by The chapter 11 debtor could not modify her residential mortgage even though much of the property securing the mortgage was used for income-producing purposes. Lee v. U.S. Nat’l Bank Ass’n, No. 20-222 (M.D. Ga. Oct. 4, 2021).
The debtor’s residence was located on forty-three acres of land of which she rented out approximately thirty-five acres as farmland. She took out a mortgage on the property in 2007 and, acting on the advice of the mortgagee, in 2010, allowed the mortgage to go into default in the expectation of refinancing the loan under the federal Housing Action Resource Test (HART). When she was unable to refinance, she filed for chapter 11 bankruptcy seeking to modify the mortgage.
US National Bank filed a claim as trustee for RMAC Trust, Series 2016-CTT (the Trust), in the amount of $253,070.25, representing $139,195.75 in unpaid principal and $82,228.15 in interest. It moved for relief from stay, and the bankruptcy court granted the motion finding that section 1123(b)(5) prohibited modification of the mortgage. The debtor appealed to the district court.
Section 1123(b)(5) provides:
A plan may modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor’s principal residence, or of holders of unsecured claims, or leave unaffected the rights of holders of any class of claims.
The debtor argued that the Trust’s security interest encompassed both residential and commercial property and, therefore, the anti-modification provision did not apply.
Noting that the issue of how to treat mortgages secured by residential property with an income-producing component has not been addressed by the Eleventh Circuit, the district court identified three approaches taken by other courts.
The “traditional statutory interpretation” approach, represented by In re Wages, 479 B.R. 575, 583 (Bankr. D. Idaho 2012), aff’d, 508 B.R. 161 (9th Cir. BAP 2014), holds that under the plain language of section 1123(b)(5), a claim that is secured “only” by real property that is the debtor’s residence, may not be modified. Under the Wages approach, the existence of other uses for the property is irrelevant so long as the property is the debtor’s principal residence.
The court here rejected the debtor’s argument that because her property was not “only” used as residential property, it was not subject to the anti-modification provision. Like the Wages court, the court found the word “only” modifies “secured” and does not require that the property be used only for residential purposes. The court noted that residential property typically includes “incidental” property not subject to bifurcation. The court also distinguished cases where the anti-modification provision was found not to apply when the debtor’s residence was shared with rental units, finding that the mortgage agreements in those cases included a security interest in the rental properties as distinct from the debtor’s residence. The court noted that policy considerations relevant to multi-family dwellings were not applicable to leased farmland.
The next approach considered by the court—the “mortgage approach”—was represented by In re Scarborough, 461 F.3d 406, 408 (3d Cir. 2006). Like the Wages court, the Scarborough court found the statutory language to be unambiguous. Unlike the Wages court, the Scarborough court focused on the word “is” in the phrase, “real property that is the debtor’s principal residence.” The Scarborough court found that if a security agreement encompasses property that does not include the debtor’s residence, it is not covered by the anti-modification provision. In that case, the debtor purchased a multi-unit property that she intended from the outset to use as both her own residence and as rental property. The mortgage documents reflected that dual use. The court found that “[w]hen 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 [bankruptcy] proceeding.”
The court in Lee found that because the property at issue was a single-family dwelling and the mortgage that did not reflect an interest in income-producing property, the approach advanced by Scarborough was inapplicable.
Finally, the court noted the “case-by-case approach,” represented by In re Brunson, 201 B.R. 351, 353 (Bankr. W.D.N.Y. 1996), where a court takes into consideration all the facts and circumstances surrounding the mortgage transaction. Such considerations may include whether the transaction was handled by the commercial or the residential mortgage department, whether the debtor had other residences, or whether the debtor’s principal occupation was as a landlord. Recognizing that this approach has been widely criticized as introducing uncertainty to the residential mortgage industry, the court found that even under this approach, the debtor’s argument failed. The debtor here earned her primary income from her work in a law firm with only a small percentage coming from the leased land. Furthermore, the interest rate charged on the mortgage was typical of non-commercial loans.
The court concluded that under any of the three approaches, the debtor’s mortgage was not modifiable in chapter 11. It affirmed.