Think you know about Lien Strips, the controversial practice featured in our post here? Well think again, because the law may be changing. Lucky for you we have an update ready to go.
WHAT IS A LIEN STRIP?
11 USC 1322(b) provides that wholly undersecured liens on real property may be removed or “stripped,” and the debt to which they relate treated as unsecured in a Chapter 13 Plan of Reorganization. Lien stripping has 2 distinct, and very desirable, benefits for debtors:
- The lien strip removes the junior lien from the property entirely; and
- The debtor only pays a percentage of the claim (as if it were an unsecured debt).
CAN A PARTIAL LIEN STRIP SUCCEED?
There is no such thing as a partial lien strip. Bankruptcy Courts will only allow a lien to be stripped if it is wholly undersecured (i.e. unsecured): that is, the secured potion is zero or negative. Moreover, lien stripping is permissible only for claims secured by the Debtor’s principle residence because a lien strip modifies the “total package of rights for which the claim holder bargained.”
QUALIFYING FOR A LIEN STRIP
For a lien to be stripped, the value of the debtor’s property as of filing, minus fully-secured non-target debts, must be = or < $0. Once upon a time meeting these requirements could be challenging; but today, when many homeowners are “underwater” as to their first mortgage and have a HELOC or 2nd mortgage on top of that, the conditions necessary for a lien strip to take place are relatively straightforward and can sometimes be met without much resistance from the affected creditor.
STRIPPING THE LIEN – WHEN, WHERE, HOW?
Federal Appellate circuits follow different approaches when it comes to lien stripping. Some Bankruptcy Courts for instance, require no more than a listing in the debtor’s Petition that bifurcates the creditor’s interest into secured and unsecured portions. Should the creditor fail to timely object, their lien is stripped.
On the other hand, other Courts require that the debtor bring a motion to strip the lien. Again, if the creditor fails to respond their lien is stripped. Still other circuits, the most conservative ones, require the debtor to bring a separate adversary case against the creditor whose lien is to be stripped. Often the latter 2 kinds of situations – motions and adversary actions – become hotly contested and require massive amounts of preparation as well as expert testimony. This kind of attention and resources is required because often the value of the underlying property is in dispute. The amount of the first mortgage on the property however, is seldom in question.
A NEW STANCE ON CHAPTER 7?
Previously, lien stripping was only allowed in Chapter 13 cases. Considering the massive downturn in the housing market that resulted in cratering home prices, this was a life vest for those that qualified. But it only applied to chapter 13 debtors. Until now?
11TH CIRCUIT FORGES NEW GROUND
In the 11th circuit case of McNeal v. GMAC Mortgage LLC, the Court held that a Chapter 7 Debtor could also strip a wholly unsecured lien. This decision reversed years of precedent. The rationale of the Court seemed to rest largely on linguistics-“stripping down” compared to “stripping off.” Frankly, this rationale sounds more like a risqué card game then modifying federal law. Realistically, policy considerations drove this decision.
In McNeal, the Debtor had 2 mortgages, the first with a balance of $176,413 and the second a balance of $44,444. The property itself was only worth $141,416. Under Chapter 13, this would qualify for a lien strip; the first mortgage was worth more than the value of the property itself, and the second mortgage was wholly unsecured. The Bankruptcy Court disregarded the argument for the lien strip however, citing a line of precedent that included a Supreme Court case that specifically said a Chapter 7 Debtor could not “strip down” a lien.
Once the case reached the Court of Appeals however, the Court determined that the Bankruptcy Court’s rationale did not apply. The controlling Supreme Court case, Dewsnup v. Timm, involved a Chapter 7 partially unsecured second mortgage; part of the lien was perfected and part was not. Thus a potential lien strip would “strip down” the amount owed on the second mortgage. The McNeal court however held that since the 2nd mortgage in that case was wholly unsecured, as opposed to being partially unsecured in Dewsnup, it was not being “stripped down” and thus the previous line of cases was not controlling. Instead the 2nd mortgage was being “stripped off” – a valid action in a Chapter 7 case.
SUPREME COURT TO FOLLOW SUIT?
On March 24, 2015 the U.S. Supreme Court heard oral arguments in two cases involving the question of whether a Chapter 7 debtor may strip a junior mortgage that is not secured by the home’s actual market value:
In Bank of America, N.A. v. Toledo-Cardona, No. 14-163, the market value of the chapter 7 debtor’s home was $77,689.00. The first mortgage owed to Quicken Loans had a balance of $135,703.00, and the second mortgage owed to Countrywide Bank had a balance of $32,000.00.
In Bank of America, N.A. v. Caulkett, 13-1421, the market value of the chapter 7 debtor’s home was $98,000.00, the Countrywide Financial first mortgage balance was $183,264.00, and the Countrywide Financial second mortgage balance was $47,855.00.
In each of the two cases, the homes were worth less than the balances owed on the homes’ first mortgages. This meant that the second mortgages were completely unsecured by any value. The chapter 7 debtors argued that under bankruptcy code section 506(a), the second mortgages should be declared avoided and stripped from the homes. In each case, the 11th Circuit U.S. Court of Appeals approved the strip-off of the second mortgages, and the banks have appealed to the U.S. Supreme Court.
Chapter 13 debtors have long enjoyed the ability to strip off wholly unsecured junior mortgages from their homes, but until recently, chapter 7 debtors have not sought the same benefit. If the Supreme Court accepts the debtors’ arguments, then all chapter 7 debtors will have the right to strip off second mortgages when no actual value of the home secures that mortgage. Such a ruling might even allow debtors whose cases are closed to petition the courts for the same relief.
So what’s the upshot? Is it time to break out the Bubbly? Are Chapter 7 Lien Strips coming to a neighborhood near you? Probably too soon to tell. One thing for sure, though. You can always reach us with questions by calling 630-378-2200 or sending your inquiry to mhedayat[at]mha-law.com. We’d love to know your thoughts.