(3) to “waive” the default caused by a transfer to the debtor in violation of a due-on-sale clause. “The debtor asserts that the plan provisions requiring the Bank, in effect, to waive the default caused by the unapproved transfer by compelling the Bank to accept current mortgage payments from the debtor and to accept payments from the Chapter 13 trustee for the arrearages are permissible under § 1322(b)(3). . . . Section 1322(b)(2) prohibits the modification of ‘the rights of the holders of secured claims . . . in real property that is the debtor’s principal residence. . . .’ As explained in [Nobelman v. American Savings Bank, 508 U.S. 324, 113 S. Ct. 2106, 124 L. Ed. 2d 228 (1993)] . . . the ‘rights’ referred to in § 1322(b)(2) are those ‘reflected in the relevant mortgage instruments, which are enforceable under [state] law.’ The debtor has neither alleged nor shown that a due-on-sale clause is not enforceable in Connecticut. The debtor’s plan, therefore, impermissibly seeks to modify the Bank’s rights in violation of § 1322(b)(2). . . . The debtor’s apparent attempt to distinguish ‘waiver’ from the thrust of the Nobelman holding is unavailing.”); First Fed. Sav. & Loan Ass’n v. Birckelbaw, 33 B.R. 720 (Bankr. E.D. Mich. 1983) (Acceleration that resulted from prepetition breach of contract when debtor sold real property without lender’s consent cannot be cured through a Chapter 13 plan using § 1322(b)(5). The prepetition sale of property triggered a due-on-sale clause, leaving no default that the debtor could cure through the plan.).
11 See In re Jordan, 199 B.R. 68 (Bankr. S.D. Fla. 1996) (Requirement that Secretary of Veterans Affairs approve mortgage assumption is subject to exceptions.).
13 276 B.R. 627 (Bankr. D. Ariz. 2002).
14 501 U.S. 78, 11 S. Ct. 2150, 115 L. Ed. 2d 66 (1991).
15 276 B.R. at 634–35.
16 276 B.R. at 640–42.