The Journal of The DuPage County Bar Association

Back Issues > Vol. 16 (2003-04)

A Hidden Trap in the Chapter 13 Treatment of Mortgage Arrears
By Scott J. Kofkin

I. Introduction

Individuals seeking protection from creditors while trying to repay at least a portion of their debt often file for relief under Chapter 13 of the Bankruptcy Code.1 One of the more common reasons for filing for relief under Chapter 13 is to stop a pending or anticipated mortgage foreclosure and force the mortgagee to resume accepting regular monthly mortgage payments plus additional installment payments in order to cure an existing mortgage default over an approved period of time. This article will address a potentially serious flaw in the way Chapter 13 plans attempt to cure a mortgage default. This flaw could result in the unwary debtor (and their potentially liable attorney) believing that a mortgage default has been cured at the completion of the Chapter 13 only to have the mortgagee declare that a default still exists, and then commence or resume a foreclosure against the subject property.

II. Chapter 13 Overview

The automatic stay2 afforded upon the filing of the petition for relief operates as a stay of the commencement or continuation of most types of collection activity.3 The petitioning debtor must file a plan4 to be reviewed and administered by a standing trustee5, must appear at a required meeting of creditors6, and must commence making timely payments under the proposed plan.7 The court conducts a hearing to determine whether the plan is to be confirmed.8 Confirmation of a plan binds the debtor and each creditor to the terms of the plan,9 and, upon successful completion of the plan, the debtor shall be granted a discharge of all debts provided for by the plan, with certain specified exceptions.10

With respect to residential mortgages, a default may be cured under a proposed plan provided that the petition for relief is filed before the residence "is sold at a foreclosure sale that is conducted in accordance with applicable nonbankruptcy law."11 In order to cure such a default,12 the plan must provide for the cure of the default "within a reasonable time" and for the maintenance of the regular monthly payments while the case is pending.13 The rights of the mortgagee, if it’s claim is secured only by the security interest in the debtor’s principal residence, may not otherwise be modified.14 This last provision sets claims secured only by residential mortgages apart from other secured claims, which can be modified by the terms of a confirmed Chapter 13 plan.15

The Code mandates certain types of provisions16 and permits certain other types of provisions,17 but neither the Code nor the Bankruptcy Rules18 provide for a standardized Chapter 13 plan. Until recently, debtors’ counsel used any of a number of formats to propose plans. These plans could vary greatly in the way they attempted to comply with the minimum requirements set out by the Code.

III. The Model Plan

By Local Rule19 the Bankruptcy Court for the Northern District of Illinois adopted, as have courts in other districts, a Model Chapter 13 Plan to by used in all Chapter 13 cases filed within the district. The Model Plan is intended to ease the review and administration of the large local volume of cases by unifying and organizing the various standard elements of Chapter 13 plans.20

One of the recurring problems with the diverse plan formats used prior to the adoption of the Model Plan related to the administration of secured claims. In order for a plan to be confirmed, it must provide for secured claims in one of three acceptable ways: The secured creditor accepts the plan,21 the collateral is surrendered,22 or the plan provides for distributions, usually in the form of payments, valued, as of the effective date of the plan, not less than the allowed amount of the secured claim.23 This last alternative requires two determinations. First, the secured claim must be valued as of the effective date of the plan.24 Then, a decision must be made as to the necessary stream of payments over the course of the plan that will provide the creditor with the necessary equivalent value.25 Plan formats that merely provided for payment in full of allowed secured claims appeared to meet the requirements, and often were confirmed. However, disputes could and did arise over whether the plan actually provided sufficient payments.26 In addition, a Standing Trustee could find after confirmation that a secured claim was filed exceeding the amount available under the plan, rendering the plan no longer feasible.

The Model Plan includes provisions designed to avoid such uncertainties. For secured claims other than mortgage arrears claims, the Model Plan form requires27 a proposed value and interest rate specified within the plan terms, thereby creating an opportunity for objection, negotiation, and resolution prior to confirmation. Indeed, if a plan provision is not challenged, the confirmation will, as noted above, bind all parties to the terms of the plan as confirmed, including the incorporated valuations.28

Mortgage arrears claims, however, are treated somewhat differently from claims of other secured creditors,29 since the rights of the holders of such claims cannot be modified except to provide the cure.30 The Model Plan mandates the fixing in the plan of the value to be paid on residential mortgage arrears "regardless of contrary proofs of claim"31 The provision has the effect, in most cases, of prompting the holders of such mortgage arrears claims to file objections to confirmation in order to obtain an amendment to the plan incorporating the proper amount of the pre-petition default intended to be cured. This has the desired effect of clarifying for all parties, including the Standing Trustee charged with properly administering the payments, exactly how much will be paid under the plan so that feasibility, among other things, can properly be assessed at confirmation.

