A chapter 13 debtor may strip off an underwater, subordinate lien on a homestead, even if the lien came into existence before the debtor owned the property, according to a decision by Bankruptcy Judge Michelle M. Harner of Baltimore.

The debtor inherited the home in 2017. It became her principal residence. The home was subject to a $55,000 first mortgage dating from 2002. The house was also encumbered by a $140,000 home equity line of credit made in 2008.

In chapter 13, the debtor scheduled the home as being worth $50,000 due to extensive deferred maintenance, structural problems and mold. In view of the low value, the debtor filed a motion to strip off the HELOC lien and convert the HELOC loan to a purely unsecured claim. The HELOC lender contended that strip-off was unavailable because the lien predated the debtor’s ownership.

In her August 15 opinion, Judge Harner began addressing the merits by explaining how “Section 1322 of the Code provides that a chapter 13 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.’” As a result, she said, “a debtor generally may not bifurcate a mortgage creditor’s claim and strip off the unsecured portion of the creditor’s lien.”

The “one exception” in chapter 13, Judge Harner said, “is a wholly unsecured mortgage claim, which may be removed from the property through sections 506, 1322, and 1325 of the Code.” As authority for stripping off an entirely underwater lien, Judge Harner cited the Sixth Circuit, which, in turn had cited six other circuits with the same holdings. See Branigan v. Davis, 716 F.3d 331, 335–36 (4th Cir. 2013).

To decide whether the debtor was eligible to strip off the HELOC lien, Judge Harner turned to valuing the property. Where the debtor contended that the home was worth no more than $50,000 due to its dilapidated condition, the HELOC lender believed that the home was worth $95,000. If there were any value in the property above the $55,000 first mortgage, the debtor would be unable to strip off any of the HELOC lien.

Judge Harner had problems with the appraisals for both the debtor and the lender. Evaluating the evidence, she concluded that the home was indeed worth $50,000.

To extinguish the HELOC lien, however, Judge Harner was obliged to deal with the lender’s contention that preexisting liens cannot be stripped off. She said that “the Creditor’s suggested result belies the language of the Code.”

Quoting Section 506(a), Judge Harner said that “a creditor holds a secured claim ‘to the extent of the value of such creditor’s interest in the estate’s interest in such property’ and an unsecured claim ‘to the extent that the value of such creditor’s interest . . . is less than the amount of such allowed claim.’” [Emphasis in original.]

When a supposedly secured creditor’s lien is “wholly unsecured,” Judge Harner said that “the debtor may treat the creditor as an unsecured creditor under the chapter 13 plan, thereby removing the lien from the property through the chapter 13 process.”

Even when the lien predates the debtor’s ownership, Judge Harner said that the amount of the allowed secured claim, “if any, is determined by section 506 of the Code, and its treatment under the Debtor’s plan is governed by sections 1322 and 1325 of the Code.”

Debunking the lender’s argument, Judge Harner held:

The language of these sections focuses on the amount of the Creditor’s claim as compared to the value of the estate’s interest in the Property. The language is not focused on the debtor’s interest or the debtor’s ability to claim an exemption. As a result, under the relevant sections of the Code, the Debtor may strip off the Creditor’s lien from the Property, provided that the Creditor’s claim is wholly unsecured.

Reserving a question of lien priority for later determination, Judge Harner ruled that “the Debtor may seek to strip off the Creditor’s lien in the Property under sections 506, 1322, and 1325 of the Code.”