ORDER ON APPEAL

RICHARD SEEBORG, District Judge.

I. INTRODUCTION

This dispute stems from a loan that was issued to finance the construction of a home on a parcel of land commonly referred to as 169 Rose Avenue ("169 Rose"). Debtor-appellants Charles and Anna Utzman ("the Utzmans") sought to plant roots in Mill Valley, California, and got financing for their property in August 2007 from creditor-appellee Suntrust Mortgage, Inc. ("Suntrust"). Years later, the Utzmans filed a petition for bankruptcy protection under Chapter 11 of the Code, and tried to bifurcate Suntrust's claim into secured and unsecured components. Suntrust then invoked the "anti-modification exception" in section 1123(b)(5) of the Code, which bars a Chapter 11 plan from modifying "a claim secured only by a security interest in real property that is the debtor's principal residence."

This appeal centers on the sole question of whether the anti-modification exception applies to stonewall the Utzmans in their continuing effort to bifurcate Suntrust's secured claim. The Utzmans insist the exception is inapplicable because they rent out a portion of their property, meaning Suntrust's claim is not secured only by an "interest in real property that is" only "the debtor's principal residence." They further insist the deed of trust ("DOT") grants Suntrust an interest in personal property, therefore defeating the exception because the claim must be secured "only by a security interest in real property" (emphasis added).

The bankruptcy court rejected the Utzmans' interpretation and barred them from modifying Suntrust's claim. There is a budding disagreement, however, both here and across the country, over the appropriate construction of the statute.

For the reasons explained below, the bankruptcy court's order denying the Utzmans' request for a decision determining Suntrust's secured claim will be reversed. Section 1123(b)(5) requires the real property to be used as the debtor's principal residence. Contrary to the Utzmans' preferred interpretation, it does not require the real property to be used exclusively as the debtor's residence. The Utzmans do not dispute 169 Rose Avenue serves as their principal residence. Accordingly, the fact that they rent out a small portion of the property does not defeat the applicability of the exception. That said, the statute does require a lender's claim to be secured "only by a security interest in real property." Under the Residential Construction Rider ("RCR") attached to the DOT, Suntrust's claim simply does not meet that definition.

II. FACTUAL BACKGROUND

Around 2004, debtor-appellants Charles and Anna Utzman acquired two vacant lots in Mill Valley, California with the intention of building a home. Though the lots are contiguous, the Utzmans elected to construct their future residence on the parcel of real property known as "169 Rose Avenue." The shovels found dirt for the first time around 2005, and after two years of progress, the Utzmans went searching for a residential construction loan.

In stepped Suntrust, which loaned the Utzmans $1,365,000 in August 2007. The Utzmans executed a note, secured by the DOT, in order to obtain the loan, and 169 Rose eventually bloomed by way of the proceeds. The property itself includes both a home office and a residential unit to rent out to third parties.1 Though 169 Rose became the Utzmans' principal residence, they did not obtain a Certificate of Occupancy.2

The DOT gave Suntrust a secured interest in the property at 169 Rose, and the nature of that interest lies at the heart of the instant dispute. On December 18, 2014, several years after constructing the property, the Utzmans filed a petition for bankruptcy protection under Chapter 11 of the Code. They soon proposed to modify Suntrust's rights under Section 506 of the Code,3 which permits the bifurcation of a secured claim—like Suntrust's—into two distinct components: the first, a secured component, for the present value of the collateral; the second, an unsecured component, for the difference between the collateral's present value and the amount of debt owed.

To implement their plan, the Utzmans moved for an order determining the value of Suntrust's claim. Suntrust opposed the motion on the ground the debtors were barred from proceeding with the modification. Suntrust invoked the "anti-modification exception" in Section 1123(b)(5) of the Code, which bars a Chapter 11 plan from modifying "a claim secured only by a security interest in real property that is the debtor's principal residence."