The Model Plan in this district is relatively new, and no challenges of this type of provision have been decided by the Seventh Circuit Court of Appeals. However, a recent decision of the Eleventh Circuit Court of Appeals, the Bateman case32 has underscored a potentially devastating loophole in this provision of the Model Plan, or of any other plan attempting to establish with binding clarity the amount of a pre-petition mortgage default.

IV. Bateman

A. Background

In the underlying Chapter 13, Bateman’s plan proposed to pay the mortgage lender a total of $21,600.00 in mortgage arrears over the course of the plan. The lender filed a proof of claim in excess of $49,000.00, but did not attend the §341(a) meeting of creditors, did not object to the plan, and did not attend the hearing on confirmation. The plan subsequently was confirmed, and payments commenced as proposed. No appeal was taken of the confirmation order, which included the $21,600.00 amount to be paid to the lender over the course of the plan.

Over a year after confirmation, the trustee alerted the debtor to the discrepancy between the plan provision and the proof of claim, and the debtor filed an objection to the claim. The lender responded, and countered with a motion to dismiss the Chapter 13 because the plan failed to comply with the requirements of the Code. The bankruptcy court sustained the debtor’s claim objection, and denied the lender’s motion to dismiss, noting "the binding effect" of confirmation and the lender’s failure to act on any of several opportunities to challenge various aspects of the proceedings.33 The bankruptcy court further held that, although the lender retains its lien through the bankruptcy, the stated amount of the arrears in the plan and confirmation order is res judicata requiring the lender, upon successful completion of the plan, to treat the mortgage as current, as of the date the $21,600.00 was paid, as if no delinquency had ever occurred. The bankruptcy court denied a motion to reconsider, and the lender appealed. The district court affirmed finding that the lender was bound by the confirmation order to the arrears amount stated in the plan, and was precluded from a collateral attack of the plan, because it failed to object previously to the plan..

B. Lower courts reversed by the Eleventh Circuit

The Circuit Court reversed the lower courts as to the binding effect on the lender’s claim, and held that, although the lender will be paid only the $21,600.00 under the plan, it retains its rights as to the remaining default, and will be free upon completion of the case to pursue it’s remedies to enforce and collect the unpaid amounts.34 The lower courts were affirmed as to the binding effect of the confirmation on the administration of the case, and as to the denial of the lender’s motion to dismiss.35

This decision casts serious doubt over whether successful completion of a confirmed Chapter 13 plan necessarily means that the pre-petition default will be deemed cured. In condensed form, the reasoning is as follows: Secured claims generally are protected to the extent of the value of the collateral securing the claim.36 However, a residential mortgage lender’s rights specifically may not be modified37 and the claim may not be compromised even if the value of the property is insufficient to fully secure the claim.38 Accordingly, the plan may not reduce the lender’s secured claim.39 Further, a secured creditor is not required to file a claim, and need not respond at all to a bankruptcy, because it retains its lien40 and the debt is not discharged.41 The lender here did file a claim for an amount contrary to that stated in the plan, which claim is "deemed allowed" and is "prima facie evidence of the validity and amount" of the arrears.42 Accordingly, the lender was not deemed to have accepted the plan, nor was the property scheduled to be surrendered. Under 1325(a)(5), the lender is entitled to retain its lien and is entitled to the full amount of its allowed claim. The confirmation order still is given its full res judicata effect, so the case was not dismissed, and will be allowed to complete upon payment of the amount stated in the plan. The lender retains its lien and its claim is unimpaired, and the debtor does not benefit from a windfall from a plan that will not pay the proper amount to cure the default.

