No Cramdown of Multi-Use Property

SHD recently obtained a court ruling which clarifies bankruptcy cramdown. The bankruptcy court for the Southern District of Florida (“the Court”) issued an opinion[i] wherein it held a chapter 11 bankruptcy plan could not modify a mortgagee’s lien on a debtor’s principal residence under the cramdown provisions of the bankruptcy code. In re: John R. Hock and Doreen T. Zic-Hock, (“Hock”). The pertinent provision of the Bankruptcy Code provides:

“[A chapter 11 bankruptcy] 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…”

In Hock, the bank lent the Hocks $499,950.00 to purchase real property. The property included their primary residence and a carriage house which the borrowers converted into three rental apartments.

The Hocks filed for bankruptcy protection under chapter 11 and during the bankruptcy proceedings sought to modify the bank’s mortgage lien under section 1123(b)(5) of the Bankruptcy Code. The bank argued its lien could not be modified because it was secured by its interest in the Hock’s principal residence and thus excluded from modification under the explicit terms of section 1123(b)(5) of the Bankruptcy Code. The borrowers countered that since the property was not exclusively used as a principal residence, but also as “income producing property,” the exclusionary clause of § 1123(b)(5) did not apply to the bank’s lien.

The Court rejected the Hocks’ position concluding that the language of 1123(b)(5) unambiguously prohibited modification of the bank’s secured lien. The Court explained the borrower’s position required the Court to read language into the statute that was not there

If Congress had meant to apply the anti-modification provisions to claims secured only by real property used only or exclusively as the debtor’s principal residence, Congress could easily have said that a chapter 11 debtor may modify the rights of holders of secured claims, ‘other than a claim secured only by a security interest in real property that is exclusively the debtor’s principal residence.’

The Court also concluded that the definition of “principal residence” in the Bankruptcy Code did “not include a provision that a debtor’s principal residence must be a structure that is used exclusively as the principal residence of the debtor.” The Court surmised: “Therefore, the definition contemplates that a debtor’s principal residence may be a residential structure that the debtor uses as his principal residence plus incidental, non-residential property.” To support its conclusion, the Court cited several other U.S. bankruptcy courts which reached the same conclusion. The Court quoted extensively from a case named In re Wages, including the succinct conclusion offered by that Court that property either is, or is not, a principal residence:

…there is nothing in the Code indicating that, once a commercial use of a property becomes sufficiently ‘significant,’ that the property ceases being the debtor’s principal residence. Simply put, either the property is a debtor’s principal residence or it is not; the existence of other uses on the property does not change that.

The Court’s opinion was well-reasoned and its refusal to modify the banks’ secured lien sets an important precedent which will serve to protect lenders from unanticipated modifications of their interests.

[i] The Court rendered the Hock decision on August 16, 2017. It has become final on September 1, 2017, barring the filing of a motion for rehearing by the debtors.