Mortgage Modification Procedures Established in Bankruptcy Courts forNorthern District of California

Effective August 1, 2015, most bankruptcy courts adopted sweeping new mortgage modification procedures, which can be viewed here.

This impressive set of new procedures was tested in Florida and certain other jurisdictions but is entirely new to the Northern District.  Specifically, the procedures provide for monitoring and mediation of mortgage modifications based upon lender consent.  Most major lenders regularly consent and have pre-registered with the electronic documentation system, which is key to the functioning of the program.

The program applies to all open and new chapter 13 bankruptcy cases in participating courts.  It may also be applied in individual chapter 11 bankruptcy cases by special request.

The new procedures streamline the processes under HAMP, HARP, Fannie Mae, Freddie Mac, FHA, VA, private bank programs and other mortgage modification procedures.  It also eliminates several common roadblocks to mortgage modification approval and dealing with mortgage modification denials, including document completion, income and expense analysis, forbearance and balloon payments, reamortization, cure of arrears and due diligence and title problems.

A key advantage is the combination of mortgage modification with bankruptcy relief, adding opportunities for discharge of unsecured debts, reorganization of priority debts and resolution of title and lien-priority issues.  This combination is likely to provide relief for thousands of debtors who were poorly served by either process standing on its own.

Mandatory Subordination Does Not Compel Claim Disalowance and Does Not Apply to Individual Debtors

In Khan v. Barton (In re Khan), CC-14-1021-TaDKi, CC-14-1041-TaDKi, CC-14-1062-TaDKi (9th Cir. BAP Dec. 9, 2014), the Bankruptcy Appellate Panel of the United States Court of Appeals for the Ninth Circuit (the "BAP") held that mandatory subordination of a claim under Bankruptcy Code Section 510(b) does not compel disalowance of the claim and does not apply to individual debtors.

In Khan, a creditor obtained judgment against the debtors and their corporation for conversion, fraud, breach of fiduciary duty and loss of common stock shares.  Thereafter, each of the debtors filed a chapter 13 bankruptcy petition.  The creditor filed proofs of claim in both cases. The creditor also commenced adversary proceedings to render the judgment nondischargeable.  The debtors responded by filing adversary proceedings for mandatory subordination of the creditor's claims under Section 510(b) and for disallowance of the claims.

The bankruptcy court ruled in favor of the creditor and dismissed the debtors' adversary proceedings with prejudice. On appeal, the BAP affirmed.

The court held that subordination of a claim does not compel disallowance because it impacts only the order of distribution among creditors, not the validity of the claim itself.  Moreover,  Section 510(b) does not apply to individual debtors; it applies only to claims against corporate debtors.

Fifth Circuit Rules "Till" Not Mandatory, Reviews for Clear Error

In Wells Fargo Bank, N.A. v. Texas Grand Prairie Hotel Realty, LLC, No. 11-11109 (5th Cir. Mar. 1, 2013), the United States  Court of Appeals for the Fifth Circuit reviewed a bankruptcy court's determination of the "cram down" rate, which is the rate of interest paid after confirmation of a chapter 11 plan on account of a non-consenting secured claim, for clear error.  Wells Fargo Bank had argued that the appellate panel should conduct de novo review.  Although the parties agreed that the "prime-plus" formula established for all chapter 13 cases in Till v. SCS Credit Corp., 541 U.S. 465 (2004) should apply (in which the court starts with the prime rate and adjusts for risk factors), the Fifth Circuit declined to adopt a uniform standard for chapter 11 cases.  The Ninth Circuit has not ruled on the appropriate standard and whether it should be applied uniformly.

Justice Kagan's First Opinion Tightens Automobile Ownership Cost Determination Under the Means Test

In her first opinion on the United States Supreme Court, Justice Elena Kagan reports the Justices' 8-1 ruling that a consumer debtor cannot deduct the IRS standard automobile ownership costs from his or her disposable monthly income under the means test if the automobile is free and clear.  In Ransom v . FIA Card Services, N.A., 11 C.D.O.S. 459 (U.S. Supr. Ct. No. 09–907 January 11, 2011), Justice Kagan explained that the means test, which is used for determining eligibility for chapter 7 and is related to the calculation of plan payments under chapter 13, includes deductions from disposable monthly income for vehicle “Ownership Costs” and vehicle “Operating Costs” pursuant to certain IRS standards.  The Ownership Costs include only loan or lease payments, and they are deemed to be $471 per month based on national automobile financing data.  Operating Costs, on the other hand, can include the expenses of driving and maintaining a vehicle.

