Overruling 22 years of precedent, the en banc 4th U.S. Court of Appeals has ruled that Chapter 13 debtors may divide some undersecured home mortgage loans into secured and unsecured claims and “cram down” the unsecured portion of such loans.
The decision reverses a 1997 opinion, Witt v. United Cos. Lending Corp., which barred the modification of a lender’s rights into bifurcated claims and resulting cramdowns, and aligns the 4th Circuit with every other court to consider the bankruptcy statute at issue.
In May 2004, Larry Hurlburt purchased real property in Leland, North Carolina, from Juliet Black for $136,000. Hurlburt paid Black $5,000 in cash at closing, and Black financed the rest of the purchase through a promissory note executed by Hurlburt in Black’s favor, secured by a purchase-money deed of trust naming Black as beneficiary.
Under the agreement, the $131,000 principal accrued interest at 6 percent per year, payable over 119 months, and a balloon payment of all remaining principal and accrued interest was due in May 2014.
When the loan matured, Hurlburt failed to pay the balance. Black initiated a foreclosure action in North Carolina state court in January 2016, claiming Hurlburt owed her approximately $136,000 under the mortgage. Hurlburt responded by filing a petition for relief under Chapter 13 of the Bankruptcy Code, which allows debtors to devise a court-approved reorganization to pay off all their debts without losing all of their assets.
In his petition, Hurlburt valued the property at $40,000. When he filed a proposed Chapter 13 repayment plan, Hurlburt proposed to bifurcate Black’s claim into a fully secured claim for $41,132, with the remainder of the claim treated as unsecured and therefore not receiving payment.
Black objected to the plan, arguing that Witt barred the plan’s proposed modification and bifurcation of her claim, and contending that she was entitled to a secured claim in the full amount due under the mortgage agreement, plus interest. The bankruptcy court agreed with Black, a ruling affirmed by the district court and a panel of the 4th Circuit. Hurlburt sought rehearing en banc, asking for a reversal of Witt.
In an 11 to 3 opinion authored by Judge James Wynn, the court did just that.
“Although we do not lightly overrule our precedent, we agree with these courts and commentators that ‘the specific context in which the language is used, and the broader context of the statute as a whole,’ establishes that Section 1322(c)(2) is best read to authorize modification of ‘claim[s],’ not just ‘payment[s],’ and therefore that a Chapter 13 plan may bifurcate a claim based on an undersecured homestead mortgage, the last payment for which is due prior to a debtor’s final payment under a repayment plan, into secured and unsecured components and cram down the unsecured component,” Wynn wrote.
Modification of claims, not just payments
Section 1325(a)(5) of the Bankruptcy Code provides that a court can confirm a plan’s proposed treatment of a secured claim if one of three conditions is satisfied, one of which is known as the “cram down power.” Relatedly, Section 506(a)(1) explains that a claim is secured only to the extent of the value of the property on which the lien is fixed, with the remainder of the claim considered unsecured, resulting in bifurcation of the claim.
Not all undersecured claims can be bifurcated and crammed down, however. Section 1322(b)(2) prohibits Chapter 13 debtors from modifying the rights of holders of secured claims that are “secured only by a security interest in real property that is the debtor’s principal residence.” As Hurlburt’s proposed Chapter 13 plan clearly modified Black’s rights under the promissory note, that provision could have been the end of the story.
But in 1994, Congress enacted Section 1322(c)(2), which provides that, notwithstanding other law, “in a case in which the last payment on the original payment schedule for a claim secured only by a security interest in real property that is the debtor’s principal residence is due before the date on which the final payment under the plan is due, the plan may provide for the payment of the claim as modified pursuant to section 1325(a)(5) of this title.”
The Witt court concluded that the meaning of the phrase “payment of the claim as modified” was ambiguous and looked to legislative history to hold that Congress intended that only payments may be modified. Over the last two decades, other courts and commentators have criticized the ruling, Wynn said.
Joining the other courts to have considered the issue, the en banc 4th Circuit found the most natural reading of the phrase “payment of the claim as modified” to permit the modification of claims, not payments, and that the prefatory phrase “notwithstanding subsection (b)(2)” signaled Congress’s intent for Section 1322(c)(2) to be an exception to, or limitation on, Section 1322(b)(2)’s anti-modification provision.
“Because Section 1322(c)(2) is an express exception to a statute dealing with the full panoply of contractual rights tied to a claim—not just the rights pertaining to payment—Section 1322(c)(2) is reasonably construed as dealing with the modification of claims in their entirety, not just the modification of payments,” Wynn wrote.
New line of cases to come
Most significantly, the 4th Circuit found that Section 1322(c)(2)’s reference to Section 1325(a)(5) further indicated Congress’s intention to authorize the modification of claims, not just payments—including by bifurcating covered claims into secured and unsecured components and cramming down the unsecured component. The “very essence” of Section 1325(a)(5) is the cram down power of a secured claim to the value of the collateral securing the debt, the court noted.
Having concluded that the plain language of Section 1322(c)(2) authorizes modification of homestead mortgage loans subject to that provision, the court declined to rely upon legislative history. Even if it had, “we do not believe that the legislative history carries much interpretive weight,” Wynn said, finding Witt’s reliance on legislative history misplaced.
“Witt … runs contrary to the plain text of Section 1322(c)(2), which authorizes modification of covered homestead mortgage claims, not just payments, including bifurcation of undersecured homestead mortgages into secured and unsecured components,” Wynn wrote. “Accordingly, with great respect for the Witt panel and the dissenting opinion, we hereby overrule Witt, reverse the district court’s judgment relying on Witt, and remand this case to the district court for further proceedings not inconsistent with this opinion.”
Three members of the en banc 4th Circuit dissented in an opinion authored by Judge J. Harvey Wilkinson III and taking the position that Section 1322(c)(2) effected “a more limited change” than that adopted by the majority because Congress failed to explicitly state its desire to overrule an earlier U.S. Supreme Court decision that provided lenders with broad protections from modifications of their homestead mortgage loans in bankruptcy.
“The majority has arrogated to itself the authority to overturn a Supreme Court decision in the absence of any clear desire by Congress to do so,” Wilkinson wrote. “This is not healthy. It is not the way our judicial system is supposed to work.”
With Witt out of the way, debtors in the 4th Circuit can now join debtors in all 45 other states to cramdown the unsecured portion of a homestead mortgage for which the final payment is due prior to a debtor’s last payment on a repayment plan, said Richard P. Cook of Wilmington, North Carolina, who represented Hurlburt.
“A chorus of jurists and academics across the country, much smarter than myself, all said Witt was wrong,” he said, including a direct circuit split with a decision from the 11th Circuit. “It was ready to be overturned.”
The decision also opens the door to an argument that any accelerated mortgage can be modified and crammed down, Cook added. When a debtor faces foreclosure, the entire mortgage becomes due, potentially triggering Section 1322(c)(2)’s cram down exception for mortgages for which the final payment is due prior to the last payment on a repayment plan, he explained.
“Whether an accelerated mortgage [versus a balloon] is now subject to cramdown will be the next line of cases now that Witt has been overruled,” Cook predicted.
Jimmy Carter of Carter & Carter in Wilmington, North Carolina, represented Black. He did not respond to a request for comment.
The 43-page decision is Hurlburt v. Black (Lawyers Weekly No. 001-100-19). The full text of the opinion is available online at nclawyersweekly.com.