Shelley D. Rucker, UNITED STATES BANKRUPTCY JUDGE.
This case is pending before the court on the objection to confirmation of the debtors' Chapter 13 plan filed by creditor First National Bank of Middle Tennessee ("FNB"). The court previously overruled FNB's objection and confirmed the debtors' plan. [Doc. Nos. 40-41, 57]. FNB had argued that the debtors' plan impermissibly modified its rights under 11 U.S.C. § 1322(b)(2) by proposing to bifurcate a single mortgage securing three notes into secured and unsecured claims. On January 30, 2017, the court entered a memorandum opinion and order overruling FNB's objection. [Doc. No. 40-41; In re Poole, No. 4:16-bk-12638-SDR, 2017 WL 401799 (Bankr. E.D. Tenn. Jan. 30, 2017)]. Applying the statutory definitions found in the Bankruptcy Code, the court determined that the three notes created three separate obligations for the debtors to pay FNB specific amounts. [Id. at *3]. The court thus determined that FNB held three claims. When the court examined each debt, it looked to the definition of a lien in the Bankruptcy Code to determine whether there was a right to charge the property to secure the payment or performance of that debt. [Id.]. Finding that each debt included a charge against an interest of the debtors' property, the court found that there was a lien for each debt. [Id.]. Thus, the court found that FNB held three liens as defined in the Bankruptcy Code securing three notes and that two of the liens had no value.
Applying 11 U.S.C. §§ 506(a)(1) and 1322(b)(2), the court found that FNB held a secured claim that could not be modified with respect to the first note because there was value in the property to support the lien. [Id. at 3-5]. However, with respect to the second and third claims representing the second and third notes, respectively, there was no remaining value in the property to support the lien. [Id. at 5]. Thus, the court held that the debtors could modify the terms of the second and third notes and treat them as unsecured in the plan. [Id.]. Accordingly, the court denied FNB's
FNB appealed. On appeal, despite the fact that the debtors did not file a responsive brief, the district court initially affirmed this court's orders overruling the objection and confirming the plan. [Case No. 4:17-cv-8 (E.D. Tenn.), Doc. No. 22]. FNB filed a motion for rehearing in the district court, which was also unopposed by the debtors. [Id. at Doc. No. 24]. In an order entered October 24, 2018, the district court granted in part the motion for rehearing, vacated its judgment affirming the bankruptcy court, and remanded the case to the bankruptcy court.
On remand, this court was instructed to consider two arguments that FNB made for the first time on appeal: (1) whether Tennessee state law applies to the question of how many liens FNB has on the property; and (2) if Tennessee law is applied, whether FNB has one lien on the property or three. [Id. at Doc. No. 29, p. 4]. FNB contends that once Tennessee law is applied to its mortgage documents, it has only one lien. FNB further contends that, if it has only one lien securing all three notes, then its lien is supported by value and its rights cannot be modified.
After reviewing the pleadings and briefs filed in this case, the record as a whole, and the applicable law, the court finds that there is only one lien, but it provides no value to FNB's second and third claims. Therefore, the court finds that FNB holds one secured claim represented by Note One and two wholly unsecured claims represented by Note Two and Note Three, respectively. The two wholly unsecured claims may by modified.
The court has jurisdiction under 28 U.S.C. §§ 1334 and 157(b)(2)(K) & (L) to hear and determine this matter.
The relevant facts are not in dispute and are summarized below.
The Deed of Trust reflects that it was given to secure all obligations owed to FNB. [Id. at 18]. It refers specifically to the obligation due under Note One under the heading "Present Indebtedness." [Id.]. It also states under a heading titled "Open-End Mortgage Clause" that:
[Id.]
In the event of a default, the Deed of Trust authorizes the trustee to sell the property and apply the proceeds, first, to pay the costs and expenses of executing the trust; then, to the debt described as the "Present Indebtedness;" and, finally, to all other debts including those obligations referred to under the "Open-End Mortgage Clause." [Id. at 20-21]. There is no priority assigned between the other obligations referred to under the "Open-End Mortgage Clause."
The debtors and FNB subsequently undertook a series of transactions on June 19, 2015. The parties executed a "Change in Terms Agreement" with respect to Note One, which then reflected a principal indebtedness of $43,535.97. [Id. at 10]. The debtors and FNB also executed a second promissory note on June 19, 2015 ("Note Two"), in the original principal amount of $5,723.80. [Id. at 12]. A third note ("Note Three") was executed at the same time in the original principal amount of $6,431.56.
