Lien Stripping in Chapter 20 Bankruptcy: a Permissible Relief to Debtors
| Publication year | 2016 |
Lien Stripping in Chapter 20 Bankruptcy: A Permissible Relief to Debtors
Jessica L. Johns
In the recent state of the housing crisis that continues to loom over homeowners in America, lien stripping has become a hot topic in the context of bankruptcies. This is especially so in the situation where a homeowner's financial situation is so grave that a debtor may pursue two separate bankruptcy cases within a short period of time. Lien stripping is a potential remedy in bankruptcy available to debtors through the process of avoiding a wholly unsecured lien. The combination of these events (seeking lien stripping relief in a second bankruptcy) creates the issue presented here that has caused a circuit court split in decisions.
In the situation of an underwater mortgage, where the amount of the debt exceeds the value of the security, the Supreme Court has prohibited debtors from reducing the amount of debt to the value of the property in what is called a "strip down." This leaves the appreciation in value of the property with the creditor. In its most recent lien stripping decision, the Supreme Court ruled that a debtor may not strip the entire dollar amount of debt on a lien when the value of the property is insufficient to secure any of the debt in a chapter 7 case. However, circuits continue to hold that this type of "strip off is permissible in chapter 13 cases.
When a debtor seeks relief in a chapter 13 within four years of receiving a chapter 7 discharge, this is colloquially referred to as a "chapter 20" case. A chapter 20 debtor has more restrictions than a normal chapter 13 debtor, namely an ineligibility of a discharge. The topic for debate is whether lien stripping is restricted in chapter 20 cases. Circuits are split, though a resolution in favor of stripping appears to be approaching. An analysis of the Bankruptcy Code and the case law on this subject indicates that a chapter 20 debtor may pursue a strip of an unsecured lien in the same manner as any other chapter 13 debtor.
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Bankruptcy offers protections to debtors seeking relief from overwhelming amounts of debt. Residential mortgage debt is often an issue during bankruptcy. Some debtors are in a situation where they must pursue a second bankruptcy proceeding within four years of a prior bankruptcy.1 When this happens, the debtor faces additional restrictions.2 This comment addresses the effect on a debtor's ability to seek specific relief on residential mortgages in this kind of double bankruptcy situation. One such relief available is "lien stripping," which essentially allows a debtor to remove the dollar amount of a mortgage that is unsupported by value in the residence. Specifically, the debtor first enters into a chapter 7 liquidation proceeding and receives a discharge and then, within four years, pursues a chapter 13 reorganization.3 Chapter 7 discharges the debtor of personal liability on the mortgage against the home.4 The mortgage creditor still has a remedy in the residence itself because the full value of the lien still exists against the property.5 Thus, a chapter 7 debtor may choose to file chapter 13 after a chapter 7 discharge as a means of finding relief, via lien stripping, from the looming danger of foreclosure on his or her residence.6
In recent times there are more and more home loans, both junior and senior, that are either partially or wholly unsecured by value in the residence, meaning the value of the residence ("Fair Market Value") is less than the amount of the secured debt.7 So, if a homeowner were to sell her residence, absent bankruptcy, the amount the homeowner would receive upon sale is not enough to pay off the mortgage(s) on the home. This can be a crippling reality, and so the Bankruptcy Code and corresponding case law develop the means for debtors to manage their mortgages in a manner that attempts to be fair to both debtors and creditors.8 What follows is a basic illustration of an important type of residential mortgage relief, lien stripping, and its relation to the issue of concern for this Comment.