V. Applicability to Local Practice

It is quite possible that the reasoning and holdings in the Bateman case could be followed by the Seventh Circuit Court of Appeals, or the Supreme Court if a similar case reaches one of those venues. At least one local bankruptcy court43 adopted a similar reasoning in a case with similar facts44 in denying a lender’s motion to vacate or amend the order confirming case and/or to reconsider disallowance of claim. In that case, the claim had not been disallowed, and the court specifically observed that the lender is merely delayed in its ability to pursue the unpaid balance until after the case is completed.

VI. Conclusion

Successful debtors relying on the binding effect of the successfully confirmed plan could find themselves again facing foreclosure for defaults the plan payments did not cover, even when the mortgage company was aware of the plan provisions and did nothing to contest them. Inexperienced practitioners need to exercise extreme caution even when relying on forms such as the Model Plan promulgated by the court.

1 The Bankruptcy Code (hereinafter "Code") is found at 11 U.S.C. §§101 et seq. Unless noted otherwise, all statute section references are to sections within Title 11. The Code is organized into Chapters, and the sections beginning with 1301 specifically govern Adjustment of Debts of an Individual With Regular Income. This article is not an overview of the various types of relief available in Bankruptcy proceedings, nor is it a primer on Chapter 13 practice, but seeks to address but one of the many difficult issues that can be presented once an individual chooses Chapter 13 relief.

2 §362 outlines actions that are stayed; exceptions to the stay, procedures for seeking relief from the stay, and sanctions available for willful violations of the stay.

3 §362(b) provides for certain actions that are not stayed, which are not relevant to the scope of this article.

4 §§1321-1323

5 §1302

6 §341(a)

7 §1326

8 §1324

9 §1327

10 §1328(a)

11 §1322(c)(1). For the current law on the expiration of the right to cure under Chapter 13 a default on a mortgage subject to an Illinois foreclosure, see Colon v. Option One Mortgage Corp., 310 F.3d 912 (7th Cir. 2003)

12 We are not dealing here with plans that pay entire mortgage balances in full within the plan term, nor are we discussing plans that provide for the sale or refinancing of the subject property.

13 §1322(b)(5)

14 §1322(b)(2)

15 Id.

16 §1322(a)

17 §1322(b)

18 The Federal Rules of Bankruptcy Procedure

19 Rule 3015-1 of the Local Bankruptcy Rules of the United States Bankruptcy Court for the Northern District of Illinois

20 The Committee Note to Local Rule 3015-1 states:

The Model Plan was adopted to provide for (1) a clear statement of the rights and responsibilities of all parties affected by the plan; (2) a uniform presentation of the matters dealt with by the plan; (3) an internal check of the feasibility of the plan; (4) default provisions that are consistent with law; and (5) flexibility to change any of the substantive provisions of the plan, but with clear notice of such changes.

21 §1325(a)(5)(A)

22 §1325(a)(5)(C)

23 §1325(a)(5)(B)

24 Assoc CommercialCorp. v. Rash, 520 U.S. 953, 960-62 (1997)

25 In re: Till 301 F.3d 583 (7th Cir. 2002)

26 Adair v. Sherman 230 F.3d 890 (7th Cir. 2000)

27 Section E5 of the Model Plan

28 §1327; Adair, supra

29 Section E4 of the Model Plan

30 §1322(b)(2)

31 Section E4 of the Model Plan

32 Universal American Mortgage Company v. Bateman (In re: Bateman) 331 F.3d 821, (11th Cir. 2003)

33 quotes and references to the lower court rulings come from the discussion in the Seventh Circuit opinion, supra.

34 Bateman, supra

35 Id.

36 §506(a)

37 §1322(b)(2)

38 Nobleman v. Am. Savs. Bank, 508 U.S. 324, 339 (1993)

39 Id.

40 §1325(a)(5)(B)

41 §1322(b)(5); §1328(a)

42 §502(a); Rule 3001(f)

43 In re: Lacresha Taylor, 02-B-06374 (Bkrtcy ND Ill ED; J. Cox, memorandum entered April 30, 2003)

44 In Taylor, Id, the confirmed plan provided for payment of $4,500 compared with its filed claim in the amount of $22,410.86.

Scott J. Kofkin is a principal and founding member of the firm now known as Kofkin, Springer, Scheinbaum & Davis. The firm’s practice concentrated primarily in bankruptcy and related matters, including consumer and business cases, trustee and creditor representation, adversary litigation, appeals, and creditor workouts.

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