Also on June 19, 2015, the debtors and FNB executed a "Modification and Extension Agreement" to Note One (the "Modification"). [Id. at 23]. In the Modification, the debtors acknowledge the loan is evidenced by Note One and the Deed of Trust. [Id.]. The Modification extends the statute of limitations for enforcement of the Deed of Trust by ten years. [Id. at ¶ 1]. The Modification deletes the original paragraph in the Deed of Trust entitled "Present Indebtedness" and substitutes the following:
[Id. at ¶ 3].
The Modification also deletes the paragraph entitled "Open-End Mortgage Clause" from the Deed of Trust and substitutes the following:
[Id. at ¶ 2].
Note Two and Note Three are not directly referenced as secured indebtedness in the Modification. However, for purposes of this opinion, the court finds that Note Two and Note Three constitute "other obligations" of the borrowers as described in paragraph two of the Modification. [See id.]. The court finds that the parties' intention to secure these obligations with this real estate is also evident in the section entitled "collateral" in Note Two and Note Three. [See id. at 12, 14].
On June 24, 2016, the debtors filed a chapter 13 bankruptcy petition. [Doc. No. 1]. FNB filed one proof of claim covering all three notes claiming a total secured debt of $57,796.14. [Claim No. 2-1]. The debtors' Chapter 13 plan proposes to pay FNB $80 per month toward an arrearage of $3,800 and a maintenance payment of $516 per month for Note One only. [Doc. No. 2, at 1]. The plan proposes to treat Notes Two and Three as unsecured debts receiving a pro rata distribution. [Id. at 1-2]. The projected distribution would be insufficient to pay all unsecured claims including Notes Two and Three in full.
In its prior decision, the court analyzed how many liens FNB has against the debtors' residence first by considering the definitions of "lien," "security interest," and "claim" under the Bankruptcy Code and then by reviewing federal court precedent. In re Poole, 2017 WL 401799, at *3-5. Although FNB did not originally make the argument before this court, FNB argued to the district court that the number of liens it possesses should properly be determined by reference to Tennessee state law. The district court remanded for consideration of this issue. After reviewing FNB's supplemental brief on remand as well as the applicable caselaw, the court agrees with FNB that the extent of the lien it possesses should be determined by state law. However, the court disagrees that a finding that FNB has only one lien should change the court's ultimate decision that Notes Two and Three may be modified.
"Property rights are determined under the law of the state in which the real property is located...." Town Ctr. Flats, LLC, v. ECP Commercial II, LLC, 855 F.3d 721, 724 (6th Cir. 2017) (citing Butner v. United States, 440 U.S. 48, 55, 99 S.Ct. 914, 59 L. Ed. 2d 136 (1979)). In Butner, the United States Supreme Court explained that:
Butner, 440 U.S. at 55, 99 S.Ct. 914 (emphasis added).
In Nobelman v. American Savings Bank, 508 U.S. 324, 113 S.Ct. 2106, 124 L. Ed. 2d 228 (1993), discussed in more detail below, the Supreme Court determined the mortgage lender's rights according to state law. Id. at 329, 113 S.Ct. 2106 ("The bank's `rights,' therefore, are reflected in the relevant mortgage instruments, which are enforceable under [the relevant state] law."). The Sixth Circuit has consistently applied this principle as well, noting that "[i]n bankruptcy, just as in diversity, state substantive law defines the parties' underlying rights and obligations." Sutherland v. DCC Litig. Facility, Inc. (In re Dow Corning Corp.), 778 F.3d 545, 550 (6th Cir. 2015).
Accordingly, the court finds it appropriate to determine FNB's rights in its mortgage documents according to Tennessee law. To the extent that the court previously determined the number of liens FNB possesses in the debtors' residence solely by reference to federal bankruptcy law, the court concludes that such a decision was in error.
In Tennessee, a "mortgage" is defined to include "a mortgage, deed of trust, or other conveyance of real property securing obligations...." Tenn. Code Ann. § 47-28-101(a)(4); see also Higdon v. Regions Bank, No. E2009-01298-COA-R3-CV, 2010 WL 1924019, at *5 (Tenn. Ct. App. May 13, 2010). A mortgage may secure a future advance of funds:
Tenn. Code Ann. § 47-28-102.
