In a recent case called In re Boukatch, the Bankruptcy Appellate Panel for the Ninth Circuit (which includes California and much of the western part of the country) was faced with whether a “chapter 20” debtor could “strip” a junior lien from the debtors’ residence even though the debtors were not going to get a discharge of their debts.
I’VE HEARD OF CHAPTER 7 AND 13, BUT WHAT’S A “CHAPTER 20” CASE?
A Chapter 7 “straight bankruptcy” is the most common type of bankruptcy, usually a very short procedure—seldom lasting more than 4 months—resulting in the discharge (legal write-off) of all or most debts. But it provides little or no direct help in catching up on home mortgage arrearages and with many other kinds of special debts. Chapter 13 “adjustment of debts” can provide significant help with home mortgages in particular, as well as other special debts such as child and spousal support arrearage, income taxes, and many vehicle loans. Chapter 13 involves proposing and getting court approval of a payment plan, making payments on that plan for usually 3 to 5 years, and then getting a discharge of all or most of the remaining debts.
A “Chapter 20” case is an informal term for a Chapter 13 case filed soon after a prior Chapter 7 case. If it’s not obvious, the “20” comes from Chapter 7 plus Chapter 13 equals “Chapter 20.”
WHY FILE A “CHAPTER 20” CASE?
If you file a so-called “Chapter 20” case—a Chapter 13 case less than 4 years after completing a Chapter 7 one—you will not receive a discharge of your debts. Often that’s not a problem because your debts would have all or mostly been discharged in the earlier Chapter 7 case.
So why would a person file a “Chapter 13” case? Usually because of the long protection from creditors that Chapter 13 can provide. For example, if you were significantly behind on your first mortgage you may be able to negotiate catch-up payments with the mortgage lender in a Chapter 7 case, but you’d have little leverage and would largely be at the mercy of whatever the lender would demand in order to avoid foreclosure. Instead through Chapter 13 you can generally force the lender to accept catch-up payments over a span of as much as 5 years.
BUT WHY FILE A CHAPTER 7 CASE FIRST, INSTEAD OF JUST DEALING WITH EVERYTHING THROUGH A SINGLE CHAPTER 13 CASE?
For two sets of reasons.
First, there are a number of tactical justifications for purposely first filing a Chapter 7 case with the intent of following up with a Chapter 13 one. For example, you may have too much debt to qualify under Chapter 13 and must first discharge that debt in a Chapter 7 case to qualify. Or you may want to discharge some or most of your debts in a Chapter 7 case to be able to concentrate on the remaining special debts that would not be discharged through Chapter 13.
Second, you may file a Chapter 7 case without any desire to file any other bankruptcy afterwards, but then circumstances change so that you want or need to file a Chapter 13 case soon thereafter. For example, you may have decided to surrender your home because you were relocating for another job in another area, but then soon after going through the Chapter 7 case you find a great local job that pays well and so you decide to save your home after all through a follow-up Chapter 13 case.
WHAT IS A MORTGAGE LIEN “STRIP”?
It’s tremendous benefit which is not available under Chapter 7 but rather only under Chapter 13. If you have a second mortgage on your home and the debt on your first mortgage exceeds the amount the value of your home, your attorney can file a motion in the bankruptcy court to verify that the second mortgage is effectively unsecured. There’s no equity securing it because it is all encumbered by the first mortgage.
Then once the second mortgage debt is ruled by the court to be unsecured, its lien can be “stripped” from the home. As a result you would no longer have to make the monthly payments on that second mortgage, or catch up on it if you were behind. The mortgage debt would be treated as a simple unsecured debt, meaning that it would be pooled together with the rest of your other unsecured debts. You would only pay on this pool of “general unsecured” debts as much as you could afford to do so during the course of your Chapter 13 case, often only pennies on the dollar and sometimes nothing at all. Then after a successful completion of the 3-to-5-year plan, all your unpaid “general unsecured” debts would be discharged—written off—and the second mortgage lien permanently taken off your home title.
