Opinion
NOT FOR PUBLICATION
MEMORANDUM DECISION
LAURA S. TAYLOR, JUDGE United States Bankruptcy Court
Debtors, Rocky L. Rudolph and Hilda S. Rudolph (collectively, "Debtors"), filed a Motion for Valuation of Debtors' Residential Real Property and Avoidance of Junior Trust Deed Held by First Security Mortgage (the "Lien Strip Motion"). Debtors allege in the Lien Strip Motion that the value of their residence is less than the total amount owed to the first and second trust deed holders and request that this Court confirm this valuation pursuant to Fed.R.Bankr.P. 3012. As a result, they also seek to strip the trust deed ("Third Trust Deed") held by Wayne Gafford ("Creditor") as beneficiary by assignment from Southern California Mortgage dba First Security Mortgage ("First Security") under 11 U.S.C. § 1322(b)(2).
Hereinafter references to code sections refer to Title 11 of the United States Code, also referred to as the "Bankruptcy Code" unless otherwise specified. References to Rule refer to the Federal Rules of Bankruptcy Procedure, unless otherwise indicated.
Creditor disputes Debtors' valuation. Creditor also challenges the validity and amount of the claim asserted by Mr. Rudolph's mother, Margaret Rudolph ("M. Rudolph"), and allegedly secured by a deed of trust (the "Second Trust Deed") senior to the Third Trust Deed. Thus, Creditor asserts that he holds an undersecured rather than unsecured claim and argues that, as a result, Debtors cannot strip or otherwise modify his trust deed.
The Court held an evidentiary hearing on May 5, 2009 (the "Evidentiary Hearing"). At that time, the Court heard testimony from valuation experts and also heard testimony from Rocky Rudolph, M. Rudolph, and Paul Rios, a representative of First Security. The Court has carefully reviewed the documentary evidence, the written valuation reports, and the testimony of witnesses at the Evidentiary Hearing. The Court now renders its decision.
Facts.
1. Debtors filed a voluntary chapter 13 petition on October 7, 2008 (the "Petition Date").
2. Their Schedule A filed on October 22, 2008 values their single family home located at 610 Calle Ricardo, Escondido, California (the "Residence") at $370,000.00. There is no dispute that the Residence is Debtors' principal residence within the meaning of section 1322(b)(2).
3. Debtors' Schedules also list:
a. a claim (the "Senior Secured Claim") secured by a first trust deed against the Residence and in the amount of $288,519.51;
b. the claim of M. Rudolph secured by the Second Trust Deed against the Residence and in the amount of $141,646.40; and
c. a claim of First Security secured by the Third Trust Deed against the Residence and in the amount of $141,520.00.
4. Debtors also filed a chapter 13 plan (the "Plan") on October 22. 2008. The Plan provides for monthly payments of $630.00 and payment of the greater of 4% or a pro-rata share of $6,655.70 to unsecured creditors. In addition, at paragraph 19, the Plan provides that: "Debtors request the court to value their principal residence at $370,000 which results in First Security Mortgage, holder of a 3rd deed of trust on debtors' residence, with a wholly unsecured claim and avoidable pursuant to 11 U.S.C. 1322 [sic] and 11 U.S.C. 506(a)(2) [sic]. This plan proposes to treat First Security Mortgage's claim on the 3rd deed of trust as wholly unsecured. Debtors will serve First Security Mortgage, the holder of the 3rd deed of trust, with notice of a motion to value collateral and strip lien with the required supporting documentation and copy of this plan."
5. Consistent with the Plan, on November 4, 2008, the Debtors filed the Lien Strip Motion and set this matter for hearing on December 9, 2008.
6. Debtors initially supported the Lien Strip Motion with the Declaration of Mr. Rudolph wherein he opined as an owner that the value of the Residence was $370,000.00.
7. Creditor filed an opposition to the Lien Strip Motion (the "Opposition") on November 24, 2008. The Opposition argues, based on a broker's price opinion dated November 19, 2008, that the probable final value of the Residence is $425,000.00. The Opposition also challenged the validity and amount of the M. Rudolph claim and argued, among other things, that any claim filed by M. Rudolph could not include interest accrual because the alleged loan "is due only if debtors 'sell or refinance' the property." (Opposition, 4:19) As a result of Creditor's valuation estimate and position regarding the Second Trust Deed, the Opposition asks the Court to conclude that Creditor's lien is not wholly unsecured and to deny the Lien Strip Motion.
