Thursday, August 4, 2011 1:30pm - Do You Wanna Dance

Thursday, August 4, 2011

1:30pm - Do You Wanna Dance: Negotiable Instruments

3:00pm The Honorable Samuel L. Bufford, Retired, Distinguished Scholar In Residence, Pennsylvania State University (University Park, PA)

Alice Whitten, Chapter 13 Trustee (Ft. Worth, TX) Sidney H. Scheinberg, Glast, Phillips & Murray, P.C. (Dallas,

TX) Page 1 of 57

INDEX

1. The Chapter 13 Alternative: A Legislative Solution to Undersecured Home

Mortgages

2. Enforcement Of Promissory Notes Secured By Real Estate

3. List of Judicial Opinions on Robo-Signers, Lost Promissory Notes, and Loan

Servicers that Fail to Account Properly for Mortgage Payments

4. MERS: The Why When and How

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DO NOT DELETE 4/22/2011 1:30 PM

1091

ARTICLES

THE CHAPTER 13 ALTERNATIVE: A LEGISLATIVE

SOLUTION TO UNDERSECURED HOME MORTGAGES

The Honorable Samuel L. Bufford *

I. INTRODUCTION

The Great Recession that began in approximately 2008 brought

severe financial difficulties to a large number of homeowners in

the United States. With a rise in the unemployment rate from

4.6% to 10%,1 many lost their jobs and their ability to make their

home payments. At the same time, with an average 30.3% reduc-

tion in housing values2 (which in some places has approached

nearly 60%),3 many homes are now worth substantially less than

* Judge Bufford served as a U.S. Bankruptcy Judge in Los Angeles for twenty-five

years until his retirement in 2010. He is now a Distinguished Scholar in Residence at

Dickinson School of Law, Pennsylvania State University.

1. According to the United States Department of Labor, Bureau of Labor Statistics,

unemployment rates rose from 4.6% in January 2007 to a peak of 10% in December 2009.

See BUREAU OF LABOR STATISTICS, U.S. DEP’T OF LABOR, USDL 07-0159, THE EMPLOY-

MENT SITUATION: JANUARY 2007, at 1 (2007), available at http://www.bls.gov/news.release/

archives/empsit_02022007.pdf (noting an unemployment rate of 4.6% in January 2007);

BUREAU OF LABOR STATISTICS, U.S. DEP’T OF LABOR, USDL 09-1583, THE EMPLOYMENT

SITUATION—DECEMBER 2009, at 1 (2010), available at http://www.bls.gov/news.release/ar

chives/empsit_01082010.pdf (noting an unemployment rate of 10% in December 2009).

2. Press Release, Standard & Poor’s, U.S. Home Prices Keep Weakening as Nine Ci-

ties Reach New Lows According to the S&P/Case-Shiller Home Price Indices (Jan. 25,

2011), available at http://standardandpoors.com/indices/sp-case-shiller-home-price-indices

/en/us/?indexId=spusa-cashpidff--p--us (explaining that the 30.3% value reflects the reduc-

tion in housing values from their peak value in 2006 through November 2010).

3. Id. (noting that Las Vegas has seen the greatest decline in housing values since

2006).

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1092 UNIVERSITY OF RICHMOND LAW REVIEW [Vol. 45:1091

the debt owed on mortgages secured by the homes.4 Some 5 mil-

lion homeowners are at least two months behind in their mort-

gage payments, and RealtyTrac predicts that some 1.2 million

homes will be foreclosed on in 2011.5 The housing crisis continues

to get worse, not better.6

Large amounts of public funds, through a variety of programs,

have been expended to try to ameliorate this problem, with dis-

appointing results.7 The federal Home Affordable Modification

Program (―HAMP‖) alone, for example, has been allocated $50 bil-

lion of U.S. government funds, of which $652.4 million has been

expended to produce a meager 520,000 permanent modifications.8

However, none of these government programs has made a sub-

stantial dent in the backlog of 11.1 million homes that are under

water where homeowners cannot make their mortgage pay-

4. See Nick Timiraos, U.S. News: Home-Purchasing Power Increases, WALL ST. J.,

Feb. 9, 2011, at A4. As of the end of 2009, nearly 27% of all U.S. homeowners owed more

on their mortgages than their homes were worth. Id.

5. Janna Herron, Banks Repossessed 1 Million Homes Last Year—and 2011 Will Be

Worse, MSNBC.COM, Jan. 13, 2011, http://www.msnbc.msn.com/id/41051419/ns/business-

real_estate/.

6. Residential foreclosures are predicted to increase by 20% in 2011. Dan Levy &

Prashant Gopal, Foreclosure Filings in U.S. May Jump 20% from Record 2010 as Crisis

Peaks, BLOOMBERG, Jan. 13, 2011, http://www.bloomberg.com/news/2011-01-13u-s-foreclo

sure-filings-may-jump-20-this-year-ds-crisis-peaks.html.

7. Created during the second Bush administration, the Hope for Homeowners Pro-

gram and FHASecure (discontinued Dec. 31, 2008), as well as President Obama’s Making

Homes Affordable Program, were meant to encourage lenders to voluntarily modify mort-

gages held by certain qualified debtors. HOPE for Homeowners Program, 24 C.F.R. § 257

(2010); Press Release, U.S. Dep’t of Hous. & Urban Dev., Bush Admin. to Help Nearly

One-Quarter of a Million Homeowners Refinance, Keep Their Homes; FHA to implement

new ―FHASecure‖ refinancing product (Aug. 31, 2007), available at http://archives.hud.

gov/news/2007/pr07-123.cfm; Press Release, Making Homes Affordable Program, U.S.

Dep’t of the Treasury, U.S. Dep’t Of Hous. & Urban Dev. & The Ad Council Unveil Nat’l

PSA Campaign To Raise Awareness Of Making Home Affordable Program (July 28, 2010),

available at http://www.makinghomeaffordable.gov/news/latest/Pages/pr_07282010.aspx.

HOPE NOW is a prominent non-governmental modification program administered by the

mortgage industry. Press Release, HOPE NOW, HOPE NOW: Mortgage Servicers Com-

pleted 101,000 Loan Mods for Homeowners in January (Mar. 10, 2011), available at http://

www.hopenow.com/press-releases.php.

8. See CONG. OVERSIGHT PANEL, DECEMBER OVERSIGHT REPORT: A REVIEW OF

TREASURY’S FORECLOSURE PREVENTION PROGRAMS, 16 n.23, 18, 44 n.114 (2010) (―To date,

HAMP has processed 519,648 permanent modifications.‖).

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2011] CHAPTER 13 ALTERNATIVE 1093

ments.9 Home prices are expected to decline another 5–10% be-

fore they reach bottom near the end of 2011.10

In addition, interest rates for secured credit have lowered dra-

matically, making home ownership much more affordable for a

given income level and debt service capacity.11 However, a home-

owner whose property value is less than the outstanding mort-

gage loans (or if the property value is near this demarcation line)

has typically been shut out of the opportunity to refinance to re-

duce home mortgage costs.12 In many such cases, the refinancing

of the mortgage debt would make the mortgage payments afford-

able instead of putting them beyond an owner’s reach.

Nonetheless, there are a substantial number of homes where

the owners could make the payments with appropriate mortgage

payment modifications. Such a modification would (a) reduce the

amount of the secured debt to the reduced value of the house, (b)

reduce the interest rate to the current interest rate, (c) change

any adjustable rate to a fixed rate, and (d) adjust the monthly

payments correspondingly.

This article discusses minor changes to the U.S. Bankruptcy

Code that would make these changes possible.13 These changes

would make avoiding foreclosure possible for a homeowner who

(a) is presently not able to make the mortgage service payments

but (b) could make payments for a mortgage that is reduced to

the market value of the property and to a fixed market mortgage

rate. The article does not address the political issue of what pro-

9. See Ruth Simon & Nick Timiraos, Mortgage Faceoff Looms for Lenders, WALL ST.

J., Mar. 28, 2011, at C1.

10. Timiraos, supra note 4 (stating that many economists expect that home prices will

decline by 5% to 10% before bottoming out in late 2011 or early 2012).

11. See Primary Mortgage Market Survey: 30-year Fixed-Rate Mortgages Since 1971,

FREDDIE MAC, http://www.freddiemac.com/pmms/pmms30.htm (last visited Apr. 15, 2011)

(displaying that interest rates on thirty-year fixed-rate mortgages have fallen from an an-

nual average of 6.03% in 2008 to an annual average of 4.69% in 2010).

