In In re Zair, 2016 U.S. Dist. LEXIS 49032 (E.D.N.Y. Apr. 12, 2016), the U.S. District Court for the Eastern District of New York became the latest to take sides on the emerging issue of “forced vesting” through a chapter 13 plan. After analyzing Bankruptcy Code §§ 1322(b)(9) and 1325(a)(5), the court concluded that a chapter 13 debtor could not, through a chapter 13 plan, force a mortgagee to take title to the mortgage collateral.
Section 1325(a)(5) provides three exclusive methods of repaying a secured creditor through a chapter 13 plan: (i) the creditor consents to the plan’s treatment of its claim; (ii) the plan provides for the creditor to retain its security interests in collateral and receive payments over the life of the plan equaling present value; or (iii) the debtor surrenders the collateral so that the creditor may pursue its legal remedies. See 11 U.S.C. § 1325(a)(5)(A)-(C). A debtor’s proposed chapter 13 plan cannot be confirmed if, as to each secured claim, it does not satisfy one of these three requirements.
At the same time, a separate section of the Bankruptcy Code provides that a plan may “provide for the vesting of property of the [debtor’s bankruptcy] estate on confirmation of the plan or at a later time, in the debtor or in any other entity.” See 11 U.S.C. § 1322(b)(9).
In Zair, the debtors’ primary residence on the shore of Long Beach, New York, was destroyed and rendered uninhabitable by Superstorm Sandy in October 2013. The debtors filed a chapter 13 case in September 2014 and scheduled the property as having a value of $255,000, with mortgage liens well in excess of value.
The debtors’ plan provided for surrender of the Long Beach property to their mortgage lender in full satisfaction of the lender’s claim and for title to be transferred to the lender upon confirmation of the plan. In other words, in addition to surrendering title to the Long Beach property, the debtors’ plan also vested title to the property in the lender. The distinction between surrender and vesting is significant to debtors and lenders alike: Debtors remain liable for post-surrender costs incident to ownership, such as taxes, whereas after title has vested in a lender, the lender is liable for those costs.
The lender objected to the proposed transfer of title, but the bankruptcy court overruled the objection and confirmed the plan. The lender then appealed to the district court.
Coexistence of § 1322(b)(9) and § 1325(a)(5)(C)
On appeal, the district court surveyed the body of case law on the issue, which is sharply divided. One line of cases bars forced vesting on the grounds that § 1325(a)(5), which specifically addresses the confirmation of plans, speaks only of “surrender” of property (i.e., not a transfer of title) as a method for satisfying a secured claim, while another line of cases allows forced vesting of title on the grounds that vesting title in a third party is generally permissible through a chapter 13 plan pursuant to § 1322(b)(9). The question becomes: Which provision governs?
The district court in Zair discredited what it deemed as the “fountainhead” of the “pro-vesting” line of cases, In re Rosa, 495 B.R. 522 (Bankr. D. Haw. 2013), noting that case was not decided under subsection (C) of § 1325(a)(5), but rather under subsection (A), due to the creditor’s implied consent to the transfer. The district court found that “§ 1325(a)(5)(C) and § 1322(b)(9) are not, in all instances, mutually exclusive.” The court concluded that while a chapter 13 plan may include a provision that is permitted under § 1322(b)(9) (i.e., that includes vesting), if such a provision “disturbs” the mandatory prerequisites to confirmation set forth in § 1325(a)(5), its inclusion will “defeat confirmability.” In other words, in order for a plan to be confirmed under § 1325(a)(5)(C), vesting is OK only where the secured creditor consents (i.e., is not forced to accept title). Otherwise, a plan can provide only for the surrender of collateral to a non-consenting secured creditor, enabling the creditor to exercise its rights, which “includes the option to do nothing at all.”
Bankruptcy Policy and Creditors’ Rights Under State Law
The district court considered bankruptcy policy and state law in its analysis. One principal reason for a debtor to transfer title of surrendered property to its secured creditor through a plan is to relieve the debtor of continuing carrying costs (e.g., taxes, homeowner association costs and insurance), which a debtor would otherwise bear while the secured lender executes its legal remedies (or does nothing). Debtors and trustees contend that without the ability to transfer title, the debtor remains saddled with these liabilities post-confirmation, inhibiting the debtor’s ability to obtain a “fresh start.”
In Zair, the court rejected the notion advanced by the “pro-vesting” line of cases that the “paramount federal interest” of a debtor’s “fresh start” preempted a secured creditor’s state law property rights. Rather, the court determined that § 1322(b)(9) and § 1325(a)(5) should not be read to alter the terms of the parties’ contract to force a secured creditor to accept title to its collateral, which such remedy or obligation was not set forth in the contract.
The Zair decision comes just five weeks after competing decisions were entered by bankruptcy courts in the U.S. Bankruptcy Court for the District of Massachusetts, creating a split of authority in that district. Compare In re Brown, Ch. 13 Case No. 14-12357-JNF (Bankr. D. Mass. Mar. 4, 2016) (overruling creditor’s objection to chapter 13 plan that provided for “surrender plus vesting” of title) and In re Sagendorph, 2015 Bankr. LEXIS 2055 (Bankr. D. Mass. June 22, 2015) (confirming plan that provided for transferring of title to mortgaged real estate to mortgagee over the objection of the mortgagee), with In re Tosi, 2016 Bankr. LEXIS 690 (Bankr. D. Mass. Mar. 4, 2016) (sustaining lender’s objection to chapter 13 plan that provided for debtor’s interest in property to be surrendered to and vest in lender) and In re Weller, 2016 Bankr. LEXIS 108 (Bankr. D. Mass. Jan. 13, 2016) (sustaining lender’s objection to plan that vested title to mortgaged property in lender without lender’s consent). The court’s holding in Zair is consistent with the growing majority position, which does not permit the forced vesting of collateral through chapter 13 plans.
While secured lenders should remain vigilant of their interests when a borrower files for bankruptcy protection, the Zair decision underscores the attention lenders should consider paying to plans filed by borrowers in chapter 13 cases, which plans seek confirmation pursuant to § 1325(a)(5)(C) through the surrender of property. Unless the lender consents, it may want to affirmatively object to any provision that also provides for the vestingof title to that collateral.