The newly enacted Small Business Reorganization Act, creating a new subchapter V in Chapter 11 of the bankruptcy code geared toward smaller enterprises, gives bankruptcy lawyers a whole new toolbox when it comes to helping entrepreneurs with less than $7.5 million in debts. One of the new sections, 11 USC s. 1190, appears to specifically allow for the first time the ability of a debtor to modify or “cram down” a home mortgage, provided that the borrowed funds were used for business purposes and not to acquire the residence.
Now let’s hope the First Circuit lets debtors in New England actually use this provision.
Why should that be a concern? Well, when debtor attorneys tried to fashion similar relief packages in Chapter 13 a few years ago, their plans were ultimately shot down by a First Circuit bankruptcy appellate panel ruling that was criticized by the National Consumer Bankruptcy Rights Center for its flawed reasoning.
The case of Bullard v. Hyde Park Savings Bank (494 B.R. 92 (2013)) involved the use a of Chapter 13 hybrid plan, a concept that at the time was approved by some of the Massachusetts bankruptcy court judges. In a hybrid plan, debtor’s attorneys piece together several sections of the code to fashion new mortgage terms that the debtor can live with.
For example, the debtor in Bullard had a two-family house that was worth less than the mortgage balance. he proposed in his Chapter 13 plan to divide, or bifurcate, the loan into secured and unsecured parts. The lender would retain its lien on the secured claim up to its value, but would be paid pennies on the dollar for the unsecured claim through the plan. The debtor would continue making regular payments to the lender outside the plan, and these would stretch on into the future, past the end of the plan.
But a First Circuit bankruptcy appellate panel (“the BAP”) comprised of three disinterested bankruptcy judges, balked at this, claiming the code itself was full of fatal contradictions. Specifically, the BAP said that code section 1322 (b) (2) — allowing the bifurcation — was incompatible with code section 1322 (b) (5) — which sets the rules for a “cure and maintain” plan with most payments going directly to the lender outside the plan, and continuing after the bankruptcy case is over.
Leaving aside the issue of whether BAP opinions have any precedential value to start with, the Bullard case essentially terminated the use of hybrid plans in Massachusetts, Maine, New Hampshire, and Rhode Island.
Fast forward to the spring of 2020: could the situation repeat with the SBRA?
Newly added section 11 USC s. 1190 explicitly states that a small business debtor “may modify the rights of the holder of a claim secured only by a security interest in real property that is the principal residence of the debtor if the new value received in connection with the granting of the security interest was—(A) not used primarily to acquire the real property; and (B)used primarily in connection with the small business of the debtor.”
However, the newly added section on discharge erases most small business debts, except any debt—(1) on which the last payment is due after the first 3 years of the plan, or such other time not to exceed 5 years fixed by the court. 11 USC 1392.
Isn’t this just asking the First Circuit to bring its flawed reasoning back again? Since most home mortgages are going to have more than 3 to 5 years of payments remaining, and most debtors aren’t going to be able to pay off the balance (even a crammed-down balance) in less than 3 years through a plan, its possible we could see the death of hybrid Chapter 11 plans in the First Circuit just like we did with Chapter 13.
Let’s hope better reasoning prevails, and debtors catch a break this time.