12. See, e.g., Gregory Scott Crespi, The Trillion Dollar Problem of Underwater Home-

owners: Avoiding a New Surge of Foreclosures by Encouraging Principal-Reducing Loan

Modifications, 51 SANTA CLARA L. REV. 153, 168–69 (2011); Eric A. Posner & Luigi Zin-

gales, A Loan Modification Approach to the Housing Crisis, 11 AM. L. & ECON. R. 575, 577

(2009); Manuel Adelino et al., Why Don’t Lenders Renegotiate More Home Mortgages? Re-

defaults, Self-Cures, and Securitization (Fed. Reserve Bank of Boston, No. 09-4, 2009).

13. See 11 U.S.C. §§ 101–1532 (2006).

Page 4



tections Congress might decide to provide to mortgage owners

and servicers as a part of such legislation.14

A highly important advantage of such legislation is that it

would preserve the principle embodied in bankruptcy law—that

the private sector should bear the economic losses resulting from

financial adversity. Through and through, bankruptcy law sits on

the solid rock that private economic losses should be kept private:

government money should not be used to bail out private econom-

ic adversities. As the experience of the last few years has demon-

strated, a breach of this principle can lead (as it has led) to a vast

depletion of public resources to support private investment, at the

cost of creating a scarcity of funds for other public purposes (or

alternatively, a vast impairment of the public credit of the gov-

ernment).

Other advantages of adopting this revision to the Bankruptcy

Code would also arise. The main advantage is that it would per-

mit the clearing of a substantial segment of the market of nonper-

forming mortgage loans and the resulting processes of foreclosure

and resale. These processes are very cumbersome and inefficient.

They result in the realization of prices substantially lower than

could be achieved in a market where a private (usually resident)

owner of a home sells it to a buyer who also expects to reside in

it.15 Further, this proposal could substantially ameliorate the now

depressed housing market that is dominated by the sale of forec-

losed homes by institutions at prices substantially lower than the

prices of private home sales.16 At the same time, as Professor

Adam Levitin has shown, this change in Chapter 13 will have lit-

tle or no impact on mortgage credit cost or availability.17

14. For draft legislation of this type, see, e.g., Helping Families Save Their Homes Act

of 2009, H.R. 1106, 111th Cong. § 103 (1st Sess. 2009). While several bills have included

such a proposal, none is a clean bill that would enact only this proposal. Further, none has

been enacted.

15. See Adam J. Levitin, Resolving the Foreclosure Crisis: Modification of Mortgages

in Bankruptcy, 2009 WIS. L. REV. 565, 603–06 (2009).

16. See Press Release, RealtyTrac, Foreclosure Homes Account for 25 Percent of All

Q3 2010 Residential Sales (Dec. 1, 2010), available at http://www.realtytrac.com/content/

press-releases/foreclosure-homes-account-for-25-percent-of-all-q3-2010-residential-sales-

6194.

17. See Levitin, supra note 15, at 599, 601–02.

Page 5



II. CHAPTER 13

Chapter 13 of the Bankruptcy Code was enacted in 1978 as

part of a thoroughgoing revision to the U.S. bankruptcy law.18

Generally, Chapter 7 provides for the orderly liquidation of deb-

tors with insufficient assets to pay their creditors in full.19 Chap-

ter 11 provides for the reorganization of individuals and busi-

nesses pursuant to a plan voted on by the creditors.20 Chapter 9

provides for the reorganization of certain municipalities.21 Chap-

ter 12 was added in 1986 to provide for the adjustment of debts of

family farmers22 (and, beginning in 2005, for family fishermen).23

Chapter 15 was added in 2005 to provide for the coordination of

international insolvency cases.24 Chapters 1, 3, and 5 of the

Bankruptcy Code contain general provisions applicable to all

kinds of bankruptcy cases (with certain exceptions).25

A. The General Scope of Chapter 13

Chapter 13, which provides generally for the adjustment of

debts of individuals with regular income, is best understood as an

alternative to a consumer Chapter 7 case.

The basic structure of a consumer Chapter 7 case is that an

―honest but unfortunate‖ debtor gives up all non-exempt proper-

ty26 (if any)27 in which the debtor has an interest on the date of

18. See Bankruptcy Reform Act of 1978, Pub. L. No. 95-598, ch. 13, 92 Stat. 2549,

2645–51 (codified in scattered sectiosn of 11 U.S.C. and 28 U.S.C.). The 1978 amendments

went into force on October 1, 1979. See Martin I. Klein, The Bankruptcy Reform Act of

1978, 53 AM. BANKR. L.J. 1, 3 (1979). The prior law had a Chapter 13 that had similarities

to the present Chapter 13, but it was different in many material respects. Id. at 17–18.

19. See 11 U.S.C. §§ 701–784 (2006).

20. See id. §§ 1101–1174.

21. See id. §§ 901–946.

22. See Bankruptcy Judges, United States Trustees, and Family Farmer Bankruptcy

Act of 1986, Pub. L. No. 99-554, § 255, 100 Stat. 3088, 3105–14 (codified as amended at 11

U.S.C. §§ 1201-1231 (2006)).

23. See Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Pub. L.

No. 109-8, § 1007, 119 Stat. 23, 187–88 (codified in scattered sections of 11 U.S.C.).

24. See id. § 801, 119 Stat. 23, 134–45 (codified at 11 U.S.C. §§ 1501-1532 (2006)).

25. See 11 U.S.C. §§ 101-562. There is no Chapter 2, 4, 6, 8, 10, or 14. These chapters

are saved for use, if needed, in subsequent bankruptcy legislation.

26. For property exemptions applicable to individuals, see id. § 522. Alternatively, in §

522(b)(2), Congress authorized any state to opt out of the federal exemption provisions and

to substitute its own state law exemptions. Some thirty-three states have exercised this

Page 6



the bankruptcy filing in exchange for a discharge28 of all unse-

cured debts29 and a fresh start in economic life.30 In a Chapter 7

case, the debtor is permitted to keep all postpetition earnings and

other postpetition property.31

By contrast, in a Chapter 13 case, the debtor keeps all of her32

prepetition property and in exchange makes monthly payments

through a Chapter 13 plan for three to five years, which must to-

tal at least as much as the creditors would receive in a Chapter 7

case.33 These payments go to a Chapter 13 trustee, who distri-

butes them to the creditors according to the Chapter 13 plan ap-

proved by the court.34

Chapter 13 is inspired by Chapter 11, which provides for the

reorganization of a business and the payment of its debts pur-

option. See WILLIAM HOUSTON BROWN, LAWRENCE R. AHERN, III & NANCY FRAAS

MACLEAN, BANKR. EXEMPTION MANUAL § 4:2 (2010 ed.).

27. In fact, approximately 93% of Chapter 7 cases are ―no asset‖ cases where the trus-

tee finds no property to administer for the benefit of creditors. See Dalié Jiménez, The Dis-

tribution of Assets in Consumer Chapter 7 Bankruptcy Cases, 83 AM. BANKR. L.J. 795, 797

(2009).

28. The Chapter 7 discharge is provided by § 727. See 11 U.S.C. § 727(a). This section

provides for the denial of a discharge for a Chapter 7 debtor for certain misconduct, chiefly

within the bankruptcy case itself. See id. In addition, certain prepetition debts are not

subject to the discharge. See id. § 523.

29. See id. §§ 523, 727(b). While Chapter 7 provides for the discharge of all debts, the

collateral for any secured debt (typically a house or a car) remains liable for the debt. See

id. § 524(e). In consequence, as a practical matter a Chapter 7 discharge discharges all

unsecured debt and the debtor remains liable for house and car payments.

30. See, e.g., Marrama v. Citizens Bank of Mass., 549 U.S. 365, 367, 381 (2007) (quot-

ing Grogan v. Garner, 488 U.S. 279, 286, 287 (1991)) (internal quotations omitted) (stating

that the basic purpose of bankruptcy is to give ―a fresh start to the honest but unfortunate

debtor.‖).

31. See 11 U.S.C. § 541(a)(1), (6). There is a minor exception that, in a Chapter 7 case,

any inheritance, life insurance proceeds (from a decedent), or marital property settlement

received by the debtor within 180 days after filing also becomes property of the estate and

available for liquidation and distribution to creditors. See id. § 541(a)(5). It is very un-

common for a Chapter 7 debtor to receive property of this type.