8. The Debtors filed a response to the Opposition (the "Response") on December 4, 2008 together with a Declaration of Appraiser Laurie Lutton. Ms. Lutton valued the Residence as of November 22, 2008 at $365,000.00 and attached a complete appraisal report (the "Lutton Appraisal") to her declaration. Debtors also requested and the Court allowed additional time to provide further evidence as to the validity of the Second Trust Deed.
9. On December 10, 2008, M. Rudolph filed a proof of claim in the total amount of $104,294.74, and, on December 22, 2008, Debtors filed a supplemental response that included a declaration of M. Rudolph.
10. On January 13, 2009, the Court scheduled an evidentiary hearing for March 25, 2009 in order to resolve the valuation issues and to determine the validity and amount of M. Rudolph's claim. The Court also issued a scheduling order for the filing and exchange of briefs, declarations and appraisals, witness lists, and proposed exhibits. Pursuant to this schedule, Creditor filed the Declaration of Craig Brock, his valuation expert. Mr. Brock valued the Residence at $395,000 and attached a copy of a Residential Appraisal Field Review Report outlining his analysis to his declaration.
11. The Court subsequently continued the Evidentiary Hearing to May 5, 2009.
Legal Background.
The Bankruptcy Code expressly provides that a chapter 13 plan may "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). In Nobelman v. American Savings Bank, 508 U.S. 324 (1993), the Supreme Court confirmed that a section 1322(b)(2) modification of a claim secured by a debtor's primary residence is not available when a section 506(a) valuation establishes that a lender's claim is partially secured. After Nobleman, however, the Ninth Circuit Court of Appeals, along with the majority of other circuit courts, held that the anti-modification protection of section 1322(b)(2) does not prohibit modification of the rights of a creditor holding a lien on a debtor's primary residence where senior liens exceed the value of the residence such that the junior creditor is wholly unsecured. Zimmer v. PSB Lending Corp. (In re Zimmer), 313F.3d 1220 (9th Cir. 2002).
Such modification is commonly referred to as "lien stripping."
In this case, Debtors seek to modify the rights held by Creditor pursuant to section 1322(b) and request that the Court determine the secured status of Creditor's claim pursuant to section 506(a). Section 506(a) provides that such "value shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property, and in conjunction with any hearing on such disposition or use or on a plan affecting such creditor's interest." In this case, Debtors intend to retain the Residence, to avoid Creditor's lien entirely, and to pay Creditor's claim under their chapter 13 plan as a wholly unsecured claim (i.e. Creditor to receive a pro rata share of $6,655.70.) To accomplish this goal, the value of the Residence cannot exceed the amount owed to the holders of liens against the Residence that are senior to Creditor's lien.
Here, both valuation experts valued the Residence as of November 22, 2008 (the "Valuation Date"). At the conclusion of the Evidentiary Hearing, Creditor's counsel questioned this date of valuation suggesting that the Court should value the Residence as of the Petition Date. Given the evidence of market decline previously provided by Debtors' valuation expert, Creditor likely intended to assert that the Court, thus, could assume a Petition Date value higher than the Valuation Date value. Ultimately, however, the parties stipulated to November 22, 2008 as the appropriate date for valuation, and the Court conducted its analysis as requested by the parties.
The case law as to the appropriate date for valuation in connection with a lien strip motion is divided with some courts utilizing the petition date and other courts choosing other dates such as the confirmation date. Given the agreement of the parties, however, and given that the Valuation Date is only approximately 45 days after the Petition Date, the Valuation Date is an acceptable date for valuation purposes.
The selection of the Valuation Date, however, does present an additional challenge for the Court as the evidence of the amount of senior debt is as of the Petition Date. Notwithstanding, the Court can reach a final decision. For purposes of this analysis, the Court can assume either that Petition Date debt calculations can be utilized or that the Debtors are making payments on the Senior Secured Claim. As there is no evidence that this claim is not regularly amortizing, the Court can assume that it is not increasing. The evidence establishes that the M. Rudolph claim does not require regular post-petition payments. Thus, the Court assumes that it increased during the period between the Petition Date and the Valuation Date. The evidence available to the Court, however, allows the Court to calculate this increase.
Discussion.
In this case, the Court first must determine whether the M. Rudolph claim is valid, in the amount of $104,294.74 as of the Petition Date, and secured by a lien senior to Creditor's Third Trust Deed. If the Court determines that M. Rudolph's claim is valid at the above referenced amount and secured by a senior lien, then the Court must determine the value of the Residence as Creditor remains a partially secured creditor at the value reached by its valuation expert. If the Court adopts the Creditor's suggested value, the Court must finally verify that Creditor remains partially secured as of the Valuation Date notwithstanding interest accrual on the M. Rudolph claim or adopt the Petition Date as the appropriate date for calculating senior secured debt.
