The Ninth Circuit Bankruptcy Appellate Panel handed down Free v. Malaier (In re Free) on Dec. 17, blocking another theory that would have prevented the invocation of so-called chapter 20.
In chapter 20, consumers first file under chapter 7 to extinguish personal liability on an underwater mortgage, then use chapter 13 to strip off the mortgage lien that survives chapter 7 as an in rem liability solely against the real property. Chapter 20 accomplishes the aim of stripping off an underwater mortgage, although the Supreme Court’s 1992 Dewsnup decision holds that a mortgage cannot be stripped off in chapter 7.
The appellate panel’s decision came less than three months after the Ninth Circuit handed down HSBC Bank USA v. Blendheim (In re Blendheim) on Oct. 1, joining two other circuits and three bankruptcy appellate panels in validating the use of chapter 20.
In Free, a couple owned a home worth $425,000. It had three mortgages totaling more than $1 million. First filing in chapter 7, the couple reduced the second and third mortgages to wholly unsecured claims. Two days after receiving a chapter 7 discharge of their personal liability on the subordinate mortgages, they filed a chapter 13 petition.
The chapter 13 trustee objected to the couple’s eligibility for chapter 13, contending the $535,000 in debt on the second and third mortgages gave them more than the permissible $383,175 in unsecured debt allowed by Section 109(e). The bankruptcy judge bought the argument and dismissed the chapter 13 petition.
Bankruptcy Judge Meredith A. Jury of Riverside, Calif., reversed in her opinion for the appellate panel.
Principally, she distinguished the Supreme Court’s 1991 decision in Johnson v. Home State Bank. That case, she said, held only that the creditor’s right to proceed in rem on an underwater mortgage gave rise to a claim that could be addressed in a chapter 13 plan, even though the debt itself had been wiped out in a prior chapter 7 case as an in personam liability.
Judge Jury held in substance that in personam debts discharged in a prior chapter 7 are not to be counted toward the unsecured debt limit in a subsequent chapter 13. She was careful to say that the holding did not dispense with any argument that the subsequent filing was in bad faith. However, that contention by itself will no longer be available in the Ninth Circuit in a typical chapter 20 case as a result of Blendheim.