32. While the pronoun ―her‖ is used as a convention in legal scholarship, in fact a ma-

jority of Chapter 13 debtors are women. See, e.g., Elizabeth Warren, What Is a Women’s

Issue? Bankruptcy, Commercial Law, and Other Gender-Neutral Topics, 25 HARV.

WOMEN’S L.J. 19, 27 n.40 (2002) (giving data to show that, in 2001, 71% of individual con-

sumer (and all Chapter 13) bankruptcy cases were filed either by women alone (39%) or as

joint petitions (32%)). It is a fair inference that women were debtors in a majority of the

Chapter 13 cases included in that sample.

33. See 11 U.S.C. § 1325(a)(4); Levitin, supra note 15, at 579.

34. 11 U.S.C. § 1322(a)(1); see id. § 1302 (describing the appointment and tasks of the

trustee).

Page 7



suant to a plan over a course of years.35 A Chapter 13 debtor must

have regular income.36 The debtor must propose a feasible plan

for the adjustment of debts within fourteen days after the filing of

the case.37 A Chapter 13 plan deals with unsecured debt by pro-

viding for the debtor to make such payments as the debtor can af-

ford and discharging any unpaid balance at the end of the plan

after the debtor makes the plan payments (―unsecured creditor

treatment‖).38 The unsecured creditors receive payments from the

trustee (who passes them on from the debtor) as provided in the

Chapter 13 plan.39 In due course, a Chapter 13 debtor receives a

discharge of all unsecured debts (unless the plan provides other-

wise).40

Secured creditors are treated quite differently from unsecured

creditors under a Chapter 13 plan. A Chapter 13 plan typically

has two separate provisions for secured debt. First, the plan typi-

cally provides for the cure of any arrearages (i.e., missed pay-

ments) on a secured debt and the payment of the regular monthly

(or other periodic) payments for the life of the plan and thereafter

until the debt is paid in full41 (―secured creditor treatment‖).42

Second, if the secured creditor is undersecured (i.e., the value

of the collateral is less than the unpaid amount on the debt), the

debt is divided into two parts.43 The secured portion is given se-

cured creditor treatment (i.e., arrearages are cured and regular

monthly payments are made for the life of the plan and until the

debt is retired).44 The unsecured portion is given unsecured credi-

tor treatment, which usually means that it is paid a much lower

percentage (and perhaps nothing at all).45

35. See id. § 1123; see also Chapter 11: Reorganization Under the Bankruptcy Code,

U.S. COURTS, http://www.uscourts.gov/federalcourts/bankruptcy/bankruptcybasics/chapter

11.aspx (last visited Apr. 15, 2011)).

36. See 11 U.S.C.A. § 109(e) (West 2011).

37. See FED. R. BANKR. P. 3015(b).

38. See 11 U.S.C. § 1328(a) (2006).

39. See id. § 1326(a)(2).

40. See id. § 1328(a).

41. In certain cases the secured debt (such as a car loan) may be paid in full according

to its terms before the end of the Chapter 13 plan. See id. § 1322(b)(5).

42. See id.

43. See id. § 506(a)(1).

44. Id.

45. Id.

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Chapter 13 secured debt modifications are limited by federal

bankruptcy common law. A modified loan must provide a reason-

able risk premium for the debtor,46 and the plan must provide for

the secured creditor to receive the present value of its collateral.47

Only a debtor who can afford a loan within these limits can quali-

fy for the modification of a loan under Chapter 13.48 In addition, a

debtor must undertake a plan requiring the debtor to live at or

near the poverty level for three to five years (mostly five years in

the present economic environment) to qualify for a Chapter 13

discharge that would accomplish the changes described.49

It is likely that a substantial number of homeowners whose

property is undersecured and who cannot afford their present

payment schedules would qualify for such a Chapter 13 plan.

There are no estimates as to how many undersecured debtors

would qualify for Chapter 13 treatment. This figure likely in-

cludes a substantial portion of those with undersecured mortgag-

es who are presently unable to make their payments, but proba-

bly far less than half. Nonetheless, this group would have

substantial size.

B. Chapter 13 Treatment of Debts Secured by Automobiles

The most common kind of secured debt in a Chapter 13 case is

a debt secured by an automobile.50 In virtually every case where

the debtor has such a loan, the collateral is worth less than the

amount owing on the debt.51 Until 2005, the foregoing description

of the treatment of an undersecured creditor was the typical pat-

tern for the treatment of automobile loans in Chapter 13 cases:

the secured debt was written down to the value of the automobile

and paid over the life of the plan until the debt was paid in full

(whether before or after the completion of the plan), and the un-

46. See Till v. SCS Credit Corp., 541 U.S. 465, 479 (2004) (discussing the factors used

to determine the size of a risk adjustment).

47. See 11 U.S.C. § 1325(a)(5).

48. See 11 U.S.C.A. § 109(e) (West 2011).

49. See 11 U.S.C. § 1325(b).

50. See generally David Gray Carlson, Cars and Homes in Chapter 13 After the 2005

Amendments to the Bankruptcy Code, 14 AM. BANKR. INST. L. REV. 301, 302 (2006) (dis-

cussing secured car lenders and home mortgage lenders in Chapter 13 bankruptcy cases).

51. See id.

Page 9



secured portion of the debt was paid at the same rate as other un-

secured creditors.52

In 2005, Congress changed Chapter 13 so that it now prohibits

the bifurcation of a debt secured by an automobile if the debtor

has not owned the vehicle for at least 910 days before the date of

filing the bankruptcy petition.53 Under Chapter 13 as modified, a

vehicle owned no more than 910 days is treated as fully secured

and must be given secured creditor treatment under the plan.54

Other vehicles are treated the same as all other secured debt (ex-

cept for principal home mortgages) described above.55

C. Chapter 13 Treatment of Debt Secured by the Debtor’s

Principal Residence

Chapter 13 singles out home mortgages for special treatment.56

Unlike all other secured debt held by a Chapter 13 debtor (except

for certain automobiles since 2005), a Chapter 13 plan may not

modify the rights of a holder of a secured claim ―secured only by a

security interest in real property that is the debtor’s principal res-

idence.‖57 Notwithstanding this prohibition, the plan may provide

for the curing of any default ―within a reasonable time‖ and

maintenance of payments during the life of the plan.58

Thus a Chapter 13 plan may provide for the payment of se-

cured debts owing by the debtor according to the following pat-

tern. The debtor may pay arrearages over the life of the plan (up

to five years), except that arrearages on a mortgage secured by

52. Id. Other secured debt in a Chapter 13 case may be collateralized with appliances,

jewelry, investment property, a vacation home, or electronic equipment. See 11 U.S.C. §

1325(a); Wilson v. Commonwealth Mortg. Co., 895 F.2d 123, 128–29 (3d Cir. 1990) (ap-

pliances and furniture). All such debts are subject to the same treatment in a Chapter 13

case as a car loan before 2005; Carlson, supra note 50, at 302–04.

53. See Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Pub. L.

No. 109-8, § 306(b), 119 Stat. 23, 80 (codified at 11 U.S.C. § 1325(a)).

54. See 11 U.S.C. § 1325(a).

55. Id.

56. See id. § 1322(b)(2). In 1994 Congress added § 1123(b)(5) to prohibit the modifica-

tion of a mortgage secured by a debtor’s principal residence in a Chapter 11 case. See

Bankruptcy Reform Act of 1994, Pub. L. No. 103-394, § 206, 108 Stat. 4106, 4123 (codified

at 11 U.S.C. § 1123(b)(5)).

57. 11 U.S.C. § 1322(b)(2).

58. Id. § 1322(b)(5).

Page 10



the debtor’s principal residence must be paid within ―a reasonable

time‖ (which is typically less than five years).59

III. THE CHAPTER 13 PROPOSAL

Given this description of the treatment of undersecured debts

in a Chapter 13 plan, we now turn to the proposal to permit a

debtor to use a Chapter 13 case to modify an undersecured home

loan to make it affordable. The main purpose of this article is to

describe in detail how Chapter 13 would need to be changed to

accomplish such a modification and to specify exact language that

would accomplish such a change.

A. Chapter 13 Background

Until recently, there was relatively little pressure to change

the special treatment of home mortgages in Chapter 13 cases.

Apart from specific markets, the value of personal residences had

never depreciated more than 10% since the Great Depression.60

At the same time, until the 1990s, it was customary for residen-

tial mortgages to require a down payment of at least 10%.61 Thus,

it was unusual for a home mortgage holder to become underse-

cured. While the recent advent of mortgages with lower down

payments produced an occasional Chapter 13 case with an under-

secured home mortgage holder, this was relatively uncommon.

