By Alan Steven Wolf of The Wolf Firm (Reprinted with permission from California Trustee's Association Newsletter - Winter 1996)
By Alan Steven Wolf of The Wolf Firm
(Reprinted with permission from California Trustee's Association
Newsletter - Winter 1996)
On July 22 1995, the Ninth Circuit Bankruptcy Appellate Panel (BAP) published its
decision entitled Mason-McDuffie vs. Peters, now commonly known as the Peters
decision. As virtually everyone in the foreclosure industry is aware, Peters held
that it is a violation of the automatic stay to postpone a foreclosure sale after
confirmation of a Chapter 13 plan. While this holding has caused its share of grief, the Peters
case does much more to California foreclosures than is apparent on the face of the case.
In order to reach its conclusion, the Peters court also held that absent express
language to the contrary, a Chapter 13 plan modifies the note to conform to the plan. The
new type of forced modification that occurs under Peters, and the ever present
forced modification that occurs under the Chapter 11 cramdown plan, both have a dramatic
effect on California foreclosures. This article explores that effect.
A foreclosure sale is of course premised on a default of some type. It is axiomatic that
if no default has occurred, than no foreclosure can proceed. It is also commonly known
that if the default under the note is cured, a previously commenced foreclosure is
rendered moot and should be rescinded.
The cure of the default generally occurs by payment of funds sufficient to bring the loan
current, i.e., reinstatement of the loan. However, there are a variety of other ways in
which the cure could occur. One obvious example is when the note is paid off. A less
obvious example is when the note is modified.
Whereas a forbearance agreement merely postpones further exercise of the foreclosure
remedy while leaving the delinquency status of the loan unchanged, a loan modification
creates a new note with new terms. Almost invariably, the new note is considered current
at the time of inception. Thus, a loan modification is distinguished from a forbearance
agreement because the modification creates a new note curing the default and rendering
moot prior foreclosure proceedings.
A loan modification generally occurs where the parties to a problem loan mutually agree to
workout the problem by creating new and better loan terms. The hope is that the new loan
will enable to the borrower to meet its obligations.
The Bankruptcy Code takes the concept of modification and pushes it to a new level.
Under the Code, the court can force the modification of a loan over the objection of a
creditor where it finds that such a modification is in the best interests of all
creditors.
The unconsented modification of a note in bankruptcy is accomplished through a Chapter 11
plan known as a cramdown. In a cramdown, the debtor proposes new terms for the note or
deed of trust. This can include lowering the interest rate, extending the term, deleting
the late charge payments or even deleting the power of sale. There is no limit to what the
debtor can propose to change. However, in order to get the court to order such changes,
the debtor must convince the court that the changes are fair and reasonable. Once so
convinced, and once the plan meets the other requirements of Chapter 11, the court can
confirm the plan and thus force the modification of the loan.
Where a plan contains modifications to the loan, the confirmation of that plan results in
a new loan with new terms. Thus, if the interest rate were lowered a new note is created
with a different payment schedule. More importantly, and unless stated to the contrary in
the plan, a note resulting from a Chapter 11 cramdown is current upon inception and thus a
foreclosure action based on the pre-modified note is rendered moot.
Most trustees are unaware of the effect that a cramdown has on their pending foreclosure.
This is because it is rare to see a cramdown. In fact, only a small percentage of Chapter
11 plans are ever confirmed and in most of those cases the real estate lender is treated
as "unimpaired," meaning that there is no attempt to modify the loan. However,
courts sometimes do cramdown loans and thus a trustee should always review the Chapter 11
plan before proceeding to foreclosure.
Whereas Chapter 11 cramdowns are rare, the Peters case essentially creates a
limited cramdown in all Chapter 13 proceedings. Under Peters, the confirmation of a
plan results in the modification of the loan changing it to conform to the Chapter 13
plan. Unlike Chapter 11 cramdowns, the Peters cramdown is limited; for example, it
does not allow a change in interest rate or a deletion of terms such as the power of sale.
However, what the Peters cramdown lacks in scope it makes up for in its success
rate. Indeed, unless the plan specifically states that there is no cure upon confirmation,
the Peters decision holds that all confirmation orders result in a recast loan
deemed current upon confirmation.
Trustees regularly involved with Chapter 11 cases have taken the Peters case in
stride and have both started a new foreclosure (once the stay has terminated in the
Chapter 13 case) and based that new foreclosure on the recast terms of the loan. In other
words, not only do they restart the foreclosure but once restarted, the new foreclosure
only shows the post confirmation default. Other trustees, not familiar with these
concepts, have attempted to continue with the prior foreclosure or having restarted, show
the default as it would have been under the loan prior to modification. Absent other
considers described more fully below, trustees who do not treat loans in confirmed Chapter
13 cases as having been modified face the real risk of having all of their sales set
aside.
If you have a confirmed Chapter 13 plan where there is no express language providing
that there is no cure upon confirmation, you have a Peters problem. What you do
with that problem depends first on how you view the scope of the Peters decision
and next on how the stay is terminated.
