Court Opinion

ID: 9859568
Source: CourtListenerOpinion
Date Created: 2023-09-24 22:02:03.810534+00
Date Added: 2024-06-11T10:53:16.869843
License: Public Domain

JOHN TESELLE, Bankruptcy Judge.
What follows might best be described as a “dissenting concurrence.”
With great reluctance, and with great respect for the legal scholarship of my colleagues, I take this opportunity to present my view on the applicability of 11 U.S.C.A. § 506 (West 1979 & Supp.1989), which differs only in part from their position.
Case Law
As noted by Judge Lindsey, the courts are not in agreement concerning the application of § 506. The apparent lack of consistency in the opinions of the courts which have dealt with this problem illustrates the uncertainty present in this area of the bankruptcy law. It is noted that the foregoing Opinion, as well as the Maitland and Dewsnup opinions, rest upon the language of § 506(a) limiting its applicability to “property in which the estate has an interest.” 1 Maitland v. Central Fidelity Bank (In re Maitland), 61 B.R. 130, 132-35 (Bankr.E.D.Va.1986); Dewsnup v. Timm (In re Dewsnup), 87 B.R. 676, 680-83 (Bankr.D.Utah 1988).
In order for a debtor to exempt property from the bankruptcy estate, at least two requirements must be met. First, the property must qualify for exemption under some state or federal statute. 11 U.S.C.A. § 522(b)(1) & (b)(2) (West 1979 & Supp. 1989). Secondly, the debtor must have an equity in the property, because it is only the debtor’s equity in such property to which the exemption attaches.2 Dewsnup, *100387 B.R. at 677 n. 1 (citing Wilson v. General Motors Acceptance Corp. (In re McCoy), 643 F.2d 684 (10th Cir.1981) and Styler v. Local Loan Fin. Servs. (In re Lanctot), 6 B.R. 576 (Bankr.D.Utah 1980)).
In those cases where the indebtedness secured by one or more mortgages exceeds the value of the debtor’s homestead, no equity exists and thus no portion of the homestead is eligible for exemption. Neither is the homestead abandoned from the estate until either a mortgage holder moves for its abandonment (usually done in connection with a motion for relief from the stay), or it is specifically abandoned by the trustee. Until either of these events occurs, the homestead remains property of the estate subject to being dealt with by the bankruptcy court.
The Dewsnup court assumed “for the purpose of this opinion, ... that the real property has been or will be abandoned to the debtors.” Id. It is submitted, however, that until abandonment, the homestead remains property of the estate subject to valuation under § 506. Such valuation may be requested by any party in interest.3 Fed.R.Bankr.P. 3012. For this reason, the rationale of Dewsnup is not well founded and unnecessarily ignores the negative impact which will result from a uniform application of its holding.
Application of § 506
My view can best be explained by considering three separate situations. Those situations involve 1) an undersecured first mortgage; 2) a second mortgage, where the value of the real property does not exceed the amount owed on the first mortgage, (hereinafter such second mortgage is characterized as “Under Water”); and 3) a second mortgage, where the value of the real property exceeds the amount due on the first mortgage but is less than the amount due on the second mortgage (partially Under Water).
I. Undersecured First Mortgage
In the case of an undersecured first mortgage, I concur with the result reached by Judge Lindsey. The drafters of the Bankruptcy Code could not have intended § 506 to be utilized to permit a debtor to achieve a greater benefit under a Chapter 7 liquidation than the debtor would be entitled to receive under a Chapter 11 or 13 reorganization. In re Mahaner, 34 B.R. 308, 309 (Bankr.W.D.N.Y.1983). Chapter 11 provides that an undersecured creditor may elect to have its claim treated as fully secured.4 Id. at 309. In a Chapter 13 case, § 1322(b)(2) precludes a § 506 valuation of a claim secured only by a first mortgage. Id.; 11 U.S.C.A. § 1322(b)(2) (West Supp. 1989). Thus, I agree that § 506 may not be used in a Chapter 7 proceeding to void any portion of an undersecured first mortgage.
II. Second Mortgage Completely Under Water
In the case of a claim secured by a second or other mortgage of lower priority which is completely Under Water, it is my view that the creditor’s mortgage is, for all practical purposes, worthless. A worthless mortgage is the equivalent of no mortgage at all; thus the claim is, in reality, not secured. This analysis permits the application of § 506 in a Chapter 13 case to void a worthless second mortgage without violating the provisions of § 1322(b)(2).
What result will ensue if a debtor is precluded from applying § 506 in a Chapter 7 case where the second mortgage is completely Under Water? In such a case, a debtor foolish enough to continue making payments on a first mortgage will only enrich the holder of the otherwise worthless second mortgage. Such payments will decrease the amount owed on the first mortgage until the point is reached that *1004each additional payment will directly increase the value of what was initially a worthless second mortgage.
Consequently, the payments to the first mortgage holder will not be made, and the resulting default will cause the first mortgage holder to soon thereafter commence a foreclosure action. This will preclude any recovery by the holder of the worthless second mortgage, who will be no better off in this situation than had the second mortgage been voided under § 506.
On these facts, the first mortgage holder will incur the expense of an unwanted and otherwise unnecessary foreclosure and the debtor will lose his or her home, without the second mortgage holder deriving any benefit from its mortgage. When the second mortgage is clearly Under Water, why not permit § 506 to be applied in a Chapter 7 case to void the second mortgage,5 thereby benefitting both the holder of the first mortgage and the debtor with no resulting financial detriment to the holder of the second mortgage? 6 If the second mortgage holder stands to gain nothing financially, the only benefit to the second mortgage holder in precluding the application of § 506 in a Chapter 7 case is either that of retribution or coercion, neither of which should be facilitated by the courts.
The argument has been made that to apply § 506 in a Chapter 7 case would deny the holder of the second mortgage its right to pay off the first mortgage and hold the property for its future appreciation. A demonstrated intent of this kind by the second mortgage holder would constitute a basis for sustaining the mortgage holder’s objection to the § 506 valuation of its mortgage. However, it is submitted that the holder of a second mortgage would file such an objection only on very rare occasions. Most real estate lenders in this judicial district have already acquired more real estate than they want to hold, do not want to become more illiquid, and are not interested in throwing good money after bad.
In addition to the foregoing, my objection to following the Utah court’s holding in Dewsnup, 87 B.R. at 683, is that while the application of its holding in this judicial district would dispose of the pending cases, in future cases knowledgeable attorneys will simply request § 506 valuations on their debtor client’s residences prior to claiming an exemption for the debtor’s residence. This will merely increase the paperwork and/or penalize those debtors who have less clever attorneys, or require the court to police such attempts,7 all of which are rendered unnecessary by my approach.
III. Second Mortgage Only Partially Under Water
The difficulty with my position arises when confronted with the problem of a second or lower priority mortgage on the debtor’s principal residence, which is partially but not completely Under Water. If the debt is secured only by a mortgage on the debtor’s principal residence, the literal language of § 1322(b)(2) would appear to prohibit the application of § 506. In this situation, consideration should be given inter alia to the following factors: the percentage of the debt that is Under Water, the term of the mortgage, the purpose for which the debt was incurred, and the rate of interest charged.
A number of cases consider these and other pertinent factors in determining whether to grant a § 506 valuation in such a case. Generally, in these cases the primary consideration is whether the second mortgage holder is of the type § 1322(b)(2) was intended to protect (i.e. long term, purchase-money mortgagees of residential property, who as a group have not been *1005abusive). See In re Shaffer, 84 B.R. 63, 65 (Bankr.W.D.Va.1988), and cases cited therein.8 Application of these criteria would necessitate proceeding on a case-by-case basis, but it is my belief the cases would be few in number and equity could be done.
Motion Practice or Adversary Proceeding
Requiring all requests for § 506 valuation hearings to be filed as adversary proceedings will prolong disposition time, and place an additional burden on the Courts and on the attorneys (which translates into placing an additional expense on the debtors), without a compensating benefit.
Bankruptcy Rules 3012 and 7001(2) appear to be in conflict. Fed.R.Bankr.P. 3012 & 7001(2). Thus, why not permit the quick- ' est, easiest and least costly procedure to be utilized, which would be to allow such matters to be brought by motion?
Conclusion
My view is predicated on a desire to facilitate the debtor’s “fresh start” when it can be accomplished, as in cases of this nature, with virtually no harm to the creditors. The language of § 506 does not preclude this result and it is my belief that equity requires such a common sense application of § 506.
Need for Uniformity
Notwithstanding my view, the purpose of the en banc hearing was to arrive at a uniform method of applying § 506 in this judicial district. In my opinion, such uniformity is more desirable than having a debtor’s rights determined by the random draw assignment of cases to specific judges made in the clerk’s office. For that reason, I defer to my colleagues and elect, in the future, to adhere to the majority opinion set forth above.9

