The Journal of The DuPage County Bar Association

Back Issues > Vol. 27 (2014-15)

Modifying the Terms of a Residential Mortgage in Chapter 13 Bankruptcies
By Berton J. “B.J.” Maley

Since its inception, the United States Bankruptcy Code has provided special protections to residential mortgage holders that other creditors do not receive. The legislative history indicates that this “favorable treatment was intended to encourage the flow of capital in the home lending market”1. One of the most notable protections in consumer bankruptcy cases is found in the anti-modification clause of 11 U.S.C. 1322(b)(2) which was enacted to protect residential mortgage lenders from modification of the terms of their mortgages.2 The anti-modification clause states that a Chapter 13 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.” (Emphasis added.)

In other words, while a Chapter 13 plan can generally modify the rights of holders of secured claims, it cannot modify the rights of holders of secured claims that are only secured by debtor’s principal residence. Some limitation on this general protection exists and can be found in 1322(b) (5) which provides that “notwithstanding paragraph (2) of this subsection, provide for the curing of any default within a reasonable time and maintenance of payments while the case is pending on any unsecured claim or secured claim on which the last payment is due after the date on which the final payment under the plan is due”. It is this provisions that borrowers typically rely on to save their homes from foreclosure in Chapter 13 as it permits them to cure any arrearage existing at the time the bankruptcy is filed while maintaining current, post-petition payments so that the loan is reinstated over the course of the bankruptcy.

Among the modifications not typically available to borrowers with respect to home loans, is the ability to “strip down” a residential mortgage to the value of the property. For most other secured claims, the bankruptcy code allows borrowers to bifurcate claims into secured and unsecured portions based on the value of the property securing the claim. In a Chapter 13, only the secured portion of a claim must be paid 100%, while the unsecured portion is usually largely dischargeable.

Over the years several exceptions have been carved out of this general protection. The most common is with respect to wholly unsecured junior mortgages. This exception occurs where there are multiple mortgages on a property, and the senior mortgage payoff exceeds the value of the property. For example, assume a home is worth $200,000.00. The first mortgage has a current payoff of $215,000.00, and there is a second mortgage of $25,000.00. The theory is that since there is no value in the property beyond the value that secures the first mortgage, there is no value at all to secure the second mortgage. Therefore, the second mortgage claim is not secured by “real property that is the debtor’s principal residence”; in fact, it is not actually secured by anything. If it is not secured by the debtor’s residence, it is therefore not entitled to protection of the anti-modification clause.

A majority of courts hold that the antimodification provision does not apply to a wholly unsecured subsequent or junior lien. The majority view focuses on the direction in Nobelman that “it is correct to look to § 506(a) for a judicial valuation of the collateral to determine the status of the bank’s secured claim.” The McDonald Court noted: “once we accept that courts must apply § 506(a), then it follows, even under Nobelman, that a wholly unsecured mortgage holder does not have a secured claim.” McDonald v. Master Fin., Inc.(In re McDonald), 205 F.3d 606, 611 (3d Cir. Pa. 2000). Nobelman’s reference to § 506(a) would be meaningless unless some portion must be secured pursuant to § 506(a) for § 1322(b)(2) to apply. Lam v. Investors Thrift (In re Lam), 211 B.R. 36, 40 (B.A.P. 9th Cir. 1997).

In re German, 258 B.R. 468, 469-470 (Bankr. E.D. Okla. 2001)3

Courts have also excepted mortgages secured by mobile homes from the anti-modification protection of 1322(b)(2) where the mobile home is not affixed to the realty on the theory that the mobile home is personal property which secures the debt in addition to real property, and thus the debt is not secured solely be real property which is the debtor’s personal residence. Of course, if the mobile home were actually attached to the real estate or it was otherwise determined to be part of the realty, the protection against modification remains. See, for examples, Williamson v. Wash. Mut. Home Loans, Inc. (In re Williamson), 387 B.R. 914, 922 (Bankr. M.D. Ga. 2008).

Another exception may exist where the property is the primary residence, but some portion of the property is used for another purpose such as renting to a third party or a commercial/business purpose. See for example, Judge Hollis’ recent opinion in In re Abrego, 506 B.R. 509, 514 (Bankr. N.D. Ill. 2014). It should be noted that there is much disagreement about applying this exception. Some courts have held that the exception only applies if a significant portion of the property is used for other purposes, if the other purpose produces significant income, or if the intent of the parties at the time the loan originated was that the property only be used as the principal residence, and many courts still maintain that as long as the property is used as a principal residence, even loans secured by multi-use property are protected.