Tennessee law recognizes the general validity of so-called "dragnet clauses" in trust deeds. In re Miller, No. 12-33943, 2015 WL 2208369, at *9 (Bankr. E.D. Tenn. May 1, 2015) (citing Duncan v. Claiborne Cnty. Bank, 705 S.W.2d 663, 664 (Tenn. Ct. App. 1985)). In a case applying Tennessee law, this court described a dragnet clause as one "which, on its face, purports to include within the coverage of the deed of trust all present and future indebtedness owed by the borrower to the lender in addition to the specific debt being secured by the deed of trust." In re Lemka, 201 B.R. 765, 767 n.2 (Bankr. E.D. Tenn. 1996) (citing Milton Roberts, Annotation, Debts Included in Provision of Mortgage Purporting to Cover all Future and Existing Debts (Dragnet Clause)— Modern Status, 3 A.L.R. 4th 690, 694-95 n.3 (1981)). In Tennessee, dragnet clauses are provided for and enforced by statute:
Tenn. Code Ann. § 47-50-112(b). "Tennessee courts recognize and enforce dragnet clauses so long as `the language contained in the dragnet clause is plain and unambiguous....'" In re Miller, 2015 WL 2208369, at *10 (quoting In re Lemka, 201 B.R. at 768); see also Higdon, 2010 WL 1924019, at *5 ("In Tennessee, future advance clauses in security instruments are recognized as valid and are enforceable according to their terms if the relevant language is plain and unambiguous.").
The dragnet clause at issue in this case is found first in the Deed of Trust, which provides:
[Claim 2-1, at 18]. The Modification executed by the parties on June 19, 2015, contains the same open-end mortgage provision. [Id. at 23]. The only relevant changes made were an extension of the statute of limitations period from twenty to thirty years and updating the "Present Indebtedness" to reference the new balance owed. [Id.].
Based on these facts, the court concludes that FNB has one lien under Tennessee law, that which was created by the original Deed of Trust as modified on June 19, 2015. That one lien secures the amounts owed under Note One described as the "Present Indebtedness" and the "other obligations" evidenced by Note Two and Note Three.
Having made that correction in its analysis, the court will turn to the issue of whether the fact that FNB has only one lien produces a different result when viewed through the prism of bankruptcy law. The court again turns to the Bankruptcy Code to determine how the debtors' bankruptcy may affect FNB's interest vis-à-vis its lien. As the court previously noted, the Bankruptcy Code defines a lien as a "charge against or interest in property to secure payment of a debt or performance of an obligation." In re Poole, 2017 WL 401799, at *3 (quoting 11 U.S.C. § 101(37)). A "security interest" is defined as a "lien created by an agreement." 11 U.S.C. § 101(51). The court has determined that FNB has one lien, and thus one security interest, under state law which secures payment of all the debts owed to FNB. A "debt" is defined as "liability on a claim." Id. at (12). A "claim" in turn is defined as a
The court previously found that FNB held three separate claims. The court's reasoning was that each note created an obligation to FNB and thus was a separate claim. The court notes that the district court previously signaled its agreement with the court's reasoning that FNB held three claims. [Case No. 4:17-cv-8, at Doc. No. 22, at 8-12]. The court concludes that the same result obtains in this case even after finding that FNB has one lien. Tennessee case law approving cross collateralization does not go so far as to consolidate separate obligations into one obligation. Cross collateralization allows the value derived from one lien to be spread across multiple obligations so far as the value goes. It may even allow one claim to improve its priority in the line of creditors looking to receive that value. See, e.g., Home Fed. Bank, FSB, of Middlesboro, Ky. v. First Nat'l Bank of LaFollette, Tenn., 110 S.W.3d 433, 437-40 (Tenn. Ct. App. 2002). It does not create more value when the value runs out.
The final question then, is whether FNB's claims may be considered separately for classification. Section 506(a) of the Bankruptcy Code defines the secured and unsecured components of debts according to the value of the underlying collateral:
11 U.S.C. § 506(a).
Section 1322(b)(2) permits a Chapter 13 debtor's plan to "modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor's principal residence." 11 U.S.C. § 1322(b)(2). The "rights" of creditors referred to in section 1322(b)(2) are those rights provided under state law, including those "reflected in the relevant mortgage instruments, which are enforceable under [the relevant state] law." Nobelman, 508 U.S. at 329, 113 S.Ct. 2106.
