Can you strip a second mortgage in a Chapter 13, even if you’re not entitled to a discharge of debt due to a previous bankruptcy filing? Many Debtors find themselves in a situation where they do not have the income to complete a Chapter 13 case, or a situation where they do not have an obligation to file under Chapter 13, and would rather seek a discharge of all unsecured debt in a Chapter 7 proceeding. However, after that time, Debtors in this situation may still wish to strip a home equity line or second mortgage from their primary residence.
Before determining whether a lien can be stripped where the Debtor is not entitled to a discharge, we must first examine when a lien can be stripped at all. In the case of Nobleman v. Am. Sav. Bank, 508 U.S. 324 (1993), the United States Supreme Court examined the relationship between 11 USC §§1322(b)(2) and 506(a) with respect to an undersecured lienholder, and noted that the threshold question of whether the creditor holds a secured claim is resolved by looking to §506(a). The rule that has been adopted by almost every Circuit Court in the nation is that a lien strip is allowed only if no part of the loan is secured. As a result, if any equity in the property can be sold to provide compensation to the junior lien holder, that is, its claim is at least partially secured after application of §506(a), it will be eligible for the protection of §1322(b)(2)’s anti-modification provision. Zimmer v. PSB Lending Corporation, 313 F.3d 1220, 1226 (9th Cir. 2002). The Court in Lane v. W. Interstate Bancorp (In re Lane), 280 F.3d 663 (6th Cir. 2002), may have stated this standard best when it wrote, “Whether a lien claimant is the holder of a ‘secured claim’ or an ‘unsecured claim’ depends, thanks to § 506(a), on whether the claimant’s security interest has any actual ‘value.’” In the alternative, “If a claimant’s lien on the debtor’s homestead has a positive value, no matter how small in relation to the total claim, the claimant holds a ‘secured claim’ and the claimant’s contractual rights under the loan documents are not subject to modification by the Chapter 13 plan.” Id.
Once it is determined that a Debtor has a right to strip a junior lien under the Bankruptcy Code, the next step in the analysis is whether a Debtor has the right to do so when a discharge of unsecured debt is not allowed, due to a previous discharge order pursuant to 11 U.S.C. §1328(f)(1). The general rule of thumb is that, if a Motion to Avoid a Lien has been allowed in a Chapter 13 case where the Debtor is entitled to a discharge, the wholly unsecured lien is stripped at the time the Debtor completes his plan payment and obtains a discharge of debt.
It is undisputed that secured debts, such as those commonly found in second and third liens to property can be discharged in a Chapter 7 case and the Creditor cannot seek financial recovery from the Debtor thereafter. As such, if a Debtor were to file a Chapter 13 case after receiving that discharge, the plan does not need to include any discharged creditors. However, the discharge does not eliminate a secured creditor’s right to an in rem proceeding (a case against the property, such as a foreclosure).
Several United States Bankruptcy Courts have recently held that a Debtor’s eligibility for a discharge is not a requirement for lien avoidance. See, In re Waterman, 447 B.R. 324 (Bankr. D. Colo. 2011); In re Tran, 431 B.R. 230 (Bankr. N.D. Cal. 2010); In re Hill, 440 B.R. 176 (Bankr. S.D. Cal. 2010). It should be noted that nothing in the Bankruptcy Code limits a Chapter 13 Debtor’s ability to modify a wholly unsecured creditor’s lien under §1322(b)(2) based on his or her eligibility for a discharge. See, e.g., Tran, 431 B.R. at 235 (citing various Bankruptcy Code provisions and concluding that the Bankruptcy Code does not “preclude a debtor that is not eligible for a discharge from filing a chapter 13 case, obtaining confirmation of a chapter 13 plan, and with the exception of the right to a discharge, from enjoying all the rights of a chapter 13 debtor, including the right to strip off liens.”); Waterman, 447 B.R. at 328-29 (finding the reasoning and analysis in Tran and other cases allowing strip offs in no-discharge Chapter 13 cases to be “persuasive and compelling”).
The Court in In Re Michael James Fisette, Bankruptcy Appellate Case: 11-6012, (8th Circuit, 2011) addressed the issue of a lien strip as an in rem proceeding and held, by seeking to strip off a junior lien, a debtor seeks to do just that: avoid the lien. He does not seek a discharge of the personal liability of the debt. Moreover, the Court explained, a discharge releases a Debtor’s in personam liability, but it does not affect the lien. See 11 U.S.C. § 524(a) and Johnson v. Home State Bank, 501 U.S. 78, 84 (1991). A strip off avoids the lien, thus extinguishing a creditor’s ability to proceed against the debtor in rem.
The long and the short of it is simply this, if a Debtor has obtained a discharge in bankruptcy, and then seeks to file a new case for the limited purpose of avoiding an in rem remedy of the Creditor, the Bankruptcy Court should consider and, in response to the case law cited allow, a wholly unsecured lien to be stripped after a discharge in a previous bankruptcy case.