Escrow Is Not Separate Collateral

Posted by NCBRC - January 23, 2017

Provisions in a deed of trust, including an obligation for the debtor to maintain an escrow account, are incidental to the residential security interest and do not remove the claim from bankruptcy’s anti-modification provision. Birmingham v. PNC Bank, No. 15-1800 (4th Cir. Jan 18, 2017).

Chapter 13 debtor, Gregory John Birmingham, filed an adversary complaint seeking to cram down his mortgage with PNC and arguing that the anti-modification provision did not apply because PNC’s claim was not secured solely by his residence. Specifically, Mr. Birmingham pointed to the provisions in the lending agreement requiring him to: 1) maintain an escrow account to cover obligations such as property taxes, 2) maintain property insurance, and 3) assign to PNC any proceeds from third parties arising out of judgments, settlements or other actions involving the property.

The bankruptcy court granted PNC’s motion to dismiss and the district court affirmed.

On appeal, the Fourth Circuit began with Nobelman v. Am. Sav. Bank, 508 U.S. 324 (1993), in which the Court found section 1322(b)(2)’s anti-modification provision precluded bifurcation of a claim secured by the debtor’s residence into secured and unsecured portions. The court then turned to the Bankruptcy Code’s definition of “residence” under section 101(13A)(A) which includes “incidental property, without regard to whether that structure is attached to real property.” Incidental property is also separately defined in section 101(27B) as including “property commonly conveyed with a principal residence in the area where the real property is located,” such as “escrow funds, or insurance proceeds.”

The court found, under these definitions, that the provisions in the deed of trust did not create separate collateral for the loan, but protected the lender’s security interest in the real property and were, therefore, incidental to that interest. The court distinguished cases in which additional property included in the deed of trust was deemed to waive the lender’s anti-modification protection. For instance, the lending agreement in Hammond v. Commonwealth Mortg. Corp. of Am., 27 F.3d 52 (3d Cir. 1994), which provided a security interest in appliances, machinery, furniture and equipment, in addition to the residence, waived the lender’s anti-modification protection.

Mr. Birmingham cited In re Bradsher, 427 B.R. 386 (Bankr. M.D. N.C. 2010) and In re Hughes, 333 B.R. 360 (Bankr. M.D. N.C. 2005), for the proposition that a security interest in escrow funds was separate from the interest in the residential property. The court found those cases inapposite. In both Bradsher and Hughes, the language of the deed of trust “expressly provided that escrow payments constituted additional security for the loan.” Because the case before it did not involve similar language, the court declined to address the holdings in Bradsher and Hughes.

The court rejected Mr. Birmingham’s request that it look to Maryland law to determine whether a security interest was created in separate collateral by the language of the deed of trust. Even if application of Maryland law would lead to a different result, the court found, state law would be preempted by the definitions and provisions in the Bankruptcy Code.

Finally, the court reasoned that because most mortgages include provisions similar to those at issue here, any other finding would effectively eviscerate the anti-modification provision. The court, therefore, affirmed the judgment of the district court.

Birmingham 4th Cir. opinion Jan 2017

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