. The bankruptcy estate "is comprised of all legal or equitable interests of the debtor in property as of the commencement of the case.” 11 U.S.C.A. § 541(a)(1) (West 1979 & Supp.1989).

. For example, under tit. 31, § 2, the debtor is entitled to exempt "[t]he homestead within any city or town, owned and occupied as a residence only, ... not exceeding one acre of land, to be selected by the owner: Provided, that the same shall not exceed in value the sum of five thousand dollars, and in no event shall the homestead be reduced to less than one-quarter of an acre, without regard to value_” Okla.Stat. Ann. tit. 31, § 2 (West 1976). Thus, if the indebtedness secured by a mortgage is $95,000.00, and the value of the homestead is $100,000.00, *1003an acre of urban homestead land may be exempted.

. The statement in Dewsnup that "[unless] the property [at issue] is abandoned ... the debtors would have no standing to assert their claim to avoidance" is contrary to the plain language of Bankruptcy Rule 3012. 87 B.R. at 677 n. 1.

. The benefits of the § 1111(b)(2) election are dubious, as its apparent advantages are substantially negated by § 1129(b)(2)(A). 11 U.S.C.A. §§ 1111(b)(2) & 1129(b)(2)(A) (West 1979 & Supp. 1989). The § 1111(b)(2) election is seldom made and it is even less frequently understood.

. It appears that this would be permitted by my colleague’s Opinion in a Chapter 13 case where the mortgage was not secured only by the principal residence. § 1322(b)(2).

. In fact, the second mortgage holder may thereby derive a benefit. The voiding of the second mortgage would convert a worthless secured claim into an unsecured claim which would thereafter be eligible to participate in any general distribution which might be made.

.Assuming that the last sentence of § 506 authorizes a court to vacate a prior valuation if the property is later exempted, abandoned, or if the proceeding is subsequently converted to one under Chapter 7.

. The Shaffer court cogently stated that Congress did not intend § 1322(b)(2) to protect short-term, non-purchase money, second mortgages. 84 B.R. at 65; See also Lyons v. First Pa. Bank (In re Lyons), 46 B.R. 604, 606 (Bankr.N.D.Ill.1985).

. Rulings made in previous cases are not affected by my election to adhere in the future to the majority opinion in this case.