4th Circuit Overrules Own Precedent, Holds Certain Primary Residence Claims Can Be Crammed Down in Chapter 13 Bankruptcies

By Daniel Cohn

The general rule in bankruptcy is that debtors cannot cram down loans secured only by mortgages on their primary residences. But wait, “what’s a cram down?” you ask. For non-bankruptcy folks, a cram down is where a debtor bifurcates a creditor’s claim into a secured claim (in the amount of the value of the property) and an unsecured claim (for the balance of the outstanding debt above the value of the property), paying the secured claim in full and paying the unsecured claim pro rata along with other general unsecured creditors. Take this example: at the time of bankruptcy filing, a lender is owed $150,000, but the property is worth only $100,000. The general rule in bankruptcy is that if the property is the debtor’s primary residence and the lender’s only collateral, the lender has a secured claim of the full $150,000. Otherwise, the debtor could cram the lender down, giving the lender a secured claim of only $100,000 that would be paid in full, and an unsecured claim of $50,000 that would be paid pennies on the dollar. Thus, we can see the obvious benefit to debtors and the obvious detriment to creditors of the powerful cram down option.

Exception: Modifications of “Short-Term” Mortgages Permitted

A statutory exception to that general rule permits certain modifications to home mortgages that mature before the end of the chapter 13 payment plan. However, there is disagreement among some courts about the scope of the modifications permitted. Since 1997, the law in the Fourth Circuit has been that, for those loans that fall within the exception, debtors may only modify the payment terms (i.e., extend the payments out through the end of the plan and lower the payment amount), but may not otherwise modify the loan (e.g., by cramming it down or lowering the interest rate). See Witt v. United Cos. Lending Corp. (In re Witt), 113 F.3d 508 (4th Cir. 1997).

That changed on May 24, 2019, when the United States Court of Appeals for the Fourth Circuit issued an en banc opinion overruling its 1997 case. Hurlburt v. Black, 925 F.3d 154 (4th Cir. 2019). The court held that debtors whose loans mature before the last payment under their chapter 13 payment plans may modify the entire loan, including cramming it down. This even extends to loans that matured (or, perhaps, were accelerated) before the bankruptcy case was filed.

Fourth Circuit History

In overruling its own precedent, the Fourth Circuit noted that its prior decision in Witt relied on a grammatical construction that did not make a lot of sense in retrospect. To understand the prior analysis and the current analysis, we first need to understand the provisions of the Bankruptcy Code dealing with cram downs. Section 1325(a)(5) of Title 11 permits a court to confirm a chapter 13 plan that crams down a secured claim. Section 1322(b)(2) provides the general rule that debts secured only by a lien on a primary residence cannot be crammed down. And section 1322(c)(2) provides the language at issue—specifically, notwithstanding section 1322(b)(2), where the debt matures before the date on which the last plan payment is due, “the plan may provide for the payment of the claim as modified pursuant to section 1325(a)(5) . . . .”

In Witt, the court concluded that the “as modified” language modified “payment” only, not the whole “claim.” 113 F.3d at 511–12. In coming to that conclusion, it observed that “claim” was part of a larger phrase, “of the claim,” which itself modified “payment.” Id. Accordingly, the Witt court concluded that the modification was permitted only with respect to the payment of the claim, not the claim itself. Id.; see Hurlburt, 925 F.3d at 161.

The New Rule

Twenty-two years after Witt, the Fourth Circuit acknowledged its previous grammatical gymnastics in Witt and recognized the multitude of courts that have disagreed with and criticized that decision. Id. (collecting cases). So, in accordance with those other courts’ decisions, and in keeping with a much more natural reading of the statutory provision, the Fourth Circuit finally came to the conclusion that “the payment of the claim as modified” means just that—the payment of the claim, as the claim has been modified. Id. This decision means, then, that in the Fourth Circuit, debtors may cram down primary residence mortgages when the last payment on the mortgage is due before the end of the chapter 13 plan. See id.

In coming to this conclusion, the Fourth Circuit’s pendulum swung from its prior grammatical gymnastics to a “plain language” reading of the statute, so much so that the court decided it need not even look to legislative history that might “ ‘muddy [the] clear statutory language.’ ” Id. at 164 (quoting Milner v. Dep’t of Navy, 562 U.S. 562, 572, 131 S. Ct. 1259 (2011)) (alteration in original).

A Strong Dissent

As the dissenting judges pointed out in their dissenting opinion, this new holding could result in “mischief” by debtors who purposefully time their filing to be able to cram down their primary residence mortgage. Hurlburt, 925 F.3d at 174 (Wilkinson, J., dissenting). The dissent also notes that one of the primary purposes of the payment modification in chapter 13, supporting the previous reading of the statute in Witt, is to let debtors dig out of accelerated loans after default. Id. at 175. (The statutory provision makes clear reference, though, to cases “in which the last payment on the original payment schedule for a [primary residence mortgage] is due before the [last plan payment],” 11 U.S.C. 1322(c)(2) (emphasis added), so it is not clear from the statute that accelerated loans, or even loans that have been recast, are eligible for modification under this provision. But that is a discussion for another court opinion and, perhaps, another blog post.) To the dissent’s point, and assuming the dissent is correct about accelerated loans being eligible, more clever (and, to use the dissent’s term, mischievous) debtors with more than five years left on the mortgage may purposefully default and prompt acceleration of the debt just to be able to then file a chapter 13 plan that crams the loan down when they otherwise would not have been able to modify the loan.

So, Now What?

The Fourth Circuit’s newest decision aligns it with the Eleventh Circuit and Sixth Circuit on debtors’ ability to cram down these primary residence mortgages. See, e.g., Am. Gen. Fin., Inc. v. Paschen (In re Paschen), 296 F.3d 1203 (11th Cir. 2002); First Union Mortg. Corp. v. Eubanks (In re Eubanks), 219 B.R. 468 (B.A.P. 6th Cir. 1998).

Hurlburt means that creditors may see a sharp rise in chapter 13 cram downs of primary residence mortgages maturing before the end of the plan in the Fourth Circuit. Creditors should pay closer attention to proposed plans, original payment schedules, and property values as they navigate this brave new world and attempt to mitigate further losses in bankruptcy cases.

About the Author: Daniel Cohn is an attorney in the Legal Department at Wells Fargo Bank, N.A., where he focuses on consumer bankruptcy issues. Before joining Wells Fargo, he was a senior associate at a large firm based in West Virginia, practicing in bankruptcy, foreclosure, and creditors’ rights; transactional and corporate matters; and financial services litigation. He is also a pilot and volunteers with Civil Air Patrol and the South Carolina Youth in Government program.


Legal Disclaimer: This blog post does not create an attorney-client relationship between the author and any reader of this post. This post contains legal information and the opinions of the author but should not be considered legal advice or the opinion of the author’s employer. Any reader of this blog post should consult an attorney rather than relying upon the information contained in this post.