Even junior mortgage holders were typically ―in the money‖ in

Chapter 13 cases.62

59. See, e.g., United Ca. Sav. Bank v. Martin (In re Martin), 156 B.R. 47, 50 (B.A.P.

9th Cir. 1999) (stating that while ―reasonable time . . . is a flexible concept, determined on

a case-by-case basis,‖ ―reasonable time‖ is limited to three years ―unless the court ap-

proves a longer period not to exceed five years.‖); In re Harmon, 72 B.R. 458, 462 (Bankr.

E.D. Pa. 1987).

60. See Arthur E. Wilmarth, Jr., The Dark Side of Universal Banking: Financial Con-

glomerates and the Origins of the Subprime Financial Crisis, 41 CONN. L. REV. 963, 967

(2009); see also David C. Wheelock, The Federal Response to Home Mortgage Distress: Les-

sons from the Great Depression, 90 FED. RESERVE BANK OF ST. LOUIS REV. 133, 145 (2008),

available at http://research.stlouisfed.org/publications/review/08/05/Wheelock.pdf.

61. Jerry W. Markham, The Subprime Crisis—Some Thoughts on a “Sustainable” and

“Organic” Regulatory System, 4 FLA. INT’L U.L. REV. 381, 385 n.22 (2009).

62. See Dennis Cauchon, Why Home Values May Take Decades to Recover, USA

TODAY, Dec. 12, 2008, http://liusatoday.net/news/graphics/housing_prices/home_prices.pdf.

Page 11



The advent of the Great Recession, beginning in 2008, changed

this picture dramatically. Since that date, U.S. homes have de-

preciated by an average of 30.3%.63 In some markets, the reduc-

tion in home values has approached 60%.64 This change has made

a large number of mortgages undersecured. In addition, the un-

employment rate rose from 4.6% to 10%, which left many home-

owners unable to pay their mortgages.65

At the same time, the average interest rate for home mortgages

dropped drastically. In 2008, the average rate for a home mort-

gage was 6.03%.66 At the end of 2010, it had fallen to 4.69%.67

However, a very large number of homeowners have been unable

to refinance their homes to take advantage of the lower rates, be-

cause they cannot provide an equity cushion for a new mort-

gage.68

The development of the securitization market for home mort-

gages has added to this problem. Securitization has stratified the

home mortgage market so that mortgage holders are contractual-

ly prohibited from making substantial modifications to home

mortgages, and their counterparties are too numerous and dis-

persed to make any efficient modification.69 This securitization

has created a collective action problem that bankruptcy law is un-

iquely designed to solve in ordinary circumstances.

B. The Chapter 13 Proposal

In light of these problems, this article describes a Chapter 13

modification that provides an alternative procedure for modifying

an undersecured consumer mortgage.70 The mortgage would be

63. See supra note 2 and accompanying text.



66. See supra note 11.

67. See supra note 11.

68. See Crespi, supra note 12, at 169–70.

69. See Adam J. Levitin, Helping Homeowners: Modification of Mortgages in Bank-

ruptcy, 3 HARV. L. & POL’Y REV. ONLINE, Jan. 19, 2009, at 1, 3–5, http://hlpronline.com/

Levitin_HLPR_011909.pdf.

70. Several bills have been introduced in Congress that would, inter alia, adopt some

of the recommendations made here. See, e.g., Helping Families Save Their Homes in

Bankruptcy Act of 2008, S. 2136, 110th Cong. § 102 (2007); Home Owners’ Mortgage and

Equity Savings (HOMES) Act, S. 2133, 110th Cong. § 2 (2007); Emergency Home Owner-

Page 12



written down to the fair market value of the property (the deb-

tor’s home) serving as collateral for the loan. The unsecured por-

tion of the loan would be given the same treatment as other unse-

cured debt in the Chapter 13 plan. The interest rate would be

reduced to the present market rate (for a borrower with the credit

standing of the Chapter 13 debtor).71 If the debtor completes the

payments under the plan, the unsecured portion of the debt (the

portion not supported with collateral) would be discharged

through the Chapter 13 discharge. The collective action problem

is solved by requiring all parties in interest to negotiate their in-

terests in a bankruptcy forum.72

To permit a Chapter 13 debtor to make such a change in her

mortgage, three alterations in the language of § 1322(b), plus one

in § 1322(c), are required.

1. First Change: Amend the Language of § 1322(b)(2)

The first change is to amend subsection (b)(2) as follows:

(b) Subject to subsections (a) and (c) of this section, the plan

may—

. . .

(2) modify the rights of holders of secured claims, other than a

claim secured only be a security interest in real property that is

the debtor’s principal residence, or of holders of unsecured claims,

or leave unaffected the rights of holders of any class of claims. . . .

2. Second Change: Add New Provision § 1322(b)(6)

To make the change to § 1322(b)(2) effective and to assure that

the intention of this change is realized (and to overrule contrary

ship and Mortgage Equity Protection of 2007, H.R. 3609, 110th Cong. None has been

enacted.

71. For an explanation of the calculation of an appropriate interest rate in the bank-

ruptcy context, see Till v. SCS Credit Corp., 541 U.S. 465, 478–81 (2004).

72. See, e.g., Susan E. Hauser, Cutting the Gordian Knot: The Case for Allowing Mod-

ification of Home Mortgages in Bankruptcy, 5 J. BUS. & TECH. L. 207, 225 (2010).

Page 13



case law), it is necessary to add a new provision inspired by

Chapter 11:

(6) provide for the extension of the maturity date beyond the

date when the final payment on the plan is due or change the in-

terest rate or other terms of a secured claim. . . .

The remaining subparagraphs of § 1322(b) should be renum-

bered to provide for the insertion of subparagraph (6).

3. Third Change: Two Technical Amendments

As a result of the change in subparagraph (2), two references in

§ 1322 to the deleted clause need to be removed. Thus subpara-

graph (5) should be amended as follows:

(5) notwithstanding paragraph (2) of this subsection, provide

for the curing of any default within a reasonable time and main-

tenance of payments while the case is pending on any unsecured

claim or secured claim on which the last payment is due after the

date on which the final payment under the plan is due . . . .

Similarly, subparagraph (c) should be amended as follows:

(c) Notwithstanding subsection (b)(2) and applicable nonban-

kruptcy law. . . .

Pursuant to amended § 1322, as described above, a debtor

would be authorized to bifurcate an undersecured mortgage

claim. In consequence, the debtor would become responsible only

for the value of the allowed secured claim (the value of the colla-

teral), and would pay the remainder at the rate provided in the

plan for unsecured creditors.73 The plan of reorganization would

then be required to provide at least for the payment of the

present value of the allowed secured claim, not the entire under-

73. While a number of Chapter 13 plans provide that general unsecured creditors be

paid little or nothing, a substantial number of Chapter 13 plans provide for the payment of

all unsecured creditors in full over the life of the plan. See William C. Whitford, The Ideal

of Individualized Justice: Consumer Bankruptcy as Consumer Protection, and Consumer

Protection in Consumer Bankruptcy, 68 AM. BANKR. L.J. 397, 405 (1994). Another substan-

tial segment provides for the payment of 70% of unsecured debts (so that the debtor can

qualify for a hardship discharge under § 1328(b), if it becomes applicable during the life of

the plan). See 11 U.S.C. § 1328(b) (2006) (discussing when a court may grant a hardship

discharge to a debtor).

Page 14



lying lien, taking into account the length of the mortgage agree-

ment and adjusting payments to reflect an interest rate deter-

mined by the national prime rate adjusted by the risk of a debtor

default under the plan.74 The amount of the underlying lien ex-

ceeding the value of the collateral (the allowed unsecured claim)

would be treated like any other general unsecured claim.75 Be-

cause present law permits debtors to offer plans—and courts to

confirm plans—that cram down undersecured claims (except

those secured by the debtor’s principal residence or a recently

purchased automobile), amending § 1322 will not fundamentally

change or affect the administration of the Bankruptcy Code.