A hearing was held on the Utzmans' motion in July 2015, and the bankruptcy court ordered additional briefing on the anti-modification exception. Appellants then argued the DOT conveys an interest in a multi-unit dwelling and personal property, so the exception does not apply because Suntrust's claim is not secured "only by a security interest in real property" that serves only as "the debtor's principal residence." Appellants grounded their argument in the Residential Construction Rider attached to the DOT, which defines the "property" securing appellants' performance as including both "real" and "personal" property.

After an additional hearing, the bankruptcy court found the anti-modification exception did apply, and therefore denied the Utzmans' motion to bifurcate Suntrust's claim. Relying on the Ninth Circuit Bankruptcy Appellate Panel's ("BAP") decision in In re Wages, 508 B.R. 161 (9th Cir. BAP 2014) ("Wages"), the court was not persuaded the rental unit took Suntrust's claim outside the exception. The court also found Suntrust's claim "is secured only by a security interest in real property" given the parties contemplated the collateral would become part of the "real property" when construction completed.4

The Utzmans filed a notice of appeal on September 15, 2015, and elected to proceed before a district court pursuant to 28 U.S.C. 158(c)(1)(A). Jurisdiction over this matter is proper pursuant to 28 U.S.C. § 158(a)(1).

III. STANDARDS OF REVIEW

The bankruptcy court's conclusions of law are reviewed de novo. See In re Markovich, 207 B.R. 909, 911 (9th Cir. BAP 1997). The bankruptcy court's findings of fact are reviewed for clear error. Beauchamp v. Hoose, 236 B.R. 727, 729 (9th Cir. BAP 1999). A factual finding is clearly erroneous if the appellate court, after reviewing the record, has a definite conviction that a mistake has been made. Id. Mixed questions of fact and law are reviewed de novo. Id. at 730.

IV. DISCUSSION

The anti-modification exception bars a Chapter 11 plan from modifying "a claim secured only by a security interest in real property that is the debtor's principal residence."5 11 U.S.C. § 1123(b)(5). The terms of the statute evince three distinct requirements: "first, the security interest must be in real property; second, the real property must be the only security for the debt; and third, the real property must be the debtor's principal residence." In re Wages, 508 B.R. 161, 165 (9th Cir. BAP 2014).

The Utzmans do not dispute Suntrust retains a security interest in "real property," or that 169 Rose has and continues to represent their "principal residence." Rather, they insist the word "only" modifies both components of the sentence such that a claim is protected where "secured only by a security interest in real property that is" only "the debtor's principal residence." Under that reading, they contend Suntrust's claim fails to qualify for protection on two fronts. First, it is not secured by property serving only as the debtor's principal residence because 169 Rose includes a rental unit, making it a "multi-family dwelling." Appellant's Opening Brief ("O.B.") at 13. Second, the Utzmans aver the claim is not secured only by a security interest in real property because the Utzmans owned personal property when their bankruptcy was filed, which allegedly constitutes collateral for Suntrust's loan under the RCR. Suntrust rejects appellants' reading of the text of 1123(b)(5), and insists in reality their claim is secured only by real property that serves as the Utzmans' principal residence.

This dispute thus boils down to a disagreement over the applicability of the exception, which correspondingly depends on whether the word "only" modifies both "real property" and "debtors principal residence." The construction of the statute, and its impact on 169 Rose, undoubtedly present thorny issues. Each component of the provision accordingly will be addressed in turn.

A. "secured only by . . . real property that is the debtor's principal residence"

Courts examining how far the word "only" travels down the text of 1123(b)(5) have come to three different conclusions. In an early case, Brunson v. Wendover Funding, Inc., 201 B.R. 351 (Bankr. W.D.N.Y. 1996), the court found the text of the statute wanting and opted instead for a functional approach. Id. at 352. The debtor had insisted the exception did not apply to bar modification of the lender's claim because her residence had two units, she operated a day care from the second unit, she earned rental income from the second unit, and the lender had a security interest in the rents. Id. at 351-52. The court elected to look to the "character of the transaction" to decide if the claim was secured only by a security interest in real property that is the debtor's principal residence. As the court saw it, "[i]f the transaction was predominately viewed by the parties as a loan transaction to provide the borrower with a residence," the court concluded "the anti-modification provision will apply." Id. at 354. Conversely, if "the transaction was viewed by the parties as predominantly a commercial loan transaction," the court explained that "stripdown will [then] be available."6 Id. Decisions in the wake of Brunson have characterized the opinion as establishing a "totality of the circumstances" test to decide whether the anti-modification provision will apply. See, e.g., Wages, 508 B.R. at 166.

