Scarborough v. Chase Manhattan Mtg

Opinions of the United
2006 Decisions States Court of Appeals
for the Third Circuit

8-28-2006

Scarborough v. Chase Manhattan Mtg
Precedential or Non-Precedential: Precedential

Docket No. 04-4298

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 PRECEDENTIAL

UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT

No. 04-4298

IN RE: FRANCES SCARBOROUGH,

FRANCES SCARBOROUGH,
Appellant

v.

CHASE MANHATTAN MORTGAGE CORPORATION

Appeal from the United States District Court
for the Eastern District of Pennsylvania
(D.C. Misc. No. 03-mc-00228)
District Judge: James McGirr Kelly)

Argued July 27, 2006
Before: RENDELL, AMBRO and ROTH, Circuit Judges.

(Filed: August 28, 2006)
Frances Scarborough [ARGUED]
5116 North Warnock Street
Philadelphia, PA 19141
Pro Se Litigant

Scott F. Waterman
Black, Stranick & Waterman
327 West Front Street
P.O. Box 168
Media, PA 19063

Irwin Trauss [ARGUED]
Philadelphia Legal Assistance
1424 Chestnut Street, 2nd Floor
Philadelphia, PA 19102
Counsel for Amicus-Appellant
National Association of Consumer
Bankruptcy Attorneys

Kristina G. Murtha [ARGUED]
Leslie E. Smilas-Puida
Goldbeck, McCafferty & McKeever
701 South Market Street
Mellon Independence Center, Suite 5000
Philadelphia, PA 19106
Counsel for Appellee

2
 OPINION OF THE COURT

RENDELL, Circuit Judge.

In this appeal, we must determine whether a mortgage on
a multi-unit dwelling in which the debtor resides qualifies for
the anti-modification protection afforded by 11 U.S.C. §
1322(b)(2). That provision protects a mortgagee from having
its claim in a Chapter 13 bankruptcy proceeding modified if the
mortgage is secured “only by a security interest in real property
that is the debtor’s principal residence.” We conclude that a
mortgage secured by property that includes, in addition to the
debtor’s principal residence, other income-producing rental
property is secured by real property other than the debtor’s
principal residence and, thus, that modification of the mortgage
is permitted. Consequently, we will reverse the order of the
District Court affirming the order of the Bankruptcy Court and
remand the case for further proceedings consistent with this
opinion.

I.

The facts relevant to this appeal are not in dispute. On
May 10, 1988, Appellant Frances Scarborough signed a
mortgage (“Mortgage”) in favor of Meritor Savings Bank,
granting a mortgage lien against her property located at 5116
North Warnock Street, Philadelphia, Pennsylvania (“Property”).
The Mortgage secured a note to Meritor Savings Bank executed
on the same date in the amount of $30,400.00. The parties
agree that the Mortgage was thereafter assigned and that Chase

3
Manhattan Mortgage Corp. is the current holder of the
Mortgage.

Scarborough sought protection under Chapter 13 of the
Bankruptcy Code on October 31, 2001. In her proceedings, she
filed a complaint seeking to bifurcate the claim of Chase
Manhattan into a secured claim and an unsecured claim
pursuant to 11 U.S.C. § 506(a) and to determine the correct
amount of the mortgage arrearage. Scarborough subsequently
filed an amended complaint to revise the alleged amounts of the
secured and unsecured portions of Chase Manhattan’s claim,
and to bifurcate Chase Manhattan’s lien on her residence to
reflect the current market value of the property, with the
remainder of the debt becoming unsecured. The Bankruptcy
Court held a trial on this adversary proceeding and concluded
that Scarborough was barred from bifurcating the secured claim
of Chase Manhattan pursuant to the “anti-modification”
provision of 11 U.S.C. § 1322(b)(2). The District Court
affirmed the ruling of the Bankruptcy Court.

The form of the Mortgage is a “Pennsylvania – Single
Family – FNMA/FHLMC Uniform Instrument,” which contains
a conveyance clause that grants the lender an interest in the
Property, as well as “all the improvements now or hereafter
erected on the [P]roperty, and all easements, rights,
appurtenances, rents, royalties, mineral, oil and gas rights and
profits, water rights and stock and all fixtures now or hereafter
a part of the [P]roperty.” On the same day that Scarborough
executed the Mortgage, she also signed a “2-4 Family Rider
(Assignment of Rents)” to “amend and supplement the
Mortgage” and further secure her note to Meritor Savings Bank.

