Cram Down Dance During Chapter 13 Bankruptcy

“Cram down” is lawyer-speak for a bankruptcy court reducing a secured interest to the value of the property. For instance, if a bass boat is worth $2,000 and there is a $4,000 balance owed to the bank, the bankruptcy court can cram down the secured interest to $2,000. The remaining $2,000 is now unsecured and paid at the same rate as other unsecured debts.

The Bankruptcy Code allows cram down of many secured debts in a Chapter 13 bankruptcy. One notable exception is a mortgage on the debtor’s primary residence found in section 1322(b)(2). A Chapter 13 debtor may not reduce the amount of a primary or secondary home mortgage simply because it is underwater. The debtor may strip off a wholly unsecured junior lien (thereby making the debt unsecured), but if any part of the junior debt is secured, lien stripping is not allowed. Cram down is never allowed.

The exception in 1322(b)(2) only applies to the debtor’s primary residence, not to other property owned by the debtor. This distinction seems simple enough, but reasonable minds can disagree about the details, and often do in the world of bankruptcy courts. Take for example the recent case of In re Benafel. In Benafel, the debtor moved out of her home under threat of foreclosure. Benafel rented out her home in March of 2010 and filed Chapter 13 bankruptcy that same month. She proposed to cram down her rental property and the trustee objected.

The issue before the Ninth Circuit Court of Appeals was when the court should determine whether the real property is a Chapter 13 debtor’s principal residence for purposes 11 U.S.C. §1322(b)(2)’s prohibition. The court said that the date for this determination should be the day the bankruptcy case is commenced – the day the debtor files for bankruptcy. On that day Ms. Benafel no longer lived in her home, so she was allowed to cram it down to value.

Moving out and filing bankruptcy can be tricky business. If this is done solely for the purpose to avoid the section 1322(b)(2) prohibition, the bankruptcy court may find the debtor has acted in bad faith. Before taking the initiative to move out of your home, speak with an experienced bankruptcy attorney for advice.