Many bankruptcy practitioners are familiar with the general tenet that an obligation secured only by a mortgage on the Debtor’s principal residence is immune from modification or avoidance by the Debtor. Sections 1123(b)(5) and 1322(b)(2) of the Bankruptcy Code protect residential mortgages from being “stripped-down” to the value of the subject real estate or subjecting the terms of the underlying obligation to modification. However, practitioners and holders of inferior mortgages should not find themselves too comfortable and conclude that their residential mortgage is always bulletproof in this “soft” real estate market. In fact, given depressed housing prices, Debtors are more incentivized to take guidance from the teachings of the United States Supreme Court to seek to avoid residential mortgages.
The decision referred to above is the Nobleman opinion issued in 1993 (Nobleman v. American Savings Bank, 508 U.S. 324, 113 S. Ct. 2106, 124 L. Ed. 2d 228 (1993)). In Nobleman, the Supreme Court held that the protections provided by Section 1322(b)(2) of the Bankruptcy Code (and 1123(b)(5) by analogy) are not absolute and only apply to protect against avoidance or modification those mortgages that are either wholly or partially secured. The Sixth Circuit Court of Appeals later concluded, relying on the Nobleman decision, that Debtors are permitted to “strip” wholly unsecured mortgages on the Debtor’s property which are, in fact, unsecured claims and not, by definition, “secured claims” entitled to the protections of Section 1322(b)(5). Lane v. Western Interstate Bancorp (In re Lane), 280 F.3d 663 (6th Cir. 2002).
Understandably, Debtors may now be more inclined to seek bankruptcy protection to achieve the benefits provided in the Bankruptcy Code as explained in Nobleman and Lane. As a result, holders of inferior mortgages may find themselves facing avoidance actions more frequently. Therefore, holders of inferior mortgages should more thoroughly analyze their collateral position before taking action in regards to a mortgage. By so doing, a mortgagee can estimate the likelihood of having their mortgage avoided in a later bankruptcy case which, depending on the results, may compel a “something is better than nothing” approach as to the credit.