Rochelle's Daily Wire

Over a dissent and in disagreement with the Collier treatise, the Eleventh Circuit created a circuit split by holding that real property with an alternative purpose is subject to the anti-modification provisions in Section 1123(b)(5) if the real property is also the debtor’s primary residence.

The May 23 opinion seems to mean that a mortgage on commercial real property cannot be modified in a chapter 11 plan when even a small part of the property is the debtor’s primary residence.

The facts were simple. The debtor owned a plot of 43 acres on which her home was located. The home occupied about 2.5 acres on one edge of the property. The debtor had always leased the remaining 40.5 acres to a farmer who farmed the acreage.

The debtor defaulted on her mortgage and filed a chapter 11 petition along with a plan to modify the mortgage by pegging the property as worth $138,000, to be paid in full about 18 months after confirmation.

The mortgage lender objected to confirmation and filed a motion to modify the automatic stay. The lender contended that Section 1123(b)(5) precluded modification of the mortgage. The bankruptcy court agreed and granted the lift-stay motion. The district court affirmed.

The Majority’s Meaning of “Is”

For the majority, Circuit Judge Robert J. Luck laid out the governing statutes. Section 1123(b)(5) permits a plan to “modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor’s principal residence . . . .”

In 2005, Congress added Section 101(13A)(A) to provide additional meaning for the words “principal residence.” The amendment says that the “term ‘debtor’s principal residence’ . . . means a residential structure if used as the principal residence by the debtor, including incidental property, without regard to whether that structure is attached to real property.”

Judge Luck said that Section 1123(b)(5) has “three distinct requirements.” (1) The security interest must be in real property; (2) the real property must be the only security for the debt; and (3) the real property must be the debtor’s principal residence. He said that the third was the only requirement in dispute.

Even though most of the real property was used as a farm, he said that the third requirement was satisfied because the real property contained the debtor’s principal residence.

Judge Luck cited the First and Third Circuits for having reached contrary conclusions. Lomas Mortg., Inc. v. Louis, 82 F.3d 1 (1st Cir. 1996); and In re Scarborough, 461 F.3d 406, 411 (3d Cir. 2006). He said that those courts “have read the anti-modification provision to require that the debtor use her real property only or exclusively as her principal residence and for no other purpose.” [Emphasis in original.]

Judge Luck described the Third Circuit in Scarborough as having “reasoned that ‘[b]y using the word “is” in the phrase “real property that is the debtor’s principal residence,” Congress equated the terms “real property” and “principal residence.’” Scarborough, supra, 461 F.3d 411. He disagreed with the Third Circuit because “the average speaker of American English would not understand ‘is’ . . . to mean only or exclusively and nothing else.”

In addition to relying on his understanding of the meaning of “is,” Judge Luck cited the 2005 amendment for the inclusion of “incidental property” within the meaning of “primary residence.” In other words, he viewed the 40.5 acres of farmland as “incidental” to the debtor’s home.

Judge Luck rejected the idea that the word “only” in Section 1123(b)(5) means that the real property must be the only property that serves as the debtor’s principal residence. Instead, he said that “only” is an adverb that modifies “secured.”

Judge Luck also rejected the idea of using a totality-of-the-circumstances approach to determine whether the property had a “significant commercial purpose” aside from being the principal residence. He said that adopting the totality-of-the-circumstances approach would add words to the statute.

Judge Luck affirmed the district court’s affirmance of the bankruptcy court’s order granting relief from the automatic stay.

The Dissent’s Meaning of “Is”

Chief Circuit Judge William Pryor “respectfully” dissented.

Judge Pryor began his dissent by reproducing an aerial photograph of the property to show that it was “primarily farmland” with the home on one edge. He criticized the bankruptcy court for having said it “was immaterial that most of the secured parcel was used exclusively for commercial farming.” He also criticized the bankruptcy court for believing that the farmland was “incidental property” even though the statute required that the property be used exclusively as a principal residence.

Judge Pryor interpreted Section 1123(b)(5) to mean that anti-modification “applies only to ‘real property that is the debtor’s principal residence.’” [Emphasis in original.] He undertook a lengthy grammatical analysis of “is” as a third-person singular, present tense verb.

In his way of thinking, Judge Pryor said that “‘is’ links a subject and a predicate so as to signify that the two are ‘equal in identity,’” citing a dictionary. He quoted the Collier treatise for saying that anti-modification only applies if the mortgage covers the principal residence and no other property. He also saw the majority as having interpreted “is” to mean “includes.”

Judge Pryor cited authorities for the proposition that anti-modification does not apply to multi-family properties. He said there could be cases that are “closer calls” to be resolved in an evidentiary hearing.

Believing that the appeals court should have remanded for the bankruptcy court to decide whether the farmland was “incidental,” Judge Prior saw the majority as having erred by holding that the debtor’s “40.5 acres of commercial farmland need not be her ‘principal residence’ for the anti-modification provision to apply.”

Observations

If a debtor owns a six-unit apartment building and one unit is the debtor’s principal residence, would anti-modification apply in the Eleventh Circuit? What if the debtor owns a 1,000-acre farm and farmed the land; would anti-modification apply if the debtor’s principal residence was on the land?

And what if the debtor owns three acres, but a separate building on half of the plot is used as the debtor’s car-repair business; would anti-modification apply?

Under the Eleventh Circuit’s holding, is all contiguous property always subject to anti-modification if the debtor’s principal residence is on the property? Does the Eleventh Circuit draw any lines?