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If you are familiar with the bankruptcy code, you know there is no “Chapter 20” anywhere in the code.  But some attorneys plan for and file so-called “Chapter 20” bankruptcies by filing consecutive Chapter 7 and Chapter 13 bankruptcies.  The basic idea is that the Chapter 7 will discharge any dischargeable debt, while the Chapter 13 can help strip a second mortgage or help create a structured payment for a debt not otherwise handled in the Chapter 7.   The most commonly useful function is to strip the second mortgage.

Of course, the obvious problem in the Chapter 13 filed on the heels of a Chapter 7 discharge is that the debtor cannot obtain a second discharge if the Chapter 13 is filed within 4 years of the Chapter 7.  Thus, the debtor shouldn’t use the Chapter 13 as a discharge tool.

In the case of stripping a second mortgage, there does not need to be a discharge.  The debt was discharged as to the debtor in the first Chapter 7.  Thus, the Chapter 13 is used to strip the second mortgage, which then becomes a discharged, unsecured debt.

Naturally, creditors disapprove of this strategy.  And several creditors have fought against it.  In the recent Eleventh Circuit case of Wells Fargo v. Scantling, Case No. 13-10558 (11th Cir. June 18, 2014), http://law.justia.com/cases/federal/appellate-courts/ca11/13-10558/13-10558-2014-06-18.html, Wells Fargo argued that a lack of discharge in the Chapter 13 prevented the debtor from stripping the unsecured junior lien holder.  As you can probably guess from my introduction, the debtor in this case had exposed junior lien holders on his property.  Specifically, the property was valued at around $118k and had three lien holders in the following order: (1) $122K (2) $79k and (3) $24k.  As you can see, no equity applied to the second or third liens.

The Eleventh Circuit held that Code Sections 506(a) and 1322(b) allowed the debtor to classify the two junior liens as wholly unsecured liens that could be stripped.  Wells Fargo argued the Section 1325(a)(5) prevented lien stripping without a discharge.  Section 1325(a)(5)(B)(i) provides that the “holder of [an allowed secured claim] retain[s] the lien securing such claim until the earlier of payment of the underlying debt determined under nonbankruptcy law; or discharge under section 1328.”  Clearly the bank was alleging that the strip cannot be finalized until the discharge.

The Eleventh Circuit ultimately held that a Chapter 20 debtor can take full advantage of the benefits of a Chapter 13 (with the obvious exception of receiving a discharge).  The court further held that the operation of Sections 506 and 1322(b) change the nature of the debt, thus disqualifying the debt for protection under Section 1326(a)(5).

The Eleventh Circuit pointed out that there is a split in the courts as to whether a lien strip in a Chapter 20 is allowed.  The court conveniently provided a list of jurisdictions holding each view.  The majority opinion allowing a Chapter 20 lien strip include the 4th Circuit, the 8th Circuit, and the bankruptcy courts of Florida, Maryland, Nevada and California.  However, dissenting opinions in S.D. Florida, S.D. California, and Illinois exist.

A Chapter 20 can be a very useful lien-stripping tool.  If you would like to learn more, please call us to set up an appointment.

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