The Second Circuit will have an opportunity to join or split with the three circuits that have upheld the use of so-called chapter 20 to strip off an underwater subordinate mortgage.
The facts before District Judge Stefan R. Underhill of Bridgeport, Conn., presented the prototypical chapter 20 case. The debtors first got a discharge in chapter 7 and filed a chapter 13 petition weeks later. In chapter 13, a valuation trial was held in which the bankruptcy judge concluded that the subordinate mortgage on their home was entirely unsecured because the property was worth less than the debt on the first mortgage.
Following another bankruptcy judge in Connecticut, the bankruptcy judge nonetheless refused to confirm their chapter 13 plan stripping off the second mortgage. The debtors’ personal liability on the second mortgage had already been discharged in chapter 7. The chapter 13 plan would have paid any surviving claims in full because the debtors were not eligible for another discharge.
Judge Underhill granted leave for an interlocutory appeal and reversed on Aug. 26, agreeing with the Fourth, Ninth and Eleventh Circuits, which have validated chapter 20 to strip off a subordinate mortgage where the property is worth less than the senior mortgage. Judge Underhill agreed with a 2013 decision where Chief Judge Janet C. Hall of New Haven, Conn., opined in dicta that chapter 20s were legitimate.
To read ABI’s discussion of the Ninth Circuit’s Blendheim decision from last year, click here.