A decade later, in Scarborough v. Chase Manhattan Mortgage Corporation, 461 F.3d 406 (3d Cir. 2006), the Third Circuit decided the word "only" did in fact modify "debtor's principal residence."7 Id. at 408. As before, the debtor insisted the exception did not apply because the lender's claim was secured by a two-unit property that included an income-producing rental unit. Id. at 410. The court held the plain meaning of the text required acceptance of this argument. Specifically, "[b]y using the word `is' in the phrase `real property that is the debtor's principal residence," the Third Circuit believed "Congress equated the terms `real property' and `principal residence.'" Id. at 411. Because the terms were co-extensive, the Third Circuit accordingly concluded "the real property that secures the mortgage must be only the debtor's principal residence in order for the anti-modification provision to apply." Id. (emphasis in original).

The Ninth Circuit BAP reached the opposite conclusion recently in Wages, 508 B.R. 161 (9th Cir. BAP 2014), the case upon which the bankruptcy court relied in denying the Utzmans' modification. In Wages, the debtor maintained the exception did not apply because the residence included a home office, and a portion of the property was also being used to operate a trucking business. Id. at 163. The court found the plain meaning of the statute required it to reject the debtor's contention, and held "the anti-modification exception applies to any loan secured only by real property that the debtor uses as a principal residence property, even if that real property also serves additional purposes." Id. at 168 (emphasis added). The BAP followed the approach of the bankruptcy court in In re Macaluso, 254 B.R. 799, 800 (Bankr. W.D.N.Y. 2000), which emphasized the statutory text does not protect from modification claims secured only by an interest in property that is exclusively the principal residence. Wages, 508 B.R. at 167.

Turning to the Third Circuit's analysis in In re Scarborough, the BAP was unpersuaded for two reasons. First, the court disagreed with the textual argument because it "add[ed] a second `only' into the statutory language to further limit the application of [the provision]." Id. at 167. The court found "[t]here simply is no second `only'" in 1123(b)(5), "nor any way to read the one usage of that term to limit the use of the property rather than limiting the extent of the collateral." Id. (quoting In re Schayes, 483 B.R. 209, 215 (Bankr. D. Ariz. 2012)).

Second, the BAP rejected that "real property" could be equated with "debtor's principal residence," and noted Scarborough did not grapple with the Code's newest definition of the latter term.8 In particular, both the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 and the Bankruptcy Technical Corrections Act of 2010 amended the definition of "debtor's principal residence" in section 101(13A). See Pub. L. 109-8, 119 Stat. 23 (Apr. 20, 2005); Pub. L. 111-327, 124 Stat. 3557 (Dec. 22, 2010). It now "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."9 11 U.S.C. § 101(13A). Because "the definition avoids defining `real property' and also clarifies that whether a structure is a principal residence is independent of whether it might be real property," the BAP found the terms could not be considered co-extensive, and thus "an analysis which equates the two is misplaced." Id. at 166.

The Utzmans spurn Wages in favor of Scarborough on two primary bases. To start, they assert Wages is factually distinguishable from the instant case because Wages involved a business rather than an income-producing rental unit. This argument is unavailing because the holding of Wages renders the distinction inapposite.10 See Wages, 508 B.R. at 168 (implying the nature of the "additional purpose" for which the debtor's principal residence is used is immaterial).