4
The Family Rider provides that “Borrower unconditionally
assigns and transfers to Lender all rents and revenues of the
Property” and that, “[u]pon Lender’s request, Borrower shall
assign to Lender all leases of the Property.”

The Property is a two-story semi-detached residence that
was converted to a multi-unit dwelling prior to Scarborough’s
purchase, with one apartment on the first floor and one
apartment on the second floor. Scarborough lives on the first
floor of the Property and rents the second floor apartment to a
tenant pursuant to a lease agreement. She testified at trial that
she purchased the Property with the intent of living in one unit
and renting the other, and with a goal of eventually acquiring
other investment properties. Scarborough further testified that
she informed the bank she was buying the Property, in part, as
an investment.

Scarborough testified at trial that the value of the
Property was $13,000.00. Chase Manhattan submitted the City
of Philadelphia’s Board of Revision of Taxes Property Record,
which listed the value of the Property as $26,500.00.
Scarborough has appealed the Board of Revision of Taxes’
valuation, but her appeal had not been decided as of the date of
trial.

II.

The District Court had jurisdiction over Scarborough’s
appeal from the Bankruptcy Court pursuant to 28 U.S.C. §
158(a). We have jurisdiction under 28 U.S.C. § 158(d). Our
standard of review is plenary because the issues before us

5
involve statutory interpretation and conclusions of law. In re
Cellnet Data Sys., Inc., 327 F.3d 242, 244 (3d Cir. 2003).

III.

The normal rule in bankruptcy is that a claim that is
secured by a lien on property is treated as a secured claim “only
to the extent of the value of the property on which the lien is
fixed.” United States v. Ron Pair Enters., Inc., 489 U.S. 235,
239 (1989). To the extent that the amount of the claim is
greater than the value of the property, it is considered
unsecured. 11 U.S.C. § 506(a)(1).1 “Thus, a claim that is not

1
Section 506(a)(1) states in pertinent part:

An allowed claim of a creditor
secured by a lien on property in
which the estate has an interest, or
that is subject to setoff under
section 553 of this title, is a secured
claim to the extent of the value of
such creditor’s interest in the
estate’s interest in such property, or
to the extent of the amount subject
to setoff, as the case may be, and is
an unsecured claim to the extent
that the value of such creditor’s
interest or the amount so subject to
setoff is less than the amount of
such allowed claim.

6
fully collateralized can be modified, and the creditor said to be
‘crammed down’ to the value of the collateral.” In re Ferandos,
402 F.3d 147, 151 (3d Cir. 2005).

Section 1322(b)(2) of the Bankruptcy Code carves out an
exception to this general rule. That provision permits a debtor
in a Chapter 13 case 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, or of
holders of unsecured claims, or leave unaffected the rights of
holders of any class of claims.” 11 U.S.C. § 1322(b)(2)
(emphasis added). The purpose of § 1322(b)(2) is “to
encourage the flow of capital into the home lending market” by
affording anti-modification protection to home mortgage
lenders. Nobelman v. Am. Sav. Bank, 508 U.S. 324, 331 (1993)
(Stevens, J., concurring); see also Ferandos, 402 F.3d at 151
(“The legislative history of § 1322(b)(2) ‘indicates that it was
designed to protect and promote the increased production of
homes and to encourage private individual ownership of homes
. . . .’” (quoting In re David, 989 F.2d 208, 210 (6th Cir.
1993))).

Scarborough argues there are two reasons that the anti-
modification protection of § 1322(b)(2) does not apply here.
First, she contends that the Mortgage and Family Rider grant
Chase Manhattan an interest in collateral that is not real
property, namely, rents derived from the Property. Second, she

11 U.S.C. § 506(a)(1).

7
argues that the anti-modification provision does not apply to a
claim secured by a multi-unit property in which one unit is the
debtor’s principal residence and the other is an income-
producing rental unit.

A.

We have little trouble rejecting Scarborough’s first
argument based on our reasoning in Ferandos. We look to state
law to determine whether rents are deemed to be real property.
Ferandos, 402 F.3d at 155. Under Pennsylvania law, real
property is defined to include rents. See 21 Pa. Cons. Stat. Ann.
§ 3 (West 2001); In re Abruzzo, 245 B.R. 201, 209 (Bankr. E.D.
Pa. 1999), vacated on other grounds, 2000 WL 420635 (E.D.
Pa. Apr. 10, 2000); Marine Nat’l Bank v. Nw. Pennsylvania
Bank & Trust Co., 454 A.2d 67, 70 (Pa. Super. Ct. 1982).
“Accordingly, the grant of an interest in rents does not render
the claim secured by anything other than the real property.”
Ferandos, 402 F.3d at 155. Thus, Chase Manhattan is not
denied the protection of § 1322(b)(2) merely because it took an
interest in rents derived from the Property.