1. M. Rudolph Holds a Valid Claim Secured by a Senior Lien.
Prior to trial, Creditor challenged M. Rudolph's claim arguing, in the alternative, that it should be disregarded as a sham or that it should be allowed only as to principal. At the Evidentiary Hearing, Creditor emphasized the alleged inappropriateness of allowing interest accrual on the M. Rudolph claim and, in particular, argued in closing that it would be unfair to do so in that M. Rudolph did not actually intend collection of interest. The Court having considered all evidence and argument determines that, as of the Petition Date, M. Rudolph held a valid claim in the amount of $104,294.74 and that this claim is secured by the Second Trust Deed.
First, the evidence establishes that M. Rudolph advanced the principal amounts allegedly owed by Debtors. Mr. Rudolph and M. Rudolph both testified that M. Rudolph made a series of loans to her son over a period of time that allowed him to purchase the Residence, to become current on the amounts owed in the connection therewith, and/or to otherwise meet his obligations.
Second, the evidence supports the validity of the note and note terms that form the basis for M. Rudolph's calculation of the principal and interest amount owed by Debtors. The evidence establishes that M. Rudolph initially made undocumented loans to Debtors but eventually determined that these loans should be formally documented. As a result, in 2004, the Debtors executed and delivered a note and deed of trust. The deed of trust was properly recorded on March 16, 2004.
The note is actually payable to the Harris Living Trust dated April 10, 1997 a family trust of which M. Rudolph is a Trustee. The Court inquired regarding this possible inconsistency, but is satisfied that M. Rudolph's testimony regarding the loans was not inconsistent with fact and simply lacked precise differentiation between amounts advanced personally and amounts advanced through her family trust.
Creditor asserts that this documentation does not reflect the true intent of M. Rudolph and the Debtors. Initially, Creditor supports his theory by questioning M. Rudolph's failure to enforce her note at its stated maturity date in 2005. M. Rudolph and Mr. Rudolph both testified in response that prior to maturity it was clear that Debtors were unable to repay the note at maturity and that, as a result, M. Rudolph agreed to extend the maturity date and to require payment in full at the time of a refinance or sale of the Residence. Given the family relationship, and having assessed the candor of the witnesses, the Court determines that this testimony accurately evidences the current status of the M. Rudolph loans and adequately counters Creditor's argument.
Creditor also supports his argument that this loan is illusory by questioning M. Rudolph regarding partial refinances that occurred after the date of the oral loan modification. The Court finds M. Rudolph's explanation convincing. In short, the loan proceeds were not sufficient to pay off the obligation and the proceeds were otherwise necessary to protect and preserve the Residence and/or to meet other family needs of Mr. Rudolph.
The Court finds that M. Rudolph adequately explained her willingness to wait for repayment. She stated that she believes the loans to be a good investment and that the Residence is a nice piece of property. Clearly, she believes that ultimately she will receive payment in full. Given her age. M. Rudolph also has made accommodations in her estate plan to reduce Mr. Rudolph's inheritance by the amounts Debtors owe to her so that a failure to repay the loans prior to her death does not negatively impact the inheritance of her other children. Thus, the Court concludes that the evidence regarding anticipated repayment effectively refutes Creditor's argument that M. Rudolph does not require repayment.
The Court acknowledges that the estate planning referenced above likely occurred as a result of questions raised at M. Rudolph's deposition. Having observed M. Rudolph's testimony, however, the Court concludes that this modification was motivated by a genuine desire to do fairness to Mr. Rudolph's siblings rather than a nefarious attempt to better support an illusory claim for repayment.
Creditor also asserts that even if the M. Rudolph loans are valid as to principal that interest is not properly payable. This argument is not supported by any evidence; the M. Rudolph note includes an interest provision.
Finally, Creditor suggests that M. Rudolph was duplicitous in communications with First Security regarding the amount owed on her loan and her interest rate intentions and that these actions support an elimination or reduction in the amount that she properly can claim as senior to Creditor's claim. The Court, however, finds no evidence to support this assertion. First, there is no evidence that Creditor or First Security ever asked M. Rudolph for a payoff balance or inquired regarding interest. Mr. Rios' testimony confirmed that the communications with M. Rudolph were designed to determine whether her loan was in default - a question that M. Rudolph answered accurately given the oral loan modification. Mr. Rios' testimony indicates that he clearly understood the nature of M. Rudolph's loans and understood that she did not require regular payments.
