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Small Business Reorganization Act Permits Stripping Down a Mortgage

Last Updated: Friday, April 24, 2020

A recent decision published on April 10, 2020 by a New York Court allowed a Chapter 11 case pending for 15 months to redesignate for treatment under the Small Business Reorganization Act.

The Judge examined the debtor's ability to strip down the mortgage to the value of the property under Section 1190(3). He said that subsections (A) and (B) do not bar the debtor from using the section "outright." While the Judge did not fully decide the issue, he scheduled a hearing to decide whether the debtor could use Section 1190(3) and offered his interpretation of subsections (A) and (B).

The debtor would not be allowed to cut down the amount of the mortgage under subsection (A), he said, if the debtor used the mortgage proceeds "primarily to purchase the Debtor's residence." Under subsection (B), the Judge said he must decide "whether the primary purpose of the mortgage was to acquire the debtor's residence."

When it comes to applying Section 1190(3), the Judge said that an "inflexible reading of this statute would bar legitimate business owners such as the Debtor from obtaining relief under the SBRA."

To rule on whether the debtor qualified to use Section 1190(3), a hearing will be held to decide (1) whether the mortgage proceeds were used primarily to further the debtor's business; (2) whether the property was an integral part of the business; (3) the degree to which the property was necessary to run the business; (4) whether customers must enter the property to use the business; and (5) whether the debtor uses employees and other businesses to run the operations.