C. Explanation of the Proposal

The first change is the substantive change in Chapter 13. It de-

letes the provision prohibiting a Chapter 13 plan from modifying

a claim secured only by a security interest in the debtor’s princip-

al residence and permits a Chapter 13 plan to include such a

modification.76

The second change, the addition of a new § 1322(b)(6), is re-

quired to reverse case law interpreting § 1322. None of the con-

gressional bills has addressed this issue. The leading opinion

needing reversal to implement this proposal is Enewally v. Wash-

ington National Bank (In re Enewally) from the Ninth Circuit.77

In that case, the debtor owned two rental properties, and the se-

cured creditor was undersecured as to each.78 The Chapter 13

74. See id. § 1325(a)(5)(B)(ii); Till, 541 U.S. at 478–81.

75. See 11 U.S.C. § 1325(a)(4). Unsecured creditors in Chapter 7 frequently receive

payment on a very small percentage of their claim, or nothing at all. Id. §§ 507(a), 726(a),

727(a). As a practical result of this provision, it is quite possible that a Chapter 13 debtor

will have to devote very few or no funds to the repayment of general unsecured claims that

are not entitled to priority. Id. §§ 507, 1322(a)(2).

76. It could be argued that § 1123(b)(5), which is identical to § 1322(b)(2), should also

be amended to delete the same phrase. Compare id. § 1123(b)(5) (providing that a Chapter

11 bankruptcy plan may not modify a claim secured by a security interest in real proper-

ty), with id. § 1322(b)(2) (providing that a Chapter 13 bankruptcy plan may not modify a

claim secured by a security interest in real property). Section 1123(b)(5) was borrowed

from Chapter 13 when it was added to the Bankruptcy Code in 1994. See Bankruptcy

Reform Act of 1994, Pub. L. No. 103-394, § 206, 108 Stat. 4106, 4123 (codified at 11 U.S.C.

§ 1123(b)(5)). This issue is beyond the scope of this article.

77. 368 F.3d 1165 (9th Cir. 2004).

78. Id. at 1167. The debtor also had a principal residence, as to which the plan pro-

posed to cure the arrearages over the life of the plan as provided in § 1322(b)(5). Enewally

Page 15



plan (as modified) proposed to strip off the unsecured claims on

the two rental properties, but not to change either the duration of

each loan or the interest rates.79 The bankruptcy court (pursuant

to an opinion written by the author herein) held that Chapter 13

permitted such a plan proposal for rental property because it did

not come within the exception of § 1322(b)(2).80 The Ninth Circuit

upheld a reversal by the district court and found that Chapter 13

requires that all changes in a claim must include the payment in

full of the claim as changed over the life of the plan.81

New § 1322(b)(6) is inspired by § 1123(a)(5)(H) in Chapter 11.82

Because Chapter 11 now includes the language of § 1322(b)(2),83 §

1123(a)(5)(H) is needed in Chapter 1184 to support the common

practice in Chapter 11 cases of modifying the duration, amount

and interest rate of a secured claim.85 Chapter 11 also authorizes

stripping the unsecured claim of an undersecured creditor in a

v. Wash. Nat. Bank (In re Enewally), 276 B.R. 643, 647–48 (Bankr. C.D. Cal. 2002), aff’d

in part, rev’d in part, No. SA CV 02-459-GLT, 2002 WL 34178495 (C.D. Cal. Nov. 26,

2002), aff’d, 368 F.3d 1165 (9th Cir. 2004).

79. In re Enewally, 276 B.R. at 645–46. Pursuant to the plan, the unsecured overage

claims in the rental properties would be discharged at the end of the plan, provided that

such a discharge was entered. Id. at 645.

80. See id. at 652–53.

81. See In re Enewally, 368 F.3d at 1172.

82. See 11 U.S.C. § 1122(a)(5)(H) (2006).

83. Compare id. § 1322(b)(2), with id. § 1123(b)(5) (same language in each provision).

84. Professor Mark Scarberry argues that Enewally prohibits stripping down a lien in

a Chapter 13 case even without the language in § 1322(b)(2). See Mark S. Scarberry, A

Critique of Congressional Proposals to Permit Modification of Home Mortgages in Chapter

13 Bankruptcy, 37 PEPP. L. REV. 635, 661–65 (2010). Professor Adam Levitin contends, in

his response to Professor Scarberry, that Enewally is a decision from only one circuit court

(albeit from the largest United States federal circuit) that does not establish national case

law, particularly since it has not been followed much. See Adam J. Levitin, Back to the Fu-

ture with Chapter 13: A Response to Professor Scarberry, 37 PEPP. L. REV. 1261, 1267–69

(2010). This paper proposes the legislative overruling of Enewally to make clear that it

will no longer be good law anywhere after the Chapter 13 change proposed herein is legis-

latively adopted.

85. See Jack Friedman, What Courts Do to Secured Creditors in Chapter 11 Cram

Down, 14 CARDOZO L. REV. 1495, 1496 (1993). Stripping down the unsecured portion of an

undersecured creditor’s claim is not permitted in a Chapter 7 case. See Dewsnup v. Timm,

502 U.S. 410, 417 (1992). Section 1322(b)(2) has prohibited such an action in a Chapter 13

case since it went into force in 1979. See In re Enewally, 368 F.3d at 1171–72. However,

the practice has always been different in Chapter 11 cases.

Page 16



Chapter 11 plan.86 It will have the same effect in a Chapter 13

case pursuant to the proposed change.87

In order to avoid the strict time constraints for repayment re-

quired by Enewally, the best solution is the addition of a new

provision to Chapter 13 permitting the modification of the dura-

tion, amount, and interest rate of all secured claims.

The third change involves two technical amendments to § 1322,

both of which simply remove the extraneous references to the re-

pealed antimodification provision in § 1322(b)(2). Since amended

§ 1322(b)(2) will permit the modification of all contract rights, in-

cluding those resulting in the cure and reinstatement of a claim

secured by a principal residence, it is not necessary to include

language in § 1322(b)(5) to ensure that result. For that same rea-

son, § 1322(c) should also be identically amended.

D. Who Will Qualify to Use This Change

To qualify for mortgage modification under the amended Chap-

ter 13, a debtor would have to file a Chapter 13 bankruptcy case.

Chapter 13 has entry requirements that such a debtor must satis-

fy. First, there are debt ceilings that exclude creditors with too

much debt: a Chapter 13 debtor is disqualified if the debtor has

more than $1,081,400 in ―noncontingent, liquidated, secured

86. See, e.g., First Fed. Bank of Ca. v. Weinstein (In re Weinstein), 227 B.R. 284, 290

n.4 (B.A.P. 9th Cir. 1998) (recognizing an established pre-1994 practice to permit a Chap-

ter 11 individual debtor to strip down an undersecured mortgage on the debtor’s principal

residence); Wade v. Bradford, 39 F.3d 1126, 1129 (10th Cir. 1994) (noting that Chapter 11

debtors could strip down lien on residence notwithstanding Dewsnup); In re Jones, 152

B.R. 155, 173 (Bankr. E.D. Mich. 1993) (stating that a categorical prohibition on lien

stripping in Chapter 11 cases ―would disrupt established pre-Code law‖); cf. Harmon v.

United States ex rel. Farmers Home Admin., 101 F.3d 574, 581 (8th Cir. 1996) (allowing

lien stripping in a Chapter 12 case).

87. It could be argued that § 1123(b)(5) should also be repealed. However, there are

rather few Chapter 11 cases where a debtor seeks to strip down the unsecured portion of

an undersecured home loan. In the fiscal year ending September 30, 2010, only 14,191

Chapter 11 cases were filed nationwide. See Bankruptcy Filings Up Nearly 14 Percent

Over Last Fiscal Year, U.S. COURTS (Nov. 8, 2010), http://www.uscourts.gov/News/News

view/10-11-08/Bankruptcy_Filings_Up_Nearly_14_Percent_Over_Last_Fiscal_Year.aspx.

However, only a small proportion of these cases involved individual debtors, id. tbl. F-2

(12-Month Period), and only a small portion of the individual debtor Chapter 11 cases in-

volved an issue of stripping down an undersecured home mortgage. Thus, this change in

Chapter 11 would have little impact on the existing home mortgage crisis.

Page 17

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debts‖ and more than $360,475 in similar unsecured debts.88

Second, a Chapter 13 debtor must propose a plan that meets the

statutory requirements for confirmation.89 Third, and most im-

portant, the plan must be supported by a budget showing that the

debtor plans to live (with certain qualifications) within the spar-

tan restrictions that the Internal Revenue Service attempts to

impose on taxpayers to qualify for a plan to pay tax arrearages

over a period of time.90 This would require that the debtor and the

debtor’s family live at or near the poverty level for the life of the

plan.