Notably, the statute does not limit its application to property that is used only as a principal residence, but refers generally to any parcel of real property that the debtor uses for that purpose. So long as the only collateral is a single parcel of real estate, it matters not that that parcel may fulfill many uses or be divided into many units. The statutory requirements are fulfilled whenever the debtor principally resides in that real estate or some part thereof. In short, this court finds no ambiguity in the statutory language. Because the property serves as Macaluso’s principal residence, he may not modify in Chapter 13 the mortgage that that property secures. In re Macaluso, 254 B.R. 799, 800 (Bankr.
W.D.N.Y. 2000) Other litigation over “additional security” which may remove a mortgage from the protection of 1322(b)(2) has to do with the language of the mortgages themselves. Many form mortgages contain language which appears at first glance to grant security in things other than the real estate. The Federal National Mortgage Association (“Fannie Mae”)/Federal Home Loan Mortgage Corporation (“Freddie Mac”) Illinois form mortgage for single family contains the language“TOGETHER WITH all the improvements now or hereafter erected on the property, and all easements, appurtenances, and fixtures now or hereafter a part of the property. All replacements and additions shall also be covered by this Security Instrument. All of the foregoing is referred to in this Security Instrument as the ‘Property’.”4 Other mortgages may contain similar or even broader language regarding property which secures the loan. Even mortgages on property intended to be the borrower’s principal residence may sometimes contain language granting security in rental payments though this is not standard.

Several cases historically held that such language in a mortgage did not remove the mortgage from the protection of 1322(b)(2) because the interests described are incidental to the mortgaged real estate and was “common boilerplate” language in many mortgages. The issue was addressed in the Northern District of Illinois as early as 1992 by Judge Erwin I. Katz who examined the issue with respect to a mortgage which included “ ‘rents, issues and profits thereof and all apparatus and fixtures of every kind for the purpose of supplying or distributing heat, light, water or power, and all plumbing or other fixtures’ that may be placed in any building on the property, as well as an assignment of ‘all the rents, issues and profits as additional security’ and the right to use insurance proceeds to repair the premises or to repay the obligation.” In re Jackson, 136 B.R. 797, 801 (Bankr. N.D. Ill. 1992). The court found that “with respect to the fixtures and insurance proceeds addressed therein, the claim is secured only by an interest in the real property used as the Debtor’s principal residence”, but that the pledge of an assignment of rents was an additional security interest as the “assignment of rents derived from the property does not automatically flow from a mortgage on the debtor’s principal residence as an incident of ownership” and thus removed the mortgage from the protection of 1322(b). Jackson, at 802, 803. Judge Katz acknowledged that there was a significant split of authority on the issue.

It was this split of authority which Congress tried to address as part of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA)5 . BAPCPA added definitions of “Debtor’s Principal Residence” and “Incidental Property” to the Bankruptcy Code.

(13A) Theterm“debtor’sprincipalresidence”—

(A) means a residential structure if used as the principal residence by the debtor, including incidental property, without regard to whether that structure is attached to real property; and

(B) includes an individual condominium or cooperative unit, a mobile or manufactured home, or trailer if used as the principal residence by the debtor.

11 U.S.C. 101(13A)
(27B) The term “incidental property” means, with respect to a debtor’s principal residence—

(A) property commonly conveyed with a principal residence in the area where the real property is located;

(B) all easements, rights, appurtenances, fixtures, rents, royalties, mineral rights, oil or gas rights or profits, water rights, escrow funds, or insurance proceeds; and

(C) all replacements or additions.

11 U.S.C. 101(27B)

These definitions were in line with the long term bankruptcy policy of Congress to afford protection to residential mortgage holders by ensuring that 1322(b)(2)’s anti-modification protections applied even if the language contained“additional security” language of the kind described above. Courts even extended protection for additional security not included in the definitions above:

The definition of incidental property added by Congress through BAPCPA does not change the prohibition against modifying residential mortgages and it is unlikely that Congress, by defining“incidental property,” … The codification of “incidental property” appears to codify Davis and similar decisions and was not intended to limit “incidental property” to those items specifically described in § 101(27B). If anything, the broad general term“rights,” included in the list under § 101(27B)(B), should be read at least coextensively with the “bundle of rights” discussed in Davis.