B.

Scarborough’s second argument presents a question of
first impression for our Court: whether a claim secured by an
interest in real property that includes the debtor’s principal
residence as well as other income-producing rental property is
“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).
Based on the plain language of § 1322(b)(2), we conclude that

8
a creditor does not receive anti-modification protection for a
claim secured by real property that includes both the debtor’s
principal residence and other rental property that is not the
debtor’s principal residence.

By using the word “is” in the phrase “real property that
is the debtor’s principal residence,” Congress equated the terms
“real property” and “principal residence.” Put differently, this
use of “is” means that the real property that secures the
mortgage must be only the debtor’s principal residence in order
for the anti-modification provision to apply. We thus agree with
the reasoning of the Bankruptcy Court for the District of
Connecticut when it noted that § 1322(b)(2) “protects claims
secured only by a security interest in real property that is the
debtor’s principal residence, not real property that includes or
contains the debtor’s principal residence, and not real property
on which the debtor resides.” In re Adebanjo, 165 B.R. 98, 104
(Bankr. D. Conn. 1994). A claim secured by real property that
is, even in part, not the debtor’s principal residence does not fall
under the terms of § 1322(b)(2). Consequently, “real property
which is designed to serve as the principal residence not only
for the debtor’s family but for other families is not encompassed
by the clause.” Id.; see also In re Maddaloni, 225 B.R. 277,
280 (D. Conn. 1998) (“[T]he use of ‘is’ without any modifier
(e.g., ‘in whole’ or ‘in part’) does not evince an intent by
Congress to apply the antimodification provision to real
property that includes, but is more than, a debtor’s residence.”);
In re McGregor, 172 B.R. 718, 720 (Bankr. D. Mass. 1994)
(relying on plain language of § 1322(b)(2) to permit
modification of claim secured by “the debtor’s residence and
property which has ‘inherently income producing’ power”); In

9
re Legowski, 167 B.R. 711, 714 (Bankr. D. Mass. 1994) (same).

This analysis is consistent with our pattern in previous
cases of reading § 1322(b)(2) literally and narrowly. “On the
several occasions that we have had the opportunity to apply §
1322(b)(2), we have focused on the plain language of the
section . . . .” Ferandos, 402 F.3d at 151; see also id. at 154
(“We note . . . that our Court’s reasoning to date has followed
what we might describe as a plain meaning approach to our
application of [§ 1322(b)(2)]. That is, . . . we have read section
1322(b)(2) to mean what its language literally states . . . .”).
Thus, we have repeatedly rejected a de minimis exception to §
1322(b)(2) and consistently held that a creditor who takes a
security interest in any collateral that is not real property does
not receive anti-modification protection. See In re Johns, 37
F.3d 1021, 1024 (3d Cir. 1994); In re Hammond, 27 F.3d 52,
56-57 (3d Cir. 1994); Sapos v. Provident Inst. of Sav., 967 F.2d
918, 925 (3d Cir. 1992); In re Wilson, 895 F.2d 123, 128-29 (3d
Cir. 1990). Likewise, we have eschewed reliance on legislative
intent in analyzing § 1322(b)(2), Ferandos, 402 F.3d at 155, and
have also held that the subjective intent of the parties is
irrelevant under the provision, Wilson, 895 F.2d at 129.

Where the anti-modification protection of § 1322(b)(2)
is at issue, our sole concerns are (1) whether the claim is
secured only by real property, and (2) whether the real property
is the debtor’s principal residence. Just as a creditor who takes
any interest in personal property forfeits the benefit of §
1322(b)(2), so does a creditor whose claim is secured by any
real property that is not the debtor’s principal residence. If a
mortgage includes language that “is effective to grant an interest

10
in such collateral, the mortgagee is at its peril in not deleting it.”
Ferandos, 402 F.3d at 155.

