In re Schayes – principal residence of Chapter 11 debtors

     Section 1123(b)(5) of the Bankruptcy Code prevents a debtor from modifying claims that are secured only by the debtor’s “principal residence.”  In In re Schayes, 2012 Bankr. LEXIS 5598 (Bankr. D. Ariz. 2012), decided by Judge Haines on December 4, 2012, the court held that a home that the debtors purchased for investment purposes but which was their only residence on the petition date was the debtors’ “principal residence” for purposes of section 1123(b)(5). 

     The debtors purchased the subject property in 2007 and lived in the property for one year as required by the original financing contract.  The home was vacant from 2008 until February 2011 when the debtors moved back into the property.  The debtors filed their Chapter 11 bankruptcy petition in July 20, 2011.  The debtors continued to live in the home.

     The debtors argued that the property should not be deemed their principal residence for purposes of § 1123(b)(5) because they never intended to use it as their principal residence. They argued that their only intended use of the property was to rent it out to generate income and that they moved into the property solely for the business purpose of putting the property into a rentable condition and protecting it from further deterioration until it could be rented. Their proposed Chapter 11 plan provided that they would move out of the property and the property would then be rented. The debtors argued that that their intention rather than their actual use should be determinative for purposes of § 1123(b)(5).

     However, the court noted that the Bankruptcy Code does include a definition for a principal residence. Section 101(13A) defines the term "debtor's principal residence" as: "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.”  The court concluded that “the definition of ‘principal residence’ in § 101(13A) unambiguously hinges on how the debtor actually uses the structure, not the debtor's intentions at any point in time.”

     The court noted the suggestion of an uncodified “multi-use exception” to section 1123(b)(5).  See In re Scarborough, 461 F.3d 406, 411 (3d Cir. 2006) (“the real property that secures the mortgage must be only the debtor’s principal residence in order for the anti-modification provision to apply”). However, the court distinguished Scarborough and similar cases, noting that, “[t]he basis for the uncodified exception in each of these cases was a multiple actual use of the property, not a single actual use as the debtor's principal residence coupled with another intended or hypothetical use.”