What
Has Gone Before
Back in
April, I posted about the U.S. Supreme Court's denial of certiorari on an
unpublished order of the 11th Circuit Court of Appeals, in which the 11th
Circuit followed a previous unpublished decision that allowed wholly unsecured
liens to be "stripped off" in Chapter 7, using 11 U.S.C. §§506(a)
& (e). As I discussed in that post, the 11th Circuit interpreted Dewsnup v. Timm, 502 U.S. 410 (1992) to
be limited to partially secured first mortgages, and followed its own
precedent -- handed down before Dewsnup v. Timm -- in ruling that 11 U.S.C. §506 could be used
to void wholly unsecured mortgages and liens in Chapter 7. See Folendore v. United States Small Bus. Admin., 862 F.2d
1537 (11th Cir. 1989).
I also
noted that the 11 Circuit stood as an outlier on this issue, and that the other
circuits reaching the same issue had ruled that Dewsnup v. Timm controlled (and forbade) the use of §506 against wholly unsecured
liens in Chapter 7. My prior blog post is here: http://impudentbankruptcylawyer.blogspot.com/2014/04/now-in-play-506d-strip-offs-in-chapter-7.html
The 11th Circuit Speaks Again
The 11th
Circuit, on June 18, 2014, published a decision in which it adopted the
majority view allowing debtors to use a "Chapter 20" to strip off
liens. The decision is Wells Fargo Bank,
N.A. v. Scantling (In re Scantling), ___ F.3d ____ (11th Cir. Docket No
13-10558, 6/18/14), and you can read it here: http://www.ca11.uscourts.gov/opinions/ops/201310558.pdf.
You won't
find "Chapter 20" in the Bankruptcy Code; bankruptcy lawyers use it
as a term of art to describe a two-step process used to strip off unsecured
junior liens and mortgages. First, the debtor files a Chapter 7 bankruptcy and
obtains a discharge of the underlying promissory note and other debt. Second,
immediately after the Chapter 7 discharge, the debtor files a Chapter 13, in
which the debtor files a plan (usually with token payments for lien creditors)
and files a motion, under 11 U.S.C. §506, to determine that the liens remaining
after the Chapter 7 are void because they are wholly unsecured.
Here's
the trick: the debtor in these circumstances does not care that he or she
cannot get a "discharge" in Chapter 13; the debtor's sole purpose is
to use his or her Chapter 13 case to void and "strip off" the
unsecured mortgages. 11 U.S.C. §1328(f) mandates a four year waiting period
(after the date the debtor filed the prior Chapter 7) for filing a Chapter 13
in which the debtor seeks a discharge. But -- nothing in the Bankruptcy Code
prohibits the debtor from filing a Chapter 13 for another purpose in that four
year waiting period, so long as the debtor can confirm a plan according to the
dictates of Chapter 13.
Wells
Fargo argued that the Chapter 13 plan and discharge must go hand-in-hand.
However, a Chapter 13 plan does more than secure a discharge after all its
payments are completed: it allows the debtor to cure mortgage defaults; pay off
income tax debt over five years, without further accrual of interest and
penalties; and allows the avoidance of wholly unsecured mortgages, even on the debtor's
primary residence. 11 U.S.C. §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." Although the SCOTUS has ruled that Chapter 13
debtors cannot use §506(a) to modify a partially secured mortgage on a
residence, Nobelman v. American Savings Bank, 508 U.S. 324 (1993), most
circuits -- including the 11th Circuit -- have ruled that a §506(a) valuation
can be combined with §1322(b)(2) provision in a plan to void a wholly unsecured
mortgage. See Tanner v. Firstplus
Financial, Inc. (In re Tanner), 217 F.3d 1357 (11th Cir. 2000). In other
words, if there is no equity in the residence to secure any part of the
mortgage, the mortgage becomes a wounded gazelle on the African savannah, and
the Chapter 13 plan is the lion.
The 11th
Circuit recognized Chapter 13's versatility and thus followed the majority of
bankruptcy courts, district courts and circuit courts in allowing Ms.
Scantling's "Chapter 20" and her plan to void Well Fargo's second and
third mortgages on her residence.
Of
particular interest is footnote 5 of the decision, in which the 11th Circuit
stated:
We are also mindful of the recent
unpublished opinion in Wilmington Trust,
National 5 Ass’n v. Malone (In re Malone), No. 13-13688, 2014 WL 1778982
(11th Cir. May 6, 2014), which was decided after oral argument in the instant
case, in which a panel of this court recently found it was bound by prior
published decisions and affirmed a decision by the bankruptcy court, in a
Chapter 7 proceeding, that allowed a debtor to strip off a worthless second
priority lien.
The
Bottom Line
Debtors
in the 11th Circuit have the best of both worlds: if they are daring, they can
try to strip off their wholly unsecured mortgages in their Chapter 7 case (and
now, those debtors have a footnote in a published opinion to cite). If they are
not daring (and have the funds for filing two bankruptcy cases), they can take
the safer route of a "Chapter 20" to get rid of their second or third
mortgage.
©Kevin C. McGee 2014
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