The strategy known as chapter 20 – where a consumer strips off a subordinate, underwater mortgage and also escapes personal liability for the debt – is a nonstarter in the court of Bankruptcy Judge Mark Houle of Riverside, Calif.
In a so-called chapter 20 case, the consumer first files under chapter 7 to extinguish personal liability on an underwater mortgage. Later, the consumer initiates a separate chapter 13 case to strip off the mortgage lien that survived chapter 7 as an in rem liability solely against the real property. Although the Supreme Court’s 1992 Dewsnup decision holds that a mortgage cannot be stripped off in chapter 7, the high court so far has thrown up no explicit roadblock to prevent chapter 20 from stripping off an underwater mortgage.
The case before Judge Houle involved a chapter 20 fact pattern that is easier to swallow than some. Owning a home with a subordinate mortgage, the debtor filed a chapter 7 petition 2012 and received a discharge. In 2017, she filed a chapter 13 petition. Because the chapter 13 filing fell more than four years after the chapter 7 discharge, the debtor would be eligible for a chapter 13 discharge on completion of her plan payments.
Contending that her personal liability on the subordinate mortgage loan was extinguished by the prior chapter 7 discharge, she filed a motion in the later chapter 13 case to strip off the subordinate mortgage under Section 506(a), contending the property was worth less than the first mortgage debt. Had she succeeded, the debtor would have paid nothing to the subordinate lender through her chapter 13 plan, and the subordinate mortgage would no longer encumber her home.
Although Judge Houle apparently stripped off the mortgage in his July 23 opinion, he evidently saddled the debtor and her chapter 13 plan with an allowed unsecured claim for the entire amount of the subordinate mortgage, even though the subordinate mortgage debt was effectively rendered nonrecourse in the prior chapter 7 case.
Although his reasoning is unclear, Judge Houle held that the claim of the subordinate lender, “originally secured by property of the estate, is converted to an unsecured claim against the estate after lien avoidance.”
Rod Danielson of Riverside, Calif., the chapter 13 trustee in the debtor’s case, told ABI in a phone interview that there will be fewer chapter 20 cases in Judge Houle’s court, since “there is no advantage to doing a 7 first because a discharge in chapter 13 will do the same thing.”
Judge Houle’s opinion is notable for contrary authority from his circuit that he does not cite.
He does not cite HSBC Bank USA v. Blendheim (In re Blendheim), 803 F.3d 477 (9th Cir. Oct. 1, 2015), where the Ninth Circuit seemingly joined two other circuits and three bankruptcy appellate panels by validating the use of chapter 20. Strictly speaking, Blendheim held that the debtors could strip off an underwater subordinate mortgage in chapter 13 even though they were ineligible for a chapter 13 discharge because their new filing came too soon after their prior chapter 7 discharge.
He also does not cite Free v. Malaier (In re Free), 542 B.R. 492 (B.A.P. 9th Cir. Dec. 17, 2015), where the Bankruptcy Appellate Panel in his circuit 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.
To read ABI’s discussion of these and other chapter 20 cases, click here, here and here.