In a recent Fourth Circuit case, originating from our Maryland courts, the court held that a debtor can strip off a wholly unsecured lien in a chapter 20 case. Branigan v. Davis (In re Davis), 716 F.3d 331 (4th Cir. 2013).
A “Chapter 20” case is not defined anywhere in the bankruptcy code, but is a symptom of the recession. It refers to a situation where a debtor a files a chapter 13 case within four years of a chapter 7 filing. Because the chapter 13 is within four year, the debtor is ineligible for a Chapter 13 discharge. 11 U.S.C. § 1328(f)(1). The Chapter 7 normally would discharge debtor’s personal liability on an unsecured consensual lien. But the lien would remain on the asset because chapter 7 does not allow lien stripping of consensual liens.
Therefore, to get rid of the consensual lien, debtors have to file a chapter 13 which allows unsecured liens to be stripped off the property. However, these case presented a dilemma for the courts because debtors in chapter 20 cases are not entitled to a discharge and therefore it was unclear if liens could be stripped off in that instance.
A creditor whose lien is secured by debtor’s property maintains such a lien until the debt is paid off. A good example would be a mortgage company’s lien on your home. When you bought your home your lender asked you to execute a deed of trust. This is the document that ties your loan, note, to your property giving the bank a lien on your home as security. As you know, this means that should you fail to pay your mortgage the bank can foreclose on your home to recover its investment. The bank’s secure lien remains on your home until you pay it off.
According to a lawyer from 410law.com, unsecured liens occur whenever the value of the first mortgage and second mortgages or other liens such as home equity line of credit exceed the value of the asset. If the value of the asset is less than the first mortgage, any second mortgages or HELOCs would not have any equity to attach and are considered unsecured.
Example:
First Mortgage $300,000.00
Second Mortgage $ 85,000.00
Fair Market Value: $200,000.00
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Underwater Value – $185,000.00
With the property $185K under water the Second mortgage has no equity to attach to and therefore is considered unsecured.
Unsecured consensual lies can be stripped off the property. As a result, the debtor can get remove the lien from their property completing the process of extinguishing the debt started by a discharge of personal responsibility in chapter 7.
Debtor’s filing chapter 20 case still need to make sure they can sustain an objection based on bad faith. Filing a chapter 20 case for the sole purpose of stripping a lien will most likely result in an objection from the chapter 13 trustee.
In conclusion, if your home has lost significant value you may benefit from a chapter 20 filing to get rid of secondary liens.