Kreitzer v. Household Realty Corp. (In re Kreitzer), 489 B.R. 698, 706 (Bankr. S.D.
Ohio 2013)6

Notwithstanding Congress’s attempt to codify opinions which held that such additional security common “boilerplate” language did not remove a mortgage from the protection of 11 U.S.C. 1322(b)(2), the controversy continues. On February
6, 2015, Judge Bruce W. Black issued his opinion in In re Victor J. Fini, case number 13-47450 in the U.S. Bankruptcy Court for the Northern District of Illinois [2015 Bankr. LEXIS 436]. In Fini, the mortgage contained fairly standard language regarding fixtures, improvements, water and mineral rights, etc., but also included the line “In addition, Grantor grants to Lender a Uniform Commercial Code security interest in the Personal Property and Rents.” The debtor attempted to modify the rights of the mortgage holders asserting that the language extends the security beyond personal property that is incidental to the real estate and so the mortgage interest was not protected by 1322(b) (2). The mortgage holder argued that the language did not remove the mortgage from the protections under the line of cases described above.

In examining the new definitions of “Debtor’s Principal Residence” and “Incidental Property”, Judge Black concluded that “an interest in fixtures that arises under real property law is part of an interest in real property that is the debtor’s home, for our purposes” even though these definitions are limited to fixtures and have previously been ruled to be an non-exhaustive list of items which may be incidental property. Judge Black concluded that the mortgage gave the mortgage holder an incidental interest in both fixtures and in goods that could be removed and repossessed under the U.C.C. thus removing it from the protection of 1322(b)(2). Since Judge Black’s opinion relies principally on the reasoning of the Reeves opinion7, an opinion pre-dating the BACPA amendments by almost twenty years, many other courts may disagree particularly in light of the strong public policy in favor of protecting residential mortgages.

Although no notice of appeal of Judge Black’s decision has been filed as of this writing, it is likely that this issue and other related issues will continue to be litigated as borrowers and their attorneys continue to try to find exceptions to the anti-
modification provisions of 1322(b)(2).

1 See, Justice Stevens concurring opinion in Nobelman v. American Sav. Bank, 508 U.S. 324 (U.S. 1993).

2 “This limited bar was apparently in response to perceptions, or to suggestions advanced in the legislative hearings, … that, homemortgagor lenders, performing a valuable social service through their loans, needed special protection against modification thereof (i.e., reducing installment payments, secured valuations, etc.). Grubbs v. Houston First American Sav. Asso., 730 F.2d 236 (5th Cir. Tex. 1984)

3 See also: Zimmer v. PSB Lending Corp. (in Re Zimmer), 313 F.3d 1220 (9th Cir. Cal. 2002)

4 The Illinois-Single Family- Fannie Mae/Freddie Mac Uniform Instrument can be found online at

5 Pub. L. No. 109-8, § 306, 119 Stat 23, 80-81.

6 “Davis” refers to the Sixth Circuit’s opinion in Allied Credit Cop. v. Davis, 989 F.2d 208, 211-12 (6th Cir. 1993). In Davis, “the Court held that the granting of a security interest in “rents, royalties, profits, and fixtures” did not take the mortgage out of the protection afforded by the § 1322(b)(2) exception because such interests are “incidental benefits” that do not constitute additional security under § 1322(b)(2). In Davis the Court emphasized that “items which are inextricably bound to the real property itself as part of the possessory bundle of rights” do not render the mortgage modifiable. Id at 213.” Kreitzer v. Household Realty Corp. (In re Kreitzer), 489 B.R. 698, 704 (Bankr. S.D. Ohio 2013)

7 In re Reeves, 65 B.R. 898 (N.D. Ill. 1986)

Berton J. “B.J.” Maley is the Managing Bankruptcy Attorney at Codilis & Associates , P.C. and typically represents residential mortgage servicers. He is past chair of both the DuPage County Bar Association and the Chicago Bar Association bankruptcy committees. He received both his J.D. and B.A. from Loyola University of Chicago.

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