In Ransom, the chapter 13 debtor claimed the full Ownership Cost as well as Opweating Costs of $388 per month for a car that the debtor owned free and clear.  A creditor, namely FIA Card Services, objected to the claim of Ownership Costs and argued that the payments to creditors proposed in the plan should be increased in light of the resulting higher disposable monthly income.  The bankruptcy court agreed and denied confirmation of the plan.  The Ninth Circuit Bankruptcy Appellate Panel and the Ninth Circuit Court of Appeals affirmed.

The Supreme Court focused on the language of 11 U.S.C. § 707(b)(2)(A)(ii)(I), which provides that:  “The debtor’s monthly expenses shall be the debtor’s applicable monthly expense amounts specified under the National Standards and Local Standards, and the debtor’s actual monthly expenses for the categories specified as Other Necessary Expenses issued by the Internal Revenue Service for the area in which the debtor resides.”  Specifically, the Justices ruled that the term "applicable" means that the debtor must have actually incurred the expense.  In other words, the Ownership Costs do not apply if there are in fact no loan or lease payments.  The opinion further notes that the Ownership Costs do not include the expenses of driving or maintaining an automobile, which are covered by the separate Operating Costs deduction.

The Justices did not discuss the debtor's policy argument or alternative interpretation of the term "applicable."  These may be similar to the arguments advanced in a recent Credit Slips article.  The article argues that:  "[W]e also can think of the 'ownership expense' as the cost of saving up to replace an existing car. In addition, if we deny an ownership expense to a debtor who owns a car free and clear, we create an incentive to buy a new car on credit just before filing bankruptcy so that there is an actual out-of-pocket 'ownership expense' the debtor can deduct." 

Justice Scalia filed a dissenting opinion, arguing that the term "applicable" does not do as much work as the majority thinks.  "A House of Lords opinion holds, for example, that in the phrase ‘in addition to and not in derogation of ’ the last part adds nothing but emphasis.  Davies v. Powell Duffryn Associated Collieries , Ltd. , [1942] A. C. 601, 607."  Specifically, Justice Scalia argues that the phrase simply makes the IRS tables applicable to the means test.  The tables have entries for "one car" and "two cars," but not "no car."  In other words, the first two entries are applicable of the debtor has a car, and the last is applicable if the debtor has no car, regardless of whether there are any loan or lease payments.

In an interesting twist, the Credit Slips article criticized the Office of the US Trustee for having published guidelines on the means test that stated, without qualification, that the Ownership Costs could not be deducted if the automobile is free and clear; in other words, the US Trustee decided the Ransom case before the Supreme Court did.

By Reno F.R. Fernandez III

We're Making News!

Check out my article in The Recorder on a recent Supreme Court decision, Hamilton v. Lanning, which is likely to significantly impact chapter 13 plan payments. - Reno

Five Year Commitment Period In Chapter 13 Bankruptcy Not Applicable If Debtor Has No Projected Disposable Income

In In re Kagenvaema, 541 F.3d 868 (9th Cir. 2008), the Ninth Circuit ruled that a voluntary Chapter 13 bankruptcy filed by a debtor with no “projected disposable income” is not subject to the “applicable commitment period” under Bankruptcy Code Section 1325, which requires debtors with above-median income to repay unsecured creditors over a minimum period of five years. In other words, a chapter 13 debtor can confirm a plan with a repayment period shorter than five years if the debtor’s “projected disposable income” is zero or a negative at the time the petition is filed. In this case, the proposed repayment period was 36 months.

In 2005 Congress added the five-year commitment period for chapter 13 debtors with above-median income as part of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”). Under BAPCA, “disposable income” is calculated by adding up past income and subtracting certain standard and actual expenses, including mortgage payments. This calculation is relatively straightforward, but courts disagree over the meaning of “projected disposable income.”

The Kagenvaema decision puts the Ninth Circuit at odds with some other federal circuit courts. Some courts take a flexible approach, holding that a bankruptcy judge can take into account the debtor’s actual income (as opposed to the debtor’s statutory “disposable income”) and circumstances arising subsequent to the bankruptcy filing, such as an increase in income. See In re Frederickson, No. 07-3391, — F.3d —-, 2008 WL 4693132 (8th Cir. Oct. 27, 2008); In re Lanning, — F.3d —-, 2008 WL 4879134 (10th Cir. 2008). This flexible approach has been subject to the criticism that it allows bankruptcy courts to ignore the “disposable income” calculation, which allows debtors to deduct certain expenses. The Ninth Circuit’s approach in Kagenvaema provides more certainty in calculating “projected disposable income,” and greater flexibility in crafting a chapter 13 plan.