Notably, this strip-down would not be available to debtors fil-

ing their cases under Chapter 7,91 the most popular chapter for

consumer debtors.92 Thus a debtor opting under Chapter 7 for a

clean slate and a fresh start as of the date of filing the bankrupt-

cy petition (after turning over all non-exempt property to the

trustee for liquidation for the benefit of creditors)93 would not be

eligible for this treatment for her home.94

E. The Benefits of this Change in Chapter 13

The most important benefit of such a change in Chapter 13, for

our discussion here, is that it restricts the losses in the consumer

real estate market to the private sector and insulates the gov-

ernment purse from these losses. The government does not con-

tribute any funding to achieving this result. The costs of the

Chapter 13 system are carried by the U.S. court system, supple-

88. 11 U.S.C.A. § 109(e) (West 2011). These statutory ceilings are adjusted for infla-

tion every three years. 11 U.S.C. § 104(a) (Supp. III 2009). The last such adjustment was

made effective April 1, 2010. See id.

89. See 11 U.S.C. § 1325 (2006).

90. See id. § 1325(b)(3); see also id. § 707(b)(2)(A)–(B) (discussing when granting relief

by dismissing a case under Chapters 11 or 13 would constitute abuse).

91. See Dewsnup v. Timm, 502 U.S. 410, 417, 420 (1992) (holding that a Chapter 7

debtor cannot strip down an undersecured claim that ―is secured by a lien and has been

fully allowed pursuant to § 502‖).

92. Chapter 7 accounts for approximately 70% of consumer bankruptcies. Robert J.

Landry, III, An Empirical Analysis of the Causes of Consumer Bankruptcy: Will Bankrupt-

cy Reform Really Change Anything?, 3 RUTGERS BUS. L.J. 2, 8 (2006).

93. See supra text accompanying notes 26–31.

94. A Chapter 7 trustee would not sell a debtor’s home if the secured creditor was un-

dersecured, because the creditor would be entitled to all of the value in the house and

there would be no benefit for the unsecured creditors. Instead, in due course the trustee

would abandon the property back to the debtor. See FED. R. BANKR. P. 6007.

Page 18



mented by filing fees (court costs) and a percentage payment to

the Chapter 13 trustee who administers the case (administration

costs). Private losses in the residential real estate market, if any,

remain private and do not drain the public treasury.

This proposal has two additional important features. First, for

a Chapter 13 debtor who can afford the payments under the re-

structured loan, the debtor can keep the home and make afforda-

ble payments to the lender (or its successor). The debtor does not

incur the loss of the home or the impact of a foreclosure on the

debtor’s credit report, and the debtor can get on with her life.95

At the same time, Chapter 13 is cheaper for the lender.96 The

lender is much more likely to be paid.97 A court-approved repay-

ment plan providing for the payment of reduced mortgage pay-

ments is likely to result in payments to the secured creditor. The

present value of the stream of payments under the plan will most

likely substantially exceed the amount that a bank can realize

from reselling the property after foreclosure (which must be dis-

counted for the delay in the foreclosure process and in the resale

process).98 The lender likely receives no payments during the fo-

reclosure process and certainly receives none during the delay be-

tween foreclosure and resale of the residence.99 In addition, the

lender does not incur the costs and administrative burden of own-

ing and marketing the property, almost surely at a loss, or of re-

cognizing this loss on its balance sheet.100

This change in bankruptcy law also solves the contractual,

practical, and economic problems resulting from the securitiza-

tion of the vast majority of home mortgages. The bankruptcy so-

lution solves the collective action problem that prevents mortgage

owners from finding an economic solution to a mortgage afforda-

bility problem. In addition, under mortgage securitization, mort-

gage servicers are typically the only parties who have any author-

95. The costs to a debtor of foreclosure are usually substantial. The debtor suffers a

loss of community ties, friendships, religious affiliation, ―schooling, childcare, medical

care, transportation, and even employment.‖ Levitin, supra note 15, at 569.

96. See id. at 610–11.

97. See id. at 607.

98. See id. at 606–07.

99. See id. at 629.

100. See id. at 606. Foreclosure imposes larger losses on lenders, on the average, than

bankruptcy modification of their loans. See id. at 618; see also Levitin, supra note 69, at 7.

Page 19



ity to act on behalf of mortgage holders, and the servicers are typ-

ically prohibited by contract from making loan modifications, or

their right to make such modifications is severely limited.101 The

servicers lack sufficient personnel to handle a large number of

consumer contacts and lack the financial resources to hire such

personnel. In addition, in many cases, foreclosure is more profita-

ble to loan servicers than modification of a loan.102 All of these

problems disappear immediately for loans modified pursuant to

the proposed Chapter 13 change.

Furthermore, such a program makes good politics. Because

such a program would reduce the incentives for a homeowner to

abandon the property, the community bears a smaller burden of

vacant houses, loss of property taxes, and the failure of the resi-

dents to maintain their properties and to support and contribute

to community life.103

IV. CONCLUSION

The principal purpose of this article is to specify the changes

needed in Chapter 13 of the U.S. Bankruptcy Code to put into

place a Chapter 13 solution for the home ownership problem in

the United States. This solution is both simple and elegant: delete

from § 1322(b)(2) the phrase ―other than a claim secured only by a

security interest in real property that is the debtor’s principal res-

idence.‖ A second change incorporates language from §

1123(a)(5)(H) to make it explicit that a Chapter 13 plan may ex-

tend the maturity date and change the interest rate and other

terms of a debt instrument. Third, some minor technical changes

would implement these alterations.

As the foreclosure crisis continues to deepen, modification of

certain underwater mortgages under Chapter 13 of the Bank-

ruptcy Code can make a substantial contribution to the stabiliza-

tion of the housing market. Unlike any other existing or proposed

solutions to the problem, ―bankruptcy modification offers imme-

diate relief, solves the market problems created by securitization,

101. See, e.g., Levitin, supra note 69, at 5.

102. See id.

103. See Levitin, supra note 15, at 569 (discussing the costs foreclosure can have for

third parties).

Page 20



addresses both problems of payment-reset shock and negative eq-

uity, screens out speculators, spreads burdens between borrowers

and lenders, and avoids both the costs and moral hazard of a gov-

ernment bailout.‖104 Thus, while the bankruptcy solution is not a

magic bullet, ―it is a quick, fair, efficient, and administrable re-

sponse that would help stabilize the housing market and prevent

the deadweight social and economic losses of foreclosure.‖105

Most importantly, this solution can be accomplished at no cost

to the federal government or any other governmental agency.

Like all bankruptcy law, the costs of this solution rest entirely on

the private sector (and rest principally on those responsible for

bringing on the housing crisis).

104. Id. at 647–48.

105. Levitin, supra note 69, at 9.

Page 21

ENFORCEMENT OF PROMISSORY NOTES

SECURED BY REAL ESTATE

PROF. SAMUEL L. BUFFORD DISTINGUISHED SCHOLAR IN RESIDENCE

DICKINSON SCHOOL OF LAW PENNSYLVANIA STATE UNIVERSITY

STATE COLLEGE, PA U.S. BANKRUPTCY JUDGE (retired)

PROFESSOR JULIA M. METZGER ADJUNCT PROFESSOR OF LAW

DICKINSON SCHOOL OF LAW PENNSYLVANIA STATE UNIVERSITY

STATE COLLEGE, PA

BRIEF REVIEW OF UCC PROVISIONS

A huge portion of commercial debt in the United States (and elsewhere) is documented

in promissory notes. Along with drafts (including checks), the rights of third parties in promissory notes are governed by UCC Article 3. Article 3 defines what a negotiable instrument is and specifies how ownership of those pieces of paper is transferred. See § 3-104(e). A check is a draft drawn on a bank. See § 3-104(f). Promissory notes and drafts are generally categorized as “commercial paper” or “negotiable instruments.” The rights under Article 3

chiefly apply to a “holder” of a negotiable instrument, usually a third party who is not the original

payee of the instrument. A fundamental feature of the law of negotiable instruments is the doctrine of merger: the

document itself is the claim or the debt that it evidences. Thus the debt is merged into the instrument itself. Under the merger rule, the only way to transfer the debt represented by the instrument is by physical delivery of the instrument itself.

In bankruptcy cases, state substantive law controls the rights of note and lien holders, as

the Supreme Court pointed out more than 40 years ago in United States v. Butner, 440 U.S. 48, 54-55 (1979).

Definition

Page 22

The definition of negotiable instrument is in § 3-104(a). It must contain “an unconditional

promise or order to pay a fixed amount of money, with or without interest . . . .” The instrument

may either be payable to order (i.e., it identifies a specific person on whose order it is payable) or to the bearer (the holder of the instrument). A negotiable instrument may be payable on demand or at a definite time, with or without interest.