Next, the Utzmans insist 1123(b)(5) is ambiguous and turn to the legislative history, which they argue supports the interpretation of the text adopted by the Third Circuit in Scarborough. Specifically, a House Judiciary Committee report on the Bankruptcy Reform Act of 1994 reveals Congress intended to "conform[] the treatment of residential mortgages in chapter 11 to that in chapter 13, preventing the modification of the rights of a holder of a claim secured only by a security interest in the debtor's principal residence." H.R. Rep. No 835, 103d Cong., 2d Sess. 46 (1994), reprinted in 1994 U.S.C.C.A.N. 3340, 3354. The report explains the exception "does not apply to a commercial property, or to any transaction in which the creditor acquired a lien on property other than real property used as the debtor's residence." Id. This proposition was supported by citation to a case called In re Ramirez, 62 B.R. 668 (Bankr. S.D. Cal. 1986). There, the lender held a security interest in property that consisted of the debtor's principal residence and two rental units. Id. at 668. The court declined to apply the anti-modification exception because the lender's security interest extended to the debtor's rental property, and thus it was not secured only by an interest in the debtor's principal residence. Id. at 670. Though not relied on by the courts in either Wages or Scarborough, the Utzmans take this history to suggest that Congress did not intend to bar modification of a claim secured by an interest in a multi-unit dwelling.

Having reviewed the evidence, the court's interpretation of 1123(b)(5) in Wages is correct. Once again, the provision bars a Chapter 11 plan from modifying "a claim secured only by a security interest in real property that is the debtor's principal residence." Looking to the plain language, the word "only" is an adverb used to modify the word "secured," whereas the clause "that is the debtor's principal residence" modifies the term, "real property."11 The placement of "only" suggests it limits the extent of the collateral for the secured debt, and not the use of the property deemed the "debtor's principal residence." True, Congress used "is," rather than "solely" or "includes," to tie "real property" to "debtor's principal residence." That does not afford a basis, however, for "only" to extend its reach beyond its plain limitation to "a security interest in real property."12

Scarborough's analysis is unconvincing because the text simply does not contain a second use of the word "only." Moreover, to the extent the two terms are "equated" by the word "is," that argument is still unavailing. Real property is a "debtor's principal residence" even if it is something else, too, so the word "is" does not suggest the property must serve "only" one function—that of the debtor's principal residence. Scarborough's hyperliteral translation reads the word "is" in isolation and the resulting interpretation is accordingly unpersuasive because it ignores the plain meaning of the language taken in its broader context.

Even setting these interpretive calisthenics aside, Scarborough did not construe the latest version of the statutory text. The 2005 bankruptcy amendments added for the first time a definition of "debtor's principal residence," and also defined the term "incidental property," which appears in that definition. These changes make clear Congress did not equate the terms "real property" and "debtor's principal residence."13 Scarborough's contrary finding, and its treatment of the terms as co-extensive, therefore cannot be accepted.

The legislative history need not be reached in light of the plain meaning of the text. In any event, its consideration here would not clearly resolve the relevant question. On one hand, the committee report explains the exception does not apply where a "creditor acquired a lien on property other than real property used as the debtor's residence." H.R. Rep. No 835, 103d Cong., 2d Sess. 46 (1994), reprinted in 1994 U.S.C.C.A.N. 3340, 3354 (emphasis added). This language suggests the real property need not be employed exclusively as the debtor's principal residence. On the other hand, the citation of Ramirez plainly suggests Congress contemplated the exception would not apply where a lender's security interest extended to a debtor's multi-unit rental property.14 Setting the committee report aside, the 2005 amendments also shed light on Congress's intent.15 That statute added a broad definition of "debtor's principal residence" in a title headed: "Discouraging Bankruptcy Abuse." See Pub. L. 109-8, Title III, 119 Stat. 23, 24 (2005). The term is detailed specifically in section 306 of the Act, whose caption indicates it is intended to "[g]iv[e] secured creditors fair treatment in chapter 13." See Pub. L. 109-8, § 306, 119 Stat. 23, 24 (2005). This evidence suggests Congress defined "debtor's principal residence" to discourage abusive bankruptcy filings, and to benefit secured creditors in their various interactions with bankruptcy petitioners. Indeed, when the definition of "debtor's principal residence" is substituted for that term in 1123(b)(5), the provision suggests Congress did not intend the real property to be used exclusively as the debtor's principal residence.16

