The U.S. Court of Appeals, Fourth Circuit, has become the first U.S. Court of Appeals to approve “chapter 20″ lien stripping. Although virtually all U.S. bankruptcy courts allow the “stripping” (vacating and eliminating) of completely unsecured junior mortgages on homestead real estate, the Fourth Circuit is the first circuit-level appeals court to approve lien stripping in a chapter 13 which follows closely on the heels of a chapter 7 bankruptcy filing. In re Davis (Branigan v. Davis), No. 12-1184 (4th Cir. May 10, 2013).
“Chapter 20″ is a colloquial term for a chapter 13 bankruptcy filed within four years of a chapter 7 case.
A junior mortgage is the second, third, or any other mortgage which is junior to the first mortgage upon homestead real estate. Although junior mortgages cannot be stripped or otherwise modified in a chapter 7 bankruptcy (although the Eleventh Circuit has allowed this practice in an unpublished opinion), junior mortgages can indeed be stripped off in a chapter 13 bankruptcy, if the junior mortgage is entirely unsecured.
An example of an entirely secured junior mortgage would be where the home’s value is $200,000 and the first mortgage has a balance of $250,000; if the home is also subject to a second mortgage in the amount of $50,000 the second mortgage is not secured by any actual value of the real estate. To think of this example in another way, if a foreclosure sale were to occur on this underwater home, the first mortgage would receive only $200,000 (the home’s value) and the second mortgage would get absolutely nothing. This is what the bankruptcy code means when it categorizes a junior mortgage as entirely unsecured.
“Chapter 20 junior mortgage lien stripping” means stripping an entirely unsecured junior home mortgage in a chapter 13 bankruptcy case which is filed within four years after a chapter 7 filing by the same debtor. The question whether this is permissible arises because the debtor is not eligible for a discharge of debts in a chapter 13 filed within four years of a chapter 7 discharge.
Many are surprised that someone can file chapter 13 bankruptcy within four years of filing chapter 7 — isn’t there a mandatory eight year waiting period between bankruptcy filings? The answer is no. A debtor can file chapter 13 at any time, it’s just that a chapter 13 debtor cannot receive a discharge, in the new chapter 13 case, if the case is filed within four years of a previous chapter 7 case.
Mortgage banks have raised the argument that even if junior mortgage lien stripping is allowed in chapter 13 bankruptcy cases, it should not be allowed in a no-discharge chapter 20 case. If the debtor cannot receive a discharge of debts, the argument goes, then how can the chapter 13 filing strip off a junior mortgage?
In In re Davis, the appeals court noted that lower courts have been split on the question of chapter 20 lien stripping, although one Bankruptcy Appellate Panel had approved this practice in In re Fisette, 455 B.R. 177 (8th Cir. BAP 2011).
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