In Nobelman, the Supreme Court considered whether, in a Chapter 13 case, an undersecured claim secured only by a mortgage on a debtor's principal residence could be bifurcated into its secured and unsecured components. The debtors in Nobelman sought to "strip down" the mortgage lender's secured claim of $71,335 to the home's value of $23,500. Id. at 326, 113 S.Ct. 2106. The Supreme Court determined that a Chapter 13 debtor should first look "to § 506(a) for a judicial valuation of the collateral to determine the status of the bank's secured claim." Id. at 328, 113 S.Ct. 2106. If the valuation reveals that a claim has a "secured component," the debtor may not use section 1322(b)(2) to modify the lien. Id. at 331, 113 S.Ct. 2106. The Supreme Court held that "§ 1322(b)(2) prohibits a Chapter 13 debtor from relying on § 506(a) to reduce an undersecured homestead mortgage to the
In Lane v. Western Interstate Bancorp (In re Lane), 280 F.3d 663 (6th Cir. 2002), the Sixth Circuit considered "whether the implications of Nobelman would bar modification of the rights of a creditor who, although the holder of a lien on the Chapter 13 debtor's homestead, has solely an `unsecured claim' under § 506(a)." Id. at 664. The Lane debtors sought through their Chapter 13 plan to modify the rights of a second mortgagee whose lien on the debtors' homestead was wholly unsecured. Id. at 665. Applying the principles of Nobelman, the Lane court began its analysis by looking first to section 506(a) to determine whether the lender's claim was properly classified as "secured" or "unsecured." Id. at 667-69. The Lane court explained that such an approach "means that it must make a difference whether the overall claim belongs in the pigeonhole marked `secured claims' or the pigeonhole marked `unsecured claims,' as those terms are defined in § 506(a)." Id. at 667. The Lane court found that "the only apparent reason why the classification could make a difference is that the special protection accorded by the antimodification provision [of § 1322(b)(2)] extends to the rights of holders of `secured claims' and does not extend to the rights of holders of `unsecured claims.'" Id. at 668.
The Lane court explained:
Id.
The second mortgagee in Lane possessed a claim that was wholly unsecured or, in other words, a lien that had no value. Id. Thus, the court determined that the second mortgagee held an unsecured claim and that "the rights of a creditor holding such a claim `may' be modified by the debtors' Chapter 13 plan." Id. According to Lane, in the Sixth Circuit, a wholly unsecured junior lien on a debtor's principal residence is not protected from modification by section 1322(b)(2). The Lane court set forth the following template for considering whether a lien on a debtor's
Id. at 669.
FNB's argument disregards the significance of starting by analyzing each claim and focuses only on whether the lien has value for any one of FNB's claims. If it does, then FNB argues that any debt that can be dragged under the net of that lien cannot be modified no matter how independent it is of other obligations or unlikely it is to be supported by any value from the collateral. Both Nobelman and Lane start with the claim and look to determine what actual value the lien provides toward repayment of the claim. The court finds that in this case, FNB contracted with the debtors in the Deed of Trust that the proceeds of any sale would be applied to the Present Indebtedness first. [Claim 2-1, at 20-21]. The parties have also stipulated that the value of the property is less than the balance due under Note One. Thus, there is no "actual value" to support Note Two and Note Three. They are wholly unsecured.
FNB argues that the court should reach a different conclusion because there is only one mortgage document. FNB contends that there is only one lien against the debtors' residence, and, because that lien has economic value, the lien may not be bifurcated. Under that theory, the issuance of separate notes is immaterial, and the existence of one security document is paramount. In support of this position, FNB relies heavily on Nobelman and Lane. However, neither case addressed a factual situation exactly like the one presented here. In Nobelman, the Supreme Court addressed a situation with one note holder secured by a lien created by one mortgage instrument. In Lane, there were two different note holders, each secured by a lien created by its own mortgage instrument. Here, the debtors have multiple notes with the same creditor, secured by a security interest in real estate evidence by one deed of trust that prioritizes the use of proceeds to satisfy the obligations.
In addressing FNB's argument in its prior opinion, the court noted the following reasoning from Nobelman regarding the importance of a "unitary note":
Nobelman, 508 U.S. at 331, 113 S.Ct. 2106 (internal citations omitted) (emphasis added). While not explicit, the highlighted sentences indicate that the Supreme Court might have gone the other way had the bank's contractual rights been contained in multiple notes, because it would have then been possible to modify the terms of a wholly unsecured note without affecting any rights provided by the secured note. The court continues to find the Supreme Court's reasoning persuasive. In its prior opinion, the district court signaled its approval of this reasoning. [Case No. 4:17-cv-8, at Doc. No. 22, at 13-15]. Even on appeal and reconsideration, FNB has not demonstrated how modification of the contractual terms of Notes Two and Three, for which the lien provides no actual value, would modify the rights of FNB under Note One or the Deed of Trust.
Under the current stipulation of value, the court finds that debtors may modify the terms of Notes Two and Three. The court overrules the objection of FNB to the plan based on its contention that modification is prohibited. The parties reserved the right to hold a hearing on valuation should the court overrule FNB's objection as to bifurcation. Accordingly, the court will proceed with the valuation hearing. Should the court find that the value is more than $44,000, the Debtors must be prepared to prove the priority of Notes Two and Three if they still seek to treat either note as an unsecured claim. The court will enter a separate order to set an evidentiary hearing on the value of the residential property to determine whether the plan properly provides for the claims based on Notes Two and Three.