Thus, the Court determines that M. Rudolph held a valid claim in the amount of $104,294.74 as of the Petition Date.
2. The Creditor's Assertions as to Value Are Better Supported by the Evidence.
In this case, the Debtors' expert values the Residence at $365,000, while the Creditor's expert values the Residence at $395,000. The Debtors suggested in closing argument that the Court should resolve this difference by simply splitting the difference between the two valuations. While the Court does have discretion to utilize a number different from that selected by either of the appraisers, the Court after considering the evidence in this case determines that it would be inappropriate to do so. First, the Court acknowledges its lack of expertise as an appraiser. Second, the Court acknowledges that it lacks the information necessary for precise and objective adjustments to the expert analysis contained in the underlying valuation reports. Here, the appraisers took entirely different approaches as to the appropriate comparables and as to the appropriate adjustments to value necessary to derive value. As a result, the Court rejects the suggestion that it arbitrarily split the difference and, as a result, engages in the task of analyzing the valuations to determine which is more credible.
To aid in this endeavor, the Court focused on those factors typically utilized by other courts such as the appraisers' methodologies, the quality of the appraisal report, their testimony on direct and cross examination, and the appraisers' respective ability to substantiate the basis for the valuation. The relative experience of the appraisers was relevant. After careful consideration of the evidence, the Court concludes that the Creditor's opinion of value is the more credible.
a. Mr. Brock Provided a Coherent Framework for Valuing the Residence.
Mr. Brock provided testimony outlining the factors that buyers consider when moving into the Residence's market area that well supports his valuation analysis. He testified, in short, that buyers are looking for view, privacy, and lot size. The Court finds this testimony compelling and concludes that the Residence which offers a panoramic view on over two and a half acres with a private driveway well meets these buyer needs. Ms. Lutton provided no contrary evidence in this regard, and her testimony suffered from the lack of such a market driven approach to valuation.
He also pointed out that this property is adjacent to the amenities of Escondido while providing the privacy and view desired by buyers in this community.
b. Mr. Brock Provided Superior Comparables and Value Adjustments.
Despite the small difference in value, the parties utilized not a single common comparable. In reviewing the comparables, the Court determines that those used by Ms. Lutton were less appropriate. First, she utilized properties that had significantly less acreage in two cases. The Residence sits on over two and a half acres, while two of the comparables utilized by Ms. Lutton were located on less than half an acre. And the comparable closest in acreage to the Residence was located approximately eight miles away. Mr. Brock persuasively testified that this comparable was too far away to be appropriately considered. And Ms. Lutton's own testimony provided support for this conclusion. The Court finds Mr. Brock's testimony that acreage is important to buyers in the Residence's market area to be compelling and concludes that Ms. Lutton did not appropriately consider acreage when selecting her comparables.
The Court also concludes that Ms. Lutton underestimated the value of the view from the Residence as compared with her comparables. Pictures of her comparables show homes that lack panoramic views. The Court did not find her testimony that these views were "comparable" to the view from the Residence to be persuasive. In her testimony, she appeared to struggle as she attempted to square the photographic evidence with the uncontroverted testimony that the Residence enjoys a desirable view.
The Court also disregards her suggestion that Mr. Brock's adjustments on account of view were too high. Given her complete failure to adjust for view in her own valuation analysis, her criticism lacks credibility. Ms. Lutton's errors in this regard are significant given Mr. Brock's persuasive testimony that buyers in this market strongly desire view properties. Mr. Brock described the Residence view as panoramic with mountains on all sides and a view down to the city of Escondido. Mr. Rudolph acknowledged a panoramic view from one side of his property, but noted that it was blocked by foliage on the other side. The Court understands this to be an acknowledgement that with landscaping a panoramic view is possible. Thus, the testimony strongly supports the Court's conclusion that the Residence has a view that would be highly desirable to buyers and that Ms. Lutton failed to take this factor into appropriate consideration.
