He didn’t abolish so-called chapter 20 entirely, but Bankruptcy Judge Robert E. Grossman of Central Islip, N.Y., has made it unworkable for many chapter 13 debtors.
The typical chapter 20 case works like this: The consumer first files under chapter 7 to extinguish personal liability on a subordinate, underwater home mortgage. Later, sometimes the day after receiving a chapter 7 discharge, the consumer files 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.
When chapter 20 works, the debtor emerges from the subsequent chapter 13 case with the underwater mortgage stripped off and no personal liability on the subordinate mortgage debt.
The Ninth Circuit Bankruptcy Appellate Panel has validated chapter 20, at least when the debtor receives a discharge in chapter 13. See Washington v. Real Time Resolution Inc. (In re Washington), 602 B.R. 710 (B.A.P. 9th Cir. July 30, 2019). To read ABI’s report on Washington, click here.
In Judge Grossman’s modified version of chapter 20, the lien is stripped off in the subsequent chapter 13 case. Although the debtor’s personal liability on the mortgage note was discharged in the prior chapter 7 case, he ruled that the mortgage debt is nonetheless an unsecured claim to be treated like all other unsecured claims in the chapter 13 plan.
The Underwater, Subordinate Mortgage
The facts demonstrate why Judge Grossman’s modified chapter 20 was likely unpalatable for the debtor in the case before him.
The debtor had received a chapter 7 discharge 12 years earlier. She filed a chapter 13 petition in early 2021, listing her home with a value of about $550,000. The home was subject to an $850,000 first mortgage and a $300,000 second mortgage. The second, or subordinate, mortgage was underwater, meaning there was no equity in the property above the first mortgage to satisfy any portion of the second mortgage.
The debtor’s personal liability on the subordinate mortgage had been discharged in the prior chapter 7 case. However, the second mortgage remained a lien on her home as a consequence of Dewsnup v. Timm, 502 U.S. 410 (1992).
The debtor filed a chapter 13 plan promising to pay unsecured creditors 100%.
Aiming to escape all liability on the second mortgage and effectively void the second mortgage lien, the debtor filed a motion asking Judge Grossman to strip off the subordinate lien and declare that the lender’s unsecured claim would be zero under the chapter 13 plan.
In his August 5 opinion, Judge Grossman said he would strip off the lien, but he ruled that the entire amount of the mortgage debt would be a valid, unsecured claim in the debtor’s chapter 13 plan to be paid in full over the life of the plan, if the debtor were to confirm the plan.
The decision may have made chapter 13 unworkable for the debtor, given that she was proposing a 100% plan for unsecured creditors. Chapter 13 still might work if the best interests test would allow the debtor to reduce the percentage payout to an amount she could realistically afford.
Critique of Courts Permitting Chapter 20
Judge Grossman said that courts disagree on a chapter 13 debtor’s ability to strip off an underwater mortgage when the in personam obligation on the mortgage loan was discharged in a prior chapter 7 case.
Courts that eliminate subordinate mortgage debt in a subsequent chapter 13 rely on “several problematic assumptions,” Judge Grossman said. Those courts “equate[] the discharge injunction with the elimination of the underlying debt.” The discharge does not eliminate the debt, it only bars collection as a personal liability of the debtor, Judge Grossman said.
Judge Grossman went on to say that the claim filed by the mortgage holder in the chapter 13 case “is not an act to collect a discharged debt and does not run afoul of § 524.”
Courts that eliminate the debt in chapter 13 also overlook Section 522(c), Judge Grossman said. That section provides “that the property remains liable during and after the case for debt secured by a lien that is (i) not avoided under subsections (f) or (g), and (ii) not void under § 506(d).” Therefore, he said that “the in rem lien securing the mortgage claim that survives bankruptcy is protected to the extent that it is not void under § 506(d).”
Judge Grossman went on to say that Section 506(d) does not provide a mechanism to disallow a claim. As such, he said that the claim on the subordinate mortgage “is fully enforceable and cannot be disallowed under § 502.”
Judge Grossman held that the debtor “is required to treat [the subordinate lender] the same as all unsecured creditors. [The lender] and the Debtor’s other unsecured creditors are entitled to payment consistent with § 1325(a)(4) (the best interest of creditors test) and § 1325(b) (the disposable income test), which could mean payment of a small percentage of their claims or payment in full.”
Judge Grossman granted the debtor’s motion by allowing the debtor to strip off the lien but disallowed the motion to the extent that the debtor sought to reduce the amount of the claim to zero, based on an assumption that the debtor confirms a plan and receives a discharge.
Observations
There are good arguments on both sides of chapter 20. The aversion to eliminating both the claim and lien rests in part on the idea that the lender’s efforts at collecting the claim in the chapter 13 case is not in violation of the discharge injunction. Is the filing of a claim in chapter 13 an act to collect a discharged debt as a personal obligation of the debtor?
Section 102(2) cuts both ways. The section says a “claim against the debtor” includes a claim against property of the debtor. On the one hand, the section suggests that the lender’s in rem claim against the property is a claim against the debtor in chapter 13. On the other hand, does the section also suggest that the lender is violating the discharge injunction by asserting an in rem claim?
One day, the issue will reach several courts of appeals. There may be a split dropped into the laps of the justices on the Supreme Court, who may once again be asked to reexamine whether Dewsnip was correctly decided.
If the justices are inclined to believe that Dewsnup was a mistake that ignored the plain meaning of the statute (as the late Justice Antonin Scalia argued), debtors may prevail by stripping off the underwater lien while eliminating the mortgage debt in a later chapter 13 case.
Advocates of chapter 20 may have an attractive argument based on the plain language of the statutes, but those in Judge Grossman’s camp appeal to a sense of fairness in believing that a subordinate lender should have a claim paid the same percentage as other unsecured creditors.
He didn’t abolish so-called chapter 20 entirely, but Bankruptcy Judge Robert E. Grossman of Central Islip, N.Y., has made it unworkable for many chapter 13 debtors.
The typical chapter 20 case works like this: The consumer first files under chapter 7 to extinguish personal liability on a subordinate, underwater home mortgage. Later, sometimes the day after receiving a chapter 7 discharge, the consumer files 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.
When chapter 20 works, the debtor emerges from the subsequent chapter 13 case with the underwater mortgage stripped off and no personal liability on the subordinate mortgage debt.