Sixth Circuit BAP Rules that "Chapter 20" Debtor May Strip Off Valueless Liens
Lien stripping is a process that involves eliminating junior liens (such as a second mortgage) through the bankruptcy process. In a recent appeal to a Sixth Circuit Bankruptcy Appellate Panel ("BAP"), the BAP overturned a bankruptcy court's denial of a Chapter 13 debtor's motion to avoid the lien of an inferior mortgage lien holder.
The case, In re Cain,1 involves a "Chapter 20" individual debtor, which is a colloquial term for a debtor who files a Chapter 7 case, and shortly thereafter files a Chapter 13 case. In the "Chapter 20" case at issue, because the debtor had received a Chapter 7 discharge within the last four years, she was ineligible for a discharge in the subsequent Chapter 13 case.
Approximately five years after her Chapter 13 Plan was confirmed, the debtor filed a Motion to Avoid Mortgage Lien on Real Estate against Amerifirst Home Improvement Financial Company ("Amerifirst") to effectuate the terms of her Chapter 13 Plan avoiding Amerifirst's second mortgage on the debtor's residence. At the time the debtor filed her Chapter 13, the debtor's residence was valued at not more than $100,800, and was encumbered by a first mortgage of $106,306.38. Amerifirst held a second mortgage in the amount of $9,415.28.
No one, including Amerifirst, objected to the motion. However, the bankruptcy court denied the motion on the basis that because the debtor was ineligible for a discharge, the Bankruptcy Code's lien stripping power was unavailable to the debtor.
The BAP reversed. In its analysis, it discussed the three different approaches that bankruptcy courts have taken when considering the issue of whether a debtor may strip off a wholly unsecured, junior mortgage lien on a debtor's primary residence in a Chapter 13 case filed less than four years after obtaining a Chapter 7 discharge.
The First Approach. Some courts do not permit lien stripping of wholly unsecured liens under these circumstances because it would result in a "de facto discharge."
The Second Approach. Other courts allow lien stripping in "Chapter 20" cases, but hold that the parties' pre-bankruptcy rights reinstate after the Chapter 13 Plan has been consummated. In other words, a "Chapter 20" debtor must pay debts in full under the Chapter 13 Plan in order to avoid liability on the junior, unsecured lien.
The Third Approach. The final approach, one that the BAP described as the "growing consensus," permits the stripping of a junior, unsecured lien because nothing in the Bankruptcy Code prohibits it.
In reversing the bankruptcy court, the BAP adopted the third approach. While noting that the issue is one of first impression in the Sixth Circuit, the BAP based its holding, in part, on the fact that the third approach is most consistent with the Sixth Circuit's decision in Lane v. W. Interstate Bancorp (In re Lane),2 which considered the implications of the Supreme Court's decision in Nobleman v. Am. Sav. Bank.3
In Nobleman, the Supreme Court considered whether a debtor could bifurcate- treat part as secured and part as unsecured - a partially secured claim on the debtor's principal residence. The Supreme Court held that such a claim should be classified as secured if any portion of the claim is secured, regardless of whether the amount of the claim exceeds the value of the security interest (i.e., the secured creditor is under-secured). Such a claim, the Supreme Court ruled, therefore is protected under the anti-modification clause found in Bankruptcy Court section 1322(b)(2). In short, a lien on a principal residence cannot be stripped under these circumstances.
In Lane, the Sixth Circuit considered Nobleman's implications when a lien holder has only an unsecured claim against a debtor's residence. Because the amount of the senior lien on the debtor's residence exceeded the value of the property, the second mortgage in Lane was entirely unsecured, and the Sixth Circuit ruled that Bankruptcy Court section 1322(b)(2) could not prevent the lien from being stripped.
In Cain, the bankruptcy court ruled that because the debtor was ineligible for a discharge it could not strip off Amerifirst's lien. In its reversal, the BAP stated that the bankruptcy court disregarded the "road map" set forth in Nobleman and Lane by failing to first determine the proper classification (secured or unsecured) of Amerifirst's claim. While following the road map, the BAP found Amerifirst's claim to be unsecured because the value of the senior mortgage exceeded the property value (an undisputed fact in the case). Then, applying Lane's reasoning, the BAP held that it was "the wholly unsecured status of Amerifirst's claim, rather than the Debtor's eligibility for a discharge" that was determinative in this case. Because nothing in the Bankruptcy Code prevents it, the BAP ruled that "a Chapter 20 debtor may avoid a wholly unsecured lien on the debtor's principal residence."
1 Docket No. 13-8045 (BAP 6th Cir., July 14, 2014).
2 280 F.3d 663 (6th Cir. 2002).
3 508 U.S. 324 (1993).
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