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Decided: April 27, 2016

The Fourth Circuit affirmed in part, reversed in part, and remanded for review.

In 2011, plaintiffs, William Anderson, Jr. and Danni Jerrigan purchased a house from defendants, Wayne and Tina Hancock using a loan financed by the defendants. In exchange for the loan, the plaintiffs granted defendants a deed of trust on the property and executed a promissory note with monthly payments based on an interest rate of five percent over a term of thirty years. The note included a provision that stated if the plaintiffs default on the loan, the interest rate would increase to seven percent. Two years later, the plaintiffs defaulted on the loan, and the defendants imposed the seven percent interest rate. The defendants initiated foreclosure proceedings.

Shortly thereafter, plaintiffs filed for bankruptcy. The plaintiffs filed a proposed bankruptcy plan that proposed to pay off the loan using the five percent interest rate for each missed payment. The Defendants objected, stating that the payments should continue to reflect the seven percent interest rate. The bankruptcy court agreed with defendants, and found that the use of the five percent interest rate ran afoul of 11 U.S.C. § 1322(b)(2), which prevents plans from modifying the rights of creditors whose interests are secured by debtors’ principal residences.

The plaintiffs appealed to the district court, arguing their bankruptcy plan should be allowed to “cure” the increased default rate of interest. The district court rejected this argument, but held that acceleration and foreclosure were an alternative remedy to the default rate of interest, so that once the defendants accelerated the loan the interest rate reverted back to five percent. As such, the interest rate for a payment depended on whether the loan was in accelerated or decelerated status.

The plaintiffs again appealed, contending that a cure under the bankruptcy code could bring the loan back to its initial rate of interest. The Fourth Circuit disagreed, finding the deceleration of the loan and avoidance of the foreclosure to be the cure under the code. In reaching this conclusion, the court examined whether the proposed change of interest qualified as a “cure” under 11 U.S.C. § 1322(b)(3) or (5), or a prohibited “modification” under § 1322(b)(2). Relying on Nobelman v. Am. Sav. Bank, 508 U.S. 324, 329 (1993), the court determined that a change in the interest rate amounted to a fundamental alteration of the debtors’ obligations, thereby modifying the defendant’s rights. The court also examined the definition of the term “cure” within the context of the code, finding the term focuses on the ability of a debtor to decelerate and continue paying a loan. Understanding that the meaning of cure focuses on the maintenance of pre-existing payments, the court held that modification of the interest rate would amount to an improper modification.

The court further rejected plaintiffs’ argument that this interpretation would lead to an unfair result counter to the purpose of the bankruptcy code, providing two purposes of default interest rates. First, default interest rates represent the time value of money, and second, they serve as compensation for taking on risk. As such, the court argued that it did not intend to harm the plaintiff, but to enforce the statute and protect the mortgage market.

Finally, the Fourth Circuit disagreed with the district court’s finding that a five percent rate of interest should apply after acceleration of the loan because the court’s determination that accelerate was an alternative remedy was not a plausible construction of the promissory note.

Accordingly, the court affirmed the judgment of the district court insofar as it required that post-petition interest payments be calculated using the seven percent default rate of interest, but reversed the part of the judgment which applied only a five percent rate of interest to payments after acceleration, and remanded the case to the district court for further proceedings.

Full Opinion

Megan Clemency