Last week President Obama announced an ambitious and expensive plan to stabilize home prices and help homeowners in trouble with their home loans avoid foreclosure. The plan proposes incentives for investors and servicers alike to encourage loan modification even before homeowners default on their loans. However, one key element of the administration plan costs the taxpayers very little but could provide extensive relief from foreclosure.
What is now being described as “Judicial Modification” is really the well known bankruptcy concept referred to as “Cramdown”. The word does not appear in the language of bankruptcy code but this innovation emerged as a tool for debtors when the 1978 bankruptcy code was enacted by congress. The term is used to describe the modification of creditors’ rights, against their will, when the negative impact on a particular creditor is substantially outweighed by the benefit to the debtor.
The Helping Families Save Their Homes in Bankruptcy Act of 2009 was introduced early in the 111th Congress (2009-2010) in both the House of Representatives as H.R. 200 by Representative John Conyers, a Michigan Democrat, and S 61 in the US Senate by Senator Richard Durbin, an Illinois Democrat. This legislative proposal would lift a longstanding limitation contained in the bankruptcy code with respect to the rights of homeowners and residential lenders in a bankruptcy proceeding.
The bankruptcy code provides for modification of the rights of secured creditors in both Chapter 11 and Chapter 13 cases. Under current law, a Chapter 13 plan is permitted to include, pursuant to 11 USC §1322(b)(2), language that will “modify the rights of holders of secured claims” with the express exception that no “claim secured only by a security interest in real property that is the debtor’s principal residence” may be so modified.
The White House proposes “careful” legislative changes that allow bankruptcy judges to modify mortgages written in the last few years when there are no other reasonable options for families with problem loans. The proposed plan provides that:
“When an individual enters personal bankruptcy proceedings, his mortgage loans in excess of the current value of his property will now be treated as unsecured. This will allow a bankruptcy judge to develop an affordable plan for the homeowner to continue making payments. To receive judicial modifications in bankruptcy, homeowners must first ask their servicers/lenders for a modification and certify that they have complied with reasonable requests from the servicer to provide essential information. This provision will apply only to existing mortgages under Fannie Mae and Freddie Mac conforming loan limits, so that millionaire homes don’t clog the bankruptcy courts.“
While the proposal is more limited than the current legislative initiative, it will cost the taxpayers relatively little by comparison with the many other investments being made by the Obama administration in an attempt to improve the economy. As a bankruptcy lawyer, I have no doubt this portion of the Homeowner Affordability and Stability Plan will do a great deal to keep many families in their homes.