In In re Lane,( George Lane, et. Al v. Western Interstate Bancorp), 280 F.3d 663 (6th Cir. 2002), the Sixth Circuit Court of Appeals, following the direction of the U.S. Supreme Court’s decision in Nobleman v. American Savings Bank, 508 U.S. 324, 113 S.Ct. 2106 (1993), held that §1322(b)(2), or what is commonly known as the anti-modification clause, did not protect an unsecured mortgage-holder from modification of its lien through the chapter 13 plan process. What this means is that if the mortgage creditor is not a holder of an allowed “secured claim” as defined by §506(a), the debtor may “strip off” the mortgage and treat it as an allowed “unsecured claim,” thus receiving the same treatment as all other general unsecured creditors through a confirmed chapter 13 plan. Through this process, if the chapter 13 debtor completes his plan and receives a discharge, the court’s ruling effectively allows the debtor to remove the lien from the property while paying possibly only pennies on the loan. This could be an attractive prospect for a debtor whose home value is slumping in the current economic downturn. This article’s focus is on whether this process is beneficial for either party.
The now-unsecured mortgage-holder who has to wait anywhere from 20-60 months before receiving any monies from the chapter 13 estate obviously does not benefit from having it’s lien stripped. This creditor advanced funds with the expectation of repayment, or at least, a security interest in the collateral. Yet because of the slumping real estate market, the creditor must idle by while its claim is converted to an unsecured debt. While lien-stripping through the chapter 13 process is not new, it has become more prevalent in the past 12-16 months due to the substantial decrease of values of homes across the nation. Until the market recovers and values of homes begin to rise, mortgage lenders can expect debtors to continue to attempt to strip liens off their real estate through the chapter 13 process.
An interesting question is whether this process ultimately benefits the debtor/borrower. Debtors will of course be relieved to hear that they may be able to remove a worthless lien on their property and pay relatively little to unsecured creditors through the plan. However, debtors must be cautioned that permanent removal of the mortgage lien is only effectuated upon discharge under §1328(a). Due to the percentage of chapter 13 cases that fail, debtors may not realize that there is more to be done than just the filing of a petition in bankruptcy to avoid a lien. When a case is either dismissed or converted to a case under chapter 7, the lien is reinstated and likely will be far more delinquent than when the process began. The debtor may be forced to surrender the real estate in a chapter 7 process, or, in the case of dismissal, face immediate action by the mortgage lender. In my experience, the debtor may even be so delinquent as to preclude any loss-mitigation options that may have been available had the debtor treated the mortgage creditor differently through the chapter 13 process.
In addition, some debtors propose chapter 13 plans that attempt to strip the lien of an unsecured mortgage creditor without having filed an adversary proceeding pursuant to Fed. R. Bankr. P. 7001. The Sixth Circuit Court of Appeals seemed to suggest that an adversary is necessary when so expressed by the rules. See In re Ruehle, 412 F.3d 679 (6th Cir. 2005). In Ruehle, the Sixth Circuit upheld the bankruptcy court’s and Bankruptcy Appellate Panel’s decision that the “discharge by declaration” language, attempting to discharge a student loan as an undue hardship by mere recitation of such in a plan, violated the creditor’s due process rights, and resultantly, the loan was not discharged. The message the court delivered is that when Congress had contemplated the filing of an adversary, and the consequent heightened-notice requirements, attempting to circumvent such through a provision in a chapter 13 plan could result in the discharge being declared void or subject to attack through a Federal Rule of Civil Procedure 60(b) motion.
Attempting to strip a lien through the chapter 13 plan while not filing an adversary proceeding may lead to the same result as in Ruehle. Fed. R. Bankr. P. 7001 requires filing an adversary when determining the validity or extent of a lien. Failing to file an adversary could lead to the lien-strip being rendered invalid post-confirmation or post-discharge, leaving the debtor to face almost certain foreclosure and a failed chapter 13 process.
In the end, in this author’s opinion, the lien-stripping process in chapter 13 fails to provide the benefits that the Bankruptcy Code intended to give to debtors with unsecured mortgages on their residences. Continuing down the path that is being paved right now will tighten mortgage lending and result in debtors losing the very real estate they attempted to protect when entering bankruptcy—ultimately benefiting neither party.