In addition, a negotiable instrument must satisfy five other requirements of § 3-104(a):

(1) the obligation must be unconditional; (2) the obligation must be a fixed amount (with or without interest); (3) the obligation must be payable to bearer or to order; (4) the obligation must be payable either on demand or at a definite time; (5) the promise or order may not state any other undertaking or instruction by the obligor to do anything in addition to the payment of money. See § 3-104 Comment 1. The fifth requirement has three exceptions (i.e., other promises that may be included): (1) a promise respecting collateral to secure the payment; (2) authorization of the holder to confess judgment or realize on or dispose of collateral: (3) a waiver of any law intended for the advantage or protection of the obligor. See § 3-104(a)(3).

Negotiation A negotiable instrument is transferred from the original payor by negotiation. §3-201(a). For “order paper,” the instrument must be endorsed and delivered; bearer paper can be

transferred by delivery alone. §3-201(b). However, in either case, for the note to be enforced, the person who asserts the status of the holder must be in possession of the instrument. See UCC § 1-201 (20) and comments.

The original and subsequent transferees are referred to as “holders.” Holders who take

for value, in good faith, and with no notice of defect or default are called “holders in due course,”

and take free of most defenses. See §§ 3-305(b).

Many promissory notes involved in real estate transactions (including consumer home mortgages) do not meet the fifth requirement of § 3-104(a) because they include other undertakings by the borrower. The principal consequence of such a provision is to prevent a subsequent holder from being a “holder in due course.” In the current mortgage crisis, there

has been rather little litigation on the issue of whether a note meets the § 3-104 requirements. Enforcement A central concept for the enforcement of a promissory note is the “person entitled to

enforce.” The maker’s obligation is to pay the amount of the note to the person entitled to

enforce the note. See § 3-412. The maker’s payment to the person entitled to enforce results

in the discharge of the maker’s obligation. See § 3-602. The failure to make payment when due to the person entitled to enforce the note constitutes dishonor of the note. See § 3-502.

Page 23

Dishonor entitles the person entitled to enforce to commence enforcement action. There is never more than one person entitled to enforce at any given time. Section 3-301 provides three ways to qualify as a person entitled to enforce a note. First, the person may be a holder of the note in virtue of having met all of the requirements for a holder. Determining to whom a note is payable requires examination not only of the face of the note but also of all indorsements. This determination requires an examination of the original document: a copy, especially a copy made at the time the transaction took place, is insufficient to determine to whom the note is payable. The second way to qualify as a person entitled to enforce a note is to have possession of the note without proper indorsements. If the note has been delivered to such a person with intent to transfer all of the prior holders interest in the note, but it has not been properly indorsed, the new possessor is a person entitled to enforce the note. (Such a person is also entitled to a proper indorsement by the transferor – see § 3-203(c)). The right to enforce may also pass by operation of law, such as through subrogation or for estate administration. Lost Notes The third way to qualify as a person entitled to enforce the note is the only way to enforce a note without possession. This limited situation may apply if the note was lost, destroyed or stolen. To qualify for this alternative, the person must show that (1) the person had possession of the instrument and was entitled to enforce it when loss of possession occurred, or that the person acquired ownership of the instrument from such a person; (2) the loss of possession was not the result of a transfer by the person or a lawful seizure; (3) the person cannot reasonably obtain possession of the instrument because it was destroyed, its whereabouts cannot be determined, or it is in the wrongful possession of a person who cannot be found or is not amenable to service of process. See § 309. The person must prove the instrument’s terms and the right to enforce the instrument. In addition, a court enforcing the note must that the person required to pay the instrument is adequately protected against any loss resulting from a claim by another person to enforce the instrument: this usually requires the posting of a bond. The merger principle (the debt is merged into the instrument itself) requires that the original must be produced to enforce it. Producing the original in such circumstances is a cost of the holder in due course status. In addition, the borrower is normally entitled to a return of the promissory note, duly canceled, when the obligation is paid in full.

EVIDENTIARY ISSUES

Page 24

The foregoing law can raise difficult evidentiary issues in showing that a person is entitled to enforce. First, the merger rule requires the original note because the obligation is merged into the note. Second, (apart from the lost note provisions) the original promissory note must be provided to show the terms of the note and the proper indorsements (and that there are not any indorsements showing that the person attempting to enforce is not disqualified). It is not necessary to prove that the holder is a holder in due course (and thus that most defenses are inapplicable) unless a defense is raised to enforcement of the note. However, the person entitled to enforce the note must show that the obligor has defaulted. Because virtually all payment records are kept electronically, the party enforcing the obligation must provide sufficient evidence to prove the admissibility of the electronic records. The recent use of “robosigners” to prove the electronic records shows that the lending industry

has not shouldered this responsibility sufficiently. See, e.g., In re Vargas, 396 B.R. 511, 517-19 (Bankr. C.D. Cal. 2008). The proof of electronic records can be a substantial burden requiring various witnesses with expertise on the computer system and the accounting records. See, e.g., In re Vinhnee, 336 B.R. 437 (9th Cir. B.A.P. 2005).

RECENT CASE LAW

Misrepresentations to the Court as to Servicer Status

Ameriquest Mortgage Corp. v. Nosek, 609 F.3d 6 (1st Cir. 2010)

First Circuit decision affirmed the imposition of sua sponte sanctions on Ameriquest by the bankruptcy court for failure to disclose to the court that Ameriquest was not the holder of the mortgage but only its servicing agent. However, the court reduced the sanctions imposed on Ameriquest from $250,000 to $5000 because of lack of harm to chapter 13 debtors and that the sanctions were imposed by the court sua sponte.

The circuit court decision was an appeal from the district court’s affirmance of the bankruptcy

court’s imposition of $250,000 in sanctions on Ameriquest. The district court had also affirmed the imposition of $25,000 in sanctions against Ameriquest’s local counsel, which were not

appealed. The district court reversed the $100,000 in sanctions against Ameriquest’s national

counsel because it did not sign any pleadings and thus was outside the scope of Rule 9011. In addition, the district court reversed sanctions imposed on Wells Fargo because it was not a party to the bankruptcy court proceedings until late in the case.

Lost Promissory Notes

Marks v. Braunstein, 439 B.R. 248 (D. Mass. 2010)

District court holding that recorded assignment of mortgage was not sufficient to establish assignee's standing to enforce lost promissory note, and assignee failed to demonstrate that he exercised due diligence in his search for note.

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Failure or Refusal to Account Properly for Mortgage Payments in Bankruptcy

In re De La Fuente, 430 B.R. 764 (S.D.Texas 2010)

Wells Fargo held in contempt for failure to account properly for post-petition payments made by successfully reorganized chapter 13 debtors and had failed to live up to agreed judgments in the case. Wells Fargo had repeatedly repeatedly failed to correct its records and had repeatedly imposed late charges and other fees on the debtors notwithstanding the fact that the debtors had timely made their payments under the chapter 13 plan.

In re Jones, 418 B.R. 687 (E.D.LA 2009)

Court imposed Accounting Procedures remedy on Wells Fargo after finding it had improperly collected certain charges in violation of terms of debtor’s confirmed plan and in violation of the

automatic stay. The court imposed this remedy and found that punitive damages were insuficient because Wells Fargo had violated a settlement agreement in the case and had “stubbornly” refused to change its procedures notwithstanding findings in several cases that the

procedures failed to comply with bankruptcy law, and that it continued to make the same errors in all its filings in claims and relief from stay motions.

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List of Judicial Opinions on Robo-Signers, Lost Promissory Notes, and Loan Servicers that Fail to

Account Properly for Mortgage Payments

I. Robo-Signers

Figueroa v. Merscorp. Inc., 2011 WL 3328221 (S.D. FL 2011)

Defendants allege that the persons executing alleged fraudulent assignments in order to gain standing to

complete foreclosures were robo-signers who lacked any knowledge of the truth or falsity of the

documents they were signing.

Jarbo v. BAC Home Loan Servicing, 2010 WL 5173825 (E.D. MI 2010)

Plaintiff’s complaint does not allege claims based on foreclosure process problems related to the use of

robo-signers, but the court does mention that the use of robo-signers in the preparation of flawed and/or

fraudulent documents in connection with pending foreclosures is an issue that needs to be and is being

addressed elsewhere.