Interpreting the exception to apply to a debtor's principal residence, even if it also serves additional functions, is similarly consistent with the statute's purpose. By enacting the exception, Congress sought to afford "favorable treatment" to residential lenders to "encourage the flow of capital into the home lending market." Nobelman v. Am. Savings Bank, 508 U.S. 324, 332 (1993) (Stevens, J., concurring); BAC Home Loans Servicing, LP v. Abdelgadir, 455 B.R. 896, 903 (9th Cir. BAP 2011) (noting 1123(b)(5) has the same purpose as the anti-modification exception in 1322(b)(2)). Interpreting the exception to require only that the real property be used as a debtor's principal residence affords greater protection to residential lenders, promoting the issuance of loans. This bright-line approach also fosters certainty in the home lending market. Specifically, it counteracts the fear raised by the Third Circuit in Scarborough that petitioners will sidestep the exemption by renting a portion of their property to another on the eve of their bankruptcy filing.

In sum, section 1123(b)(5) requires the real property be used as the debtor's principal residence; it does not require the real property be used solely as the debtor's principal residence, or be deemed the debtor's principal residence in light of the totality of the circumstances. Given the Utzmans do not dispute 169 Rose serves as their principal residence, the fact that they rent out a small portion of the property does not defeat the applicability of the exception. Exercising de novo review, the bankruptcy court's construction of the statute accordingly will be affirmed. In addition, its finding that 169 Rose is the debtor's principal residence is not plainly erroneous. The bankruptcy court's holding on this issue altogether is affirmed.

B. "secured only by a security interest in real property"

The next issue is whether Suntrust's claim is secured "only by a security interest in real property." The Utzmans insist the RCR establishes it is not. Specifically, the RCR defines Suntrust's collateral to consist of "Property" with a capital "P," then describes that term as containing both "Real" and "Personal" property.17 Because the Utzmans contend they owned personal property on the date their petition was filed, they submit Suntrust's claim falls outside the exception as it is secured by collateral that does not constitute "real property."

Suntrust responds its claim "is secured only by a security interest in real property" because the parties contemplated the collateral would become part of the "real property" upon completion of construction. Specifically, the RCR provides it "will no longer have any force or effect" once a residence is built on 169 Rose resulting in a Certificate of Occupancy. At that point, Suntrust submits it will retain a security interest only in the items of personal property that have been integrated into, or have become fixtures of, 169 Rose Avenue. The Utzmans counter that some of the personal property will not be incorporated into the real property, and object in any event to the issue being decided based on the hypothetical future character of the property. The relevant date for determining the applicability of the exception, in the eyes of the Utzmans, is the date upon which their original bankruptcy petition was filed.

The bankruptcy court framed the dispute as whether the personal property transforms into real property by virtue of the language contained in the parties' deed of trust. Alas, there is a split of authority on how to go about answering that question.

On one side of the debate, courts employ a textualist approach both to the statute and the DOT on the theory the anti-modification exception prohibits lenders from taking a security interest in anything other than the debtor's principal residence. See Lomas Mortg. v. Louis, 82 F.3d 1, 7 (1st Cir. 1996); Hammond v. Commonwealth Mortg. Corp. of Am., 27 F.3d 52, 56-57 (3rd Cir. 1990). On the other side, courts look to the purpose of the statute to conclude the exception applies if the additional collateral incorporated by the DOT is "inextricably bound to the real property itself as part of the possessory bundle of rights," In re Davis, 989 F.2d 208, 213 (6th Cir. 1993), or "nothing more than an enhancement which is or can, by agreement of the parties, be made a component part of the real property[,] or is of little or no independent value," In re French, 174 B.R. 1, 7 (Bankr. Mass. 1994).

