The Ninth Circuit joins two other courts of appeals and three bankruptcy appellate panels in holding that a mortgage can be “stripped off” through use of so-called “chapter 20.”
A chapter 20 strip off typically arises when someone first goes through chapter 7 and gets a discharge while owning a home where debt on the first mortgage is more than the value of the house. Although a bankrupt’s personal liability on a valueless second mortgage is eliminated by discharge, the second lien remains on the home as a result of the U.S. Supreme Court’s 1993 Dewsnup decision, thus leaving the homeowner vulnerable to foreclosure of the second mortgage after chapter 7.
When the same homeowner files a subsequent chapter 13 petition, some bankruptcy courts and district courts do not permit strip off, or elimination of the second mortgage, usually reasoning that strip off is unavailable because the debtors aren’t entitled to a discharge in chapter 13.
In an Oct. 1 opinion, Ninth Circuit Judge Jay S. Bybee sided with the Fourth and Eleventh Circuits by holding that a lien can be stripped off in chapter 20. In a case called Boukatch, the Ninth Circuit Bankruptcy Appellate Panel allowed strip off in chapter 20.
In the case before the Ninth Circuit, the consumer debtors first filed under chapter 7. They then filed a chapter 13 petition one day after receiving their chapter 7 discharge, which removed the first mortgage on their home as a personal liability. Because liens ride through chapter 7, the mortgage remained on their home. The chapter 13 petition was designed to prevent or delay foreclosure.
In a holding significant for the typical chapter 20 cases, Judge Bybee held that debtors can avoid liens in subsequent chapter 13 cases even though they are not eligible for discharge.
The bank argued unsuccessfully that the chapter 13 case must end in either conversion to chapter 7 or dismissal because the debtors were barred from another discharge since the chapter 7 discharge occurred within four years. Judge Bybee said the Bankruptcy Code is “devoid” of any requirement that a subsequent chapter 13 case must be converted or dismissed when the debtor cannot have a discharge. He also rejected the bank’s argument that stripping off a lien in chapter 20 would circumvent Congress’s intent to prohibit successive discharges.
Judge Bybee’s decision did create a split of circuits on a subsidiary issue. The bank relied on a 2005 Seventh Circuit decision called Sidebottom for the proposition that one debtor cannot have chapter 7 and chapter 13 cases pending simultaneously. He followed the Eleventh Circuit’s 1989 Saylors opinion, which found no per se rule prohibiting simultaneous bankruptcies.
Judge Bybee upheld the bankruptcy court’s finding of no bad faith filing because preventing foreclosure is a legitimate use of chapter 13.
To accomplish a chapter 20, the bankrupts must pay their remaining debts in full in their subsequent chapter 13 case, although they are not required to pay the mortgage debt because it would have been eliminated as a personal liability in their prior chapter 7 case.
The Ninth Circuit case was atypical because the debtors were not stripping off a subordinate mortgage. Instead, a mistake by the bank allowed them to eliminate the first mortgage on their $450,000 home.
In the chapter 13 case, the debtors objected to the bank’s secured claim, contending that their signatures had been forged. Perhaps thinking that the lien nonetheless would pass through chapter 13, the bank did not object, and the bankruptcy court entered an order disallowing the secured claim. Using Section 506(d), Judge Bybee said the bank’s lien therefore became invalid once the chapter 13 plan was confirmed and the debtors completed payments.
In subsequent cases, lenders might argue that ratification of chapter 20 strip off is dicta because the case could have been decided purely on Section 506(d). That argument might not hold weight, however, because the bank argued unsuccessfully in the circuit that the chapter 13 case should have been dismissed.