In contrast, Mr. Brock's analysis utilized comparables that were geographically closer to the subject, more similar in size of lot, and carefully adjusted on account of comparable view. Ms. Lutton suggested that one comparable should be disregarded as a result of the fact that the home was a "manufactured home." The Court disagrees. Mr. Brock made an appropriate adjustment to indicate the superior quality of the Residence. Further, Ms. Lutton suggested that she better selected comparables in terms of sale dates. The Court determines, however, that the range of sale dates utilized by Mr. Brock was not unreasonable. Thus, the Court determines that Mr. Brock's analysis is superior and, as a result, values the Residence at $395,000 as of the Valuation Date.
c. The Court is Unable to Conclude That Mr. Rudolph's Evidence Regarding Need for Repair Negatively Impacts the Valuation Testimony Otherwise Given.
At the Evidentiary Hearing, Mr. Rudolph testified that the Residence requires approximately $20,000 in repairs as a result of a leak and resulting wood rot. The Court ultimately determines that this testimony does not require a deviation from either of the expert opinions regarding value. First, both appraisers reviewed the Residence interior and both agreed that the condition of the Residence was good. Thus, while the Court does not disbelieve Mr. Rudolph, the conditions are not such that they were viewed by either appraiser as materially affecting their overall assessment of improvement condition and/or requiring adjustment for improvement condition relative to comparables.
Second, while Mr. Rudolph provides an estimate, there is no evidence that Mr. Rudolph has any particular expertise in the area of home repair and, as a result, the Court must view his assessment as a guess. There was no objection to the testimony and the Court accepts the same. However, the weight to be given this testimony is very limited.
Finally, and perhaps more importantly, neither expert discussed this factor at the Evidentiary Hearing. Thus, the Court has no evidence to allow it to determine whether the appraisers were unaware of this condition and/or to ascertain if knowledge of this factor would have altered their opinion of value. While it is tempting to simply deduct this amount from Creditor's appraisal (or the Debtors' appraisal) the appraisal process does not support such an approach. As a result, the Court accepts Mr. Rudolph's assessment of certain problems with the Residence, but concludes that such evidence does not require an adjustment to its conclusion of value.
3. Creditor Was an Under Rather Than Unsecured Creditor as of the Valuation Date.
As discussed above, the Court appropriately assumes that the amount owed on the Senior Secured Claim did not increase and likely decreased during the 45 days between the Petition Date and the Valuation Date. The M. Rudolph claim, however, increased during this same period as a result of interest accrual. Happily for the Court, M. Rudolph acknowledged in her declaration and testimony that the note bears simple interest and that compounding is not appropriate. As a result, the Court can review the M. Rudolph note, which is in evidence, and, thus, concludes that this interest accrual did not render Creditor wholly unsecured as of the Valuation Date.
This case well evidences the problems inherent in cases where valuation and debt levels fuctuate widely during a chapter 13 case. While the Court is not required to decide the issue here given the agreement of the parties as to the appropriate date for valuation, the Court notes that use of the petition date is well-supported in the decisions of other courts and appears to this Court to be the most fundamentally fair point for analysis. Ordinarily, the petition date is the "watershed date of a bankruptcy proceeding." Johnson v. GMAC (In re Johnson), 165 B.R. 524, 528 (S.D. Ga. 1994.) And, "... creditors' rights are fixed (as much as possible) as of that date. Id. This approach is: "clearly supported by 11 U.S.C. § 502(b) which states the general rule that, when an objection to a claim is raised.....the court, after notice and a hearing, shall determine the amount of such claim as of the date of the filing of the petition..." Brager v. Blum (in re Brager), 39 B.R. 441, 443 (Bankr. E.D. Pa. 1984). Given that the petition date is a date utilized by other courts in cases such as this one and given the long gap between the Valuation Date and dates utilized by other courts such as a comfirmation date or plan effective date, the Court feels it prudent to make clear that the evidence already available supports a conclusion that Creditor was under rather than unsecured at the Petition Date. The evidence suggests market decline during the fall of 2008. Thus, the Court can conclude that on the Petition Date the Residence was, if anything, more rather than less valuable.
CONCLUSION
Therefore, the Court concludes that the value of the Residence was $395,000.00 as of November 22, 2008. The Court also concludes that the liens senior to that of the Creditor totaled less than this amount as of that date. As a result, Creditor is an under rather than unsecured creditor. Thus, Debtors are not entitled to use 11 U.S.C. § 1322(b)(2) to strip Creditors' lien.
Creditor is to submit an order consistent with this Memorandum Decision within 10 days. As this is an atypical case, the presumptive fee does not adequately compensate Debtors' counsel for his work on this matter. Thus, counsel for the Debtors may submit his fee application within 30 days if he desires to request fees on account of the Lien Strip Motion in excess of the presumptive fee.