Chapter 20 Lien Stripping

In the recent case of In re Gerardin, 2011 WL 1118495 (Bankr. S.D. Fla. 2011), Bankruptcy Judge, Robert A. Mark ruled that debtors, who previously obtained a discharge of their debts in chapter 7, may not use chapter 13 plans to “strip off” junior mortgage liens that are wholly unsecured. The Geradin opinion arose out of the consolidation of seven bankruptcy cases where the debtors filed chapter 13 bankruptcies soon after receiving their discharge in their prior chapter 7 cases. The seven cases were pending before three bankruptcy judges who conducted a joint hearing on the various motions relative to this issue.

In its analysis, the bankruptcy court pointed out that the Bankruptcy Code recognizes that an obligation secured by collateral may be bifurcated into a secured claim for the debt equal to the value of the collateral and an unsecured claim for any debt over that value. 11 U.S.C. §506(a)(1). Id. at 2. Thus, in bankruptcy cases, a debtor or trustee may seek to value a creditor’s collateral for the purpose of reducing that creditor’s secured claim to the value of its collateral, while the remaining allowed claim is treated as an unsecured claim. Id. When the secured claim is partially reduced this is known as a “strip down.” Id. When the lien is completely removed because the claim is not secured at all (usually a second or third mortgage on real estate), this is known as a “strip off.” Id. A chapter 7 debtor may not use section 506 to strip down or strip off a lien. Id. citing Dewsnup v. Timm, 502 U.S. 410 (1992); Talbert v. City Mortgage Servs., 344 F.3d 555, 562 (6th Cir. 2003); Ryan v. Homecomings Fin. Network, 253 F.3d 778, 783 (4th Cir. 2001). A chapter 13 debtor may not strip down a lien secured solely by debtor’s principal residence. Id. at 3. However, in the Eleventh Circuit, a chapter 13 debtor may strip off a lien, even if it is secured solely by a debtor’s principal residence, if the creditor’s claim is completely unsecured because the property is worth less than the senior liens. Id. citing Tanner v. FirstPlus Financial, Inc., 217 F.3d 1357 (11th Cir.2000). Notwithstanding the above, the bankruptcy court ruled that lien stripping may not be accomplished under 11 U.S.C. § 1325 when a debtor is ineligible to receive a discharge. Id.

In each of the seven consolidated cases, the bankruptcy court found that the creditors had an allowed secured claim against the debtors’ bankruptcy estates in the form of a mortgage lien encumbering the debtors’ properties. Id. In so ruling, the bankruptcy court relied upon the Supreme Court case of Johnson v. Home State Bank, which held that a creditor with an obligation secured by a lien on a debtor’s property, but which creditor has no in personam claim against a debtor due to a prior bankruptcy discharge, nonetheless has a claim against a debtor in a subsequent chapter 13 case. 501 U.S. 78 (1991). Id. As a result of the ruling that the creditors have allowed secured claims, the bankruptcy court held that the liens cannot be modified under 11 U.S.C. §506(d)[1]. Id. at 4.

The bankruptcy court further found that for debtors to strip off a lien in a chapter 13 case, their proposed treatment of the secured claim in their chapter 13 plan must comply with 11 U.S.C. § 1325(a)(5)[2]. Id. citing Am. Gen. Fin., Inc. v. Paschen, 296 F.3d 1203, 1205–06 (11th Cir. 2002). In the consolidated seven cases, the Chapter 13 Trustee, and the mortgage holders opposing the debtors’ position, argued that the debtors cannot satisfy the § 1325(a)(5) requirements because they are not paying the underlying debt in full and they are not eligible to receive a discharge under section 1328[3]. Id. at 6. The bankruptcy court agreed and held that a debtor’s inability to receive a discharge in a “Chapter 20” case prevents a debtor from stripping wholly unsecured liens in a chapter 13 plan as the actual strip off or lien avoidance only occurs at discharge. See, e.g., In re Fenn, 428 B.R. 494 (Bankr. N.D.Ill.2010); In re Mendoza, 2010 WL 736834 (Bankr. D.Colo. Jan. 21, 2010).

In sum, the bankruptcy court concluded that a debtor who is not eligible for a chapter 13 discharge because the debtor’s unsecured debts were discharged in a prior chapter 7, may not strip down or strip off a lien. This ruling effectively takes away a debtor’s option to file a “chapter 20” bankruptcy.

[1] 11 U.S.C. § 506(d) states that, with some exceptions, “to the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void.”

[2] Section 1325(a)(5) sets forth the following alternative required treatments of a secured claim in a chapter 13 plan—

(5) with respect to each allowed secured claim provided for by the plan—

(A) the holder of such claim has accepted the plan;

(B)(i) the plan provides that—

(I) the holder of such claim retain the lien secured by such claim until the earlier of—

(aa) the payment of the underlying debt determined under nonbankruptcy law; or

(bb) discharge under section 1328; and

(II) if the case under this chapter is dismissed or converted without completion of the plan, such lien shall also be retained by such holder to the extent recognized by applicable nonbankruptcy law;

(ii) the value, as of the effective date of the plan, of property to be distributed under the plan on account of such claim is not less than the allowed amount of such claim; and

(iii) if—

(I) property to be distributed pursuant to this subsection is in the form of periodic payments, such payments shall be in equal monthly amounts; and

(II) the holder of the claim is secured by personal property, the amount of such payments shall not be less than an amount sufficient to provide to the holder of such claim adequate protection during the period of the plan; or

(C) the debtor surrenders the property securing such claim to such holder;

[3] 11 U.S.C. §1328(f) precludes discharge under chapter 13 if the debtor received a discharge in a chapter 7 case filed during the 4 year period preceding the filing of the chapter 13 case.