For more about this see my earlier blog post, “Protecting Your Family Home: Second Mortgages.”
SO WHY IS A MORTGAGE LIEN STRIP A PROBLEM IN THE “CHAPTER 20” SITUATION?
Because there is no discharge of debts at the end of the Chapter 13 case following in less than four years after a Chapter 7 case, some courts have decided that a mortgage lien “strip” is not allowed in this situation. Indeed that is what a bankruptcy judge in Arizona decided, which led to the Bankruptcy Appellate Panel case mentioned at the very beginning of this blog post, In re Boukatch. This issue was one of “first impression,” having never been decided by this court before.
WHAT HAPPENED IN RE BOUKATCH?
Serge and Lori Boukatch owned a home in Phoenix, Arizona worth $187,500. They owed Wells Fargo Bank more than $228,000 on a first mortgage and MidFirst Bank more than $67,000 on a second mortgage. In 2012 a Chapter 13 case they had filed earlier was converted by the bankruptcy court into a Chapter 7 one, resulting in a discharge of their debts in March of 2013.
About a year later the Boukatches filed a Chapter 13 case, doing so way before the four years when they would have been entitled to get a new discharge of their debts. They understood that they had already discharged their debt to MidFirst on the second mortgage (along with all or most of the rest of their debts) through their prior Chapter 7 case. Their Chapter 13 payment plan provided that the MidFirst second mortgage would be stripped off the home, based on the lack of any equity supporting that lien. Neither MidFirst nor the Chapter 13 objected to that provision in the plan.
When the Boukatches attorney filed a motion to determine the value of their home and to strip the MidFirst lien, again there were no objections. But the bankruptcy judge, citing a 2012 decision by a district court judge in San Diego, said they could not strip the MidFirst lien in the “Chapter 20” context. The Boukatches then filed an appeal to the Bankruptcy Appellate Panel.
HOW DID THE BANKRUPTCY APPELLATE PANEL (“BAP”) DECIDE IN FAVOR OF ALLOWING THE LIEN “STRIP”?
This appeals court started by acknowledging that “[c]ourts across the nation are split on the issue”—” whether a chapter 20 debtor is entitled to strip off such liens when no chapter 13 discharge will be entered. ”
The court reviewed in detail the decisions and analyses of those “court across the nation,” and explained, again in detail, why it agreed with “the growing consensus of courts” in deciding “that nothing in the [Bankruptcy] Code prevents chapter 20 debtors from stripping a wholly unsecured junior lien against the debtor’s principal residence, notwithstanding their lack of eligibility for a chapter 13 discharge.”
The BAP’s rationale started with the undisputed fact that “MidFirst’s lien has no value because the senior lien held by Wells Fargo exceeds the value of the property by approximately $40,000. Consequently, . . . MidFirst’s claim is ‘unsecured’ . . . .” Continuing, “the wholly unsecured status of MidFirst’s claim, rather than Debtors’ eligibility for a discharge, is determinative.” . . . . “By seeking to strip off a wholly unsecured junior lien, Debtors seek to do just that: avoid the lien. They do not seek a discharge.” (Citations to other court opinions excluded.)
The BAP concluded that the Bankruptcy Code “:
does not prevent Debtors’ ability to strip off MidFirst’s wholly unsecured junior lien in their chapter 13 plan, because nothing in the Bankruptcy Code prevents chapter 20 debtors from stripping such liens off their principal residence . . . . We further conclude that plan completion is the appropriate end to Debtors’ chapter 20 case. Unlike a typical chapter 13 case, the lien avoidance will become permanent not upon a discharge, but rather upon completion of all payments as required under the plan.
So the BAP reversed the decision of the bankruptcy court when it denied the Boukatches’ lien stripping motion and ordered it to allow that motion.
Update: The 9th Circuit Court of Appeals in HSBC Bank v. Blendheim (In re Blendheim), No. 13-35412 (Oct. 1, 2015) also concluded that a discharge is not necessary to lien strip.