Debtors who are filing a Chapter 13 bankruptcy now may be able to deem a second mortgage that was once secured as unsecured debt, and treat the lender in the same way other unsecured creditors are treated in Chapter 13 plans. This change stems from a case currently before the U.S. Court of Appeals for the Eighth Circuit, and involves challenges to lien stripping practices in "Chapter 20" cases, where a debtor seeks Chapter 13 bankruptcy protection after filing for a Chapter 7 bankruptcy and receiving a discharge on unsecured debts.
Before the latest amendment to the bankruptcy code in 2005, a debtor could discharge unsecured debts through a Chapter 7 bankruptcy, then immediately tackle arrearages on secured debts through a Chapter 13 bankruptcy; essentially giving the debtor an additional 36-60 months to pay off the liens that survived the Chapter 7 case, or debts that were not discharged, without having to surrender the property. Since then, a debtor may still file a chapter 13 immediately after a Chapter 7 discharge, but may not obtain a Chapter 13 discharge after receiving a Chapter 7 discharge filed within four years.
In the case, In re Fisette, the debtor proposed to strip the liens on his second and third mortgages through a Chapter 13 bankruptcy even though he received a Chapter 7 discharge one year earlier. According to court filings, the debtor's home was underwater, meaning that the loans attached to the home exceeded its value. The fair market value of the home was $145,000, and there were three mortgages attached to the property. The first mortgage had an outstanding balance of $176,312, leaving the other two mortgages completely unsecured.
Neither the second nor the third mortgage holder objected to the plan. However, the bankruptcy judge ruled that under Minnesota law, a debtor could not strip the unsecured mortgages. The Bankruptcy Appellate Panel (BAP) reversed the decision, but the bankruptcy trustee for the District of Minnesota then appealed the panel's decision to the 8th Circuit. A decision is expected in spring 2012. The BAP's ruling allowed lien stripping while the matter was pending before the 8th Circuit.
Lien stripping is hardly a new phenomenon. Rather, it has become quite common as the foreclosure crisis eroded home values, and attorneys regularly help debtors eliminate such debt through Chapter 13 bankruptcies. Essentially, if a home is no longer valuable enough to serve as the security interest the mortgage was originally based on, it is considered unsecured, and it is akin to credit card debt. In a Chapter 13 bankruptcy, the mortgage holder's lien can be stripped from the estate and they will receive a pro rata share of the amount paid to unsecured creditors. Hence, the term "lien stripping."
However, not all second mortgages may be treated in this way. The home must be the primary residence of the debtor and is no longer valuable enough to serve as the security interest the mortgage was originally based on. In fact, the home must be worth less than the superior lien holder's interest in order for the subordinate lien to be stripped and deemed unsecured.
In these situations, bankruptcy attorneys can arrange for lien holders to release their liens, (usually though a payout or by other legal means) without resorting to bankruptcy. However, the Fisette decision could allow lien stripping in these situations regardless of creditor objections, and bring Minnesota in line with the rest of the country when it comes to discharging unsecured debt attached to real property.
If you have questions about how to save your home through bankruptcy, or whether you would be eligible to strip unsecured liens from your property, an experienced bankruptcy attorney can help.