Bucy v. Aurora Loan Services, LLC., 2011 WL 1044045 (S.D. Ohio 2011)

Plaintiff claims that defendants misrepresented that the robo-signer of an affidavit in a foreclosure had

personally knowledge of the plaintiff’s mortgage account.

Davis v. Countrywide Home Loans, Inc., 2011 WL 837048 (S.D. Indiana 2011)

Plaintiffs allege that the Countrywide executives who signed affidavits related to the foreclosure of their

home were “known robo-signers” who had no personal knowledge of the matters they attested to.

III. Lost Promissory Notes

In re Perrysburg Marketplace Co., 208 B.R. 148 (N.D. Ohio 1997)

To determine the validity and priority of mortgages against a leasehold on real property leased by Chapter

11 debtor, the bankruptcy court applied state law in determining whether mortgagee could assert its claim

under a lost promissory note.

General Financial Services, Inc. v. Thompson, 987 F.Supp. 505 (M.D. LA 1997)

Owner of lost promissory note was able to recover because he produced an affidavit that attested to his

compliance with Louisiana law and the defendant failed to rebut the evidence.

Beal Bank, S.S.B., v. Caddo Parish-Villas South, Ltd., 218 B.R. 851 (N.D. Texas 1998); In re Caddo

Parish-Villas South, Ltd., 250 F.3d 300 (5th Cir.)

Secretary of Housing and Urban Development (HUD) satisfied requirements of Louisiana UCC and, thus,

was entitled to enforce lost mortgage note where HUD was in possession of note when loss occurred.

Resolution Trust Corp. v. Love, 36 F.3d 972 (10th Cir. 1994)

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Inability of mortgagee to produce original promissory note underlying mortgage did not preclude

mortgagee from recovering on note after mortgage foreclosure sale left deficiency, under Wyoming

statute.

Marks v. Braunstein, 439 B.R. 248 (D. Mass. 2010)

Recorded assignment of mortgage was not sufficient to establish assignee's standing to enforce lost

promissory note, and assignee failed to demonstrate that he exercised due diligence in his search for note.

III. Loan Servicers that Fail to Account Properly for Mortgage Payments

Failure or Refusal to Account Properly for Mortgage Payments in Bankruptcy

In re De La Fuente, 430 B.R. 764 (S.D.Texas 2010)

Wells Fargo held in contempt for failure to account properly for post-petition payments made by

successfully reorganized Chapter 13 debtor.

In re Thrash, 433 B.R. 585 (N.D.Texas 2010)

In re Moffit, 390 B.R. 368 (Bankr. E.D. Ark. 2008)

Court issued injunction against lender who misapplied and failed to record payments, sent

incomprehensible and frightening mortgage statements, and engaged in further mismanagement of

debtor’s loan.

In re Stewart, 391 B.R. 327 (E.D.LA 2008)

Wells Fargo had difficulty producing certain information about claims it submitted. Opinion includes a

good discussion of the Fidelity MSP software platform used to manage home mortgage loans and the AIS

service that scans bankruptcy filings and compares them to the loans issued by Wells Fargo.

In re Jones, 418 B.R. 687 (E.D.LA 2009)

Court found that Wells Fargo had improperly collected certain charges in violation of term’s of debtor’s

confirmed plan and of the automatic stay.

In re Fitch, 390 B.R. 834 (E.D.LS 2008)

Accounting provided by Wells Fargo in this case was an improvement, although there will still some

issues, from the accounting in Stewart and Jones.

In re McKain, 2009 WL 2848988 (E.D.LA 2009)

Detailing the storied career of Ocwen, who once again appears before the court for improperly

administering a loan, providing illegible and radically incorrect mortgage statements, and attempting to

collect fees and costs to which it is not entitled.

Abusive Accounting Processes

In re Christoper W. Schuessler, 386 B.R. 458 (S.D.N.Y. 2008)

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JP Morgan Chase accounting policy preventing bankruptcy debtors from making payments at a bank

branch was an abuse of process.

In re Nosek, 363 B.R. 643 (Bankr.D.Mass. 2007)

Ameriquest Mortgage Company was sanctioned for failing to adjust its accounting procedures to reflect

payments on pre-petition arrears made through the debtor’s Chapter 13 plan.

Breach of Implied Covenant of Good Faith and Fair Dealing

Ihebreme v. Capital One, N.A., 730 F.Supp.2d 40 (D.D.C. 2010)

Court denied a motion to dismiss claim that Chevy Chase Bank breached the implied covenant of good

faith and fair dealing by failing to credit payments made online.

Ferris v. Federal Home Loan Mortgage Corp., 905 F. Supp. 23 (D. Mass. 1995)

Court held the bank had breached the implied covenant of good faith and fair dealing when it failed to

account properly for payments made to a mortgage escrow account.

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PANEL BIOGRAPHIES

Judge Samuel L. Bufford is a Distinguished Scholar in Residence at Penn State University, where he began teaching in 2011. Prior thereto, he served for 25 years as a bankruptcy judge in Los Angeles, in the Central District of California, one of the busiest bankruptcy courts in the United States. During this time he oversaw more than 100,000 bankruptcy cases, including more than 2500 cases involving the reorganization of business under chapter 11. His most famous case was the

Anna Nicole Smith case, in which the United States Supreme Court affirmed his decision that the dispute with her husband’s rich relatives belonged in a bankruptcy court and did not have to be litigated in a Texas state court.

Judge Bufford is the author of two books, numerous law review articles and 95 published opinions. His book, United States International Insolvency Law, was published in 2009. In addition, he is a frequent lecturer throughout the United States and abroad on issues of bankruptcy law and legal ethics. Judge Bufford served as editor in chief of the America Bankruptcy Law Journal from 1990 to 1994.

Judge Bufford has taught more than 25 seminars for judges and other professionals abroad since 1991. He has taught and consulted recently in Korea, Abu Dhabi, China, France, Mexico, Oman, Egypt, Jordan, Tunisia, Albania, Algeria, Ecuador, Romania, Serbia, Montenegro and Morocco. He has also conducted seminars in Los Angeles and consulted with visiting judges and government officials from numerous countries including Russia, Serbia, China, Thailand, Romania and Montenegro.

Judge Bufford was Nomura Lecturer on Law at Harvard Law School for the winter, 2005 term, where he taught a course in international and comparative insolvency law. He also taught this course at Harvard in 2004, and at the University of Southern California in 2006. He has also been a law professor at Ohio State University. He earned his law degree from the University of Michigan, where he was an editor of the Michigan Law Review and of the Journal of Law Reform. In addition, he holds a Ph.D. in philosophy from the University of Texas and was a philosophy professor for nearly ten years.

Alice Whitten was appointed as the Standing Chapter 13 Trustee in Fort Worth, Texas on October 1, 2009. Prior to her appointment as Chapter 13 Trustee she was Senior Vice President - Associate General Counsel for AmeriCredit Corp. & AmeriCredit Financial Services, Inc. She also served as their Senior Vice President – Special Accounts. From 1995 to 2001 she was in private practice with Forshey & Prostok, LLP and Cantey & Hanger, LLP in Fort Worth, Texas and West, Webb, Allbritton &

Gentry, P.C. in College Station, Texas. Ms. Whitten is admitted to practice before the Northern, Eastern and Southern Districts of Texas, and the Fifth Circuit Court of Appeals. She serves as Chairperson of the Non-Mortgage Committee for the National Association of Chapter 13 Trustees.

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Ms. Whitten graduated from St. Mary’s University School of Law with her Juris Doctor Degree, cum laude, in 1995. She received a B.S. Degree in finance from the University of Minnesota in 1992.

SIDNEY H. SCHEINBERG of Glast, Phillips & Murray, P.C., Dallas, Texas received his J.D. from the University of Memphis, Southern Methodist University and a B.B.A. degree from the University of Memphis. Mr. Scheinberg’s practice focuses on the representation of secured creditors such as automobile finance companies and national banking associations in bankruptcy

litigation and in state court matters throughout Texas. Additionally, he litigates commercial disputes and other civil matters. Mr. Scheinberg has spoken at numerous seminars on bankruptcy law and commercial litigation nationwide and has hosted talk radio programs on legal matters. He is a member of the State Bar of Texas, the State Bar College, the Commercial Law League of America, the Executive Counsel for the Southern Region, the National Association of Chapter 13 Trustees, the NACTT Creditors Auxiliary, and the American Bankruptcy Institute.

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Documents

Thursday, August 4, 2011 1:30pm - Do You Wanna Dance