One objection to this reading of § 1322(b)(2) is that “a
debtor could easily sidestep the . . . home mortgage exception
by adding a second living unit to the property on the eve of the
commencement of his Chapter 13 proceeding.” In re Bulson,
327 B.R. 830, 846 (Bankr. W.D. Mich. 2005); see also In re
Guilbert, 176 B.R. 302, 305 (D.R.I. 1995) (arguing that, under
the approach we adopt, “homeowners poised to file for
protection under Chapter 13 would, as a matter of course, seek
temporary tenants prior to their filing”). However, for purposes
of § 1322(b)(2), the critical moment is when the creditor takes
a security interest in the collateral. “It is at that point in time
that the underwriting decision is made and it is therefore at that
point in time that the lender must know whether the loan it is
making may be subject to modification in a Chapter 13
proceeding at some later date.” Bulson, 327 B.R. at 846.

We have noted that, when considering whether a
mortgagee has taken a security interest in any property other
than real property, we look to the terms of the mortgage. See
Ferandos, 402 F.3d at 155 (“[T]he language [of the mortgage]
and its effect [are] key . . . .”); Wilson, 895 F.2d at 129 (“Having
listed personal property as collateral, [the creditor] has a secured
interest in it.”). Similarly, here, we look to the character of the
collateral at the time of the mortgage transaction. When a
mortgagee takes an interest in real property that includes, by its
nature at the time of transaction, income-producing rental
property, the mortgage is also secured by property that is not the
debtor’s principal residence and the claim may be modified in

11
a debtor’s later Chapter 13 proceeding. A mortgage secured by
an interest in a multi-unit dwelling, one unit of which will be
used to generate income, falls within this category of modifiable
claims.2

There is no question in the instant case that the Mortgage
and Family Rider granted Chase Manhattan an interest in real
property that was not the debtor’s residence. Chase Manhattan
cannot, and does not, claim surprise, as it was well aware that

2
For purposes of bankruptcy cases commenced after
October 17, 2005, a “debtor’s principal residence” is defined as
“a residential structure, including incidental property, without
regard to whether that structure is attached to real property.”
Bankruptcy Abuse Prevention and Consumer Protection Act,
Pub. L. 109-8, § 306(c) (2005) (codified at 11 U.S.C. §
101(13A)). In such cases, “incidental property” includes
“property commonly conveyed with a principal residence in the
area where the real property is located.” Id. (codified at 11
U.S.C. § 101(27A)). We need not decide whether a rental unit
located in a multi-unit dwelling could fit within this definition
of “incidental property,” and therefore be part of a debtor’s
principal residence under 11 U.S.C. § 101(13A). Because
Scarborough commenced the instant case four years prior to
their effective date, these statutory definitions do not apply here.
See Bankruptcy Abuse Prevention and Consumer Protection Act
§ 1501(a). Consequently, we leave for another day the question
of whether, or how, the Bankruptcy Abuse Prevention and
Consumer Protection Act altered the scope of the anti-
modification provision of § 1322(b)(2).

12
the Property was a multi-unit dwelling and that Scarborough
would occupy only one of the units while she rented the other.
This was precisely why Chase Manhattan required Scarborough
to execute the Family Rider, which included an assignment of
leases and an assignment of rents. We have no hesitation in
concluding that Chase Manhattan’s claim is not “secured only
by a security interest in real property that is the debtor’s
principal residence.” 11 U.S.C. § 1322(b)(2).

We recognize that other courts have found the language
of § 1322(b)(2) to be less than clear. Most notably, the Court of
Appeals for the First Circuit concluded that “[t]he ‘plain
meaning’ approach to § 1322(b)(2) appears . . . to be, in the end,
inconclusive.” Lomas Mortgage, Inc. v. Louis, 82 F.3d 1, 4 (1st
Cir. 1996); see also Bulson, 327 B.R. at 839 (“Congress left
undefined the phrase ‘real property that is the debtor’s principal
residence.’”). Accordingly, the Lomas Court turned to
legislative history for guidance in interpreting § 1322(b)(2).
Although we do not believe that the text of § 1322(b)(2) is
ambiguous, and therefore need not rely on legislative history to
resolve this case, the reasoning of Lomas further bolsters our
conclusion that Chase Manhattan should not receive anti-
modification protection.

The Lomas Court resolved the textual ambiguity it
perceived in § 1322(b)(2) by examining the legislative history
of the Bankruptcy Reform Act of 1994, Pub. L. No. 103-394,
108 Stat. 4106 (1994), which amended Chapter 11 of the
Bankruptcy Code. Lomas, 82 F.3d at 6. Among the changes
that the Act made to Chapter 11 was to add a home mortgage
anti-modification provision that is identical to § 1322(b)(2). See

13
11 U.S.C. § 1123(b)(5) (permitting a Chapter 11 debtor 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”). With the addition of this
provision, Congress sought to “conform[] the treatment of
residential mortgages in [C]hapter 11 to that in [C]hapter 13.”
H.R. Rep. No. 835, at 46 (1994), reprinted in 1994
U.S.C.C.A.N. 3340, 3354.

