Lenders beware. The "Helping Families Save Their Homes Act of 2009" bill, which would change chapter 13 to allow bankruptcy judges the ability to modify home mortgages, has passed the House. Though the bill sounds appealing on the surface, underlying issues may create a potential legislative nightmare for the residential mortgage lending industry.
If enacted, its provisions could devastate the mortgage markets as we know them. Such provisions could influence bankruptcy judges to apply similar concepts in commercial lenders' chapter 11 cases, at great cost to lenders.
Scope of the Bill
Currently, chapter 13 bankruptcy law does not allow a bankruptcy judge to modify the terms of an existing home mortgage. Any debtor who wishes to retain a primary residence on which there is a mortgage must continue to pay, even if the debtor gains court approval of a chapter 13 wage earner plan that otherwise modifies debts. The proposed legislation would subvert this social compact, which has run for over 30 years.
The bill would allow: (1) bankruptcy judges to "cram down" a value of a lender's secured claim on a residential mortgage to the value of the property as of the date of the bankruptcy court hearing on confirmation of a chapter 13 plan; (2) payments of interest at the prime rate published by the Federal Financial Institutions Examination Counsel in the "Average Prime Offer Rates—Fixed" table plus "a reasonable premium for risk"; and (3) extension of the mortgage term to the longer of (a) the remaining term of the mortgage or (b) 40 years. To understand how far-reaching that last provision is, there are no instances of a cram-down approving a 40-year repayment term under current bankruptcy law.
Adding insult to injury, the lender would not benefit from appreciation in the property value following confirmation. If the property appreciates in value after the cram-down, the lender can recover at most 80% of the appreciation, and loses 20% of the appreciation in each succeeding year. So, if the borrower holds the cram-down property for four years, the borrower reaps all of the appreciation!
The legislation would apply to pending as well as future chapter 13 cases, and does not change any existing requirements for being a debtor in a chapter 13 case. Thus, any debtor with less than $250,000 in unsecured debts and less than $750,000 in secured debts and regular income can file a chapter 13 case and seek a mortgage "modification."
The legislation also contains "safe harbor" provisions allowing servicers to engage in loan modifications even if applicable servicing and pooling agreements prohibit them from doing so without consent of all holders.
This legislation permits over-exuberant borrowers within the chapter 13 debt limits to file for chapter 13 and gain virtually all of the benefit of a modification at the lenders' expense. Further, the legislation will negate the veto rights of those who in securitizations have the right to say "no" to modifications that propose such terms.
Billions of dollars may be lost as underwater homeowners rush to re-write mortgages on terms to which no lender would have initially agreed. Though the legislation purports to apply only to chapter 13 cases, debtor-sympathetic bankruptcy judges may look to the chapter 13 40-year term authority as a "guideline" for decisions regarding what modifications of commercial loans are "fair and equitable" in chapter 11 cases. Various courts have viewed past chapter 13 loan modification decisions as instructive for chapter 11 cases. Thus, if this chapter 13 legislation becomes law, bankruptcy judges may be tempted to apply some of these new chapter 13 provisions to chapter 11 commercial loan cram-down cases.
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Copyright © 2009 Herrick, Feinstein LLP. Lending and Restructuring Alert is published by Herrick, Feinstein LLP for information purposes only. Nothing contained herein is intended to serve as legal advice or counsel or as an opinion of the firm.