CRAMDOWN ALERT: Bankruptcy Judges to Modify Terms of Eligible Primary Presidential Mortgages in Chapter 13 Bankruptcy

February 25, 2009

To update, the “Helping Families Save Their Homes Act of 2009” (H.R. 1106) is anticipated to be voted on the House floor on February 26, 2009. This larger housing package includes a cramdown measure would amend Section 1322 of Title 11 of the USC to grant bankruptcy judges the ability to modify the terms of a eligible primary residential mortgage for homeowners in chapter 13 bankruptcy.

The following summarizes: (1) key refinements made to the cramdown measure in H.R. 1106 since previous version of the measure ( including H.R. 200) w ere introduced and reported in the House Judiciary Committee; and ( 2) a recap of highlights of the cramdown measure.

(1) Key Changes to Cramdown Bill

The cramdown language in H.R. 1106 largely mirrors a previous cramdown bill (H.R. 200), but includes three refinements: (1) limiting the eligible mortgages to those originated before the date of enactment of the bill; (2) requiring borrowers to notify their lenders 15 days before filing for bankruptcy; (3) clarification regarding TILA claims to establish that only major violations of TILA would invalidate creditor claims during a bankruptcy proceeding. Notably, the measure also includes a sliding-scale of conditions for payment to the loan holder if the debtor sells the principal residence within four years after the modification with balance outstanding.

(2) Recap of Highlights of the Cramdown Measure

To recap, the following are among the highlights of the cramdown language in H.R. 1106:

Mortgages Must be Originated Before Effective Date, Must be For Principal Residence. To qualify for the bankruptcy cramdown, the mortgages must: (1) have been originated before the effective date (e.g. the date of enactment of the bill); and (2) secured by a security interest in the debtor’s principal residence (e.g. not secondary or vacation residences).

Borrowers Must Notify Lenders 15 Days Before Filing for Bankruptcy. The measure includes a new provision that the debtor must certify he/she has contacted the holder (or the entity collecting payments on behalf of the holder) of the mortgage claim at least 15 days before the commencement of the bankruptcy filing and regarding the modification of the loan that is subject of the bankruptcy claim.

Judges May Limit Adjustments in Interest Rates. Where a loan includes an adjustable interest rate, the measure would allow judges to prohibit, reduce, or delay such adjustments to interest rates applicable on and after the filing of the plan.

Judges May Extend Repayment Period. The measure would allow judges to extend the repayment period for up to 40 years total (reduced by the period for which such loan has been outstanding) or the remaining term of the loan, beginning on the date of the order for relief.

Judges May Modify to Fixed Annual Rates Equal to Current Prime. The measure would permit judges to modify loans to a fixed annual rate equal to the currently applicable average prime offer rate plus a reasonable premium for risk for the payment of interest accruing after the date of the order for relief.

Conditions if a Debtor Sells the Principal Residence Within Four Years After the Mortgage Modification. Notably, the measure includes a sliding scale of conditions if a debtor sells the principal residence securing the mortgage before completing all payments under the plan and receives net proceeds from the sale, such that if the residence is sold: (1) within the first year after the modification, then the debtor must make payment to the mortgage holder for 80 percent of the amount of the difference between the sales price and the amount of such claim (plus costs of sale and improvements) (2) within the second year after the modification, then the debtor must make payment to the mortgage holder for 60 percent of the amount of the difference between the sales price and the amount of such claim (plus costs of sale and improvements); (3) within the third year after the modification, then the debtor must make payment to the mortgage holder for 40 percent of the amount of the difference between the sales price and the amount of such claim (plus costs of sale and improvements); (4) within the fourth year after the modification, then the debtor must make payment to the mortgage holder for 20 percent of the amount of the difference between the sales price and the amount of such claim (plus costs of sale and improvements). Notably, the payment by the debtor to the mortgage holder must occur not later than 15 days after receiving the proceeds from the sale.

TILA Claims. The measure includes clarification on the types of TILA violations that would invalidate creditor claims during a bankruptcy proceeding. Specifically, section 102 amends Section 502(b) of Title 11 of the USC to clarify that the claim for a loan secured by a security interest in the debtor’s principal residence is subject to a remedy for rescission under TILA notwithstanding the prior entry of a foreclosure judgment, except that nothing in shall be construed to modify, impair, or supersede any other right of the debtor.

Provisions for Combating Excessive Fees. The measure would amend Section 1322(c) of Title 11, USC, by adding that: (1) a plan may provide for the waiver of any prepayment penalty on a claim secured by the debtor's principal residence; (2) the failure of a party to give required notice shall be deemed a waiver of any claim for fees, costs, or charges for all purposes, and any attempt to collect such fees, costs, or charges shall constitute a violation; and (3) the debtor (or debtor's property or estate) is not liable for a fee, cost, or charge that is incurred while the case is pending and arises from a debt that is secured by the debtor's principal residence except to the extent that (a) the holder of the claim for such debt files with the court and serves on the trustee, the debtor, and the debtor's attorney notice of such fee, cost, or charge before the earlier of 1 year after such fee, cost, or charge is incurred; or 60 days before the closing of the case; and (b) the fee, cost, or charge is lawful under applicable nonbankruptcy law, reasonable, and provided for in the applicable security agreement; and is secured by property the value of which is greater than the amount of such claim, including such fee, cost, or charge.

Effective Date. The effective date for the measure is the date of enactment.

Note: We are still further reviewing and this summary does not include discussion of the following: standing trustee fees, adjustments to Veterans Affairs loans, payment of FHA mortgage insurance benefits, adjustments as a result of modification of rural single family housing loans in bankruptcy, or unenforceability of certain provisions as being contrary to public policy.

Written by Kirsten Wegner