The bankruptcy court looked to the Ninth Circuit BAP's decision in In re Lee for guidance. 215 B.R. 22 (9th Cir. BAP 2007). There, the debtors argued their DOT gave the lender an interest in property beyond their principal residence, and the lender shot back the language amounted to mere "boilerplate" and never was intended to create a security interest in anything other than the residence. Id. The BAP concluded "boilerplate" language in a DOT should not defeat the applicability of the exception. It therefore barred modification because the collateral was "nothing more than an enhancement which is or can, by agreement of the parties, be made a component part of the real property[,] or [wa]s of little or no independent value." Lee, 215 B.R. at 26. Adhering to that precedent, the bankruptcy court applied the anti-modification exception in the instant case because it concluded the parties intended the personal property to become real property when construction was completed.

Simply put, the text of the statute requires a lender's claim to be secured "only by a security interest in real property." Under the RCR, Suntrust's claim does not meet that unambiguous condition.

To start, "the petition date is the appropriate date for determining whether the anti-modification provision of § 1123(b)(5) applies to a secured claim." Wages, 508 B.R. at 164 (citing In re Abdelgadir, 455 B.R. 896, 902-03 (9th Cir. BAP 2011); In re Benafel, 461 B.R. 581, 591 (9th Cir. BAP 2011)). On the petition date here, the RCR was operative because 169 Rose was incomplete. Suntrust's claim was thus secured by the personal property it bargained for in the language of the deed of trust.18 Given a claim that is secured by an interest in personal property loses the benefit of section 1123(b)(5), the bankruptcy court's finding that the exception does apply accordingly must be reversed.19

Importantly, the bankruptcy court did not engage in the aforementioned analysis because it understandably adhered to the rule in Lee. That approach, however, effectively reads the word "only" out of the text of section 1123(b)(5).20 Under the approach in Lee, the exception still applies when a claim is secured by personal property, so long as that property is of little independent value, or can (but need not) become a component of the real property. It is difficult to reconcile this interpretation of the text with the plain language Congress elected to enact, given that language bars modification of a claim secured "only by a security interest in real property." 11 U.S.C. § 1123(b)(5) (emphasis added).

Suntrust concedes as much, noting the contrary approach is "closer to the provision's literal words." Appellee's Br. at 54. Suntrust does not acknowledge, however, that the plain language interpretation is also consistent with Congress's intent. Though it need not be reached, the legislative history explains the anti-modification exception "does not apply . . . to any transaction in which the creditor acquired a lien on property other than real property used as the debtor's residence." H.R. Rep. No 835, 103d Cong., 2d Sess. 46 (1994), reprinted in 1994 U.S.C.C.A.N. 3340, 3354. That proposition was bolstered by citation to a case from the Third Circuit, In re Hammond, 27 F.3d 52 (3rd Cir. 1994), which permitted modification of a claim that was secured by a principal residence and "all appliances, machinery, furniture[,] and equipment." Id. at 53-54, 58. Like the lender in Hammond, Suntrust bargained for collateral that, for the time being, includes personal property. Its claim therefore falls outside the confines of protection Congress created in section 1123(b)(5). Exercising de novo review, the bankruptcy court's contrary interpretation of the DOT must be reversed. In short, when a lender maintains an interest in a debtor's personal property in addition to their principal residence, the anti-modification exception does not apply and the bankruptcy code permits bifurcation of the claim into secured and unsecured components.

V. CONCLUSION

Section 1123(b)(5) requires the real property be used as the debtor's principal residence; it does not require the real property be used solely as the debtor's principal residence, or be deemed the debtor's principal residence in light of the totality of the circumstances. Given the Utzmans do not dispute 169 Rose serves as their principal residence, the fact that they rent out a small portion of the property does not defeat the applicability of the exception. Nevertheless, the statute requires a lender's claim to be secured "only by a security interest in real property." Under the RCR, Suntrust's claim simply does not meet that definition. The bankruptcy court's conclusion that the anti-modification exception applies accordingly must be reversed. The action is remanded to the bankruptcy court for further proceedings.

IT IS SO ORDERED.