• Lien Stripping: Should a debtor's eligibility for a discharge be a factor?
  • July 14, 2014 | Author: Keri Ebeck
  • Law Firm: Weltman, Weinberg & Reis Co., L.P.A. - Pittsburgh Office
  • Anyone who practices bankruptcy is familiar with Chapter 7, Chapter 13 and most likely Chapter 11, but what about a Chapter 20? To some, the question is whether a Chapter 20 bankruptcy is part of the bankruptcy code? The answer is - not technically, but a Chapter 20 bankruptcy does exist. A Chapter 20 is when a debtor files a Chapter 7, receives a discharge and then proceeds to file a Chapter 13 in an effort to strip a wholly unsecured mortgage lien. The question that courts, lawyers and judges are dealing with in many jurisdictions is whether those debtors who are ineligible for a Chapter 13 discharge are able to strip a wholly unsecured mortgage lien?

    In a majority of the courts, most jurisdictions are holding that wholly unsecured mortgage liens can be stripped off and treated as unsecured mortgages without the benefit of a Chapter 13 discharge. The courts are grappling with various arguments and issues to determine if debtors are to accomplish such under §1325, 1322 and 506. Pursuant to §1325(a)(5), a holder of a secured claim provided for by the plan shall retain the lien securing such claim until the earlier of "the payment of the underlying debt determined under non-bankruptcy law; or discharge under section 1328." On its face, §1325 appears to deal with secured claims only - the question is, what about wholly unsecured mortgage claims? Additionally, §1322 (b)(2) states that "the plan may modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor's principal residence or of holders of unsecured claims, or leave unaffected the rights of holders of any class of claims." A majority of the courts are relying upon §506(d) to determine the value of the collateral in question. If under 506(d) the value determined leaves a mortgage lien completely unsecured, the court will then look to §1322(b)(2), which allows rights of unsecured creditors to be modified. By valuing the collateral at zero, the debtors are able to modify the rights of the creditor under §1322 and strip the wholly unsecured mortgage lien. The argument is that under §1325(a)(5), the holder of a secured lien retains its lien until discharge, but if the debtor is not eligible for a discharge, there can be no effective lien strip. The parties in In Re Davis argued, to which the Court agreed with, that "Congress did not intend to alter the ability of the bankruptcy courts to enter lien-stripping orders in Chapter 13 cases. And this is so regardless of the availability of a discharge. A discharge, the debtors say, extinguishes only in personam liability...Because the debtors here have already discharged their in personam liability in the prior Chapter 7 proceedings, they have no need for a discharge with respect to the liens." Once the lien strip order becomes effective and the plan is confirmed and completed, a discharge is not needed to strip the lien. The lien becomes stripped upon plan confirmation and completion.

    Of the courts that dissent and do not allow Chapter 20 lien strips, view §1325 as a protection from the Chapter 20 case, by stating in the section itself that a secured creditor retains its lien until discharge. The term "allowed secured claim" in Section 1325 (a)(5) is not defined by, or predicated on, an application of Section 506(a)... "Section 506(a) provides for the judicial valuation of an allowed secured claim, without altering the secured status of a creditor." The other argument is that Chapter 20 lien strips can be viewed as an end run around the Dewsnup case which held that a mortgage lien (secured or wholly unsecured) cannot be stripped in a Chapter 7.[6] But those who argue against this believe that if Congress had intended not to continue allowing lien strips in a Chapter 13 after a Chapter 7 discharge, they would have specifically "fixed" the problem with the BAPCPA Amendments of 2005.

    As it stands now, more and more jurisdictions are continuing to follow Dewsnup and not allow Chapter 7 lien strips, but at the same time, allowing the debtor to proceed and file a Chapter 13 (i.e. Chapter 20 case) and ultimately strip the mortgage lien without a discharge of the debtor.

    If a creditor reviews a plan with a lien strip or the creditor receives an adversary to strip a lien, immediate review of the jurisdiction and law is needed to determine what rights the creditor may have.

    1 11 U.S.C. §1325(a)(5)(B)(i)
    2 11 U.S.C.§1322(b)(2)
    3 In Re Davis, 716 F.3d. 331 at 335
    4 In Re Davis, at 337. In Re Johnson, 501 U.S. at 84.
    5 In Re Davis, at 340 (dissent)
    6 Dewsnup v. Timm, 502 U.S. 410