The House Judiciary Committee’s Report on the Act
stated that § 1123(b)(5) “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.” H.R. Rep. No 835, at 46. To support this
proposition, the Committee cited In re Ramirez, 62 B.R. 668
(Bankr. S.D. Cal. 1986). Id. at 46 n.13. The Lomas Court
believed that the reliance on Ramirez was significant because
that case “squarely holds that the antimodification provision of
§ 1322(b)(2) does not apply to multi-unit houses where the
security interest extends to the rental units.” Lomas, 82 F.3d at
7; see also Ramirez, 62 B.R. at 669-70. The citation to Ramirez
was a “clear expression of congressional intent” that anti-
modification protection should not be afforded in Chapter 11 to
mortgages on multi-unit dwellings. Lomas, 82 F.3d at 7.
Because Congress intended to give the same anti-modification
protection to residential mortgages in Chapter 11 as in Chapter
13, the Lomas Court concluded that this expression of
legislative intent applied to § 1322(b)(2) as well as §
1123(b)(5). Id.

The Committee Report’s citation to Ramirez undoubtedly

14
supports our conclusion that where a creditor’s “security interest
extends to . . . rental property[,]” the creditor’s “claim is not
secured only by property that is the debtor’s principal
residence.” Ramirez, 62 B.R. at 670. Though we believe that
the plain language of § 1322(b)(2) leads to this result, the
legislative history on which Lomas relied is further evidence
that our conclusion is consistent with congressional intent.

A handful of courts have found that the text of §
1322(b)(2) is clear, but that it clearly says the opposite of what
we conclude, namely, that the word “is” means “includes.”
Under this reading, the anti-modification provision does not
exclude other uses of the property besides the debtor’s principal
residence. See In re Macaluso, 254 B.R. 799, 800 (Bankr.
W.D.N.Y. 2000) (“[T]he statute does not limit its application to
property that is used only as a principal residence, but refers
generally to any parcel of real property that the debtor uses for
that purpose.”); Guilbert, 176 B.R. at 306 (“[T]he language of
§ 1322(b)(2) ‘does not say, nor does it in any way imply that if
the debtor’s principal residence is also used to house other
tenants, paying or otherwise, that [the mortgagee’s claim] may
be open to modification by the home owner.’” (alteration in
original) (quoting In re Guilbert, 165 B.R. 88, 89 (Bankr. D.R.I.
1994))).

Yet another line of decisions adopts a case-by-case
approach to the issue of whether a mortgage receives anti-
modification protection. In these cases, courts have employed
a flexible, multi-factor test to determine whether the parties
intended the loan to be residential or commercial in nature at the
time it was made. Loans that are commercial in nature may be

15
modified, whereas residential loans may not. See Litton Loan
Servicing, LP v. Beamon, 298 B.R. 508, 511-12 (N.D.N.Y.
2003); In re Brunson, 201 B.R. 351, 353 (Bankr. W.D.N.Y.
1996). Both the District Court and Bankruptcy Court followed
this approach.

Our reasons for not adopting the positions expressed in
these cases should be evident from our discussion above. In our
view, the plain language of § 1322(b)(2) equates the real
property that collateralizes a mortgage with a debtor’s principal
residence. Where a creditor takes an interest in real property
that is not the debtor’s principal residence, such as property that
will be used as income-generating rental property, the anti-
modification provision does not apply. We also believe that the
multi-factor test introduces uncertainty and unpredictability to
residential mortgage transactions because it requires courts to
engage in a subjective, hindsight analysis as to the intent of the
parties. Not only is such uncertainty harmful to the residential
lending market, see Bulson, 327 B.R. at 842, it is unnecessary
in light of the plain language of § 1322(b)(2).

IV.

A claim that is secured by any interest in personal
property or real property that is not the debtor’s principal
residence may be modified in a Chapter 13 bankruptcy.
Because Chase Manhattan took an interest in real property that
was income-producing rental property, not Scarborough’s
principal residence, its claim can be modified. Accordingly, we
will reverse the order of the District Court affirming the order
of the Bankruptcy Court and remand the case for further

16
proceedings consistent with this opinion.

17