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Debtors utilize lien stripping in situations where the creditor has a wholly unsecured lien.9 In bankruptcy, lien stripping generally begins with a valuation of the claim to determine if it is secured or unsecured.10 Then, the Code allows for the avoidance of (some) claims that are not secured, subject to restrictions applying to residential mortgages.11 After the valuation, a creditor with an undersecured lien has a secured claim and an unsecured claim, and a creditor with a wholly unsecured lien has an unsecured claim.12 This illustrates a similar position for the creditor as it would be without bankruptcy law: the creditor is protected for the dollar amount of the value of the property.13
While lien stripping allows the debtor to "strip off" a wholly unsecured debt, a similar, yet critically different, modification is a "strip down." A strip down arises from a situation where the lien on the residence is greater than the value of the property (partially secured or undersecured).14 In such a situation, as previously discussed, the Code splits the lien into a secured claim and an unsecured claim.15 The strip down occurs when the debtor seeks to void the unsecured claim, essentially reducing the amount of the lien to the value of the secured claim.16 On the other hand, a "strip off" arises in a situation where the debtor has more than one lien on the residence and the value of the residence is insufficient to secure any amount of the junior lien.17 Thus, the debtor seeks to completely remove the junior lien(s) from the residence because it is not secured and instead are completely without value, absent personal liability, and, thus, unsecured.18
It is important to identify the major differences between bankruptcy cases to provide for an understanding of chapter 20 cases. Chapter 7 cases are liquidation bankruptcies19 whereas chapter 13 cases are individual
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"reorganization" cases.20 A chapter 20 case arises when a debtor files a chapter 13 within four years of receiving a discharge in a chapter 7 case.21 The Code specifically prohibits a chapter 20 debtor from receiving a second discharge within four years, pursuant to the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA").22 A chapter 13 case requires a creditor to retain allowed secured claims against the debtor until payment in full or discharge.23 Because a chapter 13 debtor in a chapter 20 bankruptcy cannot receive a discharge, some courts have held that this provision prevents lien stripping, requiring the debtor to retain the lien until full payment.24 As discussed later, the discharge eligibility of a debtor is irrelevant regarding lien stripping in chapter 20 cases because lien stripping involves unsecured claims, not secured claims.
Through the development of Supreme Court decisions—described below—strip downs in both chapter 7 and chapter 13 cases are prohibited against a debtor's principal residence.25 If the property's value supports any portion of a lien, the entire lien is considered secured and protected from strip down.26 However, strip offs give rise to a different debate. When a debtor has senior and junior mortgages on his or her principal residence, the issue becomes which mortgages are susceptible to lien stripping or modification by an otherwise permissible method in the Code. In its recent decision, Bank of America, N.A. v. Caulkett, the Supreme Court disallowed lien stripping of a wholly underwater junior lien in chapter 7 cases, extending the reasoning from the Court's decision against strip downs in chapter 7 cases.27 The Court has yet to rule on the permissibility of strip offs in chapter 13 or chapter 20 cases. However, a majority of circuits permit strip offs in chapter 13 cases.28
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The current issue arises when a chapter 20 debtor seeks to strip off an entire junior residential mortgage that is unsupported by the property's value. While circuits are split on this issue,29 a chapter 20 debtor should be able to find relief in a strip off in the same manner as any other chapter 13 debtor. This Comment will show that developed case law permits a chapter 13 debtor to utilize the relief of a strip off through a two-step process: (1) valuing the claim under § 506(a); and (2) utilizing the modification provision in § 1322(b)(2) to strip the lien.30 Because a chapter 20 debtor is a chapter 13 debtor in the last leg of the chapter 20 case, she should be eligible to claim this same relief as a chapter 13 debtor. To support this contention, the Background section of this Comment discusses lien stripping in chapter 7 and in chapter 13 cases. Next, this Comment will present an analysis of lien stripping in chapter 20 cases, as well as the opposition to chapter 20 lien stripping, including ineligibility for a discharge in chapter 20 cases.
A. Dewsnup, Caulkett, and Chapter 7 Lien Stripping
In a chapter 7 bankruptcy all of a debtor's non-exempt assets are gathered and liquidated, so that the proceeds can be distributed to creditors,31 leading to a discharge of the debtor's personal liability on debts.32 Dewsnup v. Timm prohibits strip downs on residential liens in chapter 7 cases, and Caulkett prohibits strip offs in chapter 7 cases.33
1. Chapter 7 Bankruptcy Cases and Lien Stripping
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parts: an in personam element and an in rem element.35 The chapter 7 case discharges the debtor's in personam liability, and the in rem (claim against the property) survives discharge.36 Because the in rem portion remains after a chapter 7 discharge, some debtors then pursue relief in a chapter 13 bankruptcy case, i.e. to strip or...
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