As trustees are well aware, prior to the Peters decision there were no
bankruptcy limitations on postponing foreclosure sales and once the stay was terminated,
the trustee could continue with a pending sale. Peters is said to have changed that
result because it is an appellate decision rendered by the Bankruptcy Appellate Panel for
the Ninth Circuit. However, before anyone follows Peters it is important to note
that it is not entirely clear that the Peters decision is binding on bankruptcy
courts in California. Peters is an appeal of a decision rendered by the Nevada
bankruptcy court. There is cogent legal argument that such a decision does not bind
California bankruptcy courts. Of course, there cogent legal argument for the proposition
that it does bind our courts. Thus, there is authority for merely ignoring Peters,
but that would be a bad bet.
Another scope issue revolves around the pending appeal. Peters is up on appeal
before the Ninth Circuit Court of Appeals. A decision should be rendered within the next
six months. The case is likely to be overturned on appeal for reasons not relevant to this
article. Some people take the position that since Peters is likely to be overturned
on appeal that it is safe to ignore it now. While I agree that it is likely to be
overturned on appeal, it is far from certain to be overturned. Moreover, even if
overturned, the case is not likely to have retroactive effect. Thus, ignoring Peters
because of the pending appeal is also a bad bet.
Unless you like the excitement of big time gambling, it is probably best to assume that
Peters is binding in California and govern your actions by the following guide:
111 Simple Relief From Stay
Start a new foreclosure and base it only upon the post confirmation default.
Analysis:
An order terminating the stay in and of itself does not solve the Peters problem.
Termination of the stay does not in any way change a confirmed Chapter 13 plan. Therefore,
while the creditor obtained relief, it is still bound by the modification that occurred
when the plan was confirmed.
121 Relief From Stay With Language Ratifying The Pending Foreclosure
Continue with the prior foreclosure.
Analysis:
As noted above, a simple order terminating the stay does not solve the Peters
problem. Nonetheless, a motion for relief from stay can sometimes be a foundation for a
court order which does solve the Peters problem.
Technically, in a motion for relief from stay, the court can only terminate, annul or
condition the stay. However, it is often the custom and practice of bankruptcy judges to
make rulings outside the scope of the motion. For example, courts often make rulings
stating the amount necessary to reinstate a loan. Similarly, courts sometimes make rulings
not only annulling the stay, but specifically ratifying the prior foreclosure actions.
Therefore, a motion for relief from stay can be effective not by terminating the stay, but
rather by rulings that the court might make which are technically outside the scope of the
motion. Thus, if the court not only terminates the stay, but expressly provides that
confirmation of the Chapter 13 plan did not cure the loan and that the prior foreclosure
is still binding and of full force and effect, then the Peters problem is basically
gone; most title companies should accept such an order. Some courts will be willing to add
this language; some will not. It seldom hurts to ask.
131 Order Dismissing Case
Restart the foreclosure but base it on the entire pre and post confirmation default; i.e.,
use the default amount that you would have used had the loan not been modified.
Analysis:
When a case is dismissed, it is as if the loan modification were mutually rescinded by
the parties replaced with the old loan terms. Some people believe that this entitles the
prior foreclosure to proceed as if the bankruptcy never occurred. I disagree. Upon
confirmation of the plan, the note was modified and the foreclosure was rendered moot. The
fact that the modification is later set aside does not reestablish the failed foreclosure.
141 Order Dismissing Case With Language That The Plan Is Vacated
Continue with the prior foreclosure.
Analysis:
As noted above, dismissal rescinds the loan modification replacing it with the original
note but the fact that the plan was confirmed and the loan was at one time modified
renders the pending foreclosure moot. A dismissal order with language providing that the
Plan is vacated solves this problem. "Vacate" means to annul. If the plan is
annulled, then the plan never occurred and thus the note was never modified and the
foreclosure was never rendered moot. This is a similar analysis to those instances where
the stay is annulled- if you go to sale in violation of the stay and the stay is annulled,
the stay never occurred, there was no violation of the stay and the sale is valid.
Conclusion
The Bankruptcy Code provides the Debtor the ability to force a modification of a loan. The
modification can take place in a Chapter 11 cramdown or in a Chapter 13 Peters
cramdown. If a cramdown occurs, a trustee must carefully analyze what to do with its
pending foreclosure. Moreover, if a trustee starts a new foreclosure under a loan subject
to cramdown, it must carefully determine the proper amount in default.
For further information please contact:
The Wolf Firm, A Law Corporation, is an "AV" rated law firm which concentrates on providing superior legal services to the mortgage banking industry. The firm's national clientele includes many of the largest mortgage bankers in the country, as well as a variety of savings banks, commercial banks, commercial finance companies, credit unions, and the Resolution Trust Corporation. With a staff of approximately forty individuals, including attorneys, certified paralegals, legal secretaries, administrators, clerical personnel, and a full time computer systems analyst, the firm represents its clients on a wide range of matters including all aspects of both residential and commercial/multifamily mortgage loan origination and servicing, securitization, regulatory compliance, bankruptcy, and litigation related to the foregoing in both federal and state courts throughout California. For more routine matters, such as residential bankruptcies, evictions and receiverships, The Wolf Firm has developed extremely cost-effective and efficient programs using specially trained paralegals and computer technology to assist its attorneys in handling these matters at rates that are the most competitive in the State of California and, through its membership in the USFN, the Firm is able to arrange similar services in virtually every state in the nation.
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