In the past, our firm, Acclaim Legal Services, mainly filed Chapter 13 bankruptcies to stop foreclosure sales and give borrowers the opportunity to cure outstanding mortgage arrearages. More and more, we are seeing clients choosing to surrender their property under the Chapter 13 plan due to severely declined house values. Chapter 7 may seem like the obvious choice when surrender of property is the goal, however, in many circumstances an individual may not be eligible for Chapter 7 (e.g., too much income, prior Ch. 7 within 8 years) or their overall circumstances may dictate that a Chapter 13 is more appropriate (e.g., non-exempt property exists and client seeks to avoid liquidation; substantial priority debt exists that the debtor needs an opportunity to pay as it would be non-dischargeable in Ch. 7; debtor seeks to reorganize other secured debts such as a vehicle while surrendering his or her home).
The majority of states are “recourse” jurisdictions which allow mortgage companies to pursue borrowers for deficiencies that remain following a foreclosure sale. Previously, if homeowners had just a first mortgage, they generally could walk away without further obligation or indebtedness to the mortgage holder. This was primarily due to the mortgagee submitting a “full debt bid” at the foreclosure sale thus negating the possibility of a deficiency on the note. The tide has now turned and we are seeing banks begin to submit less than full debt bids and subsequently pursue borrowers for loan deficiencies after the foreclosure sale. A recent Wall Street Journal article, “House is Gone but Debt Lives On,” detailed the national trend: Visit our website for more information.
This has pushed many homeowners towards bankruptcy to resolve the debt. Chapter 7 provides a fresh start to eliminate mortgage debt as well as other unsecured debts. Chapter 13 provides the chance for debtors to reorganize their debts, improve their credit and create a balanced budget.
11 USC 1325(a)(5) provides debtors with three options for the treatment of secured claims under a Chapter 13 plan, two o f which may be implicated when a debtor seeks to surrender their property. Subsection (A) allows confirmation if "the holder of such claim has accepted the plan" and, absent such acceptance, subsection (C) allows confirmation if the plan provides for surrender of the collateral to the secured creditor. 11 U.S.C. § 1325(a)(5)(C).
So what if your client wishes to surrender their property under the Chapter 13 plan – what are the implications? The two primary objectives of a debtor in proposing to “surrender” real property in a Chapter 13 Plan are to:
· Resolve or discharge the outstanding indebtedness. In general, 11 USC 506(a) permits a creditor to file a general unsecured claim to the extent the creditor’s claim is undersecured (i.e., the value of the collateral is less than the amount of the claim). See In re Finley, 408 B.R. 111, 114 (Bankr. E.D. Mich. 2009). The key component of the Plan is to ensure that the “debt” is “provided for by the plan” such that a discharge pursuant to 11 USC 1328 is effective to extinguish the indebtedness. A plan that is silent as to the potential unsecured claim or classifies the creditor/claim in a section of the plan preserved for 1322(b)(5) claims (i.e., “continuing claims”) is insufficient and creates an ambiguity.
· Divest themselves of the responsibility for the property (although in some instances debtors will seek to stay in the property for an extended period of time). Many debtors are under the impression that filing a Chapter 13 which offers to “surrender” property “washes their hands” of the responsibilities inherent in property ownership such as maintenance, insurance, and condominium association dues. A proposed or confirmed Chapter 13 Plan which offers to “surrender” collateral to a creditor or creditors does not effectuate a legal transfer of ownership and the responsibility for the property remains that of the debtor post-confirmation. Surrender as used in a Chapter 13 Plan merely states an intention on behalf the debtor to make the property available to the creditor to pursue its state law remedies. Further, although the bankruptcy may be pending, pursuant to 11 USC 1327(b), confirmation of the case vests all of the property of the estate in the debtor. Your client must be advised and informed that filing a Chapter 13 Plan which “surrenders” property does not obviate their responsibility to maintain the property.
In order to avoid some of the pitfalls related to surrendering property in a Chapter 13 plan, here are some effective drafting suggestions:
- Consider creating a separate section or classification in the Plan for “Property to Be Surrendered to Secured Creditor” and name the Creditor and the collateral and detail the proposed treatment of the indebtedness.
- For example: Property/collateral shall be surrendered to creditor in satisfaction of their secured claim. To the extent an unsecured claim exists, creditor shall be treated as a general unsecured creditor.” See Branch Banking & Trust Co. v. Coffia (In re Coffia), 2010 Bankr. LEXIS 1563 (Bankr. S.D. Ga. Mar. 22, 2010) (confirming a Plan which proposes to surrender collateral in full satisfaction of creditor’s “secured claim” over creditor’s objection as court ruled that creditor retained right to seek reconsideration of its claim pursuant to 502(j) to assert a deficiency) (also, finding that “surrender” treatment pursuant to 1325(a)(5)(C) necessarily satisfies a creditor’s allowed secured claim)
- Property/Collateral shall be surrendered to Creditor. Any deficiency allowed pursuant to creditor’s non-bankruptcy rights shall be treated as a general unsecured claim and shall be subject to discharge pursuant to 11 USC 1328.”
- Property/Collateral shall be surrendered to Creditor in full satisfaction of the outstanding debt” (this language can be used to the extent the debtor asserts that the claim is fully secured or the creditor’s non-bankruptcy rights restrict the collection of a deficiency). Of course, this language may solicit an objection from a creditor that asserts a non-bankruptcy right to a deficiency. Or the language may not draw an objection in which case the creditor will likely be deemed to have “accepted” the Plan pursuant to 1325(a)(5)(A) and any effort to collect a deficiency would be objectionable.
Note: Much of this article was derived from conference materials prepared by Managing Attorney for Acclaim Legal Services Christopher Jones for the ABI Veteran’s Day Conference, Detroit, Michigan, 11/11/11.
About the Author:
Attorney William Johnson has practiced bankruptcy law for 15 years. In 2003, he founded Acclaim Legal Services to help Michigan residents file Chapter 7 and Chapter 13 bankruptcy. Acclaim Legal Services has 5 offices in the following cities: Ann Arbor, Southfield, Dearborn, Warren and Flint, Michigan.
Attorney Johnson has authored several articles on bankruptcy-related articles for Aspatore Books, a division of Thomson Reuters. He is actively involved Member of United Way’s Michigan Foreclosure Task Force, The Foreclosure Prevention & Stabilization Collaborative.