Since Bank Canceled Debt by Issuing a 1099-C, it No Longer Had Mortgage on Debtors’ Home Under State Law

Since Bank Canceled Debt by Issuing a 1099-C, it No Longer Had Mortgage on Debtors’ Home Under State Law

Debtors and Bank dispute the effect of a 1099-C “Cancelation of Debt” form that Bank issued to Debtors in 2013. Debtors argue that the 1099-C shows that Bank canceled their debt. Debtors seek confirmation of a plan that orders Bank to release the accompanying mortgage lien on their home. Bank objects and argues that it did not file the 1099-C to cancel the debt but simply to comply with IRS regulations. Bank argues that, even if the 1099-C does cancel the debt as to Debtors, it does not cancel the in rem obligation of the property.

The parties agree on the underlying facts. In 2009, Debtors entered into a $62,000 mortgage loan with Bank secured by their home. That mortgage was behind a senior mortgage. At some point Debtors stopped making payments on the note and defaulted on their debt. Bank was unable to collect on the debt. Bank could not foreclose because there was insufficient equity in the property to pay off the senior mortgage.

In 2013, Bank decided to stop collection activity. Bank issued a 1099-C form to Debtors and the Internal Revenue Service. That form shows that Bank canceled $59,667.34 of debt. Bank asserts that it issued the 1099-C to comply with Internal Revenue Service regulations. The purpose of forms 1099-C are to show canceled or discharged debt as income to the borrower. When Debtors filed a subsequent tax return, they included the $59,667.34 of canceled debt from Bank as income and paid taxes on it. The parties dispute whether these facts show that Bank canceled the debt.

Debtors filed bankruptcy. Debtors now ask the Court to confirm a Chapter 13 plan that states that Bank’s debt was canceled in 2013 and to order Bank to release its lien on Debtors’ property. Debtors argue that this language is appropriate because the 1099-C shows that their debt to Bank secured by their home was canceled. Debtors argue that Bank’s mortgage is bound to the underlying note. Debtors conclude that Bank now has a $0 mortgage lien clouding their title. Debtors’ plan requests an order that Bank release its lien on their home.

Bank objects to its treatment under the plan. Bank argues that Debtors’ plan improperly modifies their rights as a holder of a claim secured by a principle residence in violation of § 1322(b)(2). Bank  argues that the 1099-C does not cancel the debt or prove that it canceled the debt. Bank argues that it stopped collection activity and issued the 1099-C simply to comply with IRS regulations. Bank argues that the 1099-C form alone is not sufficient to prove that it canceled the debt.

Bank further argues that, even if it canceled the debt, that cancelation was only effective with respect to Debtors’ personal obligation—not the mortgage. Bank argues that the in rem obligation of the home itself remains. Bank concludes that it has a $59,667.34 claim secured by Debtors’ primary residence that Debtors’ Chapter 13 plan cannot alter.

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